Monday, September 15, 2008

Reality sets in for Lehman, AIG, WaMu

While I do not like seeing the financial system like this, I do like seeing the government taking its proper role on the sideline protecting taxpayer money. It seems like it took $5 trillion of Fannie and Freddie's liabilities on the treasury balance sheet to shake them up. It's not like they had any money to lend anyways. They would have to get it from overseas bond investors.

I do not know what happened at Lehman, Bear, Fannie, Freddie, etc., but they obviously had no risk controls in place. Perhaps it was their use of VaR as a primary risk model. A black swan event, that a statistical model would say there is a 1 in 1,000 chance, actually happens quite a bit more often than that. This is how trend followers make money; hitting the home run on an event that would seem to happen less often than you would think. These investment banks, save JP Morgan and Goldman Sachs, did not understand that too well. Some basic trading rules would have been good advice:

Sell your losers, ride your winners
Risk only a small portion of your capital on a bet
Have systemic exit rules to get you in and out rather than flawed, emotional human thought

It doesn't matter to shareholders now since they have lost their investment. All they had to do was look at the chart to tell there was something terribly wrong:




On a side note, my trading system has been short the market since early June and has cleaned up. This year it is up over 50% and stands be up even more at the end of today. I may begin marketing this service for a nominal subscription fee. More on this on a later date.

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