The Hedge Fund Headache By William CateHedge Funds are dangerous. They play with
D-bomb and Hedge Fund managers don't know what they are doing. They are like children playing with a landmine in a sandbox. It's fun and exciting until darn thing goes off. A D-bomb explosion would have same impact on global financial market, as an H-bomb would have denoted over Salt Lake City. The result would be a multi-century wasteland after explosion. A D-bomb explosion means that our Civilization will be facing a new multi-century Dark Age.
The D-bomb is Derivatives Market. In theory, derivatives are balanced risk investments that allow Hedge Funds, banks, insurance companies and others to profit from spread created by bet. The three design problems with D-bombs are that risk is usually an either or option that doesn't factor in a third alternative. Many bundled derivatives have components that don't represent outside financial instruments that might have value after a D-bomb explosion. The Derivatives Market represents about forty times total value of all world currencies combined. If D-bomb goes off, all world currencies would be worthless about forty times over. There simply isn't enough money to cover a D-bomb meltdown.
In simple terms, a derivative is merely a bet. And it can be a bet on anything: interest rates, exchange rates, stocks, commodities, etc.Find a counter-party willing to wager against you, and you havecreated a derivative. And to make bet you usually only have to put downa small fraction of bet amount. However, if their bet explodes, Hedge Fund must cover leveraged amount of their bets. It's this coverage requirement for dangerous bets that puts global financial market at risk. The D-bomb risk/reward ratio doesn't make sense to anyone who understands it.
Consider Long Term Capital Management. In 1998, it was largest Hedge Fund in world. It's derivatives shenanigans almost triggered collapse of entire global financial system. It careened to brink of failure and would have gone under if U.S. Government had not organized an emergency bailout. That bailout took taxpayers of twenty countries to cut timer to D-bomb denotation. And, Long Term Capital Management wasn't even an American Hedge Fund.
The global derivatives market is around $272 trillion, according to recent figures from Bank of International Settlements. And three big American banks' JP Morgan Chase, Bank of America and Citicorp - account for $77.6 trillion of money being bet.
European banks are at risk for over $100 trillion and are global center for D-bomb development. However, America is racing to close D-bomb gap. Because they aren't regulated like banks, U.S. Hedge Funds are on cutting edge of D-bomb development. American Hedge Funds manage over one trillion dollars, up from thirty nine billion in 1990. In first quarter of 2005, wealthy investors added twenty seven billion dollars to capital of Hedge Funds. These Funds are borrowing billions of dollars from major brokerage firms and others. With help of Hedge Funds, America is closing D- bomb development gap. A small bad bet can easily bring down largest financial institution. Hedge Fund trading may account for up to 50% of trading volume on NYSE. A few bad bets would collapse Dow Industrial Average. Because there are no reporting requirements, nobody knows how well or badly Hedge Funds are doing. However, I've never met a Hedge Fund manager who wasn't seeking new blood for their operations. If they were doing so well, they wouldn't need a constant influx of new capital.
