U.S. Economic/Financial News

Hedge-Fund Crash Threatens To Pull Down Banks

The collapse of the Greenwich, Connecticut-based hedge fund Amaranth in mid-September is now hitting commercial and investment banks, according to recent financial press reports. Amaranth had leveraged its $9.2 billion in paid-in capital into $41 billion in borrowings from commercial and investment banks, which are not all accounted for. "Amaranth borrowed $4.50 for every dollar of its own equity at stake, according to documents it distributed to investors," Bloomberg reported Sept. 25. In June, Amaranth Advisors LLC had $9.2 billion in paid-in capital, that is, its own money, plus money given to it by investors. Amaranth then borrowed an additional $41.4 billion to with which to speculate. Now, in the space of the first two weeks of September, Aramanth's paid-in capital fell to $3.2 billion, a loss of $6 billion, but it still owes its $41.4 billion in debt, the vast majority borrowed from commercial banks and investment banks like Goldman Sachs and Morgan Stanley.

Despite reports to the contrary, Amaranth is braindead; it is only being maintained as a fiction, to give time to the largest banks to attempt to find a way to pay off Amaranth's large debts, and extricate it from multiple-layered derivatives bets in natural gas and commodities. This is only part of the picture: Amaranth was also a "big prime-brokerage client to a lot of firms," according to a top trader, meaning it lent money to other firms. At the same time, there are several other hedge funds in trouble. The Sept. 24 London Observer reported on hedge funds' losses in Britain, in a story, subtitled, "The $130 billion [British] sector is hemorrhaging cash." The Observer focused on GLG, representative of hedge funds which are headquartered in London or the Isle of Man.

A Washington-based source reported that at the Sept. 27 meeting of 13 international banks at the New York Fed, on the subject of derivatives, "the Fed will discuss ways for the private banks to pick up the losses, and establish responsibility and self-regulation to absorb bailouts of hedge funds." Lyndon LaRouche commented that as the bankers "try to manage the situation and spread out the losses of each hedge fund, they accelerate the crash."

Hemorrhaging Hedge Funds Face Investigations

As more and more hedge funds lose money or blow out entirely as a result of the housing and commodities bubbles bursting, and falling interest rates, calls for investigation and even regulation are growing louder. The London Guardian on Sept. 25 reported that the entire British-based "$130 billion [hedge-fund] sector is haemorrhaging cash," and simultaneously being audited and investigated more aggressively by the British Inland Revenue (tax agency). The Wall Street Journal on Sept. 26 reported that another class of hedge funds which is losing money as a whole, is "activist funds" which try to force management changes, dividend payouts, etc.—the well-known Kerkorian/Icahn/Robert Paulson type of funds which are somewhat under 10% of the estimated capital of hedge funds overall. And one of them, aptly named Pirate Capital LLC, is under SEC investigation for failing to disclose holdings of more than 5% in companies' stock. Many of the energy-derivatives-based hedge funds, of which Amaranth is the spectacular case, are also losing money in recent months.

"Rages at Crooked Hedge Funds" headlined Investment News Sept. 26, recounting Sen. Arlen Specter's (R-Pa) Judiciary Committee hearing that morning, at which he angrily lectured the SEC's enforcement division director, Linda Thomsen. Specter said he was "interested in indictments, even more interested in convictions, and most interested in jail sentences."

Ex Fed Head Warns vs. Hedge Funds, Derivatives

Unregulated hedge funds and derivatives may cause "a crisis that is truly a mess." So stated former New York Fed President William McDonough, who led the LTCM bailout operation in 1998, according to Bloomberg Sept. 26. McDonough, now Merril Lynch vice chairman, said that while the SEC is leaving hedge funds largely unregulated, it "invariably demands now that the Federal Reserve interest itself in institutions other than the banks more than it had to in the past." He added: "One would hope that we would not wait for a crisis that is truly a mess for the Congress and the President to look at the structural issues and decide to put in place a supervisory system that is more appropriate."

Current New York Fed President Timothy Geithner, at a panel discussion in New York Sept. 26, also said the U.S. Federal Reserve may have to extend its supervisory authority to securities firms and hedge funds, as they are playing a growing role in the financial system. "We have capital-base supervision over a diminished and smaller share of the system as a whole." He was responding to a question from J.P. Morgan executive vice president Heidi Miller.

The same Bloomberg wire reporting on McDonough and Geithner, emphasized that Chip Burrus, assistant director of the FBI, identified hedge funds as "an emerging threat" in an Bloomberg interview.

More Painful Auto Cartelization Coming

A New York auto analyst warned Sept. 25 that there may be a "fall surprise" coming in the auto industry, whose sales and financial problems are becoming more acute. There could even be a combination of Ford and GM, forced from the outside by hedge funds led by a combination of the Kerkorian interests, and ESL, a $15 billion or so New York-based hedge fund. These hedge funds could soon attempt to get outright shareholder control of GM, and try to force a combination with Ford. If this cartel were formed, it would mean "a totally painful restructuring," the analyst said. But so would any combination of either GM or Ford with Carlos Ghosn's companies; Ghosn and GM's Rick Wagoner will meet again in Paris this week on this. Meanwhile, Chrysler CEO Tom LaSorda has joined the bloodbath, announcing at an Automotive Press Association lunch in Detroit Sept. 25 that Chrysler is planning "structural changes"—the code for plant closings and permanent job cuts. It has already "temporarily" closed three plants.

Illustrating the reason: U.S. auto sales will fall further down to 16.3 million units for 2006, according to estimates by industry executives and analysts at a Reuters-sponsored "Autos Summit" in Detroit. This is down from 16.9 million in 2005 and 17.1 million in 2004. European-wide sales are expected to fall to about 14 million in 2006 (about 3% lower than last year), and Japanese sales about 9% down from 2005. These executives also acknowledge sales will keep falling in 2007, though trying to convince themselves that that collapse will be a "slight further drop."