April 9, 2021
If mistakes make you smarter, then Bill Hwang must be a genius.
Hwang lost around $20 billion in the recent implosion of Archegos Capital Management, his family office investment vehicle.
If there’s any justice in the world, Hwang will be barred from the finance industry for his investment sins… so maybe he won’t have the opportunity to apply the high-priced lessons of the fiasco.
I – and you, unless you happen to be one of the 85 wealthiest people on earth (No. 86 on the Forbes list is worth just $19.9 billion) – don’t have 20 yards to blow on financial speculation that makes trapeze training without a net seem safe by comparison.
We can, though, learn from Hwang’s errors… for free.
First, though… let’s rewind to review the spectacular collapse of a shadowy investment vehicle that, until a few weeks ago, was as anonymous as a baguette at a bakery shop.
Back in 2012, in his hedge fund Bill Hwang sold short (that is, borrowed shares in anticipation of buying them back lower for a profit) the shares of three Chinese banks based on inside information. He also tried to manipulate the share prices of these stocks by – according to the SEC – “placing losing trades in an attempt to lower the price of the stocks,” which would benefit his short positions.
Hwang was caught, pleaded guilty, and paid a $44 million fine. If you’re a teacher and you hit a child, or you’re a chauffer and you drive drunk, your career is over. Hwang did the investment equivalent… but was back at it just a year later.
That’s when he launched Archegos Capital Management, a family office – which is kind of like a friends-and-family hedge fund – with around $200 million. Even though that’s donuts-and-coffee money in the hedge-fund world – and despite his pedigree as a financial criminal – within a few years, Hwang was a prime broker client in a handful of the world’s biggest banks.
A prime broker is kind of like a Four Seasons concierge for the money wants and needs of hedge funds and family offices. Instead of courtside tickets to a Nets game or a table at a Michelin three-star restaurant, prime broker clients get access to an array of financial tools and tailor-made investment products… and lots of cash to borrow.
One of Hwang’s favorite tools was the total return swap, a customized derivative whereby the speculator receives – for a handsome fee – returns that are tied to a specific asset… without actually owning the asset. (In some markets, these kind of vehicles are called “contract for difference.”)
In a swap, the investor doesn’t actually own any underlying asset, which can be a stock (as in Hwang’s case), currency, commodity, or anything else with a market price. Since the investor owns a contract, rather than the asset itself, there’s nothing to report to regulators (or other banks) about position size or risk exposures.
Swaps allow for privacy – as well as massive leverage. Hwang was able to get leverage of as much as 20-to-1 with some swaps, according to the Financial Times. That means he could put down $5 to buy a $100 stock. If the stock fell to $95, Hwang’s prime broker would require more collateral. If he couldn’t deliver more cash, the lender would sell off part of the underlying stock in what’s called a margin call.
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This kind of speculation is like juggling nitroglycerin while pogo-sticking through a minefield… and Hwang was doing this with several prime brokers.
For a while, everything was good, as Hwang’s heavily leveraged shares rose. Some of his biggest bets included ViacomCBS (VIAC) – a collection of TV networks fighting a losing battle against cable cutters – rose 700% from March 2020 lows. Discovery (DISCA), home to an even more dull collection of dated TV assets, rose 300%. Shares of Baidu (BIDU), China’s version of Google, jumped just over 300%. Hwang quietly became one of the wealthiest men on Earth – on paper, at least.
Most people would have taken some cash off the table. Instead, Hwang doubled down… with additional leverage. Rather than reduce his risk, Hwang poured on the jet fuel. As Bloomberg explained…
The incredible thing about Bill Hwang is that he made enormous levered bets on risky stocks, and those bets worked out perfectly and made him immensely wealthy in the course of a year or two, and he seems to have plowed every cent of it back into increasing those levered bets.
Perhaps Hwang was a savvy (lucky?) stock picker – but like the restaurant owner who gives himself anonymous positive reviews on Yelp, he wasn’t playing fair. Using the massive leverage extended by his prime brokers, Hwang likely played a big role in driving up the share prices of his (indirect) holdings himself.
For example, ViacomCBS was around an $8 billion stock when Archegos started buying, with daily trading volume of around 30 million shares. For someone with Hwang’s buying power and determination, ramping up the share price would be as difficult as buying all the milk at the local Kroger.
It’s nice work if you can get it – buy a stock on leverage, push up the share price by buying a whole truckload of shares, leverage some more and buy more shares… rinse and repeat. Along the way, benchmark-tracking investors (such as S&P 500 Index ETFs and other funds) would also need to buy the stock, as it rose faster than the index as a whole.
But as Hwang surely knew, it wouldn’t take much to end it all. ViacomCBS, one of Hwang’s holdings, unwittingly struck the match to his house of straw on March 22, when it announced it was going to issue $3 billion in new shares. The company wanted to take advantage of its strong share price performance to fund its recently launched Paramount+ subscription streaming platform, and other efforts.
Big capital raises can often pressure a company’s share price – since there are suddenly a lot more shares to be absorbed by the market. Current shareholders are often expected to participate, in part so that their holding isn’t diluted.
As a major shareholder (via his prime brokers) of ViacomCBS, Archegos – according to Bloomberg – was expected to buy around $300 million in the offering. But Hwang didn’t take part in the offering – likely because he didn’t have the cash, since Archegos was so levered.
The share price of ViacomCBS fell by a quarter within two days after the smaller-than-anticipated offering. Some investors who received a bigger allocation than they’d thought they’d get sold some shares, and a grouchy analyst comment contributed to bad sentiment.
And that drop was all it took for Hwang’s number to be called – as Archegos was suddenly hit with margin calls.
And it was probably right around this time that Archegos’ prime brokers realized that they were in bed with other prime brokers – who all had with similar exposure in the same stocks through Archegos.
Two of Hwang’s prime brokers, Morgan Stanley and Goldman Sachs, quickly sold tens of billions of dollars of shares they held for Archegos into the market, mostly via block trades (which are prearranged, large sales to a small number of big buyers).
They unloaded their exposure to Archegos a lot faster than Japanese bank Nomura, which announced that it will post a $2 billion loss on the episode. And Swiss bank Credit Suisse said it would take a $4.7 billion hit, and announced the departure of a string of senior executives (including – not surprisingly – its head of risk management).
How did they lose so much money, so fast? If your town’s biggest Jaguar dealership goes bankrupt, and creditors want as much of their capital back as soon as possible, they’re going to try to sell a Jaguar to anyone who has a drivers license and can fog a mirror. When there’s suddenly a huge amount of supply – whether it’s Jaguars or shares of VIAC (down 47% now from recent highs) or DISCA (-44%) or BIDU (down 34%) – it’s a buyer’s market.
(In theory, Nomura and Credit Suisse didn’t have to sell, and crystallize their losses. But by taking on positions in a handful of stocks as large as the GDP of a medium-sized African country, they’d be in immediate violation of regulatory risk standards. And there’s no future in a bank turning itself into a de facto hedge fund by taking on the positions of a client that went bust.)
The Archegos story is far from over (though HBO is probably already reviewing script proposals). Bill Hwang hasn’t lined up his live interview with Oprah to tell his side of the story. The SEC, in its latest shut-the-barn-door-after-the-horse-left initiative, will likely soon announce measures to reduce abuse of equity swaps.
But it’s not too early to think about the lessons of the whole thing…
When in doubt, sell first – and ask questions later. If you’re in a room with one exit and a fire breaks out, do you bum rush the door… or do you discuss with the other people in the room the best way to evacuate, so that everyone can get out safely?
According to press reports, when it was clear that Archegos was going down, Hwang’s prime brokers discussed a standstill agreement – whereby they’d work together to unwind the enormous share positions each was holding.
But they didn’t come to an agreement, and then it was every bank for itself – and Goldman Sachs and Morgan Stanley were the first out the door. There’s no honor among thieves (or bankers), as the CEO of Goldman Sachs told CNBC…
From my perspective, our risk controls worked well. We identified risk early on. We took prompt, corrective action to lower our risk… And I can’t really speak to what other banks have done and how they’ve handled the situation, but I’m very pleased with how our team handled it.
Goldman Sachs and Morgan Stanley had their eyebrows slightly singed on the way out. But Nomura and Credit Suisse suffered third-degree burns and serious respiratory system damage.
The message here? If you’re in doubt – whatever the source of the doubt – sell. The worst that happens is that you get your cash back. There’s no putting the toothpaste back in the tube once the asset you’re holding is worth a fraction of what it was a few weeks before… There’s no “no questions asked” return policy for shares.
Steer clear of banks that will never learn. Credit Suisse – which I wrote about last summer – is the financial equivalent of the circus clown who’s hit in the face by a cream pie, steps on the business end of a rake, walks into a telephone pole, and then gets leveled by a Mac truck. Its antics are mildly amusing – and a cautionary tale.
But it’s a nightmare for the clown – and, in this case, its shareholders. In the aftermath of the Archegos affair, Credit Suisse said it may cut its dividend, and suspended its share-buyback program. The shares are down 25% since February, and about as much over the past five years… during which time the S&P 500 has doubled.
Credit Suisse CEO Thomas Gottstein took the job – like being named the Titanic’s captain before its fateful journey – in early 2020. His predecessor was shown the door following an embarrassing episode in which Credit Suisse admitted spying on a former employee – before which the former CEO allegedly got into a Christmas party shouting match with the employee (also his neighbor) over the location of trees in his yard.
“Serious lessons will be learned,” Gottstein said in a statement earlier this week. After this – and a series of other (also costly) misadventures in recent months – he’s probably hoping for more Spy versus Spy scandals, and a break from balance sheet holes the size of Zurich.
Credit Suisse has proven its incompetence with the mission-critical task of risk management. If it fails at the big things, it’s difficult to see why it’d be any better at the small things: Like executing trades, mailing monthly statements to customers, and getting the decimal on the correct side of the zero. As of late last year, Credit Suisse had around $1.3 trillion in assets under management – but why would anyone trust their money with a bunch of clowns?
If you do business with Credit Suisse – or, for that matter, any organization that can’t do the important things well – you might want to ask yourself why.
When you’re gifted a big return – take it. Small shareholders of ViacomCBS – a patchwork of analogue entertainment assets in a digital world, that’s now worth around one-tenth of Netflix – were handed a gift: A 700% return in a year, as they rode the tsunami-sized wave of capital from Archegos.
Those folks have something in common with long-time shareholders of a sleepy video-game retailer that was well past its sell-by date – Robinhood favorite GameStop. In that case, GameStop shares exploded by more than 100 times from one-year lows when the stock became the obsession of “kamikaze capital” Reddit speculators.
(ViacomCBS recently relaunched its CBS streaming package as Paramount+ – which is like Grandpa strapping on shiny new white New Balance sneakers and thinking that he’ll be ready to run a marathon. It was no reason, though, for the shares to be the best-performing member of the S&P 500.)
If you see a $100 bill on the ground, and there’s no moral dilemma about who it might belong to, do you pick it up? Of course you do. When a stock rises to the moon, it doesn’t necessarily mean you’re smart… you might just be lucky. Fortunately, it doesn’t matter which. Just be sure you sell before the magic vanishes… and the share price falls.
Expect your bank to screw you. Morgan Stanley and Goldman Sachs didn’t play just two sides in Archegos… they played every side. They were selling shares of ViacomCBS as part of the company’s secondary offering at $85 per share, below what had been the recent high at $100. Meanwhile, their colleagues were growing worried about monster positions in the same stock held for Archegos… and hours after selling billions of dollars of new ViacomCBS shares to their customers, they were flogging deeply discounted blocks of the same stock, as part of liquidating Archegos assets. ViacomCBS shares are now trading around $43 per share.
“There’s definitely the potential for a conflict,” a former head of the SEC said to CNBC, which is bureaucratese-speak for “there’s less conflict in a war than what went on there.”
Morgan Stanley and Goldman Sachs sold their blue-chip investor customers – pension, mutual and hedge funds who have been trading with them for years – a lot of stock… even though they knew that they’d shortly be selling a lot more, which would hurt the share price. It’s a lousy way of doing business.
Would they treat their small customers – people with a Morgan Stanley financial advisor, or an account at Marcus, the Goldman Sachs online bank – any differently? When it’s a matter of big money, it’s a bum rush for the exit… and too bad if the client, big or small, is trampled.
Bill Hwang was lucky at making money – and skilled at losing it. Hopefully his lessons will be more permanent than his wealth was.
Many of you have e-mailed us about Buck’s MLB strike out in Georgia daily from earlier in the week…
Actually, I stopped watching “woke” sports last year. No football (damn I missed the Cowboys!), no baseball, no nada. Well, we did tune in the Super Bowl as the wife wanted to watch the commercials. But she didn’t even watch her beloved Broncos. We don’t need political education from professional sports. – George R.
Buck Sexton Reply: George, I’m glad to hear you’re taking action on this. I honestly think that professional sports have become weaker media products in recent years, particularly baseball and basketball. The players seem like a bunch of overpaid babies who all want to pose as civil rights heroes one minute while posting photos of their Ferraris and mansions the next. I haven’t watched professional sports with any regularity in years, and I don’t miss it.
We all know the Democrats are not known for their governing prowess. We simply need to look at the last two Presidents from the Party. No, what the Democrats are known for is their support of Liberalism the remaining of three predominant 20th century philosophies (Fascism, Communism, Liberalism) and “trumpeting equal rights and now equity while fostering incomparable material inequality. Its legitimacy rests on consent, yet it discourages civic commitments in favor of privatism; and in its pursuit of individual autonomy, it has given rise to the most far-reaching, comprehensive state system in human history.” These are not people interested in what is good for the whole. Let’s keep that in mind. I do not think Manfred of MLB, is aware of the gang with which he has hung his star. Coca Cola, Delta and Harry’s are in the same place as MLB. Boycotting all products and services of these enterprises is something we should all be engaged in. – David B.
Buck Sexton Reply: David, I completely agree that boycotts cannot be a one-way street any longer. If we continue to allow the woke Left to weaponize their beliefs against (and now through) corporate media, we will lose the culture entirely and with it, all relevant political power.
Baseball’s popularity has been in decline for years – they’ve now rung their death knell. The statistics that will be fun to watch now will be the ratings cascade, starting with the All-Star Game. Maybe all the new gambling companies can take bets on that game within a shame. That’s what I’ll now be root root rooting for. – Gary S.
Buck Sexton Reply: Gary, without the shared sense of history and Americanism underpinning baseball, it’s just not a compelling value proposition for a lot of people to sit there and watch millionaires play catch for 3 hours. To be honest, I’ve always thought it was boring as a spectator sport, but now that their politics are coming to the forefront, I hope more people decide that MLB is both boring and ignorant.
Great column, Buckster. This woke crap is destroying the very fiber of our beloved country. Gone are the days when congressmen represent their constituents. Ergo, gone is the very essence of congress. Our president is a joke, “c’mon man,” and our v.p. couldn’t make it out of the second round of the democratic primary. What’s the morning line on MLB changing their mind? Kenny G
Buck Sexton Reply: Kenny G., You have great taste in political commentary. Also, I love your whole catalogue of work on the saxophone.
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