Readers of my blog will recall that a recurring theme has been my contention that the level of leverage employed by hedge funds places their creditors in dire straights when the funds get one wrong.
I mention this to show how the prime brokers, and their banking arms, are beholden to the hedges in uncomfortable ways, making them far more likely to assist in manipulations that would "solve" niggling problems for the funds, should they get into trouble. I believe that is what goes on in NFI, which the shareholder lawsuit against the brokers should reveal.
My favorite paper, the NY Post, has an article about ABN Amro's deal being in jeopardy due to the blowup of a relatively small hedge fund that bet disastrously against natural gas.
Now, think about that. A half billion dollar fund screwed the pooch, and Amro's deal is in danger of falling apart.
Amro doesn't have the ability to manipulate the natural gas market, as it is far too large.
But imagine if the same disastrous bet were made in a thinly traded stock like NFI, and those standing to take the big loss were the brokers who effectively made the market in the stock. Do you think they might help their borrower out, by reducing the price and sustaining the depression, thus eliminating the crisis? Or do you think they would set their jaws, and take the fallout like men, stoic and resolved?
My point has always been that when you have hedge funds employing 10, 20, 30 times leverage, playing stocks to the downside, it is just a matter of time until one of them gets things badly wrong in a way that could vaporize their lenders - unless those lenders could step in and help the direction of the bet out.
Anyone doubt that happens?
Imagine if you are a bank, whose hedge fund clients have hundreds of millions, or billions of dollars worth of failed shares. At today's mark to market, those billions are now worth $20 million - but if they had to be bought, they would be billions again. Your big hedge fund clients have thus created a cataclysmic contingent liability, and your ass is on the line should they mismanage one of their bets. And then they call one wrong - say a mortgage lender from the sticks goes 4 times the money while they have been doubling down, and unless it can be successfully depressed virtually forever, your client could implode. So what do yo do? And what if your in-house hedge fund has been compounding the problem by trading alongside them, thus creating your own liability? What choice do you really have? Especially if the penalties for failing to deliver indefinitely are puny compared to the rewards?
But Cox feels that the market's discipline will keep bad things from happening.
Chris? Sweetie? Check it out. Back in the 1920s, pools of anonymous cash manipulated the markets - they were called stock pools. Today they are called hedge funds. Back then, the same market discipline was in force, and we had massive crashes every 6 or 8 years. So that didn't really work out so well, huh? And then, as now, Wall Street argued that there was no need for regulation - that the market was a "perfect entity."
Here we are, 80 years later, and the same argument is being advanced about the same phenomena, by the same folks - Wall Street's mouthpieces.
Did anyone ever give you any market history classes before they made you the chief regulator?
Here's my take. The markets tend to make disastrous decisions based upon unbridled greed, and those that ultimately pay for their idiocy are the taxpayers. Hedge fund leverage exposure, and the resultant manipulations of their targets, especially when the play turns against them, is an invitation to manipulate. The system has EVERYTHING to lose by not doing so. To expect differently is silly.
Amro's experience echoes Refco's creditor's experience. The lesson is not a hard one. Unregulated pools of anonymous money, moving the markets with no checks or balances, is a disaster waiting to happen. These mini-disasters are your warning alarms. Listen to them. The train is running off the tracks, and all the hypothetical discipline in the world ain't going to keep it from derailing.
Speaking of odd occurrences, there is another nasty article about FFH in the Post hard copy, which is absent from the on-line issue. Could it be that the legal team there is concerned about liability for putting those articles on-line? Why? Any legal experts out there who can chime in and help us out here? Why would there be 4 or 5 articles saying mean things about FFH, a Canadian company, and yet NONE of them are available on-line? The author was contacted for an explanation, but he claims he doesn't know why, that he just writes them.
What is the explanation?