GLOBAL
BUSINESS: another
form
of "climate" change...
California
here we come!
How about Net's impact..."Triple-A Failure"
article.
USING IRON TO
ABSORB CO2: Iron dust is poured into the
sea to supplement the levels reaching oceans on winds from arid areas.
Iron consumed by plankton helps photosynthesise carbon dioxide to
produce oxygen. Some plankton is eaten by sea creatures;
the rest sinks, sealing its
carbon deep in the ocean for decades, centuries or millennia. The
boom is funding various clean energy projects, from developing
hydrogen fuel cells to turning algae into fuel and creating synthetic
fuels through biological engineering. Economics 101: at right, American field no longer to
be conserved?
FOOD
one big problem...where the rubber
meets the road is
another! And how about the
Fannie and Freddie impact?
Changing of
the guard? Metrics makes news...and hedge funds. What
went wrong?
NEXT: Bail
out banks? How about Bernie
Madoff's clients? American car makers?
GLOBAL
BUSINESS: Not
the
same MBA degree your grandfather got! Or your mother,
either. Housing crisis looming?
Food?
Gas? Oil Supply? Wall
Street
woes?
Madoff on this
page;
also here and here.
New York real estate
crisis? GASB link - and even a Fairfield County connection!
Hey Ponzi: What’s Your Exit Strategy,
Exactly?
NYTIMES
By Catherine Rampell
December 17, 2008, 11:33 am
I have never understood why someone would ever
start a Ponzi scheme when, by definition, there’s no way to end it.
The scam works by bringing in new unwitting investors to pay off the
old unwitting ones. Since there’s no actual investment involved — just
a transfer of money backward, with some portion presumably pocketed by
the Ponzi schemer — keeping the scheme going requires an endless supply
of new investors. The schemer’s liabilities only get bigger as time
goes on, and there’s no way to end the ploy. Other than jail, that is.
Or death. Or perhaps faking one’s own death.
Take Bernard Madoff, who, it is said, concocted a $50 billion Ponzi
scheme. How could he be financially sophisticated enough to (1) con
some of the richest, most financially literate investors around, and
(2) build a complex paper trail hiding his investments, but also be (3)
financially unsophisticated enough not to realize there’s no way to end
such a ploy?
I recently asked a few experts what such Ponzi perpetrators might
envision their “exit strategies” to be. They generally fell into four
categories:
1) Cut and run. This strategy is usually used by small-time crooks
taking aim at lower- to middle-class investors.
These swindlers are the Harold Hills of the world. They walk into Rock
Island with the intention of ripping everyone off, changing their
identities, hopping back on the train, and then proceeding da capo in
River City. (Unless they fall in love with a comely librarian along the
way, of course.)
“There’s a certain type of sociopathy to many schemers,” says Mitchell
Zuckoff, a journalism professor at Boston University and author of
“Ponzi’s Scheme: The True Story of a Financial Legend.”
Few of the big-time Ponzi schemers go this route, though. This is
because big Ponzi schemes are almost always based on exploiting the
trust of a tightly knit social network. The victims are usually members
of ethnic communities, elite country clubs, churches or other social
hubs where people are unlikely to do their due diligence because they
trust their friend, family member, clubmate or neighbor, and have seen
others in the same social circle get rich through the proposed
“investment opportunity.” In Mr. Madoff’s case, for example, the
victims appear to be primarily rich Jewish investors, whom he met
through elite groups like the Palm Beach Country Club. The Foundation
for New Era Philanthropy, a notorious Philadelphia-area Ponzi scheme,
preyed on Christian religious organizations and charities.
If you’re well-connected enough to create a
large-scale Ponzi scheme, you’re probably too well-connected to be able
to, or perhaps even want to, cut yourself loose.
Charles Ponzi himself had ample opportunities to disappear back to his
Italian homeland unnoticed, Mr. Zuckoff said.
“He was bringing his mother over to Boston, from Rome,” he said. “He
set her up here. He was canceling the honeymoon he’d planned to take to
Italy with his new wife. He could have taken the money and run, but
instead he chose to put down roots. He even invested in local banks.”
2) Turn (or return) the business into something legitimate. Unlike the
schemers in #1, these Ponzi architects likely started out with some
hope for legitimacy. They wanted seed money to kick off some brilliant
investment idea. But then the “brilliant” idea falls through. They are
then in the position of having to pay off initial investors. Rather
than declare failure, they recruit new investors to pay off the old
ones.
They may be stuck in a rut, but they have confidence (or perhaps,
self-delusion) that they’re so clever that they’ll come up with
another, better idea and strike it rich that way.
This was more or less Charles Ponzi’s strategy.
He had grand plans for arbitrage of international postal reply coupons,
a sort of postage stamp that was recognized by post offices around the
world. He planned to buy the coupons cheaply in Italy and then resell
them in the United States at a several-hundred-percent profit. He
couldn’t work out the logistics, though, and ended up collecting more
and more “seed money” to finance his brilliant idea. Mr. Zuckoff said
Ponzi eventually started looking for another brilliant plan but failed.
“He truly thought he could eventually turn around and go legitimate,”
Mr. Zuckoff said.
As in Ponzi’s case, this exit strategy pretty much always fails because
the schemers are looking for the big scalp — and there’s never an
investment profitable enough to fill that deepening pocket of debt.
3) No exit. These schemers, usually from relatively humble backgrounds,
are deeply insecure. They have felt like impostors their whole lives,
whether in the country club or on the trading floor. They expect to be
exposed for something, sometime, somewhere, which allows them to
rationalize fraudulent behavior. They focus on denying and delaying the
inevitable for as long as they can — and living well until they get
caught.
“They have classic impostor syndrome issues,” said James Walsh, author
of “You Can’t Cheat an Honest Man: How Ponzi Schemes and Pyramid Frauds
Work … and Why They’re More Common Than Ever.” “It’s a classic case of
overconfidence as a mask for underconfidence. It’s Freud 101.”
4) Get elected to Parliament. After scamming millions of Russians in
the 1990s, Sergei Mavrodi promised his broke investors that he would
get their money back with taxpayer funds if they elected him to the
Russian Duma. He was, in fact, elected. And voilà, his election
gave him parliamentary immunity from criminal prosecution.
Admittedly, this exit strategy has limited applicability. It didn’t
even work for very long for Mr. Mavrodi, whose parliamentary immunity
was revoked and who eventually landed in prison.
***
There is more overlap than the simple categories I’ve laid out here
would imply; Mr. Ponzi, for example, had other run-ins with the law
involving financial dishonesty, so it’s not as if he was exactly
hell-bent on legitimacy.
It’s also hard to say, based on the limited information available,
where within this array of strategies Mr. Madoff fell (assuming the
allegations against him are true). He probably was banking on exit
strategy #2, the turn (or return) to legitimacy.
Most Ponzi schemes last a year at most, experts say. (Charles Ponzi’s
lasted just nine months.) This indicates that Mr. Madoff, who had been
investing clients’ funds since at least 1960, probably started out
legitimate or semi-legitimate.
“I don’t know the ins and outs of what happened here,” said Stephen P.
Zeldes, a professor of finance and economics at Columbia Business
School. “He may have initially had a few bad years, or a few bad
quarters, and not wanted to tell that to investors,” Mr. Zeldes said.
“Maybe he then pretended that returns were better than they were,
thinking he could make it up some future years. Maybe he was thinking
he could gamble a bit, get a good return, and no one would ever know.”
In other words, Ponzi schemers don’t necessarily start out as such, and
as sophisticated as they are, they may not consciously accept the fact
that they’re engaging in a Ponzi scheme. They fool themselves into
thinking that the Ponzi scheme is merely a stop-gap measure to hide
their losses until they (theoretically) come up with something
brilliant.
“I don’t think he originally started thinking he was going to scam his
investors,” says Utpal Bhattacharya, a finance professor at the Kelley
School of Business at Indiana University who studies financial crime.
“His original motive was probably to hide his losses.”
Top investors 'hit by $50bn
con'
Some of
the world's wealthiest
private and corporate investors are reported to be victims of an
alleged $50bn fraud by Wall Street broker Bernard Madoff.
Mr Madoff is alleged to have confessed to a huge
Ponzi scheme (pyramid fraud). Reports say the main owner of the
New York Mets baseball team, Fred Wilpon, and former American football
team owner Norman Braman are among the victims. Others facing
losses reportedly include French bank BNP Paribas, Japan's Nomura
Holdings and Zurich's Neue Privat Bank.
Prosecutors say Mr Madoff, ex-head of the Nasdaq stock
market, has described the fraud as "one big lie".
A federal judge has appointed a receiver to oversee Mr Madoff
firm's assets and customer accounts, while the 70-year-old banker has
been released on $10m bail.
Shares drop
Hundreds of people are thought to have
invested with Mr Madoff, among them international banks, hedge funds
and wealthy private investors - who are all trying to find out the cost
of the alleged fraud.
Spanish newspapers said the leading bank Santander had
invested with Mr Madoff.
Bramdean Alternatives, a UK-based asset management company
run by Nicola Horlick, saw its share value drop by over 35% after it
revealed that nearly 10% of its holding was exposed to the New York
broker.
One hedge fund, Fairfield Greenwich Group, said its clients
had invested $7.5bn with the firm.
'Major disaster'
Lawyers for worried investors fearful that
they had lost their savings, attended court on Friday for a hearing on
the disposition of Mr Madoff's remaining assets. The hearing was
cancelled after an agreement was reached to appoint a receiver.
Brad Friedman, a lawyer for some of the investors, said:
"There are people who were very, very well off a few days ago who are
now virtually destitute.
"They have nothing left but their apartments or homes - which
they are going to have to sell to get money to live on," he told the
New York Times.
One investor, Lawrence Velvel, 69, told the Associated Press
that he and a friend may have lost millions of dollars between them.
"This is a major disaster for a lot of people. You work all
your life, you finally manage to save up something ... lots of people
are getting fully or partially wiped out."
'Pyramid scheme'
Mr Madoff founded Bernard L. Madoff Investment Securities in
1960, but also ran a separate hedge fund business.
According to the
US Attorney's criminal complaint filed in court, Mr Madoff told at
least three employees on Wednesday that the hedge fund business - which
served up to 25 clients and had $17.1bn under management - was a fraud
and had been insolvent for years, losing at least $50bn.
He said he was "finished", that he had "absolutely nothing"
and that "it's all just one big lie", and that it was "basically, a
giant Ponzi scheme", the complaint said. He told them that he
planned to surrender to the authorities but not before he used his last
$200m-$300m to pay "selected employees, family and friends".
Under a Ponzi scheme, also known as a pyramid scheme,
investors are promised very high returns on their investment, while in
reality early investors are paid with money collected from later
investors.
If found guilty, US prosecutors say he could face
up to 20 years in prison and a fine of up to $5m.
Dire Forecast for Global Economy and Trade
NYTIMES
By MARK LANDLER
December 10, 2008
WASHINGTON — The world economy is on the brink of a rare global
recession, the World Bank said in a forecast released Tuesday, with
world trade projected to fall next year for the first time since 1982
and capital flows to developing countries forecast to plunge 50 percent.
The projections are among the most dire in a litany of recent gloomy
prognostications for the world economy, and officials at the World Bank
warned that if they proved accurate, the downturn could throw many
developing countries into crisis and keep tens of millions of people in
poverty. Even more troubling, several economists said, there is
no obvious
locomotive to propel a recovery.
American consumers are unlikely to return to their old spending habits,
even after the United States climbs out of its current financial
crisis. With growth in China slowing sharply, consumers there are not
about to pick up the slack from the Americans. The collapse in oil
prices — a side-effect of the crisis — has knocked the wind out of
consumers in oil-exporting countries.
“The financial crisis is likely to result in the most serious recession
since the Great Depression,” said Justin Lin, the chief economist of
the World Bank, summarizing the projections.
The bank forecasts the global economy will eke out growth of 0.9
percent in 2009, down from 2.5 percent this year and 4 percent in 2006.
That is the slowest pace since 1982, when global growth was 0.3
percent. Developing countries will grow an average of 4.5 percent next
year — a pace that economists said constituted a recession, given the
need of these countries to grow rapidly to generate enough jobs for
their swelling populations.
“You don’t need negative growth in developing countries to have a
situation that feels like recession,” said Hans Timmer, who directs the
bank’s international economic analyses and projections. He predicted
rising joblessness and shuttered factories in many developing countries.
The volume of world trade, which grew 9.8 percent in 2006 and an
estimated 6.2 percent this year, will contract by 2.1 percent in 2009,
the report said. That drop would be deeper than the last major
contraction in trade: 1.9 percent in 1975. Net private flows of
capital to developing countries are projected to
decline to $530 billion in 2009, from $1 trillion in 2007.
The loss of that capital will sharply constrict investment in
emerging-market economies, the report said, with annual investment
growth slowing to 3.4 percent in 2009 from 13 percent in 2007.
Several countries are also being hurt by the decline in the prices of
oil and other commodities — a phenomenon the World Bank characterizes
as the end of a five-year commodities boom — though the decline in food
and fuel costs has relieved the pressure on people in other countries.
The sudden drop in capital flows poses a particular danger to oil
exporters, some of whom have run up heavy debts.
“They’ll have to roll over that debt, one way or the other,” said Simon
Johnson, a former chief economist of the International Monetary Fund.
“That’s going to put a huge squeeze on these countries.”
Mr. Johnson said the calmer atmosphere in foreign markets belied the
gravity of the situation. Spreads on credit default swaps — a common
yardstick for whether a country’s government is in danger of default —
continue to signal potential trouble for Ireland, Italy, and Greece.
The authorities in Greece are battling violent street protests in
Athens and its suburbs, fueled in part by the deteriorating economy.
Reflecting what is by now conventional wisdom, the World Bank
recommended that countries undertake large fiscal stimulus programs to
cushion the downturn. The bank itself has committed up to $100 billion
in aid to developing countries over three years.
If there is a silver lining amid the gloom, it is the relief that lower
food and fuel prices mean for poorer countries. While the prices of
almost all commodities have fallen sharply since July, they remain
higher than in the 1990s, which the bank says should prevent future
supply shortages.
As the World Bank’s experts struggled to find a historical analog for
the slump, they said it had more in common with the Depression of the
1930s than with the severe recessions of the 1970s or 1980s.
“It is not just a supply shock,” Mr. Lin said. “It is not just a drop
in demand; it is a lack of availability of credit.”
Deutsche Bank, in a forecast issued this week, was even more
pessimistic. It said global growth would drop to 0.2 percent in 2009,
with the United States, Europe, and Japan in recessions of roughly
equal severity.
China, which grew 11.9 percent in 2007, will slow to 7 percent this
year, the bank projects, and 6.6 percent in 2010, when the rest of the
world is slowly recovering. “It’s not going to be the spark that
reignites global demand,” said Thomas Mayer, the chief European
economist for Deutsche Bank. “We’re almost in an air pocket, where we
don’t have a new global driver of growth.”
The paradox of thrift
Analysis
By Steve Schifferes
Economics reporter, BBC News
24 November 2008
Should we save or should we spend?
The gloomy economic news and the rapid fall in the value of houses and
shares has worried many households. With many having borrowed
heavily during the boom, there may a strong temptation to pay off debt
or save more for a rainy day - something which until now has not
characterised the UK economy.
But if this happens, will the government's plan to boost the economy
through greater spending work?
Paradox of thrift
According to the economist John Maynard Keynes, writing in the midst of
the Great Depression in the 1930s, thrift may be a virtue for an
individual, but not necessarily for the economy as a whole.
He argued that the more people saved, the more they reduced effective
demand, thus further slowing the economy. This was one reason, he
pointed out, that a recession can become self-reinforcing.
Keynes also argued that, faced with slowing demand, businesses would
not necessarily use the extra savings available in the economy to
invest. He wrote that "up to the point where full employment
prevails, the growth of capital [investment] depends not at all on a
low propensity to consume but is, on the contrary, held back by it."
And, in the Keynesian theory, as the slump in demand cascaded through
the economy, the resulting slowdown would mean that everyone had less
income - ultimately reducing the absolute amount of savings, even if
people increase the proportion of their income they put aside.
As unemployment grew, investment would fall, whatever the level of
savings.
Government help needed
But how can we persuade the reluctant consumer to spend, and the
reluctant businessman to invest?
Keynes' answer was that it was only the government that could overcome
the collective paradox that what was good for the individual would
weaken the economy. This is now the theory being embraced by the
chancellor, who has abandoned his fiscal rules for the time being in
order to pour money back into the economy. And cuts in interest
rates by the Bank of England are also designed to encourage businesses
to continue to invest.
But the freeze in the credit markets is making these less effective,
making the need for a cash injection into the economy stronger - at
least according to Mervyn King, the governor of the Bank of England.
Spectre of deflation
There is another reason why the government wants to give a jolt to the
economy now. It is the fear that prices will actually start to
fall as the slowdown gets going.
And deflation - falling prices - would certainly reinforce the paradox
of thrift.
If consumers expect prices to drop further in the future, then they
have an even stronger incentive to delay their purchases until later,
when they can benefit from lower prices. Deflation, especially in
asset prices like houses, can be very long-lasting, as recent
experience in Japan suggests.
So one reason the government may want to temporarily cut VAT now is to
convince people that prices are going to go up later, thus encouraging
them to spend.
Rational expectations
Will these measures work?
One reason Keynesian explanations of the economy fell out of favour in
the last few decades was the rise of a new economic theory - rational
expectations.
This argued that people were aware that any government borrowing would
have to be paid back later. As a result they adjust their expectations
accordingly, and do not spend as much as predicted.
Since this time, the government will be signalling its intentions to
claw back the money it spends in future budgets, perhaps we will all
save more to cover our future loss of income.
This theory may well apply to the financial markets, which are making
the price of UK debt more expensive on the grounds it is likely to
expand dramatically.
But the psychology of individuals may be different.
In the first place, some people may not be able save much whatever
their expectations. Money that goes to pensioners surviving on the
state pension, for example, may go straight into spending.
And some psychological research suggests that people do not "discount"
very effectively in the long term.
So we may be under-estimating the attractiveness of spending even in
the midst of a recession.
This, at least, has to be the government's hope as it embarks on its
most audacious economic U-turn since Labour came to office in 1997.
Feds to rescue Citigroup by pumping $20B into firm
New Haven Register
Associated Press
Monday, November 24, 2008 5:22 AM EST
WASHINGTON — The government unveiled a bold plan Sunday to rescue
troubled Citigroup, including taking a $20 billion stake in the firm as
well as guaranteeing hundreds of billions of dollars in risky assets.
The action, announced jointly by the Treasury Department, the Federal
Reserve and the Federal Deposit Insurance Corp., is aimed at shoring up
a huge financial institution whose collapse would wreak havoc on the
already crippled financial system and the U.S. economy.
The sweeping plan is geared to stemming a crisis of confidence in the
company, whose stocks has been hammered in the past week on worries
about its financial health.
“With these transactions, the U.S. government is taking the actions
necessary to strengthen the financial system and protect U.S. taxpayers
and the U.S. economy,” the three agencies said in a statement issued
Sunday night. “We will continue to use all of our resources to preserve
the strength of our banking institutions, and promote the process of
repair and recovery and to manage risks,” they said.
The $20 billion cash injection by the Treasury Department will come
from the $700 billion financial bailout package. The capital infusion
follows an earlier one — of $25 billion — in Citigroup in which the
government received an ownership stake.
In addition, Treasury and the FDIC will guarantee against the
“possibility of unusually large losses” on up to $306 billion of risky
loans and securities backed by commercial and residential mortgages.
Citigroup is such a large, interconnected player in the financial
system that if it were to collapse it would wreak havoc on already
fragile financial and economic conditions. The company has operations
in more than 100 countries.
Analysts consider Citigroup the most vulnerable among the major U.S.
banks — especially after it failed to nab Wachovia Corp., which was
bought instead by Wells Fargo & Co. That was a missed opportunity
for Citi to gets its hands on much-needed U.S. deposits that would
bolster its cash position.
Fund Managers See Need for Some
Tighter Restrictions
NYTIMES
By LOUISE STORY
November 14, 2008
Five prominent hedge fund managers testified Thursday before a House
committee that they supported tighter regulation of their industry.
The managers — Philip A. Falcone, Kenneth C. Griffin, John Paulson,
James Simons and George Soros — all said they would support rules that
required hedge funds to provide information about their funds to a
regulator, provided the information was not divulged to the
public. Their support of greater disclosure represented a
significant change for an industry that has historically fought more
regulation.
But the managers, who were paid on average $1 billion last year, varied
in their support of regulation. Mr. Soros, well-known for his liberal
views, was the strongest supporter of rules to reign in the nearly $2
trillion industry. Mr. Griffin, the founder of Citadel Investment
Group, was the most hesitant, stating that he would “not be averse” to
such disclosure rules when asked if they were needed.
The hearing, held by the House Committee on Oversight and Government
Reform, is part of a series of investigations in what caused the
financial industry. Earlier on Thursday, two prominent academics
testified that they believe hedge funds should face greater
regulation. The managers’ support for greater disclosure — though
it would not be public disclosure — may surprise some peers. Hedge fund
managers have generally shunned disclosure rules, and one manager
successfully sued the government to block the Securities and Exchange
Commission from requiring all hedge funds to register with the agency.
At the same time, the five disagreed over whether the tax treatment of
their funds should be changed, and they disagreed on whether there
should be rules about their use of leverage, or borrowed money.
Mr. Griffin, who has long indicated that his company will become a
diversified financial services company, said that if hedge funds were
pushed into a new “paradigm,” the rules must be made very clear.
“So long as I know what the rules are, I can conduct my business to be
well within the lines,” Mr. Griffin said.
After the hearing, some lawmakers said witnesses had had made clear
that hedge funds have the potential to cause risk to broader markets.
“All of them went on record in support of more regulation, all of them
went on record in support of more transparency,” Representative Carolyn
B. Maloney, a Democrat from New York, said.
It was less clear how the government would go about using additional
disclosure from hedge funds. During the morning, Andrew Lo, a professor
at the Sloan School of Management at the Massachusetts Institute of
Technology, and David Ruder, a professor emeritus at Northwestern
University School of Law, said hedge funds needed to disclose more
information. But Mr. Lo went as far as suggest that the information
should be public, while Mr. Ruder, chairman of the S.E.C. in the late
1980s, said it should be kept confidential.
Mr. Lo, who has studied hedge funds for a decade, said more information
was needed for him to determine how much risk hedge funds brought to
the markets.
“The fact is that we cannot come to any firm conclusion because we
simply don’t have the data,” said Mr. Lo, who is affiliated with an
asset management company that manages several hedge funds. “Additional
transparency, even now, will provide some sense of what we’re likely to
see over the next year or two.”
The House committee asked the five managers to provide information
about their most highly paid employees, their fund’s financial returns
and their holdings of some mortgage assets. The committee also wanted
e-mail messages about the tax treatment of their compensation. A
spokeswoman for the committee said earlier this week that the five
managers submitted the information, and that the committee was still
determining what to release.
One witness, Houman Shadab, a senior research fellow at The Mercatus
Center at George Mason University, said that more disclosure could be
harmful.
“When that type of information is created by regulators it creates a
false sense of security among market participants that these risks are
being adequately monitored and managed,” Mr. Shadab said.
Another topic of the panel was the tax treatment of hedge fund
managers’ earnings. Currently, part of their earnings is taxed as
capital gains, which has a far lower rate than the income tax. Mr.
Soros and Mr. Simons both supported forcing managers’ earnings to be
taxed as ordinary income. But Mr. Griffin, Mr. Paulson and Mr. Falcone
did not.
“You make a billion dollars, but your rate can be a as low as 15
percent,” said Representative Elijah E. Cummings, a Democrat of
Maryland. “Is that fair?”
I-BBC
Now there are runs on countries
Robert Peston 23 Oct 08, 10:11 AM
The sickness afflicting the global financial economy has entered a new
and worrying phase.
It started last summer with the closing down of big chunks of the
wholesale money and securities markets. Then we saw a succession
of crises at individual banks, as institutional providers of funds
withdrew their cash from banks they perceived as weak (culminating here
in the nationalisations of Northern Rock and Bradford & Bingley,
and the rescue takeover of HBOS).
In September the entire banking system was on the brink of total
meltdown, because of semi-rational fears that almost no bank was safe
from collapse.
And now we're seeing a massive flight of capital out of economies
perceived to have been living beyond their means - either because they
have a substantial reliance on foreign borrowings, or because they are
net importers of good and services, or both.
Commercial lenders to these economies - banks, hedge funds, mutual
funds and so on - want their money back now. That's driving down their
currencies, pushing up the cost of borrowing for their respective
governments and undermining the strength of their respective banking
systems. So they need financial help to tide them over - and with
the global economy slowing down, those economies perceived as lacking
the resources to cope on their own may need support for months and
years.
Queuing up for the intensive care ward are Iceland, Hungary, Pakistan,
Ukraine and Belarus, all of which are in discussions about accessing
special loans from the International Monetary Fund, the emergency
medical service for the global economy. But there has also been a
substantial withdrawal of capital from South Africa, Argentina and -
most worrying of all - South Korea.
Let's put this into some kind of context.
The annual economic output of Pakistan, Hungary and Ukraine is
something over $100bn each - which is not trivial but does not put them
near the top of the rankings in terms of the size of their GDP.
However, the output of Argentina is well over $200bn and that of South
Korea is around $900bn. In fact, South Korea is the 13th biggest
economy in the world. If you add together the GDPs of all the
economies currently diagnosed with toxic BO by international investors
you arrive at a sum that's not far off the economic output of the UK.
And the sums of debt involved are also fairly substantial. Hungary has
external debt of more than $100bn, Ukraine has foreign borrowings of
$50bn, while Pakistan's dependence on overseas funding is nudging $40bn.
As for South Korea, which hasn't requested formal help from the IMF,
its foreign debt is nearer $200bn. Now you may think this is all
about remote countries, with no relevance to you. Well, that would be
wrong. We're all connected. It's been very fashionable for
pension funds to invest in developing economies in recent years. If
you're saving for a pension, you may own a chunk of South Korea or
Argentina.
If you're very unlucky, your pension fund may have belatedly put some
of your cash into one of the many hedge funds being royally mullered by
the way they borrowed vast sums to invest in some of these emerging
economies.
And of course the woes of these economies reduce their ability to
purchase from abroad, which acts as a further serious drag on global
economic growth. Also the UK is being buffeted directly by
international investors' re-awakened distaste for economies perceived
to be too dependent on foreign capital or credit from institutions and
companies. What's happening to South Korea - where its currency,
the won, has fallen 29% in the past three months, and shares have
fallen well over 20% in a week - is particularly worrying for us.
South Korea is a great manufacturing and exporting nation. Its balance
of trade is vastly healthier than the UK's.
But like the UK, South Korea's banks are dependent on wholesale funds
that are being withdrawn because of fears that those banks face losses
on imprudent deals (not lending to homeowners, as is the case in the
UK, but currency hedges with local companies - see my note "Crisis is
business as normal").
Of course, our banks - and South Korea's - are being shored up by
massive financial support from taxpayers. But if investors no
longer think the UK's banks are at risk of collapse, they then look at
our other vulnerabilities - such as public sector borrowing which is
rising very sharply because of the costs of the bank rescues, dwindling
tax revenues and the need to spend our way through the economic
downturn.
They also look at our structural trade deficit and our huge reliance on
financial flows generated by a City of London and a financial services
industry that's shrinking fast. As I've pointed out in a
tediously repetitive way, the sum of all we've borrowed - the aggregate
of corporate, personal and public sector debt - is equivalent to three
times our annual economic output. That's a vast amount of debt to
repay - and it's all the harder to do so at a time when our most
successful industry, financial services, is in some difficulty and the
global economy is slowing down.
If international investors fear our credit isn't what it was and are
selling pounds, we should hardly be surprised.
NEW YORK TIMES MUST-READ BUSINESS WRITERS'
SERIES HERE.
---------------------------
Global creditors end U.S. spending spree
Wasington Times
Patrice Hill
Sunday, October 12, 2008
The crash unfolding on Wall Street is not just the fall of once-mighty
banks and corporations that took on too much debt, but the collapse of
an American economy and lifestyle that for decades has been purchased
with credit cards.
The nation's creditors - many of them foreign countries such as China
and Brazil with ample economic needs of their own - reached a point
this summer at which they were no longer willing to extend new loans in
light of burgeoning default rates.
One of every 10 American homeowners has stopped making mortgage
payments, and high-flying investment banks such as Lehman Brothers and
Bear Stearns that peddled American debt around the world found
themselves in bankruptcy and default.
The boycott by foreign lenders is forcing U.S. businesses and consumers
to live more within their means, while political leaders frantically
try to find ways to keep the financial sector alive without the free
flow of an estimated $3 billion a day from abroad, analysts say. The
spigot of foreign money in the heyday of the credit boom earlier this
decade enabled everyone from Wall Street's best and brightest to
college students with no income to easily obtain cheap loans.
"The party is over," said Peter Schiff, president of Euro Pacific
Capital. "The current financial storm represents the death throes of
the old global economic order, and perhaps the birth pains of a new
one. The sun is setting on the borrow-and-spend culture that has all
but defined us for a generation. ... The sooner we come to grips with
this, the better."
The nation's increasing reliance on debt to grow and prosper is
manifested in the current account deficits that have increased
dramatically this decade. Those deficits show how much the U.S.
collectively spends more than it produces and how much money is owed to
the rest of the world. The federal deficit hit an unprecedented $812
billion in 2006, at the peak of the housing bubble, before declining to
$738 billion last year as the housing market crumbled.
The huge external debt was financed for years with a flow of credit
from abroad, but that suddenly shut down in July, when foreigners
pulled $25.6 billion out of U.S. stock and bond markets, according to
the Treasury's most recent figures on international capital flows.
About the same time, Fannie Mae and Freddie Mac, former favorites of
Asian investors in particular, started having trouble raising funds.
The government later took over the mortgage giants as they became
insolvent.
"We can no longer entice foreigners into lending us their available
savings," said Mr. Schiff. "Given that we are already too loaded up on
existing debt that we cannot realistically repay, who can blame them
for not wanting to lend us more?"
With the abrupt shutdown of the credit spigot this summer, the housing
and credit markets faced an outright crisis and easy loans all but
disappeared. Consumer spending reached its biggest decline in years as
banks - having difficulty raising funds - severely limited access to
mortgages, home-equity loans and other kinds of credit.
"The day of reckoning appears to have arrived," said Stephen Stanley,
chief economist at RBS Greenwich Capital, noting that scarcer credit is
forcing Americans to save more of their income and spend less. One
result is that the trade deficit is now dropping at a 25 percent annual
rate, he said. "As Americans retrench, the structural imbalances that
the world bludgeoned us about will shrink in size all too quickly."
Political and financial leaders always knew that the inevitable end of
the great debt binge would be painful, forcing Americans to
dramatically cut back spending and bringing on a long, deep recession
that Mr. Stanley and other economists are predicting.
"We have warned for years to be careful what you wish for on this
count," he said.
Laura Nishikawa, an analyst with Innovest, a credit-research group that
is predicting a major rise in credit-card defaults, said consumers took
on increased debt in recent years to finance middle-income and affluent
lifestyles even as their wages were stagnating and savings were
dwindling.
"The mortgage problem is, in fact, a symptom of a deeper crisis of
deteriorated consumer financial health," she said.
Now, big banks like Bank of America, Citibank, JPMorgan Chase, Capital
One and American Express - themselves hard-pressed to get loans in
bank-funding markets - are reducing consumers' credit-card limits and
home-equity lines and limiting credit-card-balance transfers, putting
already pinched consumers into serious binds, she said.
"When they reduce credit availability, consumers won't have the ability
to roll their debt over, and the issuers will essentially force
customers into default," she said.
Consumers sank deeper into debt during the housing boom, when easy
initial mortgage terms allowed them to buy bigger, more expensive homes
and rapid appreciation opened the door to cash-out refinancings and
home-equity loans that financed other spending.
"Millions of households have been operating just like hedge funds for a
long time," said Brent Wilson, analyst with Reochronicle.com, a Web
site tracking foreclosed homes, describing how ever-increasing debt
financed the doubling or tripling of house prices in many areas that
have now deflated.
"They borrowed ever-increasing amounts of money to finance an asset
whose price depends on borrowing ever-increasing amounts of money. The
financial profile of hedge funds and millions of households is almost
identical," he said. Now, "the financial sector is on its knees, since
they financed the speculation."
But the problem was not confined to real estate, he said. "The fact is
that the whole economy to some extent has been operating like a hedge
fund for a long time - households, corporations, state governments,
Wall Street, cities" - all leveraging assets like real estate to
finance a spending binge, he said.
"It looks like a long period of consolidation has set in," he said.
"Many weaker companies will go bankrupt, many more banks will go under
- with or without help from the federal government, stocks will
probably be weak for some time."
Many analysts find it disconcerting and ironic that the solutions
offered by the Treasury, Federal Reserve and Congress rely on massive
issues of debt from the Treasury to try to save cash-strapped banks,
homeowners and corporations.
The Treasury is about the only American entity that still has easy
access to cheap loans as investors seeking safe havens pile money into
Treasury bills paying close to 0 percent interest. The Treasury,
already the world's biggest debtor, has been adding to its red ink at a
prodigious rate to finance rescue programs that could drive the U.S.
budget deficit to an unprecedented $1 trillion next year.
"The intention of all these daily federal interventions is to keep the
credit spigots open, so Americans can go even deeper into debt to buy
more stuff they can't actually afford," Mr. Schiff said.
"The sad reality is that we borrowed and spent our way into this
crisis, and we are not going to borrow and spend our way out of it," he
said. "Savings can't be magically concocted into existence by a
printing press, but can only be created by consumers who spend less
than they earn."
Armageddon
avoided
I-BBC
Robert Peston 8 Oct 08, 04:42 PM
The symbolism couldn't be worse.
Gordon Brown commits £400bn of taxpayers' money - equivalent to
about a
third of our entire economic output - to rescuing the banking
system.
And central banks from Asia to Europe to North America slash interest
rates. In other words, there's been a co-ordinated global attempt
to
prop up the financial system and save individual economies from a deep
dark recession.
Yet the FTSE 100 plumbs new depths.
What on earth's going on? Are we all doomed? Well, the
symbolism is a
bit misleading, because the FTSE 100 is massively unrepresentative of
the British economy. The main reason it's fallen is because of
sharp
falls in the prices of giant mining companies that are listed on the
London exchange. So does that mean the FTSE 100 drop doesn't
matter?
No, for two reasons.
First, one of the untold horror stories of the credit crunch is that
it's wreaking havoc with the investments that underpin the value of
millions of people's pensions. Also, the reason for the fall in
those
mining companies is that there's been a further sharp drop in the price
of commodity and energy prices. Good news in a way, if it leads
to
lower household bills.
But the cause of those drops is a slowdown in economic activity
throughout the world and the onset of recessions in several developed
economies.
So what Gordon Brown and central banks have done today should stave off
economic Armageddon - but it's probably too late to save us from
months, or even years, of sluggish growth.
Wall Street Pulls Back Amid Credit Concerns
NYTIMES
By THE ASSOCIATED PRESS
Published: October 8, 2008
Filed at 9:23 a.m. ET
NEW YORK (AP) -- Wall Street headed for another volatile session
Wednesday as investors doubted that an emergency interest rate cut
would revive credit markets that have been stagnant for weeks.
Investors were initially encouraged after central banks including the
Federal Reserve cut interest rates in a coordinated effort aimed at
restoring confidence in the market and help end the global financial
crisis. But their enthusiasm faded as they realized a rate cut doesn't
guarantee that businesses and consumers will have an easier time
obtaining credit anytime soon, and that the economy is still in
jeopardy because of a lack of lending.
''With all of this occurring as a coordinated effort is showing that
everybody out there is trying to fight this thing, and that should
bring some confidence back to the market,'' said Scott Fullman,
director of derivatives investment strategy for WJB Capital Group.
''But, the big question now is can the credit market open for
business.''
The Fed noted in a statement that the market turmoil posed a further
threat to an already shaky economy; it was joined in the rate cut by
banks including the European Central Bank, Bank of England, The Bank of
Canada, the Swedish Riksbank and the Swiss National Bank.
Dow Jones industrial average futures fell 290, or 3.04 percent, to
9,248. Standard & Poor's 500 index futures fell 36.80, or 3.66
percent, to 969.00, while Nasdaq 100 futures dropped 50.75, or 3.76
percent, to 1,286.25.
European indexes, which were down about 5 percent before the rate cut,
pared some of their losses. In Britain, the FTSE-100 fell 1.43 percent,
Germany's DAX dropped 2.55 percent, and France's CAC-40 dropped 1.95
percent.
In Asia, the Nikkei 225 closed 9.38 percent lower and Hang Seng tumbled
8.17 percent hours before the rate cuts were announced; their declines
showed the extent of the worldwide gloom.
''The credit market is still tight, there's no money out there,'' said
Todd Leone, managing director of equity trading at Cowen & Co.
''Everything the Fed is doing will eventually help, but people have to
realize that it will take some time and that the economy is going to
get worse during the next few months.''
Investors had been extremely anxious in recent days for a rate cut, and
while the Fed had taken other steps this week to try to ease the
stagnant credit markets, including buying commercial paper, the
short-term debt used by companies, its moves weren't enough to stanch
losses that have taken the Dow Jones industrials down 875 points in
just two days this week.
It is very likely that stocks won't begin to recover for good until
investors are certain the credit markets are functioning in a more
normal fashion. But there are also severe economic problems including
heavy job losses and high unemployment that will also need to show
improvement.
Credit has all but dried up in the weeks after the failure of Lehman
Brothers Holdings Inc. Banks have been reluctant to lend for fear they
won't be paid back. That in turn has been stifling the economy, and led
to the huge plunges on Wall Street in recent weeks.
Demand for short-term Treasurys remained high because of their safety;
investors are willing to take extremely low returns just to have their
money in a secure place. The yield on the three-month Treasury bill,
which moves opposite its price, dropped to 0.53 percent from 0.81
percent late Tuesday.
Investors also bought up longer-term Treasury bonds, which don't draw
as much demand in times of fear. The yield on the 10-year note fell to
3.48 percent from 3.51 percent late Tuesday.
The first third-quarter earnings reports are showing signs of strain on
companies, and that is adding more uncertainty to the stock market.
After the close Tuesday, Alcoa Inc. said it would conserve cash by
suspending its stock buyback program and all non-critical capital
projects. The aluminum company's earnings fell 52 percent.
What Crisis? Some Hedge Funds Are
Gaining
NYTIMES
By LOUISE STORY
November 10, 2008
Bernard V. Drury is a rarity on Wall Street: a hedge fund manager who
is making money rather than losing it.
While most hedge funds are sinking into red this year and unsettling
the markets in the process, a handful of them are posting spectacular
gains. Mr. Drury’s fund, for instance, is up 60 percent since Jan. 1.
How did he do it? Mr. Drury, a former grain trader, is not giving away
his secrets. He relies on proprietary computer models to chart tides in
the markets and to ride the prevailing currents.
But however smart or lucky the moneymakers have been, a few bad trades
can end any hot streak. Despite Wall Street’s reputation as a place of
big money and bigger egos, many of the winners are reluctant to boast,
particularly given the gaping losses threatening some rivals.
“There’s going to be, naturally, a lot of forms of disillusionment with
hedge funds,” said Mr. Drury, who opened his fund, Drury Capital, in
1992.
Indeed, gloomy talk of an industry shakeout is getting louder as
returns at most funds sink lower. Over the last few months, some funds
have been forced to dump stocks and bonds because their investors want
their money back. Wall Street traders worry that another big wave of
withdrawals in mid-November could further unsettle the markets.
All of which makes the big winners stand out even more. Hedge fund
returns, on average, are down 20 percent. But one in every 50 funds is
up more than 30 percent — an astonishing performance, considering the
broad stock market is down even more than that.
Winners include trend-followers like Mr. Drury; market-spanning macro
funds, which dart in and out of an array of markets and bet on
everything from Apple Inc. to zinc; and niche players that are buying
insurance policies or making loans to small companies.
Some of this year’s stars are familiar names on Wall Street. For
instance, a fund managed by John Paulson, who reportedly was paid $3.7
billion in 2007 after betting against the subprime mortgage market, has
gained nearly 30 percent this year in his largest fund, investors say.
But some of the other moneymakers are not well known, and could benefit
as competitors close and investors look for new places to park their
money. Hedge-fund traders who make a killing are often lionized within
the industry. One good year can vault a small player to the big leagues.
But with so many funds down — only one in three has made any money this
year — the price of admission to the winner’s circle has fallen. A
showing that would have been considered dismal only a year ago is now
viewed as a standout success. Traders even joke that down 10 percent is
the new break-even. Actually making money is all the more rare.
“This year, anything north of 10 percent is spectacular,” said Pierre
Villeneuve, managing director of the Mapleridge Capital Corporation, a
$750 million hedge fund in Canada that is up 18 percent.
Other funds with big winnings include R. G. Niederhoffer Capital
Management; Conquest Capital Group; MKP Capital Management; the Tulip
Trend Fund, run by Progressive Capital; and funds run by John W. Henry
& Company.
Never before have so many funds been down. In 5 of the last 10 years,
fewer than 15 percent of hedge funds lost money. Even in the worst
year, 2002, 31 percent finished down, according to estimates from
HedgeFund.net, a unit of Channel Capital Group. This year, some 70
percent of hedge funds had lost money from Jan. 1 through the end of
September.
To a degree, hedge funds are hostage to their stated investment
strategies, and investors judge them accordingly. Funds that specialize
in convertible bonds and stocks, for example, are among the worst
performers this year because those markets have been hard hit in the
financial crisis.
Losers include well-known traders like Kenneth C. Griffin, who runs the
Citadel Investment Group; Lee S. Ainslie, head of Maverick Capital; and
David Einhorn, the head of Greenlight Capital, who called attention to
the troubles at Lehman Brothers before many others.
Still, funds that specialize in investment strategies that have
suffered could come out looking good if they manage to post even modest
gains. For instance, Exis Capital, a $150 million fund that trades
stocks, is up 9 percent this year, even after the fund’s manager took
their 50 percent fee, according to investors. The average stock fund,
by comparison, is down 22 percent, according to estimates from Hedge
Fund Research. In commodities trading, Touradji Capital Management is
up 11 percent even as its competitor, Ospraie Management, was forced to
liquidate a large fund.
At some hedge fund companies, this year’s performance is mixed.
Trafalgar, a hedge fund in London, manages 10 funds. Three are down,
but two — a volatility fund, and “special situations” fund — are up
more than 20 percent, according to an investor.
Trafalgar declined to say what special situations it had pounced on.
Volatility funds, a category that is broadly doing well, focus on
trading options and try to profit when the markets swing wildly as they
have lately.
Lee Robinson, co-founder of Trafalgar Asset Managers, said his firm’s
success set it apart from competitors.
“Every investor is going to say, ‘What did you do in September ’08,
what did you do in October ’08?’ and if you were down significantly,
you’re going to have trouble raising money,” Mr. Robinson said. “The
most important question is not, ‘How much money am I getting back?’
it’s ‘Do I get my money back?’ ”
Several managers who are doing well did not want to brag at a time when
so many of their industry colleagues were struggling.
“You don’t do victory laps,” said Adam Stern, a partner at AM
Investment Partners, whose volatility fund is up 6.75 percent this
year. “It’s a very sad time for a lot of people. People worked very
hard, and they’re losing a lot of money and net worth.”
Marek Fludzinski, one of this year’s winners, remembers what it was
like to be a loser. Mr. Fludzinski, the chief executive of Thales Fund
Management, was among the computer-loving quantitative fund managers
who suffered in 2007, when his fund lost 8 percent. Investors
immediately began asking for their money back, so Mr. Fludzinski shut
the $1.6 billion fund and started anew.
Now his computer-driven fund, created in May, has grown to $350 million
from $80 million in assets and is up 14 percent.
Mr. Fludzinski said the important factor in running a hedge fund these
days was simply surviving.
“Don’t do something that will kill you,” said Mr. Fludzinski, who uses
a database with 14 years of prices on thousands of stocks to try to
spot patterns like the forced selling of stocks.
Marc H. Malek, a former UBS trader who manages $611 million, is up 44
percent in his macro fund. But even as new investors approach his
company, Conquest Capital, the firm is also receiving redemption
requests from investors who want their money back, Mr. Malek said.
Investors are pulling cash from wherever they can.
A growing number of troubled hedge funds are temporarily refusing to
give investors their money back by freezing their funds, in industry
parlance. But others are profiting from the waves of panic that have
convulsed the markets this year.
Roy Niederhoffer, founder of R. G. Niederhoffer Capital Management,
whose more famous brother, Victor, made and then lost a fortune
trading, is up more than 50 percent. To predict how investors will
behave, Roy Niederhoffer, who majored in neuroscience at Harvard,
delves into psychological research.
But Mr. Niederhoffer does not need much research to tell him that some
investors chase winners. With his fund soaring, investors are piling
on. His assets under management have climbed to $2 billion, from $700
million earlier this year.
Still, Mr. Niederhoffer is not planning any celebrations.
“The greatest danger at a time like this is hubris,” he said. He has
banned fist-pumping victory poses on his trading floor.
Hedge
Fund Results Seen Going From Bad
to Worse
NYTIMES
By REUTERS
By Joseph A. Giannone and Svea Herbst
Published: November 7, 2008
Filed at 8:13 a.m. ET
NEW YORK (Reuters) - As brutal as September was for hedge funds,
October was even worse.
Hedge fund industry trackers Barclay Hedge, Hedge Fund Research Inc and
Hennessee Group LLC will report over the next few days just how poorly
the $1.9 trillion industry performed last month. It was a period of
plunging stock prices, frozen debt markets and fire-sales by banks
scrambling to boost cash.
"You had one of the worst months in the equity markets that you had in
decades. You add to that the ban on short selling, which destroyed
convertible arbitrage, and the equity strategies were hurt badly," said
Sol Waksman, founder of industry tracking service Barclay Hedge.
Some of the most successful names in the industry were hammered last
month, as funds lost more money than they did in a September that
featured the Lehman Brothers bankruptcy, the near collapse of American
International Group <AIG.N>, and one of the steepest stock market
drops ever.
David Einhorn's Greenlight Capital, lauded for predicting Lehman's
financial woes, suffered heavy losses from a short position on
Volkswagen <VOWG.DE> after the German carmaker's shares spiked.
Greenlight, down 16 percent in the first nine months this year, is seen
posting bigger declines for October.
Ken Griffin's Citadel Investment Group, down 15 percent in September,
is seen dropping further in October. Lee Ainslie's Maverick Fund is
expected to be down again after falling more than 19 percent in
September.
Also stumbling is Goldman Sachs <GS.N>, which told clients the $7
billion Goldman Sachs Investment Partners fund has lost nearly $1
billion since its launch in January thanks to wayward bets on
commodities, metals, energy and agriculture.
Earlier Thursday, shares of London-based hedge fund managers Man Group
<EMG.L> tumbled 31 percent partly on fears the firm's Man Global
Strategies fund would see more outflows. Man's total assets under
management have fallen to $61 billion from $68 billion at the end of
September.
The HFRX Global Hedge Fund Index, compiled by Hedge Fund Research Inc,
had a negative 9.3 percent rate of return in October and through
Tuesday was down 19 percent this year.
By comparison, the Standard & Poor's 500 Index fell 17 percent in
October -- its ninth-worst decline ever-- and 32 percent for the year.
Still, the poor performance of hedge funds -- which charge high
management and incentive fees -- shook up confidence in an investment
vehicle that was supposed to protect clients by serving as a "hedge"
against market swings.
Charles Gradante, co-founder of Hennessee Group, said hedge funds were
down 7 percent in October, about 3 percentage points lower than they
"should be." Usually, hedge funds fall about one-third as much as the
overall market, he explained.
"They were down so much largely because of the volatility, and markets
not acting on fundamentals but fear," Gradante said. Some of the
hardest hit were those focused on emerging markets, Europe and
convertible arbitrage, he said.
Not all funds suffered. Short-seller funds were up about 10 percent for
the month.
Even so, fund managers were forced to deal with plunging markets,
anxious clients pulling out their money, and wide-scale de-leveraging
that put more pressure on asset values. All that plus a ban on
short-selling.
"I would expect that redemptions by historical standards are quite
high. Not a day goes by where we don't see that such and such a fund is
putting up gates," said Barclay's Waksman.
Michelle Celarier, editor of Absolute Return, a magazine focused on the
hedge fund industry, said it's too early to predict if the industry's
October results lagged September.
Based on preliminary data, at least half of the funds that submit data
to the magazine lost money in October. But with three of the five worst
months in a decade recorded in March, July and September this year, it
is clear hedge funds are suffering.
"I think we can predict September and October together will be worst
back-to-back months that we've ever seen," Celarier said. And with
redemption demands draining cash, "I don't see it getting any better
anytime soon."
Investors
Flee as Hedge Fund Woes
Deepen
NYTIMES
By LOUISE STORY
Published: October 22, 2008
The gilded age of hedge funds is losing its luster. The funds, pools of
fast money that defined the era of Wall Street hyper-wealth, are in the
throes of an unprecedented shakeout. Even some industry stars are
falling back to earth.
This unregulated, at times volatile corner of finance — which is
supposed to make money in bull and bear markets — lost $180 billion
during the last three months. Investors, particularly wealthy
individuals, are heading for the exits.
As the stock market plunged again on Wednesday, with the Dow Jones
industrial average sinking 514 points, or 5.7 percent, the travails of
the $1.7 trillion hedge fund industry loomed large. Some funds dumped
stocks in September as their investors fled, and other funds could
follow suit, contributing to the market plummet.
No one knows how much more hedge funds might have to sell to meet a
rush of redemptions. But as the industry’s woes deepen, money managers
fear hundreds or even thousands of funds could be driven out of
business.
The implications stretch far beyond Manhattan and Greenwich, Conn.,
those moneyed redoubts of hedge-fund lords. That is because hedge funds
are not just for the rich anymore. In recent years, public pension
funds, foundations and endowments poured billions of dollars into these
private partnerships. Now, in the midst of one of the deepest bear
markets in generations, many of those investments are souring.
Granted, hedge funds are not going to disappear. In fact, some are
still thriving. Even many of the ones that have stumbled this year are
doing better than the mutual fund industry, which has also been hit
with withdrawals that have forced their managers to sell.
But the reversal for the hedge fund industry represents a sea change
for Wall Street and its money culture. Since hedge funds burst onto the
scene in the 1990s, they have recast not only the rules of finance but
also notions of wealth and status. Hedge-fund riches helped inflate the
price of everything from modern art to Manhattan real estate. Top
managers raked in billions of dollars a year, and managing a fund
became the running dream on Wall Street.
Now, for lesser lights, at least, that dream is fading.
“For the past five or six years, it seemed anybody could go to their
computer and print up a business card and say they were in the hedge
fund business, and raise a pot of money,” said Richard H. Moore, the
treasurer of North Carolina, which invests workers’ pension money in
hedge funds. “That’s going to be gone forever.”
As are some hedge funds. For the first time, the industry is shrinking.
Worldwide, the number of these funds dropped by 217 during the last
three months, to 10,016, according to Hedge Fund Research.
Even some of the industry’s most well-regarded managers are starting to
retrench. Richard Perry, who until now had not had a down year for his
flagship fund in more than a decade, has laid off some employees. Mr.
Perry, who began his career at Goldman Sachs, is moving away from
stock-picking to focus on the troubled credit markets.
Three other hedge fund highfliers — Kenneth C. Griffin, Daniel S. Loeb
and Philip Falcone — have suffered double-digit losses through the end
of September.
Steven A. Cohen, the secretive chief of a fund called SAC Capital, has
put much of the money in his funds into cash, reducing trading by some
of his workers.
Many hedge fund investors, particularly the wealthy individuals, are
flabbergasted by their losses this year. The average fund was down 17.6
percent through Tuesday, according to Hedge Fund Research.
“You’re seeing a lot of shock, a lot of inaction, a lot of reassessment
of where their allocations are and what to do going forward,” said
Patrick Welton, chief executive of the Welton Investment Corporation,
whose fund is up double-digits this year.
Many investors, Mr. Welton said, had hoped hedge funds would protect
them from a steep decline in the broader market. But in many cases,
that has not happened.
Now Wall Street is buzzing about how much money could be pulled out of
hedge funds — and which funds might bear the brunt of the redemptions.
Funds have set aside billions of dollars in cash to prepare for
withdrawals, and many prominent funds require their investors to leave
their money in the funds for years. That could help relieve some of the
pressure.
But because hedge funds are largely unregulated, they do not publicly
disclose the identity of their investors or whether they have received
requests for withdrawals. While it might make sense to pull money out
of poorly performing funds, investors might also exit funds that are
doing well to offset losses elsewhere.
Institutions — pension funds, endowments and the like — pushed into
hedge funds after the Nasdaq stock market bust at the turn of the
century. Many hedge funds had prospered as technology stocks crashed,
leading these investors to believe they would in the future.
In Massachusetts, for instance, Norfolk County broached the issue with
the state’s pension oversight commission, said Robert A. Dennis, the
investment director of the commission. Mr. Dennis was impressed that
hedge funds had fared so much better than the broader stock market.
Though Mr. Dennis says he recognizes the risks that come with selecting
hedge funds, he thinks they remain a good investment. Next week, the
state commission will vote on whether to allow some towns with pension
funds below $250 million to invest in hedge funds, a move Mr. Dennis
supports.
“Hedge funds are having a bad year, absolutely, but they’re still
holding up better than stocks,” Mr. Dennis said. “Losing less money
than another investment is, while not great, it’s still something to be
at least satisfied with.”
But now that the days of easy money are over, some fund managers are
throwing in the towel.
One manager, Andrew Lahde, was blunt about his decision.
“I was in this game for the money,” Mr. Lahde wrote to his investors
recently. He made a fortune betting against the mortgage markets,
calling those on the other side of his trades “idiots.”
“I have enough of my own wealth to manage,” Mr. Lahde wrote. He did not
return telephone calls seeking comment.
And what wealth there has been. More than anything else, hedge funds
are vehicles for their managers to take a big cut of profits. The
lucrative economics of the industry is known as “two and 20.” Managers
typically collect annual management fees equal to 2 percent of the
assets in their funds, and, on top of that, take a 20 percent cut of
any profits. Last year, one manager, John Paulson, reportedly took home
$3 billion.
But with the industry under pressure, those fat fees are being
questioned. Mr. Moore and other investors are starting to ask whether
hedge funds deserve all that money. Mr. Griffin, who runs Citadel
Investment Group in Chicago, plans to offer funds with lower fees.
More changes could be coming, including increased regulation. The House
Committee on Oversight and Government Reform is scheduled to hold a
hearing about regulation next month with five hedge fund managers who
reportedly made more than $1 billion last year: Mr. Griffin, Mr.
Falcone and Mr. Paulson, as well as George Soros and James Simons.
Will
hedge fund investors cash in
today?
Greenwich TIME
By Michael C. Juliano, Staff Writer
Article Launched: 09/30/2008 08:00:45 AM EDT
There's tension in the hedge fund industry as investment analysts said
they expect many investors to cash in their holdings today after
Monday's House rejection of a $700 billion bailout for the nation's
financial system.
Many hedge funds consider Sept. 30 a quarterly redemption period when
investors may cash in investments.
K. Daniel Libby, a senior portfolio manager for Select Access Funds of
the Greenwich investment firm Sands Brothers, said he expects many
investors to notify hedge fund operators that they are pulling their
investments today so they can get out by year's end.
"For any hedge fund investor who has not reduced his risk to exposure
up until now, they're definitely going to take the last opportunity
now," Libby said.
Many investors will give their 90-day notifications, as required by
many hedge fund operators, to sell their assets so they can make them
liquid them by the end of the year instead of six months from now,
Libby said.
"I think, on the margin, people are more likely to be redeeming," he
said.
But other observers of the hedge fund industry, such as Steve
McMenamin, executive director of the Greenwich Roundtable, an
investment research firm, don't expect investors to back out today.
"I think some hedge fund investors would like to move to increase their
cash positions to protect their capital and buy at the bottom,"
McMenamin said.
Joel Schwab, managing director of hedgefund.net in New York, said
sophisticated investors probably will stay in hedge funds, which number
about 300 in Greenwich.
"If anything, hedge funds are likely one of the better parts of their
investment portfolios," Schwab said. "While going through their worst
period ever, hedge funds are still doing a lot better than other
investments."
The bailout failure may cause less experienced investors to panic and
leave hedge funds, but the industry will do fine, Schwab said.
"Will that cause people to back out of hedge funds?" he said.
"Absolutely, but it's hard to tell how many."
Despite the market uncertainty, Shariah Capital in New Canaan will
invest $150 million in three hedge funds with the Dubai government.
Shariah-compliant strategies are designed for Islamic investors. The
Quran doesn't allow a person to sell something he doesn't own, which
rules out short-selling - a widely used strategy that enables hedge
funds to post high returns even in bear markets.
Together, Shariah and Dubai have put $50 million in Toqueville Asset
Management, which specializes in precious metals, coal and steel
investors Zweig-DiMenna International, and Lucas Capital Management,
investors in natural gas.
"We want to make it clear that we're investing in capital markets,"
said Eric Meyer, president and chief executive officer of Shariah
Capital. "We're tying to look a bit longer term."
A Squeeze on Leading Fund Chiefs
NYTIMES
By LOUISE STORY
Published: September 30, 2008
Lee S. Ainslie, Louis M. Bacon and Daniel Loeb are some
of the most successful hedge fund managers around. But even they lost
big lately as the markets turned chaotic.
While their showing was better than that of the broad stock market, it
nonetheless underscored how difficult this year had been for hedge
funds — and how much pain might yet lie ahead. The average fund is down
10 percent for the year, as of last Friday, according to Hedge Fund
Research, and much of those losses hit in September.
The news could not come at a worse time for the $2 trillion industry,
which manages money for some of the largest pension funds, endowments
and foundations. Many hedge funds ask investors to provide three
months’ notice if they would like to take their money back. And for
year-end withdrawals, the deadline was this week — meaning that
investors were evaluating their hedge fund holdings just as lightning
struck the markets.
“Some of the selling you saw in the stock market Monday was clearly
hedge fund managers selling to be ready for redemptions,” said David
Salem, chief investment officer for the Investment Fund for
Foundations, which invests $8 billion for charity endowments.
Mr. Salem said he did not redeem a penny this week, but he believed
funds would continue to suffer as others cashed out.
On Tuesday, RAB Capital, a British fund manager reportedly froze
redemptions on its fund for three years, meaning that investors could
not take money out until 2011. RAB, once a high-flying fund, has lost
more than 54 percent of the value in one of its funds this year and
double digits in others, according to HSBC.
The credit squeeze has affected hedge funds in some of the same ways
that it hit banks. And now they face new rules from the Securities and
Exchange Commission about short-selling, a trading tactic that many
funds use to bet against stocks.
Maverick Capital, a hedge fund in Texas run by Mr. Ainslie, lost 11.4
percent in September. That put Mr. Ainslie, a disciple of the noted
investor Julian Robertson, down 13 percent for the year, according to a
report from HSBC that includes data through last Friday. Mr. Ainslie
did not return phone calls seeking comment.
At least three funds run by Moore Capital, which is headed by Mr.
Bacon, stumbled in the last couple of weeks. A spokesman for Moore
Capital declined to comment.
Third Point Offshore, led by the activist investor Mr. Loeb, was down
only 1.2 percent as of Sept. 12. But over the next two weeks, it fell
to a 6.6 percent loss for the month. That leaves Mr. Loeb down 13.8
percent this year.
“Look, they’ve had their hands tied behind their back,” said Dick Del
Bello, senior partner of Conifer Securities, a company that provides
administrative support to hedge funds. “Look at what has happened to
the market in the last two weeks. And they can’t play the downside?”
Many funds took their money out of the markets to try to avoid trouble.
The cash-outs signal that some managers chose to lock in gains from the
year, instead of taking additional risks. It also signals that some
expect they will need cash on hand to pay for redemptions.
It is not only the troubled funds that could face withdrawals. Some
investors may take money from funds that are performing well, simply
because those funds have looser redemption policies.
“The investors who are rushing for the exits will do so where they can,
not where they want to,” said Andrew Barber, a director at Research
Edge, an investment research firm in New Haven, Conn.
Hedge funds employ a wide range of investing strategies, but it was
those who invest in public companies that took the toll over the last
few weeks. The value fund of Fir Tree Partners lost 10 percent last
month, even though it was up 2 percent in mid-September. The last two
weeks left the equity hedge fund down 17.7 percent for the year as of
last Friday, according to HSBC.
Paul Tudor Jones’s Raptor Fund fell nearly 2 percent in September,
putting its losses at nearly 12 percent for the year. It will be months
before the impact is known from hedge fund redemptions on the markets.
As investors take back their money, hedge funds sometimes must sell
their positions, although they typically have months to do so.
While many investors will flee, some investors said they were willing
to stick with veteran hedge fund managers.
“It would be very unwise to conclude that someone who has been
demonstrably good at managing money for years has suddenly lost their
compass,” Mr. Salem said. “The compass may just be malfunctioning in
the current environment.”
ON
THE HORNS OF A DILEMMA
Read
full draft text (as of Monday A.M., September 29, 2008) here,
courtesy of the New York Post.
True
cost of the rescue
I-BBC
Robert Peston
20 Sep 08, 02:27 PM
The US Government has just admitted that the financial system was on
the verge of total meltdown. And it's right. On Thursday, even blue
chip companies were having difficulty rolling over their short-term
borrowings.
Armageddon was minutes away - averted by Hank Paulson's plan to insure
money-market funds and cut the gangrene out of the banking system.
The US Treasury Secretary is working over the weekend to nationalise
around £450bn of banks' balance sheets - equivalent to a third of
the
British economy.
So, if anything, he was guilty of understatement when he conceded that
the "financial regulatory structure is sub-optimal, duplicative and
outdated".
However, on Friday - in reaction to all of that - stock markets were
partying as though its 1999 again.
Hmmmm.
That doesn't feel like quite the right reaction to me.
Investors are probably right to conclude that one great source of
stress will be lifted from the banking system, as and when Paulson
sucks their toxic subprime loans, unsellable asset-backed securities,
and radioactive collateralised debt obligations into a vast, lead-lined
box financed by US taxpayers.
In the country that brought us Ghostbusters, he is styling himself as
the Debtbuster.
And it's not all front: the risk of a calamitous, domino-effect,
collapse of banks all over the world - and especially throughout the US
- has receded somewhat.
That said, the devil will be in the detail of the mechanics of the
rescue. What we don't yet know, for example, is whether Paulson's First
Toxic Bank - as I shall christen his vehicle for buying the stinky
housing loans - will pay the written-down price for the debt, the
market price (which after Lehmans collapse is lower than the
written-down price) or a discount to the market price.
This matters.
There is an argument that Paulson should pay a discount to the market
price, to protect US taxpayers and soundly spank the banks and their
owners.
However if he did that, banks' capital resources would be further
depleted, which would further undermine their ability to lend to the
rest of us. And it wouldn't do a great deal to reinforce the
foundations of the creaking banking system.
But if he bails banks out at the price of this stuff in their books or
above, well that would be an acknowledgement that an entire generation
of banking executives had behaved wholly irresponsibly in their lending
practices for years.
Arguably, they should all be sacked and thrown on to the mercy of a
jobs market made all the less kind by their own recklessness.
Let's assume for now that Paulson finds a mechanism to extract the
poison from the banks, without enfeebling them in the process. Can we
all then breathe a sigh of relief and assume our economic prospects
will improve markedly?
Sadly, I don't think so.
Banks, money managers, controllers of trillions of dollars on behalf of
the cash-rich states of Asia and the Middle East have all had a painful
lesson in the meaning of risk over the past fortnight.
They will for an extended period - possibly years - be less willing to
fund our banks without demanding a significant increment in what the
banks pay them. That'll increase the cost of money for all of us, which
will make most of us feel quite a lot poorer for some time.
Also, you can kiss goodbye to the kind of financial creativity,
innovation and competition that accelerated the growth of the UK and US
economies over the past few years.
Our retail banks, commercial banks and investment banks will all be
subject to much tighter regulation. Which will dampen their growth and
their profitability.
Just the elimination of HBOS as an independent bank has removed from
the scene a competitive thorn in the side of the other big banks which
a few years ago shook them out of their torpor to the benefit of
consumers and small businesses - for all that it's patently true that
HBOS didn't properly appreciate the risks it was running in the way it
financed itself.
The UK's unsustainable economic dependence on the City and financial
services is coming home to roost.
The shrinkage of that sector may - just on its own - reduce economic
growth by well over one percentage point over the coming year.
But, perhaps more significantly, the cutting down of finance into a
smaller more regulated industry, and a semi-permanent rise in the
perception of the risks of lending, will reduce the potential growth of
the economy, probably for many years to come.
Even after the lean years are passed, and there may be a couple of them
to come, subsequent recovery may be lacklustre. After the boom years,
we may be entering the dismal grey years.
Painful Path To More Realistic Growth:
Growing home prices, and credit derived from the resulting
equity, provided the illusion that increasing purchase power without
increasing wage growth was sustainable. Income and buying became
disengaged.
Editorial
By The Day
Published on 9/16/2008
At some point the federal government had to say no. It could not
continue saving every major investment corporation from its own bad
decisions. That's not how a free market system works.
When it came to underwriting a plan to save Lehman Brothers, the
government finally drew the line. Whether that line comes too late or
too soon is impossible to judge until the current crisis plays out. And
crisis is the right word.
After failing to engineer a government bailout or get help from fellow
bankers, Lehman Brothers filed for bankruptcy Monday. At the same time
Merrill Lynch, also on the point of collapse, agreed to sell itself to
Bank of America for roughly $50 billion.
Combined with the demise of Bear Stearns earlier in the year, three of
the five giants of Wall Street, the major independent brokers, will
soon be gone, leaving only Morgan Stanley and Goldman Sachs. The
carnage is unprecedented, the economic fallout incalculable.
Despite dramatic and controversial steps by the Treasury and Federal
Reserve to address the crisis, it continues to escalate. The Fed took
on billions of dollars in risky investments to make the sale of Bear
Stearns possible before it collapsed. It has opened its discount window
ever wider to provide liquidity to financial institutions, and lowered
standards for the collateral it would accept. More recently the
Treasury Department effectively nationalized the troubled mortgage
finance companies Fannie Mae and Freddie Mac, leaving U.S. taxpayers
essentially owning the bulk of the nation's mortgage market, and not a
healthy market at that.
But the waves of institutional failures continued to crash on shore.
The government has done all it can, and arguably too much, to try and
stop the current downward spiral. It appears the time has come to let
the situation play out and find the true bottom.
Over the past decade the real wages of the middle class, when measured
against the cost of living, have declined, yet consumer spending showed
steady growth. Credit, combined with diminished savings, made that
mathematical equation work. Growing home prices, and the credit derived
from the resulting equity, provided the illusion that increasing
purchase power without increasing wage growth was sustainable. Income
and buying became disengaged.
Long-accepted standards for responsible lending and borrowing became
passé. No longer did borrowers have to have sufficient income
and a healthy down payment to obtain a home mortgage. This easy credit
fueled housing sales, which drove up prices, which fed more reckless
borrowing. But then the bubble burst. Housing sales plummeted, as did
prices. Equity evaporated and foreclosures soared. And now the debt
that backed all those derivatives, hedge funds and leveraged
arrangements is not getting paid back and seeming untouchables, such as
Lehman Brothers, are pushing daises.
The reaction of the stock market Monday was predictable - the Dow Jones
industrial average sinking 504 points, the biggest single-day loss
since markets reopened after the 9/11 attacks in 2001. With each prior
bailout announcement the markets had risen, as if the need for
government intervention was good news. On Monday it was as if a day of
reckoning had arrived.
The resulting convulsions will likely lead to even tighter credit as
commercial banks and securities firms seek to preserve capital and
limit risk going forward. Tighter credit will likely slow the economy
and deepen the recession.
Painful as that may be, the result will be a more reality-based
economy, with purchasing and borrowing habits again tied to income.
Both Wall Street and Main Street are getting a tough, but inevitable,
reality check.
There
Will Be Blood
NYTIMES
By Stephen Davidoff
September 15, 2008, 12:45 pm
Call it the Weekend That Changed Wall Street.
The upheaval of the past few days offers some lessons about the markets
and how a financial crisis turns fatal. Here are a few that I’ve been
thinking about.
Lesson 1: Perception Is Everything
In financial crises, your actual capital adequacy and liquidity does
not matter. Both Lehman Brothers and Bear Stearns — and Lehman
particularly — were felt to be adequately capitalized only days before
their fall. But once people thought that the end was near, the trading
stopped, liquidity dried up, and the capital fled.
Steven M. Davidoff, writing as The Deal Professor, is a commentator for
DealBook on the legal aspects of mergers, private equity and corporate
governance. A former corporate attorney at Shearman & Sterling, he
is a professor at the University of Connecticut School of Law. His
columns are available at The Deal Professor blog.
Lesson 2: Uncertainty Is Death
Lehman’s unfortunate problem was that we have already gone through one
round of capital market infusions. The infusions have left the
investors, mostly sovereign wealth funds, deep under water. Now, with
continuing uncertainty over the price of Lehman’s assets, no one wanted
to get hit again and potentially be forced to invest even more months
from now — or worse yet, lose more money. Had Lehman faced this problem
earlier or later in the cycle, it might have avoided bankruptcy (though
probably still lost its independence).
It is the old adage all over again: If you can’t price assets, you
can’t buy them.
Lesson 3: Know When to Fold ‘Em
John Thain, the chief executive of Merrill Lynch, made the right move
in selling his firm to Bank of America. He took a deal when it was on
the table. A month from now, it might have been better, but the
whispers were that Merrill would be next. And in a down market,
whispers can kill.
Lesson 4: Sometimes, You Can Only
Raise Capital When You Don’t Need It
Lehman issued $4 billion in preferred stock in April — the share
offering was oversubscribed. Even then, though, people whispered that
the capital raise was a sign of weakness, reflecting Lehman’s anemic
balance sheet. This paradox helped bring about the death of both Bear
and Lehman: They needed capital, but raising it only made people more
concerned about their state.
It is a Catch-22 for which we have yet to find a solution. And that is
why, even to the bitter end, Lehman didn’t access the Federal Reserve’s
emergency loan facility. If it had, everyone would have assumed it was
in trouble.
The whole conundrum supports raising the capital reserve levels for
investment banks. Ultimately, Lehman, Bear, Merrill and their balance
sheets couldn’t stand the predicament.
Lesson 5: But Be Careful When You Do Raise
Capital
The clauses and terms you agree to can further inhibit financing. For
example, Washington Mutual raised $7 billion from a consortium led by
TPG. But there is an antidilution clause in that financing that resets
the share price paid by TPG to any subsequent, lower share price paid
in any further equity raised until October 2009.
This protects TPG from getting diluted out on its investment, but is
now preventing WaMu from raising more equity unless TPG is included.
Lesson 6: Bankruptcy Is Not the End of
The World (For Some)
In the end, Lehman only filed for Chapter 11 protection at the holding
company level. The remaining companies below the holding company remain
functioning. Some will be sold, some will be run off and Lehman may
even try to emerge from bankruptcy. There’s only a slim chance of that,
but substantial parts of Lehman will live on.
Lesson 7: The Sky Is Not Falling
Things are tough, but the economy is still in reasonable shape. All of
these troubles at Lehman, Bear, A.I.G. and WaMu are attributable to the
housing crisis. If we solve that, we will begin to emerge from the
woods. While parts of the country are stabilizing, others appear caught
in a declining feedback loop. It would help most if we found a floor on
the housing decline. To the extent the government is the answer here,
then this is where it should focus.
Lesson 8: Shorts Kill
Shorting is a necessary mechanic in our capital markets. But in
financial crises, shorting, and the whispers it generates, can be
deadly for financial stocks that exist on trust (see Lesson 1). In
these times, we need limits on shorting of financial institutions.
I know the shorts will scream that this is a lynch mob, but it’s not.
It is merely a confined and short-term limit on their activities over
the next few months. In the interim, there will still be thousands of
other shorting opportunities that the short-sellers of the world can
use to feed their families.
Lesson 9: Moral Hazard Is an Overused
Term
Don’t talk to me about moral hazard. The shareholders of Lehman had no
more say in the operation of their company than in the case of Bear or
Fannie Mae. If we are really going to stop moral hazard, we will
meaningfully punish the people who took these positions and approved
them (i.e., management). The step that the FHFA just, to block the exit
packages of the chief executive officers of Fannie and Freddie Mac, was
a good start.
Lesson 10: In Every Sad Moment, There
Are Winners
Congratulations to Jon Marzulli at Shearman & Sterling for
representing Merrill Lynch, as well as Robert D. Joffe at Cravath
Swaine & Moore and Ed Herlihy at Wachtell Lipton Rosen & Katz
who represented Bank of America. Weil Gotshal & Manges is
representing Lehman.
These are nice, and well-deserved, assignments for them and the rest of
the lawyers I missed giving a shout-out to. Get some sleep.
Lesson 11: Henry Paulson Runs the U.S.
Economy
Not President George W. Bush, not Federal Reserve Chairman Ben Bernanke…
A note: For those who watch the Fed, it announced Sunday that it would
take as collateral much riskier assets — including equities, junk
bonds, subprime mortgage-backed securities and even whole mortgages —
in exchange for emergency loans through the Primary Dealer Credit
Facility.
In a day of big news, this is equally as big as the other events.
Before, the Fed justified the facility by saying it would only take on
safe assets. But now, the taxpayers are really going to be guaranteeing
the balance sheets (and investments) of the financials.
In the end, I’m a bit sad today. Both Merrill and Lehman were great
institutions and will be missed. I wish my friends there the best…
-----------------
About Steven Davidoff
Steven M. Davidoff, writing as The Deal Professor, is a commentator for
DealBook on the world of mergers and acquisitions. A former corporate
attorney at Shearman & Sterling, he is a professor at the
University of Connecticut School of Law and, during the academic year
2008-09, a visiting professor at the Michael E. Moritz College of Law
at Ohio State University. His research focus is on corporate
governance, regulation of hedge funds, mergers and acquisitions, and
securities regulation. His prior scholarship is available on the Social
Science Research Network
Professor Davidoff graduated from the Columbia University School of
Law, where he was a Harlan Fiske Stone Scholar, and received a B.A.
from the University of Pennsylvania, cum laude with honors. He has a
masters in finance from the London Business School.
As Financial Empires Shake, City Feels No. 2 on Its Heels
NYTIMES
By PATRICK MCGEEHAN
Published: September 12, 2008
Early last year, Mayor Michael R. Bloomberg and Senator Charles E.
Schumer sounded the alarm that New York City was in danger of losing
its status as the world’s pre-eminent financial hub to London. And that
was before one of the biggest investment banks on Wall Street, Bear
Stearns, collapsed and a second, Lehman Brothers, teetered on the brink
of failure.
Now New York City officials and economists are worrying even more about
the future of the city’s financial sector. New York City will surely
remain a leading center of global finance when the current crisis is
over, they say, but its days as the clear leader may be ending.
“This is the worst financial-services crisis of our lifetime,” and Wall
Street is its epicenter, said Robert N. Sloan, who heads the
financial-services executive recruiting practice at Egon Zehnder
International in Manhattan. “You have major firms that have imploded or
are at risk of imploding. It is a deconstruction — and a reconstruction
to follow — of the financial-services industry as we know it.”
Many analysts point out that the resources of big financial companies
were migrating toward London well before the current crisis. The banks
reoriented themselves to capitalize on the rapid growth in Asia, “which
left London as really the springboard to conducting business looking
east,” Mr. Sloan said.
London’s ascendance threatens more than egos and bragging rights. Wall
Street is widely regarded as the most important sector of New York’s
economy. While it is not the biggest employer, it has provided about
one-fourth of all the personal income earned in the city in recent
years and about 10 percent of the city’s tax revenue.
Lehman Brothers alone could be the source of as much as $100 million in
annual income tax in the city, estimated Marcia Van Wagner, a deputy
city comptroller.
The rivalry became more heated after 2005, when companies making their
first sale of stock raised more money in London than in New York.
Although that shift may have been only temporary, it spurred American
officials to call for regulatory changes to make Wall Street more
attractive to foreign companies seeking to raise money.
Mayor Bloomberg and Senator Schumer used a study conducted at their
direction by McKinsey & Company, a consulting firm, to argue that
“if we do nothing within 10 years, while we will remain a leading
regional financial center, we will no longer be the financial capital
of the world.”
In a report issued this week, the World Economic Forum also ranked the
United States just barely ahead of Britain in an assessment of global
financial development. The report ranked the United States first for
the size and efficiency of its banks but second to Britain when it came
to investment banks, brokerage firms and other financial companies.
Nouriel Roubini, a professor of economics at New York University who
was one of the study’s authors, said the two countries were quite
similar in their strengths and weaknesses. Both, he said, are suffering
in the current crisis and may deserve even lower marks for financial
stability when it is over.
“This is a very severe economic and financial crisis where hundreds of
banks are going to go bust,” Mr. Roubini said, adding that the damage
would not be confined to the United States. “Swiss banks like UBS have
lost as much as Citigroup,” he said.
Facing its biggest quarterly loss ever, Lehman, one of the six largest
firms on Wall Street, said on Wednesday that it would unload many of
its assets and shrink significantly. The firm, which employed more than
28,000 people at the start of this year, has lost about 95 percent of
its stock-market value in less than two years.
Lehman’s throes, coming just half a year after Bear Stearns collapsed
suddenly, rattled city officials who already were concerned about the
depth and breadth of the damage on Wall Street. This year, banks and
brokerage firms have announced 83,000 job cuts worldwide, and most of
those were in New York.
“There’s going to be a lot of realignment of the financial sector, and
this is just the beginning of it,” Ms. Van Wagner said. “We certainly
seem to be going in the direction of fewer firms. It could be a smaller
industry.”
But how much of New York’s loss will be London’s gain — or Hong Kong’s
or Dubai’s — is a sensitive topic with the city’s officials and
business leaders these days.
Foreign investors may shy away from investing in American companies and
American markets, said Kathryn S. Wylde, the chief executive of the
Partnership for New York City, an association of large employers. She
was quick to add that global financial markets were linked and that the
big Wall Street firms were also some of the biggest in other countries.
“It’s important to remember that Lehman is a London firm as well,” Ms.
Wylde said. “This stuff hurts London just like it hurts New York.”
It is true that like the United States, Britain is suffering through a
housing slump that has hurt its market for mortgages and other forms of
debt, but New York firms pioneered and dominated the sales and trading
of bundles of risky mortgages. The report Mayor Bloomberg and Senator
Schumer released last year cited Wall Street’s dominance of the market
for subprime loans as one that European banks could cut into by
adopting “U.S.-style” lending practices.
Now, that subprime market is often called the sickest segment of the
American financial market, and is a major cause of the current crisis.
London, on the other hand, has become a much bigger magnet for the
sales and trading of various types of derivatives, securities that
companies buy or sell to hedge against certain risks, such as
fluctuations of interest rates or currencies. Some of those lines of
business have remained profitable through the recent bond-market
crisis.
And that has potentially strengthened London’s hand in its rivalry with
New York: Indeed, the biggest Wall Street firms have moved entire
derivatives-trading operations to London in the last several years.
Still, some city officials were loath to accept that Wall Street’s
influence might be diminished by the disappearance or drastic
downsizing of some of its most prominent firms, like Lehman.
Seth W. Pinsky, the president of the city’s Economic Development
Corporation, said that city officials would do what they could to help
Lehman but that the firm was grappling with some issues that were
“outside of the scope and authority of the city government.”
He said he was unaware of any discussions between Lehman executives and
city or state officials about what might be done to prevent a complete
collapse of the firm. (On Friday, Lehman was courting buyers as its
stock continued to fall.)
Mr. Pinsky said he would not speculate about Lehman’s prospects but
added that after past periods of upheaval on Wall Street, new firms had
emerged to replace those that did not survive. “New York remains the
world’s financial capital, and we think the financial institutions in
the city are sufficiently broad and deep that once we emerge from the
current environment that New York will still be in the same position,”
he said.
S.E.C.
Concedes Oversight Flaws Fueled Collapse
NYTIMES
By STEPHEN LABATON
Published: September 26, 2008
WASHINGTON — The chairman of the Securities and Exchange Commission, a
longtime proponent of deregulation, acknowledged on Friday that
failures in a voluntary supervision program for Wall Street’s largest
investment banks had contributed to the global financial crisis, and he
abruptly shut the program down.
The S.E.C.’s oversight responsibilities will largely shift to the
Federal Reserve, though the commission will continue to oversee the
brokerage units of investment banks.
Also Friday, the S.E.C.’s inspector general released a report strongly
criticizing the agency’s performance in monitoring Bear Stearns before
it collapsed in March. Christopher Cox, the commission chairman, said
he agreed that the oversight program was “fundamentally flawed from the
beginning.”
“The last six months have made it abundantly clear that voluntary
regulation does not work,” he said in a statement. The program “was
fundamentally flawed from the beginning, because investment banks could
opt in or out of supervision voluntarily. The fact that investment bank
holding companies could withdraw from this voluntary supervision at
their discretion diminished the perceived mandate” of the program, and
“weakened its effectiveness,” he added.
Mr. Cox and other regulators, including Ben S. Bernanke, the Federal
Reserve chairman, and Henry M. Paulson Jr., the Treasury secretary,
have acknowledged general regulatory failures over the last year. Mr.
Cox’s statement on Friday, however, went beyond that by blaming a
specific program for the financial crisis — and then ending it.
On one level, the commission’s decision to end the regulatory program
was somewhat academic, because the five biggest independent Wall Street
firms have all disappeared.
The Fed and Treasury Department forced Bear Stearns into a merger with
JPMorgan Chase in March. And in the last month, Lehman Brothers went
into bankruptcy, Merrill Lynch was acquired by Bank of America, and
Morgan Stanley and Goldman Sachs changed their corporate structures to
become bank holding companies, which the Federal Reserve regulates.
But the retreat on investment bank supervision is a heavy blow to a
once-proud agency whose influence over Wall Street has steadily eroded
as the financial crisis has exploded over the last year.
Because it is a relatively small agency, the S.E.C. tries to extend its
reach over the vast financial services industry by relying heavily on
self-regulation by stock exchanges, mutual funds, brokerage firms and
publicly traded corporations.
The program Mr. Cox abolished was unanimously approved in 2004 by the
commission under his predecessor, William H. Donaldson. Known by the
clumsy title of “consolidated supervised entities,” the program allowed
the S.E.C. to monitor the parent companies of major Wall Street firms,
even though technically the agency had authority over only the firms’
brokerage firm components.
The commission created the program after heavy lobbying for the plan
from all five big investment banks. At the time, Mr. Paulson was the
head of Goldman Sachs. He left two years later to become the Treasury
secretary and has been the architect of the administration’s bailout
plan.
The investment banks favored the S.E.C. as their umbrella regulator
because that let them avoid regulation of their fast-growing European
operations by the European Union.
Facing the worst financial crisis since the Great Depression, Mr. Cox
has begun in recent weeks to call for greater government involvement in
the markets. He has imposed restraints on short-sellers, market
speculators who borrow stock and then sell it in the hope that it will
decline. On Tuesday, he asked Congress for the first time to regulate
the market for credit-default swaps, financial instruments that insure
the holder against losses from declines in bonds and other types of
securities.
The commission will continue to be the primary regulator of the
companies’ broker-dealer units, and it will work with the Fed to
supervise holding companies even though the Fed is expected to take the
lead role.
The Fed had already begun regulating Wall Street firms that borrowed
money under a new Fed lending program, and the S.E.C. had entered into
an agreement under which its examiners worked jointly with Fed
examiners, an arrangement that is expected to continue.
The S.E.C. will still have primary responsibility for regulating
securities brokers and dealers.
The announcement was the latest illustration of how the market turmoil
was rapidly changing the regulatory landscape. In the coming months,
Congress will consider overhauls to the regulatory structure, but the
markets and the regulators are already transforming it in response to
events.
Still, the inspector general’s report made a series of recommendations
for the commission and the Federal Reserve that could ultimately
reshape how the nation’s largest financial institutions are regulated.
The report recommended, for instance, that the commission and the Fed
consider tighter limits on borrowing by the companies to reduce their
heavy debt loads and risky investing practices.
The report found that the S.E.C. division that oversees trading and
markets had failed to update the rules of the program and was “not
fulfilling its obligations.” It said that nearly one-third of the firms
under supervision had failed to file the required documents. And it
found that the division had not adequately reviewed many of the filings
made by other firms.
The division’s “failure to carry out the purpose and goals of the
broker-dealer risk assessment program hinders the commission’s ability
to foresee or respond to weaknesses in the financial markets,” the
report said.
The S.E.C. approved the consolidated supervised entities program in
2004 after several important developments in Congress and in Europe.
In 1999, the lawmakers adopted the Gramm-Leach-Bliley Act, which broke
down the Depression-era restrictions between investment banks and
commercial banks. As part of a political compromise, the law gave the
commission the authority to regulate the securities and brokerage
operations of the investment banks, but not their holding companies.
In 2002, the European Union threatened to impose its own rules on the
foreign subsidiaries of the American investment banks. But there was a
loophole: if the American companies were subject to the same kind of
oversight as their European counterparts, then they would not be
subject to the European rules. The loophole would require the
commission to figure out a way to supervise the holding companies of
the investment banks.
In 2004, at the urging of the investment banks,