Hedge funds loans to break the banks
Posted on 24 September 2008 with no comments from readersI have been watching the American bail-out plan with a sense of disbelief: can this really be the magic solution to put Humpty Dumpty back together again?
One problem is that the bail-out only addresses the banking sector. It does nothing to address the hedge funds which have just been decimated by the ban on shorting.
It might look amusing to think of the hedge funds who had been shorting the bank stocks suddenly getting shafted. But whose money were they playing with? Yes, it came from their subscribers but who else? Well, the banks of course – and given the massively geared nature of the hedge funds this means another round of huge
bad loans.
How much have the hedge funds borrowed from the banks and now lost shorting their stocks? You just know that we have to be talking hundreds of billions here, these guys do not do things on the cheap.
A poster on the Global Edge Investors discussion board who goes by the name of Cgnao spelled out a possible road map brilliantly:
1) Short sellers are mostly hedge funds and other highly leveraged speculators, betting using borrowed money.
2) They went short because they anticipated bank failures and they were making huge profits because they were right.
3) Central banks and governments step in and change the rules.
4) Regardless of fundamentals the shorts have to cover, sending shares of insolvent banks higher.
5) The general public believes the market has turned and buys those banks, sending shares even higher and hedgies’ losses spiralling.
6) The huge losses the hedgies are taking make them default on their leveraged loans.
7) But think about it, who lent them the money? The same banks they were shorting! More bank collapses follow. Investors get scared and dump their positions. No shorts left means no more short covering rallies and the ensuing crash is all the greater.
The only hope is that the funds were properly hedged – but that seems unlikely as you do not hedge against a possible sudden change in the rule book. Alan Greenspan says banning shorting of banks is a ‘disaster’ and he could be right on this one.
no Comments posted by readers:
great post! i found your site on the comments over at the telegraph. i put your link on my blog as it brings the middle east in. and is interesting…of course. ptp
Fascinating that the Banks end up loaning to Hedge Funds that short them.
Is this not The Classic example of exponential leveraging through multiple counterparties?
But, some hedge funds, such as RAB and Charlemagne are also trapped in long positions with pretty illiquid holdings, in commodity explorers and producers, quoted on AIM and the TSX-V. Current redemptions on these hedge funds are killing them and are causing a downward spiral of portfolio company SPs that are quite detached from the probable fundamentals. I won’t quote to you victims of this from my own stock portfolio, or your readers will just think that I’m trying to ramp them. Maybe a ban on shorting these stocks would help – I dunno.
Erm … the ban was on new shorts. Nothing about closing existing positions (or was the US different? – seems unlikely). A hedgie who hung on and didn’t panic should be doing just fine on those shorts.