Leverage

I do not have a position in the market. I cut my long positions when the Nifty fell below 5304 yesterday. My system is unlikely to create any opportunities for a buy today unless we see a really large move. I might sell short by 50% of my total exposure if the Nifty falls below the first one hours low.

I have read about the MF Global bankruptcy with increasing consternation. No, it is not that I am worried about the creditors and the problems that they could face. I am worried about the fact that media and commentators are focusing on the fact that this ex Goldman person transformed the company into a proprietary trading outfit and that it was the prop trading that caused the bankruptcy. I am worried that the wrong lessons are being learned because it was not prop trading that caused the bankruptcy. It was the LEVERAGE. Even the subprime crisis was not due to the fact that bad mortage loans were made. It was the leverage on top of the loans in the form of CDOs, synthetic CDOs and CDS that caused the blowup. When Lehman went under they had levered around 35 times. MF Global was levered around 40 times. This is stupidity. Even a 2.5% drop in asset value can wipe out your networth.

As long as strict exposure limits are adhered to and as long as exposures are taken in only exchange traded derivatives, prop trading can still be of value to any organisation that intends to enhance its return on invested capital.

I keep worrying these days about all this and more. The European crisis, the American debt, the Chinese slowdown and the problems within India. Then I saw my daughter agonising through yesterday about what gift to buy her friend for her birthday and immediately felt better. Her problem was one thing that I could at least attempt to solve unlike the problems that I agonised over. It is another matter that all my suggestions were summarily rejected as totally uncool.