Yen Carry Trade Disaster
Over the past several years hedge fund managers grew accustomed to making solid returns by engaging in Yen positive carry trade transactions. The “carry trade” became an easy way for hedge fund managers to rake in profits and big fees without doing all that much work.
A brief explanation of how that was an easy way to make money is that fund managers were able to borrow yen at extremely low interest rates as the Japanese economy languished in a deep recession. The cheap money could than be exchanged for, say US Dollars, and used to invest in higher yielding investments.
This trade worked beautifully with a weak Yen, extremely low interest rates in Japan, and a US home mortgage market that was robust. A lot of the funds borrowed in Yen were reinvested in US sub prime home mortgages. It was a wonderful world while it lasted.
Now market conditions have drastically changed. The fund managers are getting hit hard at both ends of the trade. The Yen is strengthening as the Japanese economy improves and the US Dollar tumbles against all major currencies. The strong Yen costs hedge funds money as they have to eventually buy Yen back to settle their loans.
Then the disaster in the sub prime home loan lending market is killing the hedge funds. Many sub prime borrowers are not able to repay their loans, especially ARM’s, as interest rates and payments are reset at much higher levels than set at the loan closings. Thus the hedge funds have invested in assets that have turned very sour.
With foreclosures already at record levels and the vast majority of Adjustable Rate Mortgages (ARMs) due to be reset over the next year it appears that this disaster is just getting started.
A number of hedge fund sponsors have already been forced to liquidate their funds, with huge losses for all that were involved in the funds. This includes some names in the industry like Bear Sterns.
The yen will likely continue to be strong as the carry trade continues to be negative. Funds will be forced to unwind positions and this means they will have to buy back a hell of a lot of Yen at losses that may well turn out to be at the disaster level.
The impact on hedge funds , investment banks, and commercial banks who became heavily involved with the Yen/subprime housing loan market carry trade is going to be substantial. Probably substantial enough to seriously undermine share prices on world stock exchanges as the liquidity challenges spread.
