Sunday, April 27, 2008

Hard landing after hedge fund “mass heist “

The herd, the hedge fund and the billion dollar rip-off. How we all got mugged

Herd-like behaviour among investors is not simply explained by stupidity. Most asset bubbles are fairly obvious phenomena, even while they are still inflating, yet despite the fact that everyone knows they must eventually deflate, they remain strangely seductive. Nor is this apparent willingness irrationally to ignore the dangers explained entirely by greed: you know it's a bubble, you know it will eventually end, but hey, prices could double again before gravity takes hold.

Posted by doomwatch @ 10:28 AM (841 views)
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3 thoughts on “Hard landing after hedge fund “mass heist “

  • Back to Pensions again:-

    ‘Unfortunately for you and me, some wretched trustee or rule-setter somewhere will have decreed that, because hedge funds are such a spectacularly high-performing new asset class, part of your pension must be invested in them even though common sense would tell you it’s a con. Hey-ho.’

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  • There’s little discussion of the role of the monoline insurers in all this. When the monolines gave AAA ratings to the senior (debt-type) tranches of CDOs/securitised vehicles this enabled banks to leverage massively because AAA rated securities on balance sheets require no more than 0.56% of capital cover (8% general capital requirement multiplied by 7% risk weight on AAA securities under the Basel II agreement). Because of this miniscule capital cover AAA tranches paying no more than Libor + 10 basis points (0.1%) often produced a 20% return on equity. Various conduits and Structured Investment Vehicles also decided to ‘ave some of that. The further twist was that they used short-dated funding through another little-discussed piece of financial alchemy – maturity transformation, or the morphing of long-term assets like municipal bonds into short-term debt that was usable for cash investments. It has been estimated that almost $6 trillion has been morphed in this way. Junior (equity-type) tranches of CDOs were also leveraged and therefore risky, but the hit they took was greatly magnified by the short-term funding of the senior tranches – instead of being locked in for a long time, as was usual, the holders of these senior tranches forced fire-sales that drove down prices and, in many cases, bankrupted the juniors. It was a run on securitised credit, like a old-style bank run. The core players in this game knew that they were creating cluster bombs. (See the JP Morgan Global Issues report ‘How the crisis will change markets’ for more on this.)

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