Archegoes Capital Management: Overdose On Leverage.

How Prime Brokers feed leverage to Hedge Funds.

If you've ever been in a position to get compensated by your clientele, you will appreciate the dynamic at work on Wall Street. A few select clients can make or break your career. And many times these kinds of clients can even determine the outcome of the entire firm.

Such is the way that the Prime Brokers work on Wall Street. They deal with the cream of the crop. The very top of the investment world: The Hedge Funds.

Hedge Funds are like no other client, they throw off revenue like no other. Not even giant mutual fund companies can mean as much to a prime broker as a Hedge Fund.

For one thing, they can be the most active traders in the market, with the exception of High-Frequency Trading firms but HFT's are their own brokers.

Hedge Funds usually have the largest margin positions, producing a ton of revenue for the Prime Broker. As well as stock lending revenue.All of this with relatively little support required. Remember at the Prime Broker level, each fund is but one client, so the support required is minimal.

So what is it that Hedge Funds want most from their Prime Broker? Answer? Leverage.The Hedge Fund's primary goal in life is to attain the highest possible return for clients. And that requires leverage and lots of it.

I'm aware of Hedge Funds with a current level of 10 to 1 leverage. And I'm sure many out there far exceed that published number. So for a Hedge Fund like Archegos Capital Management, that really means that the $10 billion in assets under management really trades as if it were a $100 billion dollar fund.

It also explains how the fund's demise could result in as much as a $20 billion dollar loss to the Prime Brokers who were supporting Archegoes.It also explains why a Hedge Fund, which is sailing along without a care in the world just the week before last. Can be out of business this week.

Leverage is a a terrible two-edged sword and it cuts both ways. All it took was a slight drop in a few of Archegos' holding, to start the margin calls rolling in.

In the case of Archegos, those margin calls centered on a couple of media companies Viacom CBS, and Discovery Inc, parent of the Discovery channel among other media properties.

Thus began a vicious cycle, where first the stocks lost value, which is the basic collateral in a margin account. Then the Prime Broker is forced to sell more stock to meet the margin call. Which in turn lowers the price, and sets off another round of margin selling.

It isn't a pretty picture.

But it is a warning to everyday investors. The amount of leverage on Wall Street is extremely high right now.

So beware of the impact that over-levered funds of all kinds can have on this market when they implode.

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