The news that yet another multi-billion-dollar hedge fund operation - Ellington Capital Management - has run into trouble and is trying to sell off chunks of its portfolio to meet margin calls, underscores just how serious the problems are with these exotic investment vehicles, MSNBC contributor Chris Byron reports. They are worse - much worse - than people think.

The news also points up just how little is actually known about the hedge fund world itself. The unknowns range from who the market's major players are, to how much money they've borrowed against their equity capital to get in the game, to how they've invested the leveraged funds thereafter. As the Ellington Partner case vividly shows, the whole thing remains shrouded in layer upon layer of mystery and obfuscation.

Nonetheless, evidence obtained from sources inside the firm show that Ellington is a bigger, more leveraged - and more troubled - operation than had been previously thought. Contrary to recent press reports that the firm has approximately $1 billion of assets, a source at the organization has confirmed that as of Aug. 31, the Ellington group had approximately $1.844 billion of partner capital in the business.

What's more, the fund was - and is - more leveraged with borrowed money than anyone realized, with $5 of borrowed capital in its portfolio for every $1 of partner money. That in turn made the firm's total presence in the market, as of the start of September, more than $9.4 billion.

According to a source at the firm, on Monday evening, the fund's management began informing investors that "unprecedented liquidity constraints" in the market were "restricting" the ability of Ellington to finance its business as it had done in the past.

It was a briefing that came across more like a living obituary for the firm itself. With the value of the portfolio's assets plunging, management told investors that the firm had been hit with margin calls that began on Friday, Oct. 9. Having no choice, the firm thereupon began liquidating a "significant portion" of its portfolio holdings to meet the calls. The management briefing ended with an appeal to investors for "patience...in these difficult times."

Greenwich, Connecticut-based Ellington Partners, which is headquartered across town from Long Term Capital Management - the mega-fund that nearly collapsed in September - is run by aging boy wonder Michael Vranos. He's the handsome and mercurial one-time amateur bodybuilder who rose to fame as the head of mortgage-backed securities trading at Kidder Peabody & Co. Kidder is the now-defunct investment firm that was sold by its parent, General Electric Co., to the Wall Street investment firm of PaineWebber & Co. in 1994 following the Joe Jett scandal.

Jett - another bodybuilder - is the Harvard MBA who worked across the floor from Vranos at Kidder and was fired and charged with securities fraud following massive trading losses in government bonds. Jett was eventually cleared of fraud, but is no longer working on Wall Street and when last heard from was in fact believed to be employed as a furniture mover in Brooklyn. Following the collapse of Kidder, Vranos and a college chum from Harvard - Laurence Penn, who headed mortgage securities trading at Lehman Bros. - quit Wall Street and set up a Connecticut hedge fund. For startup money they tapped Ziff Brothers Investments, which contributed between $30 million and $100 million, depending upon whom you talk to. The Ziff fund - an investment vehicle of the Ziff publishing family - was headed by Daniel Stern, another pal of the two men since college days.

By August of this year, Ellington Partners had ballooned into a three-fund operation with large - yet eerily mysterious - portfolios of assets. For example, the June 1998 issue of Worth Magazine carried an admiring profile of the Vranos operation. Yet the story seemed oblivious to the existence of any but the smallest of Vranos's three funds - Ellington Mortgage Partners, with stated "assets" of $287 million.

But the Ellington operation was - and is - much larger than just that one fund, which New York-based Managed Accounts Reports Inc., a hedge fund tracking service, says was showing assets of $340 million as recently as the end of July. In addition, the operation includes an offshore fund (Ellington Overseas Partners) which M.A.R. Inc. puts at $504 million in assets, and a third entity going by the name Ellington Composite fund, for which M.A.R. shows $1 billion of assets.

Altogether, those assets alone total $1.844 billion. And that in turn is nearly double the stated assets cited in a Wall Street Journal article today when the newspaper quoted sources as claiming that the operation had begun an auction liquidation of fund assets to meet margin calls.

But neither the Journal story nor M.A.R., Inc.'s reported assets for the Ellington group reveal the first thing about just how big the portfolios of the three funds actually are - which is to say, how much money has been borrowed by the funds' managers to ramp up, or leverage, the earning power of the portfolios.

Expectedly, officials at Ellington Management declined to disclose anything about the leverage in their portfolios. But a story carried on the Bloomberg business newswire early today offered at least some enlightenment. The story cited sources as having seen for-sale offering documents from Ellington, listing mortgage securities totaling $1.5 billion.

With a credible source inside the firm now confirming that as of Aug. 31 the group had partner capital of $1.844 billion under management - and another $7.6 billion or so of borrowed money on its books - the attempted sale of $1.5 billion in portfolio assets would indicate that the paid-in capital of the firm's partners stands a clear chance of being wiped out altogether.

Fund Hedge Strategy

According to a top Wall Street fixed income markets expert, Ellington Capital Management may well be suffering from a boomeranged hedge that is now devastating the portfolio positions of a large number of funds: buying corporate or mortgage debt, then "hedging" the position with an offsetting short-sale of U.S. Treasuries.

"Putting on this type hedge makes sense in stable markets," says the source. "It allows you to pick up the spread between corporates and Treasuries with a lot of leverage and very little risk. But the problems at Long Term Capital Management created a flight to quality that has caused corporate debt to decline against Treasuries. As a consequence, anyone with a short position in Treasuries is now getting slaughtered."

This source, and others, says that the drying up of liquidity throughout the fixed income market is being aggravated by continuing uncertainties regarding the future of Long Term Capital Management itself. The fund collapsed last month with nearly $100 billion of borrowed money on its books.

Long Term Capital was rescued by a consortium of Wall Street investment banks and others, but sources on Wall Street say that nearly a month later the hedge fund's positions still have not been unwound. "We hear lots of rumors that much of the rescue capital at Long Term Capital Management is gone already," says the source. "And a lot of the selling of corporate debt that is now hitting the market appears to be coming from funds that are not involved in the Long Term Capital situation at all, but that know there is still more selling to come straight out of the fund's portfolio. They thus want to get out in front of it."