The Breakdown - Hedge Funds Failures, Bankruptcies and Pandemic Fatigue

Episode Date: October 27, 2020

Today on the Brief: Turkey’s real inflation rate 3x official number Hot new DeFi protocol Harvest Financial hacked Bitcoin whales hit largest number since 2016 Our main conversation is about the rise of a new wave of COVID-19 and the economic fallout we’re still trying to address. NLW discusses why we’re starting this next wave more emotionally drained, politically divided and economically fragile than we were in March.

Everything that we're seeing from the crypto markets to bankruptcies to hedge fund failures, to zombie companies, to questions of the American workforce, they're all part of the same story. And I think that we can't ignore how they are interconnected. If we just try to isolate them and look at them only in the context of themselves, we simply won't get the full picture. That's what I'm trying to do. That's what I'm trying to make sense of as we figure out what comes next. Welcome back to The Breakdown with me.

It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by crypto.com, nexo.io, and elliptic, and produced and distributed by CoinDesk. What's going on, guys? It is Monday, October 26th, and today we are talking hedge fund failures, bankruptcies, and pandemic fatigue. First up, however, let's do the brief. First on the brief today, a quick follow-up on Turkey. My show on Friday was about the fiat failures of 2020, and one of the case studies was Turkey. Well, I've been following Professor Steve Hanke, who's an economist at Johns Hopkins, a senior fellow, and the creator of the Trouled Currencies Project at the Cato Institute, who keeps a third-party measure of inflation in Turkey. And he just reported that the numbers that he's showing are very different than the official numbers.

The official inflation number for September 2020 in Turkey was 11.75%, but Hanky's calculations put annual inflation at a devastating 39.99%. On top of this, Turkey is seeing more unrest as well. It's in a weird international tit-for-tat with France, with the president of Turkey calling for a boycott of French products after back-and-forth comments from the French president. Next up on the brief, the latest defy attack. Harvest Finance was the newest darling in Defy, growing quickly to over a billion dollars in total value locked, but their farm token has now cratered 65% in less than an hour after 25 million in value has been drained from an attack on the harvest finance pools. Since people started noticing the attack this morning, investors have pulled at least 350 million

from the site, and that's just at the time of recording. By the time you guys hear this, I'm sure it will much more. The story is still developing, but the team at Harvest said basically that the economic attack was made possible by manipulating stable coin prices on Curve Finance, which is another DeFi protocol that the contracts on Harvest interact with. This is the latest in a string of defy attacks, which should be a reminder to everyone in this space how nascent it is and how many challenges things like composability and the money Legos of protocols interacting with one another, create. Instead, however, the team at Harvest was just days ago bragging about having more value locked than non-crypto projects like Monzo. Then, as pointed out by Crypto Cobain, they're tweeting,

quote, for the attacker, you've proven your point. If you can return the funds to the users, it would be greatly appreciated by the community, including many bystanders watching Defi from afar. This is a ruthless emerging market with no rules that are going to be respected. So you have to believe and understand that if you're in this space, this is the type of thing that's going to happen. It's why I keep saying that people should be glad that there hasn't been any sort of real retail push into defy. It has to be able to figure out how to deal with these types of threats before it's ready for anything even approaching the mainstream. Last up on the brief today, the number of Bitcoin whale addresses is the highest it's been since the fall of 2016.

Glass node defines Wales as single network participants holding at least 1,000 Bitcoin. That number is currently 1939, an increase of 2.2% just last week, and a total increase this year of more than 14%. So how to interpret this, Willy Wu on Twitter put it this way. Many look at the Bitcoin price and doubt it's a hedge. High net worth individuals and funds certainly consider it to be true and betting on that with real money. Since this latest round of USD money supply expansion,

whale entities have increased their holdings of Bitcoin markedly. In other words, you might not think that Bitcoin is a hedge, but an increasingly large number of the world's rich certainly seem to. And that transitions us to our main conversation, this idea of what the impacts of the money supply expansion are. This episode is brought to you by crypto.com, the Crypto Super app that lets you buy, earn, and spend crypto all in one place and earn up to 8.5% per year on your Bitcoin.

Download the Crypto.com app now to see the interest rates you could be earning on BTC and more than 20 other coins. Once in the app, you can apply for the Crypto.com metal card, which pays you up to 8% cashback instantly on all purchases. Reserve yours in the Crypto.com app today. In this crisis, many investors aim to keep and grow their digital assets. Others seek to maximize the yield on their cash. NXO allows you to achieve exactly these two goals.

The company offers instant crypto credit lines against all major cryptocurrencies, with interest rates starting from only 5.9% APR. NXO also lets you earn up to 10% annually on your Fiat and digital assets. What's more, interest is paid out daily, and you can add or withdraw funds at any time. Get started at nexo.io. Introducing Elyptic, the preferred crypto-compliance partner for businesses who want to grow with confidence.

The busiest compliance teams rely on Elliptic's rigorous blockchain monitoring solutions to scale up and save money. Protect your customers. Manage your risk. Scale your business. Visit elliptic.co slash coin desk to talk to a cryptocompliance expert today. That's elliptic.com slash coin desk. Today we have to return to a topic that has been almost the background noise

for everything we've discussed for the last seven or eight months. The inescapable backdrop of everything economic is COVID-19, both the disease itself, but also how we deal with it or choose not to. Coronavirus was back in the news this weekend for a number of reasons. On CNBC, U.S. reports more than 83,000 coronavirus cases two days in a row as experts warn of difficult winter. This is higher than the previous record in mid-July of about 77,000 cases in a day. In 37 states, cases grew 5% or more last week, and the national average is up more than 14% from a week ago. There was also a cluster around Vice President Mike Pence that was kept hush-hush, including his chief of staff. Add on top of this growing unrest and unease in Europe where cases are back on the rise and lockdown procedures are tightening again.

The new refrain everywhere seems to be we're in for a hard stretch. Mark Meadows, the White House chief of staff, was on CNN. yesterday and said we are not going to get control of the pandemic. Instead, as someone summed up on Twitter, says we will instead try to get therapeutics and vaccines rather than trying to control the spread. Ben Hunt's interpretation of this says, I don't see any other way to interpret this. The declared national policy of the United States is to play for 2021 herd immunity through vaccine distribution next year and uncontrolled spread in this wave. The next three months are going to be very difficult, especially in the Midwest. One of the challenges, of course,

is that people are absolutely sick of this thing, and not just sick of the disease itself, but sick of the response. The Wall Street Journal published a major piece this morning called Pandemic Fatigue is Real and it's spreading. Collective exhaustion with coronavirus restrictions has emerged as a formidable adversary for governments. They look at how the stats have changed on self-regulated behavior, especially around things like social connection. The percentage of Americans avoiding small gatherings with friends and families stood at 71% in May, but is down to 45% in September. Of course, this is understandable.

Being told that we can't see small groups of family and friends is unnatural for people even if they think and know that they're doing it for a greater cause. There's a limit to how much people can bear. There's also, as I mentioned, a rise of new curfews and other lockdown protocols, as Europe also sees a surge in this latest wave. Meanwhile, the economic toll just keeps piling up. Kids are absolutely screwed with the poorest kids being screwed the most. And the knock-on effects of kids being out of school is really bad for women in the economy in particular. Parents are having to drop out of the workforce because of needing

to be home to help with homeschooling. August and September saw more than a million people drop out of the workforce with 80% of them being women. Now, this podcast obviously isn't about social policy, but it is infuriating to see the just total lack of leadership in any party of any stripe. Of course, we can't just lock down people indefinitely, but also doing nothing isn't working, and we still have the same looming specter of hospital capacity that we've always had and never addressed. Michael Mina, who's an epidemiologist, tweeted in only three days, the 14-day average change in COVID-19 hospitalizations has skyrocketed from 7% to 15%. This means hospitalizations are not simple, increasing but accelerating upwards at a faster pace. What's clear is that we're going to have to

somehow deal with this new wave from a place of utter exhaustion, frustration, and even more economic fragility than we had to deal with the first time around. Speaking of economic fragility, there are two stories that I wanted to mention that are doing double time around social media. The first is about bonds and bankruptcies and is called bond defaults deliver 99% losses in new era of U.S. bankruptcies. This is from Bloomberg, and it's such a good piece that I'm actually going to read a few paragraphs from it. Bankruptcy filings are surging due to the economic fallout of COVID-19, and many lenders are coming to the realization that their claims are almost completely worthless. Instead of recouping, say, 40% on every dollar owed, as has been the

norm for years, unsecured creditors now face the unenviable prospect of walking away with just pennies, if that. While few could have foreseen the pandemic's toll on the economy, the depth of investors' pain from corporate distress was all too predictable. Desperate to generate higher returns during a decade of rock-bottom interest rates, money managers bargained away legal protections, accepted ever-widening loopholes, and turned a blind eye to questionable earnings projections. Corporations, for their part, took full advantage and gorged on astronomical amounts of debt that many cannot now repay or refinance. It's a stark reminder. It's a stark reminder. of the long-lasting repercussions of the Federal Reserve's unprecedented easy-money policies.

Ultra-low rates helped risky companies sell bonds with fewer safeguards, which creditors seeking higher returns were happy to accept. Now, amid a new bout of economic pain, the effects of those policies are coming to bear. So here are a few examples of that debt. Debt issued by the owners of Men's Warehouse, which filed for court protection in August, traded this month for less than two cents on the dollar. When J.C. Penicco went bankrupt and auction held for holders of default protection, found the retailer's lowest price debt was worth just 0.125 on the dollar. For Neiman Marcus Group, that figure was 3 cents. The loose lending terms that investors have agreed to mean that by the time corporations file for bankruptcy now, they've often exhausted

their options for fixing their debt loads out of court. They've swapped their old notes for new ones, often borrowing against even more of the assets in the process. Some have taken brand names, trademarks, and even whole businesses out of reach of existing creditors and borrowed against those too. While creditors always do worse in economic downturns than in better times, in previous downturns, lenders had more power to press companies into bankruptcy sooner, stemming some of their losses. This is another part of the zom bifocation story that we've been talking about on this show for months. Easy money doesn't just make it so that companies can borrow more. They can borrow with these sort of ridiculous terms that ultimately leave creditors holding the bag, and we should

ultimately care about those creditors holding the bag and getting nothing, because it creates more likelihood that in the future those creditors simply won't exist. There won't be the right types of incentives. Credit is incredibly important to a market economy. It's incredibly important to starting new things, building new business lines, basically getting things created for the future. But when we have all this zombie debt taking up space, it crowds out the good that might otherwise be created. Okay, second story that's ripping around social that I want to to mention that has to do with our economic fragility is actually about hedge funds, which is fascinating. It's from Bloomberg as well, and it's called hedge fund giants lose their appeal as havens in global

turmoil. Investors have thronged the largest hedge funds since the last financial crisis as they sought safety and size. Now they're paying a hefty price. Super-sized funds are failing their clients during a period of market upheaval that, in theory, should pose an unprecedented chance to make money. Instead of profiting, though, some of the world's biggest hedge funds have barely managed to protect their investors from losses. A hedge fund's research gauge that gives more weight to larger players was down 4.4% through September, while all hedge funds on average managed to eke out a small profit. A reckoning looms as clients accelerate their flight. Investors pulled 89 billion from hedge funds in the first nine months of the year, mainly from large firms. So basically what's been going on

is that over the last 10 years, the biggest hedge funds have just gotten nothing but bigger. institutions replaced individuals as the biggest investors pushed out further on the risk curve than they had been in the past. And because those new institutions, while they were being pushed out on the risk curve, they still had the perception of safety of big funds. Because of that, the larger size of these large funds made them radically less nimble. Going back to the article, they wrote, size has become a burden. The sheer scale of some funds makes it harder for them to react by switching in and out of bets. So when volatility royal stocks bonds currencies and commodities earlier this year, a large number of giant players lost record amounts of money.

The eight months through August were ugly. Bridgewater Associates' flagship fund lost 18.6%. Renaissance institutional equities was down 13%. Winton's main fund slumped about 19% and so on and so forth. Andrew Beer, who's the founder of Dynamic Beta Investment, said, The irony is that the hedge fund industry was built on investing with small nimble managers who could exploit esoteric investment opportunities. The last several years have shown that sometimes big might be too big,

especially when fees consume most performance. The reason that I'm adding a hedge fund story into this podcast about pandemic fatigue is that it's all connected. Everything that we're seeing from the crypto markets to bankruptcies, to hedge fund failures, to zombie companies, to questions of the American workforce, they're all part of the same story. and I think that we can't ignore how they are interconnected.

If we just try to isolate them and look at them only in the context of themselves, we simply won't get the full picture. That's what I'm trying to do. That's what I'm trying to make sense of as we figure out what comes next. And I appreciate you hanging out while we go through it. So until tomorrow, guys, be safe and take care of each other. Peace.