Are Hedge funds destroying the economy?

[ladelfina]

that's sarcasm, right?

 

[ladelfina]

Just came across this short 2-part BBC presentation on credit default swaps:

YouTube - Credit Default Swaps - the next crisis?pt1

 

[james22]

The MBA president says right out: Wall Street should "not try to do all these fancy financial instruments"!

The creation of complex financial markets has brought about economic progress. These sophisticated instruments, like derivatives, have facilitated risk-sharing on a global scale, boosting innovation and hence prosperity. There is no economic rationale for distinguishing this “virtual capitalism” from “real capitalism”: nothing real has ever been produced without first being financed. The new instruments aren’t free of problems, as seen in the subprime failure. Financial enterprises are enterprises like any other—they think up new ideas, try them out, and sometimes crash. But even in a time of financial crisis, the global benefits of the new financial markets have surpassed their costs. The debate among economists today concerns only the degree of transparency and regulation necessary for their effective functioning.

Economics Does Not Lie by Guy Sorman, City Journal Summer 2008

 

[ladelfina]

nothing real has ever been produced without first being financed.

excuse me?

 

[Art G]

Many years ago, a man I consider the smartest I've ever met regarding financial matters (and more) told me that whatever I do, stay away from derivative products. This was good advice then, better now.

 

[FinanceDude]

Many years ago, a man I consider the smartest I've ever met regarding financial matters (and more) told me that whatever I do, stay away from derivative products. This was good advice then, better now.

Smart man..........

 

[ladelfina]

and Art, FD, how do you propose to do that? Seeing as virtually every bank and pension fund and municipality from Peoria to Prague to Peking has invested in those sneaky derivatives?

 

[FinanceDude]

and Art, FD, how do you propose to do that? Seeing as virtually every bank and pension fund and municipality from Peoria to Prague to Peking has invested in those sneaky derivatives?

Buy individual stocks of companies that aren't so tied into that arena. I am not a fan of the banks recently, they got greedy and now are getting their just desserts.

I douibt Kraft Foods or General Mills is buying CDOs to enhance their cash reserves. Their only hedging is in the futures markets for corn and wheat........

 

[Art G]

Yeah. What FD said.

 

[ladelfina]

FD, I have KFT! ooo you must be psychic.
i meant that there are exposures everyone has that can't be avoided.
You still put your money IN a bank. (Banks have CDOs)
You have various forms of insurance. (Insurers have CDOs)
You have a brokerage acc't. (MMFs have CDOs)
You pay property tax (your municipality has bought CDOs; the bonds they issued are insured by insurers with CDOs).
You may have a pension whose fund is exposed to CDOs
You have USD, and you pay US taxes, to fund a government that is trading treasuries for... privately generated CDOs of uncertain to no worth.

link found at The Big Picture:
http://www.bloomberg.com/news/marketsmag/pensions.pdf

Only 5-10% of CDOs are owned by hedge funds.

----

The creation of complex financial markets has brought about economic progress. These sophisticated instruments, like derivatives, have facilitated risk-sharing on a global scale, boosting innovation and hence prosperity. There is no economic rationale for distinguishing this “virtual capitalism” from “real capitalism”: nothing real has ever been produced without first being financed. The new instruments aren’t free of problems, as seen in the subprime failure. Financial enterprises are enterprises like any other—they think up new ideas, try them out, and sometimes crash. But even in a time of financial crisis, the global benefits of the new financial markets have surpassed their costs. The debate among economists today concerns only the degree of transparency and regulation necessary for their effective functioning.

Economics Does Not Lie by Guy Sorman, City Journal Summer 2008

Came across a comment elsewhere that I thought was relevant, to the effect that..
..the system that we think we have is "capitalism". Capitalism requires capital. When you systemically remove capital from the equation, you no longer have "capitalism".. but something else: "creditism".

A financial structure based on "creditism" can only fail, and is failing before our eyes.

 

[FinanceDude]

FD, I have KFT! ooo you must be psychic.

maybe I could become the next Suze Orman by being the "physic FA"............

You still put your money IN a bank. (Banks have CDOs)

True, and the dumb ones loaded up, and now their "provisions for loan losses" are eating up the dividends they used to pay YOU.......

You have various forms of insurance. (Insurers have CDOs)

Insurers have been dumping them faster than water over Niagara Falls.....

You have a brokerage acc't. (MMFs have CDOs)

Some do, not the ones I use.........

You pay property tax (your municipality has bought CDOs; the bonds they issued are insured by insurers with CDOs).

My local municipality doesn't buy insurance for their bonds. Since I live in a state where 98% of folks pay their property taxes on time, I'm not too worried about the health of the bonds issued.....

You may have a pension whose fund is exposed to CDOs

I don't have a pension, no worried there...........

You have USD, and you pay US taxes, to fund a government that is trading treasuries for... privately generated CDOs of uncertain to no worth.

The beautiful thing about the Fed is they can PRINT money if they need it.........

Came across a comment elsewhere that I thought was relevant, to the effect that..
..the system that we think we have is "capitalism". Capitalism requires capital. When you systemically remove capital from the equation, you no longer have "capitalism".. but something else: "creditism".

The Treasury creates capital everyday, as does the Fed. Foreing investors buy a TON of US Treasuries as a hedge against their own currencies, etc. There's plenty of capital out there.........

A financial structure based on "creditism" can only fail, and is failing before our eyes.

The current mortgage mess is not as bad as the S&L crisis was........

 

[MichaelB]

The current mortgage mess is not as bad as the S&L crisis was........

I'm not sure about this last point. The treasury has now guaranteed Freddie Mac and Fannie Mae credit and stated they (we) will also help their equity - after Bear Sterns - and lots of liquidity is being fed into the financial markets via the TLF. Moral hazard runs rampant right now.

The S&L crisis hit the banks and property markets. This one has now made it into foreign banks, the insurance industry, investments banks and hedge funds. Bases on recent news, the auto industry as well - via financing. I kinda think this one is (or will be) an order of magnitude bigger and badder.

It's not the end of the world as we know it, but it sure is one big pile of stinking feces. There will be lots more pain to go around.

Michael

 

[Texas Proud]

Ladelfina...

It seem by your post and others that all CDOs are 'bad'.... this is just not true... Many moons ago I was trustee for 28 of them... and many of them were overcollateralized and had pretty steady cash flow. They are only bad if the underlying assets are bad.

TP

 

[ladelfina]

I understand that there might be ones that are ok.. BUT the "beauty" of them is that they have been widely used in ways that are neither transparent nor regulated.. so who can tell? Financial entities invented them expressly to hide and dilute crap into big crap smoothies; we'll be lucky if the AAA smoothies only turn out to be 30% crap instead of 90%.. is that your point? to that.

The biggest issue is, of course, the mortgage-backed CDOs.. and an interesting analogy is here (bolding mine):

The benign view of CDOs is that they represent an important technological improvement that allows for better pooling of risk. I would characterize the main concerns as centering on whether in the process existing financial arrangements have accurately priced aggregate risk.

First let me clarify what I mean by aggregate risk. Some risks are inherently undiversifiable. One can understand that point most clearly with Robert Lucas's elegant asset-pricing model. Suppose that the entire economy consisted of one big potato farm. All financial assets would then ultimately be nothing more than claims against future potato production, and there is no way they can credibly promise to deliver more potatoes than are actually available. If there is a bad harvest, people will be hungry, and no clever set of financial instruments can possibly insure you against that.

An example of the kind of aggregate risk I have in mind is thinking through what would be the consequences of, say, a 20% decline in average U.S. real estate prices, and what that might mean for default rates.

Let me next clarify what I mean by mispricing of this risk. I am not concerned about whether those who are bearing the aggregate risk (i.e., setting themselves up to be the guy who has the fewest potatoes when times are bad) earn a higher expected return to compensate them for the risk. Rather, my concern is whether they may have invested in assets with a negative expected return. For example, if you purchased an asset with an 85% chance of a 15% return (which you'll earn as long as a recession does not occur), and a 15% chance of a -100% return (you're wiped out if it does), then your expected return would be -2.25%.

The specific kind of example that comes to mind is New Century Financial Corporation, which was pushed into bankruptcy from a substantially more modest aggregate shock than the one I am concerned about here. The concern about mispricing is that if loans were extended that should not have been, the magnitude of both the real estate boom and its subsequent bust are amplified substantially relative to what they would have been with accurate pricing of aggregate risk.

But who would be so foolish to have invested hundreds of billions of dollars in extra risky assets with negative expected returns? The logical answer would appear to be-- someone who did not understand that they were accepting this risk.

So here is the heart of the question that troubles me-- who is the residual bearer of risk if there is a substantial decline in U.S. real-estate prices?

To the extent that the answer might be the taxpayers who are liable for government employee pension commitments ([1], [2]) or a perceived public fiscal commitment to the government sponsored enterprises, then I think a reasonable case can be made that the bearers of the risk were indeed insufficiently informed.

If there has been some mispricing of aggregate risk, then the magnitude of the economic consequences of the housing cycle are going to be greatly amplified. Indeed, the reason I have been developing increasing concern about this possibility is that it looks to me like we are already seeing evidence of just such effects. The ongoing woes of the housing market are clearly now reflecting something much more than a simple response to higher interest rates. But all this has happened without any significant undiversifiable shock, such as an actual recession or broad decline in real-estate values. What will happen when such a shock finally does arrive?

If any of our readers can see the answer to these questions more clearly than I can, I would welcome your insights and reassurance that all is well.

written June 2007
Econbrowser: CDOs: what's the big deal?

 

[Texas Proud]

I understand that there might be ones that are ok.. BUT the "beauty" of them is that they have been widely used in ways that are neither transparent nor regulated.. so who can tell? Financial entities invented them expressly to hide and dilute crap into big crap smoothies; we'll be lucky if the AAA smoothies only turn out to be 30% crap instead of 90%.. is that your point? to that.

The biggest issue is, of course, the mortgage-backed CDOs.. and an interesting analogy is here (bolding mine):


written June 2007
Econbrowser: CDOs: what's the big deal?

Not at all... I can tell you that some of the ones I had were AAA and still are AAA... I had an auto insurance CDO that was 10% over collateralized... it was used when you decide to make payments on your auto insurance instead of paying it all at once. They sold your loan to the trust so they could have working capital.. So, it would have say $110 million in loans and only $100 million of bondholders... and they were broken up between senior and junior bonds... so if you were the most senior bondholder.... you might have $40 million invested with $110 million of collateral.... not a bad ratio IMO...

Also.... CMOs is for mortgage loans....

 

[Art G]

Well perhaps today some of you have begun to grasp what I was so gently trying to explain about hedge funds and the destruction of the market. FINALLY, they've decided they should do something about naked shorting? I guess the powers that be have made their millions. How unbelievably sad.

 

[FinanceDude]

Well perhaps today some of you have begun to grasp what I was so gently trying to explain about hedge funds and the destruction of the market. FINALLY, they've decided they should do something about naked shorting? I guess the powers that be have made their millions. How unbelievably sad.

A couple of the whizkids who figured out how to package those CDOs and make the numbers work made BILLIONS on the sales to big investment banks, that's with a "B"...............

 

[Art G]

Well besides the fact that it's a complete manipulation of the market and causes the average investor to lose confidence in not only the stock market, but the economy as well; taking a stock down to a reasonable price is one thing, but destroying them is another. Let's use FNM as a good example.....do you not think naked shorting of this stock to....oh say....$2 might cause a concern?
These massive hedge funds are making certain people incredibly wealthy at the expense of many, many others.
Assume you own a restaurant and I patronize it every day, but I never pay my check....

WOW! I overshot the share price. Who'da thunk it?

 

[Art G]

Again, there is a whole different story between shorting a stock vs. naked shorting a stock. The whole naked short issue was allowed by brokerages in order to make a more liquid and efficient market. Hedge funds have totally manipulated that rule for their own benefit, and humongous hedge funds have used the rule to create one sided trading. The uptick rule was at least in place to try and control drastic price falls, the lifting of that rule creates an open window for those same funds to do as they please.
Give it time, you all will understand what I'm saying soon enough.

Didn't think it would happen quite so soon.

 

[Art G]

Well then, I'm pulling all my money out of the market and buying annuities.

FD, funny but I could eat out every night with the amount of cards I get about free dinners. Now that Art clued me in about hedge funds ripping me off I can find out all about annuities.

In re-reading this thread, here was about the only good response and I'm betting you didn't listen to yourself.

 

[73ss454]

Yeah, annuities seem to be safe.

 

[ziggy29]

Yeah, annuities seem to be safe.

Well, maybe they are after Uncle Sam rescues them... that's more than they are doing for my 401K.

 

[73ss454]

Well, maybe they are after Uncle Sam rescues them... that's more than they are doing for my 401K.

Speak with Art, he can help you move the 401K over to an annuity by tomorrow.

 

[Art G]

Yeah, annuities seem to be safe.

That's it?? No apologies, no "hey maybe you were right and trying to teach me something"? I could have guessed. On internet sites you have two types of people, one that wants to learn, and one who wants everyone to know how smart they think they are. Guess where you fall.

As to the annuities, go back and read any of my posts regarding them and you'll see time and again I said it was important to research what percentage of money is in annuities for the company, and how sturdy the company is. I moved any money I could from AIG months ago.
For the record, I still can't guarantee the safety of your money there, but if it goes to zero in a mutual fund or stock, how's that better?

 

[73ss454]

Hey Art, you like annuities and I don't, let's leave it at that.