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BruceB wrote:
> However, there is supposedly PLENTY of regulatory
> oversight of the financial institutions that lent LTCM the money to go > on their leveraged bond spree to begin with.
Bruce:
Yes, you would think that bank regulators would be attuned to these problems. In
practice, I assure you that the people that overlook a bank's risk area finds
out about the incredibly stupid overuse and abuse of leverage by the fund
managers.
Let me start with a small example. I trade cash currencies. Sometimes I am
active, sometimes I go a month without doing much. The clearing house where I
have the majority of my accounts has a 24 hour cash currency desk. I can do cash
deals there of easily 25 X leverage per trade of my ending account balance
today. My account balance changes depending on my market activity, since I don't
get adequate interest on my funds on deposit.
Now, that cash currency desk is filled with young currency traders. I don't have
any friends on that desk and their spreads are too wide [The reasons are fake,
but the example is valid]. So to keep me a happy customer, the clearing
firm/bank also lets me have EFP and cash currency rights, with no money on
deposit with three other clearing firms/money center banks. And they also let me
have EFP limits with two other FCMs that are not attached to any bank. They give
me this nice treatment because I have been a great customer with the firm for 20
years. And when I was managing large amounts of money, I did business with them.
I like them, they like me.
At each of those places I am allowed to trade at about 25 X my closing balance
as of today. The limits haven't changed for several years. Now, imagine what
would happen if I went on a crazy spree and began recklessly using those lines.
Maybe I lost a bunch in the Globex session on S&Ps and I want to leverage way up
to try to get some cash back... In miniature, this is what non regulated hedge
funds, or regulated funds that are trading non regulated instruments, have
available to them. many times, the granting of this ridiculous credit is the one
thing a bank trading area can do to capture a fund's business. What does the
bank get out of it? Wouldn't you like to have a half hour lead on the rest of
the market with the news that Soros was selling 2 billion sterling? Or better,
how about buying $500 million US against New Zealand? All you have to do is buy
your $50 million US while you do his order and then watch him drive it your way.
Is that enough profit to make a trading manager go throw a tantrum to get
increased credit limits for a fund manager? In these times of non-existent
spreads, you bet your life. It happens every day.
I'll post more examples if anyone really finds this stuff interesting. When you
start looking at letters of credit and derivatives and clearing risks that
extend not to the party you lent to, but the third or fourth party down the
chain, it's amazing how much 'risk' that can be generated rather quickly right
in front of a bank's lending manager and the bank examiners.
Again, I don't want to fill the list with off subject discussions.
I hope all of you in the southeast US coast are safe, and I hope everyone has a
very fine weekend.
Best,
Tim Morge
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