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Posted by on Nov 4, 2011 in Markets, TG Roundup

Updated: Tick, Tock. Tick, Tock.

Update on Saturday, Nov 5: CME issued a clarification to its Friday’s release. Zero Hedge deciphers again:

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.

Zero Hedge just posted this comment on a late Friday circular from 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?

 

 

9 Comments

  1. Srinivas Garu
    Bloomberg has two responsibilities: As a mayor he needs to make sure the financial svcs employment tax base is intact and as a business owner make sure he generates profits to his shareholders while making sure his employees earn more and pays more in city taxes. Do you see the conflict. I think he is fulfilling both responsibilities but are they effective? It depends on your vantage point. BTW, when he started his data svc business there were no toxic products such as CDS/CMOs etc all of which germinated from the abusive nature of greedy who ironically used the data that his bloomberg terminals spit out every second supposedly to help good side of the financial services industry and provide transparency of global market,s financial transactions.

    On the broader point, the banks are saying ” don’t blame us for our immoralities because you -the govt promoted the notion of greed is good in the name of free markets with lapse regulation enforcement and stupid policies”. As Gloucon challenged Socrates in Plato’s Republic, why would someone adapt a virtue of morality when there is no cost to pay otherwise? we also learned through ages the morality can’t be legislated and hence unenforceable. Here goes in to toilet the famous Adam Smith (Wealth of Nations) “invisible hand of free markets” will take care of the immoral behaviors of the free market participants. My foot!

    • Well said!

    • Srinivas,

      Not only Barry, but also another guy wrote strong rebuttals to Bloomberg (here). However, the guy who first started this fight against Bloomberg’s ridiculous comments was Matt Taibbi. Here is the link to Taibbi’s article, which I posted on my Facebook wall. Taibbi doesn’t mince his words.

      I am in the middle of writing an article on this kind of rhetoric (“banks did nothing wrong”, “it’s all the fault of Fannie Feddie and Barney Frank”). I will post it sometime this week.

  2. ZH has no logic but effectively succeeded in BOOP (blowing out of proportion) the ill worded CME statement calling on margin requirements. Looks like CME clarified what they meant in today’s release. Any body who speaks margin language as a banker does knows instantly what it means when CME said they honor 1:1 maintenance margin regardless of initial margin. When a stupid from blogosphere gets panicked not really understanding what the CME statement means and rants and raves then it goes viral in similar monkey see monkey do blogs. I think ZH followed suit to it’s repetitional hazard. Also anytime a margin call is issued it must be on the basis of a market close reference and CME did a poor job in communicating it. Instead hot heads thought it is issued at 7pm after close forcing clients to fill perceived margins before the start of next trading day I.e. Sunday. How stupid they can be? Hope the CME clarifications today help calm hot heads. However my bigger point on market liquidity remains knowing that not all trades with MF global are equity related shorts but most of them are futures and over the counter and on multiple asset classes. Further a good 5 trading days elapsed since MF blew up the damage may be limited. Again who knows?

  3. Yes your data suggests what you fear. I am not cruel to spoil your weekend to read the following paper in support of your thesis.
    http://scholar.princeton.edu/markus/files/liquidity.pdf
    But any data/chart is rearview driving. One can get blind sided ever once in a while. Generally speaking the head on collision can be averted by a careful driver lot easier than rear end collision let alone a blind sided collision in which the driver has some participatory role unbeknownst to him. Here is what I see ahead that may mitigate the liquidity crunch but may not be able to avoid extreme volatility in the market before year end:
    1) Most of the hedge fund redemption calls for Nov came in lower than expected and already settled.
    2) there is over a trillion $ sitting on side lines and money markets. However some of it going to fill the bank capital requirements.
    3) individual investors and Institutional (MF, Pension etc) are under pressure to get back in the raising market before year end to show portfolios with winning stock positions in yr end client statements.
    4) don’t ever bet against the insanity of central bankers to keep the liquidity spigots open and the policy makers smooth talk and bickerings.
    5) market making function is increasingly out sourced to computer networks from humans and is global in nature and hence the 7pm CME announcement to lessen the impact when US markets open on Monday.

    All said, I totally agree with you that markets will be very volatile till mid Jan’12 and it’s not for faint hearted avg. Investor. My suggestion to all, don’t over react on one days event/move in the market and don’t watch the gloom/doom tube/news and focus on your day jobs and earning money good old fashioned way. Be a smart investor taking profits/losses in a disciplined fashion and don’t believe in eternal buy & hold strategy.

    • I just posted an update. I am still trying to understand ZH logic. Will get back with my thoughts later.

  4. WOW sounds scary at first but since most of the leveraged bets lately being ‘short positions’ worldwide across all asset classes, we may get a pleasant upside due to forced unwinding(net short covering) of positions by CME for clients who fail to put up 100% margin by Tuesday. If this happens then the blue chips get beaten hard while most shorted stocks may get a surprise pop due to forced covering/ unwinding. Be careful not to over react. That said who really knows what really happens now that this information is widely known and somewhere in the world it’s not a weekend!

    • I won’t dare question your wisdom on this one. But you said, “since most of the leveraged bets lately being ‘short positions’ worldwide across all asset classes…” I too thought about it.
      First of all, NYSE October short interest (on or before Oct 15) dropped a lot (see chart). Since then through Oct 28, stocks rallied a lot more, during which period S/I must have dropped even further. I doubt if the short interest has increased much during this past week..

      This should affect mostly naked call/put sellers. See the CBOE P/C ratio since Aug 1. It is elevated but not alarming.
      Historically, when margins were tightened (going back to early 30s) that too after liquidity is dried up, the markets took it on the chin. The thing that made me scratch my head is why release this at 7:00 PM on a Friday – just like all bad news comes out conveniently around that time? Putting these things together, I won’t be very sure about “the upside surprise.” As one comment on ZH reads:

      it’s indicative of cash shortages. The economy doesn’t really support the growth of credit so everyone, in realizing that there is a shortage of it, is demanding more of everything upfront because the “down the road” picture doesn’t look like anyone will be able to pay.

      the system is no longer “creditworthy.”

      Amen to that! Then again, I’ve been wrong several times before.
      ———————————–
      CBOE Calls, Puts and P/C Ratio by date
      8/1/2011 835698 642292 1477990 0.77
      8/2/2011 968588 669703 1638291 0.69
      8/3/2011 1149196 907911 2057107 0.79
      8/4/2011 1469249 1407781 2877030 0.96
      8/5/2011 1785419 1666080 3451499 0.93
      8/8/2011 1626572 1757508 3384080 1.08
      8/9/2011 1642992 1454262 3097254 0.89
      8/10/2011 1316596 1072809 2389405 0.81
      8/11/2011 1485474 930061 2415535 0.63
      8/12/2011 1000680 769969 1770649 0.77
      8/15/2011 976356 680288 1656644 0.7
      8/16/2011 871701 646514 1518215 0.74
      8/17/2011 913260 757149 1670409 0.83
      8/18/2011 1167915 1137881 2305796 0.97
      8/19/2011 1085078 1132715 2217793 1.04
      8/22/2011 1029436 755987 1785423 0.73
      8/23/2011 1142588 773185 1915773 0.68
      8/24/2011 889331 596897 1486228 0.67
      8/25/2011 963088 739005 1702093 0.77
      8/26/2011 876466 639332 1515798 0.73
      8/29/2011 1001277 534098 1535375 0.53
      8/30/2011 850586 605908 1456494 0.71
      8/31/2011 923055 596354 1519409 0.65
      9/1/2011 738498 508892 1247390 0.69
      9/2/2011 725864 606779 1332643 0.84
      9/6/2011 849554 647928 1497482 0.76
      9/7/2011 830322 512709 1343031 0.62
      9/8/2011 798570 577831 1376401 0.72
      9/9/2011 919865 794221 1714086 0.86
      9/12/2011 849212 610703 1459915 0.72
      9/13/2011 797237 578038 1375275 0.73
      9/14/2011 1004384 653585 1657969 0.65
      9/15/2011 1042979 716668 1759647 0.69
      9/16/2011 1241722 837458 2079180 0.67
      9/19/2011 917408 572266 1489674 0.62
      9/20/2011 956066 604554 1560620 0.63
      9/21/2011 1011710 811781 1823491 0.8
      9/22/2011 1324954 1146906 2471860 0.87
      9/23/2011 988705 643688 1632393 0.65
      9/26/2011 919383 543907 1463290 0.59
      9/27/2011 974479 605616 1580095 0.62
      9/28/2011 625736 521166 1146902 0.83
      9/29/2011 768438 620753 1389191 0.81
      9/30/2011 843171 677235 1520406 0.8
      10/3/2011 983138 831258 1814396 0.85
      10/4/2011 1301264 1013454 2314718 0.78
      10/5/2011 1023835 709097 1732932 0.69
      10/6/2011 934752 641683 1576435 0.69
      10/7/2011 820148 566876 1387024 0.69
      10/10/2011 829353 519073 1348426 0.63
      10/11/2011 747982 582457 1330439 0.78
      10/12/2011 1070265 678094 1748359 0.63
      10/13/2011 807994 582024 1390018 0.72
      10/14/2011 1036262 616890 1653152 0.6
      10/17/2011 844008 598331 1442339 0.71
      10/18/2011 1059472 662125 1721597 0.62
      10/19/2011 1101987 789216 1891203 0.72
      10/20/2011 1021232 754652 1775884 0.74
      10/21/2011 1454046 727112 2181158 0.5
      10/24/2011 1228143 643691 1871834 0.52
      10/25/2011 881882 681255 1563137 0.77
      10/26/2011 979200 692415 1671615 0.71
      10/27/2011 1765401 902824 2668225 0.51
      10/28/2011 1098158 613245 1711403 0.56
      10/31/2011 714739 550780 1265519 0.77
      11/1/2011 1068073 959797 2027870 0.9
      11/2/2011 785840 522020 1307860 0.66
      11/3/2011 929767 593716 1523483 0.64
      11/4/2011 828748 673138 1501886 0.81