Since The Husband is a Certified Financial Analyst, I leave to him the dealings in high finance, but this was a most interesting article in yesterday’s WSJ: A Daring Trade Has Wall Street Seething.
Here’s the snazzy graphic:
What happened was that the little guys who knew what they were doing outsmarted the big guys who weren’t, and now the big guys are crying. Felix Salmon has the summary:
Basically, a tiny Texas shop called Amherst sold a huge amount of credit protection, at extremely high prices, on a small and obscure bond backed by Californian subprime mortgages. Although the original issue was $335 million, by the time Amherst sold the protection, the amount outstanding was just $29 million: less than 10% of the original amount, and small enough that Amrherst could purchase the remaining loans and pay the bonds off in full.
That wouldn’t normally make sense: the value of the loans was a fraction of the cost of paying off the bonds. But by paying the bonds off in full, Amherst got to keep all the insurance premiums it had been paid by JP Morgan and others, all of whom were speculating on an imminent default. Clever!
J.P. Morgan Chase & Co., Royal Bank of Scotland Group PLC and Bank of America Corp. thought the bonds would default, but got outwitted by Amherst. Good for Amherst.
As forJ.P. Morgan Chase & Co., Royal Bank of Scotland Group PLC and Bank of America Corp., play me the world’s smallest violin.
Or, as Econobrowser put it,
For my money, the first rule we need would be a law, not a rule, that notional not exceed actual.
Barring that, here’s another rule I trust: a fool and his money are soon parted.