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World Crisis scenarios for the 21st century – Worldwide economic depression.(update 12)

Posted by Adrian on March 7, 2008

World Crisis scenarios for the 21st century – Worldwide economic depression.(update 12)

When the financiers (banks) of economic booms start to contract rapidly, the costs of interbank rates skyrocket, and the company default rate indexes start to move upward rapidly. This is already occurring within the US recession, and now also with the global slowdown. It is a very worrying development for global markets.

The credit crisis or credit crunch is yet to reach a defining climax, in that sense we may not have seen a real devastating blow from the credit squeeze globally. But the writing is on the wall.

In simply terms, the banks are restricting credit or calling in debts. This in turn is effecting the ratio and credit rating of indebted companies. So investors that are trading debt backed bonds such as corporate bonds, tracked primarily by the iTraxx which is showing default speculation rising rapidly. If business can’t finance, or refinance debts –  they are in trouble, hence bankruptcy. A troubling scenario on a global scale.

The collapse of Hedge Funds industry could be that wider precursor shock to a financial markets. The hedge fund industry is a heavily leveraged industry (like the Private Equity industry) that borrowed for a lot margin investing. Which is possibly on the verge of systematic failure. A industry that in all reports is very vulnerable to the current global credit crunch, in the sense that a tightening of the credit markets via the banks, is inevitably going to hamper growth in the industry. Paired with potential margin calls on ‘bets’ gone wrong – you could see a panic withdrawal on an industry that relies on huge amounts of investor capital for it’s high returns and management fees. The hedge funds now are locking out investor withdrawal. Similar to a banking crisis, but more exclusive to high yield investors. But never less an indication of systemic failure in the finance industry; on a large scale of losses,

from Business Week online,

“Since November at least 24 hedge funds have barred or limited investors from taking their money out, tying up tens of billions of dollars for an indefinite period. Among them: GPS Partners, a $1 billion fund that bets mainly on natural gas pipelines; Pursuit Capital Partners, a $650 million portfolio with troubled debt; and Alcentra European Credit, a $500 million fund that owns slumping loans used to finance private equity buyouts. The new rules affect not only the pension funds, endowments, and well-to-do families that buy the funds directly but also smaller individual investors exposed through diversified portfolios of hedge funds, known as funds of funds. Some hedge funds have broad powers under their contracts with investors to make such changes at their discretion. “It’s the largest period of redemption suspensions in the industry’s history,” says Jonathan Kanterman, a managing director with Stillwater Capital Partners, a money manager.

It’s understandable why hedge funds would want to keep investors from pulling out their money en masse. In this market, any sales would almost certainly be at cut-rate prices, guaranteeing big losses in portfolios. And once managers start dumping assets, there’s also the danger that big banks, which provided the funds with credit lines to amp up returns through what’s known as leverage, will demand their money back as collateral shrinks. Those margin calls would prompt further sales, setting off a vicious cycle that could ensure a fund’s demise.”

The credit tightening is not just going to effect consumers that use debt for everyday purchases, the credit tightening that is occurring is most certainly effecting companies from small to medium, finance, industry and so on.

Recent troubles with US mortgage bank (Thornburg Mortgage) and US mortgages trusts (REITS) – (not Hedge Funds) is an indicator of the problems when margin calls are missed in current credit markets environments.

from CNN business:

“Thornburg Mortgage (TMA) plunged 51.5% on bankruptcy fears after the residential mortgage lender said it had failed to meet a $28 million margin call and is now in default on $320 million in financing. Margin calls require borrowers to pay back loans or offer more collateral.

Mortgage real estate investment trusts (REITs) slid after Carlyle Capital Corp, a Dutch company that invests in mortgage-backed securities issued by Fannie Mae and Freddie Mac, missed margin calls and received a notice of default. Other mortgage REITS falling include Annaly Capital Management (NLY), MFA Mortgage Investments (MFA), Anworth Mortgage Asset Corp. (ANH) and Capstead Mortgage (CMO).”

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2 Responses to “World Crisis scenarios for the 21st century – Worldwide economic depression.(update 12)”

  1. […] dumping them. Not too mention the precarious position the Hedge Funds industry is in (discussed in World Crisis Scenarios for the 21st century – worldwide depression (update 12). As a prelude into widespread ‘panic’ fund withdrawals), in regards to […]

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