Monday, August 27, 2007

Where to start???

The past 10 days serves as an excellent illustration with regards to the proper selection of significant variables going forward.

As the popular press has stressed, quantitative funds who have modeled the markets based on the historical relationships (be they correlative or factually dependent) between sets of prices have suffered some unsettlingly correlated losses.

These numerical relationships are, to put it mildly, "under stress". There are certain members of the press who see the results and quote some amporphous quality called "trading wisdom" and harken back to open-outcry systems, which by implication must be better during these conditions. But what do they mean by this?

Simple: The ability to utilize a deep-thinking form of educated common sense. It is the ability to "connect the dots" using metaphorical and narrative arguments as opposed to data-driven statistical or combinatory reasoning.

And, giving a nod to Soros, any system with thinking participants will produce self-sustaining bubbles as competition will chase profits and drive down the opportunity costs of prudent restraint..."No covenants on your Sub-prime backed equity tranche mortguage securities?? Who are we to argue?? Nobody else is either!! Give us the fee and see you later."

Quantitative analysis is no different. The investment industry has been flooded with brilliant mathematical minds all employing similar (or worse, functionally indentical) trading algorithms. Many have spectacular historical results which bred competition and duplication, using the same arbitrage arguments, the same financing vehicles to fund the trades and the same amount of leverage to make the crumbs on the floor look like loaves of bread.

And then someone yells "FIRE!!!" in the factory with one emergency exit, and the devil takes the hindmost.

Friday, August 17, 2007


and early.

The capital markets were moving to re-price risk categories. As I stated in the last post, beyond the initial euphoria of today, what will the logical interpretation of the Fed's surprise cut in the discount window rate today be?

I suppose we will have our answer monday, but this observer believes that the move will stoke suspicion that the capital markets (especially the credit markets, with CP rates blowing out today in spite of the cuts) are not as healthy as they appear an that a "calamity" may have arisen...

Thursday, August 16, 2007


A problem with saying that you will not lower rates barring "calamity" is that if you do indeed lower rates, participants will surmise that ragnarok is indeed upon us.

Wednesday, August 15, 2007

Fed watch...

As I have stated a few times before, the Fed cannot cut now. It is between the rock of inflation expectations (using Headline inflation as opposed to core inflation as criteria) and the obvious point that additional cuts will be calamitous for the dollar due to interest rate differentials with other currencies.

And today we hear from Bill Poole, noted inflation hawk, who squelches hopes for a rate cut barring "calamity" (whatever that is...) The following is from Bloomberg:

``It's premature to say that this upset in the market is changing the course of the economy in any fundamental way,'' he said in an interview in the bank's boardroom. ``Obviously, there could be an impact, but we have to rely on some real evidence.''

Barring a ``calamity,'' there is no need to consider an emergency rate cut, Poole said. His comments were the first by a Fed official since the U.S. central bank joined counterparts in Europe and Asia to inject emergency funds after a surge in money- market rates. The Fed has added $71 billion of reserves in the past five trading days.

Poole, 70, said businesses have maintained their hiring and investment plans and banks have sufficient capital to weather the credit-market turmoil. The St. Louis Fed chief stressed that the best course is for policy makers to assess the latest economic data when they next meet Sept. 18. The comments contrast with the certainty that traders put on a rate cut next month.

``If the data confirm the market's view that the economy is sagging, we'll have to decide whether to share that view,'' said Poole, who votes on the rate-setting Federal Open Market Committee this year. He cited the monthly jobs, retail sales and industrial production reports as key gauges he'll be watching.


Lots of this today as every asset manager in the known universe has a theory of why the credit crunch has happened and what will happen now that its here.

The problems will continue, and, as in the dot-com bubble, all the excesses will in hindsight found to be egregious and unwholesome..."greed" some will say. "Indictment" will be uttered by the government against selectively chosen transgressors (under the oft-utilized "the more publicly known, the better" criteria).

I expect international (especially emerging market debt) spreads to blow out a bit as well, effecting equity markets further. Credit crunches are sticky.

But. Soon, very will be time to go the other way.

Monday, August 13, 2007


This is a very astute move. One day before the last day to enter in redemptions, GS announces a cash injection into two of its hedge funds that have lost significant value during the volatility of the last two weeks. This effectively shores up the "run on the bank", and is a wonderful example of an investment bank using readily marketable names (such as Hank Greenberg THE most savvy and tough businessmen on the planet) to increase confidence among its investors. A wonderful marketing move, and this is the only reason why GS would seek to publicize this bailout (which of course is denied to be a bailout). One has to applaud.

Friday, August 10, 2007

The Paper Dragon and the Yuan...

A 67% trade surplus with the US. Over 5% inflation. Chinese are angry about the Blackstone deal, and are somewhat "disappointed" with the Shanghai elites gambling the People's money away...and now appear to be involved with Bear Stearns. Interesting.

In this age of information, it is not good when a communist country displays this kind of arrogance and disregard for its very large proletariat...

Thursday, August 09, 2007


...of leverage.

First, Europe. American investors have been putting positions into the Euro markets for some time to avoid reg. T guidelines.

Second, the Yen carry is unraveling as risk positions are paired (and we see the effects of the reduced positions in short-term yields as per the previous post). Asia is melting down at the moment and fear of contagion is everywhere.

Both of these circumstances levered up positions put on by American Hedge Funds, and the funding requirements they face now are all over the press.

Rumors abound regarding several Hedge Funds who are in trouble...and for my part, I hope that a certain fund manager in CT can make it through this tumultuous period, as he is most assuredly massively short vol.

The decline should be orderly... and we should end up at 1320 or so as I stated last year. the August Fed meeting awaits as a last hope for those who are long, but Bernanke, notwhithstanding the eurodollar market (which is pricing in one, possibly two cuts) will not budge unless ENERGY decreases. Oil controls everything right now.

Flight to quality.

A yield curve like this is "usually" not good for stocks (going back 30 years). A flight to quality with attendent credit concerns and a well-publicized liquidity injection of funds from the ECB (allowing levered positions in the U.S. seeking safe haven from Reg T.)that was, um..."deft".

Observe the short end of the curve dear reader in the past 48 hours...

Date 1 mo 3 mo 6 mo 1 yr 2 yr 3 yr 5 yr

08/08/07 5.04 4.95 5.01 4.89 4.64 4.64 4.69
08/09/07 4.70 4.81 4.86 4.74 4.49 4.51 4.58

Now...THAT is good old-fashioned curve steepening!

Quant funds

An interesting article in the WSJ today highlights some of the issues I have been telling people for some time: Program trading exhibits similar herd-like behavior of many other markets...and to make matters more complicated, they typically use large amounts of leverage.
Of course, there had to be other players benefiting from the other side of the trades (which may or may not be quantitiative), but the general trend to quant shops in the hedge fund industry may improve the perceived uncertainty with the presentation of elegant equations and data that supposedly quantifies "risk" that cause investors to become wildly overconfident. And when the false security of numbers fails to perform as promised, investors begin their redemptions.

The punch line from the article:

"The reliance on models can be especially problematic because many quant
hedge funds have very similar models. That means they are often doing
the same trades and buying the same shares. Moreover, because the
strategies are supposed to be market-neutral, with no net positive or
negative bent, the funds often borrow large sums so they can bet more
and achieve better returns when things go their way.

That massive borrowing adds to the pressure when markets reverse course
several times in the course of a single day, as the stock market has
done repeatedly in recent weeks, or when tried-and-true relationships
between different markets suddenly break down."

Wednesday, August 08, 2007

The Paper Dragon assumes a threatening posture...

...which is an empty threat. Again, the I remind the reader that selling into declining prices, when everyone else knows what you are doing, will only lead to severely declining prices on the assets that have not been sold yet, leading to massive wealth drain and a decline in the national balance sheet. Another wonderful example of attempting to cause hysteria and worry for political gain, which is something of a national sport in China.

Readers here are directed to the book "The Three Kingdoms" for more on the Chinese aptitutde for deception - its simply part of the game and represents their cultural and historical answer to Machiavelli and Richelieu.

In any case, below is the news article in all of its silly splendor. One must ask: Why would the Chinese do this now, and who profits from a perceived increase in the animosity between our nations?

China threatens to trigger US dollar crash

By Ambrose Evans-Pritchard

Last Updated: 9:23am BST 08/08/2007

The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US Treasury bonds if Washington imposes trade sanctions to force a yuan revaluation.

Two Chinese officials at leading Communist Party bodies have given interviews in recent days warning, for the first time, that Beijing may use its $1,330bn (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress. Shifts in Chinese policy are often announced through key think tanks and academies.

Described as China's "nuclear option" in the state media, such action could trigger a dollar crash at a time when the US currency is breaking down through historic support levels.

It would also cause a spike in US bond yields, hammering the US housing market and perhaps tipping the economy into recession.

It is estimated that China holds more than $900bn in a mix of US bonds.

Xia Bin, finance chief at China's Development Research Centre (which has cabinet rank), kicked off what appears to be government policy, with a comment last week that Beijing's foreign reserves should be used as a "bargaining chip" in talks with the US.

"Of course, China doesn't want any undesirable phenomenon in the global financial order," he said.

He Fan, an official at the Chinese Academy of Social Sciences, went further yesterday, letting it be known that Beijing had the power to set off a dollar collapse, if it chose to do so.

"China has accumulated a large sum of US dollars. Such a big sum, of which a considerable portion is in US Treasury bonds, contributes a great deal to maintaining the position of the dollar as a reserve currency," he told China Daily. "Russia, Switzerland and several other countries have reduced their dollar holdings. China is unlikely to follow suit as long as the yuan's exchange rate is stable against the dollar.

"The Chinese central bank will be forced to sell dollars once the yuan appreciated dramatically, which might lead to a mass depreciation of the dollar."

The threats play into the presidential electoral campaign of Hillary Clinton, who has called for restrictive legislation to prevent America being "held hostage to economic decisions being made in Beijing, Shanghai or Tokyo". She said foreign control over 44pc of the US national debt had left America acutely vulnerable.

Simon Derrick, currency strategist at the Bank of New York Mellon, said the comments were a message to the US Senate as Capitol Hill prepares legislation for the autumn session.

"The words are alarming and unambiguous. This carries a clear political threat and could have very serious consequences at a time when the credit markets are already afraid of contagion from the sub-prime troubles," he said.

A bill drafted by a group of US senators, and backed by the Senate Finance Committee, calls for trade tariffs against Chinese goods as retaliation for alleged currency manipulation.

The yuan has appreciated 9pc against the dollar over the last two years under a crawling peg but it has failed to halt the rise of China's trade surplus, which reached $26.9bn in June.

Henry Paulson, the US Treasury secretary, said any such sanctions would undermine US authority and "could trigger a global cycle of protectionist legislation".

Monday, August 06, 2007


Now, like every other dicatator in history, we see Chavez laying the populist and pseudo-legislative groundwork for perpetual power. Propoganda will surely follow demonstrating his "unique" sensibilities and attendent populist "mandate" from the people.

Very similar to Putin.

Thursday, August 02, 2007

Meanwhile, in the Caribbean...

...a storm of an entirely different kind of volatility is forming:

No ponts for anticipating the obvious...

...and the first suits stemming from the Bear Stearns debacle have arrived:

The Washington Post reports: Bear Stearns Cos not only is seeking bankruptcy protection, but was hit on Wednesday by a legal claim stemming from the meltdown of two of its hedge funds, sending its shares, already under pressure from woes at a third fund, to a 19-month low.

The securities firm has been slapped with an arbitration claim for allegedly misleading investors about its exposure to subprime mortgages. The claim, filed with the NASD, was brought on behalf of a 73-year-old retired insurance salesman in Wisconsin who lost $500,000, according to the man's lawyers.

Investors have been widely expected to bring legal claims against Bear Stearns, which has been particularly hard hit by the contraction in the market for loans to home buyers with poor credit histories. "I think there's probably more where that came from," said Bill Fitzpatrick, an analyst at Johnson Asset Management in Racine, Wisconsin. "I suspect they're going to be vulnerable to a series of lawsuits."

The arbitration filed by Jacob Zamansky of law firm Zamansky & Associates, together with another lawyer, Ross Intelisano of law firm Rich & Intelisano, involves one of those funds, the High Grade Credit Strategies Credit Fund. It was filed on Wednesday morning and was brought against both Bear Stearns and Bear Stearns Asset Management, the lawyers said.

Wednesday, August 01, 2007

Trial balloons from the Fed...

...via Steven Beckner:

"First, while the Fed does not want a downturn, it doesn't want booming
growth fueled by overly exuberant markets either. Second, the repricing
of risk does not come as a total surprise to the Fed. Third, it is not
the Fed's job, nor its inclination, to bail out firms like Bear Stearns
or Countrywide that have made bad bets. Fourth, as its policy reversal
in August 1998 showed, the Fed is prepared to act aggressively to ease
credit when it perceives a liquidity crisis threatens financial and
economic stability. But fifth, there is a high hurdle for such action,
and it is doubtful whether that threshold has been reached or even
approached as yet."

So much for the Greenspan put.