Will the Hedge Fund MELTDOWN Crash Markets?

hey everyone meet kevin here we've just

heard about a complete debacle

that has started around tuesday of last

week and has lasted until today

and it has to do with hedge fund agreed

margin the collapse of loans after a

margin call and a complete disaster in

the hedge fund market

that has been echoing throughout well

the stock market even today not only

have we seen

many shares sell off last week but

shares have been selling off today and

people are wondering

wait a second what the heck is happening

is what just happened with this hedge

fund potentially going to happen again

or other companies at risk

should we just sell and get the heck out

of this disaster is this really a

once in a decade margin call or is that

just a nice way of making us feel good

until the real crap hits the fan

well this video i'm going to break down

exactly what the heck just happened

over the last week so you can fully

understand what's going on

why it happened and whether or not we

expect that it will happen

again or not all right here we go so

first things first

you got to know about this guy bill he

founded an

offshoot of a successful fund called the

tiger fund in america and he founded

this

in asia and eventually he managed over 5

billion

dollars of money in this offshoot of the

tiger fund

however they kind of got screwed in 2008

when the volkswagen short squeeze was

happening

and after a few years they decided you

know what we're going to shut down the

tiger fund in

asia bill huang was the leader of the

tiger fund in asia

so it's kind of like the game stop

squeeze but except it was volkswagen

back then

that really hurt them so in 2012 and i'm

really condensing the history right

because it doesn't matter so terribly

much but we're going to get through this

so in 2012 they decided you know what we

just don't want to be a regulated hedge

fund anymore

let's just give everyone their money

back who invested in our hedge fund

and uh you know there's some charges

that maybe we uh

you know did some insider trading to

make some money

and uh let's just uh plea guilty pay a

44 million dollar slap on the wrist

fine and uh take our company private so

we don't have to deal with the freaking

regulators as much anymore because the

regulators are apart

yeah so that's exactly what bill went

did he went private and

this was very common over the last

decade we saw a lot of hedge funds go

from being hedge funds which are much

more regulated by the sec

to basically just being private family

funds and see family funds

only really work with direct family

assets so you actually have to

kind of map out a family tree and go see

we're all connected somehow all the

people who are investing in this and

because we're all connected

we're good we don't have to disclose as

much that's one of the big benefits of

being a family fund is

you just get to hide from regulators a

little bit more because

you see the security and exchange

commission cares not whether or not what

you are selling

is good they just care that what you are

selling is honest

to the public but if you're selling to

people within your family they don't

really care as much because if you want

to screw your family

i guess that's on you and that's kind of

exactly what happened here

except uh mr bill william decided to

call this fund

arcago and archaico now managed about

10 billion dollars in assets which this

sounds like a family that i kind of want

to be able to say i'm a part of

because i want a part of that 10 bill

but i don't want to be a part of the

shadiness and that's what we're going to

get into here's the shadiness i'm just

saying

family with 10 bill there's enough money

to go around where you've got a family

or 10 bill okay

that's a lot of money but anyway so

here's apparently

what happened so mr bill had about 10

billion dollars in assets

uh roughly that's that's what we know

right now it could honestly have been

much less

and uh mr bill decided to get involved

in a very common

hedge fund tool known as total return

swaps sometimes these by the way are

also called

total rate of return swaps and that's

going to make sense in a moment

or cash settled equity swaps i actually

purpose i personally think

the easiest way to remember what these

swaps are is just think

total rate of return swap that's really

really useful and it'll make a lot of

sense when we go through the example

because literally what you're doing is

you're swapping rates of returns with

somebody and the reason i say i like the

total rate of return swap

is i kind of think about it like this

let's say i agreed to pay

somebody four percent interest uh but

then they made

15 on a certain stock let's say

i could take those interest rates and

swap them i'm like give me the 15

you just keep the interest rate uh now

the same works in reverse which

could be dangerous as well and so we'll

talk about this example but

total rate of return swap will help you

keep this a little bit straight because

it gets a little funky and then you're

going to get to see exactly kind of what

happened here okay

so best thing to do now is just go right

into an example

and show you how these things break down

so the easiest thing to do is

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little as five minutes okay pitch over

all right so here's how this works

arcago says hey we've got 10 billion

dollars in cash

we want to purchase a swap from you

and the cool thing about swaps is

because we're a hedge fund

and because we're risky people we want

to take on a lot of

leverage we want our 10 billion dollars

to really control like

30 billion dollars of money because whoa

if we make a 10 return on 30 billion

dollars that's like making three billion

dollars in profit

versus if we only used our own money we

would only have a billion dollars in

profit

yeah leverage yeah oh but wait leverage

works both ways so it's not always as

simple as ideal as it seems

so what happens here is exactly how a

swap works and remember how i talked

about that rate of return swamp okay

that's gonna be really fun here and so

what happens here

is arcago says hey you know what why

don't we pay you

three percent interest on top of what

your cost of capital is which might be

let's say

libor at uh 0.28 percent which those are

just standard things like you could look

up what's the one-year libor today

okay it's just a basic cost capital

thing that banks use

don't get caught up in that basically

archaego is saying hey we're going to

pay

you 3.28 interest

uh interest and what we want you to do

is we want you to take our 10 billion

dollars as collateral

and we want you to go buy 30 billion

dollars of let's say

viacom because we're really bullish on

viacom

and the banks credit suisse deutsche

bank goldman they're like

okay yeah sounds good we get to make

three percent and

uh if your stocks go down you pay us if

they go up no problem like

you you pay either way is the theory so

the bank is kind of like cool we're

making 3.28

and the goal is we really have little

risk because if

the value falls we'll just call you up

and do a margin call

that's the theory so the bank's like

cool we'll make interest and rk goes

like cool

we'll get to leverage up our money this

is actually really really common happens

all the freaking time

and so the way this would work is just

like this let's draw a little line here

and the easiest way to understand this

is just via a simple example

let's take that 30 billion dollars and

let's say the market

goes up 20 so all of a sudden that 30

billion dollars creates a 20

return which equals 6 billion dollars of

a return

well over here you've got that 3.28

in interest so take 30 billion dollars

times 3.28

in interest let's say it took a year

that's 984

million dollars and that represents a

3.28

so this was a positive swap in this case

because

in this case arcago says sweet

we have a swap contract so please swap

these returns bank you get

the 3.28 payment in other words you get

the 984 million dollars

and we get the 6 billion

dollars thank you very much so we paid

our fee for the six billion dollars we

got our six

a billion dollars it cost us 984 a

million dollars

great awesome very very profitable trade

and that's exactly how these

swaps work but what if the opposite

happens and it's even more extreme

so let's say the opposite happens so now

we've got 30 billion dollars at viacom

but all of a sudden the stock goes down

40

to the minus well crap that's minus

12 billion dollars now technically over

here on 30 billion dollars

the interest payments we're still that

984 million

uh dollars but the banks are like okay

we need to swap here

let's do our swap we get the 984 mil

you guys got to eat the 12 billion

dollars in losses here because the stock

went down

and now we're gonna perform the swap

negative 12 billion

the bank gets the 984 million that's how

it's supposed to work when things go bad

but wait a minute wait a minute big

problem archaico

only has 10 billion dollars so they are

upside down they get a margin call

because the banks are like yo your

stocks are plummeting

you guys need to come up with capital rk

goes like yeah we

don't have enough to cover how much that

just went down

and goldman deutsche bank credit suisse

are like uh

fine sell viacom and so they just

batch sell or bulk sell these

shares at a discount to try to get rid

of them to protect themselves from

further losses

okay but that's just an example right

this is just a hypothetical example

yes this is true this is just a

hypothetical example but guess what

happened in the market over the last few

weeks

stocks have been pretty volatile

especially certain asian stocks like

baidu or even other companies like neo

has been pretty rough too

but uh this particular fund invested in

companies like tencent and baidu which

have both been feeling the burn lately

on top of that they were investing in

viacom

which is a stock that has returned over

600 percent

in the past year it's been pretty

incredible

until of course they decided to raise

some money

sell some stock and that led the

company's

price their stock price or share price

to fall dramatically and

suddenly fell maybe 27.9

or something like that in addition to

all of the other uh

falling values that this fund has been

dealing with

leading the banks to say yo you're

running out of money margin call time

homie

and all of a sudden what happens they

run out of money banks are like that's

it

we're gonna batch sell these shares and

the shares fall

even further so that's an example

turned reality archago took around 10

billion dollars in assets

leveraged them up to 30 billion dollars

when the swap went ugly

they didn't have enough money to cover

it and there wasn't enough disclosure

for

society or the sec to actually even know

what the heck

was going on because they're a family

fund that kind of

in the background in a shadow way got

more than 10

stakes in some of these companies that

sold off massively because they weren't

technically holding the shares

the banks were technically holding the

shares and so that's how they got

screwed

now what are the risk factors here

because look

credit suites just lost two billion

dollars uh nomura another fund they're

losing a lot of money as well because

they were involved on the other side of

this

swap goldman sachs says that their

losses are immaterial and

deutsche bank liquidated early one of

the other issues by the way is

apparently multiple of these banks

we're looking at archagos's collateral

and they're like oh you got 10 bills

sure we'll lend you this much basically

in a swap

and they were all kind of referring to

the same original 10 bill

so it's possible that maybe they that 10

bill was leveraged up way more than

normal or maybe they actually had less

than we thought they had and they were

able to leverage that up way more than

normal

so there's a whole big issue of

transparency here

and in some sense it's kind of like

how's the dude at goldman supposed to

know that the guy

also securitized that cash collateral

they had

at a different bank hard to know because

the system's not really transparent

right

it's a disaster anyway so now we kind of

know what happened

now we got to ask ourselves what is the

risk of this

actually happening again is this the

beginning of the

end so to speak well look this could

totally happen again

this stuff is super normal this is the

same kind of crap

that happened almost the same kind of

crap that happened in 2008 except in

2008 it was credit default swaps and

mortgages

so when the values of mortgages went

down all these swaps

got obliterated because all of a sudden

like a 10 trillion dollar mortgage

market

was leveraged up not three times like in

this archagos

case but instead it was leveraged up

nine times to

a 90 trillion dollar market it was a

massive balloon

a massive bubble that got popped

instantly

so what is the risk going forward well i

mean the reality is

the hedge funds are being their classic

selves

they're oftentimes are reckless suits

who are over leveraged overly

competitive

and poorly regulated people because of

all these shadow

and toxic and arcane products that exist

with massive incentives for short-term

profits

that ends up meaning when they get hurt

everybody else

ends up getting screwed and holding the

bank because the hedges

and all these people doing these short

term massive whale trades on mass

leverage don't give a crap other than

trying to make whale trades

and becoming a somebody by making big

bucks when they get lucky one time

but when it goes bad it goes bad real

fast

this is exactly why people like warren

buffett say don't

get into big leverage that's exactly why

i say look if you're going to even touch

leverage keep it under 20

folks 20 so for every dollar you have

maybe 10 to 20 cents or keep it at zero

ideally then you don't have to worry at

all then you don't lose sleep at night

but these folks for every dollar they

have they're at like

three to four dollars of leverage it's

ridiculous that's how when all of a

sudden

you turn on cnbc or whatever and the

suits are up there going yeah we're

rotating into this sector

they're doing that because every dollar

they can pump up a stock

is like three or four dollars in their

pocket it's

massive leverage and there's no surprise

that these weenie baby hedge funds are

constantly rebalancing money and

constantly getting margin called

because they're all so close to the

brink all the time because money is so

freaking cheap everybody is borrowing

more and more and more money

and it's really dangerous now do we

think that

more of this is going to happen because

of this like are we going to end up

having like

uh you know an after effect or

aftershocks throughout the rest of the

system because of this

probably not probably not if there were

going to be more dominoes that would

have fallen over they would have fallen

over by now

mostly because we've already had

basically credit suisse and the banks

say look we've absorbed the loss it's

over let's move on

now that doesn't mean there aren't more

archago or

kegoses out there totally possible if

they're more of them out there

in fact you can pretty much almost

guarantee that there are and that's just

in the family hedge fund

business right or they're not really

hedge funds but the family fund business

like hedge funds do this stuff regularly

too now they have to be a little bit

more

transparent but so what even if they

disclose their holdings

it doesn't necessarily mean anybody's

actually worried about it until poopy

hits the fan

so yeah markets are very very fragile

and the reason they are so fragile is

oftentimes because of

leverage so keep yourself safe stay in

as little leverage

of a position as possible ideally you

get to zero leverage on stocks

ideally you're at 65 no more than 65

leverage on your real estate that is

ideally cash flowing

and you could just continue investing

for the long run and watch all these

weenie babies

lose their freaking minds and you could

just go

by the dip thanks y'all thanks for

watching if you found this helpful

consider sharing the video and folks

we'll see

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