The first big test of a new-look financial system
a day later, fire-sales by pension funds caused the yield on government bonds to spiral out of control. Contagion then spread to the American Treasury market, which is as volatile and illiquid as it was at the start of covid-19. The cost to insure against the default of, a global bank, has risen sharply.
Equity markets have been just as turbulent, but they have at least continued to function. “You might not have liked the price you were seeing,” says Tal Cohen of Nasdaq, a stock exchange, “but you were always seeing a price.” He has yet to witness “demand destruction”, the thinning out of the order book when buyers and sellers begin to pull their orders en masse.
The result is that there are layers of protection around the financial system’s most important institutions. At the heart of markets are clearing houses, which settle trades in stocks and derivatives between their members . To join a clearing house a member must post an “initial margin” in case of default; that margin can climb if markets move. The system is stress-tested against the default of even the clearing houses’ largest members, such as JPMorgan Chase or Citigroup.
“American banks are unequivocally much stronger,” says a bank boss. Few are making such statements about European banks, and certainly nobody is about Credit Suisse. The firm had a return on equity of minus 14% last quarter, its share price has tumbled and its market capitalisation is now just $12bn. Yet even Credit Suisse is not near a Lehman-style collapse. It holds 14% of its assets as capital and has debt worth only six times its equity.
Michael Burry, who shot to fame in 2008 after shorting mortgage-backed securities, is concerned by unsecured consumer finance given the growth of “buy-now-pay-later” providers and the ease with which consumers have been able to tap credit-card lines. Goldman Sachs, a bank, ventured into consumer credit in 2019, helping to launch the Apple card. It now has a default rate of 3% over the past six months, unusually high even for sub-prime consumer lending.
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