Deutsche Bank warns that AI fund liquidations and the KOSPI crash are symptoms of accumulated leverage.

Last week, the "AI Oracle" fund was forced to liquidate $16 billion in positions due to a leveraged trading failure, while South Korea’s KOSPI index plunged over 20% within 48 hours before rebounding. Deutsche Bank analysis suggests these two seemingly isolated, random events are in fact symptoms of the same underlying issue: years of accumulated leverage within ETFs, margin accounts, and hedge fund books under a decade-long low-interest-rate environment. The frequency of VIX spikes has risen noticeably since 2022, and traditional safe-haven assets have failed repeatedly during market shocks. Deutsche Bank warns investors to stop treating each market fluctuation as an isolated incident—policymakers are effectively “intentionally” introducing volatility to curb excessive leverage. Hidden built-up risks still persist in areas such as private equity and public corporations.

Article author and source: Wall Street Journal

Last week, Situational Awareness, the hedge fund under the “AI Oracle,” was forced to liquidate $16 billion in stock positions after its highly leveraged bets on AI companies failed. During the same period, South Korea’s KOSPI index plunged more than 20% within 48 hours, then rebounded 25% from its low, closing the week nearly flat.

The market viewed these two events as isolated "noise," quickly absorbed and moved on. After a brief period of volatility, the market ultimately returned to calm.

However, this “forward-looking” consensus may be a dangerous misinterpretation. Although the collapse of the “AI Oracle” fund and the sharp decline in Korean stocks did not appear to trigger a systemic market crash, Deutsche Bank believes both are symptoms of the same phenomenon—leveraged buildup during the low-interest-rate era—and should not be viewed as isolated events.

According to Zhui Feng Trading Platform, analysts including Luke Templeman from Deutsche Bank Research wrote in a report on August 3:

We believe this interpretation is incorrect, or at least incomplete. Both events are symptoms of the same underlying condition: leverage—present in ETFs, margin accounts, and hedge fund books—that has been fueled by over a decade of low and stable interest rates.

The KOSPI completed a full "V-shape" within a week, with the index nearly returning to zero. However, Deutsche Bank's report points out that this figure is severely misleading.

An index fluctuating by 45 percentage points over several days is economically distinct from remaining unchanged.

This is due to the mechanics of leveraged positions: during declines, leveraged and margin positions are typically mechanically and irreversibly liquidated, regardless of any subsequent rebound. While index-level gains and losses may be hedged, the wealth loss experienced by individual investors—especially retail traders using leverage for the first time—cannot be recovered by a rebound. Retail traders who have been liquidated cannot return.

Reports indicate that more than 3% of South Korean adults received margin calls within the past two weeks. The report states, “If accurate, this figure is deeply concerning.”

This is not an index fluctuation; this is real household wealth loss.

This crash in Korea had a specific triggering mechanism: in April this year, single-stock leveraged ETFs tracking Samsung Electronics and SK Hynix were officially listed.

These two underlying assets are already mega-cap stocks with market capitalizations exceeding $1 trillion, and retail investors hold a significant portion of their shares. After the launch of leveraged ETFs, retail exposure to leverage on these stocks surged dramatically almost overnight. When the underlying stocks declined, the amplified downside effect of the leveraged products triggered a cascade of liquidations.

Analysts warn that this is not a story unique to Korea. "Similar products are also growing rapidly in the United States and Europe."

If a similar event occurred in the U.S., the transmission pathway would be far more destructive than a single hedge fund liquidating its positions—it would penetrate consumer spending (as households facing margin calls cut back on expenditures), credit markets (as brokers and lenders reassess collateral), and market sentiment (as retail participation reverses).

Deutsche Bank compared Korea's situation to another case: the apparent isolated collapse of Silicon Valley Bank (SVB), which in reality forced policymakers to effectively guarantee deposits across the entire U.S. banking system—an intervention scale far exceeding the magnitude of the original issue.

The lesson is not that every small thing will escalate into a systemic event, but that those which do escalate were almost never obvious beforehand.

The liquidation of the "AI Stock God" fund and the flash crash of the KOSPI appear unrelated. Deutsche Bank believes they are different symptoms of the same underlying issue: over a decade of low and stable interest rates has systematically encouraged the accumulation of leverage in ETFs, margin accounts, and hedge fund portfolios.

It’s like the foundation of a building slowly settling over many years—unnoticeable on the surface until a trigger point causes cracks to appear.

Analysts have also observed that market and policy-making attention has long been focused on sovereign debt risk, while the risks associated with household leverage have been systematically underestimated—although the growth rate of household leverage is trending toward a plateau, its absolute level remains high.

When we display this chart, customers' attention will focus on the rise in sovereign debt rather than the plateau in household leverage.

This "focus shift" is precisely why household leverage risk is currently systematically underestimated.

Data from Deutsche Bank shows that the frequency of VIX spikes since 2022 has been significantly higher than the average over the past decade.

Analysts directly link this phenomenon to the normalization of monetary policy rates by central banks worldwide: during the era of low interest rates, market volatility was suppressed, leading to the accumulation of leverage; as rates return to normal, the force suppressing volatility disappears, and the accumulated leverage begins to seek an outlet.

Since interest rate normalization began in 2022, the frequency of "low-volatility" events in the VIX has been significantly higher than over the past decade. Meanwhile, traditional safe-haven assets—gold, the U.S. dollar, the Swiss franc, the Japanese yen, U.S. Treasuries, and German bunds—have failed to effectively hedge risk during multiple shocks since 2020, including the COVID-19 pandemic, the 2022 rate hikes, the 2025 tariff shock, and the 2026 Iran war.

Analysts wrote: "If safe-haven assets continue to fail when they are needed most, the implicit buffer that investors rely on is much thinner than before, increasing the likelihood that future 'minor volatility' events could escalate into larger problems."

Deutsche Bank also proposed a noteworthy analytical framework: Is the Fed intentionally introducing volatility?

The report cites analyst Rob Armstrong, who noted that Fed Chair Walsh's withdrawal of forward guidance may not have been a mistake, but rather a deliberate policy choice aimed at reintroducing an "uncertainty premium" to the market to curb excessive leverage.

He withdrew forward guidance as a deliberate attempt to reintroduce an 'uncertainty premium' into the market—because lower volatility had caused the market to accumulate leverage beyond normal levels.

Forward guidance suppressed daily volatility, and stable prices along with a calm market encouraged governments and market participants to borrow beyond normal levels. Wash could not openly articulate this logic without triggering market panic, so he expressed it in vaguer, "umpire"-style language—but to Armstrong, the policy actions pointed in the same direction.

Analysts wrote: If policymakers truly believe that greater everyday volatility is healthy, investors should expect more events similar to "Situational Awareness liquidation" and "KOSPI crash," and stop treating each one as an isolated, disconnected incident.

Deutsche Bank listed two areas that still carry hidden backlog risks at the end of the report:

Private Equity: A large number of technology, media, and telecommunications (TMT) assets acquired during the near-zero interest rate era remain on PE firms’ books, with holding periods far exceeding expectations due to a closed exit market. “The清算时刻 may still lie ahead.”

Publicly traded companies: Many still carry inefficient assets acquired during the previous wave of debt-driven mergers and acquisitions, resulting in low asset turnover rates—a lingering effect of cheap financing that encouraged growth focused on revenue over profitability.

Analysts wrote: “The market’s instinct is to classify the Situational Awareness fund collapse and KOSPI volatility as 'noise,' since neither has currently evolved into a systemic event. This instinct could be dangerous, especially as policymakers are willing to tolerate greater daily fluctuations.”