So Amaranth, a hedge fund, loses $6.5 Billion, almost all its investors' money, almost everything, in just a few weeks. Ouch.
But for some reason, this hasn't had much of an impact in the markets or media. Yet. But oh it will, and so will the blow-up of hedge funds worldwide who helped enable the late great housing bubble.
Everything changed once mortgages were commoditized. The local banker - he doesn't care if a homedebtor can handle the payments, is truthful on his mortgage application, or is fiscally sound. Nope, it's not his worry anymore - since that loan is bought up by Fannie or Freddie, commoditized, packaged and sold to hedge funds.
So the 24-year-old kid's $2.2 Million? That's not owed to some bank in Sacramento. Nope, that's part of some commoditized tranche, and owed to hedge fund investors around the world.
Guess what. That money ain't gonna be paid back. Someone will lose that money. And not Casey, he'll just walk (or run). Not a bank. Maybe Fannie or Freddie if they didn't commoditize it. But most likely it's the hedge funds. And they're about to blow.
But what do we expect, based on the bizarre structure of hedge funds. They collect a yearly management fee, say 3% of all investments. Then the managers keep 25% of all gains. So what do you think they'll do? Nope, it's not hedging, it's gambling like there lives depended on it. The riskiest, most unsound, most outlandish and most out of control investing you'll eve see. Because if they get big returns - even one year - they're rich beyond their wildest dreams.
And if they fail, if their gamble turns nose-down, and they lose, like Amaranth, everything in a blink, well, they just walk away, and try again at another fund another day.
Walk away. Just like Casey. Just like millions of homedebtors during the upcoming collapse. Just like Congress, Banks, Regulators, Common Sense and America's Future.
Just walk away.
Amaranth Advisors LLC, seeking to return what's left of clients' money after losing $6.5 billion on natural-gas bets, hired Fortress Investment Group LLC to help sell its hedge-fund holdings.
Amaranth is trying to prevent its collapse, the largest in hedge-fund history, from becoming more costly for investors.
Amaranth's meltdown capped a tumultuous month for the industry. Regulators in the U.S. and Malaysia began investigating Aeneas Capital Management LP of Mount Kisco, New York, more than two weeks ago after bad bets on Malaysian stocks caused losses of about 60 percent in one of its funds. Pirate Capital LLC, which oversees $1.7 billion, said last week that half of its 10-member investment team quit.
Hedge funds are largely unregistered pools of capital that let managers participate substantially in gains on the money invested. There are more than 8,000 hedge funds with $1.2 trillion in assets, more than double the figure five years ago, according to Hedge Fund Research Inc. in Chicago
October 02, 2006
The shadowy world of hedge funds, the blowup of Amaranth, the 24-year-old $2.2 Million homedebtor, and the late great housing bubble
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18 comments:
The housing market has justifiable received much attention recently. Both the disastrous war in Iraq and the housing market boom worked to jump start the USEconomy in 2003. They also ignited the commodity bull market.
Now both ignition forces are hotly contested for their carelessly crafted corruption. Spin can put a pretty face on a pig, but not this nightmarish civil war and certainly not this housing market.
Under-stated is the economic benefit from the military war, especially to commodity demand. Under-stated is the political component involved in the Fanny Mae distribution of mortgage funds.
Few analysts seem to properly recognize the upcoming housing market decline, its bear market highly likely to form a gathering storm with vicious momentum. Yet another laughable “Soft Landing” has been forecast.
Such an outcome seems far more convenient, politically valuable, delusional wishful thinking, than adept well-founded analytical forecast. The entire concept of Soft Landings would make an interesting chapter in Economic Mythology. We have never seen one, but we continue to have them thrust before us by proclaimed experts.
The Soft Landing forecast is a convenient weapon used to deceive, in the wake of busted bubbles and ended trails. Doctored statistics unquestionably aid in the real-time telling of the story. A new fairy tale is needed, and sure as shooting, as a new calamity presents itself.
http://www.kitco.com/ind/Willie/sep292006.html
http://finance.yahoo.com/columnist/article/futureinvest/10116
The spectacular decline in the asset values of Amaranth Advisors LLC, the once highly-successful hedge fund, illustrates an important lesson for investors: there is no easy path to higher returns.
Hedge funds are often sold as “alternative investments” that control their risks and are uncorrelated with other markets. But Amaranth shows, as the collapse of Long Term Capital management (LTCM) did nearly a decade ago, that “controlled” or “hedged” risks can easily go awry. Investors must be aware that the history of hedge fund performance is far too short to reveal the true risks hidden in their operations.
Is a 401K safe?
I do not know how heavily hedge funds invest in CMOs (collateralised mortgage obligations).
However, I do know that a lot of the repackaged securities get given a cedit rating and end up in very conservative portfolios - pensions funds, bond funds, "balanced funds" and the like.
anon#
Depends on what you mean by 'safe'. I imaine the houing crash will cause the economy to contract, and you have to understand that in a shrinking economy you cannot really pay interest, as paying interest depends on growth. All you can do is to create the illusion of paying interest by printing more money. So I imagine the 401K will get payed out, but that inflation will reduce its vlue to pennies on the dollar.
traineeinvestor#
The problem is that a lot of these mortgage backed securities have gotten a higher credit rating than they deserved.
as to "is a 401k safe"
yes if you've moved it into cash (lots of money market options for you)
no if you're in stocks
however, the vast majority of folks with their life's savings in 401ks are in stocks.
the way the game is rigged, most folks do not short stocks via their 401k. most do not keep their 401k $ in cash or money market funds
most bet that stocks will go up
so what happens when real estate crashes and stocks crash
people lose everything - their home that they thought was worth tons more than they paid for it is not. money that they thought was there for retirement in their 401k is not
what's left?
the government giving handouts
Keith and all HP'ers,
Regarding the shady betting of hedge funds:
I've posted this link before but here it is again..
www.thesanitycheck.com
There are other americans who see what is going on as well, and in my opinion... your blog, and this man's (Bob O'Brien, a pen name due to the very real possibility of being harmed for what he is up to) are allies in the same battle (positive change) coming from different launching points. There are about five regular contributors who do research, and request FOIA data, and present it at this site.
The perspective launch point over there is the stock market/Wall St. corruption and specifically a brand of security price manipulation called naked shorting, or failing to deliver.. a practice used by hedge funds.. also a VERY bad bet, and one that even the SEC is writing laws grandfathering their past fails in to prevent/protect these funds from going belly up by having to buy in all these fails...
Just Google Regulation SHO by the SEC for more info..
The hedge funds are very dangerous, and their regulation is almost non-existant. What little regulation they have is easily worked around in broad daylight through simple restructuring into multiple funds to stay below a dollar value threshold.
There IS a big picture here, and if you piece together these two blogs you will get a much more nuanced idea of how fragile this house of leveraged cards really is.
Thanks for all you do here each day.. your blog is a great read.
Good luck to us all.
Anonymous said...
Is a 401K safe?
(Reply) Uh, no, a 401(k) is about the most UNSAFE vehicle in which you can be trapped. And it does NOT matter if you switch the electronic digits from stocks to money-market funds in your little sheeple pen that the government and Wall Street has constructed for you.
Nope. Sorry.
What you are going to find as the economic collapse plays out is that the 401(k) will be "ripe pickin's" for the government and Wall Street to confiscate from you.
Think about it. Firstly, do you know WHO lobbied for the creation of the 401(k)/IRA/ (Actually ERISA) laws in the first place?
Hint: It wasn't the AFL-CIO.
Indeed, it was big business who didn't want to be on the hook to pay all the sheeps retirement benefits.
Once these accounts were set up--and grew exponentially in the 80's as the Boomers were reaching peak earnings years--Wall Street was waiting in the wings.
Have you looked closely at who your plan "adminstrator" is?
Or how much you are being clipped for fees (both disclosed or hidden?) each year?
But the the worst parts are yet to come. What do you think is gonna happen to the stock market as 77 million Boomers all try to cash out their stock-infested 401(k) over the next few decades?
Furthermore, you have been given NO guarantee that the government won't significantly raise your taxes when it comes time to withdraw.
Can YOU say "Baaaa", little sheep?
Turning to the hedge fund world, this is only the tippy-top of the corrupt, iceberg of fiat money-fractional reserve lending-central banking-securitization-derivatives.
We are reaching the end stages of this particular Ponzi scheme. Look for more and more convulsive shocks to the system and hundreds of "Amaranth's" going forward.
>> Furthermore, you have been given NO guarantee that the government won't significantly raise your taxes when it comes time to withdraw.
I've been wondering about that off and on for years. Who's to say that the tax rate doesn't go up to 90% sometime in the future when it's time for you to start withdrawing your retirment funds?
God, we're sooo f***ed...
Hedge Funds are very misunderstood. Casual investors think of them as "risky" partnerships that have great potential to generate profits but at the cost of increasing risk.
The truth is, Hedge Funds have been around for many, many decades. They are, by definition, "safer" investments, hence the name "Hedge" Funds.
Due to the partnership structure, they are allowed to implement "alternative" investment strategies to "hedge" their investments and reduce risk.
They do have different payment structures and unlike Mutual Funds, generate profit based on performance as opposed to total assets under management.
Just in the last decade however, Hedge Funds have gotten increasingly popular. Basically, the "average joe" is indirectly becoming more and more of a player (via pension and fund of hedge funds vehicles). And we all know what happens when the "average joe" gets into things....
So now, the Hedge Funds industry has exploded. In a bad way. While there are still many, many out there that are an excellent combination of risk and performance (usually the one that existed before this boom), a lot of new "n00b" funds run by younger inexperienced traders have sprung up. For example, the trader that took down Aramanth was in his early thirties.
So, as a result, Hedge Funds have changed, and so has its image.
Due Diligence is KEY when investing in Hedge Funds.
Also, regarding MBSs... while Hedge Funds DO hold a lot of them, Mutual Funds still hold the majority of that bond market.
Check the Center for International Securities and Derivatives Markets for the latest stats.
Regardless, it are the GSEs who are the guarantors of these packaged commodities who will be damaged- not the Hedge or Mutual Funds. They have gotten into the MBS essentially "risk-free" thanks to the GSEs and other risk management derivative instruments available out there.
Ultimately, the same group of people will get affected in the worst case scenario: the "average Joe". Basically, the GSEs will have to get bailed out by the Fed using Taxpayer's money, so in the end, it's the same thing. The middle class will continue to get pummeled.
Cheers, and keep blogging Keith-
MMAfia
I invested my first dollar in the US financial markets in Aug. '84, more than 26 yrs. ago. I weathered the '87 Crash with minimal losses, I rode the '90s bull, but didn't get caught in the tech bubble, I avoided The Crash", and I've made a fortune in rental properties, 6 of 8 I have sold since summer '04.
However, with what is happening in the financial markets since '00 to date, I confess I don't have a clue anymore. The list of indicators I've followed for a qtr. of a century suggest that GLOBAL recession is a virtual certainty by Q1 '07, and we might even have decelerated to near 0% q-q growth in Q2.
But, apart from predictable narrowing of leadership to a handful mega-cap stocks, the major indices are not rolling over. Why, I have not a bloody clue.
My screens I use to pick value stocks result in virtually NOTHING, which has been the case since summer '04 and fall '05 to date. The last time this occurred was from summer-fall '98 to winter-summer '02. Everything is overvalued, implying inferior risk-adjusted performance for 3-5 yrs.
Yet, I have a model I've used since the late '80s which implies that the 5- and 10-yr. Treasury yields could decline to 2-2.5% in the next 2-3 yrs., which implies that the Fed is going to cut the funds rate to 0%. Savings and MMF yields will fall to 0%. IOW, we risk a Japan-like decline in the yrs. ahead.
Speaking of Japan, I also expect that the Nikkei is setting up for another 2- to 3-yr. bear market, as is most other equity markets around the world.
Cash is king.
The reality of hedge funds is pretty different from what you intimate.
Yes, some make huge bets, but the people funding them, i.e. banks and pension funds, are NOT naive rubes.
They know the structure of rewards and the temptations very well, and they spank the hedge funds appropriately. Bankers pull lines of credit when they see stuff.
Pension funds, the new big investors, do not want to see Big Swinging Dick bets the way that Soros & Rogers once did. They are looking for good Sharpe ratios at 8% per year.
And remember, when Amaranth blew up, somebody was on the other side of those trades making some great coin. Probably hedge funds as well.
Hedge funds move money around---but for the most part are not macroeconomically significant in developed countries.
This is wholly different from the home mortgage situation---because there that was a true asset bubble with NEW MONEY being created via the banking system and puffed into liar loans and preposterous properties.
People are suspicious of hedge funds because they look tricky---no the real danger is the dirt simple cheating and greed that's sweeping the land.
People want to blame the "nerds", the "powerful", (and sometimes the "Jews") with hedge funds and don't want to blame their dad, their friends, and themselves for the mortgage bubble. And for voting for a land war in Asia. War is inflationary. Always has been, always will be.
But, apart from predictable narrowing of leadership to a handful mega-cap stocks, the major indices are not rolling over. Why, I have not a bloody clue.
Apparently the Chinese Central bank decided to stop buying as many US dollar bonds a few months ago.
Given that returns on other government bonds are pathetic (Yen? Euro?) and their governments are in no better fiscal shape than the US government, what else would they invest in? What might survive worldwide inflation?
What can be moved into quietly and without suspicion? Of course, large-cap global equities.
Maybe gold's next? But if the Chinese central bank bought lots of gold they would just about corner the market, and disrupt things, like making the US dollar tank as people saw gold shoot up. That would hurt their much larger bond portfolio.
This way they can try to keep the illusion of prosperity so that their factories keep on going and they aren't faced with a billion rioting citizens.
Great blog Keith and good topic. Like you, I believe we are in for a big ka-boom soon. However my investing efforts have been wrought with wrong guesses. I have been wondering what if the Fed/Gov has another rabbit to pull out of thier a$$es?
Just for speculation, why not give us YOUR take on the next possible bubble, in a seperate post?. If you absolutely HAD to guess where the next bubble might come from.
The Government/Treasury has enough $$ and power to cause some weird actions in the stock market. What about a PPT orchestrated stock market rally in 2007???? Everybody can get rich all over again??
Love to hear YOUR take followed by reader's posts.
Anus capital management indeed! Good ol' OPM.
Actually some hedge fund insiders estimate the total value of investments in hedge funds well over $2.5 trillion. No one really knows.
"the major indices are not rolling over. Why, I have not a bloody clue. "
I suspect a lot of rational investors sold real estate in 2004-06 and many put some of the proceeds into index funds and blue chips. Even more has flowed to blue chips as people spotted movement there after six years of dead money. However, I think these inflows are coming to a halt and most likely a quick reversal in November after the housing data (from Sept deals) and builders/banks dumping inventory to clear it from their books before year end trips the major indices into a correction. It might even start before November, depending on how intensive the rethuglicans' TERRORISM!!!! campaign season gets.
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