Monday, June 25, 2007

Haircuts and leverage

I worked in the hedge fund industry when it imploded in 1998 -- Russia defaulted on the rouble, which most hedge funds had bet against. Some hedge funds were more levered than others, and they had to reduce their positions (sell into a falling market) to make their margin calls. Selling into a falling market drives prices down further, which can then, in a chain reaction, force less levered funds to unwind their positions, and so on and so forth.

Bear Stearns' hedge fund was bailed out in an effort to avoid just this sort of forced unwinding. We'll see if it's enough to dry up the liquidity that's been flooding the market.


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