Over the last 72 hours, I’ve variously suggested that while the Archegos saga wasn’t likely to trigger a systemic meltdown, it was virtually assured to attract the attention of US lawmakers.
On Monday morning, for example, I wrote that,
Depending on the scope of the fallout, opportunistic lawmakers in Washington could attempt to capitalize on the debacle. After all, anything that can be couched in terms of transparency (or a lack thereof) on Wall Street is amenable to political grandstanding, especially when it involves hedge funds. We’ve gone from “Roaring Kitty” to Tiger Cubs gone wild in the space of two months.
Then, in “Sometimes You Blow Up,” I alluded to executives being “hauled in” for an “inquisition.” Finally, on Monday evening, I wrote that with the SEC and FINRA starting to dig into the swaps, it was “just a matter of time before lawmakers start tweeting.”
Fast forward to Tuesday and Elizabeth Warren was on it. “Archegos’s meltdown had all the makings of a dangerous situation — largely unregulated hedge fund, opaque derivatives, trading in private dark pools, high leverage, and a trader who wriggled out of the SEC’s enforcement,” America’s foremost bank crusader said, in an email to the media. “Regulators need to rely on more than luck to fend off risks to the financial system: We need transparency and strong oversight to ensure that the next hedge fund blowup doesn’t take the economy down with it.”
You can bet that’s just the start. JPMorgan on Tuesday estimated bank losses from the boondoggle at between $5 billion and $10 billion. That was two to five times as large as the bank’s previous estimates. “We are still puzzled why Credit Suisse and Nomura have been unable to unwind all their positions at this point,” Kian Abouhossein wrote, cautioning investors to stay apprised of any commentary emanating from credit agencies.
Just hours later, S&P revised its outlook on Credit Suisse. “Potential material loss from a single client exposure raise questions about the quality of the group’s risk management and risk appetite,” S&P said, adding that,
In our view, there is a meaningful risk that clarification of the reasons for a potential material loss related to a single client may reveal deficiencies in Credit Suisse group’s risk management system or a risk appetite that is not commensurate with the current ratings. As a result of its investment banking and asset management activities, Credit Suisse’s risk profile remains complex and entails financial and nonfinancial risks. We already reflect this in our assessment of the group’s risk position as moderate and business position as adequate. The potential US hedge fund loss follows the recent closure of four supply chain funds connected to Greensill, which similarly raised questions about Credit Suisse’s management of exposure concentrations.
None of that is positive. Which is why S&P’s outlook is now Negative (from Stable).
As S&P alluded to in their rationale, things have been rocky for the bank. The Archegos drama is insult to injury, and the market is starting to reflect as much (figure below).
S&P tried to strike a somewhat upbeat tone. “We expect financial damage to Credit Suisse will remain contained,” they said, adding that the bank can probably “absorb the negative financial impact from the possible loss.”
That said, S&P reckons that between “accumulated potential losses” tied to Greensill and the Archegos losses, “a material proportion of the 2021 results” could be “consumed.” S&P does still believe the group can “report robust underlying earnings and remain profitable overall.”
Meanwhile, MUFG described “an event” in its EMEA securities business. The bank is “evaluating the extent of the potential loss,” but currently pegs it at around $300 million. It won’t have “any material impact on business capacity or financial soundness,” the bank said.
For once, Wells Fargo gets to say it came out of a debacle unscathed. “We had a prime brokerage relationship with Archegos,” the bank said in a statement, before proudly declaring that Wells was “well collateralized at all times,” has no remaining exposure and “did not experience losses related to closing out” the exposure.
Golf clap.
As the late, great Edwin Starr said: “Swaps. What are they good for? Absolutely nothing. Say it again, y’all.”
The fundamental problem is that there is no central registry of the leverage being offered to clients. The prime brokers claim that those are “valuable competitive secrets” that cannot be entrusted to the SEC or Fed.
The result? Every firm does its due diligence and credit work on each client without knowing how much the client is borrowing from other street firms. So credit lines get approved on that basis, even though everyone knows full well that the client is getting some amount of credit from other firms. It’s legal and regulatory CYA.
So why do they extend credit? Goldman gave us a hint when they said that they started lending to the “family office” again due to competitive pressure.
Back in the early 80s, I had a B-school class taught by a scion of a legendary family. We were discussing the first Latin American debt crisis. We humble students prepared by reading through national accounts data, all of it scary.
Towards the end of the class, the professor asked us “Well, after reading all of this, would any of you have made those loans?” I was the only one who raised his hand. The prof incredulously asked me why, I told him “Well, if I wasn’t lending to those countries my bosses would call me in and ask me why. I’d try and explain the risk but they would reply that all of our competitors were making the loans and making big money on them. I’d be told to to go back and reconsider my caution or they would hand the book over to someone who would.”
A simple case in career versus risk management.
Of course, if the loans blew up, I’d be the one calling the headhunters, not them!
CDS’s are now a well know investment vehicle thanks to “The Big Short” book and movie. When the entire US economy was blowing up last time, most Americans had no idea what was going on and fell for the “blame it on Fannie” narrative out of the White House. If the market unwinds on the backs of CDS vehicles again, it will be a familiar terminology to everyone with PTSD flashbacks driving urgent calls for change to Washington.