When Genius Failed

S

SiSePuede!

So I finally just read this book. Give me a break, I'm young and was busy reading Hugo and Mishima.

Anyway, how does everyone else feel about the derivatives market? Since reading the book, it scares the shit out of me. I've often thought that everything could go down if there's a breakdown in the derivatives market.

A global crash, even an Asian crisis that resonates in S. America where Asian demand for metals is heavy, to Russia where oil is, etc. could send the derivatives market into a tumble could it not? The leverage that cheap cheap debt has brought must have also caused many piggish funds/banks to become leverage pigs like LTCM was. Liquidity looks for good returns and all the MBS and CDO buyers are going to get stuffed with that...but much of that was well spread about and mixed in with traditional mortgages.

I'm just curious what fears, curiosities, worries, etc. other people have about another crisis like the LTCM crisis happening. There is a lot more money floating around now and I can't imagine it wouldn't be a larger crisis due to the growth in the derviatives market in the last 10 years.
 
Quote from SiSePuede!:

I'm just curious what fears, curiosities, worries, etc. other people have about another crisis like the LTCM crisis happening. There is a lot more money floating around now and I can't imagine it wouldn't be a larger crisis due to the growth in the derviatives market in the last 10 years.
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Sometimes SSP, the problem is so huge that there is no point in worrying about it.

There will always be something to trade.
 
I think what happened in LTCM is that so many investment banks were falling over themselves to get the trading business of the fund that they were extending ridiculous amounts of leverage, way above and beyond the call of duty. I think the book describes in several instances where the haircuts the banks required were dropped almost to nothing just to get LTCM to clear trades through them.

The more LTCM would clear from a specific bank, the more commissions/fees they would generate and as long as they were generating such high returns the firms would be more than happy to keep extending leverage. Basically they allowed LTCM to get so far over the edge.

But when it looked like it was going to unwind, it really did not. It caused a scare in the markets but the beauty of when a LTCM or Amaranth goes over the ledge, the other banks step in and pick them apart and make a killing unwinding those positions at pennies on the dollar. I think this act of stepping in to take over and profit from the carnage keeps the markets from really falling apart when an overleveraged entity takes it to far.

Also after LTCM, I doubt an investment bank is going to allow any fund to run up such a leveraged tab again in the future. Quite a few heads rolled at those firms when they were left holding the bag.

The derivatives markets are enormous and many blame them for exaggerated moves in the markets at times but they serve a puspose like any other security and I think the risks for the most part are diffused through the market place.

Barings Bank went down after one trader's excessive use of derivatives and as devastating as it was to Barings (bankruptcy) the market overall did not suffer significantly since on the other side of those losses were some firms making money. (Barings may not be best example since internal controls were non existent).
 
I was in the fixed income markets when LTCM went under - it was not a pleasant time for anyone in the business with money on the line in the credit markets. There was a serious question of whether or not the LTCM strand would bring the whole web down. Then the Fed and the top IBs/brokerage houses came to the rescue to save the whole game.

After seeing that happen, now matter how huge and unregulated the derivatives markets get (and systemic risk grows exponentially), I think the Street has too much of a vested interest to see it all end. I think we may see individual market sectors blow up, but they will be contained whenever necessary by the powers that be - individual gaming tables will burn to the ground, but they will never let the casino go up in flames - gotta keep the game going.
 
My concerns are:

Derivatives seem to be mildly understood in the markets and seem to be a sort of underworld that hugely impact the markets but are neither seen nor understood.

Cheap money coming out of Asia is letting funds pile on cheap debt to buy companies at 30% premiums over their stock price which is already 15-30X the earnings of the company. This is ridiculous. Paying 50X earnings for a company is nuts just because there is cheap money to be used.

LTCM did have too much leverage and banks were bending over backwards to get their business, it was truly a unique situation and I agree with you on that. But my concern is that when the market's "liquidity" dries up more which it inevitably will, and a fund like Amaranth makes a big wrong bet, can't that quite easily trigger a liquidation of other assets pick apart the bones of Amaranth?

And what happens if a fund like Amaranth is involved in a ridiculous amount of derivative contracts and they go belly up? Couldn't that heavily disrupt an entire market?

My curiosity is what happens if a contagious cold goes alight again...like over-investment in China? While I haven't been to China, going next year, all I've read lends to the idea that they're going to far far overbuild long before they realize that they have more buildings than people or jobs or money to fill those buildings. Building new cities out of nothing is just not something that seems wise. We'll see.

Time tells all...but if China overbuilds and there's a halt to growth for whatever reason(jobs, higher costs of production, post-Olympic blues, etc.) S Asia can catch a cold which will cut demand for metals and oil from S. America and Russia which will mean less profits to American companies who are finding much more business overseas since domestic spending isn't growing at a pace to sustain what we see in the markets.
 
Quote from SiSePuede!:



LTCM did have too much leverage and banks were bending over backwards to get their business, it was truly a unique situation and I agree with you on that. But my concern is that when the market's "liquidity" dries up more which it inevitably will, and a fund like Amaranth makes a big wrong bet, can't that quite easily trigger a liquidation of other assets pick apart the bones of Amaranth?

And what happens if a fund like Amaranth is involved in a ridiculous amount of derivative contracts and they go belly up? Couldn't that heavily disrupt an entire market?

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The question is whether Amaranth was aa crisis contained to the market it was trading in (energy futures, nat gas I believe) or did it spread. I think we saw that it was contained and we heard stories of traders who made millions stepping in and unwinding Amaranth's positions or better said, taking the other side of it.

So I believe the market can absorb a single Amaranth shock. If we get a global crisis it could be a domino effect but there always seems to be a sector of the market making money on the other side to cushion the blow OR the market eventually corrects itself to some extent. The initial shocks are disasterous but it eventually settles, like it did after LTCM and the Asia/Russia crisis.

I read somewhere that a large use of derivatives can acually help the market in times of crisis since they can hedge large exposed positions, but I would tend to think most are speculating with derivative, not hedging.
 
Quote from optioncoach:


So I believe the market can absorb a single Amaranth shock. If we get a global crisis it could be a domino effect but there always seems to be a sector of the market making money on the other side to cushion the blow OR the market eventually corrects itself to some extent. The initial shocks are disasterous but it eventually settles, like it did after LTCM and the Asia/Russia crisis.
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That's my concern. Not everything is liquid and that whole theory that everything should return to normality with time is what really failed LTCM.

A global crisis would/could/should see no one really making money. What if a fund or a bank hedged and then was caught with their pants down elsewhere and are then unable to fulfilly their hedges. The thing is, if a tsunami hits Asia or a hurricane hammers the states or another crisis hits markets that makes everyone hit the exits then who knows, all bets are off I'd guess.


I read somewhere that a large use of derivatives can acually help the market in times of crisis since they can hedge large exposed positions, but I would tend to think most are speculating with derivative, not hedging.
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I think the derivatives market is a big unknown. The same way the guys at LTCM didn't really know what would happen, though they perhaps should have, their models didn't incorporate the market reality that every man(bank/fund) works for himself and will no necessarily be there to but out derivatives contracts or positions, or anything. If all of a sudden there is a crisis, who want to hang on to AMZN at 100X earnings.

A collapse in just one section of the derivatives market might trigger a crisis in another sector which might trigger another, etc. etc.

Don't you think there is just a big unknown out there, especially regarding derivatives? I just don't see how anyone(the article you read) can track and understand the complexities involved in derivatives enough to suppose that it will bolster markets in times or trouble. That would be an indication that excessive confidence might be something that has everyone standing around watching a crisis waiting for the markets to correct while a meltdown happens.

Just because they're smart doesn't mean they have any clue as to what happens when something that hasn't occurred does and how each mentality that makes up the different fund/banks will react. :D
 
What if aliens showed up and took over the world?

If ya believed all the doom and gloom from the 80's, you missed one helluva ride. Probably just getting back to break even on gold, lol.
 
Quote from Covertibility:

What if aliens showed up and took over the world?

If ya believed all the doom and gloom from the 80's, you missed one helluva ride. Probably just getting back to break even on gold, lol.
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Who said anything about doom and gloom? If you were dumb enough to load into the markets in 1999 you're probably just getting back to break even...what's your point? :confused:

It's an objective wonder about markets. You don't have concerns about the markets? You just trust everything and think everything will always be ok? Good job if you do, takes a lot of trust in unknown factors to blindly buy into that shit. :D
 
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