Risk Rap

Rapping About a World at Risk

Foggy Mountian Breakdown

It was all going along as planned. Paulson’s 3 page USS TARP was carefully constructed and sitting in dry dock. His exemplary stewardship and all out PR campaign had all oars in the water and the crew rowed with great athletic precision. America’s Chief Fear monger “W” was recruited to address the nation to explain the complicated nuances of mortgage backed securities and issue a stern warning about the cataclysmic consequences if we failed to act positively on TARPs adoption.

The free marketeers of Wall Street had skillfully wheeled their Trojan Horse into the heart of the capitol city of the free world. Disguised as a kind of Noah’s Ark to float the ship of state through the pending economic tsunami; the ships Captain Henry Paulson, tour director W and the able crew of yeoman Democrats implored their countrymen to quickly board the Ark to avoid the pending economic apocalypse. The cost of steerage passage, a cool $700 BN. A small price to pay for a tiny slice of economic subsistence pie.

The deal that was done became undone as the Maverick from Arizona boldly sailed into town on an apolitical hydrofoil boasting a “Nation First” bumper sticker and presumingly powered only by fuel efficient populist sentiment. He sat at the feet of his party leader the BIG W, smiled for the camera, fingered his pen, said little and did much less. He took great risk to accomplish this feat. He sat on the right side of the table, exposing the left side of his melanoma scarred face to the frenzied cameras of the political paparazzi. McCain did not care that his least flattering side was exposed. It was truly a moment of profiles in courage.

This morning WHOO HOO WAMU was seized by the FDIC and sold to JP Morgan. TPG a very clever private equity firm lost a big chunk of its investors capital (see Risk Rap post 4/9/08). Even the fat cats are taking a haircut on this one. Yes the banking crisis is real and the rising tide of economic duress needs drastic and immediate attention.

There is a great reluctance by my countrymen to sheepishly accept this deal. I think they believe in the principles of free market capitalism that has been religiously preached to them by the very same leaders who are now resorting to the impressment of their tax dollars to force them aboard this life raft. I hope we understand the price we may pay for the courage of our convictions.

For now the TARP deal, like the stasis in our government and the frozen debt markets are broke and lost in a foggy mountain breakdown. Watch this space for periodic progress reports as we chart the fantastic odyssey of our rudderless ship of state.

Music: Earl Scruggs and Friends, Foggy Mountain Breakdown

Risk: depression, recession

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September 26, 2008 Posted by | elections, McCain, Paulson, politics, TARP | , , , , , , , , , | Leave a comment

Hedge Funds Flight to Quality

Volatility in the equity markets, credit market dislocations and continued concerns about market liquidity are prompting hedge funds to seek out prime brokerage and custodial relationships with investment banks that boast healthy balance sheets.

JP Morgan’s acquisition of Bear Stearns has given hedge fund mangers pause to think about the financial health and balance sheet condition of their principal counterparties. The potential insolvency of first tier investment banks was once unimaginable. But the near bankruptcy of Bear Stearns due to losses in mortgage derivative and financing businesses, the persistent rumors concerning Lehman Brothers financial condition and the continued quest of Merrill Lynch, Citibank, UBS, AIG and Morgan Stanley to seek funding from Sovereign Wealth Funds to bolster capital adequacy is driving hedge funds to secure relationships with bank’s that have healthy balance sheets.

Risk aversion is a strong theme for all providers of credit. Hedge funds have a voracious appetite for credit. Many hedge funds require generous lines of credit to support highly leveraged and short selling trading strategies. If their prime broker becomes capital constrained these funds will not be able to execute their strategies. So the need to maintain relationships with healthy banks that provide consistent access to large lines of credit is critical.

The potential effect of market contagion in the event of Bear Stearns’ insolvency was the primary issue of concern that prompted the Federal Reserve to take its unprecedented action. Had Bear Stearns become insolvent the levered positions of its substantial hedge fund and correspondent broker clientele would create a wave of defaults that would cascade throughout the global capital market industry. Extreme market volatility and the negative effect on market liquidity in equity, futures, debt and foreign exchange markets could have been dramatic.

Hedge fund managers also require that banks have a product set, support infrastructure and market presence they require as trading strategies become more sophisticated to include numerous asset classes trading on multiple global exchanges. Cross-netting of product set positions and margin account requirements are important for hedge funds as well as the bank. Cross-netting of all positions helps fund mangers to gain preferential finance rates and transaction fees. Cross-netting for bank’s is a critical risk management tool to determine its aggregated exposure to the numerous investment positions of large sophisticated hedge fund complexes.

As the large money center banks struggle to integrate their global capital markets and investment banking businesses, capital adequacy in line with the requirements of the Basel II initiative heighten the need to measure and fund sufficient regulatory capital levels. The temptation of banks to arbitrage their regulatory and economic capital balances will certainly be put to the test as they seek to woo lucrative hedge fund business. The continually expanding global hedge fund industry may pose a competitive threat to the commercial credit side of these banking institutions as liquidity in the credit markets continue to be a pressing concern. It bears watching and it will be interesting to monitor developments to see if community banks can take advantage of its larger competitors capital constraints posed by its focus on capital markets business.

I can hear the frenzied flying now.

You Tube Video: Flight of the Bumblebee

Risk: capital markets, hedge funds, credit, commercial banking, regulatory, Basel II

June 5, 2008 Posted by | banking, Basel II, Bear Stearns, hedge funds, investments, regulatory | , , , , , , , , , , | Leave a comment