No one likes an alarmist know-it-all (except maybe the folks riding Michael Burry’s coattails through the 2008 financial collapse… but even a lot of those folks thought he had lost his mind).
I know I’m a bond guy, and we’re predisposed to see glasses as half empty. BUT, I’m starting to worry even more than I did in August that the markets are starting to rhyme with 2008.
Back in that August post, we noted the many parallels between today’s markets and those of 2007–2008.
One key difference we highlighted: we hadn’t yet seen signs of excessive leverage.
Well… in my estimation, that’s changing (and fast).
The shift in my thinking came while reading Andrew Ross Sorkin’s new book, 1929. As he’s been promoting it, he’s raised some uncomfortable parallels that stuck with me. I’ve always been a fan of ARS’s work — Too Big to Fail remains one of the best breakdowns of the 2008 crisis, and Billions is a favorite show of mine. Each gave me a favorite quote (though the Billions one of them isn’t printable here).
In Too Big to Fail, when AIG executives were panicking over how to post collateral for the government loan, one older exec asked, “What about the vault?” — referring to the room holding bearer bonds they could use as collateral.
It’s a great reminder of how much hidden leverage existed then… and how easy it was to miss.
Today’s version of that hidden leverage might be sitting inside the AI boom. Barron’s recently nailed it with the headline: “Nvidia, Microsoft, and OpenAI: This Chart Captures AI’s Circular Financing.”
“Since Nvidia agreed last month to invest $100 billion in its customer OpenAI, investors and analysts who follow artificial intelligence have awakened to that industry’s circularity.
Nvidia puts money into OpenAI. OpenAI and its data center partners buy chips from Nvidia. Other circles encompass Microsoft, Oracle, and the data center firm CoreWeave.
The circles remind some on Wall Street of the wash trades between venture capital-backed start-ups before the first internet bubble burst 20 years ago—or the guy who asks you to lend him a $20 bill so he can buy you a beer. AI skeptics are chortling.
Since a picture is worth a thousand words, see below:
Sources: Barron's
If that doesn’t make you pause… it should. Things are starting to look familiar.
My memory of 2007–2008 is still vivid — funny how certain kinds of pain stick with you. I always thought humans were wired to forget pain (otherwise, childbirth wouldn’t happen more than once). But in finance, some pains never fade.
During the crisis, derivative exposure was so widespread and opaque that no one understood who was on the hook for what. The result? Capital markets froze.
I remember sitting next to a money fund manager as she tried to figure out which municipal bond insurer was about to lose its AAA rating.
Not pleasant times.
Back in our original blog, we said:
“Most post-mortems on the Great Financial Crisis boil it down to two culprits: too much market risk (duration mismatches, leverage, liquidity illusions), and credit risk that looked manageable until it suddenly wasn’t. The packaging changed... but those two variables were always at the core.”
AI’s circularity seems to wrap both of those risks into one neat, shiny package. Financial markets are endlessly inventive when it comes to repackaging risk — which is exactly why they need guardrails.
Then again, what do I know? Like I said, I’m just a bond guy… we’re born waiting on the other shoe to drop.
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