Janet Tavakoli: "Greater Global Risk Now Than At Time Of LTCM"

Tyler Durden's picture

Janet Tavakoli, from Letters to the Editor, Financial Times

Greater Global Risk Now Than At Time Of LTCM

Sir, The Financial Services Authority claims that hedge fund gearing has decreased (report, May 2) and the Federal Reserve Bank of New York suggests that there is no close correlation between hedge fund returns making the current situation less alarming than in the past (May 3). I believe it was Winston Churchill who said we must alert somnolent authority to novel dangers; but in this matter authority seems complacent, and the dangers are not novel.

The FSA produced numbers from a partial survey of hedge funds and discussed "average" leverage, thus highlighting the well known flaw of averages. If a swimming pool's average depth is four feet, but the deep end of the pool is eight feet, non-swimmers are presented with unacceptable risk. The average would suggest non-swimmers can safely use the pool, but a drowning man finds out the hard way that the average doesn't contain information descriptive of the risk.

The NY Fed uses data to examine volatility and correlations, both of which are not of much use in a crisis when correlations deviate from historical measures and even approach one. Indeed even today, one should consider that hedge fund returns are anything but independent. Hedge funds are often called "alternative" assets, but they have not created new asset classes. Hedge funds invest in the global markets along with other investors, albeit hedge funds may be more creative, more illiquid and may employ more leverage.

"Tavakoli's law" states that if some hedge funds' returns soar above market averages, then others must crash and burn. If one accepts that passive investors are indexed and reap average market returns, then active investors that reap extraordinary returns above the market average are offset by active investors who experience extraordinary losses in aggregate.

The current situation may indeed be different from that presented by Long Term Capital Management, but it may be even more alarming, not less alarming. Due to the use of structured products and derivatives, hedge funds can take on hidden leverage above and beyond that which can be explained by polling prime brokers. Furthermore, illiquid structured products will experience a classic collateral crash when hedge funds try to liquidate these assets to meet margin calls or collateral "cures".

Since 2000, assets invested in hedge funds have more than tripled to around $1,500bn. While on average leverage may appear manageable, some hedge funds - Amaranth to cite a recent example - employ high degrees of leverage. A potential source of a "great unwind" arises from a trigger event affecting highly leveraged hedge funds, and another potential source is systemic risk that effects a larger cohort of hedge funds.

Many hedge funds are not highly leveraged, and they will weather the storm. But the explosion of hedge fund investments in illiquid assets combined with leverage currently pose a greater risk to the global financial markets than we experienced at the time of the LTCM debacle.

 

 


 

As for the true nature of hedge fund leverage, here is the most recent update presented previously two weeks ago.

 

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So Close's picture

If Gold and Silver are money and Fiat is a house of cards than it is just a matter of time.   Probably worth remembering that being early is the same as being wrong.

reload's picture

I didnt junk you, but; its not the same - early is early, however early with leverage can be just as bad as being wrong. I think the real point here is that the `structured products` are not very liquid at the best of times. When a fund is feeling clever and invincible they are tempting, `look at me - I have bought a bespoke instrument which will allow me to profit when things pan out as I predict` - but when TSHTF no chance to get out at a `reasonable` price in a fast market. The structured product groups of the TBTF -bank/brokers love these instruments, they sell them with large inbuilt margins and construct esoteric hedges to lock in & `book` their profits. The purchaser of the product is their prisoner if he needs to unwind in a hurry or a fast market. We have seen from the Goldman MBS debacle that the TBTF have no qualms about inflicting `maximum pain` on their clients, margin gathering and stop loss hunting has not gone out of fashion. Great article, JT is a smart cookie.

Harlequin001's picture

If all the world is as safe financially as our leaders would have us believe then all the world's governments need do is to buy protection for their own debt by multiples of 2 through CDS and default, just like Goldman did when it shorted its stock of CDO's. We could all then be twice as wealthy having paid off our debts in default and have a similar sum left over for the next twenty years of largess.

If all the world was as safe financially as our leaders would have us believe then there is no need to bail out any bank, or any company for that matter since all can now buy CDS against their own debt. Do we now conclude that since none of the worlds central banks have yet done this the entire 600 trillion dollar derivatives market is nothing but a well known 'shining lie' that no one can now deal with since the problem is now far too great.

Collapse is the only possible outcome

HelluvaEngineer's picture

No worries.  Tim Geithner's got your back!

Crisismode's picture

Is that why he stuck a knife in it?

 

This summer is going to make for some very interesting fireworks, and I'm not referring to July 4.

unununium's picture

You mean a trigger event like oh, I don't know, the default of a sovereign European state?

redpill's picture

It's going to be fun to watch the ECB and IMF try to stop it.  Like watching a little kid who thinks if they flap their arms hard enough they'll be able to fly.

Ahmeexnal's picture

Or a war involving Syria and it's neighbor?

Syrian protesters along the Israeli border were paid thousands of dollars by President Bashar Assad's regime to take part in Sunday's demonstrations where more than 20 people were killed, ynetnews.com reports.

The Reform Party of Syria said intelligence sources told them that the Syrian protesters were poverty-stricken farmers.

They were paid $1,000 for showing up to the protests and their families would be paid $10,000 if they died, according to ynetnews.com.

http://www.foxnews.com/world/2011/06/07/syrian-protesters-reportedly-pai...

Sad Ass ASSad knows his time is up. His only hope is to engage in full scale war with Israel in order to preserve his throne. Syrian soldiers have now joined protesters and are shooting down the elite Syrian forces still loyal to ASSad:

http://www.foxnews.com/world/2011/06/07/syrians-in-northern-region-feari...

BEIRUT -- Mutinous Syrian soldiers joined forces with protesters after days of crackdowns in a tense northern region, apparently killing dozens of officers and security guards, residents and activists said Tuesday.

espirit's picture

Ever heard of kicking the can down the road?

Refinance the interest payment, problem solved.

MonsterZero's picture

Greece gets Interest only with 50 year ARM.

Gubbmint Cheese's picture

nope - terms are too onerous.

Try a "pick-a-pay" with a minimum payment option. All accrued interest just gets added to the balance.

:P

SheepDog-One's picture

Or, dirty bombs in US cities?

Enceladus's picture

Exactly

AKA "The Fukushima Effect"

or non-linear dynamics or 1+1=2+1=18,

The financial engineers working tirelessly to keep the back up generators working in the basement of the Fed and Treasury and on Wall Street will never see the 30 meter tsunami about to wash over the plant.

JLee2027's picture

We appear to be on the verge of the great collapse.

Cognitive Dissonance's picture

Again?

I thought we already did that in 2008? Dammit.......did I miss a memo?

redpill's picture

 No that was just a transitory event, obviously caused by a lack of liquidity.  Thankfully we've been pulled into roaring recovery by HFT robots that generously provide the liquidity that our economy needs.

DoChenRollingBearing's picture

+ 1

JLee, and those of you who have commented positively re my replies here at might enjoy my blog, where I write about gold & silver, guns & ammo, TEOTWAWKI, Peru, etc. please send me an email if you would like the link to my blog.  Name above at gmail.  Please assure me that you will be nice.

Cognitive Dissonance's picture

Please don't invite Tyler. We don't wish to distract him from the insanity at hand. He's already busier than a one armed Silver and Gold buyer.

nantucket's picture

man, the Mayans may turn out to be right after all.  I'm going to live it up like Dec 21, 2012 is the collapse of the whole enchilada.  After that,....who knows.

redpill's picture

mmm enchiladas.  Don't have to worry about my gut if the world is ending, I suppose.  Ole!

 

Ahmeexnal's picture

The ancient Maya Rabbis knew what the modern scientists still deny.

espirit's picture

Nah, the date was last changed to Oct 21 of this year from May.  Besides, we don't know if the Mayans started their calendar with year zero or one, so better be prepped to leave this year between Oct and Dec.

I'll hold your PM's for you.

FreeNewEnergy's picture

Dec 21, 2012

Something wrong here: 12/21/2012. Seems like, for more symmetry, there should be no zero, thus, the magic date would be 12/21/2112.

Delving further, we find, through the arcane Pythagorean system known as numerology (and before junking me, Pythagorus was indeed the founder. Look it up) we get a result, in the first instance of 11, a prime number, and useful if one wants to predict the end of the world, though 1 or 9 could be equally insightful. Also, remember that 1+1=2, so the 11 reduces to 2, rendering it useless as a predictive tool for end times.

100 years into the future, 12/21/2112 is reduced to 12, or 3, again, not much help. If you really want to get to the end of the world, or end of time. 1 or 9 is preferred.

6/7/2012 is today, which is 18, or 1+8=9. There. The world ends today. Crap, and I just needlessly shaved.

See you all on the other side. Bring your own.

Clampit's picture

The prophet Neil Peart would seem to agree. ;-)

You also assume it's the 10 digit humans who decide what base. After considerable reflection on the matter with my 6 year old son, I'm beginning to think the three toed sloth is woefully overlooked. That and the dolphins, who have the luxury of using the same base as my laptop and coincidentally give the same answer of 101010.

Cognitive Dissonance's picture

Sorry but the Mayans didn't predict the end of the world, just the end of one age and the beginning of another.

MSM has been beating the end-of-the-world horse just like it does every other fear mongering horse.

FreeNewEnergy's picture

Ah, thanks for clearing that up. And that's obviously bullish for stocks, right?

Cognitive Dissonance's picture

Yes. And please use maximum leverage as well. But only use funds you have borrowed to begin with, then deposit them in a margin account and go to town.

Keep me updated. I care.

cougar_w's picture

Keep me updated. I care.

We can all feel the love. :)

Oh there is a new story up if you want some more warm fuzzies:

http://madscienceunlimited.com/fiction/uncomfortableWithTheTruth.html

Fortran is being bad again. Or is it good? She's not sure herself, but I'm leaning toward the former myself  in the off chance she'll then submit to a firm spanking.

FreeNewEnergy's picture

Hey, you're right. 12/21/2011 reduces to 10, which is 1, which would correlate to TEOTWAWKI. (see my post below, or above, depending on whether you're standing on head or tipped your i-pad over the wrong way).

Dixie Rect's picture

I hear helicopters.

FreeNewEnergy's picture

I'm so confused. Should I buy the dips, sell the chips, or flip the condo?

SheepDog-One's picture

Dip the guacamole, sip the Corona.

redpill's picture

Screw the dip, buy fresh avocados and make guacamole.  Eat the chips with it.  And then pay off the condo and live there while the world implodes.

Ahmeexnal's picture

What's the matter with you? No Adonis DNA? No tiger blood in your veins? Time for a Charly Sheen inspired weekend -midweek.

redpill's picture

Tried to come up with a Tigers Blood cocktail involving Bloody Mary mix and Jaeger.  Didn't work out well.

Commander Cody's picture

One more enhancement: Stop paying on the condo.

FreeNewEnergy's picture

How about I flip the dip, chip the condo and spunk a monkey?

SheepDog-One's picture

'Hedge funds'...another part of the problem. Everyone in on record margin leveraged to the gills livin it up, then when it implodes they run around crying about how it all could have gone so wrong and get bailed out by the taxpayers with a gun to their head.

qussl3's picture

Gun is empty, time to call the bluff.

Iceland is proof.

DogSlime's picture

As long as we don't have to bail them out, I say let them leverage all they want...

Just so long as this time when they fail, they fail.

Franken_Stein's picture

 

A top Bilderberg member has revealed that globalists are panic-stricken about a potential eurozone crisis caused by a Greek debt default that could precipitate the collapse of the Euro and also derail the wider agenda for multi-regional currency unions and eventually a global currency system.

Appearing on the Alex Jones Show yesterday, veteran Bilderberg sleuth Jim Tucker said that the Euro will again be the subject of crisis talks at this years globalist confab in San Moritz, Switzerland, with power brokers desperate to rescue the single currency from a collapse that numerous financial analysts see on the horizon.

 

DogSlime's picture

They'll just offload whoever they deem to be "toxic" members of the Eurozone, won't they?

Tuco Benedicto Pacifico Juan Maria Ramirez's picture

Death to the New World Order!

Tuco Benedicto Pacifico Juan Maria Ramirez

RobotTrader's picture

No doubt a "surprise" announcement is due any day now from the "O-Team".

Something that will "shock and awe" the stock market.

The question is when is the ideal time to make such announcement to inflict the maximum amount of pain on the shorts?

qussl3's picture

Eventually it will suit TPTB to shear the longs, wonder when that is.

redpill's picture

I thought you were going to go short on the S&P?  What happened?

FreeNewEnergy's picture

STFU, robo. You're a clown. Please go away.