Why did Citadel hit the dumps in 2008?
Been watching a lot of old Ken interviews from back in the day talking about why Citadel hit the shitter in 2008, with their perfectly hedged + market neutral, confused as how they lost billions -- maybe you could argue that they just took directional losses as the market went down -- but anyone know specifics as to why they took such heavy losses nearly to the point of wiping them out? Also been wondering what they've done since to change that...
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Disclosure - I wasn't in finance in 2008 yet so this is what I was able to gather based on what's publicly available. Keep in mind this was 16 years ago so their strategy has evolved considerably vs. back then.
By the end of 2008, Citadel's two main funds had lost around 55% of their value, with the funds being down 22% in October and 14% in November alone.
I would push back regarding point 3: You should watch Ken's interview with Goldman. In the first couple of minutes he explains how Citadel in 2008 used LTCM's process of funding their business (i.e. control of client portfolio's during a big drawdown). That process is the only reason they survived in 08.
Upon digging deeper, you're right.
Looks like they didn't pay out redemptions during 2008, so unlikely forced selling was a major contributor to the losses.
Willing to bet they weren't "perfectly hedged" back in 2008, and were taking more directional bets. Also willing to bet the risk management was very VERY different (if it even existed at all). A ton of what is considered risk management today was designed as a response to 2008, when a lot of funds didn't even have a person or department doing anything here.
Also the carnage involved with everything financial markets in 2008 was pretty widespread; if you were levered up and not perfectly hedged, you got hit. Any firm perceived to have exposure to this carnage saw massive redemptions, further compounding the issues.
When markets go weird correlations typically break down, this was true during the dot com bubble, the financial crisis, and March 2020. In these cases there is never a perfect hedge, you just need to expect higher variance and not utilize all of your risk bullets at marginal edge levels.
True, but even if you *were* perfectly hedged, that wasn't safe back then due to counterparty risk since a lot of derivates weren't on a clearinghouse. If you hedged your risk via a swap with Bear Sterns, Lehman Brothers, Cit, AIG, etc, then "perfect hedging" didn't help you cause they were bankrupt and had no money to pay your winnings. Also, it was such a crazy time that any illiquid derivative hedge got marked down so much that we were losing money both on the position and *also* losing money on the hedge too, even though they were supposed to move in opposite directions.
And even for the liquid futures and options trading on a "safe" clearinghouse like CME -- people forget it now, but at the time, there was a very real fear that maybe margin requirements were insufficient and some large company might go bankrupt faster than the clearinghouse could sell off their positions, which would stick the CME with multi-billion dollar losses, which would be borne by anyone trading there, even if their positions theoretically netted to a perfect hedge.
I was at Citadel in 2008. Fund was down 55% that year.
1) Subprime mortgage took a bit hit. We had recently bought the mortgage portfolio from ETrade and that took a huge loss.
2) All the stock indexes were down 20-30% that year, and even though we had all these fancy factor reports claiming our positions were uncorrelated to the market, they weren't really. In a financial crisis, all the correlations go to 100%. A lot of our book was basically over-leveraged exposure to S&P.
3) We had a bunch of illiquid positions (I remember there was a huge dividend swap position) which were actually fine but the world was in a crisis so our broker marked the position way down and we had to cough up a lot more cash for margin.
4) The one bright spot was high-frequency-trading. Today Citadel Securities is completely separate from Citadel; but back then it was technically a separate entity but not really, and it still contributed some of its pnl back to the hedge fund. HFT made us over a billion dollars that year, and if it hadn't been for that, Citadel surely would have gone under.
5) Ken never officially said this, but I'm 100% certain he was mere inches away from shutting down the firm in December of that year. There were several signs (for instance, the policy used to be any bonus over some amount, I think it was like 300k, had to be deferred into the fund; but at bonus time that year they announced a last minute change significantly raising the amount of non-deferred so that most junior and mid level people got a full cash bonus without having to defer anything. This was widely interpreted by my coworkers as a sign that Ken was about to shutdown the firm and didn't want to screw junior-level employees over by unnecessarily locking up a bonus for no reason.) But as it turned out, everything started bouncing back again the next year.
I had joined Citadel in early 2008 and had a guarantee on my bonus, but they didn't honor that guarantee and gave me less than I was promised. But considering everything that was going on, I thought the amount they did give me was still incredibly generous for the circumstances.
I’ve heard Citadel frequently reneges on Guarantees, not just in 2008. I’m sure there’s always more to the story but on face value it sounds bad/illegal.
I mean maybe I could have sued, but TBH, considering the firm (and half of Wall Street!) was teetering on the edge of bankruptcy, I thought the amount they gave me was still incredibly generous for the circumstances. It was definitely more generous than they needed to be. So I have nothing bad to say about Citadel on that event.
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