Hedge Hogs (not the cute prickly kind)

I just finished reading Hedge Hogs by Barbara Dreyfus.  The book recounts the rise and fall of the Amaranth hedge fund and its star trader Brian Hunter.  In the summer of 2006 Amaranth lost approximately USD 6BB trading natural gas.  I have some personal interest in this story because at the time there were two other large hedge funds Centaurus and MotherRock also trading natural gas.  The clearing firm that I worked for at the time had to deal with the blowout of MotherRock - which resulted in large part from Amaranth's enormous positions.  This is a well  written and fast paced book and it does well to capture the environment of the time as I remember it.  I recommend it.

On page 139 of the book there is a passage that every risk manager should read and re-read and re-read again.  This takes place during February of 2006.  A that time, Hunter's positions were already extremely large and growing.  He was making money.  A lot of money.

Arora went to Jones to express his concerns over the size of Hunter's positions.  A little while later he also brought it up with Maounis.  "They reacted positively and told me they appreciated my input,"  Arora later said.

"Harry has a good nose for smelling danger," says an analyst who knows him.  "Harry saw what Hunter was doing was so risky that it was dangerous."

But Hunter was minting money.  "Most people were just amazed at how much money he was making," remembers a former Amaranth trader.  "You don't want to kill the goose that lays the golden eggs.  It was good for everyone when he was making money."

Other traders, back-office staff, and executives could see Hunter's profit-and-loss statements and could guess at the amount of money he traded.  Some could see his spreadsheets.  Other portfolio managers raised an eyebrow as they watched the volatility of his book.  But there was little incentive to say anything.  Everybody could see their bonuses growing.  If Hunter was trading outsized positions, he was earning outsize profits - he earned the firm USD 320 million in February.  He must know what he's doing, people told themselves.

"Human nature is such that when someone is making a lot of money, you don't question them," says another Amaranth trader.

Nothing was done about Arora's concerns.