Don’t overestimate the leverage effect. If $150 billion of loan values are not paid, either through forgiveness or loan modification, then that’s exactly $150 billion of losses, not $1,500 billion. Some hedge funds or investors in derivatives or other instruments may be heavily exposed to that $150 billion of losses. But it’s still… $150 billion.
Of course, these loans found their way into many other assets, so there could be assets worth (let’s go nuts here) many trillions that are affected in some way by the loans with losses. But the only way that the $150 billion can become much bigger is a crash in liquidity that forces sales of related assets at fire-sale prices that go beyond the actual losses on the underlying loans. What’s the chance that the financial community will sit on the sidelines twiddling their thumbs and let that happen? I know we like to complain about them, but I don’t think I’d call them stupid or self-destructive.
I fully expect this episode to trigger a generally higher price for risk in the markets, but adding 20-50bp to average corporate spreads, for example, is not earth-shaking, and is long overdue. And people would look closer at their hedge funds, that’s all.
