Brokers are selling over $30 billion worth of positions in imploding hedge fund Archegos Capital Management, shaking markets. Wall Street does not know exactly how many positions the fund holds for two reasons:

• It is very lightly regulated because it’s organized as a “family office,” rather than a typical hedge fund
• Archegos didn’t actually own most of the stocks it took positions in, if any. Instead, it owned derivatives called “contracts for difference (CFD’s),” which have few disclosures.

Some experts liken the Archegos blow-up to the bankruptcy of Bear Stearns, which helped precipitate the financial crisis:

“We don’t know how far the tentacles go,” said Joe Saluzzi, co-head of trading at Themis Trading. “Early in the Bear Stearns crisis, the market was fine — until it wasn’t.”

Others are comparing the liquidation of the hedge fund’s positions to that of Long Term Capital Management (LTCM) in 1998, which caused severe market turbulence and ultimately required a bailout:

“This reminded me a lot of the Long-Term Capital situation,” Steve Sosnick, chief market strategist at Interactive Brokers, told Insider in an interview.

Long-Term Capital Management, a massive hedge fund staffed by famed traders and Nobel Prize-winning economists, employed such highly leveraged trades that it threatened to expose America’s largest banks to more than $1 trillion in default risks by 1998. The “genius” hedge fund nearly collapsed had it not been for a bailout package from the Federal Reserve and some major Wall Street banks.

However, Archegos’s positions appear to be far smaller than those of LTCM. Nonetheless, Archegos was very heavily leveraged:

Shrouded by the secrecy of CFDs, Hwang was able to build up almost $50 billion in stock positions on the back of the $5 billion to $10 billion that Archegos managed.

Perhaps the greatest source of worry for markets is uncertainty over exactly how many positions Archegos has and with which banks. This counterparty risk was a driving factor in the LTCM crisis in 1998 and the financial crisis of 2008:

…it seems clear that the banks didn’t realize until too late that they were holding similar positions, with malign implications for efforts to keep markets in those shares from falling further.

“You can have a suspicion that maybe this person is doing this trade with a bunch of other people,” said Jay Dweck, a former trading and risk-management executive at Goldman and Morgan Stanley and now consults for banks and hedge funds. “But no one knows the aggregate.”

In all, given the smaller size of the portfolio being liquidated and the current buoyant state of markets, I don’t expect any extreme shock from Archegos going under. I think the experience with LTCM, Bear Stearns, Lehman and others will also stand banks and regulators in good stead when dealing with Archegos. But you could see some choppiness for a while as we find out who is exposed to Archegos and wind down those positions.

Another possible outcome is stricter regulation, especially of these opaque family offices, which I think would be good for markets. Indeed, regulators are already scrutinizing hedge funds after the run-up in GameStop shares this year stung some with huge losses. From the WSJ:

The steep losses at Archegos come as a council of top U.S. regulators known as the Financial Stability Oversight Council is already scheduled to meet on Wednesday to discuss hedge-fund activity during the pandemic-triggered crisis.

For more on Archegos and markets, check out these posts:

• A Giant Hedge Fund Is Imploding, Taking Stocks with It
• GameStop Sales Down 40% in 2 Years
• Almost All SPACs Lose Money and They’ve Never Been More Popular

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