I assume that by now you’ve read one of the WSJ or Bloomberg articles on Bill Hwang and the collapse of Archegos Capital, a hedge fund with an estimated $10-15 billion in AUM 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 why I used the quote marks in a second. There are so many touchpoints between these events and what we’ve been focused on here at Epsilon Theory that I hardly know where to start, but let’s see where this goes …
Like many other hedge fund luminaries (Chase Coleman, Lee Ainslie, Steve Mandel, Andreas Halvorsen, John Griffin, etc. etc.), Hwang is a Tiger Cub, meaning that 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 and Quantum, 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.
Julian famously broke up the band as the Nasdaq bubble burst in early 2000, and the Cubs went their separate ways, seeded by Julian and his LPs. Hwang set up Tiger Asia, where he had great returns by following the playbook that had worked so well for him in the mothership, and Hwang 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 with the establishment of a Big Data program to review suspicious hedge fund trades (yes, there are Epsilon Theory notes on Reg-FD enforcement and its impact on alpha generation: here and here), 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. And like Stevie did with his “family office” (Point 72), within a few years Hwang started taking outside investors and was back in full swing as a hedge fund master of the universe.
Did Hwang learn his lesson and change his tiger stripes? Again … LOL. What Hwang learned was how to avoid getting caught. With the establishment of Archegos Capital, Hwang stopped shorting stocks or taking long positions 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 felons like Bill Hwang. A tiger cub? I prefer the Epsilon Theory lingo. The guy’s a raccoon, pure and simple, and once a raccoon, always a raccoon. They can’t change their stripes, either.
So here’s how it worked. An investment portfolio based on total return swaps had one wonderful quality for the prime brokerage operations of the banks involved here, and two wonderful qualities for a raccoon like Hwang.
For the prime brokers, that wonderful quality was fee and spread income. Under almost any conceivable conditions (hold that thought!), market risk on the swap could be hedged more cheaply than the trading fees, structuring fees and net interest margin that they charged Archegos, yielding a “risk-less” income stream of millions of dollars per year.
For Hwang, the two wonderful qualities were:
- massive embedded leverage, as 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, and
- zero reporting requirements with regulatory authorities, as the only thing that Archegos “owns” are these private derivative contracts with TBTF banks, leaving Hwang free to run the old Tiger Asia playbook without having that pesky SEC tracking his trades.
Again … LOL.
So how did this fraud 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 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 degen-style, this isn’t a portfolio that has obviously crapped out. This is a portfolio that needs the sails trimmed, not blown out. No, I think something else triggered the decision by Goldman Sachs et al to exercise whatever liquidation provisions they had in their ISDA (the contract governing their swaps, derivatives and prime brokering) with Archegos. 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 GS (let’s call it The Producers con), or
- 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.
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 GS and MS 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 Producers 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. 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 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.
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.
Three weeks ago, I wrote this to ET Pro subscribers:
I think that the collapse over the past week of Greensill Capital has a lot of systemic risk embedded within it, particularly as the fraudulent deals between Greensill and its major sponsors – Softbank and Credit Suisse – come to light. And that’s not even considering Greensill’s second tier of sponsors – entities like General Atlantic and the UK government – all of whom are up to their eyeballs in really dicey arrangements.
Is this a Madoff Moment for the unicorn market? Honestly, if you had asked me a few weeks ago, I would have told you that a Madoff Moment was impossible in our narrative-consumed, speak-no-evil market world of 2021. Now I’m not sure.
Two weeks ago, I wrote this to ET Pro subscribers:
No, the thing that has my spidey-sense tingling is that I think there are lots of other Greensill specialty lenders out there, lots of other Tokio Marine insurance wrappers out there, lots of other Softbank shadow banking facilities out there, lots of other Credit Suisse absolute return funds out there, all geared and levered to global trade and supply chains at precisely the moment when globalization is reversing after three decades-plus of a one-way trade.
Last week, I wrote this to ET Pro subscribers:
Specifically, I think THIS can work: a long/short go-anywhere investment program based on the Narrative Machine IP and a macroeconomic thesis of deglobalization and multipolar geopolitical conflict, supply chain and trade finance stress, and push-inflation pressures within a highly levered global economic system.
There is a tide that is flowing out today, and it’s revealing Lex Greensill and Bill Hwang 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 if Credit Suisse is taken out in the street and shot in the head like Bear Stearns.
The big trade is figuring out how deeply the Japanese financial system has been corrupted (Softbank, Tokio Marine, Nomura).
The big trade is figuring out what happens when the squeezes and corners from insane hedge fund and shadow banking leverage come undone.
Sounds like fun!