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Non-Tech : Derivatives: Darth Vader's Revenge -- Ignore unavailable to you. Want to Upgrade?

To: Merritt who wrote (980)	10/27/1999 10:25:00 AM
From: Henry Volquardsen	Read Replies (2) \| Respond to of 2794

Merritt, And don't many major banks still have excessive (well, maybe not excessive to a derivatives trader<g>) derivatives exposure? depends on your perspective. I of course think not. For one thing look at the empirical evidence. When the markets made an extreme move that brought LTCM and a number of hedge funds down how many banks suffered large trading losses? Very few that I can think of. That would tend to argue that the positions were not excessive. But more to the point of your general quaestion is how has the Fed responded. To start it is worth noting that when dealing with the banks the Fed can accomplish a lot through administrative messages. This stuff doesn't get announced publicly the way margin requirement changes are announced. The Fed monitors bank derivatives positions closely. They require sufficient capital to support positions and they monitor control measures. The Fed maintains a constant dialogue and demand complete transparency as to what is going on inside a bank. Something clearly went wrong in the LTCM situation. The question is what. As we have already noted the major problem was the size of their positions were to large for the amount of capital. Why did the banks allow this to happen? One of the things that struck me during the post mortem was the number of banks who thought that only one or two banks were dealing with LTCM. This led them to way underestimate the size of the positions and believe there was more capital support. This was exacerbated by LTCM's apparent refusal to fully disclose their positions. I know of firms that didn't deal with LTCM because of this lack of transparency and the inability to determine what was really going on. So why did the banks that did deal with LTCM accept this situation.? Prestige. LTCM was considered one of the most prestigous names with an all star cast. I know of at least two firms where the internal controls turned LTCM off only to be overruled by the most senior management. It has amazed me that the executives involved were not forced to resign. What I would be interested in knowing is what the Fed has done to enforce internal controls at that level since that is where some of the biggest failures were. Henry