by Pam Martens and Russ Martens, Wall St On Parade:
Credit Suisse presents a cautionary tale about creating so much innovation in the realm of credit derivatives that one gets named “Credit Derivatives House of the Year.” That award might sound like a good thing to traders who make their living cooking up and trading exotic derivatives but it might sound like a very bad thing to pension funds and mutual funds who own big chunks of the stock and bonds of that bank and remember how credit derivatives blew up much of Wall Street in 2008.
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On September 28, Risk.net named Credit Suisse the “Credit Derivatives House of the Year.” Three businesses days later, Credit Suisse saw its own Credit Default Swaps blow out to more than 300 basis points and some of its own bonds trade at 63 cents on the dollar. Simultaneously, its shares traded at an intraday low of $3.70 in New York on October 3, closing at $4.01, and putting it in crisis management mode.
On the same day that its stock, bonds and Credit Default Swaps were exhibiting severe stress, Reuters decided to run an article in the early afternoon reminiscing on the serial scandals that have plagued the global bank: words like “cocaine,” “kickbacks,” “fraud,” and “spying,” reminded investment managers of just how voluminous and varied Credit Suisse’s scandals had been of late.
Losing billions of dollars on derivatives and being scandalized in news headlines is apparently no barrier to getting an award from Risk.net.
In late March and early April of last year, Credit Suisse lost $5.5 billion from the highly-leveraged, highly concentrated stock positions it was financing via tricked-up derivatives for Archegos Capital Management, the family office hedge fund of Sung Kook “Bill” Hwang. Archegos blew up on March 25, 2021 after it defaulted on margin calls to the banks financing its trades. (See our report: Archegos: Wall Street Was Effectively Giving 85 Percent Margin Loans on Concentrated Stock Positions – Thwarting the Fed’s Reg T and Its Own Margin Rules.)
To cover their backsides, the Board of Credit Suisse decided to hire the BigLaw firm, Paul, Weiss, Rifkind, Wharton & Garrison, to conduct an internal investigation of the matter. On July 29, 2021 Paul Weiss issued a 165-page report on its version of what happened. Paul Weiss found no fraud had occurred — just zombie risk management at a Global Systemically Important Bank (G-SIB). (We’re not sure if fraud might have been a less troubling determination.)
This is how the Paul Weiss report portrayed the zombie risk managers at Credit Suisse:
“The Archegos-related losses sustained by CS [Credit Suisse] are the result of a fundamental failure of management and controls in CS’s Investment Bank and, specifically, in its Prime Services business. The business was focused on maximizing short-term profits and failed to rein in and, indeed, enabled Archegos’s voracious risk-taking. There were numerous warning signals—including large, persistent limit breaches — indicating that Archegos’s concentrated, volatile, and severely under-margined swap positions posed potentially catastrophic risk to CS. Yet the business, from the in-business risk managers to the Global Head of Equities, as well as the risk function, failed to heed these signs, despite evidence that some individuals did raise concerns appropriately.”
And this:
“…a Prime Services business with a lackadaisical attitude towards risk and risk discipline; a lack of accountability for risk failures; risk systems that identified acute risks, which were systematically ignored by business and risk personnel; and a cultural unwillingness to engage in challenging discussions or to escalate matters posing grave economic and reputational risk. The Archegos matter directly calls into question the competence of the business and risk personnel who had all the information necessary to appreciate the magnitude and urgency of the Archegos risks, but failed at multiple junctures to take decisive and urgent action to address them.”
The report from Paul Weiss sounds very similar to the findings of the U.S. Senate’s Permanent Subcommittee on Investigations’ on how JPMorgan Chase dodged risk limits and lost more than $6 billion using bank depositors’ money to make high risk derivative trades in the London Whale scandal of 2012-2013. That 300-page report found the following:
“In the first three months of 2012, when the CIO [Chief Investment Office] breached all five of the major risk limits on the Synthetic Credit Portfolio [SCP], rather than divest itself of risky positions, JPMorgan Chase disregarded the warning signals and downplayed the SCP’s risk by allowing the CIO to raise the limits, change its risk evaluation models, and continue trading despite the red flags.”
And, of course, there were also the zombie risk managers at Morgan Stanley who allowed Howie Hubler to lose at least $9 billion on derivative trades following the 2007-2008 financial crisis. Bestselling author, Michael Lewis, wrote about Hubler’s losses in his book, The Big Short, describing Hubler as a star bond trader at Morgan Stanley, making as much as $25 million in one year. Hubler was one of the Wall Street traders who made early bets that lower-rated subprime bonds would fail. He used credit default swaps to make his bets. But because he had to pay out premiums on these bets until the collapse came, he placed $16 billion in other bets on higher-rated portions of the subprime market, according to Lewis. When those bets failed, Morgan Stanley lost at least $9 billion.
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