Leverage

This note is a bit alarming. There are three ways to make A LOT of money. One, pick stocks well (Warren Buffett and James Simons. The second is starting an incredible software company. And the third way is real estate -- see what Mort Zuckerman has accomplished.

What they have in common is leverage. Suppose you have a sharp eye and know a good deal -- you buy a piece of property for 100,000 and put 10,000 down. You make some minor modifications, you market the property better, place increase 25% in value in one year. You sell for 125,000. Now your increase on investment is not 25%, it's 250% (your 10,000 is now $25,000). Nice.

I think what happened here is a bunch of hedgies bought MBS securities with two ideas in mind -- one, they thought the MBS securities would give them a nice steady return. Two, they thought the securities could be used as collateral to increase the amount of leverage in purchasing equities.

That's why we see patterns emerging where at some point during the day, a bunch of equities are sold. And then, later in that day, there is a huge rally. The sell off is occurring b/c as the MBS securities start to lose value, the banks are demanding the funds put up more collateral. Plus, I bet the banks are tightening their margin rules and asking for more in the bank to cover the loans. So then you are a hedge fund, you need to have cash on hand to keep your leveraged positions around, there is limited liquidity in the credit markets, so your safest (only) option is to drop your equities.

Now on the other side, I'm a trader -- there is nothing fundamental in most of the market to justify the sell off of these equities. So I start buying up.

The next day, same thing happens, funds need to sell to cover -- so I sell too! And then at the end of the day I buy back the shares. Nice!

Somebody is making a lot of money right now.