Hedge Fund Woes Finally Hitting the Fan?

Peter Viles, blogger at the LA Times, writes today about the saber rattling going on among a few of the big bullies on Wall Street, most recently Bear Stearns, JP Morgan, Deutsche Bank, and Merrill Lynch. It seems that those risky subprime mortgage financing vehicles that were all the rage until 2006 are coming back to haunt the current owners.

This touches on a domain that central bankers have been jawboning about for months now, the credit derivative and securitization market imbalances that are becoming dangerously out of whack. They know--and Wall Street bankers must know (even if they don't act like it)--that there are factors at work in the global economy that have created huge waves of what the financial world calls "liquidity," or large holdings of spending and investing money, if you will.

You have only to follow the recent buzz around the newer Basel II accord to see that the international banking community is aware of the problem; however, just like hyper-gifted children, they sometimes have a hard time disciplining themselves. This lack of self-discipline is creating much central banker angst, because the central bankers are supposed to be supervising banking activity. If they fail to do so, their respective governments will either have to mop up the mess (i.e. bail somebody out) or take blame for the devastating consequences that are potentially very bad for the dollar (not that anyone seems to care anymore) and horrible for the US economy.

The nature of the factors behind this liquidity has provoked much speculation, but as yet there is no consensus. The US banking-overseer head honcho, Ben Bernanke, blames it on what he has called a "global savings glut" (as though there could exist an excess of savings). Personally, I suspect that the central bankers themselves are at least partially responsible, but I'm not so sure they would agree. (See this previous post in rebuttal to a couple of Fed researchers who tried to pass the buck.)

But whatever the cause, the fact is that trillions of dollars are currently roving the earth looking for a roost, and everywhere they have chosen to alight they have caused bubbles, to wit the 2000 dot.com event and more recently the 2002-2006 housing boom. Other more sustained and recent bubbles can be found in the current securitizations and derivatives markets, where high-rollers bet on the odds of certain financial events happening. (See my article at Prudentbear.com for a discussion of the process.) Until recently, much of this activity centered around the subprime mortgage market, which as we all know is now turning very sour.


[Thanks to ironicconsumer.com for the photo.]

Now, if these particular bubbles burst, they will smack the face of some pretty embarrassed Wall Street fellows who, up until now, have been riding pretty high, making trillions of high-roller subprime risk-taking profits. Who are these gamblers? The same hedge fund managers about whom Peter Viles blogs.

But it goes beyond a mere squabble among bankers. If these bubbles burst, the amount of money involved is so large that the mess could be substantial. This situation must have every central banker on the edge of his seat, wondering whether he will be able to juggle this new event, on top of the rest of the problems of the economy that they are supposed to manage. (See my earlier post for more.)

I wouldn't want to be in their shoes--and I certainly won't be buying hedge fund stock any time soon. (Yes, they're trying to pass the buck, too.)