Hedge fund failures to increase following staggering losses

By Neil Behrmann


April 2008: Staggering loss estimates of the International Monetary Fund, confirm George Soros's concerns that hedge fund failures will increase this year.

The IMF Financial Stability Report reckons that out of a total of almost US$1 trillion “mark to market losses” i.e. value downgrades of a variety of credit securities, the hedge fund share, is $110 billion to $200 billion. The IMF says that loss calculations should be treated with caution, because they depend on the quality of disclosure, and are sometimes based on estimates of exposures. The institution is highly critical of inadequate hedge fund transparency.

“Hedge funds tend to hold the riskiest tranches of structured products,” complains the IMF.

The IMF reports that the warning signs of hedge fund troubles relating to US sub prime debt go back as far as 2005. Actual losses then were $6.7 billion. Indeed cumulative losses of hedge funds exposed to US subprime debt from 2005 to November 2007amounted to a staggering $47.3 billion, states the IMF. As at November 2007, hedge fund exposure to the US subprime market was $77.6 billion or 24 percent of the total.

“Until recently, one of the remarkable features of the current crisis was how few large hedge funds have failed,” notes the IMF. This situation is changing with the intensification of the crisis as …..fewer hedge funds are able to secure the leverage required to meet return targets on low-yielding assets.”

Credit default swaps dangerous market -  George Soros

The IMF is particularly concerned that if investment bank prime brokers decide to tighten credit, there could be more hedge fund collapses. An increase in margin or deposits on credit derivative positions to 10 per cent, from an initial 3 per cent, would force some funds to sell nearly 70 per cent of their holdings, warns the IMF. “Such increases in margins have been far from unprecedented…..It would therefore be unsurprising if there were more hedge fund failures in coming months.”

The IMF report confirms the worries of hedge fund players.  George Soros. contends that the high-risk credit default swaps (CDS) market is like a Sword of Damocles hanging over global markets. CDS are a form of insurance against bond issuers defaulting on their interest payments.

“Nobody knows the counterpart risk in case of a default. At about US$45 trillion, they are five times bigger than the government bond market,” says Soros. According to the IMF, banks are the biggest participants, but hedge funds account for almost a third of market participants in this market.

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