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Soapbox: Archegos and more toxic bank lending

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A mammoth container vessel gets stuck in the Suez Canal and creates a bottleneck in global trade. Total trading losses from the grounding are calculated at $54 billion. Meanwhile, a ‘family wealth’ firm called Archegos – from the Greek, meaning ‘the one that takes the lead’ – blows up, leads to mammoth losses for banks, and jolts the stability of the global financial system. With another $10 billion down the drain.

A black swan event is something unpredictable, beyond what is normally expected. The grounding of the container vessel Ever Given in the Suez Canal was unpredictable and unexpected – but surely the implosion of Archegos was built-into the financial system, which seems to have learned nothing from the Great Financial Crash of 2007-09? Given the way that banks still operate, where massive leverages (using debt to invest) are commonplace, an Archegos event was just waiting to surface. What is worrying is that, thanks to banks having learnt little from the 2007-09 debacle, there may be more Archegos’ lurking.

Some recent notable ‘black swan events’: Source: Visual Capitalist

 

‘Family office’ sounds cozy

Archegos is (or maybe that should be ‘was’) a ‘family office’ that traditionally handles investment and wealth management for a wealthy family, generally with at least $100 million of investable assets. It started life in 2013. As of last year Archegos managed $10 billion.

That definition – ‘family office’ – is important.

After the Great Financial Crash of 2007-09 the US tried to tighten its scrutiny of the financial services industry. It passed into law the ‘Dodd-Frank Wall Street Reform and Consumer Protection Act’. This was intended to restore stability and resilience to the financial system. However, as the former Economist financial journalist David Shirreff said in his excellent short book, which called for a ‘banking revolution’ after the 2007-2009 systemic meltdown, “the Dodd-Frank Act of 2010…lost its edge in the course of implementation”.

Critically all ‘family offices’ are excluded from some of the criteria of the definition of ‘investment adviser’. The Private Investor Coalition or PIC, which was formed in 2009 and is an opaque “coalition of single family offices” proudly lists as one of its ‘accomplishments’ its successful lobbying in Washington D.C. to get family offices exempted from the US Securities and Exchange Commission (the SEC – America’s financial watchdog) registration as financial advisers.

Archegos was created by Bill Hwang, formerly of Tiger Asia Management, a multi-billion dollar hedge fund. In 2012, Hwang pleaded guilty on behalf of Tiger Asia Management to US charges of fraud. The charge was that through insider trading the firm gained $16 million of illicit profits in 2008 and 2009.

The primary holdings of Archegos were in total return swaps, an arcane financial instrument whereby the underlying stocks are held by banks – which meant that Archegos had no obligation to disclose its large holdings, which it would have had to do if it had dealt in regular stocks.

 

 

How does a man with a criminal record for insider trading get to manage a ‘family firm’? And is that ‘family firm’ definition a mere fiction, constructed so as to avoid SEC scrutiny?

There could be as many as 10,000 ‘family offices’ around the globe, with around $6 trillion of assets under management. The Investment Advisers Act of 1940 – from which ‘family offices’ are excluded – requires registration with the SEC. Had Archegos not been able to elude the SEC’s supervision, it would never have got off the ground – registration with the SEC fails if “the adviser or one of its employees has” committed a securities-related crime.

What has happened?

As recently as 2018, Bill Hwang was deemed by Goldman Sachs to be so risky that it refused to do business with him. That blacklisting didn’t last long. He soon became a valued (and valuable) client of Goldman Sachs, which was joined by the likes of Morgan Stanley, Credit Suisse, Nomura and other investment banks who formed an orderly line to lend him billions of dollars so that he could make his highly leveraged bets on the US media companies ViacomCBS and Discovery, and various Chinese companies such as the internet company Baidu.

Wall Street analysts had begun to feel uncomfortable about the speed of the stock price rise of some of these companies – ViacomCBS had surged past $100 from $14 and Discovery had climbed from $30 to $80 in a few months – and they started to downgrade them, triggering downward spirals in their price.

By Friday last week, the value of Archegos’ holdings had dropped and his banks started to make margin calls – asking Archegos to deposit additional money, or sell some of stock. Archegos started to sell and is thought to have sold shares worth $3 billion, triggering a wider sell-off and price falls, not just in the shares held by Archegos but also the banks that had extended credit to Archegos. The share price of Nomura and Credit Suisse fell by more than 10% on Monday this week.

As in 2007-09, bankers have again been seduced by greed and shown themselves unable to assess their own exposure to risk. In the words of the Financial Times: “Hwang was seen as a compelling prospective client by prime brokers, the potentially lucrative but risky division of investment banks that loans cash and securities to hedge funds and processes their trades. Concerns about his reputation and history were offset by a sense of the huge opportunities from dealing with him…The fee-hungry investment banks were ravenous for Hwang’s trading commissions and desperate to lend him money so he could magnify his bets”.

 

What will happen now?

It’s possible – but unlikely – that we could be headed for a repeat of the 2007-2009 years, when banks blew themselves up via complex derivatives based on their over-leveraging. Some are optimistically pointing to the fact that banks are much better capitalised today, so are more able to withstand this kind of shock. Yet it is thought that around 10 banks racked up more than $50 billion of credit exposure to Archegos. The biggest fear is that what happened at Archegos could be the start of a domino effect; another Japanese bank, Mizhuo, has started an internal investigation into possible losses resulting from its involvement. Two others – Nomura and Mitsubishi UFJ – have warned they face losses of (respectively) $2 billion and $270 million.

Scarcely a decade after the last financial implosion regulatory control and banks’ self-supervision has failed once more. David Shirreff wrote that “‘sophisticated finance’ has developed into a self-serving, self-congratulating culture”; a culture that clearly – from the evidence of the banks’ failure to scrutinise Archegos – remains a threat to the preservation of financial value.

And that’s why Glint was created in 2015 – to enable everyone to own gold, to use gold as money, regardless of how rich or poor. And to be free of the kind of banking culture that is too cavalier about risk. Placing money on deposit with banks is no longer as safe as it used to be. Placing money in gold with Glint does not carry those banking risks – the gold is physically allocated to you (meaning no-one else but you can touch it), and is held in a secure Swiss vault.

Around the campfire: “Don’t say that – I’ve just bought a house”

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When I had the idea for Glint during the global financial crisis of 2008, it seemed obvious to me that the world deserved a reliable form of money. We all needed a form of money that insulated you from the destructive effects of inflation and from potential breakdowns in the highly leveraged financial system. To me, then and now, the answer was – incorruptible gold.

The everyday man and woman on the street easily understood the idea. My mother would often say: “Son, money doesn’t buy you what it used to.” London cabbies would tell me that “gold, always holds its value”. Experienced high net worth individuals, those who had worked hard through cycles of booms and busts over the last 50 years, they also got it.

But many of the younger analysts and fund managers, those who control the wallets of the big venture capital companies, didn’t get it. They had never experienced double-digit interest rates or difficult recessions.

The 2008 crisis was not allowed to play out. Instead of toppling over the economy was propped up by huge amounts of central bank stimulus. That led to the biggest period of growth seen in over 100 years. No bad thing one might think. Except, what was that growth built on, apart from illusions and credit?

The existing monetary system benefitted some people hugely, even during that 2008 crisis. Easy for them to get a multi-million mortgage; money poured into the funds they managed, fat bonuses returned.

I remember saying to one investment committee that just because house prices were going up in London, it didn’t mean that they always would, and explaining that a house in Japan worth 16 million in 1990 was now, twenty years later, worth 5.5m. The head of the committee looked alarmed and said: “Don’t say that, I’ve just bought a house”. It was probably a very nice and expensive house that was paid for with money lent at very low interest, nearly free, of course only available to those who has a big enough deposit. They were clearly quite short sighted… they didn’t invest in Glint.

Glint continued to find funding from contrarian investors, including many individuals who have worked hard all their lives to build up their wealth. People who have experienced the cycles of boom and bust and who worry about where the global economy and central bank policy is heading.

Covid-19 slammed us into this economic crisis, one that many had expected, but which has turned out to be far worse than anyone imagined. Most people in the investment community that I speak to are now extremely worried about the economy and global debasement of foreign currencies, thanks to the vast government borrowings that have been built up in the space of a few weeks. Suddenly it seems, I am not the daft contrarian, but we at Glint may argue, the visionary.