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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: regli who wrote (84999)	8/14/2007 5:09:50 AM
From: GUSTAVE JAEGER	Respond to of 110194

Aug 14, 2007 Hedge funds need trimming By Peter Morici The recent market meltdown had much less to do with bad subprime loans than advertised. It was caused more fundamentally by excesses at hedge and private-equity funds. Those contraptions, invented by the sinfully wealthy barons of Wall Street, have lied to themselves and their investors about the efficacy of their schemes. Now they are quiet in their sins as bad home loans take the rap for a global meltdown the US housing market is not large enough to cause. In essence, hedge funds have been pairing put and call options with borrowed money from banks. Derivatives may have fancy drapings, but most of what goes on boils down to complicated buy-sell pairing. Those pairings are based on computer models and the like, which establish patterns of stocks moving in opposite directions. That can work for one or a few investors, with a very small share of market capitalization, betting against the market. But when hedge funds multiply, they in essence bet against one another and require one another to validate their bets. So betting on borrowed money endangers commercial banks stupid enough to believe the Brahmans that peddle their paper. It's akin to a Las Vegas bookie taking only bets on the Washington Redskins football team and none on its opponents, while financing the book on money borrowed from a New York bank. An Ivy League Ponzi (pyramid) scheme! In this environment of complex financial derivatives operations, private-equity firms such as Cerberus have been pushing paper that is not backed by sound business plans. For example, Chrysler is merely a grand subprime scheme. Chrysler may be redeemable, but Cerberus head John Snow has not explained how. He doesn't have the skills for that. The European Central Bank (ECB) was correct to shore up banks' balance sheets by providing more liquidity. But its high-profile tender offer did more to scare markets than to calm them. Banks are calling in notes from hedge funds and denying private-equity funds new loans for questionable investments. It's a modern-day run on the bank, where the banks become the depositors and the hedge and equity funds are the banks. Unfortunately, the ECB behaved as if it were the late US president Franklin Roosevelt during the Great Depression, and it is in out of its depth. Roosevelt did more than provide liquidity, he closed the banks so that depositors could not withdraw their savings and stopped the banks from foreclosing on farm and home loans until sanity resumed. The ECB and Fed need to get between the banks and the hedge and private-equity funds, much as New York Federal Reserve Bank president William McDonough did in the Long-Term Capital Management crisis in 1998 when he organized a bailout of US$3.625 billion by the major creditors to avoid a wider collapse in the financial markets. Or the ECB and Fed need simply to provide liquidity and take a lower profile. In the end, the ECB and Fed need to reassure markets through steady, calm action and not behave as the ECB did - like a frightened child. Peter Morici is a professor at the University of Maryland School of Business and former chief economist at the US International Trade Commission. (Copyright 2007 Peter Morici) atimes.com