I also found this very interesting comment while out last night trolling around the blogosphere -- it was a response to someone who was wondering how it could be possible that China claimed last week they had no exposure to US sub-prime --
Brad,
Like you I have no idea what China's true exposure is to subprime assets nor would I be surprised if we later discovered that it was much higher than reported. This isn't necessarily because they are dishonest or incompetent, although they might be both, but rather because they may be looking in the wrong places. I remember that during the Mexican crisis in 1995 Lehman Brothers at first reported that they had a very manageable Mexican exposure, but later it turned out their real exposure was so great that rumors had it that the firm nearly went under.
The problem [with Lehman] was that they had looked for Mexican exposure only on the Latin American trading desk, then managed by Con Egan, who was much too savvy to allow himself to get wiped out by the Mexican crisis. But the bigger exposure, it turned out unexpectedly, was on the repo desk, where it had been seen as an extremely profitable business but was poorly understood and poorly managed.
It may be that there is a lot more exposure [in China] than at first reported but we have been looking only in the obvious places, and not figured out yet where else the exposure might lie. One thing that we should also be thinking about as a consequence of the subprime mess is the impact of the crisis on volatility. I am pretty sure that Chinese institutions have been big buyers of structured notes because my many PKU and Tsinghua students who now work on trading desks have been telling me for years that selling structured notes was the most profitable business for foreign banks in China (indeed one French bank in China makes nearly all of its money selling structured notes and derivatives).
This matters because most buyers of structured notes are looking for yield enhancement, and in structured products that almost always means imbedding short option positions in the notes. Buyers of these products are always short volatility. That means that if the volatility of the asset to which the note is indexed rises, the value of the note MUST fall if correctly marked to market. With vol rising on nearly all financial assets, it would be astonishing if none of the notes held by Chinese institutions were affected. I guess it would also be surprising if they were correctly marked. We will have to just wait and see.
Written by Michael Pettis on 2007-09-04 22:54:01
In addition to what Buddy there is saying about a lack of mark-to-market, I would also assign a much greater probability than he does to the 'lack of admission of exposure' explanation, given that those responsible for blowing the PRC's money in the US sub-prime market would likely be executed.
So, quite aside from our hunting around for global banks that are being exposed who can't repay their leveraged loans because they are insolvent, another portion of this CDO/CDS mess may have been taken like a divot out of players like the PRC who may have been using their accumulated capital to play instead of loans -- as a consequence, without a lender to publicly scream 'Hey, I want my money back', we may never hear about these losses as they needn't be reported.
I remember posting a similar thought to this a few months back about small college endowment funds and the like who may have been burned -- their fund manager may just get fired over it and that's all you'll ever know |
