Avalanche from Archegos shows cracks hidden beneath the surface


Financial markets experienced the equivalent of an avalanche last week. The trigger initially seemed trivial: American media group ViacomCBS’s share price slipped after the group decided (quite reasonably) to sell $ 3 billion in stock, in response to a particular near-tripling in its share price last year.

This fall inflicted heavy losses on the portfolio of the Archegos Family Office, which has been heavily exposed to Viacom. This in turn sparked margin calls and stock sales, as its major brokers attempted to liquidate Archegos’ portfolio to protect themselves. The rubble can create between $ 5 billion and $ 10 billion in losses for blue chip brokers, JP Morgan Chase said.

The good news is that this avalanche does not seem to have created serious systemic risks, since the banks seem able to absorb the blow. It’s a small victory for regulators who increased capital requirements after the 2008 global financial crisis.

But the bad news is that the episode exposes broader vulnerabilities in the financial system. After all, as any backcountry skier knows, avalanches usually don’t just happen from idiosyncratic shock, but because the underlying snowpack is unstable.

Last week’s debacle indicates that the system today is plagued with multiple, half-hidden cracks. On the one hand, there is an alarming lack of transparency on family offices, even if they have recently exploded in size and influence. There is even less clarity on the derivatives that Archegos used to make bets.

Investment banks continue to struggle to judge their prime brokerage risks, in part because of internal silos. Years of loose monetary policy have made financiers so jaded by soaring asset prices that few questioned whether the counterintuitive rally in Viacom’s stock price made sense, given the mixed fortunes of the world. ‘company.

Most striking of all, Archegos apparently operated with more than five times the leverage. This is comparable to the patterns seen before the 2008 crash and appears to have been “the very definition of insanity” given the concentrated nature of his portfolio, as financier Mike Novogratz said.

So was Archegos an anomaly? Or a trend? No one can say for sure, given the lack of transparency in the shadow banking world. But I believe the latter. After all, family offices are not the only part of the financial industry that has escaped effective control; just watch what recent Greensill scandal watch on supply chain finance. Viacom was certainly not the only stock showing particular price fluctuations; gyrations in the GameStop price were much more savage.

Indeed, if you scan the financial landscape, you may see several pockets of bizarre pricing behavior – or foam. Take Bitcoin: the price of a coin had a nine-fold increase Last year. Crypto evangelists argue that this makes sense given the threats of inflation on fiat currency and the increased acceptance of crypto assets by the general public. Perhaps. But the sheer scale of the rally suggests that large, unseen speculative coins are also at work.

Or, for an even more colorful example, look at the exorbitant prices charged for “non-fungible tokens”, Or unique cyber collectibles. Newly created crypto gazillionaires who are now diving into this realm attribute these high prices to scarcity: NFTs are meant to be unique. But the market has not been tested and if someone cracks the code to replicate NFTs, the whole investment thesis will implode.

Or for a more common example, consider green stocks such as Tesla. The electric vehicle maker’s share price has risen about 600% over the past year, amid the hype (and bizarre projected evaluations) by investment groups such as Ark. Part of this rally could be justified by the news White House support for electric vehicles. However, Tesla’s popularity also reflects a shortage of green assets last year, relative to growing investor demand – and that could easily change if, for example, automakers produced more electric vehicles.

Or think about the corner of technology known as software as a service. SaaS companies with the most optimistic forecasts for next year’s earnings are now valued on the stock market at around 40 times earnings, on average, according to calculations presented to me by some venture capitalists. Before 2019, the average was 11 times closer.

It might make sense if you think that last year’s digital service boom will continue indefinitely. This is not the case if last year’s coronavirus lockdowns simply pushed forward demand for future digitization, which seems highly likely.

Make no mistake: I don’t foresee imminent avalanches in all of these areas; nor suggest that these are the worst examples of speculative scum. What happens in certain parts of the sphere of special purpose acquisition vehicles and the world of junk bonds could be worse.

But the key point is this: Archegos’ rubble shows that years of excessively loose monetary policy not only left asset prices high, but also created half-hidden pockets of leverage. When the two collide, disaster can erupt. And the big problem today is that, even though the price scum is visible, it is extremely difficult to say where the pockets of excessive debt are, or how the exposures are interconnected, because shadow banking is so not very transparent.

So it is a tragedy that the Trump administration so seriously undermined the Office of Financial Research, the body created after the 2008 crisis to monitor interconnected risks. Doubly, because if the Federal Reserve (and other central banks) keeps negative interest rates in place, this financial foam could soon exceed anything seen in 2000 or 2007. As with snow, an area of sparkling market can conceal hidden and widening cracks. .

gillian.tett@ft.com



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