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Leverage, Complexity, and Systemic Risk: Comparing LTCM and Archegos' Total Return Swap Mass

The Long-Term Capital Management (LTCM) meltdown in 1998 and Bill Hwang's total return swap (TRS) mass in 2021 were two major financial collapses that caused significant damage to the global financial system. Despite happening decades apart, there are notable similarities between these events that can provide valuable insights into the causes and consequences of financial crises.


The distinction between being a genius or a fool can sometimes be as narrow as a hair's breadth.


LTCM was a hedge fund that used complex financial models to make highly leveraged bets on the bond markets. In 1998, a series of market shocks and unforeseen events led to the fund's failure, causing losses of $4.6 billion for its investors. Similarly, in 2021, Archegos Capital Management, managed by Bill Hwang, used TRS to make highly leveraged bets on a number of stocks. When some of these bets went wrong, the fund faced margin calls from its prime brokers, leading to a fire sale of its holdings and losses of over $10 billion.


One of the primary similarities between these events is the heavy reliance on leverage. Both LTCM and Archegos used leverage to amplify their returns, but this also meant that losses could quickly spiral out of control. LTCM was leveraged at a ratio of 25 to 1, while Archegos was reportedly leveraged at a ratio of 5 to 1.


Another similarity is the use of complex financial instruments. Both LTCM and Archegos used sophisticated financial models and derivatives to make their bets. LTCM's strategy involved making bets on the relative price differences between various types of bonds, while Archegos used TRS to make leveraged bets on stocks.

In both cases, the firms were able to operate relatively under the radar, with little public oversight. LTCM was a private hedge fund, while Archegos was a family office, and both were not subject to the same level of regulatory scrutiny as publicly traded companies.


The modest family fund shook up the biggest banks.
The modest family fund shook up the biggest banks.

Furthermore, there are concerns that other funds could have similar characteristics or risk profiles, which could lead to another mass. Regional banks are currently experiencing a liquidity crunch and run, which could lead to massive margin calls on repos that these funds are using to increase their leverage. This is why it is essential to monitor and be mindful of how the repo market and interest rates fluctuate to prevent another potential black swan event.


Lastly, both events had systemic risks. LTCM's failure threatened to spread throughout the financial system due to its large positions in the bond markets. Similarly, Archegos' mass liquidation had the potential to cause a domino effect in the stock markets.


The LTCM meltdown and Archegos' TRS mass have striking similarities. Both relied heavily on leverage and complex financial instruments and operated with little public oversight. The systemic risks of their failures threatened to spread throughout the financial system. These events highlight the importance of strong risk management and regulatory oversight to prevent and mitigate the impact of financial crises. Monitoring the repo market and interest rates is essential to avoid another potential black swan event, especially as the liquidity crunch and run on regional banks continue.

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