![]() He’d branched out into other markets, such as options and Eurodollars, which were U.S. (It did.) He also sensed bigger fish at the money-center banks in New York-the ones that sent to the CBOT Big Dogs the massive orders that swept through the pits like a tornado. He’d given up his dream of being a pit trader, sensing that the rise of computer trading would have a profound impact on open-outcry trading. Spitznagel had moved to New York City earlier that year. And yet, Spitznagel marveled, you couldn’t tell if he was winning or losing. He glanced at the trader next to him, a white-haired guy in his mid-forties who, on a daily basis, traded hundreds of millions in bonds. Spitznagel was sitting amid rows of seasoned traders in the Manhattan office of Eastbridge Capital, a major dealer in U.S. The financial tailspin was later dubbed “the Asian flu.” Currencies in Thailand, Malaysia, South Korea, Hong Kong, and elsewhere were cratering as the countries’ economies buckled under the weight of the truckloads of debt they’d incurred during a red-hot expansion in the 1990s. Markets had been wobbling up and down for months amid widespread currency turmoil in Asia. “There’s global shock,” a Morgan Stanley strategist said. Shock waves from the fall rippled across global markets, sending indexes in China, Japan, Germany, France, UK, and the U.S. Hong Kong’s Hang Seng Index was down 10%, bringing a four-day decline to a total of 23%. ![]() Figures flickered across his Bloomberg Terminal. A quiet, eerie panic had broken out all around him. Spitznagel looked at the numbers and scratched his head. After a few years, Spitznagel rose to the second highest stair in the pit, a hair’s breadth from the Big Dogs like Baldwin. The calm markets of the previous few years, he realized, had been an illusion-one that deceived some of the most sophisticated traders on the floor. He even managed to eke out a healthy profit. He never held on to a position after it took a small loss, which meant he was never at risk of losing everything. ![]() At the time, it was America’s biggest municipal bankruptcy.įor Spitznagel, the great bond massacre of 1994 was when Klipp’s lessons truly paid off. Famously, the rate hikes bankrupted Orange County, California, which had made ludicrous bets on interest-rate derivatives. Stanley Druckenmiller, one of the world’s biggest hedge fund managers, lost $650 million in two days. Traders all around Spitznagel blew up, including his idol, Tom Baldwin, who fought a losing battle against the unstoppable force of the crash. The surprise move sparked a global bond-market panic. Then, in November, Greenspan swung for the fences: a staggering three-quarters of a percentage point increase, bringing the federal funds rate to 5½%. By August, the Fed had boosted rates nearly two percentage points. Slowly at first, he started cranking up short-term rates to stifle growth, dealing incremental pain to bond investors (as interest rates rise, the value of bonds declines). A company could only issue so many bonds, but a bank could sell a limitless number of derivative contracts linked to a single basket of bonds or commodity.Īs the economy gained strength, Federal Reserve chairman Alan Greenspan began to fret about inflation. Derivatives had another trait that made the quants giddy: Their growth was theoretically infinite. Derivatives also had the habit of magnifying volatility as the risk ramified from the underlying asset- interest rates, commodities, bonds-into the derivatives like a fuse setting off a bomb. The bond market wasn’t just bigger, it was becoming more opaque as Wall Street’s financial wizards learned to hide risk in these secretive mathematized fun-house machines. And a new factor, the rise of the quants-traders or risk managers who use advanced mathematics and computers to predict the market or build complex financial products such as derivatives-was making things ever more complicated. The economy had been expanding for three years. Spitznagel got his first taste of a severe market crisis as an active trader in 1994.
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