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Unrenowned Hedge Fund Causes Chaos on Wall Street

March 30, 2021

The names of the key players are different, but the lessons similar. The spectacular implosion of hedge fund Archegos Capital Management, much like the famed Gamestop saga earlier this year, serves as a reminder of the dangers posed by extreme leverage, secret derivatives, and rock-bottom interest rates.


Stocks of media companies crashed Friday as Wall Street banks that lent to Archegos forced the firm to unwind its bets. The epic firesale wiped out more than half of Viacom's value last week alone.


Major banks face billions of dollars in losses from their exposure to Archegos. Both Credit Suisse and Nomura tumbled Monday after warning of significant hits to their earnings.

The most startling part about the tale of Archegos is that it is a firm that few people had ever heard of before this weekend. And yet in this era of easy money, Archegos was able to borrow so much that its failure created shockwaves large enough to ripple across Wall Street — and impact everyday Americans' retirement accounts.


In January we were all glued to the news and the stock market when another hedge fund, Melvin Capital Management, nearly collapsed after its massive bets against Gamestop were blown up by an army of traders on Reddit. Investors were surprised to learn about the sheer size of the short positions anticipating the video game retailer's stock price would fall.


When Gamestop shares instead went to the moon, Melvin Capital suffered staggering losses and was forced to reach a $2.8 billion bailout with larger rivals.


Archegos Capital was using borrowed money — apparently a ton of it — to make outsized bets that propped up media stocks. This type of excessive leverage is made possible by extremely low interest rates from the Federal Reserve.


The full scale of these bets wasn't clear until now.


Perhaps in an effort to avoid making public disclosure filings, Archegos reportedly used derivatives known as total return swaps to mask some of its large investment positions. Investors using these swaps receive the total return of a stock from a dealer and those returns are typically amplified by leverage.


Typically, investors who own more than 5% of a stock are required to report that stake with the SEC. These filings do not appear to have been made this time.


The share sale that broke the camel's back


Seeking to capitalize on its skyrocketing stock price, ViacomCBS announced plans for a $3 billion share sale. Up until that point, ViacomCBS shares had nearly tripled on the year. But the share sale appeared to be too much for the market to handle and the media boom morphed into a rout.


Archegos faced margin calls from its Wall Street lenders. A margin call by a broker requires a client to add funds to its account if the value of an asset drops below a specified level. If the client can't pay up — and in this case, Archegos apparently couldn't — the broker can step in and dump the shares on the client's behalf.


Goldman Sachs, one of Archegos' lenders, seized collateral and sold shares on Friday, This so-called forced liquidation set off a bloodbath Friday that drove down shares of ViacomCBS and Discovery more than 25% apiece.


Credit Suisse said that the default by a "significant US-based hedge fund" would cause a major hit to its earnings. Based on reports we can tentatively confirm that Archegos was the firm causing the losses for Credit Suisse.


Nomura said its losses could be as much as $2 billion from "transactions with a US client."


Archegos hasn’t yet made a comment about the crisis at the time of writing.


 




Image Source: Getty Images