Streetwise Professor

March 31, 2021

Margin Call: From Movie to Reality Show

Filed under: Economics,Financial crisis — cpirrong @ 2:10 pm

The film Margin Call is an entertaining portrayal of big bank culture and behavior during the Financial Crisis. The basic plot involves a Wall Street bank that realizes that it holds a lot of toxic real estate/mortgage securities, and wants to unload them before everyone else figures out that their price is going to collapse. It succeeds, and saves itself from the fate of Lehman or Bear. I had to look past the basic plot vehicle: the ability of the bank to execute such massive sales without causing the price decline that it predicted is rather doubtful, at best. That said, the plot does provide an excellent backdrop for the personal dramas and interpersonal dynamics and characters that are Wall Street (and the City).

The Archegos implosion is a reality show version of Margin Call–right down to the title. The massive “private office” run by former Tiger Management wunderkind Bill Hwang put on massive positions (some long, some short) in a relatively small set of stocks. At least some of those positions were in the form of total return swaps, rather than purchases of the underlying stocks. Swaps embed leverage. A TRS is equivalent to a position in the stock financed with borrowing. It’s not clear from the reporting, but some may also have been old fashioned leveraged bets, with purchases of stocks on margin.

When prices went against the positions, Hwang faced huged margin calls that he did not meet. The prime brokers with whom he dealt then needed to liquidate large positions in the losing securities. Some of these stock holdings might have been the collateral that Hwang had posted, which the prime brokers seized when he defaulted. Some of them were almost certainly shares that the banks had bought as hedges of the total return swaps. Once Hwang defaulted, the banks’ short positions in the TRS went away, and they no longer needed the hedges.

Here’s where the Margin Call analogy really kicks in. Apparently Hwang’s major prime brokers, including Credit Suisse, Nomura, Morgan Stanley, and Goldman, discussed a coordinated liquidation of the stock positions in order to mitigate a panicked . Goldman (and maybe MS) listened politely, then pipped the others to the post and sold the stocks in big blocks before the others did. As a result, Credit Suisse and Nomura lost billions, and apparently Goldman and Morgan Stanley didn’t.

Goldman’s behavior is redolent of what they did in the Long Term Capital Management (LTCM) situation. One would have thought that CS and Nomura would have taken that into consideration, and hadn’t made themselves into the hindmost for the Devil’s taking.

Interestingly, although the block “fire sales” impacted the prices of the stocks Hwang traded, there doesn’t appear to have been a wider market fallout. Billions ain’t what they used to be. Even tens of billions ain’t what they used to be.

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  1. Trillions are the new billions!

    Comment by aaa — March 31, 2021 @ 8:51 pm

  2. I need to rewatch margin call but from memory they crush prices in getting out – but their average price represents a survivable loss. The decision to take that pain, and the phone calls for the late-in-the-day sales – where clients are sitting on huge losses – were both nice details.

    Comment by isp001 — April 1, 2021 @ 12:38 am

  3. “discussed a coordinated liquidation of the stock positions in order to mitigate a panicked”
    Wouldn’t that be market manipulation?

    Comment by HibernoFrog — April 1, 2021 @ 7:56 am

  4. It always amazes me that banks and other financial institutions continue to make the same old again and again. I live in Edinburgh and they have a resource called the Library of Mistakes to try and educate people in financial services into understanding the recurring disasters that seem a feature of financial markets.

    This is their rationale: “The library promotes the belief that quantitative economic algorithms provide a false sense of objectivity, and that trusting these imperfect models is a recipe for disaster. The books offer readers a chance to turn to financial history as a way to learn from past mistakes instead of relying on how economics should theoretically function under unrealistic assumptions.”

    It is said that financial institutions, in particular, should have a resident economic historian who, like the slave in the court of the king, should be whispering in the ear of the senior management about what should keep them awake at night.

    Failure to understand leverage, to realise that if you have a client who is not price sensitive and hence a good customer (without realising that there’s a good reason for this), and to assume that you can rely on market liquidity are just three of the egregious mistakes that have gone on here. And it is not just “fringe” players either. Look at the list of those who’d lent money to Archegos.

    Plus ca change…


    Comment by Peter Moles — April 1, 2021 @ 9:03 am

  5. @SWP… An excellent book on the LTCM events is “Inventing Money” by Nicholas Dunbar. Dunbar’s telling demonstrates his erudition. You come away with a lot of contempt for John Corzine. Now, knowing certain outcomes, it is an even more rewarding read. Corzine’s screwing of people and organizations didn’t end with LTCM. And the end of the LTCM saga foreshadows the financial crisis that happened 10 years later. The LTCM crisis was all about 10-year instruments, and there is revenge in 2009 for some of the characters at the end of the LTCM tale in 1999.

    Comment by Richard Whitney — April 1, 2021 @ 2:34 pm

  6. Amazing how far Credit Suisse has fallen from an elite Swiss wealth management bank to an also ran like Citibank.

    Comment by Joe Walker — April 1, 2021 @ 2:54 pm

  7. @Joe–CS has become a joke. This isn’t its only FUBAR. One of many.

    Comment by cpirrong — April 3, 2021 @ 12:14 pm

  8. Prof, what made Hwang such a wunderkind at Tiger? It appears the guy is bright and has an enormous set of brass cojones – the TRS manoeuvre was apparently intended to evade reporting to the SEC, and allowed him to place leveraged bets via numerous banks so as to aggregate tens of billions of exposure – but does he in the end make any money for his clients? In the famous phrase, are we mistaking leverage for genius?

    And why didn’t the banks try to hedge their exposure with puts?

    @Peter – the Library of Mistakes is a brilliant idea. And, one of my ideas when working at the Australian Treasury was to form a small (2-3 person) team of historians, who would advise on how ‘new’ policy ideas had turned out in the past (‘More deficit spending!’), and who would write up the processes and outcomes for each decision taken in a year. It never became reality.

    Comment by Ex-Global Super-Regulator on Lunch Break — April 4, 2021 @ 4:20 am

  9. …and the female head of Risk gets to pursue new opportunities in real life (Lara Warner) and in the movie (Demi Moore)

    Comment by ML — April 7, 2021 @ 7:22 am

  10. @ML. LOL. So true.

    Comment by cpirrong — April 7, 2021 @ 12:13 pm

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