Swimming with the Razorfishes

Sunday, August 12, 2007

News

I read the Wall Street Journal for work. Certainly not for enjoyment. And I very often complain about the Journal's very poor writing and bonkers editorial page.

The Journal, however, is one of the few papers that covers the news of finance and industry well. When Amaranth imploded, the Journal ran a long, fascinating account of the events leading to the crisis, the attempts to keep the fund alive, and the aftermath, including who picked up the pieces of Amaranth's portfolio. It truly was intriguing, and serves as a good lesson for what is going on now relative to the "subprime crisis" and the resulting tightening of credit.

In this tradition, the Journal ran an article this past Friday about the lead-up to and conditions of the IKB bailout. [Of course, the Journal's website being a walled garden, I can't link to it]. The thing to note from both IKB and Amaranth is that investment losses alone did not bring the funds down; termination of both funds' credit brought the end. Credit ran out partly because of actual risk, but also (largely) because of perceived risk or simple fear. Hedge funds rely on short-term debt to fund operations, so when credit dries up, they run out of money rather quickly.

What frightens me about the current subprime craze is the somewhat irrational reactions in the market. A broad credit crunch is the modern equivalent of a run on the bank. I'm hoping we don't see that happen.

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