More Money Than God_Hedge Funds and the Making of a New Elite

by Sebastian Mallaby

  20. Johnson recalls, “I could just feel the energy of the two men just picking up…There’s a funny kind of body language when you say something to people, and their eyes kind of start to go to each other. Like they’re looking at each other like ‘Whoa, yeah.’ It was visceral.” Johnson interview.

  21. Scott Bessent recalls that Quantum wanted to limit its risk in the sterling trade to the investment gains it had made so far that year. Hence Quantum worked out what it would lose if sterling moved to the far side of the band permissible within the exchange-rate mechanism and capped the capital it risked accordingly. (Scott Bessent, interview with the author, January 18, 2008. See also Steven Drobny, Inside the House of Money: Top Hedge Fund Traders on Profiting in the Global Market (Hoboken, NJ: John Wiley & Sons, 2006), p. 275.) But Johnson and Druckenmiller have a different memory. Druckenmiller says, “I didn’t think that [sterling moving to the other end of the band] was remotely possible. I felt very strongly that just couldn’t happen because these economies were so ass-backwards. So yeah, theoretically it could have gone to the other side of the band. I didn’t even consider it, to tell you the truth.” (Druckenmiller interview, June 4, 2008.)

  22. This exchange is recalled by Robert Johnson. Johnson interview; Robert Johnson, e-mail communication with the author, November 10, 2008.

  23. “It was almost like you could feel a big inhale. You know, like you’ve seen when Michael Jordan goes to dunk. You can just see his eyes get big. It was fascinating. I walked out of there with absolutely no question that we were going to go after this thing. I knew other people in the banks and counterparties would imitate us.” Johnson interview.

  24. On an average day in 1986, for example, $58 billion worth of currencies were traded on the world’s markets; but by 1992 the daily turnover had almost tripled to $167 billion. These data come from the U.S. Federal Reserve. They include spot trading, forward trading, and swaps and are adjusted for double reporting by participating dealers. Interestingly, before 1986 the foreign-exchange markets were so insignificant that the Fed did not collect data on them. See http://www.newyorkfed.org/markets/triennial/fx_survey.pdf.

  25. The intervention came on August 21, 1992. At the end of Europe’s trading day, the dollar’s value had scarcely budged from its preintervention level, and four days later the dollar hit a record low against the deutsche mark. Contemporary news accounts show that the authorities’ failure was not regarded as inevitable; the triumph of market muscle over government intervention was not fully understood until after sterling’s debacle a month later. For example, a Reuters story on the August intervention quotes Klaus Weiland, a trader at Deutsche Girozentrale-Deutsche Kommunalbank, as saying: “Today’s intervention restores some of the central banks’ credibility.” (Erik Kirschbaum, “Central Banks Battle to Support Flagging Dollar,” Reuters, August 21, 1992.) Commentators in the Economist and the Financial Times noted that the central banks’ failure raised doubts about the efficacy of intervention, but they presented these doubts as a novel factor in global finance. “Yesterday’s action raises questions about the credibility of internationally co-ordinated exchange rate policy,” the FT’s Lex Column noted (“D-Day for the Dollar,” Lex Column, Financial Times, August 22, 1992); the failed intervention “has reinforced the lesson that currency intervention works only if it is allowed to affect domestic monetary policy; it cannot do the job on its own,” the Economist noted (“Forever Falling?” Economist, August 29, 1992, p. 65). Writing with the benefit of hindsight, Norman Lamont, the British finance minister, was more definitive in describing the August failure as a telling portent of a changed world. (Lamont, In Office, p. 222.)

  26. Italy had devalued the lira previously, most recently in 1987. But those earlier devaluations had been smaller and had been initiated by the Italian government in order to boost exports. In 1985, for example, the Italian government was widely thought to have instructed ENI, the Italian energy giant, to initiate a deliberate run on the lira in order to force Italy’s European partners to accept devaluation. In 1992, by contrast, the Italians fought devaluation tooth and nail, with the support of the Bundesbank.

  27. By any previous standards, the Bundesbank’s intervention was colossal. The largest ever intervention by the Federal Reserve, which had taken place in 1989, had involved the selling of just $1.25 billion.

  28. The passage that follows draws extensively on Lamont, In Office, pp. 220–26.

  29. Ibid., p. 231.

  30. Soros recalled: “When Norman Lamont said just before the devaluation that he would borrow nearly fifteen billion dollars to defend sterling, we were amused because that was about how much we wanted to sell.” Anatole Kaletsky, “How Mr. Soros Made a Billion by Betting Against the Pound,” Times (London), October 26, 1992.

  31. Will Hutton, “Inside the ERM Crisis: Black Wednesday Massacre,” Guardian, December 1, 1992, p. 15.

  32. “I did not in any way foresee the scale of what was to happen, let alone that the next day would see the end of our membership of the ERM. It simply did not cross my mind.” Lamont, In Office, p. 245.

  33. “Basically, it was the German central bank just trashing Britain…. It was so obvious what was going on.” Druckenmiller interview, March 13, 2008.

  34. Speaking of Soros’s advice to go for the jugular, Druckenmiller says, “This gets back to the genius we were talking about. I can do all my fancy analysis. I can have the concepts, I can do the economics, and I can even have the timing, but one simple statement like that in terms of size…We probably got twice the profit I would have had without that snide comment he made about ‘Well, if you love it so much….’” (Druckenmiller interview, March 13, 2008.) Gerry Manolovici, an equity specialist at Soros Fund Management, recalls, “Schlesinger was asked after the lira devaluation whether now everything was stable. And Schlesinger said, ‘No, other countries missed the opportunity to devalue.’ At this Soros went nuts. He scoured the world for credit to put on short positions.” (Gerry Manolovici, interview with the author, March 31, 2008.)

  35. Soros recalls, “Basically, I said, ‘This is the moment, they are capitulating, go for the jugular.’ And he went, and even I went. I don’t normally make phone calls, but I was also calling looking for counterparties.” Soros interview, January 16, 2008.

  36. Druckenmiller recalls, “We really went after this thing and kept going and going and going like the Energizer bunny…. So anybody with a brain is going to ask his dealer, ‘What the hell is going on?’ And I know people talk. It’s Quantum.” Druckenmiller interview, June 4, 2008.

  37. Soros recalls, “I remember we called everyone who was willing to put on an additional position to sell sterling…. It wasn’t possible to find counterparties who were willing because they had limits to how much they could do.” Soros interview, January 16, 2008.

  38. Louis Bacon recalls, “I don’t think I’d ever talked to George before. Having George talk was like having a demigod coming down from on high to talk to you.” Louis Bacon, interview with the author, July 21, 2009.

  39. Bessent interview.

  40. Scott Bessent recalls, “We could push the bank against the wall. They would have to buy an unlimited amount of sterling from us.” Bessent interview.

  41. David M. Smick, The World Is Curved (New York: Portfolio, 2008), pp. 183–84.

  42. Lamont, In Office, p. 249.

  43. The minister was Kenneth Clarke. See Philip Johnston, “Ministers Caught in a Maelstrom as the Pound Plunged Through the Floor,” Daily Telegraph, September 13, 2002.

  44. Soros interview, January 16, 2008; Scott Bessent, e-mail communication with the author, November 8, 2008.

  45. The $27 billion includes $4.1 billion worth of sterling purchases by other central banks. Under the rules of the exchange-rate mechanism, these would have to have been repaid by the Bank of England. See Lamont, In Office, p. 259.

  46. The magnitude of sterling’s fall depends on the period chosen. At its trough, reached in March 1993, sterl
ing was 16 percent down, implying a cost to British taxpayers of over $4 billion. But the immediate fall was 14 percent, and sterling fluctuated around that level through December.

  47. There are various estimates of the total sterling selling by Soros Fund Management. Druckenmiller recalls that he sold about $7.5 billion on behalf of Quantum, a figure that would have excluded selling by Soros in his side account. (Druckenmiller interview, March 13, 2008.) Soros, in an interview one month after the trade, put the total sterling sales at almost $10 billion. Meanwhile, two former Soros employees give substantially higher estimates. Kaletsky, “How Mr. Soros Made a Billion.”

  48. According to news reports, these banks were Citicorp, J.P. Morgan, Chemical Banking, Bankers Trust, Chase Manhattan, First Chicago, and Bank America. (See Thomas Jaffe and Dyan Machan, “How the Market Overwhelmed the Central Banks,” Forbes, November 9, 1992, pp. 40–42.) It is notable that hedge funds made larger profits on the sterling trade than banks, even though banks managed far more capital. Further, hedge funds were the leaders in the currency trades, with banks that executed their trades then copying them on their own books. The IMF’s Capital Markets report, commissioned after the collapse of the European exchange-rate mechanism, noted that the determination of hedge funds “to position themselves favorably for possible exchange rate realignments in the ERM apparently served as a signal for other institutional fund managers to re-examine their own positions…. Thus, although hedge funds have less than $10 billion in capital, their potential influence on forex markets [was] larger.” (International Monetary Fund, “International Capital Markets,” 1993, p. 11.) Given the size of Soros’s profits relative to those of the banks, the IMF was understating the point by a wide margin.

  49. As of late October, Soros’s profits on his sterling position stood at $950 million. But at that time Soros was correctly expecting that sterling would ultimately fall further, so the eventual profit was probably larger. If Soros Fund Management exited its estimated $10 billion position with a profit averaging 14 percent, a reasonable estimate of the truth, it would ultimately have made $1.4 billion. Kaletsky, “How Mr. Soros Made a Billion.”

  50. Stephen Taub, Nanette Byrnes, and David Carey, “The $650 Million Man,” Financial World 162, no. 14 (July 6, 1993): pp. 38–61.

  51. The Swedish trade was conceived by Robert Johnson. On the secrecy of the Swedish trade, Druckenmiller recalls, “By then at least we learned to keep our mouth shut.” Druckenmiller interview, June 4, 2008; Johnson interview.

  52. David Israelson, “France Tries to Halt Speculation on Franc,” Toronto Star, September 23, 1992.

  53. Larry Elliott, Mark Milner, Ruth Kelly, and David Gow, “After Black Wednesday: The Currency Puzzle Remains Unsolved,” Guardian, September 17, 1993, p. 17.

  54. Robert Johnson recalls, “One of the reasons I left Banker’s Trust and joined Soros is I didn’t know if Banker’s Trust had the courage to go after something so threatening to government structures when they have to have a banking license. I knew George did.” Johnson interview.

  55. Soros recalls, “I warned him [Trichet] that he’s liable to be attacked, and I said, ‘I’d like to be helpful and therefore I will not take a position.’” (Soros interview, June 10, 2008.) Elsewhere Soros has said, “When the French franc came under attack, I really believed I could have toppled it if I joined the fray. This led me to behave rather foolishly. I chose to abstain from speculating against the franc in order to be able to express what I thought were constructive suggestions. This had doubly unfortunate results: I lost what was a profit opportunity, and I annoyed the French authorities even more with my comments than I would have done by speculating against the franc. It taught me a lesson: Speculators ought to keep quiet and speculate.” (Soros, Soros on Soros, pp. 85–86.) This passage gives a sense of Soros’s split personality but should be treated with a grain of salt. For one thing, Quantum made money by not betting against the franc. For another, Soros failed to keep quiet and speculate during the emerging-market crisis, as described in chapter nine.

  56. “I fight for many causes in my life, but I don’t particularly feel like defending currency speculation.” Soros, Soros on Soros, p. 83.

  57. Kaletsky, “How Mr. Soros Made a Billion.”

  CHAPTER EIGHT: HURRICANE GREENSPAN

  1. I am grateful to Michael Steinhardt and Tricia Fitzgerald for providing full historical performance data, which are also presented in Appendix II.

  2. Shadowbanks later made loans to companies and home buyers, whereas Steinhardt’s early version focused on the government bond market.

  3. Steinhardt recalls that his main broker, Goldman Sachs, was providing leverage “overjoyedly.” Michael Steinhardt, interview with the author, December 15, 2008.

  4. Steinhardt recalls that his leverage on U.S. government bonds was exceptionally high. His leverage on European bonds was more like twenty to one, and the leverage for his funds as a whole might have been less than ten to one. Steinhardt interview. See also Steinhardt, No Bull, p. 224.

  5. The Goldman partner was Leon Cooperman, formerly the boss of the asset management division of Goldman. The Salomon partner was Stanley Shopkorn, the head of equity trading. In 1993 John Meriwether left Salomon Brothers and raised $1.2 billion for a fund called Long-Term Capital Management.

  6. The estimate of three thousand hedge funds comes from the International Advisory Group in Nashville. Even this excluded offshore funds. See Gary Weiss, “Fall Guys?” Business Week, April 25, 1994.

  7. Dyan Machan and Riva Atlas, “George Soros, Meet A. W. Jones,” Forbes, January 17, 1994, pp. 42–44.

  8. Laurie P. Cohen and Michael Siconolfi, “The Cruelest Month: Before May’s Squeeze, One in April Wounded Investors in Treasurys,” Wall Street Journal, October 7, 1991.

  9. Laurence Zuckerman, “$76 Million to Settle Treasury Note Charges,” New York Times, December 17, 1994.

  10. Michael Siconolfi. “Salomon, Two Funds Set to Settle Claims,” Wall Street Journal, March 31, 1994.

  11. Bob Woodward, Maestro (New York: Simon & Schuster, 2000), p. 116.

  12. Further illustrating his concern about a potential Wall Street backlash, Greenspan had used the occasion of his January 31 testimony before Congress to deliver a warning to equity investors: “Short-term interest rates are abnormally low in real terms,” he declared, signaling that a rate hike was coming. (See Hearing of the Joint Economic Committee, “1994 Economic Outlook,” 103rd Congress, Second Session, January 31, 1994.) In his autobiography, Greenspan recalls that his message was unusually explicit in that testimony: “It was like banging a pot.” (Alan Greenspan, The Age of Turbulence: Adventures in a New World (New York: Penguin Press, 2007), p. 154.) Vincent Reinhart, a senior Fed economist at the time, recalls that Greenspan’s effective anticipation of equity-market reactions was matched by the surprise he experienced at the hands of the bond market. (Vincent Reinhart, interview with the author, September 11, 2008.)

  13. Federal Open Market Committee transcript, February 3–4, 1994.

  14. By February 8, the ten-year bond yield was 5.98 percent, twenty-four basis points up from the yield at the start of the month.

  15. During 1993, Quantum made big profits on the yen-dollar rate and was acutely sensitive to the links between the exchange rate and trade talks. By January 1994, Druckenmiller’s bet against the yen was worth an astonishing $25 billion, demonstrating not only his confidence in the trade but also the rapid growth of Quantum since the sterling coup less than two years earlier. Although this trade blew up in February, Druckenmiller was fortunate to have sold his large portfolio of European bonds in January 1994. Combined with a successful trade in copper, this allowed him to get through the turbulent year of 1994 without losses. Stanley Druckenmiller, interview with the author, June 4, 2008. See also David Wessel, Laura Jereski, and Randall Smith, “Stormy Spring,” Wall Street Journal, May 20, 1994.

  16. Between February 11 and February 15, the ten-year Treasury yield moved
from 5.88 percent to 6.20 percent.

  17. Data for Japan come from Bloomberg Generics, a time series of active debt issues. No such series exists for Italy and Spain; data for these countries come from analysis of expired bond issuance by Paul Swartz of the Center for Geoeconomic Studies at the Council on Foreign Relations.

  18. “Where It Hurts: Bets on Foreign Debt Go Bad and Punish Big Players in U.S.—Bankers Trust and Others Feel Pain From Europe and ‘Emerging Markets’—Steinhardt Takes a Big Hit,” Wall Street Journal, March 3, 1994.

  19. Randall Smith, Tom Herman, and Earl C. Gottschalk Jr., “Mean Street,” Wall Street Journal, April 7, 1994.

  20. Steinhardt, No Bull, p. 224. Various news accounts put Steinhardt’s European risk at $7 million per basis point or lower, but I have taken Steinhardt’s estimate in his autobiography as the most authoritative.

  21. Steinhardt recalls, “We were losing money and I couldn’t quite catch my breath; things were happening and we had positions and it was as if I just didn’t quite have the ability to understand where we were and why we were where we were. It was as if we were playing yesterday’s or last year’s game.” Steinhardt interview.

  22. “I remember Michael being very upset. I just want to sell them. I just want out. It’s over, just sell them. And the guy not being able to execute it and sell them.” John Lattanzio, interview with the author, December 15, 2008.

  23. “Where It Hurts.”

  24. Steinhardt, No Bull, pp. 225 and 227. Steinhardt elaborates: “My great problem, as humbly acknowledged, was I didn’t know what I was talking about. I didn’t know the names of the securities, the names of the French ten-years, whatever they call them…. I didn’t know who made the markets and all this other stuff…. I didn’t know that there could be substantial differences between the French bonds and the Germans and the gilts and the Americans…. I mean, I didn’t know. And that’s when I got killed…. Was I ever dumb and cocky.” Steinhardt interview.