Money Stuff: People Are Worried About Deleveraging

The basic fact of finance is that there are a lot of big important firms whose job is to borrow money to own financial assets. Sometimes the value of the financial assets goes down, a firm has to pay back the money it borrowed, but the assets it owns are now worth less than the loans against them. So the firm has to go sell other, better assets to raise money to pay back the loans against the assets that went down. (This is called “contagion.”) Or, worse, all of the firm’s assets are worth less than the loans against them, so the firm goes bust, its creditors seize the assets, and they have losses.

Often the leveraged firms in that story are banks. In modern markets, the big banks seem to be pretty heavily regulated and well capitalized, and people worry a bit less about them than they did in, say, 2008. There are other sorts of leveraged firms. In 2022 it was crypto exchanges. In 2023 it was US regional banks, and also Credit Suisse.

In recent years a lot of the worry has been about highly leveraged multistrategy hedge funds, which have in some ways taken over the role that big investment banks used to play, and which borrow lots of money to own financial assets like US Treasury bonds. This is called “the basis trade”: Hedge funds borrow money, buy Treasuries, sell Treasury futures to asset managers, and collect a tiny spread. Because (1) they borrow quite a lot of money and (2) this trade has gone wrong before, people worry about it. “People are worried about the basis trade,” I wrote in a headline in 2023. And we talked last month about a proposal for the US Federal Reserve to set up a facility to bail out those trades if something went wrong: The hedge funds are big owners of Treasury bonds, Treasury bonds are important to financial plumbing, and if they are forced out of this trade — because the trade moves against them, or just as part of a general deleveraging — then that will be bad for the market. 

Anyway, uh, the value of financial assets has gone down? Pretty broadly? So the obvious question is: Will there be deleveraging? And if so, where? My Bloomberg colleague John Authers writes:

If there is reason for concern, it stemmed from the bond market, which suffered an epic selloff [yesterday]. As the dollar gained a little, it’s unlikely that it was foreigners who were selling Treasuries. And as the stock market was directionless amid the drama, it’s hard to believe that asset allocators exited bonds to put money there. …

A logical but alarming explanation is that someone somewhere had to make forced sales to raise cash. … Particular concern attaches to the multi-strategy hedge fund groups that operate several different investment teams — “pod shops” in the Wall Street lingo. As the dust settles on an extraordinary day, traders will be most concerned for the health of the pod shops in their midst.

And the Financial Times reports:

Market participants said the declines in the $29tn Treasury market on Monday reflected several factors, including hedge funds cutting down on leverage — or borrowing used to magnify trades — and a broader dash for cash as investors sheltered from swings in the wider market. ...

Investors and analysts pointed in particular to hedge funds that took advantage of small differences in the price of Treasuries and associated futures contracts, known as the “basis trade”. These funds, which are large players in the fixed-income market, unwound those positions as they cut back on risk, prompting selling in Treasuries.

“Hedge funds have been liquidating US Treasury basis trades furiously,” said one hedge fund manager.

But it adds that “investors across the board sold Treasuries to raise cash, with one fixed-income trader pointing specifically to traditional asset managers.” And Bloomberg News reported yesterday that “down in the financial trenches, hedge funds had been reducing risk heading into April and there has been little panic selling.” It does not, to the naked eye, look like a panicky deleveraging. And of course, for many funds, volatility is an opportunity to make money. “Michael Platt’s BlueCrest Gains 20% on Trump Tariff Volatility,” reports Bloomberg.

I will say though. I wrote the other day:

You could crudely characterize a portion of the trade between Vietnam and the US as (1) Vietnamese wages are lower than US wages, so Vietnamese people make sneakers and t-shirts that they sell to the US cheaply for dollars and (2) the US financial system is big, so Vietnamese people invest those dollars in US financial assets. We are good at making financial assets, they are good at making low-cost clothing, so we trade. To Trump this is necessarily unfair and we must stop it. …

Now my biases are obvious: I am a financial columnist because I find finance delightful, and a world in which the US gives people finance and gets back inexpensive goods strikes me as good for the US. We give them entries in computer databases, they give us back food and clothing: That is a magical deal for us! 

The basis trade is one of the purest examples of the US being good at making financial assets. Primarily in the sense that the US government is a huge low-cost producer of risk-free debt that trades at low interest rates, and then secondarily in the sense that there is this finely tuned mechanism to direct those Treasuries to their best uses, with hedge funds borrowing a lot of money cheaply to buy Treasuries and turn them into futures for consumption by asset managers. There is a huge ecosystem — Treasury markets, repo markets, hedge funds, asset managers — built around the efficient manufacturing of US interest rate products, because that is what the US financial system does.

There are some reasons to think that this business of trading, you know, interest-rate products for shoes is good for the US. Manufacturing interest-rate trades is less physically demanding than manufacturing sneakers is, it pays better, it scales better. 

But this is precisely the trade that President Donald Trump’s administration doesn’t like. Trump’s tariffs are designed specifically to eliminate US bilateral trade deficits in goods: Instead of the US buying sneakers from Vietnam and Vietnam buying financial assets from the US, we will have a sort of barter system in which the US buys physical goods (sneakers, etc.) from Vietnam and Vietnam buys physical goods (also sneakers?) from the US.

Right now, many foreign countries sell goods to the US, get dollars, spend some of the dollars to buy goods from the US, and use the rest to buy US financial assets. In the Trump system, they will use all of their dollars to buy goods from the US, and no financial assets. This, the Trump administration argues, will be good. It is bad for foreigners to buy US financial assets. Trump trade counselor Peter Navarro writes:

The US cumulative trade deficits in goods from 1976 — the year chronic deficits began — to 2024 have transferred over $20tn of American wealth into foreign hands. That’s more than 60 per cent of US GDP in 2024. Foreign interests have taken over vast swaths of US farmland, housing, tech companies, and even parts of our food supply.

Steve Miran, chairman of the Council of Economic Advisers, said in a speech yesterday:

While it is true that demand for dollars has kept our borrowing rates low, it has also kept currency markets distorted.  This process has placed undue burdens on our firms and workers, making their products and labor uncompetitive on the global stage, and forcing a decline of our manufacturing workforce by over a third since its peak and a reduction in our share of world manufacturing production of 40%. …

There are other unfortunate side effects of providing reserve assets.  Others may buy our assets to manipulate their own currency to keep their exports cheap.  In doing so, they end up pumping so much money into the U.S. economy that it fuels economic vulnerabilities and crises.  For example, in the years running up to the 2008 crash, China along with many foreign financial institutions, increased their holdings of U.S. mortgage debt, which helped fuel the housing bubble, forcing hundreds of billions of dollars of credit into the housing sector without regard as to whether the investments made sense. China played a meaningful role creating the Global Financial Crisis.

Foreigners are happy to give us sneakers in exchange for our financial assets, but Trump and Navarro and Miran don’t want that trade. They worry that the foreigners are too happy to pay for our financial assets, that they pump “so much money into the U.S. economy that it fuels economic vulnerabilities and crises.” [1] There is too much foreign demand to own our tech companies, so we have to reduce it, by making the tech companies’ stocks worth less. That part seems to be working.

Similarly, the US is at the cutting edge of manufacturing interest-rate futures, but it is now US industrial policy to stop doing that and get back to manufacturing physical goods in factories. I don’t know, seems bad for the basis trade, no?

Last year, Keith Gill, the meme-stock influencer known as “Roaring Kitty,” tweeted a drawing of “a man leaning forward with what looked like a gaming controller.” This post drove up the price of GameStop Corp. stock by about 180%, creating something like $9 billion of market value. [2]

Probably you read that paragraph and were like “oh yes I remember that.” Or perhaps you don’t remember that particular situation, but you have lived in a world of meme stocks for some time now, so that paragraph strikes you as unremarkable even if the details are new to you. If you have been in a coma for the last five years, though, you probably found that paragraph pretty strange. Surely I have neglected to mention some important detail there. Surely the $9 billion of value came from something other than a guy at a computer posting a picture of a guy at a computer. No. I’m sorry. 

I wrote at the time:

Is this just how life is now? In January 2021, the whole GameStop experience was new, and there was perhaps some genuine uncertainty about how things would turn out. ... And then the stock mostly fell back to earth, and the meme-stock machine ran again on other stocks with mostly diminishing results, and you could imagine that the whole thing was a confluence of novelty and social media and pandemic-era boredom and incautious short sellers that would not repeat itself. But in fact is this just a permanent feature of financial markets?

I don’t know. The GameStop revival mostly did fizzle. Yesterday this happened:

A wild stock-market swing based on false information added $2.4 trillion in value and erased it almost as quickly this morning.

The episode played out in just over half an hour, all based on misleading reports that said President Trump was considering a 90-day pause to implementing tariffs.

It underscored how easily misinformation and Wall Street’s high-frequency trading strategies that react to headlines in seconds can impact asset prices.

News that tariff-shocked investors had been dying to see began circulating on social media shortly after 10:10 a.m. in New York: “HASSETT: TRUMP IS CONSIDERING A 90-DAY PAUSE IN TARIFFS FOR ALL COUNTRIES EXCEPT CHINA,” the headline read, in an apparent reference to words from Kevin Hassett, director of the National Economic Council.

Stock indexes soared. After trading as much as 4.7% lower early in the session, the S&P 500 rose to trade up 3.4% in a jarring intraday reversal. The broad-based index added $2.4 trillion in market value in the ten minutes from 10:08 to 10:18 a.m., according to Dow Jones Market Data.

By 10:41 a.m. it had all been wiped out. The S&P 500 erased $2.5 trillion in value in around 23 minutes after the White House quickly denied that such a pause was being discussed.

You could define a meme stock as one that moves on social-media information that is not related to the cash flows of the underlying business. When Roaring Kitty tweets a picture, that has nothing to do with GameStop’s operations; people buy the stock because they enjoy buying the stock together as a sort of online social game, not because of any underlying business fundamentals. This, obviously, is not that. The difference between the net present value of the future cash flows of publicly traded US companies under Trump’s stated tariff regime, and the cash flows of those companies under some “nah just kidding” version of that regime, plausibly is $2.4 trillion. These are absolutely real macroeconomic calculations, even if some of the inputs are fake tweets.

But it is kind of meme-y, isn’t it? The main input to the calculation really is the whims of one extremely online guy, which he often expresses on social media. It does not seem particularly helpful to have some economically motivated, game-theoretic model of his approach. It has become conventional in modern markets to talk about a “Fed put” or “Powell put”; a lot of investment decisions are motivated by theories about what Jerome Powell will say or do. But those theories tend to be grounded in some underlying economic model: “Jerome Powell will not want a market crash, and if X happens there will be a market crash, so he will lower rates” or whatever. Your theory of Powell’s mind reflects your economic model, and what you think his economic model is. 

Is your theory of Trump’s mind like that? Maybe; what do I know. Bloomberg’s Carmen Reinicke writes:

The episode laid bare just how binary the potential outcomes are as Trump proceeds with his global trade war. If he leaves tariffs on, as he says he will, the economy could quickly contract and sink the S&P 500 into a bear market. Take them off, though, and the economy can churn higher and stocks will reclaim records.

“There’s no question that if Trump woke up tomorrow and said, ‘you know what? I’m not doing this’ the markets would just move back to a new high,” said Ross Gerber, chief executive officer of Gerber Kawasaki Wealth and Investment Management.

Just a theory of whimsy. I do feel a little bit like the meme stock episode prepared us for this. Ten years ago, if you were a professional investor, you could have had a more or less rational theory of how financial markets operated, and if someone showed you a picture of a guy with a game controller leaning forward in a chair you would have ignored it. Now every professional is hardened from years in the meme-stock battles; everyone understands that “what mood will the guy wake up in tomorrow” is a normal question of financial analysis. This is just how life is now.

In other news: People have emailed to ask questions of the form “was this market manipulation” or “is this a good way to do market manipulation?” My best guess — I know nothing — is that the bad social media post was an honest misinterpretation of something Hassett actually said.

What about the hypothetical, though?  In some ways I am tempted to say “building up credibility for years by accurately posting real all-caps financial news headlines for people who don’t have subscriptions, and then burning all of that credibility at once by posting a single fake headline that moves markets by $2.4 trillion, is honestly pretty good market manipulation” (not legal advice!), but I’m not sure that’s right. If you are doing market manipulation, I think you want depth, not breadth. Moving GameStop by 50% is more valuable to you than moving every financial asset in the world by 5%: Your capital is limited, and causing a $2.4 trillion move isn’t worth $2.4 trillion to you. From a certain (dumb) perspective, that fake headline was briefly one of the most valuable pieces of writing in human history, but the person who tweeted it couldn’t capture most of its value.

MicroStrategy Inc., now known as Strategy, is a publicly traded pot of Bitcoins with a software company attached to it. Strategy’s stock trades at a large premium to the value of its Bitcoins, for reasons that we have discussed frequently but that are ultimately mysterious. As a public company, Strategy issues financial statements. What should the financial statements say? From first principles, Strategy is a pot of Bitcoins, so the balance sheet should say things like “this is how many Bitcoins we hold, and what they are worth.”

But what should the income statement say? I mean, Strategy sells software and stuff; presumably the income statement should reflect that. It issues debt to buy more Bitcoins; it pays interest and has offering expenses and so forth. But if you abstract away all of that and think “Strategy is basically a pot of Bitcoins,” what is the net income of a pot of Bitcoins? Plausible answers might include:

1. The income statement for a pot of Bitcoins isn’t very interesting so I am not even going to read it.
2. The income statement for a pot of Bitcoins should not reflect any income: If you hold some Bitcoins one quarter, and you hold the same Bitcoins the next quarter, you are not doing a business, so you have no revenue and no expenses and so no income.
3. The income statement for a pot of Bitcoins should reflect income equal to (i) the number of Bitcoins in the pot times (ii) the increase (or decrease) in the price of Bitcoin. The income statement should reflect changes in the economic value of the pot, which means changes in the price of Bitcoin.

I am a little partial to Answer 1 — do you read the income statement of your S&P 500 index fund? — but I think you are not really allowed to say that about publicly traded companies. Loosely speaking the official answer used to be Answer 2, [3] and then it changed to Answer 3, so now Strategy marks its Bitcoins to market through its income statement. This is intuitive and, in a sense, not informative: If you know how many Bitcoins Strategy holds, you can easily look up the price of Bitcoin, and then you will know how much the pot of Bitcoins is worth. It seems somewhat redundant for Strategy to send you a lengthy report saying that changes in the price of Bitcoin changed the value of its stash of Bitcoin. I understand why Strategy would do it — public companies are subject to securities disclosure rules — but I don’t understand why you would care.

But I don’t understand anything about Strategy, so:

Michael Saylor’s Strategy said it will register an unrealized $5.9 billion loss in the first quarter after adopting an accounting change that requires valuing the digital asset at market prices.

Shares of the dot-com-era software maker turned leveraged Bitcoin proxy formerly known as MicroStrategy fell as much as 14% on Monday. Earlier, Bitcoin wiped out almost all of its gains since Donald Trump’s US presidential election win in early November.

Strategy and fellow corporate buyers of Bitcoin are being made to recognize the unrealized changes that often produce big swings in earnings or, in the case of Strategy last quarter, losses. Strategy waited until the first quarter to adopt the accounting change that was approved last year.

Yes, I just, if your company is a pot of Bitcoins then the value of your company changes with the value of Bitcoin; how could it be otherwise?

It would be a weird coincidence if, in this era of rapidly improving artificial intelligence, Shopify Inc. had exactly the correct number of human employees. Like there are probably some areas where 100 human employees could pretty quickly be replaced by two employees and an AI model. There are probably some areas where 100 human employees would work better if there were 110 human employees, and where AI can’t substitute for the human touch. But it would be weird if there was a team where 100 human employees are all absolutely necessary, but one more employee would be excessive. It would be weird if AI could do the job of every prospective Shopify employee but of zero current Shopify employees. But the Wall Street Journal reports:

Shopify won’t make new hires unless managers can prove artificial intelligence isn’t capable of doing the job, according to a new memo from Chief Executive Tobi Lütke.

Teams at the e-commerce company need to integrate AI into their workflows, and doing so will be expected of all employees going forward, according to the memo, which Lütke shared on social media. 

“Before asking for more Headcount and resources, teams must demonstrate why they cannot get what they want done using AI,” he wrote. “What would this area look like if autonomous AI agents were already part of the team?”

I feel like the answer he is looking for is “the team would be smaller,” though the Journal notes that “the memo didn’t say whether the company’s AI philosophy would lead to layoffs.”

Last October, Elliott Management, the hedge fund, launched a podcast about Southwest Airlines Co. At the time, Elliott was running a proxy fight at Southwest, pushing for changes in management and strategy, and these days I guess investors want to get their information via podcasts on their way to work. So Elliott met them where they were and podcasted about its proxy fight. That is, I assume the podcast was about the proxy fight; I did not, you know, listen to the full season. We talked about it at the time. It worked, in the sense that Elliott reached a deal with Southwest that gave it some board seats and much of what it wanted. Southwest’s stock closed at $30.37 the day before the podcast launched; it closed at $31.86 last Wednesday (pre-tariffs; it’s much lower now). Did the podcast add $700 million of value to Southwest? I mean, no. But that would be a pretty good podcast.

Anyway this is now routine:

Elliott Investment Management L.P. ("Elliott"), which manages funds that together make it a top five shareholder in Phillips 66 (NYSE: PSX) (the "Company" or "Phillips"), today announced the launch of the Streamline 66 Podcast, a new series that will feature 1:1 conversations with Elliott's highly qualified director nominees ("Nominees" or "Nominee"), as well as industry experts. Episodes can be accessed on Streamline66.com, and are available on Apple, Spotify and everywhere podcasts are heard. You can not only listen to the conversations on all major podcast feeds, but you can also watch the episodes on YouTube.

I really want them to do a full range of proxy-fight-related podcasts. Like sure an interview show with the board nominees is the obvious move, but what about a highly produced Serial-style narrative podcast that tries to crack the mystery of why Phillips 66’s shareholder returns are disappointing? A foul-mouthed sports chat show where the hosts sometimes gratuitously insult Phillips 66’s executives? A sleep-aid podcast where they read the 10-K out loud? The podcasting business is tough these days and activist shareholder podcasts are a bright spot.

Hackers Spied on 100 US Bank Regulators’ Emails for Over a Year. Billionaires Seek to Take Companies Private as Market Melts. PNC Names Former BlackRock Star Mark Wiedman as President. American Whiskey Braces for Another Trump Trade War. Musk calls Navarro “moron” as trade spat intensifies. Elon Musk Rage Quits Gaming Livestream After Repeatedly Dying, Gets Mercilessly Mocked by Viewers. Man’s 7 ‘Emotional Support’ Tigers Seized in Nevada. 

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