swimming with sharks

[ronin]

Trying upgrade my capacity to understand the credit market, and what those crazy hedge funds are doing to screw up the market this time, I found this: http://www.pimco.com/LeftNav/Latest+Publications/2005/Kiesel_Adult_Swim.htm
I've had to read it over twice, but I think I'm starting to get it.  Leveraged credit derivatives anyone?

 

[riskadverse]

Interesting article. I have to think there are some serious problems out there that are being hush hushed. As confident as Pimco sounds - and they are marketing themselves throughout the article, I would guess they are sweating bullets concerning the current hedge fund "anomalies".

 

[Nords]

Re: Chumming with sharks

Kiesel's analogies are making me seasick. And I can't help but notice that PIMCO's writers work very hard to baffle us with bull so that we'll give up and just buy their products to take care of us. (DOW 5000-- are we there yet, Bill?)

Frank Partnoy's "Infectious Greed" says that the investment banks have been able to lay off a lot of bond-default risk (which previously went to banks) on hedge funds & us dumb retail investors. The investment banks & regular banks still end up holding the quality end of the tranches while the rest of us are swimming in the sewers. Buy, hey, we're more liquid than ever and what could possibly go wrong-- the Russians couldn't default on their debt again and LTCM is MUCH more careful now, right?

 

[ronin]

This article offers more insight into the issue and deals more specifically with the hedge fund problem, if there is one.

http://moneycentral.msn.com/content/P116159.asp

 

[Nords]

This article offers more insight into the issue and deals more specifically with the hedge fund problem, if there is one.

http://moneycentral.msn.com/content/P116159.asp

Good one-- thanks. Yep, I bet the hedges are bailing as fast as they can find the liquidity...

 

[unclemick]

Buffett has been less than thrilled with derivatives for a while. Hasn't he been unwinding any he found in some of his insurance acquistions for a while now

 

[Nords]

Re: Gen Re's derivatives

Buffett has been less than thrilled with derivatives for a while. Hasn't he been unwinding any he found in some of his insurance acquistions for a while now

From Buffet's 2004 annual letter:
"The wind-down of Gen Re Securities continues. We decided to exit this derivative operation three years ago, but getting out is easier said than done. Though derivative instruments are purported to be highly liquid – and though we have had the benefit of a benign market while liquidating ours – we still had 2,890 contracts outstanding at yearend, down from 23,218 at the peak. Like Hell, derivative trading is easy to enter but difficult to leave. (Other similarities come to mind as well.)

Gen Re’s derivative contracts have always been required to be marked to market, and I believe the company’s management conscientiously tried to make realistic “marks.” The market prices of derivatives, however, can be very fuzzy in a world in which settlement of a transaction is sometimes decades away and often involves multiple variables as well. In the interim the marks influence the managerial and trading bonuses that are paid annually. It’s small wonder that phantom profits are often recorded.

Investors should understand that in all types of financial institutions, rapid growth sometimes masks major underlying problems (and occasionally fraud). The real test of the earning power of a derivatives operation is what it achieves after operating for an extended period in a no-growth mode. You only learn who has been swimming naked when the tide goes out."

 

[ronin]

It seems like there is very little regulation in this area.  Also there is poor visibility.  The charts show heavy run up in usage of these derivatives with accelerating amounts of leverage involved.  That means that not only are the hedge fund owners on the hook hugely when a trade goes sour, the finacial house that loaned out the dough is in a precarious spot when the margin calls go out.  Since performance of the funds seems to be generally reported only quarterly, there may be looming a flood of redemptions from well-heeled (but probably less informed than they should be) investors who didn't think they could lose money, much less large bundles very quickly.  That could ripple through the system for a while.  I suspect, as Nords pointed out above, the big guys (like Goldman, ML, etc) will do there level best to profit while shielding their prime hedge fund customers from as much pain as possible.  I think a lot of pigs wearing lipstick and sundresses will be sold as mail order brides to the great unwashed retail trade.  But hey as long as you get some long term companionship...   And the gems, that fall like angels from the sky, will be cherry picked by the likes of said financial houses, pension funds and the Pimcos of the world to upgrade their portfolios.  And so it goes.  I do think, combined with a rising interest rate environment, I'd be very leery of adding to junk bond positons at this juncture.

 

[Nords]

... I'd be very leery of adding to junk bond positons at this juncture.

Agreed-- I think Berkshire Hathaway is junk free. If junk was a deal they wouldn't be holding $41B in cash-- although Buffett has a long history of only discussing what he did last year, not last week.

 

[lazyday]

usatoday

A rumored bet gone bad, it turns out, is what has investors on edge. The rumor, which originated abroad on May 10 and quickly made its way to U.S. trading desks, was sobering: One or more of the roughly 8,000 hedge funds was allegedly in financial trouble, victim of a losing trade involving both the stock and debt of troubled automaker General Motors.

The rumors have yet to be confirmed, but investors remain shaken....

Edit: shorten link so thread is more readable

 

[ronin]

From Mike Hartman's market wrap-up in Financial Sense On-line (5/18/05):

"All the credit for this excerpt goes to Doug Noland of the Prudent Bear. When I read this, I thought it was an accurate description of what we are seeing today.

'One trouble with every inflationary creation of credit is that it acts like a delayed time bomb. There is an interval of indefinite and sometimes considerable length between the injection of the stimulant and the resulting speculation. Likewise, there is an interval of a similarly indefinite length of time between the injection of the remedial serum and the lowering of the speculative fever. Once the fever gets under way it generates its own toxics.' (page 11)

'Nor was our financial system weakness solely in the banks. Throughout the whole business of providing capital for our economic life there ran a pollution – the habit of making money by manipulation and promotion of securities. And that promotion too often disregarded the merits of the goods it sold. In addition, the financial world, instead of providing merely the lubricants of commerce and industry, had often set itself up to milk the system. Worse still, instead of being financial advisers to commerce and industry, the financiers had, in many ways, set themselves up to dictate the management of it.' (page 23)

'The credit system in all its phases should be merely a lubricant to the systems of production and distribution. It is not its function to control these systems. That it should be so badly organized, that the volume of currency and credit, whether long or short term, should expand and shrink irrespective of the needs of production and distribution; that it should be the particular creature of emotional fear or optimism; that it should dominate and not be subordinate to production and distribution – all this is intolerable if we are to maintain our civilization.' (page 25/26)

'It was difficult for the public to believe that such griefs and tragedies lay hidden in so obscure a process as credit inflation when forced on an already optimistic people.' (page 14)

Now here’s the kicker…Mr. Noland described the quote as follows, 'I thought I would share a few excerpts I ponder from The Memoirs of Herbert Hoover – 1929 to 1941 that capture the essence of major systemic Credit Bubble dynamics.' Back then, just as today, people were told debt is a good thing…go out and buy something with your credit card! I also noticed the part that described the fraud and manipulations of Wall Street promoters…looks like there really is nothing new under the sun!"