Who Is the Next Long-Term Capital Management?
With over $500 trillion in derivatives tying together the global economy, it only takes a grain of sand in the financial machination to smoke the system.
- Tommy DeVito, Goodfellas
Yesterday we noted that 10-year swap spreads turned negative for the first time ever as risk premiums plummeted, and pointed to the fine folks at Bloomberg for further color.
There are a handful of interpretations floating around the street this morning, at least among those who monitor such things. Some are saying the action was effectively the unwinding of a bad bet; perhaps those banking on higher Treasury yields, or a reversal in the corporate bond or mortgage markets. Others suggest scared bears are scrambling for risk, a capitulation of sorts as the market refused to blow a fuse.
What's the right read? The honest answer is, "I don't know." Perhaps it's a combination of the above, or maybe something that will only show itself with the benefit of hindsight. What's clear is that it's a piece of the puzzle. Our job is to interpret how it fits into the big picture.
I was speaking with Professor Peter Atwater last night and we noodled something that isn't currently being discussed in the media sphere -- the unintended consequences of the Fed Policies as it relates to quant models.
Does anyone remember the Nobel Prize winners at Long-Term Capital Management? Its fixed income arbitrage, statistical arbitrage and pairs trading, coupled with high leverage almost toppled the capital market system when it failed spectacularly.
Why did it fail? One of the inputs "zigged" when it was supposed to "zag."
With all eyes on financial institutions, sovereign defaults, state bankruptcies and pension shortfalls, I'll humbly submit reason #11 to be wary of this scary bull-unforeseen systemic risk emanating from quant models gone awry. This is the first time in history 10-year interest rate swap spreads turned negative. I would venture to guess it wasn't "modeled' that way by the quant geeks.
With upwards of $500 trillion in derivatives tying together our finance-based global economy, including institutions, central banks and the taxpaying public, it only takes a grain of sand in the financial machination to smoke the system.
That's not saying it will happen. It's simply stating that it could. That's a worthy nugget of information as we collectively shape our risk profiles
Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at firstname.lastname@example.org.
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.
Daily Recap Newsletter