What would you have donedifferently as the crisis occurred? Essay

The sharp disagreement of the Supervisory Board and its old board about the fundamental of MGRM’s forward-delivery program was what decided MG’s fate and not its inability to deal with a short-term liquidity need. The huge losses in 1993 of MGRM’s occurred so that MG’s Supervisory Board reassess its priors about the possible risks involved in it forward-delivery programmes. The risks that could occur (rollover and credit risk) are considered to be the reason of their decision of ending their forward-delivery program. Moreover, it is highly believable that the Supervisory Board thought that MGRM’s strategy was fatally flawed a fact that can be proved by their rejection on December of alternative actions that could have protected the company against further margin outflows. They were even describing the hedging strategy of MGRM as “a game of roulette”

They could have protected theirselfs against further outflows due to price decline by purchasing put options on energy products that where available in that time. A strategy that could have neutralized the further outflows on MGRM’s swap positions and long futures. The decision of the Board to liquidate MGRM’s derivatives position was considered a wrong time decision. When the liquidation occurred, the price was at its lowest in many years with sustainable losses for the company when they were sold (the liquidation period started at 17 December 1993, when the new management took control). If the Supervisory Board had not ordered the liquidation at that time but sometime later (so they had held the hedge for some time more) the situation of the company would have been totally different from today. From the time that liquidation started to 8 August 1994 the crude oil prices increased from $13.91 to $19.42 and so did the heating prices by almost $2 ($18.51 to $20.94) and the gasoline prices rise as well by almost $7.7 (from $16.88 to $24.54 a barrel).

So, considering the increasing in the prices and if the Supervisory Board of MG had not liquidated at that time, the MGRM company would have had a massive in-flow of margin funds on its derivative positions.

Other ways that the Board could have used to protect the MGRM company would have been the following:

The board of the parent company could have used a different, less risky, hedging strategy to reduce risk exposure. They could have used a minimum variance hedging strategy, reducing its funding risk. Furthermore, they could have used strips of long dated furores or forwards with delivery dates that matched those on its forward delivery contracts (suggested by Mello and Persons). A strategy without needing to roll positions forward and so would have not been exposed into rollover risk.

So, whether the MG’s Supervisory Board decision of abanding the hedging program was the correct one, it is clear that the lack of understanding at the Board level played a significant role in the fate of MGRM. The boarding was criticized for not understanding fully their subsidiaries activities and not supervising and monitoring those activities adequately.

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