Banks Tightening Screws Further on Hedge Funds

Those on the hedge fund beat may recall how themasters of the universe have in most cases suffered a reversal of fortune. 2008 was a bad year for most strategies, and the perterbations of September and October made matters worse. Sudden plunges in markets lead to margin calls, and the funds would sell whatever seemed most least bad to sell at that particular moment. Iwt was a regular feature those two months to see sudden downdrafts that looked to be someone dumping a large position.

To make matters worse, prime brokers, the friendly money junkies to hedge funds, had been getting more and more restrictive. both raising rates and reducing the amount of credit on offer. That too put pressure on levered funds to reduce positions.

To add insult to injury, investors have been withdrawing funds, to the point where some funds have restricted redemptions, arguing that the investors would be better served if the positions were liquidated gradually and opportunistically, rather than against a short timetable.

The reason for the long-winded intro is two-fold. First, there is still a fair bit of hedge fund liquidation in the pipeline, due to the need to meet payout obligations. We now have an additional source of hedge fund selling pressure, namely, that banks are cutting down even further on hedge fund borrowing.

From the Wall Street Journal:

Under financial pressure, securities firms are dividing their hedge-fund clients into lists of those they consider best able to weather the financial turmoil and those they’re less sure of. The result is that more funds may have to merge, find other financing at higher cost or close.

The squeeze, described by a range of brokerage-firm and hedge-fund officials, takes different forms. For instance, they say firms have reduced financing for the flagship fund run by John Meriwether, a founder of Long-Term Capital Management, the fund whose near-collapse caused a brief market crisis in 1998. The move has forced Mr. Meriwether’s Relative Value Opportunity fund — down 42% in 2008 — to reduce its borrowing to finance trades, putting pressure on returns…

Banks also have pressed Kenneth Griffin’s Citadel Investment Group, whose biggest funds lost 54% last year, to sell some securities and reduce its borrowing to finance trades…

Being on banks’ less-favored lists doesn’t necessarily mean a death knell for hedge funds…But since many hedge funds make heavy use of borrowed money, or leverage, reduced financing can crimp performance…

Wall Street banks have put 200 or more other funds on what might be called B-lists: funds seen as either too risky — because they could fold — or not profitable enough to the banks….Some funds find that brokerage firms are adding monthly “custody fees” or “administration fees” and ceasing to accept certain assets as collateral on loans.

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  1. Anonymous

    Tell me something: whatever happened to the SEC officials who testified in the House that they had Executive Privelage?

    What was that, two weeks ago? Isn’t it a little bizarre that the holdovers from the old administration claimed they had executive privelage….and no one, not in Congress, not in the media, and not in the new administration has apparently checked up on it? I realize the Madoff investigation would still be ongoing, but this non-lawyer doesn’t see how the matter of the SEC claiming EP would affect that case. So why the silence?

    Hell, maybe they did have EP, from the Obama administration, no less….

  2. Anonymous

    March will be an interesting month, as some hedge funds who refused withdrawals at year end will have to start providing them to those investors that still want it. I don’t think the risk of hedge funds is over yet.

  3. Swedish Lex

    Banks should by now, i.e. 18 months into the crisis, have a full picture of the situation of their clients and should be able to “stress test” their positions simply by tweaking the inputs a bit.

    Geithner’s stress tests are de facto already done. Is he simply buying time to pave the way for nationalisation as many think?

    When we did this in Sweden, the auditors were with us all the time. We often spent more time with them than with the CFOs. They were anxious to protect the reputation of themselves and their firms and did thus not automatically assume a defensive position when we came in an questioned the values of the assets, the collateral, etc.

  4. Anonymous

    What rubbish from the WSJ:

    “Under financial pressure, securities firms are dividing their hedge-fund clients into lists of those they consider best able to weather the financial turmoil and those they’re less sure of. The result is that more funds may have to merge, find other financing at higher cost or close.”

    The WSJ should investigate and report that Hedge Funds are being selected for salvation based on how well connected they are and how much influence they can bring to bear. The taxpayer is purchasing the time for this bailout. Part of the racket now is to keep selected hedgies afloat so they can be bailed out. Move your CRAP now to the TARP or select FED Window of your choice. The final deluge and collapse will come when this work is completed. With 8-10000 Hedgies, this could take a while. College chums of Timmie and Bernie first.

  5. Anonymous

    Hedge funds use a lot of different strategies Aggressive Growth, Distressed securities, Emerging markets, fund of funds, Income ,Macro, Arbitrage, Securities Hedging, Market Timing, Short Selling and Value to name but a few. Some but not alll, hedge fund strategies tend to hedge against downturns in the markets being traded. Those Hedge funds which don’t actually hedge their investments portfolios and are essentially gambling are the ones which are having the biggest problems.

    Hedge funds appear to be intertwined with banking in many ways with banks often using hedge funds to protect their exposures to certain markets. Pension funds are also big users of hedge funds and we are all going to have to put a little bit more into our pension pots as a result of the demise of some of these hedge funds.

    For me although In some ways I would like to blame the fraternity of rich for picking which funds survive in reality I think it has a lot more to do with hedge fund strategies.

  6. fresno dan

    Annoymous at 10:43:

    originally posted 2/5/09 at 5:56 am
    being a bureacrat, I like the precedent of bureacrats citing “executive privilege” from US presidents who are no longer US presidents.
    Nest step – US presidents who are no longer alive (Taft said executive privilege!)
    Final step – any president of anything (the president of the order of nudist tiddly winkers cites executive privilege!!!)

    The bureacracy loves EP – why answer questions when you don’t have to!!!

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