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Strategies & Market Trends : Mish's Global Economic Trend Analysis -- Ignore unavailable to you. Want to Upgrade?

To: RealMuLan who wrote (67575)	8/13/2007 11:31:07 AM
From: RealMuLan	Respond to of 116555

A good article --"How the crunch in credit bit Wall Street smh.com.au Marcus Padley August 11, 2007 ... Hedge fund hangoverIt's going to get worse. The average hedge fund is geared six times or to seven times. On that basis the average hedge fund investor has an exposure which says that if the hedge fund moves 14 per cent to 17 per cent they have a 100 per cent loss. That is big risk. To take that sort of risk they need a lot of certainty. This uncertainty has the potential to cascade the highly geared funds - to cause a "run" on hedge funds. This is perhaps the biggest risk. ... The point being that the hedge fund crisis develops slowly. All those people scared off by the news of a collapse in the subprime mortgage market, the credit crunch or that some hedge funds are freezing redemptions will have put in for redemptions. But they won't have got their money yet. The funds may not have even registered the redemption yet because it is not the due date for them to be in yet. The funds may not have sold enough exposure to cover the redemption. Redemptions are a delayed time bomb waiting to slap the credit markets later. We can't see it, but the selling is still going on. It's just slower and it's opaque. If the average hedge fund is geared seven times then a $1 redemption leads to $7 of credit market selling. Redemptions create delayed geared selling and every day the unexecuted potential selling is building - because the redemption mechanisms are so slow. The 1987 crash happened shortly after electronic screen dealing was introduced in the British market. It happened quickly because the process to deal was fast. Selling a hedge fund is slow. If hedge funds were listed on the NYSE or the Australian Stock Exchange there would have been a crash already. The message is, THIS IS NOT OVER. ... There is, CNBC says, $US4 trillion of US corporate bonds (someone tell me the real numbers). About $US600 billion is exposed to the subprime mortgage market. Some $US120 billion has gone bad. As the investors, funds and hedge funds have realised they don't want to be holding any subprime mortgage market exposure they have tried to sell. But no one wants to buy. So they can't sell. The liquidity (the market) has gone, dried up. The investors in hedge funds and funds with exposure to the subprime mortgage market hear about the problems and want their money back. They put in redemption requests. The funds exposed to the subprime mortgage market can't meet those redemptions. So they freeze redemptions. Now everyone in a hedge fund is worried about their own fund and its exposure to the subprime mortgage market. So they put in redemptions even if the fund (as in the case of the Macquarie Fortress Fund) doesn't have, or says it doesn't have, an exposure. Now all funds in the corporate debt market are getting redemptions. On the seven-times gearing equation they are all trying to sell big chunks of their debt exposure for relatively small redemptions. The gearing is working the other way. Everyone is selling everything to meet redemptions and expected redemptions. All the investors in corporate debt now want out. Even the quality (non-hedge) funds and the big trading banks sense the problem and want fewer corporate bonds and more government bonds - now there is a "flight to quality". Funds are selling junk and buying quality. This is why 10-year bonds in the US suddenly started to improve as the credit crunch hit. Now the selling has spread from those selling from necessity to those selling to make money from the event. Yields on corporate bonds rise. Yields on government bonds fall. Liquidity is gone in the corporate bond market - the abyss is here. Lo and behold, the subprime mortgage market contagion has caused a credit crunch in the whole debt market. In the short term it will get worse. In the long term the net effect will be that corporate debt is re-priced against the bond market. It is harder (more expensive) for companies to raise capital. The weighted average cost of capital calculation drops company valuations. Stocks are worth less. Growth (and ambition) is affected. Price-earning ratios fall."