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01 July 2015

Do We Heed Alarm Bells?



Last week, I wrote (in the ‘Metal Bulletin’) that I am always rather nervous of traders who tell that they have discovered a new - and obviously better - way of conducting business. My theme there was about credit, and whether or not there is a particular cultural aspect to it that gives some players an advantage. Anyway, I referred to Kaines Corporation (mid 1980s trading house, for those not familiar with the name) in the context of trying to do things ‘differently’. I was quite correctly taken to task by a former trader from that company who pointed out that in that case, the problem was not entirely due to the belief that they were somehow able to be ‘different’, but also to the fact that the management did in fact not really understand how the business was operating.

Hearing Alarm Bells

That reminded me of something else, about the way there are things we hear which should set alarm bells ringing, but which frequently, in the enthusiasm of the business, we sometimes let slip by without reacting promptly. Now, in this case, a couple of years after the final demise of Kaines, I met someone who had been one of the accounting controllers at the company. He had an interesting story; he had, he claimed, become concerned about the LME option position and had gone to discuss it with his superior. He pointed out that the company was selling - in volume - both put and call options. On the surface, nothing wrong with that, of course - as long as the overall strategy made sense and the risk controls were in place. However, my point is that the reply he got from his boss should have triggered something; he was told, “Well, don’t worry, if they’re selling puts and calls, those will hedge each other, so it will be OK.”  Mmmm. I don’t think so. But the fact is that, despite knowing that that was not so, he accepted it; the signal hadn’t triggered the alarm. Later, of course it did…….but too late.

And here’s another one, where I was the gullible party. A few years later, in the mid-1990s, I and one of my colleagues had dinner with someone who was at the time one of our biggest clients. He ran the hedge book of a large aluminium group, and had a substantial credit line with us. At the time, aluminium was pretty volatile and we were talking to him about the way we saw the market developing. “Well,” he said, “I’m in a different position to most. It doesn’t matter to me if the market goes up or down; I make a profit both ways.” When we pressed him to explain, he told us that he had two books, one for alumina (his intake) and one for metal (his outgo). So, if the price went up it suited one, and if the price went down, it suited the other. Effectively, he was simply speculating, taking profits against market moves and hoping losses would ultimately be avoided. In a market that moved up and down, well, it was not a particularly good hedge strategy (in fact, it wasn’t really a hedge strategy at all); but with a sustained move in either direction which was not pretty soon reversed, it was a recipe for potentially really serious problems. Although my colleague and I did comment to each other that it wasn’t a normal style of hedging, frankly, at the time, the alarm bells didn’t ring. We didn’t go straight in to the credit department and say we were concerned about how the position might develop. Then the sustained move did happen, and the whole thing blew up. 

Again, the first time I met a particular Japanese trader, one whose fame (?) ultimately spread way beyond the base metals business, he carefully explained to me that he was different from all the others I would meet in Tokyo, because his employers could not move him from his job. Why? “Because I am the only one who understands the position.” That should have set off klaxons as well as bells, at the very least. In fact, in this case, it wasn’t my decision, in the end, because he didn’t want to trade with us anyway. But if he had, I suspect I would have gone along with it.

Reacting?

So why don’t we listen harder to the alarm bells? I guess it’s a combination of two major factors. One, when these things tend to be said while things are going well and we gloss over them, because everything is hunky-dory and we’re making money; why spoil a good thing? And the other reason, I think, is that the people who make these less than credible statements are very often big figures in the business; perhaps we are slightly awed by reputations and not prepared enough to be sceptical.

But Don't Ignore This One

Anyway, those examples are all in the past; here’s one we really should be heeding, right now. This is a quote from an article in the ‘Times’ of 29th June, in an piece discussing Greece and the Euro and the Eurocrat attitude towards Tsipras’ announcement of a referendum. 

“Minister after minister attacked the idea of holding a referendum, questioning the ‘capacity of the common people’ in Greece to understand ‘complex’ proposals ‘The deal on the table is so technical to explain that a normal citizen, not people like us, would find it hard to form a view,’ one EU official said.”

Really? It's 'them' and 'us' now, is it? Where 'we' instruct and dictate, and 'they' follow and obey? Well, I’m clearly one of the ‘normal citizens’, not ‘people like us’, and actually, I think I understand far better than that unnamed official; trying to shoehorn all those disparate nations, with their own economic drivers, into a single currency, to satisfy certain egos, was never going to work. That official's statement should be making a cacophony of warning sounds, if it’s not already too late. Whether Greece stays or goes, the unsustainability of the Euro is surely now plain enough for even its greatest admirers to understand (and yes, I include Richard Branson) and the game will inevitably move on to Spain, Portugal, Italy and (dare to whisper it) France …. This is an alarm bell not to ignore.

(As I have said before on this issue, criticism of the Euro should not necessarily be interpreted as implying the same view towards the EU itself.)


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