By Chris Clair | March 12th, 2010
Posted in Galleon
It can be difficult making things work as a couple. There are so many phases to a relationship.
There’s the “intensifying” stage. Together forever. I’m so proud to stand with you.
February 8, 2010: “Galleon Figure Chiesi stands by Rajaratnam.”“[Chiesi] said she considers Mr. Rajaratnam a good friend and it is “an honor and a privilege” to stand next to him in court.”
The intensifying stage is sometimes quickly followed by the “break-up” stage. I think we should see other people.
March 12, 2010: “Two Main Galleon Defendants seek Separate Trials.”“‘Jurors would become confused as to which evidence pertained to which conspiracy count and, in turn, which defendant,” the lawyers [for Chiesi] said. ‘Some of this evidence … could have a damning effect and would never be heard by a jury if Chiesi were tried alone.’”
Different couples move though these stages at different speeds….
At its most basic level, Anton R. Valukas’ report on the Lehman failure is the story of our Wall Street worship culture encapsulated in one firm.
Corporate hubris: check
Accounting chicanery: check
Questionable asset valuations: check
Shareholder appeasement: check
Corporate executive denial of knowledge and/or accountability: check
Greed: check
Billions of dollars of other people’s money lost: check
Failure of regulatory oversight: check
Failure of the media to fulfill its skeptical watchdog role: check
I could go on, but what’s the point?
I mean, are these revelations really so shocking? Look at where most of the attention is focused: the so-called Repo 105 transactions. ZeroHedge takes on Repo 105, quoting extensively from the examiner’s report with appropriate indignation. There’s plenty more here at FT Alphaville and here on DealBook.
I see it boiling down this way: Lehman took bad assets and moved them off its balance sheet so as to appear as though it was reducing its leverage. The idea was to make everyone think the bank was healthier than it actually was, to hang on and hopefully ride out the storm. And it worked, at least for a while. Check out the headlines in mid-March:
From the Houston Chronicle, March 19, 2008: “Lehman Bros., Goldman Sachs aim for transparency.” “Investment bank stocks soared Tuesday after Goldman Sachs and Lehman Bros. reported better-than-expected profits that soothed the frayed nerves of investors who were bracing for a domino effect after the near-failure of Bear Stearns.”
From The Guardian, March 19, 2008: “Wall Street exhales: Lehman and Goldman have no liquidity worries.”
From The Wall Street Journal, March 19, 2008: “Goldman, Lehman Earnings: Good Comes From the Bad.” “Lehman in particular benefited from growing evidence that rumors it could face the kind of cash crunch that forced Bear to sell itself to J.P. Morgan Chase & Co. for a $236 million pittance Sunday were overblown. Its shares were up $14.74, or 46%, to $46.49 in New York Stock Exchange composite trading at 4 p.m.”
Get the picture? Better-than-expected Lehman results = a boost to the firm’s stock price and calming of fears on the Street. See, it’s all OK now. Hardly anybody really cared to ask how Lehman managed to report good news when everyone was expecting bad news. And even if they had, it’s not likely Lehman would have said anything about Repo 105.
From pages 734 and 735 of the examiner’s report (or pages 17 and 18 of the 336-page section on Repo 105): “Lehman never publicly disclosed its use of Repo 105 transactions, its accounting treatment for these transactions, the considerable escalation of its total Repo 105 usage in late 2007 and into 2008, or the material impact these transactions had on the firm’s publicly reported net leverage ratio. According to former Global Financial Controller Martin Kelly, a careful review of Lehman’s Forms 10-K and 10-Q would not reveal Lehman’s use of Repo 105 transactions.”
Valukas wrote in his report that Kelly expressed his concerns about Lehman’s Repo 105 transactions to CFO Erin Callan and her successor, Ian Lowitt, telling them that “Repo 105 transactions meant ‘reputational risk’ to Lehman if the firm’s use of the transactions became known to the public. In addition to its material omissions, Lehman affirmatively misrepresented in its financial statements that the firm treated all repo transactions as financing transactions—i.e., not sales—for financial reporting purposes.”
According to Reuters and other news sources, Erin Callan’s lawyer declined to comment. Shocking. Attorneys for the others were’t available. Equally shocking.
Once Callan’s attorney gets his or her arms around the report, though, I’d be willing to bet the defense will be along the lines of: Repo 105 had been used for nearly a decade; it wasn’t illegal; there were no intentionally material misrepresentations; there was no accounting fraud; we complied with GAAP; etc. Which may be all true.
Former Lehman CEO Richard Fuld’s attorney is saying his client didn’t know what the Repo 105 transactions were. “‘He didn’t structure them or negotiate them, nor was he aware of their accounting treatment,’ attorney Patricia Hynes said, noting that the firm’s outside auditor and legal counsel had not raised any concerns about the transactions with [Mr. Fuld].”
Willful ignorance? It’s certainly not an original defense. But “unoriginal” is probably the nicest thing Dick Fuld will be called today.
The longer I live, the more convinced I am that many of the people popularly regarded as “smart” or “responsible” are in fact a bunch of ignorant dumbasses who’ve Forrest Gump-ed their way to positions of respect and power. I’m pretty sure I could have run Lehman Brothers as well as Dick Fuld did, although I’d like to think that if I saw something like “Repo 105″ in a memo or email I’d be curious enough to ask what it was. Or maybe just curious enough to ask, “Everyone thought our results were going to suck. How come they suck less than everyone thought?”
It’s entirely possible Callan and others in positions of responsibility at Lehman saw nothing wrong with buying a little time in the markets, and saw Repo 105 as an acceptable way to do that.
Which is, in fact, the problem.
When a company takes bad stuff from its books over here and moves it over there without telling anyone, thus distorting the true financial picture of the firm, it should be wrong. It’s not always, but it should be. Repo 105 would probably find some staunch defenders among the anti-fair value/anti-mark-to-market crowd—the same folks responsible for pressuring FASB to water down its accounting rules. Their point is well-taken: They shouldn’t be penalized for holding assets that are at the time illiquid and hard-to-value. Like mortgage-backed assets back in 2009 when the markets were frozen.
You know what? Tough. Write it down, take the pain and then when the markets un-freeze reflect the new asset values on your balance sheet. More volatility? Yup. Might the hit to the stock price ding some execs’ compensation? Quite possibly. But if you can’t take the short-term pain, don’t buy those securities. And if you say “hundreds of thousands wouldn’t have been able to buy homes (or do whatever) if we hadn’t bought those securities,” that may be true. I think history will show some people shouldn’t have been able to buy houses—or 42-inch LCD TVs, or Hummers.
Look, the world is volatile. Artificial smoothing leads to artificial confidence, in individual firms and in the markets as a whole. And I think we’ve seen where that leads.
Not everyone bought the bullshit Lehman was shoveling. The first thing I thought when I read about this report yesterday was that David Einhorn was right. Short sellers take their share of grief, some of it deserved, Einhorn is right about something else, too, something more important than just Lehman: As Emma Trincal noted in her story, Einhorn thinks “Wall Street is more eager to accuse short sellers of conspiring against corporations than it is to scrutinize companies’ financial statements.”
That’s nothing new. And if you sit back and reflect on it, neither are the revelations of Lehman’s behavior contained in the examiner’s report currently getting so much attention.
By focusing on Lehman, we may miss the broader picture, which in my opinion is that this kind of behavior is rampant, it’s widely-accepted and it’s under-reported. We will be traveling down this road again soon. The question is which company will be the subject of an examiner’s report next?
With U.S. markets taking a holiday on Friday, April 2 – Good Friday – New York City-based hedge funds are chipping in to help Habitat for Humanity. The Hedge Funds for Habitat-NYC campaign needs volunteers to help renovate community space in a distressed Big Apple neighborhood. A minimum contribution of $500 is required (all proceeds benefit Habitat-NYC). Space is limited. To reserve slots on the Hedge Funds for Habitat team, or for more information, call James Andrews at (212) 991-4000 Ext. 330, or e-mail him at jandrews@habitatnyc.org.
In these tough economic times, it’s nice to know some people are still making enough to get by. For those of you curious about which hedge fund managers made Forbes magazine’s annual list of billionaires, but not curious enough to comb through the whole list yourself, FINalternatives has done the legwork.
Here’s the list:
35. George Soros, $14 billion
45. John Paulson, $12 billion
59. Carl Icahn, $10.5 billion
80. James Simons, $8.5 billion
113. Steve Cohen, $6.4 billion
171. Stephen Schwarzman, $4.7 billion
212. John Arnold, $4 billion
(tie) Ray Dalio, $4 billion
(tie) Daniel Ziff, $4 billion
(tie) Dirk Ziff, $4 billion
(tie) Robert Ziff, $4 billion
258. Bruce Kovner, $3.5 billion
(tie) David Tepper, $3.5 billion
287. Daniel Och, $3.3 billion
297. Paul Tudor Jones II, $3.2 billion
316. Edward S. Lampert, $3 billion
354. Stanley Druckenmiller, $2.8 billion
374. Leon Black, $2.5 billion
(tie) David Shaw, $2.5 billion
437. Julian Robertson, $2.2 billion
488. Philip Falcone, $2 billion
536. David Bonderman, $1.9 billion
536. Alan Howard, $1.8 billion
556. Wilbur Ross, $1.8 billion
582. Israel Englander, $1.7 billion
655. Louis Bacon, $1.5 billion
(tie) James Dinan, $1.5 billion
(tie) Stephen Mandel, $1.5 billion
721. Marc Lasry, $1.4 billion
773. Glenn Dubin, $1.3 billion
880. Michael Hintze, $1.1 billion
(tie). T. Boone Pickens, $1.1 billion
(tie) Henry Swieca, $1.1 billion
Clearly, the guys at the bottom need to start working harder. And what’s with the family collusion among the Ziffs? If I was Dan Och, I’d be wondering…. Actually, if I was Dan Och I’d be floating on a blow-up raft in a warm cove on my own private island. Dubin & Swieca - SUNY Stonybrook guys make good.
By Rich Blake | March 11th, 2010
Posted in The Offering
“The issuer-pays model is fraught with conflicts,” said Connecticut Attorney General Richard Blumenthal, appearing on CNBC Wednesday [March 10].
Earlier in the day, Blumenthal, invoking a state unfair practices law, The Unfair Trade Practices Act, filed a civil suit in Hartford Superior Court against the two largest rating agencies, Moody’s Investors Service and Standard & Poor’s. The Connecticut AG’s suit claims that Moody’s and S&P deliberately, misleadingly, slapped favorable ratings on dicey structured products in an effort to maintain favor with bank issuers buttering their bread.
Asked by CNBC’s Erin Burnett about damages being sought, Blumenthal didn’t bite. He declined to throw out any big scary numbers on live television, what with most of the stock market watching him, although he did tell The Hartford Courant that the figures possibly could reach into the hundreds of millions of dollars.
Blumenthal, at least in the CNBC segment, appeared less concerned about recouping dollars from Moody’s and McGraw-Hill, and more intent on shaming the agencies under the auspices of reforming their practices in the spirit of consumer protection. And while fixed-income portfolio managers and trustees of public pension funds deserve the same fundamental rights as guzzlers of scalding hot McDonald’s coffee, it remains to be seen whether public outrage over shady Wall Street practices has enough fervor left to go around later in the year when it comes time to make more hay with faulty ratings given to complex securities backed by various forms of loans and revenue streams. Will the public, or a jury for that matter, have much tolerance for any narrative in which the central character is a AAA-rated ABS CDO vehicle issuing debt and equity, then investing the proceeds in various forms of securities, including but not limited to RMBS Alt-A….
Perhaps Blumenthal is looking to strike a blow on behalf of Connecticut-based hedge funds—among the foremost consumers of the research coming from Nationally Recognized Securities Rating Organizations and which Blumenthal believes to be so odious. I have yet to see any partners of a folded hedge fund seek reparations from raters.
Blumenthal sued the rating agencies separately, last summer, claiming that they were giving out better ratings to Wall Street wares and weaker ones for municipal issues in a sort of two-tiered system.
So for those keeping score, Blumenthal has sued rating agencies because some ratings are too low now, and also because others were too high then.
Congress is in the midst of a massive financial reform steel cage match. When the grab bag of proposals get sorted out, it could be, under one possible legislative scenario, easier for investors to sue rating agencies. This liability question already looms large over the entire industry. Rating agencies, after all, are already getting sued, left, right and center.
One major Lehman-related lawsuit filed by two pension funds against the big rating agencies was dismissed in late January by Southern District New York State Judge Lewis Kaplan who said that under the Securities Act of 1933 the agencies were not liable; they weren’t the issuers. If Consumer Reports or Kelley’s Blue Book ever gave Toyota a good safety shout out in past years, would anyone think to file suit against them?
CalPERS is currently suing the rating agencies—it’s a case involving SIVs. Banks sold CalPERS instruments tied to off-balance sheet financings. CalPERS is blaming the rating agencies now that they have been burned.
(”Sure, I like my coffee hot your honor but I didn’t expect it to burn my lips off!”)
The SEC is in the midst of rewriting rules that require ratings in the first place, but only for some types of securities. After the infamous Penn Central debacle in the early 1970s the SEC required credit issues to be rated, thus giving birth to a humongous industry.
Interestingly, today, money market funds kicked and screamed over the possibility that ratings would no longer be required as part of their investment mandates; they did not want the ratings requirement removed from the rule books likely because when they screwed up and bought something that went sour they could still have someone to blame.
Even as they reconsider rating requirements, the SEC is also, rightfully, going after the practice of ratings shopping.
Among the many fairly standard but no less dubious Wall Street practices, which in hindsight seem particularly unscrupulous, was banks awarding ratings gigs to the agencies who handed out the most favorable ratings to their structured products. On a corporate bond or a muni, rating agencies all have access to the most of the same cash flow and balance sheet info. But for a structured, securitized product, such as an ABS tied to a stream of credit card receivables, well that’s bespoke, private, the issuers have that info and it’s all unique to the deals they are selling.
To prevent ratings shopping from ever happening again, the SEC wants to make all the data points that go into the creation of a rating available to any NRSRO who wants it, so as to have the fixins’ to come out with their own unsolicited rating. In effect the SEC is fostering a “second opinion” market in the credit rating realm.
If this data is centralized, accessible, and second opinions can be issued, perhaps Moody’s or S&P can come out with better, more accurate, must-read assessments of downside risk. Maybe these unsolicited ratings will spawn new spread-bet markets or attract a loyal fan base, even earn the agencies some investor-pay model fees flowing from various money managers and stewards of retirement funds who by the way surely never solely relied on a rating to provide them creditworthiness assurances in much the same way that the parents of a ten-year-old boy wading into rough Montauk surf wouldn’t solely rely on the lifeguard back on the beach to prevent their frolicking lad from getting sucked out to sea.
Some niche rating agencies could in theory take all the second opinion data (which is supposedly to be made digitally available on an issuer-sponsored website) and bust out their own more skeptical ratings of an ABS CDO causing the market to reconsider the issuer-paid ratings, so fraught with conflict, as Blumenthal pointed out.
More likely, the niche agencies won’t bother because they won’t be getting paid for unsolicited ratings.
Maybe there will no longer be rating agencies because the regulatory crackdown, political blowback, legal bills and damage awards will in the end crush them. At that point every money manager and pension fund would be on their own with no one to blame but themselves when, seduced by the charms of higher than treasury yields and some slick team of salespeople, they get their lips burned off.
By Chris Clair | March 10th, 2010
Posted in General
“So much for Objective Journalism. Don’t bother to look for it here–not under any byline of mine; or anyone else I can think of. With the possible exception of things like box scores, race results, and stock market tabulations, there is no such thing as Objective Journalism. The phrase itself is a pompous contradiction in terms.”
- Hunter S. Thompson,“Fear and Loathing on the Campaign Trail ‘72″
Same data, same source, very different takes. I had a journalism professor who maintained there was no objectivity in journalism. As soon as a reporter picks a quote to use or cites one statistic instead of another, subjectivity is introduced. In this case, it’s not even that cut-and-dried. Both stories cite the same statistics, it’s just that one emphasizes the change year-over-year while the other focuses on single-year numbers. Both are equally true and equally accurate.
I’ve been covering hedge funds for about 10 years, and in that time I’ve seen them shift from investments most people had never heard of to topics of conversation among friends of mine with no connection to finance. I used to say I wrote about hedge funds and get a blank stare. The other night I was at a college alumni function with a bunch of younger people I’d never met and every person I talked nodded knowingly when I said “I cover hedge funds.” Reactions ranged from “Oh, Madoff” to “Oh, Greece.”
Granted, not everyone understood the hedge fund connection to the home of the Gyro, but the perception was that hedge funds are somehow, possibly illegally, making money off the misery of another country.
I tried to tell people there’s nothing “illegal” about it, at least not yet. Speculation is legal, and has been encouraged in financial markets, especially since the passage of the Commodity Futures Modernization Act of 2000, which threw open wide the door to trading the same esoteric over-the-counter derivatives upon which much scorn has been heaped the past couple of years.
I remember those days well. They were among my first covering risk management and derivatives at Pensions & Investments. I knew very little about the industry then (it could be argued that I know only a little more today), and the phrase that stuck in my mind when people talked about the proposed derivatives legislation was “legal certainty.”
At the end of the day, the CFMA eliminated concern a court could rule that swaps and other since-popularized derivative instruments had to be traded on regulated exchanges. That would have killed the business, many argued. The idea behind the eventual treatment of these derivatives by the legislation was that the pre-CFMA 2K uncertainty was constraining innovation and denying investors access to important risk management tools. Everybody, it seemed was on board with this notion.
A Bloomberg story last month noted that Gary Gensler, the chairman of the Commodity Futures Trading Commission, who was a big supporter of the CFMA 2K and fought hard for its passage, has now come to the conclusion that the very over-the-counter instruments exempted from regulation by the CFMA 2K now must trade on-exchange. Gensler is far from the only CFMA 2K supporter to have been converted in this way. Alan Greenspan and Arthur Levitt Jr. have both seen the light, as it were, according to Bloomberg.
“Former Federal Reserve Chairman Alan Greenspan and former Securities and Exchange Commission Chairman Arthur Levitt Jr., both of whom supported the 2000 law, have expressed regret that derivatives were not more tightly controlled.”
What did looser control bring? Well, in the Credit default swap market it brought explosive growth. What was a $180 billion market in 1997 grew to $5 trillion by 2004 and an estimated $62 trillion by the time the bottom fell out of the credit markets in 2008. That’s a ridiculous growth rate, and far more indicative of a frenzied speculative bubble than a rush to embrace a new risk management tool. Of course, it’s easy to say that in hindsight, but when it’s happening it’s exciting, and much of the supposed “watchdog” financial press was caught up in reporting on the superheated growth rate, but decidedly less focused on its implications.
And so here we are, at a point in time where hedge funds and naked credit default swaps are being blamed for exacerbating Greece’s financial woes, and both are facing tighter regulatory scrutiny.
Today’s Wall Street Journal details the expanding criticism of the swaps market by people with the power to shape policy, both in Europe and the United States. The Journal discusses Gensler’s most recent views, while the Washington Post does a deep dive into the European Commission’s moves toward banning credit default swaps in sovereign debt. The Irish Times goes after naked credit default swap trading. And Janet Tavakoli warns on Huffington Post today about naked CDS on U.S. debt
Swaps and other derivatives, and hedge funds’ use of them, is no longer a topic only for finance geeks and traders. That’s probably not good news for the laissez-faire/Chicago School/free market crowd, but good news for the Keynesians. The pendulum is on its way back.
Call me an unintended acceleration skeptic. These days that’s like saying I don’t believe climate change is real or that I think the Earth is 5,000 years old.
I do believe climate change is real, however, and I believe all the science I’ve been taught over the years that the Earth has been around a lot longer than 5,000 years. But I don’t believe people’s cars are just running away out of control, not without some additional factors at play, anyway.
What’s the hedge fund connection? The smart money, in the short term, may be betting against Toyota’s share price. But in the long run I think the company will be a good long bet.
I’m not a scientist or an engineer, and I have never worked as an investigator for the National Highway Traffic Safety Administration. But I am old enough to recall the Audi sudden unintended acceleration cases from the 1980s. Many of those claims were attributed to driver error (hitting the gas instead of the brake), however Audi did take some steps to further separate the brake and gas pedals due to the complaints. There is one consolidated class-action lawsuit left in that case that I know of—Audi owners who claimed the re-sale value of their cars was hurt by the allegations and subsequent Audi recall. After 22 years of legal maneuvering, that case is still active in the courts. Meanwhile Audi has continued to make cars.
Look, it’s not that I don’t believe cars can suddenly and unexpectedly accelerate and that drivers can reasonably report being unable to stop them. In the pre-drive-by-wire electronic engine control days, gas pedals could get stuck to floor mats, or stuff rolling around on the floor could get behind the brake pedal. These days, computers control everything and presumably can go wiggy. Additionally, for reasons related to physics (heat) and mechanics (vacuum pressure), brake systems become less effective when a car’s throttle is wide open.
And yet, Car and Driver magazine tested three cars and in each of the cases the brakes were strong enough to overcome the engine’s acceleration. Even the 540-horsepower Rousch Stage 3 Mustang was eventually dragged to a stop.
“From 70 mph, the Roush’s brakes were still resolutely king even though a pinned throttle added 80 feet to its stopping distance. However, from 100 mph, it wasn’t clear from behind the wheel that the Mustang was going to stop. But after 903 feet—almost three times longer than normal—the 540-hp supercharged Roush finally did succumb, chugging to a stop in a puff of brake smoke.”
Granted, the lack of confidence at 100 miles per hour, even among experienced drivers, means that less experienced drivers would probably panic. But the brakes still eventually overpowered the engine.
I think what’s most likely at work here is a combination of bad ergonomic design (Toyota’s floor mats), an abysmal driver education system, distracted driving and plain opportunism (read: “plaintiffs”).
Toyota is fixing the ergonomic problems. I’m less convinced (and obviously Toyota is, too) that the vehicle ECMs are suddenly opening the throttles, but if we’re both wrong and there’s a severe software problem Toyota will address it for its own survival.
What I’m getting at is that even with all the bad publicity surrounding Toyota of late, these acceleration issues will mostly boil down to a) driver error, b) design flaws, or c) software flaws. There will be lawsuits, but as the Audi example shows they will likely drag on for years. Toyota seems willing to fight any claims that it has been negligent. A billion-dollar-plus settlement seems a remote possibility.
Meanwhile, once this period of hyper-focused bad publicity passes, two realities will emerge: First, Toyota by and large builds good vehicles that are affordable. And second, most of those vehicles are perceived as fuel-efficient. Oil prices are back above $80 a barrel.
There are plenty of holes in my argument, no doubt. But that’s my take on it anyway. Go long Toyota.
By Rich Blake | March 8th, 2010
Posted in The Offering
The bucket of Relative Value strategies tracked by Hedge Fund Research notched a 0.22 percent gain in February, marking the 14th straight month of positive returns for the investment style, according to Ken Heinz, HFR’s president.
The last time the RV category registered a decline was in December 2008.
Relative value, as many readers probably know, is hedge fund industry catch-all jargon for strategies seeking to exploit pricing dislocation between two related or similiar securities, usually bonds. If Long-Term Capital Management still existed, most likely it would be considered a relative value fund.
Fixed-income arbitrage and convertible arbitrage are among the most common sub-styles of RV.
When the financial meltdown/credit crisis hit in late 2008, liquidity on Wall Street dried up like Scottsdale in summer. RV, which inherently requires leverage to make the discrepancy exploitation game worth playing, got slammed, Heinz explained.
“But as liquidity has come back in to the market, relative value has benefitted and has proven the most consistent performer of any category we track,” Heinz explained.
Among the best performing sub-style within Relative Value is “multi-strategy relative value,” he added.
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