Is That What We Call Them Now?

Some odds and ends from the newswires that caught my attention:

1. Did you know that nearly 50% of all commercial paper (CP) outstanding, the short term debt issued by corporations to fund day-to-day operations, are asset-backed? They are commonly issued by funding corporations to make loans, purchase mortgages, etc. Why does it matter? Because such money market instruments are heavily bought by money market funds (MMF's), those supposedly ultra-safe repositories of peoples' savings. Most Americans may not be aware of this, but several european "enhanced" MMF's (they go by names like "LIBOR Plus") have already experienced heavy losses due to asset-backed CP investments going sour. We're not talking 1-2% losses here, but double digit hits. One insurance company had to bail out its own fund.
2. KKR said yesterday that its funding costs have increased significantly and that this may "adversely impact the returns of (their) LBO transactions". Citigroup estimates that $330 billion of bonds and loans for announced deals remain unsold. This is more than chicken feed and it certainly takes much more than a "snap of his fingers" to get $20 billion now, as a private equity honcho bragged just a few months ago.
   
3. Goldman arranged an infusion of $3 billion into one of its quant hedge funds, after it was down 28% just this month alone. They hope that such a show of confidence will avert other investors from cashing out. My opinion? In for a penny, out of a pound. Oh, and on the use of "investor" as a term to describe those that partake of the hedge fund joys, I am reminded of what Alan Greenspan had to say of the dotcom "investors" back in 1999-2000: "Is that what we call them now?"
   

Injections of Futility or, Bail and Fail

The big central banks are injecting temporary liquidity into the system, at around $150 billion a pop, most of it as O/N loans to banks (i.e. here today, gone tomorrow). This amount is large when compared to normal CB money market operations, but it is less than a drop in the bucket when compared to the size of the credit market, currently in turmoil. For the US alone, total credit market debt outstanding is $46 trillion, an amount so unfathomable that it defies comprehension (it translates into $400,000 of debt for every single US household).

The global liquidity injections thus amount to 0.32% of this debt alone and given the size of the still developing credit crunch, they are but mere exercises in futility. Of course, they must be undertaken if only because that's what central banks are obliged to do under their role as lenders of last resort (Prof. Bernanke has written two books on the subject), but I do not for an instant believe they are going to make any real difference. In the end, they act mostly to underscore the extent of the problem and the Fed's predicament.

This is not a repeat of the 1998 LTCM situation, where a single large player made a wrong bet and was quickly bailed out to avoid more serious consequences to an otherwise sound financial system. Rather, today it is the whole system that is in deep trouble: it relies on too much debt piled on top of overinflated assets, further complicated by monstrous amounts of derivatives. The most apt analogy I can think of is a runaway nuclear reaction, with central banks in the role of small lead rods - too small to contain it once it gets going.

There is nothing within the sole purview of the Fed, or any other central bank, that it can do to transform and rectify the system; its relative size is too small in comparison to the modern financial behemoths. Goldman Sachs alone has balance sheet assets of $943 billion, an amount larger that the GDP of every country in the world except for the top 10. But, tellingly, their equity is a mere $38 billion, so their leverage is a troubling 25x and this is before the off-balance sheet items, like various swaps. Nevertheless, the days when a large private financial house could act as de facto central bank (e.g. Morgan in the 1890's) are gone forever, even if some fervid neo-conservatives would like to see the government drowned in a bathtub.

There is a glaring paradox here: those same free market enthusiasts that ardently proclaim the supreme efficiency of modern finance in allocating capital where it's best utilized, go begging to the government to save them when their capital evaporates due to their own folly. It is actually not a paradox at all, of course - since time immemorial such behavior has been known simply as childish, or wanting to have your pie and eat it, too. Actually, since central banks are owned and financed by governments (i.e. taxes), they want to have their pie and eat everyone else's, too. Laissez faire when it suits, sauve mon derriere when it doesn't. That's called virulent capitalism, not free market economics.

There is certainly a strong ethical dimension in the divisive question that has come up in recent days: should the CB's bail out the big financiers and their rich customers with public money, or should they let them learn a sharp lesson about risk vs. reward? There are firm proponents of both opinions, but there is also a third one: Even if they bail, they are still going to fail. The reason was made clear above, i.e. it is the whole asset-credit system that is in trouble, not just a few players within it.

We need a Plan B to deal with this situation and we need it ASAP, but...

(a) I am certain there is currently no Plan B. Ideologues with blinders are running the show right now and they can't even fathom that Plan A could be wrong. Witness the extremes to which Plan A could theoretically be taken, if all else fails (helicopter cash). This is not novel thinking, just much more of the old.

(b) Any Plan B would by necessity seriously damage the vested interests that reign within Plan A and would immediately be painted as dangerous, radical and unpatriotic.

(c) Individual human thought may leap, but society's habits change only gradually and then only after the proof hits them hard over the head. Witness global climate change, for example.

Attempting to close on a more humorous note, maybe the central banks could start by changing how they name their money market operations. For example, the ECB calls the injection of an unprecedented 95 billion euro "a fine tuning operation". The whole orchestra sounds like a dozen buzz saws ripping through rusted sheet metal and they worry about A sounding flat?

So, in this hot summer season, here's my own suggestion, inspired by a film by Lina Wertmuller:

Travolti da un insolito destino nell'azzurro mare d'Agosto

or, in English,

Swept away by an unusual destiny in the blue sea of August.

P.S. For the reader comment section: If you have seen the film, who do you think should play the market-equivalent parts of Gennarino the sailor and signiora Raffaella?

Perspective

With the so-called subprime credit crunch spilling over into Europe and then the rest of the world, I think we need to take one step back to gain some perspective.

First, let's dispense with two common misconceptions - or outright lies, if you prefer:

1. It is not a "US subprime credit crunch", but a credit crunch, period. The trouble surfaced first at low-quality mortgage loans because that was the weakest in a long series of weak links. The problem, taken as a whole, is too much debt assumed by too many borrowers who cannot hope to service it without relying on constantly higher asset prices. In other words, it is a classic asset-credit bubble, only this time it is not contained within one country but it spans nearly the entire globe.
2. Liquidity is not a stash of cash sitting in an account, looking for assets to buy. Liquidity is (a) access to reasonably cheap credit and (b) the ability to sell assets at reasonable prices, quickly and in size.

The corollary from (1) above is that the current credit crunch is not a "spreading out" from sub-prime to other sectors, but the initial phase of what is likely to be a long, drawn-out process of declining debt and asset prices. It could happen in one fell swoop (aka Crash), but that's what central banks are for, as we saw yesterday. They cannot stop the process, but they can act as lenders of last resort to slow it down. However, even if there is a "sudden event", I expect it will be followed by many more years of aversion to debt and risk. There is simply too much reliance on debt and asset appreciation in the global economy for it to go away in one step, however severe.

The proof to (2) above has been brewing for weeks, but finally made headlines yesterday as the ECB, Fed and BOJ had to intervene to provide... liquidity (if there was so much to begin with, where did it all go?). Liquidity is directly connected to credit because if everyone demanded cash in exchange for all goods and services the economy would immediately collapse into Medieval mode. Credit is a function of trust, i.e. the expectation of repayment, and thus liquidity is a function of trust - or confidence, if you like.

Bubbles of all sorts are phenomena of excessive confidence vs. the cash generating capacity of the underlying assets that are being inflated and they pop when excess confidence evaporates. We are now in the first stages of a credit - liquidity - confidence crunch, brought upon by the final realization that asset prices have moved so high that they cannot satisfy their debt loads out of cash flow.

And thus, Fed's Fearsome Phantasm (I couldn't resist) is raising its ugly head: persistent deflation that cannot be cured by lower interest rates. A liquidity trap, as is known to central bankers. Most scoff at the idea that we could actually experience falling prices in the US, but they are clearly mistaken and the evidence is all around us, though usually misinterpreted by the casual observer. Just a couple of examples because I have to catch a boat (ah, summertime...):

(a) House prices are now dropping in absolute terms, the first time since the Great Depression. A quarter of US GDP is related to housing activity.

(b) Because of China's huge manufacturing overcapacity, most consumer goods are cheaper today than years ago. If final demand fails to keep up with production (already happening, look at retail sales) we will see even lower prices and business failures.

(c) Negative saving rates and no access to credit means purchases must be curtailed and/or assets sold. That's deflationary.

(d) ..and finally, if anyone still believes that modern-era fiat currencies can be inflated to kingdom come to avoid the trap, think of Japan.

Have an interesting weekend...though the Chinese would consider this a curse.

"The Complete Evaporation of Liquidity"

As I usually do, I wrote this today for posting tomorrow. Events are running ahead fast, however, and I think it is more timely to post it today.


On March 15 I posted what has turned out to be a prophetic entry titled "Well, What Do You Want It To Be?" , which followed the various stages in securitizing and derivativizing a simple home mortgage up to the fourth degree (CDO, CDS, hybrids, funded vs. unfunded, etc). By that stage the resulting structured instrument is completely unrecognizable vs. the original mortgage and is impossible to price without a long list of assumptions about future default rates, the shape of the yield curve, volatilities, etc. The various institutional owners, mutual funds among them, relied on daily, weekly or monthly indicative valuations from their broker-dealers who were more than happy to oblige by concocting essentially fictitious quotes, since no one was selling, anyway. But the real price is always revealed when you finally have to sell and then the firm quote you may get could be... -95, i.e. no bid - 95 offered. A completely worthless quote that cannot be used to price anything, let alone sell.

BNP-Paribas, the largest bank in France and one of the largest in the world, took the highly unusual and severe step of stopping the calculation of NAV's and suspending redemptions for three of its mutual funds that held such mortgage-related instruments because, and I quote: ``The complete evaporation of liquidity in certain market segments of the U.S. securitization market has made it impossible to value certain assets fairly regardless of their quality or credit rating''.

Let's translate, though it is quite straightforward for an official release:

a)The complete evaporation of liquidity = No one wants to buy, there are no bids.

b) Impossible to value = Brokers/dealers aren't even giving us official indications - too scared of their implied legal obligations.

c) Regardless of their quality or credit rating = Those AA or AAA ratings are on paper only. God knows what they really are.

There are also several highly disturbing facts:

1. These are plain vanilla mutual funds from a highly reputable bank, not some high-roller leveraged hedge fund. Supposedly ho-hum, safe and with daily pricing and redemption privileges. They are designed for the conservative middle-class investing public who are putting money away pour les enfants, or towards a house down-payment.
   
2. The amounts involved are quite large: as of July 27 the three portfolios together amounted to $2.8 billion.
3. The structured bonds in question are rated AA or better.

The myth of "containment" is now completely and utterly destroyed. If vanilla mutual funds are in such trouble, can you imagine what is happening to the balance sheets of hedge funds? For example, those that bought mezzanine CDO's on margin which now have NO BID? Or, how about those that wrote naked CDS's on those same CDO's?

Here's a question to ask the SEC, NASD and, of course, the OCC (Comptroller of the Currency: Ensuring a Safe and Sound National Banking System For All Americans): Do you have any idea whatsoever what the real exposure is to the hedge funds of the institutions you are charged with overseeing? Especially those large deposit-taking institutions (aka banks) that also act as prime brokers (soup to nuts package deal to hedge funds, from transaction services all the way to margin lending). Because if liquidity has evaporated, what's the collateral ultimately backing those savings and checking accounts worth?

..................................

...and as I finished writing this the ECB had to intervene in the interbank euro money market to provide 90 billion euro at 4% (normal amts. are around 5 billion) because banks started to deny lending to one another, pushing O/N rates to 4.7% - if they could get any, that is. This being an area I know very well, I cannot emphasize enough how concerning this is. The ECB became the lender of last resort, a role that central banks hope to never have to play because it means the financial system has seized up. Likewise, dollar O/N LIBOR rates shot up to 6% from 5.37% yesterday and this is for the biggest, strongest banks like BofA and Barclays. The Fed just did a 14 day repo to add liquidity at 5.25% - no news on the amt. yet. (just in $15 billion).

If the banks are nervous about lending money O/N (just one day) to one another, what do you think they are doing with their hedge fund customers? Calling in margin loans (yen included)? Bigger haircuts on the collateral? Higher interest rates? Pressuring them to reduce debit balances by selling positions? All of the above?

Plan A: The Con. What's For Plan B?

The word "con" comes from confidence, as in a con man first gains your confidence and then proceeds to rob you blind. That first step is crucial, because peoples' natural suspicion prevents them from doing truly stupid things until someone gains their trust. The Fed under Bernanke is no different. Their inaction on interest rates Tuesday is a simple confidence trick, a head game: "See", they said, "the economy is just fine. No need to worry about credit risk at all - in fact we are worried about inflation. Trust us". Now, the Fed is not intent on robbing anyone directly, so I have to believe their intentions are good, even if their choices are limited by current circumstances. Ever since the Great Depression the Federal Reserve's biggest nightmare has been a deflationary spiral - hence the cash helicopter that Mr. Bernanke is so famous for.

Given what is happening out there in the economy and financial markets, a bit of confidence trickery is all they could do. Imagine if they had come out and said this, instead: "We are very worried about the zooming cost of credit risk and what it is doing to the economy, so we are lowering interest rates starting immediately". The damage this would have done to the market's morale would have been much greater than any benefit from a 25 or 50 bp cut in rates. So, the party line is now firmly set from Wall Street, to the Treasury Dept., the Fed and on up to the White House: "The US and global economy are sound, all that's happening is some very risky debt and related assets are being re-priced. The situation is well contained and poses no threat whatsoever to the rest of us. Now, go shopping."

I honestly hope they don't believe their own b.s. and that they have a Plan B all worked out and waiting, just in case the con game approach doesn't pan out. Because in the Great Depression the Hoover administration (1929-1933) kept thinking it would all be sorted out quickly - just as soon as the bad debts and their associated assets could be dealt with. Andrew Mellon, the Treasury Secretary at the time, wanted to "liquidate everything" and believed that a panic was not altogether a bad thing, because "it would purge the rottenness out of the system". Easy for him to proclaim "leissez faire": being one of the richest people in the world, he didn't have to sell apples, eat in soup kitchens or sleep in flop houses, like the millions of unemployed who were let go in the liquidation process.

Therefore, I hope that Plan B isn't of the dogmatic "do nothing and the free economy will sort things out" type, because 98% of the US population has not participated meaningfully in the prior asset price rally and is just going to get anihilated, crushed between high debt and job losses. Keep in mind that the kind of economy we are running these days can shed jobs at the blink of an eye. All it takes is to throw the desks in a van, turn off the lights and tell the landlord to find another tenant. No factories, no heavy machinery, no unions, no long-term capital to recoup and no stake in the community, either.

I think we need way out-of-the-box thinking for Plan B, because the same old, same old (and this includes Keynes) is just not going to cut it in a planet of nearly 7 billion souls running out of cheap food, fuel and usable water, but full of WMD's mostly owned and operated by the 5% of the population that consumes 25% of those resources and on the hook for 80% of all debt outstanding in the entire world (and that's before counting the immense unfunded liabilities to Medicare and Social Security).

P.S. Isn't it curious how in the past few days markets rally in the last half hour before the close? Pure coincidence, of course... must be all those traders coming back to the office after a long, lazy summer lunch at Fraunce's and suddenly realizing they had forgotten to buy all day long. So they panic and rush to place huge buy orders in the time remaining - "at market", of course. Or even higher, if at all possible, please :) Just look at yesterday's hilarious intraday chart for GS. From 190 to 197 in 3 minutes. Those must have been really good oysters...

Sticker Shock At The Risk Emporium

As Mr. Treasury Secretary Hank Paulson so elegantly understated it, risk is being "re-priced".

The blinds are down, the "Grand Sale" sign is gone and shopkeepers are hastily re-arranging their window displays. Suppliers are calling daily, even hourly, with higher quotes and they can hardly keep up with changing all the price tags. Customers, used to rock bottom prices, walk away shaking their heads in disgust vowing to look for cheaper merchandise elsewhere, only to discover that the same thing is happening everywhere. What's more, several previously abundant products have been pulled from the shelves completely and dozens of smaller stores have closed for good, having gone from riches to rags literally within days.

The big stores are still in business, but their owners are not feeling too chipper, either. They know that when prices go up so fast and so much, customers simply can't adjust. Sticker shock is bad news for business and it does not matter if your are selling pizzas or mezzanine loans.

Back to the financial community.. As risk gets re-priced banks and brokers (particularly) have to mark their own portfolios to market and that hurts, though there are dozens of tricks to mask and ease the pain. But their real risk exposure is elsewhere: it resides in their major customers' balance sheets, those hedge and private equity funds that borrowed so heavily to speculate in overvalued, risky assets from stocks and CDO's to real estate in Romania. (Are you familiar with the term "prime broker"? If not, you should be.) The risk connection is direct, even if a few domino drops away.

The game could be sustained for as long as no one wanted their money back. But everyone now knows that risk is being re-priced at the Risk Emporium - and who wants to get stuck inside? Get the money out first, ask questions later, because there is an infinite amount of time but a finite amount of money, despite all the nonsense about liquidity. This is where and when things get nasty: withdrawal requests combined with margin calls can bring down leveraged funds within days, even hours. Funds can stop redemptions, but all this means is that customers will most definitely get wiped out, because margin calls have priority.

If this sounds alarmist, it is. Because in talking yesterday with a long-time friend in the business he said: "Those guys at Goldman and Morgan, they are smart, they'll figure it out - it will be OK". How does it go? Denial, hope, anger, capitulation, apathy... I am alarmed because we are now clearly past the "denial" stage and in full "hope" mode. Even Mr. Paulson acknowledges the problem, but "we have a strong economy", etc. We can see this in the way markets are acting: the "hopefuls" are looking for bottoms, just 5% off the top.

In speaking with a broker whose observations I highly respect, she had this to say: "This time around it won't be the little guy who gets stuck. It will be the supposedly "smart" money, the hedge funds and the big-time individual speculators... unless of course the little guy is somehow convinced to jump back in, right now". Now, that would be a shame, wouldn't it?

Don't Worry, Be Happy

Adding insult to injury, the two Bear Stearns hedge funds that went belly up recently have filed for bankruptcy in the court of...the Cayman Islands. The fact that most assets were held and managed in NYC is of little consequence to the legal state of incorporation, which was in fact the Caymans. And here's another fact: 3 out of 4 hedge funds in the whole world are incorporated there, a miniature country of three islands 100 square miles in total, with a population of 45.000 souls - there must be something in the air, eh? Their main industry is financial services, but by that they mean being the de jure corporate seat - the de facto part takes place in more properly exciting locations, like Manhattan and The City.

There comes a time, however, when the law of the land must be invoked, e.g. liquidation under bankruptcy. Creditors will have their day in court and so will management, of course. The judge, who is not going anywhere anytime soon (except perhaps to the aptly named Pirate's Den Pub down the road) will most definitely keep in mind that there are plenty of other such statelets with sun, rum and lax incorporation laws ready to pounce on the juicy fee business generated for hundreds of his legal brethren active in the incorporation and registry business in George Town. That being the case, what are the chances that the local courts will rule against management?

To make sure that the sunny courts of Cayman will be totally unhurried and unmolested in reaching their just decisions in due time, Bear Stearns has also filed in Manhattan courts a motion for protection against all lawsuits there, while the process goes on down south. Let's see if that judge grants them their wish...

Meanwhile, the stock market bounced yesterday on (unsubstantiated) hearsay that the government will somehow intervene to limit the hemorrhage in the credit market. Earth to Mars: there isn't enough money in the till to bail out every one, or even some, of the troubled "institutions". Oh, the Fed will soon enough decide that interest rates need to come down substantially to "better reflect the current business environment", but this time they will be pushing on a string. As I have said before, it is not the price for using the money that matters now (interest rates), but the fear of principal loss - and for that there is no price. When the situation reaches a certain qualitative point, the higher the interest someone is willing to pay to borrow money, the less the chances of his getting it. Lenders see that as a desperate sign of panic and stay away. Greed is suddenly replaced with "better safe than sorry". Then the specialized vultures will eventually swoop in, pay ten cents on the dollar and fly away to await the next cycle. At that price they can afford to wait a long time, sipping a rum punch by the pool of the Ritz-Carlton - in Grand Cayman, of course...

P.S. Today, we learn of another victim of margin calls: Luminent Mortgage (NYSE: LUM ...where do they come up with those names?). Things are becoming more and more sudden... I mean REALLY sudden: the stock was near $11 a month ago, with an all time high of $15ish. Five days ago it was at $8 and today it is trading at 75 cents. You want fast? This is what the word vertigo was invented for. And remember, for each unmet margin call there is a major lender who is taking the hit.

Crocodiles Wept

As the title of this blog implies, things are now moving quickly in the debt world - but in the opposite direction than was previously the case. "Liquidity" - that incredibly misapplied term used to confuse the uninformed about what is simply debt - is drying up faster than a crocodile's tear.

Witness the incredible plunge in the fortunes of American Home Mortgage, which went from near an all-time high of $35 per share in February to bankrupt and worthless today. The company specialized in Alt-A mortgages, the next step up from sub-prime and listed some of the world's largest banks as its main unsecured creditors (Deutsche, JP Morgan, Bank of America, et al), who are on the hook for unspecified amounts, out of a total of $19 billion in debt. Given the nature of the mortgage business and banking in general, there are going to be some serious impairment charges coming up soon for lots of such creditors.

The loss of some 7.000 jobs at AHM in one fell swoop is also characteristic of how suddenly things are happening in our "modern" finance era. When the stool of "high liquidity" is kicked from underneath, there is nothing to hold up the corporate structure but thin air - and gravity is a harsh mistress to the overextended. Finance job security is notoriously cyclical, despite what seemed to be the case in the last few years. "Easy come, easy go - so save for the rainy day because it always rains in the end", is how an aged friend in the business used to put it and he knew darn well what he was talking about: he had started out as lowly office boy in a brokerage office. In August 1929.

The buzz saw is being applied to other, more august companies' shares: Bear Stearns has plunged from $170 to $100, Goldman Sachs from $230 to $175, JP Morgan from $53 to $43, Merrill Lynch from $95 to $70. Yes, they are rebounding today... but is it because their prospects are suddenly much brighter, or is it because the dead crocs are bouncing?

To answer that, answer this simple question: Say you are Archie, the chairman of the investment committee of the Upper Navonia State Teacher's Pension Fund, assets under management $3 billion, of which you had previously agreed to place $300 million in "alternative" investments like hedge funds and such. Your salesman from Upper Bracket and Co. calls you and recommends you add to your positions: "Such a GREAT opportunity, Archie!!" he says, with just a trace of anxiety in his well-trained pitch. "Well, yes Bob... that may be the case, but can you please first explain WHY we're down 12% on the original $300 mio? Just a contained situation, you say? Aha, well let's wait until the situation stops bleeding cash all over the place and THEN I'll put some more in, huh? I have pensioners and employees to answer to and they read the papers, too, Bob....Yeah let's do lunch next week...I'll call you."

Residential Construction Jobs: A Closer Look

The July jobs report is coming up Friday (we got a early look from ADP yesterday), so I thought I would do a piece on employment, particularly construction jobs.

Residential construction activity has come down sharply and yet the Bureau of Labor Statistics still reports next to zero job cuts in the sector. For a clearer picture of what is happening, I have indexed the number of jobs, the number of units currently under construction and the number of housing starts - see chart below (1985= 100, click to enlarge). Construction activity has fallen sharply, yet no significant job cuts are observed.

Data: BLS, Census Dept.

I have also produced a chart of two ratios: jobs to units under construction and jobs to housing starts. Reported jobs per unit being constructed are somewhat high, but it is the jobs per unit started that look abnormally high, i.e. by historical standards the BLS is reporting way too many such jobs still in existence for each house being started. If the jobs/starts ratio was the same as during the previous construction cycle low in 1991, it would translate into 806.000 jobs today vs. the June BLS report of 1.003.000 (seasonally adjusted). By this metric, the BLS is over-reporting residential construction jobs by nearly 200.000.


There have been several explanations offered for this discrepancy, most commonly that illegal immigrants are off the books and therefore their layoffs are not counted. While the home construction industry is a significant user of such workers, it does not explain the sudden jump in the ratios, i.e. if their numbers were increasing disproportionately vs. legal workers in recent years, this fact would have shown up in the ratios before 2005, as fewer workers per unit started.

I have another explanation: Builders have been holding on to their workers even when starts fell off rapidly, hoping for a turn-around in their business. They could afford to do so because the previous cycle was long and extremely profitable and they still had lots of unfinished work in progress. We see this from the jobs per unit under construction ratio which is still within "normal" parameters.

Nevertheless, given the deepening troubles in real estate, home builders must be getting very worried. If the current summer home sales season ends without any significant upturn, the charts above suggest we may see a much larger seasonal layoff come October-November - or sooner if builders decide to jump the gun. Those 200.000 "extra" jobs may disappear within 2-3 of months, putting a lot of additional pressure on consumer spending.

I believe we will be seeing this starting with Friday's jobs report.

Roach Motel Hedge Funds

As the credit crunch continues, more and more hedge funds are getting squeezed between lower asset values and margin calls. The news is everywhere and in my opinion will get much, much worse. The credit crunch is morphing into a confidence crunch, whereby previous "savvy investors" suddenly realize that they were in fact "delirious speculators" and rush to save whatever money they can by pulling it out.

This is somewhat of a throwback to bank runs and thus the suspension of redemptions is very ominous. In plain words, you can't get your money out. "What? Outrageous!", you say. "Read the fine print", they say. After obtaining a 10x magnifying glass and poring over the 300+ pages of print in the offering document that you so quickly signed when visions of sugar-plums were dancing in your head, you discover that, lo and behold, fund managers can indeed do that. It is supposedly for your protection, so as to avoid selling assets at distressed prices.

I am of the opinion that most of the hedge funds that have sprung up in the last 3-4 years are becoming financial "Roach Motels" (R). Money has checked in - but it won't be checking out and as more "investors" get news of suspensions the rush to get their money out will only intensify.

The situation will also impact private equity funds, but the process will likely take longer (at least the portion that will become public). The game there involves much bigger boys and girls (think "Carlyle") with similar-sized greed and tanker-fulls of hubris - notice the word "tanker", it is significant. It also happens that such "participations" come with very complicated strings attached, a web that reaches to the very heart of global government and corporate elites. They make stupid mistakes like everyone else (human folly is as old and common as stones), but they have far greater means to cover them up, at least until they have left center stage. Nevertheless, for some it won't be so easy.

I am referring to Sovereign Funds, that immense financial folly so fashionable with au-courant government officials and their well-fed bankers, who know better than their peon "subjects" what they should be doing with their money. More services? Oh no, no. Better health and education? Are you daft? Investment in alternative energy R&D? Please... A majority of such Sovereign Funds prefer...hedge funds and private equity funds. I repeat, this is investing money from the public purse. Is that apropos? Hell, no. (Is it lucrative? Hell, yes.)

A private investor can always choose if he will or won't check into the Roach Motel Fund - but in the case of Sovereign Funds the public at large is never consulted. If a private investor has only himself to blame for his credulity, in extremis masses have more direct and effective ways of exacting recompense for losses sustained by decisions made by corrupt or inept officials. If this plays out as I think it ultimately will, I won't be surprised to see major political upheavals in some capital cities, with some denizens checking into real roach motels, complete with barred windows and barbed-wire fences - or worse. After all, if a mild case of construction-related kickbacks merits the death sentence, what punishment is appropriate for the loss of $10 billion when vox populi is shaking the President's?Chairman's/Sheikh's windows?

If this sounds almost barbaric to western ears, it is the way the cookie crumbles in most of the rest of the world. Why does this matter to us, right here, right now? It does, because those that have previously signed-off on such sovereign investments are well versed in the principles of survival under Mosaic Law, as applied to official government scapegoats. In other words, if ANYONE expects Chinese or Oil money to save them with fresh infusions of cash, they are simply deluding themselves.