The Tasgall Group

Hedge funds may not be imploding (at least not yet), but certainly some investors are going to be angry about the returns for some of their “Hedge” funds (as Quicksilver has pointed out in the past, very few hedge funds live up to their name by actually hedging).

The guys over at DealBreaker (a self-proclaimed Wall Street Gossip Rag) have posted a list of letters going out to hedge fund clients, as well as a non-verified list of returns for some of the big boys. Losses range from the respectable (-2.3% YTD) to the ridiculous (-66% YTD).

Every investment strategy has drawdowns and periods when their strategy doesn’t work, so it’s not really fair to point at the returns for this year and make any real conclusions. We will, however, see how well the managers set investor expectations for events like this, as well as whether or not their leverage ratios really factor in all the adverse market conditions we’ve recently experienced.

Just a quick comment on something I’m observing… the TIP/TLT ratio is falling rather quickly, which implies that market expectations of inflation are dropping. In fact, this indicator argues for a big deflation scare that is coming down the pipeline.

Yes, the bailout, Fed actions, and Treasury spending all are hugely inflationary, but I am pretty sure you’ll be hearing more about deflation soon.

Ok, people, if this?thing is going to happen, that obviously sets us up for a certain future, depending on your views. So, if you had $100,000 to invest in the aftermath of a bill passing and you had total flexibility (within reason, e.g. stocks, options, futures, metals, Treasuries, FX), do you have a bead on an optimal “Living-with-the-Bailout” portfolio/asset allocation plan? I’m stumped right now (or rather more concerned with stopping the bill that dealing with the aftereffects) but wondered if any of you smart dudes had one in the works. And I obviously know that you all will be concentrating on things like debt reduction etc. but I’m interested more in your ideas for profiting from this even if you don’t plan to actually pursue that route. I’d also like to see how the plan ties into your outlook for various markets.

Wonder why the US Dollar is so strong against the Euro lately? The European banks were apparently using AIG to get past capital reserve requirements… and with AIG being knocked out of the game, a lot of problems start piling up quickly…

The K-10 annex of AIG?s last annual report reveals that AIG had written coverage for over US$ 300 billion of credit insurance for European banks. The comment by AIG itself on these positions is: ??. for the purpose of providing them with regulatory capital relief rather than risk mitigation in exchange for a minimum guaranteed fee?. AIG thus helped to organise regulatory arbitrage on a gigantic scale. A formal default of AIG would have had a devastating impact on banks in Europe. This explains why AIG?s problems had sent shock waves through the share prices of European banks. For the time being the US Treasury has saved, inter alia, the European banking system, but given that AIG is to be liquidated European banks now have to scramble to find other ways of obtaining the ?regulatory capital relief? they appear to need urgently.

Get all that? It’s less well known than it should be, but Europeans banks have long been gaming their regulators, having far less than the actual capital reserves that they needed given their balance sheets. AIG filled the hole, selling credit defaults swaps to European banks via which they could tell regulators that they were adequately covered — at triple-A, no less — while carrying less cash than required.

From Kedrosky.

As a note about how quickly things change… the BDI (Baltic Dry Index) has gone from a little over $11,000 in May 2008 to right around $3,200 today. I’m not sure what units that is measured in (dollars per ton per 1000 miles?), but if you’re shipping tons of raw materials by ship, you just saw your shipping costs get cut by over 2/3 in about 5 months.

This isn’t some stock market where we have “evil short sellers” or forced selling through margin calls… and it’s not a bond market where people are refusing to lend each other money… this is the material cost to ship something around the world, and it’s crashing hard.

One. Just one stock in the S&P 500 was up today [9/29/08]. And guess which one it was? Campbell Soup (CPB). Talk about a bomb shelter stock!

–Bespoke

I think we all know the story of Cassandra in Greek Mythology… where Cassandra could see the future, but no one would believe her.

While I read John Mauldin’s weekly email this morning, I couldn’t help but think back to the many dire warnings that Mauldin had back when “the music was playing” and everyone was convinced there was little wrong in the world of high finance.

A friend asked me a couple months ago, “didn’t anyone see the current situation coming?” My answer was, yes, more than a handful of people warned about everything that has been happening… and they were all laughed out of the room; they were dismissed as crazies…

Mauldin’s true bent is not that of perma-bear… but rather that of contrarian. When the music was playing, he pointed out the dangers. Now that the dangers are front-and-center, he cites where the markets have gotten too pessimistic. In the process, he makes a few comments that I feel compelled to write about. The comment that struck most loudly was this:

Again, the US government is the only entity with enough size and patience to act. We do not have to bail out Wall Street. They will still take large losses on their securities, just not as large a loss as they are now facing in a credit market that is frozen. As noted above, there are many securities that are being marked down and sold far below a rational price.

I certainly don’t want to be running a business, market, or industry in such a way that the US Federal Government is the only hope for long-term success. Maybe everyone else has more faith in government and congress than I do…

Where are we now? A $700 Billion Federal Government Stabilization Plan (pronounced: Bailout) is required to keep the entire country from falling into economic ruin. I would argue that if there was even a 1% chance that this situation would be reached — we have serious shortcomings in that industry, and we need regulation and rules to keep it from happening (in contrast, instead of 1%, the current situation was pretty much inevitable). And if that’s the point we’re at now, we’re better off starting a new set of banks with this money than bailing out the current ones who created such a clusterfuck (that one word truly describes the inter-connected nature of the current situation).

[Sidenote: Incidentally, more than a few of the rules actually were in place, such as a 12-to-1 maximum leverage ratio… and that rule was waived for 5 wall street firms on a special exemption so they could lever up to 30 and 40-to-1.]

Quite frankly, I find it shocking that Mauldin is standing up for so many who made mistakes that he forewarned of, yet their excuse is “everyone else was doing it,” and “I wouldn’t have made my quarterly numbers” (and that includes the ratings agencies). No wonder no one but the US Government has the patience to act — we’ve trained everyone to think short term, and the current government bailout would only re-enforce this bad conditioning.

As to the rationality of pricing these assets… if Mauldin thinks they are so irrationally priced, why doesn’t he act? Why doesn’t he put his money (and the many hedge funds who he works with) to work? If those buyers avoid leverage, then they have very little at risk, according to Mauldin’s logic. Ah, I made two critical assumptions in that rhetorical statement… that anyone in the investment world can avoid the siren song of leverage, and that Mauldin’s logic is correct that pricing is irrational.

Maybe Mauldin has forgotten one of his own points, in a secular bear market, ratios get compressed… he made the point when talking about stock P/E ratios falling in a decade-long trend, but why wouldn’t it apply to the returns on an investment like the tranched mortgage paper as well? Investors would expect to see higher returns in the future, rather than lower returns…

This other quote from Mauldin is also telling…

The average voter? They will see stock market investments off another 25% at the least. Home prices will go down even more.

I guess that a perpetually rising stock market and home price should be added to the entitlements that the US government (or more specifically, our politicians) want to guarantee to the US public. I recognize Mauldin is writing an open letter to a politician, and that is what resonates… but I for one, am disgusted that those in favor of the bailout to cite further declines in the stock market and house prices as rationale and motivation for the bailout. Stocks will stop falling on their own accord; house prices will stop falling when they are affordable again. No government bailout will allow us to skip the corrections in price that are required.

Let me try and have my own little Cassandra prediction… the bailout will be passed, maybe even tomorrow. And the markets bounce, maybe even for a month or two. Everything that Still-President Bush warned of in his speech the other night (failing banks, stock market falling, retirement accounts falling, home values continuing to fall, foreclosures continuing to rise, and more expensive credit for businesses and farmers) still happens. But, luckily, the elections will be over by then… And by then, all the politicians who spend other people’s money on bailouts will either have their job renewed, or it will be someone else’s problem.

But now, I don’t have all of Cassandra’s problems… after all, in mythology, Cassandra didn’t have her own brokerage account. I’m positioned for a bounce, but I also don’t think the bear market is over.

As someone with Georgist sympathies, that’s too bad.

I don’t normally get political here so I’ll just say that if you happen to be suspicious of this bailout stuff, you might want to check out this site which is both an analysis and a petition that you can sign if you want to tell the people in charge just where they can stick it. Not that I have an opinion, mind you. Surely not.

What does this have to do with the free market? As Kevin?Carson?likes to say, if this is the free market, then I’m against it. Of course, it is not the free market. The free market is a profit and loss system void of privilege. When businesses fail, they are supposed to actually fail, not turn to the taxpayers. What we really have is (state or political) capitalism, corporatism, or fascism. An essential characteristic of this system is that while profits are private, losses are socialized, i.e., ultimately covered by the mass of people without political clout.

It is worth making an aside here. When the banks actually run out of money they can?t lend. Asset prices depend critically on the ability to borrow against them (and that includes the price of current mortgages in the secondary market). When the banks can?t lend asset prices can fall to very low ? indeed insanely low levels. At the height of the crisis some 2 bedroom apartments walking distance from the centre of Oslo (one of the richest cities in the world) and with full 180 degree fjord views traded hands for USD15000. You would have easily made 30 times your money buying those properties. Property prices can fall to very low levels without any bank lending. Indeed the ability to borrow to buy assets is often crucial in maintaining their prices?

…from this article on the Norwegian financial crisis. Credit-based inflation…an idea at the same time obvious?(once you are made aware) and profound. The implications of this for the idea of wealth, poverty and the understand of value are bone-chilling. Or am I making too much of it?