Morgan Stanley and Goldman Sachs are linking their lending to hedge funds to the market's assessment of the credit worthiness of the investment banks. Morgan Stanley will reportedly evaluate the amount of leverage it will supply to hedge funds based on the price of its own credit insurance pricing. Goldman is said to be linking its willingness to provide loans to hedge funds based on its bond prices.
The report of both changes ran in the Financial Times. The changes would limit the ability of hedge funds to borrow from either firm if borrowing by Morgan and Goldman became too expensive, indicating a lack of market confidence in the financial health of the firms.
In one sense, this seems a practical response to volatility in the credit markets, reducing exposure to hedge fund leverage as credit markets for financial companies become unsettled. It does, however, create a self-serving dynamic for the investment banks. If hedge funds taking the view that the companies have become unstable push up CDS or bond yields on the firms, they may find themselves unable to borrow from the firms. In other words, it gives the hedge funds an incentive not to bet against Goldman and Morgan.
The FT says the plans to link hedge fund leverage to the broader credit markets has been in the works for sometime. "These arrangements for determining the size of lending commitments to hedge fund clients were being put in place before the collapse of Bear Stearns," Henny Sender writes. "But implementation has gathered pace as investment banks seek ways to guard against the sudden loss of confidence - and resulting withdrawal of market funding - that crippled Bear."
MS and Goldman change approach to lending [Financial Times]
Posted by guest, Aug 18, 2008 3:32PM
Seems pretty smart to me...
Maybe they should have linked lending rates to CDS/bond prices as well?