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Frank Hayden
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Mr. Hayden has over twenty years experience as a risk management professional within the energy sector. As a risk management professional, areas of experience include risk tolerance and limit structure, risk policy, stress testing, new product approval, hedging policy, liquidity measurement,... More
My company:
Risk and Decision, LLC
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  • Birthrate, GMO, Hypothecation and Large Numbers

    This week, there were a few interesting news items that resonated with me.  First was the announcement of the 7 billionth person being born.  I recall my high school and university experience where the debate focused on the world running out of food.  I suppose the great hedge is continual access to machinery & farming equipment, access to markets, technology improvement, and overall world peace.  I'll add this point - the next time a “greenie” talks trash about genetically modified organics, ask them about Norman Borlaug - ask them how we are to feed the world?   I am all for great tasting, bug feed chickens – however this is a luxury that a very small percentage of the world population can afford.  We need GMO’s.

    The second news item dealt with the problems of MF Global.  I imagine that it helped rally the occupy Wallstreet protesters and brought back hot flashes of broker-dealer misdeeds of yesteryear.  The Wallstreet journal reported “window dressing” practices, customer accounts being short $600MM, etc..  Regardless of whether or not the money is found, it reminds me of one of the topics taken up in the new Dodd-Frank regulation dealing with the hypothecation of assets and segregation of account/funding and independent amounts.  Do not take my word for it - ask an attorney - but in the ISDA Credit Support Annex, paragraph 6 addresses the issue of holding and using of posted collateral, ie the right to hypothecate.  Be that as it may, only the New York Law Credit Support Annex addresses the security interest form of collateralization and specifically the segregation into non-hypothecable accounts.  The English law form considers title transfer form of collateralization.  Most of this deals with over collateralization.  In theory, the ability to hypothecate customer’s assets relates to securities borrowing and lending activity of the broker dealer and can get very complicated.  

    In March, 2010, ISDA published a white paper addressing independent amounts, all in the context of the Dodd-Frank regulation.  I’ve clipped out the paragraph below for my readers, but highly recommend the entire white paper as it fleshes out many of the issues.  Specifically;

    “In a Dealer insolvency, if an End User delivered an Independent Amount (IA) directly to such Dealer and such IA was rehypothecated or commingled with such Dealer’s assets, and such dealer is over collateralized by virtue of such IA, then the End User will have a general unsecured claim for the recovery of such IA and would be entitled to a pro rata distribution along with all other general unsecured creditors.  This type of claim ranks behind other creditor claims of higher priority, and thus in many insolvencies general unsecured creditors get paid less than 100% of their claim amount.”

    “As recent events demonstrate, this is not merely a hypothetical risk.  In the case of Lehman Brothers, many investors may be exposed to significant losses in part because they had effectively over collateralized Lehman through the provision of IA.  These IAs were generally delivered directly to Lehman, with the right of rehypothecation.   This meant that the IAs were permitted to be freely used by Lehman, and were not segregated or afforded any client asset protections. (emphasis is mine, not ISDA) Therefore, following Lehman’s bankruptcy filing, claims for the return of cash and securities posted to meet IA requirements were treated as general unsecured claims on the debtor’s estate. These were given the same priority as claims of other general creditors, meaning in this particular case that counterparties will likely only recover a small percentage of the value of any IA posted.”

    Well, you heard it from me first – check your clearing documentation as well as ISDA agreements - in particular the issue of rehypothecating independent amounts.  I suspect after all the shouting is done, the crying will be centered on issues similar to the condition outlined by ISDA in March, 2010.

    Lastly, the crisis in Europe continues to evolve and all eyes remain fixated on policy makers.  While this may be true, I will remind my readers about the law of large numbers, hence the “risk on, risk off” trade.  There are no probabilities to the trade.  The dice will only roll once.  One can be massively right or massively wrong.  That being said, given the overall macro economics, the volatility surface seems skewed to the puts.  For example, OEX which is the symbol for the S&P100 index - shows the volatility for the way-out-of-the-money call being approx. 21%.  Whereas the volatility for the way-out-of-the-money put is approx. 29%.

    In other markets, and assuming bullish news - crude continues to show consolidation under $95 setting an upside target of $105; natural gas is setting up an upside target of $4.10; and gold stands poised to break over $2000.  CYA: ALL COMMENTS & TARGETS PROVIDED ARE MY SOLE OPINION.  THE IDEAS EXPRESSED IN THIS NEWSLETTER ARE FOR GENERAL INFORMATION PURPOSES AND ARE NOT RECOMMENDATIONS TO TRADE.  I AM NOT SOLICITING MONEY, CAPITAL AND/OR OTHER.

    Thank you for reading my newsletter –


    Have a great weekend!





    Tags: GLD, TBT, UNG
    Nov 04 9:24 PM | Link | Comment!
  • Leveraging & Contagion
    Last week, news broke regarding the EU bond deal. EU policy makers announced a deal whereby private investors (a.k.a. “banks”) take a 50% haircut and the European Financial Stability Facility (“EFSF”) is leveraged four or five fold. Clearly policy makers are working toward ensuring that the Greek crisis remains contained. However, the haircut represents an acknowledgement that the situation is not good, and it appears that leveraging is required because finding additional money is not an easy of a task. None of this appears to address the concern that Ireland, Portugal or other sovereign “might-could” seek a similar deal.   
    Acknowledgement that the situation is dire is a positive development. I say this because as a risk manager, real risk management occurs in the discussion. Often a “holdout” bogs down leadership with details of right or wrong, skirting the issue and/or confusing the decision makers. The proverbial elephant in the room is never discussed. It goes without saying - risk management is nested in probabilistic events. Pretending an exact science is to ignore the probabilistic roots of risk management.   
    It is positive in the sense that change can now happen. Change grounded in real economics tends to be for the better. To understand the change required, I highly recommend reading the September IMF Global Financial Stability Report (web link   

    Basically, there are a few points I would like to highlight in today’s newsletter. From the Iceland experience, we learned that GDP vs. bank asset size matters. From the Greek crisis, we learned that debt to GDP matters. Lastly, from both examples, large international banks relying on wholesale financing arrangements experience sudden liquidity issues when large deposits are relocated.    
    Considering the above, it stands to reason that if liquidity is provided by a sovereign to support a large financial institution, the debt to GDP ratio as well as the sovereign's credit standing is impacted.  For example, data shows that Italy while having the lowest concentration of bank assets (compared to GDP a little more than 50%), it has the highest debt to GDP ratio – in excess of 100%. As such it is important to understand last week's haircut announcement and subsequent leveraging of the EFSF.  
    As with any haircut, haircuts impact cash on hand. Replenishing the cash calls on the liquidity supporting the margin call. In the real world, variance margin is cash.  Basically, variance margin is a cash call to support overnight changes in value.  A cash call has to be met or the asset is liquidated and a claim filed.  In leveraging, timing is everything. Leverage works only when the cash “in” versus cash “out” vary over time. This is why market stress forces de-leveraging – correlations approach one (1).  Real market stress follows a margining process that brings into the here-in-now the net present value. In other words, using a leveraged facility to support sovereign debt would only work if only one sovereign requires support.  This is similar to an issue regulators face regarding settlement risk. Having a probabilistic amount of capital will only address the conditions when the settlement failure is smaller than the set aside - in this case, one or two to of the sovereigns facing stress. 

    So why leverage at all?  There is a chance it will work. As in any game, adding time to the board should help in putting up more points.  The most likely scenario is that leveraging provides more time for policy makers to find the cash.  In my humble opinion, the leveraging of the facility actually presents a contagion “catalyst”.
    In other news, US natural gas has managed to rally thru the downtrend that has been in place since early June. The rally opens upside targets as expected given the beginning of the winter heating season. Crude has pushed thru the downtrend that his been in place since the May $114.83 highs and appears to be consolidating in low 90’s.  Gold & silver have bullish stories as well. I think in the weeks ahead we will hear more about the pressure on the Super Committee to provide a viable debt and deficit reduction plan. Additionally, the surrounding chatter regarding European crisis and the US Presidential race will only “amp” the issues at hand. Overall, I remain cautious.      
    Thank you for reading my newsletter - have a great weekend!
    Kind regards,
    Frank Hayden
    Oct 30 8:25 PM | Link | Comment!
  • Gold vs. Platinum

    In my August 19th newsletter I spoke of two trades involving gold – the “doomsday” & the “reversion to mean”.  The doomsday trade was a bet that as industrial demand fails to materialize, platinum falls relative to gold. At the same time and in a united manner, the monetarist continue to follow an easy money policy.  In this case, gold would continue to remain strong and outperform platinum.  Only when things return to "normal" will the traditional platinum to gold premium return.  As to myself, I faded this bet – thinking that the platinum premium would stay (sold gold, bot platinum) and I stopped out early this week.  Those that find themselves in a hole should stop digging...


    As an aside, due to extenuating family circumstances I have not been able to publish my newsletter for a few weeks and in that time the Fed announced operation twist, and people seem to be putting some risk back into the market. 


    Putting risk on – scanning the news, one news item seems to be adding stability.  It relates to IMF’s European head Antonio Borges saying that the International Monetary Fund "could" invest in the sovereign debt of Spain or Italy.  All in all, this helps shore up the idea that Greece will be another Lehman.  (let's hope not!)  As events continue to develop, I wonder if European fiscal unity will happen in the same fashion that Goldman & Morgan gave up their investment bank independence?  Will the pressure of a Greek default and subsequent bank re-capitalization make fiscal unity more likely?  Apparently the market thinks this as the euro has rallied off it's lows.  However, if in the future, truth remains stranger than fiction, could it be that just as the Volcker rule is making Goldman Sachs reconsider why they became a bank (subject to the Bank Holding Act), perhaps the European Financial Stability Facility (EFSF) will cause the same heartburn for Germany & France.  It would be interesting to understand the ability to restructure to EFSF - after the crisis comes down.  For example, will it be easy to leave?   All in all, it helps explain why the double top in Gold does not seem to be paying off - although it does not necessarily explain the recent rally in the Euro (probably has more to do with short covering than bull run...)


    Operation twist – this effort is aimed at changing the duration of the Fed’s balance sheet – extending the maturity of the central bank’s treasuries in a bid to lower long term borrowing cost – a flattening of the yield curve.  A contango yield curve is strong medicine for the banks, and this effort is strong encouragement to extend credit into the retail market.  Another knock-on effect that has received considerable airtime is highlighted by Barclay’s Capital analysts regarding 10 year equivalents and duration.  The analysts conclude that operation twist is similar to QE2 - $400 of “twisting” equates to approximately $375 billion 10 year equivalents.  In other words, both the quantitative easing program and the twisting program crowd out duration hunters, bidding up bond prices.  I think it is easy to forget the “goal” of the monetarist – balancing supply & demand of money.  While quantitative easing is printing money today, twisting is spreading it out over time. As with any credit loss, capital is destroyed – so the trick is to print just enough money to offset the capital destroyed. Print too much and you have inflation, print too little and you have recession.  I am sure some economists are measuring the duration effects of credit losses and comparing this against QE and operation twist.  Suffice to say, there is more artform involved in matching money supply & demand than science. 


    Perhaps the gold vs. platinum trade is best summed up with the notion that if you believe the central bankers can figure it out, pre-financial crisis “norms” are restored.  Platinum will have a premium over gold and GLD will no longer be one of the largest ETF’s.  However, for the time being, it appears there are a lot of skeptics regarding the central banker’s ability to manage thru this process with exact foresight – hence Gold remains bid.

    Lastly, it is important to remember that no one is bigger than the market.  In the end, the efforts of governments to heavily influence price and interest rates will have to "clear" a market price.  The governmental "push" has to be founded in fundamentals that the market clearly supports.  On the other hand, and not to be circular, the ability of the government to create those fundamentals rest more with the legislation and tax policy than with central banks.  There has always been a market to clear the risk - even in the days of hyper-inflation there was a black market.

    In other markets, natural gas has broken over a downtrend that has been in place since early September, and crude is pushing up against a downtrend that his been in place since the May $114.83 highs.  



    Tags: GLD, GS, TBT, Commodity
    Oct 14 4:05 PM | Link | Comment!
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