Hedge fund blowups

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Murray Boyd
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Hedge fund blowups

Post by Murray Boyd »

Well, I've read that a number of quantitative hedge funds are taking a beating (search google news to find lots), including AQR, which was in the news a couple of years ago for betting on value stocks, if I remember correctly.

http://www.google.com/search?client=saf ... 8&oe=UTF-8

I wonder if we'll Taleb saying, "I told you so!"
Kaja Whitehouse at WSJ.com quotes Lehman Brothers’ Matthew Rothman who has been taking note of the extraordinary stresses the current market has been putting on quantitative investment models and those that invest in them.

“Wednesday is the type of day people will remember in quant-land for a very long time,” said Mr. Rothman, a University of Chicago Ph.D. who ran a quantitative fund before joining Lehman Brothers. “Events that models only predicted would happen once in 10,000 years happened every day for three days.”
-- http://abnormalreturns.com/2007/08/12/things-change/

Sure, blame the models!
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stratton
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Post by stratton »

I can't remember where, but one hedge fund manager said he was now 90%+ in cash. I assume he wasn't engaged in CDO or subprime leveraging or he wouldn't have been able to sell this easily.

I'm wondering how over blown the credit crunch is? I was talking to a mortgage broker and if you want a loan with 20% down, 30 year fixed and with a good credit rating the loan companies getting a loan is pretty easy. Last weeks 6.5x% 30 year fixed rate is now 6.25%. So it looks like "conforming" loans are doable. It's the "no doc" loans that are hard. The mortgage broker said no doc loans are 65% loan-to-value at a "high" interest rate. That's a 35% down payement.

This is anecdotal evidence and worth what you're paying to read it. :-)

Paul
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Post by Valuethinker »

stratton wrote:I can't remember where, but one hedge fund manager said he was now 90%+ in cash. I assume he wasn't engaged in CDO or subprime leveraging or he wouldn't have been able to sell this easily.
Although via derivatives, you can be 90% in cash and still have lots of exposure.

There is a group of hedge funds out there that are up 100% or more, having been short selling sub prime debt and the stocks of companies involved in sub prime.

Money is being made.
I'm wondering how over blown the credit crunch is? I was talking to a mortgage broker and if you want a loan with 20% down, 30 year fixed and with a good credit rating the loan companies getting a loan is pretty easy. Last weeks 6.5x% 30 year fixed rate is now 6.25%. So it looks like "conforming" loans are doable. It's the "no doc" loans that are hard. The mortgage broker said no doc loans are 65% loan-to-value at a "high" interest rate. That's a 35% down payement.

This is anecdotal evidence and worth what you're paying to read it. :-)

Paul
It's difficult to know. I certainly hear of people having their lines of credit pulled-- business and personal.

So far, the US and the world economy, underlying, are in good shape. So this should prove to be merely a passing storm.

It's not so much the collapse of non-doc loans in the US (small part of the US housing market and the world economy) as the cascading effect that they have caused on CDO ratings, etc.

The result is there is a 'buyer's strike' on, where deals can't get funded. The normal pools of liquidity have dried up. If this goes on, this will be bad for the economy.
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MossySF
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Post by MossySF »

Hayman Subprime up 100%+ in July alone shorting subprime -- and up 300%+ ytd.

http://www.bloomberg.com/apps/news?pid= ... refer=home

Hayman's letter to investors explaining the situation.

http://www.dealbreaker.com/images/pdf/HaymanJuly07.pdf

I've been browsing thehousingbubbleblog.com for about 9 months now -- perhaps the focus is too much on bad news but everything there backs up the above letter to the T. Every day, you read multiple quotes from sellers, borrowers, real estate agents, mortgage brokers that leave you speechless. Like this one which I actually read in my local paper first:
‘He was declined because they wouldn’t do stated-income loans above 90 percent anymore,’ Williams says. ‘If he provided full documentation for his income, he wouldn’t qualify for the loan because he doesn’t make enough money’
Uhh ... did this agent/broker just tell the newspaper he's helping a borrower lie about his income on mortgage documents? And the mortgage market freeze-up is the only reason why this fraudulent loan was declined?[/quote]
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Post by Valuethinker »

MossySF wrote:
I've been browsing thehousingbubbleblog.com for about 9 months now -- perhaps the focus is too much on bad news but everything there backs up the above letter to the T. Every day, you read multiple quotes from sellers, borrowers, real estate agents, mortgage brokers that leave you speechless. Like this one which I actually read in my local paper first:
‘He was declined because they wouldn’t do stated-income loans above 90 percent anymore,’ Williams says. ‘If he provided full documentation for his income, he wouldn’t qualify for the loan because he doesn’t make enough money’
Uhh ... did this agent/broker just tell the newspaper he's helping a borrower lie about his income on mortgage documents? And the mortgage market freeze-up is the only reason why this fraudulent loan was declined?
[/quote]

1. yes he did lie and he just told the newspaper that

2. no it's not the only reason, but it is the main reason. 2 years ago, with constantly rising housing prices, lenders didn't care, they just made the loans. So yes, the freeze-up is why this is not happening now.

it was a classic 'pass the parcel' game, with everyone taking their commission and passing on the risk. Lenders didn't care because they were only brokers/ originators. They securitised the mortgages by passing them on to investment banks rather than holding them on balance sheet as in the bad old days of banking. Investment banks repackaged the mortgages and passed them on to hedge funds, who levered their positions to buy them. Pension funds invested in the hedge funds (as well as taking the CDOs on themselves).

This is how European financial institutions are going bust on US financial malfeasance. If you are playing poker, and you cannot figure out who is the mug, you are the mug.

Investment banks had the right to 'put' bad mortgages back on the originators. But if the originators go broke, that's a useless guarantee. So investment banks were buying up originators.

Now the investors are suing the investment banks who are in turn suing the originators.

The worst part is the honest people caught in the middle of this. They'll be trying to pay their mortgages, or trying to reschedule, but they have no direct contact with the owner of their mortgage. The servicer, if it is still in business even, is just a call centre somewhere, and has no authority to take decisions. *this* will make the problem worse than previous downturns (as will the new personal bankruptcy laws, which will prevent/ delay the market from sorting this out).
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Post by larryswedroe »

few thoughts here

This is a very serious situation, not overblown at all. If anything UNDERBLOWN. The credit markets for non-Treasury paper basically locked up last week. Any weak credit, you could not sell at almost any price. And with the mark down in values leading to margin calls is why this is disaster potentially --for many.

You have potential now for vicious circle--Falling values, leading to margin calls, leading to forced sales into highly illiquid market with almost no bids (vultures will eventually show up) and thus you get pricing "gaps" with collapsing prices. Then it starts all over--you get more markdowns leading to more margin calls, etc.

I spoke with PIMCO guys and they told story about a fund that got margin call and had to meet $4b call by next day. They asked for bids. Only thing they could get any bids on was the relatively highest grade paper--high investment grade. PIMCO put a very low bid in, figuring if they got it fine, the paper was high quality. They got the bid because the seller was forced to sell. No choice.

If you see pressure on the Fed Funds rate then you know there is liquidity problem. That is what we saw last week. With all Treasury rates falling Fed funds rose because banks had to borrow to meet liquidity needs. That is why the Fed stepped in. And will likely have to do so again.

This really could get serious and a contagion could easily happen with spreads widening on all risky stuff very quickly and sharply. Or it could end quickly. As always my crystal ball cloudy. But for what it is worth I don't think we are near the end. Let alone at the end.

There is plenty of cockroaches to crawl out yet--risks showing up--One hedge fund expert from Lehman said this--pretty amazing--last week we had three days in row of events that our models said would occur once in 10,000 years. Thought I heard same thing from LTCM guys (:-))

Those that don't know their financial history are doomed to repeat it.

And it is periods like this that are why IMO you limit fixed income to the highest credit quality--equity risks showing up and you don't want the fixed income risks to show up at same time--you want them to be stable or rising (even better).
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one more thing

Post by larryswedroe »

Even pristine JUMBO mortgages which used to trade at 25bp over conforming loans (eligible to be sold to FNMA and Freddie) with full doc and perfect credit got hit real hard

The same loans last week GAPPED to 80bp over FNMAs even if you could get one (for less than perfect credits the spread obviously widened much more). That is huge change. Lenders lost on their pipeline about 4-5% of the value. And that is why you are seeing margin calls from the banks and that leads to shutdowns of mortgage lenders who cannot meet them.

This is very serious folks. The FED IMO will likely have to pump in huge amounts of liquidity.

I just hope they let the moral hazard play out--people need to learn that risk is risk. Take it and pay the price at some point. Not free lunch.
Robin
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Post by Robin »

I just hope they let the moral hazard play out--people need to learn that risk is risk. Take it and pay the price at some point. Not free lunch.
Agree entirely. FED needs to provide enough liquidity during a short-intermediate time frame to restart transactions so repricing can occur. But the investors holding the paper should have to take the hit, I agree.

Wonder how many pension funds will take a mark down. My DB plan at work is quite conservative ... likely not much exposure and already overfunded to boot.
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Random Musings
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Post by Random Musings »

FED needs to provide enough liquidity during a short-intermediate time frame to restart transactions
I believe these liquidity transfusions are very short in nature by the Fed - as I recall about 3 days in this case. Odds are, the ones in the crunch won't be able to sell (or have to sell lower than they want) - which will require more short-term liquidity infusions.

RM
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stratton
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Post by stratton »

Larry Swedroe wrote:There is plenty of cockroaches to crawl out yet--risks showing up--One hedge fund expert from Lehman said this--pretty amazing--last week we had three days in row of events that our models said would occur once in 10,000 years. Thought I heard same thing from LTCM guys ()
All those leveraged hedge funds would appear to each be a little black swan breeding ground. You get 10,000 of them doing close to the same thing and their models don't work any more.

The SEC was looking at all the financial companies last week to make sure they follow accounting rules and don't try to hide internal losses. Hopefully they'll find as many CDOs and CMOs as possible so we can work them out of the system.
And it is periods like this that are why IMO you limit fixed income to the highest credit quality--equity risks showing up and you don't want the fixed income risks to show up at same time--you want them to be stable or rising (even better).
Ah common Larry, live a little. Put 0.1% in some EM bonds. :-)

I bailed on any junk and EM bonds several weeks ago because of the can't sleep factor. I went through 100% equities in the last bear market, but the bonds need to be worry free.

Paul
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stratton
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Post by stratton »

Larry Swedroe wrote:I spoke with PIMCO guys and they told story about a fund that got margin call and had to meet $4b call by next day. They asked for bids. Only thing they could get any bids on was the relatively highest grade paper--high investment grade. PIMCO put a very low bid in, figuring if they got it fine, the paper was high quality. They got the bid because the seller was forced to sell. No choice.
I forgot about the vicious cirles from leverage.

What about bond funds holding more subprime than they let on? What I'm worried about what's listed as "AAA" isn't really AAA because they assembled a AAA tranch to mathematicly be AAA by a few basis points. When in reality its something like 85% AAA, 10% alt-a, 5% subprime. If a couple percent of those lower rated parts of the tranch default then its not AAA any more.

Theoretically you could take a bunch of alleged AAA tranches, assume they're fully AAA, and assemble more mathematical AAA tranches. Repeat the cycle a few times and your AAA could be almost half trash if repeated enough.

Paul
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Adrian Nenu
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Pack Mentality Among Hedge Funds Fuels Market Volatility

Post by Adrian Nenu »

http://www.nytimes.com/2007/08/13/business/13hedge.html


"Hedge funds with computer-driven or quantitative investment strategies have been recording significant losses this month.

The managers of these funds are the products of the trading desks of the big investment banks, like Goldman Sachs and Morgan Stanley, both of which have investment operations that use computer models.

The cross-fertilization has raised fears among some analysts that it is not only the hedge funds that are being hit, but the trading desks at the banks as well.

“These guys all know each other, and they all have the same strategies,” said Ernest P. Chan, a quantitative trading consultant who has done computer-driven research at Morgan Stanley and Credit Suisse. “They came from the same schools, and they get together for drinks after work.”

Looks like the efficient markets are adapting even faster to hedge fund strategies and becoming less exploitable.

Adrian
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Post by Valuethinker »

Robin wrote: But the investors holding the paper should have to take the hit, I agree.
Rest assured, whoever was holding the parcel when the music stops, will pay the price.

However it is the people who need credit in the ordinary course of business: whether a company (small or large) trying to fund its working capital, or an ordinary person trying to take out a mortgage, who are going to take the next tranche of pain.

The Commercial Paper market has more or less shut down. People are refusing to do business with some banks. This isn't hedge funds, this is *banks*.

When the banking system stops working, the economy doesn't take long to follow.
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simba
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Credit crunch / imploded hedge funds

Post by simba »

Financial Times has a wonderful interactive map of the global impact of the credit crisis.
http://media.ft.com/cms/29d73c76-473b-1 ... 9fd2ac.swf

This site tracks all the hedge funds that imploded.

Another interesting site is the Mortgage Lender Implode-O-Meter that tracks and lists all the mortgage lenders that have imploded.
They have a watch list for ailing lenders that are about to implode.
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baw703916
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Just a thought...

Post by baw703916 »

It seems like a lot of the problem with mortgage brokers making loans that nobody could repay, has to do with the borkers knowing that they weren't going to be holding the loan for very long...so as long as they could sell it to somebody else, they had no reason to act responsibly.

Would a requirement that a mortgage originator had to hold a certian percentage of loans made for a certain length of time, be reasonable, or meddlesome?

Of course, this wouldn't solve the problem of all the subsequent stupidity by hedge funds, etc. But common sense says that making loans that can't be repaid is bound to end badly, one way or another...

Best wishes,
Brad
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Re: Just a thought...

Post by Valuethinker »

baw703916 wrote:It seems like a lot of the problem with mortgage brokers making loans that nobody could repay, has to do with the borkers knowing that they weren't going to be holding the loan for very long...so as long as they could sell it to somebody else, they had no reason to act responsibly.

Would a requirement that a mortgage originator had to hold a certian percentage of loans made for a certain length of time, be reasonable, or meddlesome?

Of course, this wouldn't solve the problem of all the subsequent stupidity by hedge funds, etc. But common sense says that making loans that can't be repaid is bound to end badly, one way or another...

Best wishes,
Brad
Some kind of reversionary mechanism, to be sure.

However, the investment banks had the right to 'put' bad mortgages back on the originators. If the originators go broke, that right is less than useless.

There was an article in the Financial Times (which has had great coverage of this crisis) about the fraud in the sub-prime process. It reminded me so much of the late dot com bubble, down to the fraudsters who just took money and never bought houses with it. At some level, the Regulators were asleep at the switch.
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preserve
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Re: Just a thought...

Post by preserve »

baw703916 wrote:It seems like a lot of the problem with mortgage brokers making loans that nobody could repay, has to do with the borkers knowing that they weren't going to be holding the loan for very long...so as long as they could sell it to somebody else, they had no reason to act responsibly.
Its the people that created the structure. The mortgage brokers are/were a bunch of pawns. They were paid to do what they did.

Walstreet execs well knowingly used and payed mortgage brokers to do the dirty deed. They too were paid with bonus's and stock options for helping the mortgage brokers along.

Mega Bonus's and Options are the ultimate moral hazard we have in our corporations and walstreet.
edge
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Re: Just a thought...

Post by edge »

preserve wrote:
baw703916 wrote:It seems like a lot of the problem with mortgage brokers making loans that nobody could repay, has to do with the borkers knowing that they weren't going to be holding the loan for very long...so as long as they could sell it to somebody else, they had no reason to act responsibly.
Its the people that created the structure. The mortgage brokers are/were a bunch of pawns. They were paid to do what they did.

Walstreet execs well knowingly used and payed mortgage brokers to do the dirty deed. They too were paid with bonus's and stock options for helping the mortgage brokers along.

Mega Bonus's and Options are the ultimate moral hazard we have in our corporations and walstreet.
This is correct. Has everyone forgotten the massive bonuses handed out just a few months ago? Now a lot of those bonuses are based on performance that has evaporated. Too bad the bonus hasn't evaporated.

There is a serious, short term, moral hazard that can screw up the capital markets.
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baw703916
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In defense of regulation

Post by baw703916 »

I respectfully think that you all may be misinterpreting the gist of my comment a little. Greed and stupidity certainly are nothing new, nor are they likely to go away anytime soon.

Corporate executives paying themselves handsomely for doing deals of dubious prudence is...well, par for the course.

But that's where a responsibly regulatory agency is supposed to come in. Requiring the loan originator to hold a certain portion of the loan portfolio would make it much more difficult for bankers to pay mortgage brokers to "do the dirty deed"

Sure there's plenty of blame to go around. But selling mortgage-backed securities based on mortgages that aren't properly underwritten and whose risk therefore can't be properly assessed, is pretty much fraud in my book.

Best wishes,
Brad
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