The below article discusses a recent report by the Fed which focuses on Counterparty Credit Risk Management (CCRM) as a crucial component to reducing the risk of a system wide implosion
Fed Report: Risk Management Best Defense Against HF-Caused Market Failure
In English, this means that you should be careful who you are dealing with, especially when lending them billions of dollars.
Seeing how difficulties in underwriting the credit risk on something as simple as a home mortgage can have massive impacts when magnified to a large scale (aka the recent implosion in CDO’s and other mortgage back securities) leads me to wonder how inadequate CCRM – or not being careful enough with your hedge fund counterparties – will impact the balance sheets of prime brokers as the credit cycle plays out.
The NY Times today mentioned that woes are even spreading to blue-chip funds: $3 Billion Hedge Fund Is Down 10% for Year.
This further highlights how challenging it is to adequately implement CCRM in a dynamically changing environment while you are at the same time competing for business.
Finally, it looks as though funds may be feeling the back-lash from this reality setting in as Prime Brokers have started implementing stiffer terms for certain hedge funds: Hedge Funds Feeling the Heat
As with the regulation of subprime lending, closing the spigot too fast could cause greater volatility as the system looks to digest an increasing level of distress…Or maybe this is just enough CCRM to keep things from spiraling out of control.