Good Hedge fund article

[dex]

Hedge funds struggle to cope | Collateral damage | The Economist

All this means that hedge funds have been unable to ride to the rescue of global markets. According to the IMF, the average cash balance of hedge funds has risen from 14% last year to 22%, while the amount of leverage (borrowed money) they use has fallen from 70% of capital to 40%. In theory, that gives them the firepower to buy now that prices have fallen; in practice, they may need their cash to repay clients that want to redeem their holdings. Charles MacKinnon of Thurleigh, a fund manager for private clients, says it has given notice on some 70% of its hedge-fund positions.
Individual hedge funds will doubtless be brought down by this crisis. Their fall will have far less economic impact than that of either Lehman or Bear Stearns, although if they are forced to sell assets that will not help the banks. But the industry can feel justifiably aggrieved. It has not only been clobbered by a crisis that started in a regulated industry (investment banking), but it has been given a good kicking by the regulators too.

 

[Leonidas]

What a mess. Here's a new twist I had not heard of before:

Nor is that the end of the hedge funds’ problems. As an investment bank, Lehman Brothers was active in prime brokerage, a vital source of finance for hedge funds. When prime brokers lend money to hedge funds, the funds are required to put up collateral (Treasury bonds and the like). Lehman then used this collateral as security for its loans, a standard industry procedure known as “rehypothecation”. But the result has been that assets belonging to some hedge funds have been ensnared by Lehman’s bankruptcy. One leading lawyer describes this as “an unmitigated disaster”.

 

[audreyh1]

Yes, Leonidas that "twist" is part of what caused the immediate credit freeze after the Lehman bankruptcy, and also started a run on money market funds which is why the Fed immediately stepped in to "guarantee" money market funds as of 9/18/08.

Audrey

 

[Gone4Good]

Nor is that the end of the hedge funds’ problems. As an investment bank, Lehman Brothers was active in prime brokerage, a vital source of finance for hedge funds. When prime brokers lend money to hedge funds, the funds are required to put up collateral (Treasury bonds and the like). Lehman then used this collateral as security for its loans, a standard industry procedure known as “rehypothecation”. But the result has been that assets belonging to some hedge funds have been ensnared by Lehman’s bankruptcy. One leading lawyer describes this as “an unmitigated disaster”.

Yup, this is but one small fact that contradicts the "let them all go bankrupt" argument espoused by some on this site. In retrospect, allowing Lehman to go bankrupt was a colossal mistake.

To the OP, hedge funds in aggregate won't be riding to anyone's rescue. Rather, they are likely part of the problem as the relative healthy ones liquidate assets to meet redemptions. The unhealthy ones liquidate assets to meet margin calls. Several of the best will be around to scavenge the remains, but I wouldn't expect them to have the financial might to save the system.

 

[audreyh1]

Yes, I think hedge funds are more the problem right now, as they are a big part of the forced selling that happened last week. They also tend to get caught "leaning the wrong way" and end up causing sudden sell-offs in various asset classes - this year in commodities is a good example.

Audrey

 

[socca]

It's interesting how the role played by hedge funds as eager purchasers of ever-more-risky (and profitable) securities didn't appear in any of the mainstream media articles I've read these last few weeks. When most people think of hedge funds, they think of wealthy investors and unbridled greed. The interesting question is to what extent Paulson's original plans for the $700B bailout money - purchasing bad debt - would have benefited hedge fund owners, managers, and investors. If the bailout benefit for these folks would have been substantial, mentioning the hedge fund connection would have made the bailout even more politically unattractive than it already was.

 

[2B]

Every study on hedge fund performance I've seen puts the average return of hedge funds below market indexes. However, their standard deviation is extremely wide so there are always funds that make eye popping returns. That keeps the rubes coming. Just because someone has a lot of money doesn't mean they manage it well.

The typical, if not all, hedge fund gets a large cut of the profits plus a stiff management fee. The hedge fund does great if they guess right but don't do too badly if they don't. The clients take the risk.

I suspect a big part of the carnage last week was due to hedge fund margin calls. We ought to start seeing the corpses washing up onto shore within the next few days.

 

[2B]

Yes, Leonidas that "twist" is part of what caused the immediate credit freeze after the Lehman bankruptcy, and also started a run on money market funds which is why the Fed immediately stepped in to "guarantee" money market funds as of 9/18/08.

Audrey

I was surprised that Lehman wasn't given a Bear Stearns exit. That would have effectively wiped out the shareholders but preserved the preferreds and bonds that are held by the other financial institutions. The takeover of Fannie and Freddie also did not protect the preferreds which caused an immediate writedown throughout the financial industry. These companies all held massive amounts of eachothers preferreds. Writing them down to zero just creates a domino effect.

Protecting preferreds does smack of "wall steet bailout" but that's what we're going to do to protect the overall economy. The cost of protecting the preferreds would have been a lot cheaper than what we're going to do with the banks now and move us a lot further towards total socialism.

When Lehman failed I wondered if Paulson was using it as "payback time."

 

[Leonidas]

Protecting preferreds does smack of "wall steet bailout" but that's what we're going to do to protect the overall economy. The cost of protecting the preferreds would have been a lot cheaper than what we're going to do with the banks now and move us a lot further towards total socialism.

When Lehman failed I wondered if Paulson was using it as "payback time."

Ben Stein on Lehman's fall.

So, as I drove home from La Jolla to the comfort of my dogs in Los Angeles, I thought, “Well, what now? Now that we are facing a situation of complete unpredictability with a financial system fluctuating between state socialism and chaos, what do I do?”

http://www.nytimes.com/2008/10/12/business/12every.html?em

I saw some of Fuld's testimony on the Hill and was stunned. I only kept $300 Million!

Apparently others aren't all that crazy about him either.

Richard Fuld, the former CEO of the former banking giant Lehman Brothers, was punched in the face while working out in the company gym after the announcement that the 158-year-old firm was filing for bankruptcy.

Journalist Vicki Ward says she heard the story thusly: "He was on a treadmill with a heart monitor on. Someone was in the corner pumping iron, and he walked over and he knocked him out cold." She said she would have done the same to Fuld.