Stock Research - Amaranth Hedge Fund Collapse What Happens When Your Friendly Banker Becomes Predator
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The Collapse of Amaranth: When a Friendly Banker Turns Predator
Introduction
The story of Amaranth LLC, a colossal hedge fund that lost $6 billion of investors' money, offers critical insights into the financial world. The circumstances of its downfall, especially involving its interactions with JP Morgan, warrant examination.
A Metaphor
Imagine experiencing chest pain and visiting a doctor you've trusted for 30 years. He conducts tests and tells you the results will determine your fate. When you return for the results, he proposes a bet: $1 million that you’ll survive. Would you take it? Knowing he has the results, likely not. This scenario mirrors the predicament Amaranth faced.
How Amaranth Fell
Hedge funds operate similarly to smaller brokers, depending on larger clearing firms for trade. For Amaranth, JP Morgan was this clearing broker, or Prime Broker. The fund placed risky bets on the energy futures market, amplifying them with high leverage, sometimes up to 8:1. When these bets soured, Amaranth was required to provide additional margin to cover potential losses.
In a desperate move, Amaranth sought to offload its toxic trades to Goldman Sachs, offering $2 billion in cash to secure the deal. However, JP Morgan refused to release these funds, fearing potential risks. This left Amaranth scrambling to find an outside partner to take over the trades or infuse capital.
The Unfolding Drama
With knowledge of Amaranth’s dire situation, market players recognized its vulnerabilities. Competitors, like sharks, capitalized on this, further straining the hedge fund. Even as Merrill Lynch considered a funding deal, Goldman Sachs raised their price, demanding hundreds of millions more to complete the transaction.
JP Morgan, privy to Amaranth’s financial positions as the clearing broker, held significant clout. Their understanding of both the market and Amaranth's struggles positioned them advantageously. Like a blackjack dealer aware of every hand, JP Morgan was in an enviable spot.
The Final Deal
Over a tense weekend, discussions ensued, culminating at 5:30 AM on Wednesday. JP Morgan, along with Citadel Investment Group, inked a deal. Amaranth absorbed $800 million in portfolio losses, while JP Morgan and Citadel received $1.6 billion to take the trading positions off Amaranth’s books, plus additional funds for options and commodity positions.
Conclusion
JP Morgan reportedly netted $725 million from this deal. Once a pillar of conservative banking, the institution’s actions raise questions about the role of greed in their decision-making. Did they prioritize profit over a potential bailout for Amaranth? The implications are worth pondering.
Richard Stoyeck
[stocksatbottom.com](http://www.stocksatbottom.com)
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