Losses stemming from Archegos Capital Management’s forced liquidation of more than $20 billion in holdings “is the third near accident this year so far,” Allianz Chief Economic Adviser Mohamed El-Erian told Yahoo Finance on Tuesday.
"We are in March and we've had three near accidents that could have had systemwide effects. And it tells you that when so much liquidity has been put in the system, there is excessive and in some cases irresponsible risk taking," he said.
The collapse of Archegos, a family office founded by investment manager Bill Hwang, is sending shockwaves through Wall Street after its bets pushed lenders to initiate a margin call, ultimately forcing the firm to sell positions in ViacomCBS (VIAC), Discovery (DISCA), Baidu (BIDU) and Tencent Music (TME), among others.
“We saw it in February with retail investors, buying on margin of GameStop. We saw it with the hedge funds shorting 140% of the float. We've seen it now with a family office,” said El-Erian. “It tells you a lot of people have been saying the best thing to do right now is to leverage. Why? Because financing is so cheap and so available.”
The street is still trying to gauge the total losses to banks exposed to Archegos' fire sale. So far, Nomura (NMR) indicated a $2 billion hit, Japan's MUFG (MUFG) flagged a possible $300 million loss and Credit Suisse (CS) warned of “significant” losses. JPMorgan projects losses in the range of $5 to $10 billion, “well beyond normal unwinding scenarios for the industry.”
“We are still puzzled why Credit Suisse and Nomura have been unable to unwind all their positions at this point,” JPMorgan wrote in a note to clients on Tuesday. “Archegos was highly leveraged at 5-8x (i.e. $50-80bnE of exposure for $10b billion of equity) and the use of equity-swaps increased the inability of [prime brokers] to see the concentration risk in holdings within the hedge fund in question.”
While some investors fear widespread contagion, El-Erian told Yahoo Finance he believes it’s an ‘isolated situation.’
He does, however, warn that it may lead to banks becoming more cautious, resulting in tightened financial conditions.
“We should not be worried about short-term, medium, narrow contagion. This is an isolated situation of excessive leverage, concentrated positions, and a bit of overlays,” said El-Erian. “This was an accident waiting to happen and it happened. It may lead banks to be more cautious about extending credit and that in itself could be the longer term contagion from this.”
Seana Smith anchors Yahoo Finance Live’s 3-5 p.m. ET program. Follow her on Twitter @SeanaNSmith
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