Goldman Sachs and Archegos Reveal a Blind Spot for Fed

Throughout the uncertainty of the Covid-19 pandemic, investors have at least taken comfort in knowing the global financial system was more or less on solid ground. Sure, risk assets plunged briefly in March 2020, and even U.S. Treasuries experienced the highest volatility in more than a decade, but central banks calmed that turbulence quickly.

“This time around, the regulated part of the financial system held up very well,” Federal Reserve Chair Jerome Powell said after the central bank’s decision on March 17. “We actually monitor financial conditions very, very broadly and carefully. And we didn’t do that before the global financial crisis 12 years ago. Now we do. And we’ve also put a lot of time and effort into strengthening the large financial institutions that form the core of our financial system.”All was well — or so it seemed. 

Now less than two weeks after Powell’s remarks, Bill Hwang’s Archegos Capital Management has reminded the world just how fast things can unravel in the financial system during periods of acute stress, particularly for those institutions that aren’t the absolute largest. According to Bloomberg News, market participants estimate the former protege of Julian Robertson’s Tiger Management had built up assets of anywhere from $5 billion to $10 billion in recent years, and total positions may have topped $50 billion. That kind of money might not be enough to create a huge domino effect around the globe, but it should put investors on high alert for another episode that could.

Let’s start with the secretive derivative trades that made Archegos such a powder keg in the first place. Bloomberg reported that Hwang used banks including Nomura Holdings Inc. and Credit Suisse Group AG to build up leverage through swaps or so-called contracts-for-difference. This method meant Archegos could amass huge positions in Chinese technology firms and U.S. media companies without having to disclose its position or future transactions, all the while potentially never even owning most of the underlying securities. Banks, meanwhile, can use CFDs as a way to get around the more restrictive capital regulations imposed after the 2008 financial crisis.

The allure of outsized profits was apparently enough to take Hwang out of the penalty box at Goldman Sachs Group Inc., which reportedly refused to do business with him as recently as late 2018. At some point since then, the investment bank synonymous with Wall Street removed his name from its blacklist and allowed him to become a top client. Goldman might have been one of the last in, but it was sure to be among the first out: Archegos was forced to dump more than $20 billion of stocks on Friday, with Goldman and Morgan Stanley among those putting up huge block trades in shares of Discovery Inc., Farfetch Ltd., GSX Techedu Inc. and ViacomCBS Inc. 

More on the Meltdown at Archegos:

Goldman has said that any losses are likely to be immaterial, a person familiar with the matter told Bloomberg. Although that might seem like a victory for Powell’s claim of the strength of the largest financial institutions, the U.S. bank’s move nevertheless had wide-ranging consequences for overseas lenders that didn’t rush for the exit as quickly.

Nomura tumbled 16%, the most on record, after releasing a statement that the estimated amount of its claim against an unidentified U.S. client (reportedly Archegos) was about $2 billion. It also had to take the rare step of yanking a $3.25 billion bond deal from the market after it had already priced and was set to settle in mere hours. Now the Japanese bank will presumably have to obtain the funds at a more punitive cost.

Meanwhile, Credit Suisse plunged by as much as 17%, the biggest intraday decline since the financial crisis, after signaling its loss may be “highly significant and material to our first-quarter results.” It’s just the latest bit of bad news for the Swiss lender, which is also immersed in a scandal over the demise of Lex Greensill’s trade finance empire.

It’s certainly possible that Archegos is just a one-off bad bet that went awry for a number of financial institutions. The broad market is taking the news in stride, with the S&P 500 Index flat after closing at a record high last week. Still, the fact that banks were so willing to do business with a fund manager who was charged with insider trading less than a decade ago isn’t exactly reassuring. Were they even aware that Hwang had obtained leverage from so many different places? Goldman’s reversal only adds to the intrigue.

This brings me back to what Powell said earlier this month. “Over the long expansion, longest in U.S. history, 10 years and eight months, rates were very low … the things that have tended to really hurt an economy and have in recent history hurt the U.S., we didn’t see them build up despite very low rates,” he said. “A connection between low rates and the kind of financial instability issues is just not as tight as people think it is.”

Archegos’s startling blowup is a reminder that investors, regulators and banks must remain vigilant. Undoubtedly, much more went into Goldman’s decision to take Hwang off its blacklist sometime after 2018 than just persistently low interest rates and subdued volatility. But it was also around that time that Chief Executive Officer David Solomon emphasized that Goldman would push to diversify its business away from trading and toward more durable revenue streams, putting the bank “on an evolutionary path.” It wasn’t getting the kind of juicy returns that it used to — and Archegos offered a taste of the old days.

Goldman may be walking away from Archegos relatively unscathed, along with broader markets, but that’s of little solace to Credit Suisse, Nomura or anyone who bought shares that have since plunged. The world has already been battling a once-in-a-century pandemic. The last thing it needs is big banks heaping on risk in search of profits, leaving someone else to hold the bag. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.

©2021 Bloomberg L.P.

BQ Install

Bloomberg Quint

Add BloombergQuint App to Home screen.