The Breakdown - Corruption, Leverage and Cheap Money: Archegos and the Fastest Loss of Wealth in History

Starting point is 00:00:00 These aren't some galaxy brain evil schemes. It's just a lot of people fudging the rules just enough. Acting against their better judgment, just enough. Leaning into greed, just enough. It's Huang potentially not really letting all these prime brokers know how deep he was with each of the others. It's archegos using instruments that aren't illegal, but which certainly skirt around regulatory intent. And it's about banks reversing course to do business with convicted financial criminals

Starting point is 00:00:24 because the volume of their trading has just gotten too big to ignore. It's the banality of modern corruption. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.io and produced and distributed by CoinDest. What's going on, guys? It is Thursday, April 1st. And instead of bringing you some fun, cheesy, fake story, I decided to go in the exact opposite direction. Today we're going to be talking about leverage, corruption, and cheap money, the fastest

Starting point is 00:01:05 loss of wealth in history. We are talking about Archegos. This is a story that many of you have been following for coming on a week now. It is certainly one of the crazier macro stories I've ever covered here. It involves a trader with a dubious past, a group of investment banks coordinating a takedown, double-crossing margin calls, and ultimately an erasure of fortune, Thanos style. tens of billions gone in the seeming snap of a finger. On the one hand, this is the story of an individual trader, a 20-year Icarus who finally flew too close to the sun. On the other, it's the story of a market as a whole, a market that has made money extraordinarily cheap and which has normalized extreme risk, especially in the form of leverage. Let's start with the man at the center of the

Starting point is 00:01:53 story, Bill Huang. Bill's career started under the tutelage of the legendary hedge fund manager Julian Robertson. In 1980, Julian Robertson founded Tiger Management, one of the earliest hedge funds. Tigers run is the stuff of legends, building from $8 million in startup capital in 1980 to over $22 billion in the late 1990s. When Robertson unwound and shut down the fund in 2000, he started the next phase of his career, which was investing in the funds of his former employees, the so-called Tiger Cubs. To be clear, this isn't like one or two funds. We're talking about 35 to 50 of the world's top hedge funds. Rob Citrone's Discovery, Stephen Mandel's Lone Pine, Andreas Halverson's Viking, Philippe LaFant's Coatu Management, which you may recognize as the lead investor in Dapper

Starting point is 00:02:40 Lab's new $305 million round from this week. And one of those hedge funds from the Tiger Cubs was called Tiger Asia Management and came from Bill Huang. Huang started as a stock salesman at Hyundai Securities before hooking up with Robertson and becoming one of his protégés. When Tiger was winding down, Huang spun out his own fund. Tiger Asia was a New York-based fund that focused, as you might guess, on Asia. At its peak, it was managing more than $5 billion, and in general it performed well, with the notable blip of being on the wrong side of a 2008 Volkswagen short squeeze. However, most people who remember Tiger Asia remember it for its 2012 settlement with the SEC around an insider trading suit. In summer of that year, it said it planned to wind down and return outside capital, but a

Starting point is 00:03:26 months later, it was clear why. The firm pled guilty to criminal fraud charges. On December 12, 2012, the SEC released an announcement about their $44 million settlement for illegal trading in Chinese bank stocks. They said that a pair of trading schemes had produced $16.7 million in illicit profits. Huang and Tiger Asia committed insider trading by short-selling three Chinese banks based on confidential information. They covered these short positions with private placement shares purchased at a significant discount to public price. Separately, they attempted to manipulate prices in which the funds had short positions by placing losing trades in an attempt to lower the price of the stocks. The game here was to increase the management fees that others paid them.

Starting point is 00:04:10 At the same time, the Department of Justice announced criminal charges and Huang got one-year probation. So let's keep in mind, this is not some casual take a position because someone whispered you some news shit. These are complex schemes designed to profit. at the expense of not only the corporations whose stock sits at the center of the trade, but as well as to outright defraud investors in the fund by pumping management fees. In other words, this is bad guy shit. And it's not happening to some 23-year-old. It's a guy two decades into his career who, if he doesn't know better by then, he's never

Starting point is 00:04:42 going to know better. This is probably why Ben Hunt called his essay on the subject, a tiger can't change its stripes. This isn't the type of behavior that just goes away. So what happens after the insider trading payout and probation? Well, Huang can't really manage other people's money anymore, so he technically converts Tiger Asia into a family office. That means he's now just managing his own money. He starts with $200 million and over the course of the next eight years turns it into an approximate $10 billion, which is an insane return. You're talking about something like 63% annualized return over that entire period. Which brings us to today. Now we have the background, so let's discuss how Huang was involved. investing and with whom? Again, this is a guy who has been convicted of insider trading, shamed in the industry, and there are a few big implications of that. First, as we said, he's now playing with his own money. At least he was to start. Second, he's persona non grata with the big banks. Third, he's looking for strategies that don't require deep disclosures to regulators,

Starting point is 00:05:41 i.e. he wants to operate as discreetly as possible. Let's go to that second point, persona non grotto with the big banks. This describes Huang's social position for most of the 20 teens. As recently as 2018, Goldman Sachs had determined that he was too risky and refused to do business with him. But, as I said before, Huang was crushing it, building a portfolio in the billions. At some point, the greed overwhelmed the fear and the lure of tens of millions of dollars a year in commissions and fees, switched that policy, and Goldman Sachs began working with Huang again. Which gets us to the third implication of his previous conviction, the type of instruments he wanted to use and the scrutiny he wanted to avoid.

Starting point is 00:06:23 Archigos wasn't taking huge positions in companies directly. Instead, they were dealing primarily with a type of derivative known as a total return swap. A total return swap is a contract with the broker-dealer, where the investor agrees to be on the opposite side of some security trade. So instead of buying shares in a company, you buy a contract with someone like Goldman Sachs that says something to the effect that they will owe you money if the stock goes up or you will owe them money if the stock goes down, or vice versa, depending on where you want to

Starting point is 00:06:52 place your bet. For the investor, it's a pure play derivative, a zero-sum betting game between counterparties. That said, on the other side of the trade is a bank, a prime broker, who hedges by buying the underlying asset. So for the main investor, Archegos in our situation, these total return swaps mean that their fund has massive, effective exposure to a specific security without actually holding any of the underlying of that security. That means, of course, no governance rights, but it also means far less exposure. When regulators see who owns the company's stock, it's not Archegos, the originator of the bet, who's on the books. It's the counterparty investor like Goldman Sachs. In this way,

Starting point is 00:07:32 anonymity is one big benefit of a strategy like this for an investor like Huang. But there is another huge benefit, and that's leverage. With a derivative like a total return swap, Archigos was only required to put up a fraction of the actual capital at play, say, for example, 15 cents on the dollar. In effect, this means that Huang's estimated $10 to $15 billion portfolio was actually playing with more like $50 to $80 billion of exposure. Now, of course, nothing in the world is free and the cost of this leverage comes on the other side. The possibility that changes in asset prices create a margin call that can't be covered by existing collateral and forces a rapid unwind of a position. This catches us up to early last week. We've got a convicted financial criminal

Starting point is 00:08:16 betting in a highly opaque way with 5 to 8x leverage, aided and abetted, not just by Goldman Sachs, but by an absolute fat stack of prime brokerages that Huang had deals with. We're talking Goldman Sachs, Morgan Stanley, UBS, Deutsche Bank, Credit Suisse, and Numura. Now, of course, the important thing to note here is that it wasn't just one big firm willing to do business with this guy. It was all of them. Looking for the best way to unlock your crypto's liquidity? Nexo.io is exactly what you need. Borrow against your digital assets at just 5.9% APR.

Starting point is 00:08:53 Earn passive income with yields of up to 12% and swap between more than 75 market pairs with the instant Nexo exchange. Try the Nexo wallet app to get the whole 360 degrees of crypto banking. Get started at nexo.io. At the end of last week, there were some crazy rumblings in the market. Friday, $20 to $30 billion in stock positions are dumped by a number of big banks in huge blocks. Bloomberg called them, quote, a series of market-roiling trades so large and hurried that investors described them as unprecedented. And at first, it wasn't clear what the cause was.

Starting point is 00:09:32 Goldman sent an email to clients late Friday saying that it had been one of the banks who was selling, detailing $10.5 billion in trades, but without naming Arcagosa Huang in that email. Over the weekend, the story started to come into greater picture. Goldman Sachs and Morgan Stanley had both forced the liquidations on Archegos, and because of the leverage, by the time they had done that, there was basically nothing left for the other firms. Nomura is expected to lose about $2 billion on the unwind and Credit Suisse, 3 to 5 billion. Huang himself has gone from a 10 billionaire to a nothing air, literally overnight, which truly has to be one of the greatest unwindings of personal wealth in history.

Starting point is 00:10:11 So WTF happened. One of the things that has struck many as strange is why this happened now. Huang is a guy who, whatever you think of him, traded through the dot-com boom, September 11th, the great financial crisis, the Volkswagen short sell we mentioned, COVID-19, and right now the markets are at or near all-time highs. What gives? Why now? Seems like there are a couple different parts to the story. First, it does seem like there was trouble in some of the positions, particularly Viacom CBS.

Starting point is 00:10:40 Their stock had been doing so well that they tried to issue $3 billion in new stock. The market turned against them with at least one influential researcher saying it was worth more like $55 than the $85 it was being offered at, and that spooked investors and triggered a sell-off. Now, the interesting wrinkle in this story is that the leverage-by-demand of Archegos could have actually been a meaningful contributor to the inflated asset price in the first place, in a way sowing the seat of its own demise. This is why it's dangerous when things like total return swaps of

Starting point is 00:11:10 obscure who is buying a security. It means we have no idea about why. Why a particular investor thinks a stock is worth what it is, and that can easily make the market overvalue things in a pretty big way. So as these big positions were turning negative, the Wall Street Journal reported that on Thursday, Archegos asked their banks and prime brokers to meet to hash out a strategy to liquidate its holding. This is according to someone with insider knowledge. The call ended without clear agreement, but there was a working proposal for the banks to hold off on large trades and to talk again over the weekend. Goldman Sachs and Morgan Stanley clearly left that meeting completely ignoring that tacit agreement, and when they went home, pulled the big red fire alarm

Starting point is 00:11:50 because by the next day, they were racing to liquidate positions and not be the last in the game of musical chairs. When all was said and done, they got out fast, limiting their losses, while those other firms were left holding the bag. Now, as I mentioned, this is just with the Wall Street Journal reported. Others have speculated that there was more going on than just a meeting that Archegos themselves convened. Patrick Boyle, in a video in his excellent on finance YouTube channel, discussed the idea that the meeting might have been called because of greater regulatory scrutiny around Huang himself. Another recent financial scandal around Greensill had embroiled at least one of these prime brokers. Perhaps over the last few weeks, those impacted by GreenSill,

Starting point is 00:12:29 which, if you're interested by the way, we can definitely do a different show on, were tasked with revisiting all of their bank's outstanding relationships, and were basically forced from on high to start to figure out how to get out of bed with people like Huang. Ben Hunt's note on the blow-up raised two other possibilities. One, the idea that the banks discovered that Archegos was double dipping and promising the same collateral to multiple prime brokers. Or two, the idea that U.S. regulators might be coming to the prime brokers with questions. To be clear, he's not saying he knows this happened, only that they're the only answers that make sense to his brain about why this would happen now. Here's how Ben argues that it seems strange that it would just be Viacom taking a

Starting point is 00:13:08 turn to cause this whole thing. Quote, here's what did not go wrong for Huang. I don't think Huang blew up because positions like Viacom and Discovery went horribly 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 Archiego's love to press. But even if he was doubling down on losses in true degenerate gambler style, this isn't a portfolio that is broken down to a degree that would clearly put your prime brokers into all-out panic mode. This is a portfolio that needed the sales trimmed, not blown out.

Starting point is 00:13:46 So why did the banks blow it out? I think something else triggered the decision by Goldman Sachs and Morgan Stanley to exercise whatever liquidation provisions they had in their custody and counterparty credit agreements with Archegos. I think it was a margin call, in quotes, not a margin call. What can trigger a in-quotes margin call? By which I mean the forced liquidation of positions held at your prime broker, even if you're not in violation of net capital requirements? And that's where Ben gets to his two thoughts around finding out that there was some double dealing on the part of Archegos and double dipping in the form of collateral, or again, an investigation coming their way. These are the type of speculations that can take weeks, months, or even years to be

Starting point is 00:14:26 fully revealed. Such is the nature of financial scandal. It takes time to unwind the layers of opacity to uncover the truth. This is especially the case if there are regulatory investigators involved now. I expect we'll have a much clearer picture in a few months. Given all that, let's discuss some fallout implications and interpretations. The first has to do with leverage. This whole episode is a reminder of just how normal trading with leverage and doing so with exotic financial instruments has become. One has to think that this is at least in part a byproduct of the shift of everyone farther out onto the risk spectrum in the search for yield, a byproduct, as we've discussed, of a decade or more of extremely low interest rates. In a way, this episode is revealing a systemic

Starting point is 00:15:08 challenge. And interestingly, I've seen probably a half dozen media pieces that try to connect this story to other strange market aberrations from 2021. Game stop and NFTs, most notably. Basically, the argument is that the broader macro environment is warping everything. I'm not totally sure I buy those two examples, but I do think that something weird is happening is too strong a sense to ignore. The next interpretation for me has to do with a twist on the idea of too big to fail, which is too big to get screwed. Goldman and Morgan Stanley's fast action saved them billions and left others like Namura holding the bag in a huge way. It's worth noting to me that in these types of scenarios, it's just never the big guys that end up getting screwed. But finally,

Starting point is 00:15:48 let's talk about the fallout. Over the next few weeks, we'll probably see a lot of blame be heaped on the instruments themselves, these total return swaps. Given just how opaque they are, seems like a fine focus. However, I agree with Ben Hunt wholeheartedly when he states, quote, in the days and weeks to come, you'll hear the usual suspects say that swaps and derivatives are the problem here. The problem is doing business with convicted criminals like Bill Huang. The phrase that I keep coming back to in my head is the banality of modern corruption. These aren't some galaxy brain evil schemes. It's just a lot of people fudging the rules just enough, acting against their better judgment, just enough, leaning into greed, just enough. It's Huang

Starting point is 00:16:30 potentially not really letting all these prime brokers know how deep he was with each of the others. It's archegos using instruments that aren't illegal, but which certainly skirt around regulatory intent, and it's about banks reversing course to do business with convicted financial criminals because the volume of their trading has just gotten too big to ignore. In other words, like I said, it's the banality of modern corruption. And it's stories like this that make the accusations of regulators that somehow, cryptocurrency and Bitcoin are a driving force in financial crime, just drip and ooze with hypocrisy and non-reality. But alas, that is a story for a different day. For now, I'll wrap there. I hope this was helpful in you wrapping your heads around this crazy

Starting point is 00:17:13 archigo situation. Like I said, I anticipate we'll learn a lot more in the coming weeks. and you know I'll make sure to let you know if and when there are any relevant updates. For now, I appreciate you listening. If you enjoyed the show, go throw a rating or review on Apple iTunes. It makes a big difference. Until tomorrow, guys, be safe and take care of each other. Peace.

The Breakdown - Corruption, Leverage and Cheap Money: Archegos and the Fastest Loss of Wealth in History

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