One week ago, in our initial take on the biggest hedge fund collapse since LTCM, we explained that - in our view - the catalyst for the failure of the Archegos hedge fund, which had as much as 10x leverage allowing it to hold some $100BN in positions, was Morgan Stanley and Goldman breaking ranks with their fellow prime brokers, and sparking the biggest margin call since Lehman and AIG.
Turns out we were right.
In the most detailed account yet of what happened in the fateful 24 hours between March 25 and 26, when many - but not all - of Archegos' big prime brokers starting dumping blocks of Bill Hwang's margined stock, CNBC's Hugh Son writes that "the night before the Archegos Capital story burst into public view late last month, the fund’s biggest prime broker quietly unloaded some of its risky positions to hedge funds, people with knowledge of the trades told CNBC."
That prime broker was Morgan Stanley and to avoid what could have been up to $10 billion in losses, the bank sold about $5 billion in shares from Archegos’ holdings in media and Chinese tech names to a small group of hedge funds late Thursday, March 25, roughly around the time a last ditch negotiation between prime brokers including Credit Suisse failed to reach a compromise to avoid a firesale.
Morgan Stanley's scramble to "be first" is a previously unreported detail that shows the extraordinary steps some banks took to protect themselves from incurring losses from a client’s meltdown. The moves, Son reports, benefited Morgan Stanley, while banks that were slow to react such as Credit Suisse and Nomura have seen billions in losses and widespread C-Suite layoffs. Credit Suisse said Tuesday that it took a $4.7 billion hit after unwinding losing Archegos positions; the firm also cut its dividend and halted share buybacks.
It was also not previously known that Morgan Stanley had the blessing of Archegos itself to shop around its stock late Thursday. The bank offered the shares at a discount, telling the hedge funds that they were part of a margin call that could prevent the collapse of an unnamed client.
Alas, all those hedge funds that bought Archegos holdings late on Thursday are now deep underwater on their positions. That's because Morgan Stanley had information it didn’t share with the stock buyers: as CNBC details, the basket of shares it was selling, comprised of eight or so names including Baidu and Tencent Music, was merely the opening salvo of an unprecedented wave of tens of billions of dollars in sales by Morgan Stanley and other investment banks starting the very next day.
And now, it is Morgan Stanley's other clients - those who bought the Archegos positions when approched by the mega broker - that are furious at the bank for having been betrayed and not receiving that crucial context, according to one of the people familiar with the trades. The hedge funds learned later in press reports that Hwang and his prime brokers convened Thursday night to attempt an orderly unwind of his positions, a task which we reported last week proved to be impossible especially once word of the conclave got out.
That means that at least some bankers at Morgan Stanley knew the extent of the selling that was likely and that Hwang’s firm was unlikely to be saved, CNBC's sources claim. And, as we explained one week ago in "Goldman And Morgan Stanley Broke Ranks ", it was that knowledge that helped Morgan Stanley and rival Goldman Sachs avoid losses because the firms quickly disposed of shares tied to Archegos.
Morgan Stanley had another reason why it had to be first, smartest or cheat: it was the biggest holder of the top ten stocks traded by Archegos at the end of 2020 with about $18 billion in positions overall, its prime broker going crazy in how much leverage it allowed Hwang to put on via Total Return Swaps. Credit Suisse was the second most exposed with about $10 billion, these sources noted. According to CNBC, that means that Morgan Stanley could’ve faced roughly $10 billion in losses had it not acted quickly.
"I think it was an ‘oh shit’ moment where Morgan was looking at potentially $10 billion in losses on their book alone, and they had to move risk fast," the person with knowledge said. Meanwhile, for those who missed it, this is how Credit Suisse lost $4.7 billion.
And while Goldman’s sale of $10.5 billion in Archegos-related stock on Friday, March 26 was widely reported after the bank blasted emails to a broad list of clients, Morgan Stanley’s move the night before went unreported until now because the bank dealt with fewer than a half-dozen hedge funds, allowing the transactions to remain hidden.
Needless to say, all those hegde funds would like nothing more than inflicting major pain on James Godman's bank, although in retrospect, their losses are their own fault: the clients which comprise a subgenre of hedge funds dubbed “equity capital markets strategies,” don’t have views on the merits of individual stocks. Instead, they’ll purchase blocks of stock from big prime brokers like Morgan Stanley and others when the discount is deep enough, usually to unwind the trades over time.
Alas, that deep discount would prove to get much more deep in coming days.
After Morgan Stanley and Goldman sold the first blocks of shares with the consent of Archegos, the floodgates opened. Prime brokers including Morgan Stanley and Credit Suisse then exercised their rights under default, seizing the firm’s collateral and launching a full blown firesale on Friday as CNBC details:
In a wild session for stocks on that Friday in late March came another twist: Some of the hedge fund investors who had participated in the Thursday sales also bought more stock from Goldman, which came later to market at prices that were 5% to 20% below the Morgan Stanley sales. While these positions were deeply underwater that day, several names including Baidu and Tencent rebounded, allowing hedge funds to unload positions for a profit.
"It was a gigantic clusterf--- of five different banks trying to unwind billions of dollars at risk at the same time, not talking to each other, trading at wherever prices were advantageous to themselves,” one industry source said.
While Morgan Stanley exited most Archegos positions by Friday, March 26 it had one last holding: 45 million shares of ViacomCBS, which it shopped to clients on Sunday. The bank’s delayed disposal of Viacom shares has sparked questions and speculation that it held onto the stock because it wanted a secondary offering run by Morgan Stanley the week before to close. A clusterfuck indeed.
Yet in a repeat Wall Street irony, while many funds are furious at Morgan Stanley they will get over it quick: as CNBC concludes, despite leaving some of its hedge fund clients feeling less-than-thrilled, Morgan Stanley isn’t likely to lose them over the Archegos episode because the funds want access to shares of hot IPOs that Morgan Stanley, as the top banker to the U.S. tech industry, can dole out.
In other words, half Boiler Room, half Margin Call.... which is a good excuse as any for us to end with one of the best Wall Street movie clips in the past decade, one which in 2011 predicted with uncanny accuracy everything that would happen to Archegos and its prime brokers...