Louis Lovas
09-26-2008 01:33 PM
Financial Meltdown the impact on CEP
Watching,waiting, wondering are the catch phrases of late. What will be theeventual conclusion of the meltdown and subsequent bailout of ourfinancial system? Like many of you, I've been steadfast in my search for information,watching the news, reading blogs and op-ed's about how we got intothis mess. I anxiously await our government's response. As ahomeowner and family man with a retirement plan I am keen tounderstand this predicament. I also have a vested interest from aprofessional sense. The event processing technology in which we immerse ourselves is well entrenched in this same financialcommunity. Below I share a few thoughtsand perspectives on our troubled financial times and how it mightimpact event processing technology.
Short Selling induced volatility
The idea behind short-sell trading is to sell anasset (i.e. shares of stock) that you the seller don't really own. Then with luck the price drops, youbuy the shares at the new lower price return the shares you borrowedand pocket the difference. Short sellingstrategies are common place in equities, currencies and futuresmarkets and have been in use for a number of years.Which of course came to a complete halt when the
FSA and the
SEC banned short selling in an effort tostave off market instability. The
FSA's clampdown gaged only a small number financial instruments, whereas the
SEC's actionwasmore punitive, setting restrictions on 800 companies. Once thoseregulatory bodies announced the crackdown the investment bankcommunity, hedge funds and asset managersreluctantly scaled back their short selling strategies to comply. Shortselling is a common use-case for CEP. These recent restrictionsare a clear indication of the need for algo strategies to bedynamically adaptable to market or regulatory conditions, whether inshort selling or other types of strategies. It's imperative thatthe development tools provide the means to swiftly enable changesto strategies.
All told, theshorting restrictions were applied to those instruments that hadmassiveimpact on the market's stability. Just determining the marketimpact, the instability orgeneral volatility was an investigative research project where CEPcould have played a significant role. Volatilityis a statistical measure of the scale offluctuations in a price or index. By looking at historical norms, theFSA concluded 29 stocked exceeded those historical norms and the SECdetermined it was 800. While I don't know if either regulatory bodyused a CEP product they clearly could have. Used in conjunction with atickdatabase for the historical market data, a CEP product like Apamaprovides the tool set and language to rapidly construct a market impactanalysis solution with the ability to carry-out amulti-year analysis.
Leveraged induced risk
Investment banks rely heavily on borrowed money, so much sothe typical "
leverage ratio" is 30 to 1. That means forevery tangible dollar held, 30 are borrowed. Whileleverage can and does create the opportunity for huge windfall profits,it can also
incur massive riskand huge losses.As long as markets are reasonably stable it allows for predictablebehavior of investment strategies thus permitting banks to make moneyon borrowed money and continue to leverage. However, asinstability invades it erodes many aspects of investmentstrategies. Lossesbegin to mount - on the investment itself, on the borrowed amount and the interest payment of the borrowed sum.
So how can CEP play a more active role in this highly leveraged world? With risk mitigation. CEP is emerging as a key constituent in
real-time riskmanagement systems. One example is in deal-monitoring / position keeping systems.Auto-hedging is also a technique employed by risk systems tokeep positions within the boundsof tolerable risk
limits. One form of hedging is short-selling (see above).Risk management systems define allowabletolerances for trading, positions and P&L. With a 30 to 1 leverage ratiothose tolerance limits seem terribly high. So when the market takes a turn for theworse, losses become astronomical. This is not the fault of the risksystems themselves but the allowable limits established by the bank'sbusiness then coded into the risk systems that permit highlyleverage positions. One can only image that investmentbanks will be adjusting the limits on their risk downward a few notches. Itwill also spark the opportunity for them to invest in newer moreflexible real-time risk solutions. In volatile, ever changing marketconditions risk systems need to be dynamically adaptable. CEP is anideal technology to fill that need.
Reclassified Investment Banks
The last two major investment banks, Goldman Sachs and Morgan Stanley, have recently
changed status from an investment bank to a commercial bank.In doing so they can now take deposits in the form of checking andsavings accounts as a source of funds to shore up losses created by their highlyleveraged positions. But
commercial bank status means they face a litany of Federalregulation. For one, the 30 to 1 leverage ratio will be prohibited. The daysof windfall profits in good times (and catastrophic losses in badtimes) are over. The Fed's also provide a safety net in theform of an
emergency loan program for commercial banks. Goldman and Morgan now qualify to be protected by this net, thus preventing them from suffering the same
fate as Lehman.I'm sure they had this in mind when they requested the change ofstatus. I wonder if Goldman and Morgan will be buying newnameplates for the front entrances to signify their new commercial designation?
"
In every crisis, opportunity"could be an appropriate catch phrase for the eternal optimist. Whilethis meltdown certainly has the appearance of doom and gloom, in theendbanks are in the business to make money and they will find a way. Eventprocessing technology will be at the fore-front of that endeavor. Regulations will simply draw a box around which they operate. Itwill stir the creative spirit to achieve within these newboundaries. New forms of algo strategies, real-time risk monitoring andsurveillance will be required as a result of the imposed bans andregulations. CEP technology - the Apama platform, will be at the forefront of this new (banking) world order.
Source...
09-26-2008
