World Economic News

Forbes on Credit Derivatives: 'Will They Blow?'

"A Dangerous Game: Hedge Funds Have Gotten Rich from Credit Derivatives. Will They Blow?" is the title of an Oct. 10 article in Forbes magazine by Daniel Fisher. Fisher claims that what happened with Amaranth was minor compared with what may be in store with credit derivatives. "If you want to fret over the next financial catastrophe, ... focus on something far more obscure: credit default swaps." The danger is that hedge funds have so much tied up in credit default swaps. When something goes wrong, "the pain will be widespread."

Fisher writes that, "The notional amount—the aggregate of bonds, loans and other debt covered by credit default swaps—is now $26 trillion. This is ... twice the annual economic output of the U.S."

The danger is that hedge funds now account for 58% of all trading in credit default swap derivatives. The mega-hedge funds D.E. Shaw and Citadel are two of the primary funds in this credit derivatives business. A failure of credit default swaps will collapse the $1.3 trillion hedge-fund business.

Hedge Funds: 'A Spectre Is Haunting Finance'

"Hedge Funds: Casino Capitalism" is the title of the second editorial in the London Guardian Oct. 10, which talks of a "spectre haunting finance—the spectre of hedge funds." No one knows how big they are, but there are estimates that "their value is now equivalent to the UK's annual national income." The high risks are noted, but no matter, since only the rich are speculating here, says the paper. Then, it adds: "Unfortunately, the effects go wider. For one thing, pension funds are increasingly investing, on behalf of members who often have modest incomes, and no awareness of the risks involved. For another, the interconnectedness of finance means that a crash in one part of the system can easily produce calamity in another. And with investment banks reportedly falling over one another to offer fashionable hedge funds all the borrowing that they want, a downturn in fortunes could hit the banking system hard. True, colossal losses at the fund Amaranth last month did not produce wider disaster, but there can be no guarantee of such luck next time. When it comes to systemic financial stability, we all bear the consequences, so the precautionary approach is normally the wisest."

The Guardian is running two days of reports on hedge funds.

Financial Times: Hedge Funds Pose Systemic Threat

Writing in the London Financial Times Oct. 13, commentator John Plender warned that the big danger is not just the hedge funds, but the systemic risk that will soon become a systemic crisis.

"If the real worry is systemic risk, a more fundamental threat comes from the change in the structure of banking whereby credit risk is packaged into tradeable IOUs or hedged via credit derivatives and shunted off bank balance sheets."

Plender explains how banks and financial institutions no longer consider risk when lending money because of this system. "In fact, the new financial system is increasingly a game of pass the parcel. At some point the music will stop, because in finance it always does. The interesting question then will be whether a coordinated bailout of the kind mounted for the Long Term Capital Management hedge fund in 1998, or a lifeboat operation such as the secondary banking rescue in Britain in the 1970s, would be possible any more.

"The answer is probably not." The next "banking crises will be messy," he concludes.

Locust Funds Target German Industry

The locust funds have launched their autumn offensive for massive takeovers in German industry, news wires reported Oct. 9. Equity and other locust funds are going for a wild takeover drive around the globe, notably in Germany, where Bain Capital has already tried to buy up shares of Continental Tires—which was repudiated. Other prominent funds like Permira and CVC (UK), or Fortress (U.S.), plan raids on leading German industrial firms such as MAN, Siemens, DaimlerChrysler.

Texas Pacific Group alone has a war chest of $15 billion for such offensives, all funds together have collected $300 billion for takeover attacks which operate under extreme debt repayment pressure, because the funds are mostly using borrowed short-term capital from other banks, insurance companies, pension funds, and private investors.

There is tremendous, highly speculative bubble-building activity involved, for example in Fortress's plan to offer its real estate in Germany on the stock market at a value of more than Eu5 billion, whereas experts say it is not even worth Eu3 billion, altogether, and the difference cannot be compensated by increasing the rent of tenants such as those in the 48,000 flats in Dresden that Fortress purchased in March.

Blowing More Debt Bubbles in the Steel Industry

Another highly debt-leveraged takeover is in the works in the steel industry. According to sources cited by the Wall Street Journal Oct. 7, the Indian Tata Group, including steel and other industries, will try a takeover of the much larger British steelmaker Corus, which is one of the top ten in the world. Tata will offer $10 billion: Not only is this 50% more than Corus's current stock valuation; it is ten times greater than any investment which the Tata group has previously made. "Tata Steel would have to load up on debt to make a bid for Corus, according to analysts."