Watching Bill Hwang’s Archegos Capital Management hedge fund stumble triggers more traumatic memories than veterans of global finance like to admit.
For many, the parallels between the 1998 explosion in long-term capital management and Hwang’s forced liquidation of more than $ 20 billion in shares on March 26 were too strong to be reassured. The details differ, but the underlying forces – heavily leveraged positions that collide with the Hubristic belief that past crises cannot happen again – are essentially the same.
And, unfortunately, another LTCM-like crash could be next.
That’s the message Nouriel Roubini sends to television screens and podcasts in Manhattan, where the economist teaches at New York University’s Stern School of Business. It’s not easy to ignore Roubini, who is part of a very small group that can credibly claim to have predicted the 2008 global financial crisis. However, we often wish he was wrong.
Sadly, Roubini appears to be on to something as he warns of negative borrowing costs in the developed world and epic budget laxity has pushed risk-taking into the stratosphere. Cycle-corrected price / earnings ratios are, according to Roubini’s calculation, the highest since 1929 and the early 2000s.
“We are seeing widespread foam, bubbles, risk taking and leverage,” Roubini told Bloomberg last week. “A lot of players have put on too much weight and too much risk and some of them are going to explode.”
Roubini, known as “Dr. Doom, ”believes the most obvious trigger will be the rise in yields on US Treasuries above 2%. This could panic investors of all asset classes and trigger powerful selling waves.
This is especially the case here in Asia, the region that holds the largest US Treasury debt. It could gain momentum of its own, driving up corporate, mortgage, asset and municipal debt rates. A rise in yields would also lead to sharp revaluations of stock prices.
This scenario of soaring Treasury rates also frightens Goldman Sachs analysts. Scott Minerd of Guggenheim Investments is concerned that further Archegos-type shocks may be possible as 2021 unfolds. And the prospect sends waves of anxiety to Tokyo.
Hwang, a New Yorker born in South Korea, has a rather unusual background. In 2012, the former student of hedge fund Tiger Management under Julian Robertson was essentially blacklisted after pleading guilty to insider trading. The Archegos family office, founded in 2013, was its comeback.
Last month’s balance sheet shed light on global banks resuming dealing with Hwang, wowed by lucrative trading commissions. They include Nomura Holdings, Credit Suisse Group and Morgan Stanley. Since then, Nomura has warned of “significant” losses. His initial estimate was around $ 2 billion.
Mitsubishi UFJ Financial Group has joined the list of global players facing heavy losses. On April 2, Japan’s Finance Minister Taro Aso said the government was reviewing the losses suffered by Nomura, Mitsubishi UFJ and potentially other Tokyo giants. The Bank of Japan is on guard for any credit event in the markets.
This moment is filled with irony. Japan avoided the worst of the Lehman Brothers crash in 2008 by being exposed primarily to local markets. Since then he has ventured abroad to reap better yields. This pivot is now testing a Japanese economy which is already suffering from the shocks linked to Covid-19.
“The losses announced by some Japanese financial institutions following complex transactions with a US client will test the robustness of their risk controls, especially in foreign markets,” said Fitch Ratings. “Expanding into offshore markets was one of the means to achieve higher profitability in a moderate domestic operating environment with structural challenges, such as persistently low interest rates and a declining population.”
The recent losses, says Fitch, “highlight the risk appetite of these institutions when they are looking for profit and whether they are adequately compensated for the risks incurred during economic cycles.
The sale of Hwang’s assets hit Asian companies far removed from Japan. On the chopping block: About $ 6.6 billion from New York-listed Baidu Inc., Tencent Music Entertainment Group and Vipshop Holdings Ltd.
Chinese internet companies, some listed in the United States, have been the main targets of hedge funds in recent years. However, as US growth gains momentum, much of that capital has doubts about Chinese stocks.
Why remain exposed to corporate governance risks on the continent and the still alive possibility of write-offs? One of the actions that moved against Hwang was education company GSX Techedu, which Muddy Waters Research accused of exaggerating sales by more than 70%.
It is the hyper-fragile frame that Roubini is eyeing because he fears, once again, the worst.
“You are facing a spike in growth and we are also facing incredible pressure from a fund flow point of view, where you haven’t really seen significant bond exits,” he says.
But what if we do? What if yields rose from Washington to Beijing, devastating one or two giant hedge funds?
The good news is that the global system is better positioned than it was in 1998 or 2008 to withstand severe turmoil. The bad news is that another LTCM crack-up could be in the cards soon. And at any time.