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Hedges blames the hedgers
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August 28, 1998: 10:58 a.m. ET
Analyst says emerging markets are getting hit hard by liquidations
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NEW YORK (CNNfn) - Russia's economic crisis seems to be contagious, as this week's selling has spread to markets far removed from Russia. How did it spread so quickly from one market to another?
One factor is the growth and importance of hedge funds, which place big bets on the market with wealthy investors' money. James Hedges, president of LJH Alternative Investment Advisors, appeared on "Business Day" to assess the impact of hedge funds in the market sell off.
DEBORAH MARCHINI, CNN ANCHOR: The hedge funds -- how much have they sustained in overall losses?
JAMES HEDGES, PRESIDENT, LJH ALTERNATIVE INVESTMENT ADVISORS: Well, it's difficult to ascertain right now. What is knowable is that there is a multiplicity of hedge funds managers out there that are being affected by the losses in Russia, both directly and indirectly. There are global funds, emerging market funds, as well as global fixed-income funds that are being hit. What is going on is there is a spill-over leading out of Russia, a crisis focusing on liquidity in the markets, and subsequently other strategies like convertible bonds, high-yield debt, distressed securities, are all being hit by the America as well at the same time. So the ramifications are not just specifically focused in Russia, but more over a broader, broader base.
MARCHINI: Right now it's liquidity concerns?
HEDGES: It is.
MARCHINI: Do you think there are hedge funds out there that will have to shut their doors as a result of this?
HEDGES: Unfortunately so. There are a number of funds out there that have encountered very substantial trading losses either due to redemptions coming from investors that are concerned about the liquidity, or from the fact that they are getting margin calls, and a number of hedge funds possibly will close. We, indeed, know of some hedge funds that are being faced with billion dollar-plus margin calls at this time.
MARCHINI: And can they meet them?
HEDGES: Absolutely not.
MARCHINI: All right. What happens when a hedge fund closes without paying back what it owes?
HEDGES: Well, in the past there has been precedents that has basically led to where hedge funds have closed down. There have subsequently been law suits, and then settlements with the prime brokerage firms.
MARCHINI: In the meantime, though...
HEDGES: The investors lose everything, of course.
MARCHINI: Of course. And in the meantime, this is why we're seeing so much pressure on bank and brokerage stocks in the United States, because these are the lenders to the hedge funds.
HEDGES: That's true. You know, we saw the CSFB, and a number of the major banks' trading operations writing down immediately hundreds of millions of dollars of bad debt. And that's going to be a continued problem on earnings, as well as the lending environment.
MARCHINI: We'll be hearing more of this, basically, from Wall Street. Now, let me ask you about those hedge funds that can cover their losses. They have to liquidate investments somewhere in order to do that. What markets are getting hit by hedge fund liquidations?
HEDGES: Unfortunately, it's pretty much across the board. We're finding that, as I said earlier, anything that is a fixed-income instrument, except for T-bills, is getting hit pretty dramatically. We've seen spreads widening to a major degree. You are also seeing Latin American stocks and emerging-market hedge fund managers being hit quite hard. You see very attractive situations. Brazil and Venezuela and telecom stocks, as an example, getting whacked recently, in spite of the fact that they are fundamentally sound. It's a function of a crisis of liquidity.
MARCHINI: Are these hedge funds in control of enough money that they're selling actually moves, not only individual stocks, but whole markets?
HEDGES: It is fair to say that in certain circumstances that hedge funds can have a dramatic impact on the market's liquidity. But nonetheless, what you've got to keep in mind is that there are bank proprietary trading desks, and a number of other operators in the market that have substantial influence. And so, when of all these move in corollary, in concert with one another, that's when we have trouble.
MARCHINI: Briefly, is the hedge fund selling over yet?
HEDGES: I don't think so. I think it's probably pretty close, but nonetheless, we've had recognition of the losses, and I think we're probably near the end. 
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