Malt Liquidity 41
Reservoir Drawdowns
On a personal noteā¦
Monitor transport is a serious ordeal! And after a few days on the road, there seems to be plenty to sound off on. Iām glad to be back exactly where I started - in front of a monitor plucking away at a keyboard at 5 in the morning, just in a different time zone.
Mr. Green
There are a lot of moving parts in the Archegos saga, but itās a tale as old as time itself: leverage is a bitch. When funds blow up, itās not really as much about what theyāre trading as it is how much they are messing around with. And I totally get it! If Iāve raised money, how do I justify sitting on the sidelines? Sure, I could trade within my limits, but given that the leverage is so cheap against such massive amounts of assets, it makes sense to use it just a little bit right? After all, performance bonuses are not risk-adjusted, theyāre return-adjusted (i.e. benchmarked). What is amusing about this situation, though, is how quickly it turned into pure ābrokerās dilemmaā, where everyone is pointing fingers at everyone else for setting up the house of cards. The cell reception is too poor atop the ivory tower to be able to use Robinhood, so the āinfinite leverageā a fund gets is through custom lending agreements with prime brokers. A fund wants some leverage, so they go to a bankās prime broker. The bank wants interest, so theyāll hash out a rate for you so you can get your Liberian-GDP sized bonus. However, Bill Hwang seems to have gone around to every bank possible for leverage and was trading leveraged products on top of the raw cash leverage.
Any good aficionado of the mobster genre knows that when someone canāt pay you back, you liquidate their stuff and take what you can, or you break their kneecaps. As a bank, you kneecap someoneās net worth by liquidating their positions and paying yourself what youāre owed. To be clear, fund blowouts happen all the time, but it usually happens in volatility trading, where you inherently have to be leveraged to make any money. However, when so many major parties are known to have massive positions to unwind, a couple things will happen. A core principle of trading is that you never want to trade against the size unless you have serious edge. If someone shows size or someone is known to have an obligation to trade size, the bid/ask will drop off and the price will move against you, because who wants to buy into the first billion of sales when there is 19 more to come? (As we have noted with the BoJ before - the size itself is the market, in a way.) Thus, if you know your own counterparty risk, it is to your own benefit to sell before everyone else does. But if everyone else comes to the same conclusion, you impact the price even more selling as a group. Sound familiar?
Mr. Gold
Before my hiatus I was lamenting the downfall of āvampire squidā Goldman turning into āSquidwardā Goldman:
Goldman just isnāt the same anymore. They went from selling structured products in the guise of āmanaging riskā to Greece, Libya, and Malaysia with the intention of profiting by taking the other side and being labeled a āvampire squid wrapped around the face of humanityā to making retail credit cards and āhigh yieldā savings accounts. The bank which has possibly the most rigorous style guide on the planet and created a font for people to use called āGoldman Sansā that was intended to come with the caveat that āthe terms of the license prohibited the disparagement of Goldman Sachsā is now focused on the shareholder for the first time in its multiple decades of being a public companyā¦
But boy am I delighted to see the amoral, soul-sucking profiteering return:
Goldman Sachs Group Inc. and Morgan Stanley were quick to move large blocks of assets before other large banks that traded with Archegos Capital Management, as the scale of the hedge fundās losses became apparent... The strategy helped limit the U.S. firmsā losses in last weekās epic stock liquidation, they said.
Credit Suisse and Nomura werenāt major sellers Friday, traders said.
To be clear, Goldman did not āfront-runā anything. They still probably lost money on the liquidation alone. But Goldman is also notorious for still maintaining robust trading desks - while the execution traders and the flow traders canāt communicate, any trader worth their salt (as Goldmanās are) would notice the block flow, especially given that Goldmanās execution brokers would, you know, route the orders through their own internal systems, potentially even ātipping offā the flow desks. This isnāt front-running! Showing size is just showing your hand in a public manner. Execution traders do not have the privilege of executing flow in a discretionary fashion, and any smart trader should be able to pick up that something was going on internally. This is just adding insult to injury, though:
Goldman Sachs analyst Shinichiro Nakamura downgraded Nomura to Neutral from Buy with a price target of 630 yen, down from 750 yen. The analyst reduced estimates to reflect Nomura's disclosure that it could book losses in its prime brokerage business.
Mr. Swiss
Itās been a rough couple months for Credit Suisse. First there was the Greensill situation which clearly will be resolved in courts as insurers and banks point their fingers at one another to assign fiscal blame, and now they seem to be the biggest Archegos bagholders:
Bank shareholders are bracing for a multibillion-dollar hit from a fire sale of positions held by hedge fund Archegosā¦
In a profit warning Monday, it said the losses could be āhighly significant and materialā to its first-quarter results.
Berenberg analysts put Credit Suisseās Archegos losses at around $3.2 billion and estimated another $531 million in losses at the bank from the collapse of Greensill, which Credit Suisse lent money to and partnered with for a $10 billion set of investment funds.
First, a bit of practical (not financial) advice: be very, very wary of buying the dip when you have no knowledge of the counterparty risk. The only people that know what CSās exposure is here are the risk āmanagersā at the bank itself and the people they transacted with. āBuying the dipā in CS here is going up against ginormous levels of information asymmetry, and itās plainly obvious that all these āestimated lossesā coming out of CS are underestimates - after all, they donāt want to show you they still have size to sell. The equity fantasy is always grounded in the debt reality, however:
The spread over Treasuries for the Swiss bankās 4.875% dollar bonds due in 2045 widened 8.5 basis points, among Tuesdayās worst performances in the investment-grade market, according to Trace.
Among the largest global investment banks, Credit Suisse is now deemed riskiest in the eyes of derivatives traders. Its five-year credit-default swaps gotĀ up toĀ 74.7 basis points on Tuesday, the highest since July, according to ICE Data Services.
Bank losses are not just monetary losses. These kind of events permanently affect who you can work with, what your deal flow is, and the scrutiny your lending practices will face going forward. Itās a brutal problem to have as itās the institutional version of the mathematical reality that if I lose 50% of my money, I have to return 100% to make it back. As a lender, if I underprice risk and get screwed, I have to start looking for riskier lending to make back what I lost, which leads to incentivizing suspect borrowers by underpricing their true lending risk, leading to more losses. Itās kind of sad, really, as CS was the prisoner who tried to get all the lads to cooperate and failed miserably:
Emissaries from several of the worldās biggest prime brokerages tried to head off the chaos by holding a call with Hwang before the drama spilled into public view Friday morning. The idea, pushed by Credit Suisse, was to reach some sort of temporary standstill to figure out how to untie positions without sparking panic, the people said.
But any agreement was elusive, and by Thursday night, some banks had shot off notices of default to Archegos to seize collateral and potentially shop it to buyers to contain the banksā potential losses, the people said. Yet even then, it wasnāt clear when terms with Archegos would allow sales to proceed, one of the people said.
Soon came the finger-pointing over who was breaking ranks, the people said. Some emerged from the talks suspicious that Credit Suisse wasnāt fully committing to freezing sales. By early Friday, rival banks were taking umbrage after hearing that Goldman planned to sell some positions, ostensibly to assist Archegos. Morgan Stanley began drawing public attention with block trades.
Mr. (In The) Red
One thing you learn traversing through Asian casinos is that āhigh limitā in Vegas is āminimum betā in Singapore. And at the poker table, āgame theory optimalā just means āas much action as possibleā which really brings a tear to my eye as I remember the days where using solvers and memorizing Stockfish opening lines werenāt necessary. Anyhow, hereās a short profile of Bill Hwang, the guy who set this chaos off:
Mr. Hwang managed around $10 billion of family money through Archegos.
Truly, one has to appreciate the commitment to YOLO Bill showed here. Something tells me that all these prime brokers arenāt going to comp the costs of their liquidation, and itās pretty astonishing that someone bet their entire net worth levered both on a cash basis and notionally many times over. After all, leverage is the most addictive drug - how do you go back to playing penny slots after watching Goobr? Derive once, shame on me. Derive twice, shame on you for lending to me based on cash and not the notional of what Iām trading.
In the summer of 2012, Tiger Asia said it planned to wind down and return outside capital to investors. Later that year, the firm pleaded guilty to a criminal fraud charge and agreed to pay $44 million to settle civil allegations by U.S. securities regulators that it engaged in insider trading of Chinese bank stocks.
The common rationale on insider trading (and the truth of the matter!) is that you shouldnāt do it, itās bad, and definitely by and large illegal. My own suspicion is that a lot of funds back in the day ātimed the marketā through what was essentially a surreptitious wink wink nudge āit would be a good idea to not have a position in our stockā type of informational asymmetry. But, to be fair, hedge funds are in the game of information asymmetry! They spend gobsmacking amounts of money on stuff like tracking corporate jets to try and predict mergers. This doesnāt even work that well and costs $100,000+ a year (which is worth noting in trading as well - the reason people sell block trade alerts is because, by and large, they are almost entirely noise when used in a forward looking fashion, but can always be pointed to after the fact to āexplainā trades and why you obviously should have followed those blocks.) But there is a clear difference between civil charges and criminal charges (trading aside - just in the reasonable doubt standard alone), and Bill Hwang is no Stevie Cohen. Dodging insider trading charges is a tough game, donāt you think? I find the whole āfamily officeā thing hilarious, as itās the finance version of being put on time-out to go play with your billions of dollars.
Mr. Hwang is Christian and has spoken about his faith publicly. In an interview posted on YouTube in 2018, he said one of his goals was ātrying to be a great investor.ā He also said he was investing in companies that were benefiting society.
To be honest, Iām pretty curious how a āGod intended for me to know this information ahead of everyone elseā would work as a legal defense. The whole force majeure of divine intervention in trading positions, ya know?
On that noteā¦