July 5, 2007 (LPAC) -- Joseph Lam, Chief Executive of the Hong Kong Monetary Authority, warned of a panic in the system coming from exactly the type of crisis unfolding now around Bear Stearns.

Writing in the "Viewpoint" column on the Authority website, Lam said that hedge funds threaten "significant systemic risk" which is "most likely to arise from the failure of a systemically important hedge fund that has large exposures to other financial institutions." Lam points to the Amaranth and Bear Stearns crises, noting that such a hedge fund failure, "and any panic sell-off afterwards, could push up the risk premium, causing a sharp decline in asset prices that might eventually drain the market of liquidity. It might also trigger herding behaviour among some less sophisticated hedge funds."

Lam also notes that the "potential systemic risk from hedge funds is further amplified by their unstable capital base, which is likely to shrink quickly in times of stress either because of redemption by the investors or the funds' leverage ratio being too high. The latter problem is becoming more acute, because it is difficult to accurately measure the embedded leverage in complex structured products."