Black swan risks – accounting for unknown unknowns:

Black swan risks – accounting for unknown unknowns.

In life, there will always be things you can’t see.

Events that happen that no one can predict.

They’re sometimes known as black swans, a term first coined by Nicolas Nassim Taleb.

There are 3 characteristics of a black swan:

1. An unpredictable event, 
2. An event that ends in severe and widespread consequences 
3. After the occurrence of such an event, people will rationalize it as having been predictable.

That’s what this meme stock short squeeze will be known as in history.

The ultimate black swan event that no one predicted.

Most of the people in Wall Street and high finance don’t know this is coming. They’ve brushed off the meme stock phenomenon as something small.

It’s not.

It’s going to blow up the whole system.

As Charlie Munger said and Shane Parrish writes in his mental models book, you need to think of second and third order consequences when looking at events.

Let me explain why this is a black swan event people aren’t paying attention to, but will blow up the whole world financial system.

In January, Gamestop underwent a short squeeze where the stock went from in the tens of dollars to almost $500 dollars in the matter of a few days. The market lost billions of dollars when this happened.

But buying was shut-off on these stocks so more people couldn’t jump into the fold. 

However, all this did was create a Barbara Streisand effect where even more people jumped in.

I first wrote about the Gamestop short squeeze in January and have been following it every day since. 2 subreddits who are the heart of this movement, superstonk and amcstock, had small amounts of followers. I remember Superstonk when it was under 50k followers and amcstock under 10k followers. Now both of those groups have ballooned to over 500k and 400k followers respectively.

Everyone who looks and uses Reddit does not always subscribe and/or comment. There are many lurkers, like myself, who just read and look at what people have to say.

So that’s millions of people around the world who have been following this story and buying in every day.

The mainstream media is trying to convince the world that nothing is going on and this is just like any other short squeeze that we see in other stocks, but it’s much bigger than that.

The funds at the centre of the fiasco are some of the largest hedge funds and market makers in the world, like Citadel.

If they get short squeezed out of all their money, which could happen, the world economy blows up in everyone’s face.

Let me explain how.

Hedge funds and market makers partner with banks to give them leverage. If they raise 10 billion dollars in real money, the bank might give them 5x leverage meaning they get to use 50 billion dollars in the market.

With this 50 billion dollars, these hedge funds go long and short on certain stocks. They bet some stocks will rise and others will fall.

The problem is if they get short squeezed, the bank comes knocking at the door for margin calls.

Margin calls means they need to put more cash in their account to maintain it, otherwise the bank takes over and sells everything.

This is fine if only a small number of funds do this because the banks should have the cash on hand to cover any losses.

However it’s disastrous if it’s with large institutions, hedge funds and family offices because the bank is on the hook.

That’s what happened with Archegos.

Everyone in finance knows about the story of Archegos and how Bill Hwang lost $20B in a few days. There’s a really good video explaining it (here)

There’s evidence that Archegos was linked to the Gamestop short squeeze in January, but nothing has been proven.

What we do know is that Bill Hwang, a convicted insider trader, was allowed to maintain margin accounts with several banks and buy swaps on specific companies.

Swaps basically mean that Hwang had ownership of certain companies through the banks via derivatives but it was never made public.

Side note - there was no transparency, and that’s one of the big problems on Wall Street. Blockchain solves this and that’s why the switch to decentralized finance is happening because anyone can see everything at all times.

As long as he maintained his account with the banks and the stocks continued to hold their value, everything was fine.

Shit hit the fan when Viacom/CBS announced it was selling shares thereby diluting the stock and causing it to drop.

Hwang was on the hook but he couldn’t fulfill his margin requirements, so the banks margin called him.

Some banks like Goldman got out ok by selling all their securities before their counterparts did, but others like Credit Suisse and Nomura got screwed. They lost billions of dollars in his transactions.

The issue is that this is just the tip of the iceberg.

What if the one of largest hedge funds in the world aka Citadel gets margin called by their banks?

The banks are screwed.

The reason no one is accounting for this risk right now in the system is because it’s never happened before.

Mr. Taleb talks so beautifully about this because black swans are unforeseen.

We never had social media before.

We never had Covid before.

Because of this, most people in finance today don’t recognize how much those two factors have changed everything.

Once buying was shut off in January and people around the world saw how Wall Street plays by a different set of rules, it invigorated millions of people online. They banded together by using publicly available information, most of which is doctored by these same banks and hedge funds, to come together to support a specific cause. 

The internet is the biggest hedge fund in the world and the world will soon understand that reality.

When people act together and coordinate effectively, revolutions can occur.

We’re in the midst of the greatest transfer of wealth in the history of the stock market all because people online decided to learn about the market.

Great investors know we’re in a massive bubble. Howard Marks and Jeremy Grantham, two of the most famous investors in the world, called this the everything bubble.

Stanley Druckenmiller, whose track record is legendary, said this was the craziest and most speculative environment he’s seen in his entire life, and the man is 70 years old.

These guys know this environment is crazy and will all come crumbling down soon, as every bubble in history has done.

They don’t know what the match is that lights the whole market on fire.

I do – an event no one has seen before and may likely never see again.

So next time you’re reminiscing on the direction of your life, always think about black swan risks - the moments that no one sees coming, yet completely change the course of history.