[NYTr] Hedge funds' panic was behind worldwide market collapse

[All the News That Doesn't Fit]

Sunday Telegraph (UK) - Aug 12, 2007
http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/08/12/cnmarkets112.xml


Hedge funds' panic was behind worldwide market collapse

By Helen Power and Dan Roberts

Panic selling by hedge funds has emerged as the hidden cause of the
contagion spreading through the global financial system.

Billions were wiped from the value of listed companies around the
world on Friday, with Britain's FTSE100 index experiencing its worst
day in more than four years.

Initially, turmoil was limited to credit markets, but it quickly
spread to global stock markets after central banks were forced to
intervene to keep markets from collapsing completely.

As the world's stock markets pause for breath this weekend, it is
becoming clear that hedge funds, which are supposed to help stabilise
the financial system by diversifying risk and providing liquidity,
were instead at the epicentre.

City sources said problems spiralled when top investment banks
including Goldman Sachs, Lehman Brothers, and Merrill Lynch -- whose
prime brokerage arms act as lending banks to the hedge funds --
insisted that the funds settle a greater proportion of their debts
at the end of the day than they had done previously.

Other banks are said to have followed suit. "Everyone has hiked
margin calls and anyone who says they haven't is lying," said one
banker.

The increased payments forced hedge funds to sell assets to cover
their losses. One London banker said both Thursday and Friday were
characterised by remarkably light but very volatile trading in
London with those who didn't have to sell staying at home while
those who were forced to sell were badly punished.

"This is a one-in-a-100-year event in which there are extremely
unusual correlations that no one prepared for," one banker warned.
"We are in a situation where everyone is very scared."

Financial stability was further shaken as hedge funds' losses
mounted, compounding fears that some funds could collapse. Goldman
Sachs's Global Alpha fund, the US fund AQR, and New York-based Tykhe
Capital were rumoured to be in particular trouble, although this
could not be confirmed.

Many so-called quantitative funds with supposedly low-risk strategies
involving investment in both debt and equities were particularly
hard hit because weeks of turmoil in the credit markets made it
impossible for them to sell debt, forcing them to sell more stable
equity assets at a loss.

"In the last week people have had to meet margin calls by selling
equity positions. The quant strats [quantitative funds] have been
hit hardest and it's become a bit of a perfect storm. Prime brokerages
are increasing margin requirements so you have a self-fulfilling
prophecy and spiral down," said one senior banker.

"The black boxes [funds' computerised investment strategies] are
all similar. They are getting completely crushed," added another.

It has also emerged that many funds had invested in the same
companies, causing prices in otherwise unconnected companies to
fall dramatically.

Because hedge funds borrow much of the money they invest from banks,
the concern is that contagion could spiral again when the markets
reopen.

Gavyn Davies, Prime Minister Gordon Brown's former economic adviser,
warned yesterday that central bankers around the world would need
to address serious deficiencies in the regulatory system once the
crisis had blown over. Meanwhile the Financial Services Authority
began to audit London banks to assess their exposure to the US
sub-prime mortgage crisis and to highly leveraged corporate loans
following a similar move by the US Securities and Exchange Commission.