Archegos avalanche shows cracks are hidden under the surface
There are worrying pockets of bizarre price behaviour in the shadow banking world
Gillian Tett
Financial markets experienced the equivalent of an avalanche last week.
The trigger initially seemed innocuous: US media group ViacomCBS’s share price slid after the group decided (quite sensibly) to sell $3bn of stock, in response to a peculiar near-tripling of its share price in the past year.
That fall inflicted big losses on the portfolio of the Archegos family office, which was heavily exposed to Viacom.
This in turn triggered snowballing margin calls and share sales, as its prime brokers tried to liquidate the Archegos portfolio to protect themselves.
The rubble may create $5bn-$10bn of losses for prime brokers, JPMorgan Chase says.
The good news is that this avalanche does not appear to have created serious systemic risks, since the banks seem able to absorb the blow.
That is a small victory for regulators who raised capital requirements after the 2008 global financial crisis.
But the bad news is that the episode exposes broader vulnerabilities in the financial system.
After all, as any back-country skier knows, avalanches do not usually occur just because of an idiosyncratic shock, but because the underlying snowpack is unstable.
Last week’s debacle indicates that the system today is plagued with multiple half-hidden cracks.
For one thing, there is alarmingly little transparency about family offices, even though these have recently exploded in size and influence.
There is even less clarity about the derivatives that Archegos used to make bets.
Investment banks continue to struggle to judge their prime brokerage risks, partly because of internal silos.
Years of loose monetary policy have left financiers so blasé about soaring asset prices that few questioned whether the counter-intuitive rally in the Viacom share price made sense, given the company’s mixed corporate fortunes.
Most striking of all, Archegos was apparently operating with more than five times leverage.
This is comparable to patterns seen before the 2008 crash and seems to have been “the very definition of insanity”, given the concentrated nature of its portfolio, as financier Mike Novogratz says.
So was Archegos an anomaly?
Or a trend?
No one can tell for sure, given the lack of transparency in the shadow banking world. But I believe the latter.
After all, family offices are not the only part of the financial sector to have escaped effective oversight; just look at what the recent Greensill scandal shows about supply chain financing.
Viacom was certainly not the only stock displaying peculiar prices swings; gyrations in the GameStop price have been far wilder.
Indeed, if you scan the financial landscape, you can see multiple pockets of bizarre price behaviour — or froth.
Take bitcoin: the price of a coin has had a ninefold increase in the past year.
Crypto evangelists argue this makes sense given inflation threats to fiat currency, and increased mainstream acceptance of crypto assets.
Possibly so.
But the sheer scale of the rally suggests some big unseen speculative plays are at work too.
Or, for an even more colourful example, look at the sky-high prices being charged for “non-fungible tokens”, or unique cyber collectibles.
The newly minted crypto gazillionaires currently diving into this sphere attribute these high prices to scarcity: NFTs are supposed to be unique.
But the market is untested and if anyone cracks the code to replicate NFTs the entire investment thesis will implode.
Or for a more mainstream example, consider green stocks such as Tesla.
The electric vehicle maker’s share price has risen about 600 per cent in the past year, amid hype (and bizarre projected valuations) by investment groups such as Ark.
Some of that rally might be justified by the new White House support for electric vehicles.
However, Tesla’s popularity also reflects a shortage of green assets last year, relative to soaring investor demand — and that could easily change if, say, car manufacturers produce more electric vehicles.
Or ponder the corner of tech known as software as a service.
The SaaS companies with the most bullish projections for next year’s earnings are now being valued in the stock market at about 40 times earnings, on average, according to calculations shown to me by some venture capitalists.
Before 2019, the average was nearer 11 times.
That might make sense if you think last year’s boom in digital services will be sustained indefinitely.
Not so if last year’s coronavirus lockdowns simply brought forward future digitisation demand, which seems entirely likely.
Don’t get me wrong: I am not predicting imminent avalanches in all these sectors; nor suggesting these are the worst examples of speculative froth.
What is happening in parts of the sphere of special purpose acquisition vehicles and the junk bond world may be worse.
But the key point is this: the Archegos rubble shows that years of excessively loose monetary policy have not just left asset prices elevated but created half-concealed pockets of leverage, too.
When the two collide, disaster can erupt. And the big headache today is that while price froth is visible, it is frustratingly hard to tell where the pockets of excessive leverage lie, or how exposures are interconnected, since the shadow banking sector is so untransparent.
It is thus a tragedy that the Trump administration so badly undermined the Office for Financial Research, the body created after the 2008 crisis to monitor interconnected risks.
Doubly so, since if the Federal Reserve (and other central banks) keeps negative interest rates in place, this financial froth could soon outstrip anything seen in 2000 or 2007.
As with snow, a sparkling market surface can conceal hidden, and widening, cracks.
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