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Minyan Mailbag: Hedging Bets After AIG

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Will hedge funds short companies with CDS exposure?

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Editor's Note: The following is a discussion of AIG by two Minyanville contributors, Minyan Peter and Prof. Reamer, which originally appeared on the Buzz & Banter and is reprinted here for the benefit of the Minyanville community.


Minyan Peter,

Does the AIG (AIG) deal make it more likely that hedge funds will find companies that have CDS exposure and short them toward zero, while expecting the Federal Reserve to come in and wipe out equity holders? And if so, what can be done to avoid this?

Minyan P

MP,

For what it's worth, this was raised on Larry Kudlow last night by one of his guests.

I would caution Minyans that in times like this both positive and negative views tend to move to extreme as people talk their books.

On this specific comment, I would highlight that AIG stock fell more than 90% from its high before there was any mention of the Fed stepping in.

I think it's very telling that we have moved to a point where there is both love and hatred of the Federal Reserve - which goes back to my other point - where you stand depends on where you sit.

-Minyan Peter

From Prof. Reamer:

Regarding Minyan Peter's mailbag, it is an urban myth that hedge funds can ''make'' companies' equity go to zero. You need the marketplace to sell en masse for that to happen – we're not talking about companies with limited floats, etc.

So to answer the new question – will the AIG (AIG) deal make the marketplace re-assess the true equity value of companies with extreme leverage? Yes, I believe it will, which brings into full relief yet another unintended consequence of the Fed's commitment to what I would call economic violence.

Like the Fannie Mae (FNM)/Freddie Mac (FRE) bailout destroying the secondary market for preferreds, the AIG bailout distorts the financing market just the same.

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