It's not so much that a high flying hot-money hedge fund has crashed and burned. In the search for yield in the current black box driven market, highly leveraged dollars must be risked to "earn" nickels and pennies. The concern is that such a blowup may spark a domino-like effect as a cascading debt default unwinds across the financial spectrum.
Nothing worse than making billions on paper and finding out the corresponding long to your short can't pay. Thus the concept of counter-party risk emerges. Because when you can't get paid for a winner you can't pay for your losers and so on and so on down the chain. It is not uncommon for these hedge funds to be leveraged ten or twenty times their capital. They can literally be wiped out in the blink of an eye.
Then of course there are the derivatives -- what Buffet has referred to as "financial weapons of mass destruction." Some of these derivative contracts can bring leverage of a hundred times across dozens of interlocking financial contracts. They serve to convert low cost debt into paper profits according to modern accounting techniques -- all in the name of "hedging" risk.
There is a fear that a systemic crash along the lines of this firm's woes can easily be triggered by fat tail standard deviations, rogue traders or some kind of event that sparks unheard of volatility. The majority of NYSE trading is now done between computer programs and there is some concern that the US government is monetizing its own debt through offshore purchases in the bond markets.
It is all extremely complicated and based with ever escalating levels of debt as the foundation. No one really knows what is going on now but you should expect to see more of these kind of stories.
I wouldn't worry about it though. After all, we have it on very good authority (CNBC) that the economy is sound.
HG
These areas of investment need to be looked into, and regulated to ensure stability.
$4 Billion is not chicken feed....Some sort of sanity needs to be build in to this stuff, or just get rid of it.
If this stays contained, to this single firm, then so be it. But if it spreads, as you suggest and causes domino's to fall, then it needs regulatory stability.