Tuesday, January 1, 2013

Big Hedge Fund Whacked – And Warm Feelings


One of the biggest leveraged hedge funds in the world got hit with a 2×4 during the 4th Q. This fund has a mixed bag of assets, but was heavily exposed to big FX positions.


The fund made a big “bet” recently when they went short EURYEN. This turned sour in a very big way; the EURYEN moved an incredible 14 big figures against them in just 60 trading days.

Street players, who know of this currency spec, refer to it as a “Size” position. At the end of Q3, it came to a lumpy short $40B. There were rumors that the fund added to the short during the Q (not confirmed yet). But even if the book was kept static, the mark-to-market loss comes to $5+B. That’s serious money to anyone.


Note: The short EURYEN book is looking terrible for this fund. The new Japanese Prime Minister is forcing a devaluation of the currency. The Japanese Central Bank is doing its best to achieve that devaluation. It’s possible that the fund will have to cover the short. If so, it could turn that “paper” loss into a cash loss.

I think the well-paid managers of the fund are kicking themselves in the ass over this speculation. They got creamed on this stinker, and this could be just the beginning of the losses.



Adding to the carnage was a monster sized bet short EURUSD. Last reported, this mega-position was $220B short! It’s possible that this number is now close to one-quarter trillion. It was a good Q for the EURUSD, and that means a bad Q for the fund. The 6+ big figure move up in the Euro versus the dollar translates into a paper loss of a staggering $11b!


All in, the losses from FX come to $16.5B. The fund has reserves of about $50b, so the quarterly swing is not a crisis, but it’s an eye-opener. 30+% of those reserves went out the window in one Q. Wow!


The fund in question has a strong capital base and loyal investors. But the management will have to explain to those investors how it managed to lose such a large percentage of its “cushion” in such a short period of time. Those investors will, no doubt, ask the very pertinent question: “Why is the fund making such big FX bets?”


Management is also going to have to address the issue of leverage – this fund is now running at 10 to 1. The high level of leverage, and the mega billions involved (much of which is tied up in derivatives), makes this fund a high risk/return player. Investors will have to ask themselves, “Do we still want to be on this roller coaster?”



So who is it that is running such a big FX book? And who are the investors that are on such a wild ride?


That would be the Swiss National Bank.  The “investors” are the Swiss people.




I know, I know. Central Banks aren’t hedge funds, and they can’t take losses because they can always print more money. I respond to this by saying that the SNB is acting very much like a leveraged hedge fund. It’s making currency “bets” with the people’s money. It’s taking some very big risks. In an attempt to diversify one risk, they are just adding different risks, and that effort is backfiring.


Like the US Fed, the SNB sends its annual profits back to the people (Treasury in USA, Cantons in Switzerland). The book losses at the SNB will reduce the amount of the payouts to the Cantons, so the losses will be felt.


Switzerland is a small country with a GDP of about $600B. If the FX losses at the SNB were applied to the US economy, it would translate into a half-trillion dollar loss.  That would be a very big deal indeed. The FX losses since September come to $2,000 for each and every Swiss citizen. The word “Shellacking” comes to mind.



I bring up this story to make a point. (Don’t worry about the SNB) What happened at the SNB is because the SNB absorbed risk from the Swiss economy (the currency peg). As the SNB absorbs risk, it will, by definition, have to take losses from time to time.


The SNB has absorbed currency risk; other central banks have taken credit, liquidity and duration risk out of their respective markets. In the aggregate, the risk transfers have been massive. That’s why the global capital markets are so “calm”.



To me, the private sector looks “okay” for the time being. It’s the Public Sector that has the potential to produce a black swan over the next year or so. I conclude that the “confidence” factor is going to be an issue. The questions hanging in the air include, “Are all these governments really money-good?” “Are the key governments and their leaders able to maintain confidence in this fragile system?” “Are ‘they’ going to do the ‘right’ things?”


The world’s largest economy has just set itself up for a crisis in 60 days. China Inc. is sitting on a gazillion of dodgy loans. Japan Inc. is in hock up to its eyeballs (and is in the process of slow motion devaluation). The EU will, this year, be forced to make good on its promise of “Unlimited” printing. Where’s the confidence in that pile?


This confidence “thing” is hard to anticipate. It comes and goes quickly. The year is starting out with a fairly high level of “warm feelings”. I’m not at all convinced that those feelings are justified.  The list of things that could trip up the Public Sectors, and their deciders, is too long.






  1. A 30% loss of reserves in one quarter is merely an eye opener, not a crisis? WOW. I appreciate that much of those losses came from artificially dampening FX risk for Swiss companies, but even so. Forcing the CHF down (pegging it to a failing Euro) isn’t dampening volatility, its a real loss — a very real transfer from Swiss savings accounts to prop up insolvent “Club Med” governments (and France too).

    I would love to hear your thoughts on the “confidence” angle — not for Switzerland, but for the G7 generally. Seems to me it is a lot like figuring out the “in” thing for teenagers … I have no idea what the latest hula-hoop / Twitter thing is, and less idea why. But I can almost guarantee that whatever is “that’s hot” at the moment will be “so yesterday” by this summer.

    The regime in Washington DC is simply not economically feasible over a 10-15 year horizon (ie well within the investment horizon of a new manufacturing plant or the duration of equities). It is no longer a political discussion of what priorities should be — it is obvious (to anyone who can do addition / subtraction) that Washington has promised way more than they are able to deliver. Even if we assume a good amount of tax increases and the end of Afghanistan / Iraq wars — the numbers do not work.

    Raising taxes high enough to fund current spending will crush the economy (even if Obama “wins” all his new taxes against the rich, it won’t be enough). Crushing taxes on the middle class would be needed to keep current spending plans going (and forget about all the new spending these morons are talking about).

    Japan has been doing this Keynesian stimulus spending + quantitative easing stupidity for more than 20 years … and they have nothing to show for it but debt and loss of global standing. There is absolutely no sane reason to think that PM Abe doing the same dumb things won’t produce more of the same outcome.

    No one would consider Europe a first world economy if not for historical bias (I think behavioral economists call it “anchoring”?). If printing currency solved anything, Italy and Greece would be EU powerhouses instead of Germany and Netherlands. Draghi’s plan to print Italian Lira is going to produce the same results it did before the Euro.

    I don’t know when Wall Street / Canary Wharf will “suddenly” realize that hula hoops and endless deficit spending is so yesterday. Maybe they wake up tomorrow, maybe next month, maybe next year.

    It seems eerily like 2007 housing market in many ways … lots of magazine articles about unsustainable deficit spending, declining “Joe Average” income colliding with increasing taxes. Central planners orchestrating shotgun weddings of JPM/Bear Stearns and coerced FASB rule changes … central planners doing shotgun weddings of German / Italian / Greek sovereign bonds, and GASB rule changes to make public pensions “plausible” for another year. At some point soon, there won’t be another sucker agency/member country to force into shotgun wedding/bailout. The constant accounting rule changes will cross the line from plausible yet highly unlikely, to “we can’t sell that even to the party faithful”.

    We all know that Bear Stearns was a “one time event”, the subprime contagion is well contained, the Greek debt situation is solved, the Irish/Portugal/Spain/Italy/France situation is solved, the EFSF/ESM/xyz-pdq is the final solution, Lehman Bros is another “one time event” but don’t be surprised if Merril Lynch happens next week. And no matter what you may have heard, the Treasury Secretary did not blackmail BankAmerica into bailing out Merrill. Countrywide was another “one time event” and so was IndyMac. It may look like TARP made a profit by shifting all the losses to FNMA/FHLMC — but that is just because you are using an old version of TurboTax. The Frank-Dodd Act ordered FASB to issue a ruling that up is down, plus is minus, and FHA issuing 95% LTV refis to underwater borrowers is nothing to be concerned about. This is a government that hasn’t run balanced *spending* (not a balanced budget — balanced *spending*) in over 50 years; faced with unpayable promises, Obama wants to spend even more.

    Day trading is what it is, but there is no way to invest pensions or business capital spending (or anything with a medium term horizon) in a country where the government is officially planning on spending itself bankrupt.

    All I know is: when (not if) the little child yells out that the emperor no clothes, the fire doors are way too narrow for most of the audience to exit

  2. Small.Business.Guy.1 says:

    “The questions hanging in the air include:

    1) “Are all these governments really money-good?”
    2) “Are the key governments and their leaders able to maintain confidence in this fragile system?”
    3) “Are ‘they’ going to do the ‘right’ things?””

    Wouldn’t this be a more immediate problem if applied to some of the larger State governments here in the US? We’ve got at least 2 state governments (CA and IL) which certainly qualify, and both NY and NJ took a hard body shot from Sandy (and want say, $80 bil from the Feds – good luck with that).

    And maybe (just MAYBE) we’ll get a 60 day ‘pass’ on all of those issues before the debt ceiling brawl goes forward. Maybe the real ‘fiscal cliff’ we should have been worried about was more likely to happen at a state level.

    I think we’ll get a better handle over the next week seeing if there is any ‘celebrating’ going on, or anybody claiming ‘victory’. If there’s none of that nonsense, then I’m at least somewhat (very limited) hopeful. But if the WH tries to take a ‘victory lap’, then they have forgotten an old political adage: “When you lose, say little. When you win, say less”.

    Taking a victory lap at this point is just rubbing people’s faces in ashes and laughing at them. Hard to forget, and harder to put aside the next time the same people come around looking for cooperation on other issues.

  3. Dave from California says:

    Forgive my ignorance but didn’t the SNB buy Euros to maintain the peg? If Euros went up, wouldn’t it have made money?

    Or did it diversify out, by then selling those Euros and buying dollars/Yen. And thus losing money on that diversifying trade?

    If so, wouldn’t the amount they made on the Euros they had left cover their losses on the dollars/Yen leg? They couldn’t have sold all their Euros could they?

    • They bought Euros to defend the peg, then diversified out of Euros into dollars and Yen.

      I make fun of the SNB in this piece, but I also try to make the broader point that CBs are taking all sorts of risks. The SNB just happened to have a bad Q in FX, so it was the “excuse” to write this article.

      I’m an equal opportunity “basher”. Today it is the SNB, two days it was Paul Krugman.

      The PK piece got a number of folks riled up. I got a note from someone at the FT:


      I had to look that up…………

      • “sardonic”.

        I had to look that up…………

        Now, that’s funny! :)
        Bruce, don’t worry about the FT. They’re just jealous that you can make money and write better than them.

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