about 1 year ago • 1 min
Years of near-zero interest rates and macroeconomic stability have created a few excesses – for example, in corporate debt, private markets, and asset management products. And at the same time, new actors have replaced banks at the core of the financial system, creating a new system that’s really never been tested. Now, with central banks hiking interest rates and economic growth slowing, there’s more risk that “something breaks”.
That risk is something we can quantify. Goldman Sachs tracks 70 indicators of “stress” in financial markets, capturing both liquidity risk (i.e. markets stop functioning well) and solvency risk (i.e. defaults). By looking at the proportion of those indicators that are elevated relative to their history, you get an idea of how fragile the system might be. And right now, those liquidity and solvency risks are maybe not at extreme levels, but they are elevated, at levels seen before past crises. More importantly, they’re both rising rapidly.
Now, this doesn’t necessarily mean we’re destined for another financial crisis or a financial accident. As I wrote here and here, today’s financial system does appear more resilient than it was in 2008. Then again, that’s what we’ve said before each past catastrophe. When it comes to financial crises, there’s only one thing that seems certain: we won’t be able to predict what’ll break, when it’ll break, or how bad things might get.
The lesson here: use caution. Avoid leverage when you can, don’t bear too much risk, make sure your portfolio can handle larger-than-usual losses, and have a plan in mind in case the sea gets rough. You might never face a storm, but a good captain is always prepared.
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