Wall Street issues another cautionary tale as Archegos Capital Management, a low-key but high stakes hedge fund, ended up imploding. As ViacomCBS, Discovery and other media titans' stocks crashed Friday, Wall Street banks forced the hedge fund to liquidate its bets. The epic firesale wiped out half of Viacom's value last week alone, and the bleeding isn’t stopping.
Billions in Losses
Major Wall Street firms are facing billions of dollars in losses from their exposure to Archegos. Credit Suisse and Nomura stocks fell after they warned investors of their involvement. Archegos, while being a relatively low-key firm, managed to borrow obscene amounts of money. And when they imploded, shockwaves ripped through the financial sector and impacted many client accounts.
Art Hogan, the chief market strategist at National Securities Corporation, thinks that banks should have learned their lesson by now. “It's a wake-up call. With leverage, comes risk. This is the second time we've learned a lesson this year about leverage,” he noted. Earlier this year, Melvin Capital Management almost went belly-up after betting on the imminent demise of GameStop (GME), a video game retailer. Instead, activist investors propped up GME’s stock and forced Melvin to cover its losses with a $2.8 billion bailout. “We saw it on the short side when GameStop blew up. Now we are seeing it on the long side,” Hogan said.
Hidden in Plain Sight
Archegos Capital, funded by controversial investor Bill Hwang, began using borrowed money to prop up media stocks. The Fed’s low-interest rates apparently helped make this flood of borrowed money available for hedge funds such as Archegos. In addition, Archegos positioned itself as a family investment vehicle owned by Hwang, which helps it escape scrutiny like other public firms.
Archegos essentially borrowed money from banks to take huge positions in companies and continue to trade in anonymity. Meanwhile, analysts believe that the hedge fund’s exposure to companies such as Viacom and Discovery is more than 10%. Usually, large shareholders identify themselves as insiders and are subject to additional regulations. Instead, Archegos continued to stay hidden in plain sight.
By dealing via total return swaps, Hwang managed to evade disclosure of his transactions even.
Ultimately, the strategy backfired as the stocks Archegos backed up began falling. First, Viacom tried to capitalize on its booming stock price by announcing a $3 billion share sale. Instead, This complex strategy backfired last week. Seeking to capitalize on its skyrocketing stock price, ViacomCBS announced plans for a $3 billion share sale.
However, the market didn’t exactly warm up to the proposal. Instead of the foreseen gain, the move sent prices plunging. Then, as prices fell Archegos faced margin calls from its Wall Street lenders, including Nomura, Goldman Sachs, and Credit Suisse. Once Archegos couldn’t pay up, the banks seized their stock holdings and sold them, pushing prices down even more. While the banks did not mention Archegos by name, they said they suffered losses to cover defaults by a “major hedge fund.”
Who is to Blame?
As Wall Street started picking up the pieces, questions arose on why Archegos managed to get so many backers. During its previous incarnation at Tiger Asia Management, the SEC charged the firm and Hwang with wire fraud related to illegal profits of up to $17 million. This caused the hedge fund to undergo probation for a year and forfeit its $16 million earnings. Major banks moved on from Tiger Asia and Hwang after the scandal.
Meanwhile, Hwang reinvented his company and named it Archegos. He also registered it as a family investment vehicle to avoid public scrutiny. Soon, the large banks gravitated back to Hwang and served as advisers to his appetite for large deals. Then, Viacom happened. And it’s back to square one. The sure loser? Viacom and the other stocks.
Watch the CNBC News video reporting how Archegos Capital bypassed U.S. regulation:
What do you think will happen next as big banks will now recoup their losses in the wake of hedge fund Archegos’ implosion? Who should take the blame for this situation? Let us know what you think by sharing your comments below.