00:00:02 Speaker 1: Bloomberg Audio Studios, Podcasts, radio news. Who are you? 00:00:09 Speaker 2: I'm Sylvia Killingsworth. 00:00:11 Speaker 1: How much introduction should we do with you? 00:00:13 Speaker 2: I could give you my title, I could give you my middle name. I could give you my data birth social Security number. 00:00:21 Speaker 1: Hello, and welcome to the Money Stuff Podcast, your weekly podcast where we talk about stuff related to money. I'm Matt Levian and I write The Moneystuff Colm for Bloomberg Opinion. 00:00:32 Speaker 2: And I'm Sylvia Killingsworth. I'm an editor at large for Bloomberg Ideas and Culture, and I run a great newsletter called on Books, which Matt has been featured and will be featured in. 00:00:41 Speaker 1: The podcast has been featured. This is the Money Stuff Podcast, which usually features me and Katie Greyfield in my co host, but she is away for six months. Katie is on parental and so our plan was to have a rotating cast of guest hosts. And you are the first sacrificial victim. 00:01:09 Speaker 2: Here I go, Here you go. 00:01:11 Speaker 1: You're talking about situational awareness. Now, yes, okay, you want to yes, I don't. I don't know what's to say. The guy blew up, I mean sorry, the guy didn't blow up. The latest report. So this is there's a hedge fund called Situational Awareness. It started by Leopold Ashanbrenner, who's a former Open AI employee who like left like age Yeah, he's like twenty five. 00:01:31 Speaker 2: From Columbia, nineteen elevictorian. 00:01:34 Speaker 1: He wrote some essays in twenty twenty four called Situational Awareness, the gist of which is like, oh, boy is going to be really big, and enough people found that compelling that they aim a lot of money to run a hedge fund to basically bet that I would be really big, which broadly speaking, was a bet that worked really really really well for like the last two years. And he's like returned like a thousand percent by like tune, and you know, he's like very plugged into AI and seems to make good bets on like who will be the winners of the AI boom and all this stuff, and. 00:02:08 Speaker 2: Did create he worked, He knows a lot of stuff, He understands how it works. He can see the future. 00:02:13 Speaker 1: So sorry. The news today is that he apparently got blown out of a lot of his positions because his prime brokers sent to margin calls. They like didn't have enough money, and so the prime brokers kind of helped him offload a lot of stuff. Citadel, the big hedge fund, ended up owning a lot of his public stock positions. He still has like a big anthropic stake. And like the reporting that I saw today was that his assets under management have declined to like ten billion. 00:02:38 Speaker 2: Do lear. 00:02:39 Speaker 1: But so that's the story. Basically, like he got margin called, you know, because there's been a drawdown in AI bets in the last couple of weeks, and so he was very long a lot of AI companies, memory chip companies, things like that, and very short you know, like software companies, and both of those moved against him for whatever reason, sure fundamental reasons, technical market sentiment reasons, people knowing that he had them, and maybe hunting him, like I don't know. But anyway, the movie against him. He got margin calls, He got blown out of a lot of his positions. Sit Itell now owns a lot of his thock bets and by the way, all of his trades like have recovered today. This is recording, which is like what happens when these things happen, right. 00:03:17 Speaker 2: Oh, like as a result of this, as a result. 00:03:20 Speaker 1: Of like the problem being fixed, and it's like these positions have moved from weekends. People who have a lot of margin leverage and might have to sell to strong hands have Stadelho like got him at a discoun and so now there's no more worry about selling pressure coming in these positions, and. 00:03:38 Speaker 2: So everyone feels better. 00:03:39 Speaker 1: Everything's recovered, and so cidadel has made probably a lot of money in twelve hours. 00:03:44 Speaker 2: His bets weren't wrong. He just kind of caught out as they look a long time. 00:03:49 Speaker 1: Yeah, like they're down in the last month, but like they're way way up since the beginning of the year. Overall, kind of every stock he bought at the beginning of the year is up, you know. But what I wrote today is basically like if you're making like long term bets on like things like Anthropic that were kind of like didn't exist five years ago, sure now, like trillion dollar companies, if you're making these long term, extremely volatile bets, you have to expect that at some point there will be some volatility, right, Like some of these memory stocks will like go up a thousand percent, this is a little too much, and we'll go down a little shit, right, And if you are constantly running at I don't know what his leverage was, but let's say three times leverage. If you have ten billion of your own money and you're making thirty billion dollars of bets and you're constantly scaling out the bets as you make more money, then this will always be fragile, and at some point there will be a drawdown and you will have to pay back your debt and you will get margin calls and your prime brokers will make you sell your positions and you will be blown out of these long term bets because you had essentially. 00:04:50 Speaker 2: Short term finance, short term financing. 00:04:53 Speaker 1: Which is kind of what hedgemon margin debt is, right, And you know, if you think of like what sit at all those all they did, I mean a lot of things, but like, the deep thing they do is think about this, right, the deep thing they do is think about, like, if something bad happens, how do we survive, Like how do we make sure that our funding doesn't get pulled? And so some of that is having contracts that say, you know, instead of like we can get a margin call and blown out in twenty four hours, it's like, you know, we have longer term debt. Big hedgehes issue bonds for these reasons, but some of it is like just having a risk culture and a reputation of not getting blown up so that your prime brokers will not worry about you. Whether if you're like a twenty five year old you start a hedgehind two years ago, your prime berls will worry about you. And if you get a margin call and you're like, I need more time, guys, they'll say no. So I do think that, Like, you know, what I wrote today is that situational awareness is like essentially in the business of like thinking about the long term future of AI right, which has been a great business for them until two weeks ago. Sure sitde like in the business of thinking about funding risk and find the funding risk blew situational awareness and now Citadel owns their bets on AI. And I also I mentioned this in a footnote, but there's another guy who had bad funding for his anthropic bets. Like one way to think about Sam Bankman Freed is that he was a really smart venture capital investor in AI like he bought I think he had a couple of other like very cool positions, but certainly he was a very early, very big investor in anthropic and bought a stake in Anthropic that you know, they sold it a couple of years ago to in the bankruptcy estate. But like he had like eight percent of enormous yeah, you know, stuff that's worth tens of billions of dollars today. But he bought that with like the very worst short term funding imaginable, which is like money stolen from the customers cryptoi exchange. He would say, not stolen, right, and money borrowed money whatever, money from the customers of his crypto exchange. And when your crypto exchange, you know, when people try to with throw money and you're like, I'm sorry, I can't give you the money, it sounds really really bad, even though like like you know, the line is great, right, And so that worked out very very poorly for him. Leopold work in some sort of FTX fund at some point, like crucially did not do that, Like he borrowed money from banks on prime brokerage terms very you know, in very normal ways. But it does sort of lead to the same problem, which is you can be blown out of the bets prematurely, right, Like you know, if Sam Bankmanfree had kept his Anthropic bet, it would be worth one hundred billion dollars today, if Situational Awareness had kept their AI bets, like you know, they probably be you know, an eighty billion dollar fund in a year, right, like like it's just like you can't volatility. 00:07:53 Speaker 2: Is it the leverage or is it the term of the financing like the time I mean, and like. 00:08:02 Speaker 1: Their equity value is not zero. So if they had non callable leverage, right, like if they had issued bonds to finance these positions, like if they had issued like tenured, non call, non putable bonds, like they would just have the money and they would be fine. 00:08:21 Speaker 2: You know, I do think that, Yeah, you can both, I guess right. 00:08:25 Speaker 1: Yeah. It's like I thought about a lot this sort of thing a lot in like the crypto world, Like this is what three hours was up to. In crypto, there are a lot of people who like think they're doing a like liquid markets trade, but are kind of doing a like venture capital trade. And if you're funding adventure, well, like like in crypto, this was more obvious because like people were putting money into like you know, things that had just been invented. But like Situational Awareness was making a long term bat on like a market going from like almost nothing to enormous, and so to have that bet pay off, you need to see it through for the long term. Like you could be wrong for a while, right, and they were really right for a while, which they just levered up the bet and that worked on poorly. Like to make a long term bet like that, you need long term funding. The other thing that like is crazy to me is their returns in their first like two years or one thousand percent, which like too good, it's too good. If they had not had any leverage, they would have returned I don't know, two hundred percent, like oh, like it would have been so good, and then they'd be fine, right, they'd be down, you know, thirty percent this month and they'd be like, well, sorry, guys, you're still up two hundred percent. 00:09:39 Speaker 2: Your point being like that's like maybe a red flag kind of number. 00:09:42 Speaker 1: No, it's not exactly read. It's just like they do you just have yeah, but they don't mean like, you know, it's not like fake. It's just like that's the result of leverage. And I think it's you know, because they were a hedge fund and they're like, well, hedge funds par of money, and like, we really believe in this bet. So we want to, you know, make it as big as possible, right, But if you're levered portfolio returns two hundred percent, like you don't need more leverage, You're fine. Two hundred percent is great, Like you can just get two hundred percent, And they instead got a thousand percent and then got blown out this week. 00:10:17 Speaker 2: So it seems like they weren't really very aware of the situation. 00:10:37 Speaker 1: You're the first guest host, and I sent you I think like last Friday. Yes, I was so excited about this I don't even know how to pronounce it. This company, this biotech royalty company called Exoma. They did something so weird and I was like, you were really getting thrown into the defense. We are a start in your podcast with a record date mix up? 00:11:02 Speaker 2: There is no for me. 00:11:04 Speaker 1: And you, I think rolled your eyes, but I didn't see it. So should we talk about Exoma? Yes? Should I tell this story? 00:11:11 Speaker 2: Yes? You should? Because what is a record date? 00:11:14 Speaker 1: So there's two biotech royalty companies like Sooma has this like litigation going on. So what they did is they sold themselves to Ligan for thirty nine dollars a share in cash plus like a claim on that litigation. It's called the CVR continued. 00:11:27 Speaker 2: Value rate contention basically value right contingent value rate. 00:11:30 Speaker 1: So like, if in the next few years they win the litigation, the old shareholders get some money. 00:11:35 Speaker 2: If they don't, they don't, it's like potentially an IOU. 00:11:38 Speaker 1: Yeah, it's a it's a flyer on this lawsuit. So like instead of like lieg in paying them cash for the expected value of the lawsuit, they get the upside on the downside of the lawsuit, And like, the CBR is probably worth that five bucks, like an expected value, And they agreed to sell themselves for those two things. And the merger closed on July fourteenth, And a few weeks before the merger closed, they put out of press release being like the record date for the distribution of the contingent value rights is five PM on July thirteenth, which is the day before the merger closing date. And so you had this situation where if you owned the stock on July thirteenth, you got the CVR, which is worth about five bucks, and if you own the stock on July fourteenth, you got the thirty nine dollars in cash. 00:12:23 Speaker 2: But those are slightly different. 00:12:25 Speaker 1: The merger closing date so if you own the stock when the merger closed, you got the cash. Normally, if you own the stock on the merger closes, you get whatever you get right just cash or stock or CVRs or whatever. But for some reason, they put it an announcement saying that the CVR had a record date the day before the merger closed. And what that means because stock trades settlet plus one, so like, if you buy stock on Monday, you got the stock on Tuesday. What that means is that if you bought the stock on July thirteenth, which is like the Monday, the day before the merger closed, if you bought the stock on July thirteenth, the press release seemed to say you didn't get the CVR because you wouldn't set up until the next day, so you would get the thirty nine dollars, but you wouldn't get the CVR. 00:13:05 Speaker 2: That seems unfair. 00:13:06 Speaker 1: It seems unfair and strange and not how mergers work, and also not what they had previously said. And like the merger proxy, they were like, you'll get the consideration at the merger clothing. But they put up this press release and people believed it, including like Nazdak, which told traders like you need to own it by Friday July tenth to get the CVR, and so on July thirteenth, the stock traded down. Basically, they traded down like it didn't trade to thirty nine. Some people thought, no, this is wrong, I will get the CVR, so traded like forty bucks. So a lot of people did a trade where you would buy the stock on Friday, you would get the CVR, and you'd sell the stock on Monday, thinking that you would keep the CVR because the record date was different from the merger closing date. And then like two days after the merger closed, they put out a shameful press release saying, nope, never mind, we're not using the record date. This was all wrong, like mergers close when they close, and so about that. So I've heard from people who like did this trade and were sort of laying low because they worried that the company would take the CVR away from them. But that appears to an they appear to have got it. 00:14:11 Speaker 2: They put out a press release like that. 00:14:12 Speaker 1: I don't really know. 00:14:13 Speaker 2: People get very convinced when you said earlier like that's natural mergers work, right, and it was a press release just to say, oh, by the way the CVR. 00:14:20 Speaker 1: Yeah, it's very strange, like people don't understand this stuff, like people get confused about how record dates work and X dates work. And in fact, I've mentioned Exoma previously bought another biotech company that like also messed up its record dates stuff. It put out a press release basically. 00:14:35 Speaker 2: Exoma bought a company that did this, and then Exoma sold itself to a company and did this. 00:14:39 Speaker 1: Yes, yes, apparently this is common in biotexas to mess up record dates. 00:14:43 Speaker 2: I don't really know what was it a similar thing where they put out a press release saying by the way they. 00:14:48 Speaker 1: Put they put they put out an ambiguous press release. 00:14:51 Speaker 2: Oh right, it's a opposing things and yeah. 00:14:53 Speaker 1: So like the press release said, if you own it through like August twenty fifth, and you get the thing. But it also said that August twenty five if it was the X date, which is a technical term meaning you don't get the thing. So it said you do and don't get the thing on August twenty fifth, And eventually they had to clarify it after the fact, after and the stock traded in between the price of the thing and the price without the thing, because some people read the press with these one way and some people read the press with this the other way. Similarly, here, like the stock traded between the price with the CVR and the press without the CVR because people genuinely didn't know how to take things and different people had different opinions and that's what makes the market. 00:15:28 Speaker 2: I know you don't really care about this, but I'm really hung up on this idea of why did they put out a press release saying what day the record date was or changing the record date? Do you think that they thought, like is it like a full on clerical error of like, because like would you put out a pressure release that just says, like, by the way, the closing date is. 00:15:47 Speaker 1: Well, I think that like there's sort of not a record date for a merger, like when the merger closes, the people who owned the stock get like the stuff, right, But like, I think that it occurred to someone at the company. We are distributing something we have, like this thing, the CVR, and we're giving it to people, And when a company gives shareholders something, that's a distribution right with a record And I think they just got confused about whether it was a distribution quote unquote, or whether it was just what happens in the. 00:16:14 Speaker 2: Merger and right, do you think that they thought that they were trying to clarify like, by the way, whoever has the CVR on this date gets it. 00:16:21 Speaker 1: I think they were thinking that, like the mechanism for giving the shareholders the CVR was a thing called a distribution, and to do a distribution, you need to distribute it to shaholders a record as of a certain date. And so they were just like, this is how we give them the CVR. But that's not how you give them the CVR. The way you give them the CVR is the merger closes and poof they get the CVR. Right, It's just like a different mechanism. 00:16:41 Speaker 2: So you're saying they were maybe treating it like a dividend. When you do a dividend, you put out a price. Really everyone, Okay, So maybe they were they thought it was. 00:16:48 Speaker 1: A dividend, right, I see, right, that's right. 00:16:50 Speaker 2: I think, why do I know that's good enough? Guess have you ever seen that before? Well, just those two times, just those two times. 00:16:56 Speaker 1: You see this in like people trading credit trades where they some people read a bond of nuture one way and some people read it the other way, and they think like the company can or can't strip assets from creditors or something, and they don't really know until either the company does it or like years later when they litigate it. Right, there's a certain like trade of. 00:17:15 Speaker 2: Like right, the trade is like somebody's guessing that it is or isn't included and they have different pricing. 00:17:21 Speaker 1: Yeah, there's a trade of like reading the documents better than someone else, or like reading the documents better than the company, or like reading. 00:17:27 Speaker 2: The documents like something you might do if you were like a law school person, if you went to law school and you are like, oh, I had noticed in the contract that it says this, I'm gonna. 00:17:36 Speaker 1: There's definitely like an industry of former lawyers who now do like discovering flaw trades at hedge funds. Sohthough, doesn't you don't have to go to law school, Like one thing I learned in finance is that you can. There are people who are good, intuitive natural lawyers even if they haven't been to law school. 00:17:51 Speaker 2: It would have been fun. I would have had a lot of fun. 00:17:53 Speaker 1: Yeah, you'd I mean right there are people who are good intuitive like finders of flaws and documents, who can be hedgephone managers without going to law school. And there are people who are good at spotting italicized commos who also want. 00:18:05 Speaker 2: To be clear, My profession as an editor is finding flaws and documents. 00:18:08 Speaker 1: Yeah. Well ye, different kinds, different kinds like not the not the lucrative kinds always. 00:18:13 Speaker 2: No, they don't, maybe for the bold. 00:18:31 Speaker 1: I feel like I spent all morning talking to you about structured notes. Yes, what do you want to know about structured notes? 00:18:39 Speaker 2: Okay? Is this a structured note? 00:18:41 Speaker 1: Okay, let's let's do what this is. 00:18:43 Speaker 2: Okay. 00:18:44 Speaker 1: So there's a Bloomberg story this week about basically banks or financial firms are rolling out structured notes on SpaceX. So SpaceX went public about a month ago. Its stock has fallen below the IP price. It went up and then it went down. It's not a rough time, and banks are rushing to sell people structured notes on SpaceX. And I think the stuff like this is interesting because a structured note is kind of There's two ways to think about the trade, right. One way is we have these let's say retail clients, high net worth clients, individual clients, and we want to sell them stuff that they want to buy. And so the story here is something like SpaceX went down. We want to give you something that has SpaceX in the name, but like protects you from some downside won't go down as much as SpaceX. And so the Bloomberg story by lu Wang was like about banks are rushing to sell these high net worth clients something that looks like SpaceX with some downside protection. But if you look at the notes like they are something slightly different, which is the other way to think about structured notes, is that banks have these retail clients. The retail clients, yeah, the kind of buy whatever you sell them, and so the job of the structured notes business is to sell them the stuff you want to sell. And what happened here, I think it looks to me from looking at these structured debts is that the banks wanted to buy puts on SpaceX. They wanted to buy protection against SpaceX going down, probably because they had other clients who wanted to buy it from them, and they wanted to know buy it from someone else. And it is actually very easy to buy puts in the form of a structured note, and so the structured nottes have like roughly the shape of the retail investors give the bank money, The bank holds onto the money for a while for a year or two. When the note expires in a year or two, the bank gives the customers money back with a big interest payment. So like there's one, there's a Morgan Stanley one that pays back one hundred and forty cents on the dollars. So you put a one hundred dollars today and eighteen months you give back one hundred and forty dollars unless SpaceX is down a lot. I think in that case it's down fifty percent. SpaceX is down fifty percent, then you lose the same percentage of your money. So if you put a one hundred dollars SpaceX is down sixty percent, you get back forty dollars. So that to Morgan Stanley looks like they have bought a put on SpaceX. Yeah, like they have bought insurance on SpaceX's stock from their retail customers. It doesn't say that, right. What it says is like, this is a thing. 00:21:22 Speaker 2: That this is a structured note for the customer. This is a structured note link to SpaceX. Yeah, that gets you what exactly what does the retail investor think they're getting or what are they getting. 00:21:33 Speaker 1: So the thing actually says on the perspective, which I don't know if any reads, but the securities are for investors who seek a return based on the performance of SpaceX and who are willing to risk their principle and forego current income and returns above the upside payment in exchange for the upside payment future and the limited protection against loss of principle. So what they're sort of saying is this is a way to get some exposure to SpaceX. But if SpaceX goes down a little bit, you don't lose. 00:21:56 Speaker 2: Money a little bit up to a certain point. 00:21:59 Speaker 1: Yeah, SPAX goes down forty nine percent, you don't lose money. SpaceX goes up thirty nine percent, you get a forty percent return, which is better. SpaceX goes up one hundred percent, you get a forty percent return because you always get a forty percent return unless it goes down a lot. So, like there's a payoff graph in the thing, and it's just like a flat line above a certain you know, above down fifty percent, and then below that it looks like you on SpaceX. 00:22:23 Speaker 2: So so it's limited at the top but not at the bottom. 00:22:25 Speaker 1: Yeah. Right, it's a flat return in almost all cases, except when SpaceX crashes you lose money. And so for Morgan Stantly, that's like we have bought insurance against a SpaceX crash from retail customers, and for the retail customers it's like, ooh, I get forty percent unless things go. 00:22:39 Speaker 2: Bad, right, right, Yeah, they like to see The. 00:22:43 Speaker 1: Marketing is sort of like you're getting some sort of SpaceX pad that is like downside protected or whatever. But from Morgan Stanley's perspective, they're sourcing puts on SpaceX and it's hard to buy very out of the money puts. Why two reasons, So that's what you're warning something. You just want to buy insurance against SpaceX going down a lot, right, So you're like, I don't care if if it goes down ten percent, that's fine, but like, I want to buy insurance against it going down fifty percent. One. People don't like to sell you that because that's very out of the money put it's not worth very much. It has a very low probability of paying out, and so they can't charge you that much for it because it's like improbable, but in the state of the world where it pays out, it's very bad for them. They have to pad a lot of money. And also like something has gone wrong like the AI bad. Yeah, like the AI boom has collapsed or something. So in a world where SpaceX insurance pays out, like the people selling it to you will be very sad, and so they don't want to sell you that except at a very high price. And the other reason is like conversely, you don't want to buy that insurance from like some hedge fund. Yeah, because in a world where that insurance pays out like that hedge fund might have. 00:23:50 Speaker 2: Blown up, right, right, So you're saying, this is a way for them to get out that put without touching the very out of the money actual put. 00:23:58 Speaker 1: This is a way for them to buy very out of the money puts on SpaceX from people who don't quite realize that they're selling out of the money puts on SpaceX their retail customers. 00:24:05 Speaker 2: So they didn't want to do it, so they got their retail customers. 00:24:08 Speaker 1: Of course. Of course, that's what structured nottes are. It's like structured notes are sourcing like weird volatility risk from your retail customers so that you can sell it to hedgepes. 00:24:17 Speaker 2: So that's not a structured note. Was just a note with like a derivative in it. 00:24:20 Speaker 1: Yeah, but like why did they put that derivave? And I mean part of it is marketing. Part of it is like people want particular trades right like it. But part of it is like they have some inventory and they're like what weird stuff can we. 00:24:35 Speaker 2: You're sort of meeting several obligations. 00:24:38 Speaker 1: At once, right, and like they're real magic thinking. 00:24:40 Speaker 2: About structured notes differently now, Yeah, you tell me. 00:24:43 Speaker 1: That you keep getting pitched structured notes. 00:24:46 Speaker 2: Should I should? I guess I should be more skeptical. 00:24:49 Speaker 1: I think I told my financial advisor on my first day, like, by the way, I'm a former derivative structure, so don't come out with these structure does But no, Like I mean, like the whole game is like you're in the derivative lab. You're like a bucket of stuff, and you like pick stuff out of the bucket of stuff and you're like, how do I make this thing look cool? Like how do I make this How do I tell a story that's like, oh, this stuff is you should really buy this stuffy? 00:25:15 Speaker 2: As you said, you have inventory. 00:25:16 Speaker 1: It's like, yeah, it's interesting because you don't exactly have inventory. You have like some list of like options, exposures and like volatilities, and you're like, how can I turn this into a product that people will be excited to buy and their answers and like a lot of what banks are doing is you know, buying some puts from retail. But like you never say that. 00:25:37 Speaker 2: Is this financialization? Is this financializing something? 00:25:40 Speaker 1: Is it financializing SpaceX stuff? M I mean this is just like it's just like you know, this is the business structure. Notes are old and noble business. And that was the Money Stuff Podcast. 00:26:04 Speaker 2: I'm Matt Levine, and I'm Katie Greifeld, and I'm Sylvia Killingsworth. 00:26:07 Speaker 1: You can find my work by subscribing to the Money Stuff pouletter on Bloomberg dot com. 00:26:12 Speaker 2: And you can find me by subscribing to the on Books newsletter at Bloomberg dot com. 00:26:16 Speaker 1: We'd love to hear from you. You can send an email to Moneypod at Bloomberg dot net. Ask us a question and we might answer it on the air. 00:26:24 Speaker 2: You can also subscribe to our show wherever you're listening right now and leave us a review. It helps more people find the show. 00:26:30 Speaker 1: The Money Stuff Podcast is produced by Anamazerakis and Moses Onam. 00:26:34 Speaker 2: Our theme music was composed by Blake Maples. 00:26:37 Speaker 1: Amy Kean is our executive producer, and Cheryl Brumley is Bloomberg's Head of Podcasts. Thanks for listening to The Money Stuff Podcast.