One of the features of a banking crisis is that there is so much that is familiar each time. Even if I may be permitted to leap into the future the inevitable enquiry that tells us it will not be allowed to happen again. Also it is quite rare that a blow up is alone as bankers are pack animals and copycats and if they see business elsewhere will rush to mimic iy So right no now doubt teams are being dispatched to make sure that other banks keep out of the news headlines if they can. As the story unfolds were see another issue which is a blow up like Archegos puts others in the firing line as it liquidiates
Archegos Capital
Let us open with a note of the scale of the issue here.
Losses that triggered the liquidation of positions approaching $30 billion in value bring to light complicated financial instruments used by European investors that are effectively banned in the U.S. but could still have spillover effects domestically. ( MarketWatch )
Okay so even in these times US $30 billion is a chunky sum to try and liquidate in one go. I also note the use of “effectively banned in the US”. It sounds as if they are not quite so sure.
There is an issue with the trades in that they were a type of over the counter or OTC product where you deal direct with someone. This poses issues as what if one side cannot pay? Anyway below is a description of hat was taking place. CFDs are Contracts for Differences.
CFDs are a kind of derivative instrument that allow traders to place a directional bet on the price of a security without actually buying or selling the underlying instrument, Julius de Kempenaer, senior technical analyst at StockCharts.com, explained to MarketWatch via email.
“It works much like a futures contract on, say, an index. The buyer and the seller agree on the price of a transaction sometime in the future. At the end-date, or earlier if they decide to unwind the position beforehand, only the difference between the actual and the agreed price will be settled.”
“If the price went up the seller pays the buyer the difference, and vice versa,” the analyst wrote. ( MarketWatch )
The issue here is the differences between this and a futures contract, It will have standardised rules and as well will have clearers that in the event of a failure will protect trades in the market. Who you trade with does not matter whereas in the case of a CFD it matters a lot.
That gets added to when we note this.
The StockCharts.com analyst explained that CFDs are leveraged bets, where investors can use borrowed money at a fraction of the cost of the underlying asset, “typically around 10-20% depending on the volatility of the underlying market.”
“This means that you can get a position worth $1 million and only need $200,000 in margin. That allows building big positions very rapidly without a lot of market impact,” he said. ( MarketWatch)
Hang on as that is not quite right. You can build a big position without having to put up much cash as in this instance you are geared five times. So five times the profit if times are good but also five times the losses if things go the other way. Returning to market impact that is a risk transferred to the counterparty. Depending on how they hedge whether it be by stock purchases or options you could have a rather large market impact if they hedge a position with a delta of five. If you have followed the story of GameStop you will know that this sort of thing was supposed to increase market impact as those dealing with geared customers ( in this instance options) went and hedged the position. As an aside GameStop is at US $181 so something if still going on there.
There is another risk here and we get this if someone has geared five times but is at that limit with that counterparty. If they then go elsewhere there is an obvious issue.
On top of the leverage, sources reported that Hwang may have been able to obscure his investment fund’s exposures by using multiple banks to execute the firm’s trades. ( MarketWatch )
Reuters are keen to emphasise the leverage here.
Archegos had assets of around $10 billion but held positions worth more than $50 billion, according to the source, who declined to be identified.
The Banks
The issue here is that they are on the other side of the gearing so have five times the risk. Also their risk is with only one counterparty unlike on an exchange where risks are pooled and managed via the clearing system. On the other side they get commission and take a spread from the CFD trading. So it starts well on the income side and should a fund trade actively then the income rises and those responsible look towards big bonuses. But at the same time risk is rising in two ways. The first is that to get that income the bank is taken an ever bigger risk with one counterparty. The next as it continues to grow is that the stock or equity invested in can get swamped too. We see that from what happened to one.
The sales approached $30 billion in value, some of the people said, and fueled a 27% plunge Friday in shares of ViacomCBS—an unusually large decline in a widely held, large-capitalization stock on a day with no significant company-specific news. ( Wall Street Journal)
There are all sorts of issues here because we have a case of the Grand Old Duke of York as the share price for Viacom is US $45 as opposed to the peak of US $101 last week. So we see the liquidation effort tumbling the price. But as the share has been as low as US $11.92 in the last year what is a fair price? Archegos has pumped and dumped the price leaving some investors with Blood Sweat and Tears.
What goes up must come down
Spinning Wheel got to go ’round
Talkin’ ’bout your troubles
It’s a cryin’ sin
Ride a painted pony
Let the Spinning Wheel spin
You got no money, you got no home
Spinning Wheel all alone
So in a sense Viacom is a sort of victim although it has at times been a beneficiary. Oh what a tangled web and all that….
Losses
Due to the way the financial week opens the first news came from Japan.
Nomura is currently evaluating the extent of the possible loss and the impact it could have on its consolidated financial results. The estimated amount of the claim against the client is approximately $2 billion based on market prices as of March 26.
Next up came an organisation that seems to have set Deutsche Bank as its role model. Credit Suisse got itself into rather a mess with Greensill Capital and the losses this time around seem to be mounting.
CREDIT SUISSE POTENTIAL LOSS ON ARCHEGOS MAY REACH $7 BILLION EQUIVALENT TO TWO YEAR PROFIT – SOURCE ( @acpandy)
This brings in another feature where we get the news like it has notches on a rope as @Rifleamp points out.
Last friday, they said 2 billion loss. Monday 4 billion. Now 7 billion. What is wrong? Market is up everyday.
Someone may also have come up with a “cunning plan” for hedging the loss. I have seen one or two of these in my time. What happens then is a situation that you think cannot get any worse does. For example I once saw a US $250,000 loss converted into a US $1 million one via that route.
There will be a litany of smaller casualties of this particular war as well.
*MITSUBISHI UFJ SECURITIES SEES $300M LOSS TIED TO A U.S. CLIENT ( @lemasabachthani )
Comment
There is a familiar list of issues every time. Let me start with one I have not mention so far is that one should always get nervous when an investor or hedge fund gets lauded. Obviously some are better than others but that is not the only reason for out performance. Then there is the issue of trading in size with one counterparty where apparently both are winning. Next we get leverage where you get a position you cannot afford but also by that definition can lose more than you can afford. Unlike with buying a call option where there is a stop loss provided by the option price.
Switching to the banks they have the issue of balancing income ( fees and commission) with risk. This so often hits the issue that when someone is encouraged to get more income the risk goes up to. That is fine until it isn’t when it is usually too late.
So we are left wondering how many share prices have been pumped up by this sort of leverage? Then how many will go wrong? That matters because whilst these schemes inflate bankers bonuses when they go right, when they go wrong in scale they tend to end up with the taxpayer footing the bill.