Derivatives: Darth Vader's Revenge Message Board

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Non-Tech : Derivatives: Darth Vader's Revenge

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To: Henry Volquardsen who wrote (165)	9/25/1998 12:31:00 AM
From: ahhaha	Read Replies (1) of 2794

Of course it is margin call. The pledging banks could loose a good portion of their pony if the long T continues South. The question is who is on the other side of the trade? At this point the banks either have to cover and carry the other leg or they have to sell the long and take the short loss. It looks like they aren't going to do either. They're going to wait. It is like an exposed naked short. The market moves in the direction of crucifixion when it smells a fish on the hook. There is another factor moving the fish toward Gethsemane. Daily billions pour into the long T coming from foreign branches of Japanese private banks. Japan simply refuses to address their banking problems. They don't want the world to know how intractable the situation has become. It wasn't that bad nine months ago, but every action in the interim has exacerbated the situation until now the private banks are moving as much dough as they can offshore. The flow is relentless and that means the T bond hasn't bottomed. If that is the case then the bailout in the form of holding all positions is a disaster. They can't take that risk. They must close out all short positions. If they persist, the cascade potential rises and could force an internal squeeze on our banking system. The FED has already been pumping like there is no tomorrow. They have been doing this in ever increasing quantities for months. The consequence is an exploding money supply currently rising at something in excess of 20%. Up to several days ago the fed funds rate had been sticky even with voluminous purchases of RPs. The inter bank demand for loanable funds has been firm. Now we have this leveraged bank speculation snafu so that further downside action of the T-Bond will force the FED to make a private loan or the FED will have to increase the rate of pumping. They don't want to make the loan because then they are in the position of the pony banks. So, the only way out is to open the money floodgates. This will have the result of increasing monetary inflation expectations which would cool the advance of the T-Bond, but at what price? The money creation most likely would go into price increases more than it would go into production. In either case the outcome isn't good. An acceleration of GNP growth could develop a life of its own and inevitably the FED would have to knock it down with higher rates. Higher rates would also slow foreign dollar factoring and coincidentally cause a substantial sell-off in the dollar. Rising rates and falling dollar don't sound good either with a still pricey stock market. The FED could have leaned against the wind like many fed presidents wanted earlier this year. Then they wouldn't be in this awkward position. There is not much difference between exchange margins and those of collateral. The FED establishes all minimum margin requirements. There is no "change to equity". It is possible to post equity on call, but that is extremely expensive. If you mean there is an earnings consequence for a losing bank, definitely. The loss must be charged against the next quarter's earnings and that could have a short term bank stock effect. Usually it is transient because stock values are determined by what the bank is doing in general, not on extraordinary occurrences. However, if the bank has only a portfolio of arbitrages, the market will go beyond merely discounting the implied risk, it will punish the stock because loss of confidence. Their good name becomes dirt. See Herstadt.

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