How do you lose US$5 billion in one week?

lesm · 24 September 2006

For those who thought they may have lost some money...there are others who have lost more.

http://articles.moneycentral.msn.co...ionDollars.aspx

Amaranth Advisors has violated a cardinal rule of investing: Never make a trade that could put you out of business.

The Greenwich, Conn.-based hedge fund was scrambling today to sell holdings after a wrong-way wager on natural gas cost it roughly half of its $9.5 billion portfolio.

Amaranth's brokers -- including Goldman Sachs and other big financial firms -– stepped in to help the hedge fund raise cash by liquidating some of its assets.

Amaranth made about $1 billion last year, when energy prices were going up. But its energy desk failed to predict the extent of the recent downturn in natural gas prices, the fund told investors in a letter that went out on Monday.

The trade that led to the huge loss was attributed to 32-year-old Brian Hunter, an experienced energy trader who headed Amaranth's energy desk for the past five months. His trades brought in $800 million for the firm last year, and Hunter pocketed at least $75 million in compensation, according to Trader Monthly magazine.

Hunter's downturn was as sudden as it was shocking. He was up about $2 billion as recently as the end of August, The Wall Street Journal reports. Then Hunter's trades lost $5 billion in about a week.

andy · 24 September 2006

yeah i read about that. Apparently the guy who was responsible for losing the money has lost alot of money before.

lesm · 24 September 2006

andy said:
yeah i read about that. Apparently the guy who was responsible for losing the money has lost alot of money before.

Yes, he had a blowup when he worked for Deutsche Bank and the Amaranth guys new about it before they hired him.

scsl · 24 September 2006

lesm said:
Yes, he had a blowup when he worked for Deutsche Bank and the Amaranth guys new about it before they hired him.

But at Amaranth, he made hundreds of millions on natural gas bets. His bosses were very impressed and made him head of energy trading. However, their ultimate mistake was letting him use more than half of the funds' capital despite Amaranth claiming to be a "multi-strategy" hedge fund.

As harsh as it is, a hedge fund that lacks the risk management capabilities had disaster coming their way. Management, and not Hunter, should be imprisoned to prevent this from occuring again.

... this reminds me of Nick Leeson and how he singlehandedly broke Barings Bank.

bowser · 24 September 2006

Sounds more like gambling...

Realist · 24 September 2006

Everyone's a hero in a bullmarket.

People that get stung early on in their investing or trading careers learn the hard way.

Success breeds confidence that leads to failure.

Obvious this guy and this team had what was coming to them.

Sultan of Swing · 24 September 2006

I bet Hunter still gets to keep the $75 million he pocketed himself last year.

Smurf1976 · 24 September 2006

Sounds awfully like LTCM Mk 2 to me. A situation that many bears have long warned about.

happytrader · 24 September 2006

Hmm that loss is almost on a par with Nick Leeson's. You would think that they would have risk management teams whose sole purpose is to manage position size and respond to stop losses. This relying on one persons ability, reputation and integrity is ridiculous especially since he would have been trying to maintain his status. When stress levels get too high logic goes out the window.

I see Nick has a website now.

Cheers
Happytrader

Magdoran · 24 September 2006

lesm said:
For those who thought they may have lost some money...there are others who have lost more.

http://articles.moneycentral.msn.co...ionDollars.aspx

Hello Les,

Great article, thanks for posting it.

This is quite a disturbing story that I have been following. It is reminiscent of Enron and Worldcom, in that the derivatives that were being used had upside while the trading positions were right, but had significant downside if they weren’t managed if the market reversed.

To lose this amount of money requires an extraordinary dereliction of risk management by running with such heavily exposed positions with a blatant disregard for risk to reward parameters.

There really is no excuse for this kind of recklessness. But time and time again, large organisations have fallen lead by an insatiable greed. The pattern is echoed through a range of similar failures.

For a few years significant profits are made outperforming the market by some organisations, and then suddenly they are broke. This usually stems from a misuse of derivatives based on a belief that a long term trend will continue, with no contingency planning for strong adverse moves.

In bull markets, corrections can be very sharp and deep, so running without hedging or management strategies near possible tops amazes me.

Regards

Magdoran

TjamesX · 24 September 2006

Amaranth Advisors has violated a cardinal rule of investing: Never make a trade that could put you out of business.

The Greenwich, Conn.-based hedge fund was scrambling today to sell holdings after a wrong-way wager on natural gas cost it roughly half of its $9.5 billion portfolio.

Amaranth's brokers -- including Goldman Sachs and other big financial firms -– stepped in to help the hedge fund raise cash by liquidating some of its assets.

Amaranth made about $1 billion last year, when energy prices were going up. But its energy desk failed to predict the extent of the recent downturn in natural gas prices, the fund told investors in a letter that went out on Monday.

The trade that led to the huge loss was attributed to 32-year-old Brian Hunter, an experienced energy trader who headed Amaranth's energy desk for the past five months. His trades brought in $800 million for the firm last year, and Hunter pocketed at least $75 million in compensation, according to Trader Monthly magazine.

Hunter's downturn was as sudden as it was shocking. He was up about $2 billion as recently as the end of August, The Wall Street Journal reports. Then Hunter's trades lost $5 billion in about a week

I like the wording 'bought in 800 million last year'....... did he make it or was it luck. With the amount these guys trade with, statistics would probably show it would not be unusual to be up a large amount over a short period.

Extrapolate the performance a year further and the net position is down 4 bill..... and he got a 75 mill in compensation.

There's nothing like money to motivate - and to me it looks like a fair amount of the blame can be laid in how compensation is paid to these guys. Did he feel any real pain in losing 5 bill - I would say apart from a bruised ego, the fact he got 75 mill the year before means he doesn't really need to find another job, and so wouldn't really care a great deal.

How would you trade if you were given 100 mill of other peoples money to trade with in the market, and any return above 20% you keep.... I would say your aversion to risk dramatically changes when its not your money - you feel the upside but not the downside

Seems like this guy was trading to his personal risk/reward profile and not the companies....

TJ

lesm · 24 September 2006

Here is another article that gives more background on Hunter.

http://www.moneyweb.co.za/shares/international_news/184580.htm

The Amaranth risk management team must have gone to sleep somewhere along the way.

Cheers.

Realist · 25 September 2006

TjamesX said:
How would you trade if you were given 100 mill of other peoples money to trade with in the market, and any return above 20% you keep....

I'll have a $100 Million on black please, umm I mean red. Woops too late..

Realist · 25 September 2006

Though unknown in public, he had created a buzz on Wall Street -- a wunderkind to some, a ticking bomb to others. From a cramped trading desk here, he thrived on big price swings, reaping billions of dollars on price declines and surges alike. But late last week, he watched with growing alarm as gas prices took a steep dive, particularly in futures contracts for delivery of gas for this coming winter. His losses mounted in after-hours trading last weekend.

Probably nicked off early on Friday avo off to his holiday home with some ladies, pops the champagne, parties hard and returns to work Monday morning, woops forgot to close that trade out, oww down $5B oh well not my money who cares?

WaySolid · 25 September 2006

To me it's a story about reward/punishment skew, too much leverage and too little regulation.

I have heard it said that our current fiat world currency system is an ongoing first time experiment, I can't think of any other precident in history. There is a lot of leverage and liquidity growth going on still and It's possible that any cascade meltdown will start with a run on the USD. More great wealth transfers on the way I suspect.

Magdoran · 25 September 2006

TjamesX said:
I like the wording 'bought in 800 million last year'....... did he make it or was it luck. With the amount these guys trade with, statistics would probably show it would not be unusual to be up a large amount over a short period.

Extrapolate the performance a year further and the net position is down 4 bill..... and he got a 75 mill in compensation.

There's nothing like money to motivate - and to me it looks like a fair amount of the blame can be laid in how compensation is paid to these guys. Did he feel any real pain in losing 5 bill - I would say apart from a bruised ego, the fact he got 75 mill the year before means he doesn't really need to find another job, and so wouldn't really care a great deal.

How would you trade if you were given 100 mill of other peoples money to trade with in the market, and any return above 20% you keep.... I would say your aversion to risk dramatically changes when its not your money - you feel the upside but not the downside

Seems like this guy was trading to his personal risk/reward profile and not the companies....

TJ

Fully agree TjamesX,

This is consistent with my growing suspicions that when such organisations are posting huge profits, that they are achieving this through great risk. The question then is how good are they at managing that risk.

If a hedge fund is playing a specific sector, and that sector has reached a level where it may have topped (or bottomed if short), and has posted large profits, I’d be pretty nervous about future performance.

That’s not to say there aren’t responsible managers in some organisations, but that there is an unknown risk involved with dealing with such funds if the investment regimen is not fully regulated. With the advent of so many new financial products over the last 20 years with such intricate complexities involved, it is almost impossible to unravel the labyrinth like structure to determine the real risks involved. I suspect that even the managers can’t make a realistic estimation of risk either.

Regards

Magdoran

Magdoran · 25 September 2006

WaySolid said:
To me it's a story about reward/punishment skew, too much leverage and too little regulation.

I have heard it said that our current fiat world currency system is an ongoing first time experiment, I can't think of any other precident in history. There is a lot of leverage and liquidity growth going on still and It's possible that any cascade meltdown will start with a run on the USD. More great wealth transfers on the way I suspect.

Fully agree with this perspective.

The explosion of a range of instruments like Collateralised Debt Obligations (CDOs) and similar complex derivative products has seen a sustained off the books gambling culture develop in the corporate world over the last 20 or so years, leading to collapses like Enron and Wordlcom to name a few.

It does seem to be one huge experiment, augmented by high speed data links and a major advance in IT capabilities (both software and hardware).

Fully agree, there is no precedent for these times. It is however not new in a market sense when you look back at the “south Sea Bubble in the early 1700s for significant collapses to occur, so there are some parallels. It is the complexity of financial instruments and the influence of technology that is unique.

Magdoran

karmatik · 25 September 2006

happytrader said:
I see Nick has a website now.

Cheers
Happytrader

Nick Leeson is now the financial man of a small soccer team in the west of Ireland, which happens to be my home town. Bet he didnt see that coming a few years back!

Pat

Pat

tech/a · 25 September 2006

How do you lose US$5 billion in one week?

Actually Im an expert in Small business.
I have start with Large Businesses and turn them into small ones.

StockyBailx · 10 October 2006

Wow reading this thread really helps me contemplate, the effects of losing. Deafinatly understand the risks of playing too big or being over confident. And most certianly to scared to hedge now. I think I will stay with what I know best, and most certianly be sure I have invested in a winner from all angles.

That Poor Bastard, must of thought he had more friends than he could pock a stick at. Read sum excellent comments in hear a long the way. Felling a little sorry for Mr Hunter, But I quess he'd been judging to many book covers. Must of taught him a lesson, running to new surrounding ammounst the footballers, were he can show off. With his head down **** up? good luck to the man I say. (greed isn't healthy)

How do you lose US$5 billion in one week?

lesm

andy

lesm

scsl

bowser

Realist

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Sultan of Swing

Smurf1976

happytrader

Magdoran

TjamesX

lesm

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WaySolid

Learner

Magdoran

Magdoran

karmatik

tech/a

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