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.
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?