The Journal is good on the perilous state of the hedge-fund industry, including the latest closures, here.
Debt, of course, is essential to the modern hedge fund. That leverage has helped funds squeeze more gains out of many thinly profitable investment strategies such as merger arbitrage and senior loans of big companies. For example: A fund that borrows $5 for each $1 of equity can turn a 5% gain from a leveraged-loan investment into a 25% gain.
But, just as some homeowners are finding that a home declining in value can wipe out their down payment, hedge funds are learning how sensitive their investments are to even modest declines. One main problem: Collateral backing their borrowing is also falling in value, and banks are demanding more collateral in turn. Such collateral calls typically kick in when a fund loses 25% of value. That creates “forced selling” for funds, pushing stock-market averages lower.
The current mix of investor withdrawals, declining markets and banks withdrawing financing can be dangerous for even large hedge funds, says Antonio Munoz-Sune, head of the U.S. for fund of funds EIM. “The combination can take anyone down,” regardless of size.
If you think there was a lot of screaming about bailing out Wall Street, imagine the caterwauling if we’re forced to bail out Greenwich, Connecticut. Their paychecks have been much, much bigger.
Breakingviews is smart today in pointing out that hedge funds’ compensation structures, like those at investment banks, led them to take on too much risk.
With a 2 percent fee to manage money and 20 percent of profits, hedge funds are structured to gamble other people’s money. There’s no clawback provision when the manager loses tons of money, as lots of hedgies are doing now. That needs to be reformed.
And breakingviews is very pessimistic about the economy, as well it should be.
The Journal says commercial real estate is the next shoe to drop, quoting a JPMorgan report that estimates 7 percent of the $3.4 trillion in outstanding debt will go bad in the next decade. That would be the highest rate since the commercial real estate depression of the late 1980s and early 1990s.
But it’s not clear to me from the Journal if that number includes condos, which are often considered commercial real estate loans, even though they’re residential projects. It seems to, though the paper confuses the issue here:
After years of plunging residential property valuations, commercial real estate is heading into the danger zone as office vacancies rise, stores close and hotel bookings fall…
Defaults on commercial real-estate debt remain less than 1%, compared with more than 10% at the worst point of that earlier collapse. Rents and vacancy rates have so far remained solid, enabling most properties to pay their debt service.
The major exception has been construction loans to single-family home builders and condo developers.
It seems to be saying that residential is the real problem with “commercial” real estate.
Finally, the Journal is good today with one of its classic page-one “aheds”, this one on “ICE Air” the illegal-immigrant repatriation airline whose business is soaring these days.
While U.S. airlines downsize and scrimp on amenities, one carrier is offering its passengers leather seats, ample legroom and free food. But frequent fliers probably don’t want a ticket on what may be the fastest growing “airline” serving Central America.
This carrier is run by U.S. Immigration and Customs Enforcement, the federal agency responsible for finding and deporting undocumented immigrants. A crackdown on illegal immigration has led to a spike in deportations and the creation of a de facto airline to send the deportees home.