Travel is back! We were in the Dominican Republic last week, our first international trip since COVID. It was...refreshing, in a lot of ways. The flight out of Logan crack-of-dawn early, so we stayed in an airport hotel the night before. There was a line at check-in, and the parking lot was completely full. Also full - the 4:30am shuttle bus to the airport in the morning. Literally every seat. Not "every available socially-distanced seat", every single seat in the thing. And the airport was the busiest we've seen since the Sunday after Christmas. The line for Cinnabon in BWI was a solid 30 people deep. Also, Terminal A in BWI is now open again, which it wasn't in June, November, December, or January.
Perhaps the most striking thing about the fellow passengers? It wasn't Spring Break week, the airport wasn't packed with families and little kids. It was mostly older folks. A lot of white hair, and way more Columbia, sneakers, and backpacks than Hugo Boss, oxfords, and briefcases. Have vaccine, will travel.
(As an aside, to get back into the States from overseas requires either a negative COVID test within 3 days or documentation of a positive test and recovery within the previous 90 days. Even if you've had COVID and recovered, we'd highly recommend going the negative test route. Watching the airline check-in employee try to make sense of a random lab printout and equally non-uniform clearance from a random state health department leaves a lot of room for translational errors. Just go with the standard lab report from their own country's labs that they're used to seeing.)
Relatedly, have you noticed how almost every restaurant or retail shop has a 'Now Hiring' sign posted in the window? At least they do up here. It makes us optimistic for what could be a rather booming economic recovery this summer, especially if vaccinations continue apace.
Which brings us back to the disconnect between financial markets and the underlying economic reality. The stock market bottomed on March 24th last year and was up around 40% through May while in real life, lockdowns were becoming more draconian and more and more businesses were getting shuttered.
We wonder if there will be any symmetry to this coming out the other side - businesses are hiring, travel is coming back, countries are reopening borders, economic activity is picking up...but this has already been effectively "priced in" by the markets. Is there much upside to be captured in stocks from economic growth when that growth merely confirms the underlying assumptions justifying such market levels in the first place? We shall see.
And on the flip side, might there be downside market risks independent of what's happening in the real world? It definitely feels like yes. So far this year, we've seen three pretty spectacular financial blowups. That's one per month, and the one that just hit over the weekend is the largest hedge fund blowup in over 20 years.
Back in January, Melvin Capital blew up during the GameStop fiasco, which we already discussed. By some reports, "blew up" was 50% losses in January - to the tune of $4B - but Melvin is still in business. This was a fairly straightforward case of a fund with poor risk management controls using excessive leverage and getting margin called. But behind the scenes, there was concern that a clearinghouse might fail, which is why they (the clearinghouse) jacked up margin requirements on Robinhood (and other brokerages), which is why you saw those trading restrictions in the individual stocks.
Earlier this month, Greensill Capital blew up. "Blew up" meaning a $7B or so enterprise value and 863 employees in 16 offices globally to bankrupt in a couple weeks. Greensill was into supply chain finance - a middleman who bought from suppliers that needed money and sold to buyers who wanted longer payment terms. No issues there. But! Then Greensill took the invoices (money owed from buyers) and packaged them into funds, and sold the funds to investors.
Well, technically, Greensill didn't sell the funds, Credit Suisse and other asset management firms did. I'm only going to paraphrase what happened with Greensill, if you would like a delightfully sarcastic yet disturbing pullback on the curtain of finance, read this article on Greensill from Ben Hunt over at Epsilon Theory.
The tl;dr is that Greensill lent a bunch of money to a UK steel magnate, and then got a portfolio manager to buy a boatload of the repackaged securitized loans. The steel companies were a little shoddy, the loans didn't get repaid, the portfolio manager got fired (as did the CEO of the portfolio manager's company), and lots of money vaporized.
But then! SoftBank puts $3B into Greensill. So Greensill loans more bunches of money to suppliers (that happen to be owned by SoftBank), but the loans end up being worthless because the suppliers are super dicey, so Greensill writes off the loans by converting them to common equity at an obscene valuation (determined by SoftBank) which makes it look like Greensill hasn't actually lost any money.
So these worthless loans from Greensill that Credit Suisse has been buying and has to know are worthless because that other asset manager blew up over them a couple years back...Credit Suisse keeps buying them! Good thing there's a friendly Japanese insurance company willing to give those loans a safe-as-a-money-market rating. Coincidentally, SoftBank put $500M into Credit Suisse funds after putting $3B into Greensill. Also coincidentally, Credit Suisse was lead advisor for Greensill's new capital raise four months ago at a valuation of $7B.
For some reason, the Japanese insurer stopped playing the game. Without the insurance behind them, the loans were revealed as worthless, and the whole scheme fell apart, and now Credit Suisse is in hot water, as is David Cameron (former Prime Minister of England and special advisor to Greensill), the governor of West Virginia (whose company borrowed $850 million from Greensill) and something like 35,000 jobs in the various steel supplier companies that are no longer getting any money.
The whole thing kind of rhymes with both 1MDB in Malaysia (except that was Goldman instead of Credit Suisse) and the subprime mortgage crisis in the US, doesn't it?
And then just this week, Archegos Capital blew up. Archegos had $10B under management last year, making this the largest hedge fund blowup since the ironically-named Long-Term Capital Management in 1998. Like Melvin, Archegos is run by a pedigreed hedge fund trader that was involved in a previous insider trading scandal. Like Melvin, Archegos liked to take outsized bets with massive leverage that evaded reporting requirements (except in this case it was total return swaps and certificates-for-difference instead of short positions).
Archegos apparently bet big on a handful of media companies. Like Melvin, something - perhaps in this case a failed stock offering last week by ViacomCBS - moved the wrong way and they got margin called. Unlike Melvin, Archegos's margin call is being reported as $20B.
That is not the kind of margin call that gets paid.
So Archegos is pretty much donezo, and all these prime brokers (investment banks) who loaned Archegos money to buy stock are now on the hook. By "on the hook", we mean holding a lot of stock collateral that's worth less than the money they lent against it. Reportedly, they all got together to try and figure out how to collectively exit the position with minimal losses. But then, in something out of the movie "Margin Call", Goldman Sachs apparently broke ranks and sold out of their position first in a massive block trade.
This started a fire sale of the media companies Archegos had bet on, as all the prime brokers started unloading their positions as fast as possible. Here's what a one-year chart of ViacomCBS looks like:
The red and green bars on the bottom of the chart are volume. That's what a multi-billion dollar block trade fire sale looks like. Here's Discovery:
Same thing. Largest-ever daily decline in both companies on more than 10x recent daily volume.
In terms of broader industry effects, ripples will continue being felt from this one for a while. There were at least six prime brokers involved with Archegos. Goldman and Morgan Stanley got hit the least, as they were the first to sell on Friday morning. Nomura is reporting something like a $2B loss as a result of Archegos, and Credit Suisse might be looking at more like $3-4B. Smaller losses at other firms total possibly another $1B, and that's not to mention the loss of capital at those banks (and everywhere else!) from the share price decline. Separate from their Archegos exposure as prime broker, Morgan Stanley is at least a 5% shareholder in 7 of the 8 Archegos media stocks being reported on and a 10% shareholder in 2 of them.
So. All in all a big start to the year for lessons of risk management and the perils of promoting speculative behavior with easy-money policies. We'll leave you with one last observation involving SoftBank - the following slides are pulled directly from their investor presentation downloads, without any editing. Seems perfectly legit to us!
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