T Nation

CME Goes To Collateral DefCon 1


This is from ZeroHedge....
After the article I will try to give a basic interpretation for those that do not have a familiarity with the markets. Please pay close attention.

The most important news announcement of the day was not anything to came out of Cannes (as nothing did), nor from Greece (the merry go round farce there continues unabated). No, it was a brief paragraph distributed by the CME long after everyone had gone home, and was already on their 3rd drink. It is critical, because not only is this announcement a direct consequence of what happened with MF Global several days ago, but because also it confirms one of our biggest concerns: systemic liquidity is non-existanet. We confirmed interbank liquidity in Europe was at an all time low earlier today, and can only assume the same is true for US banks. But what is very disturbing is that this is just as true at the exchange level, where it appears the aftermath of the MF collapse is just now being felt. What exactly was the announcement. Unless we are completely reading it incorrectly, it is nothing short of a margin call for tens if not hundreds of billions worth of product. Because as of close of business on November 4, today, the CME just made the maintenance margin, traditionally about 26% lower than the initial margin for specs, equal. For everything. Which means that by close of business Monday, millions of options and futures holders will be forced to deposit billions in additional capital to the CME just so they are not found to be margin deficient, and thus receive a margin call. Naturally, since it is very unlikely that this incremental amount of liquidity can be easily procured in one business day, we anticipate the issuance of hundreds of thousands of margin calls Monday, followed by forced liquidations of margin accounts across America... and the world. Just like when Lehman blew up, it took 5 days for Money Markets to break. Is this unprecedented elimination in the distinction between initial and maintenance margin the post-MF equivalent of the first domino to fall this time around?

So what does this mean? I am still trying to wrap my head around it, but just to cover your ass consider doing the following...

If your bank is open tomorrow morning withdraw as much cash as you can from savings and checking. You can always put it back if there are no ripples.

Make a run to the grocery and stock up with a little extra food in non perishable form. Can goods, etc.

If you own firearms, stock up on extra ammunition.

If you don't own firearms, consider buying a basic shot gun such as a 12 gauge pump.

Yes, I am probably being Chicken Little and certainly hope that I am. But even at a one percent chance, I would better be safe than sorry.

If you did not understand the article, this is what it means in the most basic terms. CME (Chicago Mercantile Exchange) is raising margin requirements effective Monday afternoon. Therefore, those that own securities on margin (borrowed money, ie leveraged) will get a margin call on Monday. This means that they will have to deposit money into their accounts in order to balance the reduction of credit they have been extended. The more leveraged they are, the more money they will have to come up with. What if they don't have the cash instantly available? Well then they will have to liquidate, ie sale their positions at market. This means they will be selling into a weakening market as others having to raise cash will be doing the same.

Even simpler explanation....
There is a fairly reasonable chance that the shit could begin to hit the fan on Monday. I hope I am reading this wrong, and it is very possible that I am. Nonetheless, it is not unreasonable to take some simple precautions.


How much are margin requirements increasing ?


Hmm we are living in interesting times. What are the ramifications of this if your assessment is correct?


It is really hard to say. Whether this sets things off, or something else trips the domino in a week or several months, end the end there is a price that will ultimately have to be paid. We put band aids on the financial wounds that appeared back in '08 and delayed the inevitable. In the process in has gotten worse. There is a debt time bomb that is going to explode. You are seeing it in Europe right now and in states like Detroit. The trillions in cluster fuck derivatives are lurking out of site. An implosion and reset of sorts in inevitable. How it plays out is a matter of interpretation.

When I mentioned the precautions above, I am not suggesting that the world will descend into chaos in one stroke. But I do believe that man is a panicky animal and when you pair that with the on time distribution systems that supply our foods and medicines today that can lead to ugly short term scenarios.

The whole financial system to way more inter wound than most believe. The Euro zone in the most likely place to set the ball in motion. They are already starting to play massive games of "chicken" with one another.

This is how I am playing it.
Short the Euro. In its current form it is ultimately doomed.
Deflation in now in play. Debt is dumb and cash is king. Cash in hand that is. Begin to hoard cash and move money from weak banks.
The dollar, for now, will be the king of currencies. As the reserve currency most debts are denominated in dollars. The world will need dollars to retire debt.
Gold, at least in paper form, is going to fall.
Stocks are going to fall.

There are those that will immediately start attacking my strategy with the counter argument of "hyper-inflation". Each will have to decide for themselves. I am convinced that deflation will rule the day, at least for the next four to five years.

Yes we live in interesting times. The sky is not falling, but the mother of all storms in brewing on the horizon. We will get through it and come out the stronger. To ignore the signs and take no precautions is foolish.


Thanks I hope you are right. I worry most about feeding and protecting my babies so I try to stay informed.


Wait, we mean the opposite....

What the hell. This just released by CME. Article on ZeroHedge.

Yesterday, in what is the worst-phrased and most misleading press release to ever come out of the CME, the exchange issued a notice that going forward all Initial margin would be equal to Maintenance margin. Our gut interpretation was that "Unless we are completely reading it incorrectly, it is nothing short of a margin call for tens if not hundreds of billions worth of product." Judging by the broad response, our initial reaction is what a prudent, logical human being would assume: after all, it is precisely the undercollateralization of customer accounts, and general underfunding at MF Global that is what brought that particular company down. Well, we wrong wrong. The CME, it appears has taken a page right out of the European playbook, and less than a week after an exchange-cum-Primary Dealer collapsed due to excessive risk taking, the CME has followed up its vague press release from yesterday by inviting even more risk in lowering the initial margin. Why is this a cause for even greater concern? As the CME itself says, "Initial margins are set to provide an additional buffer against future losses in the account" - so going forward that buffer has been reduced by about 30%. But what is the reasoning provided by CME: "The intent and effect of these changes is to decrease the size of any margin calls resulting from the bulk transfer of MF Global customers to new clearing members, not to increase them." So basically the CME is implicitly putting all of its existing and current clients and customers at further risk by onboarding the accounts of those clients who, like lemmings, held on to their MF Global accounts until after it was too late. Because while the lower Initial margin may apply to MF accounts, it will also apply to any Tom, Dick and Harry beginning Monday, who will suddenly see a 30% reduced gating threshold to put on a position. Any position, no matter how risky.

Naturally, if enough people suddenly jump to put on risk, and the market flips and all new positions end up underwater, who will bail out CME accounts if, like MF, there is just not enough capital on the balance sheet? MF Global?

That the CME has opted for this highly disturbing path is very troubling, and just as in Europe, where three months after the financial short selling ban, financials are trading lower than they have ever been, so the unintended consequences from this action will result in even greater stress to the system, as not a single local will leave any excess money in their account, and likely will force all specs to trade within a hair of triggering maintenance margin, due to fears of what may happen at the CME itself, now that is has implicitly onboarded moral hazard from the otherwise insolvent MF Global accounts.

It also means the systemic liquidity is about to drop to even lower and more depressed levels.

And completing the symmetry with the recent action out of Europe, we learn that said Initial Margin reduction is a "short-term accommodation" which will apply until further notice. As an indication, Europe has extended its short selling ban several times and likely will keep it until the bitter end. We expect nothing less from the CME, where the new benchmark will be one of even greater initial position leverage which is what this margin reduction effectively accomplishes.

Yet what is most troubling is the complete lack of care to the wording ot the initial press release, as if it was thrown together by a 1 month intern who had heard his boss scream something at thim from the conference room. That an event of this systemic importance requires not one but two releases, which still leaves many questions open (why does this apply to non-MF accounts? How long will this last - after all the MF onboarding is a several day event at most? What happens to new non-MF initial trades which cover just initial and immediately see margin calls as maintenance is breached due to the lack of a 25% intiial buffer) is by far the most surprising, and unfortunately leads to questions about both the CME's professionalism and competence.

So either Bernake and the White House got CME on the line or the rumblings were otherwise felt, but not CME has reversed direction.

What does this mean? Wow, I really don't know yet. We could get another risk play in the market that sees another spike up for a week or so. Maybe an immediate sell off. Depends on how they are able to spin it. Ultimately, I think it will end badly.


So did anything happen with this yet?


Nope. That's what happens when Zero Hedge gets their hands on a poorly worded press release.


Ignoring the rest of what you wrote, this paragraph isn't even accurate. There are as many longs as there are shorts in the market. If margin requirements are raised, positions have to be liquidated. There may be long positions that need to be liquidated, there may be shorts that need to be liquidated. You know what happens when an equal amount of longs and shorts all need to liquidate? Nothing. They all get out against one another, volume spikes at a given price and open interest drops.



I read an article that appeared to be reporting a important event in real time that would have a very real effect on the markets.

At first glance, they seemed to be interpreting correctly. On second glance, not so much. I corrected as such.

Your following paragraph is playing semantics and trying to start an internet fight. So in the interest of giving you your fix, fuck you.

Feel better?

Zero hedge is a good source of news to balance out the hopium of CNBC, etc. The are awful negative, but they do expose some bullshit that others look past.