Tag Archives: margin call

Bitcoin Whale Blows Up, Leading To Forced Liquidation, “Bail-Ins”

We may have found the reason for Bitcoin’s persistent weakness over the past week.

After hitting a price above $8,000 thanks to recent Blackrock ETF speculation, the cryptocurrency has dropped 10% in the past week, dropping as low as $7,300 today, leaving traders stumped what was causing this latest selloff in the absence of market-moving news.

It turns out the reason may have been a good, old-fashioned margin call forced liquidation, because as Bloomberg reports a massive wrong-way bet left an unidentified bitcoin futures trader unable to cover losses, resulting in a margin call that has “bailed-in” counter parties forced to chip in and cover the shortfall, while threatening to crush confidence in yet another major cryptocurrency venues.

According to a statement posted by Hong Kong’s OKEx crypto exchange on Friday, a long position in Bitcoin futures that crossed on Monday, July 30, had a notional value of about $416 million. After Bitcoin prices dropped sharply in subsequent days, OKEx moved to liquidate the position on Tuesday, “but the exchange was unable to cover the trader’s shortfall as Bitcoin’s price slumped.”

The exchange, which identified the problem trader only by an anonymous ID number 2051247, said the position was initiated at 2 a.m. Hong Kong time on July 31.

https://www.zerohedge.com/sites/default/files/inline-images/bitcoin%20futs%20trade.jpg?itok=7FefGVJS

“Our risk management team immediately contacted the client, requesting the client several times to partially close the positions to reduce the overall market risks,” OKEx said. “However, the client refused to cooperate, which lead to our decision of freezing the client’s account to prevent further positions increasing. Shortly after this preemptive action, unfortunately, the BTC price tumbled, causing the liquidation of the account.”

The exchange was forced to inject 2,500 Bitcoins, roughly $18 million at current prices, into an insurance fund to help minimize the impact on clients. And since OKEx has a “socialized clawback” policy for such instances, it also forced other futures traders with unrealized gains this week to give up about 18 percent of their profits.

As Bloomberg notes, “while clawbacks are not unprecedented at OKEx, the size of this week’s debacle has attracted lots of attention in crypto circles.”

The episode underscores the risks of trading on lightly regulated virtual currency venues, which often allow high levels of leverage and lack the protections investors have come to expect from traditional stock and bond markets. Crypto platforms have been dogged by everything from outages to hacks to market manipulation over the past few years, a period when spectacular swings in Bitcoin and its ilk attracted hordes of new traders from all over the world.

“Everyone is talking about it,” said Jake Smith, a Tokyo-based adviser to Bitcoin.com, in reference to the OKEx trade.

And while everyone also wants to now how much capital was actually at risk, the biggest question is just how much margin there was in the trade. The problem here is that the exchange – ranked No. 2 by traded value – allows clients to leverage their positions by as much as 20 times.

For those who rhetorcially tend to ask “what can possibly go wrong” after every bitcoin slump, well now you know.

What happens next?

OKEx, which requires traders to pass a quiz on its rules before they can begin investing in futures, outlined planned changes to its margin system and liquidation procedures that it said would “vastly minimize the size of forced liquidation positions” and make clawbacks less frequent.

According to Bloomberg, clawbacks are unique to crypto markets and expose the exchanges who use them to reputational risks when clients are forced to absorb losses, said Tiantian Kullander, a former Morgan Stanley trader who co-founded crypto trading firm Amber AI Group.

“It’s a weird mechanism,” Kullander said.

Finally, judging by the bounce in bitcoin, the market appears relieved that it has identified the culprit of the selling, and with no more liquidation overhang left, is once again pushing prices across the crypto space higher.

source: ZeroHedge

Margin Calls Mount On Loans Against Stock Portfolios Used To Buy Homes, Boats, “Pretty Much Everything”

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In a securities-based loan, the customer pledges all or part of a portfolio of stocks, bonds, mutual funds and/or other securities as collateral. But unlike traditional margin loans, in which the client uses the credit to buy more securities, the borrowing is for other purchases such as real estate, a boat or education.

The result was “dangerously high margin balances,” said Jeff Sica, president at Morristown, N.J.-based Circle Squared Alternative Investments, which oversees $1.5 billion of mostly alternative investments. He said the products became “the vehicle of choice for investors looking to get cash for anything.” Mr. Sica and others say the products were aggressively marketed to investors by banks and brokerages.

From the Wall Street Journal article: Margin Calls Bite Investors, Banks

Today’s article from the Wall Street Journal on investors taking out large loans backed by portfolios of stocks and bonds is one of the most concerning and troubling finance/economics related articles I have read all year.

Many of you will already be aware of this practice, but many of you will not. In a nutshell, brokers are permitting investors to take out loans of as much as 40% of the value from a portfolio of equities, and up to a terrifying 80% from a bond portfolio. The interest rates are often minuscule, as low as 2%, and since many of these clients are wealthy, the loans are often used to purchase boats and real estate.

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At the height of last cycle’s credit insanity, we saw average Americans take out large home loans in order to do renovations, take vacations, etc. While we know how that turned out, there was at least some sense to it. These people obviously didn’t want liquidate their primary residence in order to do these things they couldn’t actually afford, so they borrowed against it.

In the case of these financial assets loans, the investors could easily liquidate parts of their portfolio in order to buy their boats or houses. This is what a normal, functioning sane financial system would look like. Rather, these clients are so starry eyed with financial markets, they can’t bring themselves to sell a single bond or share in order to purchase a luxury item, or second home. Of course, Wall Street is encouraging this behavior, since they can then earn the same amount of fees managing financial assets, while at the same time earning money from the loan taken out against them.

I don’t even want to contemplate the deflationary impact that this practice will have once the cycle turns in earnest. Devastating momentum liquidation is the only thing that comes to mind.

So when you hear about margin loans against stocks, it’s not just to buy more stocks. It’s also to buy “pretty much everything…”

From the Wall Street Journal:

Loans backed by investment portfolios have become a booming business for Wall Street brokerages. Now the bill is coming due—for both the banks and their clients.

Among the largest firms, Morgan Stanley had $25.3 billion in securities-based loans outstanding as of June 30, up 37% from a year earlier. Bank of America, which owns brokerage firm Merrill Lynch, had $38.6 billion in such loans outstanding as of the end of June, up 14.2% from the same period last year. And Wells Fargo & Co. said last month that its wealth unit saw average loans, including these loans and traditional margin loans, jump 16% to $59.3 billion from last year.

In a securities-based loan, the customer pledges all or part of a portfolio of stocks, bonds, mutual funds and/or other securities as collateral. But unlike traditional margin loans, in which the client uses the credit to buy more securities, the borrowing is for other purchases such as real estate, a boat or education.

Securities-based loans surged in the years after the financial crisis as banks retreated from home-equity and other consumer loans. Amid a years long bull market for stocks, the loans offered something for everyone in the equation: Clients kept their portfolios intact, financial advisers continued getting fees based on those assets and banks collected interest revenue from the loans.

This is the reason Wall Street loves these things. You earn on both sides, while making the financial system much more vulnerable. Ring a bell?

The result was “dangerously high margin balances,” said Jeff Sica, president at Morristown, N.J.-based Circle Squared Alternative Investments, which oversees $1.5 billion of mostly alternative investments. He said the products became “the vehicle of choice for investors looking to get cash for anything.” Mr. Sica and others say the products were aggressively marketed to investors by banks and brokerages.

Even before Wednesday’s rally, some banks said they were seeing few margin calls because most portfolios haven’t fallen below key thresholds in relation to loan values.

“When the markets decline, margin calls will rise,” said Shannon Stemm, an analyst at Edward Jones, adding that it is “difficult to quantify” at what point widespread margin calls would occur.

Bank of America’s clients through Merrill Lynch and U.S. Trust are experiencing margin calls, but the numbers vary day to day, according to spokesman for the bank. He added the bank allows Merrill Lynch and U.S. Trust clients to pledge investments in lieu of down payments for mortgages.

Clients may be able to borrow only 40% or less of the value of concentrated stock positions or as much as 80% of a bond portfolio. Interest rates for these loans are relatively low—from about 2% annually on large loans secured by multi million-dollar accounts to around 5% on loans less than $100,000.

80% against a bond portfolio. Yes you read that right. Think about how crazy this is with China now selling treasuries, and U.S. government bonds likely near the end of an almost four decades bull market.  
 

About 18 months ago, he took out a $93,000 loan through Neuberger Berman, collateralized by about $260,000 worth of stocks and bonds, and used the proceeds to buy his share in a three-unit investment property in the Bushwick section of Brooklyn, N.Y. He says that his portfolio, up about 3% since he took out the loan, would need to fall 25% before he would worry about a margin call.

Regulators earlier this year had stepped up their scrutiny of these loans due to their growing popularity at brokerages. The Financial Industry Regulatory Authority put securities-based loans on its so-called watch list for 2015 to get clarity on how securities-based loans are marketed and the risk the loans may pose to clients.

“We’re paying careful attention to this area,” said Susan Axelrod,head of regulatory affairs for Finra.

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I think the window for “paying close attention” closed several years ago.

All I have to say about this is, good lord.

by Mike Kreiger