Best of the Week
Most Popular
1. Gold Final Warning: Here Are the Stunning Implications of Plunging Gold Price - P_Radomski_CFA
2.Fed Balance Sheet QE4EVER - Stock Market Trend Forecast Analysis - Nadeem_Walayat
3.UK House Prices, Immigration, and Population Growth Mega Trend Forecast - Part1 - Nadeem_Walayat
4.Gold and Silver Precious Metals Pot Pourri - Rambus_Chartology
5.The Exponential Stocks Bull Market - Nadeem_Walayat
6.Yield Curve Inversion and the Stock Market 2019 - Nadeem_Walayat
7.America's 30 Blocks of Holes - James_Quinn
8.US Presidential Cycle and Stock Market Trend 2019 - Nadeem_Walayat
9.Dear Stocks Bull Market: Happy 10 Year Anniversary! - Troy_Bombardia
10.Britain's Demographic Time Bomb Has Gone Off! - Nadeem_Walayat
Last 7 days
Prepare For Unknown Stock Market Price Action As New Highs Are Reached - 23rd April 19
Silver Plays a Small but Vital Role in Every Portfolio - 23rd April 19
Forecasting 2020s : Two Recessions, Higher Taxes, and Japan-Like Flat Markets - 23rd April 19
Gold and Silver Give Traders Another Buying Opportunity - 23rd April 19
Stock Market Pause Should Extend - 21st April 19
Why Gold Has Been the Second Best Asset Class for the Last 20 Years - 21st April 19
Could Taxing the Rich Solve Income Inequality? - 21st April 19
Stock Market Euphoria Stunts Gold - 20th April 19
Is Political Partisanship Killing America? - 20th April 19
Trump - They Were All Lying - 20th April 19
The Global Economy Looks Disturbingly Like Japan Before Its “Lost Decade” - 19th April 19
Growing Bird of Paradise Strelitzia Plants, Pruning and Flower Guide Over 4 Years - 19th April 19
S&P 500’s Downward Reversal or Just Profit-Taking Action? - 18th April 19
US Stock Markets Setting Up For Increased Volatility - 18th April 19
Intel Corporation (INTC) Bullish Structure Favors More Upside - 18th April 19
Low New Zealand Inflation Rate Increases Chance of a Rate Cut - 18th April 19
Online Grocery Shopping Will Go Mainstream as Soon as This Year - 17th April 19
America Dancing On The Crumbling Precipice - 17th April 19
Watch The Financial Sector For The Next Stock Market Topping Pattern - 17th April 19
How Central Bank Gold Buying is Undermining the US Dollar - 17th April 19
Income-Generating Business - 17th April 19
INSOMNIA 64 Birmingham NEC Car Parking Info - 17th April 19
Trump May Regret His Fed Takeover Attempt - 16th April 19
Downside Risk in Gold & Gold Stocks - 16th April 19
Stock Market Melt-Up or Roll Over?…A Look At Two Scenarios - 16th April 19
Is the Stock Market Making a Head and Shoulders Topping Pattern? - 16th April 19
Will Powell’s Dovish Turn Support Gold? - 15th April 19
If History Is Any Indication, Stocks Should Rally Until the Fall of 2020 - 15th April 19
Stocks Get Closer to Last Year’s Record High - 15th April 19
Oil Price May Be Setup For A Move Back to $50 - 15th April 19
Stock Market Ready For A Pause! - 15th April 19
Shopping for Bargain Souvenirs in Fethiye Tuesday Market - Turkey Holidays 2019 - 15th April 19
From US-Sino Talks to New Trade Wars, Weakening Global Economic Prospects - 14th April 19
Stock Market Indexes Race For The New All-Time High - 14th April 19
Why Gold Price Will “Just Explode… in the Blink of an Eye” - 14th April 19

Market Oracle FREE Newsletter

Top 10 AI Stocks Investing to Profit from the Machine Intelligence Mega-trend

Hedge Funds Are Pouring Into Distressed Debt

Interest-Rates / Corporate Bonds May 13, 2013 - 01:02 PM GMT

By: Money_Morning


Greg Madison writes: Regulators have demanded that banks stop engaging in so much risky behavior - chiefly, distressed debt investing. And the banks have begun to curtail this type of investing.

But this has led to an unprecedented - though not unpredictable - situation: It seems the hedge funds are picking up the slack.

The distressed debt that banks are leaving behind is getting bought up, in a big way, by credit hedge funds. Fully $108 billion worth of distressed debt investments is being picked up by these groups.

Hedge funds are not as big as the large banks, with assets running "only" into the mid-hundreds of billions. But the more moves they make, the bigger they become.

Hedge funds, money-market funds and REITs - engines of shadow-banking - have exploded recently, in terms of capital and headcount. And top talent - for top dollar - has been leaving companies like Deutsche Bank AG (NYSE: DB) and Barclays Plc (NYSE: BCS) for the greener, riskier pastures of BlueCrest Capital Management and Pine River Capital Management.

Hedge funds are less regulated than banks, because they cater to a savvier investor with different goals than someone who has a run-of-the-mill checking, savings or retirement account. Grandma is not opening up a Christmas Club account for you with the likes of Carl Icahn - yet.

This freer atmosphere makes hedge funds the natural place to turn once you begin to rule out banks. They've become "shadow banks," and they've been getting into some pretty interesting areas.

Their investment in bankruptcy claims and distressed debt is of particular note.

Why Hedge Funds Like Distressed Debt Investing

Distressed debtors are companies that have already defaulted on debt. If a run-of-the-mill gigantic bank wanted to dabble some of its trillions in assets in it, regulations dictate that they would have to beef up their reserves to offset the risk.

Not so with hedge funds. They can take advantage of the riskier opportunities that the newly hobbled banks have to pass up.

Deutsche Bank CFO Stefan Krause lamented this at a Berlin conference, saying, "There are businesses based on our capital regulation we'll not be able to do that hedge funds will be able to do."

Krause is not alone. Many large banks have scaled back some of their riskier, more capital-intensive operations, leaving what's left to the hedge funds.

And there is a lot of business to be done, with hedge funds and capital management firms beginning to resemble, at least on the surface, investment banks. Some of these firms have been able to recreate, with their poached personnel, the exact same trading teams as existed before the banks had to exit the business.

If this sounds like madness to you, there's a method to it.

When regulators force banks to give up these riskier behaviors, they're essentially transferring the risk onto these capital management firms. It's a lot easier for The System to absorb a capital management firm's going under that it would be if, say, Bank of America Corp. (NYSE: BAC) went belly-up.

We've seen what it looks like when the global banking system collapses under the weight of toxic debt.

But if a hedge fund were to go under?

We'd be treated to the sight of a hedge fund bandit fighting his way through hordes of incensed millionaires, all the way to Teterboro Airport in New Jersey and a Learjet bound for Tahiti.

Then there's the intangible, the question of character. We have seen what happens when greed overtakes all sanity at large banks. We've been there before, and we're lucky to have come out the other side.

A hedge fund manager is a horse of a different color. He's made a living on greed and elevated it to an art form. That hedge fund manager knows the difference between enterprising a worthwhile risk for a big payday and trying something beyond the limits of all stupidity. At Pine River Capital Management, they know the difference. They sure didn't at Lehman Bros.

Putting hedge funds out in front of distressed debt investing contains the risk, and somewhat limits the exposure of the financial system as a whole.

That's a good thing, right?

There's another edge to the sword, as usual.

When banks have to curtail their speculation and "alternative asset" business, it can cause problems with the banks' liquidity function, their ability to get cash from here and move it out into the markets to keep the wheels greased. Hedge funds don't have to function that way and they don't.

Moreover, hedge funds seem to have set up some real penalties for those traders who gamble and lose. Bloomberg News reported BlueCrest Capital Management traders stand to get their capital allocation slashed if they lose too much money - a serious wing-clipping. Little such disincentive exists at the banks. We all remember failed bankers taking home huge bonuses.

So the question is: Do we want to get our banks out of the heavy risk business once and for all, and put it into the hands of real pros? Do we want to risk the liquidity function of large banks and the role they'd play in easing a crisis? What role does calculated risk play in generating wealth and stability?

I get the feeling we'll see the answer soon enough.

Source :

Money Morning/The Money Map Report

©2013 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email:

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules