A Tiger Can't Change Its Stripes
March 30, 2021·32 comments·Money
Regulatory crackdowns since 2009 were supposed to eliminate the insider trading playbooks that built fortunes in finance. But convicted fraudsters never disappeared. They just learned new structures. When a criminal gets caught, serves probation, and then major banks hand him billions in leverage again, it raises a question: did regulation actually stop anything, or did it just make wrongdoing harder to see?
• Conviction became a speed bump, not a barrier. Bill Hwang pleaded guilty to insider trading in 2012, paid $60 million, and was sentenced to probation. Within years, he was back running a fund with tens of billions. The system had a mechanism to stop him. It chose not to use it.
• New instruments made old crimes invisible. Instead of buying stocks directly, Archegos used total return swaps. These derivatives gave Hwang massive leverage (5x or more) while leaving no regulatory footprint. He could run the same collusion and manipulation playbook that got him convicted, but now the SEC couldn't track his trades.
• Banks knew exactly what they were doing. The prime brokers understood that swap positions worth billions, hedged "risk-free," generated fees regardless of what happened underneath. They also understood they were doing business with a known criminal. The calculus was simple: the profits outweighed the risk.
• Something forced their hand on Friday. The Archegos portfolio wasn't blown out by losses. It was liquidated by Goldman Sachs and Morgan Stanley in a coordinated "margin call" that crushed counterparty banks like Credit Suisse and Nomura. This suggests the banks had information that couldn't be ignored anymore.
• If there are dozens more like him, what does that mean for markets? One convicted fraudster with billions in leverage produced squeezes, corners, and distortions that rippled through the entire system. The question isn't whether Archegos will blow up again. It's whether we're already inside the blowup of the next one.
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Comments
This is a good note, and a lot to unpack here. The one standout issue though is that it seems to put ET back decidedly in the deflationary camp. That doesn’t help our own internal Widening Gyre of polarization between investors in the inflation or deflation camps. We’re forced to build schizophrenic portfolios where there can be only one right answer to the inflation/deflation question, and it absolutely is an all or nothing bet.
Pretty much every problem in the US financial system boils down to leverage. A 10-year plan to reduce financial system leverage to near zero would be useful. Fairly easy to implement but probably impossible to pass until after the next collapse.
Agree 1,000%.
Ben makes the point that we need to have Clear Eyes that the behavior that has been enabled by the leverage, and passed off as normal market action by Wall Street missionaries, is rarely noted. It is the inevitable unwinds that get the attention when they are two sides of the same coin.
Not sure if that’s the case. You could have substantial blowups of Raccoon financiers AND still have runaway inflation. Not mutually exclusive.
But I also think Ben would say that ET is not ‘predicting’ inflation. I.e. their not giving an answer to the problem. They’re simply pointing out that there is an inflation narrative and that runaway inflation would also break a great many things in our world and folks are not prepared for it. This fits squarely in the min-max framework on how one should think about inflation risk.
Would that include eliminating fractional reserve banking?
In retrospect, it was a bad idea for Credit Suisse to hire the Maytag Repair Man to run the company’s internal risk controls.
On another unrelated note, Credit Suisse–the guys who have to unload a metric ton of Viacom–just raised their rating on Viacom today. I’m sure that was a coincidence.
Love those Chinese Walls! Can you say that anymore?
Torturing another reference from my generation, it is more likely Crazy Eddie, infamous for bankrupting the consumer electronics chain while loved by Wall Street, is in charge of risk at CS!
Excellent piece Ben. Clearly Huang is a shady character and has crossed some boundaries over his career but I do however feel that Julian Robertson ran a reputable shop. I dealt with them in the 90s and found them to have the highest integrity of all the big funds at the time. Perhaps some of his Cubs have strayed but the reason their performance and popularity is so high is that they have been able to generate massive alpha in the post Reg FD environment.
The real story here is that the AW Jones Model that Robertson executed has been given massive leverage by PBs. Gross leverage in these funds at 300% is not uncommon and there is a massive crowding in the names they own. The vulnerability of any strategy is popularity and to generate the same returns funds are having to add more and more leverage. This never ends well
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