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Big banks could lose big bucks after a major hedge fund defaulted on margin calls

Tuesday, March 30, 2021 by Robinhood Snacks | Disclosures

The i-banking equivalent... of defaulting on your mortgage and getting foreclosed on: getting your multi-billion dollar positions sold off after missing a margin call. Trading on margin = trading (partly) with borrowed money (usually from a broker). Margin call = when equity in your margin account falls below a minimum level, and the lender asks you to put up more of your own cash or sell positions to mitigate risk. They can happen when the value of holdings in a margin account plunges.

  • Call: Last week, a bunch of big banks told a large US hedge fund (reportedly: Archegos Capital Management) that it needed to put up more $$$ to keep its positions.
  • Response: Archegos basically said "IOU but ICPU" (I can’t pay you). AKA: it defaulted on the margin call, leaving the banks that loaned it money exposed to billions in losses.
  • Result: Banks started selling off Archegos' positions to meet the minimum equity requirements for the margin account (and recoup some of the losses).

It's a cascade effect... This big margin default is trickling down from the fund to banks to regular investors. For banks: this could mean billions in losses. Credit Suisse and Nomura warned of significant hits to their quarterly financials — both stocks plunged as much as 15% yesterday. Now, banks' damage-control is causing collateral damage: retail investors.

  • Last week: Morgan Stanley, Goldman Sachs, Credit Suisse, and others quickly dumped a bunch of stocks tied to Archegos, forcing it to liquidate nearly $30B worth of positions.
  • That selloff caused many of those stocks to fall — including Viacom, Discovery, Tencent, and Baidu — even while the broader market rose. Viacom has plunged a whopping 30% since Friday.
THE TAKEAWAY

High roller, high risk... Investment banks like Goldman lend companies billions in cash and stocks — and they make billions from these positions. Trading on margin means greater potential gain, but also much greater potential losses (that can mount fast). Before Monday’s warning, Credit Suisse said its pretax profit in January and February was the best in a decade. Now it could face billions in losses, because it may not have hedged its risk enough.