Help-wanted advertising in American newspapers fell in July to the lowest level since 1958, and online job postings also declined. The Conference Board’s index dropped to 25 last month, matching analysts’ forecasts, from 26 in June. The trend in the help-wanted measure has fallen since 2000 as print media have been losing advertising to the Internet.

U.S. Economy: Expansion Was Faster Than Estimated (Update3)
By Courtney Schlisserman

Aug. 30 (Bloomberg) — Surging exports and business spending propelled U.S. growth to the fastest pace in more than a year before turmoil in the credit markets forced the Federal Reserve to warn of a bleaker outlook.

Gross domestic product rose at a 4 percent annual rate in the second quarter, the Commerce Department said in Washington, up from an initial estimate of 3.4 percent. The median forecast of economists polled by Bloomberg News was 4.1 percent.

The figures may be the peak of the expansion for this year as the cost of borrowing increased in August and the Fed said that risks to growth “increased appreciably.” In a sign the job market is weakening, the Labor Department said today claims for unemployment benefits climbed to the highest level since April. A further report showed house prices in the second quarter rose at the slowest pace in a decade.

“The underlying economy was growing in the first half,” said Peter Kretzmer, a senior economist at Banc of America Securities LLC in New York. “We expect it to slow modestly, but not in such a pronounced way. It will slow enough, though, that the Fed will find an excuse” to reduce interest rates, he said.

Kretzmer accurately predicted the pace of expansion.

The Fed’s preferred inflation measure, which is tied to consumer spending and strips out food and energy costs, rose at a 1.3 percent annual rate. The pace of increase was the slowest in four years.

Treasury notes remained higher after the reports. The yield on the benchmark 10-year note declined 5 basis points to 4.51 percent at 5:07 p.m. in New York. A basis point is 0.01 percentage point. The Dow Jones Industrial Average fell.

Trade Deficit

A bigger jump in exports and smaller gain in imports contributed to a reduction in the trade deficit, the report on gross domestic product showed. Trade contributed 1.4 percentage points to growth, the most since 1996.

Spending on corporate construction projects and new equipment also boosted growth. Commercial construction jumped 28 percent, the most since 1981. Investment in equipment increased at a 4.3 percent pace, almost double the previous estimate.

Inventories, which were forecast to play a role in the projected increase in growth, were little changed from the initial GDP estimate published in July.

Jobless Claims

Initial unemployment claims climbed by 9,000 to 334,000 in the week that ended Aug. 25, the Labor Department said today in Washington. The four-week moving average, a less volatile measure, increased to 324,500 from 318,250.

Help-wanted advertising in American newspapers fell in July to the lowest level since 1958, and online job postings also declined. The Conference Board’s index dropped to 25 last month, matching analysts’ forecasts, from 26 in June. The trend in the help-wanted measure has fallen since 2000 as print media have been losing advertising to the Internet.

The deepest housing slump in 16 years is prompting builders and mortgage-lending companies such as American Home Mortgage Investment Corp. to fire workers. That may weigh on consumer spending, which accounts for more than two-thirds of the economy.

“Business psyche is being more and more affected by what’s been going on in the credit markets,” said Zoltan Pozsar, a senior economist at Moody’s Economy.com in West Chester, Pennsylvania. “If this continues for the next few weeks, it’ll definitely be a sign that hiring is being affected by the credit- market problems.”

Home Prices

Prices for previously owned single-family homes rose an average of 3.2 percent from a year earlier, the smallest gain since 1997, the Office of Federal Housing Enterprise, said today in Washington. Prices gained 0.08 percent from the first quarter, the slowest since a decline in the final three months of 1994.

About 14 percent of banks raised standards for mortgages to their most creditworthy borrowers and 56 percent made it more difficult for people with limited or tainted records to get loans, according to a Fed survey of senior loan officers in mid- July.

In highlighting risks to growth, policy makers reversed their stance from their last meeting on Aug. 7 that inflation was the biggest risk to the economic expansion.

Traders and economists expect the Fed to lower its benchmark overnight lending rate between banks at or before policy makers next meet on Sept. 18. Chairman Ben S. Bernanke will discuss housing and monetary policy tomorrow, when he addresses the Kansas City Fed’s annual symposium in Jackson Hole, Wyoming.

Residential Construction

Declines in residential construction subtracted 0.6 percentage point from growth in the second quarter, more than previously estimated.

Housing will probably deduct about a percentage point from GDP at least through early 2008, according to economists at JPMorgan Chase & Co.

As a result, growth will average 2.25 percent in the six months starting in October, a percentage point less than previously projected, Bruce Kasman, JPMorgan’s chief economist, said in a note to clients last week.

Lehman Lowers Forecast

Lehman Brothers Holdings Inc. lowered its forecast last week for the period covering October through June 2008 to 1.8 percent, almost a half percentage point less than previously thought.

In one of the earliest economic readings to cover August, consumer confidence dropped by the most in two years, the Conference Board said this week. The measure retreated to 105 this month and the share of people who said jobs are plentiful declined.

In today’s report, consumer spending was revised up to an annual rate of 1.4 percent from an initial estimate of 1.3 percent. The gain was still the smallest in a year.

“Our consumer is impacted obviously because they see the value of their homes go down, there’s a sort of wealth effect,” Farooq Kathwari, chief executive officer of Ethan Allen Interiors Inc., said in an interview on Aug. 28. “Yet they’re still interested in furnishing their homes, they’re still buying.”

Today’s GDP report included a first look at corporate profits for the quarter. Earnings adjusted for the value of inventories and depreciation of capital expenditures, known as profits from current production, rose 6.4 percent, the most in more than a year, to an annual rate of $1.65 trillion. Compared with a year earlier, profits were up 4.5 percent.

[TAGINFO]

To contact the report on this story: Courtney Schlisserman in Washington cschlisserma@bloomberg.net

Last Updated: August 30, 2007 17:09 EDT

Commercial Paper Extends Slump on Asset-Backed Woes (Update5)
By Darrell Hassler

Aug. 30 (Bloomberg) — The U.S. commercial paper market shrank for a third week, extending the biggest slump in at least seven years and signaling that the Federal Reserve’s attempts to lower borrowing costs have had a limited impact so far.

Asset-backed commercial paper, which accounted for half the market, tumbled $59.4 billion to $998 billion in the week ended yesterday, the lowest since December, according to the Federal Reserve. Total short-term debt maturing in 270 days or less fell $62.8 billion to a seasonally adjusted $1.98 trillion. The yield on the highest rated asset-backed paper due tomorrow rose today 0.11 percentage point to a six-year high of 6.15 percent.

Commercial paper outstanding has fallen $244.1 billion, or 11 percent, in the past three weeks, as the Fed’s Aug. 17 reduction in the discount rate has yet to entice buyers back into the market. Yields of asset-backed commercial paper due tomorrow rose to the highest in six years as investors fled to the safety of Treasury bills.

“I don’t think the Fed understands how critical the situation is,” said Neal Neilinger, co-founder of NSM Capital Management in Greenwich, Connecticut, in an interview today. “The market is going to overshoot itself and not lend money to people who deserve it.”

NSM helps manage Abacas Investments Ltd., a $1 billion structured investment vehicle funded by commercial paper. Neilinger wouldn’t discuss Abacas’s ability to fund itself.

Three-Week Decline

The 11 percent decline over three weeks is the biggest since 2000, according to data compiled by Bloomberg. Commercial paper hasn’t fallen for three straight weeks since February. More than 20 companies and funds including Cheyne Finance and Thornburg Mortgage Co. failed to sell new paper as investors balked at buying short-term debt backed by mortgage assets.

The total fall in the commercial paper may end up at $300 billion, the amount of mortgages funded by asset-backed commercial paper, wrote Tony Crescenzi, chief bond market strategist for New York-based Miller Tabak & Co. LLC, in a note today.

Commercial paper is bought by money market funds and mutual funds that invest in short-term debt securities. In asset-backed commercial paper, the cash is used to buy mortgages, bonds, credit card and trade receivables, as well as car loans. Some of the programs are backed by subprime loans. Subprime loans are issued to borrowers with poor credit or high debt.

The fall was the slowest of the past three weeks, following the two previous declines of about $90 billion each. Outstanding paper for financial companies, not asset-backed, rose for the first time in five weeks by $3 billion to $781.5 billion.

“There’s a little better functionality and if there is any glimmer of hope, that’s where we’re finding some,” said Kevin Flanagan, fixed income strategist at Morgan Stanley in Purchase, New York, in an interview today.

Rate Cut Needed?

The Fed lowered the interest rate it charges to lend to banks to encourage buyers of commercial paper after the market seized up for Thornburg, Countrywide Financial Corp. and other mortgage lenders.

The Fed “failed to bring money markets back to normal,” John Lonski, chief economist at Moody’s Investors Service in New York, said in an interview. “Credit markets are obviously in need of a rate cut.”

In a sign that buyers are still favoring safer assets, an $18 billion auction yesterday for two-year U.S. government debt drew the most demand since 1992.

The sale drew $3.97 for every $1 sold, the most since at least 1992, according to Bloomberg data. For the past 12 sales, the bid-to-cover ratio has averaged $2.77.

Cheyne, Grampian

London-based Cheyne Capital Management Ltd., the hedge fund manager set up by former Morgan Stanley bankers Stuart Fiertz and Jonathan Lourie, said yesterday that a fund it manages has been selling investments to help repay commercial paper due through November. Cheyne Finance, a so-called structured investment vehicle, holds about $6 billion in commercial paper that is mainly tied to real estate.

Funds such as Cheyne Finance typically sell commercial paper maturing in less than 270 days and use the proceeds to purchase bonds with longer maturities. The profit typically delivered from this strategy is being cut by rising yields.

HBOS Plc, the U.K.’s largest mortgage lender, said last week that it would repay about $35 billion of commercial paper owed by its Grampian Funding LLC unit as contagion from the subprime mortgage slump drove up the cost of borrowing.

To contact the reporter on this story: Darrell Hassler in Chicago at dhassler@bloomberg.net .

Last Updated: August 30, 2007 14:48 EDT

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By Sinead Cruise

LONDON, Aug 30 (Reuters) - Morgan Stanley (MS.N: Quote, Profile, Research) has completed the UK’s first residential property derivative trade with an embedded exotic option, the company told Reuters on Thursday.

Morgan Stanley and an undisclosed counterparty have agreed an exotic swap based on the Halifax House Price Index, the UK’s definitive index for trading movements in UK house prices, Morgan Stanley told Reuters.

Under terms of the groundbreaking deal, the counterparty gains if the Index rises, subject to a maximum payout but his capital is protected unless the Index falls beyond an initially specified point.

This type of exotic contract includes a “knock-in put” option and Morgan Stanley said this is the first property derivative trade to include the component.

The pricing of the deal and length of contract remains confidential but Guy Ratcliffe, who joined Morgan Stanley to spearhead its growing real estate derivatives operations in July, told Reuters the deal was worth more than 1 million pounds ($2.01 million).

“We have always enjoyed a leading presence in the direct property market but this deal illustrates our ambition to expand into the exotic derivatives market,” said Ratcliffe.

“It shows we are willing to do more than just the typical vanilla contract”, he said.

Morgan Stanley hopes the deal, which comes amid turmoil in global debt markets and a weakening in the fundamentals supporting direct investment in the physical asset class, will breathe life into the nascent derivatives market.

“Demand for these products is growing. This deal is tailored to cater for customers with a specific risk profile and these trades could become a larger feature of the retail investment market in the future,” Ratcliffe said.  Continued…

http://www.reuters.com/article/fundsFundsNews/idUSL3092685020070830

Bankers try to piece together subprime puzzle
Financial Times - 2 hours ago
By Eoin Callan and Krishna Guha Ben Bernanke, Jean Claude Trichet and other leading central bankers gather on Thursday in a lodge in the heart of Wyoming’s Grand Teton national park for the Federal Reserve’s annual Jackson Hole symposium.
Bernanke May Hear Call for Fed Activism on Regulation (Update1) Bloomberg
Wall Street All Ears for Fed Chief’s Big Speech Washington Post
Reuters.uk - Canada.com - Reuters - Forbes
all 186 news articles »

China’s savers are poised to go global

By Andrew Wood in Hong Kong

Published: August 28 2007 03:00 | Last updated: August 28 2007 03:00

A wave of private savings of up to $1,300bn could flow out of China into global bond and equity markets once individual Chinese investors gain more freedom to invest offshore, according to Capital Economics, a consultancy in London.

Last week, Beijing relaxed rules to allow mainland investors to buy shares directly on the Hong Kong stock market. Since then, the city’s benchmark Hang Seng index has powered ahead to erase all of last month’s losses from the global credit turmoil. Yesterday, it rose 2.9 per cent while a number of stocks trading at wide discounts to their mainland counterparts reached record highs on expectations of heavy buying by mainland investors.

Many analysts expect full liberalisation of rules on mainland investment.

Capital Economics said most of the $2,300bn of estimated savings in China was held in low-yielding bank accounts.

Demand for equities was strong, but the supply was limited to two mainland markets that looked increasingly overheated - Shenzhen has risen 160 per cent since the start of the year and Shanghai is up 92 per cent.

“The authorities are struggling to prevent hot capital from entering the country,” said Mark Williams, Capital Economics’ China analyst in the consultancy’s weekly newsletter.

“By encouraging outflows, they hope to ease some of the pressure on the central bank and domestic asset markets.”

Some western governments are believed to be uneasy about China’s state investment company’s recent high-profile purchases of big stakes in foreign companies such as Blackstone and Barclays. “A sustained outflow of funds from private investors would allow the Chinese state to take a step out of the limelight,” said Mr Williams.

Chinese investors, excluding the central bank, hold foreign securities worth5 per cent of annual economic output.

Mr Williams said China would generate $1,300bn of additional overseas investment if the country raised its level of foreign portfolio investment to the average for member countries of the Organisation for Economic Co-operation and Development.

“Of course, this will not happen immediately,” Mr Williams said.

“It took Japan 20 years from the opening of its capital account in the 1980s for its foreign portfolio holdings to rise from 5 per cent to 40 per cent of gross domestic product.”

Copyright The Financial Times Limited 2007

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New Bank Capital Requirements
Helped to Spread Credit Woes
August 30, 2007; Page A2

Even before the current financial firestorm passes, the search for people and institutions to blame has begun: Greed and hubris overtook common sense and propriety. Excessively easy credit overwhelmed good judgment and fueled a housing bubble. Profit-grubbing crooks took advantage of unsophisticated home buyers. Rating services blew it. Government overseers couldn’t keep up with financial innovation. U.S. regulators let shady subprime lenders slip through cracks in archaic rules. European bank regulators were blind.

The right answer will prove to be some combination of the above. One culprit, however, has gone unnoticed: A sweeping change in international rules governing the capital banks must hold. By requiring banks to boost the capital held in reserve against the loans carried on their books, the rules encouraged banks to get rid of those loans by turning them into securities to be sold to investors. Banks took the hint.

That’s complicating the Federal Reserve’s efforts to put out the current fire.

For more than 20 years, a club of central bankers has been tinkering with rules — known as Basel, for the Swiss city in which officials meet — to get banks to hold more capital so they can absorb major losses without threatening the financial system. Details are so technical that only insiders pay attention. Most of the time that’s just fine. The battles over the rules typically have had more to do with banks and countries jockeying for advantage than anything that mattered to borrowers in Boise or Bremen.

The rules are rooted in the worries of wise men like Paul Volcker, the former Fed chairman, that banks didn’t have enough capital, an especially acute concern after Germany’s Herstatt Bank defaulted on obligations to foreign banks in 1974 and the U.S. government rescue of big Continental Illinois National Bank & Trust in 1984.

The solution: A 1988 international accord required banks (in countries where national authorities adopted the rules) to hold more capital if they make riskier loans and investments. A bank that loans $100 million to other solid banks needs only $1.6 million in capital; a bank that loans $100 million to ordinary companies needs $8 million capital.

Banks are a special case. They’re traditionally at the center of the financial system; bank panics led Congress to create the Fed in 1913. And government insurance of bank deposits means most depositors needn’t worry if their banks make foolish loans. That can give bankers a heads-we-win/tails-you-lose incentive to gamble that regulators must monitor.

MORE

• Discuss: Is regulation partly responsible for the market mess?

The original Basel rules were crude, overwhelmed when banks figured out how to game them and were recently revised. The rules did succeed in getting banks to strengthen their financial footing. They did reduce the risks most banks take. Was that the intention? Yes. Is that always a good outcome? Well, maybe not.

Among other things, the rules required banks to hold more capital against an ordinary mortgage than against pools of mortgages turned into securities. So banks sold off individual mortgages and many replaced them with securities comprising pools of mortgages. Between 1988 and 1993, these mortgage-backed securities rose to more than 9% of bank assets from 2.9%.

This huge change in finance has advantages. Banks still make loans and hold them, but are more likely to originate and distribute loans. As a result, much of the risk of delinquencies on mortgages in inner-city Detroit isn’t shouldered by local banks but has been shifted to investors all over the world. (How many of these hot potatoes may actually return to bank balance sheets is a question for another column. Short answer: More than some bankers would like.)

It turns out, the folks who hold mortgage-backed securities are forced to be much quicker than banks are to acknowledge reality when the value of the collateral for loans drops. And banks now behave more like securities firms, more likely to mark down the value of assets when market prices fall — even to distressed levels — rather than sitting on bad loans for a decade and pretending they’ll be paid back.

It’s a huge contrast to the bad old days of the early 1980s when big New York banks found themselves holding lots of bad loans to Latin American governments and took years to write them down — or when Japanese banks’ reluctance to admit the size of their bad-loans problem paralyzed Japan’s economy.

But it may have some unwelcome effects: Banks aren’t the shock absorbers they once were at a moment of market panic. Because they hold fewer loans on their books, banks don’t have the ability to say, “These mortgages are more likely to be paid off than the market thinks today, and we’ll just hold on until the market comes to its senses.” Instead, the holders of mortgage-backed securities are dumping them, pushing down the price. This forces other leveraged players — those backed by borrowed money — to sell their holdings and, if not interrupted, an economically devastating downward spiral can take hold.

The Fed is now laboring to prevent such an outcome. But its tools are designed with banks in mind, not for a world in which banks have shifted risks to all sorts of other leveraged investors who are now forced to be obsessed with the value of their collateral.

The Fed, which was an enthusiastic proponent of these risk-based capital standards and securitization, is trying to prime the banking pump to put out the fire. Ironically, it’s discovering that’s harder because of unappreciated consequences of the Basel rules that were intended to make the banking system more fire-resistant.

Write to David Wessel at capital@wsj.com

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Bank Demand Hits Record for ECB Loans

Market expectations continued to fall for an interest-rate increase by the ECB at its Sept. 6 meeting, as cash-starved euro-zone banks demanded a record amount of three-month funds.

Bank Demand Hits Record
For ECB’s 3-Month Loans

By JOELLEN PERRY and MONICA HOUSTON-WAESCH
August 30, 2007; Page A6

FRANKFURT — Cash-starved euro-zone banks demanded a record amount of regular three-month funds from the European Central Bank yesterday, as market expectations for an interest-rate increase at the Sept. 6 bank’s meeting continued to fall.

In its regular three-month financing operation, the ECB pledged €50 billion, or about $68 billion, as expected. But bids for the funds totaled nearly €120 billion, and the cutoff lending rate beat expectations to hit 4.56%. The cutoff rate for last week’s extra, one-time offer of €40 billion was 4.49%, and at the ECB’s last regular three-month operation, on July 25, the cutoff rate was 4.2%.

“Some banks were bidding quite high, because they were concerned they weren’t getting enough liquidity,” said Marco Kramer, an economist with UniCredit Global Research in Munich. Mr. Kramer noted that the rise in longer-term borrowing costs “is basically the same thing as if the ECB had [already] hiked rates.” Banks are likely to pass higher borrowing costs on to businesses and consumers seeking loans.

Rates on the funds that banks lend to each other overnight have fallen to around the ECB’s 4% target since the bank injected massive amounts of short-term cash into the banking system earlier this month in response to a sharp tightening in credit markets. But three-month rates remain high, suggesting banks remain reluctant to lend to each other over longer periods.

Markets, which have been on a roller coaster since the ECB started pumping billions into money markets Aug. 9, now think there is only a small chance that the central bank will announce a quarter-point increase in its refinancing rate, to 4.25%, at next week’s meeting.

On Tuesday, ECB Executive Board member Lorenzo Bini Smaghi said markets had “perfectly understood” the bank’s president, Jean-Claude Trichet, who re-emphasized Monday that the bank isn’t “precommitted” to a rate rise. Mr. Trichet made clear that the bank, in a departure from its typical method of signaling rate decisions well in advance, is keeping its options open.

Many economists now maintain that the bank will remain on hold next week, to avoid further rattling jittery markets and to assess the economic impact of the financial turbulence.

But others contend that a still-robust economy and continuing inflation threats will push the bank to an increase next week. European Union officials yesterday said the turbulence hadn’t yet damaged the euro-zone’s growth prospects.

–Emese Bartha contributed to this article.

Write to Joellen Perry at joellen.perry@wsj.com and Monica Houston-Waesch at nikki.houston@dowjones.com

Hedge Funds Do About 30%
Of Bond Trading, Study Says

By CRAIG KARMIN
August 30, 2007; Page C3

There was a time when debt was considered a boring investment, held primarily by institutions seeking predictable returns or a steady stream of interest payments. A recent study by the consulting firm Greenwich Associates shows how much that’s changed.

Hedge funds have quickly become a dominant player in the world of debt. In some corners of the market — often among the most complex areas — they are the biggest force by far. Hedge funds are responsible for nearly 30% of all U.S. fixed-income trading, according to the survey.

DOMINATORS

• The News: A study shows how important that hedge funds have become in debt trading — they do nearly 30% of U.S. bond volume.

• Doubled Up: The amount of trading doubled in just a year, the study by Greenwich Associates showed.

• Impact on Investors: This isn’t your father’s debt. Hedge funds often focus on short-term goals, not the long-term holdings that other investors may prefer.

That level, which reflected activity over a 12-month period through April, was double the amount of trading hedge funds accounted for the previous year. Greenwich found hedge-fund trading comprises 55% of U.S. activity in derivatives with investment-grade ratings, and also 55% of the trading volume for emerging-market bonds.

The rapid rise in hedge-fund trading underscores the changing nature of the debt markets. Unlike many mutual funds that look for stable returns or pensions and insurers that want steady, long-term holdings, hedge funds frequently seek short-term gains through numerous trades they can amplify with borrowed money.

“We’ve seen over the past 10 years a proliferation of products created to meet the needs of hedge funds,” says Tim Sangston, a managing director at Greenwich Associates. “More and more of the growth in bond trading is coming from these kind of professional traders and investors.”

In some corners of the U.S. debt market, hedge funds practically are the market. For instance, hedge funds generated more than 80% of the trading for derivatives with high-yield ratings, and more than 85% of volume in distressed debt, Greenwich found.

Hedge funds also accounted for a good portion of the trading in mortgage-backed securities, asset-backed securities, collateralized debt obligations and other parts of the debt market that have suffered recently as worries over subprime loans have spread.

Analysts say these debt instruments were developed primarily for sophisticated investors like hedge funds, which sometimes use these products to protect themselves. But the debt securities have also been peddled to pension funds and other institutions that may not completely understand them.

The survey involved responses from 1,333 institutions in North America, including mutual funds, insurance companies, pension funds, banks, brokerage firms’ proprietary trading desks and federal agencies, Greenwich said. These investors were polled about their trading in 15 kinds of debt instruments. Overall, debt-market trading volume among the participants increased by 10% in the period, to $25 trillion, from the previous year.

Write to Craig Karmin at craig.karmin@wsj.com

/////////////////////////////

Hedge Funds Double Share of Fixed-Income Trades (Update1)
By Jenny Strasburg

Aug. 30 (Bloomberg) — Hedge funds doubled their share of U.S. fixed-income trading to 30 percent and dominated the market for some securities as debt-market volatility increased, according to a study by Greenwich Associates.

“The recent expansion of hedge-fund positions and trading activity has been so rapid and consistent that it is now no exaggeration to say that hedge funds are no longer just an important part of the market in some fixed-income products; they are the market,” according to the report, which covered the 12 months ended in April.

Hedge funds accounted for more than 80 percent of trading in the debt of financially distressed companies and high-yield derivatives such as credit-default swaps, the Greenwich, Connecticut-based consulting and research firm said. The loosely regulated investment pools generated almost half of U.S. trading volume in structured credit.

Hedge-fund assets worldwide increased almost threefold in the past five years to $1.75 trillion as of June, according to Chicago-based Hedge Fund Research Inc. Fund managers’ appetite for fixed-income assets has fueled growth in trading volume as well as concerns about who might buy the debt products in troubled markets.

Trading by all institutions in distressed debt more than doubled to $42 billion in the 12-month period, according to the report. Leveraged-loan trading doubled to $241 billion. Total debt-trading volume increased 10 percent to $25 trillion.

Hedge funds “appear more concerned than other U.S. fixed- income investors about liquidity risk,” according to the study, referring to worries buyers might disappear when trading becomes volatile. By comparison, other investors cited risk of default as their top worry.

Market Casualties

Bear Stearns Cos. last month sought bankruptcy protection for two hedge funds that invested in securities backed by home loans to the riskiest borrowers. The New York-based investment firm closed the funds after granting $1.6 billion in emergency financing in June and then telling investors they would get little, if any, money back.

Credit pools managed by UBS AG’s former hedge-fund affiliate Dillon Read Capital Management LLC and Sowood Capital Management LP of Boston also failed this year after the value of their holdings declined and clients sought refunds.

`Take Careful Note’

Hedge funds’ share of structured-credit trades shows that the funds “have become the biggest force” in markets for many debt instruments that are often are the most complex to price and trade, Frank Feenstra, a Greenwich Associates managing director, said in the report. “With all of the current issues surrounding subprime-mortgage debt and collateralized-debt obligations, investors should take careful note of this finding.”

About 25 percent of the trading in U.S. asset-backed securities was done by hedge funds. They were responsible for 20 percent of the volume in mortgage-backed securities trading.

Among hedge funds interviewed for the study in both 2006 and 2007, fixed-income trading volume increased about 90 percent, Greenwich Associates managing director Tim Sangston, a former fixed-income associate with Goldman Sachs Group Inc., said in the report.

Greenwich Associates based its report on interviews conducted between February and April with 1,333 mutual funds, pension funds, banks and other institutions.

Holders of fixed-income securities in general traded the instruments more frequently in the past year than previously, Greenwich Associates said. The research firm based that conclusion on data showing trading volume outpacing the rise in debt assets under management.

Comparing Returns

Institutional investors, including corporate and public pension-fund managers and endowments, expected an average return of 5.2 percent from fixed-income assets over the five years starting in 2006, the firm said. Expectations for equities were 8.3 percent; 8.8 percent from hedge funds; and 11.7 percent from private-equity funds.

Hedge fund manager can buy or sell any assets and participate substantially in profits from money invested. Private-equity firms acquire part or all of a company using debt to finance typically about two-thirds of the purchase price. They usually hold investments for three years or more while they seek to increase profits, then try to sell to other companies or investors through an initial public offering.

To contact the reporter on this story: Jenny Strasburg in New York at jstrasburg@bloomberg.net .

Last Updated: August 30, 2007 16:02 EDT

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