Bloomberg reports that Fed chair Ben Bernanke warned that housing weakness will likely continue "somewhat longer" than expected and hold back the rest of the economy. As interest rates approach 5 percent, many investors are finding stocks less attractive now that their dividends are unlikely to follow interest rates higher. Even though the services sector expanded last month, the dollar continued its prolonged weakness, especially against the euro.
Now that equities in the United States have risen so strongly in recent months, many foreign investors are taking risk off the table by winding down the carry trade in the yen and the Swiss franc. For a long time, these investors took advantage of especially low interest rates in Japan and Switzerland by borrowing money there and then investing that money in the United States. The difference between prevailing interest rates has the effect of juicing profit margins, but if the carry trade acted as a force multiplier that drove the US market higher, it could also have a multiplied effect as it unwinds.
The dollar's decline against the euro in particular and most world currencies in general is at once a long overdue structural adjustment to reflect the growing economic clout of the rest of the world and also a repudiation of US economic leadership.
Oil prices around the world have risen dramatically in recent years, yet when the dollar's effect on dollar-denominated oil contracts is factored out, the price of oil in euros and yen has not grown nearly so much. While no one expects the oil sheiks to sell their product in other currencies, a much higher percentage of global commerce will be taking place in foreign currencies as time goes on.
Showing posts with label the Fed. Show all posts
Showing posts with label the Fed. Show all posts
Wednesday, June 6, 2007
Tuesday, June 5, 2007
Did Alan Greenspan cause the Chinese stock market to collapse?
Former Fed Chairman Alan Greenspan famously warned against "irrational exuberance" as the dot com bubble neared its peak, but nothing he did succeeded in doing over the next year stopped the bubble from popping disastrously. Now that he has moved into the private sector as a consultant writ large to the world of wealthy investors concerned about the direction of the global economy, Greenspan sees another bubble on the horizon: China.
China's stock market has been growing like crazy over the past year and a half. While the underlying economy of the nation has witnessed a spectacular 10% growth rate, the stock market has soared ahead. The Chinese stock market more than doubled in 2006, and rose more than 50% from there at the beginning of 2007.
Alan Greenspan's initial comments about the Chinese economy sparked an immediate drop in the Chinese stock market that reverberated around the world. In a global economy increasingly independent of the influence of the United States, many investors feared that an unorderly collapse of China's markets could destroy prospects for global growth this year.
Now that investor's have had enough time to digest Greenspan's analysis and react accordingly, it is clear that Greenspan was on to something with regard to China. China's stock market has fallen back significantly from its heights and the rest of the world economy has shrugged off China's downturn.
Greenspan spent years at the head of the Fed in a position to access information most investors can't access. But his current role as consultant doesn't offer him any information not available to others. Rather, Greenspan has simply pointed out what everyone should have already known.
Alan Greenspan couldn't stop the dot com bust, but now that he is out of power, his influence has actually grown. No longer confined to economic doubletalk so incomprehensible that the press dubbed it "Greenspeak", Alan Greenspan can finally speak his mind. Many pundits in the financial press and his successors at world financial institutions are concerned that Greenspan is just trying to make a few bucks now that he is no longer the world's chief financial guru. It seems like Greenspan may regain much of the luster he lost with the last recession at the expense of another downturn overseas.
China's stock market has been growing like crazy over the past year and a half. While the underlying economy of the nation has witnessed a spectacular 10% growth rate, the stock market has soared ahead. The Chinese stock market more than doubled in 2006, and rose more than 50% from there at the beginning of 2007.
Alan Greenspan's initial comments about the Chinese economy sparked an immediate drop in the Chinese stock market that reverberated around the world. In a global economy increasingly independent of the influence of the United States, many investors feared that an unorderly collapse of China's markets could destroy prospects for global growth this year.
Now that investor's have had enough time to digest Greenspan's analysis and react accordingly, it is clear that Greenspan was on to something with regard to China. China's stock market has fallen back significantly from its heights and the rest of the world economy has shrugged off China's downturn.
Greenspan spent years at the head of the Fed in a position to access information most investors can't access. But his current role as consultant doesn't offer him any information not available to others. Rather, Greenspan has simply pointed out what everyone should have already known.
Alan Greenspan couldn't stop the dot com bust, but now that he is out of power, his influence has actually grown. No longer confined to economic doubletalk so incomprehensible that the press dubbed it "Greenspeak", Alan Greenspan can finally speak his mind. Many pundits in the financial press and his successors at world financial institutions are concerned that Greenspan is just trying to make a few bucks now that he is no longer the world's chief financial guru. It seems like Greenspan may regain much of the luster he lost with the last recession at the expense of another downturn overseas.
Eight Reasons Not to Worry about the Subprime Mortgage Crisis
1) The government will bail out the industry.
2) Subprime loans aren’t big enough to drag down the economy.
3) Experts like Greenspan are only exaggerating – only 2 years ago he said nothing was wrong. His media grand-standing is because he is jealous of the attention now paid to the new Fed chair Ben Bernanke who isn’t worried about subprime.
4) Any decline in housing prices just makes homes more affordable for the middle class. A declining real estate market represents a wealth transfer from rich people who own mortgages to the middle class who can now afford a home.
5) Any downside risk is completely mitigated by the real value of housing. This can’t be a repeat of the Dot Com Bust because real assets back up the loans.
6) Predatory lenders are the ones suffering. The moral good of punishing those who take advantage of the poor and financially illiterate outweighs financial loss.
7) Companies like New Century Financial have committed crimes and won’t survive under any circumstances – and that’s a good thing.
8) Falling housing prices will encourage the Fed to lower interest rates and drive broader economic growth.
2) Subprime loans aren’t big enough to drag down the economy.
3) Experts like Greenspan are only exaggerating – only 2 years ago he said nothing was wrong. His media grand-standing is because he is jealous of the attention now paid to the new Fed chair Ben Bernanke who isn’t worried about subprime.
4) Any decline in housing prices just makes homes more affordable for the middle class. A declining real estate market represents a wealth transfer from rich people who own mortgages to the middle class who can now afford a home.
5) Any downside risk is completely mitigated by the real value of housing. This can’t be a repeat of the Dot Com Bust because real assets back up the loans.
6) Predatory lenders are the ones suffering. The moral good of punishing those who take advantage of the poor and financially illiterate outweighs financial loss.
7) Companies like New Century Financial have committed crimes and won’t survive under any circumstances – and that’s a good thing.
8) Falling housing prices will encourage the Fed to lower interest rates and drive broader economic growth.
Subprime Mortgage Crisis
A subprime mortgage is any loan extended to someone with poor credit that allows them to buy a home in spite of their poor repayment history. In general, anyone with a credit score below 620 qualifies as subprime. These borrowers pay significantly higher rates of interest in order to compensate lenders for the increased risk they represent. When prevailing interest rates on home loans are 5-6%, subprime borrowers routinely pay in excess of 9%.
The problem with subprime mortgages is that when the economy weakens and people can’t afford to pay for their homes, subprime borrowers are the first and most frequent defaulters. It is important to remember that defaulting on a home mortgage is very rare. Historically, the post-Depression era has never witnessed default rates greater than 4%. Current default rates in the subprime market are in the neighborhood of 2%. While not high by historical standards, near the end of a decade-long run-up in real estate prices default rates fell to less than 1% just a few years ago. Lenders like HSBC and New Century Financial made billions of dollars at the height of the boom extending loans to almost anyone who wanted one. Now that the real estate market has weakened, these over-aggressive lenders are losing their shirts. New Century Financial in particular has exacerbated its troubles through Enron-esque accounting gimmicks and is now the subject of an SEC investigation and numerous shareholder lawsuits in connection with its collapsed stock price.
Because of the size of the real estate market, easily measured in trillions of dollars, the current subprime mortgage implosion has cost big lenders an enormous amount of money. However, home mortgages are generally one of the most secure loans that banks can make. Even if the borrower defaults, banks can foreclose on the home and generally collects about 75% of the value of the loan by selling the house. Also, subprime mortgages represent a tiny part of the total mortgage market. When 15% of the mortgage market is subprime and only 2% of these risky loans are defaulting, it is clear that most homeowners and their banks will be just fine.
Many prominent economists have claimed that they see a great risk of spillover from the subprime mortgage market into the economy at large. George Soros’ partner and former Fed chair Alan Greenspan have both indicated that the crisis could spread throughout the economy. Their rationale is that in a weakening economy, people will be particularly harmed by the declining value of their homes. Since the national savings rate is still negative, homeowners have been driving the retail economy by taking out lines of credit on their homes. As poorer people with subprime mortgages lose their homes and drive down the value of everyone’s real estate by flooding the market with houses at fire-sale prices, homeowners are much less capable of borrowing to drive consumer spending.
If things in the subprime mortgage market get worse, some prominent Democrats and Republicans from effected states are already talking about a government bailout along the lines of the S & L bailout. This is a particularly appealing model, not only because the government saved thousands of jobs immediately by buying into the Savings and Loans but also because it ultimately made money on the deal.
The problem with subprime mortgages is that when the economy weakens and people can’t afford to pay for their homes, subprime borrowers are the first and most frequent defaulters. It is important to remember that defaulting on a home mortgage is very rare. Historically, the post-Depression era has never witnessed default rates greater than 4%. Current default rates in the subprime market are in the neighborhood of 2%. While not high by historical standards, near the end of a decade-long run-up in real estate prices default rates fell to less than 1% just a few years ago. Lenders like HSBC and New Century Financial made billions of dollars at the height of the boom extending loans to almost anyone who wanted one. Now that the real estate market has weakened, these over-aggressive lenders are losing their shirts. New Century Financial in particular has exacerbated its troubles through Enron-esque accounting gimmicks and is now the subject of an SEC investigation and numerous shareholder lawsuits in connection with its collapsed stock price.
Because of the size of the real estate market, easily measured in trillions of dollars, the current subprime mortgage implosion has cost big lenders an enormous amount of money. However, home mortgages are generally one of the most secure loans that banks can make. Even if the borrower defaults, banks can foreclose on the home and generally collects about 75% of the value of the loan by selling the house. Also, subprime mortgages represent a tiny part of the total mortgage market. When 15% of the mortgage market is subprime and only 2% of these risky loans are defaulting, it is clear that most homeowners and their banks will be just fine.
Many prominent economists have claimed that they see a great risk of spillover from the subprime mortgage market into the economy at large. George Soros’ partner and former Fed chair Alan Greenspan have both indicated that the crisis could spread throughout the economy. Their rationale is that in a weakening economy, people will be particularly harmed by the declining value of their homes. Since the national savings rate is still negative, homeowners have been driving the retail economy by taking out lines of credit on their homes. As poorer people with subprime mortgages lose their homes and drive down the value of everyone’s real estate by flooding the market with houses at fire-sale prices, homeowners are much less capable of borrowing to drive consumer spending.
If things in the subprime mortgage market get worse, some prominent Democrats and Republicans from effected states are already talking about a government bailout along the lines of the S & L bailout. This is a particularly appealing model, not only because the government saved thousands of jobs immediately by buying into the Savings and Loans but also because it ultimately made money on the deal.
Thursday, May 17, 2007
Bernanke Sees No Subprime Mortgage Contagion
Reuters reports that Fed Chairman Ben Bernanke has come around to the conventional wisdom that the subprime mortgage woes that so captivated the media will not metastasize into a broader recession.
Of course, the housing sector is still the weak link in the economy these days, taking more than 1% off GDP after the top of the boom. The economy's dependence on the housing sector has been both underestimated and surprisingly narrow. Economic growth in retail has collapsed as the faltering housing market cut off easy access to home equity. Yet, the industrial sector has been almost completely unfazed. Exports have been soaring, and productivity outside of the construction industry has been chugging along nicely.
One of the unanticipated consequences of the housing sector's weakness has been the fate of Latin America. Many recent immigrants of Latin American extraction have found a livelihood in the construction industry - and they routinely send remittances back to their home countries to share the wealth with relatives. Since the top of the housing market, job prospects for these immigrants have gotten much worse and remittances have collapsed. The amount of money being funneled back to Mexico has fallen by more than 30% in the past year, and this big drop will have real consequences.
Many areas of Mexico, and not just in Chiapas, are almost completely dependent on these remittances. In five Mexican states, remittances from the United States are greater than the rest of the economic activity by everyone who remains in the country.
Subprime mortgages don't seem to be holding the US economy back, but the unintended consequences for Mexico and the rest of Latin America will certainly be severe.
Of course, the housing sector is still the weak link in the economy these days, taking more than 1% off GDP after the top of the boom. The economy's dependence on the housing sector has been both underestimated and surprisingly narrow. Economic growth in retail has collapsed as the faltering housing market cut off easy access to home equity. Yet, the industrial sector has been almost completely unfazed. Exports have been soaring, and productivity outside of the construction industry has been chugging along nicely.
One of the unanticipated consequences of the housing sector's weakness has been the fate of Latin America. Many recent immigrants of Latin American extraction have found a livelihood in the construction industry - and they routinely send remittances back to their home countries to share the wealth with relatives. Since the top of the housing market, job prospects for these immigrants have gotten much worse and remittances have collapsed. The amount of money being funneled back to Mexico has fallen by more than 30% in the past year, and this big drop will have real consequences.
Many areas of Mexico, and not just in Chiapas, are almost completely dependent on these remittances. In five Mexican states, remittances from the United States are greater than the rest of the economic activity by everyone who remains in the country.
Subprime mortgages don't seem to be holding the US economy back, but the unintended consequences for Mexico and the rest of Latin America will certainly be severe.
Monday, May 7, 2007
Excess Liquidity and the Leveraged Buyout Boom
The IHT reports that some of the private equity firms which depend on access to cheap credit with few strings are complaining about an excess of liquidity. While precise measures of liquidity are prone to error, it is clear that the amount of liquidity has been increasing rapidly. The Bank of England estimates that liquidity has doubled in the last four years.
The high price of oil, which shifts enormous resources away from the developed world to oil sheiks in the Middle East, has further exacerbated the liquidity troubles. And at least until now, China's trade surplus has gone largely uninvested. When China decides to mobilize its capital in the global markets, this will further spread liquidity.
Liquidity by itself is not a bad thing. Quite the reverse, many good investments in the past have gone unmade because of a lack of liquidity. But as the subprime mortgage market recently demonstrated, easy money leads to loose credit practices. The mortgage market is unique in its general low level of risk, but capital investments and leveraged buyouts can be very high risk. When cheap credit is extended largely without conditions, many more loans are extended than would be accepted otherwise.
Even the private equity firms themselves are concerned about the easy credit markets because competitors are encouraged to step in and bid up the price of acquisitions. These more expensive, more heavily leveraged investments then become much more risky and investors become less likely to profit.
Ironically, the Fed's chairman Ben Bernanke is currently receiving public pressure to lower interest rates in order to spur growth during a period of excess liquidity. In this environment, Bernanke is likely to leave interest rates alone for the seventh straight meeting. This will probably leave him looking indecisive and reduce his credibility in the short term, but the alternative is even worse. Bernanke can't give in to market pressures even if he will be praised in the short term.
Leveraged buyouts are fueling much of the mergers and acquisitions activity driving the stock market higher these days. The leverage is cheaper than ever thanks to excess liquidity. The liquidity would be fine in isolation, but unfortunately it is accompanied by loosened lending standards. Interest rates aren't likely to resolve the problem anytime soon, in spite of the housing bust. Hopefully the private equity gurus will have the intelligence to proceed cautiously. But don't hold your breath.
The high price of oil, which shifts enormous resources away from the developed world to oil sheiks in the Middle East, has further exacerbated the liquidity troubles. And at least until now, China's trade surplus has gone largely uninvested. When China decides to mobilize its capital in the global markets, this will further spread liquidity.
Liquidity by itself is not a bad thing. Quite the reverse, many good investments in the past have gone unmade because of a lack of liquidity. But as the subprime mortgage market recently demonstrated, easy money leads to loose credit practices. The mortgage market is unique in its general low level of risk, but capital investments and leveraged buyouts can be very high risk. When cheap credit is extended largely without conditions, many more loans are extended than would be accepted otherwise.
Even the private equity firms themselves are concerned about the easy credit markets because competitors are encouraged to step in and bid up the price of acquisitions. These more expensive, more heavily leveraged investments then become much more risky and investors become less likely to profit.
Ironically, the Fed's chairman Ben Bernanke is currently receiving public pressure to lower interest rates in order to spur growth during a period of excess liquidity. In this environment, Bernanke is likely to leave interest rates alone for the seventh straight meeting. This will probably leave him looking indecisive and reduce his credibility in the short term, but the alternative is even worse. Bernanke can't give in to market pressures even if he will be praised in the short term.
Leveraged buyouts are fueling much of the mergers and acquisitions activity driving the stock market higher these days. The leverage is cheaper than ever thanks to excess liquidity. The liquidity would be fine in isolation, but unfortunately it is accompanied by loosened lending standards. Interest rates aren't likely to resolve the problem anytime soon, in spite of the housing bust. Hopefully the private equity gurus will have the intelligence to proceed cautiously. But don't hold your breath.
Sunday, April 29, 2007
US Economic Downturn Possible, but Improbable
Reuters reports that the President of San Francisco's Federal Reserve suggested that a downturn in the US that ripples around the world is possible. Of course, she qualified that statement to make it significantly less meaningful than the article suggests. Her analysis appears to consist of noting that the US represents 25% of world production and that the US economy hasn't been doing well recently. She goes on to say that her own opinion is that growth picks up instead of slowing into a recession, but that wouldn't make for exciting headlines.
Except for the fact that most Federal Reserve Presidents talk in the most purposefully bland, obtuse language in order to avoid spooking the markets, this would be a prime example of editorial overstretch. Yet the case for a coming economic downturn needs to be considered on its merits.
The problem with the pro-recession storyline is that it lacks a promising catalyst. One could argue that interest rates are choking growth, but does anyone really believe sub 6% rates that haven't moved upward in a while are causing a slowdown? Macroeconomic instability could be blamed for a slowdown, but what exactly is the hold up? Trade is accelerating around the world, and important markets in Asia and Europe are doing better than they have in years. US relative prominence is clearly shrinking, but that has been happening every year since the end of World War II. Absolute levels of production have been steadily rising and even the increasing costs of inputs doesn't seem to have slowed the economy. Oil could certainly be a lot cheaper, but it could also be a lot more expensive. Gas prices in excess of $3 a gallon are painful, but consumers haven't cut their consumption at all.
The most promising source of weakness is obviously the housing market. The value of housing in many areas around the country has clearly been in the midst of a speculative bubble for years and is now in the early stages of a correction. The question then becomes if the securitization of home mortgages as opposed to traditional government-backed lending has caused a structural fault to develop that will continue to suck the growth out of the economy. It's impossible to say at this point, but it seems like investor's demands for tighter lending standards has already squeezed out a lot of the risky loans that caused the trouble this time around.
The President of San Francisco's Federal Reserve thinks that a worldwide economic contagion could spiral out for the US in the event of a downturn, but she doesn't think that downturn is going to materialize. Looking at the underlying problems the economy faces, slow to moderate growth looks significantly more likely than a recession.
Except for the fact that most Federal Reserve Presidents talk in the most purposefully bland, obtuse language in order to avoid spooking the markets, this would be a prime example of editorial overstretch. Yet the case for a coming economic downturn needs to be considered on its merits.
The problem with the pro-recession storyline is that it lacks a promising catalyst. One could argue that interest rates are choking growth, but does anyone really believe sub 6% rates that haven't moved upward in a while are causing a slowdown? Macroeconomic instability could be blamed for a slowdown, but what exactly is the hold up? Trade is accelerating around the world, and important markets in Asia and Europe are doing better than they have in years. US relative prominence is clearly shrinking, but that has been happening every year since the end of World War II. Absolute levels of production have been steadily rising and even the increasing costs of inputs doesn't seem to have slowed the economy. Oil could certainly be a lot cheaper, but it could also be a lot more expensive. Gas prices in excess of $3 a gallon are painful, but consumers haven't cut their consumption at all.
The most promising source of weakness is obviously the housing market. The value of housing in many areas around the country has clearly been in the midst of a speculative bubble for years and is now in the early stages of a correction. The question then becomes if the securitization of home mortgages as opposed to traditional government-backed lending has caused a structural fault to develop that will continue to suck the growth out of the economy. It's impossible to say at this point, but it seems like investor's demands for tighter lending standards has already squeezed out a lot of the risky loans that caused the trouble this time around.
The President of San Francisco's Federal Reserve thinks that a worldwide economic contagion could spiral out for the US in the event of a downturn, but she doesn't think that downturn is going to materialize. Looking at the underlying problems the economy faces, slow to moderate growth looks significantly more likely than a recession.
Friday, April 27, 2007
US Economic Growth Slows
The IHT reports that the Commerce Department's latest figures show GDP growth slowed to 1.3% in the first quarter. This slow growth is particularly annoying in light of resurgent inflation - which rose at a 4% annual rate. The Fed prefers to consider inflation figures with food and energy costs factored out, so an adjusted 2.2% rate doesn't seem likely to spawn aggressive interest rate moves. Nonetheless, despite their volatility, food and energy prices exact a real cost for the broader economy. Four dollars a gallon for gas seems a remote possibility, but $3 per gallon is much harder on economic activity than $2.25.
The culprit for slower economic growth has been the collapse of residential real estate, which fell by 17% in spite of previous declines of 18.7% and 19.8% the two quarters before. The continuing decline in real estate prices has already made housing more affordable in many of the most expensive markets in the nation, but countless mortgages are going to keep most people's current bills the same.
The weakness in the United States is already being priced into the markets. Worst-case scenarios are being floated that seemed impossible only a year ago. One Bear Stearns analyst has already raised the spectre of stagflation - the horrific combination of sustained slow growth and high inflation.
Still, no new source of a slowdown emerged in the numbers. Analysts have known about weakness in the housing sector for quite some time and energy prices have been significantly higher in the past few years. Exports continued their trend of not following a trend by declining at a 1.2% rate. This compares with an advance of 10.6% the quarter before.
Overall, the numbers suggest that the economy looked a lot like everyone already knew it looked in the broadest outlines and unambiguously weaker than expected from a shorter perspective. These numbers are quite different from last quarter's numbers, so expect a slight upward revision when the next numbers come out. But the general health of the economy is clearly much weaker than many hope for.
Interestingly, corporate profits reported on Wall Street this week don't seem to be closely tracking this slowdown. Maybe Microsoft, Apple, Google, and the others who reported this week are somehow immune, or maybe the revision will be larger than usual next quarter.
The culprit for slower economic growth has been the collapse of residential real estate, which fell by 17% in spite of previous declines of 18.7% and 19.8% the two quarters before. The continuing decline in real estate prices has already made housing more affordable in many of the most expensive markets in the nation, but countless mortgages are going to keep most people's current bills the same.
The weakness in the United States is already being priced into the markets. Worst-case scenarios are being floated that seemed impossible only a year ago. One Bear Stearns analyst has already raised the spectre of stagflation - the horrific combination of sustained slow growth and high inflation.
Still, no new source of a slowdown emerged in the numbers. Analysts have known about weakness in the housing sector for quite some time and energy prices have been significantly higher in the past few years. Exports continued their trend of not following a trend by declining at a 1.2% rate. This compares with an advance of 10.6% the quarter before.
Overall, the numbers suggest that the economy looked a lot like everyone already knew it looked in the broadest outlines and unambiguously weaker than expected from a shorter perspective. These numbers are quite different from last quarter's numbers, so expect a slight upward revision when the next numbers come out. But the general health of the economy is clearly much weaker than many hope for.
Interestingly, corporate profits reported on Wall Street this week don't seem to be closely tracking this slowdown. Maybe Microsoft, Apple, Google, and the others who reported this week are somehow immune, or maybe the revision will be larger than usual next quarter.
Thursday, April 12, 2007
Hedge Fund Billionaires and "Light Regulation"
The IHT reports that Fed chairman Ben Bernanke supports "light regulation" of hedge funds because they deal with sophisticated investors and don't demand government bailouts. This is particularly timely because foreign governments, especially Germany have been to increase pressure of hedge funds for greater transparency.
The United States however, has a history of not regulating hedge funds. Even the collapse of Long-Term Capital Management in 1998 did not cause a rush to regulation. Just last September, Amaranth Advisors lost $6.6 billion in the natural gas market.
This caught my eye because Trader Daily just published its list of the highest earning traders. The top guys are all hedge fund folks, so it is to be expected that they would be rolling in the dough. But the top 5 traders made over $1 billion each. Yes, that's right, billion with a capital 'B'. And the number one spot was held by a Houston hedge fund manager who made about $2 billion betting exactly opposite Amaranth.
It looks like hedge funds are the place to be for managers looking to make a quick buck, but it is unclear if they are going to destabilize the economy. At the end of the day, if traders think oil is going to go to $500 a barrel and buy up all the available contracts, they will only hurt themselves. Oil isn't going to end up that high, and six months later the hedge fund guys will be out on the street.
Regulators need to watch companies that think they can juice their returns by investing in the exotic derivatives and other financial incentives offered by hedge funds. As long as hedge funds are just investing "Mad Money", speculation isn't a bad thing. Just make sure that your pension doesn't do something stupid and invest in the guys who used to work for Amaranth.
The United States however, has a history of not regulating hedge funds. Even the collapse of Long-Term Capital Management in 1998 did not cause a rush to regulation. Just last September, Amaranth Advisors lost $6.6 billion in the natural gas market.
This caught my eye because Trader Daily just published its list of the highest earning traders. The top guys are all hedge fund folks, so it is to be expected that they would be rolling in the dough. But the top 5 traders made over $1 billion each. Yes, that's right, billion with a capital 'B'. And the number one spot was held by a Houston hedge fund manager who made about $2 billion betting exactly opposite Amaranth.
It looks like hedge funds are the place to be for managers looking to make a quick buck, but it is unclear if they are going to destabilize the economy. At the end of the day, if traders think oil is going to go to $500 a barrel and buy up all the available contracts, they will only hurt themselves. Oil isn't going to end up that high, and six months later the hedge fund guys will be out on the street.
Regulators need to watch companies that think they can juice their returns by investing in the exotic derivatives and other financial incentives offered by hedge funds. As long as hedge funds are just investing "Mad Money", speculation isn't a bad thing. Just make sure that your pension doesn't do something stupid and invest in the guys who used to work for Amaranth.
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