Where Wall Street’s Next Blowup Might Happen

Where Wall Street’s Next Blowup Might Happen

Finance has endured through this latest stretch of turmoil, leading many to believe that those who usually get swept away by volatility—risk-takers with borrowed money—were already out of the game after the two roller-coaster years. But some believe that a deeper rout is still coming, contends an article in The Wall Street Journal.

Investors have been reevaluating market risks since the early pandemic hit those who had leveraged trading and borrowed fast money in Treasurys hard, causing the Fed to intervene and hedge funds to pull back. Then the meme stock craze in early 2021 slammed short sellers, making those who had taken concentrated short positions rethink their strategies. Two months later, after the hedge fund Archegos collapsed, many investment banks stepped back from lending money to hedge funds, with Credit Suisse opting to stop the practice altogether. And last fall, traders began to pull back in preparation for rate hikes, in what could be seen as a rehearsal for the current volatility in the global markets. Each of these events led to less risk-taking, leaving fewer players vulnerable to 2022’s turmoil, posits The Journal.

While the cryptocurrency sector has experienced some catastrophes, such as Terra’s “stablecoin” collapse, that hasn’t affected the traditional finance world much. And thanks to reforms in the banking system made after the 2008 financial crisis, banks are much stronger nowadays than in the past.

Still, that hasn’t stopped a wave of pessimism amongst those that feel a blowup is still coming. After all, it took 18 months after the dot-com bubble burst in March 2000 for Enron to be brought down, and scandals continued to pop up for years following the 2008 crisis. Even now, developing countries that carry the most debt are in trouble; both Sri Lanka and Ghana are in economic crisis as elevated U.S. bond yields and the rising dollar affect those countries that use dollars to borrow money and local currency as income.

And the current market brings two risks that history didn’t have to contend with, the article explains. An unprecedented amount of liquidity was poured into markets around the world by central banks in an effort to rebound from the pandemic. As that liquidity drains away, problems are bound to appear. There are also many “lightly regulated shadow banks” lending an enormous amount of private debt. While those banks could sour on lending so much money, it’s more likely that investors will start pulling their money out of private-debt funds, shrinking the lending capacity and making it more difficult for companies to refinance their loans—an issue that could take years to be exposed.