A Tiger Can’t Change Its Stripes

Oh, wait. That’s not a tiger. That’s a raccoon.

In Epsilon Theory-speak, a raccoon is a financial scammer, a fraud.

Raccoons are everywhere in the investment world. I hate raccoons.

Over the past few days you’ve probably seen an article or two about Bill Hwang and the collapse of Archegos Capital, Hwang’s hedge fund with an estimated $10-15 billion in assets that was levered up more than 5x across multiple prime brokers, and came tumbling down in a “margin call” last Friday. And yes, I’ll explain in a minute why I put that in air quotes.

Almost certainly, the article you saw about Bill Hwang described him as a Tiger Cub and not a raccoon, which is too bad. I’m trying to change that animal association with this note.

Hwang is called a Tiger Cub because, like many other hedge fund luminaries (Chase Coleman, Lee Ainslie, Steve Mandel, Andreas Halvorsen, John Griffin, etc. etc.), he used to work for Julian Robertson’s OG hedge fund, Tiger Management. As the story goes, Hwang was an equity sales guy for Hyundai Securities, where he won an annual cash prize “for charity” that Robertson used to give to the “person outside the firm who contributed the most to the firm’s success”, which led to a job … LOL. This, of course, was in the heady pre-Reg FD days for golden age hedge funds like Tiger and SAC (Stevie Cohen) and Quantum (George Soros), when the line between legal and illegal inside information was, shall we say, a bit more blurry than it is today, and guys like Hwang thrived.

What is Reg FD? Specifically, it’s the 2000-vintage SEC regulation that requires publicly traded companies to eliminate selective disclosure of any information that could be deemed to be material and non-public. More broadly, Reg FD is my shorthand for the enormous efforts that the SEC and the DOJ have undertaken to make guys like Bill Hwang obsolete, even at the very real and very damaging cost of placing all private information in markets and all discretionary alpha generation under regulatory suspicion.

There are some dandy Epsilon Theory notes on Reg FD enforcement and its impact on alpha generation, notably here and here. From one of those notes, Pricing Power (pt. 3) – Government Collaboration:

In 2009 the SEC established an Office of Quantitative Research and an Office of Risk Assessment and Interactive Data, and – for operational surveillance – an Office of Analytics and Research within its Trading and Markets Division. In July 2013, the SEC announced the creation of a Center for Risk and Quantitative Analysis, to “provide guidance to the Enforcement Division’s leadership.” Taken together, these offices form the equivalent of the SEC’s version of the CIA. These offices are extremely well funded, draw some really top-notch people from the private sector, and coordinate closely with the FBI. Today’s SEC may not quite be the functional equivalent of the NSA from a data gathering and pattern inference perspective, but it’s nothing to sneeze at, either. And on the traditional surveillance side, the DOJ has been given amazing latitude by the courts of late to pursue widespread wire taps and related private communication intercepts across a wide swath of the financial services industry.

I can’t emphasize strongly enough the importance of these surveillance institutions as a tool in the political effort to transform capital markets into a political utility.

How? By taking sleepy regulatory edicts that were on the books but extremely hard to prosecute – such as the 2003 Global Research Analyst Settlement or, more importantly, Reg FD, originally adopted way back in August, 2000 – and using Big Data and Big Compute to turn them into powerful weapons.

Prior to 2009 it was very difficult for the SEC or FBI to identify any but the most egregious infractions of Reg FD, such as an email leaked by a disgruntled employee or a massive dumping or purchase of a stock. Since 2009, however, the SEC can sift through all of the trading in a company’s stock, look for what they consider to be suspicious patterns – which is by definition idiosyncratic outperformance, i.e., alpha generation – and then work backwards to create a link with, say, a 1-on-1 meeting at a sell-side conference between the company’s CFO and an analyst from the trading firm.

Basically, everything that gave Bill Hwang his “edge” – all of his contacts with corporate management who were willing to whisper in his ear, all of his go-to strategies of piling-in and piling-on with other hedgies – all of that has been in the SEC and DOJ crosshairs since 2009.

Julian Robertson famously broke up the Tiger Management band as the Nasdaq bubble burst in early 2000, and the so-called Tiger Cubs went their separate ways, seeded by Julian and his investors. Hwang set up Tiger Asia, where he had great returns for many years by following the playbook that had worked so well for him in the mothership, and he became a billionaire in his own right. That playbook, however, which was probably a hot steaming mess of collusion and insider trading even before Reg-FD, was certainly a hot steaming mess after Reg-FD, and once the SEC really started to enforce all this in 2009, it was only a matter of time before the feds nailed Hwang to the wall.

That happened in 2012, when the SEC brought criminal charges for insider trading against Tiger Asia and Hwang personally, charges that Hwang et al pleaded guilty to and paid a $60 million fine to resolve. Hwang was sentenced to one year probation. Again … LOL.

Tiger Asia had to be wound down, and like Stevie Cohen did with his similarly implicated (but never criminally convicted) SAC Capital, Hwang turned his hedge fund into a “family office” – Archegos Capital. But within a few years Hwang started taking outside investors and was back in full swing as a hedge fund master of the universe. Just like Stevie did with his “family office”, Point 72. Again … LOL.

Did Hwang learn his lesson and change his raccoon … err, tiger stripes? Okay, this time I’m actually going to laugh out loud. Bwahahahaha!

What Hwang learned was how to avoid getting caught.

With the establishment of Archegos Capital, Hwang stopped owning or shorting stocks directly. Instead, he took his positions in the form of total return swaps and similar instruments with Wall Street banks. A total return swap is a contract with a broker/dealer counterparty where you agree to be on the opposite sides of the economic outcomes of a referenced security (or any referenced data flow that can be mapped against a time series of prices, really). In other words, you don’t buy shares of stock in a company directly. You buy a contract with, say, Goldman Sachs that they will owe you money if the stock goes up (or if the company pays out a dividend or makes some other cash distribution, hence the “total return” moniker here) and you will owe them money if the stock goes down. Or vice versa if you’re short. A total return swap is a pure derivative, a distilled bet on something else going up or down in price, a zero sum game played between Big Boys who know the risks and take them with eyes wide open.

In the days and weeks to come, you’ll hear the usual suspects say that swaps and derivatives are the “problem” here. Pfft. The problem is doing business with convicted criminals like Bill Hwang.

Want my keenest Wall Street observation? Once a raccoon, always a raccoon.

Want my best financial services career advice? Never do business with a raccoon. Never.

Tigers can’t change their stripes. Neither can raccoons.

At some point in your career, maybe more than one point, you’ll be sorely tempted to invest with or partner with a raccoon. Why? Because the money will be really, really good. Because the raccoon will convincingly explain to you that Others took advantage of his “passion” for the deal or the business opportunity in the past, that he’s really a misunderstood bull or bear or tiger, not a thieving raccoon. This will be a lie. It will end up costing you money, and maybe a lot more than that, if you give in to the temptation. Just like it did for the banks that decided to work with Bill Hwang after his 2012 conviction.

It seemed like such a no-brainer. Under almost any conceivable conditions (almost!), market risk on the total return swaps that Hwang was proposing could be hedged more cheaply than the trading fees, structuring fees and net interest margin that these banks charged Archegos, yielding a “risk-free” income stream of millions of dollars per year. Besides, Bill Hwang is such a charming man. Such a family man. Such a godly man. This is a man we can trust!

So here’s how the Archegos scam worked. An investment portfolio based on total return swaps and spread across a lot of prime brokers had two wonderful qualities for a raccoon like Hwang:

  • Massive embedded leverage. These swaps are bought on margin, not cash, meaning that Hwang could receive the full economic outcome of a dollar’s worth of stock for posting, say, 15 cents in cash as collateral.
  • Zero reporting requirements with regulatory authorities. The only thing that Archegos “owned” are these private derivative contracts with TBTF banks, leaving Hwang free to run the old Tiger Asia playbook of collusion and insider trading without having that pesky SEC tracking his trades.

Laissez les bon temps rouler!

So how did this scam fall apart?

Well, here’s what did NOT go wrong for Hwang. I don’t think Hwang blew up because positions like Viacom and Discovery went horribly south on him. I don’t think he blew up because he got a margin call, as you and I understand the term. Look at all of the positions that are getting liquidated … this portfolio wasn’t down before it got sold out beneath him. To be sure, the last month or two hasn’t been great for the what-me-worry, infinite-duration stocks that Archegos loved to press. But even if he was doubling down on losses in true degenerate gambler style, this isn’t a portfolio that has broken down to a degree that would clearly put your prime brokers into all-out panic mode.

This is a portfolio that needed the sails trimmed, not blown out.

So why did the banks blow it out? I think something else triggered the decision by Goldman Sachs and Morgan Stanley to exercise whatever liquidation provisions they had in their custody and counterparty/credit agreements with Archegos. I think this was a “margin call”, not a margin call.

What can trigger a “margin call”, by which I mean a forced liquidation of positions held at your prime broker even if you’re not in violation of net capital requirements? I can think of two possibilities:

  • Goldman Sachs got wind of Archegos borrowing with other prime brokers by pledging the same collateral they pledged to Goldman (let’s call it the Max Bialystock con after the raccoon impresario of The Producers).
  • The general counsel’s office at Goldman and Morgan Stanley both got a letter from the Justice Dept. with some … ummm … pointed questions about the trades they were executing on behalf of or in connection with Archegos, an unregistered investment fund with some … ummm … questionable investors.

If I were a betting man (and I am), I’d be prepared to wager a not insubstantial amount of money that both of these for-cause reasons to tear up the ISDA and liquidate the Archegos positions came into play, with the DOJ letter being the spur to the general counsels at Goldman Sachs and Morgan Stanley et al having a phone call and enjoying a “wait, you have how much exposure to Bill?” moment.

See, that’s the thing with running the Bialystock Con … you can never let your investors (or lenders) compare notes.

A few minutes later, the head trader at Archegos gets a phone call from Goldman.

“It seems that you are in violation of section (18b), subsection (iv) of your ISDA, so we’re going to need $15 billion in cash in the next thirty seconds, otherwise we will begin liquidating your positions with massive, multi-billion dollar block trades. Yes, we’re going to do this just as sloppily as we can. Also, as per section (27), subsection (i) it is our responsibility to notify you that we have received inquiries from statutory regulatory authorities of appropriate jurisdiction in regards to your trading accounts. Have a nice day!”

While he’s listening to this, the head trader’s assistant informs him that Morgan Stanley is on hold.

I have no idea if this is how any of the events on Thursday and Friday actually went down. Almost certainly it’s not. But that’s how I’d write the screenplay.

Who gets left holding the bag here? Well, it sure ain’t Goldman Sachs and whatever other prime brokers did the liquidation on Friday. They got their cash by getting out first. Same as it ever was. The bag-holders are the prime brokers who saw their screens and telephones blowing up unexpectedly on Friday afternoon NYC-time, banks like Nomura and Credit Suisse. Man, I bet that was a miserable weekend in Geneva and Tokyo. Same as it ever was.

But that’s just the first wave of bag-holders, the forced sellers whose losses on these positions are big enough to be a problem for markets in and of themselves. The second wave of bag-holders … well, that’s us.

What do you get when you give a raccoon like Bill Hwang tens of billions of dollars AND invisibility from regulators so that he can run his collusion and insider trading schemes to his heart’s content? You get a rolling series of squeezes and corners. You get a market that is completely disconnected from reality. You get ridiculous Chinese companies pumped and dumped through US listings. You get a Tesla that’s valued at a trillion dollars. You get Gamestop.

Hunger Games

You have been told that the odds are ever in your favor. You have been told this for your entire life.

More and more, you suspect this is a lie.

I’m not saying that Hwang is responsible for all of this. I think he’s responsible for some of this. 

And I think there are a lot more Bill Hwangs out there.

The Best Way to Rob a Bank

The collapse of Greensill Capital is the first Big Fraud I’ve seen in 13 years with the sheer heft and star power to ripple through markets in a systemic way. Not since Madoff.

There is a tide that is flowing out today, and it’s revealing Lex Greensill and Bill Hwang in 2021 just as surely as it revealed Jeff Skilling in 2001 and Bernie Madoff in 2008. The big trade around Skilling and Madoff wasn’t directly on their specific scams and frauds, but on what their specific scams and frauds showed us about systemic rot in the financial system. It’s exactly the same with Greensill and Hwang today. The big trade isn’t on some company that Greensill was propping up through “supply-chain lending” or on some company that Hwang was short-squeezing or pumping. The big trade isn’t even on some common denominator sponsor for both Greensill and Hwang like Credit Suisse (although … wow). No, those are one-off, idiosyncratic trades. Interesting prop trades, sure, but limited.

The big trade is figuring out what happens when the squeezes and corners from insane hedge fund and shadow banking leverage come undone.

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  1. This is a good note, and a lot to unpack here. The one standout issue though is that it seems to put ET back decidedly in the deflationary camp. That doesn’t help our own internal Widening Gyre of polarization between investors in the inflation or deflation camps. We’re forced to build schizophrenic portfolios where there can be only one right answer to the inflation/deflation question, and it absolutely is an all or nothing bet.

  2. Pretty much every problem in the US financial system boils down to leverage. A 10-year plan to reduce financial system leverage to near zero would be useful. Fairly easy to implement but probably impossible to pass until after the next collapse.

  3. Avatar for bhunt bhunt says:

    Agree 1,000%.

  4. Ben makes the point that we need to have Clear Eyes that the behavior that has been enabled by the leverage, and passed off as normal market action by Wall Street missionaries, is rarely noted. It is the inevitable unwinds that get the attention when they are two sides of the same coin.

  5. Not sure if that’s the case. You could have substantial blowups of Raccoon financiers AND still have runaway inflation. Not mutually exclusive.

    But I also think Ben would say that ET is not ‘predicting’ inflation. I.e. their not giving an answer to the problem. They’re simply pointing out that there is an inflation narrative and that runaway inflation would also break a great many things in our world and folks are not prepared for it. This fits squarely in the min-max framework on how one should think about inflation risk.

  6. Would that include eliminating fractional reserve banking?

  7. In retrospect, it was a bad idea for Credit Suisse to hire the Maytag Repair Man to run the company’s internal risk controls.

  8. On another unrelated note, Credit Suisse–the guys who have to unload a metric ton of Viacom–just raised their rating on Viacom today. I’m sure that was a coincidence.

  9. Love those Chinese Walls! Can you say that anymore?

    Torturing another reference from my generation, it is more likely Crazy Eddie, infamous for bankrupting the consumer electronics chain while loved by Wall Street, is in charge of risk at CS!

  10. Excellent piece Ben. Clearly Huang is a shady character and has crossed some boundaries over his career but I do however feel that Julian Robertson ran a reputable shop. I dealt with them in the 90s and found them to have the highest integrity of all the big funds at the time. Perhaps some of his Cubs have strayed but the reason their performance and popularity is so high is that they have been able to generate massive alpha in the post Reg FD environment.

    The real story here is that the AW Jones Model that Robertson executed has been given massive leverage by PBs. Gross leverage in these funds at 300% is not uncommon and there is a massive crowding in the names they own. The vulnerability of any strategy is popularity and to generate the same returns funds are having to add more and more leverage. This never ends well

  11. That’s a good point. I guess I was focusing more on the implications of this behavior at scale and what that total lack of price discovery means. Artificially tremendously inflated assets (short term), but huge deflationary bust (eventually).

  12. Oh that’s fantastic.

  13. Avatar for bhunt bhunt says:

    No, it would mean moving to a non-ZIRP price of money.

  14. Avatar for bhunt bhunt says:

    That’s hilarious! I mean … it’s not funny at all. But hilarious all the same.

  15. Avatar for bhunt bhunt says:

    I agree both re: Julian and re: leverage being the culprit here.

  16. Be careful what you ask for. How much real estate is leveraged with your normal Joe/Jane at 10% of “value”.

  17. Of all the antidotes to excessive leverage, one option that never gets mentioned even in a hypothetical sense, is the eliminating (or reducing) the favorable tax treatment of interest payment.

    Tax treatment of interest is the water in which the modern financial system swims and changing that will “break” millions of Excel models and finance textbooks but may be worth considering to make debt inherently more costly in relation to equity.

    At least in theory, that would raise the hurdle rate for borrowing and dampen such instincts as borrowing to buy back shares. CEOs can hide share counts but not the tax bill that comes with repurchases.

  18. I was in PB for a short time, and I was always struck by the paradoxical idea that one of the preferred tool for risk management of complex OTC derivatives was MORE complex OTC derivatives.

  19. There is no basis risk in a hedge, just ask Long Term Capital Management. All that short convexity never comes home to roost, except when everyone is crowded into the same sets of trades and the exit gets too crowded to let everyone out.

  20. People who think that a billion dollars is a lot of money scare me.
    “A billion here, a billion there, and pretty soon you’re talking real money.”
    – Senator Dirksen (attributed)

  21. I wonder how much leverage would be in the system if real rates were positive 2% rather than negative 2%. When your cost of carry is negative, what can go wrong? Ha. You have to think that much of this lies at the feet of Fed Monetary Policy…

  22. How about this for a prediction? Family offices will be under enormous regulatory pressure going forward. They’ll be treated no different than hedge funds - with all of the required paperwork. The costs of running a family office just went up…by a lot…

  23. All of it. Trying to keep those plates spinning years into a situation the Central
    banks created by stepping into the void too many times.

  24. Avatar for Vahe Vahe says:

    Your OG gangster hypothetical “margin call” is right out of the Notorious B.I.G. - Ten Goldman Sachs Ten Commandments:

    Rule Number Uno, never let no one owe more dough than they hold cause you know the lack of cheddar breeds problems with liquidity ‘specially If that man is a raccoon.

    Number 2 - that goddamn credit? Dead it. If we don’t get our money in 30 seconds, forget it.

  25. Avatar for robh robh says:

    Call me a cynic, but I’d wager that the GS and MS prop desks had a very good Friday.

  26. absolutely true, but the division was run by salespeople who are not going to say no if the metrics (VAR anyone?) looked right and there was new revenue involved

  27. Avatar for bhunt bhunt says:

    Haha! So right.

  28. Oh my. This note would have been better for Halloween than around April Fool’s Day. That said appreciate what you are doing…

  29. Question to the pack: where would you go to learn about these OTC “strategies” or better said trades in a L/S setting? I’m mostly trying to understand the flavours du jour and how they affect the market structure (water we swim in)… Starting from nothing, so even the basic stuff likely will be somewhat informative.

  30. Avatar for bhunt bhunt says:

    Great question, Elina. I’m going to put this in a separate thread and pose it to the Forum directly!

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