Tuesday, September 26, 2006

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The dog that is not barking in financial markets

Brad DeLong makes a good point in highlighting one positive sign from the Amaranth collapse:

Amaranth blows up following a trading strategy that either had no method at all to it or was a failed attempt to corner next spring's natural gas market.

Yet there is not a sign of disturbance to the markets. Amaranth's investors have lost what is now said to be $6 billion. Some other people have the $6 billion--if they can, in turn, unwind their positions. But the system cruises on with no worries about liquidity or solvency and no changes in risk premiums.

Reassuring, I think.

posted by Dan on 09.26.06 at 02:42 PM


I think the reassuring thing is that Amaranth seems to have been a "lone wolf" in their strategy. There was neither one big winner on the other side of the trade nor other major, high-profile big losers that followed similar strategies (but it could be just too early to tell).

So, it looks like they were likely an outlier, and there was not too much concentration in the market in which they were playing.

posted by: The Unknown Professor on 09.26.06 at 02:42 PM [permalink]

This is in, I believe, a $12 Trillion dollar economy. $6B is a speck, relatively speaking.

That helps.

posted by: save_the_rustbelt on 09.26.06 at 02:42 PM [permalink]

I second the comments of the unknown professor -- amaranth seems to have been the only one on its side of its major losing trades. that presumably helped to limit contagion.

that and the fact that its prime brokers will able/ willing to help it sell its other positions w/o moving the market in those areas, and thus helped Amaranth meet margin calls on its losing natural gas spread bets.

wish i had a better grasp on this tho

posted by: brad setser on 09.26.06 at 02:42 PM [permalink]

That is the point of allowing speculators into the futures market in the first place: Liquidity. If the goal was merely efficient pricing or commoditization of a forward market, only people in a position to supply the commodity or take delivery of it would be allowed to trade.

The one thing overlooked by most but noted in your quote: The futures market is a zero-sum game. If Amaranth lost $6B, someone(s) gained $6B. They don't necessarily need to unwind their positions. The vast majority of speculators do not leave positions open overnight.

I wonder what has happened to the open interest over the last few weeks - but not enough to bother checking (then I'd have to spend time figuring out if it meant anything).

posted by: mrsizer on 09.26.06 at 02:42 PM [permalink]

I don't know if these markets are deeper than they were when LTCM blew up (that was IIRC a $4B crash) in 1998. What appears to be a major difference is the greater political stability and financial depth of many of the emerging markets that tanked in 1998.

posted by: thibaud on 09.26.06 at 02:42 PM [permalink]

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