Saturday, January 06, 2007

Hedge Funds, Junk Bonds, Ponzi Schemes

As I have said here the current trend in capitalism is not production or even productivity, that is the job of the working class, the capitalist class is busy investing capital to make more capital. And whether or not they succeed they get their rewards.

Or as Marx put it M-C-M, which spells Bubble, as in South Sea Bubble.

Capitalism now is one large Ponzi scheme fraud is to capitalism as apple pie is to America. Remember Junk Bonds.....
Contrary to the predictions of the politicians and their consultants, though, junk bonds soon revived and became a staple of American finance.

And the lastest fraud being perpetrated is the unregulated Hedge fund and Private equity market financing.

"The upper class is now serviced by a vast and growing industry, loosely called Private Equity.

The job of the private-equity investor is -- again, speaking loosely -- to exploit the idiocy of the ordinary investor, and the corporate executives and mutual-fund managers who purport to serve him."

~ Michael Lewis, Bloomberg News, 12 December 2006

Tipping Point for the Ministry of Truth?

"Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one another." - Warren Buffet

Here we learn that hedge funds account for 32 percent of credit-default swap sellers and 28 percent of buyers, up from 15 percent and 16 percent in 2004, according to a British Bankers' Association report last month. They are second to banks in each category. Pension funds and mutual funds make up 7 percent of the sellers and 4 percent of the buyers.

The Cozy Hedge Fund-Pig Man Relationship

Readers know that I have developed a theory that suggests hedge funds (Riskloves) and possibly foreign central banks (FCBs) have been the key facilitators of, and will ultimately be the bag holders for, the securities and credit bubble. The key to understanding this relationship as it pertains to Riskloves is to recognize that most of their incentives are front loaded and geared towards extreme risk taking. When a Ponzi unit security is created or securitized that’s the moment that fees are generated for the financial sphere (Pig Men). The Pig Men also collect more soft dollars “doing business” with the Riskloves. The Riskloves (and increasingly the FCBs) then take the securities. Then once the security is created, it enters into the never never land of Ponzi toxic waste, where it is blessed by another cozy player, the credit agencies. Once blessed, then these securities can be pawned off on pension and public funds, in what can only be described as a circle jerk.

A Minsky-like Restatement of Keynes Market Irrationality Warning

"The market is a complex, adaptive social system, is therefore not prone toward equilibrium, but instead subject to phase shifts, cycles, and transfomation. Groups of people who play in the market are prone to cycles of irrational exuberance and irrational pessimsim."


While You Were Watching Consumer Debt

A rising stock market encouraged investors to go into debt to trade stocks, leading to an increase in the level of so-called margin debt in 2006.

Such debt is accumulated by investors who trade "on margin" with funds borrowed from their brokers. As tracked by the New York Stock Exchange, margin debt rose to $270.52 billion in November from $221.66 billion at the end of 2005, the first time in more than six years that margin debt has topped $270 billion. December numbers will be available later this month.

The Big Trend 2007

Money will pour into the same places it did in 2006--hedge funds, private equity, emerging markets. As they are in a Ponzi scheme, returns will be stellar as long as investors believe. When they no longer do, returns will collapse. Things could get ugly. Even if they don't, 2007 will be the fourth year in a row that hedge funds will post returns that are about as good (or bad) as the overall market's. Investors will begin to realize they are getting very little for the huge fees they pay.

Financial Tornados 2006

Hedge funds, with more than $1 trillion of capital, have invested altogether unwisely and covered their losses through profits on the "carry trade," which have distorted the government debt market beyond recognition. Expect huge losses of capital in this sector should long term rates go above 61/2%

Please Do Not Buy Hedge Funds

From a few hundred funds managing some $40 billion in 1990, there are now perhaps 10,000 funds managing more than $1 trillion. The funds pursue many different strategies: Equity market neutral. Long/short sector equity. Convertible arbitrage. Emerging markets. Merger arbitrage. Distressed securities. Global macro. Because hedge funds usually come with high risk and steep minimum investment sizes, moreover (circa $1 million per fund), vehicles designed to make it easier and safer to invest in them—aka, funds of funds—have also exploded in popularity. So now, even average investors are advised to take the hedge-fund plunge

Lots of Dollars, Little Sense

Call me dense, but I'm having an awfully hard time understanding the investment world these days.

For reasons that aren't exactly clear, the supposedly smart people with all the money -- pension funds, university endowments and wealthy investors -- have decided it no longer makes sense for them to look for undervalued public companies, or promising new companies looking to go public. Instead, they prefer to put their money into private equity funds, which charge outrageous fees to look for undervalued public companies, or promising new companies looking to go public, and buy them up at a price 20 percent higher than the current stock-market price.

Of course, buying whole companies can get expensive, especially when you're talking about an energy giant such as Morgan Kinder or HCA, the country's largest hospital chain, just to give two recent examples. So to finance the deals, private equity managers have their newly acquired company issue lots of junk bonds, at high interest rates. These bonds are then bought by hedge funds, which also charge outrageous fees and also raise most of their money from pension funds, university endowments and wealthy individuals.

In a few instances, private equity funds have also begun to raise capital by issuing common stock, which also tends to be snatched up by the very same hedge funds, pension funds, university endowments and wealthy individuals.

And to top things off, the new owners invariably offer fat new pay packages to the managers of the company they've just acquired -- in most cases, the same managers who were running the company when it was public. The idea is to give them even greater incentive to maximize the value of the company, so it can be taken public again.

Now, if this sounds to you like a giant, circular Ponzi scheme, it's only because it is. As far as I can figure out, the winners will be the fund managers and their highly paid enablers, the investment bankers. And let's not forget the corporate managers, who have the chance to become fabulously wealthy if they are successful in stealing the company from public shareholders to whom they presumably owed a fiduciary duty, and later selling it back to public shareholders at a higher price.

Jocks and Geeks Theory of Financial System Dysfunction

So it goes today with so-called hedge funds, what I call USIPs (Unregulated Speculative Investment Pools, because true hedge funds of old were hedged, long one thing and short a correlated other, whereas many so-called hedge funds today are merely long and are hedged only insofar as they have taken out some insurance in the form of some kind of derivative that is supposed to protect their bets from catastrophic losses).

SEC officials nod their heads in agreement with representatives of the hedge fund industry, acquiessing to the idea that regulation isn't required because it will be "bad for investors" or "bad for the industry" or "bad for the world" and "there are enough laws on the books already" and "it's all so complicated... we don't know how." And, blah, blah, blah. Even as they cheer the SEC's wisdom to abdicate their responsibility as regulators, I can see a hedge fund manager eating dinner in the back yard of his Norwalk, Connecticut estate this weekend, and after a couple of glasses of wine, leaning forward to get closer to one of his guests who is an investor in his fund, and whispering, "I can't believe we're getting away with this."

No conspiracy but certainly a system, and a process. At this point, the hedge fund bubble system is going through a several stage process of collapse. So is the housing bubble, although the two are not directly related. One is the rich man's bubble, the other the every-man's bubble.

Brings us back to the question of motive. Why allow these systems to develop? Why did the SEC allow all those dot coms to go public? Why is 27 year old Zachary R. George of Pirate Capital allowed to bully the 55 year old CEO of Cornell Companies? Is that really good for the country? Why is it fair to use public funds to bail out LTCM when the payees had no opportunity to reap any of the benefits?

As I See It: Manipulating Money

Money manipulation was the primary reason that IBM was able to grow its earnings five times faster than revenues. To grow earnings per share, you can do one of two things: either generate more revenue or buy back your own shares to take them out of circulation. From 1995 through 2001, IBM spent a bank-breaking $44 billion buying back its own stock. "To put that in perspective," our own Timothy Prickett Morgan says, "that's almost as much money as IBM has generated selling AS/400s since 1988. They could have given away the systems and still had money left over."

IBM's other favorite profit enhancer is counting pension fund investment income. While well-managed pension funds are laudable and the income derived from them looks good on the books, they have nothing to do with shareholders. Pensioners, not investors, profit from the fund, so critics argue the income should not be used to inflate a company's stock value.

Creative accounting is not new, but the difficult lessons it teaches are quickly forgotten. A decade ago, Andersen gave its seal of approval to Charles Keating's infamous Lincoln Savings and Loan, which bilked the elderly of their life savings. Only the scale has changed and now threatens to disrupt the nation's entire economy.

Simmering--if not outright cooking--the books is so pervasive that at least one study concluded the Dow Jones Industrial Average was overvalued by 2,500 to 5,000 points. Financial reporter Dave Lindroff writes: "The London think tank reports that after comparing the earnings reports of companies listed in the New York Stock Exchange with statistics from the U.S. Commerce Department's Bureau of Economic Analysis (in which some of the more commonly used accounting 'adjustments' are pared away), it appears that U.S. corporate profits in 2001 were overstated by 27 percent, or about $130 billion."

After non-collapse

Those lower interest rates worked exactly as they were supposed to. For corporations and households with debts at adjustable rates -- those periodically changed in line with prevailing market rates of interest -- found their required interest payments shrinking, often quite dramatically. Creditworthy firms and households were also able to refinance their debts -- pay off the old ones with the proceeds of new ones, except at lower rates of interest -- and ease their burden. This freed up enormous amounts of money. At the end of 1989, according to estimates by Federal Reserve staff economists, households devoted over 18% of their after-tax income to debt service, that is, interest and principal payments; at the end of 1993, that figure had fallen below 16%. In 1990, firms were devoting nearly 40% of their profits before interest payments and taxes to interest; that figure is now below 30%. Also, lower interest rates allowed the banking system to rebuild itself. Rates paid for loans didn't fall anywhere near as much as rates paid on deposits, and long-term interest rates didn't fall anywhere near as much as short-term ones. Both developments allowed banks to rake in billions effortlessly. The first part of the mechanism is simple enough: if one year you pay your depositors 8% and your borrowers have to pay 12%, a spread of four points, and the next year you pay your depositors 3% and your borrowers pay 10%, a spread of seven points, you're a much happier banker. The second part is similar: if you take in money at 3% and invest these deposits in government bonds paying 8%, you can make 5% on your money without exercising a single brain cell. And finally, lower rates launched a tremendous rally in the stock market, which allowed corporations to sell new stock to pay off old loans. A study by the Federal Reserve Bank of New York showed that most of the money raised in the early 1990s on the stock market was devoted to the retirement of debt rather than new investments -- contrary to mainstream economic theory, by the way, which views the stock market mainly as synonymous with real investment.

While the S&Ls and junksters have disappeared, new players moved into the vacuum -- like the vast pools of speculative capital called hedge funds, who generally borrow $10 for every real dollar they have to their name, and who speculate in every market around the world. Also, lower rates have led to despair among individual investors, who have plunged into various highly speculative markets unaware of the risks involved. Should rates rise much more, and the Wall Street rout develop into something on the order of the 1973-74 bear market, when stocks lost nearly half their value, these individuals will see a lifetime of savings dwindle if not vanish. Those who are not wiped out will likely pull in their horns and stop spending money, and the marvelous carousel of consumption will creak and sputter.

Classic Financial and Corporate Scandals - part 2

White Collar Crime Report Index-Summary

Wall Street Fraud



Criminal Capitalism

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Unknown said...

Great Post.



Thanks for reading.