The snowball phenomenon may well benefit the sinking U.S. market by
masking the currency manipulattion from the very top as a method to
increase US hegemony just as the recent markets have made many wise
economic heads question the health of that US monopoly of world
currency.
On 3/21/07, Michael Keaney <michael011@xxxxxxxxxxx> wrote:
> Snowball traders playing loose in high-risk leverage game
> By Gillian Tett
> Financial Times: March 9 2007
>
> It is a truth almost universally acknowledged that a hedge fund in
> possession of a vast pile of finance will eventually start pursuing
> risky strategies when markets look too boring for too long.
>
> Thus it should be no surprise that the era of ultra-low volatility that
> existed until last week has produced endless rumours about hedge funds
> using high-octane gambits to create returns. But could this gamble with
> risk have seeped into some corners of the corporate world as well?
>
> Until now, it has been presumed that the answer was "no". After all,
> outside the private equity sector, there has been precious little
> evidence that the corporate world has been loading itself up with excess
> leverage.
>
> But in recent weeks, a tale has reached me about the emergence of some
> high-risk funding antics involving mid-sized companies in places such as
> Gemany and Italy.
>
> And while the scale of this activity is unclear, the rumours are worth
> noting - not least because if these strategies are proliferating, they
> have the potential to produce unexpected losses if market volatility
> turns nastier in the months ahead.
>
> The issue at stake revolves around structures that bankers sometime dub,
> with a dose of black humour, "snowball notes". (This is not a joke: if
> you don't believe me, try tapping this phrase into Google or Yahoo).
>
> These structures apparently work like this: a company will cut a
> derivatives deal with a bank that in effect provides virtually free
> funding for a year or two, thus allowing corporate executives to flatter
> their accounts or stave off a cash crisis.
>
> But if the finance is not quickly repaid and certain trigger points are
> breached, often linked to market interest rates, funding costs spiral
> dramatically. In one such allegedly typical structure that was shown to
> me, interest rates surge to almost 50 per cent after three years if the
> markets do not move as the company expects. This should make even a loan
> shark blush.
>
> None of this, of course, is entirely new: as long ago as 1994, Procter
> and Gamble was buying risky derivatives structures, which initially
> offered ultra-cheap financing (but then later caused unexpected losses).
>
> But apparently local European banks have started selling variations on
> these structures to mid-cap companies again over the last year, before
> later hedging their own exposure via bulge-bracket banks, in London
> markets. And the associated leverage can apparently be very high, making
> them highly sensitive to market swings (In a typical deal, a structure
> with a notional value of €75m can have more than €8m vega on it, meaning
> that any rise in volatility can create large losses. Vega measures
> sensitivity to a key market parameter such as interest rate volatility.)
>
> "When I read of central bankers sitting around scratching their heads
> worried about foreign exchange carry trades I start thinking that they
> really don't understand where the really horrific leverage is out
> there," observers one banker who has seen such trades.
>
> I would hazard a guess that the actual number of snowball deals in the
> markets is still relatively small though it is impossible to tell: such
> deals are apparently being placed, in great secrecy, in private markets
> and often involve privately held companies, such as the German
> Mittelstand. Indeed, the bulge-bracket banks often only learn about them
> as a result of associated hedging.
>
> Nevertheless, whatever the scale, the tale is striking for at least two
> reasons. First, some bankers suspect that the asymmetric hedging
> activity generated by the snowballs has helped to suppress market
> volatility in the past year. That is essentially because these deals are
> so sensitive to volatility that banks involved engage in hefty hedging,
> but end users - ie companies - are not following suit.
>
> But the second, most important point is that structures such as
> snowballs could potentially give a new tenor to any future debate about
> how the financial world has conducted itself this decade. After all, if
> a serious market shock does hit in the future, politicians are unlikely
> to shed too many tears if some hedge funds blow up. But companies are a
> different matter. Just take a look at the scandal that erupted in the US
> in the 1990s once the losses from the Procter and Gamble trade emerged.
>
> That is just one more reason to hope that last week's market volatility
> has served to inject a new, badly needed dose of caution among
> financiers and investors. And perhaps even any company that has ever
> been tempted to use this snowball trade.
>
>
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