OH NO! More Mega Losses Created by Trend Buckers!

Yes, it's true. More intellectuals got the bill for acting on their feelings about markets I would bet that they will take offense at someone referring to their "calculated actions" as feelings! Absolutely no one is better at rationalizing their behavior than an "intellectual". Regardless of explanations, they have damaged a t of people with their "hubristic" approach to markets.

SINGAPORE - Criminal investigators have launched an investigation into a $550 million loss on derivative trading by China Aviation Oil (Singapore) Corp., the main supplier of jet fuel to China, the Singapore Exchange and central bank said Friday.
Court documents obtained by The Associated Press in Singapore said the Chinese parent company was aware of the financial problems when on Oct. 20 it sold a 15 percent stake in the troubled supplier for $108 million. According to an affidavit signed by Chen Jiulin, China Aviation Oil's suspended chief executive, his company notified its parent group of its troubles on Oct. 10.
In his statement, Chen outlined the company's ill-fated venture into options trading that began with initial transactions involving 2 million barrels of oil in the second half of 2003.

According to Chen's statement, the first transactions made a profit, but the worldwide increase in oil prices in 2004 caught China Aviation Oil's trading team unprepared. Instead of leaving the market and accepting losses of a few million dollars, the company raised its bets until it was faced with losses that it could not meet.
Due to the company's inability to pay, the company's creditor-banks commended the forced closing of a number of derivative contracts," Chen said. "As a result, the potential losses that the company had been facing were transformed into actual realized losses."

This statement by Chen that the losses were only potential until the creditors forced the closure of the losing trades is priceless. Some $550 million dollars in losses was only theoretical.The evil creditors caused the losses to become real. Hello! "Ground control to Chen Jiulin".

The collapse of Britain's Barings bank in February 1995 is perhaps the quintessential tale of financial risk management gone wrong. The failure was completely unexpected. Over a course of days, the bank went from apparent strength to bankruptcy. Barings was Britain's oldest merchant bank. It had financed the Napoleonic wars, the Louisiana purchase, and the Erie Canal. Barings was the Queen's bank. What really grabbed the world's attention was the fact that the failure was caused by the actions of a single trader based at a small office in Singapore.

Leeson took unauthorized speculative positions primarily in futures linked to the Nikkei 225 and Japanese government bonds (JGB) as well as options on the Nikkei. He hid his trading in an unused BSS error account, number 88888. Exactly why Leeson was speculating is unclear. He claims that he originally used the 88888 account to hide some embarrassing losses resulting from mistakes made by his traders. However, Leeson started actively trading in the 88888 account almost as soon as he arrived in Singapore. The sheer volume of his trading suggests a simple desire to speculate. He lost money from the beginning. Increasing his bets only made him lose more money. By the end of 1992, the 88888 account was under water by about GBP 2MM. A year later, this had mushroomed to GBP 23MM. By the end of 1994, Leeson's 88888 account had lost a total of GBP 208MM. Barings management remained blithely unaware. On February 23, 1995, Nick Leeson hopped on a plane to Kuala Lumpur leaving behind a GBP 827MM hole in the Barings balance sheet.

As a trader, Leeson had extremely bad luck. By mid February 1995, he had accumulated an enormous position—half the open interest in the Nikkei future and 85% of the open interest in the JGB future. The market was aware of this and probably traded against him. Prior to 1995, however, he just made consistently bad bets. The fact that he was so unlucky shouldn't be too much of a surprise. If he hadn't been so misfortunate, we probably wouldn't have ever heard of him.

Traders sometimes speculate without authorization. Presumably, a few are able to cover their tracks. Others are caught. When they are caught, they are fired, and their employer eats the loss. Usually, neither the trader nor his employer has any interest in publicizing the incident. Leeson made headlines precisely because he was so unlucky. By the time he was discovered, he had bankrupted his employer. Publicity was unavoidable.

What is amazing about Leeson's activities is the fact that he was able to accumulate such staggering losses without Barings' management noticing. As Leeson lost money, he had to pay those losses to SIMEX in the form of margin. Leeson needed cash. By falsifying accounts and making various misrepresentations, he was able to secure funding from various companies within the Barings organization and from client accounts. His misrepresentations were flimsy at best. For example, he claimed that he needed funds to make margin payments on behalf of BSS clients, and he gave a technical argument related to how the SIMEX collected margin as justification. This claim was false. It was actually against SIMEX rules for a broker to post its own money as margin for a client. Even if the claim were true, the funds would have been needed only temporarily—until the client could make payment. Instead, Leeson continued to ask for ever more funding. Most of this came from three companies within the Barings organization:
Baring Securities Limited (BSL)—securities arm of parent Barings Plc.;
Baring Securities (London) Limited (BSLL)—BSL's London office;
Baring Securities (Japan) Limited (BSJ)—BSL's Japan office.

Nick Leeson's track record at Baring Bank was amazing. This is a classic in how a losing trader operates. I would love to know what Mechanical Trading System he was using. One could get rich just fading his system. His bosses were even sharper. They had no clue what he was doing. I'm impressed. This was the Queen's bank. If the Queen of England's Bank couldn't find good help, just imagine what kind of fools the "lesser" institutions might have hired?

Hedge funds are named after the practice of "hedging your bets," or betting on both sides of a wager. But what happens when the unexpected occurs and the whole wager goes sour? Both sides lose, but the guys who borrowed money to hedge their bets--to bet on both sides of the deal--lose the most. That's exactly what happened to Long Term Capital Management two weeks ago.

LTCM had nearly $1 trillion in bad investments, but only $2 billion in assets that it could sell to pay off its debts. Its borrowing in the past year alone averaged between 50 and 100 times its asset base, and it borrowed from the biggest of banks and brokerage houses in the world, thereby endangering a banking system already rocked by losses in Russia and the Far East. Last week, more news leaked out about this highly secretive fund and other funds just like it.Cerulli Associates, a Boston consulting firm which is preparing a report on hedge funds, estimates that there are roughly 4,500 of these funds with an estimated $300 billion in assets. That's not counting all the money these funds have borrowed to make highly risky investments. About 81 percent of the funds borrow, and most borrow just under 5 times their asset base. Imagine being able to take out a mortgage for 5 times the value of your home; no bank would do it--yet they do it for hedge funds. Why?

In the case of LTCM, the fund was managed by a few "big names" on Wall Street, including three former Salomon Brothers brokers and two Nobel Prize-winning economists, Robert Merton and Myron Scholes. They had the gloss of "expertise" to help them fleece major banks and brokerage firms, and take investment money from not just a few wealthy people, but also a bunch of "institutional investors" that were looking for wildly high returns: pension funds, endowments, and foundations--whose investments now account for about 80 percent of the total assets of all hedge funds today.

"The banks have played a double game in their dealings with LTCM. Many financial establishments and even state bodies, including the Chinese and Italian central banks, put money into it. The banks offered LTCM credit facilities that gave it a degree of leverage (the difference between the expected profit on an operation and the cost of financing it) that promised spectacular returns. They also served to offset its financial transactions. And, better still, many leading figures such as the chairmen of Merrill Lynch and Paine Webber, David Komansky and Donald Marron, put their own money into it."

"The banks' staggering lack of curiosity about the fund's activities is particularly disturbing in view of the astronomical sums involved. At the beginning of the year, LTCM had capital of $4.8 billion, a portfolio of $200 billion (borrowing capacity in terms of leverage) and derivatives with a notional value of $1,250 billion."

"But the banks had put their faith in the fund's pedigree and reputation. The founder, John Meriwether, was a legendary trader who, after a spectacular career, had left Salomon Brothers following a scandal over the purchase of US Treasury bonds. This had not tarnished his reputation or dented his confidence. Asked whether he believed in efficient markets, he replied: "I MAKE them efficient" (3). Moreover, the fund's principal shareholders included two eminent experts in the "science" of risk, Myron Scholes and Robert Merton, who had been awarded the Nobel prize for economics in 1997 for their work on derivatives, and a dazzling array of professors of finance, young doctors of mathematics and physics and other "rocket scientists" capable of inventing extremely complex, daring and profitable financial schemes."

"The fund's operations were conducted in absolute secrecy. Investigators asked questions were told to take their money somewhere else. Nevertheless, despite the minimum initial payment of $10 million frozen for three years, there was a ush to invest and the results apeared to be well up to expectations. After taking 2% for "administrative expenses" and 25% of the profits, the fund was able to offer its shareholders returns of 42.8% in 1995, 40.8% in 1996, and "only" 17.1% in 1997 (the year of the Asian crisis). But in September, after mistakenly gambling on a convergence in interest rates, it found itself on the verge of bankruptcy".

We can identify the problem here. Academics are running amok in the financial centers of the world. Their theories don't work in the real world. They never have! LTCM had some of the most honored people in the academic world running the firm. All their staff were "rocket scientists", according to their credentials. The "Best and the Brightest" (including two Nobel Prize Winners) managed to build a financial destruction machine.

In these three cases, the outcome was the same. Notice that the firm using spreads (hedging) took the biggest loss. When you approach a trillion dollars in bad losses, you are incompetent! Spread trading is not necessarily safer than trading with the trend, as LTCM proved conclusively.

Almost all of this financial carnage was due to "trading against the trend".Nick Lesson of Baring Bank was always wrong, according to the reports. This individual wouldn't "trend with the trend" if his life depended on it! He has already destroyed his career "trading against the trend"!

Chen Jiulin of China Aviation Oil shows that nothing beats a bad idea. We see clear documentation of how to let your losses ride. How many people can say that they let a loss of a few million run into a loss of $550 million dollars?Apparently, there's no rush like defying the trend!

An official inquiry found that LTCM had created a system so complicated that they were unaware of their own net position in the market. Perhaps they took the status as a "hedge fund" a little too seriously, and began hedging the hedges. LTCM never knew what the trend was, or they forgot about the trend while building their super hedges.

The idea of staying out of a market unless you have clearly identified the trend was too pedestrian for these "Whiz Kids".When John Meriwether of LTCM was asked whether he believed in efficient markets, he replied: "I MAKE them efficient". Perhaps he was also going to make markets trend his way! Naturally, John Meriwether's markets would "trend efficiently".

We should also remember that chairmen of Merrill Lynch and Paine Webber, David Komansky and Donald Marron, put their own money into LTCM. These people were the heads of brokerage houses that provide research for the investor. We can safely assume that they were given "the best information "by the people that work for them. One must wonder about the "quality" of the information the lowly retail customer is given.

A line from the GODFATHER II may be appropriate here:
"Whatcha go to college to get stupid? You're really stupid!"

It appears that we need more grade school and high school dropouts such as W. W. Cargill, W..D.Gann, Samuel Benner, J. R. Simplot,etc. These men discovered the rules of the markets, and used those rules to create enormous wealth, not destroy it!

Cargill today is the most successful grain merchant in the world.The house that W.W. Cargill built in 1865 (He built a grain flat house, and opened a lumberyard in Conover, Iowa) has grown into the largest privately held company in the world.