As strange as it may sound, Hedge Funds Blame Wall Street For Lending Crackdown.

Peloton Partners LLP, the London- based hedge-fund manager being forced to liquidate a $1.8 billion asset-backed fund, said it’s a victim of the lending drought on Wall Street.

“Credit providers have been severely tightening terms without regard to the creditworthiness or track record of individual firms, which has compounded our difficulties and made it impossible to meet margin calls,” Peloton co-founders Ron Beller and Geoff Grant said in a letter yesterday to clients.

My Comment: That is the spin. The truth is hedge funds over leveraged into debt instruments they did not understand, pushing risk premiums to all time lows. The herding behavior of hundreds of hedge funds all paying the same game had to end, yet every one of them thought they would be the ones to be able to get out. This is what happens when liquidity dries up. Every one of them is stuck. Those with the most leverage will go bankrupt.

Peloton joins Thornburg Mortgage Inc. and Sailfish Capital Partners LLC on the growing list of funds and companies that have had to sell securities or shut down after banks restricted how much they could borrow, or demanded more collateral as values of securities backed by mortgages slumped. The world’s biggest financial institutions are cutting off lines of credit to hedge funds after at least $163 billion of asset writedowns and market losses.

“More hedge funds will blow up this year than ever before,” said Michael Hennessy, who helps oversee $10 billion of hedge fund investments at Morgan Creek Capital Management in Chapel Hill, North Carolina. “Financing is much harder to get. The bubble has burst.”

My Comment: I expect 30-50% of all hedge funds in existence today will not be in business a few years down the road. Increasing risk aversion of investors over time, 20% fees, and illiquidity will all play a major role.

The price of top-rated Alt-A securities, which rank above subprime, dropped 10 percent to 15 percent this month, according to Thornburg Mortgage, the Santa Fe, New Mexico-based finance company which yesterday said it may sell securities to meet further margin calls, after burning through cash.

My Comment: I reported on “Top Rated” Alt-A securities in Evidence of “Walking Away” In WaMu Mortgage Pool. If you have not seen the chart, take a look. It’s pretty stunning. 92.6% of a Washington Mutual Alt-A pool of recent vintage was rated AAA. Yet 15% of the whole pool is in foreclosure or REO after a mere 8 months!

“Risk managers everywhere are revisiting how collateral is being priced so you’re seeing margin calls,” said Kenneth Hackel, managing director of fixed-income strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut. “As risk appetites decline, the price of assets that are used as collateral decline.”

My Comment: For many hedge funds and companies, this re-evaluation is too late. There is simply no bid now for many credit derivatives people are stuck in.

UBS needs to reduce its balance sheet from 2.3 trillion francs ($2.2 trillion) to less than 1.7 trillion francs, and reducing ties to hedge funds is a likely lever, Van Steenis wrote in an e-mail today.

An increase in margin calls may drive prices even lower, RBS’s Hackel said.

“I feel like so many shoes have already dropped, the shoe store should be empty by now,” he said. “I’d like to think we’re pretty close to the end of the game, but I can’t say that with any degree of confidence.”

My Comment: Most shoes are in mid-air, not even close to the ground. Commercial real estate is just starting to implode, unemployment is just starting to rise, people are just starting to walk away, and the equity markets have just started to fall.

Furthermore, China is overheating, commodity herding is rampant, and a blowup of the Yen carry trade has not yet gained traction. Those are shoes still waiting to drop, as is an unwinding of $50 trillion in credit default swaps, Lord only knows how many of which are marked to market.

It’s not realistic to think that the biggest credit boom in history, a boom that took over 20 years to build, a boom that went exponential over the last seven years, can be corrected in a 10% pullback in the S&P; from all time highs. Time and price are the key. We are a long, long way away on both fronts. The shoes that people think have already hit ground are still in mid-air and falling, with still more shoes still in the store to be dropped.

Mike “Mish” Shedlock
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