Thursday, July 24, 2008

How The Rich Stay Rich: Hedge Funds, Subprime Mortgage Loans, and Oil

Many people are feeling the impact of the subprime mortgage scandal. Foreclosures, falling home values, and rising energy and food costs are hurting middle-class families and crushing lower-income ones.

Recently oil prices topped $140 per barrel causing gas prices to break $4.00 a gallon. Immediately politicians, economists, and other experts began searching for reasons why. An elite few began saying that the price of oil was a bubble and about to crest, which would send energy prices lower. Since oil reached its high of $145.29 on July 3, 2008, prices have fallen dramatically. The current price of oil sits at $124.44 a barrel, a decline of nearly 15%.

So why have prices go down so far, so fast? No new supplies have been found, drilling in ANWAR and off the coastal shelf is still banned, demand hasn't dropped, we're still battling in Iraq and Afghanistan, and the war rhetoric towards Iran is at an all time high. So what's driving this decline in oil prices?

Meet, the hedge fund. A hedge fund is a largely unregulated large some of money that fund managers use to buy and sell stocks, commodities, and other investments. In addition, hedge funds practice risky trade schemes like shorts, options, and futures. Hedge funds are reserved for the rich, investors with five million dollars in assets or in cases of hedge funds with 100 or fewer investors, those that have a million in assets or more than $200,000 annual income.

To truly understand how these hedge funds are manipulating the price of oil we need to go back a couple of years. Between 2003 and 2005 hedge funds began investing in the mortgage industry. This new source of income resulted in lenders relaxing the criteria for mortgage loans and so they began offering subprime, ALT-A, and so-called NINJA (no income, no job or assets) loans.

The target market for these loans were low income families purchasing new homes and middle-class families looking to upgrade. Most of the loans were adjustable rate and interest only. By 2007 these loans began defaulting at an alarming rate and the subprime scandal was born.

The hedge funds that powered most of these lenders began dropping in value so rapidly that regulators froze many of their assets. The rich were losing money and hedge fund managers had to act. Given the situation in the Middle East, they set their sites on oil.

Since hedge funds are mostly unregulated they knew they could begin buying oil futures in large sums as long as they dumped those futures before the government looked too closely. This strategy saw the price of oil skyrocket in just a few short months and ultimately reaching a high of $145.29 a barrel, up 51% over the year.

With the fiscal quarter closing at the end of June, hedge fund managers knew the time to sell and mask their activities in the oil futures market was upon them and the sell off began. All the while the federal government remained either completely inept at recognizing the market manipulation or simply willing to give a wink and a nod to these rich investors as they deferred their risky mortgage loan losses onto the backs of the American consumer through increased oil and gas prices.

"Jim Ritterbusch, president of Ritterbusch and Associates, says a number of factors are driving down the price of crude. One of the biggest, he says, is big investors, such as hedge funds... pulling money out of the oil market."

Even fears of hurricane Dolly shutting down several refineries and hurting supply aren't enough to slow the fall of oil prices as these hedge funds dump their oil investments.

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