BEFORE THIS WEEKEND, few people will have heard of Archegos Capital Management, an investment vehicle run by Bill Hwang, a former hedge-fund trader with a chequered past. But Archegos has emerged as the entity behind a fire sale of at least $20bn-worth of equities, mostly Chinese technology shares, which roiled stockmarkets late on Friday March 26th and has left at least two global banks—Nomura and Credit Suisse—facing multi-billion-dollar losses. There may yet be more bad news or aftershocks as the Archegos affair runs its course.
The plotline has already taken shape. Archegos is a so-called family office. It manages the private wealth of Mr Hwang, who once worked for Tiger Management, a celebrated hedge fund. One of Archegos’s strategies was long-short equity. The main idea is to be indifferent to the direction of the overall market by buying (being long) some stocks and selling (being short) others. The hope is that the longs do better than the shorts. But when markets are volatile, as they have been in recent weeks, the strategy can come unstuck. This is what seems to have happened to Archegos.
The first sign of trouble was on Friday when Goldman Sachs and Morgan Stanley, two Wall Street behemoths, began selling large blocks of shares for an unnamed client who had missed a margin call—a demand for more collateral to cover losses on trades that had gone awry. The stocks that were forcibly sold might best be categorised as “second-tier tech”. They include Baidu, a Chinese search engine, and ViacomCBS, an American media conglomerate, with a streaming service that gives it the flavour of a faddish tech stock. Their prices crashed under the weight of the selling. The price of ViacomCBS shares, for instance, fell by more than a quarter. The fire sale was evidently big. Perhaps $20bn-worth of shares was dumped on an otherwise unremarkable Friday.
By Sunday it had emerged that the mystery client was Archegos. Some more familiar names were soon caught up in the drama, too. Credit Suisse said it was in the process of liquidating the positions of a client that had defaulted on margin calls, and that the related losses would be “material”. Unofficial estimates put it at $3bn-4bn. Meanwhile Nomura, a Japanese lender, said that it was on the hook for around $2bn, possibly more if stock prices fell further. These are significant losses. If not quite a lost limb, they amount to more than a flesh wound. The share price of each bank has tanked (see chart).
The full reckoning will only become clear over time. But it is possible that Nomura and Credit Suisse were slower to pull the plug than their American rivals. By making the margin call on Archegos early, and then liquidating positions quickly, the Americans may have limited the damage to themselves, but left the others nursing bigger mark-to-market losses.
The fire sale is already raising some disquieting questions. How was Mr Hwang, a little-known figure, able to run up such big losses? Leverage surely played a big part. But why then was he able to borrow so much from Wall Street in order to enhance the size of his bets? What makes this even more puzzling is that Mr Hwang had already blotted his copybook. In 2012 he pleaded guilty to charges of insider trading and was fined.
One answer is that banks are desperately searching for profits. Rules drafted after the global financial crisis make it expensive for Wall Street banks to trade on their own account. The days when they could make much money from slow-moving, unleveraged asset managers—the “long-only” crowd—are a distant memory. Such investors mostly buy and sell stocks cheaply on electronic platforms. So Wall Street banks increasingly rely on fees and commissions from fast-trading hedge funds or family offices that act like hedge funds, such as Archegos. Fees on exotic derivatives (futures, swaps, options and so on) are especially attractive to the brokerages. The appeal for the fast-money hedge-fund crowd is that many derivatives have embedded leverage. They can make large bets without having to put up lots of their own capital upfront.
In short, Wall Street can’t easily make money out of people who do not take rash bets. The problem is people who make rash bets can lose you money, too. It is probably not a coincidence that Credit Suisse and Nomura are based in countries (Switzerland and Japan, respectively) where long-term interest rates have long been stuck near or below zero. With limited opportunities to make money from lending at home, they turned to Wall Street for excitement. Unfortunately for their shareholders, they found it.
Parallels are naturally being drawn between Archegos and LTCM, an ill-fated hedge fund. In 1998 LTCM was prevented from blowing up itself and the banking system by the Federal Reserve, which co-ordinated a bail-out by its brokers on Wall Street. LTCM, too, was afforded breathtaking leverage by its brokers, who were dazzled by its principal shareholders, who included John Meriwether, a star trader formerly at Salomon Brothers, and Robert Merton and Myron Scholes, Nobel-prizewinning economists. Mr Hwang is nowhere near as celebrated. And the tentacles of Archegos do not obviously stretch anything like as far into the financial system as LTCM’s. Still, the damage to Credit Suisse and Nomura is significant. More reports of losses may emerge in the coming days. And there may yet be second-round effects in the stockmarket if other hedge funds are forced by nervous brokers to unwind their leveraged trades.
Archegos might be a one-off mishap, albeit a large one. But it is not too much of a stretch to link it to some broader recent market themes. Since November there has been a general shift away from tech-and-media stocks, which profited greatly from the stay-at-home economy, towards cyclical companies, such as banks, airlines and industrial firms, which benefit from reopening. This rotation has been given extra force by the run-up in Treasury yields in recent weeks. Archegos may well have been at the wrong end of this, at times violent, rotation. Events are moving unusually fast in the world economy and in financial markets. And when events move fast, some things get broken.