Unnamed Hedge Fund or Investor Earned $10 Billion Betting on U.S. Downgrade

According to The Daily Mail,

A mystery investor or hedge fund reportedly made a bet of almost $1billion at odds of 10/1 last month that the U.S. would lose its AAA credit rating.

Now questions are being asked of whether the trader had inside information before placing the $850million bet in the futures market.

The Daily Mail suggests this might involve George Soros, but a knowledgeable source denied it. The article also suggests that whoever made the bet could have had inside information–arguing that Obama and Geithner seem to have known for some time that a downgrade by S&P was in the works. Of course The Daily Mail is a conservative rag.

The latest bet was made on July 21 on trades of 5,370 ten-year Treasury futures and 3,100 Treasury bond futures, reported ETF Daily News.

Now the investor’s gamble seems to have paid off after Standard and Poor’s issued a credit rating downgrade from AAA to AA+ last Friday.

Whoever it is stands to earn a 1,000 per cent return on their money, with the expectation that interest rates will be going up after the downgrade.

Recall that Eric Cantor was revealed to have an investment that would have paid off handsomely if the U.S. had defaulted. Salon reported on June 27:

Last year the Wall Street Journal reported that Cantor, the No. 2 Republican in the House, had between $1,000 and $15,000 invested in ProShares Trust Ultrashort 20+ Year Treasury EFT. The fund aggressively “shorts” long-term U.S. Treasury bonds, meaning that it performs well when U.S. debt is undesirable. (A short is when the trader hopes to profit from the decline in the value of an asset.)

According to his latest financial disclosure statement, which covers the year 2010 and has been publicly available since this spring, Cantor still has up to $15,000 in the same fund. Contacted by Salon this week, Cantor’s office gave no indication that the Virginia Republican, who has played a leading role in the debt ceiling negotiations, has divested himself of these holdings since his last filing.

Why are these kinds of investments bets even legal? This is nothing but high stakes gambling, and it’s just plain wrong.


Gambling with Hunger

During the wind down of the financial crisis several years ago, a few people that read my more wonky threads asked me where I thought the next speculative bubble would develop.  I answered food more from intuition than any hard core evidence that I had at the time.  Now there is plenty of hard core evidence that validates my intuition.

Farm land and Ag. prices have been fairly stable since the 80s and represented some of the few markets that proved relatively resistant to the Global Financial Crisis.  However, there was a period of time–2007 through 2008– when some speculative practices influenced food markets.  That is why I thought it was likely to recur.   Food is, of course, a necessity so that always gives a market a degree of persistence during downturns. It does not make it safe from speculation.  The deal is that speculators made a lot of money from their counterbets to the mortgage bubbles and that money had to go some where.  I thought it likely they would head for the commodities markets since they did that before with oil, cooper, and food.  Since these investors are by nature speculators, they have similar investment behaviors and profiles.  The movement of a large number of large dollar investors from one specific clientele into any market is going to have an impact.  Speculators moved to commodities and they moved on food. You could see the momentum build and you could trace momentum riders as they entered the market.

Before I get started on the main thrust of this post, I’d like to mention that I know a lot about Shari’a compliant finance and banking because my major professor is one of its leading authorities.  Because this discussion is going to include countries where Islam is a major religion, I would like to say a few things about how Shari’a is applied to stock markets, banks, and ‘financial engineering’ in countries where populations may be pushing for these kinds of laws.  I’d also like to say that Islamic economists share my concerns even though those concerns are rooted in different philosophies.

It is important to point out that Islamic banks and investment funds were found to be resistant to the global recession compared to their conventional counterparts.  This is because gambling and speculation is outlawed in Islamic texts and therefor not allowed in Shari’a compliant institutions.  The current U.S. and European corporate form is problematic under Shari’a.   The Qu’ran is very specific about the nature of doing business.  Most of this is based on the old testament prohibition against usury but the haddith and Q’uran go further.  However, the shared old testament roots makes a lot of Islamic financial institutions similar to the ones you find in New York  with special banks run by the Orthodox Jewish communities there. We already have religious financial institutions that follow Old Testament prescriptions. I’ve had Jewish students from Orthodox congregations provide me similar information that’s rooted in the Talmud. (Yes, I’m an atheist which makes me extra suspicious of  any religious text.)

The Qur’an also promotes shared partnership/ownership and responsibility within a business as a moral imperative between all owners of that business.  It does not promote any governmental ownership.  It is considered immoral to operate a business with a never-ending, always changing ownership pool like that present in the business form of  a public corporation. Preferred stock is strictly prohibited.  All owners must have a shared responsibility for the business.  That includes the concept of ‘negative’ profits and any negative results.  If the business does something immoral or wrong, all of the owners and decisions makers owe the societal retribution and share in the shame and negative profits. No one owner can walk away from illegal activities.

Contracts that are compliant to the Shari’a are written clearly and monitored against gharar (disception) so that gambling and speculation cannot occur and so that any thing bad the business does comes back on all the owners/investors in a business.  They all hang or thrive together over long periods of time.   That is because a business and trade are supposed to bring good results for the entire community. It’s like the idea of karma.  If you do good, every thing thrives.  If you do harm, the poison spreads and you are held to account.  The contracts are enforceable in courts.  In this case, an Islamic jurist and an angry sky god will hold you to account.  You’ve undoubtedly read exactly how old testament angry that punishment can be be in the version of Shari’a practiced by the extreme Shia Islam of Iran.  Fortunately, most adherents to Islam–like the majority of adherents to Christianity and Judaism–do not adhere to literal interpretations of Old Testament prohibitions and punishments.  They hold to the underlying moral view and practices.

Shari’a compliance means no corporate form like we use here with its limited liability financiers and assumed perpetuity. This is probably why you’ve got so many people calling Islam ‘anti-capitalist’ now.  It’s not anti-capitalist at all.  In fact, it exhorts people to share and run businesses as a moral activity.  It’s the speculation and the ability to walk away from liability that is prohibited.  It is not about government takeover of private property.  It is about holding private property owners to account for the damage they may do to society and preventing that when possible.  Of course, the plutocracy hates this.

I want to explain what this means because it’s not a Marxist form or a planned market form like you saw in the Soviet Union.  This is not a ‘communist under the bed’ situation.  Derivatives and financial engineering are being vigorously discussed by Islamic economists and financiers right now.  They are separating out the forbidden, speculative activities.  This means that many hedge funds would not be able to get into projects where the owners follow Shari’a because speculation is strictly prohibited.  All investments must be matched to “real” assets. Assets cannot be created out of thin air.  So, in this situation, forward contracts or futures contracts are allowed.  Some of the synthetic deals that characterized the pre-crisis time cannot be used by firms providing investment fund opportunities to people concerned their monies be placed in Shari’a compliant ways.  Additionally, the Q’uran has a strict prohibition on hording money.  The rich must keep their funds active in the economy to please God.  Another edict is that all activities must put aside a portion for charitable activities that support widows and orphans.  I hope this gives you enough understand to place this next discussion in context and why some people may find this appealing.

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So, maybe you can understand why gambling with food assets is a big concern on many levels for developing nations.  First, you have an incredible amount  of hungry people.  There are tales of hungry people in Africa watching boats be loaded with food they grew being shipped to rich, developed countries.  Then, you have a number of regions where gambling is basically seen as doing harm to people and is prohibited by God.  I would like to remind you that most fundamentalist Christians and Orthodox Jewish Congregations believe this too.  It’s clearly part of the old testament prohibitions.  So, modern finance is running headlong into development economics as well as people with literal old testament-based religions.  Again, Orthodox Jewish congregants have a separate banking system in New York that would be considered Shari’a compliant.  I cannot emphasize this enough.

So with this in mind, there is increasing evidence that ‘Rampant Speculation Inflated Food Price Bubble”. You can see what excessive speculation is now doing to food markets.

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