Credit squeeze the air from the markets

The markets have been on a a bumpy downward ride in the last few days with London losing 2.7% today alone, a fate shared by most major markets. The news reels have been full of stories of hedge funds being hard hit by the turmoil.

Financial Times today:

BNP Paribas, one of Europe’s biggest banks, blamed a “complete evaporation of liquidity in certain market segments of the US securitisation market” for the temporary decision to stop redemptions from [three of its hedge funds]...

Collapse of demand for some forms of securitised debt made their assets impossible to value, the bank said.

Freezing the funds, which invest in asset-backed securities, was the best way to “protect the interests and ensure the equal treatment of our investors”.

Before making a comment on the markets, let me pause on the really scary thing - hedge funds investors only have liquidity when they don't need it. The moment they want out i.e. redeem their fund holdings, they find the only exit route barred. Why? Because, their only option is to sell back to the manager and when the markets are in free fall, hedge fund managers don't want to add to their problems by being forced to sell assets to fund redemption. So the investor is left to dangle - had they held the underlying investment directly at least they might have been able to liquidate at some price.

That managers are not obliged to keep the fund open for redemptions is plain wrong, when those same managers generally preclude investors from being able to trade their interests with others in a secondary market.

As for the markets, the last few days have created some interesting buying opportunities but it has also put a brake on a number of the forces that have been supporting a bull market eg the ability of private equity firms to borrow to fund their acquisition.

One firm that has been caught in the headlines was Merrill Lynch who liquidated the collateral the held as prime broker to the Bear Stearns hedge funds. By coincidence I was out in London with Lawrence Tosi, Merrill's COO a few days after they intervened and we chatted about where this was headed but neither of us saw the pace of the falls we've seen.

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posted by John Wilson @ 11:35 PM Permanent Link newsvine reddit



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