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Yet another GME question I'm afraid. Straightforward...

The GME-related hedge fund(s?) in question lost about $5 billion.

Thus, they have to send a cheque for $5 billion to their broker(s), and/or other wise have to "give someone" five billion bucks.

My main question:

  1. Has this all been paid already or is it owing as we speak?

and,

  1. If Hedge Fund doesn't have the money and goes bust, "what happens"? Who loses, a brokerage? Individual traders? Government bail out?

Can a Hedge Fund (well, any big player) bust through their margin and not be able to pay up? (Or is that conceptually impossible for some reason I don't understand?)


i.e., less any relatively trivial amount of margin they already had on hand with broker

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3 Answers 3

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The losses may be $5 billion but it's possible that not all of the losses have been realized and some of it is still on paper (some of the short positions are still open) - likely ones added later on during the short squeeze).

It's possible that there are options in the mix, allowing someone to maintain losing open positions while not totally losing their shi_t (that's shirt!), but still taking a beating.

It's also possible to improve one's margin and stave off a margin call by buying back a portion of a short position. That effectively infuses some capital and slows the rate of loss since it becomes a smaller overall position.

One of the big losing players in this was the hedge fund Melvin Capital. On Monday, it was reported that Melvin received $2.75 billion from Citadel and Point72 Asset Management (other hedge funds) to meet its massive margin calls.

In regard to margin, in general, hedge funds are no different than us. If their holdings drop below the (MMR) minimum margin requirement (Reg T is 30% for shorts but some brokers have raised it), they get a margin call. Unlike us, they're not likely to be sold out immediately because they can quickly obtain a line of capital or a cash infusion (see above) and easily to meet the margin call. I won't say that hedge funds can't reach negative equity but they can survive better than we can. However, don't think for a moment that a hedge fund's broker is going to allow them to maintain open positions when MMR keeps dropping, eg. to 15%, 10%, 5%, etc. before beginning to shut them down.

Stay tuned because in the next few weeks there will probably be a lot of war stories as the media provides greater details.

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  • Ah - your para #4 has fully answered the question I had! Thanks! So the fact is they (apparently) did not have enough $ for the margin calls, and they had to seek new capital to pay up. All makes perfect sense.
    – Fattie
    Jan 30, 2021 at 18:04
  • Re para 5, yes but even just a normal civilian can have a position open, where it moves so incredibly dramatically beyond their margin that they no longer have enough personal wealth to pay up - right? That would seem to essentially be the case here.
    – Fattie
    Jan 30, 2021 at 18:07
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    (I'm still curious what happens when, if in the example, Melvin Capital had said "Whoops. Sorry, we doin't have that. We're now bankrupt FYI." You know?)
    – Fattie
    Jan 30, 2021 at 18:08
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    @Fattie - Bear in mind this didn't happen in one fell swoop. It took 5 business days for GME to double (2 weeks ago). For someone on full margin, $20 up would require about $22 more margin so it's likely that margin calls were going out back then. If this was a normal civilian, their short GME position would have been long since closed by the broker. Yes, it's possible that an adverse move is so incredibly dramatically beyond their margin that they no longer have enough personal wealth to pay up but that would require a monstrous gap, something that didn't happen until this week. Jan 30, 2021 at 18:37
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If Hedge Fund doesn't have the money and goes bust, "what happens"? Who loses, a brokerage? Individual traders? Government bail out?

Their broker is liable for the shortfall. 'You' don't ever buy and sell shares. Your broker does the buying and selling with other brokers, on your behalf. And they have to guarantee every single trade that they do.

Brokers, like banks, are required to hold a certain amount of capital to make sure they don't go under. If a Broker loses more money than they have, then things get messy. Probably some combination of the regulator/government/other brokers end up footing the bill.

Can a Hedge Fund (well, any big player) bust through their margin and not be able to pay up? (Or is that conceptually impossible for some reason I don't understand?)

It's the broker's (and the hedge fund's) job to make sure they don't (seeing as they're the ones who'll be liable). I imagine, for massive players, they'll give you more leeway than some tiny retail account. But ultimately if prices move violently and unexpectedly, it could happen.

But even if it does happen. Chances are if you were running a massive hedge fund, you got that way by being very good at what you do. So there are probably outside players who would be willing to bail you out in return for a stake in your fund/company.

A great example would be Knight Capital Group. 10 years ago, they were the largest trader for US equities. Through a series of unfortunate events related to a software update, their algorithmic trading software went haywire one morning. Over the course of 45 minutes of trading on August 1 2012 they lost $440 Million, which was enough to virtually bankrupt the company.

They raised $400 Million from a group of investors to plug the hole, and ended up being acquired just 4 months later.

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  • "Probably some combination of the regulator/government/other brokers end up footing the bill." The SPC and SEC step in to move all accounts to another broker.
    – RonJohn
    Jan 31, 2021 at 1:08
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    @RonJohn Yes, but that doesn't magically fix the losses.
    – Kaz
    Jan 31, 2021 at 1:13
  • Quite. The broker is definitely SOL.
    – RonJohn
    Jan 31, 2021 at 1:14
  • "Probably some combination of the regulator/government/other brokers end up footing the bill." it seems this is the consensus answer. It's really strange that there is no (even nominal, putative) formalized structure for "what happens when a broker can't cover" (which would certainly be the case in this "$5b example")
    – Fattie
    Jan 31, 2021 at 13:36
  • @Fattie It's a bit like asking what happens if the banks go under. Or an insurance company. It's not something that is ever supposed to happen.
    – Kaz
    Jan 31, 2021 at 14:31
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Equity trades in the US are settled on T+2 basis, meaning that the actual exchange of stocks vs money occurs on the second working after the order is executed. Assuming the short positions were closed on Jan 13-15 as reported in the press, the trades cleared by Tuesday, Jan 19. The clearing agency for stocks is DTCC which is regulated. The DTCC establishes risk metrics and collects the collateral from its members required for stock clearing. Hedge funds go bust once in a while but brokers, especially prime brokers, who are DTCC customers are pretty good at risk management and ensure that the customers (hedge funds) maintain the necessary margin. If the net asset of the customer goes below the specified threshold, they issue margin calls.

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  • Sergei - well yes, this is all well-known, but it's inconceivable they had anything like $5 billion in margin (for a shitty little short position on a minor stock), and if there was ever a case when a hedge fund could go bust, this is it! What's the answer to my question 2, do you know?
    – Fattie
    Jan 30, 2021 at 15:34
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    Obviously they didn't keep $5B cash in the bank to maintain their short GME position but they certainly had assets of comparable scale subject to margin rates. You can check how margin works using margin calculator available at most retail brokers. The hedge fund going bust is not a problem as long as the prime broker can sell its remaining assets to maintain the margin. If it fails, the prime broker is on the hook. If the broker fails its DTCC. But it has never happened. Jan 30, 2021 at 15:50
  • HI Sergie (I'm pretty familiar with margin trading (at civilian scales), unfortunately! :) ), "but they certainly had assets of comparable scale subject to margin rates" So, that's wrong, it turns out. Apparently they ran out of money but, happily, some of their mates kicked in the cash. " If it fails, the prime broker is on the hook. If the broker fails its DTCC." Ah, that is one of the things I was asking. (A) I'm surprised the broker is on the hook (they'd never be able to cover it anyway in this case) and (B) i'm amazed that a clearing house would carry that risk, but, fair enough
    – Fattie
    Jan 30, 2021 at 18:11
  • @Fattie That is sort of the entire purpose of brokers and clearing houses. To sit in the middle so they can facilitate, intermediate, and guarantee that transactions will clear.
    – Kaz
    Feb 1, 2021 at 15:27
  • @kaz - if you say so, but I thought their purpose was to facilitate & intermediate. In business the function "facilitate/intermediate" is incredibly different from "guarantee". (And brokers / clearing houses are vastly different.) Anyway - fair enough
    – Fattie
    Feb 1, 2021 at 15:29

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