Deleveraging is a process and not a point in time.
In that regard, the markets may have seen the beginnings of the deleveraging cycle this past week.

As noted in this space last week, the cockroach theory says disruptive events often start with a seemingly singular event...and lurking are other shoes to fall.
Last week, a large family office announced it faced forced margin calls & massive losses due to losing positions. They used leverage via margin and the use of derivatives. The unraveling of Archegos Capital Management caused billions in losses as portfolios were liquidated and the firm seemed to incinerate overnight. But was this the proverbial iceberg at work?... Were we only seeing a piece of more trouble to come?

Large family offices are a very lucrative part of the prime broker ecosystem.
The fees generated by servicing clients are significant. Large institutional clients and family offices need liquidity to put on large derivative positions and they find it via their primes. The primes are a mix of large banks and clearing firms. These firms take on risks from their clients and lay them off in the marketplace. When the primes take on this risk it’s called counterparty risk.

Rule 1 on Wall Street is to "know your client"
A bank or prime must understand their client so they know their risk. As we have seen countless times, the risk is often missed by all. Frequently we see derivatives blamed for the carnage.
Do people understand the risk? Do the primes?
Smart risk management and an understanding of leverage and derivatives not only protects the client but it's also an essential safeguard to protect the prime.
Counter-party risk is only sustainable for a prime broker when they have insight into what the client is truly up to. But sometimes the desire for trades and fee income compels counterparties to drop their guard. This week we saw another shoe drop from the Archegos mess.

And the carnage spread...and the cockroach turned out to not just be one cockroach...
The iceberg turned out to be deeper and was only now becoming visible.

Credit Suisse and Nomura were the primes for Archegos.
Credit Suisse reported a $4.7 billion dollar loss due to its involvement with Archegos. CS cut its dividend and indefinitely terminated its stock buyback program.

Nomura has a similar problem and is still identifying its losses and exposure.
Most of us are familiar with the book and movie ‘The Big Short’ which chronicled the housing market failure from 2007-2009. The climate back then was ripe for change. The federal government wanted to help marginal sub-prime borrowers obtain loans and participate in homeownership. Credit and leverage to buy a home were made easy for all to access and a housing bubble was spawned.
Buoyed by seemingly unlimited amounts of liquidity from the Federal Reserve, Wall Street figured out how to profit handsomely, by packaging, repackaging, & writing insurance on those loans.
Back then the tip of the iceberg started with one money market fund breaking the buck.
At the time, the Federal Reserve believed that it was a one-off event and that it was contained.
When the first cockroach showed up, everyone thought it was just 1 ...but there are always more.
The music ended and the perception of risk had now changed.
And soon there was carnage. But it can take a while to fully play out.
We are now 12 years and counting from the great recession caused by an over-leveraged financial system. Asset prices are again levitated, and equity valuations are historically stretched.
Volatility is subdued but is this the calm before the storm? What's waiting in the wings?
USA housing values are up as we hear that the supply available for sale has shrunk.
Too many buyers chasing the scarcity of sellers. Sound familiar? We are again in a time of obvious leverage in the system, it's by design. But are we missing any risks not seen above the water?
As we saw with the Archegos debacle when things are highly leveraged they can come tumbling down.
The holdings and their risk and the very derivatives that were responsible were hiding the real risk.
Didn't anyone understand the risk? Or was it like the housing crisis where the fees being made at the time blinded the counterparties to the inherent risk?

We all know by now it's a certain recipe for disaster.
It’s Deja vu all over again.


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