Maybe the damage to the utilities would have successfully passed on to some institutional counterparty if they hedged? That is if the counterparty survived a hit of this magnitude. As I keep saying, this hedging and derivative business is not a free lunch. It is a game of Old Maid, especially in these "perfect storm" scenarios.
We now have tens of trillions of dollars of contracts that are written based on models that assumed risk could be mitigated by writing insurance against, say, higher energy prices and lower mortgage rates. After all, based on historical data, what would be the probability that natural gas would go parabolic? What would be the probability of a dramatic increase in equity volatility? Or, what would be the probability of Treasury-corporate debt spreads widening dramatically, while at the same time spreads on agency securities narrow? What would the models calculate as the probability that the faltering euro could within weeks gain 20% against the Japanese yen, or 10% against the Dollar? How about the probability of a rapid 50% drop in NASDAQ. What probability would the models have placed that the major California utilities could accumulate more than $10 billion of losses over several months and be on the brink of bankruptcy? Or, better yet, what would the models calculate as the probability that all these scenarios occur simultaneously? The probabilities would have been near zero, but it happened! The models don’t work in tornados and that's when you need them to. It's like having an insurance policy written by an institution that can't pay your claim.
And while we are on the subject of black box models lets talk about gold. Judging from the near zero beta (volatility) of gold this year, I wonder how the models calculate probabilities of a dramatic, high beta explosion there? My conclusion: if it happens, counterparties will be caught with their pants down. The biggest lie on the planet besides, "the check is in the mail" and "I'm from the government and I'm here to help you", is "your hedge will protect you". The other great lie, "gold never moves". |
