Earlier this week, Amaranth, a major hedge fund, announced massive losses in the energy markets, effectively destroying about $6 billion of their investors' capital. If anyone wants the exact machinations behind the trade that went wrong, feel free to ask and I'll explain offline. The basic gist of it, though, was that one trader took one huge bet, and it went wrong.
What I find interesting about the whole situation is that while the name of the trader, Brain Hunter, has been all over the news, I haven't seen one mention yet of the name of the firm's chief compliance officer. There are sins of comission and sins of omission. Hunter is clearly guilty of the former, but Amaranth's complaince department is just as guilty of the latter. By letting Hunter put on a position of this size, compliance allowed Hunter to put the firm at risk of collapse. Any attempt to say that Hunter hid his position size from compliance is both naive and misguided - not only were Hunter's positions so big that it would have been nearly impossible for compliance not to know about them, but it's their job to make sure they know if anyone at the firm is taking risks like that. Any trading firm worth it's salt should have a policy that the trader never has the final say in how big the positions should get.
When a trading firm has a weak compliance department, traders take advantage of the situation. I saw it when I worked on the floor, and it looks like the Amaranth situation played out the same way. I knew options guys who would strap on a huge position and hope it would work out. If it did, they got paid. If not, they'd get fired. So what? There's always another job. It seems that the Amaranth situatuion is the same thing. Basically, the story I heard from some energy guys is as follows - last year Hunter took a huge position right around hurricane season that natural gas prices would spike if a big storm hit the gulf. Nobody stopped him, so why not take a shot? At risk of losing his job, a correct bet on the weather would make Hunter a wealthy man. And, as anyone in New Orleans could tell you, that's exactly what happened, and Hunter got paid out. Big. Around $100 million, from what I heard. So, this year, Hunter strapped on the same position again. Except, the weather didn't work out as planned, and the position got killed.
Keep in mind, I don't know this actually to be true. This is the story I've heard, and while most of the facts can be confirmed, I don't actually know what Hunter was thinking. I can say, though, that given a coin toss where heads you get $100 million and tails you blow up your firm and you're never working in finance again is a pretty good bet, especially when you've already made enough money to retire on. I also can say that I know plenty of traders who'd do the same thing.
Right now I'm sure that the compliance departments at every hedge fund in the nation are reviewing their procedures to make sure this doesn't happen again. I just hope that the media and the general population also are made aware of who all the guilty parties are here.
Sunday, September 24, 2006
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