Showing posts with label Asian Financial Crisis. Show all posts
Showing posts with label Asian Financial Crisis. Show all posts

Thursday 1 April 2010

The Role of Hedge Funds in Financial Crise


The Role of Hedge Funds in Financial Crises – Stephen Brown Google

On October 2, the U.S. announced a Hearing on Regulation of  scheduled for Thursday, November 13, 2008. The focus is on the causes and impacts of the financial crisis on Wall Street, and the Committee will hear from  who have earned over $1 Billion.
The underlying premise of these hearings was expressed by Dr. , the  of Malaysia, who wrote on September 26 “Because of the extraordinary greed of American financiers and businessmen, they invent all kinds of ways to make huge sums of money. We cannot forget how in 1997-98 American  destroyed the economies of poor countries by manipulating their ”. The Prime Minister is recognized as an authority on the role of  in , given his experience managing the  as it engulfed his nation in September  ago. He is particularly critical of the role of  who will in fact be invited to testify before the House Committee at their November hearing.
It is perhaps too early to write about the causes and consequences of the current financial crisis while the storm still rages. However, it is not too early to examine the history of the earlier financial crisis. During the 1990s, according to the  had been investing steadily into . There was a net  of about US$20 billion into the region over and above portfolio and direct investment, up until 1995 and 1996 when the amount increased dramatically to US$45 billion per annum. Then with the collapse in both the Baht and the Ringgit in 1997, there was a sudden  of US$58 billion. It was self-evident to the central bankers in the region that the collapse in the currency had everything to do with an attack on the currencies of the region by well-financed international speculators. As Dr. Mahathir observed in a Wall Street Journal opinion piece that was published on September 23, 1997: “We are now witnessing how damaging the trading of money can be to the economies of some countries and their currencies. It can be abused as no other trade can. Whole regions can be bankrupted by just a few people whose only objective is to enrich themselves and their rich clients…. We welcome foreign investments. We even welcome speculators. But we don’t have to welcome share- and financial-market manipulators. We need these manipulators as much as travelers in the good old days needed highwaymen”. What was most remarkable about this statement was that its premises and its conclusion were immediately accepted by the international community, despite the fact that Dr. Mahathir did not provide any evidence to support his analysis of the role of  in the Asian financial crisis.
The first premise of Dr. Mahathir’s argument is that  act in concert to destabilize global economies. This is at best a misapprehension of the definition of a “hedge fund”. There is no such thing as a well defined hedge fund strategy or approach to investing. Rather, a hedge fund is a limited investment partnership otherwise exempt from registering with the Securities and Exchange Commission under Sections 3C1 and 3C7 of the Investment Company Act of 1940. As I note in my testimony last year before the House Financial Services Committee the available data show a remarkable diversity of styles of management under the “hedge fund” banner. The long-short strategy often associated with  captures about 30 to 40 percent of the business. The style mix has been fairly stable (in terms of percentage of funds) although there has been a dramatic rise in assets managed by funds of funds. These diversified portfolios of  are attractive to an institutional clientele. Event-driven funds focussing on private equity have risen in market share from 19% to 25% over the past decade, while the global macro style popularized by Soros has actually fallen from 19% to 3%. In my paper Hedge Funds with Style, with William Goetzmann, Journal of Portfolio Management 29, Winter 2003 101-112 we show that accounting for style differences alone explains about 20 percent of the cross sectional dispersion of hedge fund returns. The facts do not support a presumption that  adopt similar investment strategies coordinated with the objective of causing global instability. If their objective was to profit from the current instability, they were remarkably unsuccessful. According to Hedge Fund Research, the average fund this year is down 10.11 percent through September with equity  down 15.45 percent.
The second premise of Dr. Mahathir’s argument is that  are risktakers – gunslingers on a global scale. While it is true that the aggressive incentive fee structures (often 20 percent of any profits on top of a management fee of about 2 percent of assets under management) appear to encourage risk taking, career concerns are an offsetting factor. Given that the typical hedge fund has a half life of five years or less and the fact that it is hard to restart a hedge fund career after a failure, managers can be quite risk averse as we document inCareers and Survival: Competition and Risk in the Hedge Fund and CTA Industry, with William Goetzmann and James Park, Journal of Finance 61 2001 1869-1886. According to a recent Wall Street Journal article (10/14/2008)some of the few remaining successful  such as Steven Cohen of Advisors, Israel Englander of Millenium Partners and John Paulson of Paulson & Co (who is scheduled to appear in the November 13 hearings) have taken their funds out of the market and are in cash investments.
This last result seems at variance with popular wisdom that has arisen around some recent and spectacular hedge fund failures. The failure of Amaranth, a multi-strategy fund with more than $8 Billion assets under management, with more than 80 percent invested in a natural gas trading strategy, is often cited as an example of undiversified financial risk exposure. However, a close reading of the U.S. Senate Permanent Subcommittee on Investigation’s report on the Amaranth blow-up, Excessive Speculation in the Natural Gas Market shows clearly that excessive risk taking took place in a context of poor operational controls, where trading limits were exceeded multiple times and ordinary risk management procedures were dysfunctional. In recent research forthcoming in the Financial Analysts Journal Estimating Operational Risk for Hedge Funds: The ω-Score, with William Goetzmann, Bing Liang and Christopher Schwarz we argue that operational risk is a more significant explanation of fund failure than is financial risk, and that financial risk events typically occur within the context of poor operational controls.
Given that the initial premises are false, it is not surprising to find that the strong conclusions Dr. Mahathir draws from them are also false. In Hedge Funds and the Asian Currency Crisis of 1997, with William Goetzmann and James Park, Journal of Portfolio Management 26 Summer 2000 95-101 we show that while it is possible that  involved in currency trade could have put into effect the destabilizing carry trade Dr. Mahathir describes, there is no evidence that these funds maintained significant positions in the Asia currency basket over the time of the crisis. As to the question of illicit enrichment that Dr. Mahathir charges  with, his funds did not increase in value, but actually lost five to ten percent return per month over the period of the crisis.
From a point of pure logic, there cannot be any factual basis for any of these claims. Malaysia is fortunate in having a very fine and able Securities Commission. If there were any factual evidence at all to support a claim that Soros had intervened in the markets to bring down the Ringgit, it would have been produced by now. I should note that the silence is deafening. I suspect that what is really going on is that Soros was an expedient target of opportunity. The only remaining question is why, given the lack of evidence, Dr. Mahathir felt compelled to bring such serious charges against the hedge fund industry in general, and  in particular. There is an interesting story here which I document in Hedge funds: Omniscient or just plain wrong, Pacific-Basin Finance Journal 9 2001 301-311.
It is interesting to note that Dr. Mahathir’s feelings about currency speculation have changed over the years. In the shark-infested waters of international Finance the name of Malaysia’s central bank, Bank Negara stands out. In late 1989, Bank Negara was using its inside information as a member of the club of central bankers to speculate in currencies, sometimes to an amount in excess of US$1 billion a day. The US Federal Reserve Board had advised Bank Negara to curtail its foreign exchange bets, which were out of proportion to its reserves which at that time were about US$7 billion. At the time, Dr. Mahathir defended this currency speculation, referring to it as active reserve management and was quoted by the official Bernama News Agency in December 1989 as saying “We are a very small player, and for a huge country like the United States, which has a deficit of US$250 million, to comment on a country like Malaysia buying and selling currency is quite difficult to understand”. According to a report in the Times of London (4/3/1994) . Bank Negara came something of a cropper in 1992 when it thought to bet against  on whether Britain would stay in the European Rate Mechanism (ERM), and promptly lost US$3.6 billion in the process and would end up making a US$9 billion loss for 1992. Malaysia’s loss was Soros’ gain.

Sunday 19 October 2008

Asian Financial Crisis 2?

In the Asian Financial Crisis of 1997, the IMF Packages (US$) to bail out:

Korea was US$ 57bn (Dec 3, 1997)
Thailand was US$ 17.2 bn (Aug 20, 1997)
Indonesia was US$ 43.0 bn (Oct 31, 1997)

The present financial crisis that started in 2007 in US is spreading globally. It is so much bigger. It has spread to Europe. Will Asia be affected too? Will we be revisited by another financial crisis?

Could it happen again?

The possibility of having another 1997-type crisis continues to create concern among policy-makers. The reason is no other than the disruptive effects of capital flows, especially in the emerging markets.

Statistics will show why such fear still exists. During the Asian Financial Crisis, a crude estimate of private capital that flowed into the five troubled countries of South Korea, Thailand, Indonesia, Malaysia and the Philippines was almost US$ 100 billion in 1996, which was one third of worldwide flows into the emerging markets (estimated at over US$ 295 billion). That was a five-fold increase over the 1990-1993 average.

When it suddenly reversed to an outflow of US$ 12 billion the following year, it had a devastating effect on these economies. Recent statistics from the Institute of International Finance reveal a staggering fact: net private capital flows was at a high of US$ 502 billion in 2006 after a record US$ 509 billion in 2005. The amount in 2007 might be slightly lower, but still well above the level of the heady days of 1990s.

Net portfolio of equity which recorded an outflow of nearly US$5 billion in 2002 reversed to inflows of US$ 39.1 billion in 2004 and to US$69.7 billion in 2006. Imagine what this amount of flows can do to emerging economies if it were to reverse and flow out.

What was seen in 1996-97 in Asian markets was an extraordinary change in confidence, what John Maynard Keynes termed as the "animal spirit". Such reversals in sentiment are quite common, even in developed economies, but the magnitude of such incidents is greater in emerging economies because foreign investors tend to lump them together without differentiating each country.

Even when investors are able to differentiate between the fundamentals, they do not think it is logical not to follow the herd mentality as they may still incur huge losses if they do not do so.

Because of the volatility of foreign capital flows, manoeuvring macroeconomic policies becomes a difficult task for emerging economies. Excess liquidity created by huge inflows tends to cause an increase in interest rates, which in turn attracts more capital into the country.

Another policy-makers' concern over capital flows is related to the devastating socioeconomic and political effects of the Asian Financial Crisis. Economic malaise then caused a rapid increase in suffering and poverty level as millions of people were thrown on the streets without a job.

The current global economic and financial conditions are similar to the situation in the heyday of the late 1990s. Because of massive liquidity induced by extremely low interest rates in some developed countries like Japan and US, particularly during the 2001 recession, global equity and bond markets boomed.

There are of course other reasons. Some countries which are preventing their currencies from excessive appreciation find themselves saddled with huge foreign reserves following huge surpluses in their current accounts.

While some countries try to avoid a build-up in liquidity, some only exercise partial sterilisation through issuance of bonds. As a result, the massive liquidty makes its way into the stock and property markets, causing an asset bubble. Not surprisingly, stock market indices in the US, China and many countries in Southeast Asia hit new historical highs last year. Valuations were rich and in a country like China, and its price-earnings multiples look horrendous.

At the same time, mounting reserves from China and Japan ended up in the US treasury market, causing yields to drop significantly.


Ref:

Malaysian Business July 16, 2007

http://fusioninvestor.blogspot.com/2008/10/usd-596004000000000.html
US$ 600 trillion

Sunday 12 October 2008

My recollection of the 1997 Asian Financial Crisis

In 1997/98 Asian Financial Crisis, the Malaysian Stock Market dropped from 900 in 1997 to 200 in 1998, and the Ringgit dropped by about 40 percent in a year.

Let me attempt to recall the crisis from memory. There was a period of uncertainty from the start of the Asian Financial Crisis. Thailand was the first country affected. The Baht was shorted heavily. The Thai government supported its currency initially but subsequently was unable. The next country to be affected was Indonesia and its currency, the Rupee. Malaysia was initially not affected but not for long. In fact, Malaysia was able to help Thailand and Indonesia in the onset of the crisis by extending billion ringgit loans to help them support their currencies.

When the crisis affected Malaysia, there was also an initial period of great uncertainty. The Minister of Finance and the central government implemented various policies. Many of these were however unable to stabilise the crisis. The Malaysian Stock Market continued its free fall. When the market fell to 600, many thought the market was trading at a bargain at that level. Many good and fundamentally strong counters were also down with the market.

Subsequent falls in the market proved those who bought to be wrong for the short term. The market was not reacting to fundamentals for that period. Those using "fundamentals" to guide their purchases caught the "falling knife/knieves". The market got pushed down further, 500, 400, 300 and eventually capitulated to a low of 200+. On that faithful day before the implementation of drastic measures by the central government, everyone wanted to get out of the market, at any price! It would seem that there was little or even no value in any Malaysian assets on that memorable day. Panic was obvious.

I recalled the ringgit was MR 2.20 to US 1.00 before the crisis. The ringgit dropped drastically. It was soon MR 3 to US 1.00. Soon, it was MR 3.50, MR4 and even MR 4.50 (?). The falling Ringgit affected those Malaysians who were supporting their children's education overseas. Some had to stop their studies. Others suffered greatly, having lost money in the stock market and now paying almost double for the education fees in ringgit terms. These were sums in the tens or hundreds of thousand ringgits. The hardship was real and painful.

The local banks were deemed not safe to put your money. Soon there were large numbers of withdrawals from the local banks. Depositors withdrew from local banks when rumours were rampant might collapse. These same depositors parked their money into Singapore and other foreign banks. Some opened foreign currencies accounts in Singapore. A lot of money flowed out of the country too. For short and long term deposits, the interest was a high of >10% for that period of uncertainty.

Economy was down. The traders and the businesses were in deep trouble. It was difficult to get new loans or financing. The banks were tight of liquity and was unwilling to extend credit. One would be lucky not to have one's credit facility withdrawn. Those carrying large loans or debts were particularly suffering as interest rate was very high indeed. How to make money? Contracting economy, poor business sentiment and high cost of doing business translated into losses for many businesses.

On hindsight, what would you have done differently during the Asian Financial Crisis?

Are there lessons here to guide the investors on the present Global Financial Crisis?


Visit this post to learn how Malaysia got out of the Asian Financial Crisis.
http://profitmaking188.blogspot.com/ : Malaysia's Self-Prescribed Rescue Debated