Why Goldman Unsurprisingly Avoided Archegos Losses

I was running interest rate derivatives for Chase Manhattan (later merged into JPMorgan). I received a phone call late one night from a colleague informing me that LTCM was collapsing due to many highly leveraged bets going awry simultaneously. The following morning, our head of credit summarized the exposures we and the other big counterparties had to LTCM. As with Archegos, an orderly liquidation of positions looked to be the best option. But the economic incentives were similar to a cartel – each member was incentivized to secretly cheat.

The LTCM bank group was apparently sworn to secrecy. The information I had been provided made me an insider – it was obvious what trades should be done to generate immediate profits (“pay fixed in ten year swap spreads”) but I respected the rules and waited. Goldman didn’t. I saw them trading on the information they possessed about LTCM’s portfolio.

Goldman never got in trouble. Maybe what they had wasn’t inside information under a strict legal definition – interest rate swaps were bilateral agreements, not SEC-registered securities. Maybe they understood the information sharing agreement to be loose enough to allow trades to be done. What I do know is that they acted differently than we did. David Pflug, the patrician head of credit at Chase, was a man of his word who would never have resorted to legalistic identification of loopholes. Not trading on the information we had required no further explanation. We passed up a hugely profitable trading opportunity – but LTCM had been a money spigot for years.

Derivatives traders use the Greek alphabet (delta, gamma, theta) to identify portfolio risks. David Pflug later commented on the glittering mathematicians of LTCM, “for all their knowledge of Greek, they didn’t understand the meaning of hubris.”

I’ve always felt that Goldman regards legal and regulatory risk as just another risk alongside credit, rate, FX and equity risk. They all offer a risk/return trade-off. Most banks, including the one I worked at, put legal and regulatory risk off limits. There was no such thing as acceptable legal risk. Having watched Goldman over decades, I believe their culture incorporates a highly sophisticated assessment of legal/regulatory risk that allows them to consider the upside of a transgression against the possible penalty. They are very good at it, which is why they so rarely misstep. The 1MDB disaster is one of the few.

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Disclosure: We are invested in all the components of the American Energy Independence Index via the ETF that ...

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William K. 4 weeks ago Member's comment

Indeed interesting! And certainly those who play fast and loose with the rules will eventually be caught, although by who is a variable. It is also clear that some organizations cultures are devoid of integrity, (I will not name names here). At some point the truth will be revealed. And at some point judgement day will arrive, perhaps sooner for some than for others.

Flat Broke 4 weeks ago Member's comment

The problem with Wall Street is the punishments for bad behavior tend to be a monetary slap on the wrist. One that is a fraction of the money made or saved from the bad behavior. Thing about how Wells Fargo got away with stealing money from it's own customers. Or how Google was fined a mere $13 million for stealing user data that they made billions of off.

If the risk outweighed the rewards, we'd see a far more well behaved Wall Street. Or if they were threatened with jail time, that might help too.

William K. 4 weeks ago Member's comment

F.B. Certainly you are correct, unfortunately taking away every cent of the profit would be regarded as "cruel and unusual punishment" and so the bad actors do get away with their evil ways. Of course, if I were elected King things would be different. That is not likely to happen here in the USA. Plus, I do not even want to be king.

Alexis Renault 4 weeks ago Member's comment

What exactly happened with Archegos?

Adam Reynolds 4 weeks ago Member's comment