From Volume 4, Issue Number 25 of EIR Online, Published June 21, 2005

World Economic News

Treasury Secretary Snow demands there be no regulation

On a visit to Brussels, U.S. Treasury Secretary John Snow, according to London's Financial Times, "urged European leaders to stop using inflammatory anti-capitalist rhetoric or risk losing U.S. investment." Snow "urged European governments to push ahead with free-market reforms and not to adopt words or policies that deterred investors." In an interview with the FT, Snow warned: "American business people are going to put capital where they feel they are welcome, where capital is honoured and where they can get good returns." Snow in particular warned against imposing tough regulations on hedge funds, saying "Be careful with the heavy-touch approach, because these are awfully important financial market players.

"They make financial markets more efficient and move capital around and put it in the hands of those who can use it best."

Snow's statement was widely interpreted to be an attack on German Chancellor Gerhard Schroeder, who had stated his intent to push for regulation of hedge funds, during a June 13 speech to a political party Congress.

Bank for International Settlements admits financial disarray

In its latest quarterly review, the Bank for International Settlements (BIS) admits—of course covered in its typical banker's language—that global financial markets have been in complete disarray since mid-May. The overview of the report starts off:

"Credit and equity markets fell starting in March 2005 as investors retreated from investments with higher risks. Credit markets experienced their largest sell-off since 2002, while equity markets gave up most of their gains from 2004."

"Firm- or sector-specific news, particularly the troubles of US auto makers, played an important role in the retreat from riskier assets.... [C]redit spreads continued to widen and government yields to fall through to mid-May in response to nervousness about possible downside risks. Unusual volatility in the default swap market added to uncertainty in May."

"Credit derivatives markets were more unsettled than cash markets, however. Some hedge funds reportedly lost substantial amounts on trades involving General Motors and CDS index tranches. The possible systemic consequences if some of these highly leveraged players were to fail weighed on credit markets in the first half of May. Credit markets were also said to be pressured by hedge funds moves towards more liquid positions, with some funds anticipating an increase in redemptions in response to their lacklustre returns in recent months.... [A]s of early June it remained unclear whether the sell-off in credit markets had run its course."

In a special box, entitled "Stress testing of credit markets: the downgrade of General Motors and Ford", the report then goes into a lot of technical details showing how the downgradings were devastating sections of the derivatives markets, in particular credit derivatives. The box concludes:

"As losses on such relative value arbitrage trades accumulated, investors rebalanced their portfolios to adjust their hedges, meet margin calls and reduce their risk exposure. This in turn caused liquidity to deteriorate, especially in CDS index and tranche markets. Many leveraged investors had similar positions, and this concentration of activity magnified the deleveraging process. The circle of deterioration was similar in nature, albeit certainly not in magnitude, to what had occurred in 1998, following the default by Russia and near collapse of Long-Term Capital Management."

Again trying to downplay the systemic implications, the BIS then repeats the usual line that "hedge funds today appear to be significantly less leveraged than in 1998," and states, "As of early June, there was little evidence of any counterparties experiencing severe financing difficulties as a result of losses following S&Ps downgrade of the carmakers."

Europe's Largest Hedge Fund Suffered Severe Losses

GLG Partners, the largest hedge fund operation in Europe, suffered very severe losses in May. Credit Fund, one of GLG's 16 different hedge funds, lost 14.5% of its entire capital during May. This is at least the amount of losses admitted by GLG in its latest private letter to investors, "a copy of which has been obtained by the Financial Times."

GLG blames the losses on the particular mathematical model it used to price its credit derivatives. Somehow, the model "failed to foresee market swings after last month's ratings downgrades of General Motors and Ford." The FT report adds: "The admission is significant because other banks and hedge funds appear to have been using similar trading models, meaning that they may also have suffered big derivatives losses." In this hedge-fund mathematical model, the GM/Ford debt collapse (including a collateralized-debt plunge) of April and May was an event so unlikely, that its probability could be discounted entirely—but Lyndon LaRouche publicly forecast the GM/GMAC debt collapse as imminent, in late February! EIR detailed this already in March.

Concerning the overall situation, the GLG letter states: "Segments of the hedge fund community and a substantial number of investment banks are nursing material losses in structured credit trades as a result of recent market conditions." Of course, GLG calls on its investors not to withdraw funds (probably gone anyway) because it is now switching to a (supposedly) better mathematical model.

The FT concludes: "the real impact of May's credit price swings on the sector has yet to emerge, since it remains unclear whether investors are withdrawing money from hedge funds."

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