15  Even the Hedges, Princes of High Finance, are Feeling the Subprime Squeeze


We must apologize to our readers for dwelling on so many aspects of the subprime earthquake – for it is nothing less. And that conclusion shaping under our eyes needs some overview. You cannot leave it to the BIS and Wall Street that had their heads so deep in the ground to do the final summing-up.

The Wall Street Journal (28/12, "Hedge Funds Feeling Pinch on Credit, Too" by Gregory Zuckerman and Alistair MacDonald) bring yet another aspect of the monetary devastation unloosed upon the world with the utter innocence that only unlimited greed can inspire: "It isn’t just consumers who are having a harder time getting credit from lenders. It’s hedge funds, too."

Pardon my tears.

"Investment banks are cutting back on loans to hedge funds, eliminating some clients and raising borrowing fees to others. The lenders are slimming their balance sheets after heavy losses in the debt markets in recent months. And after taking multi-billion-dollar write-downs, they also are becoming more cautious as the economy slows, according to people familiar with the situation.

"‘Banks aren’t in a position to be accommodating at the moment,’ said Michael Hintze, CEO of CQS, a London-based hedge fund with $9 billion under management. If the change continues, it could put some pressure on the profits of the prime brokerage units of the major banks, which make big money by lending to hedge funds, as well as by helping the funds manage their cash and short stocks by borrowing and selling as a bet on falling prices."

That is quite a repertoire for the one song-book, and the inevitable consequences our central banks and government had completely failed to foresee.

"The move also could put pressure on the returns of some hedge funds, which often rely on healthy doses of borrowed money, or leverage, to boost returns."

"‘Leverage definitely drives returns,’ says David Gold, an executive at Watson Wyatt Worldwide, which works with corporate pension plans on their hedge-fund investments.

"In particular, Mr. Gold says quantitative funds – those that trade using certain computer models – are seeing their borrowing ability reduced, on the heels of the uneven performance of some funds this year. He says the move by the banks will have the biggest impact on the smaller hedge funds."

For, as the lullaby goes, everything must expand faster and faster in this ever shrinking world.

Thus the article continues: "‘Groups like Morgan Stanley and Goldman Sachs will feed more leverage to their biggest, better clients,’ says Mr. Gold.

"Firms are turning away more potential clients and scrutinizing newer hedge funds, worried about their ability to repay borrowed money, even though most hedge funds have had a good year, rising 12% through November.

"Prime brokers like Morgan Stanley, which has one of the largest business catering to hedge funds, have made repurchase agreements so expensive that some funds are going to rival firms to borrow money, according to people familiar with the matter.

"Hedge funds often borrow money through ‘repo’ operations, a financial arrangement in which the hedge fund sells securities to banks in exchange for cash, while entering into an agreement to [get] them back at a later date when they pay the money back. The interest rates that hedge funds pay for this borrowed money have shot up in recent months.

"One example: Morgan Stanley, which has written down more than $10 billion of mortgage assets, has been asking for as much as one percentage point over the London Interbank Offered rate [Libor] to enter into a repo agreement using ‘junk’ bonds as collateral, in recent weeks. That is up from just 0.10 point before the summer. Some rivals have raised their own rates, but not as much, says one investor. Morgan Stanley’s rate on investment-grade debt is as high as 0.40 percentage point, up from less than 0.10 percentage point, these people say.... The market is putting as new price on risk."

Formerly it was cut up and wrapped up with the other groceries just like a few slices of baloney.

"The biggest players catering to hedge funds in recent years have been such as Morgan Stanley, Goldman Sachs, and Bear Stearns. These firms don’t take deposits as a retail bank does, so they have less cash on hand. Large banks such as Citigroup Inc., UBS AG and Credit Suisse have large low-cost deposit bases, and some say they may be able to take some market share from the investment banks.

"Still, Jacques Mechelany, managing director of Geneva-based hedge fund Heritage Fund Management SA, points out that banks like Citigroup and the UBS have felt deep pain recently and may be unwilling to take risks with their balance sheets and will show more caution when lending to hedge funds."


– from Economic Reform, January 2008