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Tim:
Thanks for this posting.
I guess that our top bank officials, top investors, top money managers have
reached their level of incompetancy.
Lionel
-----Original Message-----
From: TKruzel <TKruzel@xxxxxxxxxxxxxxxx>
To: Metastock-Users-List <metastock-list@xxxxxxxxxxxxx>
Date: Friday, September 25, 1998 10:28 PM
Subject: Hedge Fund Discussion
>For Guy Tann and the rest of the list,
>
>Guy, like you I do not know about hedge funds. I took the following text
>from the
>Omega forum. So please do not attribute any of the following discussion
>to me.
>Obviously, I cannot answer any follow up questions.
>
>The following text consists of 3 e-mails that centered around the recent
>LTCM
>fiasco. I do not know any of the people who authored these e-mails so I
>cannot
>vouche for the accuracy. I did find the discussion interesting, however,
>and so
>I thought you might also.
>
>I separated each of the e-mails with two lines of
>========================.
>
>Regards,
>Tim
>
>P.S.
>I think that Rajesh should continue to post his Elliot commentary. At
>least it
>relates to the markets and trading. I certainly hope that the people who
>criticized
>him were not the same ones who blathered on and on about Bill, Monica,
>and the
>baseball homerun conspiracy. Now THAT was a waste of bandwidth (on a
>TRADING discussion forum).
>
>=============================================================
>=============================================================
>
>I'm certainly no expert on hedge funds, but I've read everything I could
>get
>my hands on over the past few days about them, and I now feel both
>better
>and worse about the whole situation.
>
>The good news is I think the meltdown scenario a lot of people are
>claiming
>will happen as the derivitives owned by failing hedge funds are unwound
>is
>greatly exaggerated. People are wondering which fund after Long Term
>Capital Management (LTCM) will need a bailout next. It appears LTCM
>really
>was the "worst of the worse," simply because they invest almost
>exclusively
>in bonds. Unlike most other assets, there is apparently no legal limit
>on
>the amount of leverage one can obtain on bond holdings. If you have a
>bond
>portfolio with a face value of $1,000, a bank can loan you $1,000,000+
>with
>only those bonds as collateral (incredibly stupid, but legal). LCTM
>therefore was employing a much larger amount of leverage than most hedge
>funds.
>
>The other thing to remember is that most of these derivatives employed
>by
>hedge funds were hedged, therefore losses on one side should have been
>offset by gains on the other. What has cost the funds so dearly is that
>in
>certain cases the party or institution on the other side of the hedge is
>not
>honoring their agreement (Russian banks...). Somebody on the list
>already
>pointed out very accurately that these funds shouldn't have even been
>entering hedge agreements with entities that were on very shaky
>financial
>grounds to begin with (Russian banks...), and therefore posed a serious
>risk
>of default. The good news is that the defaults seem to be fairly
>limited
>to just a few areas (as of right now...) , primarily in Russia and
>Malaysia,
>where currency trading has effectively been shut down.
>
>The last piece of good news is I think the quick intervention we saw
>this
>week by large financial institutions on behalf of LTCM was a smart move.
>Recent history has clearly showed that indecisive, half-hearted
>responses to
>global financial problems only end up making them much worse. I would
>rather see the parties involved overreacte now than do nothing.
>
>The bad news is in how this situation was ever allowed to happen, and
>what
>will stop it in the future. This part of the story really has me pissed
>off. Tim Morge is absolutely correct in saying one of the appeals of
>hedge
>funds is that there is very little regulatory control over them
>(especially
>those based offshore). However, there is supposedly PLENTY of
>regulatory
>oversight of the financial institutions that lent LTCM the money to go
>on
>their leveraged bond spree to begin with. How in God's name did these
>lenders not see this coming, and where the hell were the banking
>authorities
>and accounting firms that watch these lenders?
>
>Let's not forget that the Asian meltdown began over 1 1/2 years ago.
>You
>would think these people would have started pouring over the books of
>their
>borrowers to see what their overseas exposure was. Call me crazy, but
>I'd
>like to think that a hedge fund with only $4 billion in hard assets but
>over
>$90 billion worth of financial commitments would have raised some red
>flags.
>People shouldn't just be fired over this, they should be shot.
>
>I find it even more reprehensible that Greenspan and the Fed had to get
>involved to begin with. Some people take this as a sign of how the
>serious
>the problem is. I have a different view. I take it to mean that John
>Merriwhether of LTCM first went to these banks to bail him out, and they
>told him to go take a long walk off a short pier. He would've never
>gotten
>Greenspan involved unless he had been totally rebuffed on his own. A
>lot of
>people are speculating there was some kind of quid-pro-quo involved,
>like a
>promise from Greenspan to lower interest rates. Nobody knows the truth
>except for Alan, but I sure hope he didn't promise to overlook their
>past
>sins. Remember, most of the lenders who ended up giving LTCM money
>ALREADY
>had large amounts of outstanding loans to LTCM. An audit of their books
>may
>have sent a few people to jail (and should).
>
>It's bad enough that probably no one will ever get held responsible for
>this, but now Congress is going to hold hearings on hedge funds. Great,
>the
>same people who can't balance their own checkbooks with the House Bank
>are
>going to solve the hedge fund problem.
>
>The good news is I think the solution is pretty simple- TOTALLY BAN all
>leveraged investments in emerging markets. Want to short the dollar?
>Use
>all the leverage you want. Want to short the Thai Baht? Put up 100% of
>the
>money. Any lending institution providing leverage for a third world
>trade
>should be dissolved. These markets are simply incapable of dealing with
>the
>massive flow of money (both in and out) that hedge funds throw at them.
>They may grow at a slower rate because of this, but they'll be better
>off in
>the long run. Hedge funds should also have to report within 24 hours
>any
>leveraged investment they've made. If a hedge fund has a large
>leveraged
>position in a stock I own, I want to know about it so I can reach the
>exits
>first if I read their Brazilian bond trade has gone bad. They might
>have to
>sell the stock just to meet a margin call.
>
>=============================================================
>=============================================================
>
>Yes, you would think that bank regulators would be attuned to these
>problems.
>In practice, I assure you that the people that are overseeing the use of
>the
>bank's risk allocations only find out about the incredibly stupid
>overuse and
>abuse of leverage by fund managers when there is a problem.
>
>Let me start with a small example. I trade cash currencies. Sometimes I
>am
>active, sometimes I go a month without doing much. The clearing house
>where I
>have the majority of my accounts has a 24 hour cash currency desk. I can
>do cash
>deals there of easily 25 X leverage per trade of my ending account
>balance
>today. My account balance changes depending on my market activity, since
>I don't
>get adequate interest on my funds on deposit.
>
>Now, that cash currency desk is filled with young currency traders. I
>don't have
>any friends on that desk and their spreads are too wide [The reasons are
>fake,
>but the example is valid]. So to keep me a happy customer, the clearing
>firm/bank also lets me have EFP and cash currency rights, with no money
>on
>deposit with three other clearing firms/money center banks. And they
>also let me
>have EFP limits with two other FCMs that are not attached to any bank.
>They give
>me this nice treatment because I have been a great customer with the
>firm for 20
>years. And when I was managing large amounts of money, I did business
>with them.
>I like them, they like me.
>
>At each of those places I am allowed to trade at about 25 X my closing
>balance
>as of today. The limits haven't changed for several years. Now, imagine
>what
>would happen if I went on a crazy spree and began recklessly using those
>lines.
>Maybe I lost a bunch in the Globex session on S&Ps and I want to
>leverage way up
>to try to get some cash back... In miniature, this is what non regulated
>hedge
>funds, or regulated funds that are trading non regulated instruments,
>have
>available to them. many times, the granting of this ridiculous credit is
>the one
>thing a bank trading area can do to capture a fund's business. What does
>the
>bank get out of it? Wouldn't you like to have a half hour lead on the
>rest of
>the market with the news that Soros was selling 2 billion sterling? Or
>better,
>how about buying $500 million US against New Zealand? All you have to do
>is buy
>your $50 million US while you do his order and then watch him drive it
>your way.
>Is that enough profit to make a trading manager go throw a tantrum to
>get
>increased credit limits for a fund manager? In these times of
>non-existent
>spreads, you bet your life. It happens every day.
>
>I'll post more examples if anyone really finds this stuff interesting.
>When you
>start looking at letters of credit and derivatives and clearing risks
>that
>extend not to the party you lent to, but the third or fourth party down
>the
>chain, it's amazing how much 'risk' that can be generated rather quickly
>right
>in front of a bank's lending manager and the bank examiners.
>
>Again, I don't want to fill the list with off subject discussions.
>
>I hope all of you in the southeast US coast are safe, and I hope
>everyone has a
>very fine weekend.
>
>=============================================================
>=============================================================
>
>Thank you for your (as usual) insightful response. And, yes, I do
>happen to have a few questions.
>
>First, let me see if I'm correctly understanding the situation:
>
>(1) The brokerage firms who loaned Long Term Capital money to prevent a
>margin call now own 90% of the Hedge Fund. These loans were backed by
>various Banks who are being tacitly backed by the Federal government who
>is being backed by the taxpayer.
>
>(2) Hedge Fund investors have now lost 90% of their equity.
>
>(3) The brokerage firms who now own 90% of LTC are now invested in a
>situation almost as highly-leveraged as what existed prior to the loans.
>
>If this is true, what happens if/when this House of Cards begins to
>collapse? Do the brokerage firms then go to the Banks who then go to
>the Federal Government who then goes to the Taxpayer for yet another
>Savings-and-Loan-type Bail Out?
>
>What does the Federal Government do? Do they, under massive negative
>public pressure, back away from their tacit support of the Bank loans?
>
>If so, do we have a potential Bank collapse on our hands?
>
>Do we face the prospect of an OTC market collapse due to contractual
>payment obligations being broken by bankrupt brokerage firms?
>
>How does all of this effect already-weakened foreign economies and what
>effect does that then have on our own economy?
>
>What, if anything, can Alan Greenspan do to keep such a downward spiral
>from accelerating out of control?
>
>Are there other Hedge Funds beside LTC who have gone through (or are
>close to going through) the same scenario? If so, who and how many and
>just what is our total potential exposure?
>
>Did you *really* mean it when you said, "there are no regulations or it
>isn't clear which agency has jurisdiction"...or were you just being
>facetious?
>
>Is there reason for concern? Is it Trailing Ticks I'm hearing or "Tick,
>tick, tick, tick,...,BOOM"?
>
>=============================================================
>=============================================================
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