1994-04-14 - Re: Quants vs Congress

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From: “Perry E. Metzger” <perry@snark.imsi.com>
To: Mike Markley <mmarkley@microsoft.com>
Message Hash: add595a140f552f60042e70f15a1d71544299fbc81e31076384d5f40d9a57803
Message ID: <9404141646.AA28110@snark.imsi.com>
Reply To: <9404141518.AA06429@netmail2.microsoft.com>
UTC Datetime: 1994-04-14 16:46:15 UTC
Raw Date: Thu, 14 Apr 94 09:46:15 PDT

Raw message

From: "Perry E. Metzger" <perry@snark.imsi.com>
Date: Thu, 14 Apr 94 09:46:15 PDT
To: Mike Markley <mmarkley@microsoft.com>
Subject: Re: Quants vs Congress
In-Reply-To: <9404141518.AA06429@netmail2.microsoft.com>
Message-ID: <9404141646.AA28110@snark.imsi.com>
MIME-Version: 1.0
Content-Type: text/plain

Mike Markley says:
> The derivatives market is a very dangerous place also. In yesterdays 
> financial section here in Seattle there was an article about how 
> Proctor and Gamble is reporting a loss of over $100 million in the 
> mortgage derivative market.

Actually, there isn't much of a mortgages derivatives market -- unless
you think of CMOs as derivatives. The P&G loss was reportedly in some
interest rate swaps, although I haven't read too much about it.

Derivatives are no more dangerous than any other instrument. Its just
that because they are often highly leveraged you can make or lose far
more money as a percentage of your investment. However, there is no
requirement that you leverage yourself that much -- people just choose
to do so.

> Also in RISKS Digest 15.75 there is an article with the subject '
> God Grants Granite Gift to RISKS Punsters' that talks about a
> company losing $600 million over the period of several weeks in the
> deriviative market.

I believe you are mentioning Askin Capital Management.
They were trading CMOs, which are basically just packages of mortgages
that have had some fancy footwork performed on them to allow investors
to manage the prepayment risks.

Their problems were due to illiquidity in their market, which tended
to be for unusual or "junky" traunches of CMOs. Based on what I've
been able to read, they were using an arbitrage strategy between
mortgage securities that should have fallen in price with interest
rate fluctuations and those that should rise -- by having a balanced
book they should theoretically have been free of interest rate risk,
but because they were highly leveraged losses in their portfolio could
cause margin calls. Normally they could just have unwound their
matched positions in such a situation, but when the market turned
illiquid they got margin calls without being able to meet them and
because they were highly leveraged they swiftly lost most of their
capital. However, I'll note again they were not trading derivatives
per se -- just repackaged and securitised mortgages.

I'll point out that this is not the FinancialPunks list but the
cypherpunks list -- I'll discontinue the discussion here.