If you’ve ever seen the 2011 movie Margin Call, you probably remember the crucial boardroom meeting scene, asserts Mike Larson, editor of Safe Money Report.
It’s the one where a junior mortgage analyst reveals to the investment bank’s CEO that they’re sitting on an enormous pile of toxic mortgage assets.
The crux of his message? The music has stopped, the value of those assets is starting to plunge, and if we don’t get out fast—before our competitors get wind of the crisis—the firm could fail. And Jeremy Irons’ CEO responds by saying:
“There are three ways to make a living in this business: Be first, be smarter, or cheat. Now, I don't cheat. And although I like to think we have some pretty smart people in this building, it sure is a hell of a lot easier to just be first.”
I thought about that scene this week after a large “family office” firm managed to blow itself up (colloquially speaking). It did so with the help of funding from a wide range of US and foreign Wall Street firms. And its tale offers cautionary lessons for investors like you—and the markets as a whole.
So, what happened? Well, a family office is an investment firm that manages money for a small handful of very wealthy clients or even a single family. In this case, Archegos Capital Management made highly leveraged bets on a wide range of US and Asian stocks, according to the Wall Street Journal.
It did so via outright share purchases and a form of derivative called swaps. When the value of some of those stocks started falling, that leverage kicked in and losses rapidly piled up.
Archegos went to its trading counterparties...a “Who’s who” of firms based in multiple financial centers around the world, including Goldman Sachs (GS), Morgan Stanley (MS), Credit Suisse (CS), Deutsche Bank (DB), Nomura (NMR), and UBS (UBS)...and tried to negotiate a way out. The firm wanted the banks to agree to an orderly wind down of risk that wouldn’t roil the markets.
But like the fictional investment bank in Margin Call, a handful of those banks decided that it was better to “be first.” They decided to beat their competitors to the selling punch in order to minimize their losses.
Goldman and Morgan reportedly dumped a whopping $19 billion in stock in big block trades last Friday alone, according to the Financial Times. Said one banker in the FT:
“The reality is in a fire sale, if you’re not first out the door you’re going to get burned.... “There’s no honour among banks, [it’s a] question of who blinks first.”
It’s not hard to find examples of the Archegos affair’s collateral damage. Punch up charts of ViacomCBS (VIAC) or Tencent Music Entertainment Group (TME) to see a couple of them. Shares of the former lost 61% in less than two weeks!
But are there broader lessons to be learned here? What does the behavior of this firm, or the Wall Street banks that funded its aggressive bets, say about the markets?
For one thing, this isn’t the kind of stuff you tend to see very early in a bull market. It’s the kind of thing you see after stocks have had a huge run, investors and traders are feeling giddy, and they’re willing to layer risk on top of risk to maximize returns.
For another, you don’t typically see these kinds of wildly aggressive bets being made on “Safe Money”-style stocks.
Lastly, this is yet another illustration of the danger of elevated leverage. It has to be used in prudent moderation rather than excess speculation. That applies to everyone from mega-size hedge funds or family offices to individual investors and traders.
Safe Money Report focuses on these kinds of stocks, which include names in the consumer staples, food and beverage, retail, and healthcare sectors. Visit Safe Money Report here.