Despite the bounce in the stock market today, Rome, that would be Wall St, continued to burn. Credit spreads continued to be blown out and lending continued to be non existent. A man without water can survive for several days. How long U.S. economic activity can last without credit is yet to be seen. To think yesterday was a bottom I would argue is relying on the same hope of every other bottom. Just that, hope instead of facts. No fire extinguisher has emerged to extinguish the ongoing inferno and valuations yet seem attractive on a broad basis.
What is really concerning to me is the constant bombardment on market mechanisms taking away precious information from investors. First it was short trading. Banning shorts which provides information in itself. Friends have asked me what I think about the put call ratio and the VIX. My response, I don't know. Without shorts everything is blown out of having significance. The normal sign posts of bottoms and tops are at best flickering lights. Is the VIX astronomically high or are investors paying up for the only type of insurance they can buy, put premium? Then it was the government setting the clearing price in the bailout which may or may not be accurate. Now it is the attack on fair market accounting. Most of you will probably disagree with me but I really think fair market accounting is a good thing and does not carry much blame for the current situation. Blaming the shorts obviously didn't work, the market still went down so now we have to blame something else besides the obvious and so we might as well blame the accounting. The banks have been playing games with the accounting anyway with many balance sheets looking much better than they actually are. Now you are going to make it much more difficult than it already is to try and figure out what is on the balance sheet of a bank? Now that adds confidence. I think in 50 years people will be writing about what is going on and the destruction of information and be like what were those idiots thinking. The problems are obvious but people keep wanting to point to something else. It is absurd.
I think we will continue to bounce around. With the destruction of information and the destruction of market participants, volume is going to continue to dry up which will push down the equilibrium fair intrinsic value of stocks as people demand a greater premium for less liquidity and the inability to hedge easily. In my opinion the bailout plan is a bad plan anyway though something needs to be done. It will be something the hope buyers will be able to latch onto for a small period of time. The patient is dying, the city is burning, and how long the economy can put up with the stresses we are seeing in the stock market is yet to be seen. Many people forget the lag on tighter credit. Bulls constantly throw in your face the time lag in rate cuts reaching the economy. Well shouldn't there be the same time lag in liquidity drying up? The clock is ticking as more of Rome continues to burn.
Tuesday, September 30, 2008
David Abrams Profile
I enjoy reading about other money managers. This one covers David Abrams of Abram's Capital. I had read about him before and found him fairly interesting. Thanks goes to Nathan.
http://media.www.whartonjournal.com/media/storage/paper201/news/2006/01/23/Insider/Abrams.Capital.On.Investment.Strategy-1492595.shtml
David Abrams recently visited campus as part of the Wharton Investment Management Club's Speaker Series. Abrams runs Abrams Capital, an investment partnership he founded in 1999 that now has $2.5 billion of assets under management. Prior to founding Abrams Capital, Abrams spent ten years at the Baupost Group, à la Seth Klarman. Since inception, Abrams Capital has achieved compounded returns to limited partners in excess of 20%.
David Abrams will tell you that studying Shakespeare and being able to distinguish cheap art from the expensive can help you to be a better investor. He will speak to you of insights and intellectualism. And he is - no wonder - a man who tries to "leave a fair amount of time everyday to read and think." Abrams is clearly and refreshingly different. He attended Penn as an undergrad, but while many of his peers were studying discounted cash flows and the efficient market hypothesis at Wharton, Abrams was working towards a degree from the College of Arts and Sciences at Penn, where literature and a deep understanding human behavior were more de rigueur.
http://media.www.whartonjournal.com/media/storage/paper201/news/2006/01/23/Insider/Abrams.Capital.On.Investment.Strategy-1492595.shtml
David Abrams recently visited campus as part of the Wharton Investment Management Club's Speaker Series. Abrams runs Abrams Capital, an investment partnership he founded in 1999 that now has $2.5 billion of assets under management. Prior to founding Abrams Capital, Abrams spent ten years at the Baupost Group, à la Seth Klarman. Since inception, Abrams Capital has achieved compounded returns to limited partners in excess of 20%.
David Abrams will tell you that studying Shakespeare and being able to distinguish cheap art from the expensive can help you to be a better investor. He will speak to you of insights and intellectualism. And he is - no wonder - a man who tries to "leave a fair amount of time everyday to read and think." Abrams is clearly and refreshingly different. He attended Penn as an undergrad, but while many of his peers were studying discounted cash flows and the efficient market hypothesis at Wharton, Abrams was working towards a degree from the College of Arts and Sciences at Penn, where literature and a deep understanding human behavior were more de rigueur.
Sunday, September 28, 2008
Deadlier than an RNA Genome and a Protein Capsid
An RNA genome and a protein capsid of course is what makes up the poliovirus. This aptly describes what is happening within the world financial system as the infection continues to spread now manifesting itself over in Europe with Belgian Fortis, Germany's Hypo Real Estate, and Britain's Bradford & Bingley all on the verge of failure. European government have jumped attempting the American two step in trying to save their own troubled institutions. Whether they are better at America's "capitalism" than America is yet to be seen.
Without the bailout's imminent passage and fear exhaustion in the markets, I would normally be thinking rally right about now but there are so many cross currents that such a call is hard to make and I am leaning the other direction.
The hedge fund fiasco partly caused by the SEC I think is really going to pick up steam in October which could put alot of pressure on equities from a technical standpoint. Also this credit crunch is finally making it's way on Main Street and it is coming with a roar. Fertilizer companies were down 5 to 15% on Friday as a result of speculation that farmers can't get credit to buy fertilizer. That is beyond scary. Your talking world wide famine consequences if that doesn't change. Today I talked to my brother in law who is in charge of research and design for the U.S. largest bow and arrow manufacturer and in the past month they have just gotten walloped with tightening credit standards in lines they are allowed for their customers. Sonic announced on Friday that GE Capital will not be making any new loans to the restaurant firm. Main Street is now in the cross hairs.
The U.S. futures which were pointing up are now pointing to a solid lower open. Won't the lawmakers be upset if all their effort is met with a dramatic sell off in the stock market this week. That should be an interesting conversation with constituents as they point to saving their 401k and the U.S. economy with the bailout as the DOW spirals downward.
The U.S. government has essentially propped up the stock market for two weeks now (it has been weak scaffolding holding it up at best) but now what do you do? This could get really ugly.
Without the bailout's imminent passage and fear exhaustion in the markets, I would normally be thinking rally right about now but there are so many cross currents that such a call is hard to make and I am leaning the other direction.
The hedge fund fiasco partly caused by the SEC I think is really going to pick up steam in October which could put alot of pressure on equities from a technical standpoint. Also this credit crunch is finally making it's way on Main Street and it is coming with a roar. Fertilizer companies were down 5 to 15% on Friday as a result of speculation that farmers can't get credit to buy fertilizer. That is beyond scary. Your talking world wide famine consequences if that doesn't change. Today I talked to my brother in law who is in charge of research and design for the U.S. largest bow and arrow manufacturer and in the past month they have just gotten walloped with tightening credit standards in lines they are allowed for their customers. Sonic announced on Friday that GE Capital will not be making any new loans to the restaurant firm. Main Street is now in the cross hairs.
The U.S. futures which were pointing up are now pointing to a solid lower open. Won't the lawmakers be upset if all their effort is met with a dramatic sell off in the stock market this week. That should be an interesting conversation with constituents as they point to saving their 401k and the U.S. economy with the bailout as the DOW spirals downward.
The U.S. government has essentially propped up the stock market for two weeks now (it has been weak scaffolding holding it up at best) but now what do you do? This could get really ugly.
Thursday, September 25, 2008
Update to My Big Worry
China is vehemently denying those rumors (post mentioned below) but it has not stopped credit spreads from blowing out again. The TED spread is screaming. The A2/P2 spread (This is the spread between high and low quality 30 day non financial commercial paper) is beyond anything I think has ever been seen at over 410bps.
Which brings me to more Asia news. Yesterday there were pictures of the third largest bank in Hong Kong experiencing a bank run with people lined up for blocks trying to get there money out. Here Yu Yongding, a former advisor to the Chinese central bank, is calling for quick action to avoid a panic sell of U.S. debt. Oh my goodness what would such a panic sell do to the U.S.?
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=anZHfo6tQi60
Japan, China and other holders of U.S. government debt must quickly reach an agreement to prevent panic sales leading to a global financial collapse, said Yu Yongding, a former adviser to the Chinese central bank.
``We are in the same boat, we must cooperate,'' Yu said in an interview in Beijing on Sept. 23. ``If there's no selling in a panicked way, then China willingly can continue to provide our financial support by continuing to hold U.S. assets.''
An agreement is needed so that no nation rushes to sell, ``causing a collapse,'' Yu said. Japan is the biggest owner of U.S. Treasury bills, holding $593 billion, and China is second with $519 billion. Asian countries together hold half of the $2.67 trillion total held by foreign nations.
China, Japan, South Korea and others should meet soon to seal a deal, said Yu, a former academic member of the central bank's monetary policy committee. The talks should involve finance ministers, central bank governors and even national leaders, he said.
Which brings me to more Asia news. Yesterday there were pictures of the third largest bank in Hong Kong experiencing a bank run with people lined up for blocks trying to get there money out. Here Yu Yongding, a former advisor to the Chinese central bank, is calling for quick action to avoid a panic sell of U.S. debt. Oh my goodness what would such a panic sell do to the U.S.?
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=anZHfo6tQi60
Japan, China and other holders of U.S. government debt must quickly reach an agreement to prevent panic sales leading to a global financial collapse, said Yu Yongding, a former adviser to the Chinese central bank.
``We are in the same boat, we must cooperate,'' Yu said in an interview in Beijing on Sept. 23. ``If there's no selling in a panicked way, then China willingly can continue to provide our financial support by continuing to hold U.S. assets.''
An agreement is needed so that no nation rushes to sell, ``causing a collapse,'' Yu said. Japan is the biggest owner of U.S. Treasury bills, holding $593 billion, and China is second with $519 billion. Asian countries together hold half of the $2.67 trillion total held by foreign nations.
China, Japan, South Korea and others should meet soon to seal a deal, said Yu, a former academic member of the central bank's monetary policy committee. The talks should involve finance ministers, central bank governors and even national leaders, he said.
My Big Worry
Of all my worries for America's future, and I have alot, creditors pulling back is my biggest. I have brought it up before but I will bring it up again, to get a good foundation of how currency markets work and an understanding of Bretton Woods 1 and 2 Changing Fortunes by Paul Volcker is one of my favorite books. This is the dynamite that will blow up our economy. Thanks goes to Kirby for bringing this to my attention.
http://www.marketwatch.com/news/story/china-asks-local-lenders-not/story.aspx?guid={389CCD2E-9D08-4A8B-A512-F1B3E0B0BE19}&dist=hplatest#comments
Chinese regulators have asked domestic banks to stop lending to U.S. financial institutions in the interbank money markets to prevent possible losses during the financial crisis, the South China Morning Post reported Thursday. The China Banking Regulatory Commission's ban on interbank lending of all currencies applied to U.S. banks, but not to lenders from other countries, the report added, citing a source.
http://www.marketwatch.com/news/story/china-asks-local-lenders-not/story.aspx?guid={389CCD2E-9D08-4A8B-A512-F1B3E0B0BE19}&dist=hplatest#comments
Chinese regulators have asked domestic banks to stop lending to U.S. financial institutions in the interbank money markets to prevent possible losses during the financial crisis, the South China Morning Post reported Thursday. The China Banking Regulatory Commission's ban on interbank lending of all currencies applied to U.S. banks, but not to lenders from other countries, the report added, citing a source.
Tuesday, September 23, 2008
The Plan Behind the Plan
Below is from the comment section of the calculated risk blog. It is brilliant. A big thanks goes to Ron for bringing this to my attention.
*Subcommander Doom* writes:
"Jerome,
I've been puzzling why Paulson would propose legislation which is so obviously dictatorial, extra-legal and dangerous, even with the careful orchestration of the Lehman Brothers/Reichstag Fire.
I think I've just figured out why they are doing it.
All the Fed's alphabet soup of emergency liquidity facilities innovated over the past year were structured around repurchase agreements. Toxic waste securities were used as collateral for US Treasuries and dollar credit at 85 percent of face value. But as each facility expires, it has to be rolled over and increased to keep pace with the implosion of credit in the interbank markets. Well over half the balance sheet assets of the Fed have been loaned out in this way, perhaps a critical amount in excess of this estimate. Without recapitalisation, the Fed is at risk of failure in the midst of this crisis. Its Enron-style accounting for the toxic waste makes it very vulnerable to a default by any of the repo counterparties it oversees and limits its ability to enforce any constraints as well.
The Paulson plan will provide a one off opportunity for banks to take their toxic collateral back and sell it at a Paulson-determined price for cash. He issues Treasuries to finance the plan which increases the supply available. He selectively decides winners and losers, of course in making the scheme available and pricing assets, creating arbitrage opportunities and survivor bias in the process.
In the meanwhile, the removal of the toxic waste from the Fed balance sheet and redeposit of Treasuries and cash as the repos unwind gets the Fed off the hook for having hypothecated most of its assets against worthless toxic waste at Enron-styled false valuations.
If I'm right, the Paulson Plan recapitalises the Fed without ever publicly admitting that it was dangerously overextended."
*Subcommander Doom* writes:
"Jerome,
I've been puzzling why Paulson would propose legislation which is so obviously dictatorial, extra-legal and dangerous, even with the careful orchestration of the Lehman Brothers/Reichstag Fire.
I think I've just figured out why they are doing it.
All the Fed's alphabet soup of emergency liquidity facilities innovated over the past year were structured around repurchase agreements. Toxic waste securities were used as collateral for US Treasuries and dollar credit at 85 percent of face value. But as each facility expires, it has to be rolled over and increased to keep pace with the implosion of credit in the interbank markets. Well over half the balance sheet assets of the Fed have been loaned out in this way, perhaps a critical amount in excess of this estimate. Without recapitalisation, the Fed is at risk of failure in the midst of this crisis. Its Enron-style accounting for the toxic waste makes it very vulnerable to a default by any of the repo counterparties it oversees and limits its ability to enforce any constraints as well.
The Paulson plan will provide a one off opportunity for banks to take their toxic collateral back and sell it at a Paulson-determined price for cash. He issues Treasuries to finance the plan which increases the supply available. He selectively decides winners and losers, of course in making the scheme available and pricing assets, creating arbitrage opportunities and survivor bias in the process.
In the meanwhile, the removal of the toxic waste from the Fed balance sheet and redeposit of Treasuries and cash as the repos unwind gets the Fed off the hook for having hypothecated most of its assets against worthless toxic waste at Enron-styled false valuations.
If I'm right, the Paulson Plan recapitalises the Fed without ever publicly admitting that it was dangerously overextended."
Monday, September 22, 2008
Stripper Indicator
I guess no one is exempt from the deflationary spiral.
http://www.tmz.com/2008/09/19/nyc-strippers-screwed-by-sucky-stocks/
So the NYC economy is headed for the crapper, sure -- but who's really suffering? Weep for the strippers.
We're told first-hand by the pole-gymnasts at joints like the Penthouse Executive Club in NYC that biz has come to a grinding halt -- and to add insult to injury, strippers say one-dollar bills have replaced tens and twenties. Oh, the humanity!
Sources tell us traffic at some super-exclusive Manhattan nightspots is down 40-50% since the wheels came off.
http://www.tmz.com/2008/09/19/nyc-strippers-screwed-by-sucky-stocks/
So the NYC economy is headed for the crapper, sure -- but who's really suffering? Weep for the strippers.
We're told first-hand by the pole-gymnasts at joints like the Penthouse Executive Club in NYC that biz has come to a grinding halt -- and to add insult to injury, strippers say one-dollar bills have replaced tens and twenties. Oh, the humanity!
Sources tell us traffic at some super-exclusive Manhattan nightspots is down 40-50% since the wheels came off.
Sunday, September 21, 2008
11 Step Plan
I have been in contact all last week and over the weekend with a very important person in finance (manages over 100 billion). There were some terse exchanges but he asked me what I would do. I wrote an email and he forwarded it onto Washington. I had no idea he was going to do that and would have changed some of it if I would have known. I realize none of this stuff will be implemented but it was cool it made its way to Washington. Below is the exchange. You should probably read my email first at the bottom.
Email to me and XXX
Thanks Jason.
XXX- I'm not sure if you are checking this email account right now, but if you are these are ideas from a young hedge fund manager with what I would refer to as simple common sense. Sometimes we all get too close to the issue and it helps to get a truly independent view, from someone who is operating alone, and away from the crowd. There are some interesting ideas in here. It's light reading so take a second and take a look.
Since you've gone to Washington, all "hell" has broken lose. Did you know what you were getting in to. Either way, I'm glad you are there working for all of us.
Jason, XXXX is a special assistant to Sec. Paulson. Don't contact him directly.
Hope all is well with both of you.
All the best.
XXXX
My original email
First my apologies for the previous email. It was an emotional reaction as I see my industry being destroyed.
Below I describe 11 steps of what I would do now if I had absolute power. There is no perfect answer. The commercial real estate blow up is going to be a 2009 story and the corporate bank debt blow up is going to be a 2009 - 2011 story. We are headed for depression. This may give us a fighting chance to avoid that.
The primary problem is that A + B = A +B. It does not equal A + B + C. Investment bankers constantly try to convince you that it equals A + B + C, that was the whole CDO scam. I believe the entire U.S. banking system is insolvent. You cannot somehow deal with that and magically create value.
1) Have Hank Paulson, Ben Bernanke, John Mack, your calpers counterpart, and others stand at a chalk board and write "there are real problems in the U.S. economy and it is not short sellers" 10 times. They have got to recognize the issue.
2) Declare a 7 day investment bank holiday where every investment banker in America works for Paulson and Bernanke for free.
3) Identify 1,000,000 homes in America that are for sale or in foreclosure the government can buy at market prices. Assuming $200,000 per home that costs 200 billion. Bulldoze them and pass a law that mandates the lots be sold over a 5 year period 10 years from now. Put a law in place that to reverse this sale has to be approved by 2/3 of Congress
4) Examine every bank in the United States and mark every asset to current market prices. EVERY ASSET. Take the bottom 1000 banks (they will be insolvent) wipe out the equity, merge them with a good bank and take whatever assets need to be taken by an RTC structure of the government.
5) Take the second thousand banks and take the junk assets off the balance sheet at market prices. Make these 1000 banks sell preferred stock to the government in return.
6) Merge Goldman and Morgan Stanley with Wachovia or Washington Mutual taking what bad assets needed to by the RTC. All 3 above will probably cost between $400 and $800 billion.
7) Identify $500 billion in government programs you can cancel to try to save the dollar
8) Establish extensive regulatory oversight over the CDS market.
9) Backstop the entire money market industry for 6 months. Not this little 50 billion sham thing they came up with.
10) Cut interest rates to 1%. This needs to be reversed quickly if it becomes obvious that the market has stabilized.
11) Remove the short selling rule and pass a law that would require Congress to vote by a 2/3 majority for any such short ban again. That will restore confidence that the market will be a market.
Like I said this won't solve everything. It will go along way to helping. You have to a functioning banking system. Ours is insolvent. Not short sellers made problems, insolvent.
Email to me and XXX
Thanks Jason.
XXX- I'm not sure if you are checking this email account right now, but if you are these are ideas from a young hedge fund manager with what I would refer to as simple common sense. Sometimes we all get too close to the issue and it helps to get a truly independent view, from someone who is operating alone, and away from the crowd. There are some interesting ideas in here. It's light reading so take a second and take a look.
Since you've gone to Washington, all "hell" has broken lose. Did you know what you were getting in to. Either way, I'm glad you are there working for all of us.
Jason, XXXX is a special assistant to Sec. Paulson. Don't contact him directly.
Hope all is well with both of you.
All the best.
XXXX
My original email
First my apologies for the previous email. It was an emotional reaction as I see my industry being destroyed.
Below I describe 11 steps of what I would do now if I had absolute power. There is no perfect answer. The commercial real estate blow up is going to be a 2009 story and the corporate bank debt blow up is going to be a 2009 - 2011 story. We are headed for depression. This may give us a fighting chance to avoid that.
The primary problem is that A + B = A +B. It does not equal A + B + C. Investment bankers constantly try to convince you that it equals A + B + C, that was the whole CDO scam. I believe the entire U.S. banking system is insolvent. You cannot somehow deal with that and magically create value.
1) Have Hank Paulson, Ben Bernanke, John Mack, your calpers counterpart, and others stand at a chalk board and write "there are real problems in the U.S. economy and it is not short sellers" 10 times. They have got to recognize the issue.
2) Declare a 7 day investment bank holiday where every investment banker in America works for Paulson and Bernanke for free.
3) Identify 1,000,000 homes in America that are for sale or in foreclosure the government can buy at market prices. Assuming $200,000 per home that costs 200 billion. Bulldoze them and pass a law that mandates the lots be sold over a 5 year period 10 years from now. Put a law in place that to reverse this sale has to be approved by 2/3 of Congress
4) Examine every bank in the United States and mark every asset to current market prices. EVERY ASSET. Take the bottom 1000 banks (they will be insolvent) wipe out the equity, merge them with a good bank and take whatever assets need to be taken by an RTC structure of the government.
5) Take the second thousand banks and take the junk assets off the balance sheet at market prices. Make these 1000 banks sell preferred stock to the government in return.
6) Merge Goldman and Morgan Stanley with Wachovia or Washington Mutual taking what bad assets needed to by the RTC. All 3 above will probably cost between $400 and $800 billion.
7) Identify $500 billion in government programs you can cancel to try to save the dollar
8) Establish extensive regulatory oversight over the CDS market.
9) Backstop the entire money market industry for 6 months. Not this little 50 billion sham thing they came up with.
10) Cut interest rates to 1%. This needs to be reversed quickly if it becomes obvious that the market has stabilized.
11) Remove the short selling rule and pass a law that would require Congress to vote by a 2/3 majority for any such short ban again. That will restore confidence that the market will be a market.
Like I said this won't solve everything. It will go along way to helping. You have to a functioning banking system. Ours is insolvent. Not short sellers made problems, insolvent.
Saturday, September 20, 2008
2nd Letter
This is another email I sent out late Friday afternoon. Crazy times.
Dear Partners,
This is proving to be the best fold I have ever done in my life. I am a simple man. A man who is skewed (often times to a fault) towards inaction. Someone who plays spades during the day to avoid thinking about the daily market gyrations. Someone who thinks about how the life cycle of the Alaskan snow hair is related to life and the markets (something that will be in my next letter). Someone who longs and shorts stocks over a period of years. It took 30 seconds when the London news passed the wire for me to come to the conclusions of what this meant. Another 30 minutes to make several calls and send emails to make sure I wasn't losing it. The United States today is littered with investors and hedge funds that most likely imploded. Some of it very smart money who knew what they were doing. If I would not have taken the drastic action I took, we would be down hundreds of thousands of dollars today.
For example. I was short Zion Bank. I was short it as a 2009 story because I think their commercial real estate book is horrible. If your were short the stock, you better know why your short it because it had a 40% short interest. I had heated debate with other investors on the name testing and stretching my thesis. Maybe I was wrong but I felt like I was right along with a lot of other money who was short the stock as it went up over 20% in the month of August and September. This stock was near a three month high yesterday. Yesterday the stock closed at $45 a share. This morning, in four minutes the stock went to $121 a share setting an all time high by over 40% and up 169% on the day in four minutes. That ruined people!!!!! The stock is now back down up only 12% but if you had multiple names that did that at once, your toast, done.
MBIA is also another stock that I was heavily short. I first started shorting it personally 14 months ago at 60. It was the first trade I ever did when I opened my firm. The stock went to $4 a month in a half ago. The NY insurance office practiced its own manipulation giving MBIA a book of business that on the surface made it look really good. If you spent the time to dig into it looks like long term it is a horrendous deal. The type of business that MBIA did from 2004 to 2007 to get into this mess in the first place that under prices risks. The stock went from 4 to 19 in weeks. A gigantic short squeeze. I rode it out though it was painful. It dropped back to $10 prior to yesterday. After the market closed yesterday news came out that should have sent the stock down 20 to 40% today. Today it is down 6%. In my opinion, it is more insolvent than an old goose that is no longer capable of laying a golden egg. I covered yesterday. Should I short it back? It didn't make the list but it has more impact on financials than most small regional banks that did make the list. If it starts plummeting does the government step in?
Today SKF was halted. An etf ultra short on financials. The problem is that the ETF creates synthetic positions through swaps to replicate the going short financials. The people who sell them their swaps short financials to protect their swap position. These market makers can no longer do this. You have massive institutions who use this to hedge their portfolio, to make sector bets, to short the financial index while going long individual names.
This forever changes the game of investing. The short ban covers almost 800 names and it only last a few weeks but once it lifts who cares? If stocks start going down again does the government do it all over again? Does it get expanded? Even if this fixes the problem (it didn't in Pakistan, Zimbabwe, or China) you will have an overall lower equilibrium valuation on the markets because of greater risk premium demanded.
History is littered with stories of market manipulation. Almost all of them ended in failure by the manipulators. One of the most famous ones occurred in the 1970s with the Hunt Brothers trying to corner the silver market. It completely blew up in their face causing them suffer massive losses. This is the biggest market manipulation in the history of mankind. History would tell you it will most likely not end up good.
We continued our wind down today. We still own a small Mexico chicken company and a small Canadian company. Both companies are very illiquid and I have only been able to get out of about 60% of the position so far. What is left makes up currently about 1.7% of the portfolio.
I really don't know what I am going to do. I have enough money saved up that I could go work at a restaurant on a beach somewhere and learn how to surf. Something I have always thought about doing. For the time being I will wait and see how this plays itself out. Look at the investment world and see if I can play the game. Maybe short bonds and long stocks. From a philosophical utilitarian perspective (the greatest good for the greatest number) maybe this is what needed to happen. I really don't think it ultimately changes much but the markets were staring into the abyss and we needed a time out. I support everything else the government is doing including the RTC and now buying commercial paper. This short change rule (especially the day before options expiration) ruined many people. The London news hitting at 1:00 was not an accident. I am sure Treasury Secretary Hank Paulson called his Goldman buddies and told them I can't tell you anything but watch what London does. I was extremely blessed from above to see it happen and be able to determine quickly what that meant. The problem is next time there may not be any warning. How do you play those hands when a heavily shorted stock that you are also short goes up 169% in four minutes? This was a chance for long and wrong money to get out.
For America I truly hope I am wrong about a potential crash coming. I wonder though if it does happen who will everyone blame then? All week Russia was mocked for shutting their markets down two days in a row by Wall St. All I have to say is at least Russia shut it down for everyone.
I will keep everyone posted.
Dear Partners,
This is proving to be the best fold I have ever done in my life. I am a simple man. A man who is skewed (often times to a fault) towards inaction. Someone who plays spades during the day to avoid thinking about the daily market gyrations. Someone who thinks about how the life cycle of the Alaskan snow hair is related to life and the markets (something that will be in my next letter). Someone who longs and shorts stocks over a period of years. It took 30 seconds when the London news passed the wire for me to come to the conclusions of what this meant. Another 30 minutes to make several calls and send emails to make sure I wasn't losing it. The United States today is littered with investors and hedge funds that most likely imploded. Some of it very smart money who knew what they were doing. If I would not have taken the drastic action I took, we would be down hundreds of thousands of dollars today.
For example. I was short Zion Bank. I was short it as a 2009 story because I think their commercial real estate book is horrible. If your were short the stock, you better know why your short it because it had a 40% short interest. I had heated debate with other investors on the name testing and stretching my thesis. Maybe I was wrong but I felt like I was right along with a lot of other money who was short the stock as it went up over 20% in the month of August and September. This stock was near a three month high yesterday. Yesterday the stock closed at $45 a share. This morning, in four minutes the stock went to $121 a share setting an all time high by over 40% and up 169% on the day in four minutes. That ruined people!!!!! The stock is now back down up only 12% but if you had multiple names that did that at once, your toast, done.
MBIA is also another stock that I was heavily short. I first started shorting it personally 14 months ago at 60. It was the first trade I ever did when I opened my firm. The stock went to $4 a month in a half ago. The NY insurance office practiced its own manipulation giving MBIA a book of business that on the surface made it look really good. If you spent the time to dig into it looks like long term it is a horrendous deal. The type of business that MBIA did from 2004 to 2007 to get into this mess in the first place that under prices risks. The stock went from 4 to 19 in weeks. A gigantic short squeeze. I rode it out though it was painful. It dropped back to $10 prior to yesterday. After the market closed yesterday news came out that should have sent the stock down 20 to 40% today. Today it is down 6%. In my opinion, it is more insolvent than an old goose that is no longer capable of laying a golden egg. I covered yesterday. Should I short it back? It didn't make the list but it has more impact on financials than most small regional banks that did make the list. If it starts plummeting does the government step in?
Today SKF was halted. An etf ultra short on financials. The problem is that the ETF creates synthetic positions through swaps to replicate the going short financials. The people who sell them their swaps short financials to protect their swap position. These market makers can no longer do this. You have massive institutions who use this to hedge their portfolio, to make sector bets, to short the financial index while going long individual names.
This forever changes the game of investing. The short ban covers almost 800 names and it only last a few weeks but once it lifts who cares? If stocks start going down again does the government do it all over again? Does it get expanded? Even if this fixes the problem (it didn't in Pakistan, Zimbabwe, or China) you will have an overall lower equilibrium valuation on the markets because of greater risk premium demanded.
History is littered with stories of market manipulation. Almost all of them ended in failure by the manipulators. One of the most famous ones occurred in the 1970s with the Hunt Brothers trying to corner the silver market. It completely blew up in their face causing them suffer massive losses. This is the biggest market manipulation in the history of mankind. History would tell you it will most likely not end up good.
We continued our wind down today. We still own a small Mexico chicken company and a small Canadian company. Both companies are very illiquid and I have only been able to get out of about 60% of the position so far. What is left makes up currently about 1.7% of the portfolio.
I really don't know what I am going to do. I have enough money saved up that I could go work at a restaurant on a beach somewhere and learn how to surf. Something I have always thought about doing. For the time being I will wait and see how this plays itself out. Look at the investment world and see if I can play the game. Maybe short bonds and long stocks. From a philosophical utilitarian perspective (the greatest good for the greatest number) maybe this is what needed to happen. I really don't think it ultimately changes much but the markets were staring into the abyss and we needed a time out. I support everything else the government is doing including the RTC and now buying commercial paper. This short change rule (especially the day before options expiration) ruined many people. The London news hitting at 1:00 was not an accident. I am sure Treasury Secretary Hank Paulson called his Goldman buddies and told them I can't tell you anything but watch what London does. I was extremely blessed from above to see it happen and be able to determine quickly what that meant. The problem is next time there may not be any warning. How do you play those hands when a heavily shorted stock that you are also short goes up 169% in four minutes? This was a chance for long and wrong money to get out.
For America I truly hope I am wrong about a potential crash coming. I wonder though if it does happen who will everyone blame then? All week Russia was mocked for shutting their markets down two days in a row by Wall St. All I have to say is at least Russia shut it down for everyone.
I will keep everyone posted.
Thursday, September 18, 2008
Description of the Day
I took extraordinary action in my fund today. I never thought I would ever do what I did. My usual problem is inaction, not action. I honestly feel very at peace with the decision and think it was the right one regardless of what happens. We will most likely see a massive rally followed by a crash. How massive a rally depends on how much smart money sells into it. Maybe I am wrong. I honestly hope I am. Below describes my thoughts on the day with a slightly altered investment letter I sent out to Partners.
Dear Partners,
I can't believe I am sending out another mass email but things have changed dramatically since yesterday with issues that you should be made aware of.
Because of government action today in London that I believe will likely be replicated in the U.S. and maybe even expanded, I have decided on a mass liquidation of the funds portfolio. This decision was not made lightly. I discussed this decision with one of the partnerships larger investors, another fund manager, and a couple of friends in the financial world. There is a massive information gap that creates extreme bifurcated outcomes. Instead of being able to invest, it becomes gambling. I can't play if I don't know the rules of the game or if those rules are constantly changed. I don't gamble unless I have an extreme advantage. There were three government actions in the last twenty four hours that forced me to fold and wait for another hand.
1) Yesterday morning SEC Chairmen Christopher Cox announced sweeping rules on naked short selling (I won't go into the technicalities of what this means). First of all, I am not aware of anyone who participates in naked short selling besides market makers who have been exempted of this rule (they aren't any longer). There has been investigation after investigation looking for naked short selling and nothing has been turned up. Second of all, I am completely in favor of these rules. Naked short selling has been banned for over 70 year, I don't think it is happening, if it is, end it. However, last night Chairmen Cox came out with proposition for additional rules that will cause hedge funds over a 100 million in assets to report short positions on a weekly basis. This effectively kills or greatly curtails short selling for large funds for multiple reasons. It also greatly hurts mutual funds who also now short.
2) The much bigger issue and what ultimately triggered my decision was that during the middle of the day, London announced they were banning all new short selling on all financials until mid January. I never thought I would have seen this in a free market economy. This causes massive problems!!! If your a market maker and sell a naked put to an investor buying protection for a stock that he is long, you can no longer short the stock to protect yourself. As a result, insurance from a long perspective becomes much higher if it exists at all. If your a fund looking to hedge your book you cannot short another bank.
3) Paulson came out with an RTC proposal today throwing back to the S&L loan crises. I thought this was coming but thought it would be over the weekend. I applaud this action though I don't think it will work. The RTC in the 80s never bought assets. They took them over from failed S&L institutions and then slowly sold them over a period of 5 years. What is being proposed is that this entity will buy junk assets from the banks. Sounds good in theory but my guess is that no one is going to be willing to sell them. Because of accounting games, Bridgewater has estimated that there is over 500 billion in markdowns the U.S. banking system has not taken being hidden on their balance sheet. Banks are not going to want to sell these assets because then they would have to take losses not disclosed. I hope this works but my guess is it won't. Even Bill Seidman, who ran the RTC back in the 80s, doubts that this will work. I remain a skeptic but a supporter because we need something.
Reasons for Liquidation
I believed we have passed the point of no return. I believe we are heading into a recession not seen since the 1970s and quite possibly a depression. The government can scream about short sellers and the SEC can practice market manipulation the day before options expiration but it doesn't change the fundamental problems. In fact it displays they are still clueless from recognizing the actual problems and I think verifies my thesis that we are no where near a market bottom. As a result, there is very little if anything I want to be long without a short book. The problem is, the battle against the shorts is making it almost impossible to short. What started today could be a massive unwind of huge short exposure in the market. I am talking massive. 20 to 30% in a couple of weeks or months on the entire market. I was short a bank today that I believe should be much lower no matter what the government does. The stock went from $33 a share to over $47 on the London shorting news in less than two hours. That is over a 43% move on a stock that is actually near a three month high going into today. It was not a stock being driven down by evil shorts. I was short a stock that in August alone on a short squeeze went up 173%. These are the type of moves you are looking at if we see a gigantic short squeeze like you have never seen before. I am willing to live with this (I have been short 4 different stocks this year that at some point while I was short went up 70% or more while I was short, I was right and made money on all 4) but not if I don't know what the rules are, where I can hedge or add to my short position, or if I will be forced out completely by the government.
So why don't I go long if I think this short rally is coming? Because I am not a speculator and not a gambler. I think the market is massively overvalued on a fundamental basis. Once the ask quits being hit by the short coverers, I think it is possible you will see a massive crash. There will be no more buyers because fundamentally you are buying a train wreck. Maybe we crash tomorrow as investors realize the fraud that is taking place, maybe it is in a month, or maybe three months. I don't know but I am not going to speculate long playing a bounce that is government manipulated.
Outcome
So today I covered every short I had except one. A small retailer that even in good times I think files chp 11 in the next twelve months. I liquidated several long positions. Half of my remaining long book will probably be taken tomorrow by calls I previously sold. The majority of the other half I will trickle out of over the next couple of days. I also kept my remaining Russell 2000 puts. The bounce was so violent with the entire Russell 2000 index ending up close to 6% that I couldn't get out of them at a price that I thought was acceptable. These puts make up about 2% of the portfolio. If they expire worthless it will costs us 2% but they don't expire until January and by then they have a decent chance of being worth a fair amount.
Conclusion
The battle against the short sellers is misguided and one based out of complete ignorance or denial of truth. The short sellers have been the ones telling you this was coming for years. People should not be able to stand in a crowded theater and yell fire. However, people should be able to stand across the street pointing to an old theater telling everyone around that the building is a fire hazard. David Einhorn did this with Lehman, Bill Ackmen did this with MBIA, etc. etc. and instead of people listening to the whistleblowers, they ridiculed them, they defamed them, they subpoenaed them and people marched right on into the theater anyway. When the theater did catch on fire and there were casualties, those who survived tried to kill those who warned them in the first place. China has had these types of shorting rules in place for years, the stock market is still down over 60% this year. This stuff doesn't change anything but it has the potential to ruin those who are right. I honestly believe this has the potential to exacerbate a potential crash. Depending how misguided the government gets, this may ruin my profession as a hedge fund manager. It also could move stocks on a valuation basis permanently lower as a greater risk premium will be demanded if you are unable to short and buy protection.
I do not know how long I will be out of the market. It may be days or longer than a month. I have to know the rules to play the game. I would love to say we are near a bottom and this is a buying opportunity of a lifetime but I don't think it is. Assuming we are in normal times consider these numbers that an investor friend emailed me yesterday. The S&P 2007 sales were 1025. If you take normalized operating margins going back the 1940s of 8%, subtract out taxes at a rate of 30%, put a 15.6 multiple on it which is the long term average multiple going back to the 1940s you have a fair value of the S&P 500 of 855. Assume a 5% increase in sales for 2008 and the number becomes 904. Grant it those assumptions adjust slightly and you get much different value but there is no margin of safety with an S&P above 1200 especially considering the fact that we are not in normal times.
I am an avid Texas Hold Em player and the best hands I have ever played were hands where I had a large amount of money in the pot and was able to fold my hands to play another hand.
I leave it with this. I heard a trader say today that everything that has happened today is long for a trade but bad for the future of America, my future, and my children's future. I agree. The only way this works out is if we do get a 30% rally and banks use that window of opportunity to recapitalize their balance sheets selling massive amounts of stock. They won't because there is nothing wrong with them, it is all the fault of the short sellers. We may be down 20% in the next two days and I would have benefited greatly by staying in my positions. Who knows. I do know I will get two more cards next hand to play with again. As Kenny Rogers sings "know when to hold them, know when to fold them." With the government changing the rules in mid day and manipulating the market a day before options expiration day, it is time to fold them.
Dear Partners,
I can't believe I am sending out another mass email but things have changed dramatically since yesterday with issues that you should be made aware of.
Because of government action today in London that I believe will likely be replicated in the U.S. and maybe even expanded, I have decided on a mass liquidation of the funds portfolio. This decision was not made lightly. I discussed this decision with one of the partnerships larger investors, another fund manager, and a couple of friends in the financial world. There is a massive information gap that creates extreme bifurcated outcomes. Instead of being able to invest, it becomes gambling. I can't play if I don't know the rules of the game or if those rules are constantly changed. I don't gamble unless I have an extreme advantage. There were three government actions in the last twenty four hours that forced me to fold and wait for another hand.
1) Yesterday morning SEC Chairmen Christopher Cox announced sweeping rules on naked short selling (I won't go into the technicalities of what this means). First of all, I am not aware of anyone who participates in naked short selling besides market makers who have been exempted of this rule (they aren't any longer). There has been investigation after investigation looking for naked short selling and nothing has been turned up. Second of all, I am completely in favor of these rules. Naked short selling has been banned for over 70 year, I don't think it is happening, if it is, end it. However, last night Chairmen Cox came out with proposition for additional rules that will cause hedge funds over a 100 million in assets to report short positions on a weekly basis. This effectively kills or greatly curtails short selling for large funds for multiple reasons. It also greatly hurts mutual funds who also now short.
2) The much bigger issue and what ultimately triggered my decision was that during the middle of the day, London announced they were banning all new short selling on all financials until mid January. I never thought I would have seen this in a free market economy. This causes massive problems!!! If your a market maker and sell a naked put to an investor buying protection for a stock that he is long, you can no longer short the stock to protect yourself. As a result, insurance from a long perspective becomes much higher if it exists at all. If your a fund looking to hedge your book you cannot short another bank.
3) Paulson came out with an RTC proposal today throwing back to the S&L loan crises. I thought this was coming but thought it would be over the weekend. I applaud this action though I don't think it will work. The RTC in the 80s never bought assets. They took them over from failed S&L institutions and then slowly sold them over a period of 5 years. What is being proposed is that this entity will buy junk assets from the banks. Sounds good in theory but my guess is that no one is going to be willing to sell them. Because of accounting games, Bridgewater has estimated that there is over 500 billion in markdowns the U.S. banking system has not taken being hidden on their balance sheet. Banks are not going to want to sell these assets because then they would have to take losses not disclosed. I hope this works but my guess is it won't. Even Bill Seidman, who ran the RTC back in the 80s, doubts that this will work. I remain a skeptic but a supporter because we need something.
Reasons for Liquidation
I believed we have passed the point of no return. I believe we are heading into a recession not seen since the 1970s and quite possibly a depression. The government can scream about short sellers and the SEC can practice market manipulation the day before options expiration but it doesn't change the fundamental problems. In fact it displays they are still clueless from recognizing the actual problems and I think verifies my thesis that we are no where near a market bottom. As a result, there is very little if anything I want to be long without a short book. The problem is, the battle against the shorts is making it almost impossible to short. What started today could be a massive unwind of huge short exposure in the market. I am talking massive. 20 to 30% in a couple of weeks or months on the entire market. I was short a bank today that I believe should be much lower no matter what the government does. The stock went from $33 a share to over $47 on the London shorting news in less than two hours. That is over a 43% move on a stock that is actually near a three month high going into today. It was not a stock being driven down by evil shorts. I was short a stock that in August alone on a short squeeze went up 173%. These are the type of moves you are looking at if we see a gigantic short squeeze like you have never seen before. I am willing to live with this (I have been short 4 different stocks this year that at some point while I was short went up 70% or more while I was short, I was right and made money on all 4) but not if I don't know what the rules are, where I can hedge or add to my short position, or if I will be forced out completely by the government.
So why don't I go long if I think this short rally is coming? Because I am not a speculator and not a gambler. I think the market is massively overvalued on a fundamental basis. Once the ask quits being hit by the short coverers, I think it is possible you will see a massive crash. There will be no more buyers because fundamentally you are buying a train wreck. Maybe we crash tomorrow as investors realize the fraud that is taking place, maybe it is in a month, or maybe three months. I don't know but I am not going to speculate long playing a bounce that is government manipulated.
Outcome
So today I covered every short I had except one. A small retailer that even in good times I think files chp 11 in the next twelve months. I liquidated several long positions. Half of my remaining long book will probably be taken tomorrow by calls I previously sold. The majority of the other half I will trickle out of over the next couple of days. I also kept my remaining Russell 2000 puts. The bounce was so violent with the entire Russell 2000 index ending up close to 6% that I couldn't get out of them at a price that I thought was acceptable. These puts make up about 2% of the portfolio. If they expire worthless it will costs us 2% but they don't expire until January and by then they have a decent chance of being worth a fair amount.
Conclusion
The battle against the short sellers is misguided and one based out of complete ignorance or denial of truth. The short sellers have been the ones telling you this was coming for years. People should not be able to stand in a crowded theater and yell fire. However, people should be able to stand across the street pointing to an old theater telling everyone around that the building is a fire hazard. David Einhorn did this with Lehman, Bill Ackmen did this with MBIA, etc. etc. and instead of people listening to the whistleblowers, they ridiculed them, they defamed them, they subpoenaed them and people marched right on into the theater anyway. When the theater did catch on fire and there were casualties, those who survived tried to kill those who warned them in the first place. China has had these types of shorting rules in place for years, the stock market is still down over 60% this year. This stuff doesn't change anything but it has the potential to ruin those who are right. I honestly believe this has the potential to exacerbate a potential crash. Depending how misguided the government gets, this may ruin my profession as a hedge fund manager. It also could move stocks on a valuation basis permanently lower as a greater risk premium will be demanded if you are unable to short and buy protection.
I do not know how long I will be out of the market. It may be days or longer than a month. I have to know the rules to play the game. I would love to say we are near a bottom and this is a buying opportunity of a lifetime but I don't think it is. Assuming we are in normal times consider these numbers that an investor friend emailed me yesterday. The S&P 2007 sales were 1025. If you take normalized operating margins going back the 1940s of 8%, subtract out taxes at a rate of 30%, put a 15.6 multiple on it which is the long term average multiple going back to the 1940s you have a fair value of the S&P 500 of 855. Assume a 5% increase in sales for 2008 and the number becomes 904. Grant it those assumptions adjust slightly and you get much different value but there is no margin of safety with an S&P above 1200 especially considering the fact that we are not in normal times.
I am an avid Texas Hold Em player and the best hands I have ever played were hands where I had a large amount of money in the pot and was able to fold my hands to play another hand.
I leave it with this. I heard a trader say today that everything that has happened today is long for a trade but bad for the future of America, my future, and my children's future. I agree. The only way this works out is if we do get a 30% rally and banks use that window of opportunity to recapitalize their balance sheets selling massive amounts of stock. They won't because there is nothing wrong with them, it is all the fault of the short sellers. We may be down 20% in the next two days and I would have benefited greatly by staying in my positions. Who knows. I do know I will get two more cards next hand to play with again. As Kenny Rogers sings "know when to hold them, know when to fold them." With the government changing the rules in mid day and manipulating the market a day before options expiration day, it is time to fold them.
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