A casual reading of that may make it sound like Credit Suisse made some sort of conscious decision to lend money, but from what I see in the financial industry, lending is handed out like candy on Halloween, almost right down to the bowl left out on the street that says "Take Two" and uses the honor system. It's just "leverage". It came with the account and they used it, and it's likely very minimal oversight was ever exerted beyond basic automated checks asserting that sufficient assets were in place to be margin called if necessary.
I see a lot of people calling this the "everything bubble", but to my mind, history may record this as the "leverage bubble". With such low interest rates and free money being shoveled out of the helicopter as fast as it can with more than a whiff of desperation about the whole exercise, there's leverage everywhere, and leverage stacked on that leverage, and leveraged assets being held up as collateral for levered leverage. It seems, at least for today, that this was not The Great Deleveraging, but at some point in the not-too-distant future one seems inevitable to me.
(Subject to the usual "the market can remain irrational longer than you can remain solvent" timing issues, in that I wouldn't dream of trying to call a date on this, but I can't help but think The Great Deleveraging is inevitably coming, when something somewhere pops like this, and the act of margin calling to make up for it pushes down other assets in value, which causes more margin calling and assets getting automatically sold, which pushes down other assets in value, which causes more margin calling and asset selloffs, and it just doesn't stop until there's hardly a speck of leverage left in the market and valuations are a smoking crater, along with every account that was based on leverage. A basic understanding of differential equations would suggest that it's likely the market will at some point experience a phase transition, where we don't gradually go from this being impossible, to kinda happening more and more as leverage increases, but instead we can go in very short time from this being essentially impossible to completely inevitable, and nobody actually knows when this threshold will be crossed.)
"[T]he practice of 'buying on margin' allowed a person to acquire stock by expending in cash as little as ten percent of the price of a stock. The balance was covered by a loan from a broker, who was advanced the money by his bank, which, in turn, accepted the stock as collateral for the loan. Credit was easy, and the Federal Reserve System did little to restrict the availability of money for stock investment." -- article on the stock market crash of 1929
I don't have a specific one in mind, just the intuition that recursive processes can have a lot sharper of a cutoff than a less differentially-minded intuition might suggest.
You can also look at it probabilistically, rather than differentially. Consider even just "If the probability of a margin call causing a margin call is X, and a margin call occurs, how many margin calls will occur in a chain?" The number sharply goes up as your raise the probability close to one, it doesn't just smoothly increase. It's even worse once you add in to the model that the probability is not independent, but as more occur the probability of the next one also would increase. Especially if you add that non-independence in, what you'll see is a phase change, where you get a surprisingly sharp transition between "a margin call doesn't usually cause another one" to "a never-ending cascade of margin calls occurs", rather than a smooth one.
(I may post a model of this. Someone may beat me to it, too. It's not that hard.)
I'm not saying this is an accurate model of the financial system, just the sort of thing I was going for:
import random
import itertools
def withProb(p):
return random.random() < p
def avg100(f):
return sum(f() for i in range(100))/100
# Independent probabilities; look what happens as you get close to 1.
def marginCallChain(prob):
total = 0.0
while withProb(prob) and total < 100000:
total += 1
return total
# Dependent probabilities:
def marginCallDependent(prob):
total = 0.0
while withProb(prob) and total < 100000:
total += 1
prob = 1 - 1 /((1 / (1 - prob)) * 1.01)
return total
If you play with that with something like "avg100(lambda: marginCallChain(.95))", you can find that the chain starts extending a lot as you get close to 1. It's not a terribly sharp phase change, though.
"avg100(lambda: marginCallDependent(.95))" shows more interesting behavior. That only slightly raises the probability of the next margin call based on the fact that one occurred, and what you can see is that around .93-.95, you start seeing that every once in a while, the probability manages to occasionally work itself up to effectively 1 and the chain hits the upper limit I set. As you raise up towards one, you start to see it more and more often; .96 still sometimes manages to have a run of 100 without a crash, but even .965 the odds that one will occur in that run of 100 start to approach 1. There's a phase change between where 100 runs of the model have almost no probability of having a runaway to where the probability of at least 1 runaway is quite probable, and it's more sudden than a linear understanding of the process would suggest.
Again, this is not a model of the financial system; this is a simple model of the point I was making.
Okay. I see your point. I just tend to think of "phase change" as something different. But if the idea is that margin calls beget more margin calls, I can't disagree.
I see a lot of people calling this the "everything bubble", but to my mind, history may record this as the "leverage bubble". With such low interest rates and free money being shoveled out of the helicopter as fast as it can with more than a whiff of desperation about the whole exercise, there's leverage everywhere, and leverage stacked on that leverage, and leveraged assets being held up as collateral for levered leverage. It seems, at least for today, that this was not The Great Deleveraging, but at some point in the not-too-distant future one seems inevitable to me.
(Subject to the usual "the market can remain irrational longer than you can remain solvent" timing issues, in that I wouldn't dream of trying to call a date on this, but I can't help but think The Great Deleveraging is inevitably coming, when something somewhere pops like this, and the act of margin calling to make up for it pushes down other assets in value, which causes more margin calling and assets getting automatically sold, which pushes down other assets in value, which causes more margin calling and asset selloffs, and it just doesn't stop until there's hardly a speck of leverage left in the market and valuations are a smoking crater, along with every account that was based on leverage. A basic understanding of differential equations would suggest that it's likely the market will at some point experience a phase transition, where we don't gradually go from this being impossible, to kinda happening more and more as leverage increases, but instead we can go in very short time from this being essentially impossible to completely inevitable, and nobody actually knows when this threshold will be crossed.)