Harry Newton's In Search of The Perfect Investment
8:00 AM EST, Tuesday, September 23, 2008: Anyone
still in stocks is being slaughtered. The big gainers yesterday were gold and
oil -- oil "enjoyed" its biggest one-day gain yesterday since the
the early 1980s. But most hedge funds are short gold and oil.
jumping in, thinking they can make a profitable short-term trade (or even buy
something for the long-term) is being slaughtered. No one can handle (or predict)
the present Washington-induced insanity and its zillions of unintended consequences.
There's an old
saying that (I think it's from Milton Friedman) that "If you put the
Federal Government in charge of the Sahara Desert, there'd be a shortage of
sand within five years."
SEC banned short selling on about 800 financial or financially related stocks.
Instead of calming the market, it roiled it. Many traders knowing that these
800 stocks would be protected from short selling, sold them -- instead of waiting
until the stocks could be sold short in the future. Unintended consequence #1.
This is the past
few days. Yesterday the Dow fell 372.75 -- 3.3%. Traders became apparently leery
that Congress could actually pass the $700 billion bailout before it goes on
of what might be in the legislation. Everyone knows that the bailout will tighten
the bank's capital requirements. Everyone is afraid that many banks won't be
able to meet those requirements, will scramble for new capital, won't find it
and will go bust. Another unintended consequence.
Let's say Congress passes the bailout. A bank sells $100 million of toxic mortgages
to the new government entity. Is that good or bad for the bank? Depends on what
the bank valued those mortgages on its balance sheet. If it valued them at $50
million, it just made a $50 million "profit" -- good for shareholders.
What happens if it had valued them at $200 million (even though it may have
taken a $100 million writedown), then it's just incurred a $100 million "loss."
Even better, now
the banks know Congress is buying their bad loans, it makes no sense to write
the toxic mortgages down -- since Congress may choose to buy them at the written-down
prices. This would be the classic case of being hoisted on one's own petard.
Better to sell Congress a pig in the poke. ... Without the writedowns, we, as
dumb investors, are left in the dark as to what one bank may or may not be worth.
Since we won't know what one bank is worth, we'll assume that they're all
bad and sell them all. I bet there's a way to short them. Off-shore?
consequences get better. This was posted by someone called Yves Smith on a financial
We have said
more than once that a terribly misguided aspect of the Freddie and Fannie
conservatorship was the elimination of dividends on the GSEs' preferred stock.
Preferred was the best vehicle that struggling financial firms had for raising
new capital. Eliminating the dividend lead to big losses in all financial
preferred stocks, since investors assumed any bailout would similarly trash
the preferred. Indeed, it is quite possible that this move accelerated Lehman's
demise, since it closed off its best funding option.
A second reason
for taking a dim view of this move was that the Treasury had encouraged banks
to buy Fannie and Freddie preferred stocks, so any losses on these holdings
would reduce the equity of banks that owned the stock. Paulson alluded to
the issue in his statement announcing the conservatorship, and claimed very
few banks would be affected, and the impact would not be significant:
believe that, while many institutions hold common or preferred shares of these
two GSEs, only a limited number of smaller institutions have holdings that
are significant compared to their capital.
It looks like
they were wrong. From the Financial Times:
US regulators have underestimated potential bank losses on preferred stock
issued by Fannie Mae and Freddie Mac, the American Bankers Association said
third of US banks hold preferred stock issued by the two mortgage financiers
that were taken into conservatorship this month, according to an industry
survey conducted by the ABA. The average bank exposure to such securities
relative to core equity capital was 11 per cent.
impact on banks particularly Main Street community banks is
far greater than regulators first thought, wrote Edward Yingling, chief
executive of the ABA in a letter to the Treasury, the Federal Reserve and
other banking regulators.
takeover of Fannie and Freddie all but wiped out the value of $36 billion
of their preferred shares. This would force exposed banks to take writedowns
at the end of the third quarter that could impede future lending, the ABA
letter called for regulators to reconsider the suspension of dividend payments
on Fannie and Freddie preferred stock to alleviate the capital impact on banks
and avoid a multi-billion dollar decline in lending.
#4 or 5: Also posted by Yves Smith:
funds suffer mass redemptions"
One sign that the credit crisis is accelerating: Nouriel Roubini's forecasts
are coming to fruition faster. In the past, Roubini has too often played the
role of seemingly mad prophet in the wilderness until he is proven correct.
His calls that the housing bubble would collapse in a nasty way, that subprime
was most certainly not contained, that Freddie and Fannie would get in trouble,
that total credit crunch losses would reach $2 trillion, all sounded apocalyptic
and were generally ignored, to the detriment of those who failed to take heed.
The time between
Roubini making a dire forecast and it coming to pass has just collapsed. From
yesterday's Financial Times: The next stage will be a run on thousands
of highly leveraged hedge funds. After a brief lock-up period, investors
in such funds can redeem their investments on a quarterly basis; thus a bank-like
run on hedge funds is highly possible. Hundreds of smaller, younger funds
that have taken excessive risks with high leverage and are poorly managed
may collapse. A massive shake-out of the bloated hedge fund industry is likely
in the next two years.
In today's Independent
(recall that London is an even bigger hedge fund center than New York/Fairfield
County): Hedge funds could have an unprecedented level of cash pulled out
by investors this quarter, according to insiders, just as they faced millions
of pounds of losses from last week's shock regulation of short selling. It
has been a tough year for the industry with high-profile funds blowing up,
clients increasing redemptions, as well as public fury over short selling
and increased threats of regulation.
One hedge fund
expert pointed to The Hedge Fund Implode-O-Meter (HFI) as how he judges the
state of the industry. The HFI was set up online in the wake of the credit
crunch "to track as hedge funds learn the double-edged-sword nature of
the often extreme leverage they use".
"imploded funds" list has hit 51 companies.....It has 34 stocks
on its "ailing/watch list" of those that have suffered significant
value declines or temporarily halted redemptions. According to EuroHedge,
a hedge fund data provider, 272 individual funds strategies were launched
during the first six months of 2008, the lowest for nine years. In the same
time, 243 funds have been liquidated, the highest in a six-month period...
seem to have started in earnest, although currently the evidence is mainly
anecdotal. One UK hedge fund manager confided that last week had the highest
number of investors rushing to withdraw funds that he has known. The industry
will know for sure whether it is a drip or a deluge when the data providers
release their statistics for the third quarter, next month. One market analyst
said: "I know even the good hedge funds have been suffering withdrawals
recently. Investors are very nervous."
numbers are also under pressure. Some have done well out of the market disturbance,
but on average the performance numbers are at a low ebb. Andrew Baker, the
deputy head of Aima, the hedge fund trade body, said: "The performance
is undoubtedly soggy. There are not many strategies that stand out."
Yves here. Note
that short strategies had been a lone bright spot, But now that short sellers
are being pursued with a vehemence that would warm Torquemada's heart, let's
just say that their past results may not be indicative of future performance.
that strategies that have done particularly badly this year include several
run by Naissance Capital, once bankrolled by the Habsburg families, which
are down a fifth and Pico Fund, which is down 32 per cent. At Endeavour Fund,
set up by former Salomon Smith Barney traders, the second fund has fallen
by 40 per cent, while its third fund is down 38.79 per cent in 2008. In the
emerging markets, PharmaInvest Fund's investments in emerging markets are
38.16 per cent down.
have sought to lock in investors by halting redemptions. The latest example
was RAB, with its flagship Special Situations Fund, as it was so desperate
to prevent exits after a 22 per cent drop in performance that it offered vastly
reduced fees in return for a lock-in period of three years.
One of the main
problems experienced by hedge funds is the extent of leverage in the industry.
The funds were able to take on huge amounts of debt, with little capital needed
as security, to boost returns. One observer said some of the leveraged strategies
were like "picking up pennies in front of a steamroller, and that
only takes a turn in the market to cause severe problems".....
At the same
time, hedge funds, like the banks, have had to write down exposures to investments
in risky instruments including collateralised debt obligations and asset backed
securities, and also been exposed to the huge swings in the market.
is the regulators sniffing around. There have been wider calls for transparency
and official controls of the industry, which has already been stung by the
shock short-selling rules...
financial services partner at Deloitte, said: "When the dust has settled,
I expect the regulators to look at the role that hedge funds have played in
the current issues. I expect there will be increased calls for regulation,
but I doubt much will come from it."
But, there's more.
This may be good for me. Remember I bought all those Australian dollars a few
months ago, only to watch their value crater as the American dollar rose. From
May Get 'Crushed' as Traders Weigh Up Bailout (Update5)
Sept. 22 (Bloomberg)
-- Treasury Secretary Henry Paulson's plan to end the rout in U.S. financial
markets may derail the dollar's three-month rally as investors weigh the costs
of the rescue.
of spending $700 billion on soured mortgage-related assets and providing $400
billion to guarantee money-market mutual funds will boost U.S. borrowing as
much as $1 trillion, according to Barclays Capital interest-rate strategist
Michael Pond in New York. While the rescue may restore investor confidence
to battered financial markets, traders will again focus on the twin budget
and current-account deficits and negative real U.S. interest rates.
get to the other side of this, the dollar will get crushed,'' said John Taylor,
chairman of New York-based International Foreign Exchange Concepts Inc., the
world's biggest currency hedge-fund firm, which manages about $15 billion.
The dollar fell
against 14 of the world's most-traded currencies on Sept. 19, including the
euro, as Paulson unveiled the plan, while the Standard & Poor's 500 Index
rose 4 percent. The plan may end the rally that began in June and drove the
U.S. currency up 10 percent versus the euro, 2 percent against the yen and
almost 13 percent compared with Brazil's real, strategists said.
sent to Congress Sept. 20, would mark an unprecedented government intrusion
into markets and increase the nation's debt ceiling by 6.6 percent to $11.315
trillion. Officials may also start a $400 billion Federal Deposit Insurance
Corp. pool to insure investors in money-market funds.
downdraft on the dollar from the hit to the balance sheet of the U.S. government
will dwarf the short-term gains from solving the banking crisis,'' said
David Woo, London-based global head of foreign-exchange strategy at Barclays,
the third- biggest currency trader, according to a 2008 survey by Euromoney
Institutional Investor Plc.
Federal Reserve Chairman Ben S. Bernanke began plotting the rescue last week
after New York-based Lehman Brothers Holdings Inc. filed for bankruptcy, the
government seized control of American International Group Inc. and Merrill
Lynch & Co. was forced into the arms of Charlotte, North Carolina-based
Bank of America Corp.
dropped as much as 44 percent Sept. 17, the biggest one-day decline in its
history, and Goldman Sachs Group Inc., where Paulson was chief executive officer
from 1998 to 2006, lost 26 percent. Both are based in New York.
The dollar fell
2.5 percent to $1.4831 per euro as of 4:05 p.m. in New York, after dropping
1.7 percent in the week to Sept. 19. It slid 2.1 percent to 105.24 yen, extending
last week's 0.5 percent decline.
In the four
days following Lehman's bankruptcy, the ICE future exchange's Dollar Index,
which measures the currency's performance against the U.S.'s six biggest trading
partners, dropped 1.2 percent. It fell 2 percent today, leaving it little
changed this year.
years of doubting the hegemonic status of the dollar, this proves it's still
there,'' said Stephen Jen, London-based head of research at Morgan Stanley.
"But of course this situation is definitely not stable. The capital leaving
the emerging markets is only going into the dollar and that's a powerful force.
It's a very uncomfortable balance.''
By the end of
the year, the euro will weaken to $1.43 and the yen will trade at 108 to the
dollar, according to analyst surveys by Bloomberg. The dollar will depreciate
to 1.65 against the real, compared with 1.83 on Sept. 19.
dollar may suffer short-term, at least one analyst says the U.S. government's
planned rescue will strengthen the currency before long. Paulson's proposals
will return foreign-exchange markets to the trend of the past months, according
to Adam Boyton, senior currency strategist at Frankfurt-based Deutsche Bank
AG, the world's biggest currency- trading bank. Since the end of June, the
Dollar Index has gained 5 percent.
positive plan that's ultimately good for the dollar,'' said New York-based
Boyton. "It reduces risk and volatility and gets the focus back on macroeconomic
fundamentals, which suggest weakness throughout the rest of the globe next
year, with returning strength in the U.S.''
The U.S. economy
may expand 1.5 percent next year, according to the median estimate of 80 analysts
surveyed by Bloomberg. That compares with 1.1 percent for the euro-region
and 1.15 percent for Japan, the world's second-largest economy.
The rescue comes
as the U.S. budget deficit and the current-account balance, the broadest measure
of trade, grow. The Congressional Budget Office projects the spending shortfall
will increase to $438 billion next year from $407 billion. The current account
deficit is up from $167.24 billion in December.
may start to worry about the amount of debt the U.S. is taking on and its
impact on the dollar,'' said Geoffrey Yu, a currency strategist in London
at UBS AG, the second- largest foreign-exchange trader. "The fact that
they mentioned taxpayer money implies that they're going to issue debt. If
there's going to be a huge new supply of Treasuries, this will be dollar negative.
It's too much for the dollar to take.''
also concerned the bank bailout will spread to other U.S. industries suffering
from the credit crunch that's holding back an economy growing at its slowest
pace since 2001. Detroit-based General Motors Corp., the world's biggest automaker,
said last week it will tap the remaining $3.5 billion of a $4.5 billion credit
line to pay for restructuring costs.
rates may also weigh on the dollar. Futures on the Chicago Board of Trade
show there's a 45 percent chance policy makers will lower their target rate
for overnight lending between banks to at least 1.75 percent by January from
2 percent currently. A month ago, they showed a 50 percent chance of an increase
to 2.25 percent.
Rates in the
U.S. are already the lowest of any Group of 10 industrialized nations except
Japan, where they are 0.5 percent. The European Central Bank's benchmark is
for the dollar is that the Fed's key rate is 3.4 percentage points less than
the rate of inflation, the most since 1980, so investors lose money by investing
in short- term U.S. fixed-income assets.
thought that the Fed was done cutting,'' said Andrew Balls, an executive vice
president and member of the investment committee of Newport, California-based
Pacific Investment Management Co., which oversees almost $830 billion. "In
the longer term the diversification away from the dollar will remain intact.
The U.S. hasn't done itself any favors in making its assets attractive to
beneficiaries may be Brazil's real and Australia's dollar, as demand for higher-yielding
assets rebounds, according to Goldman Sachs. The two currencies, the biggest
losers versus the dollar since July, may rebound 7.7 percent and 4.6 percent,
respectively, in the next two weeks, Goldman Sachs forecasts.
that have been damaged the most have the best growth,'' said Jens Nordvig,
a strategist with Goldman Sachs in New York. "You're going to see a lot
of flows back into these currencies now.''
guys running the CFTC are newly afraid of their jobs (remember McCain says he'd
fire the head of the SEC). Another Bloomberg story this morning focused on more
Squeeze Prompts Call to Curtail Speculators (Update1)
Sept. 23 (Bloomberg)
-- U.S. lawmakers may seek to include commodity speculation limits in legislation
designed to rescue banks from bad mortgage investments after a squeeze in
oil trading sent crude to a record gain.
Crude oil for
October delivery yesterday climbed more than $25 a barrel in New York Mercantile
Exchange trading, before settling 16 percent higher at $120.92 as the contract
expired. The fluctuation, the biggest since Nymex crude trading started in
1983, prompted the Commodity Futures Trading Commission to say it was ``closely
monitoring'' prices for manipulation.
``I know for
a fact that some members of Congress are working to include speculation legislation
in the financial markets legislation,'' CFTC Commissioner Bart Chilton said
yesterday in an e-mail. ``Those efforts, I think, may get fueled by the large
spike in oil prices.''
Any move to
include commodity limits in the legislation to rescue Wall Street risks encountering
opposition from the administration and delaying the law. President George
W. Bush called on Congress not to load the $700 billion legislative rescue
plan with ``unrelated provisions.''
Oil soared yesterday
as traders who had sold the October contract had to buy the futures back on
the last day of trading, rather than try to make delivery from inventories
that had declined in the wake of Hurricane Ike. Oil for November delivery
rose just 6.4 percent to $109.37 yesterday. November crude, which is the most
active contract, was trading at $106.99 at 10:49 a.m. London time today, 2.2
The House of
Representatives approved legislation last week aimed at curbing speculation
in commodities after prices of oil, copper and corn reached records. The Senate
has failed to hold a final vote on legislation that would give the commission
authority to rein in hedge funds, securities firms and pension funds.
prepares a proposal to restore public confidence in financial markets, giving
CFTC the authority it needs would be a relevant and important set of provisions,
which should be included,'' Senator Tom Harkin, an Iowa Democrat and chairman
of the Senate Agriculture Committee, said in an e-mail yesterday.
is pushing a narrow proposal focused mainly on residential mortgages, however,
so it is not clear what the prospects may be for including anti-speculation
provisions,'' Harkin said in an e-mail yesterday.
Hurdles in Congress
While the administration
is asking Congress to move swiftly on the mortgage proposal, the measure is
already encountering hurdles, after House Financial Services Committee Chairman
Barney Frank said the plan must include limits on executive pay. Treasury
Secretary Henry Paulson rejected the idea over the weekend, suggesting it
would dissuade companies from taking advantage of the law.
Leader Harry Reid is ``not sure at this point'' whether anti-speculation measures
will be included in the bailout bill, Rodell Mollineau, a spokesman for the
senator, said in an e-mail yesterday.
$130 a barrel yesterday, 44 percent more than six days earlier, when it fell
as low as $90.51. Gasoline futures gained 4 percent yesterday to about $2.70
a gallon on the Nymex.
move reflected extreme tightness in the prompt physical market as participants
that were short oil scrambled to find physical oil before expiration,'' Goldman
Sachs Group Inc. analysts led by Jeffrey Currie said in a report dated yesterday.
Last week, the
Goldman analysts had cut their three-month crude forecast to $115 a barrel
CFTC staff will
``scour'' yesterday's oil trades in search of any illegal activity, Stephen
Obie, acting director of the commission's division of enforcement said in
a statement. ``No one should be trying to game our nation's commodity futures
There is ``likely
to be a renewed interest in taking some action in light of this price movement,''
said Geoffrey Aronow, former director of enforcement at the agency and now
a partner with Bingham McCutcheon LLP in Washington. The price swing yesterday
wasn't ``automatically a cause for suspicion,'' he said.
The Nymex declined
to comment on whether it was investigating yesterday's trades.
language ``absolutely should be included because otherwise, the guys who are
getting bailed out are going to have free reign over these commodity markets,''
said Michael Masters, of hedge fund Masters Capital Management.
`Cut Off the
testified to Congress four times this year that financial-market participants
are responsible for doubling the price of oil. He estimates oil should be
$65 to $70 a barrel.
can't curb short selling and then leave commodities unregulated,'' Masters
said in a telephone interview yesterday. "It's like a hydra, you can't
just cut off one head, you've got to cut off all the heads.''
and other large speculators amassed commodities in the first half of the year,
and prices peaked July 3. Since then, the Reuters/Jefferies CRB Index of 19
raw materials tumbled more than 20 percent. So-called net-long positions,
or bets prices will rise, in 17 of its 19 members dropped 72 percent since
July 1 to 241,370 contracts on Sept. 16, data from the CFTC in Washington
legislation to the financial rescue bill ``could be disastrous for its odds,''
Kevin Book, senior energy analyst with Freidman Billings Ramsey & Co.
Inc. in Arlington, Virginia, said in a telephone interview. ``At the same
time this is the type of issue that really gets people's attention.''
John F. Kennedy is alleged to have said "Washington
is eight square miles surrounded by reality."
Mae West said
she'd been rich and she'd been poor. Rich was better.
from Australia yesterday. The U.S. Immigration officer told them that in the
old days when the Sheriff left town, the people robbed the banks. Now, when
the Sheriff leaves town, the banks rob the people.
Welcome to America,
Cash is king.
Tennis is sanity.
This column is about my personal search for the perfect
investment. I don't give investment advice. For that you have to be registered
with regulatory authorities, which I am not. I am a reporter and an investor.
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is research for a book I'm writing called "In Search of the Perfect
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