What can we learn from collapse of Archegos Capital Management?
The Cast of Characters
Archegos Capital Management, a sort of private hedge fund company called “family office”, which acts (almost) outside of regulatory framework of SEC (USA’s Securities and Exchange Commission), because it only manages family money and not client’s money was run by Bill Hwang, ex trader with previous convictions for insider trading.
According to Bloomberg, Archegos started with $200 million of assets in 2013 and crested at almost $20 billion two weeks ago (March 2021) and most of the growth took place in the last 12 to 24 months.
System of making money out of nothing very little was not created by Bill Hwang, but the collapse of that system exposed the potential weakness in the money markets that makes some seasoned commentators very wary indeed.
The system was as follows: Bill Hwang would instruct his brokers to purchase stock in a narrow group of companies, using little of his own money and a lot of money he borrowed from banks.
This is called leverage, and it is a proven way of making rich richer. Banks like it because they earn bank fees on it, and rich investors like it because a) money are cheap to borrow and b) stock market is has grown 38% in a pandemic, so after paying banks back, the total profits are made of 1. profits on stocks and shares bought with one’s own money plus 2. additional profit made on stocks and shares bought with banks money.
In case of Bill Hwang, he was buying the stock in only eight companies, give or take. Buying the shares increased the price of the shares, making him richer on paper, and giving, also on paper, more security to banks on which they based decisions to lend him more money.
The Cloak and the Dagger:
To muddle the waters, he would not officially transfer stocks and shares from his broker to his own name, making his trades anonymous, To muddle the waters further, he borrowed from number of banks, and due to issue of banking confidentiality, banks were not aware how much he borrowed from other banks.
He kept repeating the formula. The stocks he had interest in kept being traded (by him, anonymously), and raising, raising, raising in value. With his paper fortune growing, he kept borrowing more and more from the banks.
Rumping up of Suspense
His investment vehicle, Archegos, kept borrowing and plowing the borrowed money into the same eight stocks at the maximum leverage possible. To maintain itself it needed share prices to keep growing, to keep share prices growing it needed to keep buying shares, to keep buying shares it needed to borrow money, to borrow money it needed to show banks that shares keep growing……
Until they stopped growing. One of the eight was company called Viacomm.
Viacomm board, convinced by raising share prices of their brilliance in managing the company, issued new shares to raise capital and continue to lead the company to greatness. Alas, shares did not find enough buyers (Bill Hwang was too overextended to prop the price). With shares price dropping, brokers/banks asked Bill Hwang to put up more security for the loans they already gave him. But he had no money to do it. His precarious financial position, was suddenly exposed.
Banks started selling Bill Hwang’s holdings in those eight companies to recoup the money they lent to Archegos. Selling of shares resulted in sharp decline in share price. Archegos is dead. Banks have lost money - and we are talking billions of dollars. As the share prices of companies in question were artificially inflated and will never go back up, many other investors lost money.
The final twist:
Morgan Stanley and Goldman Sachs banks did fire sale of Archegos stocks before anybody had time to get their head around what is happening. While other banks searched for co-operative approach and tried to manage the situation and prevent deep dive in assets value, they were already in the clear. As a result, Morgan Stanley and Goldman Sachs walked with no losses. Everybody else’s losses rose exponentially.
How much of the stock market growth is due to such market manipulation, and how far are we from the sort of loss of confidence in financial system that paralysed the whole monetary structure in 2008-2009?