Thursday, August 23, 2007

Uh, Oh - They're Using The Word "Contained" Again

Back before the subprime mortgage mess exploded this summer, we kept hearing from Fed officials and Bushies at the Treasury Department and the usual array of shills on CNBC and at the Wall Street Journal that the problems from subprime were "well-contained" and would not hurt the overall economy.

And then the summer hit and we learned that:

* Two Bear Sterns hedge funds had lost all but 9% of their value

* A Goldman Sachs fund had also taken a big hit from subprime issues

* American Home Mortgage was bankrupt

* BNP Paribas (largest French bank) was halting withdrawals from three funds just one week after saying its exposure to subprime problems was limited

* IKB Deutsche Bundesbank was also taking a hit from subprime problems and had to be bailed out by the German government

* The United Kingdom declared their subprime mortgage problems could be worse than those in the United States

* Financial system tightened as a result of a credit crunch related to subprime problems

* Central banks in Europe, Japan, Australia, Canada and the U.S. injected over $ 300 billion of liquidity into the financial system to fix the crunch

* Countrywide, the biggest mortgage lender, borrowed $11.5 billion to continue operations

* Australian lender Rams Group took a 20% hit from subprime problems

* August 15th was Redemption Day - the day that investors had to tell hedge funds with 45 day advance notice redemption periods that they wanted their money back (we still don't know just how many redemptions requests were actually acceded to and how many were not)

* Markets hit 10% correction levels as credit crisis continued - full-scale panic seems ready to break out in the financial markets

* On August 17, the Fed lowered the discount window rate for banks and urged banks to take advantage

* Over the next few days, Deutsche Bank, Chase, Citigroup, Bank of America, and Wachovia borrow from the discount window not because they had to but because they wanted to show support for the Fed's actions (or so they said...) - global stocks soar as a result

* Senate Banking Chairman Chris Dodd meets with Fed Chair Ben Bernanke and Treasury Secretary Hank Paulson and declares that Bernanke assured him that the Fed was willing to use all tools at its disposal to fix problems - global stocks soar again as a result

* Bank of America invests $2 billion into Countrywide in a move that is seen as a BoA expansion into the subprime business - Countrywide and BoA stock soars

* Despite the equity market turnaround, financial sector continues to shed jobs at a torrid pace (24,000 layoff have been announced since Monday, 38,000 for the month of August so far)

Amazing, the trajectory of that - from well-contained to near full-scale panic to restored confidence that central banks could handle the problems. Now we're hearing again, just one week after the Dow and the S&P were down 10% in the middle of the trading day, that problems from subprime are contained:

Aug. 23 (Bloomberg) -- European stocks climbed for a fifth day after a capital injection into Countrywide Financial Corp. reassured investors the fallout from the global credit rout will be limited.

Barclays Plc, the third-biggest U.K. bank, and Societe Generale SA of France led an advance by banks. Northern Rock Plc, the worst-performing U.K. bank stock this year, also jumped.

``It's a significant vote of confidence,'' said Simon Carter, who helps oversee $3 billion at Aegon Asset Management in Edinburgh. ``The subprime problem now looks more contained.''

...

``This $2 billion deal is very significant and bolsters Countrywide's financial position and reduces the possibility of the subprime problem extending into the wider economy,'' said Bob Parker, vice chairman of Credit Suisse Asset Management in London, which oversees $502 billion.

So there you go - it's all good.

And yet, don't you get the feeling that when we finally find out how many redemption requests were rejected on August 15th by various hedge funds, learn that many more subprime and Alt-A homeowners are going belly up as their mortgages rates reset, learn just how many jobs are going to be lost in the financial sector as a result of all the market turbulence and mortgage problems, and learn just how small those Christmas bonuses are going to be for the Masters of the Universe, that near full-scale panic will return to Wall Street?

Comments:
reality, the sub-prime mortgage story plays well in the headlines.

But, as usual, it is a story that keeps the Chicken Littles bug-eyed and frantic.

Meanwhile, investors with nerve and an understanding of the housing market are looking at the coming of profitable developments.

It seems that most people are repeatedly stunned to re-learn the fact that predicting the future is a risky game.

Wow, a few hedge-fund investors took some big hits. That's life. The portfolio managers were wrong. Who could have imagined that sometimes the smartest and most experienced people stumble?

Yet once again, people who are untouched by the mistakes of others agonize over issues they do not understand.

The economy will not suffer any more than temporary choppiness as a result of some people who can no longer afford their mortgages.

Defaults and foreclosures occur every year. Generally, no one cares. Yet this year, when foreclosures are climbing, a belief that our credit system is at the edge of collapse has seized many minds.

It's the credulousness of people who believe disaster is inches away that causes the market swings we have seen recently.
 
We don't know who has been touched or untouched by this because the Waldos are hidden and won't be known for some time.
 
reality, you wrote:

"We don't know who has been touched or untouched by this because the Waldos are hidden and won't be known for some time."

Really? Why not? Investors watch their investments. When things go wrong, it becomes crucial for those who manage investments to provide accurate data to investors.

At this point -- after it is understood that problems arisen -- it is a much bigger error to claim things are rosy than it is to state that things are bad. If there are no bids for certain mortgages, it is better to mark-down their prices rather than pretend nothing has changed. It is always possible to mark-up the prices if market intelligence warrants it.

The nature of the fallout in the subprime market is becoming clearer. There is no catastrophe pending.
 
RBE, You can see the issues I am having campaigning in Australia. It seems most of the punters don't accept hard evidence, they want the pulp fiction.
I note how often you, myself and others in the blog circle are right in predictions. Not a biggie given the constant empirical evidence; not something I particularly relish either.
More often I would be happy to be proved wrong.
But the wishful thinking, the 'everything is good' when it isn't bloody good... We are not only led by fools, most of the followers are fools as well.
 
N_S, disclosure and transparency would go a long way toward solving the problem. But hedge funds have neither. I quote from McClatchy, August 7, 2007:

A huge share of the money that's flowing through U.S. financial markets is being invested by giant "hedge funds" that aren't subject to much regulation. No one really knows what they own. And there's a chance that some of what they own is worthless.

The big systemic risk is that "people don't know anything about (hedge fund) activities," said Steven Brown, a finance expert at New York University's Stern Business School. "When you have a complete lack of disclosure, everybody is locked in the same category, and the sins of the few are visited on the many."

Brown was quick to add that he doesn't expect cataclysmic problems to emerge, but his point is that in the absence of transparency, they might. That possibility magnifies the anxieties on Wall Street and contributes to the markets' volatility.

Some analysts think that the problem — along with its solution — is rooted in transparency, or the absence of it. Most investment funds must report details of their finances to the government, which shares much of the information with the public. That's a lesson learned after the 1929 stock-market crash. The logic is that investors will make better bets if they have a better idea of what they're buying, and can calculate the risks.

Hedge funds have been excused from this transparency principle, and now some analysts think that's a mistake.

"I think they are a big anomaly. Basically they are not overseen by anybody," said Charles Bowsher, who was the U.S. comptroller general, the nation's chief auditor, from 1981 until 1996.
 
reality, you wrote:

"N_S, disclosure and transparency would go a long way toward solving the problem. But hedge funds have neither."

It would mean nothing if you and I and the SEC knew what securities were held by hedge funds. The availability of the information changes nothing.

This is yet another issue that receives the worried attention of people who know nothing about the hedge fund business. The lack of knowledge about hedge-fund holdings makes great headlines, but the secrecy does not alter the responsibilities of the hedge fund managers.

First, some funds are quite conservative. Some are very risky.

Believe me, no hedge-fund manager who operates a LEVERAGED fund that invests in sub-prime mortgages believes he runs a conservative fund. That guy drinks Pepto-Bismal in quantity.

Hedge fund managers also live in fear of big lawsuits filed by investors. If funds collapse because fund managers commit huge errors, a firestorm of legal action commences.

However, if the value of a fund merely declines, that's another matter. A small matter. Many hedge funds have a history of volatile returns. Up 40%, down 10%, up 20%, down 15%. Investors know what they are in for.

Meanwhile, in the case of mortgages, every mortgage in the country is uniquely identified. The total amount of outstanding mortgages is a well known number.

There's no trick necessary to find the total amount of sub-prime mortgages outstanding. There's also no real problem determining the amount of mortgages held on the balance sheets or portfolios of the usual acquirers of mortgages.

When you know the amount of sub-prime mortgages held by those who report these figures, you subtract that number from the total amount of sub-prime mortgages outstanding, and you pretty much know the total held by investors who don't have to reveal their holdings.

If those investors take a big hit, so what? They knew what they were getting into. They will survive.

Moreover, unlike dot.com companies, the mortgages represent real assets that don't evaporate when the finances suffer.
 
I wouldn't worry about hedge fund managers or the companies they work for getting sued by investors - they know how to inoculate themselves from any problems. That's what the Cayman Islands are for.
 
reality, you wrote:

"I wouldn't worry about hedge fund managers or the companies they work for getting sued by investors - they know how to inoculate themselves from any problems. That's what the Cayman Islands are for."

Hedge funds cannot attract investors if they are established in a way that would allow the operators to steal the investors' money.

The Cayman Islands offer certain banking advantages, but no sane investor gives large sums to organizations that can disappear to small islands in the middle of the night. This issue falls under the heading of Fiduciary Responsibility.

One of the best-known names in hedge funds these days is SAC Capital. It is headed by Stephen A Cohen and its offices are in Stamford, CT. Many others are next door in Greenwich. These guys handle billions of dollars. They depend on the good will of their investors, which they would jeopardize by appearing to have one foot out of the country at all times.

Moreover, on the professional side, these guys need to preserve their reputations. If a hedge-fund manager loses a massive amount of money like a few have in the last year, it's unlikely he will find a new job managing another fund.

Losing a little money is not the kiss of death. But taking a huge hit is.
 
So they decided to liquidate their two funds in the management-friendly Cayman Islands instead of NY because they're looking out for their investors?

Uh, huh.
 
reality, you wrote:

"So they decided to liquidate their two funds in the management-friendly Cayman Islands instead of NY because they're looking out for their investors?"

To whom are you referring? Who is the "they" above?

The IRS gets very tough on many forms of tax-avoidance scenarios. Since you claim the "they" above liquidated hedge funds in the Cayman Islands, you can be sure the IRS knows about it. If the liquidation occurred there solely to reduce taxes, the IRS will get involved.

However, since I suppose you are referring to hedge funds that posted big losses, there's very little money to hide and no reason to hide it. Thus, the investors will benefit more from deducting the losses from other profitable investments.

When you lose money, there are no taxes to evade. And you cannot make money by losing money.

There is also another issue that arises in the world of illiquid securities. Sometimes you simply cannot sell your holdings. If you can't sell -- meaning there are NO buyers for your junk -- you have a problem.

You can "mark down" your holdings to some theoretically appropriate level. But you do not know what an asset is worth until you exchange it for cash. No cash, no reliable valuation -- in the illiquid world.

In any case, you seem to believe that any action conducted in the Cayman Islands is ipso facto shady. You need more than your suspicious attitude for this conclusion to hold.
 
From Bloomberg News, August 7, 2007:

Bear Stearns Cos.' decision to liquidate two bankrupt hedge funds in the Cayman Islands instead of New York may limit creditors' and investors' ability to get their money back.

While most of their assets are in New York, the funds filed for bankruptcy protection July 31 in a court in the Caymans, where they are incorporated. The bank also used a 2005 bankruptcy law to ask a U.S. judge in Manhattan to block all lawsuits against the funds and protect their U.S. assets during the Caymans proceedings.

The Bear Stearns cases may establish a precedent that would let other failed hedge funds liquidate in the Caymans, where judges have a track record of favoring management. The local monetary authority estimates that three out of four hedge funds globally are incorporated in the western Caribbean islands.

That is the "they".
 
reality, you posted a lot of funny stuff. Journalists always need to create urgency and the feeling of direness surrounding their subjects. Let's see:

"Bear Stearns Cos.' decision to liquidate two bankrupt hedge funds in the Cayman Islands instead of New York MAY limit creditors' and investors' ability to get their money back."

As the writer noted, the Cayman liquidation MAY limit creditors. Or it MIGHT NOT.

Then:

"While most of their assets are in New York, the funds filed for bankruptcy protection July 31 in a court in the Caymans, where they are incorporated."

The preceding is a funny part. Either, as you have stressed, the assets are worth virtually nothing, or you are wrong and there is value. If the funds are worth nothing, it's irrelevant where the bankruptcy claim is filed.

Neither Bear Stearns nor the hedge funds in question actually owned the underlying real estate, which is still standing and probably occupied. Thus, it's tough to know what the writer is writing about when he mentions "assets."

Then:
"The bank also USED a 2005 bankruptcy law to ASK a U.S. judge in Manhattan to block all lawsuits against the funds and protect their U.S. assets DURING the Caymans proceedings.

Bear Stearns ASKED for legal relief DURING the proceedings. The answer may be NO.

You can be certain that investors are screaming and filing lawsuits as fast as possible. But you think the laws mean that Bear wants to screw investors. Not true. Bear needs relief from fighting with individual suit filers while it works through the problems. Burying a legal opponent in a blizzard of paperwork is an old tactic and one that keeps people from dealing with the central issue.

Then:

"The Bear Stearns cases may establish a PRECEDENT that would let other failed hedge funds liquidate in the Caymans, where judges have a track record of favoring management."

Yeah. In other words, these guys are attempting something for the FIRST TIME.

However, things are very different this time. Why? Because we are dealing with losses, not profits. The Cayman judges may be corrupt and may have taken previous actions because the earlier decisions profited the Islands.

Now we are talking about big losses. There is no obvious upside to engaging in actions that might provoke an unpleasant financial response from the US government. The US can restrict the movement of money to and from these islands. Investors have other legal options. These battles can last years and careers can vanish as a result.

Then:

"The local monetary authority estimates that three out of four hedge funds globally are incorporated in the western Caribbean islands."

The popularity of the Caymans reflects their banking secrecy and their tax-avoidance possibilities. Like I said, there's no tax advantage to losing money, and if investors believe they've been screwed, and I think they do, the people deemed responsible for the mistakes will never escape their legal hassles.

The article is all speculation.
 
From Tuesday's Wall Street Journal:

Judge Extends Order Protecting
Bear Stearns Funds for 10 Days
By CHRISTOPHER WITKOWSKY
August 27, 2007 1:46 p.m.

NEW YORK -- A federal judge on Monday barred investors from seizing the assets of two Bear Stearns hedge funds for 10 days, but indicated he is considering lifting the funds' U.S. bankruptcy protections.

Judge Burton Lifland of the U.S. Bankruptcy Court in Manhattan said he hadn't reached a decision on the funds' request for U.S. Chapter 15 protection, which would allow the funds to seek bankruptcy-law protection in the U.S. while liquidating in the Cayman Islands. Judge Lifland said it appears the two funds, though registered in the Caymans, operated primarily out of New York.

"The head office is where a critical mass of functions are carried out and that can be in a jurisdiction other than where the registered offices are located," he said. "Clearly, the principal functions here are carried out elsewhere."

Judge Lifland, however, extended an order barring creditors and investors from taking action in the U.S. against the funds for another 10 days while he decides on the funds' request to recognize the Cayman Islands as having "main jurisdiction" over the insolvency proceedings.

Under Chapter 15, added to the Bankruptcy Code in 2005, a company or court-appointed administrator may seek a U.S. court's recognition of a foreign bankruptcy case as the main, or controlling, proceeding. If Judge Lifland refuses to recognize the Caymans proceedings, the Bear Stearns funds can't take advantage of protections available under Chapter 15, including the automatic stay that blocks lawsuits and the seizure of assets.

The Bear Stearns hedge funds have asked Judge Lifland to recognize the Cayman Islands as the main jurisdiction for the proceedings. The two funds bet heavily on subprime mortgage loans and as defaults increased, creditors began to clamor for their collateral, leaving the funds short on cash.

Provisional liquidators working to unwind the funds in the Caymans estimate that the High-Grade Structured Credit Strategies Master Fund could see recoveries of $25 million, and the smaller High-Grade Structured Credit Strategies Enhanced Leverage Master Fund could see recoveries of less than $50 million.

Bear Sterns stepped in and bought out investors' positions after big Wall Street firms started fleeing the larger fund earlier this year. The brokerage assumed $1.6 billion of the larger fund's assets and has pulled the plug on the more-leveraged fund.
 
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