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A Gross Problem

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What we are living through is a system-wide disregard for gross exposures...

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In reviewing Societe Generale's record trading fraud, this weekend's Economist suggested that the Bank's largest risk management failure was its focus on "net" exposures versus "gross" exposures. At the same time however, the article, in trying to comfort readers, goes on to suggest that this issue is unique to Societe Generale.

At the risk of raising the ire of fellow devout Economist readers, I would put out there that what we are living through is not just Societe Generale's failure, but a system-wide disregard for gross exposures across capital, liquidity, credit and interest rate risk management.

For example, over the past 6 months, we have learned, albeit the hard way, the difference between "net" and "gross" exposure to SIV's as close to $100 billion of assets moved on balance sheet.

We have also learned, again the hard way, how seemingly small "net" pieces of CDO's and mortgage securitizations can carry the entire credit exposure of far larger "gross" pools of loans.

And now we are about to learn the true distinction between "net" and "gross" exposure as the monoline insurers and the $47 trillion CDS worlds fall under the market's bright light and counterparties re-evaluate and, more importantly, re-measure, their risk positions.

Given the environment, investors large and small would be wise to step back and understand what exposures they are netting, and consider a broad range of "What if's?

As I have written previously, I believe that before the year is out, many investors will see that while their hedges were correct, their counterparties were not. And for some, that will be end up being a very "gross" problem.
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