MARKET PERSPECTIVE

By J Mulraj

Aug 1- 7, 2026

The Situational Awareness of Over Leverage

Image generated by ChatGPT

By all accounts, German born whiz kid Nicholas Aschenbrenner was a brilliant student. He graduated, at age 19, as a valedictorian, from Columbia University, worked at OpenAI in a Superalignment team, before being fired for an information leak. He wrote an influential essay titled ‘Situational Awareness’, which drew the attention of investors like Jane Street (a quant fund that paid a $ 570 m fine imposed by SEBI for derivatives manipulation and price rigging), Stripe co-founders, Meta executives and others.

These investors provided the initial funding for Nicholas’ fund called Situational Awareness, despite the fact that, at age 22, he had no fund management experience.

He then made the mistake of believing the dictum of Archimedes, who had stated ‘give me a lever and a place to stand, and I will move the Earth’. Nicholas leveraged the fund 4X, from firms like Goldman Sachs, Morgan Stanley, and investing in shares of AI infrastructure companies like Korean company S K Hynix, Sandisk, Bloom Energy, Nebius, Core Weave and others. Leveraging so high magnifies earnings when the bets work out, as they initially did, with the fund growing to $45 b at its peak, but become a risk factor when bets failed.

The over leverage attracted the attention of the wily Ken Griffin, founder of the successful hedge fund, Citadel (the same Ken against whose Manhattan citadel newly elected mayor Mamdani had pointed at, in a video, as justification for a hike in property tax) who shorted the stocks held in the fund, end July 2026, just a few days before Nicholas Aschenbrenner was getting married. The stock prices fell sharply, triggering margin calls from lenders MS and GS, to pay which Nicholas was compelled to sell, creating a downward spiral.

The fund value, which had grown to $ 45 b at its peak, collapsed, within days, to $ 10 b, thus revealing other, unpleasant, uses for Archimedes’ lever. Ken, who had shot the barb initiating the fund collapse, then stepped in to rescue it, buying the stocks at the hugely discounted prices.

Leverage also recently created, in July, a stock market crash in South Korea, due to a combination of factors:
> the KOSPI, or Korean Composite Stock Price Index, is highly concentrated, with two stocks, Samsung Electronics and S K Hynix, representing over 50% of the index, which is weighted by market cap of their stocks. These companies are in AI/semiconductors
> in mid July the Central Bank unexpectedly raised interest rates, making borrowing expensive. Several of the retail investors, over 300,000 of them, had borrowed to invest, around $ 23 billion.
> In early 2026 the regulator allowed allowed single stock levered ETFs, with S K Hynix as the underlying.

When there was a collapse in AI stocks in July which killed the Situational Awareness Fund, the stock price of S K Hynix and of Samsung Electronics fell sharply. And, because these 2 stocks represented over 50% of the index, it affected the market badly. The market lost $ 2 trillion in market cap. as KOSPI fell 44%.

The fall in the S K Hynix ETF leveraged 2X was 70% from its June high.

Retail investors in leveraged ETFs lost $ 38 b.

Let’s study the ways in which financial products are first introduced as simple instruments and later contorted through ‘financial engineering’ to become financial weapons of mass destruction.

Exchange Traded Funds (ETFs) were introduced by State Street Global Advisors in January 1993. They were plain vanilla products, seeking to mirror the performance of the underlying index simply by investing collected funds in the same proportion as their weights in the index. Because of this, the net asset value (NAV) moved in a +/- 1% range from the index.

It was only in June 2006 that the USSEC permitted leveraged ETFs, responding to investor demands to allow leveraging tools to enhance short term performance, under its regulation. The problems are; 1. Unlike, say, high risk hedge funds, which allow only qualified investors to invest, the USSEC did not, as it should have, impose guard rails to prevent retail investors. Result? Korean retail investors lost 70% investing in a single stock leveraged ETF when the index dropped 44%.

Another example is the Exchange Traded Note, ETN, launched by Credit Suisse, called XIV ETN. It was designed to deliver the opposite daily return of the VIX Index. The operational mechanics required it to buy futures, when volatility rose, to maintain leverage.

On Feb 5, 2018, the s**t hit the fan. The S&P 500 dropped sharply. The VIX had the sharpest single day rise in history. Short-term VIX future some 109% in a day. Credit Suisse was required to buy them to maintain leverage.

XIV lost 90% of its value, in after market trading. Credit Suisse liquidated the fund, as allowed by the initial terms, if fund value fell 80%. Investors had no escape as the 90% loss was in after market trade.

The 2008 GFC is another example. Large commercial banks initiated mortgage loans to NINJAs, those with No Income, No Jobs and no Assets. How then, one would logically as, would they get repayment? And that’s where a mutilated financial system comes in! The banks did not worry about getting repaid! They misused a ‘financially engineered’ product called securitisation. Using this the sub prime loans were packaged together, sliced, and offloaded to retail investors as high-yield products. In this they were aided by inept/uncaring/greedy for fees rating companies like Moody’s and S&P, who gave high ratings to these securitised offerings knowing they were junk. It was the common investor which ended up losing money, not the banks, nor the rating agencies nor those who marketed the offering.

Last week the BSE Sensex ended at 78499, for a weekly gain of 404 points.

The Iran-US war continues, as does the Ukraine-Russia war. Wars don’t, sadly, come with a pre announced expiry date. A negotiated settlement does not seem possible. It is only a military escalation combined with a strongly enforced blockade that could work.

Perhaps that leverage may work.
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Comments may be sent to: jmulraj@asiaconverge.com