Moody's Warns of Potential LTCM-Scale Fund Collapse

Date: Friday, August 17, 2007
Author: John Glover, Bloomberg

Aug. 16 (Bloomberg) -- Moody's Investors Service fueled concern that the global credit crisis is worsening by speculating that a hedge fund collapse on the same scale as Long-Term Capital Management LP in 1998 is possible.

Hedge funds face potential losses on collateralized debt obligations, securities packaging bonds, loans and other assets, Chris Mahoney, vice chairman of Moody's, said on a conference call today. The funds are unable to agree on prices to sell riskier assets, causing the market to seize up, Mahoney said.

``A possible consequence of the repricing of risk assets would be the failure and disorderly liquidation of a hedge fund or other institution of sufficient size as to disrupt markets, as LTCM threatened to do in 1998,'' Mahoney said.

Moody's, criticized by policy makers and investors for failing to cut ratings on bonds backed by subprime mortgages until July when some securities had already lost more than 50 cents on the dollar, is drawing analogies between today's credit crunch and the collapse that triggered the last bailout organized by the Federal Reserve.

Moody's Corp. shares fell 1.7 percent today after French President Nicolas Sarkozy and Europe's financial regulator called for a probe into ratings firms. The stock has dropped 34 percent this year as the credit rout threatened the most lucrative part of its business.

`Height of Chutzpah'

``I'm certain there is at least one major hedge fund out there at least as rightly concerned about a collapse in Moody's as the other way around,'' said Colin Negrych, a principal at Barclay Investments Inc., a broker-dealer in New York. ``To see Moody's make forward-looking negative statements about hedge funds, who may well be suffering in large part as a result of their reliance on Moody's now evidently worthless ratings, is to witness the height of chutzpah.''

Credit markets started falling in June as two Bear Stearns Cos. hedge funds collapsed because of bad subprime mortgage bets. Goldman Sachs Group Inc., the world's most profitable securities firm and second-largest hedge fund manager, was forced to put $2 billion of its own money into one of its funds and waive some fees after it lost 28 percent this month.

Basis Capital Fund Management Ltd. yesterday told investors losses at one of its hedge funds may exceed 80 percent as the market slump prompted creditors to force the Sydney-based company to sell assets.

Forced Sales

Investors are unwilling to accept the prices offered for high-risk debt securities until they are forced to by their own lenders, a process that is likely to play out over the next three-to-six months, Mahoney said.

While the failure of a large hedge fund is a possibility, the risks are greater for smaller institutions, he said.

``There is always a risk in such a process that there could be one or more smaller institutions that could be hurt badly enough to require intervention,'' Mahoney said.

Financial markets will recover from the credit crunch and resume growth after a pause, he said.

``What we are seeing now appears to be largely a cyclical, not a secular, event,'' Mahoney said.

The demise of LTCM, the Greenwich, Connecticut-based hedge fund run by John Meriwether, coincided with Russia's default on part of its $135 billion of external debt. LTCM was betting on convergence between various types of assets, taking on as much as $125 billion of borrowings to make the trades worthwhile, according to accounts of the debacle including ``When Genius Failed: The Rise and Fall of Long-Term Capital Management,'' by Roger Lowenstein.

Sarkozy of France told German Chancellor Angela Merkel the role of rating firms in both helping to create debt securities and assess their risk needs to be examined, in a letter released today. EU Financial Services Commissioner Charlie McCreevy plans to review the management, conflicts of interest and resources of the companies, spokeswoman Antonia Mochan said at a press conference in Brussels.

To contact the reporters on this story: John Glover in London at johnglover@bloomberg.net