Eric Cantor Bets Against the Treasury
Eric Cantor Bets Against the Treasury
C.D. Alexander Evans: Eric Cantor Bets Against the Treasury
A recent Salon column written by Jonathan Easley made my jaw hit the floor. Could it really be that Eric Cantor, the Republican Congressman from Virginia and the House Majority Leader, bet against the market for U.S. Treasuries? The same Eric Cantor who is serving as the lead negotiator for the Republican Party in the debt-ceiling talks?at a time when the main risk factor for Treasury bonds is a government default? Did Eric Cantor really bet between $1,000 and $15,000 that the talks he was purportedly leading in good faith would fail?
Yes, apparently he did. But not to worry, says his spokesman Brad Dayspring, who deployed the usual defense: Cantor was just hedging. Cantor?s pension is largely in Treasury bonds, so sometime last year he decided to ?diversify his portfolio.?
While Salon is right to sharply criticize the glaring conflict of interest created by Cantor?s decision to buy (a conflict exacerbated by his decision not to sell when he became the lead Republican negotiator), Easley takes Dayspring?s explanation more or less at face value: it was a normal hedge, and while $15,000 in a ProShares Trust Ultrashort 20+ Year Treasury ETF might be a lot of money for you and me, it isn?t for Eric Cantor.
Except that what Dayspring said is completely false. This purchase it isn?t a hedge. Eric Cantor isn?t diversifying his portfolio; he?s betting that the market will suddenly collapse. Cantor bought ETF shares in a daily leveraged ETF. For various reasons known to any financial manager, nobody would ever use a purchase like this to gently balance their portfolio over long-term Treasury risk. The move only makes sense if Cantor wants to guard himself against a sudden and imminent collapse in Treasuries. Given the current political climate, his decision to continue to hold onto his short option could mean only one thing: he?s betting the government won?t reach a deal.
A brief explanation of the financial terms involved shows the cynicism of Cantor?s position:
? A ?short option? is an inverse position for a stock. If you buy shares, you bet that the price will rise. If you short shares, you bet that the price will fall. You get a payoff if the price drops, but you lose money if the price rises.
? An ?ETF? is short for an ?exchange-traded fund?; it?s a type of financial instrument that can be traded like a stock.
? ?Leverage? is the act of borrowing money to increase investment exposure. If I buy $1,000 of stock in Intel with my own money, I own $1,000 in shares with no leverage. If I borrow $1,000 and, combining it with my own money, buy $2,000 of stock in Intel, I won $2,000 in shares with 200 percent exposure. I just used leverage. Leverage increases risk, but, if you bet right, it increases return. A daily leveraged ETF is a type of fund that uses this effect.
? Treasury bonds are issued in different terms of maturity?the longer the term, the more volatile. Short-term bonds for three or so months are very stable. Long-term bonds of five to ten years are much more volatile. Ultra-long-term bonds of 20+ years are very, very volatile. On the ProShares website, Ultrashort ETFs are the most aggressive short ETFs offered.
Is it possible that Cantor is just using a very volatile and aggressive way to balance his portfolio? If he is, it?s a terrible strategy. Over time, leveraged ETFs suffer from two big problems: tracking errors (caused by the fact that the ETF does not perfectly mirror the underlying asset, i.e. Treasury bonds) and volatility drag (errors caused by the mathematical nature of the way volatility interacts with returns). Over time these errors compound and drag down the value of all leveraged ETFs.
If Cantor had bought moderately leveraged holdings in the broad stock market this wouldn?t be a problem; it would just mean he thought that the extra exposure justified the added costs. But he didn?t. Cantor bought massively leveraged holdings on the most speculative of transactions, and he bet downward. This isn?t the sort of bet a man would make if his adviser suggested gently lowering his exposure to Treasuries. This is the sort of a bet a man would make if he expected a sudden and sharp fall in the value of U.S. debt.
Because of the nature of tracking errors and the type of asset Cantor purchased, the explanation given by his spokesperson doesn?t make any sense. Cantor wasn?t diversifying his portfolio; he was placing a short-term bet to guard against the risk of his party?s own negotiations failing. It would be hard to miss these details: the prospectus for the ProShares ETF Cantor bought clearly warns about the risk of major tracking errors and cautions investors to closely reexamine their positions each day.
Eric Cantor is supposed to be negotiating in good faith for a way to end the debt-ceiling impasse. Whether he is ultimately long or short on Treasury bonds, his decision to place an aggressive speculative bet on a collapse of the value of federal debt calls his good faith as a negotiator into question. He should never have bought the shares, and he should have sold them, immediately, as soon as he became intimately involved in the debt-ceiling negotiations. His failure to do so is appalling. At the very least, House Speaker John Boehner should select a different member of the majority party to represent Republicans at the negotiating table in the future.
Image: Eric Cantor (TalkMediaNews, 2011, Flickr cc)
