Friday, March 28, 2008

Self Fullfilling confidence runs

Reading RGEMonitor and Fintag this morning the following jumps out at me.

  1. Hedgies are still dying like flies, Makes the pop-corn sound in a microwave, pop-pop-pop (This morning: Tisburry, Pentagon, JWM-Meriwhether (of LTCM fame)).
  2. Lehman is facing renewed pressure and the short hedges are sweating them (drops 8%) on "rumors"
  3. Iceland (via RGE): "Doubts over the health of its highly-leveraged banks... To prevent a confidence run ... Thor Herbertsson said speculation of a crisis is “close to becoming self-fulfilling.”

I have hypothesized in the future that the hedgies death rate is probably a sweet spot indicator of the unfolding financial crisis. They are late and early in the sense that they are first in line for margin calls and they in turn impact the markets. The bottom may be within a quarter...

10 comments:

Andrew Meyer said...

Marc,

congradulations on making the Influential OSS list. If I see a list that has someone I know on it, I'm usually at the post office...

Or reading an "no longer functioning hedgefund list..." Hedgefunds going under is probably a good thing. The estimate I heard was that the mortality rate has been about 60%. As Warren Buffett famously stated, "when the tide goes out, you find out who's swimming naked."

You asked a while ago what I thought of Greenspan's call for reform of risk models. Are you referring to his Washington post interview or to something in his book? I haven't read his book, but but I've been heavily influenced by friends who work in finance and have maintained since '97, '98 that the FED had no option but to lower rates. They still maintain the same thing, though the logic is different.

The high-level logic seems to be that if the FED and Treasury can keep the markets liquid enough, the solvency problems aren't that big and can be solved via natural attrition (hedge fund death), controlled intervention (MBS buyouts) and matchmaking (Bear and JP).

A lot of money will be made during this process. I heard a very funny story Saturday of a financial manager stalling a hedge fund manager over the phone while he IMed his partner to liquidate their position.

You asked about my little software company. In "Crossing the Chasm" style, we are focusing on risk monitoring around IT projects to eliminate surprises an improve delivery. It's an SaaS/Consulting play that's paying the bills.

Our long term strategy is to leverage the same risk monitoring capabilities to offer corporate directors and officers a dashboard to monitor corporate initiatives at a depth relevant to their contextual understanding of those inititatives.

I believe that in the aftermath of the Bear Sterns and other corporate meltdowns, the SEC, ISS and insurance providers will shift responsibility for what happens in public corporations from management to directors and officers. These officers will want transparency into what is happening in their corporations without onerous time committments.

Anytime there is a change in regulations or enforcement, there are opportunities. I believe this is an emerging opportuity that will define itself in the next two to three years. If you have any thoughts about this, I would love to know them.

Andy

Marcf said...

Andy,

thanks for the post. Yes I was referring to the interview where he talked about "missing variables" in current risk models. The book doesn't really talk about state of the art risk modeling at all and kind of glosses over the systemic risk with a heavy dose of "market knows better" optimism.

I like the way to throw these little things as if it was candy:
1- hedge fund death. Probably a good thing indeed and the quicker the better. But we are talking about 1.5Tr in assets? A trillion here, a trillion there...
2- MBS buyouts: depression-era clauses brought back out from the dead.
3- Matchmaking at the last minute, due to the tangled mess the CDS market has become, thereby throwing a lot of doubt on the self-reliance of the counter-party surveillance mechanism. With their default, the financial system would have had to freeze for weeks, rumor has it that we don't have enough troops to enforce marshal-law since they are all in Iraq.

I am starting to rally to the point you are making that the solvency problems are not severe enough to be covered by the liquidity flush. Money will get created.


Lovely story about the fund liquidation.

Legislation. Limiting the amount of leverage that a system can take on through capital ratios is probably a good thing. The securitization greatly distributed the amount of risk in the system. In theory risk isn't bad as long as it is correctly priced. Pricing complex risk is well... complex and then it seems sometimes people just forget to price in stuff like "possibility of a housing recession" and it all goes to hell in a hand-basket.
Legislation could in theory be aimed at limiting the amount of leverage that is present in the system. 10x wasn't enough, banks bypassed legislation, shadow-banking went piggy with 30-40x leverage. A slight margin of error in pricing will wipe out equity in a New York femto-second

Andrew Meyer said...

Marc,

if it really comes to pass and it interests you, congratulations on Opération Lafayette.

I may well be flippant talking about hedge fund deaths. Three things make me this way.
1. only accredited investors should have money in hedge funds.
2. its a very small world and the people who lose their jobs are extremely well paid. they will take 6 to 18 months sabbatical to see how the world readjusts, and then reinvent themselves.
3. unadulterated jealousy.

As far as the MBS buyouts are concerned, did you see Marc Faber's estimate that housing values could fall up to 60% in Southern California? With nonconformance laws written the way they are and California being a nonconformance state, that spells disaster. Maybe I can get the fed to buy out my boat. (when I moved to LA in '06, I looked at the cost of housing and bought and live on a 50 foot motoryacht. Believe me, it's definitely the cheaper and much higher quality alternative.)

It is also interesting to note that estimated corporate earnings have not been readjusted to account for the slowing economy. That has the stock market still chugging up. That cannot go on. At some point corporations will start missing estimates. Financial institutions are down 40% since 1 Jan, you've sort of got to believe the rest of the market will join them.

You're right about securitization distributing risk and you're right that at one level, it is hideously complicated. At an intuitive level, it is a theory of the commons problem. There are many examples of theory of the commons problems, but the one I first heard described how English sheep herders benefitted grazing their sheep on common land, however, eventually there were so many of them on the common land that they killed the grass and eventually the sheep.

These will be very intereting times. As my econ professor was fond of saying, you can find data and analysis to support however negative or positive of an outlook you want to take. One thing I am sure of, the market doesn't know better.

Andy

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