Sunday, October 19, 2008


As the Hedge Funds unwind. Things get whacked.

A lot of European hedge funds bought silver. And a lot of them were based in London.

Supposedly this is happening (from naked capitalism)...

The US had huge problems with broker-dealers in the 1930s...Enter the US Securities Exchange Act of 1934. This is one piece of depression era legislation that survives and thank the Good Lord for that.

What the broker dealer act does is (a) ring fence the US broker dealer and (b) limit the amount that the broker dealer can borrow against your securities and the amount of collateral it may take.

I am hardly a lawyer – so take the bush lawyer caveat – but the way it works is that the broker dealer may not borrow against your securities to finance their own business, only client business. So Lehman Brothers US broker dealer could take collateral of securities and if they had 100 million out on client margin loans the most that they could raise using client securities is 100 million and not a brass razoo more. This is really important because it meant that client assets were not used to finance Lehman’s disastrous commercial real estate and other businesses.

Moreover when you deposit a million dollars at the broker dealer and give them the right to repledge those securities they can only rehypothecate 140 percent of your outstanding balances...

So (provided the broker is not acting criminally) you should get the bulk of your money back if the broker dealer fails. And provided the capital requirements are adequate (and they mostly are) the broker dealer won’t fail. Even the Drexel Burnham Broker Dealer did not fail....

The result. Whilst Lehman brothers went bust Lehman US broker dealer did not. This pretty well saved the US hedge fund industry.

Europe however was a different story. Lehman Europe failed – and the clients of the European broker dealer (read a good proportion of the London hedge fund community) are now queuing as unsecured creditors of Lehman. Many funds have folded. Far more have been nicked. Whilst the US hedge fund business is currently looking dazed, confused and a little problematic the UK business is on life support.

In some sense this is the end of the City of London.

So even if your hedge fund bet on the right things... Because Lehman failed, your hedge fund still got screwed.

Amazing that these hedge funds didn't want their assets ring fenced. I guess it is the same mentality as everyone who trusted Lehman as a counter party (yes, including mini bond holders)...

They all believed "...Lehman Can't fail..."

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