You might be familiar with Amaranth LLC, the giant hedge fund that collapsed last fall, after blowing up $6 billion of investors’ money. It now comes out that the circumstances under which they self-destructed are worth studying.But first – A METAPHORWhat would happen if you had a pain in your chest, and you had tests taken at your doctor on a Monday who you have known and trusted for 30 years? He tells you that the results will tell you if you are going to live or die, no in between. You now visit the doctor on a Friday to discuss the results. The doctor says to you how would you like to bet on the results.You offer to bet $1 million that you are going to live. The doctor says, “I will take your bet myself.” Would you still make the bet? The answer is no, of course you wouldn’t because the doctor already knows the result. and you don’t. It’s like betting against the house in Las Vegas when the house already KNOWS how the results will turn out.This is the same situation in our opinion that Amaranth the hedge fund faced during its trading crisis. Hedge funds have to book their trades through a clearing firm, no different than many major brokerage firms clearing trades for smaller brokerage firms. The smaller firm pays a fee to the bigger firm that clears the trades for them.In the case of Amaranth the hedge fund, JP Morgan was the clearing broker, known as a Prime Broker. In essence Amaranth made bets on the energy futures markets, and these bets went the wrong way. As a hedge fund, Amaranth uses leverage when it trades against its equity, usually borrowing about 6 to 1, and sometimes as high as 8 to 1. JP Morgan as the clearing broker was the lender of the additional margin.Now when a trade goes against a hedge fund, the fund may be called upon by the clearing firm to put up more margin, meaning cash, or securities to protect the clearing firm. In this case the problem happened on a Friday. Amaranth wanted to get rid of billions of dollars of toxic bad trades by giving them to Goldman Sachs, who agreed to take them if Amaranth would give Goldman $2 billion in cash along with the trades. Goldman would then assume the risk of what happens to those trades. Amaranth wanted its clearing firm, JP Morgan to give Goldman the $2 billion from its capital account simultaneous with the movement of the trades.JP Morgan would not release the funds. They barked, stating that they felt they would still be at risk if this were to happen. A clearing firm hates risk, and never wants to take risk. Amaranth very quickly had to operate in the most treacherous waters imaginable. They had to begin talking to outsiders in a desperate attempt to structure a transaction with anyone capable of taking these trades or injecting new additional capital. Remember, this is Wall Street, the sharks were circling.Anyone who had knowledge of Amaranth’s trades knew immediately how precarious the oil markets that Amaranth was involved in. They also knew how to play the market to its own advantage using Amaranth’s weaknesses. The SHARKS came in and did trades that would work to their advantage. Within a matter of trading hours, this giant hedge fund was losing hundreds of millions of additional dollars. Merrill Lynch decided to take a piece of the funding deal, and this drove Goldman Sachs up a wall. Goldman upped the ante, and decided to charge Amaranth hundreds of millions more to do the deal which would partially save Amaranth.