If Metallgesellschaft had stuck it out the "stacked front month" hedge would have worked. Management however lost their nerve when faced with multi-billion dollar drawdowns, either the trader hadn't fully explained how the economics worked or mgmt. had said Ja, ja without comprehending.
From DealBreaker:
The following post is by Dealbreaker reader and commenter Infinite Guest.
A few years ago I was fortunate to attend a lecture given by Paul Wilmott challenging the wisdom of modeling derivatives on the assumption that there is no arbitrage. He floated an alternative approach (as but one of many possible heterodox approaches) outlining the pitfalls therein – chiefly the difficulty of convincing investors to bear with you until your thesis proves out – and toward the end he took questions. Some brave soul asked him, “Where does the money come from?”
“Thin air?” he replied.
Whether you consider money a medium of exchange, a store of value, a means of paying taxes or a means of keeping score, money in aggregate is a denominator. It purports to measure things like wealth and income. A “stable” currency in some sense is therefore desirable, and we all have a common interest in seeing to it that money is created or destroyed, made available to the economy or not, in some sort of equitable or at least responsible fashion, by people and institutions we feel can somehow be held accountable for their actions. In ordinary times one you would have very little motivation to question where money comes from but after being told every day of your life for a few years that the global financial system, having lately suffered a near-death experience, is a social ill, inherently flawed, fragile and corrupt, which might at any time blow up the economy and abscond with your job, your house and your savings in tow, then you might become if not strictly speaking curious at least concerned. You might seek safety in a gold standard or some other type of commodity money. You might get worked up about the national debt or the Federal Reserve. You might even, as IMF economists Jaromir Benes and Michael Kumhof have been doing with their excellent working paper “The Chicago Plan Revisited” search for answers in the creative past and, with the benefit of modern technology, conclude that the time has come to end fractional-reserve banking once and for all....MORE
