Updated: Tick, Tock. Tick, Tock.
The CME, it appears has taken a page right out of the European playbook, and less than a week after an exchange-cum-Primary Dealer collapsed due to excessive risk taking, the CME has followed up its vague press release from yesterday by inviting even more risk in lowering the initial margin. Why is this a cause for even greater concern? As the CME itself says, “Initial margins are set to provide an additional buffer against future losses in the account” – so going forward that buffer has been reduced by about 30%. But what is the reasoning provided by CME: “The intent and effect of these changes is to decrease the size of any margin calls resulting from the bulk transfer of MF Global customers to new clearing members, not to increase them.” So basically the CME is implicitly putting all of its existing and current clients and customers at further risk by onboarding the accounts of those clients who, like lemmings, held on to their MF Global accounts until after it was too late. Because while the lower Initial margin may apply to MF accounts, it will also apply to any Tom, Dick and Harry beginning Monday, who will suddenly see a 30% reduced gating threshold to put on a position. Any position, no matter how risky.
Naturally, if enough people suddenly jump to put on risk, and the market flips and all new positions end up underwater, who will bail out CME accounts if, like MF, there is just not enough capital on the balance sheet? MF Global?
That the CME has opted for this highly disturbing path is very troubling, and just as in Europe, where three months after the financial short selling ban, financials are trading lower than they have ever been, so the unintended consequences from this action will result in even greater stress to the system, as not a single local will leave any excess money in their account, and likely will force all specs to trade within a hair’s width at the end of the day to cover just maintenance margin, due to fears of what may happen at the CME itself, now that is has implicitly onboarded moral hazard from the otherwise insolvent MF Global accounts.
It also means the systemic liquidity is about to drop to even lower and more depressed levels.
And completing the symmetry with the recent action out of Europe, we learn that said Initial Margin reduction is a “short-term accomation” which will apply until further notice. As an indication, Europe has extended its short selling ban several times and likely will keep it until the bitter end.We expect nothing less from the CME.
The most important news announcement of the day was not anything to came out of Cannes (as nothing did), nor from Greece (the merry go round farce there continues unabated). No, it was a brief paragraph distributed by the CME long after everyone had gone home, and was already on their 3rd drink. It is critical, because not only is this announcement a direct consequence of what happened with MF Global several days ago, but because also it confirms one of our biggest concerns: systemic liquidity is non-existanet. But what is very disturbing is that this is just as true at the exchange level, where it appears the aftermath of the MF collapse is just now being felt. What exactly was the announcement. Unless we are completely reading it incorrectly, it is nothing short of a margin call for tens if not hundreds of billions worth of product. Because as of close of business on November 4, today, the CME just made the maintenance margin, traditionally about 26% lower than the initial margin for specs, equal. For everything. Which means that by close of business Monday, millions of options and futures holders will be forced to deposit billions in additional capital to the CME just so they are not found to be margin deficient, and thus receive a margin call. Naturally, since it is very unlikely that this incremental amount of liquidity can be easily procured in one business day, we anticipate the issuance of hundreds of thousands of margin calls Monday, followed by forced liquidations of margin accounts across America… and the world. Just like when Lehman blew up, it took 5 days for Money Markets to break. Is this unprecedented elimination in the distinction between initial and maintenance margin the post-MF equivalent of the first domino to fall this time around?
Simply put – a lot of data released in the last two weeks shows that market liquidity is drying up. After MF Global blew-up on 40 to 1 leverage, brokerage houses are getting antsy about all levered bets. CME is now requiring all levered (options and futures) players to shell out 100% margin by close of business on Monday, November 7.
It almost feels like CME just announced a date for market crash (may be a mini-crash), doesn’t it?
Tick. Tock. Tick. Tock. So, this is how napalm smells on a Friday night? Well, that could be a ticking time-bomb set to go off on Monday (Nov 7) or Tuesday (Nov 8) of next week.
The other possibility is that it is the sound of a broken clock (that would be me) makes. Wait a minute, broken clock is right twice daily, right?