Muppets Vs IG9 Tranches-Bernanke Puts Vs Portfolio Insurance

From Peter Tchir of TF Market Advisors

Just a couple of quick thoughts but worth thinking about.

Muppets vs IG9 Tranches

While firms and possibly regulators are searching e-mails for the word “Muppets” and other less kind descriptions of clients, they should switch their attention to IG9 and tranches.  Everything about this story seems strange.  The alleged size of the positions.  The deviation from intrinsic value.  The fact that what caused the deviation wasn’t likely direct selling of the index, but of “naked” tranches.  That the story was leaked seems weird.  There may be a lot more fallout from this escapade than we have seen yet, and not all of it (or even most of it) will fall onto the shoulders of JPM.  Here are some examples of how CDX Indices trade, and what even Single Name CDS trading is like.

If you read those and think about possible scenarios in IG9, it becomes really interesting if the whole process of CDX trading, tranche trading, mark to model, net risk vs gross risk, etc., are actually examined and scrutinized.

Bernanke Put 2012 vs Portfolio Insurance 1987

The markets are wobbly, but there is a great deal of confidence in the Bernanke “put” or the ones offered by other central bankers.  Without a doubt the central bankers watch the stock markets and are willing to do things to support it.  Great in theory, but can they react fast enough in a decline?  How many investors are “long” risk because of the Bernanke put?  I think a lot are.  The problem with the Bernanke Put, is that it isn’t a real put.  It is policy that attempts to stimulate the market.  How useful is that in a sell-off?  How many managers will risk losing more money waiting for the put to kick in?  This is particularly true as we near month end.  Hedge funds, for better or worse, have in many cases been forced to focus on monthly returns.  Being long on the hopes of a put is not the same as being long with a real actual put. 

In some ways this reminds me of portfolio insurance, which worked well, until it didn’t.  In the heat of the moment during a down movement, the comfort of a real put is very different from “owning” a theoretical one.  I am very cautious given how much chatter about the Bernanke Put I’m reading this weekend.

I will look at both of these subjects during the course of the week.  The final outcome of a serious IG9 investigation and what new distortions it would cause still confuse me at this stage, but the Bernanke Put is something investors really need to question.  Will stop-loss trading overwhelm it, even if only temporarily?


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