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Decades of insane economic policies, and the stubbornness of central
banks papering over the symptoms of a systemic crisis by providing
ever more liquidity, have produced an impossible situation as of late
May, after the GM/Ford credit shocks.
One of the effects of this unprecedented liquidity pumping has been
the biggest explosion in mortgage and other private debt titles in
history, as well as the emergence of new financial bubbles in the
bond, housing, and commodity markets. All of these financial assets
are again just the basis for financial bets of even larger
proportions: "derivatives." As most of the derivatives bets are
traded outside of official exchanges, in the form of private deals
between two counterparties, nobody really knows the actual
dimensions. A substantial amount of derivatives betting is done
by "hedge funds," which are not subject to any kind of regulation or
supervision. According to the Bank for International Settlements
(BIS), the outstanding volume of OTC ("over-the-counter") derivatives
alone amounts to $248 trillion, while the annual turnover of exchange-
traded derivatives is close to $900 trillion. It's a conservative
guess to estimate the current rate of derivatives trading at $2
quadrillion per year; that is, 50 times more than the annual economic
activity, measured by the gross domestic product (GDP), of all
countries on the planet. (See Glossary of terms on derivatives and
hedge funds.)
On May 5, a big shoe dropped into this giant financial minefield.
Standard & Poor's downgraded $453 billion in outstanding debt of
General Motors and Ford Motor Corporation to junk. On May 8, Lyndon
LaRouche indicated that the General Motors crisis is not only
a "national disaster" for the United States, but could actually
detonate the world financial-monetary system. Two days after
LaRouche's statement, markets were shaken by the fear of an imminent
repeat of the Long-Term Capital Management (LTCM) disaster, which
almost destroyed the entire system in Autumn 1998. Stock and
corporate bond markets suffered massive losses on May 10, after
traders pointed to evidence of severe problems at several large hedge
funds, as a direct consequence of GM's and Ford's downgrading. The
hedge funds mentioned in this respect included Highbridge Capital,
GLG Partners, Asam Capital Management, and Sovereign Capital. The
London-based GLG Partners has $13 billion under management, and lists
as the largest hedge fund in Europe and the second-largest in the
world.
GLG issued a statement on May 10: "All the funds are fine and we have
no concern." Highbridge Capital, that same day, wrote a letter to
investors, noting: "It is our understanding that recent volatility in
the structured credit markets is apparently related to the unwinding
of an unprofitable CDO [collateralized debt obligation] tranche
correlation trade by one or more parties.... The purpose of this
letter is to inform our investors that Highbridge has no exposure to
the trades." Highbridge was bought up last year by U.S. megabank JP
Morgan Chase. Sovereign Capital, a British hedge fund, is closely
linked to Lazard Brothers. The fund is heavily involved in East Asian
markets, and news of the possibility of its collapse had caused panic
among Asian bankers. Sovereign Capital's chairman, John Nash,
formerly worked for Lazard. Since May 10, the "LTCM-word" is in
everybody's mouth. Asam Capital Management is based in Singapore and
reportedly has lost most of its investors' money.
Top Banks Involved
The stocks of the same large banks that participated in the 1998 LTCM
bailout, and which are known for their giant derivatives portfolios””
including Citigroup, JP Morgan Chase, Goldman Sachs, and Deutsche
Bank””were hit by panic selling on May 10. Behind this panic was the
knowledge that not only have these banks engaged in dangerous
derivatives speculation on their own accounts, but, ever desperate
for cash to cover their own deteriorating positions, they also turned
to the even more speculative hedge funds, placing money with existing
funds, or even setting up their own, to engage in activities they
didn't care to put on their own books. The combination of financial
desperation, the Fed's liquidity binge, and the usury-limiting
effects of low interest rates, triggered an explosion in the number
of hedge funds in recent years, as everyone chased higher, and
riskier, returns.
There can be no doubt that some of these banks, not only their hedge
fund offspring, are in trouble right now. And the top banks are
starting to point fingers at each other. Particular attention has
been paid to Deutsche Bank. On May 17, Merrill Lynch issued a report
noting that Deutsche Bank probably has suffered significant
derivatives losses following the GM and Ford downgrading. The report
states that Deutsche Bank will not be able to maintain its rosy
performance, culminating in a pre-tax return on equity of 30% in the
last quarter. Not only has the volume of bond emissions managed by
Deutsche Bank dramatically declined during the second quarter, but
the bank may have suffered reduced business from hedge funds because
of the "recent turbulence" in the credit derivatives market, as well
as losses in its own trading positions. "Deutsche must be taking some
pain at present," concludes the report, which appeared just one day
before Deutsche Bank's annual shareholder meeting in Frankfurt.
According to Merrill Lynch, about 17% of Deutsche Bank's clients in
its debt sales and trading business are hedge funds.
When it was named as one of the victims of the GM/Ford fall-out,
Deutsche Bank chief financial officer Clemens Börsig was forced to
claim at a New York conference on May 11, that the bank "has no cash
lending exposure to hedge funds." Deutsche Bank's "exposure is fully
collateralized." Börsig said that the bank's global markets unit "has
no investments in hedge funds." The bank has a "conservative"
approach to its business with the funds and "very strict criteria"
for choosing clients, he added. Nevertheless, according to its own
2004 annual report, Deutsche Bank at the end of that year held
derivatives positions, mostly interest rate derivatives, of a nominal
volume of $21.5 trillion. That is about ten times the GDP of the
German economy.
'Hedging' to Death
The unprecedented downgrading to junk of almost half a trillion
dollars in corporate debt, which doubled the total volume of U.S.
junk bond debt, had devastating consequences for different kinds of
derivatives bets. In particular, the downgrading hit the credit
derivatives market, which provides insurance against bond defaults.
In the recent period, hedge funds have sharply increased their
exposure to a form of credit derivative known as a collateral debt
obligation (CDO). CDOs are pools of loans, bonds, and other debt
titles from hundreds of different corporations which are bundled and
sold to investors in much the same way as mortgages are turned into
mortgage-backed securities. In exchange for hefty fees, many hedge
funds have taken to selling insurance against corporate defaults. If
there is no default during the life of the contract, the seller
pockets a lucrative fee, but in the event of a default, the seller
must pay out the face value of the contract. To raise that money, the
hedge fund must often sell its most liquid assets, and that, often,
in the face of a falling market. Such "distress selling" by several
hedge funds was actually observed on May 10 and subsequent days.
Europe is extremely vulnerable to the current crisis in the credit
derivatives market, as 50% of all CDOs are euro-denominated. The same
kind of financial instruments led to the Parmalat collapse in Italy
last year.
A related kind of derivatives scheme is the so-called capital
structure arbitrage (CSA). It's one of the latest inventions in the
derivatives casino. CSAs also involve bets on corporate debt titles,
or the derivatives on that debt, such as CDOs. But the overall bet is
made more complex by adding another element: the stock price of the
respective corporation. Usually, when the prices of corporate bonds
or their derivatives falls, the stock price of the respective
corporation goes down as well. By combining the bond or credit
derivative with a bet on a falling stock price, the CSA investor can
try to "hedge" against potential losses. More convincing for hedge
funds than the limiting of risks, is the empirical discovery that
once a corporation runs into trouble, the stock price often plunges
much more violently than the bond price of the same corporation. And
that is exactly the condition under which a CDA contract generates
profit.
Now comes the problem: By the very combination””in the same week””of
Kirk Kerkorian's announcement for a partial General Motors takeover,
boosting the GM stock price by almost 20%, and the downgrading of GM
debt to junk by Standard & Poor's, crashing the GM bond price, the
arbitrage traders suffered the worst of all possible disasters.
Nobody knows how many hedge funds have already gone under in May.
Further complicating matters is the fact that many hedge fund
investors, faced with all the news and rumors circulating about
derivatives losses, are panicking, and are right now pulling out
their money””if they can. Hedge funds often allow withdrawals of funds
just once a quarter. The next date is July 1. But how to pay out
investors, when cash reserves are gone and every dollar of capital is
tied up in highly leveraged derivatives bets? To be able to meet
redemption demands, hedge funds are forced to liquidate contracts
under the present, extremely distressed, market conditions. This
means piling up even more losses, which in turn””once investors
recognize it””will further intensify withdrawals.
One indicator for the ongoing "distress selling" is the average price
of credit-default swaps (CDS), which on May 18 hit the highest level
since records started one year ago. For every outstanding corporate
bond, an investor can buy a CDS contract, by which the default risk
is transferred to the counterparty of the contract. In exchange for
this kind of protection, the investor pays a certain fee to his
counterparty, which works like an interest rate deduction on the
nominal return of the bond. Within ten days leading to May 18, the
average CDS rate has jumped up by one third, from 42 to 60 basis
points (from .42% to .6%). The sharp increase reflects not only the
rising fear for corporate bond defaults, but even more, a sudden drop
in the number of hedge funds that are willing, or able, to take over
additional default risks. The surprising rise of the U.S. dollar and
the fall of commodity prices, including oil, are also being
attributed to hedge fund emergency sales.
Beyond LTCM
Andrew Large, the deputy governor of the Bank of England, issued a
strong warning on credit derivatives on May 18. Speaking at an
international conference of financial regulators in Turkey, he
noted, "Credit risk transfer has introduced new holders of credit
risk, such as hedge funds and insurance companies, at a time when
market depth is untested." Large said the growth of derivative
instruments has "added to the risk of instability arising through
leverage, volatility, and opacity." Regulators should therefore act
and, in particular, search for credit concentrations.
Among the many voices warning against a repeat of the LTCM debacle or
worse, is non other than Gerard Gennotte, former senior strategist at
LTCM, and now working for another hedge fund called QuantMetrics
Capital Management. In statements picked up by London's Financial
Times on May 18, Gennotte pointed to the rising risk of a liquidity
crisis triggered by hedge fund blowouts, which then could lead to a
1998-style collapse. He emphasized: "You could expect something
similar to 1998, with people starting to liquidate their positions.
It starts with one position, but then they are afraid of getting
withdrawals, and it spreads across strategies."
In private discussions with EIR, an international financier confirmed
LaRouche's notion, that the downgrading of General Motors and Ford
debt was just the beginning of a much larger crisis hitting the
grossly over-extended global financial bubble””in particular the
derivatives scam. The financier said that the international financial
system is, in fact, facing a derivatives crisis "orders of magnitude
beyond LTCM." He observed that one can be certain that the Federal
Reserve, the President's Commission on Financial Markets (the so-
called "plunge protection team"), and the relevant departments of
major central banks around the world, are all on "emergency red-alert
mobilization."
Hedge funds and banks are, of course, all publicly denying reports of
a major derivatives blow-out. Any bank or hedge fund that admitted
such losses without first working a bail-out scheme, would instantly
collapse. Such implausible protestations of solvency are another
source of instability. The source further said that there is no doubt
that the Fed and other central banks are pouring liquidity into the
system, covertly. This would not become public until early April, at
which point the Fed and other central banks will have to report on
the money supply.
Regulating Hedge Funds
In response to the GM and hedge funds crises, Lyndon LaRouche issued
a statement May 14, "On the Subject of Strategic Bankruptcy," in
which he called for "new governmental mechanisms" for dealing with
these "strategic bankruptcies, bankruptcies with which existing
mechanisms of governments are essentially incompetent to deal."
LaRouche also renewed his call, from the early 1990s, for a
transaction tax on all derivatives trades, to regulate hedge funds.
By such a transaction tax, government authorities, for the first
time, could get an insight into the hedge fund activity. Currently,
there exist about 8,000 hedge funds worldwide, managing about $1
trillion in capital, compared to 4,500 hedge funds and $600 billion
in capital just two years ago. When LTCM was going under in 1998, for
every dollar of its capital, it had borrowed $30 from banks at was
running at least $400 in derivatives bets.
Allegedly, the average leverage of hedge funds today is much lower
than in the case of LTCM. At least one in ten existing hedge funds,
in most cases the smaller ones, are quietly being closed down every
year, while at the same time many more are being set up new.
A public debate on the regulation of hedge funds has already erupted
both in Britain and Germany. On top of the fears for a systemic
breakdown, there is the imminent concern that private equity funds
and hedge funds are, right now, taking over or manipulating the stock
prices of thousands of corporations in both countries. John
Sunderland, the President of the Confederation of British Industry
(CBI) came out with an attack on such funds, sounding similar to
German Social Democratic Party chairman Franz Münterfering's famous
earlier "swarm of locusts" statements. CBI Director General Digby
Jones raised the alarm bells concerning certain derivatives””
"contracts for differences" (CFD)””by which hedge funds are able to
secretly build up stakes in corporations.
In Germany, the chief executive officer of Commerzbank, Klaus-Peter
Müller, who also heads the German banking association, raised the
question: Why are we regulating small banks, while hedge funds,
moving much larger capital, are not being regulated at all?
Bundesbank board member Edgar Meister described hedge funds as
the "white spots on the map of supervisors," which are growing at
alarming speed. Even Rolf E. Breuer, who just resigned as supervisory
board chairman of the Frankfurt stock exchange (Deutsche Börse) after
losing a power fight with the British hedge fund TCI, has now
astonished the banking scene with a surprising conversion. The same
person who, as head of Deutsche Bank, had praised derivatives trading
as the shortest way to paradise on Earth, and become known in some
circles as Germany's "Mr. Derivatives," is suddenly denouncing the
short-term speculative investments of hedge funds, that are colliding
with the need for long-term productive investments and therefore
could "devastate the German economy."
Derivatives: 'Ticking Timebombs'
In an article headlined "Ticking Time Bomb in Structured Credit
Products," Switzerland's conservative financial daily Neue Züricher
Zeitung on May 19 pointed to the precarious situation in the so-
called "structured credit" market. This includes the use of capital
structure arbitrage (CSA) contracts, combined bets on the stock price
and debt titles of the same corporation. The daily states that the
purchase of GM stocks by Kerkorian caused a "brush fire" on the bond
market, which then, in particular, hit funds specialized in CDAs. The
funds faced "painful" losses when the risk premiums on GM
bonds "exploded" and the prices of related derivatives plunged, while
GM stocks, because of the Kerkorian move, jumped by 20%. Overall, the
downgrading of GM, in spite of "the fact that it didn't came as a
full surprise, triggered a chain reaction on the bond market,"
centered around collateralized debt obligations (CDO). These CDOs
fueled the "sudden explosion" of the GM risk premium. Trying to
escape from their CDO adventure, investors "at some point engaged in
panic selling, which then derailed the credit derivatives market." ””
Lothar Komp
investorsexchange@yahoogroups.com
banks papering over the symptoms of a systemic crisis by providing
ever more liquidity, have produced an impossible situation as of late
May, after the GM/Ford credit shocks.
One of the effects of this unprecedented liquidity pumping has been
the biggest explosion in mortgage and other private debt titles in
history, as well as the emergence of new financial bubbles in the
bond, housing, and commodity markets. All of these financial assets
are again just the basis for financial bets of even larger
proportions: "derivatives." As most of the derivatives bets are
traded outside of official exchanges, in the form of private deals
between two counterparties, nobody really knows the actual
dimensions. A substantial amount of derivatives betting is done
by "hedge funds," which are not subject to any kind of regulation or
supervision. According to the Bank for International Settlements
(BIS), the outstanding volume of OTC ("over-the-counter") derivatives
alone amounts to $248 trillion, while the annual turnover of exchange-
traded derivatives is close to $900 trillion. It's a conservative
guess to estimate the current rate of derivatives trading at $2
quadrillion per year; that is, 50 times more than the annual economic
activity, measured by the gross domestic product (GDP), of all
countries on the planet. (See Glossary of terms on derivatives and
hedge funds.)
On May 5, a big shoe dropped into this giant financial minefield.
Standard & Poor's downgraded $453 billion in outstanding debt of
General Motors and Ford Motor Corporation to junk. On May 8, Lyndon
LaRouche indicated that the General Motors crisis is not only
a "national disaster" for the United States, but could actually
detonate the world financial-monetary system. Two days after
LaRouche's statement, markets were shaken by the fear of an imminent
repeat of the Long-Term Capital Management (LTCM) disaster, which
almost destroyed the entire system in Autumn 1998. Stock and
corporate bond markets suffered massive losses on May 10, after
traders pointed to evidence of severe problems at several large hedge
funds, as a direct consequence of GM's and Ford's downgrading. The
hedge funds mentioned in this respect included Highbridge Capital,
GLG Partners, Asam Capital Management, and Sovereign Capital. The
London-based GLG Partners has $13 billion under management, and lists
as the largest hedge fund in Europe and the second-largest in the
world.
GLG issued a statement on May 10: "All the funds are fine and we have
no concern." Highbridge Capital, that same day, wrote a letter to
investors, noting: "It is our understanding that recent volatility in
the structured credit markets is apparently related to the unwinding
of an unprofitable CDO [collateralized debt obligation] tranche
correlation trade by one or more parties.... The purpose of this
letter is to inform our investors that Highbridge has no exposure to
the trades." Highbridge was bought up last year by U.S. megabank JP
Morgan Chase. Sovereign Capital, a British hedge fund, is closely
linked to Lazard Brothers. The fund is heavily involved in East Asian
markets, and news of the possibility of its collapse had caused panic
among Asian bankers. Sovereign Capital's chairman, John Nash,
formerly worked for Lazard. Since May 10, the "LTCM-word" is in
everybody's mouth. Asam Capital Management is based in Singapore and
reportedly has lost most of its investors' money.
Top Banks Involved
The stocks of the same large banks that participated in the 1998 LTCM
bailout, and which are known for their giant derivatives portfolios””
including Citigroup, JP Morgan Chase, Goldman Sachs, and Deutsche
Bank””were hit by panic selling on May 10. Behind this panic was the
knowledge that not only have these banks engaged in dangerous
derivatives speculation on their own accounts, but, ever desperate
for cash to cover their own deteriorating positions, they also turned
to the even more speculative hedge funds, placing money with existing
funds, or even setting up their own, to engage in activities they
didn't care to put on their own books. The combination of financial
desperation, the Fed's liquidity binge, and the usury-limiting
effects of low interest rates, triggered an explosion in the number
of hedge funds in recent years, as everyone chased higher, and
riskier, returns.
There can be no doubt that some of these banks, not only their hedge
fund offspring, are in trouble right now. And the top banks are
starting to point fingers at each other. Particular attention has
been paid to Deutsche Bank. On May 17, Merrill Lynch issued a report
noting that Deutsche Bank probably has suffered significant
derivatives losses following the GM and Ford downgrading. The report
states that Deutsche Bank will not be able to maintain its rosy
performance, culminating in a pre-tax return on equity of 30% in the
last quarter. Not only has the volume of bond emissions managed by
Deutsche Bank dramatically declined during the second quarter, but
the bank may have suffered reduced business from hedge funds because
of the "recent turbulence" in the credit derivatives market, as well
as losses in its own trading positions. "Deutsche must be taking some
pain at present," concludes the report, which appeared just one day
before Deutsche Bank's annual shareholder meeting in Frankfurt.
According to Merrill Lynch, about 17% of Deutsche Bank's clients in
its debt sales and trading business are hedge funds.
When it was named as one of the victims of the GM/Ford fall-out,
Deutsche Bank chief financial officer Clemens Börsig was forced to
claim at a New York conference on May 11, that the bank "has no cash
lending exposure to hedge funds." Deutsche Bank's "exposure is fully
collateralized." Börsig said that the bank's global markets unit "has
no investments in hedge funds." The bank has a "conservative"
approach to its business with the funds and "very strict criteria"
for choosing clients, he added. Nevertheless, according to its own
2004 annual report, Deutsche Bank at the end of that year held
derivatives positions, mostly interest rate derivatives, of a nominal
volume of $21.5 trillion. That is about ten times the GDP of the
German economy.
'Hedging' to Death
The unprecedented downgrading to junk of almost half a trillion
dollars in corporate debt, which doubled the total volume of U.S.
junk bond debt, had devastating consequences for different kinds of
derivatives bets. In particular, the downgrading hit the credit
derivatives market, which provides insurance against bond defaults.
In the recent period, hedge funds have sharply increased their
exposure to a form of credit derivative known as a collateral debt
obligation (CDO). CDOs are pools of loans, bonds, and other debt
titles from hundreds of different corporations which are bundled and
sold to investors in much the same way as mortgages are turned into
mortgage-backed securities. In exchange for hefty fees, many hedge
funds have taken to selling insurance against corporate defaults. If
there is no default during the life of the contract, the seller
pockets a lucrative fee, but in the event of a default, the seller
must pay out the face value of the contract. To raise that money, the
hedge fund must often sell its most liquid assets, and that, often,
in the face of a falling market. Such "distress selling" by several
hedge funds was actually observed on May 10 and subsequent days.
Europe is extremely vulnerable to the current crisis in the credit
derivatives market, as 50% of all CDOs are euro-denominated. The same
kind of financial instruments led to the Parmalat collapse in Italy
last year.
A related kind of derivatives scheme is the so-called capital
structure arbitrage (CSA). It's one of the latest inventions in the
derivatives casino. CSAs also involve bets on corporate debt titles,
or the derivatives on that debt, such as CDOs. But the overall bet is
made more complex by adding another element: the stock price of the
respective corporation. Usually, when the prices of corporate bonds
or their derivatives falls, the stock price of the respective
corporation goes down as well. By combining the bond or credit
derivative with a bet on a falling stock price, the CSA investor can
try to "hedge" against potential losses. More convincing for hedge
funds than the limiting of risks, is the empirical discovery that
once a corporation runs into trouble, the stock price often plunges
much more violently than the bond price of the same corporation. And
that is exactly the condition under which a CDA contract generates
profit.
Now comes the problem: By the very combination””in the same week””of
Kirk Kerkorian's announcement for a partial General Motors takeover,
boosting the GM stock price by almost 20%, and the downgrading of GM
debt to junk by Standard & Poor's, crashing the GM bond price, the
arbitrage traders suffered the worst of all possible disasters.
Nobody knows how many hedge funds have already gone under in May.
Further complicating matters is the fact that many hedge fund
investors, faced with all the news and rumors circulating about
derivatives losses, are panicking, and are right now pulling out
their money””if they can. Hedge funds often allow withdrawals of funds
just once a quarter. The next date is July 1. But how to pay out
investors, when cash reserves are gone and every dollar of capital is
tied up in highly leveraged derivatives bets? To be able to meet
redemption demands, hedge funds are forced to liquidate contracts
under the present, extremely distressed, market conditions. This
means piling up even more losses, which in turn””once investors
recognize it””will further intensify withdrawals.
One indicator for the ongoing "distress selling" is the average price
of credit-default swaps (CDS), which on May 18 hit the highest level
since records started one year ago. For every outstanding corporate
bond, an investor can buy a CDS contract, by which the default risk
is transferred to the counterparty of the contract. In exchange for
this kind of protection, the investor pays a certain fee to his
counterparty, which works like an interest rate deduction on the
nominal return of the bond. Within ten days leading to May 18, the
average CDS rate has jumped up by one third, from 42 to 60 basis
points (from .42% to .6%). The sharp increase reflects not only the
rising fear for corporate bond defaults, but even more, a sudden drop
in the number of hedge funds that are willing, or able, to take over
additional default risks. The surprising rise of the U.S. dollar and
the fall of commodity prices, including oil, are also being
attributed to hedge fund emergency sales.
Beyond LTCM
Andrew Large, the deputy governor of the Bank of England, issued a
strong warning on credit derivatives on May 18. Speaking at an
international conference of financial regulators in Turkey, he
noted, "Credit risk transfer has introduced new holders of credit
risk, such as hedge funds and insurance companies, at a time when
market depth is untested." Large said the growth of derivative
instruments has "added to the risk of instability arising through
leverage, volatility, and opacity." Regulators should therefore act
and, in particular, search for credit concentrations.
Among the many voices warning against a repeat of the LTCM debacle or
worse, is non other than Gerard Gennotte, former senior strategist at
LTCM, and now working for another hedge fund called QuantMetrics
Capital Management. In statements picked up by London's Financial
Times on May 18, Gennotte pointed to the rising risk of a liquidity
crisis triggered by hedge fund blowouts, which then could lead to a
1998-style collapse. He emphasized: "You could expect something
similar to 1998, with people starting to liquidate their positions.
It starts with one position, but then they are afraid of getting
withdrawals, and it spreads across strategies."
In private discussions with EIR, an international financier confirmed
LaRouche's notion, that the downgrading of General Motors and Ford
debt was just the beginning of a much larger crisis hitting the
grossly over-extended global financial bubble””in particular the
derivatives scam. The financier said that the international financial
system is, in fact, facing a derivatives crisis "orders of magnitude
beyond LTCM." He observed that one can be certain that the Federal
Reserve, the President's Commission on Financial Markets (the so-
called "plunge protection team"), and the relevant departments of
major central banks around the world, are all on "emergency red-alert
mobilization."
Hedge funds and banks are, of course, all publicly denying reports of
a major derivatives blow-out. Any bank or hedge fund that admitted
such losses without first working a bail-out scheme, would instantly
collapse. Such implausible protestations of solvency are another
source of instability. The source further said that there is no doubt
that the Fed and other central banks are pouring liquidity into the
system, covertly. This would not become public until early April, at
which point the Fed and other central banks will have to report on
the money supply.
Regulating Hedge Funds
In response to the GM and hedge funds crises, Lyndon LaRouche issued
a statement May 14, "On the Subject of Strategic Bankruptcy," in
which he called for "new governmental mechanisms" for dealing with
these "strategic bankruptcies, bankruptcies with which existing
mechanisms of governments are essentially incompetent to deal."
LaRouche also renewed his call, from the early 1990s, for a
transaction tax on all derivatives trades, to regulate hedge funds.
By such a transaction tax, government authorities, for the first
time, could get an insight into the hedge fund activity. Currently,
there exist about 8,000 hedge funds worldwide, managing about $1
trillion in capital, compared to 4,500 hedge funds and $600 billion
in capital just two years ago. When LTCM was going under in 1998, for
every dollar of its capital, it had borrowed $30 from banks at was
running at least $400 in derivatives bets.
Allegedly, the average leverage of hedge funds today is much lower
than in the case of LTCM. At least one in ten existing hedge funds,
in most cases the smaller ones, are quietly being closed down every
year, while at the same time many more are being set up new.
A public debate on the regulation of hedge funds has already erupted
both in Britain and Germany. On top of the fears for a systemic
breakdown, there is the imminent concern that private equity funds
and hedge funds are, right now, taking over or manipulating the stock
prices of thousands of corporations in both countries. John
Sunderland, the President of the Confederation of British Industry
(CBI) came out with an attack on such funds, sounding similar to
German Social Democratic Party chairman Franz Münterfering's famous
earlier "swarm of locusts" statements. CBI Director General Digby
Jones raised the alarm bells concerning certain derivatives””
"contracts for differences" (CFD)””by which hedge funds are able to
secretly build up stakes in corporations.
In Germany, the chief executive officer of Commerzbank, Klaus-Peter
Müller, who also heads the German banking association, raised the
question: Why are we regulating small banks, while hedge funds,
moving much larger capital, are not being regulated at all?
Bundesbank board member Edgar Meister described hedge funds as
the "white spots on the map of supervisors," which are growing at
alarming speed. Even Rolf E. Breuer, who just resigned as supervisory
board chairman of the Frankfurt stock exchange (Deutsche Börse) after
losing a power fight with the British hedge fund TCI, has now
astonished the banking scene with a surprising conversion. The same
person who, as head of Deutsche Bank, had praised derivatives trading
as the shortest way to paradise on Earth, and become known in some
circles as Germany's "Mr. Derivatives," is suddenly denouncing the
short-term speculative investments of hedge funds, that are colliding
with the need for long-term productive investments and therefore
could "devastate the German economy."
Derivatives: 'Ticking Timebombs'
In an article headlined "Ticking Time Bomb in Structured Credit
Products," Switzerland's conservative financial daily Neue Züricher
Zeitung on May 19 pointed to the precarious situation in the so-
called "structured credit" market. This includes the use of capital
structure arbitrage (CSA) contracts, combined bets on the stock price
and debt titles of the same corporation. The daily states that the
purchase of GM stocks by Kerkorian caused a "brush fire" on the bond
market, which then, in particular, hit funds specialized in CDAs. The
funds faced "painful" losses when the risk premiums on GM
bonds "exploded" and the prices of related derivatives plunged, while
GM stocks, because of the Kerkorian move, jumped by 20%. Overall, the
downgrading of GM, in spite of "the fact that it didn't came as a
full surprise, triggered a chain reaction on the bond market,"
centered around collateralized debt obligations (CDO). These CDOs
fueled the "sudden explosion" of the GM risk premium. Trying to
escape from their CDO adventure, investors "at some point engaged in
panic selling, which then derailed the credit derivatives market." ””
Lothar Komp
investorsexchange@yahoogroups.com
) to gain an insight into what the 'smart money' is betting on - based on their opinions of the fundamentals. The thought that these larger players whose money helps map the direction of the market are also playing the dumb trend following game is just asking for a disaster (ie sudden 50% overnight moves).
