Toomre Capital Markets LLC

Real-Time Capital Markets -- Analytics, Visualization, Event Processing, and Intelligence

Great Unwind

Federal Reserve Ben Bernanke: How Bad Are Subprime Losses Now?

Tomorrow, on Wednesday April 2nd 2008, Federal Reserve Chairman Ben Bernanke is scheduled to testify before the U.S. Senate Banking Committee. His testimony last July 19th resulted in headlines like Subprime losses could hit $100 billion: Bernanke. After today's whopper of a $19 billion write-down from UBS, Bloomberg is now tallying total sub-prime losses at approximately $232 billion. What will tomorrow's headline be? Perhaps Chairman Bernanke might suggest that the subprime losses might hit $500 billion or even more?

Back on July 21, 2007, Toomre Capital Markets LLC ("TCM") created the post Does $50 Billion in Sub-Prime Losses Mean Anything? At the end of that post, Lars Toomre concluded with:

TCM worries that many investors do not fully appreciate how much the investment game of the past several years is changing. Liquidity is going to be a much more valuable commodity than many realize or appreciate. Perhaps the Great Unwind is truly approaching?

The Great Unwind reference was to the provocative research piece that Stefan-Michael Staimann and Susanne Knips at Dresdner Kleinwort put out in early 2007 detailing how closely hedge funds were linked to the investment banking industry and how that business model was likely unsustainable. They strongly declared:

We believe that the great unwind is inevitable, but impossible to time. It looks like the process of building up leveraged spread bets has already run quite far. Risk premia in many markets are very low, making it increasingly difficult to find spread bets for new money. Market volatility has been driven to record lows (remember: selling a put is like shorting volatility). The process may not have much more room to run and may start to be more sensitive to factors that could threaten its delicate balance (such as a deterioration of corporate credit risk).