Friday, March 7, 2008

It's the Leverage, Stupid

From the WSJ:

The financial turmoil is taking on a new dimension: Banks that lent money to hedge funds and other big risk-takers are asking for some of it back.

Loans from banks and brokerages had allowed hedge funds, which manage some $1.9 trillion in clients' money, to amass many times that amount in investments. But as the value of mortgage-backed bonds and other investments has dropped in recent weeks, the lenders are demanding that borrowers put up more cash or assets.

This is producing a negative cycle that has policy makers deeply worried. When investors rush to dump assets, prices fall and lenders feel compelled to make further demands, or "margin calls," which cause even more selling.

So far, the turbulence touched off last summer hasn't resulted in many big hedge-fund blowups. If that changes, banks and other financial firms could end up holding even more hard-to-sell securities. Already, their troubled investments, especially in securities tied to mortgages, have cost them some $140 billion in write-downs.


The funds facing the greatest pressure are those that are highly leveraged, meaning they have large borrowings relative to the money entrusted to them. Carlyle Capital managed only $670 million in client money, but used borrowing to boost its portfolio of bonds to $21.7 billion, meaning it was about 32 times leveraged.

Who are these idiot lenders in this deal? Didn't anyone ask about the clients current margin situation? Was there any disclosure in this deal? It's looking more and more like lenders just made loans without even thinking about looking at the client's financial situation at all.