Good morning. Wall Street rallied yesterday, then faded. Sentiment is poor, and surprisingly solid results from Facebook (still boycotting “Meta” around here) after the bell seem unlikely to change that. But readers have suggested plenty of good reasons to be cheerful: it’s spring, Trump is out of the White House, and Russia is losing. Keep ‘em coming. Email me: robert.armstrong@ft.com.

Archegos and the efficient markets hypothesis

According to an SEC complaint lodged yesterday, Bill Hwang and three of his colleagues at Archegos did the following:

1. Bought staggeringly huge amounts of stocks, in very concentrated positions, mostly using money borrowed from investment banks

2. Bought tons more of those same stocks indirectly, using total return swaps (again with borrowed money) thus avoiding public disclosure of its huge, concentrated positions

3. Kept on buying those same stocks, directly and indirectly, in manipulative ways that supported their prices

4. Told lies to get more loans from their banks, which would have refused to provide funding had they known how huge and concentrated the Archegos positions were

Then in the spring of last year some of the stocks fell sharply in price, there were margin calls, and it all exploded.

As Matt Levine has pointed out, the most interesting thing about this story, as told by the SEC, is not that some people in finance are liars or that the disclosure rules for swaps could be a lot better. The interesting thing is that there is no discernible way this “fraudulent scheme” (SEC’s term) could have turned out well for Bill Hwang and his colleagues.

Could the whole operation have been a “pump and dump” scheme on a previously unimagined scale? Consider the size of Archegos’ positions in March of last year:

Archegos held those $97bn worth of shares, plus another $63bn of assorted other positions, at a leverage ratio of 344 per cent, according to the complaint. That is, for every $1 it has invested, the fund has $3.44 in banks’ money backing up those positions. Concentrated? As of late March 2022, the firm’s exposures amounted to half or more of the outstanding shares of four of the stocks listed above.

I submit that there cannot be enough buyers of these stocks at these volumes that they could be dumped, however carefully, without damaging the prices, triggering margin calls, and bringing the whole facade down. If any traders out there disagree, by all means email me.

Levine has floated the notion that Hwang and his team may have thought the stocks were actually worth the prices that their trading (allegedly) forced them up to. This is possible, though the stocks they picked (did you look at Viacom’s financials last year?) make me a little sceptical.

But assuming this to be true only makes the Archegos four look a little less insane. One thing you learn on about your second day as a stock picker is that when you think a stock is badly mispriced, you are wrong a lot of the time. If you are wrong only sometimes, you are wicked smart and you get rich. But because the firm’s bets were huge, concentrated, and leveraged, they had to be right almost all the time if their trading strategy was going to pan out.

The standard way to explain how people wrap themselves into patently unsustainable schemes is that they do it a little bit at a time. They tell one little lie and then have to tell another to cover that one up, and soon they live in a teetering tower of lies. You might apply this theory to Bernard Madoff, say, and perhaps even to Enron. But it does not work with Archegos, because these guys ramped up the their portfolio unbelievably quickly. According to the complaint, gross exposure went from $10bn to $160bn in a year.

Hwang is not just (allegedly) dishonest. He is also (apparently) out of his dang mind. And he brought at least three other people along with him on his trip to bonkersville.

Crazy people exist. This is not news. Nor does it excuse the alleged dishonesty of team Archegos, or the notable stupidity of banks which lent the firm money while various red flags flapped. But whatever version of the efficient market hypothesis you subscribe to, it needs to incorporate the fact that one or more crazy people may work at an apparently respectable firm, control an enormous amount of capital, and — for better or worse — be on the other side of the transaction you are about to do.

China’s ‘impossible trilemma’

China’s zero-Covid approach may do serious damage to its economy and therefore the world’s. Craig Botham, China economist at Pantheon Macro, pointed out that the country’s economic policy response to its own pandemic policy seems to be spinning its wheels:

The State Council on Monday urged implementation of already-announced tax cuts, rebates and fee reductions to support SMEs and manufacturers, including a further reduction in unemployment premia. These cuts were supposedly implemented from April, so this hints at problems of fiscal transmission . ..

President Xi [Jinping], speaking at the meeting of the Central Committee for Financial and Economic Affairs, called for efforts to boost infrastructure investment on Tuesday. This confirms our expectations that the government will continue to lean on this favoured stimulus tool, rather than capitulating on zero-Covid or the property sector crackdown . . . 

This comes back to the “impossible trilemma” of zero-Covid, 5.5 per cent growth, and stable debt-to-GDP

China can’t lock down, hit its growth target, and stop buying growth with debt all at the same time (in the long run, the latter two may be incompatible even without the first). The recognition that something has to give echoes all through an excellent story by my FT colleagues Sun Yu and Tom Mitchell:

Chinese regulators led by vice-premier Liu He are concerned that the government is underestimating the economic impact of its crackdown on the property sector and Covid-19 lockdowns . ..

Two other vice-premiers — Han Zheng and Hu Chunhua — have sided with the housing ministry in wanting to maintain the pressure on developers . ..

Confronted with China’s worst economic conditions and outlook since at least the beginning of the pandemic, financial policymakers have responded over recent weeks with only modest easing measures. Their reticence stems in part from fears that stronger stimulus measures would have only limited effectiveness, especially in regions brought to a standstill by Covid containment lockdowns

Can Beijing boost exports and growth, dodging the trilemma, by weakening the renminbi? Probably not, for reasons Unhedged’s friend Michael Pettis pointed out over on Alphaville. A weaker currency helps manufacturers, but also raises the cost of living, weakening domestic consumption — something China need more of, not less, if it is to grow sustainably.

Which horn of the dilemma do you think the government will choose? My money, like Botham’s, says unproductive, debt-funded investment will ramp up before long.

One good read

The reputation of president Ulysses Grant — courageous, naive, alcoholic, strategic, loyal, unsophisticated, terrible with money, terrific on a horse — is resurgent. My favourite president.