Will markets ever work again? The actions of the LME this week, in forgiving a Chinese nickel producer and certain brokers who dealt with the company their terrible trades suggest that the answer is no. James Mackintosh reports for The Wall Street Journal:
The tide went out this week in London’s nickel market, and we discovered—in Warren Buffett’s immortal words—who had been swimming naked: a giant Chinese producer that couldn’t meet its margin calls, additional security brokers require when leveraged trades lose money.
Instead of letting the market cleanse itself of this indebted trader, the exchange decided to wade in and save the firm from the consequences of its bets by canceling the trades.
This isn’t just a one-off in an obscure commodity. This is the natural conclusion of a trend that is undermining free markets and creating all the wrong incentives: A growing reluctance by the authorities to let financial groups go bust, even when they aren’t too big to fail.
The problems started on Tuesday morning, when traders on the London Metal Exchange smelled blood and nickel prices almost doubled. China’s Tsingshan Holding faced a $1 billion-or-so margin call that exchange officials feared it couldn’t meet. Rather than let it fail, which would probably have taken down several of the smaller LME brokers that had serviced Tsingshan, LME decided to cancel all that day’s trading, more than 9,000 trades worth about $4 billion.
It. Canceled. The. Trades. Not because of a fat-finger error, which exchanges often cancel. Not even because of a rogue algorithm (as regulators claimed in the 2010 flash crash in U.S. stocks). But because someone with too much leverage was going to blow up, with knock-on effects on some members of the exchange.
This is moral hazard taken to its extreme. It has always been true that if you face a $100 margin call it’s your problem, while if you have a $1 billion margin call, it’s the brokers’ problem—and the authorities might save them. What is almost unprecedented here is that the exchange authorities decided to save them with money taken from other traders, who otherwise would be sitting on fat profits.
I say almost unprecedented, because it has happened before: Arch-speculator Jay Gould, dubbed the “most hated man in America,” bribed Senator William “Boss” Tweed and corrupt New York judges in 1869 to delay settlement of his gold dealings and so avoid losses after his efforts to corner the market collapsed.
Read more here.