Hedge Fund Schadenfreude...
Louise Armitstead of the Torygraph:
Hedge fund legends hit by financial crisis: Soon the Griffins boasted a dining-room chandelier by glass artist Deborah Thomas, two installations by potter-sculptor Edmund de Waal (including a complete room of more than 600 porcelain vessels), and an architectural version of a Morandi painting.... Tisbury, a $2.7bn (£1.35bn) event-driven fund... Griffin... archetypal hedge fund manager: aggressive, arrogant and nearly always right.... The latest bite of the credit crunch has caught Griffin offguard... down 8 per cent in the first two months of the year.... Hamstrung by the lack of liquidity... new terms with his prime brokers, beg for patience from investors and offered his business for sale to bigger rivals, including GLG Partners....
Peloton Partners, the award-winning fund run by ex-Goldman Sachs star Ron Beller, imploded. Focus Capital, another EuroHedge fund of the year, wound up days later... Carlyle Capital Corporation.... John Meriwether, the man behind the collapse a decade ago of Long Term Capital Market... JWM Partners is struggling with losses of 28 per cent this month.... "This is just beginning. Somewhere been 40 and 100 hedge funds will liquidate shortly. It's a bloodbath and it will get worse."
Already investors are showing their fury. One said: "I thought volatility was what hedge funds lived for? Making money, or at least preserving cash, during volatile times is certainly what we pay them for. They have been poncing around during the good times and are now found wanting at the first sign of trouble. It's a debacle out there.".... Hedge funds have been blamed for all market woes from the implosion of Bear Stearns three weeks ago, the collapse of HBOS's share price days later and now the weaknesses of the entire Icelandic economy....
Just a few months ago these were the best brains in finance. Now they are being exposed as average fund managers at best, and potential market manipulators at worse. How many more pretenders are there out there and how much more chaos will their demise bring to the rest of the markets?... Scrambling to cope with the next stage of the credit crunch, bank bosses ordered their prime brokerage and repo departments to comb through their books again and slash risk exposure. Lending lines have been cut, just as the funds needed them most to cope with the volatility.... While hedge funds have traditionally used two or three times leverage in their funds, this figure has been multiplied to eight or nine times in many cases - and even more in some. One prime broker said: "Hedge funds have had it easy. Every man in a pink Cadillac has been able to raise money, start a fund and do really well. Frankly, those who have taken the biggest risks have come off best because markets have been so extraordinarily kind."...
The leverage that magnified gains in the rising markets has had the same impact on the way down. Weaker funds were the first victims.... Beller... often boasted that Peloton was sailing close to the wind. "I once asked Beller how he would cope if the market suddenly turned and he was forced to mark to market. He said he'd be in trouble but that would never happen." Focus Capital... EuroHedge industry award... returning more than 100 per cent in 2006. O'Brien and Bubb told investors that they had been the victims of the credit crunch and short selling.... Endeavour Capital, run by former Salomon Smith Barney fixed-income traders... 27 per cent of the value of the $3bn fund had been wiped out... 18 times leveraged.... Platinum Grove, the $5.5bn New York-based hedge fund set up by former Long Term Capital Management co-founder Myron Scholes, fell 7 per cent... London Diversified had lost between 4 per cent and 5 per cent... founders, led by David Gorton, famously took £55m in management fees... in 2004...
What's really going on? What's going on is that perhaps $6T of mortgages with a duration of a decade that had been priced at a 1% per year chance of default (with a 1/3 value haircut in the event of default) are now being priced at a 4% per year chance of default. That's a loss of $600B in market value--and if your share of that $600B is greater than your capital, or is thought to be greater than your capital and so impedes your operations, you are gone.
But truth be told it is a zero-sum game--not a real destruction of wealth. The real rates at which cash flows of constant risk are being discounted haven't changed much: there hasn't been a big redistribution of wealth between the present and the future. What has happened was that a bunch of people believed that the default risk was 1% when it was actually 2% and reported gains of $200B (of which they took 2-and-20 on the hedge fund slice, perhaps $20B, for themselves), and that now a bunch of people believe that the default risk is 4% when it is actually still 2% (unless, of course, the assembled central banks of the world fail and unemployment heads rapidly upward). So in aggregate hedge fund partners have gained $20B, hedge fund investors have paid$20B to their money managers for the privilege of losing another $200B that they never had, and there are $400B of transitory paper losses that will turn into real losses for those overleveraged and caught by the credit crunch and so forced into fire sales, and into real gains for those with steel nerves and liquidity.
Unless, of course, Ben Bernanke and company fail to contain the crisis, and we wind up in a severe depression. But then we would have much, much bigger things to worry about than $600B of missing paper mortgage value. 4 years x 3 percent excess unemployment x Okun's Law coefficient of 2 x $13T economy means a $3.1T cumulative Okun gap in lost real wages, salaries, and profits. That's the thing to worry about.
