Best of the Week
Most Popular
1. Market Decline Will Lead To Pension Collapse, USD Devaluation, And NWO - Raymond_Matison
2.Uber’s Nightmare Has Just Started - Stephen_McBride
3.Stock Market Crash Black Swan Event Set Up Sept 12th? - Brad_Gudgeon
4.GDow Stock Market Trend Forecast Update - Nadeem_Walayat
5.Gold Significant Correction Has Started - Clive_Maund
6.British Pound GBP vs Brexit Chaos Timeline - Nadeem_Walayat
7.Cameco Crash, Uranium Sector Won’t Catch a break - Richard_Mills
8.Recession 2020 Forecast : The New Risks & New Profits Of A Grand Experiment - Dan_Amerman
9.Gold When Global Insanity Prevails - Michael Ballanger
10.UK General Election Forecast 2019 - Betting Market Odds - Nadeem_Walayat
Last 7 days
Canadian Cannabis Stocks CRASH as Canopy Growth Hits a Dead End - 14th Dec 19
Retail Sector Isn’t Dead, and These 6% Dividend Paying Stocks Prove It - 14th Dec 19
Top 5 Ways to Add Value to Your Home - 14th Dec 19
Beware Gold Stocks Downside - 13th Dec 19
Fed Says No Interest Rate Hikes In 2020. What About Gold? - 13th Dec 19
The ABC’s of Fiat Money - 13th Dec 19
Why Jo Swinson and the Lib Dems LOST Seats General Election 2019 - Sheffiled Hallam Result - 13th Dec 19
UK General Election 2019 BBC Exit Poll Forecast Accuracy Analysis - 12th Dec 19
Technical Analysis Update: Tadawul All Share Index (TASI) - Saudi Arabia ETF (KSA) - 12th Dec 19
Silver Miners Pinpoint the Precious Metals’ Outlook - 12th Dec 19
How Google Has Become the Worlds Biggest Travel Company - 12th Dec 19
UK Election Seats Forecasts - Tories 326, Labour 241, SNP 40, Lib Dems 17 - 12th Dec 19
UK General Election 2019 Final Seats Per Party Forecast - 12th Dec 19
What UK CPI, RPI INFLATION Forecasts for General Election Result 2019 - 11th Dec 19
Gold ETF Holdings Surge… But Do They Actually Hold Gold? - 11th Dec 19
Gold, Silver Reversals, Lower Prices and Our Precious Profits - 11th Dec 19
Opinion Pollsters, YouGov MRP General Election 2019 Result Seats Forecast - 11th Dec 19
UK General Election Tory and Labour Marginal Seats Analysis, Implied Forecast 2019 - 11th Dec 19
UK General Election 2019 - Tory Seats Forecast Based on GDP Growth - 11th Dec 19
YouGov's MRP Poll Final Tory Seats Forecast Revised Down From 359 to 338, Possibly Lower? - 10th Dec 19
What UK Economy (Average Earnings) Predicts for General Election Results 2019 - 10th Dec 19
Labour vs Tory Manifesto's UK General Election Parliamentary Seats Forecast 2019 - 10th Dec 19
Lumber is about to rally and how to play it with this ETF - 10th Dec 19
Social Mood and Leaders Impact on General Election Forecast 2019 - 9th Dec 19
Long-term Potential for Gold Remains Strong! - 9th Dec 19
Stock and Financial Markets Review - 9th Dec 19
Labour / Tory Manifesto's Impact on UK General Election Seats Forecast 2019 - 9th Dec 19
Tory Seats Forecast 2019 General Election Based on UK House Prices Momentum Analysis - 9th Dec 19
Top Tory Marginal Seats at Risk of Loss to Labour and Lib Dems - Election 2019 - 9th Dec 19
UK House Prices Momentum Tory Seats Forecast General Election 2019 - 8th Dec 19
Why Labour is Set to Lose Sheffield Seats at General Election 2019 - 8th Dec 19
Gold and Silver Opportunity Here Is As Good As It Gets - 8th Dec 19
High Yield Bond and Transports Signal Gold Buy Signal - 8th Dec 19
Gold & Silver Stocks Belie CoT Caution - 8th Dec 19
Will Labour Government Spending Bankrupt Britain? UK Debt and Deficits - 7th Dec 19
Lib Dem Fake Tory Election Leaflets - Sheffield Hallam General Election 2019 - 7th Dec 19
You Should Be Buying Gold Stocks Now - 6th Dec 19
The End of Apple Has Begun - 6th Dec 19
How Much Crude Oil Do You Unknowingly Eat? - 6th Dec 19
Labour vs Tory Manifesto Voter Bribes Impact on UK General Election Forecast - 6th Dec 19
Gold Price Forecast – Has the Recovery Finished? - 6th Dec 19
Precious Metals Ratio Charts - 6th Dec 19
Climate Emergency vs Labour Tree Felling Councils Reality - Sheffield General Election 2019 - 6th Dec 19
What Fake UK Unemployment Statistics Predict for General Election Result 2019 - 6th Dec 19

Market Oracle FREE Newsletter

UK General Election Forecast 2019

Derivatives Trading Disasters - From LTCM to the 'Ohio Put' in nine years of easy money...

Interest-Rates / Money Supply Apr 04, 2007 - 11:19 AM GMT

By: Adrian_Ash

Interest-Rates THIRTEEN YEARS AGO , the giant German industrial conglomerate Metallgesellschaft lost $1.5 billion trading crude oil futures.

It admitted afterwards that it knew little-to-nothing about the oil market.

The next year, in 1995, Barings bank – one of Britain's oldest and most respected financial institutions – went bust thanks to a lone trade in Singapore losing some $860 million on Japanese stock futures.

The head office in London claimed it knew nothing about Nick Leeson's repeated strategy of 'double or quits'.


In 1996 Sumitomo, the world's biggest copper trader, discovered it had lost $2.6 billion thanks to a rogue trader of its own. Yasuo Hamanaka hid the losses so well, it had taken him nearly a decade to build them up!

And then in 1997, two professors from Harvard won the Nobel Prize for Economics for services to easy money. They claimed to know pretty much everything, and weren't shy of sharing their knowledge for a fee.

All it took to make big profits, said Myron Scholes and Robert C. Merton, was a clever little formula. Oh, and a huge position in derivative contracts, gearing up tiny movements into large, volatile swings in options prices. Funnily enough, gearing up tiny movements into large, volatile swings in options prices was also all it took for Long-Term Capital Management to blow up in 1998.

Both of the Harvard laureates sat on the hedge fund's board of directors. LTCM lost some $3.5 billion. And when the New York Fed learnt of the disaster, it rushed to put together a rescue package for the fund's creditors.

Four companies, five years and $8.4 billion in losses. Glancing back from here in spring '07, the funniest thing is how quaint and innocent all these derivatives disasters look today – never mind how quaint they could look by this time next year.

"The Federal Reserve provided its good offices to LTCM's creditors, not to protect LTCM's investors, creditors, or managers from loss, but to avoid the distortions to market processes caused by a fire-sale liquidation and the consequent spreading of those distortions through contagion."

So said Alan Greenspan, then chairman of the US Federal Reserve, in Oct. 1998.

"To be sure, this may well work to reduce the ultimate losses to the original owners of LTCM, but that was a byproduct, perhaps unfortunate, of the process."

Fast forward eight-and-half-years, and the unfortunate byproduct of the LTCM rescue is still known as the "Greenspan Put" – even though Sir Alan of Greenspan climbed aboard the consultancy gravy-train back in Jan. 2006.

Does his eponymous "put option" remain available today to over-geared speculators? News from Ohio says that the logic of the Greenspan Put has seeped far beyond the paper securities traded on Wall Street.

"Do you have an adjustable rate mortgage (ARM) and worry about how you are going to make your monthly mortgage payment once the loan enters the adjustable phase?" asks the Ohio Housing Finance Agency (OHFA) on its homepage.

"The Opportunity Loan is a refinance program that provides an affordable 30-year, fixed-rate financing alternative to borrowers who feel their current loan does not fit their financial circumstance," the OHFA goes on.

The loans, available from Monday, 2nd April, seem to represent some kind of breakthrough in state-sponsored aid to over-geared speculators. (Vermont's housing finance agency will also help with refinancing, but only on qualifying mobile homes.)

Who's being saved from themselves here isn't quite clear. Subprime homebuyers couldn't get a sensible home-loan even before credit standards were tightened in the face of the subprime collapse. Whereas the mortgage lenders, on the other hand, are dreading a further surge in delinquency rates and a further collapse in unsold inventory prices. The moral hazard of stalling foreclosure can only buy time.

Still, Ohio's new Opportunity Loans carry a fixed interest rate of 6.75%. Borrowers earning up to 125% of their county's median income will be able to apply. And why not? "Ohio leads the nation with 11.32% of sub-prime loans in foreclosure and 3.38% of all housing loans in foreclosure," as Martin Hutchinson notes for BreakingViews.com.

The other 54 housing finance agencies in the United States are no doubt tracking Ohio's fortunes closely. Moral hazard is catching, remember. Just ask Ben Bernanke! He caught it from his ex-boss.

"The principal policy issue arising out of the events surrounding the near collapse of LTCM is how to constrain excessive leverage," said the President's Working Group on Financial Markets in April 1999. Often referred to as the Plunge Protection Team, the Working Group fretted that the bankruptcy of LTCM "could have potentially impaired the economies of many nations, including our own" if the Fed hadn't stepped in so ably and so quickly.

Leverage since then, however, has merely switched markets – and swollen – rather than receding again. First it poured into margin accounts for private day traders...and then it sloshed into houses that no one could afford without exploding ARMs and neg-am mortgages.

There's nothing to fear, of course, for as long as the money keeps flowing. The Fed will underwrite your chosen excess. Move tables if you must, but please – do keep gaming.

And besides, "leverage in most hedge funds is generally much less than is true for most large banks and securities firms," as the professors of the Financial Economists Roundtable put it just after the LTCM collapse. So why fret about the hedge funds when the banks and brokers are so even more heavily geared? And why fret about the banks and brokers now that low-earning homebuyers owe six, seven or more times their gross income?

"All this takes us to a rather disturbing bi-modal endgame," writes Stephen Roach of Morgan Stanley in a note – "the bursting of the proverbial Big Bubble that brings the whole house of cards down, or the inflation of yet another bubble to buy more time.

"The exit strategy is painfully simple: Ultimately, it is up to Ben Bernanke – and whether he has both the wisdom and the courage to break the daisy chain of the Greenspan Put."

So far, no dice. Dr. Bernanke has yet to face expiry or exercise, in fact. His predecessor's undated promise to Wall Street has now been extended to Main Street as well.

But with Dollar interest rates up at 5.25%, there are 17 baby-steps between here and the "emergency" rate Greenspan imposed in response to the Tech Stock collapse. How low might Bernanke now go?

By Adrian Ash

Adrian Ash is head of research at BullionVault.com , the fastest growing gold bullion service online. Formerly head of editorial at Fleet Street Publications Ltd – the UK's leading publishers of investment advice for private investors – he is also City correspondent for The Daily Reckoning in London, and a regular contributor to MoneyWeek magazine.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

João Belotti
04 Mar 09, 19:50
derivatives disasters by a korean author

Hi Adrian, do you know a book about derivative disasters written by a korean journalist (female).

If you do, please could you send me the name of this book and of the author.

My email is joao@belotti.com.br


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules