What exactly caused the hedge fund deleveraging?

[Angrycat]

To answer more precisely what caused deleveraging exactly...

In 2007, everyone suddenly realized that credit was too cheap and default rates in sub-prime mortgages began to creep us as interest rates rose and house prices fell. That caused the price of the MBS, CDO and other mortgage related securities held and heavily levered to fall. When they fell, many of the funds that held them found themselves faced with margin calls and began selling the much more liquid equity secruities in their portfolios to meet margin calls.

In short, it was a repricing of risk.

 

[TheBestGuruEver]

let's say you get 25:1 or 40:1 leverage. we all know e-minis are something crazy like (depending on your broker) 4,000 to (price of e-mini times leverage ratio of 50). say 10:1. and that is a lot for most of us.

now you use your hundreds of millions and are long/short so much that if the market went to zero your entire firm is gone. you buy one emini, S&P goes to zero, you owe 40,000. now times that by ridiculous.

now one commodity tanks, coupled with the housing market that puts so many losses on the banks' balance sheet (or off) that they worry about leverage they are giving consumers and perhaps institutionals.

so risk gets pulled in.

and people NEED to sell profitable positions to cover margin calls, or the new risk parameters.

then they realize it's really impossible.

this is possibly why the dollar went up, oil down more, stock market down, etc....

selling oil and stocks and covering dollars....profitable positions to cover losses elsewhere. then that gets out of hand...and the collateral damage is massive.

is it over?

i say NO.

so sell oil, sell stocks and buy dollars.

if the housing market didn't tank, i would imagine dow at records.

suprime loans cut and diced into a billion pieces times the leverage multiplier equals WTF we are broke and need to sell winners.

 

[nutmeg]

I agree with Angrycat, funds had to post more collateral as prices fell, to meet collateral obligations they had to sell equities, I'm sure somewhere in there other funds were short on who would be meeting margin calls and what had to be sold. The redemptions came soon after the fact.

 

[crgarcia]

Quote from lrf3:

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?

Everything was overvalued, everything:
Stocks, commodities, foreign currencies, homes, mortgages, etc.

It had to collapse soon or late.