As a former fund manager, I have some things to explain and some things to ask.
First, the thing to explain:
Basically CS was one of several Prime Brokers. This basically means the guy who lends money to the speculators. Same as buying a house, you have a down payment that's your money, and then a bank lends you between 115% (boom times) and 30% (safe as houses) of the value of the house. If the house falls in value and you can't pay the mortgage, the bank can sell your house, and hopefully that will mean they recover their entire loan. Note that they only lose once the value has declined by your down payment amount.
I actually knew the boss of a PB who got fired because a rich guy came in and wanted a lot of leverage, the risk managers said no, and he overruled them. And then the customer proceeded to lose hundreds of millions speculating, and it ate the bank's capital. So it's not the first time that risk gets overruled.
So somehow, CS has lost $4.7B on this Archegos financing, after Archegos lost whatver they put up. From what I gather, Archegos had $10B of equity in total? Typically (sensibly) you don't put all your eggs in one basket as a fund, even a quite concentrated fund.
> From what I gather, Archegos had $10B of equity in total? Typically (sensibly) you don't put all your eggs in one basket as a fund, even a quite concentrated fund.
It was $20B. Hwang's whole schtick from the outset of his family office was to hyper lever up on high growth companies. By doing this he went from $1B to $20B of actual capital in about 2 years. Then he blew up spectacularly because he was levered up about 5x in a ridiculous concentration.
There's no royal road to excess returns, etc. He probably could have kept this going longer, but sooner or later one of his superholdings was going to have a market event sparking a loss (like VIAC) and even his volume wasn't going to be able to prop up the price anymore. Chain reaction from there.
This is a good cautionary tale: going around to a bunch of banks and getting crazy leverage Big Short style doesn't always end in a lionizing outcome. In fact it usually doesn't. What sucks is the leverage is going to be demonized here, when the actual problem is Hwang's lack of transparency (albeit legal) to his brokers and his frankly stupid risk management.
Plenty of funds safely chug along for years running at 3-4x leverage, they just have the good sense to keep beta < 1 and stay roughly market neutral in their long/short holdings...
> Big Short style doesn't always end in a lionizing outcome.
That movie was the worse thing that ever happened for a generation of traders. It reinforces all the worse biases traders tend to have. The moral of the story was to make a single concentrated bet, to throw risk management to the wind, to double down as you lost money, and to completely ignore any expert that disagreed with your investment thesis.
In reality for every Michael Burry, there's 100 stubborn overconfident idiots who YOLO everything into a bet that blows up in their face. First off, it's much better to make as many small independent bets than to have one big trade. It's also better to make trades with a fixed, ideally short, time horizon. Even if you're ultimately right, without a catalyst, the market can remain irrational longer than you can remain solvent.
Finally the best traders tend to be extremely open minded and willing to change their views on a dime. The human mind is heavily biased towards overconfidence. Good traders should be flipping their views as evidence comes in. This has been empirically verified by Philip Tetlock. The best forecasters are those who are quickest to change their mind. If they hear some expert with an opposing opinion, they don't dig in their heels like the heroes of The Big Short.
The problem is the qualities that make a great narrative hero are almost exactly the opposite of those that make a great trader or forecaster. We love a story about a bold contrarian, who goes all in on a single bet, and sticks to his guns no matter what obstacles come his way. The story practically writes itself.
But it's precisely this mythologizing that causes this style of trading to be the least rewarded in the market. Everybody wants to be the hero of their own story. There's way too many Michael Burry wannabes, and not nearly enough George Soroses.
Personally I don’t understand why so many people are blaming Hwang and Archegos. He lost his own money and the money of the banks who gave him leverage _without_ a proper risk assessment. I haven’t seen any claims that Hwang lied to the banks and it’s the banks’ job to do due diligence and apply sane risk management practices.
I don't personally have any skin in the game, but of course I blame him for losing his money. It's his fault, who else would I blame? Pretty cut and dry case of terrible risk management here. What seems controversial?
Nobody held a gun to his head and told him to load up crazy leverage on a highly concentrated basket of equities... And the banks that lent him money didn't have transparency as to his leverage elsewhere.
I think it's more an awe for the scale of capital destruction.
In the end this isn't a domino that topples the whole financial system, risk was taken by a guy who had money, and banks who are capitalized to lose money now and again.
>What sucks is the leverage is going to be demonized here, when the actual problem is Hwang's lack of transparency (albeit legal) to his brokers and his frankly stupid risk management.
Seems to me the onus is on CS and other prime brokers to require Hwang to disclose or otherwise do due diligence on his other bets.
They can wag their finger, but they don't legally have recourse for finding out this information ahead of time if Hwang and his existing lenders don't volunteer it. That's just the current state of play with margin lending.
yeah, that's just called gambling and stupid money. a basic task of money management is monitoring how correlated a portfolio is, and putting all of it in one basket is the opposite being mindful in that way.
it's also a good reminder of an economic reason for why we don't want wealth concentrating, because the chances of it be allocated efficiently fall. concentration worsens the effect of poor allocation. if that money was split among 1000 investors, a few would act stupidly, but a few would allocate exceptionally, and the many would be somewhat average, giving a much better overall outcome for the same amount of capital.
the more widely dispersed capital is, and the more dynamic an economy is, the more opportunities for capital to find its best use. it makes sense then why efforts along these lines (dispersion and dynamism) are vehemently opposed by the already wealthy. it's not because of capitalistic purity, but the threat it represents to their own power and influence.
if you are levered 10 to 1 and the stock has an implied vol of 10% you only need a 1 SD move to eat all your capital. Viacom is now at 60% implied vol so they could get those losses with a position as small as $10 billion.
Just curious, is that still true if your model of daily returns isn't gaussian? If prices have intermittent shocks (Ornstein-Uhlenbeck, etc) is the daily vol much higher?
Vol is a parameter in a model as well as an observed statistic. Naturally you can have jump models as well that have other parameters, but normally when we talk about it we mean the observed stat, with a standard normal implied when discussing it. Weirdly I've not often had a conversation where someone talks about alternative models, even though people do use them.
To be fair, Archegos hedged their beta exposure with short index futures. The implied vol includes both the beta vol and the idiosyncratic vol. A hedged position should be a lot less vol than being naked long.
I read elsewhere (can't read this article) that some other banks had made similar deals with Archegos, but they saw the trouble coming and were able to offload their exposure / shares (sell the house using the analogy) before other banks and thus were able to get out with limited or no losses.
Does that sound right?
It seems strange to me that using the house analogy ... there's potentially WAY more than say a 15 percent loss (using the 115% number) if other lenders decide to nope out.
Disregard the 115%, that's from the pre-GFC times when banks used to give you more money than you needed to buy the house, plus some more to buy a car.
You're right there were several deals, but again, you're allowed to ask questions as a PB. Clearly if you're lending money to a guy who is borrowing from a bunch of other people to do the same thing, you should have a think about it.
Yeah in a couple other articles it seems some banks refused to lend to / cut off Archegos at some point(s). These guys who are all leverage all the time ... seems inevitable they get it wrong.
>> From what I gather, Archegos had $10B of equity in total? Typically (sensibly) you don't put all your eggs in one basket as a fund, even a quite concentrated fund.
>> How big was the position?
I think you're trying to get to "how was the loss so big?" The size of the position is only part of the answer.
The other comments answer the size of the position. But there are several other factors here.
They probably liquidated too late -- they ended up liquidating with giant block trades. That unwind also cost a lot because the block trade is at a discount to market value. Further, the larger the unwind, the bigger the price hit you take.
Finally, these types of unwinds can spook others in the market and further drive down the price.
According to Matt Levine, Archegos's positions in sevaral companies was large enough that it had, by its own actions, significantly driven up their prices. The bubble burst when one of these companies - ViacomCBS - issued new stock with the intent of capturing more of this sudden interest, and sales of the offering fell way short of expectations.
In insane scenarios like this, is there anything preventing a company from issuing new stock, waiting for the price drop from liquidating major holders, and buying back an equivalent amount?
Hertz issued new stock when its stock started rising while it was in bankruptcy proceedings, with permission from the bankruptcy court, until the SEC told it to stop (AFAIK, the SEC did not penalize it for the stock it had issued up to that point.)
GameStop could not do this during its initial crazy ride, on account of being in a fiscal-year-end blackout period. Since then, it has said it may issue new stock.
Any company making such an offering whould have to be frank and completely transparent about the risk, to avoid any hint of securities fraud, and I would not be surprised if the company would still be sued if the price subsequently fell. In Hertz's case, being sued would not be a problem.
ViacomCBS claims to not have known that the run-up of its stock was driven by Archegos's speculation, and seems to have been harmed by the outcome. It had Goldman and Morgan Stanley leading the sale of its new issue, and it so happens that they were also prime brokers for Archgos, but bailed out fast enough to avoid big losses. Make of that what you will.
I am just repeating here what Matt Levine has said on the topic.
As someone who has worked in the Investment Banking industry for a while, I'm always amazed that risk professionals get paid significantly less than the front office guys. This in turn attracts less talented people in risk, who can then be outsmarted by the whipper snappers in the front office teams.
If IBs don't want to lose bucket loads of money every so often, pay your risk guys a bit more so you hire the same calibre of individual that would otherwise end up on the trading/structuring/quant desks.
I think it can be chalked up to cost center vs profit center.
Staffing trading makes money.
Staffing risk costs money.
It's inevitable the latter is going to get the short end of the stick, probably the bare minimum requires to satisfy regulation, when salaries are allocated.
They do care about the risks they’re taking and invest a lot of money into risk management. But the real risk management is in buying politicians with campaign donations, lobbying, and revolving door jobs after they leave office. Favorable regulations, weak punishments, and bailouts are much more effective. Bank risk departments are just risk theater.
Exactly, I always like to remind myself of the New York State court cases that reaffirmed Compliance Officers are at-will employees, and can be fired for any reason, like raising compliance issues.
I agree but i this is still playing the same game, and it's the rules that need changing
There is a system set up which incentivizes your employees to screw over their own company, by taking more risk than they should, frontrunning their own clients, etc. And it necessitates setting up your own internal police (compliance, risk) just to make sure they don't get too out of hand.
There are personal incentives there for the IB people to try to outsmart and get something past risk, or avoid getting caught by compliance, not to try to do what's best for the company or their client
Why? The shareholders & execs were free to impose stricter compliance and risk rules. They chose not to.
As long as you don't have contagion spreading to the rest of the financial system then who cares. The new rules put into place re: bank capitalization after the GFC seem to have worked here. Shareholders & execs are taking the hit, the rest of the banking system doesn't seem to be affected, and everything seems to have worked as it's supposed to in this case.
the reporting on stress testing (that i've seen, at least) implies that added rules like further limiting bank capitalization fall woefully short of preventing another contagion from spreading.
i'm down for letting banks rise and fall on their own merits, but we've not had that since before the 80's at least.
We just went through the deepest, fastest recession since the 19th century. And not a single major financial institution failed or even needed a bailout.
That's pretty firm evidence that banks are more than adequately capitalized. People want to see everything through the lens of 2008, but the difference between banks then and now is night and day.
the circumstances are drastically different, so adequate capitalization is unlikely the reason for that. this was a induced recession from outside forces, not from internally correlated ones like 2008.
dont worry - the us will bail them out like we did in 2008 when they directly caused the housing market crash.
it's priced in at this point. there is no such thing as accountability in the finance industry anymore. Make bad decisions, get bailed out. All of them are moral hazards.
Not bailing them out would be ruinous for the economy, which therefore means they must be heavily regulated. This half-implemented system of privatized gains and socialized losses is not sustainable.
There are other alternatives between allowing the economy to collapse and bailing out Wall Street.
One proposed by a Harvard Professor during the GFC was to create an Economic Development Bank of the US, seed it with the TARP money instead ($700B), and give it the mandate of financing productive growth activities (as opposed to asset speculation or consumption). The money multiplier effect implies that $700B could multiply into $7T worth of liquidity injection into productive growth activities.
Another similar model is the Japanese post-WWII industrial development model, where a central bank or Ministry of Finance finances local regional banks as they support rebuilding and industrialization of their local economy. Google the economist Richard Werner for more on this model.
All this can be done while letting big Wall St. banks fail and taking them into receivership similar to the S&L crisis. There is precedent for all of this, it’s nothing new. And certainly more options than Wall St. self-servingly presents.
The entire model is balancing risk and reward. Being careful means you'll be eaten by your competitors, your shareholders will punish you and executive comp will take a hit - what is the point of playing the game then? Instead reward taking risks and if shit hits the fan, there are always heads that can roll (if need be), fines that can be negotiated with DOJ/SEC and ever-sneakier tactics can be invented to structure even more clever deals - it is all just normal part of doing business. The two execs that got fired would have been handsomely rewarded if Bill Hwang's bet went the right way, irrespective of the recklessness.
Yeah, but the "measure of recklessness" needs to go beyond just value at risk and portfolio sensitivities. Those things can be gamed by clever people and risk can be easily hidden.
Unfortunately, most risk managers I knew barely understood the theory enough to identify the hidden risks in the books they oversaw. Most even struggled to get the right data out of the systems to do their jobs properly!
You do make a valid point - if the recklessness somehow pays off, you're a hero (eg. Paulson).
Yes, of course they have. How does a company losing a sum equal to nearly 2 years of profit not have the most dramatic impact on senior officials at said company? Where do you think the executive bonuses and value of shares (not just options, senior officials will already be vested) come from?
Beyond those losses, the head of investment banking and the head of risk were both fired yesterday.
The real problem is lower down the ranks, where someone on the trading floor can take outsized risk to boost their potential bonus, where worst case scenario they're fired without much ceremony and get another job somewhere else.
It's called the Bob Rubin trade. For years you stack up risk and profit immensely from it ($125 million). When things eventually blow up you simply... step away.
So sure, people were fired, but it's not like they are giving back all the money they made.
She's probably got a fairly sweet deal, and has already earned enough money to not need to worry too much about anything. The real hit is to her reputation, but it will make no material difference to what she can afford to have in life. I've seen plenty of disgraced bankers get hired in even more senior positions a few short months after their fall from power.
"Archegos was a fund run by and managing the personal fortune of Bill Hwang, an investor who had built up large positions in companies worth billions of pounds, despite a previous insider trading conviction."
"Credit Suisse’s investment bank under Chin acted as prime broker to Archegos funds, lending it large sums of money to allow it to build up bigger positions in the shareholdings of quoted companies. Hwang had placed big bets that certain stocks, including Chinese technology company Baidu and US media group ViacomCBS, would see their share prices rise. When the stocks fell, both Hwang and his lending banks suffered heavy losses."
This reads as if Credit Suisse was bankrolling a maverick fund manager's speculative investments.
Strikes me as a rather unhealthy disregard for risk, and completely goes against the spirit of capital preservation.
That's four thousand seven hundred million dollars down the drain - by one of the world's most prestigious banks.
A casual reading of that may make it sound like Credit Suisse made some sort of conscious decision to lend money, but from what I see in the financial industry, lending is handed out like candy on Halloween, almost right down to the bowl left out on the street that says "Take Two" and uses the honor system. It's just "leverage". It came with the account and they used it, and it's likely very minimal oversight was ever exerted beyond basic automated checks asserting that sufficient assets were in place to be margin called if necessary.
I see a lot of people calling this the "everything bubble", but to my mind, history may record this as the "leverage bubble". With such low interest rates and free money being shoveled out of the helicopter as fast as it can with more than a whiff of desperation about the whole exercise, there's leverage everywhere, and leverage stacked on that leverage, and leveraged assets being held up as collateral for levered leverage. It seems, at least for today, that this was not The Great Deleveraging, but at some point in the not-too-distant future one seems inevitable to me.
(Subject to the usual "the market can remain irrational longer than you can remain solvent" timing issues, in that I wouldn't dream of trying to call a date on this, but I can't help but think The Great Deleveraging is inevitably coming, when something somewhere pops like this, and the act of margin calling to make up for it pushes down other assets in value, which causes more margin calling and assets getting automatically sold, which pushes down other assets in value, which causes more margin calling and asset selloffs, and it just doesn't stop until there's hardly a speck of leverage left in the market and valuations are a smoking crater, along with every account that was based on leverage. A basic understanding of differential equations would suggest that it's likely the market will at some point experience a phase transition, where we don't gradually go from this being impossible, to kinda happening more and more as leverage increases, but instead we can go in very short time from this being essentially impossible to completely inevitable, and nobody actually knows when this threshold will be crossed.)
"[T]he practice of 'buying on margin' allowed a person to acquire stock by expending in cash as little as ten percent of the price of a stock. The balance was covered by a loan from a broker, who was advanced the money by his bank, which, in turn, accepted the stock as collateral for the loan. Credit was easy, and the Federal Reserve System did little to restrict the availability of money for stock investment." -- article on the stock market crash of 1929
I don't have a specific one in mind, just the intuition that recursive processes can have a lot sharper of a cutoff than a less differentially-minded intuition might suggest.
You can also look at it probabilistically, rather than differentially. Consider even just "If the probability of a margin call causing a margin call is X, and a margin call occurs, how many margin calls will occur in a chain?" The number sharply goes up as your raise the probability close to one, it doesn't just smoothly increase. It's even worse once you add in to the model that the probability is not independent, but as more occur the probability of the next one also would increase. Especially if you add that non-independence in, what you'll see is a phase change, where you get a surprisingly sharp transition between "a margin call doesn't usually cause another one" to "a never-ending cascade of margin calls occurs", rather than a smooth one.
(I may post a model of this. Someone may beat me to it, too. It's not that hard.)
I'm not saying this is an accurate model of the financial system, just the sort of thing I was going for:
import random
import itertools
def withProb(p):
return random.random() < p
def avg100(f):
return sum(f() for i in range(100))/100
# Independent probabilities; look what happens as you get close to 1.
def marginCallChain(prob):
total = 0.0
while withProb(prob) and total < 100000:
total += 1
return total
# Dependent probabilities:
def marginCallDependent(prob):
total = 0.0
while withProb(prob) and total < 100000:
total += 1
prob = 1 - 1 /((1 / (1 - prob)) * 1.01)
return total
If you play with that with something like "avg100(lambda: marginCallChain(.95))", you can find that the chain starts extending a lot as you get close to 1. It's not a terribly sharp phase change, though.
"avg100(lambda: marginCallDependent(.95))" shows more interesting behavior. That only slightly raises the probability of the next margin call based on the fact that one occurred, and what you can see is that around .93-.95, you start seeing that every once in a while, the probability manages to occasionally work itself up to effectively 1 and the chain hits the upper limit I set. As you raise up towards one, you start to see it more and more often; .96 still sometimes manages to have a run of 100 without a crash, but even .965 the odds that one will occur in that run of 100 start to approach 1. There's a phase change between where 100 runs of the model have almost no probability of having a runaway to where the probability of at least 1 runaway is quite probable, and it's more sudden than a linear understanding of the process would suggest.
Again, this is not a model of the financial system; this is a simple model of the point I was making.
Okay. I see your point. I just tend to think of "phase change" as something different. But if the idea is that margin calls beget more margin calls, I can't disagree.
Layman here. Why was Credit Suisse left holding the bag instead of the losses being distributed between the banks? Was it because they were the broker?
There wasn't a single broker. Each of these banks (8 in total I think?) all let Archgeos separately secure this levered up high-risk position.
The margin call references are quite apt. I believe it was a literal margin call. Goldman and Morgan Stanley forced Archgeos to square up their position, which forced Archgeos to liquidate their stock, which drove down the stock, which left Credit Suisse (who had been hoping for the banks to slowly unwind the position) in a terrible spot.
the money went somewhere. unless you hold CS shares it may well have gone into your retirement fund's allocation indirectly. who knows, but you're probably no worse off.
I don't work in hedge funds and have only a superficial understanding, but it seems the operative word of "hedge" was completely ignore here. He plowed a huge chunk of his positions into two companies and didn't offset with any swaps or other risk absorbers. This seems like downright malpractice and not just a bad luck.
Eh, all is fair in love and war. The bank are charging a risk premium on any transactions with him, it's their fault if they underestimate it. It's a family office, not a hedge fund taking outsider capital, so he's entering into transactions with willing counterparties using his own money.
Archegos was hedged. All of its long positions were matched with short index futures, and the fund was running at or near market neutral.
Hedging doesn't mean zero risk. It just means removing the risk of whatever it is being hedged. In this case it wasn't a general market decline that took out Archegos. It was a decline in the specific basket of stocks they were holding relative to the broader market.
Reg T is very loosely applied, and there are all sorts of work-arounds (TRR swaps, etc) and the regulators just don't seem to care that Reg T is being violated in spirit if not in letter.
I interviewed for am equity swaps trading position many years ago, in full disclosure to me the prospective employer let me know that applying Reg T to derivatives transactions would be very bad for their business.
The "Total Return Swaps" are very interesting instruments. I'm unclear how the banks can justify the paltry premiums compared to massive risks involved, other than the implicit guarantees that a Fed inspired bull market may achieve:
How did Goldman survive unscathed? Their exposure was less than JPMC, but they seem to have liquidated before the impact of the block trades hit the market price. Curious!
This wasn't really a two sided bet, Archegos bought a lot of stock and essentially borrowed a massive amount of money to buy even more stock, then the stock lost value.
If Company X is worth $60B on Monday and $40B on Tuesday then some people who were short could make a lot of money, but in general $20B of value has been destroyed and the world is poorer on Tuesday.
On a serious note, this is funny to read after the initial reports that this had a small and contained impact. Let's hope no further cascading bankruptcies happen.
First, the thing to explain:
Basically CS was one of several Prime Brokers. This basically means the guy who lends money to the speculators. Same as buying a house, you have a down payment that's your money, and then a bank lends you between 115% (boom times) and 30% (safe as houses) of the value of the house. If the house falls in value and you can't pay the mortgage, the bank can sell your house, and hopefully that will mean they recover their entire loan. Note that they only lose once the value has declined by your down payment amount.
I actually knew the boss of a PB who got fired because a rich guy came in and wanted a lot of leverage, the risk managers said no, and he overruled them. And then the customer proceeded to lose hundreds of millions speculating, and it ate the bank's capital. So it's not the first time that risk gets overruled.
So somehow, CS has lost $4.7B on this Archegos financing, after Archegos lost whatver they put up. From what I gather, Archegos had $10B of equity in total? Typically (sensibly) you don't put all your eggs in one basket as a fund, even a quite concentrated fund.
How big was the position?