Kyle Bass on his new Japan trade at the University of Chicago

Kyle Bass Personal Photo

The eminent hedge fund manager Kyle Bass, who has a big trade, also known as the “widowmaker” among market circles, because he is betting against Japanese government bonds. Last week Kyle Bass talked at the University of Chicago.

During his talk, somebody asked him a question concerning the Japan trade. Some people call it the “widowmaker” since any other investor will bet against Japan when seeing that it has the world’s largest percentage of GDP debt.

Bass was told that banks are beginning to realize that they underestimate the risk from a blowup in the Japanese bond market. That is the kind of vibe Kyle gets when he talked with his counterparty.

Moreover, Kyle Bass said that the world’s AIG is back.

Here is an excerpt from his talk at the University of Chicago:

Тhe AIG of the world is back. Here’s what I mean by that.

I have 27-year-old kids selling me one-year jump risk in Japan for less than one basis point. $5 billion worth at a time.

You know why? Because it’s outside of a 95 percent VaR. It’s less than one year to maturity. So guess what the regulatory capital hit is for the bank? It rhymes with “hero.” Right?

And, if the bell tolls at the end of the year, the 27-year-old kid gets a bonus. And if he blows the bank to smithereens, ah. He got a paycheck all year.

We’re right back there. I mean, the brevity of financial memory is only about two years. I wouldn’t sell nuclear holocaust risk in Dallas for less than a basis point. You should be fired for thinking about selling something for less than 50 basis points, you know? And yet, this is happening again.

And it’s happening in huge size. You know, huge. We bought $0.5 trillion worth of these options.

Interestingly enough, recently, one of the biggest banks in the world called me and asked me if I would close my position. That was an interesting day for us. That happened to me in 2007, right before the mortgages cracked.

They said, “You know, we ran some new risk tests.”

And I said, “Really?”

And they said, “Yeah, you know, our new stress scenario is a little bit more punitive than the last one.”

And I said, “Well, what is it?”

And he says, “We don’t want to share our proprietary secrets of our bank with you.”

And I said, “OK, then I’m not closing it.”

And they said, “Whoa, whoa, whoa, whoa. Well, how about: in our old one, we had rates being stressed 50 basis points, and the new one has rates being stressed 400.”

And I said, “Ooh, yeah, 400. That would really hurt you on this trade, wouldn’t it?”

And they said, “Yeah, we’d like to close that one.”

And I said, “Well, I’d like to, but I’m not going to do that for you, so I’m sorry.”

But anyway, they are starting to realize. Why would they run a stress test like that? Who would have them run that stress test? This is happening.

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