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FEAR AND LOATHING AS THE
HEDGE FUNDS TAKE ON THE EURO
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Gigantic bets against the euro have fuelled rumours of a hedge fund plot to cash in on the Greek crisis, and alarm bells are ringing By Sean O’Grady
Fears of a hedge fund “conspiracy” to destroy the euro gathered pace last week when US authorities ordered some funds not to destroy records of their trading in the single currency. The move comes after the US Federal Reserve promised to probe claims that the use of credit derivatives by Goldman Sachs had, ironically, helped Greece enter the Eurozone a decade ago.
Although the latest Greek austerity plan helped to calm markets and nudged the euro higher against the dollar, traders warned that the euro’s traumas were far from over. Indeed, it seems that the EU and the hedge funds are about to intensify their economic warfare, opening a new front in the US.
The US Department of Justice has asked a number of the hedge funds whose executives attended a dinner hosted by New York-based research and brokerage firm Monness, Crespi, Hardt and Co on Feb 8 to preserve their trading histories. According to an agenda obtained by Bloomberg, those present discussed a number of “themes”, including the chances of the euro falling against the dollar.
Aaron Cowen, an executive at SAC Capital Advisors, David Einhorn, head of Greenlight Capital, and Don Morgan, who runs Brigade Capital Management LLC, went to the dinner, as did a representative from Soros Fund Management.
The presence of a Soros employee has set alarm bells ringing, as George Soros’ formidable reputation as an investor --- as well as a maker and breaker of currencies --- goes before him. So far-reaching is his influence that any hint from him of negative sentiment towards an asset or currency can turn into a self-fulfilling prophecy.
While the meeting may have been no more than an exchange of ideas, with no commitments on any side, the presence of so many powerful US financial interests in one room discussing the euro will no doubt fuel the conspiracy theories now swirling around the foreign exchange markets and in political circles.
The Greek prime minister, George Papandreou, has condemned speculators with “ulterior motives” for making his country’s difficulties worse and destabilizing the euro. If the dinner meeting in New York was part of a concerted effort to move markets it might well break US anti-trust laws. Conversely, other hedge funds have said they have avoided euro denominated sovereign debt for fear of regulatory retaliation.
The forces are massing. The value of the “bets” made by hedge funds and others against the European currency has reached more than $12 billion (392 billion baht) --- almost double the amount of a few weeks ago, suggesting that the pressure will persist. The number of credit default swap (CDS) contracts made to the same effect has also soared.
Many CDSs --- in effect a means of insuring against the risk of default --- have been taken out by those with no ownership of the underlying asset, such as Greek government bonds, in so called “naked” CDS trading. Very low interest rates provided by central banks have also made such bold currency plays more viable, as they reduce the cost of funding or “covering” them.
For the moment though, the euro seems set to survive its Greek calamity. A programme of VAT rises and public sector wage cuts were widely rumoured to be the price Greece will have to pay for the long-mooted EU bailout of about €25 billion (1.11 trillion baht). It should also clear the way for a successful €5 billion bond issue.
As was widely anticipated, Athens has announced a further €4.8 billion in fiscal consolidation, about 2% of GDP, in the third package in three months. There will be a rise in VAT, further tax hikes on fuel, alcohol and tobacco, and more reductions in the public-sector wage bill.
This is in line with the demands European finance ministers have been making on their Greek counterpart. Last week’s plan also had a positive effect on the cost of insuring Greek government debt, which fell back again. How ever, a further €20 billion will need to be raised by Greece over April and May, and more explicit assurances that the other Eurozone states will stand by Greece financially may be needed.
The anticipation of a deal between Athens, Brussels and the two nations liable for much of the bill --- France and Germany --- was also heightened by the announcement that Mr Papandreou was to meet Chancellor Markel on Friday before seeing President Sarkozy today. By the time Mr Papandreou faces all his fellow EU leaders Brussels on March 16 he should be able to demonstrate concrete progress towards his stated ambition of getting Greece’s near 13% of GDP budget deficit down to 9% next year and back below the Lisbon Treaty limit of 3% by 2012.
However, mutual suspicion and name-calling between the hedge funds and regulators on both sides of the Atlantic still threatens to escalate into something more serious.
The EU’s new Internal Market Commissioner, Michel Barnier, said last week that he would investigate short sales of the euro and the abuse of the credit default swaps market. He is now supervising the Commission’s latest directive to regulate the hedge fund industry, the alternative investment fund managers (AIFM) directive. This measure has the potential to kill the EU hedge fund business, which is 80% concentrated in London.
Clauses in the draft AIFM directive that require regulatory equivalence in territories where hedge funds usually domicile their money, such as the Cayman Islands or Jersey, would effectively end many hedge funds’ life in the EU. And it is a substantial business. European hedge funds, predominantly in the UK, grew by 9.1% in the second half of last year to reach $382 billion, according to Hedge Fund Intelligence, part of a global wave of almost $2 trillion, more than enough to move certain assets or currencies, especially if leveraged with cheap central bank money.
Lord Turner, the chairman of the Financial Services Authority said last week he backed an investigation into short speculative positions. He said: “It may be that even if you banned it, it wouldn’t make a big difference contract where you don’t have an insurable interest.”
The French Finance Minister, Christine Lagarde, has said she wants the EU to take a united approach against “speculators” betting on CDSs, and the German Finance Ministry has also called for review of “over-the-counter” products such as CDSs, which are not traded on any central exchange and, arguably, lack transparency.
Such saber rattling is yielding results. Some hedge funds, including Brevan Howard and Moore Capital, have avoided euro-denominated sovereign debt because of the threat of a “regulatory squeeze”, though they may continue to take a position against the euro itself.
Brevan Howard, Eutope’s largest hedge fund, with $27 billion of assets under management, has said the short trade in Eurozone government bonds was “extended, crowded, fully pricing the fundamentals”, and indeed the CDS spreads for Greek paper have been narrowing markedly in recent weeks. The firm added that the hedge funds were facing the same sort of pressure over short-selling activity that they did at the peak of the crisis on 2008, when they were banned temporarily in some places from going short on bank shares, something that had little long-term effect on the fate of the banks.
In the war between the hedgies and the authorities, many observers believe that Spain, rather than Greece, will prove the dicisive battle-ground. As Spain’s economy is so much larger than that of Greece, a bailout would be far more difficult to fund even for the zone’s largest economy Germany, where political resistance to further rescues may be insurmountable.
In the long term, the resolution of this struggle may be political resolution of this struggle may be political rather than economic. Mr Papandreou has suggested speculation against individual nations would be rendered impossible if sovereign debt was issued by a European Treasury on behalf of all states, just as the US Treasury does. President Sarkozy has also spoken enthusiastically and often about the need for “European economic governance”.
But a pooling of budget and Treasury functions across the zone would remove the last defences of German fiscal prudence --- the others have gone. The Maastricht criteria, transferred to the Lisbon Treaty, limited budget deficits, national debt levels and outlawed cross-border bailouts. All have been, or may shortly be, swept away by the financial storm. The hedge funds are, in part, betting that the German government, or its people, will prefer to preserve their treasured economic security rather than the cherished political project of European unity.
As so often during momentous episodes in European history, it all depends on Berlin.
This article first published in the bangkok post
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2010