Friday, March 07, 2008
Capitulation
Let me give some bone tingling examples. Ok, that's hyperbole. But since I dig the markets, what you probably find snore-worthy, I find excellent and cool.
In the last few days, we have had some really astounding capitulation in the credit markets which in turn has triggered desperation selling due to margin calls. 3 notable examples are: 1) Peloton - last years European hedge fund of the year, 2007 performance up 87%, now liquidated; 2) DB Zwirn - a former $20 billion hedge fund collosus, now liquidating; and 3) Carlyle Capital, a publicly listed leveraged credit fund, positions seized. I will focus on Peloton, principally. They made a fabulous fortune last year by being very right on the trade of the day - short mortgage credit. But they didn't put that trade on naked - they hedged. Smart trade. They went long Fannie and Freddie AAAs. Those are "safe trades", because they carry an implicit government guarantee, they are perceived as a safe port in a storm. As a result, most lenders allowed you to lever them 33:1.
Well, lenders changed that rule the other day, because they needed to pull in leverage. So they doubled margin requirements. What, you say? Why? These are the flight to quality trade.
Well, when lenders don't want to lend, they want their money back. And if their contract let's them do it, they grab collateral (especially really good, easy money collateral) and blow it out the door (or just hang on to it). And so Peloton - and Carlyle - and any other hedge fund long Fannie and Freddie (think there's a few of those?) - just got pole-axed. A race to the exits ensues, and what was once a safe port in a storm, endures a technical collapse which inevitably wipes out the levered player in a few hours. The unlevered player gets to stand and buy virtually riskless securities like Fannie at very fat yields. The levered genius who had the "right trade on" gets beaten senseless by the alley thug - his prime broker - who no doubt is now long some very cheap riskless stuff. It's a little like watching a brainiac on 20 foot stilts - who's been saying nyah nyah to the muscular fellow on the street - get caught, yanked down and stomped to death. It's a cartoon. Watch how much money those market thugs make in a few months.
This won't last too much longer.
2 Comments:
By 
Charlottesvillain, at
Fri Mar 07, 01:45:00 PM:
CP,
I hope you're right. It will be interesting to see who's still standing when the dust settles.
The world is changing before our eyes. The bond insurance business has been thoroughly stomped, and the bond ratings business is unlikely to emerge from this looking much like it did two years ago. Frankly I think there is still some question about the ongoing viability of some rather large institutions, but I hope I am overly pessimistic.
Do you think the rated securitization market can recover from this? I'm watching daily downgrades of structured tranches from mid investment grade to CCC. Its hard to imagine investors trusting a AAA in that market anytime soon.
By Cardinalpark, at
Fri Mar 07, 02:08:00 PM:
you know, every time the bond market shortcircuits, people razz the rating agencies. Their idiots, a triple AAA is meaningless, blah blah blah.
That's the voice of a money loser.
The fact is, there's long records of actual performance against particular ratings which allow people to assign likely default rates to particular ratings.
I think the rating agencies will survive and credibility will be restored by performance. I think leveraged financial structures which are poorly understood will take quite some time to recapture their mojo.
But memories are short around one way options, you know.
