When the world is awash in money and investing seems easy, a lot of stuff gets overlooked. Emboldened by recent returns, the actions of their peers, and wanting to keep up with the Joneses (otherwise known as FOMO), investors start to look the other way when presented with possible red flags.
That stock you want to buy, the one with billion dollar plus losses projected for the next three years? Not to worry, the company has a very large addressable market and will obviously be far more valuable in the future. Besides, the stock doubled in the last 12 months, and you don’t want to miss out on that kind of upside anymore.
That bond you want to buy, the one with no covenants that allows management to fund stock buybacks and acquisitions as far as the eye can see? Not to worry, the company’s past performance has been solid, management would never do anything to hurt its bondholders, and besides, there’s nowhere else to find 5% yield today.
This always happens. It always happens when markets get frothy and investors start projecting today’s easy bank way into the future. And on the other side of that, know what happens when markets start to unwind? We start learning about the raccoons. Raccoons, according to Ben Hunt of Epsilon Theory, are financial scammers or frauds. And they’re very good at using bull markets in optimism and “everybody else is doing it” thinking to perpetrate their scams. This was Jeff Skilling and Andrew Fastow at Enron in 2001. This was Bernie Ebbers and co. at Worldcom in 2002. This was Bernie Madoff in 2008.
We’re starting to see a few raccoons get exposed in the current market cycle. Look at Lex Greensill and Greensill Capital and its magical supply chain finance machine. Look at Bill Hwang and his “family office” Archegos Capital. In Hwang’s case, the SEC brought criminal charges against him and his predecessor firm, Tiger Asia, in 2012. Hwang and co. pleaded guilty, but of course only received a slap on the wrist with a $60M fine and one-year probation. And yet, Goldman Sachs and Credit Suisse and other Wall Street elites couldn’t help themselves – they decided to do business with Hwang and Archegos and give him billions of dollars and structure deals that made it more difficult for regulators to follow what Hwang was doing…of course, media reports are saying that “internal examinations of risk management” are happening at the banks, and no doubt some “bad apples” will be identified. But some high up folks at those institutions made the decision to do business with a convicted fraudster. Same old Wall Street. And we all shrug our shoulders and move on. Maybe if Wall Street firms were still partnerships, and maybe if the Federal Reserve weren’t underwriting default risk for every corporation…maybe some of those bank executives would care just a little bit more about the types of clients with which they do business.
But I digress. The point here is to understand that we are at a point in the market cycle (if there is such a thing anymore) where raccoons are more prominent, where their schemes are more common, and where many seemingly reputable people will point to recent wonderful results and confidently state that this time is different.
“There is a tide that is flowing out today, and it’s revealing Lex Greensill and Bill Hwang in 2021 just as surely as it revealed Jeff Skilling in 2001 and Bernie Madoff in 2008. The big trade around Skilling and Madoff wasn’t directly on their specific scams and frauds, but on what their specific scams and frauds showed us about systemic rot in the financial system. It’s exactly the same with Greensill and Hwang today.”1