What exactly caused the hedge fund deleveraging?

lrf3 · Jun 24, 2009

What exactly triggered the hedge fund deleveraging that decimated markets last year? Was it a confluence of various events that converged at one point in time that caused all banks to panic and withdraw loans from various funds and corporations? Or could it possibly be one player or event that triggered a cascading effect on all other banks. Could it be possible that the develeraging could have been pre-planned by some entity like the Federal Reserve? Or is it simply something that was beyond anyone's control?

Why is that the Federal Reserve did not intervene immediately to provide liquidity to all these hedge funds? It could have kept asset prices from plummeting as much as they did. I guess perhaps they were just focusing on the bad debt that the banks were holding?

Dominic · Jun 24, 2009

Seemed that there where many redemption requests that started it all; I think Fortress and many others placed lockup periods on the redemptions to stop the bleeding..

risktaker · Jun 24, 2009

The Fedral Reserve should not be used to "provide liquidity" to ANY entity besides banks.

There was NO lack of "liquidity"!

What there was, was the realization by many morons that they got greedy, were leveraged up to their eyeballs & had no choice other than to liquidate & raise whatever cash they could at more reasonable prices.

Quote from lrf3:

Why is that the Federal Reserve did not intervene immediately to provide liquidity to all these hedge funds? It could have kept asset prices from plummeting as much as they did. I guess perhaps they were just focusing on the bad debt that the banks were holding?

Martinghoul · Jun 24, 2009

Quote from lrf3:

What exactly triggered the hedge fund deleveraging that decimated markets last year? Or could it possibly be one player or event that triggered a cascading effect on all other banks.

Where have you been? You have heard of Lehman Brothers, right?

lrf3 · Jun 24, 2009

Quote from Martinghoul:

Where have you been? You have heard of Lehman Brothers, right?

Of course I have. Just being a bit abstract. The Fed could have bailed out LEH just like when it forced BAC to buy ML. This is probably the single event that I was referring to as a "cascading effect." The Fed knew exactly what was going to happen if it didn't save it. LEH's debt holders were going to get screwed and have to liquidate for cash. I basically believe the Fed allowed/triggered the deleveraging because they knew exactly what was going to happen if they let LEH fail. Just want to see what other people think.

Agassi · Jun 24, 2009

Well, the fed picks and chooses who should survive and who should fail. LEH was a Goldman's fierce competitor and there is no way that idiot aka treasury secretary would bail out LEH. I mean, would you think would happen if you put the Head of the Mafia to be the Head of the Police? That was the situation.

If AIG failed, then, Goldman would have lost 20 billion dollars. So Fed had to bail out. In the end, even with all these bail outs, banks are still not lending. What a joke.

marketsurfer · Jun 24, 2009

loses?

Angrycat · Jun 24, 2009

Quote from lrf3:

What exactly triggered the hedge fund deleveraging that decimated markets last year?

Every hedge fund is limited by its clearing broker in the amount of leverage it can have. If the prices of the fund's long positions fall in value, they may find themselves in violation of leverage limits. In this case, they have to sell securities to meet margin calls. Of course, if this puts further downward pressure on prices as funds in violation of leverage limits can't be choosy about price. The extent to which this effects the market (the cascade effect) depends on how many funds are over-levered at any one time. This is impossible to determine ahead of time as price move is what puts the funds in call.

Redemptions may also force hedge funds to liquidate, but redemptions have no effect on leverage. A fund not in call does not have to reduce leverage to meet redemptions.

Quote from lrf3:

Why is that the Federal Reserve did not intervene immediately to provide liquidity to all these hedge funds? It could have kept asset prices from plummeting as much as they did. I guess perhaps they were just focusing on the bad debt that the banks were holding?

Hedge funds are not part of the Federal Reserve system and the Fed does not lend to hedge funds. Banks are part of the Federal Reserve system.

Keeping prices from falling is not and should not be a goal. The whole point of capital markets is price discovery. Creating asset inflation to prop up nominal prices is ludicrous Zimbabwenomics. Not that the Fed hasn't been doing this through the banking system, but still....

Martinghoul · Jun 24, 2009

Quote from lrf3:

Of course I have. Just being a bit abstract. The Fed could have bailed out LEH just like when it forced BAC to buy ML. This is probably the single event that I was referring to as a "cascading effect." The Fed knew exactly what was going to happen if it didn't save it. LEH's debt holders were going to get screwed and have to liquidate for cash. I basically believe the Fed allowed/triggered the deleveraging because they knew exactly what was going to happen if they let LEH fail. Just want to see what other people think.

No, I disagree completely...

The sequence of events that followed Leh came as a surprise to them. Had they known what sort of beast they were unleashing, they would have never allowed it to happen. What you have to remember is that the carnage that decimated the hedge fund space is a minor footnote in the grand scheme of things. The real sh1tshow started when the redemptions hit the money funds, which form the deposit base that's used to fund the whole system. Everything else followed...

Angrycat · Jun 24, 2009

Quote from lrf3:

Of course I have. Just being a bit abstract. The Fed could have bailed out LEH just like when it forced BAC to buy ML. This is probably the single event that I was referring to as a "cascading effect." The Fed knew exactly what was going to happen if it didn't save it. LEH's debt holders were going to get screwed and have to liquidate for cash. I basically believe the Fed allowed/triggered the deleveraging because they knew exactly what was going to happen if they let LEH fail. Just want to see what other people think.

Deleveraging started long before Lehman went bankrupt. It had been going on since the third quarter of 2007. And the Fed did not know exactly what would happen if Lehman failed. If any government body could know the effects of its policies with such precision, centrally planned command economies would work and the Soviet Union would have overtaken the U.S. in economic growth instead of crumbling. Also, the Fed wouldn't have kept interest rates too low for too long in the early 2000's such that it stoked the credit bubble.