Over-Leverage Over-Tightens – Then It Snaps

Leverage can be used in spectacular ways, whether it be to gain mechanical advantage such as the fulcrum and lever variety, all the way to the personal interactive type like that used in child rearing. i.e., No finished homework, no______ (fill in the blank.) Then, of course, there’s the more sinister versions or type as in blackmail, where I don’t think I need any “fill in the blank” examples to further the point. Everyone gets that one, at least I would hope.

Over-leverage, by contrast, is just more of the same only with far more intensity of strength. Yet, it is here, that all that good can reduce once unfathomable tasks or results from the promise for spectacular benefit, or results (i.e., building cathedrals, et cetera) – to an even more spectacular pile of rubble and despair. i.e., modern-day construction calamities.

As is always the case when using, or pushing anything to its extreme potential: All it takes is but a feather more weight, slightest gust of wind, or $1 dollar additional of blackmail – and it snaps – releasing a chain of events that makes Chaos Theory appear as unvarying science in comparison.

We all partake, as well as apply differing variations of it in our own daily lives, whether one is a race-engine mechanic that mistakenly over-tightens a connecting rod bolt (you want to talk about chaos?) to someone who is entirely maxed out in their budget and available credit-line, affording only minimum payments with not a $1 extra to spare, to then suddenly receive an unexpected bill (like a car repair) or increase in their rates. The ensuing results can make race-engine mechanics wince.

Bending to the point right before breaking is where most try to live. We do it in our personal lives in relationships with friends and family. We do it in our professional lives whether its to make money or other advancements. (think workaholic type behavior) We also do it in building projects, or retail items as a way to cut costs and such. i.e., Overbuilt vs planned obsolescence.

However, pushing limits to their breaking point has consequences. But none more so then when leverage per se is allowed to run amuck in what we perceive to understand as the banking sector. Where it is our your resources (i.e., your deposits and such) which provides the “fulcrum” for banks to place their “lever” turning what many presume as providing a necessary function of modern society. i.e., Deposit holding, loan originating, and/or payment transactional utility type resource.

That would be, as they say, naive thinking, at best.

No, today what we have is a sector of the economy known as “banking” which has been able to not only move your “fulcrum” closer to the point where the greatest stress may occur, but also has lever’d up that fulcrum in financial shenanigans that would make a street hustler envious purchasing ever-the-longer “levers.”

The true issue here is when that over-leveraged moment of singularity takes place, where the “lever” suddenly snaps, the banks don’t just replace your fulcrum (i.e., money) and start again with smaller levers. No, they’ll just take your fulcrum entirely and use it (think – give) to pay off whatever entities were employed to create the levers to begin with. Then, adding insult to injury, will ask (more like demand via the taxpayers) that you provide the necessary funds to provide new fulcrum, along with purchasing new levers.

And – If you think, or believe, the banking sector of the world is on much more “solid footing,” along with “learned its lesson about leverage” resulting from the Great Financial Crisis of ’08? I’ve got a deal on a bridge in Brooklyn for you, cheap.

Let me pose a simple question or construct for you to ponder. Ready?

What’s the difference and resulting consequences between: A) a totally maxed out personal debtor experiencing minimum payment inflation? Or, B) an emerging market debtor experiencing the very same via a stronger U.S. dollar?  Hint: Size and scale. Nothing more.

Currently there is a lot, and by that I mean just that, a lot of focus via banks of all types (Goldman Sachs™ for one) getting into the subprime area of financing. Although there have always been a sector of banking (think “buy here pay here,” et cetera) which deals primarily in this area of customers (i.e., FICO scores beginning with “5” and lower) The lure of riches in exorbitant (if not outright extortion) interest rates seems to be too much for these entities to eschew any longer.

What seems oddly coincidental is that this encroachment into the once “private” sector of risk banking is coming directly in unison with the current upheaval barreling throughout their most coveted subprime customers for decades. e.g., Emerging Markets.

Hows that all working out currently?

As of today what is collectively known as “the emerging market” is under extreme stresses. Currencies are getting hammered. (see the Mexican $Peso or Brazilian R$Real for clues) Then there’s place like Italy making waves, and the list is growing, and fast.

The reason for the above is to make very clear the implications, and what to watch, for clues going forward. The reason is very simple.

Over the last decade as the Federal Reserve (along with other central banks) allowed the conditions for the emerging market sector to leverage up in ways that would make the original housing fiasco look tame in comparisons. (i.e., enabling banks to sell their debt)

Yet, what many underestimate when trying to compare subprime analogies with emerging market crises is the doubling, if not tripling of the Knock-On effect. i.e., Think negative feedback-loops that spiral across all sectors, all nations, all credit facilities and more, causing a rush for perceived safety into the $US dollar, which accelerates and intensifies those loops exponentially so.

This is where I believe the focus should be as of today for anyone trying to pay attention, as well as anyone trying to anticipate any disruptions that may affect their business or personal well-being. For if there is one place “over-leverage” has been applied – in spades – its in the emerging markets of the last decade. Bar none. Have I mentioned China yet?

The moment one hears, reads, or sees a headline similar to “China suddenly devalues…. ” or, “________(fill in emerging market of choice) unable to meet payment….” or other in-kind, I believe that will be “that moment” all that “over-leverage” finally snaps.

And the preponderance of pressure being applied to these “levers” is coming from one area, and one area only: The increasing strength in the $US. Where that “magical” level is, no one knows. But what we do know is this: It’s heading in the correct direction where all the “bad things” rest.

If one wants another way to think about it, look at it using this analogy: “The central banks” used the wrenches in their monetary “tool boxes” to loosen the bolts of finance that allowed many of these nations “motors” to run unbridled on fueled debt. (I’ll leave U.S. comparisons for another column.)

Today, they’re not only tightening down the screws on those once loosened motors. They’re using wrenches fitted with long pipes (maybe literally!) to tighten it all back down. Problem is, just like many a person who’s busted a knuckle doing so at home can attest to: It all seems to be going so well, then…


© 2018 Mark St.Cyr