in bad times, you necessarily start to liquidate your (seemingly) good investments

From Felix Salmon:

"Hedge Fund Datapoint of the Day

This is how badly the hedge-fund universe is being shaken out these days: John Paulson lost 16% of his assets under management in the second half of 2008, and still managed to rise to 3rd place in the list of biggest hedge-fund managers, from fourth place at mid-year. Or, to look at it another way, $29 billion in funds under management was enough to garner him eighth place in January 2008, but the same number got him the bronze medal this year.

Paulson's flagship fund returned 38% last year, largely thanks to short bets which paid off when the market tanked in October. Let's say that his investors saw a 20% return in the second half alone, and that he started the second half managing $34.5 billion. Then by the end of the second half, if he'd had no redemptions, he would have been up to $41.4 billion; in fact, however, he was down, to $29 billion. Which implies that even John Paulson -- the one person who seems to be doing unambigously well during this crisis -- got a whopping $10 billion of redemption requests in the second half of 2008.

Now some of that will have been due to simple common sense and portfolio rebalancing: if one of your funds does very well while most of the rest lose money, then in order to keep your asset-allocation decisions constant you need to redeem money from the successful fund and invest it in the less successful ones. If you don't, you end up with too many eggs in one basket.

But I suspect that quite a lot of the requests are a function of a simple need for liquidity: people needing money. It's the same phenomenon which did for Bernie Madoff: in bad times, you necessarily start to liquidate your (seemingly) good investments. Fortunately for his investors, John Paulson, unlike Madoff, is not a crook."

Me:

This also goes to the point about not letting Debt-Deflation run its natural course, as Justin Fox mentions today as well. There's no telling where it will end. It's a spiraling downward with no natural stopping point, because you can't predict who and how much and under what conditions investors will flee to safety, or when they'll stop.

So, it leads to this:

"in bad times, you necessarily start to liquidate your (seemingly) good investments."

When people are fleeing John Paulson, you know that you're in the path of some major panic.

If you don't see Debt-deflation as the problem, I can understand saying let it all shake out as it will. If you do, taking that chance seems crazy. You might well shake out enough wealth that only major social change will suffice. Good luck then.

By DonthelibertarianDemocrat Posted: Mar 12 2009 4:57pm ET

there are funds which have easy enough to mark to market assets and where the assets are sufficiently liquid are refusing to give money back.

From John Hempton:

"John Paulson accuses his competitors of theft or fraud

I was reading Paulson Funds latest client letter (hat-tip Kedrosky). It is an enviable list of the things he got right this year. However one section jumped out at me – a hand grenade thrown at about 100 hedge funds:

Redemption policy

As a firm, we have not imposed any gates or other restrictions on clients withdrawing their assets. While we recognize the difficulties of the current environment, we think it’s a manager responsibility to raise liquidity to meet the needs of their investors. There is plenty of liquidity in the markets. Even in opaque areas of the markets such as in bank debt, mortgage backed securities and other distressed securities, we see hundreds of millions of dollars trading every day. We are especially surprised that many managers have restricted client withdrawas when: 1) the total redemptions are manageable (15-25% of AUM); 2) the managers have the cash; and 3) one of the stated reasons for restricting withdrawals is so the manager can continue to invest in new opportunities. Emphasis added.

I read this as John Paulson saying that there are funds which have easy enough to mark to market assets and where the assets are sufficiently liquid are refusing to give money back. Theft or fraud. Or maybe both. Moreover the liquidity according to Paulson is sufficient that funds almost never should have stop withdrawals – even in opaque areas of the market.

Now I guess it is up to John Paulson to name names – or perhaps some enterprising WSJ reporter can do it for us. Whatever – this is a big story.

John Hempton

Me:

Don said...

I agree with you about pricing and buying. Paulson and other investors have been buying since November when TARP looked to be out of the Toxic Asset business and the price fell. My theory was that the holders of these assets want and are waiting for government intervention of some kind. In fact, Liddy said just that. He considers AIG's money to be a bridge loan in order to avoid selling assets at a fire sale price.

I understand you to be saying that one way to avoid being caught up in a Calling Run is to say that you can't fulfill the calls. This would be fraud, and would also go some way to explain the supposed lack of liquidity in this market. If this is true, you have certainly seen a very important point.

Don the libertarian Democrat

February 2, 2009 9:49 AM

So what’s next for Paulson?

From Clusterstock:

"John Paulson Hits It Out Of The Park Again

John Carney | Jan 30, 09 3:54 PM

Warning: if you are having a bad day in the markets you might not want to read on any further. If you had a miserable year last year, you also might want to skip past this item in favor of all our other articles about people who are losing money just like you. Because the subject of this article is a guy who did really, really well last year.

We’re talking, of course, about John Paulson. He’s the incredibly prescient guy who made a fortune shorting the mortgage industry in 2007. And last year he did it again, largely by shorting financials.

Some highlights from the 20-page annual report for Paulson & Company that was obtained by the New York Times. (You can read the entire report here.)

• Paulson Advantage Plus, a levered fund with roughly $7 billion in assets, went up 37.6 percent. That’s after fees. How did it do so well? Mostly by better against large financial firms, including Fannie Mae and Freddie Mac.

• The non-leveraged version of the fund Advantage fund gained about 24 percent.

• Paulson’s merger arbitrage funds were all up, with the largest up 12.55 percent. How could Paulson clean up in merger arbitrage in a year when so many deals went bad? By being very careful about which deals it be on. The biggest bet was that InBev’s bid for Anheuser-Busch would go through. Paulson eventually became the largest single shareholder of Anheuser-Busch stock. That resulted in the largest return from a single investment Paulson has ever made.

Of course, no one is perfect. Several investments lost money. Which ones? Basically, the long portfolio. Paulson, it seems, just wasn’t negative enough.

So what’s next for Paulson? Here’s how DealBook describes it:

The biggest opportunity Mr. Paulson sees this year is in buying distressed debt and the firm has targeted about half the Advantage Fund’s assets to that strategy. His firm’s two credit funds were up about 19 percent and 16 percent respectively last year as they resisted the temptation to buy distressed debt such as mortgages and leveraged loans even though they were trading at what appeared to be attractive prices.

“We remain bearish on the outlook for the U.S. economy and believe the recession will extend into late 2009 and likely into 2010,” Mr. Paulson said in the letter. “The sharp contraction in the global economy, the instability of the global financial system and the ongoing credit contraction are unlikely to be resolved in the first half of 2009.”

Me:

Don the libertarian Democrat (URL) said:

Jan. 31, 11:57 AM

My understanding of Paulson's actions are a bit different. After the government seemed unwilling to buy Toxic Assets, the price fell dramatically. At that point, right at the end of the year, Paulson and a few other hedge fund managers began buying them. The question then was whether it was for a trade if the government stepped in and raised the price of TAs, or for a long term hold. I read him as continuing this policy. Of course, this means that:
1) TAs can be priced
2) If the government buys them, the price will go up
3) Some of the better deals are being snatched up

# Focus on long distressed opportunity * Mortages * Bankrupt debt * Disteressed * Capital restructurings

From Paul Kedrosky:

"John Paulson's Year-End Letter

The NYT's Dealbook has obtained a copy of John Paulson of hedge fund Paulson & Co.'s year-end letter, and it is a must-read. Paulson blew the doors off last year, heavily shorting financials, both directly and via credit default swaps, turning in 37.6% return net of fees. That is beyond outstanding in a year that destroyed many other other funds' reputations.

Looking forward to 2009, Paulson remains highly bearish. Here is his general strategy, he says, for the first half:

• Slight short exposure to equity markets
• Remain short financials
• Focus on long distressed opportunity
• Mortages
• Bankrupt debt
• Disteressed
• Capital restructurings
• Focus on strategic merger deals
• Maintain short focus on financials, with the belief that we only perhaps half-way thru.

The letter is at the NYT."

And me:

• 0
• Vote up
• Vote down

• Don the libDem

I've read that, after TARP shifted to recapitalization, the price of Toxic Assets dropped significantly, and Paulson and a few other hedge fund managers starting buying them. I concluded from that:
1) Toxic Assets can be priced
2) Owners of TA were hoping for government intervention
3) If the government decides to buy TAs, the price and availability will magically go up
4) Hedge fund managers will buy a number of the best TAs
It looks like buying TAs is part of his strategy in that letter, but the graphics are hellish to read.
As for financials, I wonder if he sees nationalization of some banks as a real possibility. I think he's very savvy, and listen to him.
Also, I wonder what happened to his charity devoted to helping defrauded borrowers get legal help. From that, I concluded that his position is close to mine, which is that many of the worst loans were actually fraud.

"So let's assume that fraud gets a free pass. "

Arnold Kling picks up a point made by John Paulson in his congressional testimony that I agreed with. First, here's Paulson:

"The Institute, launched with a $15 million grant from investment management firm Paulson &
Co. Inc., will provide funding and training to organizations that help homeowners negotiate
alternatives to foreclosure. The majority of the funds will be grants to support direct legal
assistance to borrowers in 10 or more states to fight foreclosure, predatory lenders and abusive
loan servicers. It will do this primarily by providing money to top non-profit legal-aid groups and
law school clinics."

Here's my comment:

"Since this is mainly legal help, and the loans are called abusive, maybe we should be doing what I say, which is examine the legality of these loans."

Here's the Kling post:

"Thomas Cooley writes,

The most important role for public policy is to provide incentives for servicers to restructure and modify loans, to make certain that shared appreciation contracts are part of the policy mix, and to address the legal barriers to modifying securitized loans.

Pointer from Greg Mankiw.

My wife says that I became too angry and agitated at the hearing when Ed Pinto suggested that we need a major effort at loan modifications. I do become angry and agitated every time one of these suggestions gets made.

What are the standards that you are going to use to determine eligibility for loan modification?

Many (most?) of the loans that you would be modifying involve fraud. Sometimes, it was the borrower who deliberately committed fraud. But most of the time, it was the mortgage broker. We won't be able to sort that out. So let's assume that fraud gets a free pass."

See, I don't make that assumption. However, it's becoming obvious that my idea, and Paulson's it seems, to legally challenge these mortgages is going nowhere. I suppose people will claim that it will take too long, but I actually believe that people simply don't want to deal with this legal mess. Now, it's possible that people might begin taking Fraud, Negligence, Fiduciary Mismanagement, and Collusion seriously, given this Madoff mess among others, but I'm not holding my breath.

"What we need is an honest housing market, with legitimate owners, legitimate renters and prices that balance supply and demand. Loan modifications undermine the honesty of the market. They delay the necessary adjustments. With foreclosures, it might take two years for the housing market to find a bottom. With loan mods, it will take at least ten years.

Why is loan restructuring so popular? I think it's because people are in denial. They want to think that there is some feel-good way to avoid severe adjustments in housing. But loan restructuring will worsen the pain, not relieve it."

I don't know what the correct adjustment is, and I doubt that anybody does, even experts. I don't mind a few marginal attempts to ease this fall, or try and feel out a bottom, but, as of now, I still believe that we should let housing prices fall, for reasons I've already given. Namely, I believe that it would be better for the buyers. I agree with Kling that the most generous explanation of this Flight From Fraud is yet more Wishful Thinking, a desire to get this mess over as quickly as possible, whether or not the plans offered for renegotiating mortgages would in fact do that. One big problem I have is that I believe that servicers and lenders, and, in some cases, borrowers, realize that there is this Flight To A Quick Solution Through Government Action, and have been holding out or dragging their feet in hopes of provoking such action.

As I've said with TARP, the only real solution would be for the government to go in and impose a settlement, but, in this aspect of our crisis, the legal problems are, in my mind, insurmountable. They would result in unconstitutional seizures of property, at the very least. The solution, to the extent that there is one, is going to be a number of attempts to help this situation which will, in the best possible case, marginally ease the problem. God forbid we make matters worse, but that's a real possibility.

Again, I believe that Massive Fraud is being left unexamined and unprosecuted. Stick that up your Moral Hazard Pipe and smoke it.

"“You have to be simple to have a clear strategy,” Paulson says. "

I have a few financial types I like. Don't ask me why, I'm no investor, and I don't always agree with them. Warren Buffet is one, and William Gross, who I might post about later, and I'm coming to like John Paulson. Not because he's making money now. Buffet and Gross are doing fine, but they're not exactly seers. There's something about the way he looks at the world. That's why I like Hendry. Believe me, there's nothing they say that helps me invest.

Before I go on, I feel that way about politicians. Some I like, and some, well, most I don't. I like Barry Goldwater and George McGovern, Bob Dole and Tony Blair, Robert Taft and Sam Rayburn, Benjamin Disraeli and Abraham Lincoln, John Randolph of Roanoke and Edmund Burke, Clarendon and Bolingbroke, Thomas More and Sir John Falstaff, and I'm more of an Akiva man than a Yishmael man, truth be told. To me, the two greatest men of the last half-century are MLK and Mandela, but I don't agree with a lot of their positions. So what. I love Samuel Johnson even though I find him often totally wrongheaded.

Now, to Paulson. All that to talk about an investor. I find odd juxtapositions edifying:

"Paulson Bucks Paulson as His Hedge Funds Score $1 Billion Gain

Email | Print | A A A

By Richard Teitelbaum

Dec. 2 (Bloomberg) -- There’s not a lot of light in Paulson & Co.’s 28th-floor headquarters on a drizzly November afternoon. The Alexander Calder sculpture and multicolored prints have been shipped to the firm’s new offices six blocks south. Darkness envelops the New York skyline.

The Dow Industrials have lost a total of 929 points over two days, and the jobless rate is poised to hit 6.5 percent. And John Paulson, who oversees $36 billion in hedge fund assets, isn’t exactly Mr. Sunshine either.

“You have deterioration in almost every asset class,” Paulson says. “You’re looking at declines in housing prices, the health of manufacturers and the earnings of various companies. There are rising delinquencies in auto loans and commercial real estate.”

Paulson, 52, peers over his tortoiseshell glasses. “There’s more to come,” he warns.

Paulson doesn’t smile as he says this, even though with each new calamity his bottom line grows. Paulson & Co. funds generated profits of more than $3 billion for the firm in 2007, mostly by betting the housing bubble, swollen with subprime mortgages, would burst.

As that year ended, he set his analysts poring over the balance sheets of overstretched financial institutions, including many in the U.K. “We focused on those banks with lots of mortgages,” Paulson says. “After those companies fell, we expanded our focus not just to mortgage assets, but to all credit classes.”

The payoff: Four of Paulson’s funds were among the 20 best- performing, and the 20 most profitable, hedge funds for the first nine months of 2008, according to data compiled by Bloomberg, other hedge fund research firms and investors.

$1.05 Billion Profit

The Paulson funds’ gains ranged from 15 percent to nearly 25 percent. Based on those returns, they were on track on Sept. 30 to furnish Paulson & Co. with $1.05 billion in profits.

Paulson’s performance was a striking success in a disastrous 2008 for hedge funds. The industry is reeling from convulsing markets, fleeing investors and the most serious credit squeeze since the 1930s.

Why do I think that this is important? Because this is how I believe we should understand oversight and regulation. We should be looking for the down side. Regulators should be Value Investors and Short Sellers. They should be people like Paulson.

"Paulson, sporting a French-cuffed shirt and patterned tie, looks every bit the investment banker he was when he worked for Bear Stearns Cos. in the 1980s. He says his firm’s 2008 performance benefited from market hedging -- balancing out short positions with long ones.

British regulatory filings show that Paulson funds made short-selling bets totaling more than $1 billion against Barclays Plc, HBOS Plc, Lloyds TSB Group Plc and Royal Bank of Scotland Group Plc. On average, the shares of those banks lost more than half their value in the nine months through September.

Unforgivable

The billionaire points out that his funds also went long in sectors likely to do well in a recession, including health care, utilities and tobacco. Paulson says he’s at a loss to explain why other funds were not hedged like he was. “Investors will forgive you if your returns are below average for a period,” he says. “They won’t forgive you if you lose money.”

Paulson’s returns have catapulted the soft-spoken native of Queens, New York, into the spotlight of the investing world. “This is rock star status,” says Sol Waksman, founder of Barclay Hedge Ltd., a Fairfield, Iowa-based firm that tracks and invests in hedge funds.

At a March 2008 fund of hedge funds awards dinner at New York’s Pierre hotel, Paulson & Co.’s performance was the buzz of the evening, with many of the winning managers having invested in its funds.

“Almost everyone who received an award thanked Paulson,” says one person who attended.

Paulson keeps a low profile, even by hedge fund standards. Raised in the waterside neighborhood of Beechhurst, he’s the third of four children of Alfred and Jacqueline Paulson. He credits the New York public schools, with their programs for gifted children, with giving him a leg up.

“I always had reading and math skills four or five years ahead of my grade,” he says.

Summa Cum Laude

After graduating from Bayside High School in Queens, he went to New York University, where he earned a bachelor’s degree in finance, summa cum laude, in 1978. As valedictorian, Paulson gave a graduation speech on corporate responsibility.

He went on to earn an MBA at Harvard Business School in 1980, finishing in the top 5 percent of his class. At the time, he says, banking jobs were scarce. He settled for a spot at Boston Consulting Group Inc.

Two years later, he landed an associate position at New York- based Odyssey Partners, an investment firm run by Leon Levy and Jack Nash. An Odyssey specialty was risk arbitrage, in which traders typically buy the stock of takeover targets and short that of the acquirer.

Paulson says Levy and Nash, both now deceased, taught him about risk arbitrage, real estate investing and how to profit from bankruptcies.

Levy a Mentor

“Leon was brilliant,” Paulson says. “A lot of what I know about deals today, I learned from them.”

Paulson left Odyssey to join Bear Stearns’s mergers and acquisitions department in 1984, rising in just four years to managing director.

After Bear sold shares in 1985, Paulson says, he decided he didn’t want to work for a publicly traded company and in 1988 joined privately held Gruss Partners, another risk arbitrage firm. Founder Joseph Gruss taught Paulson an important lesson.

“Joseph Gruss used to say, ‘Risk arbitrage is not about making money; it’s about not losing money,’” Paulson says."

That's great advice. Don't lose the taxpayers money.

"Paulson & Co, which he founded in 1994, also started as a risk arbitrage firm. Over the years, Paulson launched new funds to exploit market trends.

“We always operated with a lot of hedges,” he says. “We try to minimize market correlations. If you don’t, you’re going to be exposed when a market event happens.”

600 Percent Gain

He started the Paulson Credit Opportunities and Credit Opportunities II funds in 2006 after anticipating a shock in the housing and mortgage markets. In 2007, the funds racked up gains of more than 600 percent. They’re in the top 20 funds of the 2008 Bloomberg rankings for both performance and profits.

Paulson said in mid-November that more than 50 percent of the assets he managed were in cash and that the money he had invested was equally weighted between short and long positions.

“You have to get to the corner to see around the corner,” he says. “We haven’t gotten to the corner.”

He expects 2009 to reward those who invest in restructurings, strategic acquisitions and distressed credits. In November, Paulson began buying bonds backed by home mortgages, according to an investor. Spokesman Armel Leslie declined to comment. In making his investments, Paulson focuses on straightforward themes.

“You have to be simple to have a clear strategy,” Paulson says."

Bingo. That applies to TARP, regulations, you name it. I believe it, even though I couldn't make five cents running a Hedge Fund.

Now read this:

"Quant Strategies

Don’t tell that to Simons, who has earned billions for his firm through often-complex quantitatively driven trading strategies. Simons helped start Medallion in 1988 and continues to oversee the fund from Renaissance’s gated headquarters in East Setauket on New York’s Long Island.

Medallion assesses Renaissance employee-investors what may be the highest fees in the hedge fund business: a 5 percent management fee and 36 percent of profits.

Medallion has thrived in volatile times. In 1994, when the U.S. Federal Reserve raised its fed funds target rate six times to 5.5 percent from 3 percent, Medallion returned 71 percent. In 2000, when the Standard & Poor’s 500 Index fell 10.1 percent, Medallion returned 98.5 percent net of fees. In 2007, when markets began melting down, it gained more than 70 percent.

Today, Medallion is almost exclusively owned by Renaissance employees, who include mathematicians, astrophysicists, statisticians and computer programmers. They search for patterns and correlations that can divine a market’s direction. The fund spreads its bets around the world, trading everything from soybean futures to French government bonds.

Skating Along

Simons told Congress in November that Medallion, like Paulson & Co., was long and short equal amounts of equity. “By and large our business is not highly correlated with the stock market,” he said. “And so that is how we have skated along here.”

Medallion is just one of many funds that used mathematical models to profit in the first nine months of 2008. Of the 20 best performers in the Bloomberg ranking, at least six employed such strategies. One was Man AHL Diversified, No. 20 in the Bloomberg best-performance ranking, returning 7.7 percent. That gain means manager Tim Wong was on track to earn London-based Man Group Plc $72.5 million through the third quarter, according to Bloomberg data.

Man AHL typically uses computer-designed models to invest based on market trends. Fund managers that follow this path are known as commodity trading advisers, or CTAs, though their funds don’t necessarily invest solely in commodities."

Okay. They're smart chaps. But I'll stick with Paulson's modus.

"A Premium Price

“The entire premise for the hedge fund industry is that you were paying a premium price for low correlations with the markets,” says Daniel Celeghin, a director at investment management consultant Casey, Quirk & Associates LLC in Darien, Connecticut.

Managers like Paulson zigged while others zagged. That means new money by the billions is likely to come their way. Paulson managed just $7 billion in late 2006, an amount that has grown fivefold.

“Even after the trillions of dollars that have been lost, there is still a tremendous amount of money lying about,” says Barclay Hedge’s Waksman. “There is more money than there are good places to put it. Good managers are scarce.”

That, in the end, may be the most important lesson to be learned from the 2008 market rout."

Fine. Death and Rebirth. Throw in Creative Destruction now. It all comes down to people. Human Agency. Even to read the models. That's why good managers are scarce. You'd better get some as regulators, or write the regulations so that even a dunce like me can follow them.

Why Is John Paulson Buying ?

Earlier I had a post about this John Paulson post in Bloomberg:

"John Paulson, the hedge-fund manager who generated sixfold returns last year with the help of bets against subprime mortgages, has started buying debt backed by home loans, investors said.

Bonds linked to U.S. residential mortgages fell last week after U.S. Treasury Secretary Henry Paulson abandoned plans to buy distressed securities using money from the $700 billion Trouble Asset Relief Program. The ABX-HE-PENAAA 07-2 index of credit-default swaps tied to AAA-rated securities has fallen 13 percent to 36.25 since the Treasury’s announcement on Nov. 12, according to Markit Group Ltd. That indicates the bonds might fetch about 36 cents on the dollar.

John Paulson, whose New York-based Paulson & Co. oversees $36 billion in assets, said at a conference in June that he sees “opportunities this year” to buy mortgage-backed debt. While he said it was “premature” to start buying, the ABX indexes have since fallen 35 percent.

“Paulson’s timing is typically very good,” said Louis Gargour, chief investment officer of LNG Capital LLP, a London- based hedge fund that invests in distressed credit markets. “Pulling the TARP program was the last straw for this market. Now that Paulson is buying others may say this is a great trade.”

Gargour said he isn’t buying residential securities for “technical” reasons, including the prospect for legislative changes to home-foreclosure rules in the U.S."

Now, again, the importance of this is deciding whether Paulson is buying for technical reasons, in order to sell if and when the government intervenes, or whether he's investing for the long run. If it's the latter, this would matter for a number of reasons, including whether there actually is a hope that AIG can weather this crisis, and we can redeem our stock and keep collecting the interest from AIG. By the way, I was really angry about the reduction in interest to AIG.

"has started to buy securities backed by residential mortgages"

Here's an interesting story in the FT:

"John Paulson, the hedge fund manager who was called before Congress last week to discuss the big profits he made by foreseeing the collapse of the subprime mortgage market, has started to buy securities backed by residential mortgages.

Mr Paulson’s move marks the latest example of a famously bearish investor shifting gears to profit from depressed prices in the global credit markets.

US residential mortgage securities fell in value last week after Hank Paulson, Treasury secretary, said that the federal government had decided against buying toxic assets as part of its $700bn troubled asset relief programme (Tarp).

John Paulson, who is not related to the Treasury secretary, has told his investors that he started buying troubled mortgage-backed securities at the end of last week, hoping to capitalise on price falls that followed the Treasury announcement."

So, the chain of events:
1) TARP won't buy toxic assets
2) Toxic assets decline in value ( Now, what does that tell you? )
3) J. Paulson buys toxic assets

So, how long is Paulson planning on holding these toxic assets:
1) Short term ( Does he think that government will intervene? )
2) Long term ( They're going to appreciate? )

By the way, I was very impressed by his testimony before congress.

Here was his plan to help stop foreclosures:

"By providing funding and other support for attorneys who can
review loan documents and negotiate with loan servicers, we believe that many more
homeowners will be able to stay in their homes."

Here was my comment, where I tend to agree with him:

Since this is mainly legal help, and the loans are called abusive, maybe we should be doing what I say, which is examine the legality of these loans.

Here's a quote:

"This mechanism M_ purchases of senior preferred stock with warrants in troubled
institutions -- addresses the problems with the Treasmy plan. The financial
market is stabilized, companies get recapitalized, failures are avoidedJ debt
securities are supported, and time is gained for illiquid assets to mature.
The institutions continue to function, their cost of funding will decline as equity
capital increases, and innocent third parties like bank depositors, broker/dealer
clients and insurance-policy holders are all protected. The only difference is that
potential losses are kept with the shareholders where they belong."

Is he betting on the long term, hoping that the government will buy this stock and allow illiquid assets to mature?

"For several months Mr Paulson has been considering investing in distressed subprime mortgage securities, financial firms and debt used to back private equity deals.

He estimated there are $10,000bn in total in such assets."

Okay.

"In a letter to investors at the end of the third quarter, Mr. Paulson said his strategy was “to reduce leverage, maintain market exposure and maintain short credit bias”. He said: “The majority of our gains came from short positions in the equities of declining financials and CDS [credit default swaps] on financials. Generally our short exposure has been reduced as many of the companies we were short have failed.”

Mr. Paulson’s plans come at a time when other leading investors, including Jeff Aronson at Centerbridge Partners and Bruce Karsh at Oaktree Capital, are wading into the market for discounted leveraged buyout loans."

We'll keep an eye on this.

"Mr Paulson, who has $36bn under management, was scheduled to hold a dinner and wine-tasting at New York’s Metropolitan Club on Monday night so that he could brief his investors on his plans.'

I'm planning a hunk of Stilton, Bread, and Two Buck Chuck for my readers.

Henry Blodget on Clusterstock seems to believe that it's 2:

"John Paulson Goes Long: Buying Subprime And Other Mortgage-Backed Securities

One of the few folks who made a killing on the housing crash, John Paulson of Paulson & Co., has now started betting on a recovery. His plans to do so filtered into the market a couple of months ago, when he began raising the Paulson Recovery Fund, but now he's actually started buying"

"So much for the Waxman Witch Trial, as Dealbreaker had billed it. This was more like a love-in. "

Justin Fox on the Hedge Fund Hearings:

"So much for the Waxman Witch Trial, as Dealbreaker had billed it. This was more like a love-in. Some members of the House Committee on Oversight and Government Reform did razz the five multi-billionaire hedge fund managers assembled before them about the taxation of carried interest (performance fees that are taxed at capital gains rates). But two of the five--George Soros and Renaissance Technologies' Jim Simons--agreed that carried interest should be taxed as ordinary income. Paulson didn't, Philip Falcone of Harbinger Capital and Ken Griffin of Citadel were opposed with some caveats. But that discussion remained civil.

The most heated moment of the whole hours-long hearing came when Indiana Republican Mark Souder gave Soros hell for about 20 seconds for supporting marijuana legalization. But then he switched to a question about whether hedge funds helped bring markets toward equilibrium, and all was friendly again."

You've got to be kidding me.

"He waxed ominous about the dangers of leverage (his fund uses very little), saying that maybe what was needed were higher margin requirements on lots of different asset classes. He said Treasury should demand higher interest rates and bigger equity stakes when it injected capital into banks, and should also require that banks that get its money stop paying cash dividends and cap cash compensation for executives (they could pay all they want in common stock)."

I agree with him.

"That was actually too much for John Paulson. "I in no way want to be critical of Secretary Paulson," he said. "He's done a great deal for this country. He's willing to change his positions when the circumstances change."

We both studied with Keynes. Who didn't nowadays?

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Thursday, November 13, 2008 at 10:32 pm "So much for the Waxman Witch Trial" They're pretty much illegal nowadays. Read "The Crucible". "This was more like a love-in." Ah, the sixties."razz the five multi-billionaire hedge fund managers assembled before them" Hey, hedge fund manager. Hey, hedge fund manager."Souder gave Soros hell for about 20 seconds for supporting marijuana legalization" Ah, the sixties. You're joking, right?"If the hedge fund industry is worried about becoming the scapegoat" It's got to be ten more months until Yom Kippur. Rest easy for now."They mainly wanted to ask the hedge fund guys for advice." Can you guys help me get rich like you?"as long as the information stays with the regulators" Curiously, they don't want the competition knowing what their buying."who went from little-known to legendary last year by pocketing a reported $3.7 billion" He must have big pockets. I can only carry loose change."weren't going to rake him over the coals for profiting from the pain of American homeowners, he loosened up." The asbestos he was wearing was getting hot."He waxed ominous about the dangers of leverage (his fund uses very little), saying that maybe what was needed were higher margin requirements on lots of different asset classes. He said Treasury should demand higher interest rates and bigger equity stakes when it injected capital into banks, and should also require that banks that get its money stop paying cash dividends and cap cash compensation for executives (they could pay all they want in common stock)." I agree with this."Paulson did get chided repeatedly for failing to turn on his microphone when he started answering a question" He was busting their chops. ""The headline of this hearing is definitely Paulson vs. Paulson." What are the betting odds? I did pretty well with CDS's."He's willing to change his positions when the circumstances change." I remember when he told Keynes that."Carried interest should be taxed as ordinary income." I agree

"Live-Blogging the Hedge Fund Hearing": Only Later

Below is a running blog covering some of the questioning during Thursday’s testimony, with the most recent items at the top: ( With my comments in parentheses )

2:03 p.m. | The Hearing Adjourns: Mr. Waxman thanks the five men for attending the hearing, and he reiterates that unregulated hedge funds can present a “systemic risk” to the markets and the economy. ( "Systemic Risk is meaningless. Don't buy it. It will be used to excuse real human failures )

1:56 p.m. | Now, “Truth in Leverage”: Representative Darrell E. Issa, Republican of California, asks Mr. Soros whether “a good, quick beginning” to regulation would be to require “truth in leverage.” He said this would this go a long way toward preventing what has happened in the financial markets. Mr. Soros responds that “new-fangled financial instruments” are very complicated and difficult to understand. He says that regulators need to know what they are regulating, and that if they do not understand these instruments, they should not allow them. ( Calling Kurt Godel. Come on. There not that tough. )

1:47 p.m. | Truth in Advertising: Mr. Cooper asks whether it is possible to know if a hedge fund is truly hedged and mentions a Wisconsin school board that invested in a bunch of securities that got traced all around the world and eventually cost the board a ton of money. “There’s not truth in advertising,” said Mr. Cooper. Mr. Paulson encouraged pension funds to invest with managers who give them disclosure so they know what strategy they are undertaking.( FRAUD )

1:43 p.m. | Tale of Two Paulsons: Representative Jim Cooper, Democrat of Tennessee, says “the headline of this hearing is Paulson v. Paulson” — John Paulson accusing Henry Paulson of mismanaging the bailout. ( How clever. What are the betting odds? )

1:42 p.m. | Take a Puff: Mr. Simons, a known chain smoker, excuses himself likely to go have a smoke ( He really needs a drink )

1:40 p.m. | Executive Compensation: Representative John Yarmuth, Democrat of Kentucky, asks whether they have a concern about the corporate governance structure in this country and whether lawmakers should do something about executive compensation. Mr. Simons is a fan of profit-sharing for chief executives rather than stock options because “the latter is very volatile and you never know quite what he’s getting.” All of the others agree with Mr. Simons.( Don't care. Too high, but don't care )

1:33 p.m. | Tax Rates: Representative John F. Tierney, Democrat of Massachusetts, calls carried interest compensation hedge fund managers get is not for managing their money -– it is for managing other people’s money. “That ought to be taxed as regular income,” he says. Mr. Griffin responds that most of his income is taxed at the highest rate, but disagrees with raising the tax rate on carried interest. ( Tax as regular income )

1:26 p.m. | Question of Fairness: Representative Elijah Cummings, Democrat of Maryland, says that his neighbor asked him this morning: “How does it feel to be going before five folks that have gotten more money than God.” He asks the five managers if it is fair that the hedge fund managers pay less than his neighbor.

"Committee Holds Hearing on Hedge Funds and the Financial Market"

From the testimony today in Congress Under Waxman:

First, Kenneth Griffin:

"At financial institutions, we often take risk by investing in securities.
However, we have all seen the consequences of taking imprudent risk. Failures to
understand and manage risk can be severe, as we have seen far too often in recent
weeks." ( Agree )

"In this crisis, the concept of "too interconnected to fail" has clearly replaced the concept
of "too big to fail." The rapid growth in the use of derivatives has created an opaque
market whose outstanding notional value is measured in the hundreds of trillions of
dollars. As a result, there is great concern about the systemic effects of the failure of
anyone financial institution.
In the area of credit default swaps, for example, there is an estimated 55 trillion dollars of
outstanding notional contracts between market participants. This number is almost four
times the GOP of our country"

Too interconnected to fail ( Agree ) Derivative and CDS stuff ( BS )

"The creation of central clearing houses to act as intermediaries and guarantors of
financial derivatives such as credit default swaps represents a straightforward solution to
the issues inherent in today's opaque over-the-counter market. Of greatest importance,
such a clearing house will dramatically reduce systematic risk -- allowing us to step away
from the "too interconnected to fail" paradigm. Numerous other benefits will accrue to
our economy. Regulators, for example, will have far greater transparency into this vast
and important market." ( Agree, everyone does )

"I believe, and have said before, that our financial markets work best when they are
competitive, fair, transparent and stable. Proper regulation is critical. But the best
regulation is created with an eye toward unleashing opportunities, not limiting
possibilities. To achieve this, Congress, regulators and industry must all work together.
Our markets are complex and they must be well understood if they are to be well
regulated. We must solve the serious issues we face but in a way that does not stifle the
best innovative qualities of our financial markets." ( Agree, but "proper" regulation, like Bush's same use, it BS for saying nothing specific. It's like saying we'll pass good laws )

From John Paulson:

"Hedge funds are an important investment category for investors as returns are generally noncorrelated with the traditional market" ( Sounds good )

"The Institute, launched with a $15 million grant from investment management firm Paulson &
Co. Inc., will provide funding and training to organizations that help homeowners negotiate
alternatives to foreclosure. The majority of the funds will be grants to support direct legal
assistance to borrowers in 10 or more states to fight foreclosure, predatory lenders and abusive
loan servicers. It will do this primarily by providing money to top non-profit legal-aid groups and
law school clinics.
Formation of the Institute comes as the rate of subprime foreclosures, already alarmingly high,
is set to accelerate. Analysts have predicted that as many as 1.7 million foreclosures will occur
in the next two to three years. Within the next eighteen months, up to four million subprime
borrowers will see their monthly mortgage payments jump approximately 40% as initial "teaser"
interest rates expire. Servicers and lenders have largely refused to modify these abusive
subprime loans. According to a recent study by Moody's, only 1% of loans that reset to a higher
interest rate were modified by servicers. lenders and servicers are simply not modifying these
mortgages in sufficient numbers to help homeowners.
"legal resources available to help struggling families fall far short of that needed to address the
millions of abusive loans that have been made in recent years," said Martin Eakes, Chief
Executive Officer of CRL. "By providing funding and other support for attorneys who can
review loan documents and negotiate with loan servicers, we believe that many more
homeowners will be able to stay in their homes."

Since this is mainly legal help, and the loans are called abusive, maybe we should be doing what I say, which is examine the legality of these loans.

"There are major problems with the Treasury plan. First, by buying banks' worst
assets at above-market prices, taxpayers take an immediate economic loss -while
transferring wealth to shareholders and executives of the very institutions
that brought on the financial crisis.
Second, this plan puts too much discretionary power in the hands ofTreasury
officials. Who determines what financial assets are purchased and at what prices?
Who determines which bank gets to benefit from these taxpayer subsidies? Will
bank shareholders continue to receive dividends, and executives continue to get
paid huge bonuses?
When financial institutions borrow massive amounts ofmoney to invest in assets
that are now found to be illiquid arid poorly performing, it is not the
responsibility oftaxpayers to bear the resulting losses. These losses should be
borne by the shareholders.
Iftaxpayers have to step in and provide capital to keep operating enterprises that
the government decides are key to the functioning of the economy as a whole,
taxpayers must receive protection."

The only thing here odd is the determination of prices. Clearly he has no clue who or how it will be done. Why not just say that.

"Treasury Secretary Henry Paulson said at the Senate Banking Committee hearing
this week, "[the] Fannie Mae and Freddie Mac [interventions] worked the way
they were supposed to." These enterprises continued to function, maintaining homeowner access to and lowering the cost of mortgage financing. However,
managements of these companies had to leave and forfeit the compensation
packages they had negotiated.
Shareholders had their dividends blocked and remain first in line to bear losses,
as they should have been. Taxpayers came both first and last ~:.. first to get paid
backJ as the new preferred stock is senior to all shareholders; and last in realizing
losses, as common and other preferred equity would be extinguished before the
taxpayers would be at risk.
This mechanism M_ purchases of senior preferred stock with warrants in troubled
institutions -- addresses the problems with the Treasmy plan. The financial
market is stabilized, companies get recapitalized, failures are avoidedJ debt
securities are supported, and time is gained for illiquid assets to mature.
The institutions continue to function, their cost of funding will decline as equity
capital increases, and innocent third parties like bank depositors, broker/dealer
clients and insurance-policy holders are all protected. The only difference is that
potential losses are kept with the shareholders where they belong."

Here's the explanation of why they're leaving management intact. They want to keep the company structure intact, and they already did this with Fannie/Freddie, so there's a precedent.

"The Treasury plan would also entail larger outlays than the Preferred plan. By
allowing all banks to sell their worst assets to Treasury at inflated prices,
taxpayers would be subsidizing healthy banks which have access to private
capital (Goldman SachsJ J.P. MorganJ Wells Fargo, and Bank ofAmerica, for
example) as well as banks that don't have a private alternative. But under a
Preferred plan, only banks that don't have a private alternative will be given
federal assistance. This would reduce the outlay otherwise required to solve the crisis."

We all pretty much hated it.

"Few people familiar with the issues deny that Treasury action is needed to
stabilize the financial markets. However, the question is who should bear the
cost?
Under the Treasury plan the taxpayer pays the price. Under a Preferred plan, the
shareholders of the firms who created the problems bear the first loss. Who do
you think should pay?"

Now, I think that the statement that Treasury action is needed shows that he believes that a bailout in this kind of crises was and is the best thing to do. I'm saying he believed that would be the case if needed before this crisis happened.

George Soros:

"The crisis was generated by the financial system itself. This fact-that the defect was
inherent in the system-eontradicts the prevailing theory, which holds that financial markets
tend toward equilibrium and that deviations from the equilibrium either occur in a random
manner or are caused by some sudden external event to which markets have difficulty adjusting.
The severity and amplitude of the crisis provides convincing evidence that there is something
fundamentally wrong with this prevailing theory and with the approach to market regulation that
has gone with it. To understand what has happened, and what should be done to avoid such a
catastrophic crisis in the future, will require a new way of thinking about how markets work."

( Total BS: Pure Mechanistic Thinking )

"Consider how the crisis has unfolded over the past eighteen months. The proximate
cause is to be found in the housing bubble or more exactly in the excesses of the subprime
mortgage market. The longer a double-digit rise in house prices lasted, the more lax the lending
practices became. In the end, people could borrow 100 percent of inflated house prices with no
money down. Insiders referred to subprime loans as ninja loans-no income, no job, no
questions asked." ( Correct: Poor Loans: Human Agency: Forget Talk Of Systems )

"Some highly leveraged hedge funds collapsed and some lightly regulated financial institutions declared bankruptcy" ( Correct: Undercapitalized: Human Agency: Forget Talk Of Systems )

"In quick succession, a variety of esoteric credit marketsranging from collateralized debt obligations [CDOs] to auction-rated municipal bonds-broke down one after another."

( Incorrect: Esoteric Has Nothing To Do With It )

"The deepest fall of all came in September, caused by the disorderly bankruptcy of
Lehman Brothers in which holders of commercial paper-for example, short-term, unsecured
promissory notes-issued by Lehman lost their money."

( Agree )

"With the financial system in cardiac arrest, resuscitating it took precedence over
considerations of moral hazard-i.e., the danger that coming to the rescue of a financial
institution in difficulties would reward and encourage reckless behavior in the future"

( Disagree: Moral Hazard Had Already Been Compromised: No Going Back )

"When that was not enough, the American and European financial authorities committed themselves not to allow any other major financial institution to fail" ( Agree )

"Unfortunately the authorities are always lagging behind events" ( Agree )

"First, financial markets do not reflect prevailing conditions accurately; they provide a picture that is always biased or distorted in one way or another. Second, the distorted views held by market participants and expressed in market prices can, under certain circumstances, affect the so-called fundamentals that market prices are supposed to reflect. This two-way circular connection between market prices and the underlying reality I call reflexivity.
While the two-way connection is present at all times, it is only occasionally, and
in special circumstances, that it gives rise to financial crises. Usually markets correct their own
mistakes, but occasionally there is a misconception or misinterpretation that finds a way to
reinforce a trend that is already present in reality and by doing so it also reinforces itself. Such
self-reinforcing processes may carry markets into far-from-equilibrium territory. Unless
something happens to abort the reflexive interaction sooner, it may persist until the
misconception becomes so glaring that it has to be recognized as such. When that happens the
trend becomes unsustainable and when it is reversed the self-reinforcing process starts working
in the opposite direction, causing a sharp downward movement."

Wow. I agree with this:

1) People misunderstand things
2) Sometimes very badly

Ignore the engineering jargon. Totally inappropriate.

"Take for example credit default swaps (CDSs), instruments intended to insure
against the possibility of bonds and other forms of debt going into default, and whose price
captures the perceived risk of such a possibility occurring. These instruments grew like Topsy
because they required much less capital than owning or shorting the underlying bonds.
Eventually they grew to more than $50 trillion in nominal size, which is a many-fold multiple of
the underlying bonds and five times the entire US national debt. Yet the market in credit default
swaps has remained entirely unregulated."

( Agree: but he misses the point. CDS's filled the need, which were investments with less capital. Something else would have worked if they didn't. It wasn't the investment, it was the need which created the investment )

"Since the risk management models used until now ignored the uncertainties inherent in reflexivity, limits on credit and leverage will have to be set substantially lower than those that were tolerated in the recent past"

( This borders on the absurd. He just admitted the investments fit the desired lack of capital. Forget this model BS. They weren't complex so much as undercapitalized. That's what they were designed for. Their complexity was due to using less capital. He writes like he's Foucault. )

I can't take anymore. Soros wore me out. I'd rather read Hegel.