Thursday, May 7, 2009

First Alert in VIX Model in 2007: Clearly Tied to Mortgage Problem

In a prior post, I said that it was clear in February 2007 what caused the Alert in the soon to be developed Vix Asset Allocation Model in February 2007.  On 2/26/2007, the VIX closed at 11.15, a very stable reading in Phase 2 of the Stable Vix Pattern.  The VIX had been showing remarkable stability for several weeks.  Then, on 2/27/2007 it closed at 18.31, clearly an Alert under the model.  At this juncture, the very best people in a financial organization need to be focused on the issue, given the magnitude of the break.  What does it mean?  What are the ramifications? Do we really understand the scope and depth of the issue?  

On 2/22/07, HSBC fired the head of its U.S. mortgage lending business taking around a 10.5 billion dollar loss.  This is a link to a time line on the mortgage crisis from the BBC. BBC NEWS 
On 2/27/07 Freddie Mac announced tougher standards for subprime borrowers.  News Archive - Freddie Mac  Subprime lender NovaStar warned on 2/22 of staggering losses on its subprime portfolio. For a reminder of events in late February 2007, this is a good summary from BusinessWeek.Subprime 
My interpretation of it at the time was that smart money knew the scope of the problem and its potential ramifications, and started to unload equity positions.  But there can be no doubt as to what caused the spike in VIX in February 2007, disrupting the calm which had existed for months.  This was not a Trigger Event under the Model since the VIX was still in the stable range.  The second flood of bad news produced the Trigger event in August 2007.  That could not be ignored.  At that point, a large financial institution would need to bring in the best people that it can find to dig and think deep.  Of course, based on what I have read over the past two years about the leaders of our large financial institutions in 2007 and 2008, anyone raising a red flag would have been fired, no one would want to put his hand between a carnivore and a multi-million dollar bonus. 

This Model  is based more on psychology, philosophy and history than mathematical models produced by pets from MIT. 

LB re-read the rant of RB from last nightRB Touts His Horn as HQ Closes for the Evening, and decided it was best to put it back in its place.  LB took down RB's picture from the profile and substituted its own.  LB pointing out that the only reason RB has any capital to invest is due to LB's rules. 

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