Russia Crisis Hits Pimco Fund, Wipes Out Options

[CincyDem]

1. Russia was that catalyst for LTCM - the first big bailout

Long Term Capital Management were the "go to" guys in the 90's for institutional money. They kind of came from nowhere, had a couple Nobel Laureates among their group and they were printing money for their investors. They created some models that, in their mind, effectively priced risk - and then they began buying and selling risk in dozens on different markets with the goal being great returns with virtually zero risk. The buys/sells were paired up in such a way that they made money on the "spread" no matter what happened.

The issue for LTCM was that there were violating one of the immutable laws of finance - you don't get something for nothing (more formally said, risk and return are correlated). What they really had was a model with a blind spot. Instead of return with no risk, they got return for risk they couldn't see. It's like the commercials you see/hear around that promise market returns with no risk - the true statement is market returns for risk you don't understand.

When Russia collapsed in the last 90s, LTCM got a first hand training block in correlation risk - the risk that things you expected to move opposite each other to mitigate market risk suddenly start moving in the same direction. In the course of 4 trading days - these guys lost about 2.5 billion dollars. The reason was that in a crisis - all risk assets correlate...that means there wasn't anything moving in "the other direction" to mitigate their losses on their Russia positions.

2.5 billion might not sound like much today but in those days, it was big money. The Fed called a meeting of all the big investment banks that were on the other side of the trades gone bad. The Fed told them they were all going to take a haircut in an organized way to avoid this thing spinning out of control. Goldman, Bear Sterns, Lehman...all the usual suspects. They ponied up - all except Bear Sterns. 10 year later it was said that Hank Paulson (CEO of Goldman during the LTCM debacle and Treasury Secretary in 2008) repaid Bear Sterns by letting them go under.

Fast forward to today - PIMCO Total Return is one of, if not the largest bond funds out there. Just about anyone who has a company 401k probably owns some Total Return. For 401k managers, it's long been consider the safest of the safe investments. To steal a phrase - nobody every got fired for buying Total Return. IIRC Total Return has some something like 2 TRILLION under management and their strategy is a modification of the LTCM strategy - they have both long and short positions that technical should move in different directions.

I'm not a big fan of PIMCO (often referred to as PimpCo) but, IMHO, it's not a good sign to see them infected with the Russia bug right now. For LTCM management the people effected with the counterparty banks - the guys on the other side of the trades. For PIMCO, the people effected are us - the guys who have scrimped and saved to have some kind of retirement account.

Hopefully, someone finds a way to gracefully land this financial airplane we're all riding in somewhere on flat ground cuz the status quo seems to be running out of fuel.