Courtesy of Pam Martens.
If you happened to be sitting behind a trading screen on Wall Street in late August and September 1998, you’ve likely been having some déjà vu over the past seven trading sessions. Intraday rallies continue to fail; there is a thundering stampede into Treasuries; rumors are buzzing about hedge funds in trouble; waves of selling pressure suggest wholesale dumping to meet margin calls.
If you needed any more evidence that there is some serious stuff going on behind the scenes on Wall Street, you got it in yesterday’s stock market open. Within minutes the Dow Jones Industrial Average had plunged 370 points in a panic selling spree as buyers went on strike. The Dow was down as much as 458 points in early afternoon before trimming its loses before the final bell to close at a minus 173 points.
It’s all so reminiscent of late August and September 1998 when the five year old hedge fund Long-Term Capital Management L.P., replete with two Nobel laureates on board feeding exotic mathematical formulas into computers, had levered up to the eyeballs in reversion-to-the-mean bets using massive amounts of money borrowed from the major firms on Wall Street. The reversion-to-the-mean thesis was based on the idea that the widened yield spread between risky securities and safer ones would narrow, i.e., revert to the mean.
This was all in the thick of the currency and debt crisis in Russia which dictated, through plain ole common sense, that as that crisis worsened spreads would widen further, not shrink. Which is exactly what they did, causing Long-Term Capital to become Short-Term Capital. The New York Fed had to sit the Wall Street big boys down in its conference room and get agreement on a multi-bank bailout of the teetering hedge fund.
Flash forward to today. U.S. hedge funds have invested billions of dollars in the stock of Dublin-based drugmaker Shire on speculation that U.S. drugmaker, AbbVie, would consummate its buyout of the company, delivering hefty profits to the hedge funds. But the trades have gone seriously awry with Shire losing 29 percent of its value over the past two days on speculation the deal is in trouble.
Early this morning, Reuters has confirmed the hedge funds’ worst nightmare with news that AbbVie “has pulled the plug on its plan to buy Dublin-based Shire, recommending shareholders vote against the proposed $55 billion takeover…”
