At around 1715 GMT on Friday (11 October 2008), while I was caught-up in the 'Miss World 2008 Pageant euphoria', I learned of a very unsettling event: the unearthing of Bernard Madoff's (a former Nasdaq CEO) Ponzi scheme which cost the world's elite private and institutional investors an estimated US$50 billion.
As I absorbed the news feed, I recalled an insight I gained from Gerding (2006): The bursting of asset price bubbles always coincides with the discovery of scandals and irregular practices in financial markets. Evidently, Madoff's fraud validates Gerding's assertion, and subtly points towards more impending doom and gloom.
Among the 'known' institutional casualties are: a leading Spanish bank called Santander; Bramdean Alternatives - a UK-based asset management company with 10% of its NAV invested with Mr. Madoff; Fairfield Greenwich Group - a hedge-fund that invested $7.5bn of its clients' money with Madoff's firm; French bank BNP Paribas; Japan's Nomura Holdings; and; Zurich's Neue Privat Bank.
...Potential Impact
Firstly, financial service counters, across all major bourses, are going to fall precipitously in value during the coming week; because this development will intensify the crisis of confidence that the global financial system is already facing. This will in turn fuel a selling and short-selling spree of financial services counters across all major bourses. Therefore, with some financial counters already trading at anorexic prices; it is reasonable to say that some financial services firms face a great risk of being sold and short-sold to death, over the coming week.
Market volatility is already high and such a shock, when the market is highly sensitive to perturbations - like it currently is, will definitely put a lot of ailing financial services firms in a comatose state which they may never come-out of. Hence, this would undermine all efforts by governments (in most of the developed world) to bolster confidence in the financial services sector by injecting liquidity. Therefore, regulatory bodies and governments need to act decisively to avert from precipitating, an acute second-wave of the market tsunami we've been enduring since August of 2007.
I think it would be prudent for governments to dig deep into their bags of tricks, and prepare to implement tools they have used previously to mitigate the effects of similar crises. To state it more clearly, I'm advocating for the re-introduction of short-selling bans (of financial services counters) until the full-extent of the crisis is understood clearly, as I believe that the fraud is much greater than the stated USD50 billion.
If the bans are not implemented forthwith, the financial services sector will crumble (from being 'short-sold to death'), setting into motion a domino-effect of subsequent events, that will plunge the global economy into a deep recession; one that would prevail for a very, very long time.
Secondly, this development will inspire cannibalistic trading strategies, that will accelerate the downfall of the victims of this Ponzi scheme; particularly the hedge-funds (e.g. Fairfield Greenwich Group and Bramdean Alternatives) that fell prey to what is now popularly known as Madoff Magic.
...What do I mean by this?
Other hedge funds will short-sell the portfolio holdings of funds and 'strategies' affected by this crisis. They'll do this because they'll understandably believe that this crisis would trigger a series of redemption requests in the affected funds; which would then trigger forced liquidation of their holdings to meet the requirements of the redemption requests. This would in turn depress prices of some of the securities in the portfolio of the 'victim-funds'; as forced liquidation of a large chunk of securities, within an environment characterized by high market volatility, generally has a security price-reducing effect. To summarise what I've stated, 'other-hedge-funds' will short-sell the holdings of the 'victim-funds', anticipating to capture easy profits that will subsequently flow from the price reduction caused by the 'forced-liquidation-to-meet-redemption-requests phenomena'.
The net effect of all this market activity (on the broader financial markets), is largely dependent on the extent of overlap between the portfolios of 'other market players' and those of the 'victim-funds'. Where the effect of the crisis on the global financial system, is positively correlated to the degree of overlap between the portfolios of the 'victim funds' and those of 'other players' in the broader financial markets. This means that a high portfolio overlap between 'other market players' and 'victim funds', would translate into cascading of the negative effects of the fraud across the entire global financial system.
Therefore, we could be seeing in the near future a more dramatic replay of: bank collapses; the development of multiple layers of correlation among 'disparate' securities; a credit crisis; the drying-up of liquidity in most security markets and; the widening of spreads. In short the worst may be on its way.
Be prepared because it may be a bumpy ride!
As I absorbed the news feed, I recalled an insight I gained from Gerding (2006): The bursting of asset price bubbles always coincides with the discovery of scandals and irregular practices in financial markets. Evidently, Madoff's fraud validates Gerding's assertion, and subtly points towards more impending doom and gloom.
*****************
Among the 'known' institutional casualties are: a leading Spanish bank called Santander; Bramdean Alternatives - a UK-based asset management company with 10% of its NAV invested with Mr. Madoff; Fairfield Greenwich Group - a hedge-fund that invested $7.5bn of its clients' money with Madoff's firm; French bank BNP Paribas; Japan's Nomura Holdings; and; Zurich's Neue Privat Bank.
...Potential Impact
Firstly, financial service counters, across all major bourses, are going to fall precipitously in value during the coming week; because this development will intensify the crisis of confidence that the global financial system is already facing. This will in turn fuel a selling and short-selling spree of financial services counters across all major bourses. Therefore, with some financial counters already trading at anorexic prices; it is reasonable to say that some financial services firms face a great risk of being sold and short-sold to death, over the coming week.
Market volatility is already high and such a shock, when the market is highly sensitive to perturbations - like it currently is, will definitely put a lot of ailing financial services firms in a comatose state which they may never come-out of. Hence, this would undermine all efforts by governments (in most of the developed world) to bolster confidence in the financial services sector by injecting liquidity. Therefore, regulatory bodies and governments need to act decisively to avert from precipitating, an acute second-wave of the market tsunami we've been enduring since August of 2007.
I think it would be prudent for governments to dig deep into their bags of tricks, and prepare to implement tools they have used previously to mitigate the effects of similar crises. To state it more clearly, I'm advocating for the re-introduction of short-selling bans (of financial services counters) until the full-extent of the crisis is understood clearly, as I believe that the fraud is much greater than the stated USD50 billion.
If the bans are not implemented forthwith, the financial services sector will crumble (from being 'short-sold to death'), setting into motion a domino-effect of subsequent events, that will plunge the global economy into a deep recession; one that would prevail for a very, very long time.
Secondly, this development will inspire cannibalistic trading strategies, that will accelerate the downfall of the victims of this Ponzi scheme; particularly the hedge-funds (e.g. Fairfield Greenwich Group and Bramdean Alternatives) that fell prey to what is now popularly known as Madoff Magic.
...What do I mean by this?
Other hedge funds will short-sell the portfolio holdings of funds and 'strategies' affected by this crisis. They'll do this because they'll understandably believe that this crisis would trigger a series of redemption requests in the affected funds; which would then trigger forced liquidation of their holdings to meet the requirements of the redemption requests. This would in turn depress prices of some of the securities in the portfolio of the 'victim-funds'; as forced liquidation of a large chunk of securities, within an environment characterized by high market volatility, generally has a security price-reducing effect. To summarise what I've stated, 'other-hedge-funds' will short-sell the holdings of the 'victim-funds', anticipating to capture easy profits that will subsequently flow from the price reduction caused by the 'forced-liquidation-to-meet-redemption-requests phenomena'.
The net effect of all this market activity (on the broader financial markets), is largely dependent on the extent of overlap between the portfolios of 'other market players' and those of the 'victim-funds'. Where the effect of the crisis on the global financial system, is positively correlated to the degree of overlap between the portfolios of the 'victim funds' and those of 'other players' in the broader financial markets. This means that a high portfolio overlap between 'other market players' and 'victim funds', would translate into cascading of the negative effects of the fraud across the entire global financial system.
Therefore, we could be seeing in the near future a more dramatic replay of: bank collapses; the development of multiple layers of correlation among 'disparate' securities; a credit crisis; the drying-up of liquidity in most security markets and; the widening of spreads. In short the worst may be on its way.
Be prepared because it may be a bumpy ride!
