AMC Credit vs. Equity, Telling

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Broken Markets, Beyond Silly

Now we have seen everything. AMC´s 5.25s due in 2025 closed down a quarter-point at 79.796 cents on the dollar vs. the AMC equity 95% higher at $62.55.

“After 30 years of trading stocks and bonds, 95% of the time I can assure you, credit leads equities. That´s a 12.25% yield to worst vs. 5 year Treasuries at 0.79%. Sell Mortimer, sell AMC equity.”

Larry McDonald, Creator of the Bear Traps Report.

Bonds are Telling You AMC Shares are Smoking in the Dynamite Shed
AMC 5.75% due 2025 are offered at 81 cents on the dollar. Meanwhile, the stock is trading at all-time highs.  Disconnect.  In the old days when capital structure arbitrage actually worked, you’d buy bonds and buy puts in the dollar amount of the next coupon payment if you thought bonds were worth par under a bankruptcy scenario.  The put expiry would be for the month the next coupon is paid. You’d play this game every six months until it worked. But markets are so screwed up who knows if it would work anymore. What we know for sure is that the bond and the stock disagree about the risks inherent in AMC’s future.  


November 2019

Bonds 96 cents
Stock $9.50

May 2021

Bonds 80 cents
Stock $40.04

Central Banks and Market Dysfunction

With today’s endless central back accommodation – Lehman Brothers NEVER would have failed, fact. That´s what “un-free markets” have become in a world where Adam Smith’s “invisible hand” has been tied behind his back. When the cleansing process of the business cycle is NOT allowed to function over longer and longer periods of time, the moral hazard buildup will trigger a transformation into another serpent, another beast. The next Lehman awaits, just a different flavor, dressed up in unrecognizable packaging.

The fundamental problem with aggressive accommodation from central banks comes down to a market foundation built on moral hazard. Each day, week, and month the Federal Reserve provides more juice, the leverage piles up in pockets all over the planet. Of course, central bankers often do not see the toxic leverage until it is far too late. We are led by academics, NOT proper risk managers. Herein lies the conundrum. While providing excessive accommodation (the Fed is currently making $120B of asset purchases monthly), when traditional shocks arrive – as they always have – the loose fiscal policy will be untenable and looser monetary policy, inconceivable. The market is ill-prepared today – far less so than under normal conditions historically.

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Shares Complete with Butter, Comedy

Beginning today, shareholders can sign up to receive special offers and investor updates by registering at

“Investors who sign up starting today and in the coming weeks will be awarded with an initial free large popcorn usable this summer when attending a movie at an AMC theatre in the United States. The offer will be made available in their AMC Stubs rewards account.” AMC



Bullies will be Bullies. Putin, Obama – Biden 2.0, the Conflict Cometh

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Over the last week – Russia’s Foreign Ministry has said that Ukraine’s accession to NATO would lead to a “large-scale escalation” of the war in Donbas & “irreversible consequences for Ukrainian statehood.” The Kremlin said – “the new situation in east Ukraine raises the possibility of full-scale military intervention.”

The fundamental problem with aggressive accommodation from central banks comes down to a market foundation built on moral hazard. Each day, week, and month the Federal Reserve provides more juice, the leverage piles up in pockets all over the planet. Of course, central bankers often don’t see the toxic leverage until it’s far too late. Here lies the conundrum. While providing excessive accommodation (the Fed is making $120B of asset purchases monthly), when traditional shocks arrive – as they always have – the market is ill-prepared. Far far less so than under normal conditions historically. Take Covid-19 for example. Many people forget the Fed embarked on additional quantitative easing in 2019. By Q1 2020, relative value hedge funds were running 20-1 leverage – yes, stepping in front of the steamroller to pick up $100 bills. One of the primary reasons why the Fed’s March 2020 bazooka was 5x larger than the weaponry used in the post-Lehman failure era (2008) – comes down to the enormous leverage in the fixed income market. The Fed literally had to put out a fire, 10x the size of Long Term Capital Management. In March 2020, at least ten hedge funds were on the brink of failure.

*A relative value fixed income hedge fund will go long vs. short either on the run (liquid) vs. off the run (illiquid) bonds or long cash government bonds vs. futures contracts. After all, a 1% annual return levered 20x magically becomes 20%, just insert the steamroller. These funds will PRINT fabulous returns year after year and then give it all back in a week – they NEVER learn.

The Relative Value Hedge Fund Blow Up
Central Banks are the GREAT enablers, they fuel leverage and turn traditional shocks into something far, far more dangerous.

The Coming Shocks

After President Obama was elected, there was the classic test from the bully that is Vladimir Putin, some say he disdained him. Russia’s move? He took Crimea and put Eastern Ukraine, converting the region into a permanent low-grade conflict. Putin realizes the best border that he can most easily exploit while giving Russia a geographic buffer against the West is a long-lasting, low-grade conflict in quasi-failed states within his sphere of influence. Hence Georgia. Hence Transnistria Romania. Hence Syria (love that Mediterranean port!). Today, adding insult to injury – he is militarizing the Arctic Circle. As our clients are pointing out in our live institutional chat on the Bloomberg terminal – before every invasion, the invader tries to first establish the moral justification for an invasion.  Russia has already started to build a “humanitarian” justification for direct action – a strong indicator of possible action. This is exactly what is going on now.

Ukraine, Impact on Risk Assets
So far there is some evidence of additional risk being priced into risk assets. The cost of credit default protection on Russian sovereign debt is underperforming vs. South Africa and other emerging market counties, but not Brazil. 

The Ukraine – Taiwan Risk Connectivity 

China did not make a move during Obama’s reign, nor Trump’s, and Xi may think that represents a missed opportunity. But the Chinese military really wasn’t up to snuff back then. On April 21, 2016, Xi became Commander-in-Chief of China’s Joint Operations Command Center of the People’s Liberation Army. To quote Ni Lexiong (lecturer at Shanghai University of Political Science and Law), Xi “not only controls the military, but does so in an absolute manner, and that in wartime, he is ready to command personally.” At some point, you have to walk the walk, not just talk the talk. China’s military has been built up, primed, and readied. Numerous senior officials in Biden’s DoD (Dept of Defense) are ringing alarm bells about potential Chinese aggression i.e. —  against Taiwan. As Niall Ferguson reminds us all, since the Communists’ triumph in the Chinese civil war in 1949, the island of Taiwan had been the last outpost of the nationalist Kuomintang. And since the Korean War, the U.S. had defended its autonomy. Taiwan is still treasured land for Xi and China.

Meanwhile, our own military brass has been complaining for decades about how it would be very difficult for the U.S. to fight three wars simultaneously. Think – Ukraine, Taiwan, and some sort of the Middle East/Central Asia/Iran mix.

RSX Russian Equities vs. Emerging Markets EEM
Clearly, some Ukraine – Russia conflict is being priced in here. Notice the recent under-performance of RSX Russian equities relative to the mothership EEM. 

Trump Biden – Putin Xi

Again, neither Putin nor Xi made a move during the Trump administration. Why? Why did they treat each meeting with Trump officials respectfully? Why did Chinese diplomats dump all over Biden’s team in Alaska, in over the top, disgracefully so fashion? Well, Putin, Xi, and Trump are all bullies, and above all unpredictable. Think back to a playground in grade school. Bullies don’t pick on bullies. Bullies pick on snowflakes. In Biden – Putin and Xi see a weak old man in decline, a figurehead for an Obama third term of a country that itself is in decline, laden with debt, riven by internal strife, and sick of war. Realistically, what would the U.S. do if Russia made a military move on Eastern Ukraine? Nothing. And if China saw that, Taiwan would be at serious risk.

The Life of a Super-Power in Decline

During the reign of Marcus Aurelius, emperor of Rome from 161 AD to 180 AD, the omnipotent stoic philosopher spent much of his time on military expeditions along the Danube, containing German incursions. In 387 AD the first German hordes crossed, never to leave. In 410 AD the city of Rome was sacked. In 487 AD the Western Roman Empire fell. Europe wouldn’t achieve its earlier economic prosperity for 1000 years. There are literally over 200 reasons listed by scholars for Rome’s fall, but certainly among the most important is that Rome had debased its currency to pay debts, and stretched its military too long beyond its limits. Meanwhile, farmers were cutting off their thumbs to evade the military draft. No thumbs: no spear throwing, no sword-wielding. Sure, the Roman West scrounged up a strong emperor from time to time (Aurelian, ruled 270 AD to 275 AD), but then a string of weak ones would follow hard thereupon. Meanwhile, the Germans were mastering Roman military tactics, and gaining wealth from trade with Rome. And always testing Rome for any military weakness. Finally, when Rome was at its weakest, the Germans faced incursions into their own eastern flank and poured into Western Europe. And now, here we are.

Russia Forex Ruble Under-Performance
At the Bear Traps Report, we are always looking for clues – across asset classes – to validate or invalidate the constant and often obnoxious stream of news in the daily – weekly cycle. Credit risk is all-important, but a glance in the direction of currency volatility – the price someone is willing to pay for a bet in one direction or another – is a key measuring stick to monitor. Notice above how much weaker the ruble has traded recently relative to the broad, Bloomberg Dollar Index.

Testing and Probing

Today, Russia and China are continually testing and probing the U.S. for weakness, just like the Germans did Rome. Occasionally, we vote in a bully. But half of our population finds that unbearable. So we vote in a doddering weakling in the name of normalcy and decency. And that’s fair. But Putin will push. For sure. Then Xi will push. For sure.

America will fail that double test, most likely. If America passes the two tests, there will be more tests. For sure. That’s just the nature of the game. The risk-reward is never perfect but looks pretty good right now from Putin’s and Xi’s points of view.

Some of our best relationships were in Kiev for the Orange Revolution. There was vast protesting on Independence Square in Kiev when Kiev’s Chief of Police walked on to the platform and proclaimed to the crowd that the Kiev Police Department had joined the revolution. He shouted, “We are with you!” The moment was electric. Everyone knew the tide had turned in favor of the Revolution. Cheers of joy waved through the crowd. An unbelievable moment of exhilaration.

The Dnieper River is Ukraine’s longest and Europe’s fourth, rising in Russia and spilling into the Black Sea. It is well known since ancient times: Herodotus describes it in his Histories. And it cuts Ukraine down the middle, effectively resulting in three Ukraine’s: the Crimean peninsula, Western Ukraine and Eastern Ukraine. It is well known that years before his annexation of Crimea, Putin approached Poland with the following proposal: you take Western Ukraine and I’ll take Eastern Ukraine. The Polish government was shocked, but this has given a lasting impression of Putin’s strategic goals in the region.

Eastern Ukraine is much more Russian. Western Ukraine is much more Ukrainian, far more European. It was Western Ukraine that drove the Orange Revolution. When the government wanted to strengthen its hold, our friends witnessed busloads of Eastern Ukrainian thugs, heads shaved and donning long black leather jackets everyone, dumped around the perimeter of Independence Square. They were scarier than the tanks that were already there. But in the event, they were bought off with vodka and weren’t much of a factor. The Eastern Ukrainians were skeptical and indifferent. The Western Ukrainians were enthusiastic, and Kiev, passionate. The Orange Revolution prevailed.

But then the new government became corrupt as many had predicted. And that did anger Western Ukrainians because they were left out of the action. So the new government fell to the old government. But that was unacceptable to the US. So the old government fell again leaving the current mess: Crimea gone, the East in low-grade conflict, and the West sullen and demoralized.

It is a pleasant coincidence for Putin and Xi that Hunter Biden has business “experience” in Ukraine and China.

In sum, Putin believes Eastern Ukraine is ripe for the plucking, but that Western Ukraine is closed to him. When should he take the East? Now or wait for the US to elect another bully, perhaps reelect Trump himself? Now is the time. Strike while the iron is hot.

Meanwhile, Xi views it as his manifest destiny to take Taiwan. Unlike Vietnam, which does have a minority Chinese population, Taiwan is really and truly Chinese. And it is hard to square a visionary goal of China being the single greatest dominant power on earth if it can’t even “take back” Taiwan. So if Xi sees Putin consolidate Eastern Ukraine, the pressure on Xi to consolidate Taiwan will prove irresistible.

Niall Ferguson and the Taiwan Relations Act

Ferguson’s depth and work on this subject is second to none. To Niall’s point, the act states that the U.S. will consider “any effort to determine the future of Taiwan by other than peaceful means, including by boycotts or embargoes, a threat to the peace and security of the Western Pacific area and of grave concern to the United States.” It also commits the U.S. government to “make available to Taiwan such defense articles and … services in such quantity as may be necessary to enable Taiwan to maintain a sufficient self-defense capacity,” as well as to “maintain the capacity of the United States to resist any resort to force or other forms of coercion that would jeopardize the security, or the social or economic system, of the people on Taiwan.”

And perhaps none of this would matter much to markets, a couple of 10% shakeouts, if we weren’t at highly levered all-time valuation highs, with call options being bought hand over fist as a result of forever money from the Fed.

And we notice cracks here and there in the market action even at fresh new highs: Nasdaq Biotech IBB ETF acts like death (nearly 16% off the Feb highs), ARKK Innovation ETF has $25B of new inflows now WAY underwater and the S&P 600 small-cap indices look very weak. These weak spots smell too high heaven, fewer and fewer stocks are holding up the market. The TRIN index remains cautious. The Archegos affair causing the margin to be reigned in. It’s an odd new high. Perhaps it will get better. Perhaps it will gain strength and come to look like a normal bull run. It happens.

But we have real geopolitical military risks right now that we haven’t seen since the eve of WWII. Ignore that risk at your peril. We won’t.

There is only one way to pay for war without conquest: inflation. And there is only one price to pay for running away from war: loss of power. Either scenario is bad for stock markets and good for gold.
Buy war insurance now.

We believe in the Fourth Turning. We believe our slate is about to be wiped clean. We believe in creative destruction. We believe the old order of today will fall to the new consensus of tomorrow.

But between now and then there is a crash or sequence of crashes so only one word matters: risk. And that risk is not currently being discounted by the markets.




The Deal that Broke the Bank, Connect the Dots

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As a former convertible bond trader, I have always found this unique corner of Wall St. extremely telling. Over the years we have witnessed countless clues and signals that come out of the interesting players on the field.

Robert M. Bakish is now a hall-of-fame stock seller, he’s also best known as the President and Chief Executive Officer of ViacomCBS. One of the world’s leading producers of media and entertainment content, driven by a global portfolio of powerful consumer brands, including CBS, Showtime, Nickelodeon, MTV, BET, Comedy Central, and Paramount Pictures. But, could Bob’s stock selling prowess help bring a Wall St. Bank to its knees?

This month Bakish noticed an unusual move higher in his stock price, at one point in 2021 the VIAC was 73% higher. Last week, Uncle Bob wisely approached Goldman Sachs and Morgan Stanley about selling some stock. In order to get the best price, Bob wanted to keep the sale quiet and do it quickly. He wisely stressed, “keep it, discreet boys.” On March 23, they priced close to $3B of equity and mandatory convertible securities, but the size and breadth of the sale caught some market participants off guard, some more than others indeed.

“Goldman dumps billions of dollars of stock causing losses at Nomura, then Goldman analysts downgrade Nomura because of the losses and poor risk management.”

Tom Braithwaite 

By now, everyone knows Archegos’ Bill Hwang was a protégé and one of the so-called tiger cubs of legendary hedge fund manager Julian Robertson. What people don’t fully understand is how just one firm can abuse and leverage the TRS (total return swap infrastructure) across the prime brokerage underbelly of Wall St.

Typically associated with the fixed income market (in bonds), a total return swap is a swap agreement in which one party makes payments based on a set rate, either fixed or variable, while the other party makes payments based on the return of an underlying asset, which includes both the income it generates and any capital gains. The plus side for Archegos is they could hide the size of their positions and very quickly turn the buying power of $1 into $5 or even $10. “Estimates of Archegos total positions are climbing–billions, then $50 billion, now some traders estimate $100 billion. ” Fox Biz, Charlie Gasparino notes. The thing about these guys (like Archegos) is, (and there are a lot of them out there), the only way to accumulate that kind of extreme wealth in a short period of time is through the most extreme, reckless hubris lens. Ultimately, it’s the same perspective that forges the insane riches, that will also be the catalyst behind colossal losses taking place in the blink of an eye.

Who’s Left Holding the Bag?

Credit Suisse CS CASH BOND MARKETS      +15/+20 from Fri close now (Bond – Credit Risk on the Rise)

CS 4.194 4/31   146/136 5×5  +7
CS 3.869 1/29   105/95  5×5  +7
CS 4.282 1/28   155/145 5×5  +7
CS 1.305 2/27   117/107 5×5  +8

Some parts of the fixed income market remain calm, but credit risk associated with Credit Suisse is on the rise.

Credit Leads Equities

Our index of 21 Lehman Systemic Risk indicators always has a section focused on credit risk.

Institutional Client in our Live Chat on Bloomberg: “These are your ‘for cause’ reasons to rip-up an ISDA and (Goldman, Morgan Stanley) start the liquidation process of the Archegos portfolio of levered-bets. How could I start a fund of that size and just tell every other major prime broker my collateral only has eyes for them – especially after AIG?!”

There is meaningful speculation that the DOJ reached out to Goldman Sachs and Morgan Stanley on Archegos’ business practices.  Rehypothecation is the age-old practice whereby banks and brokers use, for their own purposes, assets that have been posted as collateral by their clients. The lack of transparency in the formerly highly profitable total return swap arena, left banks dancing in the darkness, oblivious. There is intoxicating greed on both ends here, greed squared. First, you have the banks who have been reaching for profits in an era of flat yield curves. “Oh, why not roll-out total return swaps to prime broker equity clients, juicy margins, lets do it.” For years, total return swaps have been used on far less volatile bond instruments, BUT putting Archegos style leverage on highly volatile equities is insane. Then there is the greed on the client-side. Many clients we respect think, firms like Archegos embraced total return swaps on high-risk equities so they could attempt to manipulate stock prices to the moon (short squeeze weaponry), wipe out short-sellers in TOTAL secrecy (no disclosures). The whole debacle is just a nasty cocktail of extreme, reckless greed.

Some Street research estimates put the stated leverage (OTC/swap) in Archegos´ reputed use of equity TRS accounted for around half of the universe of OTC equity derivatives globally. Nuts!

Unfortunately for Bill Hwang and his pile of leverage, he’s never met an overnight, size seller like Bob Bakish. Last week’s colossal VIAC offering of shares pushed deal insiders into action. The legendary “Chinese Wall” across Wall St. banks has always been made with only the finest swiss cheese. We hear the bankers involved in the stock sale leaked the details to sales covering clients and very quickly Archegos was looking at a 15% loss when it surreptitiously controlled 10-20% of all the outstanding VIAC shares. At one point last week VIAC equity was worth $60B, this week she was lurking back near $25B. On March 23, Morgan Stanley priced the stock sale at $85 (it traded as high as $100 hours later), Bakish should announce a stock buyback tonight at $45 and burn the Street’s britches into the history books. The stuff legends are made of.

An Epic Unwind – Bear Traps Report from March 27, 2021
The epic sale of stock in the Archegos unwind (see above) will leave a dark stain on Wall St. for years to come.  The Credit Suisse mess is larger than what’s priced into the market. It’s NOT a Lehman size failure but they will be forced into asset sales (CSAM), and or a size rights offering. It’s beyond sinful in financial terms that PB (Prime Broker) risk across the street has such a disgusting lack of transparency. All of this will force a “come to Jesus” for the Street’s compliance departments and force a meaningful de-leveraging. Then come the regulators and House / Senate hearings. Keep in mind, this same problem went down in January with Robinhood, they could NOT properly and efficiently quantify counterparty risk during the trading-day and were forced into a capital raise. So, Q1 2021 will be forever marked by a period of reckless risk-taking breaking the system.

Last Week’s Events will Trigger Secular Change

Wall St. has always been an industry with thousands of silos sitting in the meadow. There are times when the investment bankers are sitting on a piece of information that can nearly destroy another part of the bank (Prime Brokerage TRS Total Return Swap business) – or for sure another bank’s business. It is the ultimate game of trading on inside information, some had it first, others just a few hours later, and that can make all the difference in the world.

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Greed Breaks Things

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Sorkin and McDonald Dig In
Our Larry McDonald, author of a “Colossal Failure of Common Sense”, and Andrew Ross Sorkin of “Too Big to Fail” fame – weigh in on bank credit risk. 


Warren Buffett is found often quoting his partner Charlie Munger – “there are three ways to go broke: liquor, ladies, and leverage.”

The forced liquidation of more than $30 billion in holdings linked to Bill Hwang’s investment firm is shining much-needed light onto slimy financial instruments he used to build large stakes in companies.

Much of the leverage used by Hwang’s Archegos Capital Management was provided by banks including Nomura Holdings Inc. and Credit Suisse Group AG through swaps or so-called contracts-for-difference. We agree with Bloomberg here, it means Archegos may never actually have owned most of the underlying securities — if any at all.

The Great Deleveraging: If Nomura dropped $2 billion on the mismatch between trade execution on margin calls and/or remaining contractual risk then the knock-on effect is going to be on every Prime Broker credit desk. We will see them become far more stingy and likely tighten margin requirements. If you are making 1% and you are 10x levered that is 10% annualized, but 10% at 10x levered is 100% and so intoxicating in every cycle.

Watch Bank Credit
All the signs were there Friday. Banks with credit risk tied closest to hedge fund blow-ups dramatically underperformed.

Think of Andrew Ross Sorkin’s global bestseller, “Too Big to Fail” – the book was focused on the money center banks. That’s where the leverage was from 2005-2008.  Banks like Lehman would use phony facades like Repo-105 to juice leverage, massively. Regulators were blind, light-years behind the innovative games. Today, the leverage is now on the hedge fund side. Central banks and regulators are once again way behind. They are oblivious to many of the latest leverage weaponry, 21st-century games.

Why is this happening with equities at all-time highs?! Can you imagine the carnage if there was ever a shock to the system, an unexpected event like 9-11 would cause an extended crash, too much leverage.


The key is that hedge funds (and family offices!) are using the banks’ cost of capital via TRS.

TRS: It appears that he (Bill Hwang) transacted exclusively in Total Return Swaps.  This enables him to avoid disclosure.  Some of the positions were held at multiple banks. The banks may not have known this. How to turn $15B AUM into $80B? The fun will really start when Senator Elizabeth Warren figures out this latest insult to risk management.

The most egregious holding is GSX Technidu.  This is a Chinese education company.  Muddy Waters and others have documented how this is almost certainly a fraud.

It appears ARCHEGOS had more than half the tradable shares in swap with multiple banks.  This appears to be an attempt to corner the market and create a manipulative squeeze.  Given that the stock went from $30 when Muddy Waters first published to $140, we’d say this WAS successful.

Our complete lack of securities regulation allows for this kind of manipulation.  We should not be calling Reddit posters to be in front of Congress.  Instead, it should be Securities Regulators, who permit this manipulation.

Four LTCM Style Events in 13 Months

A. March 2020: Relative Value hedge fund Blow-up

B. January 2021: Melvin Capital Blow up

C. March 2021: Archegos Blow up

D. March 2021: The Lex Greensill Fiasco

*When central bankers do NOT allow the business cycle to function over longer and longer lengths of time, capital will always matriculate into toxic places. A moral hazard overdose has arrived.

Four in 13, all Leverage

In thirteen months, we’ve witnessed three Long Term Capital Management (LTCM) type meltdowns with a fourth still gathering steam: 1) the March 2020 Relative Value hedge fund blow up; 2) January 2021, GME short squeeze Melvin Capital Management hit; 3) the March 2021 Archegos Capital Management total return swap unwind; 4) in Europe, the Lex Greensill credit crisis is picking up steam.

Credit Suisse Equity has been Telling Us Something
Friday’s volume was pointing to some real issues. In recent weeks as the Lex Greensill debacle sucked more oxygen out of the air, CS equity has been dramatically underperforming. Institutional clients in our live chat were asking this week if Nomura’s pain is $2-4B, doesn’t that put CS in the $6-8B range? Any capital issues for the bank? Do they have to start de-risking or seek to raise more capital? All at quarter-end? With $275B of risk-weighted assets by the end of 2020 and a 12.5 CET1 ratio, this equals $34.375B capital. Clients we trust see a high risk of impairments.

LTCM blew up in 1998, losing $4.6 billion in less than three months caused by high leverage exposure to arbitrage bets across related but different securities – which fell under pressure once the Russia crisis hit. Niall Ferguson is right when he points out that LTCM’s models only used five years of historical data, thereby not including the 1987 crash. The result? Mispriced risk parameters. So when a crisis hit, LTCM blew up.

Thirteen months ago a once in a 100-year crisis hit in the form of the Covid-19 pandemic that Relative Value hedge funds hadn’t modeled for. The result? Mispricing of risk parameters. So when lockdowns hit and the Fed surprised with an inter-meeting rate cut, Relative Value strategies were crushed.

In January of this year, hedge funds such as Melvin Capital were short various small to medium-sized firms as a big percentage of the float on a highly levered basis. However, no one foresaw that fiscal stimulus checks would be used by twenty-something stock market neophytes to organize short squeezes on social media. The result? Those levered short plays blew up.

And now we have Friday’s Archegos Capital’s blow up, a hedge fund that was levered long names like Farfetch, Discovery, GSX, Teschedu, Baidu, Tencent, Music Entertainment, Viacom, Vipshop, iQiyi Inc. et al, all hedged with S&P and QQQ index shorts. What was the leverage mechanism? Total Return Swaps. The leverage caught up with Archegos. The result? Rolling liquidations of the fund’s long line items during the day. Then at 3 pm the short index cover ramp up in SPX and QQQ, nearly 2% in a straight line into the close, in spite of month/quarter-end portfolio rebalancing going the other way.

Bill Hwang who runs Archegos took $200 million and turned it into $15 billion in seven years. He used big leverage. He hung on. And he hung on some more. And finally, he hung on too long. The leverage, and more importantly, the hubris, caught up with him. Time aged, classic tale. How did he create his leverage? Total Return Swaps (TRS).

The second problem is that Archegos had TRS with multiple institutions and, given the uncoordinated large-scale selling of the same line items, it looks like the banks weren’t aware of the similarities of their cross exposures. That’s the kind of thing that may lead to regulatory scrutiny. Not illegal. Just sloppy.

A swap agreement is set up between a bank and a hedge fund. The hedge fund pays a low interest on the swap, say 2%, and the bank pays out any appreciation to the hedge fund. If there are any losses, payments are due from the hedge fund to the bank. It’s a glorified margin loan. Equity put up by the hedge fund is usually around 25% to 30%. But it can be less. The reference asset can be an equity index, a basket of specific stocks, loans or bonds. If the hedge fund’s strategy is long/short — e.g. long specific names vs short an index — the TRS is considered low risk and thus doesn’t chew up the bank’s balance sheet. The TRS means the hedge fund has risk exposure without actually owning the asset. The bank has more control in a portfolio liquidation scenario because it is the actual owner of the reference securities. Hedge funds love TRS because they get risk exposure without a large cash outlay. Essentially the funding cost comes at a slight premium to the bank’s cost of capital but at a big discount to the hedge fund’s normal cost of capital. It’s like Greece getting close to Germany’s cost of capital for being a member of the EU. The bank gives up on interest vig in exchange for transaction fees. The EU reduces Greece’s cost of capital so Greece can buy more stuff from the EU. Same generic idea. Theoretically both win — until both lose. But the hedge fund (like Greece) runs the greater risk if things don’t work out. The TRS equity cushion is meant to protect the bank in the event of untoward price movements. Hence the wild Friday.

The world survived this crisis, apparently. However, we expect in a prolonged bear market (yes, they exist), there will be more TRS disasters and eventually, they will become the focus of regulatory reforms.



Fed Chair Jay Powell and Jamie Dimon on the SLR Debacle

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The bond market is blowing up, what are we going to do about it?

Why should you care? Bonds are Driving Stock Prices
A colossal portion of “growth” stocks have their true worth embedded in the “net present value” of FUTURE cash flows. Thus, as bond yields and inflation expectations rise – tech stocks are worth a lot less.

Stock prices have been HIGHLY driven by bond prices in recent weeks, we MUST pay attention to the fixed income markets.

We noted yesterday in the Bear Traps Report  – “The question is, does this latest Fed move pave the way for no more SLR exemptions? Yes.”

Supplementary Leverage Ratio (SLR)

What is the SLR? The SLR is a measure of capital adequacy, in the years since Lehman Brothers, this is on everyone’s mind. Essentially, it measures in percentage terms a bank’s ability to take losses on its assets. The formula is SLR = (tier 1 capital)/(total leverage exposure).

What happened this week? It’s NOT Fed Chair Powell blinking under pressure from Senator Elizabeth Warren. This is a negotiated deal.

Pop quiz: What is the legal mechanism under which the Fed is independent? Its shares are owned by the member banks. Yep. That’s right. JP Morgan, Citibank, Bank of America, Wells Fargo, et al literally own the Fed. Anyone who thinks the RRP cap raise and the subsequent non-extension of the SLR exemption is wholly unrelated phenomena don’t know half of it. This was heavily negotiated. The Central Bank, believe it or not, talks to Jamie (money center banks), daily.

So it went down like this starting two weeks ago:

Fed on call to Jamie Dimon, CEO of JP Morgan: So folks, what’s cookin’?

Jamie: Eh. Not much. Kind of annoyed by this whole SLR thing.

Fed: Oh that Basel III thing that says Jamie has to raise capital against cash? That is just so stupid.

Jamie: No kidding. This is why we really appreciate having that exemption.

Fed: Yeah well, as you know, that was because of a pandemic. If Covid goes away, the exemption goes away. You all know this.

Jamie: Oh! For sure for sure but…

Fed: But you’re about to get tons of cash deposits from Treasury from fiscal stimulus. What’s the big deal? That money will all be spent soon enough. The problem will go away quickly.

Jamie: True, but before the money is spent we’ll be in non-compliance (new deposits are liabilities for banks). Can’t you just extend it?

Fed: Nah. Not in the mood. But just avail yourself of our RRP facility. Your cash will become reverse repos and you don’t have to raise capital.

Jamie: We thought of that.

Fed: I’m sure you did. (after a strained silence) But…?

Jamie: But the $30 billion cap just isn’t working for us.

Fed: Ahhh! I knew you wanted something!

Jamie: We always do!
(General laughter)

Jamie: Well, how about no cap?

Fed: Forget it! That doesn’t look right. Besides…

Jamie: Besides you need to keep your chokehold on our necks in case we get out of line on something else.

Fed: Precisely!
(General laughter)

Fed: So how much you think you need?

Jamie: Worst case $100 billion.

Fed: $100 billion. Are you crazy? Way too much. Do you think money grows on trees?

Jamie: Yes.

Fed: Oh yeah, you’re right about that.
(General laughter)

Fed: Gimme a number less than a hundo. That extra digit gives me the willies.

Jamie: $90 billion?

Fed: Too close. Make it $80 billion and we’ll throw in some language that if that’s not enough we can always raise the cap more.

Jamie: Done.

Federal Reserve Bank of New York to conduct overnight reverse repurchase agreement (ON RRP) operations with a per- counterparty limit of $80 billion per day, effective March 18, 2021.

Fed: Not quite.

Jamie: Oh God what now?

Fed: Lighten up on your treasury book.

Jamie: Say what? We thought treasuries were risk-free!
(General laughter)

Fed: Look. We don’t want to turn around and raise the RRP cap two weeks after the SLR exemption expires. That’s stupid.

Jamie: But…

Fed: But nothing. Reduce your treasury holdings. We’ll tell everyone on the planet we’re not concerned that rates are backing up, that we want inflation and full employment blah blah blah. You just do what you got to do and we’ll put a nice face on it.

Jamie: Ok. Fair.

Fed: And one last thing…

Jamie: One of you guys has to raise capital now.

Jamie: C’mon! That’s not fair! We already have to deal with the SLR exemption expiring and doing all these RRPs and selling down our treasury book and now we have to raise capital and lower our shareholders’ returns? The whole point of this convo is to avoid just that!

Fed: Brilliant, eh?( Jamie grumbling amongst themselves)

Fed: Calm down calm down. It doesn’t have to be all of you. Just one of you. You know, as a signal that you are willing and able to raise capital if need be.

Jamie: So if one of us raises capital preemptively, that signals to the markets that all of can…

Fed: Exactly. So Jamie…

Jamie Dimon: Oh no…

Fed: About this share buyback of yours that actually reduces capital…

Jamie Dimon: Oh no…

Fed: Not a good look just before the SLR exemption expires.

Jamie: Ok. I’ll take a bullet for the team I guess. Kinda sucks though.

Fed: You’ll live. Besides, once all the excess deposits are spent, you can use that cash to buy your stock.

Jamie: Oh yeah! I feel better already.
(General laughter)

Fed: $4 billion.
Jamie: $2 billion.

Fed: $3 billion and we are done with everything.

Jamie: Ok
Jamie: Sounds good to us!

Fed: Great. So the SLR exemption expires, the RRP cap is raised to $80 billion with flex above, you sell your treasuries and we talk nice, JPM raises $3 billion in prefs and everybody’s happy. Right?

Jamie: Right, the World is Saved for another day.

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Inside the Supplementary Leverage Ratio SLR – Bond Market Impact

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Our New York Times best seller is now published in 12 languages and focuses on the failure of Lehman Brothers. In the post financial crisis era, capital adequacy has been an important driver of the strength of U.S. banks relative to the rest of the world. The Supplementary Leverage Ratio SLR is the ultimate measure of capital adequacy. If the Fed doesn’t extent the SLR, it will have a large impact on the bond market, stress is high. Essentially, the SLR measures in percentage terms a bank’s ability to take losses on its assets. The formula is SLR = (tier 1 capital)/(total leverage exposure). This change reduces the denominator in the SLR calculation and as a result temporarily increases banks’ SLR.

If the Fed ends the SLR cushion, we see US banks as a net seller of Treasuries. As they are short in duration, it could well be enough to do some crowding out, and push the 10-year back up to 1.6%, and likely break above. This will put more pressure on long duration equities, aka the Nasdaq 100 NDX.

With TGA (Treasury General Account) cash coming in by this Summer to the tune of $1.1T as per the current TBAC schedule.. Bank SLR defined as Tier 1 Capital/(On + Off Balance Sheet Assets will decline. This is because deposits will come in and cash will go up at banks. Cash asset is in the denominator of SLR calc. As a result, U.S. banks won’t have room to accommodate the cash deposits.. their SLRs could trip minimum requirements.

Fed could fix all this by  excluding cash & treasuries from the SLR calc making the denominator lower and SLR higher for Banks so they don’t trip their minimum requirement which is 6% at the OpCo where most  of the deposits get flushed in with TGA.

No SLR relief means banks must turn away deposits and then there is nowhere for money market capital to reinvest (ex RRP which is still capped) that MMF Bill maturities floods more cash. So entire money market constellation trades close to zero or lower and Banks can’t buy US Treasuries no room on Balance sheet due to SLR so they start puking them out, TROUBLE!

Nominal GDP vs. Bond Yields
The Street is up at 6-7% 2021 GDP growth expectations.  BUT, including the inflation outlook – nominal GDP growth could be nearly 10% in 2021, but comparisons get tough in 2022 with growth estimates falling below 3%.

The March 31, 2021 Deadline

This month policymakers MUST consider extending the interim final rule that allows bank holding companies to exclude U.S. Treasuries and deposits held at Federal Reserve Banks from the calculation of their Supplementary Leverage Ratio (SLR) through March 31st, per ACG Analytics in Washington.

On April 1st, 2020, the Federal Reserve announced that it would exempt U.S. banks’ Treasury bond holdings and holdings at Federal Reserve Banks from Supplementary Leverage Ratio (SLR) calculations for one year. This was done “to ease strains in the Treasury market resulting from the coronavirus.” SLR rules broadly affect financial institutions with more than $250 billion in assets and require them to hold a minimum ratio of 3% Tier 1 capital against their total leverage exposure.

This form of regulatory relief enjoyed by big banks is set to expire on March 31st, 2021. If the Federal Reserve chooses not to extend the modified SLR rules, these banks will be forced to raise the level of capital held against their Treasury bonds and deposits at the Federal Reserve. This could result in a temporary decrease in market liquidity and lower demand for U.S. government debt as financial institutions reduce their exposure.

The Federal Open Market Committee (FOMC) will conclude its 2-day meeting on March 17th and an announcement on the SLR rule’s status could be made then. However, the issue has become politicized due to a recent letter by Senate Banking Committee Chairman Sherrod Brown (D-OH) and Committee member Sen. Elizabeth Warren (D-MA) requesting that the rule change be permitted to expire. Despite this, ACG Analytics believes that the SLR rule change will be… Join us…

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Gas Prices, Inflation and Inequality – All Fed Drivers

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The Fed Must Cap Real Yields: We think the following debate below is critical, an important juncture is coming at us all. Above all, we love when washout technicals line up in front of a policy response. The Federal Reserve must cap real yields in 2021 in order to preserve the economic recovery and attempt to fend off inequality. Their first weapon of choice is found in a roll-out of “calendar guidance.” Offering investors a well defined path focused on the certainty on asset purchases. All attached to a future time frame or date. If that fails, they will propose a twist (buy longer dated bonds, sell short ones) or YCC (yield curve control, simply cap 10s).

The Impact of High Rates: “A rise in real rates would give me concern that the amount of accommodation we’re providing the economy is reducing, and that might warrant us considering a policy response…“

– Neel Kashkari, President of the Federal Reserve Bank of Minneapolis

Everyone thinks we are heading for a 2013 style taper with higher real bond yields. The picture of a growth recovery (BlackRock’s Rick Rieder now talking up 7% GDP) where bond yields surge far higher than inflation expectations, that’s the consensus. This vision is laying a hammer on gold – a real yield nightmare. But with inequality being a significant eye sore for the Fed, higher bond yields relative to the rest of the world will simply strengthen the USD, suck capital back into the USA. The global wrecking ball will once again – be reborn. The negative economic feedback loop back to the U.S. is well documented. Strong greenback fueled manufacturing jobs losses most likely cost the Dems the 2016 election. The Fed must conduct monetary policy on planet Earth surrounded by other countries, NOT isolated on Mars. Likewise, with the U.S. debt profile (State, Federal and Corporate), $10T larger than it was a decade ago, each 50bps of real yield expansion comes with a gale force headwind equivalent to 150bps higher rates. Above all, today, too much debt sits below 2%, an extra $50T relative to 2018. In 2021, duration capital losses are – COLOSSAL – with higher bond yields. This is a possible inferno the Fed doesn’t want to toss a match on. The Federal Reserve cannot repeat the mistakes of 2011-2013, they must cap reals before the taper stage, if they want to extend the economic recovery that is. Thus, the convexity with gold is very attractive today. Every leg lower will act like a sling shot higher once the Fed makes their move. They must start to lay out calendar guidance, hint YCC as a future possible weapon on March 17th. We see large upside for gold, next 5 weeks.

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The Cost of Rising Yields: “A 50 basis point increase in the cost of funding for the U.S. Government is equal to the cost, the annual cost of the U.S. Navy. A 30 basis point increase is equivalent to the cost of the U.S. Marine Corps.” – Louis-Vincent Gave

Rates Impact: The UK government has just quantified a 1% rise in yields as costing £25bn in extra interest expense (OBR) which is just over 1% of GDP.

Inequality Issues Rising, a Problem for the Fed
Gasoline is testing its five year highs and Core CPI is down. Say what? How can that be? Is the government manipulating inflation measures so it can keep its money printing presses running hot? Of course! But there’s more to the story than that.  As to highly questionable lower inflation readings, it’s true. The components have changed over the decades such that if one were to calculate CPI using the 1980 formula, it would be more than twice as high as the current reading! But there is another less nefarious (or blindingly stupid) reason. An increase in gasoline prices is a tax on consumer demand. A person making $45k a year only has so much money to spend. And every dollar made is spent. So if an extra dollar goes to gas, that is one less dollar to a component of Core CPI. So higher gasoline prices take demand away from other goods and services. Higher gasoline prices exert deflationary pressure on other goods and services. 


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