Hedge Funds as Victims?

Sometimes it‚s very hard to tell how real a crisis really is. When the subprime debt debacle began to unravel this past spring, conventional wisdom held that the problem would be largely confined to the housing market and a handful of peripheral companies, most of them involved with the mortgage business.
Yet within a few months, the problem has morphed into a crisis, requiring a rescue of sorts from the world‚s central banks. Now some alarmists are talking geologist-speak and asking if this is the Big One.
The experts say it‚s very difficult to price the millions of subprime loans that have been securitized into collateralized debt obligations (CDOs). What they also mean, but don‚t want to say, is that they can‚t be sold, either.
Facing a major leverage squeeze, many classic hedge funds are being forced to sell their blue-chip positions and cover their short positions by stepping into the market and buying such infamous dogs as Vonage and Overstock.com. Even venerable Goldman Sachs was forced to pump $2 billion into a hedge fund that was down 28%.
But in an age where income inequality is an increasingly salient issue, the subprime fiasco may turn out to be a small footnote in which asset-rich hedge funds, in their quest for outsized returns, allowed lower- and middle-income folks with poor credit to spend a few years in houses that were beyond their means. One wonders what Alan Greenspan was thinking when he lauded the advent of subprime mortgages as a worthy innovation a few years ago.
Most appalling, however, was the spectacle of some hedgie types, most prominently one James J. Cramer, bellyaching and hurling insults at Federal Reserve Chairman Bernanke while demanding interest rate reductions to bail his buddies out. "People are losing their jobs," Cramer wailed. Of course, when Ford Motor Co. lays off 30,000 employees, Cramer would never think of calling for a Fed-financed bail out, but when a handful of hedge fund managers hit the pavements, it‚s apocalyptic.
Still, if banks are refusing to lend money to each other, if the mortgage business is comatose and no one knows what the securitized loans in their CDOs are worth, a 50 basis point rate cut from the Fed will do little except trigger a run on the dollar. So the Fed‚s strategy of relying on their open market operations to buy creditworthy mortgage-backed securities that possess real, measurable underlying value makes more sense than some hair-brained scheme to put hedge fund managers on the dole.
One can‚t escape without noticing that this crisis is homegrown, as opposed to those of the 1990s, which originated in places like Mexico, Thailand and Russia. Trillions of dollars worth of mortgages are facing upward resets in the next few years, so it‚s a reasonable guess that the domestic housing recession is only in its second or third inning. Why? Forget the subprime headlines; everyone who ever wanted to buy a house has already done so.
Still, the global economic boom sweeping the world appears strong enough to overpower all these negative developments and keep the U.S. economy growing, even if we‚ve never been so dependent on the rest of the world before. If so, the Big One is still lurking.
Here at Financial Advisor, we are delighted to introduce you to two new associates. Jeff Schlegel, who has written many outstanding pieces as a freelancer for the last few years, joined us as a full-time senior editor in June. And Laura Zavetz, who spent almost a decade as art director at Bloomberg Wealth Manager, where she won dozens of awards for design, came on board in July. When you read this issue, you‚ll see that in a little more than three weeks, her creativity is already emerging on many of the pages.

Evan Simonoff

E-mail me at esimonoff@fa-mag.com with your opinion onthis issue.