Steroids, Credit Growth and the Derivatives Blow Up Hall of Fame

Dean Curnutt, CEO of Macro Risk Advisors, MRA, gave the second talk today at the 31st annual CBOE Risk Management Conference.  MRA does strategy based research and Dean has been a guest speaker at previous RMC’s in the past.  Dean’s background included a degree at the University of Chicago,  working at Lehman in structured equity derivative products and as a Managing Director and head of equity salestrading at BofA.

You will never see a bad back-test, ever!

Dean began his talk by telling a story about major league baseball having a strike in 1994 which cancelled the end of that season, the World Series and the delaying the season open for a few weeks of 1995.  How did baseball bounce back?  Home runs.  Bonds, Sosa and Maguire led a very inflated rise in all of baseball over the steroid era.  The annual chart of Baseball home runs compares to the Case Shiller “price to rent ratio” in the same time period, both pointed to anomalies in those markets.

“Derivatives are financial weapons of mass destruction”, Warren Buffet.  Dean showed how Berkshire was short a massive amount of long-dated short Index Vega. Berkshire was not required to post collateral for quite a while and was not mark-to-market.

This led into Dean talking of Weapons of Financial Mass Destruction.  He distributed baseball playing cards (with gum!  Also had pictures of each person involved at that firm and stats and quotes on the back of each card) with his baseball team with nine inductees into the derivatives Blow up Hall of Fame:


Metallgesellschaft  hedge good as long as we stay in backwardation, which it didn’t.  “I could understand losing $1.3 bln by speculation, but I couldn’t see how you could lose $1.3 bln hedging”  ~ Merton Miller.

Orange County  1-3 year bonds with 10-year duration.  “I am one of the largest traders in the world, I just know these things”.  Director relied on chart from astrologer in Indiana for interest rate predictions.  Loss:  $1.7 billion

LTCM  We are the ones who developed the model.  $4.6 billion

Amaranth  Long Winter – Short Spring.  Their long US Nat Gas contracts larger than total US consumption.  Loss: $6.6 billion

Bear Stearns   AAA rated sub prime products.  Mark to market adjusted to more realistic levels.  Loss: $1.6 billion

Morgan Stanley   1 X 2 Put spread turned into 1 X 10 put spread after adjusting, which buckled when credit spreads soared.  loss:  $9 billion

AIG   Losses order of magnitude larger than the others  Loss:  ” it’s very hard for us… see us losing losing one dollar in any of those transactions.  Loss: $62 billion Q4 ’08

MF Global  50% of Book in Italian bonds, mark to market unwind at top. Loss: $1.6 bln

JP Morgan    “Tempest in a teapot” London Whale. Huge position deviated from intrinsic value.  Loss: $6.2 billion

Dean explained what went wrong with each firm, their reasoning behind trades and showed the results.

He wrapped up by summarizing:

1. Credit growth and leverage matter

2.  Mark to Market Risk Matters

3.  Reflexivity Matters – price of risk impac ts underlying

4.  Greenspan was Right   financial innovation served as buffer & strengthened system

5.  Recency Bias Matters   Will risk tomorrow look like risk today

6.  next Vol Event   market consensus may be wrong

Options provide an opportunity to change your mind.   Thank you Dean