"Hedge funds face record redemptions"

Nouriel Roubini predicted that hedge funds closures would be the next leg of the financial crisis. Large scale redemptions force hedge funds to sell assets at a time not of their choosing. More assets being dumped at a time of risk aversion is likely to lead to distressed prices, putting pressure on other players, since they will have to lower the marks on similar assets.

This could get ugly indeed…

From the Telegraph:

Hedge funds are preparing to return between 10 per cent and 50 per cent of their assets under management to investors who want their money back at the end of yet another quarter of dire investment performance.

One prime broker said: “Many funds will have to close. There were a flood of redemption notices at the beginning of the quarter but many investors said they wouldn’t actually withdraw the money if performance improved. It hasn’t.”

One hedge fund said: “We’ve produced 15 per cent returns for 10 years. This year has been bad and our funds under management have been reduced from $2billion to just $300m. This is decimation.”

Not a single hedge fund strategy has produced positive returns so far this month, with convertible arbitrage and distressed securities down an estimated 7.96 per cent and 7.34 per cent, respectively, according to Dow Jones Hedge Fund Indexes. Equity market-neutral funds, which often short a stock in one sector and go long on another in the same sector, are down 1.85 per cent.

Hedge fund of funds are expected to be hardest hit. One investor said: “You take a risk with individual managers but fund of funds are paid to make sure you’re diversified. Many have failed.”…

In particular the fee model – two per cent of assets a year for management and 20 per cent of profits – is likely to be reduced.

I hate to chest-pound, since it is singularly unattractive, but I cannot resist. I have been arguing with people for years that the hedge fund fees were unsustainable given that the industry had grown so large and average returns weren’t all that impressive. Everyone to a person maintained that hedge fund fees would never never fall, that talent was scarce and would always command a premium. The industry has grown so large that not everyone is all that talented.

It reminded me of the arguments I had in the 1980s with those who argued that credit card companies would never cut their fees (I forget whether it was $25 or more annual fee, plus 19.8% on any balances).

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  1. AndyG

    Spot the pattern:

    Bad loans are on the bank's balance sheet -> Bank is illiquid.
    Bad loans moved to the Fed's balance sheet -> Fed is illiquid.
    Bad loans moved to the Government's balance sheet -> (fill in the blank)

    The one thing that gets me about the bailout proposal is that even those who oppose it rarely mention the possibility that the US might end up defaulting. The assumption is that this would never be allowed to happen.

    One of the recurring themes of the current crisis is that things that were supposed to never happen have happened. The unthinkable has become fact.

    Yves in previous posts has been one of the few bloggers to point out the risk to the AAA rating of US debt. The thing is we all know that the ratings agencies will not downgrade, however as has happened previously in this crisis that will not matter, once the credit market has decided the US no longer deserves an AAA rating the ratings agencies opinion will be of no consequence.

    Get used to the idea of a US default. It’s inevitable.

  2. doc holiday


    Sorry to be OT, but have you heard about this stuff, e.g, Capital Magnet Fund and how it fits with The Plan?

    Re: The Housing and Economic Recovery Act of 2008 establishes a permanent trust fund called the Capital Magnet Fund within the Treasury’s Community Development Financial Institutions (CDFI) Fund. It will be financed by contributions based on Fannie Mae and Freddie Mac’s annual new business purchases from the previous year. The CDFI Fund will use these resources to provide competitively
    awarded grants to CDFIs and qualified nonprofit housing organizations to finance affordable housing
    and community development projects.

    From The Plan: DEPOSITS.—Not less than 20 percent of any profit realized on the sale of each troubled asset purchased under this Act shall be deposited as provided in paragraph (2).
    (2) USE OF DEPOSITS.—Of the amount referred
    to in paragraph (1)—(A) 65 percent shall be deposited into the Housing Trust Fund established under section 1338 of the Federal Housing Enterprises Regulatory Reform Act of 1992 (12 U.S.C. 4568); and (B) 35 percent shall be deposited into the Capital Magnet Fund established under section 24 1339 of that Act (12 U.S.C. 4569)."

    >> I'm watching this game, and have never heard of Capital Magnet Fund, so which pea is this shell covered by??

  3. Mike M

    Remind me again exactly how liquidity is going to be restored. As more hedge funds liquidate holdings, the fire-sale prices of today on debt instruments may in hindsight have been only halfway down the slippery slope of hope.

    Somewhere I read about the domino theory of deleveraging on different assets. How the contagion spreads from one class to another during debt deflation. Although Roubini has been spot on with his calls too.

    What worries me is how rosy much of the mainstream press remains when they speak of the U.S. Dave Ramsey, Ben Stein (incompetent) and many others which the vast majority of the public get their finance info are saying investing now is a golden opportunity. The slope of hope can be a vicious negative feedback loop. Many people seem to think that stocks always recover within a few years as they have been conditioned by the bull market of the last 20 yrs. (minus the tech bubble).

  4. doc burned out holiday

    Sorry, but..

    ACORN Issue Fueling Bailout Opposition


    Earlier today, when House Republican leadership framed its opposition to the bailout bill as it currently stands, a principal objection focused on the group ACORN, which the e-mail alert called “the scandal-tarnished ‘community organizing group'” — with scare quotes in the original.

    They’re referring to the Association of Community Organizations for Reform Now, a group generally allied with Democrats and derided by the GOP as corrupt, inefficient and a front-group for Democratic efforts on the ground.


    Liberals Try to Bail Out ACORN and Other Radical Community Organizer Groups

    As first reported by Warner Todd Huston of NewsBusters, Democratic lawmakers have been attempting to insert language into the bailout package to siphon off 13%* of profits (if there are any) from the sale of troubled assets and put it into a slush fund called the Housing Trust Fund. Here is the wording, apparently from Senate Banking Committee chairman Chris Dodd (D-Connecticut):

  5. m

    Who was it coined the “Politician’s Syllogism” ?

    1) Something Must Be Done.

    2) This proposal is ‘something’.

    3) Therefore, this must be done.

  6. Jojo

    Clearly, these hedge funds are too integral to the functioning of our economy and therefore, MUST be bailed out.

    Let me go out back and pluck a few more bills and coin off of my money tree. I think I best add a bit more fertilizer while I am out there also.

  7. Douglas

    I wouldn’t be concern yourself with the siphoning off of “profits” from the sale of sludge.

    It’s a misdirection ploy to create partisan bickering in order to shift the focus away from the failure of the fascist Bailout strategery.

  8. Richard Kline

    I’m not convinced that a default by the US on its sovereign debt is ‘unavoidable,’ and I say that as someone who has openly discussed such a possibility from my own longstanding concern. It is a non-trivial possibility, however. If we pass this bailout, I would submit that an eventual default becomes a signficant probability which will only be avoided by deliberate positive action, not only in the US but by all major central banks and sovereign financial actors working in concert.

    I oppose the Bullrush Bailout on many grounds, but the first and worst is that it puts us on a slippery slope toward default which we will only get off of through much greater pain subsequently. It’s and Act of Madness by Congressdweebs who are used to waving their pens and having the world sway in time. —Not this time.

  9. Jojo

    Foreign Investors and a Dollar Plunge
    Foreign central banks worry about U.S. debt load after a bailout. The greenback could suffer

    by Jane Sasseen

    Could the dollar get hammered if the $700 billion bailout goes through?

    For years the connection between the dollar and the size of the U.S. government debt has inspired one of the scariest scenarios in international finance. The U.S. depends on foreign investors to finance its budget shortfalls: 47% of Treasury bonds are held abroad. When foreigners buy this debt they support the greenback, since they need dollars to buy T-bills and other U.S. government debt. But if foreigners get spooked by the deterioration of the U.S. budget deficit, they might demand higher interest rates or even dump the U.S. paper in favor of bonds denominated in yen or euros or yuan. If the great dumping occurs, the foreign investors don’t need or want as many dollars anymore—and the greenback takes a hit.

    The scenario hasn’t played out yet: The dollar has declined but not crashed. The patience of foreign investors, however, has started to wear thin. Foreign central banks already showed their concern by urging the U.S. to take over Fannie Mae (FNM) and Freddie Mac (FNM). Now if foreign holders of U.S. equities and bonds don’t like the way the bailout or the economy is headed, Hank Paulson and Ben Bernanke could have a dollar run on their hands. “There’s no question but that investors are starting to worry about [the dollar],” says Kenneth S. Rogoff, former chief economist for the International Monetary Fund and now an economics professor at Harvard. “We will see a reassessment of the size of the flows people are willing to put into the U.S.”

    Investors and policymakers alike got a rude taste of that possibility on Sept. 22. While markets had rallied on news of the Treasury’s plan the previous Friday, the dollar plunged 2.5% against the euro as investors tallied up the huge price tag and realized the bailout wouldn’t bring a quick recovery. That was the biggest one-day drop since 2001.

    Full article

  10. Anonymous

    “Hedge fund of funds are expected to be hardest hit. One investor said: “You take a risk with individual managers but fund of funds are paid to make sure you’re diversified. Many have failed.”…

    This is nicely anonymized. But they’re talkin’ about YOU, John Mauldin — Mr. Pied Piper ‘Fund of Funds’. How are those redemption requests going? Have you thought about reinvesting some of your fat fees in a ranch in Paraguay, which has no extradition treaty with the United Snakes?

    But looking beyond individual Ponzi operators, the hedge fund rumbles suggest that no sooner than the ‘president’ signs the bailout bill with a shaky purple-Crayola ‘X’ and cartoon happy face, ‘LTCM II’ will explode in our faces, along with a fresh howl for a wider scope of relief. We saved the hedge funds in 1998, so we’ve got to do it again — or face Greenwich turning into a ghost town!

    Commenter ‘jojo’ above is on the right track. At its deepest roots, the current crisis is being caused by failure of the debt-based Bretton Woods II global exchange regime. This fatally flawed system rewards the boldest debtors — particularly the reserve currency countries — with intoxicating Bubbles, which mysteriously mutate into life-threatening black holes. The incandescent Tech Bubble of 1999 mutated into a near-80% smash in the Nasdaq, rivaling the Dow’s drop in Depression I. And the spectacular Housing Bubble demise single-handedly took out the GSEs, the entire investment banking sector, and (as you’ll soon see) the Federal Reserve. Failing to spot the linkage between these and other, earlier clues (the crash of 1987, for instance) ensures a misdiagnosis and more trouble ahead.

    Fiat currency is a doomsday mechanism. Creating currency from debt GUARANTEES nothing but a succession of Bubbles. Paradoxically, any country which moves to restore sound currency will suffer the deepest economic recession. Meanwhile, the best competitive devaluators may manage to keep a false inflationary blush of health on their cheeks.

    In a dismal abortion of democracy, it appears that the US is instinctively headed for the latter camp with its $700 bailout bill. A near-immediate consequence will be further drops in both stock indexes and the dollar, and probably a worrisome pop in long bond yields as well. But even the term “dollar crisis” will not capture the full scope of the problem.

    Bretton Woods II is broken. The glib, louche ghost of Maynard Keynes must be exorcised. I can write the founding principle of Bretton Woods III in one sentence:

    “No non-redeemable currency is acceptable in international exchange.”

    Read it and weep.

    — Juan Falcone

  11. Anonymous

    Will foreign investors continue to view US debt issues as a safe haven if the US Treasury and Fed act in ways that weaken the dollar?

    Other than as a safe haven, is their another reason for foreigners to pour their savings into the US: a country that uses foreign savings for preemptive wars and private/government consumption?

    Is the view of the US, as seen from abroad, one of a benign democracy attempting to move the rest of the world toward democratic globalisim?

    Is the view of the US from abroad one of a dictatorial fascist power that has spread terror by unilateral wars of aggression, causing the deaths of untold thousands, destroying countries wholesale, and causing fear throughout the world?

    Do you feel that Shrub/Cheney and the neocons have cast America in a good light?

    The answer to the above questions will determine how the US fairs in the coming economic crisis.


  12. Richard Kline

    I wonder where the next ‘Bretton Woods’ will be held? The last was at the Plaza in NYC. I’m betting Geneva, if not Bruxelles. Or else a flyspeck like Bermuda, which would be too, too fitting. “The Bermuda Triangulation,” i.e. US, EU, EAsia.

  13. Anonymous

    In an attempt to spend a few more days in the sun it appears that our government has reached an agreement on how to loot another $700 + Billion from the taxpayers.

    Next stop: The hollowed out state…

    The modern nation-state is in a secular decline, made inevitable by the rise of a global market system. Even developed nations, like the US, are not immune to this process. The decline is at first gradual and then accelerates until it reaches a final end-point: a hollow state. The hollow state has the trappings of a modern nation-state (“leaders”, membership in international organizations, regulations, laws, and a bureaucracy) but it lacks any of the legitimacy, services, and control of its historical counter-part. It is merely a shell that has some influence over the spoils of the economy. The real power rests in the hands of corporations and criminal/guerrilla groups that vie with each other for control of sectors of wealth production. For the individual living within this state, life goes on, but it is debased in a myriad of ways.

    The shift from a marginally functional nation-state in manageable decline to a hollow state often comes suddenly, through a financial crisis. This crisis typically has the following features:

    Corporations and connected individuals systematically loot the nation-state of financial assets and natural resources through a series of insider/no cost deals. These deals are made to “save” the nation’s economy or financial system from collapse.

    Once the full measure of the crisis is known, the nation-state’s currency falls precipitously, it’s debt becomes expensive, and it is forced to submit to international oversight/rules.

    The services the state provides rapidly evaporate as its bureaucracy is starved for cash/financing. This opens up a window for the corruption of government employees unused to deprivation.’…snip…

    To view entire article:



  14. Anonymous

    The financial statements posted on Goldman Sachs website say that Henry Paulson received restricted stock and was a beneficiary of several Goldman Sachs benefits plans. http://www2.goldmansachs.com/our-firm/investors/financials/archived/proxy-statements/docs/proxy-statement-2006.pdf

    For example, the documents say that Paulson (and other execs) would receive retiree medical coverage for himself and family members with 75% of cost paid for by Goldman Sachs. If Paulson’s rights under these pension plans would be worthless if Goldman Sachs went bankrupt, then Paulson financially benefited by bailing out AIG.

    Congress, NY AG Cuomo, and others should investigate to see if Paulson financially benefited from any of his bailouts. And if so, they should impeach, indict and prosecute him. And if Paulson destroys any documents they should prosecute him for obstruction of justice.

  15. Anonymous

    “The financial statements posted on Goldman Sachs website say that Henry Paulson received restricted stock and was a beneficiary of several Goldman Sachs benefits plans.”

    They should also investigate whether Goldman and any other banks had fraudulent marks for their securities from 2003-2006. Prosecute management for securities fraud.

  16. Matt Dubuque

    What we have here with these hedge funds is a failure of mathematical models.

    Virtually all of the pricing models used to price 500 trillion dollars in derivatives and in computerized statistical (as well as proxy) arbitrage strategies assume that stock prices (and economic shocks) are distributed in a bell-shaped curve (i.e. a normal or Gaussian distribution).

    What has occurred in reality however is that over the last 20 years we have had HUNDREDS of events so many standard deviations from the norm (otherwise known as “sigma 5 events”) that it is clear that the pricing and economic phenomena we are trying to model does NOT fit into a bell-shaped curve.

    Alternatively stated, we have now had HUNDREDS of events in the last 20 years, EACH ONE of which the computer models stated would only happen once every 100,000 years.

    The computer models just don’t work. We need to recognize that fundamental fact if we are EVER going to dig our way out of this very deep hole. The data does not match the theory.

    This horrible mistake of assuming that stock prices follow a bell-shaped curve has been AMPLIFIED beyond belief by all the major players, including hedge funds, who used HYPERLEVERAGE to “double down” their faulty bets 30 times over.
    They bet the farm, and they bet your farm too.

    Hedge funds are some of the worst offenders here.

    In summary, our computer models used to price 500 trillion dollars in derivatives (and to guide our monetary policy) are fundamentally flawed. And that enormous fundamental mistake was amplified by extremely leveraged bets.

    That’s why we are here and why we are going where we are going.

    Matt Dubuque

  17. Anonymous

    “What we have here with these hedge funds is a failure of mathematical models.”

    Management at the banks promoted securities using models they knew were wrong, just like Michael Milken promoted securities using analysis he knew was wrong.

    The worst thing about the bailout is that it will limit the damages that the banks customers and other stakeholders can sue bank management for — if management engaged in securities fraud. Buying dodgy debt from banks pumps up bank stock prices so that — if there was securities fraud — so shareholders are hurt less, and in turn, can sue management for less money.

  18. Anonymous

    Matt – You are right, and it was obvious from the beginning to the mathematically well-informed. It’s been well known in physics since the 1970s (and in electrical engineering much longer than that) that complex systems usually do not have Gaussian fluctuations.

    At a college reunion a dozen years ago, I met a former math major who was working on Wall Street. He told me that they weren’t paid to write models that are better, but to make models that are the same as everybody else’s model.

    A system in which a large number of actors mimic each other’s behavior is particularly unstable.

  19. Anonymous

    You are right, and it was obvious from the beginning to the mathematically well-informed. It’s been well known in physics since the 1970s (and in electrical engineering much longer than that) that complex systems usually do not have Gaussian fluctuations.


    That is wonderful. It is great news that it was common knowledge among quantitative securities professionals that management was using wrong models to promote its own stock and securities sold to customers. This may help prosecute them, like Milken who knew it was not appropriate to rely on prior academic research regarding bonds of “fallen angel” companies to promote Milken’s junk bonds.

  20. Matt Dubuque

    Matt Dubuque

    To the anonymous among us, I would supplement the discussion by pointing out that to use faulty mathematical models to model 500 Trillion in derivatives (and to conduct monetary policy in the ECB and England) is one thing, but it is QUITE ANOTHER to use hyperleverage to amplify the mistake.

    Not only did they use faulty mathematical models, they bet the farm and your farm and your neighbor’s farm as well. With no money down.

    Now that BOTH of these conditions have occurred we are where are and we are going where we are going.

    We will have a much clearer sense in February of next year (at the latest) how much of this is going to play out.

    Matt Dubuque

  21. kwik-e-trading

    Why do you think 2 and 20 is so high? Is it really higher than comp levels at i-banks or prop trading depts of commercial banks?

    It is hard to start a hedge fund on less than 2/20, and when investor demand makes the fund grow it certainly doesn’t need to cut fees. It seems to me that hedge fund fees may fall as a part of financial sector-wide contraction, but it doesn’t look to me like they are are currently out of line with the sector.

  22. Anonymous

    Hey River, You are full of CRAP. If the US is so bad why don’t you take your A_ _ somewhere else? Good Riddance.

  23. Anonymous

    Follow the Leader Models: or, Collapse of Information Cascades…

    ‘Information cascades are important. They explain many of the big problems we currently face. Here’s how an information cascade works:

    1) An event occurs or a problem surfaces.

    2) A person who is perceived to have good data/insight into the event or problem makes a decision.

    3) Other people, observing the first person’s decision, opt to avoid original analysis/discovery and copy the earlier decision.

    4) The more people that copy the earlier decisions, the less likely any new discovery or analysis is done.

    If the earliest decision was correct, then everything works out. If it isn’t, the error is compounded until it becomes a major problem when it collapses. In today’s world, with its copious communications systems, information cascades occur with increasing rapidity. They can spiral out of control in hours/days. This also means that on the flip side, an information cascade can collapse suddenly, when the original decision(s) is(are) proven wrong.

    An information cascade is a good explanation for why the financial industry became so hopelessly lost. They based their decisions on economic and financial theories that claimed to have predictive power in EXTREMELY complex domains (since this methodology came from careful study in academia, it was assumed to be correct). The information cascade was the rampant application of these theoretical models throughout the financial industry over decades. However, as Nassim Taleb (although the writing is often tough to decipher) points out in this brief, the true predictive capacity of these models was nil/nul/void, since they are extremely vulnerable to black swans — the collapse of the massive hedge fund, Long Term Capital Management proved this point nearly a decade ago. So, what happened when the black swan arrived that demonstrated that these models were wrong? The system imploded as confidence in all of the previous decisions made with those models are called into question (the information cascade collapsed).’…snip…


    Nasim Taleb’s ‘Black Swan’ is an excellent read, imo.

    I think the jury should remain in deliberation on the cause of the current economic train wreck. More evidence might surface. There are those that contend this entire debacle was hatched by a few Wall St Bankers who were well aware of the consequences of their actions.


  24. Anonymous

    They should also investigate whether Goldman and any other banks had fraudulent marks for their securities from 2003-2006. Prosecute management for securities fraud.

    Damned straight. If the bankers ram through a corporate handout in the face of public opposition, we need to send them to jail for any securities fraud, and we need plaintiff lawyers to bankrupt them with lawsuits.

  25. Anonymous

    Why not take it all the way to the bottom of the pile and include all the real estate sales people. They shoved hugh homes on people who would never be able to afford them and now, forclosures!!!!! They still got their commissions while their clients not are losing their homes and having to live on credit cards that will never be paid off either.
    Is this pure greed or what??? Also,
    Lets face it people—–we put these jerks in Washington—maybe now its time to get them out!!!!!

  26. Anonymous

    “Damned straight. If the bankers ram through a corporate handout in the face of public opposition, we need to send them to jail for any securities fraud, and we need plaintiff lawyers to bankrupt them with lawsuits.”

    Hell yes, billionaire Mort Zuckerman refused a recent request to invest in a secondary offering of Goldman Sachs shares because GS wouldn’t offer him the same deal as Buffett (preferred with high coupon, plus in the money warrants).

    The taxpayer should get a deal as good as buffet’s. Anything worse is a handout to bankers, and needs to be rewarded with large scale prosecutions to send bankers to jail, and civil lawsuits to bankrupt them.

  27. dearieme

    “m said…
    Who was it coined the “Politician’s Syllogism” ?”

    The first time I heard it was on the 1980s BBC comedy “Yes, Minister”. The scriptwriters were Jonatahan Lynn and Antony Jay.

  28. fresno dan

    Andy GL: I agree 100% – matters continue until they can’t – there is no law of nature that the US must have good credit – it can be squandered.

    M. Dubuque: I agee also – ecomonics is not real science and therefore not amenable to mathematical modeling. Despite numerous events that disprove the “rational player” theorem, people (irrationaly) continue to believe that people make informed rational economic decisions. This doesn’t mean I support bureaucratic decision making – I am a bureacrat and I havn’t seen a lot of logic in our bureaucratic decisions.

  29. dearieme

    Oops, “Jonathan”. And I’m uncertain about the comma after the “Yes” but youtube would resolve that.

  30. Moopheus

    Yes, yes, Mr. Falcone, we know that gold has magical economic properties that imbues rationality and wisdom upon all who touch it and gaze upon its marvelous shiny surfaces. The supernatural ability of gold to prevent stupidity and greed and excess is well documented. Lordy lordy, Jeebus hisself has ordained the that gold shall be the ultimate arbiter of value, and that the flawless mechanism of the free, unregulated markets will bring peace and joy to all. Amen.

  31. Anonymous

    Anonymous @ 11:07 – Perhaps, but I suspect that there has been criminal behavior that would be much easier to explain to a jury than misuse of Gaussian fluctuation models.

    All models are approximate. A model that’s a better approximation can make you money trading in a market. The problem here isn’t the use of approximate models so much as (1) the herd behavior and (2) the leverage. Both amplify the small errors, which would have no effect if you were trading for your own account with a unique model.

    Anonymous @ 10:56

  32. Anonymous

    The taxpayer should get a deal as good as buffet’s. Anything worse is a handout to bankers, and needs to be rewarded with large scale prosecutions to send bankers to jail, and civil lawsuits to bankrupt them.

    We also need to prosecute members of Congress. The fact that Congress is ramming through a corporate handout despite public outrage likely means some members are as corrupt as the Keating 5, who were investigated and punished for helping Charles Keating violate banking laws. We need to investigate members of Congress and the Senate to see if we can send any of them to jail.

  33. Anonymous

    “Yes, yes, Mr. Falcone, we know that gold has magical economic properties …” — moopheus

    Who said anything about gold? Not me. I said “redeemable.” But not into WHAT.

    Could be gold. Could be silver. Could be a commodity basket. Even redeemability into the securities which allegedly back Federal Reserve Notes would impose some accountability upon the current empty circularity. That’s how ETFs are held in line with their intrinsic asset values; why not currencies?

    Well, we know why, don’t we? Central banks are one-way check-kiting schemes. They can’t be arsed to offer two-way bid/ask quotes on their liabilities, as an honest broker would do.

    Gold is a suboptimal reserve asset which happens to be better than many other suboptimal choices, in that its supply can’t be multiplied without limit. Other than that, I have no particular brief for gold.

    The ultimate quantum of value, I would submit to you, is energy. Let a dollar equal a thousand ergs or a thousand BTUs, deliverable in a choice of formats (electrical, fuel, nuclear, electromagnetic, etc.) compatible with current technology. Energy, thermodynamics tells us, is fundamentally scarce. At least, our ability to obtain and exploit it is. Energy, therefore, is money in its purest, most abstract form.

    — Juan Falcone

  34. Anonymous

    Information cascades… spot on. Having worked at a rating agency through the asset backed bubble and the creation of the most complex CDOs and CSOs, it was very very clear that extreme reliance was placed on the precedent analysis being correct.

    There was no time – if we were to keep our market share and achieve the quarterly targets (thanks, Mr Market for turning what should have been an agent of the commons into a profit seeking opportunist) – to do anything like original analysis.

    But I must say the “holier than thou” name calling that persists on this site is nothing short of laughable in its hypocrisy.

    Every one of the “blame-ables” (Congressional reps, Wall Street CEOs, I-bankers, even real estate agents and mortgage brokers) is human, and they behaved completely consistently as normal human beings: maximizing their perception of optimal outcomes (measuring their own benefits against the perception of foreseeable probable costs … to them first, and secondarily, to others). To suddenly posit a world filled with courageous whistleblowers is to dwell in a fanciful world of make-believe.

    We’re imperfect. Get over it.

  35. SheldenfromBellevue

    I am confused on how exactly the US could “default” on dollar denominated debt?

    Since they have the printing press to create as many dollars as they want, there would not be a default. There would be dollar devaluation, high inflation and high interest rates for sure – but they could repay this debt (at the huge expense of the holders of this paper for sure). Is that what you mean by a “default”?

  36. Anonymous

    “Since they have the printing press to create as many dollars as they want, there would not be a default.”

    Over the past 800 years, there are examples of countries defaulting on debt denominated in their own currency. It happens when politicians think their constituents and patrons are better off by defaulting on debt, rather than inflation.

  37. Anonymous

    Oh lord, Matt Dubuque, why don’t you just start your own blog and bloviate over there. Those of us who are too dumb to grasp how much smarter you are than we find your pompously-toned lectures so, so tiresome. Go away.

  38. Matt Dubuque

    Matt Dubuque


    Taleb is a good read, as is Mandelbrot.

    Matt Dubuque

    PS: As for the faceless and personal attack of anonymous at 209pm, you are not the moderator.

    Yves is free to speak up on this issue in her usual measured way. She established quotas for the numbers of posts allowed for participants here (1 in 10, 2 in 10 if a response is received) and I have followed them.

    And others have commented that my comments are useful. I’ll leave it at that.

  39. Anonymous

    Defaulting is more or less a liquidation.

    Warehousing gold established the basis for factional reserve banking better known as legal tender.

    It is more a matter of trust when it comes to monetary systems, you are believed to perform on obligations until you can’t or won’t.

    Apparently, capitalists can’t be happy with a…… say 5% growth rate a year. Going home to a front yard bordered by a white picket fence to enjoy the wife and kids immediately after work is just to mundane. Greed kicks in as a goal.

  40. Moopheus

    “Energy, thermodynamics tells us, is fundamentally scarce. At least, our ability to obtain and exploit it is.”

    I would agree that energy is one of the essential elements of life–we need it to live, literally, but neither it, nor is anything else, is money, which is an abstraction, an artificial concept we invented for our own purposes. “convertability” is no more real than “fiat,” it’s still an arbitrary connection that we manipulate at our will.

  41. Anonymous


    I did not respond to any anon comments.

    For the average person I believe Taleb is more readable than Mandelbrot…Unless one is fond of complex math.

    This is a great site and Yves seems to keep things in order without being overbearing.

    I enjoy your comments and I always add ‘River’ at the bottom of my comments.

    Good luck


  42. Anonymous

    Yves pointedly refrains from chest-pounding, while Roubini and Mish do it all the time. And did you say she was wrong here? I note utter silence on the substance.

    The point, if I read it correctly, is that cartel pricing is destined to fail in the long term. That is hardly a controversial view, but it apparently gets denied in specific contexts.

  43. Matt Dubuque

    Hi River-

    Thanks for the kind comment.

    I thought Mandelbrot’s Misbehavior of Markets was a pretty easy, quick read.

    Do you ever visit wilmott.com?

    I’m not trying to sound pompous, I’m just trying to explain the facts as I see them.

    That said, I think it is fair to say that wilmott.com is the top quantitative finance board in the world. You might enjoy it River.

    Taleb posts there, as does the head of risk management for Citigroup, as well as a few Field Prize winners, which is the world’s top prize for mathematics.

    You might enjoy the lively discussions there. Smartest people I’ve ever met. Paul (the moderator) has kindly offered me open doors at key quant desks in London should I need it for one of my outside projects.

    I just bought a super fragrant basil
    bush that you can grow indoors in the winter. A welcome addition, the fragrance is heavenly!

    I’m off to enjoy our splendid sunshine on the roof.


    Matt Dubuque

  44. a

    “Not a single hedge fund strategy has produced positive returns so far this month, with convertible arbitrage and distressed securities down an estimated 7.96 per cent and 7.34 per cent, respectively, according to Dow Jones Hedge Fund Indexes. Equity market-neutral funds, which often short a stock in one sector and go long on another in the same sector, are down 1.85 per cent.”

    Two of three of the strategies mentioned – convertible arbitrage and market-neutral funds – depend on short selling of securities. The attack by governments on short selling, has at worst forced the hedge funds to liquidate their shorts or at best pushed the market against their positions (e.g. being short financials).

    I could be wrong, but I don’t think Gaussian assumptions had much to do with the hedgies’ loss this month.

  45. russell1200

    Matt’s comments certainly don’t bother me – and thank you for the link.

    The general goldbug theme that I have heard since the 1970s I have found annoying. The fact that I often found their arguments to be plausible being somewhat beside the point.

    I was able to fairly easily explain the current situation to my (non-finance) wife by explaining what happens when you have 3.33% losses at 30-1 leverage. But the default swap market (leverage through lack of reserves) has to be reeling.

    And the much larger interest rate swap market has to be getting scary when jumbo loans go to 9%. If you bought the fixed rate in return for the floating rate portion of the swap you have to be getting hammered. Particularly as the spread between t-bills and jumbos widened.

    Both of these are areas where lack of over site allowed (hedge funds) huge amounts of leverage.

  46. Hu Flung Pu

    Matt’s comments don’t bother me either. Although I categorize most of them as Blinding Glimpses of the Obvious – observations that he thinks are original or enlightening but in fact are neither. But he appears harmless. I find his habit of signing “Matthew Dubuque” both at the beginning and end of his posts a bit odd. But, whatever…

  47. Independent Accountant

    Hedge fund talent? Surely you jest. The average hedge fund does not beat Vanguard's S&P 500 fund. These clowns are overpaid!
    Chest pound all you want.

  48. kwik-e-trading

    But the average hedge fund is less volatile than the S&P 500.

    Hedge funds seem like the most bare bones financial operations possible. I don't see why Yves thinks 2/20 is so high. If you look at the bonuses paid at hedge funds this year (vs those paid at the even worse performing banks and brokers), I think the hedgies will come off as the more in tune with their clients.

  49. Anonymous

    I love watching these hedge funds idiots lose their jobs. They thought they were Masters of Universes. In actuality, they are as dispendible as mortgage brokers.

  50. Jojo

    The NYT ran an excellent article on math models and the quants last week. The comments were also very good overall and should be read in full.
    NY Times
    September 18, 2008, 7:52 am
    How Wall Street Lied to Its Computers
    By Saul Hansell

    So where were the quants?
    (Credit: Fred R. Conrad/The New York Times)

    That’s what has been running through my head as I watch some of the oldest and seemingly best-run firms on Wall Street implode because of what turned out to be really bad bets on mortgage securities.

    Before I started covering the Internet in 1997, I spent 13 years covering trading and finance. I covered my share of trading disasters from junk bonds, mortgage securities and the financial blank canvas known as derivatives. And I got to know bunch of quantitative analysts (”quants”): mathematicians, computer scientists and economists who were working on Wall Street to develop the art and science of risk management.

    They were developing systems that would comb through all of a firm’s positions, analyze everything that might go wrong and estimate how much it might lose on a really bad day.

    We’ve had some bad days lately, and it turns out Bear Stearns, Lehman Brothers and maybe some others bet far too much. Their quants didn’t save them.

    I called some old timers in the risk-management world to see what went wrong.

    I fully expected them to tell me that the problem was that the alarms were blaring and red lights were flashing on the risk machines and greedy Wall Street bosses ignored the warnings to keep the profits flowing.

    Ultimately, the people who ran the firms must take responsibility, but it wasn’t quite that simple.

    In fact, most Wall Street computer models radically underestimated the risk of the complex mortgage securities, they said. That is partly because the level of financial distress is “the equivalent of the 100-year flood,” in the words of Leslie Rahl, the president of Capital Market Risk Advisors, a consulting firm.

    But she and others say there is more to it: The people who ran the financial firms chose to program their risk-management systems with overly optimistic assumptions and to feed them oversimplified data. This kept them from sounding the alarm early enough.

    Top bankers couldn’t simply ignore the computer models, because after the last round of big financial losses, regulators now require them to monitor their risk positions. Indeed, if the models say a firm’s risk has increased, the firm must either reduce its bets or set aside more capital as a cushion in case things go wrong.

    Full article


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