April 2, 2021

The dumbest financial story of 2021.

If you, like me, are a casual consumer of financial news, many of 2021’s biggest…

If you, like me, are a casual consumer of financial news, many of 2021’s biggest stories have felt dumb, even by our increasingly high standards for things to feel dumb.

GameStop’s stock exploded for reasons unconnected to its underlying business, nosedived when a stock trading app decided to lock out its devoted customers from trading that hugely popular security, then rose again later. Something called a SPAC has become all the rage in mergers and acquisitions. What is a SPAC? Well, it’s nothing—a blank check inside of a shell, more or less. But then Alex Rodriguez or Paul Ryan (they are the same) gets involved and whoosh—there’s a special purpose acquisition company allegedly worth $300 million. Something called a non-fungible token has helped unremarkable pieces of the internet sell for huge sums—anything from a LeBron dunk anyone could watch on YouTube ($208,000) to a screencap of a newspaper column ($560,000) to JPG file of some art ($69 million). Additionally, a big boat got stuck in a canal, causing billions upon billions of dollars in shipping problems.

All of that was bizarre, but in retrospect it wasn’t exactly dumb. Those tales have a certain simplicity. GameStop boomed because a bunch of people realized if they bought something over and over, the price would go up. NFTs capitalized on a timeless human desire to own something “exclusive,” even if it looks like countless other versions of the same thing. Even SPACs are just following in an American tradition of people having money thrown at them because they are rich, cool, or well-connected. And the Suez Canal shipping saga makes immediate sense even to our youth. A big thing got stuck, and money stopped moving.

In fact, the dumbest money story of the year happened only in the last few days, when something most of us had never heard of collapsed and dragged some of the world’s most esteemed financial institutions into the mud alongside it. The swift fall of Archegos Capital Management is one of the most embarrassing financial plotlines in years, not just for a handful of banks but for an entire financial and governance system that really shouldn’t have let any of this happen. It takes a lot of malfeasance for giant banks to do something in 2021 that would make a neutral observer think, Wow, it’s legitimately shocking they did that. But life is full of surprises.

To get across how absurd this story is, we might start in 2012. At the time, Bill Hwang was the portfolio manager of Tiger Asia Management, a hedge fund he founded. That year, Hwang pleaded guilty to insider trading and agreed to a $44 million Securities and Exchange Commission fine. The SEC said Hwang and his business had short-sold three Chinese bank stocks based on inside information—borrowing the shares, selling them high, and aiming to buy them back low and pocket the difference.

It wasn’t just insider trading, though. According to the SEC, Hwang also got private shares of the stock at a significant discount from the market price, allowing him to profit in even further illicit ways. The SEC also said Hwang “attempted to manipulate the prices of publicly traded Chinese bank stocks in which Hwang’s hedge funds had substantial short positions by placing losing trades in an attempt to lower the price of the stocks and increase the value of the short positions.” All of it enabled Hwang and his fund to collect more in management fees from their investors. There are lots of white-collar crooks playing at a high level, but based on the SEC’s description of Hwang’s actions, he was less a garden-variety fraudster than a triple-crown winner of financial cheating: an insider trader who got unfair market discounts and tried to manipulate prices through other means. That is the kind of bulk quantity that would get someone a lifetime ban from trading if we lived in a more functional and just society.

Of course, we do not live in that society. Hwang closed his hedge fund and opened a family office, which functions like a hedge fund but manages the assets of just one or a few wealthy families. In theory, a family office gives a problem trader less opportunity to harm others, because they are not playing with outsiders’ money.

In the case of Hwang’s Archegos Capital Management, it didn’t work that way. Hwang’s office managed enough money and had enough assets that it turned out it could move markets and could screw things up for plenty of other people. Some of that was because Hwang is (was?) very rich, but the bulk of the problem appears to be that some giant banks looked at his all-world résumé of financial wrongdoing, then looked at his deep pockets, and decided, “Yes, we would like to do business with that guy.”

Among the banks that extended Hwang lines of credit were Japan’s Nomura, Switzerland’s Credit Suisse, and Wall Street’s Goldman Sachs and Morgan Stanley. As recently as 2018, Goldman had Hwang on a blacklist and would not do business with him, according to Bloomberg News. But at some point, Goldman lifted that ban. Maybe it was because Hwang demonstrated he was a reformed man who posed no risk to markets or Goldman’s business. Or maybe it was because the bank cared about collecting management fees to pad its coffers, no matter the risk to its own interests or other investors. We may never know.

Hwang used these banks to place leveraged bets on a handful of stocks in particular. They included ViacomCBS (because who wouldn’t want a piece of Paramount+?), Discovery, and the Chinese tech company Baidu, among others. Some significant portion of Hwang’s holdings was in swaps, the New York Times and others reported, which might have concealed both Hwang’s identity and the size of his holdings in certain stocks. (In a swap, as Forbes explained, parties can tailor trades for each other and avoid some federal disclosure requirements.) The Times believes banks were doing business with Hwang without knowing other banks were making the same deals.

Lo and behold, the leeway these banks gave Hwang turned out to be a problem. ViacomCBS’s stock price was doing well, and so the company tried to issue $3 billion in new stock. But an influential market researcher issued a report that said ViacomCBS’s stock was actually worth much less than the company was issuing it at: $55 instead of $85. That report spooked investors, triggered a sell-off, and lowered the price of the stock. It was bad news for anyone who had a ton of ViacomCBS stock—someone like Archegos Capital.

When someone trades on margin—with borrowed money—they may have to maintain a certain amount of collateral to satisfy their lenders. If the value of a stock holding goes down, the investor needs more collateral. Not having it triggers a margin call, where the lender can force a sell-off of the stock to bring the investor back into compliance with margin requirements. The Wall Street Journal reported that Archegos’ various banks—including Credit Suisse, Nomura, Goldman Sachs, and Morgan Stanley—had a meeting to discuss how to effectively wind down the family office’s positions. But the two American banks appear to have had little interest in acting slowly. Goldman and Morgan Stanley limited their losses by selling Archegos’ shares quickly, before the size of the sale brought on a larger fall in the stocks’ prices.

Thousands of people, as well as several companies, took on huge losses not because they did anything wrong, but because a handful of huge banks decided to bet on one shady securities trader.

Nomura and Credit Suisse were left holding the bag. Nomura said it could lose as much as $2 billion due to “transactions with a US client.” Credit Suisse’s losses are unclear, but the bank said its losses could be “highly significant and material to our first quarter results.” Both of the banks’ stock prices plummeted on Monday, after the news sank in over the weekend. That this would occur days before the all-important end of a quarter makes it all the more absurd.

Archegos reportedly had exposure to at least eight stocks that lost a combined $35 billion in market value on Friday alone, based on Business Insider’s tracking. When the family office’s margin call led to a sell-off of around $30 billion in assets—only about $10 billion of which represented its own money—those stocks were caught in the crossfire. Some have since recovered a bit, though ViacomCBS’s stock graph looks like a cliff. Anyone who owns any of those stocks—and a lot of these are common, big-name stocks that could be held by anyone—took a bath because of the Archegos margin call. Countless people might have felt the effect of the ripple.

Which brings me back to my thesis: Archegos’ collapse is the dumbest financial thing that has happened all year. It features thousands of people, as well as several companies, taking on huge losses not because they did anything wrong, but because a handful of huge banks decided to bet on one shady securities trader with a demonstrable history of being a crook. A couple of those banks then exacerbated the crisis when, to cover their own asses, they quickly sold off their own ends of the deal and abandoned any pretense of a more orderly wind-down.

All of it is much more outrageous than a bunch of people on the internet deciding to juice the price of a given stock, or someone spending $10,000 on a video of a layup in a regular season NBA game, or anything else 2021 has brought into vogue. If there is any positive to come from this story, it’s that if a group of bankers can be so badly burned by someone less than a decade removed from getting popped for insider trading—someone no one should ever mistake for a reliable partner!—then the rest of us can do anything we set our minds to. We might even be able to make lending decisions for investment banks.