Banks are demanding more capital from hedge funds to support outstanding loans resulting in the dissolution of some funds forced to liquidate assets, Bloomberg News reported Monday. ``If you have leverage, you're stuffed,'' Alex Allen, chief investment officer of London-based Eddington Capital Management Ltd., which has $195 million invested in hedge funds for clients, told Bloomberg News. Allen said the crisis is like a bank panic turned upside down with bankers, not depositors, concerned they won't get their money back. He added there are likely to be more collateral /margin-related liquidations of hedge funds in the weeks ahead.
The $2 trillion hedge fund industry is in the throes of its worst capital crunch since the Federal Reserve successfully encouraged the securities industry to provide $3.6 billion to bail-out Long Term Capital Management L.P. in 1998. Amplified by leverage and aided by innovative investment formulas, many hedge funds generated outstanding returns for much of this decade, often aided by high-performing asset-backed securities. However, as the housing market slowed and mortgage-backed securities began to fail, hedge funds started to experience the down side of their deployed leverage: banks and other counterparties who lent money for these investments had the right to and initiated requests that hedge funds put up more capital. Hedge funds that could not meet the capital requirement have been liquidated.
For example, on February 22 Tequesta Capital Advisors received a call from bankers for more capital. When Tequesta could not meet the call for more money, lenders liquidated the $150 million fund, Bloomberg News reported. At least six other funds have been forced to liquidate holdings.
Further, the hedge fund sector, while in many cases deploying capital via more-sophisticated - - and specialized - - investment techniques, nevertheless represents another data point regarding a problematic investment pattern that's occurred across the financial spectrum - - by consumers, corporations, and hedge funds alike - - namely, "recklessly deployed debt" economist Glen Langan told BloggingStocks Monday. Langan said that after the September 11, 2001 terrorist attacks monetary policy was eased to stimulate U.S. economic growth - - it brought real interest rates for banks to near zero - - and created "large lending margins and enormous incentives for banks to lend."
And lend, the banks did. To homebuyers, corporations, private equity buy-out firms, and to hedge funds, among others. In the housing sector, dozens of new mortgage products were added - - some of which contained very high-risk amortization plans. The hedge fund sector was similar, Langan said. The market is currently dealing with the effects of the subprime mortgage sector's defaults, he added, and is beginning to encounter - - as was the case with housing - - "problematic loans to the hedge fund sector." The main difference, Langan carefully noted, being that banks can often require more capital from a hedge fund if asset values depreciate, whereas that is not the case with typical home mortgages.
The above would seem to place most of the responsibility for the liquidations on lenders. Not so, in Langan's interpretation, who likened the loans as "giving a pair of ice skates to a new skater." You can train the skater, but ultimately it's the skater's responsibility to decide when to skate, watch for ice ruts, and not skate too fast for conditions. "Many hedge funds have been skating too fast for a long time, and now we're seeing the result," he said.
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