Posts filed under “Hedge Funds”
Regular readers know that I am not a fan of the WSJ Op Ed page. In addition to their playing fast and loose with facts, I find their rhetorical tactics intellectually dishonest. I also suspect that excessive usage of the drug exctasy has left most of their editorial staff crispy remnants of their former selves, subject to frequent delusional flashbacks, delirium tremens and incontinence.
But I must put those intellectual reservations aside and direct you to Martin Feldstein‘s utterly dead on piece in today’s Journal. In a straight-forward, no nonsense manner, Feldstein perfectly sums up how we got to where we are today:
"Three separate but related forces are now threatening
economic activity: a credit market crisis, a decline in house prices
and home building, and a reduction in consumer spending. These
developments compound the general weakening of the economy earlier in
the year, marked by slowing employment growth and declining real
The current credit market crisis was started by
widespread defaults on subprime mortgages. Borrowers with poor credit
histories and uncertain incomes had bought homes with adjustable-rate
mortgages characterized by high loan-to-value ratios and very low
initial "teaser" interest rates. The mortgage brokers who originated
those risky loans sold them quickly to sophisticated buyers who bundled
them into large pools and then sold participation in those pools to
other investors, typically in the form of tranches with different
estimated degrees of risk. Many of the buyers then used these to
enhance yields in structured bonds or even money market funds.
Many subprime borrowers eventually had difficulty
making their monthly payments, especially when teaser rates rose to
market levels. The resulting defaults exceeded what investors in the
mortgage pools had expected.
Credit risk in financial markets had been underpriced
for years, with low credit spreads on risky bonds and inexpensive
credit insurance derivatives provided by investors seeking to raise
their portfolio returns. With such underpricing of risk, hedge funds
and private equity firms substantially increased their leverage.
mortgage defaults have triggered a widespread flight from risky assets,
with a substantial widening of all credit spreads, and a general
freezing of credit markets. Official credit ratings came under
suspicion. Investors and lenders became concerned that they did not
know how to value complex risky assets.
In some recent weeks credit became unavailable. Loans
to support private equity deals could not be syndicated, forcing the
banks to hold those loans on their own books. Banks are also being
forced to honor credit guarantees to previously off-balance-sheet
conduits and other back-up credit lines, further reducing the banks’
capital available to support credit of all types."
Feldstein notes what many TBP readers will recognize as big themes: The significance of housing to the prior "boom," the ongoing risk of inflation, the dangers a slowing economy presents, and of course, moral hazard.
We have seen and heard a lot of anti-free market, who-was-Schumpeter-anyway?, begging for a Fed bailout. Unlike that group of socialist whiners, Feldstein makes the most eloquent and persuasive case I have yet to come across . . .
WSJ, September 12, 2007; Page A19
The opening paragraph just reached out and grabbed me:
"While it is not strictly true that I caused the two great financial
crises of the late twentieth century—the 1987 stock market crash and
the Long-Term Capital Management (LTCM) hedge fund debacle 11 years
later—let’s just say I was in the vicinity. If Wall Street is the
economy’s powerhouse, I was definitely one of the guys fiddling with
the controls. My actions seemed insignificant at the time, and
certainly the consequences were unintended. You don’t deliberately
obliterate hundreds of billions of dollars of investor money. And that
is at the heart of this book—it is going to happen again. The financial
markets that we have constructed are now so complex, and the speed of
transactions so fast, that apparently isolated actions and even minor
events can have catastrophic consequences."
Indeed, I enjoyed the rest of the book. Bookstaber was on the scene in the early days of many of derivatives now contributing to market turmoil. He rather deftly makes complex issues readily understandable, regardless of how much advanced mathematics you may have under your belt.
And, he names names. LOTS of names. All the usual suspects come under scrutiny, as well as a lot of folks who probably assumed they were not int he public eye. There will be a lot of people not very happy with his blunt, insider descriptions of the analytical errors made by major players — many of whom are still around today and in positions of authority and power.
He also accepts a lot of responsibility for many costly errors he himself made.
Overall, a fun, very informative read.
I was intrigued enough by the book that I contacted Bookstaber (the author) and Wiley (the publisher), and asked for their permission to reproduce the first chapter. They graciously sent me a pdf and text version, which you will find after the jump: All of chapter one, in both text form and PDF. I also included some mainstream media reviews after the chapter.
I have pretty good relationships with many of the publishing houses — they all want to get a book or two out of me. Anyway, if it turns out you guys like this idea, perhaps we can offer up a book or two that I am reading every month in this same format. Maybe we can have an online reading group club — it could be a good place to have a full discussion. Share your thoughts.
Enjoy chapter one.
Disclosure: No, I don’t accept money for this — it was my idea, and I approached the publisher and author about this — not vice versa. Please don’t start bombarding me with offers to promote books I am not already reading. They will be unceremoniously deleted without response.
As noted in our disclosure section, we don’t do payola here (if you click thru and buy it on Amazon, I do see some scratch).