An enormous margin call crushed a well-known family office last Friday, erasing tens of billions of dollars for several banks that put their trust in it.
Volatility skyrocketed in the broader market when Archegos Capital Management torched $20 billion in leveraged investments in ViacomCBS, Discovery, Baidu, Tencent, and Vipshop, forcing liquidations at several Wall Street Banks.
Archegos collapses, unwinding derivatives after a record margin call
The fall of Archegos is something of a canary in the coal mine for institutional investors and the broader equities market by extension.
With interest rates still at rock bottom, many institutions feel they are playing with the house’s money.
Excessive risk-taking by central banks has motivated other institutions to do the same, making ever-riskier and more leveraged plays.
This has led to overleveraging so widespread that it threatens the stability of financial markets.
The whole situation points to an investment portfolio heavily weighted towards alternatives. But we’ll get to that later. For now, let’s assess the damage.
Who is Archegos, and why should you care?
Archegos Capital Management is a family investment vehicle founded by former Tiger Management analyst Bill Hwang.
In 2012, Hwang pleaded guilty for insider trading of Chinese bank stocks and settled with $44 million from the Securities and Exchange Commission.
Despite being busted for using confidential information to guide a short-selling strategy, banks went on to support Hwang’s newly created company, Archegos.
Ironically, “Archegos” is the ancient Greek word for “leader or prince”. Hwang could certainly be considered a leader, but considering the circumstances, he hasn’t proven a very good one.
How it all went down
When a $3 billion stock offering for ViacomCBS through Morgan Stanley and JPMorgan fell to pieces earlier in the week, it created a cascade of prime brokers exiting positions on Archegos’ behalf.
The resulting margin call was enormous, with Archegos’ prime broker, Nomura, telling the press that it would be a “significant loss” of more than $2 billion.
The Archegos fire sale topped $30 billion, and the resulting liquidations have ruined Hwang’s reputation.
Traders globally are glued to their screens, waiting to see if the block trades will continue. Will the Hwang family office send shockwaves through the global financial system?
To understand the least that could happen, consider the bigger picture.
Hwang’s family office is a drop in the bucket when compared to the loosely regulated, $6 trillion family office industry. Following the Archegos implosion, regulators are discussing tighter regulations on certain financial instruments and the financial sector as a whole.
With news like the Archegos fallout, it’s no wonder disillusioned investors are finding it difficult to trust any asset, fund, or vehicle as a viable investment in today’s financial system.
Today, people like Hwang can create financial instruments out of thin air and sell them to banks while promising tens or even hundreds of millions of dollars in gains. With plenty of alleged protections, it’s hard for anyone to say no.
When these massive sinkholes appear in the markets, people fall into them. Archegos is only one of many cases of “leverage gone wrong.” With the current environment, it is likely not the last.
We witnessed the perils of excessive risk-taking on the short side when GameStop ($GME) blew up. Now we are seeing it on the long side.
The public cannot confirm or deny whether the margin-called funds in the Great Gamestop Squeeze were also heavily over-leveraged. However, it’s entirely possible.
US regulations only require margin accounts to maintain at least 50% of the dollar value of the stocks they’re trading. Margin calls were well within reach, with GME exploding in value.
But we now turn to the real culprit of all this excessive risk-taking — central banks.
Inflating the financial system into oblivion
With central banks dropping interest rates and pumping in money from every direction, inevitably, you’re going to have risk-taking.
Dallas Federal Reserve President Robert Kaplan takes a position “different than the median” compared to other Fed officials (like Powell) regarding interest rate hikes.
Kaplan tells the press that when you go to a certain level of inflation, perhaps it’s time to talk about raising interest rates.
Creeping interest rates are the top story of 2021 so far. It’s more pleasant than a pandemic but just as threatening for the world economy.
With nosebleed-level valuations in U.S. mega-caps, particularly Big Tech, the risk for markets as a whole is real, and we may be at “an inflection point.”
A recent Bank of America fund manager survey projects 2% on the 10-year Treasury as a “level of reckoning for stocks.” Most fund managers believe crossing that threshold may deliver a +10% correction across the board.
Raising rates would puncture corporate profits. Only time will tell when the next domino will fall.
Biden is preparing to announce up to $4 trillion for a new “infrastructure” plan, along with “massive tax hikes.” The federal government seems to think that COVID is a worthy excuse to spend any amount of money on anything. Needless to say, it is difficult to envision a future where the Fed does not increase interest rates to combat inflation.
What the suits cannot tell you
Bill Hwang and the financial institutions that bet on him lost billions of dollars. Central banks are feeding a widespread lack of risk management from top to bottom.
When asked about the risky behavior of investors and financial institutions today, Kaplan went on to say:
“I’m concerned about excess risk-taking, and if that excess risk-taking goes too far, whether it creates excesses and imbalances, that could ultimately create challenges.”
We’ll say what Kaplan failed to: The excess risk-taking in the markets today threatens to create more than a few challenges — it’s setting us up for catastrophe.
It’s for several great reasons that savvy investors are searching for alpha and long-term stability in inflation and volatility-resistant investments.
Some of these hedges include precious metals like gold and silver, cryptocurrencies like Bitcoin, commodities, and, of course, farmland.
For those who are concerned about overleveraging and excessive risk-taking in the market, it’s worth learning about an asset class that has historically resisted market downturns exceptionally well – farmland.
Overleveraging and high amounts of risk are serious threats, and it’s better to be prepared. Just because the banks and institutions are taking on too much risk doesn’t mean you have to.