The cat's out of the bag. Happy April Fool's!
Yesterday, the Federal Reserve officially ended its $1.25 trillion program to buy mortgage-backed securities. Today, The Motley Fool's latest venture, Long-Term Mortgage Management (LTMM), will pick up where the Fed left off by buying up $1 trillion of mortgage-backed securities. We've begun purchasing these mortgage-backed securities by raising capital from our community and combining it with a good deal of leverage. If you missed our announcement, read it here before continuing on to the update below.
We've got some bad news, Fools.
The short version
A butterfly spread options strategy flapped its wings in Asia, causing it to rain on the U.S. housing market. Long-Term Mortgage Management is now effectively bankrupt.
The long version
One of LTMM's traders in Hong Kong made a series of diversifying over-the-counter derivatives transactions today, including what he thought was a butterfly spreads option call. It wasn't.
What he actually bought was a reverse-buy credit default swap on a 56-to-1-leveraged synthetic sugar future. In a "reverse-buy" transaction, the buyer is actually selling. The problem came with the "synthetic" part of the sugar future. The sugar future was constructed synthetically using another leveraged instrument, which is a "leverager of leveragers." Basically, this made our position sensitive to the mark-to-market movements of a privately owned Chilean sand manufacturer.
Our models could not have predicted this eight-sigma event. This sort of price movement is supposed to occur only once every 17.3 days, and we had a similar event on Tuesday.
Long-Term Mortgage Management is now effectively bankrupt.
But fear not. We may be down, but we're not out. Because we've secured the government's support in writing -- it's like a "Get Out of Bankruptcy for Free" card -- we're absolutely positive that we'll be too big to fail and the Fed will bail us out with taxpayer dollars. We're expecting to officially make this announcement tomorrow, so check back with us then.