By the end of last year, the reported cost of swaps protection ballooned to $8 million up front and $500,000 a year

TO BE NOTED:

"Don’t Blame G.M.’s Creditors

Recalcitrant creditors were made scapegoats for the collapse of Chrysler, Breakingviews says. And, it says, they may play the same unhappy role if General Motors runs off the road.

G.M. bondholders who have hedged their exposures are said to want the carmaker to file for bankruptcy. But that doesn’t make them opportunistic speculators, Breakingviews argues.

If G.M. files, these investors could indeed collect on their credit-default swap contracts. But in many cases, Breakingviews says, they’ve already suffered big losses on their bonds. Making up for those is what hedging is all about.

Meanwhile, G.M.’s government-inspired overhaul plan looks like a raw deal, the publication argues. Lenders would get only 10 percent of G.M.’s new equity, rather than the lion’s share, which, as the largest block of creditors, is arguably their due, it says.

It’s also unlikely that most of the bondholders concerned are short-term speculators, according to Breakingviews. The economics of hedging G.M.’s bonds haven’t looked great in a while, it notes.

The last time it was attractive was probably in early 2007, when G.M.’s bonds fetched around 97 cents on the dollar, the publication suggests. An investor seeking to hedge $10 million of those bonds for five years would have paid about $390,000 a year in the credit-default swap market, a cost covered by the interest received on the bonds, Breakingviews calculates. By last summer, that bondholder had lost $1 million on the bonds, but that was roughly offset by the increased value of the swaps contract, it says.

But then the carmaker’s wheels had started coming off. By the end of last year, the reported cost of swaps protection ballooned to $8 million up front and $500,000 a year, and the bonds plunged in value to about 25 cents on the dollar, Breakingviews says. Buying the bonds then and insuring their $10 million face value would have cost $11 million in the first year, a losing proposition even if G.M. filed for bankruptcy, it says.

So the hedged bondholders have probably been in the game for a while, Breakingviews argues. They have the advantage of some bankruptcy insurance. But there’s little reason to excoriate them for risking a G.M. failure when the alternative deal on offer is so meager, the publication says."

if they give away their clients’ money to share in the “sacrifice,” they are stealing

TO BE NOTED:

Hedge Fund Manager Strikes Back at Obama

Clifford S. Asness is not afraid to defend himself against attacks from the Obama administration. The outspoken managing partner of AQR Capital Management, a $20 billion hedge fund in Greenwich, Conn., has written a scathing letter striking back at President Obama for his harsh words blaming hedge funds for Chrysler’s bankruptcy.

The letter is making its way around Wall Street, where it’s being met with cheers from other hedge funds managers, one of whom sent it to DealBook. Among other things, Mr. Asness said he was “aghast at the president’s comments” and called them “backwards and libelous.”

Read the full text of the letter after the jump.

Unafraid In Greenwich Connecticut
Clifford S. Asness
Managing and Founding Principal
AQR Capital Management, LLC

The President has just harshly castigated hedge fund managers for being unwilling to take his administration’s bid for their Chrysler bonds. He called them “speculators” who were “refusing to sacrifice like everyone else” and who wanted “to hold out for the prospect of an unjustified taxpayer-funded bailout.”

The responses of hedge fund managers have been, appropriately, outrage, but generally have been anonymous for fear of going on the record against a powerful President (an exception, though still in the form of a “group letter,” was the superb note from “The Committee of Chrysler Non-TARP Lenders,” some of the points of which I echo here, and a relatively few firms, like Oppenheimer, that have publicly defended themselves). Furthermore, one by one the managers and banks are said to be caving to the President’s wishes out of justifiable fear.

I run an approximately twenty billion dollar money management firm that offers hedge funds as well as public mutual funds and unhedged traditional investments. My company is not involved in the Chrysler situation, but I am still aghast at the President’s comments (of course, these are my own views, not those of my company). Furthermore, for some reason I was not born with the common sense to keep it to myself, though my title should more accurately be called “Not Afraid Enough” as I am indeed fearful writing this… It’s really a bad idea to speak out.

Angering the President is a mistake, and my views will annoy half my clients. I hope my clients will understand that I’m entitled to my voice and to speak it loudly, just as they are in this great country. I hope they will also like that I do not think I have the right to intentionally “sacrifice” their money without their permission.

Here’s a shock. When hedge funds, pension funds, mutual funds, and individuals, including very sweet grandmothers, lend their money they expect to get it back. However, they know, or should know, they take the risk of not being paid back. But if such a bad event happens, it usually does not result in a complete loss. A firm in bankruptcy still has assets. It’s not always a pretty process. Bankruptcy court is about figuring out how to most fairly divvy up the remaining assets based on who is owed what and whose contracts come first.

The process already has built-in partial protections for employees and pensions, and can set lenders’ contracts aside in order to help the company survive, all of which are the rules of the game lenders know before they lend. But, without this recovery process nobody would lend to risky borrowers. Essentially, lenders accept less than shareholders (means bonds return less than stocks) in good times only because they get more than shareholders in bad times.

The above is how it works in America, or how it’s supposed to work. The President and his team sought to avoid having Chrysler go through this process, proposing their own plan for reorganizing the company and partially paying off Chrysler’s creditors. Some bondholders thought this plan unfair. Specifically, they thought it unfairly favored the United Auto Workers, and unfairly paid bondholders less than they would get in bankruptcy court. So, they said no to the plan and decided, as is their right, to take their chances in the bankruptcy process. But, as his quotes above show, the President thought they were being unpatriotic or worse.

Let’s be clear, it is the job and obligation of all investment managers, including hedge fund managers, to get their clients the most return they can. They are allowed to be charitable with their own money, and many are spectacularly so, but if they give away their clients’ money to share in the “sacrifice,” they are stealing. Clients of hedge funds include, among others, pension funds of all kinds of workers, unionized and not.

The managers have a fiduciary obligation to look after their clients’ money as best they can, not to support the President, nor to oppose him, nor otherwise advance their personal political views. That’s how the system works. If you hired an investment professional and he could preserve more of your money in a financial disaster, but instead he decided to spend it on the UAW so you could “share in the sacrifice,” you would not be happy.

Let’s quickly review a few side issues.

The President’s attempted diktat takes money from bondholders and gives it to a labor union that delivers money and votes for him. Why is he not calling on his party to “sacrifice” some campaign contributions, and votes, for the greater good? Shaking down lenders for the benefit of political donors is recycled corruption and abuse of power.

Let’s also mention only in passing the irony of this same President begging hedge funds to borrow more to purchase other troubled securities. That he expects them to do so when he has already shown what happens if they ask for their money to be repaid fairly would be amusing if not so dangerous. That hedge funds might not participate in these programs because of fear of getting sucked into some toxic demagoguery that ends in arbitrary punishment for trying to work with the Treasury is distressing. Some useful programs, like those designed to help finance consumer loans, won’t work because of this irresponsible hectoring.

Last but not least, the President screaming that the hedge funds are looking for an unjustified taxpayer-funded bailout is the big lie writ large. Find me a hedge fund that has been bailed out. Find me a hedge fund, even a failed one, that has asked for one. In fact, it was only because hedge funds have not taken government funds that they could stand up to this bullying.

The TARP recipients had no choice but to go along. The hedge funds were singled out only because they are unpopular, not because they behaved any differently from any other ethical manager of other people’s money. The President’s comments here are backwards and libelous. Yet, somehow I don’t think the hedge funds will be following ACORN’s lead and trucking in a bunch of paid professional protesters soon. Hedge funds really need a community organizer.

This is America. We have a free enterprise system that has worked spectacularly for us for two hundred-plus years. When it fails it fixes itself. Most importantly, it is not an owned lackey of the Oval Office to be scolded for disobedience by the President.

I am ready for my “personalized” tax rate now."

investment firms and hedge funds decided to hold out for the prospect of an unjustified taxpayer-funded bailout

TO BE NOTED: From the WaPo:

"In Chrysler Saga, Hedge Funds Cast As Prime Villain
Firms Say They Were Right to Hold Out

By Steven Mufson and Tomoeh Murakami Tse
Washington Post Staff Writers
Friday, May 1, 2009

President Obama's harsh attack on hedge funds he blamed for forcing Chrysler into bankruptcy yesterday sparked cries of protest from the secretive financial firms that hold about $1 billion of the automaker's debt.

Hedge funds and investment managers were irate at Obama's description of them as "speculators" who were "refusing to sacrifice like everyone else" and who wanted "to hold out for the prospect of an unjustified taxpayer-funded bailout."

"Some of the characterizations that were used today to refer to us as speculators or to say we're looking for a bailout is really unfair," said one executive who spoke on condition of anonymity because of the sensitivity of the matter. "What we're looking for is a reasonable payout on the value of the debt . . . more in line with what unions and Fiat were getting."

George Schultze, the managing member of the hedge fund Schultze Asset Management, a Chrysler bondholder, said, "We are simply seeking to enforce our bargained-for rights under well-settled law."

"Hopefully, the bankruptcy process will help refocus on this issue rather than on pointing fingers at lenders," he said.

Political veterans said, however, that it would be tough for hedge funds to overcome their image as villains. Most politicians have a favorite punching bag. Many Republican politicians like to bash trial lawyers. Many Democrats like to take aim at big oil companies. Hedge funds can serve as a safe diamond-studded scapegoat in tough economic times.

"It's hard to go wrong right now being tough on those guys," said Jeff Shesol, a former speechwriter for President Clinton who noted that Obama had been criticized earlier for not showing enough outrage about AIG bonus payments. He said that Obama's "frustration, while it may be calibrated, is real. And it's certainly where the public is."

A senior administration official said the tough words on hedge funds were born of frustration, not politics. "The president has been pretty hard-nosed about the whole matter," said the official, who spoke on condition of anonymity. "There was no calculation involved," he added. Obama "was very willing to praise those who went the extra mile to help make this work, and that included financial institutions."

"In particular, a group of investment firms and hedge funds decided to hold out for the prospect of an unjustified taxpayer-funded bailout," Obama said. "They were hoping that everybody else would make sacrifices, and they would have to make none. Some demanded twice the return that other lenders were getting. I don't stand with them."

The president's harsh criticism may play well on Main Street, but it flopped on Wall Street yesterday. There hedge funds -- privately run funds that invest in an unlimited variety of securities and which theoretically balance different kinds of risks -- are part of the landscape.

"It sounds like people are being bullied right now," said Ron Geffner, a partner at the law firm Sadis and Goldberg, which represents hedge funds. "To play the 'I stand with Chrysler, I stand with families, I stand with the dealers, I stand with the consumers' -- that's great conceptually, but . . . I stand with the fact that we live in a capitalist society where companies who don't modify their business plans and stay current die and go by the wayside."

Geffner added that Obama's remarks made it difficult for the lenders that rejected the offer to speak publicly for fear of appearing "anti-American."

Indeed, a group of lenders issued a statement yesterday -- but did not identify its members. The group said it included approximately "20 relatively small organizations" that represented "the country's teachers unions, major pension and retirement plans and school endowments who have invested through us in senior secured loans to Chrysler."

The funds hold about $1 billion in Chrysler bonds and have turned down the government's terms. The government would have paid just under a third of the value of those bonds. However, many funds bought the bonds at deep discounts from other investors who feared the bonds might ultimately be worthless.

A few firms stepped forward to defend themselves openly. "OppenheimerFunds sought fair treatment for the shareholders of our funds and we were willing to make very significant sacrifices to reach an agreement," the firm said in a statement. But it said the government "unfairly asked our fund shareholders to make financial sacrifices greater than those being made by" other creditors. The firm said its bonds "are entitled to priority in long-established U.S. bankruptcy law."

But other observers said that the hedge funds were oblivious to Americans' worries about jobs.

"They're not getting it in their heads that this is the worst crisis since the 1930s. People are going to have to take a hit," said Sarah Anderson, director of the Global Economy Project at the Institute for Policy Studies. "It seems rather short-sighted to risk having the auto sector collapse so that they can get a few more cents on the dollar for their investors."

"The sooner prices are allowed to naturally fall to normal, post-bubble levels, and the sooner that houses become affordable"

I said that there were people who felt that the Fed's plan to help people buy houses was a mistake. Declan McCullagh on CBS News is one of them:

"In reality, more government intervention will do more harm than good. The sooner prices are allowed to naturally fall to normal, post-bubble levels, and the sooner that houses become affordable, the sooner the economy can heal itself and start growing instead of contracting.

By way of analogy, imagine a reprise of the Dutch tulip mania of 1637. Say the price of tulip bulbs has grown handsomely in the last few years, and impressive fortunes were made by early speculators.

Bidding wars erupt, with the winners hoping to resell them the bulbs at a handsome profit months or years later. Cable TV hosts proclaim that a golden age of prosperity has dawned. Prized bulbs change hands for $1 million each, and skeptics are reviled as doomsayers.

Eventually this boom leads to a bust, as new buyers become scarce, and the price of tulip bulbs suffers a dizzying fall down to $10 each. Speculators complain to Congress. Politicians pledge to use tax dollars to purchase bulbs for $1,000 or $10,000, invoking phrases like "stability" and "liquidity crisis," or offering taxpayer-backed loan guarantees to speculators.

This would sound silly for tulips, but it's close to what's happening for houses. All this will do is slow -- and not arrest -- the process of prices falling. Not even the president of the United States can veto the laws of supply and demand.

It's difficult to convince someone to buy a tulip bulb (or house) today if he thinks the price will be a lot lower in a year. Worse, government spending diverts funds away from productive purposes, including investment, education, and infrastructure. "

In general, I agree with this. But, there's one problem with this comment. It assumes that the people buying houses now won't be able to make their payments going forward. But what if they can? What if the problem isn't that current home purchasers are going to get into trouble, and banks aren't lending to them because of that. Rather, many people who can clearly afford the houses they are going to buy are being turned down because of the situation of the banks, which is being locked into a shell-shocked aversion to risk, and using money to clean up their books? How would you know?

"By usual metrics, such as the ratio of prices to incomes, the ratio of rents to mortgages, and the ratio of current prices to expected ones, some areas of the country still look pretty bubbly.

In the decade ending August 2008, according to S&P Case-Shiller data, house prices in New York metropolitan area leaped by 2.2 times, though incomes grew only modestly. The Washington, D.C. area experienced a 2.1-fold jump -- while non-bubbly areas like Cleveland saw an increase of a mere 1.17 times, which is consistent with incomes and inflation.

The median family income in Allentown, Penn. is $46,400, and the median home price is $125,000, meaning houses tend to cost 2.7x the median income. Compare that to San Francisco, where homes consume a whopping 11.6x the median annual salary. "

What if the usual metrics are wrong? They are failing to figure in demographic changes, regulation changes, wealthier people moving and concentrating in new areas where they drive up the prices,etc.? The real world metric is simply whether or not people can afford their houses. Is that metric written in stone?

"Robert Shiller, who teaches economics at Yale University, has calculated that housing prices have remained remarkably constant from 1890 through 1998, rising only 13 percent when adjusted for inflation -- through world wars, the automobile, and the rise of the two-income family. When the dot-com bubble burst, money flowed into real estate, encouraged by the Federal Reserve cutting interest rates more than prudence allowed. "

The Spigot Theory again. What does "more than prudence allowed" mean? Let's say it made it easier to fund a mortgage. Did that automatically lead to irrational and asinine lending practices?
What's the connection between low interests rates and fraud and stupidity? Is there a law for that? I'm trying to understand this phenomenon in a way that explains the way actual human beings act. Oh my God, interest rates are low, let's throw caution to the wind.

"Which brings us back to a taxpayer-funded "rescue" of homeowners. It's true that many people who bought homes in the last decade acted responsibly, made sizable down payments, and purchased a house within their means; they owe more than they paid through no fault of their own.

On the other hand, many people were speculators, fibbing about their income, lying about their assets, and treating their house as an ATM to finance cruises and flat screen TVs. Many banks were in on the game, knowingly placing people in homes they couldn't afford. Even if a bailout is justified, Washington is in no position to determine who's deserving and not. Any bailout punishes renters and Americans who were fiscally responsible by taxing them to benefit those who weren't.

Prices in some areas need to fall, and the market needs to return to normal. Eventually it will. All Washington can do is prolong the pain. "

Is a mortgage deduction taxpayer funded? My problem with this analysis is that it assumes a model of the economy to be the real economy, which has recently been proven to be a less than perfect mode of analysis. At any point in time, there are all kinds of competing incentives and disincentives moving people's decisions this way and that. It might well be that the government will, to some degree, "prop up" home prices in some theoretical model sort of way. But, on the other hand, if the people buying the houses today can afford to buy them and do, then the prices were not artificially propped up, and, even if they were or are, if people can and do freely purchase them, then the market worked. The market only fails if a significant number of people default, since there will always be some defaults. Does he really believe that new buyers, in this market, are radically prone to default?

Do I support the Fed's actions? Not really, no. But I understand what they're trying to do, and am not so sure that it can't work because of a theory I hold, however dearly.

Of course, I'm talking about houses. What works for tulips, I haven't a clue.