Losing $20 Billion in 2 days
The remarkable story of collapse of a family office due to leverage
My partner Charlie (Munger) says there is only three ways a smart person can go broke: liquor, ladies, and leverage. Now the truth is — the first two he just added because they started with L — it’s leverage. - Warren Buffet
I used to think a lot about this quote when I first read it many years ago and from what I saw and read, it seemed like that the smartest people’s downfall ended up being leverage or debt. This rang little more truer last week.
Bill Hwang, went from being almost not known to the guy who lost $20 billion in 2 days and might have taken down couple of large banks with him. It’s quite the fascinating story.
Bill Hwang ran a family office called Archegos after he was forced to shut his hedge fund because of insider trading allegations. He was almost unknown except to a small circle and accumulated almost his entire wealth of reportedly $30 billion in the last few years.
His investment strategy was to have a concentrated portfolio of few stocks, some bets were on short squeezes and to crank up the return by using leverage. Most of the positions were not hedged, there might have been some shorts, especially S&P 500 shorts but does not really protect against idiosyncratic risk from a single stock.
Which is exactly what happened here.
Bill Hwang had built a large position in Viacom, which drove up the price, and he continued to buy more which pushed the price even higher. Which is kind of crazy because you are increasing your risk by adding more leverage as the stock goes even higher.
Viacom happy that the stock had moved up, decided to raise capital by issuing new shares, totally unaware that it was driven up by Bill Hwang’s buying spree. The announcement sent the stock down as it usually happens, which put Bill Hwang in a fix.
The second sign of something wrong was Morgan Stanley had approached Bill Hwang to subscribe to the share issue and he had committed $300 million but given that he was in a fix, he could not fulfill his commitment raised some alarm.
As the stock continue to slide, some of the banks had a margin call and realized that the total leverage and risk was much larger than they had anticipated. Imagine their reactions at that moment.
First the banks tried to coordinate with other banks to handle and reduce their exposure and losses in a more controlled manner. However, Goldman Sachs and Morgan Stanley said screw it and decided to protect themselves and exited their exposure to Bill Hwang. Which is reminiscent of the clearance sale scene in the movie Margin Call.
This worsened the situation for everyone still holding the bag, which was Bill Hwang, Credit Suisse and Nomura. Credit Suisse in fact said the loss from this incident is 4.4$ billion and fired some if its key executives
It’s a fascinating story but Is there anything we can learn from this?
Like Shyam says, it’s harder and longer path to build wealth without using leverage. The biggest asset that everyone owns is their house, which most likely was purchased with a home loan, a 10 or 20 year old loan. So to say one should always avoid leverage is not the smartest thing.
Not to see 5x leveraged like Bill Hwang was, but then very few people have that kind of leverage especially to their Net worth. I wouldn’t worry about that.
But if someone is 5x leveraged, it takes a small adverse effect to have a dramatic, often irreversible impact on the portfolio.
If you are leveraged or even if not, just want to limit the volatility in your portfolio, hedge your risk more directly, against something that is more correlated to your positions.
And if you are taking a big position, hoping for an asymmetric payoff, stress test it with extreme scenarios such as Feb-March 2020 and see how it would’ve done in such conditions.
And there are always hidden risks such as this in the market. Things we did not know existed will suddenly balloon to become systemic risks in the market, though the broader market was not affected by this.
And comes to the last point, the market is at a point right now that it just shrugged and moved on from this debacle, despite the sums involved and the players.
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