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2008-10-21 Home Front: Politix

Hedge Funds, Politics, and the Market Crash

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Posted by tipper 2008-10-21 10:51|| || Front Page|| [4 views ] Top

#1 The problem with the hedge funds is they didn't hedge. Hedge funds are allowed to take extreme risks on individual investments because (in theory) each position is balanced by another investment that behaves the opposite way (e.g. a purchase of Ford stock is balanced by a short sale of GM). By carefully adjusting the amount of money on each side they can make a consistent and stable amount of money.

The problem is this requires alot of high powered math and patience that many "financial geniuses" don't have. And since hedge funds are not publicly traded, there is no requirement for hedge funds to balance their positions. The upshot is that anything goes, and anything went.

One thing about Mark to Market: The problem is that is requires a MARKET. There was a segment recently on NPR with some interbank brokers: They had 45 banks looking for money and NO offers. At any price. And there had not been and offer in 3 weeks.

According to Mark to Market, all CDs, Commercial Paper and other money market instruments from these banks should be valued at $0. This creates problems for all money market funds that hold bank paper, making the financial panic much worse than it needs to be.

Posted by Frozen Al 2008-10-21 11:56|| 2008-10-21 11:56|| Front Page Top

#2 Hedge funds are so called because they started out exploiting market inefficiencies and hedging between them. Today, there are no requirements that hedge funds 'hedge' and they may do so in innovative ways. For example, a fund looking to exploit the trend to drinking less alcohol may go long on Coca Cola and hedge by shorting Budweiser.

The point of the article is that hedge funds may have gamed the system. Highly likely IMO, but at most that was just a trigger for what already unstable.

The fact there were no offers for overnight interbank loans has nothing to do with mark-to-market.

Posted by phil_b 2008-10-21 13:47|| 2008-10-21 13:47|| Front Page Top

#3 The fact there were no offers for overnight interbank loans has nothing to do with mark-to-market.

Who wants to lend unsecured to a bank that may be insolvent tomorrow and unable to raise capital?

Posted by Nimble Spemble 2008-10-21 14:03|| 2008-10-21 14:03|| Front Page Top

#4 Phil_b,
"For example, a fund looking to exploit the trend to drinking less alcohol may go long on Coca Cola and hedge by shorting Budweiser."

This is an excellent example of how hedge funds can go wrong. Both positions will make money if people drink less alcohol and lose money if they drink more. Your example looks like a hedge, but it isn't. (Instead it is a double down)

Hedge funds are filled with "financial geniuses" making exactly these kinds of mistakes. They then go out and leverage their position (i.e. borrow other people's money) and tell lenders: "Don't worry, we're hedged against losses". Then they lose billions of dollars in a very short period of time (hours), and this is because they DIDN'T HEDGE.

As far as gaming the system. It is clear that the hedge funds are not/can not done that, otherwise they would not be losing money like water. The real problem is they are much more leveraged than other investers are allowed to be and they are losing money on hare-brained investments BECAUSE THEY DON'T KNOW WHAT THEY ARE DOING.

As for Mark to Market, I spent months at GMAC marking their securities to market every day. If there are no bids in the marketplace, the value of that class of security is $0.

Phil_b thank you for providing an example of why professional investors have lost tons of money in the last several weeks.

Posted by Frozen Al 2008-10-21 18:39|| 2008-10-21 18:39|| Front Page Top

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