Debt can be a killer

The arrest last week of the founder of the investment company Archegos, accused of securities fraud, is a great reminder of hidden debt. In March 2021, Archegos was handed over, allegedly hiding its debt from Wall Street companies as it used funky “total-return swaps” to manipulate stock prices. The inevitable collapse ruined $ 100 billion in inventory value. (Archegos’ lawyers have denied the allegations.) Separately, supply chain financier Greensill used what Fitch described as a “hidden debt loophole” and collapsed around the same time.

Are there more of these out there? I ask because we are in the most dangerous part of the economic cycle. Interest rates are rising to fight inflation, and there may be all sorts of leverage we do not know about. It’s always there. A downturn (and especially a recession) would expose these hidden horrors. In 2018, this column argued that “in times of recession, equity hurts but debt kills.” We’re figuring out if that’s still true.

More than $ 850 billion in credit card debt and $ 800 billion in margin debt are high but off the top, and that’s at least known amounts. It’s always hidden debt that comes back to bite when things fall apart. In June 1929, banks had $ 82 in deposits for every dollar in cash. Bank runs followed. The financial crisis of 2008-09 was due to incorrectly priced loans with collateral and strange derivatives on the balance sheets of Lehman Brothers, Bear Stearns and many others. Citibank used “structured investment instruments” filled with mortgages, and who knows what else to hide $ 100 billion in debt by keeping it off balance.

Now debt is back in vogue. Tesla‘s

last proxy statement shows that Elon Musk owns 73 million options and 170 million shares, of which more than 88 million were “pledged as collateral to secure some personal indebtedness.” Even if one assumes a loan-to-value ratio of 20%, it is very personal debt. In the pending Twitter deal, Morgan Stanley is providing a margin loan of $ 12.5 billion against an additional 62 million of his Tesla shares.

Tesla sold about a million cars in 2021 and was worth $ 1 trillion last week at the time of the Twitter deal. Ford Motor Co.

sold nearly two million vehicles in 2021 and is currently worth just under $ 60 billion. I’d rather have Tesla’s business than Ford’s, but maybe Tesla’s valuation is a bit fluffy. Netflix stock has fallen 72% in six months. Carvana has fallen 84% since August. Valuations are volatile and we are not even in a recession. Now may not be the time to borrow against Tesla shares.

There are reports that Mr Musk may take out a loan against his current 9.2% stake in Twitter. Yes, borrow against Twitter to buy more Twitter. Why does it sound familiar? Oh yes, MicroStrategy.

Michael Saylor, a bitcoin evangelist and CEO of Tysons, Va., The software company, has the company to buy gobs of the cryptocurrency. It recently raised a $ 205 million loan, backed by its bitcoin portfolio, to buy even more bitcoin, for a total of $ 128,687 worth $ 5 billion. In March, Mr Saylor tweeted, “Give me a handle long enough and #bitcoin to place it on and I’ll have to move the world.” He does not say in which direction. Note that Microstrategy’s enterprise value is less valuable than its bitcoin.

The latest crypto craze is decentralized financing, the ability to execute peer-to-peer transactions, bypassing centralized banks, Wall Street and governments. YouTube is full of videos with titles like “Using Defi’s Power to Exploit Any Asset.” There is even a lending and lending platform called DeFi Prime. It sounds safe, but so did the purchase of Las Vegas apartments with leverage in 2007.

A DeFi bet called Terra offers an incredible 20% return on deposits to fund a blockchain platform that uses an “algorithmic stablecoin” that maintains a $ 1 price. To do this, there is a fluctuating (but supported by nothing) cryptocurrency called Luna, which is created or destroyed to buy or sell TerraUSD stablecoin as needed to keep it stable. More than 20 years ago, Enron created and issued shares to cover losses in heavily indebted Special Purpose Vehicles until the losses became so great that the scheme collapsed. Terra’s CEO, Do Kwon, told Bloomberg that high returns on deposits are not an issue; they are like high commercial bank rates in many Asian countries in the 1990s. Someone might remind him of how it ended: with bad debts and gigantic currency crises in 1997 and 1998.

How much debt is there in cryptoworld? No one really knows, but I will not be in the way if it starts to snowball during a downturn.

Even more frightening is the $ 13.4 trillion in dollar debt that non-US borrowers owe, according to the Bank for International Settlements. It’s doubled since 2010. Maybe it’s overvalued due to hedging, but it’s a lot of outstanding dollar-denominated debt. Each time the Federal Reserve raises interest rates to fight inflation, the dollar strengthens against other currencies, making dollar debt more expensive to service. Will it all explode? I’ve seen it happen a few times. Every time debt kills.

Write to kessler@wsj.com.

Review & Outlook: The $ 44 billion acquisition of Twitter is a bet that could break Silicon Valley’s culture of progressive conformity. Photos: Reuters / Getty Images / Billboard Composite: Mark Kelly

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