July 14 (Bloomberg) -- Greenlight Capital Inc., the $5 billion hedge-fund firm run by David Einhorn, told investors it switched all of its holdings in a gold exchange-traded fund into bullion during the second quarter.
“At a minimum this will provide some savings as the costs of storing gold are less than the fees” for the SPDR Gold Trust, the New York-based firm said yesterday in a letter to investors.
Einhorn, 40, told clients in January he was buying gold for the first time amid the threat of inflation from higher government spending. The firm, started in 1996, held 4.2 million shares of SPDR Gold Trust in the first quarter, making the gold- backed ETF its biggest holding. Gold has climbed 5.8 percent this year.
The firm’s Greenlight Capital LP fund gained 16.3 percent in the second quarter, bringing its return this year to 21.5 percent boosted by investments in Ford Motor Co. debt, according to the letter, a copy of which was obtained by Bloomberg News. The fund lost 23 percent last year.
Hedge funds returned an average 9.4 percent this year through June after losing 19 percent in 2008, according to Hedge Fund Research Inc. in Chicago.
Steve Bruce, a spokesman for Greenlight, declined to comment on the letter.
‘Sparse’ Stock Picks
Greenlight said its investments in stocks it expects to rise were “sparse” in the second quarter, and that it currently has “almost no net long exposure” to equities.
“This comes from our bottom-up inability to find many good opportunities,” the firm said. “We are very cautious of the significant headwinds we still believe the economy faces.”
Greenlight said it had bought reinsurance stocks including Aspen Insurance Holdings Ltd. during the second quarter.
“The reinsurance industry suffered a double whammy last year due to storm damage and investment losses,” the firm said. “This appears to be leading to an improved competitive environment and higher returns on capital.”
Greenlight said its largest holdings at the end of the quarter were Arkema SA, a chemical maker in Paris; Criteria CaixaCorp, a Barcelona-based holding company for Spain’s largest savings bank; the debt of Dearborn, Michigan-based Ford; gold; and Pfizer Inc., the world’s biggest drugmaker.
Hedge funds are private, largely unregulated pools of capital whose managers can buy or sell any assets, bet on falling as well as rising prices and participate substantially in profits from money invested.
To contact the reporter on this story: Saijel Kishan in New York at skishan@bloomberg.net;
Showing posts with label hedge funds. Show all posts
Showing posts with label hedge funds. Show all posts
1 May 2009
Cerberus Capital Management suffers total loss on Chrysler holding ~ WP
Chrysler, the country's third-largest auto company, filed today for Chapter 11 bankruptcy protection under a plan that President Obama said will give the troubled automaker "a new lease on life."
"I have every confidence that Chrysler will emerge from this process stronger and more competitive," Obama said at a noon press conference, adding, "This is not a sign of weakness, but rather one more step on a clearly charted path toward Chrysler's revival."
Chrysler, one of the three pillars of the American auto industry, filed for bankruptcy this afternoon after last-minute negotiations between the government and the automaker's creditors broke down yesterday. U.S. officials had offered Chrysler's secured lenders $2.25 billion in cash if they would agree to writedown the $6.9 billion in secured debt that the company owed. But a small group of hedge funds refused the 11th-hour deal.
An administration official this morning expressed disappointment, saying the holdouts had failed to "do the right thing," but that "their failure to act in either their own economic interest or the national interest does not diminish the accomplishments made by Chrysler, Fiat and its stakeholders, nor will it impede the new opportunity Chrysler now has to restructure and emerge stronger going forward."
"I don't stand with those who held out when everybody else is making sacrifices," Obama said at the White House today.
Shortly before the president's remarks, a group claiming to represent the holdouts on the deal released a statement claiming that they had been "systematically precluded" from direct negotiations with the government in favor of creditors who had previously received assistance from the government.
Chrysler chief executive Robert Nardelli announced today that he will return to Cerberus Capital Management as an adviser.
"Now is an appropriate time to let others take the lead in the transformation of Chrysler with Fiat," said Nardelli in a statement. "I will work closely with all of our stakeholders to see that this new company swiftly emerges with a successful closing of the alliance."
The company's bankruptcy filing, and the U.S. government's attempt to save it, amounts to another extraordinary intervention in the economy and a landmark event in the history of the American auto industry.
Under the administration's detailed plan for a "surgical bankruptcy," ownership of Chrysler would be dramatically reorganized, the leadership of Italian automaker Fiat would take over company management and the U.S. and Canadian governments would contribute more than $10 billion in additional funding.
Company and government officials had feared that a bankruptcy would stain the brand, shake customer confidence and erode sales, but the administration said it would seek to use the process to create a new Chrysler company. Its ownership would be divided, with the company's union retiree health fund receiving a 55 percent stake, Fiat would claim as much as a 35 percent share and the United States would take 8 percent. The Canadian government would receive two percent.
The automaker's current majority owner, the private-equity firm Cerberus Capital Management, would have its holdings wiped out.
During the bankruptcy, the governments would provide $4.5 billion in new funds, with 80 percent coming from the United States and 20 percent from Canada, which hosts a number of Chrysler operations. As the company emerged from its reorganization, the United States and Canada would provide another $5.63 billion, the sources said. The U.S. funds come from the government's Troubled Assets Relief Program.
http://www.washingtonpost.com/wp-dyn/content/article/2009/04/30/AR2009043001639_pf.html
"I have every confidence that Chrysler will emerge from this process stronger and more competitive," Obama said at a noon press conference, adding, "This is not a sign of weakness, but rather one more step on a clearly charted path toward Chrysler's revival."
Chrysler, one of the three pillars of the American auto industry, filed for bankruptcy this afternoon after last-minute negotiations between the government and the automaker's creditors broke down yesterday. U.S. officials had offered Chrysler's secured lenders $2.25 billion in cash if they would agree to writedown the $6.9 billion in secured debt that the company owed. But a small group of hedge funds refused the 11th-hour deal.
An administration official this morning expressed disappointment, saying the holdouts had failed to "do the right thing," but that "their failure to act in either their own economic interest or the national interest does not diminish the accomplishments made by Chrysler, Fiat and its stakeholders, nor will it impede the new opportunity Chrysler now has to restructure and emerge stronger going forward."
"I don't stand with those who held out when everybody else is making sacrifices," Obama said at the White House today.
Shortly before the president's remarks, a group claiming to represent the holdouts on the deal released a statement claiming that they had been "systematically precluded" from direct negotiations with the government in favor of creditors who had previously received assistance from the government.
Chrysler chief executive Robert Nardelli announced today that he will return to Cerberus Capital Management as an adviser.
"Now is an appropriate time to let others take the lead in the transformation of Chrysler with Fiat," said Nardelli in a statement. "I will work closely with all of our stakeholders to see that this new company swiftly emerges with a successful closing of the alliance."
The company's bankruptcy filing, and the U.S. government's attempt to save it, amounts to another extraordinary intervention in the economy and a landmark event in the history of the American auto industry.
Under the administration's detailed plan for a "surgical bankruptcy," ownership of Chrysler would be dramatically reorganized, the leadership of Italian automaker Fiat would take over company management and the U.S. and Canadian governments would contribute more than $10 billion in additional funding.
Company and government officials had feared that a bankruptcy would stain the brand, shake customer confidence and erode sales, but the administration said it would seek to use the process to create a new Chrysler company. Its ownership would be divided, with the company's union retiree health fund receiving a 55 percent stake, Fiat would claim as much as a 35 percent share and the United States would take 8 percent. The Canadian government would receive two percent.
The automaker's current majority owner, the private-equity firm Cerberus Capital Management, would have its holdings wiped out.
During the bankruptcy, the governments would provide $4.5 billion in new funds, with 80 percent coming from the United States and 20 percent from Canada, which hosts a number of Chrysler operations. As the company emerged from its reorganization, the United States and Canada would provide another $5.63 billion, the sources said. The U.S. funds come from the government's Troubled Assets Relief Program.
http://www.washingtonpost.com/wp-dyn/content/article/2009/04/30/AR2009043001639_pf.html
27 March 2009
Its an ill wind ~ 'I'm having a very good crisis,' says Soros as hedge fund managers make billions off recession
A hedge fund manager who predicted the global credit crunch has said the financial crisis has been 'stimulating' and the culmination of his life's work.
George Soros, who predicted the global financial crisis twice before, was one of the few people to anticipate and prepare for the current economic collapse.
Mr Soros said his prediction meant he was better able to brace his Quantum investment fund against the gloabal storm.
But other investors failed to take notice of his prediction and his decision to come out of retirement in 2007 to manage the fund made him $US2.9 billion.
And while the financial crisis continued to deepen across the globe, the 78-year-old still managed to make $1.1 billion last year.
'It is, in a way, the culminating point of my life’s work,' he told national newspaper The Australian.
Soros is one of 25, top hedge fund managers from across Wall Street who have defied the credit crunch crisis to reap a total of $11.6billion (£7.9bn) last year.
The managers made their profit by trading above the pain in the markets, according to Institutional Investor’s Alpha Magazine.
Former maths professor James H. Simons, who has made billions in hedge fund Renaissance Technologies, earned $2.5 billion running computer-driven trading strategies.
And John A. Paulson, who made his fortune by betting against the housing market, came in second earning $2 billion.
Big hitters: John Paulson and James H Simons were part of a group of 25 hedge fund managers who make a total of $11.6bn
The managers made the profit in a year when losses were recorded at two of every three hedge funds and when hedge funds lost an average of 18 percent, according to the New York Times.
Two of the three managers who tied for ninth place, at $250 million, are based in Britain and include David Harding of Winton Capital and Alan Howard of Brevan Howard Asset Management.
Another Brevan Howard employee Christopher Rokos also made the list.
George Soros, who predicted the global financial crisis twice before, was one of the few people to anticipate and prepare for the current economic collapse.
Mr Soros said his prediction meant he was better able to brace his Quantum investment fund against the gloabal storm.
But other investors failed to take notice of his prediction and his decision to come out of retirement in 2007 to manage the fund made him $US2.9 billion.
And while the financial crisis continued to deepen across the globe, the 78-year-old still managed to make $1.1 billion last year.
'It is, in a way, the culminating point of my life’s work,' he told national newspaper The Australian.
Soros is one of 25, top hedge fund managers from across Wall Street who have defied the credit crunch crisis to reap a total of $11.6billion (£7.9bn) last year.
The managers made their profit by trading above the pain in the markets, according to Institutional Investor’s Alpha Magazine.
Former maths professor James H. Simons, who has made billions in hedge fund Renaissance Technologies, earned $2.5 billion running computer-driven trading strategies.
And John A. Paulson, who made his fortune by betting against the housing market, came in second earning $2 billion.
Big hitters: John Paulson and James H Simons were part of a group of 25 hedge fund managers who make a total of $11.6bn
The managers made the profit in a year when losses were recorded at two of every three hedge funds and when hedge funds lost an average of 18 percent, according to the New York Times.
Two of the three managers who tied for ninth place, at $250 million, are based in Britain and include David Harding of Winton Capital and Alan Howard of Brevan Howard Asset Management.
Another Brevan Howard employee Christopher Rokos also made the list.
9 March 2009
Hedge fund investors turn to gold
By Henny Sender and Javier Blas
Financial Times, London
Sunday, March 8, 2009
http://www.ft.com/cms/s/0/37fcba70-0c0a-11de-b87d-0000779fd2ac.html
Hedge fund investors who made money last year by betting against investment banks are now buying gold as a way of betting against central banks.
The gold bulls include David Einhorn, founder of hedge fund Greenlight Capital, who last year came under the spotlight for his short selling of shares in Lehman Brothers after arguing that the bank did not have enough capital to offset its exposure to falling property prices. Other funds looking at gold include Eton Park and TPG-Axon, investors said.
Their belief in bullion is being expressed even as gold prices have retreated from last month's break above the $1,000 an ounce level. Spot gold in London closed last Friday at $939.10, after falling last week to $900.95 an ounce.
Investors such as Mr Einhorn are turning to gold because they are worried about the response of the US Federal Reserve and other central banks to the global economic crisis. A bet on gold is essentially a bet against all paper currencies.
"The size of the Fed's balance sheet is exploding and the currency is being debased. Our guess is that if the chairman of the Fed is determined to debase the currency, he will succeed," Mr Einhorn wrote in a recent letter to his investors. "Our instinct is that gold will do well either way: Deflation will lead to further steps to debase the currency, while inflation speaks for itself."
Mr Einhorn's comments -- and the revelation he is buying gold itself -- are in line with the views held by other large institutional investors in Europe, according to bankers in London. The head of commodity sales at one major bullion bank told the Financial Times that he had never been so busy dealing in gold for large investors in his life.
Goldman Sachs, Morgan Stanley, and UBS all forecast the gold price will surge above $1,000 this year. Peter Munk, chairman of Barrick Gold, the world's largest miner of bullion, told investors last week that all countries have embarked on policies that will favour gold. "The only option to governments is to print and print more money," he said. "That will end in tears."
In the past, hedge funds, which depend on absolute returns to earn high fees, had avoided gold because it does not produce any yield and costs money to store and insure. But those issues have become less important as central banks have pushed interest rates to nearly zero, reducing the yields on currencies.
Financial Times, London
Sunday, March 8, 2009
http://www.ft.com/cms/s/0/37fcba70-0c0a-11de-b87d-0000779fd2ac.html
Hedge fund investors who made money last year by betting against investment banks are now buying gold as a way of betting against central banks.
The gold bulls include David Einhorn, founder of hedge fund Greenlight Capital, who last year came under the spotlight for his short selling of shares in Lehman Brothers after arguing that the bank did not have enough capital to offset its exposure to falling property prices. Other funds looking at gold include Eton Park and TPG-Axon, investors said.
Their belief in bullion is being expressed even as gold prices have retreated from last month's break above the $1,000 an ounce level. Spot gold in London closed last Friday at $939.10, after falling last week to $900.95 an ounce.
Investors such as Mr Einhorn are turning to gold because they are worried about the response of the US Federal Reserve and other central banks to the global economic crisis. A bet on gold is essentially a bet against all paper currencies.
"The size of the Fed's balance sheet is exploding and the currency is being debased. Our guess is that if the chairman of the Fed is determined to debase the currency, he will succeed," Mr Einhorn wrote in a recent letter to his investors. "Our instinct is that gold will do well either way: Deflation will lead to further steps to debase the currency, while inflation speaks for itself."
Mr Einhorn's comments -- and the revelation he is buying gold itself -- are in line with the views held by other large institutional investors in Europe, according to bankers in London. The head of commodity sales at one major bullion bank told the Financial Times that he had never been so busy dealing in gold for large investors in his life.
Goldman Sachs, Morgan Stanley, and UBS all forecast the gold price will surge above $1,000 this year. Peter Munk, chairman of Barrick Gold, the world's largest miner of bullion, told investors last week that all countries have embarked on policies that will favour gold. "The only option to governments is to print and print more money," he said. "That will end in tears."
In the past, hedge funds, which depend on absolute returns to earn high fees, had avoided gold because it does not produce any yield and costs money to store and insure. But those issues have become less important as central banks have pushed interest rates to nearly zero, reducing the yields on currencies.
14 December 2008
"Sorry everyone....what you've been pursuing has all been a lie, a big Ponzi, a rat-hole to nowhere....". Re-boot.
Postscript:
I want to acknowledge that the post below came from a wonderful blog, Cassandra does Tokyo and was originally titled "Bernie Comes Out of the Closet". Many thanks and apoligies to those to whom, in the heat of my enthusiam to inform and a passionate desire to widely disseminate cutting edge analysis and comment, have been short changed by my rush to republish.
We will slowly morph to a more formal review of market action, be more considerate of content providers and post more of the my original comment that has, at last, started to appear and been well received.
"Not a year has gone by during the past fifteen that I have not contemplated what Bernie Madoff did (or didn't do) to make his money. Seventy to one-hundred basis-points-a-month. Net. Net. Net. During tempests, earthquakes, panics and crashes - even during the closure of the exchange itself, Bernie apparently minted coin like few others. Even Renaissance and Shaw tripped occasionally. Not Bernie. Yet no one knew what he did. It was one of the best kept secrets in the world. Oh yeah, sure, split-strike conversions were the official line. But every skeptical arb trader knew this couldn't be true.
I also never came across an ex-Madoff trader the way one meets ex-Shaw, ex-Moore Cap, or ex-Citadel employees. Resumes are sent in reply to postings and guys have done the rounds, even if they weren't unhappy and making a moral statement. A spouse moves...whatever. Surely there must be disgruntled Madoffians somewhere, right?. Were they ummm underground? I mean, literally? My friends at a large IB (who were soliciting business from them years ago) who'd been to their offices said they looked like the bridge from the USS Enterprise (the Starship - The Next Generation version). Entry to the IM sub was strictly verboten. Uh huh. He said it was a paperless office. No paper trails. Hmmmm. Violators were fired. Weird. No one transgressed.
Whatever he did, he came a long way from arbing the odd-lots that were the reputed foundation of his activities. I knew his shop from London where he was one of the few to make markets in US stocks out of hours, and if my clients for whatever (mostly ill-advised) reason needed to trade instantly, Bernie would make a price. Not necessarily a good price, but a price. But one does so at their peril since the folk with material non-public information are more predisposed to want to trade outside hours, so the pick-off risk was huge. But he never complained.
Next thing I know, he's at the center of an electronic trading revolution - an electronic market-maker facilitator at the center of the trading universe. Yet even Timber Hill has bad hair days. Volkswagen ord-pref days. Not Bernie. Is he arbing the exchange fee structure? Is he algorithmically scalping cause he's seeing the order flow before it gets to the exchange? Maybe. Profitably? Who knows? But I didn't have a problem with an old Jewish guy making markets. This is what we DO. But there are these investment funds - Fairfield Sentry and Kingate, and these are the issue. They are Madoff-only feeders reputed to be $7bn each. Are they funding his market-making? Why does he need so much capital? What the f*ck f*ck f*cking f*ck could he be doing in the equity markets with that much capital and still keep it a secret AND deliver returns? They say they are doing these split strike conversions but I can't see how the numbers work. Nor can anyone else. The Wall Street Journal raises the red flags in an article, but it's dismissed as hyperbole disseminated by jealous competitors. But the nagging thing is: there are lots of smart guys out there. More than sixty of them near Stonybrook with Simons focused on cracking the nut faster, better quicker, and this activity and result, I can understand. But there is no sign of such exactitude or intellectual firepower at Madoff. Just 70 to 100 bps per month, secretiveness, and dissonance.
In 2000, I advised a family-office on their alternative investments and constructed a portfolio on their behalf. I had free rein. Included in their legacy portfolio was a sizable Madoff position. As a fiduciary - and a conservative one - coming on the heels of LTCM which also lacked transparency and which made it hard for me to raise capital - I dug, asked every well-connected equity-finance, prime-broker, electronic trader and HF allocator type I knew and it still didn't add up. The best and brightest still had no more insight than I, though the skeptical shared my suspicions. So, I strongly suggested they "dump it". "One isn't being compensated sufficiently for not knowing, and something just isn't right here. Yeah maybe it's OK, but I think it's not". But they liked "it" and they liked "him". "He's always paid", they said. "We've been with him a long time". Old school they were. Trusting. What the f*ck did I know anyway?
Well, it seemed to me that the "split-strike conversions" were profit shifting bookkeeping tools. Money invested in the feeders did obtain split-strike conversion positions on their books that had an implied "yield" equal to their return but it seemed these were pre-arranged combinations that shifted return back to the investment vehicles and were "phantom" positions vs. Madoff securities. In the interim, Madoff presumably has use of the entire pool of capital, to do what he pleased, plus whatever that pool could command in terms of leverage from bank lines and financing sources. It could be in anything and everything. He could be doing mutual fund timing, or mutual fund market impact trades. Credit arbitrage. Funding coup d'etats in Africa. Or buying GSCI commodity swaps. More plausibly, he could be doing option and index-option market impact trades since he was ostensibly at the center of market flow, or he could be at the center of a loan-sharking network across America earning 50%pa, and here he was passing a paltry 9% back to investors. Either he was crooked beyond belief or he was an evil contrapreneurial genius. Who would have have thought he was both??!!
Some crimes are too perfect. Some facades too well-painted to be original or convincing. A good hustler knows he must lose sometimes in order to win. THAT is the reflection of reality that makes it believable, and gives confidence to the punter who will shortly be taken out. THAT was what was wrong with Bernie Madoff's Ponzi. The people who were taken - like the Family Office and many other investors who in time will go public on their fleecing - wanted badly to believe they were onto something that was so good that they ignored the most obvious signs of bogusness. It just didn't make sense. It just didn't add up. Even Jim Simons earns it. There is no free lunch.
There is something fitting and just in the timing of this. It is emblematic of America since Reagan and the Great Leveraging. Something for nothing. Thank you, Mr Laffer. But as a philosophy and modus operandi it is, quite literally, bankrupt and without merit. And Laffer has since been proven to be full of sh*t. Now, Americans will have to confront this, the premise that greed is good and self-guiding and somehow omnisciently beneficial, for it has had repercussions down to the core of our society and values. "Sorry everyone....what you've been pursuing has all been a lie, a big Ponzi, a rat-hole to nowhere....". Re-boot."
I want to acknowledge that the post below came from a wonderful blog, Cassandra does Tokyo and was originally titled "Bernie Comes Out of the Closet". Many thanks and apoligies to those to whom, in the heat of my enthusiam to inform and a passionate desire to widely disseminate cutting edge analysis and comment, have been short changed by my rush to republish.
We will slowly morph to a more formal review of market action, be more considerate of content providers and post more of the my original comment that has, at last, started to appear and been well received.
"Not a year has gone by during the past fifteen that I have not contemplated what Bernie Madoff did (or didn't do) to make his money. Seventy to one-hundred basis-points-a-month. Net. Net. Net. During tempests, earthquakes, panics and crashes - even during the closure of the exchange itself, Bernie apparently minted coin like few others. Even Renaissance and Shaw tripped occasionally. Not Bernie. Yet no one knew what he did. It was one of the best kept secrets in the world. Oh yeah, sure, split-strike conversions were the official line. But every skeptical arb trader knew this couldn't be true.
I also never came across an ex-Madoff trader the way one meets ex-Shaw, ex-Moore Cap, or ex-Citadel employees. Resumes are sent in reply to postings and guys have done the rounds, even if they weren't unhappy and making a moral statement. A spouse moves...whatever. Surely there must be disgruntled Madoffians somewhere, right?. Were they ummm underground? I mean, literally? My friends at a large IB (who were soliciting business from them years ago) who'd been to their offices said they looked like the bridge from the USS Enterprise (the Starship - The Next Generation version). Entry to the IM sub was strictly verboten. Uh huh. He said it was a paperless office. No paper trails. Hmmmm. Violators were fired. Weird. No one transgressed.
Whatever he did, he came a long way from arbing the odd-lots that were the reputed foundation of his activities. I knew his shop from London where he was one of the few to make markets in US stocks out of hours, and if my clients for whatever (mostly ill-advised) reason needed to trade instantly, Bernie would make a price. Not necessarily a good price, but a price. But one does so at their peril since the folk with material non-public information are more predisposed to want to trade outside hours, so the pick-off risk was huge. But he never complained.
Next thing I know, he's at the center of an electronic trading revolution - an electronic market-maker facilitator at the center of the trading universe. Yet even Timber Hill has bad hair days. Volkswagen ord-pref days. Not Bernie. Is he arbing the exchange fee structure? Is he algorithmically scalping cause he's seeing the order flow before it gets to the exchange? Maybe. Profitably? Who knows? But I didn't have a problem with an old Jewish guy making markets. This is what we DO. But there are these investment funds - Fairfield Sentry and Kingate, and these are the issue. They are Madoff-only feeders reputed to be $7bn each. Are they funding his market-making? Why does he need so much capital? What the f*ck f*ck f*cking f*ck could he be doing in the equity markets with that much capital and still keep it a secret AND deliver returns? They say they are doing these split strike conversions but I can't see how the numbers work. Nor can anyone else. The Wall Street Journal raises the red flags in an article, but it's dismissed as hyperbole disseminated by jealous competitors. But the nagging thing is: there are lots of smart guys out there. More than sixty of them near Stonybrook with Simons focused on cracking the nut faster, better quicker, and this activity and result, I can understand. But there is no sign of such exactitude or intellectual firepower at Madoff. Just 70 to 100 bps per month, secretiveness, and dissonance.
In 2000, I advised a family-office on their alternative investments and constructed a portfolio on their behalf. I had free rein. Included in their legacy portfolio was a sizable Madoff position. As a fiduciary - and a conservative one - coming on the heels of LTCM which also lacked transparency and which made it hard for me to raise capital - I dug, asked every well-connected equity-finance, prime-broker, electronic trader and HF allocator type I knew and it still didn't add up. The best and brightest still had no more insight than I, though the skeptical shared my suspicions. So, I strongly suggested they "dump it". "One isn't being compensated sufficiently for not knowing, and something just isn't right here. Yeah maybe it's OK, but I think it's not". But they liked "it" and they liked "him". "He's always paid", they said. "We've been with him a long time". Old school they were. Trusting. What the f*ck did I know anyway?
Well, it seemed to me that the "split-strike conversions" were profit shifting bookkeeping tools. Money invested in the feeders did obtain split-strike conversion positions on their books that had an implied "yield" equal to their return but it seemed these were pre-arranged combinations that shifted return back to the investment vehicles and were "phantom" positions vs. Madoff securities. In the interim, Madoff presumably has use of the entire pool of capital, to do what he pleased, plus whatever that pool could command in terms of leverage from bank lines and financing sources. It could be in anything and everything. He could be doing mutual fund timing, or mutual fund market impact trades. Credit arbitrage. Funding coup d'etats in Africa. Or buying GSCI commodity swaps. More plausibly, he could be doing option and index-option market impact trades since he was ostensibly at the center of market flow, or he could be at the center of a loan-sharking network across America earning 50%pa, and here he was passing a paltry 9% back to investors. Either he was crooked beyond belief or he was an evil contrapreneurial genius. Who would have have thought he was both??!!
Some crimes are too perfect. Some facades too well-painted to be original or convincing. A good hustler knows he must lose sometimes in order to win. THAT is the reflection of reality that makes it believable, and gives confidence to the punter who will shortly be taken out. THAT was what was wrong with Bernie Madoff's Ponzi. The people who were taken - like the Family Office and many other investors who in time will go public on their fleecing - wanted badly to believe they were onto something that was so good that they ignored the most obvious signs of bogusness. It just didn't make sense. It just didn't add up. Even Jim Simons earns it. There is no free lunch.
There is something fitting and just in the timing of this. It is emblematic of America since Reagan and the Great Leveraging. Something for nothing. Thank you, Mr Laffer. But as a philosophy and modus operandi it is, quite literally, bankrupt and without merit. And Laffer has since been proven to be full of sh*t. Now, Americans will have to confront this, the premise that greed is good and self-guiding and somehow omnisciently beneficial, for it has had repercussions down to the core of our society and values. "Sorry everyone....what you've been pursuing has all been a lie, a big Ponzi, a rat-hole to nowhere....". Re-boot."
13 November 2008
The End of Wall Street ~ A story from the belly of the beast
What they were doing, oddly enough, was the analysis of subprime lending that should have been done before the loans were made: Which poor Americans were likely to jump which way with their finances? How much did home prices need to fall for these loans to blow up? (It turned out they didn’t have to fall; they merely needed to stay flat.) The default rate in Georgia was five times higher than that in Florida even though the two states had the same unemployment rate. Why? Indiana had a 25 percent default rate; California’s was only 5 percent. Why?
Moses actually flew down to Miami and wandered around neighborhoods built with subprime loans to see how bad things were. “He’d call me and say, ‘Oh my God, this is a calamity here,’ ” recalls Eisman. All that was required for the BBB bonds to go to zero was for the default rate on the underlying loans to reach 14 percent. Eisman thought that, in certain sections of the country, it would go far, far higher.
The funny thing, looking back on it, is how long it took for even someone who predicted the disaster to grasp its root causes. They were learning about this on the fly, shorting the bonds and then trying to figure out what they had done. Eisman knew subprime lenders could be scumbags. What he underestimated was the total unabashed complicity of the upper class of American capitalism. For instance, he knew that the big Wall Street investment banks took huge piles of loans that in and of themselves might be rated BBB, threw them into a trust, carved the trust into tranches, and wound up with 60 percent of the new total being rated AAA.
But he couldn’t figure out exactly how the rating agencies justified turning BBB loans into AAA-rated bonds. “I didn’t understand how they were turning all this garbage into gold,” he says. He brought some of the bond people from Goldman Sachs, Lehman Brothers, and UBS over for a visit. “We always asked the same question,” says Eisman. “Where are the rating agencies in all of this? And I’d always get the same reaction. It was a smirk.” He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number. “They were just assuming home prices would keep going up,” Eisman says.
As an investor, Eisman was allowed on the quarterly conference calls held by Moody’s but not allowed to ask questions. The people at Moody’s were polite about their brush-off, however. The C.E.O. even invited Eisman and his team to his office for a visit in June 2007. By then, Eisman was so certain that the world had been turned upside down that he just assumed this guy must know it too. “But we’re sitting there,” Daniel recalls, “and he says to us, like he actually means it, ‘I truly believe that our rating will prove accurate.’ And Steve shoots up in his chair and asks, ‘What did you just say?’ as if the guy had just uttered the most preposterous statement in the history of finance. He repeated it. And Eisman just laughed at him.”
“With all due respect, sir,” Daniel told the C.E.O. deferentially as they left the meeting, “you’re delusional.”
This wasn’t Fitch or even S&P. This was Moody’s, the aristocrats of the rating business, 20 percent owned by Warren Buffett. And the company’s C.E.O. was being told he was either a fool or a crook by one Vincent Daniel, from Queens.
A full nine months earlier, Daniel and Moses had flown to Orlando for an industry conference. It had a grand title—the American Securitization Forum—but it was essentially a trade show for the subprime-mortgage business: the people who originated subprime mortgages, the Wall Street firms that packaged and sold subprime mortgages, the fund managers who invested in nothing but subprime-mortgage-backed bonds, the agencies that rated subprime-mortgage bonds, the lawyers who did whatever the lawyers did. Daniel and Moses thought they were paying a courtesy call on a cottage industry, but the cottage had become a castle. “There were like 6,000 people there,” Daniel says. “There were so many people being fed by this industry. The entire fixed-income department of each brokerage firm is built on this. Everyone there was the long side of the trade. The wrong side of the trade. And then there was us. That’s when the picture really started to become clearer, and we started to get more cynical, if that was possible. We went back home and said to Steve, ‘You gotta see this.’ ”
Eisman, Daniel, and Moses then flew out to Las Vegas for an even bigger subprime conference. By now, Eisman knew everything he needed to know about the quality of the loans being made. He still didn’t fully understand how the apparatus worked, but he knew that Wall Street had built a doomsday machine. He was at once opportunistic and outraged.
Their first stop was a speech given by the C.E.O. of Option One, the mortgage originator owned by H&R Block. When the guy got to the part of his speech about Option One’s subprime-loan portfolio, he claimed to be expecting a modest default rate of 5 percent. Eisman raised his hand. Moses and Daniel sank into their chairs. “It wasn’t a Q&A,” says Moses. “The guy was giving a speech. He sees Steve’s hand and says, ‘Yes?’”
Would you say that 5 percent is a probability or a possibility?” Eisman asked.
A probability, said the C.E.O., and he continued his speech.
Eisman had his hand up in the air again, waving it around. Oh, no, Moses thought. “The one thing Steve always says,” Daniel explains, “is you must assume they are lying to you. They will always lie to you.” Moses and Daniel both knew what Eisman thought of these subprime lenders but didn’t see the need for him to express it here in this manner. For Eisman wasn’t raising his hand to ask a question. He had his thumb and index finger in a big circle. He was using his fingers to speak on his behalf. Zero! they said.
“Yes?” the C.E.O. said, obviously irritated. “Is that another question?”
“No,” said Eisman. “It’s a zero. There is zero probability that your default rate will be 5 percent.” The losses on subprime loans would be much, much greater. Before the guy could reply, Eisman’s cell phone rang. Instead of shutting it off, Eisman reached into his pocket and answered it. “Excuse me,” he said, standing up. “But I need to take this call.” And with that, he walked out.
Eisman’s willingness to be abrasive in order to get to the heart of the matter was obvious to all; what was harder to see was his credulity: He actually wanted to believe in the system. As quick as he was to cry bullshit when he saw it, he was still shocked by bad behavior. That night in Vegas, he was seated at dinner beside a really nice guy who invested in mortgage C.D.O.’s—collateralized debt obligations. By then, Eisman thought he knew what he needed to know about C.D.O.’s. He didn’t, it turned out.
Later, when I sit down with Eisman, the very first thing he wants to explain is the importance of the mezzanine C.D.O. What you notice first about Eisman is his lips. He holds them pursed, waiting to speak. The second thing you notice is his short, light hair, cropped in a manner that suggests he cut it himself while thinking about something else. “You have to understand this,” he says. “This was the engine of doom.” Then he draws a picture of several towers of debt. The first tower is made of the original subprime loans that had been piled together. At the top of this tower is the AAA tranche, just below it the AA tranche, and so on down to the riskiest, the BBB tranche—the bonds Eisman had shorted. But Wall Street had used these BBB tranches—the worst of the worst—to build yet another tower of bonds: a “particularly egregious” C.D.O. The reason they did this was that the rating agencies, presented with the pile of bonds backed by dubious loans, would pronounce most of them AAA. These bonds could then be sold to investors—pension funds, insurance companies—who were allowed to invest only in highly rated securities. “I cannot fucking believe this is allowed—I must have said that a thousand times in the past two years,” Eisman says.
His dinner companion in Las Vegas ran a fund of about $15 billion and managed C.D.O.’s backed by the BBB tranche of a mortgage bond, or as Eisman puts it, “the equivalent of three levels of dog shit lower than the original bonds.”
FrontPoint had spent a lot of time digging around in the dog shit and knew that the default rates were already sufficient to wipe out this guy’s entire portfolio. “God, you must be having a hard time,” Eisman told his dinner companion.
“No,” the guy said, “I’ve sold everything out.”
After taking a fee, he passed them on to other investors. His job was to be the C.D.O. “expert,” but he actually didn’t spend any time at all thinking about what was in the C.D.O.’s. “He managed the C.D.O.’s,” says Eisman, “but managed what? I was just appalled. People would pay up to have someone manage their C.D.O.’s—as if this moron was helping you. I thought, You prick, you don’t give a fuck about the investors in this thing.”
Whatever rising anger Eisman felt was offset by the man’s genial disposition. Not only did he not mind that Eisman took a dim view of his C.D.O.’s; he saw it as a basis for friendship. “Then he said something that blew my mind,” Eisman tells me. “He says, ‘I love guys like you who short my market. Without you, I don’t have anything to buy.’ ”
That’s when Eisman finally got it. Here he’d been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully understanding why those firms were so eager to make the bets. Now he saw. There weren’t enough Americans with shitty credit taking out loans to satisfy investors’ appetite for the end product. The firms used Eisman’s bet to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn’t create a second Peyton Manning to inflate the league’s stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. The only assets backing the bonds were the side bets Eisman and others made with firms like Goldman Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all. “They weren’t satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn’t afford,” Eisman says. “They were creating them out of whole cloth. One hundred times over! That’s why the losses are so much greater than the loans. But that’s when I realized they needed us to keep the machine running. I was like, This is allowed?”
This particular dinner was hosted by Deutsche Bank, whose head trader, Greg Lippman, was the fellow who had introduced Eisman to the subprime bond market. Eisman went and found Lippman, pointed back to his own dinner companion, and said, “I want to short him.” Lippman thought he was joking; he wasn’t. “Greg, I want to short his paper,” Eisman repeated. “Sight unseen.”
Eisman started out running a $60 million equity fund but was now short around $600 million of various subprime-related securities. In the spring of 2007, the market strengthened. But, says Eisman, “credit quality always gets better in March and April. And the reason it always gets better in March and April is that people get their tax refunds. You would think people in the securitization world would know this. We just thought that was moronic.”
He was already short the stocks of mortgage originators and the homebuilders. Now he took short positions in the rating agencies—“they were making 10 times more rating C.D.O.’s than they were rating G.M. bonds, and it was all going to end”—and, finally, the biggest Wall Street firms because of their exposure to C.D.O.’s. He wasn’t allowed to short Morgan Stanley because it owned a stake in his fund. But he shorted UBS, Lehman Brothers, and a few others. Not long after that, FrontPoint had a visit from Sanford C. Bernstein’s Brad Hintz, a prominent analyst who covered Wall Street firms. Hintz wanted to know what Eisman was up to. “We just shorted Merrill Lynch,” Eisman told him.
“Why?” asked Hintz.
“We have a simple thesis,” Eisman explained. “There is going to be a calamity, and whenever there is a calamity, Merrill is there.” When it came time to bankrupt Orange County with bad advice, Merrill was there. When the internet went bust, Merrill was there. Way back in the 1980s, when the first bond trader was let off his leash and lost hundreds of millions of dollars, Merrill was there to take the hit. That was Eisman’s logic—the logic of Wall Street’s pecking order. Goldman Sachs was the big kid who ran the games in this neighborhood. Merrill Lynch was the little fat kid assigned the least pleasant roles, just happy to be a part of things. The game, as Eisman saw it, was Crack the Whip. He assumed Merrill Lynch had taken its assigned place at the end of the chain.
There was only one thing that bothered Eisman, and it continued to trouble him as late as May 2007. “The thing we couldn’t figure out is: It’s so obvious. Why hasn’t everyone else figured out that the machine is done?” Eisman had long subscribed to Grant’s Interest Rate Observer, a newsletter famous in Wall Street circles and obscure outside them. Jim Grant, its editor, had been prophesying doom ever since the great debt cycle began, in the mid-1980s. In late 2006, he decided to investigate these things called C.D.O.’s. Or rather, he had asked his young assistant, Dan Gertner, a chemical engineer with an M.B.A., to see if he could understand them. Gertner went off with the documents that purported to explain C.D.O.’s to potential investors and for several days sweated and groaned and heaved and suffered. “Then he came back,” says Grant, “and said, ‘I can’t figure this thing out.’ And I said, ‘I think we have our story.’ ”
Eisman read Grant’s piece as independent confirmation of what he knew in his bones about the C.D.O.’s he had shorted. “When I read it, I thought, Oh my God. This is like owning a gold mine. When I read that, I was the only guy in the equity world who almost had an orgasm.”
On July 19, 2007, the same day that Federal Reserve Chairman Ben Bernanke told the U.S. Senate that he anticipated as much as $100 billion in losses in the subprime-mortgage market, FrontPoint did something unusual: It hosted its own conference call. It had had calls with its tiny population of investors, but this time FrontPoint opened it up. Steve Eisman had become a poorly kept secret. Five hundred people called in to hear what he had to say, and another 500 logged on afterward to listen to a recording of it. He explained the strange alchemy of the C.D.O. and said that he expected losses of up to $300 billion from this sliver of the market alone. To evaluate the situation, he urged his audience to “just throw your model in the garbage can. The models are all backward-looking.
The models don’t have any idea of what this world has become…. For the first time in their lives, people in the asset-backed-securitization world are actually having to think.” He explained that the rating agencies were morally bankrupt and living in fear of becoming actually bankrupt. “The rating agencies are scared to death,” he said. “They’re scared to death about doing nothing because they’ll look like fools if they do nothing.”
On September 18, 2008, Danny Moses came to work as usual at 6:30 a.m. Earlier that week, Lehman Brothers had filed for bankruptcy. The day before, the Dow had fallen 449 points to its lowest level in four years. Overnight, European governments announced a ban on short-selling, but that served as faint warning for what happened next.
At the market opening in the U.S., everything—every financial asset—went into free fall. “All hell was breaking loose in a way I had never seen in my career,” Moses says. FrontPoint was net short the market, so this total collapse should have given Moses pleasure. He might have been forgiven if he stood up and cheered. After all, he’d been betting for two years that this sort of thing could happen, and now it was, more dramatically than he had ever imagined. Instead, he felt this terrifying shudder run through him. He had maybe 100 trades on, and he worked hard to keep a handle on them all. “I spent my morning trying to control all this energy and all this information,” he says, “and I lost control. I looked at the screens. I was staring into the abyss. The end. I felt this shooting pain in my head. I don’t get headaches. At first, I thought I was having an aneurysm.”
Moses stood up, wobbled, then turned to Daniel and said, “I gotta leave. Get out of here. Now.” Daniel thought about calling an ambulance but instead took Moses out for a walk.
Outside it was gorgeous, the blue sky reaching down through the tall buildings and warming the soul. Eisman was at a Goldman Sachs conference for hedge fund managers, raising capital. Moses and Daniel got him on the phone, and he left the conference and met them on the steps of St. Patrick’s Cathedral. “We just sat there,” Moses says. “Watching the people pass.”
This was what they had been waiting for: total collapse. “The investment-banking industry is fucked,” Eisman had told me a few weeks earlier. “These guys are only beginning to understand how fucked they are. It’s like being a Scholastic, prior to Newton. Newton comes along, and one morning you wake up: ‘Holy shit, I’m wrong!’ ” Now Lehman Brothers had vanished, Merrill had surrendered, and Goldman Sachs and Morgan Stanley were just a week away from ceasing to be investment banks. The investment banks were not just fucked; they were extinct.
Not so for hedge fund managers who had seen it coming. “As we sat there, we were weirdly calm,” Moses says. “We felt insulated from the whole market reality. It was an out-of-body experience. We just sat and watched the people pass and talked about what might happen next. How many of these people were going to lose their jobs. Who was going to rent these buildings after all the Wall Street firms collapsed.” Eisman was appalled. “Look,” he said. “I’m short. I don’t want the country to go into a depression. I just want it to fucking deleverage.” He had tried a thousand times in a thousand ways to explain how screwed up the business was, and no one wanted to hear it. “That Wall Street has gone down because of this is justice,” he says. “They fucked people. They built a castle to rip people off. Not once in all these years have I come across a person inside a big Wall Street firm who was having a crisis of conscience.”
Truth to tell, there wasn’t a whole lot of hand-wringing inside FrontPoint either. The only one among them who wrestled a bit with his conscience was Daniel. “Vinny, being from Queens, needs to see the dark side of everything,” Eisman says. To which Daniel replies, “The way we thought about it was, ‘By shorting this market we’re creating the liquidity to keep the market going.’ ”
“It was like feeding the monster,” Eisman says of the market for subprime bonds. “We fed the monster until it blew up.”
About the time they were sitting on the steps of the midtown cathedral, I sat in a booth in a restaurant on the East Side, waiting for John Gutfreund to arrive for lunch, and wondered, among other things, why any restaurant would seat side by side two men without the slightest interest in touching each other.
There was an umbilical cord running from the belly of the exploded beast back to the financial 1980s. A friend of mine created the first mortgage derivative in 1986, a year after we left the Salomon Brothers trading program. (“The problem isn’t the tools,” he likes to say. “It’s who is using the tools. Derivatives are like guns.”)
When I published my book, the 1980s were supposed to be ending. I received a lot of undeserved credit for my timing. The social disruption caused by the collapse of the savings-and-loan industry and the rise of hostile takeovers and leveraged buyouts had given way to a brief period of recriminations. Just as most students at Ohio State read Liar’s Poker as a manual, most TV and radio interviewers regarded me as a whistleblower. (The big exception was Geraldo Rivera. He put me on a show called “People Who Succeed Too Early in Life” along with some child actors who’d gone on to become drug addicts.) Anti-Wall Street feeling ran high—high enough for Rudy Giuliani to float a political career on it—but the result felt more like a witch hunt than an honest reappraisal of the financial order. The public lynchings of Gutfreund and junk-bond king Michael Milken were excuses not to deal with the disturbing forces underpinning their rise. Ditto the cleaning up of Wall Street’s trading culture. The surface rippled, but down below, in the depths, the bonus pool remained undisturbed. Wall Street firms would soon be frowning upon profanity, firing traders for so much as glancing at a stripper, and forcing male employees to treat women almost as equals. Lehman Brothers circa 2008 more closely resembled a normal corporation with solid American values than did any Wall Street firm circa 1985.
The changes were camouflage. They helped distract outsiders from the truly profane event: the growing misalignment of interests between the people who trafficked in financial risk and the wider culture.
I’d not seen Gutfreund since I quit Wall Street. I’d met him, nervously, a couple of times on the trading floor. A few months before I left, my bosses asked me to explain to Gutfreund what at the time seemed like exotic trades in derivatives I’d done with a European hedge fund. I tried. He claimed not to be smart enough to understand any of it, and I assumed that was how a Wall Street C.E.O. showed he was the boss, by rising above the details. There was no reason for him to remember any of these encounters, and he didn’t: When my book came out and became a public-relations nuisance to him, he told reporters we’d never met.
Over the years, I’d heard bits and pieces about Gutfreund. I knew that after he’d been forced to resign from Salomon Brothers he’d fallen on harder times. I heard later that a few years ago he’d sat on a panel about Wall Street at Columbia Business School. When his turn came to speak, he advised students to find something more meaningful to do with their lives. As he began to describe his career, he broke down and wept.
When I emailed him to invite him to lunch, he could not have been more polite or more gracious. That attitude persisted as he was escorted to the table, made chitchat with the owner, and ordered his food. He’d lost a half-step and was more deliberate in his movements, but otherwise he was completely recognizable. The same veneer of denatured courtliness masked the same animal need to see the world as it was, rather than as it should be.
We spent 20 minutes or so determining that our presence at the same lunch table was not going to cause the earth to explode. We discovered we had a mutual acquaintance in New Orleans. We agreed that the Wall Street C.E.O. had no real ability to keep track of the frantic innovation occurring inside his firm. (“I didn’t understand all the product lines, and they don’t either,” he said.) We agreed, further, that the chief of the Wall Street investment bank had little control over his subordinates. (“They’re buttering you up and then doing whatever the fuck they want to do.”) He thought the cause of the financial crisis was “simple. Greed on both sides—greed of investors and the greed of the bankers.” I thought it was more complicated. Greed on Wall Street was a given—almost an obligation. The problem was the system of incentives that channeled the greed.
But I didn’t argue with him. For just as you revert to being about nine years old when you visit your parents, you revert to total subordination when you are in the presence of your former C.E.O. John Gutfreund was still the King of Wall Street, and I was still a geek. He spoke in declarative statements; I spoke in questions.
But as he spoke, my eyes kept drifting to his hands. His alarmingly thick and meaty hands. They weren’t the hands of a soft Wall Street banker but of a boxer. I looked up. The boxer was smiling—though it was less a smile than a placeholder expression. And he was saying, very deliberately, “Your…fucking…book.”
I smiled back, though it wasn’t quite a smile.
“Your fucking book destroyed my career, and it made yours,” he said.
I didn’t think of it that way and said so, sort of.
“Why did you ask me to lunch?” he asked, though pleasantly. He was genuinely curious.
You can’t really tell someone that you asked him to lunch to let him know that you don’t think of him as evil. Nor can you tell him that you asked him to lunch because you thought that you could trace the biggest financial crisis in the history of the world back to a decision he had made. John Gutfreund did violence to the Wall Street social order—and got himself dubbed the King of Wall Street—when he turned Salomon Brothers from a private partnership into Wall Street’s first public corporation. He ignored the outrage of Salomon’s retired partners. (“I was disgusted by his materialism,” William Salomon, the son of the firm’s founder, who had made Gutfreund C.E.O. only after he’d promised never to sell the firm, had told me.) He lifted a giant middle finger at the moral disapproval of his fellow Wall Street C.E.O.’s. And he seized the day. He and the other partners not only made a quick killing; they transferred the ultimate financial risk from themselves to their shareholders. It didn’t, in the end, make a great deal of sense for the shareholders. (A share of Salomon Brothers purchased when I arrived on the trading floor, in 1986, at a then market price of $42, would be worth 2.26 shares of Citigroup today—market value: $27.) But it made fantastic sense for the investment bankers.
From that moment, though, the Wall Street firm became a black box. The shareholders who financed the risks had no real understanding of what the risk takers were doing, and as the risk-taking grew ever more complex, their understanding diminished. The moment Salomon Brothers demonstrated the potential gains to be had by the investment bank as public corporation, the psychological foundations of Wall Street shifted from trust to blind faith.
No investment bank owned by its employees would have levered itself 35 to 1 or bought and held $50 billion in mezzanine C.D.O.’s. I doubt any partnership would have sought to game the rating agencies or leap into bed with loan sharks or even allow mezzanine C.D.O.’s to be sold to its customers. The hoped-for short-term gain would not have justified the long-term hit.
No partnership, for that matter, would have hired me or anyone remotely like me. Was there ever any correlation between the ability to get in and out of Princeton and a talent for taking financial risk?
Now I asked Gutfreund about his biggest decision. “Yes,” he said. “They—the heads of the other Wall Street firms—all said what an awful thing it was to go public and how could you do such a thing. But when the temptation arose, they all gave in to it.” He agreed that the main effect of turning a partnership into a corporation was to transfer the financial risk to the shareholders. “When things go wrong, it’s their problem,” he said—and obviously not theirs alone. When a Wall Street investment bank screwed up badly enough, its risks became the problem of the U.S. government. “It’s laissez-faire until you get in deep shit,” he said, with a half chuckle. He was out of the game.
It was now all someone else’s fault.
He watched me curiously as I scribbled down his words. “What’s this for?” he asked.
I told him I thought it might be worth revisiting the world I’d described in Liar’s Poker, now that it was finally dying. Maybe bring out a 20th-anniversary edition.
“That’s nauseating,” he said.
Hard as it was for him to enjoy my company, it was harder for me not to enjoy his. He was still tough, as straight and blunt as a butcher. He’d helped create a monster, but he still had in him a lot of the old Wall Street, where people said things like “A man’s word is his bond.” On that Wall Street, people didn’t walk out of their firms and cause trouble for their former bosses by writing books about them. “No,” he said, “I think we can agree about this: Your fucking book destroyed my career, and it made yours.” With that, the former king of a former Wall Street lifted the plate that held his appetizer and asked sweetly, “Would you like a deviled egg?”
Until that moment, I hadn’t paid much attention to what he’d been eating. Now I saw he’d ordered the best thing in the house, this gorgeous frothy confection of an earlier age. Who ever dreamed up the deviled egg? Who knew that a simple egg could be made so complicated and yet so appealing? I reached over and took one. Something for nothing. It never loses its charm.
Link
Moses actually flew down to Miami and wandered around neighborhoods built with subprime loans to see how bad things were. “He’d call me and say, ‘Oh my God, this is a calamity here,’ ” recalls Eisman. All that was required for the BBB bonds to go to zero was for the default rate on the underlying loans to reach 14 percent. Eisman thought that, in certain sections of the country, it would go far, far higher.
The funny thing, looking back on it, is how long it took for even someone who predicted the disaster to grasp its root causes. They were learning about this on the fly, shorting the bonds and then trying to figure out what they had done. Eisman knew subprime lenders could be scumbags. What he underestimated was the total unabashed complicity of the upper class of American capitalism. For instance, he knew that the big Wall Street investment banks took huge piles of loans that in and of themselves might be rated BBB, threw them into a trust, carved the trust into tranches, and wound up with 60 percent of the new total being rated AAA.
But he couldn’t figure out exactly how the rating agencies justified turning BBB loans into AAA-rated bonds. “I didn’t understand how they were turning all this garbage into gold,” he says. He brought some of the bond people from Goldman Sachs, Lehman Brothers, and UBS over for a visit. “We always asked the same question,” says Eisman. “Where are the rating agencies in all of this? And I’d always get the same reaction. It was a smirk.” He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number. “They were just assuming home prices would keep going up,” Eisman says.
As an investor, Eisman was allowed on the quarterly conference calls held by Moody’s but not allowed to ask questions. The people at Moody’s were polite about their brush-off, however. The C.E.O. even invited Eisman and his team to his office for a visit in June 2007. By then, Eisman was so certain that the world had been turned upside down that he just assumed this guy must know it too. “But we’re sitting there,” Daniel recalls, “and he says to us, like he actually means it, ‘I truly believe that our rating will prove accurate.’ And Steve shoots up in his chair and asks, ‘What did you just say?’ as if the guy had just uttered the most preposterous statement in the history of finance. He repeated it. And Eisman just laughed at him.”
“With all due respect, sir,” Daniel told the C.E.O. deferentially as they left the meeting, “you’re delusional.”
This wasn’t Fitch or even S&P. This was Moody’s, the aristocrats of the rating business, 20 percent owned by Warren Buffett. And the company’s C.E.O. was being told he was either a fool or a crook by one Vincent Daniel, from Queens.
A full nine months earlier, Daniel and Moses had flown to Orlando for an industry conference. It had a grand title—the American Securitization Forum—but it was essentially a trade show for the subprime-mortgage business: the people who originated subprime mortgages, the Wall Street firms that packaged and sold subprime mortgages, the fund managers who invested in nothing but subprime-mortgage-backed bonds, the agencies that rated subprime-mortgage bonds, the lawyers who did whatever the lawyers did. Daniel and Moses thought they were paying a courtesy call on a cottage industry, but the cottage had become a castle. “There were like 6,000 people there,” Daniel says. “There were so many people being fed by this industry. The entire fixed-income department of each brokerage firm is built on this. Everyone there was the long side of the trade. The wrong side of the trade. And then there was us. That’s when the picture really started to become clearer, and we started to get more cynical, if that was possible. We went back home and said to Steve, ‘You gotta see this.’ ”
Eisman, Daniel, and Moses then flew out to Las Vegas for an even bigger subprime conference. By now, Eisman knew everything he needed to know about the quality of the loans being made. He still didn’t fully understand how the apparatus worked, but he knew that Wall Street had built a doomsday machine. He was at once opportunistic and outraged.
Their first stop was a speech given by the C.E.O. of Option One, the mortgage originator owned by H&R Block. When the guy got to the part of his speech about Option One’s subprime-loan portfolio, he claimed to be expecting a modest default rate of 5 percent. Eisman raised his hand. Moses and Daniel sank into their chairs. “It wasn’t a Q&A,” says Moses. “The guy was giving a speech. He sees Steve’s hand and says, ‘Yes?’”
Would you say that 5 percent is a probability or a possibility?” Eisman asked.
A probability, said the C.E.O., and he continued his speech.
Eisman had his hand up in the air again, waving it around. Oh, no, Moses thought. “The one thing Steve always says,” Daniel explains, “is you must assume they are lying to you. They will always lie to you.” Moses and Daniel both knew what Eisman thought of these subprime lenders but didn’t see the need for him to express it here in this manner. For Eisman wasn’t raising his hand to ask a question. He had his thumb and index finger in a big circle. He was using his fingers to speak on his behalf. Zero! they said.
“Yes?” the C.E.O. said, obviously irritated. “Is that another question?”
“No,” said Eisman. “It’s a zero. There is zero probability that your default rate will be 5 percent.” The losses on subprime loans would be much, much greater. Before the guy could reply, Eisman’s cell phone rang. Instead of shutting it off, Eisman reached into his pocket and answered it. “Excuse me,” he said, standing up. “But I need to take this call.” And with that, he walked out.
Eisman’s willingness to be abrasive in order to get to the heart of the matter was obvious to all; what was harder to see was his credulity: He actually wanted to believe in the system. As quick as he was to cry bullshit when he saw it, he was still shocked by bad behavior. That night in Vegas, he was seated at dinner beside a really nice guy who invested in mortgage C.D.O.’s—collateralized debt obligations. By then, Eisman thought he knew what he needed to know about C.D.O.’s. He didn’t, it turned out.
Later, when I sit down with Eisman, the very first thing he wants to explain is the importance of the mezzanine C.D.O. What you notice first about Eisman is his lips. He holds them pursed, waiting to speak. The second thing you notice is his short, light hair, cropped in a manner that suggests he cut it himself while thinking about something else. “You have to understand this,” he says. “This was the engine of doom.” Then he draws a picture of several towers of debt. The first tower is made of the original subprime loans that had been piled together. At the top of this tower is the AAA tranche, just below it the AA tranche, and so on down to the riskiest, the BBB tranche—the bonds Eisman had shorted. But Wall Street had used these BBB tranches—the worst of the worst—to build yet another tower of bonds: a “particularly egregious” C.D.O. The reason they did this was that the rating agencies, presented with the pile of bonds backed by dubious loans, would pronounce most of them AAA. These bonds could then be sold to investors—pension funds, insurance companies—who were allowed to invest only in highly rated securities. “I cannot fucking believe this is allowed—I must have said that a thousand times in the past two years,” Eisman says.
His dinner companion in Las Vegas ran a fund of about $15 billion and managed C.D.O.’s backed by the BBB tranche of a mortgage bond, or as Eisman puts it, “the equivalent of three levels of dog shit lower than the original bonds.”
FrontPoint had spent a lot of time digging around in the dog shit and knew that the default rates were already sufficient to wipe out this guy’s entire portfolio. “God, you must be having a hard time,” Eisman told his dinner companion.
“No,” the guy said, “I’ve sold everything out.”
After taking a fee, he passed them on to other investors. His job was to be the C.D.O. “expert,” but he actually didn’t spend any time at all thinking about what was in the C.D.O.’s. “He managed the C.D.O.’s,” says Eisman, “but managed what? I was just appalled. People would pay up to have someone manage their C.D.O.’s—as if this moron was helping you. I thought, You prick, you don’t give a fuck about the investors in this thing.”
Whatever rising anger Eisman felt was offset by the man’s genial disposition. Not only did he not mind that Eisman took a dim view of his C.D.O.’s; he saw it as a basis for friendship. “Then he said something that blew my mind,” Eisman tells me. “He says, ‘I love guys like you who short my market. Without you, I don’t have anything to buy.’ ”
That’s when Eisman finally got it. Here he’d been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully understanding why those firms were so eager to make the bets. Now he saw. There weren’t enough Americans with shitty credit taking out loans to satisfy investors’ appetite for the end product. The firms used Eisman’s bet to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn’t create a second Peyton Manning to inflate the league’s stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. The only assets backing the bonds were the side bets Eisman and others made with firms like Goldman Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all. “They weren’t satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn’t afford,” Eisman says. “They were creating them out of whole cloth. One hundred times over! That’s why the losses are so much greater than the loans. But that’s when I realized they needed us to keep the machine running. I was like, This is allowed?”
This particular dinner was hosted by Deutsche Bank, whose head trader, Greg Lippman, was the fellow who had introduced Eisman to the subprime bond market. Eisman went and found Lippman, pointed back to his own dinner companion, and said, “I want to short him.” Lippman thought he was joking; he wasn’t. “Greg, I want to short his paper,” Eisman repeated. “Sight unseen.”
Eisman started out running a $60 million equity fund but was now short around $600 million of various subprime-related securities. In the spring of 2007, the market strengthened. But, says Eisman, “credit quality always gets better in March and April. And the reason it always gets better in March and April is that people get their tax refunds. You would think people in the securitization world would know this. We just thought that was moronic.”
He was already short the stocks of mortgage originators and the homebuilders. Now he took short positions in the rating agencies—“they were making 10 times more rating C.D.O.’s than they were rating G.M. bonds, and it was all going to end”—and, finally, the biggest Wall Street firms because of their exposure to C.D.O.’s. He wasn’t allowed to short Morgan Stanley because it owned a stake in his fund. But he shorted UBS, Lehman Brothers, and a few others. Not long after that, FrontPoint had a visit from Sanford C. Bernstein’s Brad Hintz, a prominent analyst who covered Wall Street firms. Hintz wanted to know what Eisman was up to. “We just shorted Merrill Lynch,” Eisman told him.
“Why?” asked Hintz.
“We have a simple thesis,” Eisman explained. “There is going to be a calamity, and whenever there is a calamity, Merrill is there.” When it came time to bankrupt Orange County with bad advice, Merrill was there. When the internet went bust, Merrill was there. Way back in the 1980s, when the first bond trader was let off his leash and lost hundreds of millions of dollars, Merrill was there to take the hit. That was Eisman’s logic—the logic of Wall Street’s pecking order. Goldman Sachs was the big kid who ran the games in this neighborhood. Merrill Lynch was the little fat kid assigned the least pleasant roles, just happy to be a part of things. The game, as Eisman saw it, was Crack the Whip. He assumed Merrill Lynch had taken its assigned place at the end of the chain.
There was only one thing that bothered Eisman, and it continued to trouble him as late as May 2007. “The thing we couldn’t figure out is: It’s so obvious. Why hasn’t everyone else figured out that the machine is done?” Eisman had long subscribed to Grant’s Interest Rate Observer, a newsletter famous in Wall Street circles and obscure outside them. Jim Grant, its editor, had been prophesying doom ever since the great debt cycle began, in the mid-1980s. In late 2006, he decided to investigate these things called C.D.O.’s. Or rather, he had asked his young assistant, Dan Gertner, a chemical engineer with an M.B.A., to see if he could understand them. Gertner went off with the documents that purported to explain C.D.O.’s to potential investors and for several days sweated and groaned and heaved and suffered. “Then he came back,” says Grant, “and said, ‘I can’t figure this thing out.’ And I said, ‘I think we have our story.’ ”
Eisman read Grant’s piece as independent confirmation of what he knew in his bones about the C.D.O.’s he had shorted. “When I read it, I thought, Oh my God. This is like owning a gold mine. When I read that, I was the only guy in the equity world who almost had an orgasm.”
On July 19, 2007, the same day that Federal Reserve Chairman Ben Bernanke told the U.S. Senate that he anticipated as much as $100 billion in losses in the subprime-mortgage market, FrontPoint did something unusual: It hosted its own conference call. It had had calls with its tiny population of investors, but this time FrontPoint opened it up. Steve Eisman had become a poorly kept secret. Five hundred people called in to hear what he had to say, and another 500 logged on afterward to listen to a recording of it. He explained the strange alchemy of the C.D.O. and said that he expected losses of up to $300 billion from this sliver of the market alone. To evaluate the situation, he urged his audience to “just throw your model in the garbage can. The models are all backward-looking.
The models don’t have any idea of what this world has become…. For the first time in their lives, people in the asset-backed-securitization world are actually having to think.” He explained that the rating agencies were morally bankrupt and living in fear of becoming actually bankrupt. “The rating agencies are scared to death,” he said. “They’re scared to death about doing nothing because they’ll look like fools if they do nothing.”
On September 18, 2008, Danny Moses came to work as usual at 6:30 a.m. Earlier that week, Lehman Brothers had filed for bankruptcy. The day before, the Dow had fallen 449 points to its lowest level in four years. Overnight, European governments announced a ban on short-selling, but that served as faint warning for what happened next.
At the market opening in the U.S., everything—every financial asset—went into free fall. “All hell was breaking loose in a way I had never seen in my career,” Moses says. FrontPoint was net short the market, so this total collapse should have given Moses pleasure. He might have been forgiven if he stood up and cheered. After all, he’d been betting for two years that this sort of thing could happen, and now it was, more dramatically than he had ever imagined. Instead, he felt this terrifying shudder run through him. He had maybe 100 trades on, and he worked hard to keep a handle on them all. “I spent my morning trying to control all this energy and all this information,” he says, “and I lost control. I looked at the screens. I was staring into the abyss. The end. I felt this shooting pain in my head. I don’t get headaches. At first, I thought I was having an aneurysm.”
Moses stood up, wobbled, then turned to Daniel and said, “I gotta leave. Get out of here. Now.” Daniel thought about calling an ambulance but instead took Moses out for a walk.
Outside it was gorgeous, the blue sky reaching down through the tall buildings and warming the soul. Eisman was at a Goldman Sachs conference for hedge fund managers, raising capital. Moses and Daniel got him on the phone, and he left the conference and met them on the steps of St. Patrick’s Cathedral. “We just sat there,” Moses says. “Watching the people pass.”
This was what they had been waiting for: total collapse. “The investment-banking industry is fucked,” Eisman had told me a few weeks earlier. “These guys are only beginning to understand how fucked they are. It’s like being a Scholastic, prior to Newton. Newton comes along, and one morning you wake up: ‘Holy shit, I’m wrong!’ ” Now Lehman Brothers had vanished, Merrill had surrendered, and Goldman Sachs and Morgan Stanley were just a week away from ceasing to be investment banks. The investment banks were not just fucked; they were extinct.
Not so for hedge fund managers who had seen it coming. “As we sat there, we were weirdly calm,” Moses says. “We felt insulated from the whole market reality. It was an out-of-body experience. We just sat and watched the people pass and talked about what might happen next. How many of these people were going to lose their jobs. Who was going to rent these buildings after all the Wall Street firms collapsed.” Eisman was appalled. “Look,” he said. “I’m short. I don’t want the country to go into a depression. I just want it to fucking deleverage.” He had tried a thousand times in a thousand ways to explain how screwed up the business was, and no one wanted to hear it. “That Wall Street has gone down because of this is justice,” he says. “They fucked people. They built a castle to rip people off. Not once in all these years have I come across a person inside a big Wall Street firm who was having a crisis of conscience.”
Truth to tell, there wasn’t a whole lot of hand-wringing inside FrontPoint either. The only one among them who wrestled a bit with his conscience was Daniel. “Vinny, being from Queens, needs to see the dark side of everything,” Eisman says. To which Daniel replies, “The way we thought about it was, ‘By shorting this market we’re creating the liquidity to keep the market going.’ ”
“It was like feeding the monster,” Eisman says of the market for subprime bonds. “We fed the monster until it blew up.”
About the time they were sitting on the steps of the midtown cathedral, I sat in a booth in a restaurant on the East Side, waiting for John Gutfreund to arrive for lunch, and wondered, among other things, why any restaurant would seat side by side two men without the slightest interest in touching each other.
There was an umbilical cord running from the belly of the exploded beast back to the financial 1980s. A friend of mine created the first mortgage derivative in 1986, a year after we left the Salomon Brothers trading program. (“The problem isn’t the tools,” he likes to say. “It’s who is using the tools. Derivatives are like guns.”)
When I published my book, the 1980s were supposed to be ending. I received a lot of undeserved credit for my timing. The social disruption caused by the collapse of the savings-and-loan industry and the rise of hostile takeovers and leveraged buyouts had given way to a brief period of recriminations. Just as most students at Ohio State read Liar’s Poker as a manual, most TV and radio interviewers regarded me as a whistleblower. (The big exception was Geraldo Rivera. He put me on a show called “People Who Succeed Too Early in Life” along with some child actors who’d gone on to become drug addicts.) Anti-Wall Street feeling ran high—high enough for Rudy Giuliani to float a political career on it—but the result felt more like a witch hunt than an honest reappraisal of the financial order. The public lynchings of Gutfreund and junk-bond king Michael Milken were excuses not to deal with the disturbing forces underpinning their rise. Ditto the cleaning up of Wall Street’s trading culture. The surface rippled, but down below, in the depths, the bonus pool remained undisturbed. Wall Street firms would soon be frowning upon profanity, firing traders for so much as glancing at a stripper, and forcing male employees to treat women almost as equals. Lehman Brothers circa 2008 more closely resembled a normal corporation with solid American values than did any Wall Street firm circa 1985.
The changes were camouflage. They helped distract outsiders from the truly profane event: the growing misalignment of interests between the people who trafficked in financial risk and the wider culture.
I’d not seen Gutfreund since I quit Wall Street. I’d met him, nervously, a couple of times on the trading floor. A few months before I left, my bosses asked me to explain to Gutfreund what at the time seemed like exotic trades in derivatives I’d done with a European hedge fund. I tried. He claimed not to be smart enough to understand any of it, and I assumed that was how a Wall Street C.E.O. showed he was the boss, by rising above the details. There was no reason for him to remember any of these encounters, and he didn’t: When my book came out and became a public-relations nuisance to him, he told reporters we’d never met.
Over the years, I’d heard bits and pieces about Gutfreund. I knew that after he’d been forced to resign from Salomon Brothers he’d fallen on harder times. I heard later that a few years ago he’d sat on a panel about Wall Street at Columbia Business School. When his turn came to speak, he advised students to find something more meaningful to do with their lives. As he began to describe his career, he broke down and wept.
When I emailed him to invite him to lunch, he could not have been more polite or more gracious. That attitude persisted as he was escorted to the table, made chitchat with the owner, and ordered his food. He’d lost a half-step and was more deliberate in his movements, but otherwise he was completely recognizable. The same veneer of denatured courtliness masked the same animal need to see the world as it was, rather than as it should be.
We spent 20 minutes or so determining that our presence at the same lunch table was not going to cause the earth to explode. We discovered we had a mutual acquaintance in New Orleans. We agreed that the Wall Street C.E.O. had no real ability to keep track of the frantic innovation occurring inside his firm. (“I didn’t understand all the product lines, and they don’t either,” he said.) We agreed, further, that the chief of the Wall Street investment bank had little control over his subordinates. (“They’re buttering you up and then doing whatever the fuck they want to do.”) He thought the cause of the financial crisis was “simple. Greed on both sides—greed of investors and the greed of the bankers.” I thought it was more complicated. Greed on Wall Street was a given—almost an obligation. The problem was the system of incentives that channeled the greed.
But I didn’t argue with him. For just as you revert to being about nine years old when you visit your parents, you revert to total subordination when you are in the presence of your former C.E.O. John Gutfreund was still the King of Wall Street, and I was still a geek. He spoke in declarative statements; I spoke in questions.
But as he spoke, my eyes kept drifting to his hands. His alarmingly thick and meaty hands. They weren’t the hands of a soft Wall Street banker but of a boxer. I looked up. The boxer was smiling—though it was less a smile than a placeholder expression. And he was saying, very deliberately, “Your…fucking…book.”
I smiled back, though it wasn’t quite a smile.
“Your fucking book destroyed my career, and it made yours,” he said.
I didn’t think of it that way and said so, sort of.
“Why did you ask me to lunch?” he asked, though pleasantly. He was genuinely curious.
You can’t really tell someone that you asked him to lunch to let him know that you don’t think of him as evil. Nor can you tell him that you asked him to lunch because you thought that you could trace the biggest financial crisis in the history of the world back to a decision he had made. John Gutfreund did violence to the Wall Street social order—and got himself dubbed the King of Wall Street—when he turned Salomon Brothers from a private partnership into Wall Street’s first public corporation. He ignored the outrage of Salomon’s retired partners. (“I was disgusted by his materialism,” William Salomon, the son of the firm’s founder, who had made Gutfreund C.E.O. only after he’d promised never to sell the firm, had told me.) He lifted a giant middle finger at the moral disapproval of his fellow Wall Street C.E.O.’s. And he seized the day. He and the other partners not only made a quick killing; they transferred the ultimate financial risk from themselves to their shareholders. It didn’t, in the end, make a great deal of sense for the shareholders. (A share of Salomon Brothers purchased when I arrived on the trading floor, in 1986, at a then market price of $42, would be worth 2.26 shares of Citigroup today—market value: $27.) But it made fantastic sense for the investment bankers.
From that moment, though, the Wall Street firm became a black box. The shareholders who financed the risks had no real understanding of what the risk takers were doing, and as the risk-taking grew ever more complex, their understanding diminished. The moment Salomon Brothers demonstrated the potential gains to be had by the investment bank as public corporation, the psychological foundations of Wall Street shifted from trust to blind faith.
No investment bank owned by its employees would have levered itself 35 to 1 or bought and held $50 billion in mezzanine C.D.O.’s. I doubt any partnership would have sought to game the rating agencies or leap into bed with loan sharks or even allow mezzanine C.D.O.’s to be sold to its customers. The hoped-for short-term gain would not have justified the long-term hit.
No partnership, for that matter, would have hired me or anyone remotely like me. Was there ever any correlation between the ability to get in and out of Princeton and a talent for taking financial risk?
Now I asked Gutfreund about his biggest decision. “Yes,” he said. “They—the heads of the other Wall Street firms—all said what an awful thing it was to go public and how could you do such a thing. But when the temptation arose, they all gave in to it.” He agreed that the main effect of turning a partnership into a corporation was to transfer the financial risk to the shareholders. “When things go wrong, it’s their problem,” he said—and obviously not theirs alone. When a Wall Street investment bank screwed up badly enough, its risks became the problem of the U.S. government. “It’s laissez-faire until you get in deep shit,” he said, with a half chuckle. He was out of the game.
It was now all someone else’s fault.
He watched me curiously as I scribbled down his words. “What’s this for?” he asked.
I told him I thought it might be worth revisiting the world I’d described in Liar’s Poker, now that it was finally dying. Maybe bring out a 20th-anniversary edition.
“That’s nauseating,” he said.
Hard as it was for him to enjoy my company, it was harder for me not to enjoy his. He was still tough, as straight and blunt as a butcher. He’d helped create a monster, but he still had in him a lot of the old Wall Street, where people said things like “A man’s word is his bond.” On that Wall Street, people didn’t walk out of their firms and cause trouble for their former bosses by writing books about them. “No,” he said, “I think we can agree about this: Your fucking book destroyed my career, and it made yours.” With that, the former king of a former Wall Street lifted the plate that held his appetizer and asked sweetly, “Would you like a deviled egg?”
Until that moment, I hadn’t paid much attention to what he’d been eating. Now I saw he’d ordered the best thing in the house, this gorgeous frothy confection of an earlier age. Who ever dreamed up the deviled egg? Who knew that a simple egg could be made so complicated and yet so appealing? I reached over and took one. Something for nothing. It never loses its charm.
Link
9 November 2008
Rant of the day ~ Collapse
Comes from Patrick Henry, Armchair economist
Hedge Fund Collapse - Major - (excerpts)
I predict and have been saying for some months now that we will experience a major hedge fund collapse soon. This will be larger than the collapse last year of the of $9 billion hedge fund Amaranth Advisors....
Also it is fascinating to see how desperately this entire process is failing...
Not even the idiots making decisions to bail out industries in Washington right now have the stomach to hand over the money to the likes of Cerebus. They would go to jail for something like that.
What if Chrysler / GMAC / Cerebus all go down the tubes? What a party that would be.
Don't be stupid. Shake all preconceived notions about the US stock market being a place to put your money for your future. The world is being reshaped as we speak and until the idiots running our government have the "balls" (for lack of a better word) to shut down the massive unregulated markets that trash the global financial system for a living and admit all of the norms that have defined the functioning of the capital markets have been completely destroyed by this massive unregulated market and their creation of "products" to place their highly leveraged bets, normal people must stay as far from this circus as possible.
If you are saving for your future, get out of the sucker's stock market before it becomes an empty dustbin.
Hedge Fund Collapse - Major - (excerpts)
I predict and have been saying for some months now that we will experience a major hedge fund collapse soon. This will be larger than the collapse last year of the of $9 billion hedge fund Amaranth Advisors....
Also it is fascinating to see how desperately this entire process is failing...
Not even the idiots making decisions to bail out industries in Washington right now have the stomach to hand over the money to the likes of Cerebus. They would go to jail for something like that.
What if Chrysler / GMAC / Cerebus all go down the tubes? What a party that would be.
Don't be stupid. Shake all preconceived notions about the US stock market being a place to put your money for your future. The world is being reshaped as we speak and until the idiots running our government have the "balls" (for lack of a better word) to shut down the massive unregulated markets that trash the global financial system for a living and admit all of the norms that have defined the functioning of the capital markets have been completely destroyed by this massive unregulated market and their creation of "products" to place their highly leveraged bets, normal people must stay as far from this circus as possible.
If you are saving for your future, get out of the sucker's stock market before it becomes an empty dustbin.
7 November 2008
A truly dismal deleveraging nightmare
We are now facing a major de-leveraging cycle and it will suppress economic growth and put a lid on the stock market for years to come.
The Absolute Return Letter - November 2008
We are only in the first or second innings of this recession, and the emerging market story has the potential to wreak further havoc. So do credit default swaps - or something else.
There is no question that hedge funds are downsizing at present. It is likely that much of the recent sell-off in equity markets around the world can be traced back to hedge fund liquidations. The problem is to obtain precise data on the phenomenon.
If we estimate that the global hedge fund industry controls about $2 trillion of capital, and we assume that 15-20% is going to be pulled out between now and year-end (which is not far from the truth according to our sources), $3-400 billion must be returned to investors between now and 31st December.
That is not the whole story though. The average hedge fund uses leverage, to the tune of about 1.4 times (see chart6).
Hedge funds need to liquidate investments of at least $500-550 billion in order to meet current redemption requests. And the real number is probably higher because some of the worst performing strategies this year are the ones using the most leverage. The real number is therefore more likely $6-800 billion, and that is a big enough sum of money to put downward pressure on the markets.
Add to this the fact that some hedge funds (mostly the bigger ones) have been selling credit default swaps (CDSs). The buyer of a CDS supposedly makes money if the underlying credit blows up. I say 'supposedly' because the payment is a function of the seller's ability to pay up.
That was why Morgan Stanley had to be saved at all cost. MS has been, and continues to be, one of the largest players in the CDS market.There is no way we can establish precisely how many CDSs hedge funds have on their books, but please consider the following: The CDS market is a $50 trillion market (give or take). Before they blew up, AIG were one of the biggest sellers of CDSs with approximately $500 billion on their books. They ran into problems (partly) because they were heavily exposed to the financial services industry which is already in recession.
If AIG, one of the largest and most sophisticated financial institutions could get themselves into trouble with barely a 1% share of the global CDS market, what will happen to the sellers of the remaining 99%?
Who 'owns' this risk? Is it hedged or not? Is it even possible to hedge the risk, knowing that your counterparty might not be able to pay up?
...de-leveraging has a long way to run yet, not so much in the hedge fund community where I suspect that much of the damage will be behind us once we pass the next major redemption hurdle on 31st December, but in society more broadly.
I have borrowed Chart 7 below from BCA Research, and it shows total US bank loans as a percentage of US GDP. Unfortunately, the picture would be much the same for many of the European countries.
European banks at risk
Stephen Jen and Spyros Andreopoulos at Morgan Stanley suggest that an already weak banking sector in the OECD could be further stifled by non-performing loans to emerging market countries. Worldwide cross-border lending now stands at $37 trillion with about $4.7 trillion going towards Eastern Europe, Latin America and emerging Asia.
Cross-border lending by European and UK banks to emerging market countries accounts for 21% and 24% of respective GDPs compared to 4% for US banks and 5% for Japanese banks (see chart 4).
Europe has about $3.5 trillion of debt outstanding to emerging market countries whereas the US has only about $500 billion on the line
The country most exposed to emerging markets is Austria with total emerging market loans accounting for no less than 85% of the country's GDP – most of it to Eastern Europe. Austrian banks have been aggressively pursuing opportunities in Eastern Europe for years.
They have in fact been so aggressive that their total lending to the region (approximately $300 billion) exceeds the amount lent by Germany to Eastern Europe. Even more worryingly, Austrian banks are the largest holders of debt on Hungary and Ukraine – two of the most fragile economies on the old Soviet bloc.
As an aside, when the global banking system collapsed in May 1931 in the midst of the Great Depression, it was a run on the Austrian banks which acted as a catalyst.
Italy is possibly in an even more dire condition. Italy's public debt is now the third largest in the world, behind the US and Japan. And, at 107% of GDP, it is almost twice the limit set by the Maastricht Treaty (so much for treaties!).
Italy is also a big lender to Eastern Europe
Unicredit alone has about $130 billion of debt outstanding to Eastern European countries. Italy's predicament is well recognised by fixed income investors. 10-year Italian government bonds now yield 1.08% more than their German sister bonds. The market is telling us that something rather unpleasant could happen to Italy.
The Absolute Return Letter - November 2008
We are only in the first or second innings of this recession, and the emerging market story has the potential to wreak further havoc. So do credit default swaps - or something else.
There is no question that hedge funds are downsizing at present. It is likely that much of the recent sell-off in equity markets around the world can be traced back to hedge fund liquidations. The problem is to obtain precise data on the phenomenon.
If we estimate that the global hedge fund industry controls about $2 trillion of capital, and we assume that 15-20% is going to be pulled out between now and year-end (which is not far from the truth according to our sources), $3-400 billion must be returned to investors between now and 31st December.
That is not the whole story though. The average hedge fund uses leverage, to the tune of about 1.4 times (see chart6).
Hedge funds need to liquidate investments of at least $500-550 billion in order to meet current redemption requests. And the real number is probably higher because some of the worst performing strategies this year are the ones using the most leverage. The real number is therefore more likely $6-800 billion, and that is a big enough sum of money to put downward pressure on the markets.
Add to this the fact that some hedge funds (mostly the bigger ones) have been selling credit default swaps (CDSs). The buyer of a CDS supposedly makes money if the underlying credit blows up. I say 'supposedly' because the payment is a function of the seller's ability to pay up.
That was why Morgan Stanley had to be saved at all cost. MS has been, and continues to be, one of the largest players in the CDS market.There is no way we can establish precisely how many CDSs hedge funds have on their books, but please consider the following: The CDS market is a $50 trillion market (give or take). Before they blew up, AIG were one of the biggest sellers of CDSs with approximately $500 billion on their books. They ran into problems (partly) because they were heavily exposed to the financial services industry which is already in recession.
If AIG, one of the largest and most sophisticated financial institutions could get themselves into trouble with barely a 1% share of the global CDS market, what will happen to the sellers of the remaining 99%?
Who 'owns' this risk? Is it hedged or not? Is it even possible to hedge the risk, knowing that your counterparty might not be able to pay up?
...de-leveraging has a long way to run yet, not so much in the hedge fund community where I suspect that much of the damage will be behind us once we pass the next major redemption hurdle on 31st December, but in society more broadly.
I have borrowed Chart 7 below from BCA Research, and it shows total US bank loans as a percentage of US GDP. Unfortunately, the picture would be much the same for many of the European countries.
European banks at risk
Stephen Jen and Spyros Andreopoulos at Morgan Stanley suggest that an already weak banking sector in the OECD could be further stifled by non-performing loans to emerging market countries. Worldwide cross-border lending now stands at $37 trillion with about $4.7 trillion going towards Eastern Europe, Latin America and emerging Asia.
Cross-border lending by European and UK banks to emerging market countries accounts for 21% and 24% of respective GDPs compared to 4% for US banks and 5% for Japanese banks (see chart 4).
Europe has about $3.5 trillion of debt outstanding to emerging market countries whereas the US has only about $500 billion on the line
The country most exposed to emerging markets is Austria with total emerging market loans accounting for no less than 85% of the country's GDP – most of it to Eastern Europe. Austrian banks have been aggressively pursuing opportunities in Eastern Europe for years.
They have in fact been so aggressive that their total lending to the region (approximately $300 billion) exceeds the amount lent by Germany to Eastern Europe. Even more worryingly, Austrian banks are the largest holders of debt on Hungary and Ukraine – two of the most fragile economies on the old Soviet bloc.
As an aside, when the global banking system collapsed in May 1931 in the midst of the Great Depression, it was a run on the Austrian banks which acted as a catalyst.
Italy is possibly in an even more dire condition. Italy's public debt is now the third largest in the world, behind the US and Japan. And, at 107% of GDP, it is almost twice the limit set by the Maastricht Treaty (so much for treaties!).
Italy is also a big lender to Eastern Europe
Unicredit alone has about $130 billion of debt outstanding to Eastern European countries. Italy's predicament is well recognised by fixed income investors. 10-year Italian government bonds now yield 1.08% more than their German sister bonds. The market is telling us that something rather unpleasant could happen to Italy.
28 October 2008
Biggest U.S. Export by far was bad paper
The bundling of consumer loans and home mortgages into packages of securities -- a process known as securitization -- was the biggest U.S. export business of the 21st century. More than $27 trillion of these securities have been sold since 2001, according to the Securities Industry Financial Markets Association, an industry trade group. That's almost twice last year's U.S. gross domestic product of $13.8 trillion.
The growth over the past decade was made possible by overseas banks, which saw the profits U.S. financial institutions were making and coveted the made-in-America technology, much as consumers around the world craved other emblems of American ingenuity from Coca-Cola to Hollywood movies. Wall Street obliged, with disastrous results: two-thirds of a trillion dollars in bank losses, about 40 percent of them outside the U.S.
''Securitization was based on the premise that a fool was born every minute,'' Joseph Stiglitz, a professor of economics at Columbia University in New York, told a congressional committee on Oct. 21. ''Globalization meant that there was a global landscape on which they could search for those fools -- and they found them everywhere.''
Eager Adopters
European banks, in particular, were eager adopters. Securitizations in Europe increased almost sixfold between 2000 and 2007, from 78 billion euros ($98 billion) to 453 billion euros, according to the European Securitization Forum, a trade organization.
Three Icelandic banks borrowed enough to buy $228 billion of assets, most of them securitizations, turning the country's financial system into a hedge fund. All three banks have been nationalized by the government, leading Prime Minister Geir Haarde to advise citizens to switch from finance to fishing.
In Germany, one bank, Landesbank Sachsen Girozentrale, bought $26 billion worth of subprime-backed investments, putting the state of Saxony on the hook for $4.1 billion.
In Japan, Mizuho Financial Group Inc., the nation's third- largest bank, acquired an entire structured-finance team, which proceeded to lose $6 billion issuing mortgage-backed securities.
Shadow Banking
The damage reaches all the way to Australia, where the town council of Wingecarribee, a municipality outside Sydney with a population of 42,000, bought $20 million of securities from Lehman Brothers Holdings Inc. Now, Lehman is in bankruptcy, the town council is in court and the securities are worth about 15 cents on the dollar.
Securitization is a shadow banking system that funds most of the world's credit cards, car purchases, leveraged buyouts and, for a while, subprime mortgages. The system, which pools loans and slices up the risk of default, made borrowing cheaper for everyone, creating a debt culture that put credit cards in wallets from Seoul to Sao Paolo and enabled people to buy luxury cars and homes. It also pumped out record profits for banks, accounting for as much as one-fifth of their revenue over the last decade.
Beginning about three years ago, investment banks revved the system's engine to boost earnings. They raised revenue by funding more subprime mortgages and cut costs by relying increasingly on the $4.2 trillion sitting in U.S. money-market funds. As it turned out, those decisions would prove fatal.
'Powerful Technology'
''It's a powerful technology that has been driven beyond the speed limit,'' said Juan Ocampo, a former consultant at New York-based advisory firm McKinsey & Co. who wrote a 1988 book popularizing structured finance. ''For the last five years, instead of going 65 mph, they've been gunning it to 140 mph, 150 mph.''
Before the invention of securitization, banks loaned money, received payments and profited from the difference between what the borrower paid and the bank's funding cost.
During the mid-1980s, mortgage-bond traders at Salomon Brothers devised a method of lending without using capital, a technique at the heart of securitization. It works by taking anything that has regular payments -- mortgages, car loans, aircraft leases, music royalties -- and channeling the money to a trust that pays bondholders principal and interest.
Off-Balance-Sheet
The word ''securitization'' implies safety. Investors with less appetite for risk buy higher-rated securities and get paid first at lower interest rates. Those with a bigger appetite get paid later and receive more interest.
Securitization's biggest innovation was the use of off-balance-sheet accounting. If a bank couldn't sell a bond or didn't want to, the asset could be sold to a trust within a so-called special-purpose entity, incorporated in a place such as the Cayman Islands or Dublin, and shifted off the books. Lending expanded, and banks still booked profits.
With this new technology, a bank could originate $100 million in loans, sell off some to investors, transfer the rest to a special-purpose entity and not have to hold any capital. The profit could be as much as 1.25 percentage points of the amount loaned, or $1.25 million for every $100 million issued.
''The banks could turn a low return-on-equity business into one that doesn't use any equity, which was the motivation for this,'' said Brad Hintz, a Sanford C. Bernstein & Co. analyst and former chief financial officer at Lehman. ''It becomes almost like a fee business because it requires no capital.''
'Capture the Prize'
Like most new products, securitization found a market at home before going abroad. Bankers at Salomon and First Boston Inc. raced from bank to bank to convince issuers it was the wave of the future.
William Haley remembers a 10 a.m. meeting in 1987 at Imperial Thrift & Loan Association in Glendale, California. As Haley, at the time a 33-year-old Salomon banker, and his team walked into the conference room to make a pitch, the First Boston team was walking out.
''We exchanged some knowing looks and then tried to beat the pants off them,'' said Haley, who now works at RBS Greenwich Capital Markets Inc., a firm specializing in mortgage-backed securities that is owned by Royal Bank of Scotland Group Plc. ''There was a fierce desire to capture the prize.''
First Boston
First Boston, housed in the same New York office tower as McKinsey, was first out of the gate in March 1985 with a $192 million computer-lease securitization for Sperry Corp., a predecessor of Unisys Corp. The bank then oversaw a series of auto-loan securitizations, including a $4 billion issue by General Motors Acceptance Corp. in October 1986, the biggest corporate debt issue at the time.
Haley's project was a $50 million deal for Banc One Corp. called Certificates for Amortizing Revolving Debts, or CARDs. It was the first credit-card securitization and a blueprint for the $358 billion of such securities now outstanding. The transaction also gave the banks a way to securitize their own assets and get them off their balance sheets, which allowed the money to be lent all over again.
The strategy was detailed in Ocampo's 282-page book ''Securitization of Credit: Inside the New Technology of Finance,'' which he co-wrote with McKinsey consultant James Rosenthal. Ocampo, who received an MBA from Harvard after graduating from the Massachusetts Institute of Technology, and Rosenthal, a Harvard Law School graduate, argued that banks could be more profitable if they used securitization.
McKinsey Book
The authors examined six of the first asset-backed transactions and gave readers a step-by-step guide for how to repeat them. They said that banks that didn't embrace the new technology would be at a disadvantage, and they predicted it would become the dominant form of financing.
''The McKinsey book helped with credibility with issuers,'' said Haley. ''It wasn't that easy in the beginning. Conferences now have thousands of people, but I remember once in Beverly Hills, I gave a speech and there were maybe 25 people in the audience. They were furiously taking notes, however.''
The new technology was spread around the world by the people who worked on the First Boston and Salomon teams. Salomon's group was led by Patricia Jehle, who later founded Bear Stearns's asset-backed unit. Another member, Michael Hutchins, started the first team at a European bank when he went to Zurich-based UBS AG in 1996. A third, Michael Normile, moved to Merrill Lynch & Co., where he ran its securities business, then switched to London-based HSBC Holdings Plc in 2004. Haley built similar teams at Lehman, Chase Manhattan Bank and Amsterdam-based ABN Amro Bank NV.
The growth over the past decade was made possible by overseas banks, which saw the profits U.S. financial institutions were making and coveted the made-in-America technology, much as consumers around the world craved other emblems of American ingenuity from Coca-Cola to Hollywood movies. Wall Street obliged, with disastrous results: two-thirds of a trillion dollars in bank losses, about 40 percent of them outside the U.S.
''Securitization was based on the premise that a fool was born every minute,'' Joseph Stiglitz, a professor of economics at Columbia University in New York, told a congressional committee on Oct. 21. ''Globalization meant that there was a global landscape on which they could search for those fools -- and they found them everywhere.''
Eager Adopters
European banks, in particular, were eager adopters. Securitizations in Europe increased almost sixfold between 2000 and 2007, from 78 billion euros ($98 billion) to 453 billion euros, according to the European Securitization Forum, a trade organization.
Three Icelandic banks borrowed enough to buy $228 billion of assets, most of them securitizations, turning the country's financial system into a hedge fund. All three banks have been nationalized by the government, leading Prime Minister Geir Haarde to advise citizens to switch from finance to fishing.
In Germany, one bank, Landesbank Sachsen Girozentrale, bought $26 billion worth of subprime-backed investments, putting the state of Saxony on the hook for $4.1 billion.
In Japan, Mizuho Financial Group Inc., the nation's third- largest bank, acquired an entire structured-finance team, which proceeded to lose $6 billion issuing mortgage-backed securities.
Shadow Banking
The damage reaches all the way to Australia, where the town council of Wingecarribee, a municipality outside Sydney with a population of 42,000, bought $20 million of securities from Lehman Brothers Holdings Inc. Now, Lehman is in bankruptcy, the town council is in court and the securities are worth about 15 cents on the dollar.
Securitization is a shadow banking system that funds most of the world's credit cards, car purchases, leveraged buyouts and, for a while, subprime mortgages. The system, which pools loans and slices up the risk of default, made borrowing cheaper for everyone, creating a debt culture that put credit cards in wallets from Seoul to Sao Paolo and enabled people to buy luxury cars and homes. It also pumped out record profits for banks, accounting for as much as one-fifth of their revenue over the last decade.
Beginning about three years ago, investment banks revved the system's engine to boost earnings. They raised revenue by funding more subprime mortgages and cut costs by relying increasingly on the $4.2 trillion sitting in U.S. money-market funds. As it turned out, those decisions would prove fatal.
'Powerful Technology'
''It's a powerful technology that has been driven beyond the speed limit,'' said Juan Ocampo, a former consultant at New York-based advisory firm McKinsey & Co. who wrote a 1988 book popularizing structured finance. ''For the last five years, instead of going 65 mph, they've been gunning it to 140 mph, 150 mph.''
Before the invention of securitization, banks loaned money, received payments and profited from the difference between what the borrower paid and the bank's funding cost.
During the mid-1980s, mortgage-bond traders at Salomon Brothers devised a method of lending without using capital, a technique at the heart of securitization. It works by taking anything that has regular payments -- mortgages, car loans, aircraft leases, music royalties -- and channeling the money to a trust that pays bondholders principal and interest.
Off-Balance-Sheet
The word ''securitization'' implies safety. Investors with less appetite for risk buy higher-rated securities and get paid first at lower interest rates. Those with a bigger appetite get paid later and receive more interest.
Securitization's biggest innovation was the use of off-balance-sheet accounting. If a bank couldn't sell a bond or didn't want to, the asset could be sold to a trust within a so-called special-purpose entity, incorporated in a place such as the Cayman Islands or Dublin, and shifted off the books. Lending expanded, and banks still booked profits.
With this new technology, a bank could originate $100 million in loans, sell off some to investors, transfer the rest to a special-purpose entity and not have to hold any capital. The profit could be as much as 1.25 percentage points of the amount loaned, or $1.25 million for every $100 million issued.
''The banks could turn a low return-on-equity business into one that doesn't use any equity, which was the motivation for this,'' said Brad Hintz, a Sanford C. Bernstein & Co. analyst and former chief financial officer at Lehman. ''It becomes almost like a fee business because it requires no capital.''
'Capture the Prize'
Like most new products, securitization found a market at home before going abroad. Bankers at Salomon and First Boston Inc. raced from bank to bank to convince issuers it was the wave of the future.
William Haley remembers a 10 a.m. meeting in 1987 at Imperial Thrift & Loan Association in Glendale, California. As Haley, at the time a 33-year-old Salomon banker, and his team walked into the conference room to make a pitch, the First Boston team was walking out.
''We exchanged some knowing looks and then tried to beat the pants off them,'' said Haley, who now works at RBS Greenwich Capital Markets Inc., a firm specializing in mortgage-backed securities that is owned by Royal Bank of Scotland Group Plc. ''There was a fierce desire to capture the prize.''
First Boston
First Boston, housed in the same New York office tower as McKinsey, was first out of the gate in March 1985 with a $192 million computer-lease securitization for Sperry Corp., a predecessor of Unisys Corp. The bank then oversaw a series of auto-loan securitizations, including a $4 billion issue by General Motors Acceptance Corp. in October 1986, the biggest corporate debt issue at the time.
Haley's project was a $50 million deal for Banc One Corp. called Certificates for Amortizing Revolving Debts, or CARDs. It was the first credit-card securitization and a blueprint for the $358 billion of such securities now outstanding. The transaction also gave the banks a way to securitize their own assets and get them off their balance sheets, which allowed the money to be lent all over again.
The strategy was detailed in Ocampo's 282-page book ''Securitization of Credit: Inside the New Technology of Finance,'' which he co-wrote with McKinsey consultant James Rosenthal. Ocampo, who received an MBA from Harvard after graduating from the Massachusetts Institute of Technology, and Rosenthal, a Harvard Law School graduate, argued that banks could be more profitable if they used securitization.
McKinsey Book
The authors examined six of the first asset-backed transactions and gave readers a step-by-step guide for how to repeat them. They said that banks that didn't embrace the new technology would be at a disadvantage, and they predicted it would become the dominant form of financing.
''The McKinsey book helped with credibility with issuers,'' said Haley. ''It wasn't that easy in the beginning. Conferences now have thousands of people, but I remember once in Beverly Hills, I gave a speech and there were maybe 25 people in the audience. They were furiously taking notes, however.''
The new technology was spread around the world by the people who worked on the First Boston and Salomon teams. Salomon's group was led by Patricia Jehle, who later founded Bear Stearns's asset-backed unit. Another member, Michael Hutchins, started the first team at a European bank when he went to Zurich-based UBS AG in 1996. A third, Michael Normile, moved to Merrill Lynch & Co., where he ran its securities business, then switched to London-based HSBC Holdings Plc in 2004. Haley built similar teams at Lehman, Chase Manhattan Bank and Amsterdam-based ABN Amro Bank NV.
13 August 2008
Whats with Gold going down
With gold pushing down toward $800 an ounce, and perhaps only days from testing that level, a lot of the discussion can be found on the internet discussion groups that goes to the idea that there is some mysterious group of ultra-rich who manipulate the price of this thing, or that, in order to screw the vast majority of folks out of their retirements and small life savings. But, is this a credible view, or is there an alternative explanation; one that's every bit as real - and achieving the same thing, but more in keeping with the notion of a rational marketplace?
As luck would have it, a few weeks back a friend of mine for many years sent me a draft of his new book which is an insider's account of what is really going on in the market from the professional standpoint.
Now, when I say professional, I really mean it. Although I can't use his 'name, my friend Mr. X. actually invented some of the types of debt instruments that are in the process of either blowing or, or just being 'repriced', depending on how much you know. He was one of the players who brought PC's to Wall Street and used them early on to get a leg up on bond trading. And yes, he knows a lot of the players mentioned in "Liar's Poker". Most would know his name, too.
His book explains in great detail how things work in financial markets. I don't mean how things kinda work, I mean how things really work right down to which hedge fund managers hang out at which bars in Greenwich, which as it turns out, is more the center of the financial world lately because it's mostly from there that the US-run private fundsoperate without transparency from offshore places like the Cayman Islands.
We were talking this weekend about how low this commodity, or that, might go, and my friend was explained how the real world worked and I made some comment, which was interrupted with a stern admonition: "Will you stop thinking about fundamentals?" Not wanting to appear an idiot, I shut up and listened.
---
"There are two chapters in my book that explain exactly what's going on in the financial markets today and it has almost nothing to do with fundaments," he began. "You really need to read the two chapters called "The Great De-Levering" and "Invisible Leverage". You can even paraphrase some of it on your site, but I'm still looking for a literary agent for the book, so no exact quotes because I'm still working."
Fair enough.
Let me sketch out where we are at the moment. We're in a world awash with excessive leverage and the world has to "de-lever" in order to get things back in balance in the world of high finance. Think of it this way: When times are good, a high quality securitized bond can be had for as little as 2-cents on the dollar. That's 49 to 1 leverage. More typical was the slightly lower rated securitized assets where leverage was a more modest 19 to 1, but still, that means putting 5% in to control the position.
What is happening with The Great De-levering" underway is actually a double whammy. First, the value of the securitized assets is dropping, so instead of a tranche being valued at 100-cents on the dollar, it might drop to perhaps 92-cents on the dollar. And then, to make matters worse, the lenders were (and are) demanding the hedge funds have more 'skin in the game'.
So say you had a MBS (mortgage backed security) that was valued at $1.00 and held with 49 to 1 leverage. Your hedge fund puts up two-cents for each $1.00 controlled. Just add zero's to the concept and you're there.
Next, because of foreclosures and jitters, you get "the call" (a telephone call that's a margin call) from your banker who's been putting up the 98-cents as a loan. The call goes something like this:
"Hi, George? That $1.00 MBS is no longer going to be marked to model. Instead, we are marking to street price and that's now 87.5-cents. And, because capital is getting more dear, we're also going to increase your margin requirement to 5% from the current 2%."
Look at what this has done to my hedge fund P&L: I used to show $1.00 of assets on the strength of my MBS but since it has been repriced, This asset just dropped 12½%/ And now, to stay in the game, I will need to put up 5% of the 87.5-cent asset or 4.375-cents instead of the two-cents I had in earlier. My hedge fund sudden looks like a poor lending risk - and that would trigger more margin calls in itself. Yikes!
Now, you need to ask this simple question: "How many hedge funds can lose 12½% and more than double their actual cash in the game to hold that position? Answer: Effectively None.
---
Placed in this position, the hedge fund, which has been enjoying great profits from this trade before repricing, now finds that they are upset down, so the only way to get out of the trade is to sell the repriced assets into the market to liquidate the position, but that sale will happen at the new lower price. And then, if there's any kind of gap left, they will have to sell off other assets, too. Things become self-reinforcing on the downside.
You can see what happens now, right? One asset class going toes up means that assets that were maybe just fine (and fairly priced) have to be sold off to balance the books. And because that asset is sold at a discount (like gold contracts, or silver, just as a hypothetical) those prices begin to move down.
My friend's book explains how on March 16th of this year, one of the lenders, Bear Stearns, got into trouble because so many hedge funds were trying to get so many dollars out. Being crafty folks, some of the smart folks involved noticed the Bear was bleeding and decided to lay on some serious put options betting that Bear shares would go down.
---
Although there are lots of headlines around this morning asking "Who bought $1.7 million "Lottery Ticket" on Bear Streans collapse?" like it was some kind of 'inside" job, there were ots of people on the Street who sensed what was happening and could have placed off-setting bets. And this one happened to pay off - BIG. To the tune of $270-million.
The reason the bankers and government (Fed/Treasury) had to bail out Bear was that as one of the largest market makers of Credit Default Swaps (CDS) if Bear hadn't been saved with your $30-billion of taxpayer bailout, we would be in the midst of the Second Depression right now today. As it is, the slower unwinding may be a little more easy to deal with and it will keep at least most of the 'blood' off the hands of the oil party. We're years from this being over.
---
Most taxpayers aren't going to 'get it' and will be quick to adjudge that if someone who's smart can make a quick $270 million, how come we're getting stiffed for $30-billion? Ignorance has its price.
The really knowledgeable players already knew who the key fund lenders were - and because of Bear's key role, the funds were watching and knew when the withdraw money, so I'm not inclined to think criminal conspiracy so much as think it's a more or less natural outcome of "The Great De-Levering." Smart folks make money, dumb folks lose and sheep get sheared.
---
So how far is down? My friend, who's background in finance qualifies him to answer the question better than 99.9% experts, isn't sure. He's looking for it to continue on for probably a couple of more years and in that time, we'll go through episodes of relative quiet (like now) or we will hit another downdraft, by my reckoning perhaps this fall.
"We've got about $500-trillion in synthetics to de-lever, but some of that is double-counted, and some is counted four times, but it's still lot of money," he explains. "And the hedge funds only have about a trillion to play with. So you can see there's a lot of downside potential."
As good as my confidant is at running numbers out, there's no way to tell when it will all stop. But if you're looking for a wild-*ss guess, try this observation: "There are about 9,000 hedge funds out there right now. I wouldn't think the de-levering is over until maybe 6,000 of them have gone broke...and the 3,000 that remain will be a mix of winners and those barely hanging on..." That's only a guess. No one knows for sure.
What's going on right now in the markets - and it's spreading across all kinds of commodity markets and resulting in massive price deflation -- is also pushed along as the result of what my source calls "Invisible Leverage."
Here's why it's going on even as we speak. If I give you $200 to invest in stocks, and you put $100 on each of two stocks and one doubles, while the other falls to half its value, how does your return look?
The answer is the first $100 goes to $200, while the other goes down to $50, so at the end of the day, your stock picks are worth $250 - or a hefty 25% return, even if you get only 50% right. Sweet, huh?
Since stocks can make a great return with 50/50 odds on the upside, the hedge traders make their long side bets in the stocks, but because the odds of success run more like 25-1 against you on the long side of bonds, they make their bearish bets in bonds... they couldn't do this until the CDS (Credit Default Swap) market developed, which allowed traders to "go short" in the credit markets.
What was developed to be a hedging product turned out to have such a good risk/return profile for bears that we now have the weird situation where the short-side bets against some bonds can be 10 to 50 times the size of the bond issues themselves. It is the limited capital needed to enter the CDS that gives the market its "invisible leverage" -- the cash market is only allowing 1-1 or maybe 3-1 leverage (look at CDO sale to Lone Star with financing by Merrill), but CDS protection buyers (the bears) can still get 19-1 leverage . JP Morgan got a nice 29-1 leverage from the taxpayers on Bear Stearns' mortgage portfolio, but that's another story...
---
There's a lot of 'pile on' in play, too. The lemming-like behavior of the retail customers is apparently nothing when compared to the lock-step behavior of hedge funds. All it takes is a word here or there at those particular places in Greenwich, and 'poof!' A whole asset class gets whacked, and thanks to the circular nature of the game, everything else de-levers to some extent as margin calls come in for the players 'caught out'. A failure here, means pressure there, kind of thing.
You won't get to see all this working out in real-time, though, because the offshore funds don't have to report like the regulated players in the US, even though many of the plays are phoned in from Connecticut.
---
Right now, I'm trying to bottom fish a few $17.50 December commodity call options for my personal account. I think the predictive linguistics have laid out a pretty good scenario for what may happen, and if they're right, a quick flight to hard assets might come about before Thanksgiving due to Middle East events to come. But, if it doesn't, I wouldn't be surprised by that outcome, either. I think of it as a $1,500 scratch ticket.
As my friend's book points out, there's nothing wrong with leverage at modest levels, like the 20% down conventional loans to buy a home - that's still a great use of leverage. But 2% (and less) to control huge financial abstractions? That's coming to an end. Painfully.
----
What's hard for people to conceptualize is that a sell off of one commodity (or stock) generates margin calls in others, which in turn drives selling in non-related markets, and those in turn cascade in slow motion which might more properly be called a "Crashcade" although I haven't spied that term (or "Debtberg" in my friends book, yet.
But, before the Second Depression becomes apparent, I'm betting the Oil Party will start another international distraction going and we'll all be blaming some group in another country and getting all whipped up into a frenzy to carpet bomb there. Late October, maybe?
The distractions to come may serve to blame-shift, but I think you can see now that the "PowersThatBe" might readily be described as hedge fund managers reacting to market forces at work.
As luck would have it, a few weeks back a friend of mine for many years sent me a draft of his new book which is an insider's account of what is really going on in the market from the professional standpoint.
Now, when I say professional, I really mean it. Although I can't use his 'name, my friend Mr. X. actually invented some of the types of debt instruments that are in the process of either blowing or, or just being 'repriced', depending on how much you know. He was one of the players who brought PC's to Wall Street and used them early on to get a leg up on bond trading. And yes, he knows a lot of the players mentioned in "Liar's Poker". Most would know his name, too.
His book explains in great detail how things work in financial markets. I don't mean how things kinda work, I mean how things really work right down to which hedge fund managers hang out at which bars in Greenwich, which as it turns out, is more the center of the financial world lately because it's mostly from there that the US-run private fundsoperate without transparency from offshore places like the Cayman Islands.
We were talking this weekend about how low this commodity, or that, might go, and my friend was explained how the real world worked and I made some comment, which was interrupted with a stern admonition: "Will you stop thinking about fundamentals?" Not wanting to appear an idiot, I shut up and listened.
---
"There are two chapters in my book that explain exactly what's going on in the financial markets today and it has almost nothing to do with fundaments," he began. "You really need to read the two chapters called "The Great De-Levering" and "Invisible Leverage". You can even paraphrase some of it on your site, but I'm still looking for a literary agent for the book, so no exact quotes because I'm still working."
Fair enough.
Let me sketch out where we are at the moment. We're in a world awash with excessive leverage and the world has to "de-lever" in order to get things back in balance in the world of high finance. Think of it this way: When times are good, a high quality securitized bond can be had for as little as 2-cents on the dollar. That's 49 to 1 leverage. More typical was the slightly lower rated securitized assets where leverage was a more modest 19 to 1, but still, that means putting 5% in to control the position.
What is happening with The Great De-levering" underway is actually a double whammy. First, the value of the securitized assets is dropping, so instead of a tranche being valued at 100-cents on the dollar, it might drop to perhaps 92-cents on the dollar. And then, to make matters worse, the lenders were (and are) demanding the hedge funds have more 'skin in the game'.
So say you had a MBS (mortgage backed security) that was valued at $1.00 and held with 49 to 1 leverage. Your hedge fund puts up two-cents for each $1.00 controlled. Just add zero's to the concept and you're there.
Next, because of foreclosures and jitters, you get "the call" (a telephone call that's a margin call) from your banker who's been putting up the 98-cents as a loan. The call goes something like this:
"Hi, George? That $1.00 MBS is no longer going to be marked to model. Instead, we are marking to street price and that's now 87.5-cents. And, because capital is getting more dear, we're also going to increase your margin requirement to 5% from the current 2%."
Look at what this has done to my hedge fund P&L: I used to show $1.00 of assets on the strength of my MBS but since it has been repriced, This asset just dropped 12½%/ And now, to stay in the game, I will need to put up 5% of the 87.5-cent asset or 4.375-cents instead of the two-cents I had in earlier. My hedge fund sudden looks like a poor lending risk - and that would trigger more margin calls in itself. Yikes!
Now, you need to ask this simple question: "How many hedge funds can lose 12½% and more than double their actual cash in the game to hold that position? Answer: Effectively None.
---
Placed in this position, the hedge fund, which has been enjoying great profits from this trade before repricing, now finds that they are upset down, so the only way to get out of the trade is to sell the repriced assets into the market to liquidate the position, but that sale will happen at the new lower price. And then, if there's any kind of gap left, they will have to sell off other assets, too. Things become self-reinforcing on the downside.
You can see what happens now, right? One asset class going toes up means that assets that were maybe just fine (and fairly priced) have to be sold off to balance the books. And because that asset is sold at a discount (like gold contracts, or silver, just as a hypothetical) those prices begin to move down.
My friend's book explains how on March 16th of this year, one of the lenders, Bear Stearns, got into trouble because so many hedge funds were trying to get so many dollars out. Being crafty folks, some of the smart folks involved noticed the Bear was bleeding and decided to lay on some serious put options betting that Bear shares would go down.
---
Although there are lots of headlines around this morning asking "Who bought $1.7 million "Lottery Ticket" on Bear Streans collapse?" like it was some kind of 'inside" job, there were ots of people on the Street who sensed what was happening and could have placed off-setting bets. And this one happened to pay off - BIG. To the tune of $270-million.
The reason the bankers and government (Fed/Treasury) had to bail out Bear was that as one of the largest market makers of Credit Default Swaps (CDS) if Bear hadn't been saved with your $30-billion of taxpayer bailout, we would be in the midst of the Second Depression right now today. As it is, the slower unwinding may be a little more easy to deal with and it will keep at least most of the 'blood' off the hands of the oil party. We're years from this being over.
---
Most taxpayers aren't going to 'get it' and will be quick to adjudge that if someone who's smart can make a quick $270 million, how come we're getting stiffed for $30-billion? Ignorance has its price.
The really knowledgeable players already knew who the key fund lenders were - and because of Bear's key role, the funds were watching and knew when the withdraw money, so I'm not inclined to think criminal conspiracy so much as think it's a more or less natural outcome of "The Great De-Levering." Smart folks make money, dumb folks lose and sheep get sheared.
---
So how far is down? My friend, who's background in finance qualifies him to answer the question better than 99.9% experts, isn't sure. He's looking for it to continue on for probably a couple of more years and in that time, we'll go through episodes of relative quiet (like now) or we will hit another downdraft, by my reckoning perhaps this fall.
"We've got about $500-trillion in synthetics to de-lever, but some of that is double-counted, and some is counted four times, but it's still lot of money," he explains. "And the hedge funds only have about a trillion to play with. So you can see there's a lot of downside potential."
As good as my confidant is at running numbers out, there's no way to tell when it will all stop. But if you're looking for a wild-*ss guess, try this observation: "There are about 9,000 hedge funds out there right now. I wouldn't think the de-levering is over until maybe 6,000 of them have gone broke...and the 3,000 that remain will be a mix of winners and those barely hanging on..." That's only a guess. No one knows for sure.
What's going on right now in the markets - and it's spreading across all kinds of commodity markets and resulting in massive price deflation -- is also pushed along as the result of what my source calls "Invisible Leverage."
Here's why it's going on even as we speak. If I give you $200 to invest in stocks, and you put $100 on each of two stocks and one doubles, while the other falls to half its value, how does your return look?
The answer is the first $100 goes to $200, while the other goes down to $50, so at the end of the day, your stock picks are worth $250 - or a hefty 25% return, even if you get only 50% right. Sweet, huh?
Since stocks can make a great return with 50/50 odds on the upside, the hedge traders make their long side bets in the stocks, but because the odds of success run more like 25-1 against you on the long side of bonds, they make their bearish bets in bonds... they couldn't do this until the CDS (Credit Default Swap) market developed, which allowed traders to "go short" in the credit markets.
What was developed to be a hedging product turned out to have such a good risk/return profile for bears that we now have the weird situation where the short-side bets against some bonds can be 10 to 50 times the size of the bond issues themselves. It is the limited capital needed to enter the CDS that gives the market its "invisible leverage" -- the cash market is only allowing 1-1 or maybe 3-1 leverage (look at CDO sale to Lone Star with financing by Merrill), but CDS protection buyers (the bears) can still get 19-1 leverage . JP Morgan got a nice 29-1 leverage from the taxpayers on Bear Stearns' mortgage portfolio, but that's another story...
---
There's a lot of 'pile on' in play, too. The lemming-like behavior of the retail customers is apparently nothing when compared to the lock-step behavior of hedge funds. All it takes is a word here or there at those particular places in Greenwich, and 'poof!' A whole asset class gets whacked, and thanks to the circular nature of the game, everything else de-levers to some extent as margin calls come in for the players 'caught out'. A failure here, means pressure there, kind of thing.
You won't get to see all this working out in real-time, though, because the offshore funds don't have to report like the regulated players in the US, even though many of the plays are phoned in from Connecticut.
---
Right now, I'm trying to bottom fish a few $17.50 December commodity call options for my personal account. I think the predictive linguistics have laid out a pretty good scenario for what may happen, and if they're right, a quick flight to hard assets might come about before Thanksgiving due to Middle East events to come. But, if it doesn't, I wouldn't be surprised by that outcome, either. I think of it as a $1,500 scratch ticket.
As my friend's book points out, there's nothing wrong with leverage at modest levels, like the 20% down conventional loans to buy a home - that's still a great use of leverage. But 2% (and less) to control huge financial abstractions? That's coming to an end. Painfully.
----
What's hard for people to conceptualize is that a sell off of one commodity (or stock) generates margin calls in others, which in turn drives selling in non-related markets, and those in turn cascade in slow motion which might more properly be called a "Crashcade" although I haven't spied that term (or "Debtberg" in my friends book, yet.
But, before the Second Depression becomes apparent, I'm betting the Oil Party will start another international distraction going and we'll all be blaming some group in another country and getting all whipped up into a frenzy to carpet bomb there. Late October, maybe?
The distractions to come may serve to blame-shift, but I think you can see now that the "PowersThatBe" might readily be described as hedge fund managers reacting to market forces at work.
10 September 2007
Hedge funds post shock losses
Some of the grandest names in the hedge fund world suffered last month having failed to anticipate the turmoil in the markets and failing to produce the absolute returns they promise investors.
The list of badly-hit hedge funds in August reads like a Who's Who of the best-known on Wall Street, according to investors.
They include Paul Tudor Jones, philanthropist and head of Greenwich, Connecticut-based Tudor Investment Corp; his friend and former colleague Louis Bacon of Moore Capital; Bruce Kovner, super-secretive head of Caxton Associates; and Matthew Tewksbury, who bought Wall Street trader Monroe Trout's hedge fund business and renamed it after himself.
The falls leave many of the biggest hedge funds in the world telling investors they have lost money for the year to date, while some of those that weathered the storm – such as Raymond Dalio's Bridgewater Pure Alpha fund – have returns this year only just better than cash.
The results are likely to rattle investors who are worried that the hedge industry had one of its worst months in August.
"There's a big concern about the redemptions in September in the hedge fund industry," said Arnauldt de Torquat, chief executive of Harmony Asset Management, a London fund of hedge funds that has not faced big redemptions itself.
The difficulties at Tudor are particularly painful for investors because Tudor – founder of the biggest hedge fund charity, the Robin Hood Foundation – profited handsomely from the 1987 market ructions, correctly betting that the market would fall.
Tudor BVI Global, the $6bn fund run by Mr Tudor Jones, tumbled 5.5 per cent in August to leave it down 1.5 per cent for the year, while Raptor, the $6bn Tudor fund run by head of US equities James Pallotta, was down 5.6 per cent in the month and down 9 per cent for the year so far, investors said.
Caxton's $11bn flagship fund was down 4.8 per cent in August, for a loss of 1.5 per cent this year, while Tewksbury's $3bn Investment fund fell 8 per cent, more than wiping out all this year's gains. Moore's $7bn Global fund fell 5.7 per cent in August, and its $4bn Fixed Income fund was down 4.3 per cent, although both remain up for the year.
Many other big-name managers struggled in August, with Atticus, a New York-based activist and financial specialist, down more than 10 per cent in both its flagship funds as holdings including Barclays and Deutsche Börse were hit hard in the month – although both funds remain up for the year.
Third Point, an aggressive activist run by Dan Loeb, was down 8.3 per cent, leaving it up 6.8 per cent for the year, while in the UK several funds from Lansdowne, GLG and Sloane Robinson had a weak month, investors said.
Jeffrey Gendell, who runs Tontine Associates from Greenwich, Connecticut, produced one of the worst results of all the big name managers with a 7.9 per cent drop in his $1bn Overseas fund – although it is still up 7.6 per cent this year. By contrast, his Financial Partners fund leapt 8.4 per cent in the month, one of the best performances – but remains down 37 per cent for the year, among the worst of all managers.
However, some well-respected managers have done very well. John Paulson of Paulson & Co produced another month of spectacular returns across his funds thanks to aggressive shorts of US subprime mortgages. Philip Falcone's Harbinger Capital distressed fund gained 3.7 per cent to take its total return for the year to more than 55 per cent.
Big name managers Dan Och of Och-Ziff, Izzy Englander of Millennium Partners and David Tepper of distressed debt specialists also came through the month with gains or slight falls, leaving them securely up for the year. The $6bn Bridgewater Pure Alpha fund was up 0.4 per cent for the month, for a gain of 3.6 per cent this year.
Copyright 2007 Financial Times
The list of badly-hit hedge funds in August reads like a Who's Who of the best-known on Wall Street, according to investors.
They include Paul Tudor Jones, philanthropist and head of Greenwich, Connecticut-based Tudor Investment Corp; his friend and former colleague Louis Bacon of Moore Capital; Bruce Kovner, super-secretive head of Caxton Associates; and Matthew Tewksbury, who bought Wall Street trader Monroe Trout's hedge fund business and renamed it after himself.
The falls leave many of the biggest hedge funds in the world telling investors they have lost money for the year to date, while some of those that weathered the storm – such as Raymond Dalio's Bridgewater Pure Alpha fund – have returns this year only just better than cash.
The results are likely to rattle investors who are worried that the hedge industry had one of its worst months in August.
"There's a big concern about the redemptions in September in the hedge fund industry," said Arnauldt de Torquat, chief executive of Harmony Asset Management, a London fund of hedge funds that has not faced big redemptions itself.
The difficulties at Tudor are particularly painful for investors because Tudor – founder of the biggest hedge fund charity, the Robin Hood Foundation – profited handsomely from the 1987 market ructions, correctly betting that the market would fall.
Tudor BVI Global, the $6bn fund run by Mr Tudor Jones, tumbled 5.5 per cent in August to leave it down 1.5 per cent for the year, while Raptor, the $6bn Tudor fund run by head of US equities James Pallotta, was down 5.6 per cent in the month and down 9 per cent for the year so far, investors said.
Caxton's $11bn flagship fund was down 4.8 per cent in August, for a loss of 1.5 per cent this year, while Tewksbury's $3bn Investment fund fell 8 per cent, more than wiping out all this year's gains. Moore's $7bn Global fund fell 5.7 per cent in August, and its $4bn Fixed Income fund was down 4.3 per cent, although both remain up for the year.
Many other big-name managers struggled in August, with Atticus, a New York-based activist and financial specialist, down more than 10 per cent in both its flagship funds as holdings including Barclays and Deutsche Börse were hit hard in the month – although both funds remain up for the year.
Third Point, an aggressive activist run by Dan Loeb, was down 8.3 per cent, leaving it up 6.8 per cent for the year, while in the UK several funds from Lansdowne, GLG and Sloane Robinson had a weak month, investors said.
Jeffrey Gendell, who runs Tontine Associates from Greenwich, Connecticut, produced one of the worst results of all the big name managers with a 7.9 per cent drop in his $1bn Overseas fund – although it is still up 7.6 per cent this year. By contrast, his Financial Partners fund leapt 8.4 per cent in the month, one of the best performances – but remains down 37 per cent for the year, among the worst of all managers.
However, some well-respected managers have done very well. John Paulson of Paulson & Co produced another month of spectacular returns across his funds thanks to aggressive shorts of US subprime mortgages. Philip Falcone's Harbinger Capital distressed fund gained 3.7 per cent to take its total return for the year to more than 55 per cent.
Big name managers Dan Och of Och-Ziff, Izzy Englander of Millennium Partners and David Tepper of distressed debt specialists also came through the month with gains or slight falls, leaving them securely up for the year. The $6bn Bridgewater Pure Alpha fund was up 0.4 per cent for the month, for a gain of 3.6 per cent this year.
Copyright 2007 Financial Times
11 August 2007
Big liquidation triggers hedge-fund turmoil
Some compare upheaval to LTCM collapse; market-neutral funds are hit hard
By Alistair Barr, MarketWatch
SAN FRANCISCO (MarketWatch) -- The liquidation of a big hedge fund or investment-bank trading portfolio is wreaking havoc in some parts of the hedge-fund business, managers and investors said Thursday.
Black Mesa Capital, a hedge-fund firm that uses computer models to track down investment ideas, said that at least one large hedge fund or investment bank is liquidating "massive" trading portfolios, according to a letter the Santa Fe, N.M.-based firm sent to investors Wednesday.
'Clearly, something is amiss in the markets that few in our strategy, if anyone, have experienced before.'
— Letter to Black Mesa investors
The warning is causing disruptions and triggering big losses among other so-called market-neutral hedge funds, Black Mesa said in its letter, a copy of which was obtained Thursday by MarketWatch.
"Clearly, something is amiss in the markets that few in our strategy, if anyone, have experienced before," Black Mesa's managers, Dave DeMers and Jonathan Spring, wrote. DeMers declined to comment Thursday.
The firm's hedge fund, which has about $1.9 billion in long positions and $1.9 billion in short positions, was down roughly 7.5% this month through Aug. 7. Those losses could grow to as much as 10% for August so far, Black Mesa noted.
A $700 million hedge fund run by Goldman Sachs (GSGoldman Sachs Group, Inc
GS ) , the North American Equity Opportunities fund, has sold some of its positions recently after losses, a person familiar with the matter said on Thursday. Goldman's biggest hedge fund, the Global Alpha fund, has suffered losses and may also be selling positions, but the person stressed that this fund is not shutting down.
'Quant' quake
The Global Alpha fund, which manages $9 billion, is a so-called quantitative fund, using computer models to locate investment opportunities.
Such "quant" funds are popular among hedge-fund investors. Many use a market-neutral strategy, which aims to balance long positions with short trades, or bets against securities. Others are so-called statistical arbitrage funds, which analyze the historical relationships between related securities and trade when those relationships get out of whack.
Many players in this part of the hedge-fund business have similar positions and use lots of leverage, or borrowed money, to increase their bets. However, that magnifies even small losses. Some of these hedge funds also have relatively permissive redemption periods, allowing investors to take their money out every month, with 30 days' notice or less.
So if losses trigger investor redemptions, these funds may have to sell lots of their positions. That, in turn, puts more pressure on the historical relationship between related securities, handing more losses to other hedge funds in the space.
If such positions are sold by lots of managers at the same time, the most leveraged funds get hit the hardest, possibly forcing big liquidations of portfolios, which triggers a chain reaction.
Two hedge-fund investors who didn't want to be identified said the current turmoil is reminiscent of the 1998 collapse of Long-Term Capital Management.
That giant hedge fund had some arbitrage positions based on the historical relationship between related securities. It made bets on the relationship between the prices of government securities from around the world. When Russia defaulted and devalued its currency, the ruble, there was a flight to quality that caused the prices of U.S. Treasury securities to spike.
LTCM collapsed amid rapid market dislocation and had to be bailed out by several of the world's largest investment banks as part of a plan organized by the Federal Reserve.
Highbridge
On Wednesday, Black Mesa told investors that other market-neutral hedge funds had suffered losses of between 5% and 15% so far in August.
The Highbridge Statistical Market Neutral Fund, a $1.8 billion hedge fund run by the J.P Morgan Chase (JPMjp morgan chase & co com
JPM ) unit Highbridge Capital, fell more than 5% this month through Aug. 8, according to the bank's Web site. The fund uses computer models to pick undervalued and overvalued securities and maintains roughly equal positions on both sides to iron out the effect of broad market fluctuations.
Hedge fund investors also highlighted other firms that use quantitative and market neutral strategies, but it's not clear whether these firms have suffered losses.
Barclays Global Investors, the money management arm of U.K. bank Barclays PLC (UK:BARC: news, chart, profile) , is one of the world's largest quantitative fund managers. The firm also runs market-neutral hedge funds.
It's not clear whether Barclays funds have suffered any losses recently. Spokesman Lance Berg declined to discuss performance or the strategy of the firm's hedge funds.
"At this time we are maintaining risk levels and feel that our portfolios are positioned appropriately," Berg said.
AQR Capital, Algert Coldiron Investors and Tykhe Capital were among other hedge fund firms mentioned by investors. Representatives at those firms didn't return calls seeking comment on Thursday.
The Wall Street Journal reported that Tykhe, run by former D.E. Shaw managers, has suffered losses of about 20% in August, and is moving quickly to trim its investment positions.
Similar to Amaranth
Black Mesa said it started reducing its leverage and selling positions to raise cash on Monday. As of Aug. 8, the firm said it had between 50% and 100% of its portfolio in cash and had brought leverage down to 0.5 to 0 times its assets, according to the letter.
The market disruptions began on July 25, when Black Mesa spotted signs of a major liquidation by another market participant. That continued through the week, handing the firm its biggest losing day ever, when it was down 3% on July 27.
The firm analyzed what caused its losses over that weekend and concluded that the behavior of the markets were similar to mid-September 2006, when giant hedge fund firm Amaranth Advisors liquidated its market-neutral equity portfolio to meet margin calls triggered by energy trading losses, Black Mesa explained.
'Me-too' liquidations
As August began the selling continued, the firm said in its letter.
"Either the original liquidators had just paused, and/or others had begun to liquidate their market-neutral books on Wednesday, August 1," DeMers and Spring wrote. "By Friday, August 3, there seemed to be no abatement in the liquidations and over the weekend, we confirmed with other market-neutral managers that they were suffering similar losses."
Black Mesa then began to wonder whether others in the market-neutral space, having learned of these liquidations and having lost money themselves, could start cutting leverage in their own portfolios too.
"There was (and is) the possibility that, as great as liquidations had been so far, that it was just the beginning of a spiral of me-too liquidations," DeMers and Spring wrote.
The two managers said they didn't know now long such dislocations could last, noting that it could be two days, two weeks, two months or even two quarters.
Black Mesa said there are now "enormous profit opportunities" but the firm said it remains on the sidelines until signs of liquidations in the market dissipate.
Alistair Barr is a reporter for MarketWatch in San Francisco.
By Alistair Barr, MarketWatch
SAN FRANCISCO (MarketWatch) -- The liquidation of a big hedge fund or investment-bank trading portfolio is wreaking havoc in some parts of the hedge-fund business, managers and investors said Thursday.
Black Mesa Capital, a hedge-fund firm that uses computer models to track down investment ideas, said that at least one large hedge fund or investment bank is liquidating "massive" trading portfolios, according to a letter the Santa Fe, N.M.-based firm sent to investors Wednesday.
'Clearly, something is amiss in the markets that few in our strategy, if anyone, have experienced before.'
— Letter to Black Mesa investors
The warning is causing disruptions and triggering big losses among other so-called market-neutral hedge funds, Black Mesa said in its letter, a copy of which was obtained Thursday by MarketWatch.
"Clearly, something is amiss in the markets that few in our strategy, if anyone, have experienced before," Black Mesa's managers, Dave DeMers and Jonathan Spring, wrote. DeMers declined to comment Thursday.
The firm's hedge fund, which has about $1.9 billion in long positions and $1.9 billion in short positions, was down roughly 7.5% this month through Aug. 7. Those losses could grow to as much as 10% for August so far, Black Mesa noted.
A $700 million hedge fund run by Goldman Sachs (GSGoldman Sachs Group, Inc
GS ) , the North American Equity Opportunities fund, has sold some of its positions recently after losses, a person familiar with the matter said on Thursday. Goldman's biggest hedge fund, the Global Alpha fund, has suffered losses and may also be selling positions, but the person stressed that this fund is not shutting down.
'Quant' quake
The Global Alpha fund, which manages $9 billion, is a so-called quantitative fund, using computer models to locate investment opportunities.
Such "quant" funds are popular among hedge-fund investors. Many use a market-neutral strategy, which aims to balance long positions with short trades, or bets against securities. Others are so-called statistical arbitrage funds, which analyze the historical relationships between related securities and trade when those relationships get out of whack.
Many players in this part of the hedge-fund business have similar positions and use lots of leverage, or borrowed money, to increase their bets. However, that magnifies even small losses. Some of these hedge funds also have relatively permissive redemption periods, allowing investors to take their money out every month, with 30 days' notice or less.
So if losses trigger investor redemptions, these funds may have to sell lots of their positions. That, in turn, puts more pressure on the historical relationship between related securities, handing more losses to other hedge funds in the space.
If such positions are sold by lots of managers at the same time, the most leveraged funds get hit the hardest, possibly forcing big liquidations of portfolios, which triggers a chain reaction.
Two hedge-fund investors who didn't want to be identified said the current turmoil is reminiscent of the 1998 collapse of Long-Term Capital Management.
That giant hedge fund had some arbitrage positions based on the historical relationship between related securities. It made bets on the relationship between the prices of government securities from around the world. When Russia defaulted and devalued its currency, the ruble, there was a flight to quality that caused the prices of U.S. Treasury securities to spike.
LTCM collapsed amid rapid market dislocation and had to be bailed out by several of the world's largest investment banks as part of a plan organized by the Federal Reserve.
Highbridge
On Wednesday, Black Mesa told investors that other market-neutral hedge funds had suffered losses of between 5% and 15% so far in August.
The Highbridge Statistical Market Neutral Fund, a $1.8 billion hedge fund run by the J.P Morgan Chase (JPMjp morgan chase & co com
JPM ) unit Highbridge Capital, fell more than 5% this month through Aug. 8, according to the bank's Web site. The fund uses computer models to pick undervalued and overvalued securities and maintains roughly equal positions on both sides to iron out the effect of broad market fluctuations.
Hedge fund investors also highlighted other firms that use quantitative and market neutral strategies, but it's not clear whether these firms have suffered losses.
Barclays Global Investors, the money management arm of U.K. bank Barclays PLC (UK:BARC: news, chart, profile) , is one of the world's largest quantitative fund managers. The firm also runs market-neutral hedge funds.
It's not clear whether Barclays funds have suffered any losses recently. Spokesman Lance Berg declined to discuss performance or the strategy of the firm's hedge funds.
"At this time we are maintaining risk levels and feel that our portfolios are positioned appropriately," Berg said.
AQR Capital, Algert Coldiron Investors and Tykhe Capital were among other hedge fund firms mentioned by investors. Representatives at those firms didn't return calls seeking comment on Thursday.
The Wall Street Journal reported that Tykhe, run by former D.E. Shaw managers, has suffered losses of about 20% in August, and is moving quickly to trim its investment positions.
Similar to Amaranth
Black Mesa said it started reducing its leverage and selling positions to raise cash on Monday. As of Aug. 8, the firm said it had between 50% and 100% of its portfolio in cash and had brought leverage down to 0.5 to 0 times its assets, according to the letter.
The market disruptions began on July 25, when Black Mesa spotted signs of a major liquidation by another market participant. That continued through the week, handing the firm its biggest losing day ever, when it was down 3% on July 27.
The firm analyzed what caused its losses over that weekend and concluded that the behavior of the markets were similar to mid-September 2006, when giant hedge fund firm Amaranth Advisors liquidated its market-neutral equity portfolio to meet margin calls triggered by energy trading losses, Black Mesa explained.
'Me-too' liquidations
As August began the selling continued, the firm said in its letter.
"Either the original liquidators had just paused, and/or others had begun to liquidate their market-neutral books on Wednesday, August 1," DeMers and Spring wrote. "By Friday, August 3, there seemed to be no abatement in the liquidations and over the weekend, we confirmed with other market-neutral managers that they were suffering similar losses."
Black Mesa then began to wonder whether others in the market-neutral space, having learned of these liquidations and having lost money themselves, could start cutting leverage in their own portfolios too.
"There was (and is) the possibility that, as great as liquidations had been so far, that it was just the beginning of a spiral of me-too liquidations," DeMers and Spring wrote.
The two managers said they didn't know now long such dislocations could last, noting that it could be two days, two weeks, two months or even two quarters.
Black Mesa said there are now "enormous profit opportunities" but the firm said it remains on the sidelines until signs of liquidations in the market dissipate.
Alistair Barr is a reporter for MarketWatch in San Francisco.
1 August 2007
Sorry we lost most of your money
July 30, 2007
To Our Investors in Sowood Alpha Fund LP and Sowood Alpha Fund Ltd.:
Sale of Assets
Today we made the painful and difficult decision to sell substantially all the funds’ portfolio to Citadel Investment Group. We took this step to protect your investment. Our actions over the weekend followed severe declines in the value of our credit positions and non-performance of offsetting hedges. Given what we were facing and our uncertain ability to meet margin calls, we sought other buyers for some or all of the positions. Citadel offered the only immediate and comprehensive solution. The transaction enabled us to avoid anticipated forced sales at extreme prices that would have been made in order to satisfy obligations under our counterparty agreements.
Performance Update
After the transaction with Citadel, the Net Asset Value (NAV) of Sowood Alpha Fund Ltd. and Sowood Alpha Fund LP will have declined approximately 57% and 53% month to date respectively, and approximately 56% and 51% calendar year to date respectively. As a result, our NAV as of July 30 is approximately $1.5 billion.
Current Plans
We will be advising you of plans to distribute assets as soon as we can, subject to reserves and holdbacks for completion of the audit, contingencies and potential liabilities. Proceeds will be distributed in accordance with the governing documents of the funds. We will seek to retain key staff to manage the distribution process going forward.
We understand this is a very difficult moment for you and are committed to keeping all lines of communications open. Since we are still working through positions and details of the transaction, it will take us a few days to organize everything in a manner that will satisfy your questions. That said, we are planning to hold one-on-one meetings starting next week with investors. In addition, we are planning a listen-only conference call later this week at which time I will discuss the actions we took over this past weekend and next steps.
Background
During the month of June, our portfolio experienced losses mostly as a result of sharply wider corporate credit spreads unaccompanied by any concomitant move in equities and exacerbated by a marked decline in liquidity. This occurred over a broad range of credit related instruments. In the first two weeks of July, spreads continued to widen, and we experienced a loss similar to June. The weakness in corporate credit – particularly focused on loans and loan credit default swaps – accelerated sharply during the week of July 23. Until the end of last week these developments, while reducing the value of our portfolio, were manageable. Our counterparties had not severely marked down the value of the collateral that the funds had posted nor changed our margin terms, and immediate liquidity needs could be met.
However, towards the end of last week, given the extreme market volatility, our counterparties began to severely mark down the value of the collateral that had been posted by the funds. In addition, liquidity became extremely limited for the credit portion of our portfolio making it difficult to exit positions. We, therefore, reached the conclusion over the weekend that, in the interest of preserving our investors’ capital, the appropriate course of action was to sell the funds’ portfolio. We believe that the arrangement with Citadel provided our best option under the circumstances, since we were unable to find other sources of liquidity.
Conclusion
We are very sorry this has happened. We have always attempted to do the very best for our investors. A loss of this magnitude in such a short period is as devastating to us as it is to you. We are committed to acting in the best interests of the funds’ investors and to keeping investors informed of decisions made in furtherance of this objective. We sincerely appreciate your patience and understanding during this challenging period.
Sincerely,
Jeff Larson
To Our Investors in Sowood Alpha Fund LP and Sowood Alpha Fund Ltd.:
Sale of Assets
Today we made the painful and difficult decision to sell substantially all the funds’ portfolio to Citadel Investment Group. We took this step to protect your investment. Our actions over the weekend followed severe declines in the value of our credit positions and non-performance of offsetting hedges. Given what we were facing and our uncertain ability to meet margin calls, we sought other buyers for some or all of the positions. Citadel offered the only immediate and comprehensive solution. The transaction enabled us to avoid anticipated forced sales at extreme prices that would have been made in order to satisfy obligations under our counterparty agreements.
Performance Update
After the transaction with Citadel, the Net Asset Value (NAV) of Sowood Alpha Fund Ltd. and Sowood Alpha Fund LP will have declined approximately 57% and 53% month to date respectively, and approximately 56% and 51% calendar year to date respectively. As a result, our NAV as of July 30 is approximately $1.5 billion.
Current Plans
We will be advising you of plans to distribute assets as soon as we can, subject to reserves and holdbacks for completion of the audit, contingencies and potential liabilities. Proceeds will be distributed in accordance with the governing documents of the funds. We will seek to retain key staff to manage the distribution process going forward.
We understand this is a very difficult moment for you and are committed to keeping all lines of communications open. Since we are still working through positions and details of the transaction, it will take us a few days to organize everything in a manner that will satisfy your questions. That said, we are planning to hold one-on-one meetings starting next week with investors. In addition, we are planning a listen-only conference call later this week at which time I will discuss the actions we took over this past weekend and next steps.
Background
During the month of June, our portfolio experienced losses mostly as a result of sharply wider corporate credit spreads unaccompanied by any concomitant move in equities and exacerbated by a marked decline in liquidity. This occurred over a broad range of credit related instruments. In the first two weeks of July, spreads continued to widen, and we experienced a loss similar to June. The weakness in corporate credit – particularly focused on loans and loan credit default swaps – accelerated sharply during the week of July 23. Until the end of last week these developments, while reducing the value of our portfolio, were manageable. Our counterparties had not severely marked down the value of the collateral that the funds had posted nor changed our margin terms, and immediate liquidity needs could be met.
However, towards the end of last week, given the extreme market volatility, our counterparties began to severely mark down the value of the collateral that had been posted by the funds. In addition, liquidity became extremely limited for the credit portion of our portfolio making it difficult to exit positions. We, therefore, reached the conclusion over the weekend that, in the interest of preserving our investors’ capital, the appropriate course of action was to sell the funds’ portfolio. We believe that the arrangement with Citadel provided our best option under the circumstances, since we were unable to find other sources of liquidity.
Conclusion
We are very sorry this has happened. We have always attempted to do the very best for our investors. A loss of this magnitude in such a short period is as devastating to us as it is to you. We are committed to acting in the best interests of the funds’ investors and to keeping investors informed of decisions made in furtherance of this objective. We sincerely appreciate your patience and understanding during this challenging period.
Sincerely,
Jeff Larson
7 June 2007
Hedge Funds versus Bear Stearns
NEW YORK, June 7 (Reuters) - Hedge fund managers are accusing Bear Stearns Cos. (BSC.N: Quote, Profile , Research) of trying to manipulate the market in securities based on subprime mortgages, the Wall Street Journal reported in its online edition.
The confrontation provides a rare look into the complex trading in the mammoth U.S. mortgage market, which played a critical role in financing the housing boom, and the complicated relationships between hedge funds and investment banks, the paper said.
Hedge funds that had sold short such securities made profits when an index tied to a basket of subprime bonds was falling. But the index has recovered in recent weeks, leading to howls of protest from hedge funds, according to the report.
The chief critic, John Paulson of Paulson & Co., a $12 billion fund, says Bear Stearns wanted to prop up faltering mortgages-backed securities by purchasing individual mortgages that were rapidly losing value to avoid doling out billions in swap payments, the Journal reported.
Bear Stearns is one of Wall Street's largest players in the market for credit default swaps. By selling swaps, Bear bet the subprime home loan market would improve or at least turn out to be healthier than expected.
Neither Bear Stearns not Paulson & Co. immediately returned calls seeking comment. The head of Bear's mortgage business denied the allegations, according to the report.
A downturn in the U.S. housing market this year has led to rising defaults in the subprime mortgage market, which caters to borrowers with weak credit histories. More than two dozen subprime lenders have collapsed, while others have tightened their lending standards
The confrontation provides a rare look into the complex trading in the mammoth U.S. mortgage market, which played a critical role in financing the housing boom, and the complicated relationships between hedge funds and investment banks, the paper said.
Hedge funds that had sold short such securities made profits when an index tied to a basket of subprime bonds was falling. But the index has recovered in recent weeks, leading to howls of protest from hedge funds, according to the report.
The chief critic, John Paulson of Paulson & Co., a $12 billion fund, says Bear Stearns wanted to prop up faltering mortgages-backed securities by purchasing individual mortgages that were rapidly losing value to avoid doling out billions in swap payments, the Journal reported.
Bear Stearns is one of Wall Street's largest players in the market for credit default swaps. By selling swaps, Bear bet the subprime home loan market would improve or at least turn out to be healthier than expected.
Neither Bear Stearns not Paulson & Co. immediately returned calls seeking comment. The head of Bear's mortgage business denied the allegations, according to the report.
A downturn in the U.S. housing market this year has led to rising defaults in the subprime mortgage market, which caters to borrowers with weak credit histories. More than two dozen subprime lenders have collapsed, while others have tightened their lending standards
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