Liquidation Incident Reflects Risks in US Financial Market

Wall Street’s recent hedge fund liquidation incident has drawn the attention of global investors. A hedge fund called Archegos was forced to close its positions because of its attempts to leverage borrowed money to inflate stocks, which impacted the multinational banks that financed it. The resulting loss of tens of billions of dollars incited panic in the global market. Chinese investors are paying particular attention to this matter, and a major reason for this is that a large part of the hedge fund’s gamble is made up of so-called China Concepts Stock. This creates an image in the minds of many: Did rumors about China Concepts Stock cause this liquidation?

What must be explained first is that hedge funds are just one type of institutional investor in the stock market; moreover, not all hedge funds are speculators accustomed to borrowing money, employing leverage and gambling. Looking at the problem from a professional perspective and paying attention to the health of the United States financial system, one must question the multinational banks that have lent money to such gamblers and have suffered huge losses: Goldman Sachs, Morgan Stanley, Wells Fargo, UBS and Credit Suisse of Switzerland and Japan’s Nomura. Clearly, it is a problem of risk mitigation in the U.S. banking industry that has enabled financial gamblers to gain enough bargaining chips to give gambling a go. Even more concerning is that the U.S. financial market has already been overvalued. The surface-level design of derivatives has become more sophisticated, but hidden financial leverage continues to grow as well. This reality both provides more precise tools for financial gamblers and increases the difficulty for regulators to penetrate assets and funds.

It is precisely because of the gambling nature of some hedge funds and the negative influence of the derivatives market that, following the subprime mortgage crisis, the U.S. government tried to tighten the supervision of household lending and hedge funds through the Dodd-Frank Act. However, the implementation of this bill was constrained by many financial interest groups. The U.S. regulators also “inadvertently” cut corners in order to improve market liquidity, which directly led to this liquidation incident.

Banks that finance gamblers are also to blame. Everyone should still remember when during the Spring Festival, GameStop, a junk bond, was repeatedly hyped up by speculators in the U.S. stock market. There was no lack of financial institutions behind both sides of the “bull and bear'' market transactions.

Demonic stock speculation and fund liquidation are all sources of chaos in the stock market. From the perspective of the central bank, the U.S. Federal Reserve’s super quantitative and loose policy has made the capital cost for major banks nearly zero, and financing for stock speculation institutions has become a high-yield business. It is not difficult to understand that big banks conduct risk assessment with one eye closed in order to gain leverage and attract high-quality clients.

It is evident that the ultra-loose monetary policy in the U.S. and the regulatory bills that have not been strictly implemented have created systemic risks in the financial market, which eventually led to this liquidation incident. Obviously this “pot” should not be backed by China Concepts Stock. After all, the regulatory issue over the accounting standards of China Concepts Stock is no longer news. Whether a listed company or a regulatory agency in China or the U.S., both are actively coordinating to reduce the impact of technical issues of accounting standards on market valuations. In recent years, the number of new Chinese concept stock IPOs facing slander from ill-willed U.S. politicians each year has not fallen but actually increased. This simply shows the reason and wisdom of the business communities in these two countries.

As for political and business speculators who argue about China-U.S. relations and fan the flames in the financial markets and among public opinion, they are driven mostly by ulterior motives. Technically speaking, in 2021 the U.S. is facing rising inflation pressures, and the financial market’s response in asset values creates a risk of bursting the bubble. In the past two months, the risk of prices falling for China Concepts Stock is much lower than that of many U.S. stocks that were hotly speculated last year. An example is the famous large-cap star stock Tesla, which fell from its highest price of $900 per share in early February of this year to $540 per share just a month later.

In summary, the recent chaos in the U.S. financial market is not for the sake of financing Chinese high-tech companies. On the contrary, the U.S. real economy has long been unable to provide the stock market enough IPO investment targets. In the past two to three decades, Chinese assets with growth potential went public on the U.S. market for financing, which greatly eased the asset shortage of U.S. financial investments and consolidated the U.S. capital market’s position as a global leader. This is a winning instance of China-U.S. funding, assets and capital cooperation.

With the construction of China’s multi-level capital market, especially the accumulation of China’s private capital, the Chinese people have money in their hands and many high-quality companies no longer have to travel to the U.S for financing. Therefore, as far as the risks associated with China-U.S. financial cooperation, the American financial system is should be the focus of most concern. Only by continuously maintaining a properly regulated market environment, supplemented by a normalized monetary policy, can the U.S. capital market remain attractive to global high-quality assets and maintain Wall Street’s global financial status.

For China, on one hand it must learn the lessons of the U.S. stock market. These include strictly controlling commercial banks’ financing of speculative activities, strictly controlling the leverage ratio of various investment funds in the stock market, implementing risk control rules for financial security companies’ margin trading and securities lending and appropriately developing the derivative OTC market. We must not allow deposits in commercial banks to flow to the stock market for use in speculation.

On the other hand, the best way to resolve the disputes over China Concepts Stock and curb the fraudulent subsidies of blind speculation technology is to encourage multi-level capital markets to closely serve technology companies and use modern financial service inventions to transform and serve the real economy. This specifically means actively encouraging already-listed traditional industrial enterprises to transform their business models through high-tech targets and upgrade via mergers and acquisitions. In recent years, facilitating the issuance of additional stocks, the creation of the science and technology innovation board and the reform of the registration system are all important manifestations of the steady progress being made on the supply-side structural reform of the stock market.