The arrest last week of the founder of the investment firm Archegos, charged with securities fraud, is a great reminder of hidden debt. In March 2021, Archegos was overleveraged, allegedly hiding its debt from Wall Street firms as it used funky “total-return swaps” to manipulate stock prices. The inevitable collapse destroyed $100 billion in stock value. (Archegos’s lawyers have denied the allegations.) Separately, supply-chain financier Greensill used what Fitch described as a “hidden debt loophole” and collapsed around the same time.
Are there more of these out there? I ask because we’re in the most dangerous part of the economic cycle. Interest rates are rising to combat inflation, and there could be all sorts of leverage we don’t know about. There always is. A slowdown (and especially a recession) would expose these hidden horrors. In 2018 this column argued that “in downturns, equity hurts but debt kills.” We’re about to find out if that’s still true.
More than $850 billion in credit-card debt and $800 billion in margin debt are high but off their peaks, and at least they are known amounts. It’s always hidden debt that comes back to bite when things fall apart. In June 1929, banks had $82 in deposits for each dollar in cash on hand. Bank runs followed. The 2008-09 financial crisis resulted from mispriced collateralized loans and weird derivatives on the balance sheets of Lehman Brothers, Bear Stearns and many others. Citibank used “structured investment vehicles” loaded with mortgages and who knows what else essentially to hide $100 billion in debt by keeping it off its balance sheet.
Now debt is fashionable again. Tesla’s last proxy statement shows Elon Musk owning 73 million options and 170 million shares, of which more than 88 million were “pledged as collateral to secure certain personal indebtedness.” Even assuming a 20% loan-to-value ratio, that’s a lot of personal indebtedness. In the pending Twitter deal, Morgan Stanley is providing a $12.5 billion margin loan against another 62 million of his Tesla shares.
Tesla sold around a million cars in 2021 and was worth $1 trillion last week at the time of the Twitter deal. Ford Motor Co. sold almost two million vehicles in 2021 and is currently worth just under $60 billion. I’d rather have Tesla’s business than Ford’s, but perhaps Tesla’s valuation is a tad fluffy. Netflix stock has fallen 72% in six months. Carvana is down 84% since August. Valuations are fleeting, and we aren’t even in a recession. Now may not be the time to borrow against Tesla shares.
There are reports that Mr. Musk may take out a loan against his current 9.2% stake in Twitter. Yes, borrowing against Twitter to buy more Twitter.
