No, it wasn't quite like that. It wasn't about collateral. I can explain with a metaphor if you like.
Sure, there was no chance that MF was geared at 80x in a spec. The Street is littered with guys who got blown-out of box arbitrage (among other arbs) due to leverage. Spreads and liquidity are inversely-correlated. LTCM was geared at 100-150x on the on/off the run 30s. It doesn't matter whether is was spec or a leveraged arb -- they still blew-out.
The most incredibly stupid thing to me is that they completely ignored the correlation between the two trades. I really don't think that either of two, taken by itself, would have killed them.
If you can explain without a metaphor it's better. I'm not sure why there is the need for the opaqueness. Had the bond prices not moved and no additonal collateral was required then Corzine would have pocketed his profit in 2012 I presume. Please explain why the issue wasn't about the need to post additional collateral when the sovereign bond prices fell? They played a textbook bond-repo to maturity arb, were overleveraged, and couldn't make the collateral payments when the bond prices fell. What do you think we are missing here?
It's not opaqueness... I have already mentioned it in the other thread and it's not just a simple cash-and-carry trade. 6 yards of shorter-dated periphs funded for term doesn't kill somebody like MFG with margin calls.
Why is it not just a simple cash-and-carry trade? You didn't provide many details in the other thread...if I recall you said they borrowed short, lent longer in the repo book... Not trying to wind you up here, it's just that I'm having trouble understanding your angle, and usually you add something to the discussion so I think I'm not alone in wanting to get to the bottom of what you mean when you say, "it's not really bonds" Are you saying they didn't need to post much additional capital and were faced with large margin calls?
MFG's bet was they could withstand bond(collateral) volatility until maturation date. They could not due to excess leverage (40:1) afforded to them under the repo clause. As bonds dropped in value, counterparty called to refresh repo-agreement to original collateral financing ratio. Martinghoul: ? The 6.3BB net exposure was 5.2x their tangible common equity. Per http://sec.gov/Archives/edgar/data/1401106/000119312511207641/d10q.htm, they had ~$710MM cash back in June. With $1.3BB revolving credit line burned, peanut gallery market cap and associated junk rating, not difficult to see why they exploded in such fashion. It's futures brokerage may have cleared massive CME volume (world leader), net-net it was still a small company losing market share/profitability for some time.
Because, to my knowledge, it wasn't a cash-and-carry trade. A cash-and-carry trade of 6 yards of short-dated periphs doesn't kill someone like MFG. So yes, of course, they were faced with margin calls, but they weren't that large, in the grand scheme of things. The issue is that, quite apart from the actual bond position (let's call it Position 1), they had a VERY large repo book, which was long collateral and short cash in term and being funded in short dates (Position 2). So it wasn't a cash-and-carry trade, but an attempt to capture some extremely juicy term premium. The problem, of course, is that, as soon as the mkt finds out about Position 1, your counterparties get spooked and the funding you were relying on to keep rolling Position 2 disappears. And that's when you're dead.
Yeah, sure, it's a large(ish) position, liquidity-wise, but how much do you think short-dated EUR periph paper moves? Have you tried to estimate how much collateral they would have had to post as a result of the â¬6bn bonds they were long dropping in value? Despite all the noise you hear in the press, these are still govt bonds, not subprime CDOs.