Posts filed under “Hedge Funds”
Forget the good bank/bad bank, I have an even bigger beef with this INSANE absurdity: Why are the taxpayers making good on hedge fund trades gone bad?
I cannot figure that one out.
When AIG first faltered, there were two companies jammed under one roof. One was a highly regulated, state supervised, life insurance company. In fact, the biggest such firm in the world.
The other firm was an unregulated structured finance firm, specializing in credit default swaps and other derivatives.
The first firm was Triple AAA rated. They had a long history of steady growth, profitability, excellent management. They made money (as the commercial goes) the old fashioned way: They earned it.
This half of the company held the most important insurance in many families’ financial lives: Their life insurance. When an AIG policy holder passed away, the company paid off the policy, providing monies that get used to pay off mortgages, kids’ colleges, and surviving spouse’s life time living expenses. Given the importance of this payment, one can see why it is crucial to make sure there are sufficient reserves to make good on the promise of the life insurance policies. The actuarial tables used are conservative, the accounting transparent. The policy payoffs rock solid, utterly reliable.
AIG, this insurance company, was well run. It made a steady income, provided a valuable service to its clients.
It was also very solvent.
The other part of the firm was none of the above. It was neither regulated nor transparent. It existed only in the shadow banking world, a nether region of speculation, and of big derivative bets. This part of the company engaged in the most speculative of trading with hedge funds, banks, rank speculators, gamblers from around the world. Huge derivative bets were placed, with billions of dollars riding on the outcome. It served a far more limited societal function than the Life insurance portion, other than a legal pursuit of profit.
This part of AIG was nothing more than a giant structured finance hedge fund. Despite the fact this hedge fund had no rating, no supervision or oversight, it managed to trade off of the Triple AAA rating of the regulated half of the firm. Somehow, it was treated as if it was Triple AAA, regulated and guaranteed by the government.
This was nothing more than a giant scam, perpetrated by the people who were running the AIG hedge fund.
It was exempt from any form of regulation or supervision, thanks to the Commodities Futures Modernization Act. This ruinous piece of legislation was sponsored by former Senator Phil Gramm (R), supported by Alan Greenspan (R), former Treasury Secretary (and Citibank board member) Robert Rubin (D), and current presidential advisor Larry Summers (D). It was signed into law by President Clinton (D). It was the single most disastrous piece of bipartisan legislation ever signed into law.
As you might have guessed by now, this portion of AIG is the INSOLVENT half.
Here is the question that every single taxpayer should be asking themselves: WHY AM I PAYING $1000 TO BAIL OUT THIS GIANT HEDGE FUND?
Of all the many horrific decisions that Hank Paulson made, this may be his very worst. That is a very special description, given his track record of incompetence and cluelessness.
What should have been done?
Simple: When we nationalized AIG, we should have immediately spun out the good, solvent life insurance company. It is a highly viable standalone entity.
The hedge fund should have been wound down in an orderly fashion. Match up the offsetting trades, the rest go to zero. End of story.
You as a credit default swap gamblor have no reasonable expectation that anyone other than the incompetent firm you placed your bet with is going to make good. You had as your xounter party another hedge fund. Tahatwas the risk YOU — not the yaxpayer — assumed. That is was under the roof of a legitimate insurance company is irrelevant.
Right now, we are into this clusterfuck for $166 billion — every last penny of which is a needless waste.
Taxpayers should not be bailing out hedge fund trades. This insanity must cease immediately .
We add another chapter in the ongoing debate between Barron’s, the weekly paper that is sister to the WSJ, and James Cramer, the former hedge fund manager now turned pundit/CNBC star/game show host. The back and forth between CNBC and Barron’s amounts to an absurd debate over what Cramer’s stock picking record on the show…Read More
Part of the story about the Madoff Ponzi scheme was that Madoff created this elusive, difficult-to-become-a-member club. The exclusivity and rejections made membership all the more desirable to greedy investors. That actually is turning out to be somewhat of a myth. There is much more to his canny trick of rejecting investors than initially meets…Read More
The Quote of the Day comes from David Swensen, Yale University’s endowment’s chief investment officer, in Tuesday’s WSJ: Fund of funds are a cancer on the institutional-investor world. They facilitate the flow of ignorant capital. If an investor can’t make an intelligent decision about picking managers, how can he make an intelligent decision about picking…Read More
Paul Brodsky & Lee Quaintance run QB Partners, a private macro-oriented investment fund based in New York.
Outlook: As we look at the macroeconomic landscape at the onset of 2009 we see obvious negatives and not-so obvious positives for nominal asset prices. The negatives include:
• Almost unanimous deflationary expectations
• Tattered household balance sheets
• Almost no corporate growth visibility
• A higher cost of debt funding for most businesses
• An obliterated mortgage banking industry
• General pessimism among consumers and homeowners
• Heightened global military tensions, as energy exporting nations with nascent democracies struggle to maintain control while their economies contract
The lesser-recognized positives for nominal asset prices include:
• Trillions of new US dollars sitting latent in foreign reserve accounts that could be used to purchase assets at distressed prices
• Extraordinary amounts of inflation being generated by the Fed (and much more to come) – trillions of new dollars sitting latent on bank balance sheets waiting for the multiplier effect to turn them into up to 10 times that amount, leading to higher nominal prices for commodities, goods, services and financial assets
• US and European governments and central banks willing to act as “bad banks” so that their private sectors can maintain and/or enhance the nominal paper value of their assets
• The recent crash of commodity input costs and downward wage pressures, which should temporarily help businesses produce positive earnings at lower revenue levels
• US fiscal policymakers actively subsidizing home affordability and consumer recuperation
• A likely return to US–led global realpolitik, in which developed countries attempt to engage current and potential flashpoints in the developing world with diplomatic solutions.
If past is prologue, there are strong reasons to fade the notion that G7 economies are headed for a 1930s-type deflationary depression. Chief among them is that all economies of the world (via their respective central banks) issue fiat currencies, which means they can simply print money (inflate) to counteract organic deflationary pressures. This was not the case in the 1930s and it is precisely what global policymakers have begun to do.
As we look across the global investment landscape we see:
• Almost 0% “risk-free” global nominal rates of return (and therefore, substantially negative real rates), implying a dearth of risk capital at work in the markets
• Historically wide yield spreads across most tertiary bond markets (widest since the 1930s in many cases), implying; 1) a dearth of risk capital, 2) internal rates of return closer to risk-adjusted, inflation-adjusted equilibria, or 3) both
• Recently crashed global commodity prices, implying; 1) a dearth of risk capital relative to global demand, 2) global equilibrium pricing that better reflects sustainable global demand
• Generally weak US equity prices, implying; 1) a dearth of US dollar-denominated risk capital, 2) more sustainable corporate enterprise values and capital structures
• Weak US and European real estate prices, implying that previous high watermark values
We see both a reasonably-argued case for general pessimism – the continuance of declining fundamentals, and a reasonably-argued case for optimism – quickly improving commodity and equity markets (in nominal terms) that anticipate the end of poor fundamentals. The pessimistic case is obvious to all and markets either greatly or fully reflect that case. The optimistic case (in nominal terms) is less obvious, proven by generally declining prices of risk assets.
David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs, including Morning Call, Power Lunch, Kudlow & Company, Squawk on the Street, Squawk Box Asia, and Worldwide Exchange. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).
“This is a major disaster for a lot of people. You work all your life, you finally manage to save up something, and somebody who’s entrusted with it, it turns out suddenly he’s a crook. Lots of people are getting fully or partially wiped out.”
-Lawrence Velvel, 69, Dean of the Massachusetts School of Law who said he and friends had lost millions among them.
“Those with the biggest financial gains generally had their money managed by Madoff. It was an honor having him handle your fortune. He didn’t take just anybody. He turned down all kinds of people, and that made you want to give the man even more of your money. When he took your fortune, he told you that he would tell you nothing about how he achieved his returns.”
-Laurence Leamer, a Palm Beach based journalist, writing in the New York Post, December 13.
First to the structural business issues.
Cumberland Advisors did not and does not have a single penny in any fund directly or indirectly positioned with, having custody with, or in any way associated with Madoff. The Madoff structure violates all of our internal disciplines. Madoff required that investment management, brokerage, and custody all be with him under the same roof. At Cumberland we require that each of these three functions be separated by task, separately evaluated, and separately reported.
Cumberland will not invest in any conduits or vehicles where the sponsor refuses to disclose the contents of the investment. Furthermore, we recommend that our clients avoid any investments they do not understand. We also avoid any investment about which we cannot obtain a full and completely clear description, so that the investment’s merit may be independently evaluated.
Moreover, at Cumberland, all discretionary managed accounts separate asset custody from brokerage and from Cumberland as manager. Our performance reports and asset lists are separate and independently compiled from those of the custodian broker or bank. Managed accounts that are in custody at a broker have explicit permission for us to trade “street wide” when it benefits the client. We will not accept a managed account where the brokerage transactions are captive to the broker custodian unless there is a specific pricing of transaction costs and the client knows what their broker will charge them. Cumberland never acts as broker and never mixes commissions with fees. We are a fee-for-service only manager.
We recommend this structure for all of our institutional consulting clients where we are not the discretionary manager but only consultants on the strategy. We also recommend this for those whom we are advising on boards and as trustees. In fact, we advise that those who place funds as a fiduciary in any other format should consult their legal counsel before doing so, in order to ascertain if they are in compliance with fiduciary standards.
The Madoff affair’s implications for lawyers, accountants, trustees, boards, etc…