IS A LARGE BROKER USING CLIENTS’ FUNDS TO COVER ITS LOSSES?

Even if everything is “back to normal” and everyone is behaving as if the events from two weeks ago were just a bad nightmare, with the VIX free-falling in a way never seen before (from 66 below 18 in 7 trading days, while every time before it took months to normalise after a volatility shock), it is hard to put aside that strange feeling that something is off in the markets.

This is what we know for sure so far:

• Japan experienced a crash even worse than the 1987 record.
• On Monday the 5th, Retail Brokers “pulled the plug” during US hours, claiming technical problems.
• On Tuesday the 6th, Japan’s BOJ, MOF, and FSA met to discuss the market situation. Needless to say, it was something incredibly unusual, but nothing significant was communicated to the public in the press conference that followed.
• Brokers and Market Makers were on the hook for hundreds of billions in transactions to settle (“DID A CREDIT EVENT TRIGGER ON MONDAY? THERE IS A GOOD CHANCE TO KNOW THE ANSWER IN THE FOLLOWING HOURS”)
• The Bank Of England Short-Term Repo OMO just hit an ATH this week, above ~34bn GBP, and this need for cash is clearly linked to events related to the JPY carry trade implosion (“THE JPY CARRY TRADE IMPLOSION CONTAGION IS ALREADY SPREADING INTO THE UK”)

Before continuing, let me highlight again the question we are trying to answer here:

“One very peculiar thing about the 1987 crash is that many brokerages went bust. So how is it possible that Japan suffered a stock market crash of a magnitude never experienced before, not even in 1987, and no damage has been reported so far among its major market participants?”

Now, as I anticipated in this post here, there is a lot of “gossiping” apparently going on behind closed doors regarding a hedge fund that might have suffered significant losses 2 weeks ago, and a broker was very exposed to it. This situation isn’t that different from the Archegos events in 2021, which ultimately led to the implosion of Credit Suisse, right? Here is where a chat with a former Credit Suisse employee helped point me in the right direction of what really happened at that time and what might actually be happening right now.

So here is what he told me:

• “Why do you think they put all the Credit Suisse files under secrecy for 50 years? If things that shouldn’t have happened in the bank didn’t happen, there would not have been a need for it.”
• “If the bank was supposed to be solid and capitalized, then why did clients and counterparts start to pull out funds until it became a stampede out the door?”

These two sentences gave me a lot to think about, and I started to look for similarities to what might have happened in the past. Here is where I found an interesting case: MF Global.

MF Global was once upon a time a major broker on Wall Street that made some poor proprietary bets on European risky sovereign debt in the market, which ended up deeply underwater. How did MF Global manage to conceal its losses and related liquidity issues? It transferred funds from client accounts into its own proprietary accounts. It all unfolded the night of the 28th of October 2011 during a conference call between MF Global CEO Corzine and the chairwoman of the SEC, Mary Shapiro. Banks and trading partners were pressuring MF Global to post collateral on its Total Return Swap bets on European sovereign credit turned sour, while MF Global traders in London were seeking $200m more to keep those positions open. The SEC, on its side, wanted MF Global to find a buyer to take it over, and during the due diligence, the $950m of missing customer funds surfaced on Sunday, the 30th of October. On the 31st of October, MF Global filed for Chapter 11, and the rest is history.

Of course, with Credit Suisse documents under secrecy for another 49 years, it will be impossible to know exactly what happened during the bank implosion and its emergency rescue orchestrated by the Swiss regulator with the help of the FED (yes, feel free to check out UBS/CS merger documents where is put black on white the merger was conditional upon keeping access for CS to FED liquidity facilities). However, the way it all unfolded and the urgency to arrange a merger with UBS in a fortnight is highly suspicious, to say the least, considering the tips I got and comparing the unfolding of that event with the MF Global one.

Now, what are the chances that another major broker is in a very similar situation (major unreported losses and fighting a liquidity crisis) right now? Let’s also add these two elements to the puzzle:

• The speed at which requests for a FED emergency rate cut surfaced, with futures at some point pricing a 60% probability for the event, while this made no sense at all since it would have worsened the JPY carry trade unwinding.
• The fact that VIX spiked to 66 BEFORE the US stock market opened on Monday the 5th, and that’s only possible as a result of institutions rushing for tail hedges, not retail speculation.

I personally ran the numbers multiple times over and over again; it is simply not possible everyone went through what happened in Japan coming out without even a bruise. Is someone keeping his mouth shut and, like MF Global did many years ago, or potentially Credit Suisse not too long ago, using customer funds to deal with its own liquidity issues? Forgive me, but this is the only possible way to “square the circle” and land to where we are today when everything seems “back to normal,” but it is so hard not to feel something is wrong with that.