By Pam Martens and Russ Martens: April 13, 2021 ~
When Jerome Powell, the Chairman of the Federal Reserve, appeared for an interview this past Sunday night on the CBS investigative program, 60 Minutes, he asserted complete ignorance of the amount of margin debt currently being used to inflate the stock market to one new historic high after another. The exchange between Powell and 60 Minutes host, Scott Pelley, went as follows:
Pelley: “The securities industry has reported that $814 billion has been borrowed by people investing in the stock market, borrowed against their portfolios. That’s a 49 percent increase over last year.
“And the last time it grew that much was in 2007, before the Great Recession. And the time it grew that much before that was 1999, just before the dot com implosion. At what point does the Federal Reserve start to rein in this speculative bidding up of stock prices based on borrowed money?”
Powell: “That sounds like margin debt. I don’t know that statistic. I really can’t react to that statistic. I would say the main thing that we do is we make sure that the financial institutions that we regulate and supervise understand the risks that they’re running, manage them well, have lots of capital, lots of liquidity, and highly evolved risk management systems so that they do understand the risks they’re running and have plans to deal with them. And that way, when there are shocks, for example, if there were to be a big market correction, you will see financial institutions that are strong enough to stand up to that. Not just private financial institutions, but also markets and things like that, payment utilities and things like that. That’s really what we do.”
For just how well Powell’s plan of action held up as the pandemic took hold in the spring of last year, see here.
Pelley provided Powell with perfect examples of how excessive levels of leverage and unfettered risk-taking on Wall Street blow up markets and the U.S. economy, citing 2007 and 1999. Today, the Fed supervises some of the most highly leveraged financial institutions in the world – including Wall Street banks that are fueling not only their own internal leverage but also fueling obscene levels of leverage by loaning out hundreds of billions of dollars to hedge funds. For Powell to claim ignorance of one of the most important statistics used to monitor excess leverage in the financial system is an insult to the American people.
One good reason that Powell may have wanted to dodge this issue of margin debt is that he knows very well from his days as a Wall Street insider that the $814 billion margin debt figure cited by Pelley is just the tip of the iceberg.
The $814 billion margin debt is the latest amount reported by Wall Street’s self-regulator, FINRA, for February 28, 2021. Indeed, that figure stands 49 percent higher than the $545 billion reported at the end of February in 2020.
But as Powell well knows, and the public is just learning through the recent implosion of the family office hedge fund, Archegos Capital Management, Wall Street’s largest banks are not actually reporting all margin debt that is fueling the sharp rise in stock prices.
According to FINRA’s Rule 4521, Wall Street firms are only required to report margin debt for “margin accounts for customers” held at “member firms.” By “member firms,” FINRA means the broker-dealers it supervises. FINRA does not supervise Wall Street banks that are also engaging in highly-leveraged trading — it supervises just the broker-dealers owned by those bank holding companies. For example, according to the most recent report from the Office of the Comptroller of the Currency (OCC), Goldman Sachs Bank USA, a federally-insured bank, has $271.65 billion in assets versus a notional (face amount) of $42.24 trillion in derivatives. (See Table 4 in the OCC report’s Appendix here.)
On April 1, Financial Times reporter, Robert Armstrong, provided insight into how Wall Street banks are creating private derivative contracts known as swaps, to magically transform margin loans used for stock trading into simple collateralized loans for reporting purposes. This has enabled the Wall Street banks to secret these margin loans away from the eyes of regulators and, in doing so, ostensibly dramatically under report the amount of margin debt in the financial system. Armstrong writes:
“Banks earn steady income streams on total return swaps through the regular fees investors such as hedge funds pay to enter into the agreement. The investor is then paid by the bank if the stock, or other related assets including indices, rises in value. The bank also provides investors with any dividends that come with holding the stock.
“The bank offsets its exposure by either owning the underlying shares, taking the opposite position with other clients with an opposing view, or buying a hedge from another financial institution.
“If the stock falls, the investor has to post regular payments, ranging from daily to quarterly, to make the bank whole.”
But according to numerous media reports, the swap arrangement the banks had with Archegos gave it full discretion on what stocks it wanted to buy and sell — making this structure sound like simply a dodge of the rules on transparency and risk.
This swap structure has not only enabled the amount of margin debt in the system as a whole to be dramatically underreported but it has also allowed hedge funds to obtain much higher initial margin debt than is allowed under the Federal Reserve’s Regulation T, which sets initial margin at 50 percent of the stock’s purchase price, not the six to one margin (and possibly higher) that was provided by the Wall Street banks to the Archegos family office hedge fund.
We checked via email with the Federal Reserve last Thursday to inquire if there is any official rule or regulation that exempts hedge funds from Regulation T’s margin requirements. Their answer was that they are “not aware of any rule that exempts those firms from Regulation T requirements.” Clearly what the Wall Street banks have been doing is ripe for litigation and Congressional hearings.
Just how many family office hedge funds or regular hedge funds are using this same swaps maneuver, which has become a cash cow on Wall Street? Financial Times reporter Armstrong notes this:
“The business, which has grown rapidly since the financial crisis, accounts for more than half of banks’ total equity financing revenue, Finadium calculates — more than traditional margin lending and lending out shares for shorting combined. Synthetic financing continued to take share from other forms of equity financing in the first half of this year.”
The company, FINTRX, calls itself the “preeminent Family Office data and research solution.” According to the firm, there are “3,000 unique Family Offices globally.” So far, just one has blown up this year in the U.S., creating billions of dollars in losses at Fed-regulated banks. How many more will it take before the Senate Banking and House Financial Services Committees schedule hearings?
One other metric that suggests this unreported margin debt debacle may come back to haunt Jerome Powell’s dunno nuttin’ about margin debt nonsensical statement on 60 Minutes is the OCC report showing that JPMorgan Chase was carrying $2.65 trillion in stock derivatives as of December 31, 2020. (See JPMorgan’s Federally-Insured Bank Holds $2.65 Trillion in Stock Derivatives; How Did It Avoid the Archegos Blowup?)