World Economic News
New LTCM Catastrophe Expected in World Markets
Get ready for a new LTCM disaster hitting world financial markets, warned the lead editorial in the German economic daily Handelsblatt on Sept. 8. The piece, headlined "Full Risk," picking up recent reports on the rapidly expanding hedge-fund business, starts off by pointing to what happened six years ago: "On Sept. 22, 1998, top managers of 13 banks met in the office of the New York Federal Reserve. They were very concerned about the stability of the worldwide financial system, because the hedge fund Long-Term Capital Management (LTCM) was in trouble due to failed speculations on Russia bonds. Under pressure from supervision agencies, Wall Street on the next day put together a rescue package for LTCM." Six years later, "banks and hedge funds are again engaging in risky financial transactions" in order to boost profits. "The entire sector has enormously expanded its risk positions in the last few years." Financial traders in particular are using derivatives, once described by Warren Buffett as "financial weapons of mass destruction."
The linkage between hedge funds and banks is even stronger today than it was six years ago. Banks are not only copying the trading schemes of hedge funds, but are furthermore eager to become so-called "prime brokers" of the funds, that is, providing them with everything needed, from credits to trading platforms. "Some New York banks are even renting office space for their customers," a development which has led to the emergence of "hedge fund hotels."
It's high time, states the editorial, that bank managers remember what happened in September 1998. Since the beginning of this year, the $900-billion hedge fund business has not earned any money. "Some funds have been hit by huge losses. Dozens of hedge funds have been dissolved in recent monthsso far without receiving much attention. But any moment a big bomb can explode."
Derivatives Turnover Exploded in the First-Half 2004
According to the latest quarterly review by the Bank for International Settlements (BIS) issued Sept. 6, "The aggregate turnover of exchange-traded financial derivatives contracts expanded strongly in the second quarter of 2004. The combined value of trading in interest rate, stock index, and currency contracts amounted to $304 trillion, a 12% rise from the first quarter of the year. The busy quarter followed an even more active first quarter, resulting in 43% growth for the first half of the year." This means that the annual turnover of exchange-traded derivativeson top of these there are the bilateral OTC derivatives bets traded directly between the big banksis on a path to reach at least $1.2 quadrillion in 2004, roughly a quadrupling compared to the year 2000.
Most of the exchange-traded derivatives turnover comes from short-term interest rate contracts ($280 trillion in the second quarter). While European exchanges accounted for most of the derivatives growth during the first quarter, U.S. exchanges reported a 44% increase in interest-rate derivatives turnover in the second quarter to $150 trillion, almost double as much than in the fourth quarter 2003. The BIS links these extreme growth rates to the turmoil on bond markets during April and May, when long-term yields suddenly started to rise from record lows. The "central bank of central banks" notes that it has not seen such dramatic shifts on derivatives markets since the fourth quarter of 2000.
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