Mauboussin on Strategy: The Failure of Arbitrage

Author's Avatar
May 21, 2008
It’s like there are two businesses here—the old business, which works fine under normal conditions, and this stand-by business, when the world goes mad. And for that, you either need to buy insurance or have a pool of stand-by capital to take advantage of these opportunities.





When Lead Steers Get Lost


Sometimes people aren’t there when you need them the most. Almost 30 years ago, investment firm J.F. Eckstein & Company bet that the gap between Treasury bill futures and the underlying securities would narrow. The trade, which Eckstein had successfully put on before, was particularly attractive, so the firm increased the size of its typical bet. But this time the gap widened, triggering margin calls and quickly slashing Eckstein’s capital.


Eckstein had no choice but to seek help. His rescuer, as it turns out, was a thirtysomething bond trader named John Meriwether. Meriwether, who had just set up a bond arbitrage desk at Salomon Brothers, immediately saw the virtue of the trade and agreed to take over a significant part of Eckstein’s portfolio. Following some short-term pain, the trade unfolded as Eckstein had originally anticipated, providing a windfall for Salomon and launching Meriwether’s career.


Read the complete article