The most shocking part about ArcGos’ story is that it is a firm that some people had heard of before this weekend. And yet in this era of easy money, Archgos was able to borrow so much that its failure caused massive setbacks to create a wave in Wall Street – and affected the retirement accounts of Americans everyday.
Art Hogan, chief market strategist at National Securities Corporation, said, “It’s a wake-up call. With leverage, there comes risk.” “This is the second time we have learned a lesson about leverage this year.”
“We saw it on the short side when the Gametop exploded. Now we’re looking at it on the long side,” Hogan said.
Opaque financial instruments
Archaeos Capital was using the borrowed money – apparently a ton of it – to make the excluded bets that held up media stocks. This type of excessive leverage is made possible by the Federal Reserve’s extremely low interest rates.
The full scale of these bets was not yet clear.
Archaego could not be reached for comment on Monday.
“Anytime a derivative is involved, you don’t really know how deep the theory is,” said Joe Saluzzi, co-head at Themis Trading.
Stock sale that broke the camel’s back
This complex strategy backfired last week.
Archaeogus faced margin calls from its Wall Street lenders. If the value of an asset falls below a specified level, a margin call by the broker requires a customer to add money to their account. If the client cannot pay – and in this case the Archivos apparently cannot – the broker can and will dump the shares on behalf of the client.
One of the archaeologists’ lenders, Goldman Sachs, seized collateral and sold shares on Friday, a person familiar with the matter told BCCI Business. This so-called forced liquidation set up a bloodbase on Friday that hijacked shares of Viacombs and Discovery by more than 25.
Credit Suisse said a default by a “significant US-based hedge fund” would lead to a large drop in its earnings. A person familiar with the matter told CNN Business that Archigos was the cause of Credit Suisse’s loss.
Nomura said its loss could result in $ 2 billion in “transactions with an American customer”.
Founder of hedge fund involved in insider trading scam
This episode showcases Wall Street’s complex web linking firms – and the risk to banks to leverage large amounts.
Dennis Kellehar, CEO of Better Markets, said in a statement, “Systematic risk is overshadowed by secret and mutual leverage, trading and derivatives in astronomical undisclosed amounts.”
Hogan said investors should remember the risks inherent in banks’ business lines.
“They see the credit of the customers, but it’s always right now,” he said.
Recurrence of long term capital management?
“It’s probably not long-term capital,” Hogan said, citing reforms that mean banks are less risky before the 2008 crisis. “I don’t think it’s the tip of the iceberg.”
“We don’t know how far the tentacles go,” Saluzzi said. “Early in the Bear Sterns crisis, the market was fine – until it wasn’t.”