Gary North

March 1, 2008

Peloton Partners, LLP, a $1.8 billion British hedge fund shut its doors this week. Its managers blamed Wall Street's unwillingness to lend money.

``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.

Right. "It's not our fault. It's those tight-fisted Wall Street lenders who did not recognize what a great company we had here."

Great is as great does. These guys didn't see the credit crunch coming. They were caught flat-footed. They blame Wall Street. They should blame their failure to understand the Austrian School's theory of the business cycle.

Two other firms have also shut down: Thornburg Mortgage Inc. and Sailfish Capital Partners LLC.

Banks demanded additional collateral. Collateral? What's collateral?

``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.'

UBS AG, Goldman Sachs Group Inc., Merrill Lynch & Co. and Deutsche Bank AG were among the firms that lent money to Peloton, said people with knowledge of the matter, who declined to be identified. Officials at the banks declined to comment.

Investors in Peloton's $1.6 billion Multi-strategy Fund cannot get their money out for the time being. This was not one of the strategies they had plannbed on, I guess.

Now, it's not just subprime packages that are falling. The higher-rated Alt-A securities are falling. The decline was 10% to 15% in February.

``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.'

These experts did not see it coming. They thought they could play the carry trade game forever: borrowing short and lending long. This strategy always blows up when money gets tight.

The dominoes will continue to fall.

The stock market has not discounted this, contrary to the economists. Optimism blinds investors at the tail end of a cycle. The best and the brightest have already shown that they did not have a clue about the risks they were taking. Real fear has not gripped stock investors yet.

It will.