Why mortgage and hedge funds have put us in the gun: Gottliebsen

The mortgage fund freeze has escalated the number of superannuation investors who are demanding to exit the managed fund equity system. At the moment it is containable, but if the move to quit shares balloons we will see big forced selling of Australian s

The mortgage fund freeze has escalated the number of superannuation investors who are demanding to exit the managed fund equity system. At the moment it is containable, but if the move to quit shares balloons we will see big forced selling of Australian stocks.

Government bungling over bank guarantees helped create the problem, and they will have to act quickly this week to restore confidence on mortgage funds. The problem would not be as severe if it did not coincide with the dramatic demise of American hedge funds. At one point at the weekend, the New York futures market had to be suspended because the panic selling from hedge funds was so great.

The desperate selling on Wall Street, minerals markets and of the Australian dollar last night shows that we are witnessing the destruction of vast numbers of hedge funds – a truly basic change in the global market structure.

Just how much is invested in hedge funds is hard to determine but, including their borrowings, it is well over $US1000 billion. So we are looking at a crash that ranks with the big historic collapses going all the way back to the tulip disaster centuries ago, when the bubble burst over astonishingly high prices for tulip bulbs in Holland.

It is these hedge funds that drove prices upward in a vast number of market areas, but in the last year or so a great many funds focused on commodities, miners and Australian dollar-denominated securities. They were among the best global performers. Accordingly, just as the Australian market was one of the main beneficiaries of the hedge fund boom it has been one of the main sufferers, as the hedge funds scramble out of our dollar and related securities. Their selling is multiplied by other groups.

The basic structure of many hedge funds was flawed because their equity was redeemable and they then leveraged that equity four and five fold. Once markets turned against them they were doomed.

Of course, not all hedge funds have been destroyed and there will be a small number of funds that survive. Those that get through will prosper. My guess is that the destruction of large numbers of hedge funds and the massive losses they have incurred will be the next problem area for banks. According to official US figures about $US31 billion of global hedge fund assets were redeemed in the September quarter and the value of hedge fund holdings fell by $US179 billion. The asset falls and redemptions in the current quarter will be much greater.

The big falls in metal prices will hit our mining stocks again next week, but the fall in our dollar lessens the impact on the bottom line, when converted to Australian dollars. Once the hedge funds have been finally driven out of the commodity, mining equity and Australian dollar markets they should stabilise. Australia must then hope that the efforts of the Chinese to restore their growth rates will be successful. There is a very good chance they will be, but it will take until at least 2010.

And of course these problems escalate the jitters among superannuation holders who are starting to say “enough is enough”.