Keith Fitz-Gerald

Four Ways to Sidestep the Street's Big Money Bulldozer

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As scores of highly leveraged hedge funds dump billions of dollars worth of holdings at once, they effectively "flood" the markets with whatever the asset is that they are trying to sell. In doing so, they push the values down for the rest of us.

For example, imagine a house in your neighborhood selling for 50% of its appraised value. Upon completion of the sale, all "comparables" in the area, including your own home, will likely take a hit as a result. So it's in everybody's interest to keep prices as high as possible.

But nobody can do that when there are more homes than buyers -- even in the best neighborhoods.

So when is it going to stop?

We don't know. No one does. Hedge funds are notoriously secretive in their reporting, so even though there are estimates as to how much they own and (by implication) how much they owe, it's hard to gain perspective on how much leverage is actually being used. Nor do we really know who holds what asset -- especially as it relates to potential liquidations.

Where There's Smoke …

During the weekend, rumors were flying that U.S. Federal Reserve examiners are hounding Citadel Investment Group LLC regarding "counterparty risk" and its exposure to debt. Citadel, naturally, vehemently denies this, but lately where there's smoke, there's certainly been the potential for fire.

Then there's Europe. Despite the fact that many Europeans find it fashionable to blame the whole financial-system meltdown on the United States, mounting evidence suggests they may be the biggest hypocrites of all.

Data from the Bank of International Settlements shows that Western European banks may hold as much as $4.7 trillion in cross-border bank loans to Eastern Europe, Latin America and emerging Asian markets, which means, as London-based financial expert and Chartered Financial Analyst Nicholas Vardy described it as "the exposure of continental European banks to a whole set of 'subprime' nations in the form the former Communist bloc may be the Achilles' heel of the European banking system."

That means that "the elephant in the room is that while public sector debt was held in check by policymakers, private debt as a percentage of GDP exploded, as that was not part of convergence criteria to join the Eurozone."

The fear shared by my professional trading colleagues is that this exposure may trigger a second credit crisis, and more market mayhem similar to that of 1931, when Credit-Anstalt failed and set off a global banking crisis.

If true, that suggests the market drops we've seen so far may be only the tip of the iceberg when it comes to a whole set of "subprime" nations in the former Communist bloc, which has been the stomping grounds for Austrian and German banks in recent years. And it's very personal as millions of adventurous capitalists there took out loans in Swiss francs, U.S. dollars and even Japanese yen -- only to find that their repayment terms in local currencies are soaring as each of these currencies has.

Evidently, nobody told them the "carry trade" works in reverse.