How Wall Street makes money

Hey everyone,


So yes, earnings season is now over, and out with a bang for sure. A few multi-billion dollar hedge funds just went under.

Why?

They bought about 400 million oil futures contracts at a basis of above 135. Most of this money was borrowed at a high leverage ratio. In normal human words - they borrowed A LOT of money, used ALL OF IT to buy oil contracts (which you only need 10% of the money up front). Then the price of oil dropped to 115.

I don't know exactly what's about to transpire to those funds...but the drop this week in oil prices has been in part a result of the assets being seized and liquidated. You can thank them for your previously high gas prices.

Anyway, the title of this article is "How Wall Street Makes Money" - and I fully realized I didn't tell you how wall street makes money but rather, how wall street loses money. So, what I have been desperately trying to figure out is how quickly those assets were liquidated and at what cost basis were they liquidated at.

Why?

Because the loss on those futures contracts was on borrowed money, if those loses are greater than what those hedge funds were worth (and I'm willing to bet they are), some bank out there just lost a few billion dollars. If that bank was a Washington Mutual or someone that wasn't very stable to begin with, there could be another bank collapse on our hands. Obviously, for the amount of money these funds had to borrow to execute trades of this size - it had to be one of the big ones. There are only a few banks that could give out loans this size - probably either a Bank of America, Washington Mutual, Wells Fargo, and Wachovia. Wachovia and Washington Mutual are on thin ice. Wells Fargo and Bank of America are stable, which is why I am most inclined to believe its them....but it seems so unlike the businesses themselves. Bank of America and Wells Fargo don't seem the type to allow a major line of credit this large to go unmonitored in this kind of lending evironment. I don't think it would be one of the investment banks (Lehman, Goldman Sachs, etc. ) because they really don't do this kind of thing.

The whole thing is very odd.

Anyway, the way Wall Street makes money is by shorting the bank whoever loaned these hedge funds enough money to make stupid bets like these. Every time someone goes under, knowing who they bought or borrowed from, sold or lent money to, and competed with is critical to exploiting short term and long term movements in the stock price.

That's how Wall Street makes money. Its not easy...but it is simple.

-Mansij Hans, E.I.T.
Member, Intigril Capital Management