Busch: Deleveraging and Hemorrhaging
The extreme moves in the emerging markets had a very distinct feel of forced sales due to margin calls or redemption calls. With the Brazilian stock market closing after a drop of 10% and the currency vanishing, we are experiencing a evaporation of liquidity as flows go all in one direction. There are several stories circulating that are clues to the same mystery.
First, Bloomberg reports that Lehman Brothers Holdings Inc.'s hedge-fund clients may have to pay more collateral on $65 billion of assets frozen when the investment bank went bankrupt a month ago. "Lehman's London-based prime brokerage has about 3,500 active clients including hedge funds that own about $45 billion in securities, Steven Pearson, the partner at PricewaterhouseCoopers responsible for unraveling Lehman's U.K. operations, said in an interview. They hold an additional $20 billion in short positions, or bets that prices will fall."
Next up, we have a story saying that hedge fund managers Paul Tudor Jones and Steven Cohen sold assets to raise cash this month as credit markets seized up and stock prices dropped. "Jones, who has been running Tudor Investment Corp.'s biggest fund for 22 years, made his move after watching the Mexican peso tumble 16 percent since the start of October, said two people with knowledge of the decisions by the Greenwich, Connecticut-based firm. Tudor manages $18 billion.
Cohen, who oversees $16 billion at his SAC Capital Advisors LLC in Stamford, Connecticut, ordered traders to sell amid the worst equity rout since the 1930s, a person familiar with the firm said. The firm now holds about 50 percent of assets in cash." (Again, Bloomberg.)
Lastly, we have a story circulating again that US Treasury Secretary Hank Paulson stated he wanted to shut down weak hedge funds and regulate the rest (House Committee on Oversight and Government Reform). This could be making banks ever more cautious in allocating loans and capital to this investment group.
All three stories combine to show a microcosm of what is negatively impacting hedge funds. They are forced to sell assets to raise capital to meet redemptions or margin calls. Or simply to just sit out and wait for the smoke to clear on the fire burning investors. These forced flows show up in extreme moves in thin markets like we're seeing today in the the Brazilian stock market (-10%) or the South African rand (-7.7%). It also shows up in funds selling what they can (US equities and munis) instead of what they need to (emerging market debt/stock markets).
Hedge fund deleveraging/hemorrhaging is one more variation on this theme of a credit crisis. It underscores just how far the fire needs to burn before it runs out of fuel.
See more of what Andrew Busch has to say on this topic on CNBC TV Wednesday at 4:30 and 9:30 p.m. ET.