Goldman Sachs saves itself again 🦺

Every now and then, a Wall Street fund blows up. And GS plays its games.

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Good morning,

The meltdown of Archegos Capital will soon be just a distant memory. But for some investment banks, it’s a lesson in non-cooperation. 

The puzzle of how India controlled the virus is now spiralling again as the country records the biggest spike in daily cases. Have we gained any perspective yet?

And LG Mobile bows out of the race. It fought valiantly but maybe it deserves some credit for all its innovation over the years. 

Goldman Sachs doesn’t have a trolley dilemma in the Archegos Capital saga

Goldman Sachs is like that kid in school who’s involved in all the mischief but manages to slip away quietly before the sh** hits the fan. 

Last week, the investment bank escaped almost unscathed from the big blowout of Archegos Capital Management run by Bill Hwang. Meanwhile, investment banks like Nomura and Credit Suisse are likely to report billions of dollars in losses. 

So how did Goldman Sachs escape?

Before we get to that, here’s the backstory:

In 2013, Bill Hwang began Archegos to manage his family’s wealth. It had a capital of US$200 million. But less than a decade later, it swelled to almost US$20 billion. That kind of wealth creation is dizzying even in the world of high-flying stock traders and investors. 

So, how did this jump happen?

Two words – leverage and swaps (with a healthy dose of luck). 

Leverage is when you buy a stock with a little bit of your own money and then you borrow money from your broker to buy stocks. Archegos was allegedly depositing US$15 as collateral or margin with its brokers and borrowing US$85. 

Swaps have a similar characteristic. Part of Archegos’ bets took the form of total-return swaps in which the broker buys the stock, the fund pays a fee, bears the loss if the stocks fall, and keeps the gains if the stock rises. The fund can get exposure to the stocks by paying limited funds upfront. The brokers are betting that the worst won’t happen and they earn a fat fee for taking the risk. 

The risk to the brokers in both these cases is pretty much the same. When clients trade using leverage, they keep a margin with the broker. If the stock prices fall, and the client loses more money than what they deposited, then the loss is the broker’s. 

One really bad day is all it takes for it to blow up.

On the other hand, it’s a risk that large brokers consider worth taking because the fees they earn is lucrative. In 2020, the prime brokerage business which does these activities, made US$30 billion.

Now given its size, Archegos had multiple brokers to handle its trades—Goldman Sachs, Morgan Stanley, Credit Suisse, Nomura. And on Monday last week, Archegos and its brokers came face to face with that one really bad day.

That day, ViacomCBS, one of his largest holdings whose stock price had risen more than 150% in 2021, announced it would sell new shares. The offering pressured the stock, sending it down more than 25% in the aftermath of the announcement.

Because of Archegos’s highly concentrated positions, the sharp drop in Viacom hit the fund’s portfolio, and many in the market believe that Archegos started selling other stocks in its portfolio to cushion the blow. Those sales sent other stocks it held tumbling, including Discovery. Suddenly, the collateral Archegos had given the banks was no longer enough to back the loans. Banks hit Archegos with margin calls to back up its trades, which initially were met by the fund, but as ViacomCBS fell further on Wednesday, the firm didn’t have the money to provide its lenders, a person involved in the unwinding said.

Remember that US$15 that Archegos was depositing with its brokers? Well, it turns out that it wasn’t enough when the stocks started falling sharply. 

So the brokers got together to hash it out and protect themselves. After all, all of them were exposed to the same stocks in Archegos’ portfolio. And it was in their best interest to work together and minimise the damage as the stock price crashed. 

The proposal that emerged was to hold off on large trades and not sell in a hurry. But Goldman Sachs (and even Morgan Stanley) decided to play the game differently after they realised the extent to which they themselves could get hurt.

This meme is a perfect illustration of how Goldman Sachs dealt with its ‘trolley dilemma’—save one or save the many. Instead of worrying about its client Bill Hwang or the other brokers who were in the same tight spot, it put itself first (if you’re wondering what the trolley dilemma is, see here).

And Goldman Sachs started selling, crushing both Bill Hwang and other brokers. 

And it’s not the first time that Goldman Sachs has run the trolley over its peers and clients according to Simon Lack, Managing Partner at SL Advisors:

In 1998, when hedge fund Long Term Capital Management (LTCM) was blowing up [due to high leverage], their biggest swap counterparties gathered to discuss an orderly liquidation.

[...]

But the economic incentives were similar to a cartel – each member [like the brokers] was incentivized to secretly cheat.

The information I had been provided made me an insider – it was obvious what trades should be done to generate immediate profits but I respected the rules and waited. Goldman didn’t. I saw them trading on the information they possessed about LTCM’s portfolio.

Goldman never got in trouble. Maybe what they had wasn’t inside information under a strict legal definition – interest rate swaps were bilateral agreements, not SEC-registered securities. Maybe they understood the information sharing agreement to be loose enough to allow trades to be done.

WcMgcq

But hey, it’s Goldman Sachs. What can you do?


PS: I’d recommend reading ‘When Genius Failed: The Rise and Fall of Long Term Capital Management’ to understand how levered bets broke the company run by Nobel Prize winners

It was a stupid virus, they said

If the last few months of the pandemic has proved anything, it’s that the Covid-19 virus is evolving quicker than the human response to it.

The virus is shifty. It’s unpredictable. And when no one was looking, it branched out into variants that are tricking the human body. For instance, the latest mutation alters the spike protein on the surface of the virus. So that makes it just a bit harder for antibodies to latch on and destroy the virus. 

We’re locked in an evolutionary battle with the virus. But we’re also, perversely, the cause for it getting stronger. Mutations E484K (also called Eek, which I think is a fitting human reaction to it) are actually instances of resistance to the human immune system.

Just for a second, stop to think how twisted that is. The virus is smarter than us because we’re giving it the tools to learn. Kind of like the world’s deadliest AI.

The good news is that the realisation puts a few things into perspective for the human race:

1. The plateau is a peak

All the while the numbers were down, the virus was mutating. Waiting in the wings for the right conditions to manifest itself again. 

“The variant is no different from the original in how it spreads, but infected people seem to carry more of the virus and for longer, said Katrina Lythgoe, an evolutionary biologist at the University of Oxford. “You’re more infectious for more days,” she said.

[…]

“Case plateaus can hide the emergence of new variants,” said Carl Pearson, a research fellow at the London School of Hygiene and Tropical Medicine. “And the higher those plateaus are, the worse the problem is.”

2. Each mutation could be a mini-outbreak

It would do us good, say epidemiologists, to treat each mutation as a different virus.

“The best way to think about B.1.1.7 and other variants is to treat them as separate epidemics,” said Sebastian Funk, a professor of infectious disease dynamics at the London School of Hygiene and Tropical Medicine. “We’re really kind of obscuring the view by adding them all up to give an overall number of cases.”

This means more research and funding needs to go into tracking these variants, and possibly altering future vaccines, drugs or public health policies to target particular strains.

3. The virus isn’t going anywhere

If there was any doubt about the virus’ longevity, by now we should be convinced that not only is the virus smart, it’s also going to be a permanent fixture in our lives. 

Even the most aggressive vaccination plan won’t stop the virus, or its mutations, from spreading. This means work, travel, and economic activity will have to be planned in short-term bursts. And masks, tests, and vaccine passports become a part of life. Being superhuman in the age of Covid will mean two things: getting scientifically smarter, but also being smart about the little things—masks, hand-washing, and not overcrowding. 

The virus has a ticking brain. And it won’t hesitate to use it against us.

RIP to one of the crazy ones

Original ideas are no longer welcome in smartphones.

Ok, bear with me, that argument has been the case for some time. But the phrase rings particularly true this week after Korea’s LG announced it will cease making smartphones from July.

At its peak, LG was the world’s third-largest smartphone company based on sales, behind only Samsung and Apple thanks to innovative software, camera features, and services like payments. But now it has become the first (once) major name to bow out. It cited tough competition. 

Indeed, budget Android devices from Chinese firms pack a quality experience and have eaten up the market.

Its dismal run included nearly six years of consecutive quarterly losses for LG Mobile. (When I wrote for TechCrunch prior to joining The Ken in 2019, every once in a while I’d go through their financials and note just how bad things were.)

So, yes, this chaos didn’t come out of nowhere. LG moved to outsource some of its mid-range devices in a bid to stay alive, but it couldn’t stem the bleeding. Now it is closing because it wasn’t able to find a buyer for the unit. 

That’s no big surprise. LG Mobile’s market share is minuscule. It accounted for an estimated 3% of all global sales in 2018—no doubt it is lower still now. That’s despite efforts including large-screened ‘phablets’, Lego-like modular devices, and its unique dual-screen Wing device.

There were many eulogies on the internet, but most focused not on LG’s devices but the firm’s sense of innovation—which was spurred by the need to stand out from competitors that focused on cut-throat prices.

Many of today’s smartphone-owning youth might not see LG, Sony or HTC as mobile brands, but the trio were pioneers. HTC developed Google’s first Nexus device, Sony raised the bar for camera phones, while LG is credited with pioneering a number of features that have now become standard.

LG Mobile is no more, HTC sold most of its once-roaring mobile business to Google in 2018, and Sony downsized its wildly-unprofitable phone business between 2014 and 2016.

Today’s smartphones look and feel very alike. It’s hard to see that changing. Steve Jobs might not have pictured LG as one of “the crazy ones” he paid respect to, but for its perseverance until 2021, LG Mobile must be worthy of consideration.

That’s a wrap for today.

Don’t forget to write in with your thoughts and observations on how this pandemic is reshaping businesses, societies, and economies. We will be back tomorrow.

Stay safe,
Nithin
[email protected]

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