[A-List] The Coming Showdown

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

A major showdown is shaping up between hedge funds, investment banks and 
commercial banks.  Unlike LTCM, whose trouble was one fund being too big 
to exit without massive loss, the current Achilles heel is the 
proliferation of funds all imitating each other, with aggregate sums 
that defies orderly liquidation. Instead of one big fat man on a small 
row boat, no matter which side he moves, the boat overturns, we now have 
three thousand guys all moving together from side to side on a ferry 
boat in a storm, each move rocking the boat harder until its capsizes.  
The investment bank power houses are looking to make a killing from the 
demise of the hedge funds on the theory that someone's loss is someone 
elses' gain in any market. The do this by having more capital than any 
one single hedge fund. The commercial banks are looking to high profits 
from trading credit derivatives derived from the debts. The game is a 
three-legged stool that needs a cooperative symbosis among the three 
components to stay afloat. When anyone of the three starts to seek gains 
at the expense of the other two, the game implodes and guickly 
transforms into a game of survival of the earlier exit, which in 
financial terms is a systemic rout.

When the hedge fund industry loses $100 billion, that money goes to the 
parties betting against them, which are the investment banks. The flow 
of funds is intermediated by commercial bank loans. The hedge fund 
investors as a group loses $100 billion and the investment bank share 
holders get $100 billion less investment bankers' take.  No big deal in 
the macro picture. The trouble is leverage. Most hedge fund strategies 
rely on leverage to reap high profit and a loss of over 10% can be 
fatal, leaving the other two components in the game with uncollectable 
collectables. And the meltdown begins with margin calls that distorts 
the flow of funds.

The housing bubble burst, while a heavy load, is not going to be the 
straw that will break the camel's back. The straw will be the hedge funds.


Henry C.K. Liu