by in Public

Shoot First, Ask Questions Later

Shoot FirstOne reason traders tend to shoot first is because we know the market is like a crowded nightclub: at the end of a long evening of debauchery, it is filled with people doing things they wouldn’t while sober, and one cannot count on there being enough (or even functional) fire doors to let everyone out.
The fire never kills them; it’s always the smoke.
And so it was last night that smoke from the Wall Street Contagion billowed out of BNP Paribas in European trading, resulting in ECB intervention:

ECB Offers Unlimited Cash as Bank Lending Costs Soar
Aug. 9 (Bloomberg) — The European Central Bank, in an unprecedented response to a sudden demand for cash from banks roiled by the subprime mortgage collapse in the U.S., loaned 94.8 billion euros ($130 billion) to assuage a credit crunch.
The overnight rates banks charge each other to lend in dollars soared to the highest in six years within hours of the biggest French bank halting withdrawals from funds linked to U.S. subprime mortgages. The London interbank offered rate rose to 5.86 percent today from 5.35 percent and in euros jumped to 4.31 percent from 4.11 percent.

Buried in the fine print was the 22 percent spike in Japanese rates, hastening the unwinding of carry trades:

Liquidity fears spark volatility in global markets
“But overnight dollar rates surged from 5.22 per cent on Wednesday to 5.86 per cent, the highest level since 2001. Overnight sterling rates hit 6.16 per cent and overnight euro deposit rates jumped to 4.70 per cent, also the highest since 2001. Even overnight yen rates rose, up from 50 basis points to 61 basis points.”

Forward looking traders and investors contemplate the effects on brokerage house earnings:

Buyout loan exposure
Investment banks are stuck with more than $200bn (€145.4bn) in high-yield debt in the pipeline amid the recent credit squeeze, an analysis conducted by UBS analyst Glenn Schorr showed.
Goldman Sachs tops his list, both in absolute and relative terms, with the investment bank committed to $71.5bn in leveraged loans. A majority of this is related to fund buyouts, at the end of the second quarter, representing about 8% of the firm’s total assets.
Merrill Lynch had an estimated $49bn in leveraged loan commitments, or 5% of its assets. Lehman Brothers was committed to $43.9bn in leveraged loans, representing 7% of its assets. Rounding out the list was Morgan Stanley, with $34.8bn in commitments, or 3% of assets, and Bear Stearns with $19.6bn, i.e. 5% of its assets.
Schorr estimated that the banks involved could take a 10% hit on these loans, although he expects the actual haircut to be much smaller. At the high end, such a loss would equate to about 25% of earnings for this year, he calculated.

Quant funds are under siege, as if the computers programmed themselves or something:

Blind to Trend, ‘Quant’ Funds Pay Heavy Price
Computers don’t always work.
That was the lesson so far this month for many so-called quant hedge funds, whose trading is dictated by complex computer programs.
The markets’ volatility of the past few weeks has taken a toll on many widely known funds for sophisticated investors, notably a once-highflying hedge fund at Wall Street’s Goldman Sachs Group Inc.
Global Alpha, Goldman’s widely known internal hedge fund, is now down about 16% for the year after a choppy July, when its performance fell about 8%, according to people briefed on the matter.

Eric Falkenstein analyzed the reasons behind statistical arbitrage strategies getting crushed, as Financial News US reports the details:

Losses mount as hedged bets go wrong
Data from Hedge Fund Research shows equity market neutral funds lost 1.15% on Monday and were down another 0.57% on Tuesday, which makes it the worst performing strategy this week.
Monday was the worst day for these funds since Hedge Fund Research started collecting data in March 2003 but market sources said losses yesterday were even greater. Several funds are understood to have month to date losses of more than 15%.
The biggest losses are understood to come from statistical arbitrage funds, which typically trade pairs of stocks, where a long position offsets another short. They try to exploit short-term pricing inefficiencies in markets and make thousands of trades a day.

Lost in the heat of the moment is some reflection of how it all came about in the first place. Personally, I think the global asset bubble has its roots in the simultaneous bursting of the Japanese equity and real estate bubble back in 1990.
Rather than let their banks fail, Japanese policitians and the BOJ simply lowered rates to zero in hopes that the bad loans would work themselves out over time. This resulted in a stagnant Japanese economy and 17 years where investors and housewives borrowed cheaply in yen and reinvested in anything around the globe.
Further reading:

The lesson for the American central bank? Provide liquidity: yes. Bailouts: no.