Sometimes, You Blow Up

There’s more to worry about than the (latest) trials and tribulations of Tiger Cub Bill Hwang, although you wouldn’t know it to read the headlines plastered across financial media outlets this week.

As one reader pointed out, Hwang actually doesn’t come across as having been all that reckless on the leverage front, or at least not if estimates of Archegos’s capital are accurate and you define “reckless” in the context of infamous cases of leverage gone awry.

“Archegos looks positively conservative next to, say, Long Term Capital Management,” Reuters wrote Monday, on the way to reminding anyone younger than 30 that in the lead-up to the financial crisis, investment banks “routinely” carried leverage that makes Hwang’s positions seem pedestrian — at least on that score. Issues around concentration and transparency are another story, though.

Read more: Tetris

One problem with this discussion is that it’s difficult to know how to frame the issue, because when it comes to these sorts of debacles, reader perception is highly subjective. Depending on what kind of market participant you happen to be, events like this can be funny, distressing and everything in-between.

For veterans who’ve “seen it all” (so to speak), this kind of thing generally falls into the “stuff happens” category (and I’m omitting the expletive), or at least until the “contagion” headlines aren’t just headlines anymore and the dominoes start to tip.

While the GameStop saga served as a stark reminder that nobody has ever truly “seen it all,” margin calls and flameouts are things that happen. Colloquially, it’s risky to run around gambling billions using leverage, even if the leverage you employ falls well short of that associated with history’s most spectacular implosions.

Over the last 72 hours, myriad outlets and web portals have engaged in the usual hair-on-fire media race to pen the definitive take, but as ever, that’s impossible because the story isn’t over yet. Even if you fancy yourself the fastest, smartest “gun in the West,” you can’t tell the whole story because it’s still unfolding.

In all likelihood, this will end up being amenable to the following short summary: Sometimes, you blow up. It’s just a matter of whether you take a few people with you or not. Usually, it’s not systemic.

If all blow-ups were systemic (and you’d think they were based on media coverage), the history of markets would just be a frenzied tale of spectacular, rolling booms and busts.

Oh, wait. That’s actually a pretty accurate description of market history. Maybe it is all systemic!

Anyway, as FT‘s Robin Wigglesworth (who doesn’t like me, by the way) wrote Monday, “early signs are that [the Archegos Capital blow-up] will probably prove the biggest since Long-Term Capital Management’s collapse.”

If that turns out to be even a semblance of true, you can expect politicians to get involved. I touched on the transparency issues in “Tetris” (linked above) and also on Sunday evening (here). Wigglesworth went on to note that even though Archegos’s status as a family office made it exempt from “a lot of the standard regulatory disclosures demanded of hedge funds… banks’ prime brokerage desks appear to have failed basic ‘know your customer’ processes.”

That’s true in a general sense. And it’s certainly a line of criticism lawmakers would pursue in the event any executives are hauled in for another inquiry (read: inquisition). But it’s not true in a literal sense. Obviously, Wall Street knew full well who their customer was. “For years, as they watched Archegos send business elsewhere, senior staff in Goldman’s equities division tried to cultivate Hwang as a client,” Bloomberg wrote Sunday. “Yet every attempt to open an account for him was blocked by [the] compliance department [due to] Hwang’s checkered past.”

As Reuters put it, “Hwang was a walking risk factor.” I was more generous in my choice of words, calling this the latest chapter in a story that hasn’t always been entirely wholesome. (“Who among us,” right?)

In his (somewhat hyperbolic, but reasonably well-written) piece, Wigglesworth went on to say that the answer to questions about whether Archegos poses a systemic risk is “probably no.”

Still, for everyday people and especially for any unfortunate, unsuspecting souls holding shares in the affected companies, this was probably a psychologically damaging experience. Something like this: “How could it be that someone I’ve never heard of is allowed to effectively be a top owner of the companies whose shares I own without disclosing his stake?” And: “How could it be that this ‘walking risk factor’ got his foot back in the door at systemically important banks?” And: “How can it be that those banks are allowed to knock down my stocks with massive, opaque block trades?”

The unvarnished truth is simply that this is a casino. And if you’re participating, you’re a gambler. You can mitigate that by adopting a scrupulously conservative approach, but that doesn’t make you immune to the vagaries of involving yourself in what, at the end of the day, is just a massive, interconnected, international market for speculation.

The line between equities as “ownership stakes in a company” and poker chips has always been blurry. Even if you prefer the former characterization, someone else prefers the latter. And they’ll act accordingly, sometimes to your detriment.

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9 thoughts on “Sometimes, You Blow Up

  1. Love the humor on this piece, especially welcomed on a Monday. I have as of now little concern that this blow out episode will turn into a systemic shock, but I am nonetheless curious (and cautious) to see the impact the dealer selling will have in an illiquid market while both he Russell and NDX sit in negative gamma vs the spot, might be enough to trigger a mini panic going into quarter end with many afraid of rebalancing flows. I suspect this is just another Manic Monday in Wall Street and although I’m prone to go fishing for opportunities during market scares I will sit this one out.

  2. Thanks H, a good piece, a good case study and reminder that equities are both investments and poker chips, independent of your particular reasons for buying in. It’s a good idea for the investors to remember that, especially for those of us small enough to be reliant on the market to help us make it through our later years. The gamblers already get that, and probably count on us investors contributing tailwinds to drive the equities higher for them.

  3. Your last two paragraphs are a great summary of the current landscape.
    I do not like being in a situation akin to walking across a mine field- but against the backdrop of the Fed’s printing presses, I do not see this changing.

  4. An individual investor should avoid high leverage, and watch position sizes in a portfolio if they are individual stocks particularly. The biggest risk so far to this blow up is sentiment and financial conditions. It looks like some investment banks get caught out, but not all of them. My biggest concern is whether this is a canary in the coal mine regarding leverage or is just a one off.

  5. “How could it be that someone I’ve never heard of is allowed to effectively be a top owner of the companies whose shares I own without disclosing his stake?” That right there is the real issue casino or not! How can one do proper DD on a company? The ability to synthetically hold a top ownership spot without reporting it needs to end!

  6. There is no evidence that any particular set of strategies works all the time. People like Bruce Kovner are highly respected because they want to know. How will I know i am wrong? When will I know I’m wrong? What is the right position size? What time horizons historically work best for me? How do I stay sufficiently informed? Do I religiously follow a daily checklist? If I have clients, do I match my postions to what I said I would do? If my thinking has changed do I let my clients know?

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