Rich Man's Panic

More hedge funds get liquidated: two Australian funds investing in ... leveraged debt securities. Why do they do that? Another Bear, Stearns fund has redemptions stopped. Babblevision says many other hedge funds are stopping redemptions. Hedge funds are becoming roach motels ;-)

Wall Street margin departments are writing down all those CDO/CLO/CBO investments and the funds are getting liquidated if they had margin debt. If not, they're getting redemptions and still have forced selling. Wall Street is eating its own children, having created these funds and all those structured securities. Much of this equity selling is likely hedge funds selling whatever they can to fund redemptions. Or selling in the fear of future redemptions. Or selling in just plain fear.

Rich investors are probably pulling money out of all kinds of hedge funds in fear. I never understood why anyone rich takes large risks to make more money. Why not just index and accept your 10% average return with no worries? There's more to life than making more money.

So the rich who thought they were being so smart investing huge amounts in hedge funds now find themselves trapped. Perhaps the infatuation of the rich with making more money investing in hedge funds might finally start winding down. Perhaps hedge funds will no longer draw crowds at business schools. Perhaps the hedge funds will no longer be cocktail party banter in Palm Beach, Park Avenue, and Greenwich.

In 1902-4 a mild economic downturn occurred. In July in 1903, a panic occurred on Wall Street followed by a second panic in late September to mid-October, but led to no general economic effects, hence was named the "Rich Man's Panic". No banking panic occurred.

So in 2006-2007 the US economy moved from rapid growth to moderate growth while housing moved from a boom to a bust. Huge sums in hedge funds were invested in garbage loans. So they are now being wiped out. And the rich are panicking and trying to get their money out of hedge funds. This is a 2007 version of the Rich Man's Panic.

Other Notes:

A: Hmmm. Harvard lost $350 million through an investment in Sowood, a hedge fund managed by an ex-endowment fund manager. I guess he was one of the genius's who left in the manager pay controversy. Nice job, Harvard. Grrrrrr.

B: Hedge funds are mostly a game of "heads I win, tails you lose" - these managers were a big slice of the profits when they happen to be right, and the investors lose bigtime when they are wrong.

C: A long side futures play is tempting here, but re-reading my post, why should I take the risk? I have plenty invested long term in good quality stocks.

D: Commodities are holding up rather well. Interesting.

E: These unpredictable moves are why you MUST use time diversification. Buy a partial position (1/4 to 1/2) and add when either time or price has moved. I will wait to add the rest of my big play in big cap financials. Time-wise I'll wait until at least October. Price-wise adds need an improved chart or a big drop.

F: I expect a secular decline in hedge funds will hurt the big brokers with heavy "prime brokerage" exposure. And I expect all these problems with mortgage brokers and small mortgage banks will drive business to the big banks in the long term.