Contrary to expectations for a "great deleveraging" following the 2008 financial crisis, global debt has not decreased; instead, it has shifted and grown substantially. While Western consumers and banks somewhat reduced their leverage, this was more than offset by increased borrowing from companies and, especially, governments. China also saw a significant surge in its debt, transforming the global debt landscape into a "bipolar" system.
The nature of leverage has evolved beyond simple debt, incorporating five key complexities that heighten risk. Modern leverage often involves complicated linkages, such as equity bets collateralized by long-dated Treasury bonds, exposing investors to multiple market movements. Debt is increasingly supplied by institutional investors, not just banks, and its servicing relies more on asset values than cash flow.
There's a growing trend of "embedded leverage" where financial engineering, like digital or binary options, can lead to disproportionately high losses from modest market changes. This makes assessing risk and loan-to-value challenging, particularly as exposure spreads across a long chain of entities with differing credit standards. This increasing complexity makes traditional regulatory tools like disclosure and capital requirements less effective, as information lags and risk modeling becomes more difficult.
The financial system has become increasingly reliant on speculation, often backed by governments and central banks, making it difficult to control leverage. This dynamic, characterized by financial innovators outpacing regulators, suggests that the "arms race" of leverage will continue. The end of cheap money has amplified concerns about the accumulated leverage, as it raises risks of financial instability and potentially large losses when market conditions shift.
