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Monday, March 03, 2008 10:11 AM

Margin Calls Force Selling of Assets, Falling Prices

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Margin calls are picking up steam. Many are not being answered. The Telegraph is reporting Ex-Goldman stars liquidate Peloton funds.

The credit crunch has forced Peloton Partners, a $3bn (£1.5bn) hedge fund run by former Goldman Sachs star traders, to liquidate its two investment funds, leaving its founders millions of pounds out of pocket. Ron Beller and Geoff Grant decided to sell off the assets of Peloton ABS (asset-backed securities) and the Peloton Multi-Strategy Fund about 10 days ago when it became apparent that they could no longer meet margin calls from investment banks.

Peloton's ABS fund was one of last year's best performers, netting returns of 87pc after betting against the riskiest types of sub-prime debt, but it began to face difficulties after the market for even highly-rated asset-backed securities froze last year. The Multi-Strategy Fund had a 40pc stake in the ABS fund and could not continue to trade once it was closed.
Excessive Leverage Results In Fire Sales

What went wrong at Peleton was not asset quality, but rather excessive leverage in an illiquid market.
It was not that the fund was invested in weird or wonderful sub-prime, collateralised, etc; its problem was that it appears to have been leveraged to buy reasonable quality but now illiquid asset-backed securities.

With the credit crunch draining away cash, the company was unable to finance the exposure and was forced to find buyers at any price. With no buyers, it was forced into what appears to have been a fire sale.

The list of funds not permitting withdrawals is getting bigger and as it rises so the rate of redemption closedown may increase as those still with a departure route see heavy withdrawals at a time when they are unable to sell the assets (at a reasonable price), which have been bought on the back of the margins placed by their backers.

A bit of an Armageddon scenario I'm depicting and we are, of course, nowhere near this situation yet…but….the vulture funds are circling.

Implosion Fears At Hedge Funds

Implosion fears are rising as Focus Capital slashes positions.
Focus Capital, an award-winning US-based hedge fund, has liquidated some of its biggest positions, raising fears of another implosion in the high-rolling sector.

The fund, which is run out of New York and Geneva, has caused turmoil as it dumped large positions in a raft of Swiss small cap stocks in recent days.
Unanswered Margin Calls at Bank of Montreal

After taking a series of significant writedowns over last couple of weeks, the Bank of Montreal is facing still another $500 million in writedowns after failing to meet margin calls on two of its trusts.

These moves guarantee more BMO writeoffs are coming and they threaten a proposed bailout of $33 billion in frozen Asset Backed Commercial Paper.

I wrote about this story at length over the weekend. Please see Bank of Montreal Misses Margin Calls for more details.

Thornburg Mortgage Hit With Margin Calls

More writeoffs at Thornburg are on the horizon. Thornburg's $300 million margin-call is proof enough.
Thursday's disclosure from Thornburg Mortgage (TMA) that it was forced to pay $300 million in new margin calls is the first warning bell of what might be another spiral of write downs -- and thus more dilution to come -- in the financial sector.

The Thornburg situation is significant for several reasons. During the "go-go" days of the subprime boom, Thornburg represented the gold standard of conservative underwriting standards for the whole sector. It kept only the highest-quality assets on the balance sheet, and thus when the whole subprime sector caught a fever last summer, TMA was widely believed to be a "thriving oasis" in the subprime desert.

But when the commercial paper market effectively shut down back in August, Thornburg's share prices tumbled from the high $20s into the teens in a matter of days. Because of their heavy reliance on short-term financing in a form of commercial paper, Thornburg was forced to sell some of their best assets at a huge discount to meet margin calls, which triggered more write downs and thus more margin calls. Unfortunately, as the most recent announcement from TMA and UBS confirms, it looks like we might be in for another round of the same troubles.
Fingers Point In Wrong Direction

Hedge fund managers who herded into illiquid one way bets pushing risk premiums to all time lows, need to look into a mirror to see where the problem is. Instead, Hedge Funds Blame Wall Street Instead Of Themselves.

Hedge funds blaming Wall Street is a lot like banks blaming people for "walking away" instead of themselves for making $500,000 loans based on stated incomes everyone knew were lies. Now that risk is blowing sky high at banks and hedge funds, few are willing to look into the mirror to see their role in the mess.

Cash Is King

For years people have been telling me that there is no difference between money and credit. This action proves otherwise.

When things are liquid, money and credit "look" the same. It's all an illusion. For starters, credit can (and is) is being withdrawn, even against hard assets. See Countrywide And Chase Shut Off The Cash Spigot for details on home equity lines of credit.

And unlike credit on bank balance sheets, cash in the bank may be "worth less" tomorrow but it is extremely unlikely to be "worthless" tomorrow.

As banks and brokerages are scrambling for more cash, hedge funds and others are getting migraines trying to produce that cash. By now it should be plain to see: Liquidity is a coward. It runs away at the first sign of trouble. Cash however, is hoarded in times of trouble. Cash, not credit, is king. It's important to understand the difference.

Finally, Gold is the ultimate form of cash. It represents a true flight to quality. Gold is the only money that is not someone's liability. It's no wonder that gold has been soaring. However, to the extent that hedge funds may be over leveraged in gold (or commodities in general), a sharp pullback could easily be coming. One possible trigger might be an across the board margin hike on all commodity futures.

Excessive leverage everywhere needs to be unwound, and it will be. Those expecting more margin call migraines will not be disappointed.

Mike "Mish" Shedlock
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