Jim Rogers Questions Taleb’s $20 Billion Notional (and So Do I)

Jim Rogers commented on my article, “Where Were the Drama Pundits [Whitney, Taleb, and Gasparino] When it Mattered?” at Wall Street Pit.

I doubt anyone reading this needs the following recap, but just in case here it is. Jim’s words carry a lot of weight in this business. Everyone I know (well, not Meredith Whitney, but I don’t know her) listens up when Rogers says he is short a stock or that a company will go bankrupt. Jim Rogers has a brilliant and credible track record, backs his opinions with facts, tells you how it worked out in the end, and has his own money riding on the outcome. His books on his travels are filled with observations about economies, societies, governments, and life. They should be required reading in every business school.

Rogers writes that he never received a death threat even though he regularly appears on business news programs stating he is short a stock or that a company is likely to go bankrupt.” *

He also noted I had written: “’$20 billion’ referred to a ‘notional’ amount of derivatives that produced between $250 to $500 million in gains, it raises further strategy questions.” Rogers weighed in: “Strategy questions? It raises more questions than that. A ‘$250 to $500 million’ gain on $20 billion is peanuts — 1 or 2%??”

Jim Rogers is absolutely right; I didn’t go far enough. He raises a legitimate point.

The fund in question is Universa’s “black swan” fund. The purported strategy was to buy out-of-the-money put options on stocks and broad market indices and hedge tail risk for clients (note that this is not a hyper-inflation fund or one of the other funds that may be managed by Universa). What are the details of the derivatives that required $20 billion in notional to produce so few gains?

It is unlikely Universa could justify using the over-the-counter market, which would have involved trading with the banks and former investment banks, because the strategy would also have created large counterparty credit risk, which would have to be hedged. That would seem inconsistent with a “black swan” fund.

If the strategy included shorting certain stocks, it can sometimes produce large losses, so that is inconsistent with the idea of the potential of only losing small amounts of money while awaiting a big payday, as a “black swan” fund is supposed to do. There can be unanticipated events resulting in a market upturn, and a short sale would create enormous losses, not get rid of tail risk for losses.

Perhaps credit derivatives were involved, but one would have to hedge the counterparty risk, and again, why the large notional amount with so few gains?

Jim Rogers is right to take me to task for not raising more issues about a “black swan” fund that reportedly had only $300 million under management in January 2007, used derivatives with a notional amount of $20 billion, and produced gains on that notional amount of only $250 million to $500 million. There might be a reasonable explanation, and it seems I am not alone in wondering what that explanation could be.

Janet Tavakoli’s book on the causes of the global financial meltdown and how to fix it is: Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (Wiley, 2009).

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About Janet Tavakoli 34 Articles

Affiliation: Tavakoli Structured Finance, Inc.

Janet Tavakoli is the founder and president of Tavakoli Structured Finance, Inc. (TSF), a Chicago based consulting firm providing expert experience and knowledge about maximizing value in the capital markets in the face of complexity and uncertainty. TSF provides consulting services to financial institutions, institutional investors, and hedge funds.

Ms. Tavakoli was years ahead of the financial industry predicting lax underwriting and misrating of structured financial products would result in the collapse of the global credit bubble. She also predicted the collapse of the thrift industry, Long Term Capital Management, and First Alliance Mortgage prompting Business Week to profile her as "The Cassandra of Credit Derivatives." [2008].

Ms. Tavakoli pointed out grave flaws in the methodology for rating structured financial products in her books, Structured Finance & Collateralized Debt Obligations (2003, 2008), and Credit Derivatives (1998, 2001). She wrote the first letter the SEC posted in February 2007 in response to its proposed rules for the credit rating agencies; she made the case that the NRSRO designation for the rating agencies should be revoked for structured financial products.

Ms. Tavakoli is frequently published and quoted in financial journals including The Wall Street Journal, The Financial Times, Business Week, Fortune, Global Risk Review, RISK, IDD, Chicago Tribune, Los Angeles Times, LIPPER HedgeWorld, Asset Securitization Report, Journal of Structured Finance, Investor Dealers' Digest, International Securitization Report, Bloomberg News, Bloomberg Magazine, Credit, Derivatives Week, TheStreet.com, Finance World, and others.

Frequent television appearances include CNN, CNBC, BNN, CBS Evening News, Bloomberg TV, First Business Morning News, Fox, ABC, and BBC.

Tavakoli is a former adjunct associate professor of finance at Chicago Booth (the University of Chicago's Graduate School of Business) where she taught "Derivatives: Futures, Forwards, Options and Swaps".

Janet Tavakoli is the former Executive Director, Head of Financial Engineering in the Global Financial Markets Division at Westdeutsche Landesbank in London. She headed market risk management for the capital markets group for Bank One in Chicago. Tavakoli headed the asset swap trading desk at Merrill Lynch in New York, headed mortgage backed securities marketing for Merrill Lynch in New York, and headed mortgage backed securities marketing to Japanese clients for PaineWebber in New York. She also worked for Bear Stearns heading marketing for quantitative research.

She is the author of: Credit Derivatives & Synthetic Structures (1998, 2001), Collateralized Debt Obligations & Structured Finance (2003), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, September 2008), and Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (Wiley, 2009).

During her career, she has been registered and licensed with the SFA, NASD, ASE, CBOE, NYSE, PSE and the NFA and has passed the series 7, 63 and 3 qualifying exams.

Ms. Tavakoli has a B.S. in Chemical Engineering from Illinois Institute of Technology and an MBA in Finance from University of Chicago Graduate School of Business.

Visit: Tavakoli Structured Finance

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