Sle,
First off, I want to say that even though I don't know you personally, you are in my thoughts and prayers as you go through your stay at the hospital. I know that many are made stronger through times like these and want to encourage you in your fight.
I'm not a 'i've got to have the last word' kind of guy but your last post raised some interesting points that I felt I had to answer.
" I think that quant traders recognize the limits of the methodology quite well - otherwise there would be no new work done in that field. All that was said about LTCM, you have to admit that if they were a bit less leveraged they would have made a killing over the last couple of years if their investors did not panic and they weren't forced to liquidate their positions. Look at the corp/gov spreads then and now. It was no different then any other trader blowing themselfs up by overleveraging combined with liquidity issues. Tonns of regular traders blow themselfs up in a similar manner every day. As we all know, any liquidity problem will last longer then you can stay solvent"
I beg to disagree with the above. As Lowenstein put it, the LTCM guys were bending over to pick nickels in front of a bulldozer. That was their strategy, they needed the leverage to make it work. By DEFINITION, if you are cognizant of the limitations of your correlation analysis you DO NOT bet the farm and use 100:1 leverage. Your argument (I'm glad I took Logic in college) appeals to 2 flawed constructs. One is appealing to a fact that would not qualify as a 'Markov' time, to use a term from probability for finance. As you probably know, if a technical setup qualifies as a markov time, it is kosher and statistically testable. If not, it's no more helpful than tea leaves. A markov time simply does not let you draw any inference from FUTURE information. In your argument above, you are operating with the current knowledge that spreads did narrow, but this information was unknown to the Fed and LTCM at the time. More precisely, they simply could not know WHEN those spreads would narrow. If we could run alternative histories using a monte carlo simulator, I wouldn't be surprised if we find that more often that not, actions taken by those bozos would result in the destruction of the financial system. But unfortunately, that(monte carlo) is impossible, and we only have one isolated event to draw inferences from. This time, the Fed came to the rescue. Who knows what would have happened if they didn't take action.
My point is, that Scholes, Merton, Meriwether and consorts, did not have ANY respect for risk. They really believed that they were right. Their post blow up statements don't even show a hint of remorse. I don't care that this time, we know that the spreads eventually narrowed. That's not the issue. The issue is that back then in 1998, no one could say what would happen because no one could know what would happen, no big surprise there. You can't brush away LTCM's lack of liquidity to meet margin calls under the carpet, that was not a minor issue, that was THE issue.
They bet the farm and now had their heads handed to them, and not only that, risked maiming the system. You can't say now with the comfort of 20-20 hindsight, it would have been okay. Sorry mate, that's intellectual cheating.
Second flaw in your argument is the use of a red herring. The fact that many traders blow up does not justify LTCM's blow up. All it does is remind us that LTCM is also on the list of failures. This has been belabored on other threads, if your strategy is such that it eventually leads you a situation where you can't meet margin calls and have to put your house on the market, then it ain't a strategy. It's a time ticking bomb. These are the rules of the game in finance and the futures markets. You either meet the margin call or you are OUT. No whining, no 'come-on-we-know-this-convergence-is-coming-back-someday' attitude. Take it like a man and play by the rules. Don't rationalize. Why do think Soros kicked out Niederhoffer? Because he had the wisdom to recognize the walking time bomb that he was. And history has vindicated Soros twice. (Note to Nied fans, I'm not going to argue with any of you, I've seen the other thread and have vowed not to waste my time)
"I was the one who brought up the Goldman story to illustrate smart trading on the side of institutional investors. Nobody FORCED the counterparties to buy the swaps, all of the conditions were openly discussed. If someone offers you free money, time to think again. OTC trading is like playing chess for money - all figures are open, both players see them, but there is a difference between Casparov and some fellow from Washington Square. When someone dumps/pumps some stock to kill a barrier option he/she is short - do you find that unethical too? What about if you happend to have a good model of volatility skews and short/long some options - are you cheating?"
You are absolutely right. No one forced nobody. True. However, what I cannot be sure of is whether those people really carried out their responsibilities in alerting their clients to the full list of risks involved in the trade. My guess is that they probably highlighted some risks and deliberately ignored others for obvious reasons. One may argue, ok, why would they even bother telling their clients what the risks were other than 'legal' stipulations? (makes me think of the mexican bonds fiasco in Partnoys book) Fair enough, then yeah, it's a jungle out there. Bt you know what, one of these days, no one is going to come out and play anymore with our favorite crocodiles.
Not surprising that the volume of otc transactions is slowing down. People can only get shafted so many times.
Last point. Re the bond trading prowess of some. Sure your sheet metal worker will not be able to handle IR derivatives. In life, there's a distribution of abilities out there. Some are in that right tail and get paid a lot of money to handle complex financial products. Good for them. I just don't think they are such a big deal.
I'll tell you, the only people I esteem are those who can trade the markets. People who can put their cohones on the line and take a long or short position. People like Tudor Jones, John W Henry, Vic Sperandeo and the list goes on. Are they perfect? No. Did they have big drawdowns along the way? probably. Did they ever blow up? No. Were they CONSISTENT over the last 20 years? Yes.
That's what I call sophistication man. Whether a strategy is simple/smart or not is irrelevant. It is your staying power that is a testament to your ability. And I can tell you that the record of Wall Street is cyclical. It moves from one hot area to another over time. The only consistent thing about big banks is that they always end up taking the little guy out.
Over and out.
Good trading to you,
Maverick.
