A new report shows that hedge funds are borrowing too much to invest in credit derivatives, findings that will surely bolster the arguments of regulators and other hedge fund opponents that hedge funds present a danger to the global economy.
The study, from Fitch Ratings, warns that derivate transactions financed with borrowed money may “result in a number of hedge funds and banks attempting to close out positions with no potential takers of credit risk on the other side” in a market downturn. According to Greenwich Associates, hedge funds are responsible for 60% of credit-default swap trading and a third of trading in collateralized debt obligations.
Fitch noted that the funds’ influence on the credit derivative and debt markets is growing at a “dramatic pace,” as growing problems in the sub-prime mortgage market pushed U.S. corporate bond risk premiums to their highest level in two years. Some $50 trillion worth of credit derivatives were bought and sold last year, more than twice the 2005 level.