Gangs of New York

Edmund Burke "Among a people generally corrupt liberty cannot long exist."

Hedge funds acting in a predatory manner towards other funds is like a dog bites man story.

However there are a few new things in this story worth pointing out.

According to this report Goldman Sachs is disclosing the most largely held positions of some hedge funds and distributing the list to others with the objective of fomenting a group effort in shorting them, artificially driving down the price, creating more forced redemptions and losses for the fund investors.

Can you imagine if some other company was doing that? With the financial stocks?

Think the elimination of the uptick rule and the widespread toleration of naked shorting is an accident?

The second point of interest is the targeting of specific sectors such as emerging markets, mining, and energy stocks.

What this will accomplish, beside the obvious short term racketeering, is to exaggerate the downward move in some prior favorites, setting up some potentially lucrative short covering rallies when the stocks reach ridiculous valuations on the forced selling and targeted shorting, after the trading banks cover their shorts and buy in for pennies on the dollar.

And don't think for a minute that Goldman and their ilk does not have a 'most shorted' list that it is circulating around to its own select group of traders to target those buys.

We still wonder if some of the Wall Street banks are using their privileged information to short squeeze the European banks who they loaded up with fraudulent debt and are now in dire need of short term dollar liquidity. This is a classic rip-their-face-off after you kick them maneuver.

Its like setting a fire in a crowded theatre after having charged high admission prices for a musical production that did not exist, and then having thugs at all the exits to charge even stiffer fees to leave the building.

And watch to see who benefits the most from this bailout plan and what they do with your money.

The Financial Times
Hedge funds prey on rivals
By Henny Sender in New York
October 2 2008 23:34

Hedge funds are embracing trading strategies designed to profit from the unwinding of large positions by their competitors, market participants say.

The increasingly cannibalistic activity stems from the wave of redemptions hitting hedge funds.

Because so many firms hold similar positions, forced selling by one in response to redemptions can have ripple effects, forcing other funds to sell.

More nimble hedge funds have sought to profit from the dynamic by taking short positions in securities known to be widely held by rivals. Goldman Sachs publishes a list of 50 “very important” hedge fund positions.

In its Wednesday update Goldman said: “Forced selling to cover redemptions and deleveraging . . . has put downward pressure on selected stocks.”

A favourite strategy of hedge fund managers during the bull market – mimicking the positions of others – has been turned on its head, Goldman said. “Buying the most concentrated stocks . . . has been a poor strategy during the current bear market.”

The announcement last month that Ospraie Management was winding down its flagship fund encouraged predatory activity.

One Hong Kong-based manager sent a note urging friends to short emerging and mining shares favoured by Ospraie.

Some hedge fund managers say they have been monitoring the positions held by Ospraie, if only to be ready if other funds with the same positions are forced to liquidate their holdings.

“I certainly wouldn’t want to be long any of these companies,” said one. “I want to lock up six-month borrowing on these shares and short them.”

Ospraie’s founder, Dwight Anderson, told investors on September 4 that 60 per cent of its losses in July and August stemmed from equities, mainly in energy and mining.

Its largest position was in Xto Energy, which had dropped from $73.74 in June to just under $43 and was among the 20 most widely held stocks by hedge funds, according to Goldman, Mr Anderson said.

Firms are also monitoring Deutsche Bourse because of a big position in its shares held by Atticus, which has told investors in its main hedge fund it is down 25 per cent so far this year.

Greenlight Capital, the hedge fund run by David Einhorn, told investors in a letter on Wednesday it was down 17 per cent so far this year, in part because “investors have been unwinding trades that they otherwise believe make sense”.

Greenlight said it would “try to be opportunistic” in response.

Waves of Credit Default Swaps Incoming

Have you wondered why the Treasury asked for a $700 Bn emergency package with the full force of the Fed behind them, and gave the Congress less than a week to deliver it?

Either these fellows have lost their nerve or the markets are riding to a fall, and it could be terrific.

We've been looking for some event, something that would have created such an extraordinary set of actions as we have seen in the past few days.

This just might be it. Special thanks to Yves Smith for flagging it.

Time to start settling those Credit Default Swaps for Fannie and Freddie (Oct. 6), Lehman Brothers (Oct. 10) and Lehman Brothers (Oct 23).

LIBOR is eight standard deviations from the norm, because the banks don't know who is holding what in their cards, but there might be some Aces and Eights in there. The TED spread is at an all time record high.

An insurance company is said to be heavily exposed.

Do you need to buy a vowel? Let's hope we get lucky.

Brace for impact.

Postscript 4 October - Given that the Congress has now passed the 'Economic Stabilization Act' and Hank and Ben have a fresh roll of walking around money, we'd like to think that a crisis can be averted on Monday. Obviously they have seen this coming and have not only a plan, the willing cooperation of the holders of the swaps, but also now sufficient taxpayer money to persuade certain institutions to accept settlements that are 'reasonable.'

Let's watch carefully how the Treasury acts this week, as best we can, for it will speak volumes.


The Financial Times
Settlement day approaches for derivatives
By Aline van Duyn in New York
October 1 2008 03:00

The $54,000bn credit derivatives market faces its biggest test this month as billions of dollars worth of contracts on now-defaulted derivatives on Fannie Mae, Freddie Mac, Lehman Brothers and Washington Mutual are settled.

Because of the opacity of this market, it is still not clear how many contracts have to be settled and whether payouts on the defaulted contracts, which could reach billions of dollars, are concentrated with any particular institutions.

According to dealers, insurance companies and investors such as sovereign wealth funds, which are widely believed to have written large amounts of credit protection through credit default swaps on financial institutions, could have to pay out huge amounts.

"There is a lot at stake," said an executive at one big dealer. "This is a crisis time, and if these auctions do not go well, or if the amounts investors and dealers have to pay is seen as not being fair, it could have further negative repercussions on the CDS market."

The "auction season" starts tomorrow, when the International Swaps and Derivatives Association has scheduled an auction for Tembec, a Canadian forest products company. This is followed by Fannie Mae and Freddie Mac auctions on October 6. Then, Lehman is settled on October 10, and Washington Mutual is scheduled for October 23.

Even though it is possible that some participants in the credit derivatives market will have to make large payouts, the flipside is there could also be big winners. For every loss in credit derivatives, there is a gain.

The amount of contracts outstanding that reference Fannie Mae and Freddie Mac alone is estimated to be up to $500bn. The default was triggered under the terms of derivatives contracts by the US government's seizure of the mortgage groups, even though the underlying debt is strong after the explicit government guarantee.

The CDS contract settlement could result in billions of dollars of losses for insurance companies and banks that offered credit insurance in recent months. The recovery value will be set by auction. Usually, the bond that is eligible for the auction that trades at the lowest price - the so-called cheapest-to-deliver - is the one that sets the overall recovery value for the credit derivatives.

In the Lehman case, numerous banks and investors have already made losses due to exposure to Lehman as a counterparty on numerous derivatives trades. The auctions next week are for credit derivatives which have Lehman as a reference entity. There are likely to be fewer contracts outstanding than for Fannie Mae and Freddie Mac because Lehman was not included in many of the benchmark credit derivatives. However, exposure remains unclear, which is one concern that regulators now have about the credit derivatives market.

Lehman's bonds have been trading between 15 and 19 cents on the dollar, meaning investors who wrote protection on a Lehman default will have to pay out between 81 and 85 cents on the dollar, a relatively high pay-out.

The previous biggest default in credit derivatives was for Delphi, the US car parts maker that went bankrupt in 2005 and which had about $25bn of CDS.

TED Spread Soars to a New Record - Symptom of the EuroDollar Squeeze?

There is a real possibility that the TED Spread blowout is not an artifact of risk per se, but a symptom of the US dollar squeeze in Europe.

US Dollar Rally and Deflationary Imbalances Overseas

TED is an acronym for Treasury and EuroDollar. A Spread is just the difference or 'distance' between one thing and another.

Eurodollars are bank deposits denominated in U.S. dollars but held at locations outside of the U.S.

Initially, the term only referred to dollar deposits in London but has been expanded to include dollar deposits at any offshore location.

T bills are US Treasury debt of short duration are considered to be risk free.

TED Spread = Yield on Eurodollar deposits - Yield on T Bills

The TED Spread is the difference between U.S. Treasury bill yields and yields for Euro deposit contracts of the same maturity, generally three months.

Demystifying the TED Spread

The Dollar Rally and Deflationary Imbalances in the US Dollar Holdings of Overseas Banks

Dollar Assets and Liabilities in the International Banking System

In reading the Assets and Liabilities reports of the Bank for International Settlements (BIS), we have been examining the holdings of the reporting banks with respect to the changes in US dollar denominated assets and liabilities.

The Eurodollar had been a component of M3 and was discontinued by the Fed in 2006.



When a multinational company deposits US dollar receipts from an export business in their domestic banks those deposits are frequently held in dollars. Think of it as a short term Certificate of Deposit denominated in US dollars.

Overseas banks may take those customer dollar deposits (liabilities) and place them in dollar assets such as CDO tranches and interest yielding debt instruments which are held as dollar assets on their books.

If those dollar assets decline because of a financial event as we are seeing today, the depositors may choose to withdraw their dollar deposit from the bank as they mature.

This places the bank in an awkward position since the corresponding assets have deteriorated in value, but the nominal value of the certificate of deposit liability remains the same with the requisite interest accrual.

As a result, a demand for dollars can be generated in the foreign country that is artificial but very real in terms of day to day banking operations.

This is the 'artificial dollar short' and monetary deflation about which so many have spoken. It is specific to Europe in this case because the ECB cannot print dollars, it can only obtain them from the Federal Reserve.

It has more of the characteristics of a supply disruption or a liquidity crunch in that demand is temporarily exceeding supply because of an exogenous event.



The central banks arrange swap operations, such as between the Fed and the ECB, to exchange Euros and Dollars to maintain the liquidity of their domestic operations.

If handled inefficiently or under event duress this could have the effect of creating a short term currency imbalance, increasing the cost of euro-dollar swaps, and driving the 'price' of the dollar higher in the short term, and perhaps quite sharply if the event is of sufficient magnitude.

As the imbalances are resolved the 'fundamentals' should reassert and relative values among currencies revert to the mean.

But in the short term a significant amount of dislocation and distress could occur in the arbitrage and banking markets.

We believe that we are in such an occasion now, as the European banks had been slow to markdown their degraded US assets, and had relied on swaps written by companies such as AIG which have failed, leaving the banks a day late and literally 'a dollar short.'

The resulting sharp rally in the US dollar is therefore likely to be an anomaly which will correct, and perhaps quite sharply, once the effect of the short term imbalances dissipates.



We do not have access to a Bloomberg terminal but would speculate that EUR.USD swaps have risen higher recently as the withdrawal pressures in the European banking system increased. This has little to nothing to do with the relative prospects for the fundamentals, but are what we like to refer to as 'the technical trade.' Real enough to the trader, but transitory.

Have you missed the exquisite irony that it was the US banks that sold the foul debt assets to the overseas banks that are now driving the demand for US dollars. And the US banks are quite possibly squeezing their foreign countrparts in the process?

We wonder if the ECB and other Central Banks agree with this and therefore understand that decreasing the value of the US dollar relative to their currency might be an effective policy response to some liquidity problems in their domestic banking system.

They may already be attempting to accomplish this, given the recent increases in the Fed swaplines with their foreign central bank counterparts. But they may also be getting squeezed by some multinational trading banks and funds.

Although we have been discussing this using the Euro as an example, the situation would apply to any national banking system which has been long deteriorating US debt and the monetary dollar fruits of the US current account deficit and their own mercantilism.

Don't confidence men generally rely on the gullibility and greed of their marks? We doubt the economic hit men are missing this opportunity to profit from a position of relative advantage.

No wonder some nations are complaining that they need a new basis for international trade not based on the dollar.

"It's good to be the King."