30SEP08:
31DEC08 INDICES:
FTSE100:3550
DOW30:7550
# HEDGE FUNDS:4425 30JUN08: Oil to be USD200 by 30OCT08 USA Inflation to be 7.5% by 30OCT08
...oops 23APR08:
Next Rights Issue:
HBOS...yes
All & Lec ...
...1 Nil. 17APR08: Oil to be USD127 by 30SEP08
...16MAY08 losing my touch 27FEB08:
2 Banks go bust by 30JUN08
BS down, Lehman (a bit late I know) 20NOV07: Northern Crock to be sold for 15p
Nationalized 01NOV07: Oil to be USD103 EOM
...peaked too soon 08OCT07:
SEC to fine Goldman for pricing issues
...still waiting 15JUN07: ML to buy-out BS
JPM got there first 06JUN07: The Big Crash: 17OCT07
...well it's here
FiNTAG has been in negotiation with a number of US TV networks to provide consultancy and even an acting part in up and coming programs about Hedge Funds. The well known 3 letter acronym TV stations, all detailed on our "who reads us" website page, have a sit com and a serious 24 type series in the pipeline and you will find many of themes I rant on about featuring heavily. It is nice to know that my random views and opinions are appreciated. Having hired an agent, TV is not where it is at and I am still waiting for that all important call to Hollywood.
We all like high drama and a good soap opera, but this weekend's news is a bit of a damp squid.
Where as the SEC closes the doors, the FSA says hello to USD2000 mom and pop investors.
The US is to relax rules to allow board directors to be hired and fired more easily.
The words slump, crash and recession are banished from the vocabulary of commentators.
The subprime threat is overplayed and 2007 will continue to boom, apparently and Goldman Sachs bonds go from Junk status to AAA in a week. Bloomberg disagree and say 1.5 million will be homeless.
Hedge Funds and Private Equity are morphing into each other.
Structured Product providers see the light of day.
Misc news
Pirates look at taking out France's largest supermarket chain and the UK's best loved chemist Boots (telegraph). What do they both have in common? Lots of expensive real estate looking to be sold and leased back. And who said Pirates were just asset strippers?
In little over a fortnight, the Financial Services Authority will publish proposals that hedge funds should be allowed to be sold to small investors. This means that at least some of these funds could be marketed directly to the public, so as early as next year UK-based investments such as unit trusts or open-ended investment companies (Oeics) could provide access to hedge funds for savers putting in as little as £1,000.
The proposals are bound to create a stir. The FSA has been forced to defend plans to relax rules for overseas investment funds selling shares on the London Stock Exchange. The new rules, which would see hedge funds and other offshore firms facing a lighter regime than UK-based equivalents, drew a barrage of criticism. John McFall, chairman of the Treasury select committee, accused the FSA of introducing a 'gaping hole' in the protection given to investors.
In response, the FSA's director of retail policy, Dan Waters, said the proposals were vital if Britain was to maintain its competitiveness, and praised hedge funds for 'reinvigorating' the sector. Nevertheless, they remain controversial. Recent months have seen fierce debate in the EU and US about greater regulation, and the Bank of England has proposed a voluntary code of practice for those that are London-based. Meanwhile, Germany has pledged to use its presidency of the G8 this year to push for greater transparency from hedge funds.
Even the FSA has concerns. Last October, Waters himself repeated warnings that some funds were 'testing the boundaries of acceptable practice'. And just three years ago the FSA rejected a similar move to widen access to small investors, concluding that there was little demand for this from either the public or the hedge fund industry. So why do it now?
'Because they're already being sold to them,' says FSA spokesman Robin Gordon-Walker. As well as being able to buy hedge funds over the internet from other EU countries, investors have access to the shares of a growing number of hedge fund managers listed on the LSE (a number that the new rules would increase). And some investors are referred to offshore hedge funds by financial advisers.
The FSA hopes the rule change will mean more small investors end up in funds over which it has direct control. 'We think if it's going to happen anyway, it should be done in a regulated way,' says Gordon-Walker.
Many in the industry have welcomed the move to greater liberalisation, but worries remain. The first is about risks . Hedge funds have become notorious for their use of leverage - borrowing money to top up their investments. This boosts profits but leaves them open to big losses. Last September, Amaranth Advisors lost $6bn in a matter of weeks.
'The problem is that the term "hedge fund" has been hijacked by a load of gamblers,' says Mark Dampier of adviser Hargreaves Lansdown. 'A traditional hedge fund is all about reducing risk and safeguarding capital. It shouldn't be a highly geared betting fund.'
Hedge funds vary widely, and many argue that they are far less exciting than the media make out. Many funds, for instance, still take the approach that Dampier supports. Investment manager GAM is a good example. It runs one of many 'absolute return' funds, which aim to make money regardless of what share prices are doing. This invests in equities when markets are rising and uses hedge funds to provide modest growth when markets are falling. Similarly, Matrix, an offshore hedge fund manager, offers an 'equity-market-neutral' fund. This aims to provide only 2 to 3 per cent above the return you might get on cash in a year. The attraction is that it says it can do so even if the stock market takes a dive.
Moreover, the FSA is only proposing to allow the marketing of funds of hedge funds (which is what the Matrix fund is). These put money in a number of underlying hedge funds, diluting the impact should any of them lose heavily.
As Matthew Butcher at broker Brewin Dolphin explains, these hedge funds became popular during the 2000-02 stock market falls and are pitched at more cautious investors. 'Most people in the industry would say that investors who can't face losing much money can't afford not to invest in them,' he says.
The other problem with hedge funds is less easily brushed over: they can be incredibly complicated. As well as being able to invest in almost anything (from shares to African debt to feature films) they also use a range of investment strategies, some of which take a mathematics degree to understand. It is telling that although hedge funds have been around for 60 years, there is still no generally accepted definition of what they are.
According to Roger Lawson at the UK Shareholders Association, this could leave small investors open to being talked into investments that will do them little good. 'I don't think most retail investors would understand hedge funds,' he says. 'They'd be sold on the basis that they have a wonderful track record and small investors would get sucked into them.'
A big rise in the number of hedge funds in recent years means there are a lot more mediocre ones around. Furthermore, because retail investors will have to use funds of hedge funds, they also face two lots of fees - one to the underlying hedge funds (normally 1.5 to 2 per cent of the investment plus 20 per cent of any profits) and a similar fee to the manager of the fund of hedge funds. Those going through a stockbroker or a unit trust might even find themselves paying a third layer of fees.
On the other hand, as Hugo Shaw at adviser Best Invest explains, given the relatively modest returns many will promise, hedge funds may struggle to attract smaller investors. But Shaw and others argue that it is worth it, particularly given the recent woes in the stock market. The real danger, they say, is that even those who could benefit from hedge funds may decide ignorance is bliss.
Long and short of it
There are now more than 9,000 hedge funds reckoned to be managing about $1.5 trillion - a growing proportion of it from pension funds and endowments. Most hedge funds are based offshore, with locations such as the Cayman Islands, Bermuda and Ireland all popular. This is partly for tax reasons.
They represent a wide range of strategies, from the global macro funds popular in the early 1990s (which aim to profit from shifts in interest or exchange rates) to event-driven funds, which bet on mergers or takeovers.
Among funds of hedge funds, market neutral and equity long/short strategies are widespread. These rely on 'shorting': the fund borrows assets its manager suspects may fall in value, sells them, and then buys them back later at the cheaper price. The hedge fund should make money if the market falls, although in that case it will be losing money on its 'long positions' - assets it has bought in the hope their price would rise.
The aim is to reduce the risk by giving up some potential profit to hedge against the risk of a fall.
Fintag says Whereas the SEC moves the investment threshold level up to deter mom and pop investors, the FSA looks at going the other way and encouraging mom and pop investors.
Now why would there be such a contrariety view? Perhaps it is because the FSA regulates hedge funds and the SEC spends all its time suing them?
Plans to allow investors to nominate their own rival candidates to an entrenched board have shot to the top of the agenda ahead of the spring season of annual shareholder meetings, which kicks off this week at Hewlett-Packard, the computer manufacturer.
The aim is to make directors fearful for their jobs, and therefore keener to respond to the concerns of investors.
HP and other companies are being asked to allow long-term shareholders to suggest their own candidates to stand on the ballot alongside the board's own candidates, avoiding the need for a vicious and costly battle to impose a new board from outside.
Although the companies are vigorously opposing the moves, corporate governance campaigners believe the upswing in shareholder democracy is unstoppable.
The new campaign comes on the heels of last year's successful push to end Soviet-style elections, where withheld votes were not counted and directors could be re-elected even if the only vote they received was their own. A wave of companies adopted rules that said candidates should win at least 50 per cent of votes cast, raising the possibility that they might fail to be elected.
This year's battle to allow shareholders to propose alternative candidates is the logical next step, according to Richard Ferlauto, director of pension and benefit policy at AFSCME, which represents public-sector pension funds. It could, he said, encourage executives to improve their own behaviour, reducing strategic blunders and driving out excessive boardroom pay.
"The idea is that by having this power, we would need to wield the power only infrequently," he said. "It is about improving the rights of shareholders, which are significantly less advanced in the US than they are in Europe. In the UK, it takes just 10 per cent of shareholders to force a special meeting that can replace the whole board, but it isn't used very often."
Unseating entrenched boards is a long and costly business, usually beyond the means of long-term institutional shareholders. Such "proxy battles" require rebel investors to fund and organise their own ballot of shareholders.
These have been on the rise in recent years, with characters such as the veteran investor Carl Icahn trying to force his way on to the boards of Time Warner, Motorola and other companies. However, they remain the preserve of hedge funds, able to put up the millions of dollars such a campaign costs in the expectation of winning a sudden jump in the share price.
Fintag says Well the first thing that will happen is the pay of Director's will go through the roof. Payoffs will increase and the supply of board directors will go down. The jury is out at FiNTAG. Having seen how football/soccer/association managers rotate at British football clubs, the instability often affects the players and productivity falls. As the team is relegated, the best players leave and the manager is sacked. Parallel this to a corporates situation and we may find companies yo-yo all over the place.
OLD HEAD
Listen to Mr Greenspan - there's nothing so fragile as a bubble (guardian) After the January World Economic Forum I expressed some concern about the remarkable optimism - nay, complacency - manifested there about the course of the world economy. Earlier in the month I had quoted Herb Stein, an adviser to President Nixon in the 1970s (on economics, not burglary or cover-up). The quotation was: 'If something can't go on forever, it will probably stop.'
An alert reader challenged the 'probably' (which originated via an American economist 'correcting' Professor Wynne Godley, who had used the quotation without 'probably'), and sent me an article written by Stein himself, in which 'probably' does not appear, and 'cannot' (rather than 'can't') does.
You pays your money and you takes your choice. It often happens with famous quotations. Incidentally, Stein quotes Nixon as having once said: 'Honesty may not be the best policy, but is worth trying once in a while.' That may explain quite a lot. Anyway, Stein tells us that 'Stein's Law' was first pronounced in the 1980s, and elaborates thus: 'This proposition, arising first in a discussion of the balance-of-payments deficit, is a response to those who think that if something cannot go on forever, steps must be taken to stop it - even to stop it at once.'
The implication, I take it, is that policy makers don't necessarily have to do anything about what will stop anyway. One does not know whether former Federal Reserve chairman Alan Greenspan had this in mind when saying last week about the so-called 'carry trade' (the huge amounts of money converted from yen to other currencies to take advantage of differentials between interest rates, which have driven the yen down and made Japanese exports more competitive than ever) that 'at some point it's got to turn'. But recent shenanigans in the financial markets seem to indicate that riskier investments are not as popular as they were.
So far, most of my fellow commentators seem to be relaxed about stock markets and the outlook for the world economy, and dismissive of Greenspan's assessment that there is a possibility of a US recession later this year.
The difference between Greenspan now and Greenspan when the great man was chairman of the Fed is that he can now say what he thinks, as opposed to what he thinks he ought to say. The reason for the insouciance of many financial market operators and commentators is that there is an assumption that the central banks (considered all-powerful except by central bankers themselves) can be relied upon to bail the US and other economies out as soon as trouble appears. There is empirical evidence for this in the past decade, and it is quite a contrast with the pre-Keynesian days of the inter-war years.
This is all very well as long as the central banks do not panic about inflation. There has been precious little reason to do so in recent years, because the weakening of the unions and the impact of 'globalisation' have together produced what is known in the trade as a 'benign' inflationary environment. Why, in Japan they have even been trying, without much tangible success, to inject a little inflation into the system.
As Professor Lord Desai puts it in his compulsively readable Marx's Revenge - The Resurgence of Capitalism and the Death of Statist Socialism: 'Democratic power can push the bargaining strength of the worker up to a certain point. If it threatens profitability too much, then capital withdraws or migrates .... Social-democratic parties everywhere [at the end of the 1980s] saw that restoration of profitability mattered once capital became mobile. But once it had become mobile, it demanded co-operation from the workers, not conflict. And it got that co-operation.'
It has become clear in recent months that trade unions are beginning to think they have been far too co-operative. One sees this in the bitter outbursts about the behaviour of hedge funds, private equity groups and senior corporate executives by such models of moderate trade unionism as John Monks, former general secretary of the TUC and now representing the much wider group of European trade unions.
One also sees it in the sporadic outbursts of discontent about low wage deals, not least in the UK public sector. But apart from the factors highlighted by Desai (whose book was published in 2002), we have witnessed the additional disinflationary factor in recent years of the remarkable influx of Continental workers to the UK - and not just from eastern Europe. French is rapidly becoming London's second language.
The small inflationary bubble of recent months has been associated with the lagged impact of earlier rises in the price of energy. Now the prospect is of lower energy prices later this year, and, according to the Governor of the Bank of England, Mervyn King, there is the possibility of quite a sharp fall in inflation. Yet there continue to be noticeable worries among central bankers about 'asset bubbles' - not least in housing.
A vogue phrase among financial regulators has been 'the underpricing of risk'. The convenient reaction to recent upheavals in the financial markets is that there has been a 'healthy and necessary correction'. Has been? All over? One wonders. The problem with the modern phenomenon whereby it is assumed that the central banks will always bail the system out is that there is an inherent bias in favour of bubbles and the traditional excesses of capitalism. There is an uneasy feeling in the air that all is not quite right.
Fintag says I love the way the terminology of the markets has changed over the years. Markets go up or down and revert somewhere near the mean. Strange how the words "recession", "slump", "crash" have been replaced with "correction", "risk repricing" and "wobble". Perhaps when there is a full scale market drop will these tame and unemotive words be replaced by "suicide", "phones not answered" and "liquidate to cash".
BOOM TO CONTINUE
Banks set to overcome mortgage fears (financialnews-us) Concerns about the exposure of US investment banks to the recent turmoil in the mortgage markets are overblown, according to analysts. But the banks could show signs of pressure in emerging markets and credit trading when they start reporting first-quarter figures this week.
Results from Goldman Sachs and Lehman Brothers, whose first quarter ended last month, will give an indication of concerns in the sub-prime loan sector. UK bank HSBC last week took a $10.6bn (€8bn) hit for bad debts after problems in its US mortgage lending business. More than 20 sub-prime lenders have closed.
Despite these concerns, Lauren Smith, an analyst at Keefe, Bruyette & Woods, a financial services investment bank, has raised her earnings per share estimates for Goldman Sachs and Morgan Stanley.
She said: “We believe concerns over big brokers' exposures to sub-prime is overdone.”
A sub-prime loan is one in which the borrower has difficulties in obtaining mortgage financing because of poor credit or hard-to-document income or assets.
Smith said investment banks were distributors or transfer agents for the loans which stayed on a bank's balance sheet for up to 45 days waiting to be securitised.
Keefe, Bruyette increased first-quarter earnings estimates for Goldman Sachs by 15% to $4.80 because of higher-than-expected revenues from fixed income, currencies and commodities and equity trading.
Morgan Stanley's earnings per share estimates rose from $1.79 to $1.82 because of higher trading and investment banking revenue assumptions.
Fintag says Only last week Goldman bonds were rated as Junk because of their exposure to subprime and other bad debts. How it has all changed. Now they are healthier than Devon cream. What an amazing turnaround ...
As many as 1.5 million more Americans may lose their homes, another 100,000 people in housing-related industries could be fired, and an estimated 100 additional subprime mortgage companies that lend money to people with bad or limited credit may go under, according to realtors, economists, analysts and a Federal Reserve governor. Financial stocks also could extend their declines over mortgage default worries.
The spring buying season, when more than half of all U.S. home sales are made, has been so disappointing that the National Association of Home Builders in Washington now expects purchases to fall for the sixth consecutive quarter after it predicted a gain just last month.
``The correction will last another year,'' said Mark Zandi, chief economist for Moody's Economy.com in West Chester, Pennsylvania.
A five-year housing boom that ended in 2006 expanded home- ownership to a record number of U.S. households. Now it has given way to mounting defaults, failing subprime mortgage companies and an increasing number of unsold homes.
Last Housing Slump
If this slump follows the same pattern as the last one, in 1991, it will persist for at least another year and may fuel a recession. New-home sales declined 45 percent from July 1989 to January 1991 and about 1 percent of all U.S. jobs, or 1.1 million, were lost in that recession, said Robert Kleinhenz, deputy chief economist of the California Association of Realtors.
This time around, new-home sales have declined 28 percent since September 2005, hitting a low in January, the last month for which data is available. And though the national jobless rate is near a five-year low this month, mortgage-related jobs fell by almost 2,000 in January alone. At least two dozen of the more than 8,000 mortgage lenders have been forced to close or sell operations since the start of 2006.
Subprime lenders Ameriquest Mortgage Co. in Irvine, California; Ownit Mortgage Solutions LLC and WMC Mortgage Corp. in Woodland Hills, California; Mortgage Lenders Network USA Inc. in Middletown, Connecticut and Fremont General Corp. together have fired more than 5,600 workers in the past year.
New Century
New Century Financial Corp., the second-largest subprime lender, cut 300 jobs. The Irvine, California-based company lost 78 percent of its market value last week and stopped making new subprime loans, prompting speculation it will seek bankruptcy protection. Its 7,000 remaining employees wait to see if the company will survive.
Fremont General, the Brea, California-based lender that is trying to sell its residential-mortgage unit, was ordered to stop making subprime loans by the U.S. Federal Deposit Insurance Corp. last week. Fremont was marketing and extending loans ``in a way that substantially increased the likelihood of borrower default or other loss to the bank,'' the FDIC said last week.
Doug Duncan, chief economist of the Washington-based Mortgage Bankers Association, predicted in January that more than 100 home lenders may fail this year.
The subprime crisis ``has taken the fuel out of the real estate market,'' said Edward Leamer, director of the UCLA Anderson Forecast in Los Angeles. ``The market needs new money in order to appreciate, and all of that money is gone for a very long time. The regulators are not going to allow it to happen again.''
Higher Rates
Subprime mortgages are given to people who wouldn't qualify for standard home loans and typically have rates at least 2 or 3 percentage points above safer prime loans. The portion of subprime loans that financed new mortgages rose to 20 percent last year from 5 percent in 2001, according to the Mortgage Bankers Association.
Subprime loans contributed to a home-ownership rate that reached a record 69.3 percent of U.S. households in the second quarter of 2004, up 5.4 percentage points from the same period in 1991, according to the U.S. Census Bureau.
``Probably the gain in home ownership over the last four, five years, is almost entirely due to looser lending standards,'' said James Fielding, a homebuilding credit analyst at Standard & Poor's in New York.
Refinancing Option
As home prices steadily gained from 2001 to 2006, homeowners who fell behind on mortgage payments could sell their homes and pay off their loans or get better refinancing terms based on the higher value of their property. Now that home values are declining, many borrowers won't be able to refinance because they would have to come up with the difference between their new mortgage and what their home is now worth.
Defaults may dump more than 500,000 homes on a housing market already saturated with leftover inventory built during boom times, New York-based bond research firm CreditSights Inc. said in a March 1 report.
The portion of subprime loans more than 60 days delinquent or in foreclosure rose to 10 percent as of Dec. 31, from 5.4 percent in May 2005, the highest in seven years, according data compiled by Friedman Billings Ramsey Group Inc. of Arlington, Virginia.
Many of the delinquencies came from loans where borrowers didn't have to provide tax returns or other evidence of income, or where they financed 100 percent or more of the home's value, CreditSights analyst David Hendler wrote in a March 5 report. Other defaults came on adjustable-rate mortgages with artificially low introductory ``teaser'' rates, sometimes with ``option'' payment plans that allowed borrowers to defer interest.
`Beginning of the Wave'
Banks ought to be concerned about such loans and are likely to see more missed payments and foreclosures as consumers with weak credit histories begin to face higher monthly mortgage payments, Federal Reserve Governor Susan Bies said last week.
``What we're seeing in this narrow segment is the beginning of the wave,'' Bies said. ``This is not the end, this is the beginning.''
About 1.5 million U.S. homeowners out of a total of 80 million will lose their homes through foreclosure, University of California-Berkeley economist Ken Rosen said last week.
``The subprime borrowers paid too much for their homes, and all of a sudden, they'll see their house value drop by 10 to 15 percent,'' Rosen said.
Borrowers at Risk
The Center for Responsible Lending in Durham, North Carolina, said in a December study that as many as 2.2 million borrowers are at risk of losing their homes, at a potential cost of $164 billion, from subprime mortgages originated from 1998 through 2006.
The number of U.S. foreclosures rose 42 percent to 1.2 million last year from 2005, according to Irvine, California- based RealtyTrac, while delinquencies in the last three months of 2006 rose to the highest level in four years, the Federal Reserve said.
Housing and related industries, which account for about 23 percent of the U.S. economy -- including makers of everything from copper pipes to kitchen cabinets -- fired about 100,000 workers last year. The total will be higher this year, according to Amal Bendimerad of the Joint Center for Housing Studies at Harvard University in Cambridge, Massachusetts.
By the end of this year, job cuts at companies including Benton Harbor, Michigan-based Whirlpool Corp., Masco Corp. of Taylor, Michigan, and St. Louis-based Emerson Electric Co. may exceed the fallout from the 1991 housing slump, said Paul Puryear, managing director at St. Petersburg, Florida-based Raymond James & Associates. The Bureau of Labor Statistics doesn't give data for housing-related job losses.
`Fallout'
``The fallout in the early 1990s was much worse than what we've seen so far, but this downturn is not over,'' Puryear said. ``The full impact hasn't hit yet.''
U.S. House Financial Services Committee Chairman Barney Frank, a Massachusetts Democrat, said he may propose legislation to reign in ``inappropriate'' lending, and a House subcommittee is scheduled to consider subprime lending and foreclosures March 27.
``The standards got loosened so much, and there's always the pressure to make money that there was pressure to maybe make the questionable loans that shouldn't have been made,'' said Ohio Representative Paul Gillmor, the subcommittee's top Republican, in a March 9 interview. ``The major problem has been the overall deterioration in credit standards by lenders that's exacerbated by those who are unscrupulous.''
The Federal Bureau of Investigation says mortgage fraud is ``pervasive and growing'' and the incidence of such fraud has almost doubled in the past three years.
`Unscrupulous Individuals'
``There has been an increase in unscrupulous individuals in the market,'' said Arthur Prieston, chairman of the Prieston Group, a San Francisco-based company that investigates mortgage fraud. ``There's an unfair assumption of a connection between subprime failure and fraud. But there is a connection between early default and fraud.''
Mortgage fraud is committed when a borrower misrepresents himself or his finances to a lender. Some of that fraud involved speculators. They drove up prices during the boom by ordering new homes with the intent of selling them immediately after taking possession.
That ``flipping'' inflated demand and put the speculators in competition with the homebuilders, propelling the median U.S. home price to $276,000 last June from $177,000 in February 2001.
`Housing Bubble'
``A lot of the housing bubble was speculation,'' said Mike Inselmann of the Houston-based research firm Metrostudy.
When home prices got so high that speculators could no longer turn a profit, they canceled their contracts and walked away from their down payments.
Cancellation rates for new homes have surged to almost 40 percent of home contracts, Margaret Whelan, a New York-based analyst at UBS AG, said in a report on March 2.
That forced the top five U.S. homebuilders -- D.R. Horton Inc., Pulte Homes Inc., Lennar Corp., Centex Corp. and Toll Brothers Inc. -- to write off a combined $1.47 billion on abandoned land in the fourth quarter of 2006.
On top of that, new home sales plunged 17 percent last year from 2005, the biggest decline since 1990, according to the Chicago-based National Association of Home Builders. Existing home sales fell 8.4 percent in 2006 from a record in 2005, according to the National Association of Realtors.
`All 12 Months'
Donald Tomnitz, D.R. Horton's chief executive officer, said last week that his Fort Worth, Texas-based company would miss its projections for this year and that ``2007 is going to suck, all 12 months of the calendar year.''
Concern that the housing slump and defaults in the subprime mortgage industry will affect earnings at the largest banks and lenders has hurt financial stocks. They are the worst performers in the Standard & Poor's 500 Index since the benchmark reached a six-year high on Feb. 20. The group lost 5.6 percent, outpacing the broader index's 3.9 percent drop.
Investment banks including Merrill Lynch & Co., Deutsche Bank AG and Morgan Stanley have spent more than $4 billion over the past year to buy home-loan companies as add-ons to their mortgage-bond trading businesses. They needed loans to repackage into securities to sell to investors. Demand for higher yields led them into the subprime market. As that business flourished, financial firms either invested in subprime lenders of bought them.
`Too Early to Tell'
The number of U.S. financial institutions in the mortgage business jumped 16 percent to 8,848 in the past four years, according to the Federal Financial Institutions Examination Council.
``It's a little too early to tell how it shakes out for investment banks,'' said Andrew Davidson, president of New York- based Andrew Davidson & Co., which advises fixed-income investors on mortgage bonds. ``If it turns out that they have large losses, the investment banks tend not to be very forgiving and usually terminate businesses that haven't worked for them.''
Dale Westhoff, a senior managing director at New York-based Bear Stearns Cos., the largest underwriter of mortgage bonds, said last week that failing subprime lenders ``are going to be absorbed very quickly.''
``Hedge funds and private equity are going to play a very important role in buying distressed assets,'' Westhoff said.
In contrast to the 1991 housing skid, worker productivity is increasing, consumer confidence is expanding, interest rates remain within 1 percentage point of the 40-year low and the jobless rate fell to a five-year low last month. Last month, 7.4 million new and existing homes were sold, more than twice the 1991 bottom.
Optimists
And real estate people tend to be the world's most optimistic, said Bryce Bowman, director of development for Randolph Equities LLC in Chicago.
``There's a lot of capital chasing real estate and that has not ceased with this bust,'' Bowman said. ``Developers have stopped building crazy speculative housing developments and are burning off their inventory, so we're excited about the end of '07, and we want to be ready to go when business picks up in '08.''
Fintag says There is a housing crash; or there isn't a housing crash. Thank goodness I am in the UK waiting for our own version. Luckily I own property in Monaco and that never goes down in price.
Six hedge funds and non-bank institutions have now joined a cluster lobbying for membership of MTS, triggering deep unease among some investment banks, which have exclusive access to the platform, and consequently dominate trading in the €4,000bn (£2,700bn) eurozone government bond market.
The news came as senior officials admitted MTS could face censure from competition authorities if it blocked the funds.
"If we say No to these [funds], we have to say why - otherwise we could attract the attention of antitrust [authorities]," Gianluca Garbi, head of the Italian-based MTS, told the Financial Times.
That is because some of the hedge funds have promised to abide by all the "market making" rules - which would put them on a similar footing to banks in this market.
Some banks argued that hedge funds could trigger the "unravelling" of the bond-trading system, which is shaped by a complex set of so-called "market maker" rules that require MTS members to supply continuous price quotes.
MTS is in consultation about the request to admit the funds, but is not due to decide definitively until next month.
The hedge funds and trading groups pressing to join MTS include Citadel, Getco and DRW, three Chicago-based firms that have risen to prominence in the US Treasuries market, as well as Man Group, Vega and a large Indian hedge fund.
The approaches have sparked a heated debate in the eurozone region about the most effective way for governments to raise finance in the bond markets, and encourage secondary trading in these government bonds.
In the US there are no such restrictions on trading of Treasuries and most trading in liquid US government bonds between big operators takes place on two platforms, eSpeed and BrokerTec.
Fintag says The sooner the better.
HEDGIES VERSUS PIRATES
Hedge fund strategies (ft) Take-Two Interactive Software is most well known for a video game series called Grand Theft Auto, in which players get to fire big guns and drive fast cars. These days, with the company's founder convicted of falsifying business records and losses piling up, Take-Two's thrills and spills are a little closer to home. Little wonder that shareholders are kicking up a fuss.
What is unusual is the make-up of the coalition planning to overthrow the current board. Standing alongside fund manager OppenheimerFunds - which owns almost a quarter of Take-Two's stock - are decidedly un-mainstream hedge funds such as Steve Cohen's SAC Capital.
Mr Cohen is famous for often generating thumping returns with an investment horizon measured in hours. The move into activism is in keeping with a broader trend of hedge funds and private equity houses spreading into each other's territory. Private equity dabbles in minority equity stakes and credit funds these days. Meanwhile, SAC has hired a team from Ripplewood Holdings to build its private equity capabilities. In an interview given last year, Mr Cohen said that returns from rapid fire trading are not what they used to be - mainly because so many others are at it.
In branching out, SAC at least benefits from a strong brand. Many others in the growing ranks of the hedge fund industry are less well established. Generating "alpha" - individual outperformance as opposed to market tracking - is harder as competition intensifies. Even mainstream asset managers are launching cheaper funds that make use of shorting stocks these days. Achieving alpha in this more competitive environment encourages, for example, investing in less liquid assets. As long as clients are agreeing to longer lock-ups, hedge funds can do this. But that creates dangers of its own, particularly when the appetite for risk abates. Passengers who feel the need for speed should pick their driver carefully.
Fintag says Pirates may have bigger wallets stuffed with borrowed cash, but Hedgies are much smarter. Let the battle commence.
STRUCTURED PRODUCT PROVIDERS
Time to stand up for structured products (ft) Structured products are perhaps in the same position as private equity and hedge funds - misunderstood and misrepresented. Critics focus on the opacity of the products and the costs involved. Recent analysis by Barclays Capital in its Equity Gilt Study, and ABN Amro and the London Business School in the 2007 Global Investment Returns Yearbook, found the use of options hedging to limit equity volatility led to the loss of most of the equity risk premium.
Those in the traditional fund management business are often hostile, particularly continental European managers who have seen structured products make significant inroads into their business.
For example, Gian Luigi Costanzo, Generali Investments chief executive, believes structured products are "a disaster". They are only good for the structuring bank and the distributor, and do not provide interesting returns for the end client, he maintains. The commissions to distributors built into the products are one of the reasons why the mutual fund market has been losing market share. Mutual funds fees are not as transparent as Mr Costanzo might like to claim, but are far more so than those of structured products.
Mutual funds, particularly Ucits, the cross-border funds, also offer the advantage of being the only products regulated in the interests of the investor, according to Efama, the European Fund and Asset Management Association.
Efama says the rules covering financial products sold in Europe should be redrafted to provide a level playing field. Funds are at a disadvantage compared with insurance products and structured products, which do not have to disclose charges in the same way and can be brought to market more quickly.
Stefan Bichsel, president of Efama, says 700 structured products a day are issued in Germany and can be sold across European Union borders under the prospectus directive. It can all be done fast and with less information, he says.
Efama would like to see a distribution directive covering all savings and investment products, and an investment management directive with a sub-chapter on Ucits. Ucits is a worldwide brand and should not be compromised, says Mr Bichsel. But it could be enshrined in a more logical structure.
Mr Costanzo's prescription is also more transparency, along with efforts to improve financial literacy. But even the financially literate struggle with some structured products, he says.
Retail structured products have yet to prove they are a valuable addition to the product range for investors. Proponents such as Marc Gordon at Close Fund Management point to the track record of their products as evidence and suggest derivative-based products offering a clear risk/return proposition are exactly what investors need.
However, Mr Gordon says those products put together by investment banks have not generally been structured in the best interests of investors, particularly from a cost point of view.
What about the offerings of private banks and wealth managers? Increasing numbers include structured products as part of the product range. At a recent gathering of winners of this year's private asset management awards, organised by Tru-Est, firms such as Berry Asset Management and Newton Investment Management said they were adding structured products and hedge funds to the mix in response to client demands for diversification.
Kleinwort Benson said clients were looking for risk-adjusted returns and structured products could help provide them. They gave access to asset classes that might otherwise be difficult, such as commodities or credit, but in a controlled way and with liquidity. Merrill Lynch said being part of a large organisation was an advantage as structuring resource was in place.
No doubt there are interesting opportunities to be created for sophisticated clients, but sceptics still suspect the interest in structured products is more to do with margins than making risk-adjusted returns.
Sarasin Chiswell said some structured products were complex, opaque and expensive, and suggested the flood of such products would prompt people to ask questions about how much they were paying in fees.
The suspicion that opaque products hide high charges is often well-founded. If structured products are good value, providers must produce evidence by coming clean about all the costs.
Some of the criticism of structured products may well come down to sour grapes at the success of something that seems to sell well. Equally, it may stem from a lack of understanding. Clearly neither applies to the analysis by Barclays Capital or ABN Amro and London Business School.
The concern is not necessarily motivated by a view that high charges are generally bad for customers either. Mr Costanzo makes the comparison with hedge funds, often criticised for their lack of transparency and high costs.
With hedge funds, he says, you know what the charges are and the expected return, even if you don't know how those returns are made. And a diversified portfolio of hedge funds has provided better returns than structured products in years of market volatility.
So the verdict is, yes structured products may be misunderstood and misrepresented. But if they are, it is because providers have done a poor job of explaining them and proving their worth.
Fintag says Funny how the Structured Product providers who help provide immense liquidity to the markets are rarely mentioned in the media. Perhaps it is because the people who work in SP departments make IT geeks look like social butterflies. I am only kidding. They are the life blood to finding ways around the red tape that exists in most of the world's markets.
We say that not as a man who has just had his vacation in a bathing suit, but as one who has spent the last couple of days reading the financial press. The two are alike in that every time you look, the picture seems to get worse.
A brief summary of the subprime industry's business model: There is a market, lenders noticed, of people who cannot afford houses and do not qualify for the credit necessary to buy them. On the surface of it, lending money to these people does not seem like a business you would want to take up. But 'subprime' borrowers could be decent fish, the sharks reasoned, as long as they could make the mortgage payments. The quants did the math. The strategists looked ahead. Even if the occasional client couldn't pay up, they had the rising housing market to lift the value of their collateral. And so, a new 'go-go' financial industry got going...and pretty soon, its hustlers and entrepreneurs - like the whiz kids of the dotcoms who preceded them - were driving Ferraris and drinking Chateau Petrus.
The Orange County (California) Register:
“For Kal Elsayed, a former executive at New Century Financial, a large lender based in Irvine, driving a red convertible Ferrari to work at a company that provided home loans to people with low incomes and weak credit might have appeared ostentatious, he now acknowledges. But, he says, that was nothing compared with the private jets that executives at other companies had.
“'You just lost touch with reality after a while because that's just how people were living,' said Mr. Elsayed, 42, who spent nine years at New Century before leaving to start his own mortgage firm in 2005. 'We made so much money you couldn't believe it. And you didn't have to do anything. You just had to show up.'”
It was this last line that caught our attention and triggered our disappointment. It reminded us how each generation of geniuses are later unmasked as frauds and fools. It reminded us too of what weak-minded simpletons we humans are; we are always falling for our own line of guff.
Modern Homo Sapiens Economicus believes in capitalism. He believes in it as he once believed in the Holy Trinity or the Virgin birth - as dogma. And so, he takes up its tenets and excesses without question or arriere pensees. And, he makes as big a mess of it as his ancestors did of the Crusades.
This is as true of the lumpen as it is of the masters of the universe.
Recall Henry Paulson's soothing words:
“Credit issues are there, but they are contained,” the U.S. Treasury Secretary said to reporters in Tokyo during a four-day tour of Asia. The U.S. financial sector is healthy and most institutions won't feel “a big impact.”
But a big impact is just what institutions feel - after they have flapped their wings and taken to the air. Typically, they come down with a thud.
The geniuses packaged, bought and sold subprime debt right until they heard the crashing noises. They believed the credits were good as long as homeowners could make their payments. And they saw no reason why homeowners wouldn't be able to make their payments as long as they had jobs. That was their line of guff; and they believed it. In a world of full employment, there was no reason for the mortgages to go bad - in theory. But theories arise as needed when there is a sale to be made.
The theory was that low interest rates were giving a whole new group of borrowers access to credit. The reality was that, what made credit available to un-creditworthy borrowers, was the kind of corruption that wishful thinking hides, but that mirrors...and history...reveal.
“What drove the housing-led cycle was not as much the cost of credit,” notes Merrill Lynch's David Rosenberg, “but rather the widespread availability of credit - irrespective of your FICO score [a measure of your ability to repay]...only a third of the parabolic run-up in the home price-to-rent ratio was due to low interest rates. The other two-thirds reflected other non-price influences, such as lax credit guidelines by the banks and mortgage brokers.”
Now, despite 4.6% unemployment and 4.7% yield on 10-year Treasury notes...the subprime lending business is crashing and burning. From Orange County comes news that the aforementioned New Century Financial is trading below $5 a share...a precipitous fall from its high of $66 in December of 2004. At today's price, in theory, the Golden State lender must be the bargain of a century, with a dividend yield of 167%. But, again, the reality is different: The news report also tells us that the company may be forced into bankruptcy.
While the subprime lenders are being pulled from the wreckage, the superprime borrowers are still flying high. In theory, hedge funds charge extraordinary fees for extraordinary performance - 2% of capital and 20% of performance. For what? To return to the Greek alphabet, for helping investors get 'alpha' - a rate of return above and beyond 'beta,' which is what the general market produces.
Warren Buffett, probably the greatest investor who ever lived, says the whole idea is “grotesque.” In last week's letter to shareholders, he explains that you could invest in his “hedge fund,” otherwise known as Berkshire Hathaway, and pay no management fees at all.
The compounded average annual gain of Berkshire Hathaway from 1965 to 2006 is 21.4%. What does the average hedge fund get? In 2006, hedge funds produced a 14% return, almost doubling the 7.6% of 2005 and better than the 10% they did in 2004. Over the longer run, hedge funds show an annual return of about 7%.
Mark Gilbert, summing up for Bloomberg News, concludes that hedge funds, “levy outsized fees on the pretense of generating tons of clever alpha, when they are really just seizing the beta available to anyone.”
In other words, in practice, the hedge fund managers, like the dotcom entrepreneurs and the subprime lenders, are not really geniuses at all. They make their money just by showing up...just like everyone else. And they get the same rate of return. Or worse.
Many funds and hedge funds jumped into Japan after that market went up 40% in 2005. The following year, 2006, was disappointing. The Nikkei Dow rose barely 4%. How did the hedge funds do? As Merryn Somerset Webb reported last week, “far from proving their ability to make absolute returns in any market conditions, [hedge funds] did particularly badly; they all fell between 5% and 20% over the year.”
Subprime lenders did not hedge the risk inherent in lending to weak borrowers. Instead, they sought it out and leveraged it up. Hedge funds seem to have done the same thing - reaching out a little too far in order to grab a few extra points of yield. Now, we wonder who owns the $23 billion of New Century Financial debt...and who owns the rest of the debt in the subprime area? We wonder too, who owned the $2.5 trillion worth of equity value that disappeared last week? Surely, there's some more 'big impact' lurking out there...still waiting to hit someone.
We look in the mirror and hope it isn't us.
Regards,
Bill Bonner
The Daily Reckoning
Editor's Note: Bill Bonner is the founder and editor of The Daily Reckoning. He is also the author, with Addison Wiggin, of The Wall Street Journal best seller Financial Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley & Sons).
In Bonner and Wiggin's follow-up book, Empire of Debt: The Rise of an Epic Financial Crisis, they wield their sardonic brand of humor to expose the nation for what it really is - an empire built on delusions. Daily Reckoning readers can buy their copy of Empire of Debt at a discount - just click on the link below:
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Whereas the SEC moves the investment threshold level up to deter mom and pop investors, the FSA looks at going the other way and encouraging mom and pop investors.
Now why would there be such a contrariety view? Perhaps it is because the FSA regulates hedge funds and the SEC spends all its time suing them?