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I Will Gladly Pay You Tuesday

Are hedge funds turning into wimps or, in this case, Wimpys?

Our depression-era hero was famous for saying "I will gladly pay you Tuesday for a hamburger today" and that seems to be the game plan of hedge funds who are telling all the rich folks to please, please, please not panic as they clamor for withdrawals.

The problem is (aside from the fact that these funds' performance have pretty much gone down the tubes) that there is not enough ACUTAL money in the world to pay these rich people what they thing they're worth.  That's what a liquidity crisis is, not enough actual cash to back up our phony-baloney asset prices.

I wrote about this problem back in March, but no one listens to me.  At the time I warned:  "We have taken a couple of Trillion dollars of discretionary income out of the hands of average Americans and put it into the hands of wealthy people who put it into the hands of brokers who put it into the hands of oil companies who buy back their own stock and employ no additional workers and produce nothing new other than better balance sheets! This is not a platform for long-term economic growth!"

In short – nobody EARNED those dollars your virtual portfolio is stuffed with.  No goods and services were created, we simply decided that a $200,000 home was "worth" $500,000 and that a $45 barrel of oil was "worth" $70 while simultaneously telling employees that their contributions were worth less.  That was OK(ish) as long as employees had the illusion of wealth because their primary asset, their homes, was increasing in value and low rates let them borrow against them (in $Trillion$) but now it turns out those fully leveraged homes may NOT be worth $500,000 which puts both the consumer AND the lender in a bit of a bind.

When the banks phony-baloney balance sheets are full of assets that are backed by securities that may be overvalued by 15-20% and some joker says "show me the money" – well, funny story actually…  There isn't any!

Or at least there's a lot less than you thought there was.  As George Bailey tries to explain to the worried townsfolk: "You're thinking of this place all wrong. As if I had the money back in a safe. The money's not here. Your money's in Joe's house…right next to yours. And in the Kennedy house, and Mrs. Macklin's house, and a hundred others. Why, you're lending them the money to build, and then, they're going to pay it back to you as best they can. Now what are you going to do? Foreclose on them?…Now wait…now listen…now listen to me. I beg of you not to do this thing!

That all sounds wonderful when delivered by a great actor like Jimmy Stewart but how would the townsfolks have felt if they knew Mrs. Macklin had bought a 3 bedroom home for $750,000 that had actually cost just $180,000 to build on a $80,000 plot of land just 7 years earlier?  What if they knew that Mrs. Macklin's piano lessons only gave her an income of $5,000 a month so it would take over 12 years of her entire salary to pay for the house but she qualified for the loan by putting up her life savings of $75,000 as a deposit and keeping her payments down to just $2,329.56 a month by taking a 1.5% ARM loan?

Why would Mr. Macklin do such a terrible thing?  Well because Uncle Billy (the mortgage broker) told her it was the best house she could afford and Mr. Potter (Alan Greenspan) promised the townsfolk that ARM loans were an excellent way for homeowners to realize the American dream and the realtor had told her she'd make a fortune because the home would be worth double that before her rate adjusted to $4,490.79 at 7%.  What if just one of Mrs. Macklin's 3 financial advisors is wrong and she can't refinance of sell her home before her mortgage shoots up to 90% of her income?  Unfortunately, Uncle Billy forgot to mention that she would be making interest only payments those first 5 years and would gain NO equity in her home.  This helps the bank make sure they recover as much of her $75,000 deposit as possible in the event the home drops 10% and Uncle Billy assured George that the housing market was rock solid!

The housing bubble drove the commodity bubble which drove an equity bubble which drove the balance sheets of pretty much everybody to amazing levels but since they all depend on the other one sustaining their BS values to keep going, we run into a pretty deep problem when people want their money back.

That means George is screwed along with Mrs. Macklin (and you!) and it turns out there are a lot of George Baileys out there running hedge funds.  Barry Ritholtz compiled several letters from hedge funds to their investors and I'm sure Jimmy Stewart would gladly give one of his Oscars to these fine gentlemen, who would certainly melt it down for gold immediately:


  • The fund is down approximately 7.5% net, for the month of August, through August 7. We are likely to be down more by the time you read this letter, perhaps as much as 10% MTD.  We have worked overtime to understand the causes of these losses and, as a result of these analyses, began delevering our virtual portfolio (already delevered from 3.5x per side to 2.75x per side in July) starting on Monday, August 6. Since then we have continued to liquidate positions and, as you read this, the virtual portfolio is somewhere between 0.5x and 0x levered, i.e. between 50% and 100% in


  • we believe a very large (or several very large) trading entities, possibly very large hedge funds or investment banks or both, are liquidating massive market-neutral virtual portfolios. Since Black Mesa generally attempts to make money by intercepting cash flows moving from securities of lesser value to those of higher value, investment flows that ignore security-specific value, such as broad liquidations to meet margin calls, can cause losses to Black Mesa’s virtual portfolio.


  • …By delevering (your money back to you) we could miss the opportunity for profits associated with a large reversion when the liquidations stop. On the other hand, if liquidations were to continue we would pretty much be assured of continuing losses for whatever period they persisted. Our decision was to let our fear overrule our greed and start a move to the sidelines. Since Monday, August 6, we have been steadily delevering our virtual portfolios and expect to be well below 1x today, August 8. We have done our best to delever our funds and managed accounts down on a

    pari passu basis. (We will gladly pay you Tuesday!)



Barclays Global Investors, August 13th:


  • Over the past several days, the 32 Capital Fund Ltd has experienced an unusual rise in volatility and cross sectional risk. This spike in risk began with our US strategies and quickly spread to international markets. We believe that the catalyst for the abrupt rise in volatility has been non-BGI quantitatively managed hedge funds de-levering their virtual portfolios, i.e. liquidating their positions. Other managers appear to be de-levering on account of several factors, including redemptions by fund-offunds, voluntary reductions in gearing levels brought on by the recent change in the volatility regime, and selling by multi-strategy funds looking to raise cash to compensate for losses and reduced liquidity in their sub-prime and other fixed-income holdings.


  • Based on our own research and market knowledge, we believe that this increase in volatility is technical rather than fundamental in nature. By technical, we are referring to the need of many funds to raise liquidity over the short term. This de-levering, regardless of the rationale, has resulted in a number of funds closing out positions simultaneously. While this has had a significant short term impact on equity markets, the evidence does not suggest a change in underlying company fundamentals. Nor do we believe that there has been a significant shift in investor sentiment. Instead, the recent dislocation appears to be primarily driven by changes in short term liquidity, which have in turn impacted the risk and leverage of many of our equity market competitors.


  • Highbridge Statistical Opportunities Fund, August 9th:

    • We wanted to update you on the $1.7 billion Highbridge Statistical Opportunities Fund (HSOF), our statistical arbitrage fund which engages in a levered equity market neutral strategy, investing in the U.S., European and Asian equity markets. As you may be aware, many hedge funds and asset management firms utilizing similar strategies are experiencing unprecedented volatility. As of the close of business yesterday (August 8), HSOF was down approximately 16% net year-todate and 18% net month-to-date.


  • Sowood Capital Management, July 30th:


    • Today we made the painful and difficult decision to sell substantially all the funds’ virtual portfolio to Citadel Investment Group. We took this step to protect your investment. Our actions over the weekend followed severe declines in the value of our credit positions and non-performance of offsetting hedges. Given what we were facing and our uncertain ability to meet margin calls, we sought other buyers for some or all of the positions. Citadel offered the only immediate and comprehensive solution. The transaction enabled us to avoid anticipated forced sales at extreme prices that would have been made in order to satisfy obligations under our counterparty agreements.


    • After the transaction with Citadel, the Net Asset Value (NAV) of Sowood Alpha Fund Ltd. and Sowood Alpha Fund LP will have declined approximately 57% and 53% month to date respectively, and approximately 56% and 51% calendar year to date respectively. As a result, our NAV as of July 30 is approximately $1.5 billion.

    • We will be advising you of plans to distribute assets as soon as we can, subject to reserves and holdbacks for completion of the audit, contingencies and potential liabilities. Proceeds will be distributed in accordance with the governing documents of the funds. We will seek to retain key staff to manage the distribution process going forward. We understand this is a very difficult moment for you and are committed to keeping all lines of communications open.



It was way back in September that I wrote "Amaranth – When Hedge Funds Forget to Hedge" and, at the time, I thought XOM's $70 value was a bit ridiculous.  I also warned that the brokers simply had too much money (on paper anyway) and they were overpaying for assets at the top.  In that article I said: "This is the kind of out-of-control commodity spending that took down Amaranth, only it’s happening in slow motion at the investment houses." 

This is one of those times when I would truly hate to say: "I told you so."



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  1. Another excellent morning post. Yipe, you told me so, Phil !

  2. Holding CFC Sep 20 Puts and BCSI Sep 70 Puts. Any thoughts on either?

    Hoping for a pullback on BCSI but I’m getting nervous now.

    CFC nobody seems to really have a grasp on what’s going to happen to these jokers.

  3. I hope mrn is around to do his delevitation on CFC again this morning.

  4. BCSI – I dumped my puts yest …got really nervous…

  5. I don’t follow BCSI but it seems like a Cramer pump job to me. Wouldn’t touch it either way. CFC is NOT going BK (famous last words) so I’d be taking some off the table at a retest of $20 unless it’s really plunging.

    On to new post!