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Hedge Fund Failures is Fire in the Projection Room

Interest-Rates / Financial Crash Aug 02, 2007 - 12:29 AM GMT

By: Tim_Iacono


Many people in high places continue to assert that problems with hedge funds and subprime lending do not pose a systemic risk to the financial system.

If these important people did think the entire financial system was threatened, do you think they would tell us?

FireWhy would they tell us?

Wouldn't that be like the projection room crew yelling "FIRE!" in a crowded theater as they attempt to suppress the flames from something that was ablaze upstairs?

Maybe some patrons already got a whiff of something foul smelling, but not enough to compel them to make for the exits while the movie plays on.

Hopeful that the flames could be beaten back, the theater staff would probably delay notifying the audience until they were sure their patrons were threatened - otherwise life and limb may be risked as panicked movie-goers all made a hasty retreat from the building at the same time.

Inciting a panic would only make things worse, unless of course the small fire turned into a much bigger fire and, in the end, no one survived because no one yelled "FIRE!"

Is that what's happening in financial markets today?

A fire in the projection room?

A week ago, a report from ratings giant Moody's claimed there were "serious reasons to worry" but that systemic risk was not among them since "financial institutions retain a high capacity for withstanding shocks."

Last month, Fed Governor Kevin Warsh testified before the House Financial Services Committee stating that there may be more downside to go in the current credit market tumult, but, "We don't see any immediate systemic risk issues."

At the same hearing, Treasury undersecretary Robert Steel said that the recent sell-off in subprime securities "does not seem to be a systemic issue."

Earlier this year, current Fed chief Ben Bernanke noted there were indeed systemic risks from the GSEs (Fannie Mae and Freddie Mac), referencing former Fed chief Alan Greenspan's successful effort to reduce the role of GSEs in the financial system - in this case the systemic risk was clearly identifiable, derived from the GSE's implied government guarantee.

Other than that, there is nary a systemic risk to be found.

Over a year ago, Ben Bernanke spoke on the subject of hedge funds and systemic risk, ultimately rejecting the idea of somehow making hedge funds less opaque to "allow authorities to monitor this possible source of systemic risk and to address the buildup of risk as it occurs."

Maybe that would have been a good project to undertake in early 2006 rather than watching things unfold as they are now with no tools and no data at their disposal.

Almost ten years ago, former Fed chief Alan Greenspan noted that when banks "are undercapitalized, have lax lending standards, and are subjected to weak supervision and regulation, they become a source of systemic risk both domestically and internationally."

Lax lending standards and weak regulation leading to systemic risk...


Earlier today, it was revealed that another hedge fund from Bear Stearns is in deep doo-doo. According to the report, they have "blocked investors from pulling money out of a third fund as losses in the credit markets expand beyond securities related to subprime mortgages" . Unlike the two Bear Stearns funds that went belly-up last month, this $850 million asset-backed fund had no leverage and virtually no exposure to subprime mortgages.

Call it systemic risk, call it what you want - whatever it is, it is spreading.

In this most recent case, it's as if the movie-goers are locked inside the theater, unable to leave, while a fire burns out of control in the projection room, yet nobody yells "FIRE!"

By Tim Iacono
Email :

Tim Iacano is an engineer by profession, with a keen understanding of human nature, his study of economics and financial markets began in earnest in the late 1990s - this is where it has led. he is self taught and self sufficient - analyst, writer, webmaster, marketer, bill-collector, and bill-payer. This is intended to be a long-term operation where the only items that will ever be offered for sale to the public are subscriptions to his service and books that he plans to write in the years ahead.

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