Monday, December 11, 2006

Digging through the rubble at Amaranth

Via Brad DeLong, this detailed Bloomberg article on the demise of Amaranth. One intriguing part of the story, discussed before at DealBreaker, is that their prime broker JP Morgan put the squeeze on them, took over their positions, and sold at a big profit:

It must be nice to be a JPMorgan prime brokerage client. First they squeeze you on the margin call, then scoop up your assets and make $750 million by selling them. Wonder how Amaranth founder Nick Maounis feels about JPMorgan these days.

The Bloomberg piece reports that, when it came time to meet margin calls

Amaranth's paper profits in natural gas were significant, yet it couldn't realize all of the gains selling. Traders and hedge funds knew Amaranth was desperate to get out of its trades, so they wouldn't pay current prices....

Brad seems to think the journalists are in error here. Perhaps it is shocking to an academic that markets aren't perfectly liquid ;-) The comment below clears things up.

[DeLong] ''I have to confess to some puzzlement over the statement that Amaranth "was desperate to get out of its trades" but couldn't because its counterparties "wouldn't pay current prices." The current price--the price at which you should mark to market--is the price at which you can sell, not a price at which you cannot sell.''

Untrue. And one of Amaranth's biggest problems was that this is not so... The "last trade" price is not necessarily the "market-clearing price for my whole stake" price. Indeed there are often discounts for block trades -- that is, for liquidity -- even for things with a heck of a lot more underlying value than some out-years natural gas futures contracts.

7 comments:

wolfgang said...

Steve,

you seem fascinated by the world of quants and hedge funds.
Some of those guys write their own blog.

steve said...

Wolfgang,

Thanks for the link to Derman's blog.

I'm fascinated by the quant/finance world because I almost went there myself, and most of my peers from grad school or postdoc days are there now. (Also, most of my former PhD students.)

Moreover, finance has its own intellectual appeal - lots of interesting stuff happening, and lots of data :-)

I recall sitting in on Merton's class at HBS when I was a postdoc, and then reading (superficial) coverage of LTCM in the press (also, some people I knew went there to work), then it blew up. Why? Only a small number of people really understand what happened.

Amaranth is also a big collapse, but caused barely a perturbation in the global financial system.

Steve

Anonymous said...

Derman's book is pretty good too. It has the best description I've seen of life as a theoretical physics grad student/postdoc.

steve said...

I think I reviewed Derman's book here some time ago...

Here it is:
http://infoproc.blogspot.com/2004/12/life-as-quant.html

Joe Rotger said...

It's the same LTCM story all over again... Awhile back, this is what I ventured at contango http://thefountainhead.typepad.com/contango/2006/09/they_had_to_tak.html

"However, what really fascinates me of this story, is what may be going on right now at Amaranth: the actual takeover by the creditors; and how the traders from these banks eagerly learned and played LTCM's positions to extreme pain to extract the final 100's of millions of USD out of this knowledge alone--trading is unforgiving..."

BTW, LTCM profited from trading huge amounts in very tiny arbitrage situations --everybody and their mother were willing to lend them money --they had the prestige...

James said...

As Steve said: Amaranth is also a big collapse, but caused barely a perturbation in the global financial system.

This important piece is why this story is actually quite different from the LTCM story.

Joe Rotger said...

As I recall, for the LTCM ordeal the Fed intervened only in their capacity to muscle the banks into... making a bundle.
I guess it was easy to guess what the banks would be eager to do... a second time around.

Blog Archive

Labels