On Jefferies

Bruce Krasting's picture

This story got on the wild side yesterday. The stock broke for 20% in just 22 minutes. Then, just as fast, it came back and closed down a barely noticeable 2%. The rebound came after some "comforting" words by management. Some thoughts.

I will start on the plus side by saying that having Leucadia National (LUK) in the deal gives me comfort (LUK has a 28% stake in JEF). I've always known them to be a savvy bunch. They were willing to up the ante by another $12mm today. This makes me think that JEF is not the next crisis. That’s not to suggest that it's on my buy list.

While the market seemed very satisfied with the words from the company, I was left wondering what's going on.

The message that I got was:


“We’re fully hedged on $2.5b of investment grade EU sovereign bonds.” 

“Stop worrying!”

I don’t find that comforting at all. I get more worried when they say stuff like this.

This is simple. If Jefferies is hedged up AND both (all) legs of the sovereign bond positions have been MARKED to MARKET (as we have been told they have) then there is very little reason not to unwind this position. Yes, the actual unwind might result in an incremental loss, but if you believe that there are legit marks on this, then it should not be that big a deal.

If that were to happen JEF would get off the front pages and off of the “short” list. At one point today they lost 20% of their market cap. The bond positions on the books are simply not worth that kind of headache.

My first guess is that this is what we will get. In a week or so Jefferies will announce they have offloaded the positions the market does not like. If they don’t, we will see JEF back in the cross-hairs. I’m quite sure the guys at both Leucadia and Jefferies are well aware of this fact.

Say I’m right and this ends with an unwind. To me, there are very dark consequences to that outcome as well.

There is absolutely nothing wrong with capital that takes on risk in the pursuit of gain. Leveraging sovereign bonds is as old as the hills. It’s bread and butter for capital. If there are fewer risk takers, there will be less liquidity. Period. That translates to higher and higher borrowing costs for the sovereign issuers. The party will stop without the dancers.

I can’t see a soft landing to the JEF story. If they don’t clean up the books the market will grow suspicious (again) and junk the stock. If they do clean the books, dozens of global firms who make markets and take positions in Sov. bonds will have to back out. We may have a situation where the firms who do play in this space will have their stocks attacked. That road's a game ender.



We’re fairly close to the boiling point. I think things ratchet up another big notch if the Italian 10 year breaks through 6.75%. Last I saw, it was 6.20%. Dangerously close.


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Cthonic's picture

There is absolutely nothing wrong with capital that takes on risk in the pursuit of gain. Leveraging sovereign bonds is as old as the hills. It’s bread and butter for capital.


Except that it's not real capital that is taking these risks, it is cheap financing ultimately provided by Fed and guaranteed by taxpayers without their consent.


If there are fewer risk takers, there will be less liquidity. Period.


Gambling other people's borrowed funds (and getting paid regardless of the way the gamble turns out) is hardly risk taking.


That translates to higher and higher borrowing costs for the sovereign issuers. The party will stop without the dancers.


So be it.  Leverage is like an amplifier in a cyclic network with positive feedback.  For a given system's impedance, there is a threshold level of amplification which, when surpassed, the network will quickly be driven to saturation.  Saturation in the real world leads to component failure, which changes the topology of the network.  Failure can be localized, or cascade.  The powers-that-be can try either to save their (physical) necks, or to save the current finance model.  Which, as you say, is as old as the hills, and in need of some serious clean sheet re-architecting.

Augustus's picture

The suggestion that Jefferies "get clean" by simply substantially unwinding the positions is a good one.  It reduces the leverage on the capital.  And it would allow them to be one of the first out the door.  Reducing positions has been suggested as the alternative for the BIG BANKS which are supposed to have larger capital bases or reduced leverage.  The govt. ministers believe they can command a capital raise and dilution.  The proper route might simply try to reduce requirements by reducing asset size.  That leads to bond sales and certainly not purchases.  Who could be the buyer for the off-loading and, following that, the new issuance?  ECB is already bankrupt with the writedowns they need to take on the belly full of Greek bonds they took in on that failed effort.  Now the focus shifts to supporting Italy.  Who will buy any more of this stuff when facing a big deleveraging on the way?

DOT's picture

Are we to expect another big reverse repo week at the Fed ?

Seems like the liquidity to prop the market is disappearing.



fd: I need guidance, I watched the Obama kiss the Cannes;my brain hurts.

Chappy's picture

Now I'm short Jef and LUK.  Anyone else care to suggest some crappy firms they expect to go next?  I've tried making intelliegent guess and random guesses and lose money either way.  I figure any guess on here is at least a 50/50 for going under so I'm in.

prains's picture

chappy you're operating in a 5/95 pond and your "alpha"is the small side. there is no 50/50, better to buy lotto, odds will be more in your favour.

boiltherich's picture

When the euro goes away JEF and anyone else playing in the euro bond market is going to be destroyed and anyone invested in them will also be destroyed.  Then we will see if the risk/return ratio justified the confidence.  Of course they will get made whole via massive bailouts by you and me the taxpayers.  But that is another topic.  When this happens CDS insurance will not be able to pay, the scope will just be to great. 

Hephasteus's picture

Another great post bruce.

There's no such thing as fully hedged. Risk can not be created or destroyed. Only transfered.

Mercury's picture

 Yes, the actual unwind might result in an incremental loss, but if you believe that there are legit marks on this, then it should not be that big a deal.

Or a big loss.  How low do you have to go hitting bids to get out of that amount of Euro (and which ones?) sovereign debt these days?

Bruce Krasting's picture

Well you ask an excellent question. We are talking about a $2,5b "matched book". That is not a big deal. To buy or sell $1b of Bunds is a 3 second phone call (or just electric). So if you're right and the issue is liquidity and JEF can't trade out of this without a massive hit we are dead dead dead.

That would mean that the EU debt market is completely dis-functional.

handex's picture

who did they hedge with? who is the counterparty on the hedge?


Prophetwithoutprofit's picture

I will start by saying I do not know anything about hedging sovereign bonds.  I did observe the EU play fast and loose with the issue of Greek default, engineering a 50% haircut and not triggering the CDS protections.  How can any dealer/investment firm say there are fully hedged when you do not know when the politicians will change the rules or jerry rig a solution depriving the hedger of protetction? Wouldn't this effectively destroy the sovereign market and firms dealing in their bonds

MobBarley's picture

You lost me at 'investment grade'


El Oregonian's picture

It only gets bitter from here.

disabledvet's picture

JEF seems to me like the smallest of fish in smallest of fish tanks packed with the biggest of predators. we'll see but i agree...their existence is always threatened...and now they are vulnerable. Thanks John Corzine!

Mister Ponzi's picture

Jefferies has been aggressively expanding into market making in European bonds. Consequently, as the company pointed out, their sovereign holdings are market maker inventories. Why, then, is the company supposed to drop these holding?

Clowns on Acid's picture

Bruce if JEF is hedged on a 1:1 basis (more of a sov pairs trade), why wouldn't they maintain their position?

Are you suggesting that any Inv bank with a hedged or pairs trade in Sov begin to unwind?

I may agree from a concentration / liquidity point of view, but from a price risk point of view, I wouldn't think that you or I or any investor has enough info to make that call.

HD's picture

Why is 6.75% significant?

Bruce Krasting's picture

Because it's a line in the sand. It will be a point where margin requirements on collateral will be raised. That will create more selling.

HD's picture

Thanks - appreciate all of your posts.

gangland's picture

6.24800 +0.05400 +0.87%

it's selling off scary took about 10 minutes to go from 6.239 to 6.248

LongBallsShortBrains's picture

You'll never keep up with the ticker

Bananamerican's picture

where else can you find a picture of the dude's balls under 7 amerikanazi flags?


williambanzai7's picture

It can't be good Toto.

apberusdisvet's picture


If the great derivative unwind begins, it will soon be obvious that there is no such thing as a "hedge" without risk.  All it will take is one of the counterparties going BK (AIG anyone?) and the dominoes will start tippling.

disabledvet's picture

yeah i didn't hear "we have 10 tons of gold as collateral" blow out of JEF's mouth. This is true.

Desert Irish's picture

Thanks Bruce,

Question - At what yield do you think the ECB will throw in the towel or be unable to continue purchasing Italian 10 year bonds?

prains's picture

Question - At what yield do you think the ECB will throw in the towel or be unable to continue purchasing Italian 10 year bonds?


when they can no longer pay the power bill to run the Heidelbergs...................infinity and beyond

max2205's picture

Being public is never worth the crap you got to put up with

ThisIsBob's picture

Try telling that to the kids at Groupon this morning.

Dr. No's picture

Its a sugar high.  Ask them in 1 year when the complimentry yogurt and trail mix is takenn away from the break room.  2 years from now, the unlimited vacation will be switched to PTO use-it-or-loose-it two weeks.

Not saying its bad.  But give me an example of bennies being increased after going public.

DOT's picture

Wait ! Unlimited trail mix is a vested RIGHT !  Er, for the Corp. Officers, that is.

ThisIsBob's picture

You are giving them 2 years?  Well, God bless you.

MrSteve's picture

Again, BK breaks it down like a seminar on Kindleberger's work. Revulsion and cries of "off with their heads" related to scandals are part of panic cycles. Seeing a panic in internet time requires keen thinking.

The imploding sovereign bond collapse points to a deepening depression, world-wide.

Bruce is one of the best weathermen forecasting on ZH! Thanks for the insights.

covert's picture

govts always default. so there really isn't a bond.