in Hedgefundistan: Its gonna get a lot worse
Financial operations do not lend themselves
to innovation. What is recurrently so described and
celebrated is, without exception, a small variation on an
established design . . . The world of finance hails the
invention of the wheel over and over again, often in a
slightly more unstable version. A Short History of
Financial Euphoria, John Kenneth Galbraith
Stock-Markets / Credit
Jul 22, 2007 - 03:04 PM
Two columns of black smoke can be seen rising over Wall
Street and disappearing into the ice-blue New York sky.
Not quite. The plumes of smoke are all that's left of two
major hedge funds which blew up just weeks ago leaving
nothing behind but a few smoldering embers and a mound of
> The compiled assets of the Bear Sterns High-Grade
Structured Credit Strategies Fundnearly $20
billionhave vanished into the miasma of cyber-space
where they will soon be joined by $1.4 trillion of other,
equally worthless, Collateralized Debt Obligations (CDO).
If you look carefully, you can almost see the mangled and
bloodied bodies of the CDOs, the CSDs, the RMBS and the
other shaky debt-instruments being pulled from the
wreckage and tossed unceremoniously on the bonfire.
Is this how it all ends? The first whiff of trouble in
the housing market and thenin a flash--all the
funds in Hedgistan begin teetering towards
No Value-No Bids
According to Bloomberg News, Bear Sterns announced last
week that there's little value left in one of
its funds and no value left in the other.
Nothing, nada, zippo.
The news was like a bucket of cold water dumped on the
stock market leaving slack-jawed traders shuddering in
What does it all mean?
Does that mean that the entire hedge fund
empirewhich is built on a foundation of dodgy loans
and quicksand---may be headed for the crapper?
No one really knows. But a pall has settled-in over
downtown Manhattan where gloomy-looking men in pinstriped
suits are waiting for the other shoe to drop.
Y'see, the hedge fund industry is based on the bizarre
notion that one does not have to produce anything of
value to make boatloads of money. You don't even need
assets any more---just a risky loan that can be
transformed into an investment grade security through the
magic of securitization a sprinkling of Wall
Street snake oil.
Abrah Kadabra---presto-chango It's like taking shards of
bottle-glass and selling it as the Hope Diamond. Who's
The only catch is that--now that these toxic CDOs are
going to auction--there are no bids. That's a bad thing.
No bids means that $1.4 trillion of shaky
investments have no discernable market-value. The CDOs
were graded mark to model which translates
into mark to fantasy. It means that the
investment bankers and hedge fund managers got together
over Martinis one night and pulled a number out of a
Now no one wants to buy them. They're worthless.
The skydiving hedge funds just pulled the CDO rip-chord
and nothing came out but confetti.
And that's just half the story. There's trillions of
dollars in derivatives riding on these shaky CDOs. That's
enough to bring down the whole market in a heap once
interest rates rise or liquidity dries up. Now it's just
a matter of when now, not if.
This illustrates an important point, though. It shows
what it takes to be a good hedge fund manager:
Take a shabby sub-prime mortgage; chop it into
investment, mezzanine and
equity tranches. Bundle it with other equally
suspect mortgage backed securities (MBS). Decide
(arbitrarily) what the CDOs are worth Tell your banker.
Leverage at a ratio of 10 o 1. Take 2% off the
top plus salary for your efforts. Buy a summer home
in the Hampton's and a Lexus for the wife. Wait for the
crash. Then repeat.
Congratulations; you are now a successful hedge fund
Oh yeah; and don't forget to prepare a few soothing words
for the investors who just lost their entire life savings
and will now be spending their evenings squatting beneath
a nearby freeway off-ramp.
We're so very sorry, Mrs. Jones. Can we get you
some cardboard-bedding to keep off the rain?
The problems that are appearing in the stock and bond
markets all started at the Federal Reserve when Fed-Chief
Alan Greenspan opened the sluice-gates in 2003 and
lowered interest rates to 1%. (Way below the rate of
inflation) Since then, trillions of dollars have flooded
into the markets creating multiple equity bubbles in real
estate, stocks and credit.
Serial bubble-maker Greenspan is to finance-capitalism
what Wrigley is to chewing gum. The greatest flim-flam
man of all time.
The Fed has tried to conceal the massive increase to the
money supply, but the evidence is everywhere. (Many
analysts now calculate that inflation is running at
roughly 13%) Food and energy have skyrocketed. Housing
prices have soared. Everything has gone up except the
cheapo imports which the Fed uses to manipulate the
The gigantic housing bubble is mostly Greenspan's doing.
After printing-up mountains of cash and creating
artificial demand through low interest rates; he promoted
his product-line with the typical huckster sales-pitch.
Maestro advised us that the extension
of credit to all-God's creatures, worthy or not, is a
Here's a clip of Alan praising subprime lending in a
speech on April 8, 2005:
"With these advances in technology, lenders have
taken advantage of credit-scoring models and other
techniques for efficiently extending credit to a broader
spectrum of consumers. . . . As we reflect on the
evolution of consumer credit in the United States, we
must conclude that innovation and structural change in
the financial services industry have been critical in
providing expanded access to credit for the vast majority
of consumers, including those of limited means. . . .
This fact underscores the importance of our roles as
policymakers, researchers, bankers and consumer advocates
in fostering constructive innovation that is both
responsive to market demand and beneficial to
Yes, of course, with all these advances in
technology and new-fangled credit-scoring
models why would we need to verify a
loan-applicant's income or require that he scrape
together a measly $5,000 for a $450,000 mortgage?
That's all so 20th Century!
Now that foreclosures are mushrooming at an
unprecedented pace, the Fed is trying to distance itself
from the problem by blaming the banks for their shoddy
underwriting practices. But the guilt lies with the
Central Bank. Its all part of their whacko plan to crush
the dollar and create a police state.
It may sound trite, but inflation is theft.
Unfortunately, inflation is also part of the ruling
class' strategy to rob the poor, fuel the stock market
with cheap credit, and move jobs overseas. It is the
autocrat's method of social
engineering---shifting wealth from one class to
another by simply printing more money and pumping it
through the system via low interest rates. Remember,
bankers know that people will ALWAYS borrow money if
lending standards are relaxed and the money is cheap
enough. At 1%, the Fed was basically losing money on
every transaction, but persisted with their plan anyway.
Anyone who cares to go back and trace interest rates
moves for the last 7 years will see that the Fed is
really a political organization that decides monetary
policy entirely on the basis an elite agenda that
supports endless war, outsourcing of American jobs, and
Are you surprised?
Now, a bad situation is about to get a whole lot worse.
Consumer credit rose last month by a whopping
12.9%---credit card debt by 9.8%! Since housing prices
have flattened out, homeowners can no longer borrow on
their dwindling equity (Mortgage Equity Withdrawal; MEWs)
which is forcing the maxed-out American consumer to use
plastic even though rates are averaging from 18% to 27%
Automobile repos have also hit historic highs. But the
real damage is showing up in the subprime market where
the percentage of defaults continues to rise unabated.
In itself, a correction in real estate is not enough to
bring down the whole economy. Unfortunately, the
contagion from the subprime meltdown has spread to the
stock market, the insurance industry, banking and
pensions. Not even Secretary of the Treasury, Henry
Paulson or Fed-master Ben Bernanke are claiming that the
subprime problems are contained anymore. Just
this week, the scholarly looking Bernanke said to
Senators on the Hill that the housing market has
It's about time. If anyone still has any doubts about the
magnitude of fiasco, I recommend they look over these
eye-popping charts which tell the whole story. The
housing blowdown will spread the carnage from sea
to > shining sea. http://www.itulip.com/forums/showthread.php?p=12232#post12232
The faltering housing market has drawn attention to an
even more colossal credit bubble that is limping towards
earth as loan requirements tighten and liquidity dries
The prevailing fear on Wall Street is that we may be
seeing the beginning of a global credit crunch.
The danger is not just the subprime loans or even the
mortgage companies that made the loans, but the overall
risk to the secondary market where these loans have been
sold as CDOs to the tune of $1.8 trillion.
In this new deregulated environment, the banks don't have
to rely on savings anymore to make the loans. They simply
originate the loans, take their commission, and sell the
debt as CDOs. They're even allowed to sell the risk of
default through credit default swaps (CDS) which are a
form of insurance that minimizes the banks exposure.
These weird innovations have spawned riskier and riskier
loans and increased the likelihood of damage to the
The Toxic Cycle of Debt?
Economics correspondent, Stephen Long, explains it like
The problem that arises from the subprime mortgage
collapse is that it creates a toxic cycle of debt. Banks
originate loans or bundle up loans that mortgage
companies have made and sell the risk on to the hedge
funds. Then the hedge funds say, Hey, we've got
this product that has an investment grade rating so we'll
borrow against it from the banks.' (oftentimes leveraged
at a ratio of 10 to 1) Now the hedge funds are trying to
buy the original loans to stop them from going into
default.(The hedge funds are forced to slow the
rate of foreclosures so they won't go bankrupt.)
So, what happens when these shaky bonds (CDOs) are
Will the hedge funds fall like dominos just like the
subprime mortgage-lenders? Will we see liquidity
evaporate in the broader market triggering a plunge in
the stocks and a massive sell-off in the bond market?
CDOs were conjured up with the idea that vast amounts of
money could be made on very meager assets through a
complex expansion of leverage. They were promoted as
limiting risk by spreading it to a greater
number of investors and providing extra protection
through derivatives. Mortgage Backed Securities were
sliced and diced into more risky and
less risky tranches depending on investor
appetite. Only nowto everyone's
surprise---collateralized debt obligations with
stellar Triple-A ratings have been getting hit by the
subprime market's woes. (Wall Street Journal,
Bernanke revises subprime outlook) On top of
that, the ABX derivative index has started showing
pronounced weakness at the top of its ratings
structure. (ibid WSJ, > 7-19-07)
Get it? In other words, even the VERY BEST of these
multi-trillion dollar investments are beginning to
falter. The contagion is spreading through the entire
market. The CDOs are worthless. No one wants them. In
fact, the whole new regime of exotic debt-instruments
which emerged from 2000-on, is barely hanging on by a
thread. One minor downturn in the stock market and the
hedge funds will go freefalling through open space.
A speech by Robert Rodriguez of First Pacific Advisors
(CFA) gives us a good idea of the enormity of the money
involved. In his Absence of Fear address in
Chicago on June 28, 2007 he states:
Since 2000 hedge funds have more than doubled in
number, while their assets have tripled. They too are
using elevated levels of leverage, as are PE (Private
Equity) firms and investors in highly leveraged fixed
income securities. These funds are heavy users of
derivatives. The Global derivatives market grew nearly
40% in 2006--the fastest pace in the last nine years--to
$415 trillion, per the Bank of International Settlements.
The amount of contracts based on bonds more than doubled
to $29 trillion. The actual money at risk through credit
derivatives increased 93% to $470 billion, while that
amount for the entire derivatives market was $9.7
trillion. The International Monetary Fund, in its April
Financial Stability Report, estimated that
credit-oriented hedge fund assets grew to more than $300
billion in 2005, a six-fold increase in five years. When
levered at 5-6x, this represents $1.5 to $1.8 trillion
deployed into the credit markets. Fitch, in their June 5,
2007 special report, Hedge Funds: The Credit
Market's New Paradigm, says that despite the upward
trend in maximum allowable leverage, notably, no
prime broker reported raising margin requirements in
response to historically tight credit spreads and growing
concerns about the general level of risk-complacency in
the credit markets.
If Rodriguez's eye-popping numbers are
accurate and the market slumps a mere 5%, the value
of a hedge fund's assets could lead to a forced sale of
as much as 25% of its assets. If the market falls
just 10%, the fund would get a 50% haircut!
Yikes! That just shows how over-exposed the industry
As the requirements on mortgages gets tougher and the
subprime market continues to languish; bankers will
naturally become more hesitant to loan zillions of
dollars to hedge funds and private equity firms. When
credit gets tighter, the hedge funds will begin to
nosedive which will send the stock market in a long-term
swoon. That's what happens when a market is this
over-leveraged. It's unavoidable.
The markets are now perfectly poised for a full-system
breakdown. FDIC Chairman Sheila Bair expects a CDO time
bomb. She summed it up like this: "Its going to get
worse before it gets better. How much worse, I don't
By Mike Whitney
Mike is a well respected freelance writer living in
Washington state, interested in politics and economics
from a libertarian perspective.
Market Crash Forecast Suggests New 9/11
Paul Joseph Watson
Monday, August 27, 2007
Mystery trader bets on huge downturn that could only
be preceded by catastrophe
A mystery trader risks losing around $1
billion dollars after placing 245,000 put options on the
Dow Jones Eurostoxx 50 index, leading many analysts to
speculate that a stock market crash preceded by a new
9/11 style catastrophe could take place within the next
The anonymous trader only stands to make
money if the market crashes by a third to a half before
September 21st, which is when the put options expire. A
put option is a financial contract between two parties,
the buyer and the writer (seller) of the option, in which
the buyer stands to benefit only if the price of the
"The sales are being referred to by
market traders as "bin Laden trades" because
only an event on the scale of 9-11 could make these
short-sell options valuable," reports financial blogger Marc Parent.
Dow Jones Financial News first reported on the story.
The trader stands to make around $2
billion from their investment should an event trigger a
market crash before the third week in September.Such a
cataclysmic jolt could only happen as a result of two
factors, China dumping its vast dollar reserves in
reaction to the sub-prime mortgage collapse, which it has threatened to do, or a
massive terror attack on the same scale or larger than
9/11 itself was foreshadowed by
unprecedented put options that were placed on United
and American Airlines. Though the Securities and Exchange
Commission refused to reveal who placed the options, private researchers traced the
investments back to the Deutsche Bank owned
Bankers Trust, which was formerly headed by then
Executive Director of the CIA, Buzzy Krongard.
Put options on Morgan Stanley and Merrill
Lynch, two of the World Trade Center's most prominent
occupants, also spiked in the days before 9/11.
News of the suspicious trades is
dovetailed by the comments of Former US Treasury secretary
Larry Summers yesterday, who told ABC News that the
risk of a recession in the U.S. was greater that at any
time since 9/11.