Biting the Hedge Fund Hand That Could Save the Economy

As the current administration continues to scold hedge fund "speculators" and blame them for potentially forcing Chrysler into bankruptcy for not accepting a deep discount on their debt (before they finally relented), those same firms may now hold more keys to the success of some of the programs being pushed by the same folks doing the scolding (see Bloomberg article).

While smaller in numbers and size than just one year ago, hedge funds are still in many instances those with the most capital and risk tolerance to participate in programs such as the TALF and PPIP. Yet, while hedge funds like making money, they hate losing it even more, especially when those losses are driven in part by the rules of the game being changed. Given the recent move to ignore and subordinate more senior debt to a status lower than other parties, hedge funds may be more cautious with future investments opportunities.

Such program participation may soon get another test as hedge funds weight their options as GM (GM) goes through its own restructuring. Holders of GM bonds have just a few weeks to decide if they want to swap their debt for a 10 percent equity stake in the company - while the government and the United Auto Workers union-run health care funds get 50 and 39 percent, respectively. While not only getting the short end of the stick, those debt holders who also hold CDS contracts would most likely favor a bankruptcy filing (see Financial Times article).

Estimates have investors holding $34 billion in CDS on GM, with profits on the order of $2.4 billion if GM were to default. In what is not much of a surprise, current CDS prices are indicating that a bankruptcy filing is likely. The complicated and extensive lines of debt and derivatives will make both a GM bankruptcy, and any strong arm tactics, much more difficult to execute. Given less of an incentive to participate in the next restructuring, hedge funds may find others offering a little more cooperation, and maybe even a seat at the table going forward. At some point, you cannot keep slapping the hand that may save you.

Comments

[James Wilson:]

Hedge Funds, Please pardon my bad language.

May 13 06:33 AM

[Tom Armistead:]

We have hedge funds to thank for the naked short-selling, CDS manipulation and rumor mongering wthich brought the financial crisis to fruition.

They need to co-operate in cleaning up the mess they made.

They should be taxed and regulated appropriately to level the playing field for those who work, save and invest, as opposed to those who speculate, manipulate, and destroy value.

May 13 07:09 AM

[Daniel Moser:]

Geez...I thought we were in this financial mess becuase major banks and residential mortgage companies went extremely lacks on responsible lending which allowed consumers to live WAY beyond their means using home refinancing as a source of income coupled with credit cards, and generally no real savings.

Thank you for clearing it up...everyone should be able to own a home regardless of their ability to pay and quite frankly Wall Street should be willing to finance it. Hedge funds, speculators, manipulators, and value destroyers are all to blame for our financial mess. Thank goodness we have Larry Summers, Tim Geitner, Rahm Emmanual, etc. who have never worked for such corrupt institutions that destroy value and offer nothing productive in the economy. These are great, hard working, honest individuals who we should be grateful were never involved in 1920s style "Chicago Politics" in the modern age. They are definitely not likely to do any backdoor deals in which a select few get filthy rich while laying all the risk off on the taxpayer.

The stock market and the United States economy will be much better off in the United Socialists States of America when Obama finally sets a few ground rules. Rule 1: the stock market WILL go up 5% per year for the rest of our lives with no fluctuations. Rule 2: NO ONE is allowed to bet against rule 1 from happening.

Sounds like a sustainable plan to me. I can't wait to wake up when they actually ban short selling all together leaving investors literally nothing to do to protect themselves financially against market meltdowns. Pension system failed, social security is failing, 401K and IRAs are not likely to escape the Obama administration as tax free or tax reduced investment vehicles (plus long only investments in the stock market are tenious at best at this point anyways). What is a young person to do in order to save for any sort of retirement? Hey when Obama and the Chicago mob bosses rewrite finance and how the stock market structurally works to include the above mentioned rules....I guess I know what I can do to save for retirement. I will give money to "the party" which will then manage to manipulate economic data such that I believe I am earning 5% per year in a very Madoff similar fashion. Sounds great to me.

*Essentially everything I have written is laced with sarcasm in case my writing wasn't clear.

May 13 08:41 AM

[Trane250:]

Correction: "Short sellers" are not "investors." They are speculators or to use the more euphemistic term "players." Many of these hedge funds bought GM bonds on the secondary market hoping to make a killing if GM's fortunes improve. Obama did an end run around them. Serves them right.

May 13 09:21 AM

[Matthew Trahan:]

Wake up people, investing is speculating.

If one examines a company and thinks it is a good investment, it is because he or she believe that the -price will rise- therefor they believe it is -undervalued-. That is pure speculation.

If one thinks a company is undervalued and wishes to speculatate on the price rising, he or she buys shares.

If one believe that a company is -over-valued and wishes to speculate, the only way they can do so is if they already owned the company and sell their shares. However that is likely a small portion of market participants. Thus we have short selling.

Without an equal number of people with the -ability- to move the price higher and lower, an unatural upward pressure manifests itself in artificially inflated prices, leading to larger crashes when the market finally can properly price the company.


On May 13 09:21 AM Trane250 wrote:

> Correction: "Short sellers" are not "investors." They are speculators
> or to use the more euphemistic term "players." Many of these hedge
> funds bought GM bonds on the secondary market hoping to make a killing
> if GM's fortunes improve. Obama did an end run around them. Serves
> them right.

May 13 09:45 AM

[Ferdinand E...:]

Two cheers for hedge funds, at least those that survice. The last I heard there were about 8500 hedge funds in the world, and about 1000 of these go into the tank every year. One of the directors of the Swedish central bank put in a good word for hedge funds last year, but that is because this ignoramus wants a high paying non-job with one of these organizations. I hope that he got his job, and with one of the 1000.

May 13 09:50 AM

[Canbyte:]

A pox on hedge funds. Hedge funds hedge! Hedge (v): to go long and short simultaneously ie TM long and short GM. Given that hedgies are/were 25% of the market you can see that this hedging automatically creates huge inventories of duplicate (shorted) shares. Did anyone ask to borrow your shares?

Learn more - click on my website which links to a petition to abolish shorting and to discussion sites etc.

May 13 10:16 AM

[Old Trader:]

I'm with the side that views hedge funds as important actors in the play. They provide liquidity, and often , serve as the "canaries in the coal mine", when something's amiss...(think back to Enron, for example).

Obama's slamming of the hedge funds in his speech was merely another example of the use of the "bully pulpit" used by TR, another populist president....(not a criticism, per se...merely an observation).

May 14 12:59 AM

[irondoor91:]

Mssrs. Obama, Biden, Reed, (Ms) Pelosi, Emanuel, Kennedy, and on and on ad nauseum. None have ever held a legitimate job, owned or managed a company, developed, implemented and been responsibile for profit & loss. They've never had to give up their own income and borrow money so the company they own could meet payroll. In other words they are capital destroyers, not creators.

Basically, they are useless and interchangeable bloodsucking freeloaders whose approach to governance and reelection is lying to the non-taxpaying public freeloaders that their policies will make their pitiful lives better.

The only thing that keeps the polical class in Washington in power is their ownership and control of the printing press at the Treasury Department and the Fed. One supplies money to the other to buy what the other needs to sell.

But, why would we expect anything different?

May 24 10:25 PM