Leopold Aschenbrenner graduated from Columbia University as valedictorian of his class in 2021 at the age of 19. A math whiz, he worked briefly at the AI firm OpenAI before publishing his 165-page June 2024 treatise, “Situational Awareness: The Decade Ahead.” The essay, which predicted the course of AI’s development, catapulted Aschenbrenner to stardom.
Shortly thereafter, with a few hundred million dollars, Aschenbrenner formed a hedge fund, which he named Situational Awareness. The fund quickly attracted investors.
Aschenbrenner built concentrated positions in high-flying AI stocks such as SK Hynix, a major South Korean semiconductor company. The fund made rapid and hugely impressive gains, with assets under management growing to as much as $45 billion. To juice returns even further, Aschenbrenner borrowed heavily from banks to amplify his bets.
Everything seemed to be going swimmingly, until the recent sell-off in AI stocks caused Situational Awareness to post a loss of 67% in July. Because the fund was highly leveraged, Aschenbrenner was faced with ever-growing margin calls from his lenders as stock prices cratered. He had to either raise cash from new investors or sell assets. Under the circumstances, the latter became his only choice.
Citadel, a large hedge fund, stepped in to buy some of Situational Awareness’s assets in a fire sale. The Wall Street Journal reported that the Citadel purchase was limited to the portion of the firm’s public-stock portfolio that was financed with borrowed money. Situational Awareness retains the remainder of the portfolio that was funded with client capital.
The Economist argues that investors in Situational Awareness “deserved to lose their shirts.” The newspaper says those investors should have known better than to risk their capital with “a 24-year-old Silicon Valley wunderkind with no prior trading experience.”
During the 2008 financial crisis, governments were left with little choice but to bail out certain financial institutions. Not doing so would have risked a collapse of the global banking system, the consequences of which would have been an economic catastrophe. In the years since that cataclysmic event, policymakers have introduced a raft of regulations that limit the level of risk banks can take with their capital.
I agree with The Economist that when smart people knowingly choose to put their money at risk, the rest of us shouldn’t bail them out when they lose. Those measures governments took to rescue banks in 2008 have since poisoned politics in many countries. Average citizens were—and continue to be—terribly upset about the fact that their hard-earned tax dollars were used to save banks and investors who had behaved recklessly but suffered little to no punishment for their sins.
As things stand now, the lending banks’ exposure to Situational Awareness has shifted to Citadel, a more established and stable hedge fund. However, there are investors whose holdings are still with Situational Awareness. They are the ones for whom The Economist appears to have little sympathy.
These recent events involving Aschenbrenner and his hedge fund illustrate something I often think about. For many people, financial market participants like those Situational Awareness investors are merely greedy individuals who seek exploitative ways to make profits. While they may not be angels, they do provide a valuable service to society. The capital they put at risk supplies some of the liquidity that greases the numerous moving parts of the economy.
Risking capital in financial markets is often akin to playing with live grenades. In some cases, it can be a zero-sum game. When one party to a transaction gains spectacularly, the other loses their shirt—and sometimes worse. Tens of thousands of investors play this dangerous game every day. In reality, few of the losers are ever bailed out by any government or entity. Their only hope is to live to fight another day, but they don’t always get that chance because some don’t survive the explosions of the incendiary devices they hold in their hands.
We, the public, often see and choose to focus on just the winners. After we call the winning “gamblers” whatever harsh names we think of, we ask our elected officials to tax them out of existence. We never spare a thought for the losers.
Despite what The Economist said about the Situational Awareness investors, perhaps we should, at least once in a while, remember to send our sympathies to those who lose their garments.