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Government Watchdog Warns Market Crash Risk Rising: “One-Sixth Of All Hedge Funds Are 15x Leveraged”

December 5, 2017

Government Watchdog Warns Market Crash Risk Rising: “One-Sixth Of All Hedge Funds Are 15x Leveraged”

One wonders if the Fed ever reads the reports issued by the Office of Financial Stability, which does a surprisingly good job of laying out the risks facing the market at any one time, which incidentally are far greater than various Fed presidents would care to admit. If it did, it would learn from the just published annual report, that “market risks — risks to financial stability from movements in asset prices — remain high and continue to rise” and that “low volatility and persistently low interest rates” both of which have been caused by the Fed and other central banks “may promote excessive risk-taking and create vulnerabilities.”

While the OFR said that strong earnings growth, steady economic growth, and increased expectations for stimulative fiscal policy have provided further support to asset valuations, this “increase in
already-elevated asset prices and the decrease in risk premiums may leave some markets vulnerable to a large correction,” a polite government term synonymous with “crash.” It then notes that “such corrections can trigger financial instability when important holders or intermediaries of the assets employ high degrees of leverage or rely on short-term loans to finance long-term assets.”Furthermore, echoing Minsky, the OFR did its best paraphrase of “stability is destabilizing” by noting that “historically low volatility levels reflect calm markets, but could also suggest that the financial system is more fragile and prone to crisis.”

Speaking of valuations, the OFR was clear to warn that these are “high by historical standards. The cyclically adjusted price-to-earnings ratio of the S&P 500 is at its 97th percentile relative to the last 130 years. Other equity valuation metrics that the OFR monitors are also elevated.”

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