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

by Sebastian Mallaby

  45. The quotations from the Goldman trader in London and from Corzine are taken from Lowenstein, When Genius Failed, pp. 174–75.

  46. Peter Fisher, interview with the author, March 6, 2009.

  47. Fisher recalls thinking, “It’s not going to be like Drexel Burnham. We’re not going to be at the command center trying to decide what we’re going to do with the collateral, and we can kind of work it out because we’ve actually got the assets. This is a hedge fund and there are no assets here. So in the event of default, all that risk is now transferred to these seventeen brokers, who are going to be duty-bound to liquidate. Their lawyers are going to tell their trading desks, ‘We gotta close this out as fast as you can because we have a duty—we can’t just sit on these positions.’” Fisher interview. See also Lowenstein, When Genius Failed, pp. 188–89.

  48. The stock prices of banks such as Merrill Lynch and J.P. Morgan had fallen by almost half over the summer.

  49. In later congressional testimony, both William McDonough, the head of the New York Fed, and Greenspan emphasized that the Fed’s willingness to broker a rescue of LTCM was heightened by the already febrile state of the markets. In light of the later collapse of the hedge fund Amaranth, this is important. Amaranth looked in 2006 like proof that hedge funds could blow up without destabilizing the financial system. But the world could absorb shocks in 2006 in a way that it could not in 1998—or, for that matter, in 2008. This is why it is impossible to say categorically whether hedge funds, or even some subset of hedge funds, do or do not pose systemic risk. The answer depends on market conditions, as argued in the conclusion.

  50. Fisher recalls, “All the talking heads are saying that it’s because the video of Bill Clinton’s Monica Lewinsky deposition is going to be aired at nine o’clock New York time. I remember very clearly as the week progressed that Dave Komansky [Merrill Lynch’s boss] and I just thought that was the funniest thing ever.” Fisher interview.

  51. Rosenfeld, Harvard Business School presentation.

  52. By Wednesday Bill McDonough had returned from London and was chairing the meetings, but Fisher was participating as a backbencher. Fisher interview.

  53. Rickards interview.

  54. Alan Greenspan, “Private-sector refinancing of the large hedge fund, Long-Term Capital Management.” Statement before the Committee on Banking and Financial Services, U.S. House of Representatives, 105th Congress, Session 2, October 1, 1998.

  55. “In August 2007, the risk-management structure cracked. All the sophisticated mathematics and computer wizardry essentially rested on one central premise: that the enlightened self-interest of owners and managers of financial institutions would lead them to maintain a sufficient buffer against insolvency by actively managing their firms’ capital and risk positions. For generations, that premise appeared incontestable [sic] but, in the summer of 2007, it failed.” Alan Greenspan, “We Need a Better Cushion Against Risk,” Financial Times, March 27, 2009, p. 9.

  56. Alan Greenspan, “Private-sector refinancing of the large hedge fund, Long-Term Capital Management.” Statement before the Committee on Banking and Financial Services, U.S. House of Representatives, 105th Congress, Session 2, October 1, 1998.

  57. Reflecting on the evolution of his thinking, Peter Fisher comments, “I was reluctant to say then, ‘Therefore we should regulate leverage.’ I guess I got myself halfway there. I was saying, ‘The problem was leverage, but how do we regulate that?’ Ten years on the problem is leverage and we just got to regulate it; we got to find a way. So that’s the policy change for me in ten years.” (Fisher interview.) Equally, Vincent Reinhart, a senior Fed economist at the time of the LTCM failure, reflects, “Extraordinarily, 1998 was followed not by a reining in of leverage but by an acceleration. The opposite of the logical lesson was drawn.” (Vincent Reinhart, interview with the author, September 11, 2008.)

  CHAPTER ELEVEN: THE DOT-COM DOUBLE

  1. See Tom Wolfe, The Right Stuff (New York: Picador, 1979), p. 9.

  2. Julian H. Robertson, letter to the limited partners, October 2, 1998. Emphasis in the original.

  3. The account of the yen loss is based mainly on an interview with Dan Morehead, Tiger’s currency trader. (Dan Morehead, interview with the author, September 2, 2008.) Robertson himself wrote that “the dollar/yen trading market, which is typically quoted in $100 million increments with a 5 basis point bid/offer spread, collapsed in the early part of October to a $50 million increment and 50 basis point spread. Given this thinness, volatility reached unprecedented levels with the price moving 17 percent in one 48-hour period.” (Julian H. Robertson, letter to the limited partners, November 4, 1998.)

  4. Tiger’s “Quarterly Review,” circulated to investors in July 1999, reports that total leverage for Tiger Management stood at just over 500 percent as of January 1, 1999. This ratio factored in the use of futures and took account of both equity and macro positions.

  5. Robertson letter, November 4, 1998.

  6. Discussing the vast size of Tiger’s yen short, a former Tiger analyst explains, “You had to be willing to fight with Julian to make things bigger or smaller. Because when Julian fell in love with an idea, at times he would just keep taking it up. There were no risk limits, size limits, position limits, whatever else. So you had to have the personal fortitude to go through a very unpleasant process, to have him be pissed at you, to fight him not to be bigger. And as the population of Tiger changed at that time period, fewer people were willing to fight him, confront him…. Julian would be like, ‘I like this idea. Let’s be bigger.’ And the analyst was like, ‘Yes, yes, yes.’ So they just let Julian get bigger and bigger without letting him know that he was becoming the market.”

  7. Michael Derchin, Tiger’s airline analyst, says Robertson “saw Soros make a lot of money on the macro side, and I think he got attracted to it. And so he made some very big macro bets that blew up on him.” Michael Derchin, interview with the author, March 18, 2008.

  8. For an excellent scholarly treatment of this dilemma, see Markus K. Brunnermeier and Stefan Nagel, “Hedge Funds and the Technology Bubble,” Journal of Finance 59, no. 5 (October 2004).

  9. John Cassidy, Dot.con: The Greatest Story Ever Sold (New York: HarperCollins, 2002), pp. 3–8.

  10. Julian H. Robertson, letter to the limited partners, August 7, 1998.

  11. Tiger’s share of US Airways fluctuated around the 20 percent level. In June 1998 it was just about exactly 20 percent, judging from SEC filings. On March 5, 1999, Bloomberg reported that Tiger owned about 19 percent of US Airways. At the end of 1999, Tiger owned about 22 percent of the airline, according to Tiger’s SEC 13F filing for the last quarter of 1999.

  12. Derchin interview. Derchin was Tiger’s airlines analyst.

  13. Julian H. Robertson, letter to the limited partners, April 7, 1999.

  14. “Most important in impacting our negative performance has been that Tiger has bought and sold some thirty-one billion dollars worth of securities over the last ten months. These sales of longs and purchases of shorts have been done primarily to reduce leverage in line with our smaller size. The cost of liquidating these positions has been high…. Tiger’s success has been as a long-term investor. Quarterly withdrawals are incompatible with long-term investment.” Julian H. Robertson, letter to the limited partners, August 6, 1999.

  15. Richard A. Oppel Jr., “A Tiger Fights to Reclaim His Old Roar,” New York Times, December 19, 1999.

  16. Other prominent hedge-fund managers observing Tiger’s plight explicitly drew the lesson that secrecy was essential to stability. For example, Louis Bacon of Moore Capital delivered a speech in London in April 2000 drawing this lesson. See Alexander Ineichen, “The Myth of Hedge Funds,” Journal of Global Financial Markets 2, no. 4 (Winter 2001), pp. 34–46.

  17. Stanley Druckenmiller, interview with the author, June 4, 2008.

  18. Druckenmiller recalls, “I had never had a big drawdown from the day I arrived at Quantum until then. Even in
’94, when everyone got smoked, I was up 4 percent. I had never known any period of tension…. Anyway, in 1999 I find myself down 18 percent in the month of May, and oh, by the way, the market is sharply up. You’re talking about a very proud guy who has never had a down year, essentially, and I’m getting killed. Obviously this is in the newspaper.” Stanley Druckenmiller, interview with the author, March 13, 2008.

  19. Robertson’s refusal to buy into the bubble was not quite absolute. In March 1999 he created a $200 million subportfolio to invest in technology, and by late 1999 Robertson claimed that the subportfolio was up 62 percent. But a $200 million subfund was too small to affect Tiger’s prospects. According to Tiger’s reports to investors, total exposure to the technology and communications sector (longs minus shorts) equaled 7 percent of Tiger’s capital as of September 30, 1999. By contrast, exposure to the transportation sector came to 9 percent of capital. See also Oppel, “A Tiger Fights.”

  20. Jane Martinson, “Cyber Stars Corraled at the Ranch,” Guardian, July 10, 1999, p. 27. Warren Buffett’s Berkshire Hathaway fell 23 percent in 1999 against a 20 percent return for the S&P 500 (including dividends), marking Berkshire’s first annual decline since 1990.

  21. Gary Gladstein, the veteran managing director of Soros Fund Management, recalls Druckenmiller’s visit to Sun Valley as a turning point. Equally, Carson Levit recalls, “Stan went out and got religion in Sun Valley on the new economy thing.” Carson Levit, interview with the author, June 17, 2008.

  22. Druckenmiller interview, March 13, 2008.

  23. Levit interview. Robertson confirms that Tiger’s sale of South Korea Telecom helped to drive the price down in the summer. See Julian H. Robertson, letter to limited partners, September 10, 1999.

  24. David Einhorn. Fooling Some of the People All of the Time: A Long Short Story (Hoboken, NJ: John Wiley & Sons, 2008), pp. 33–34.

  25. Cassidy, Dot.con, pp. 95–96.

  26. Michael Lewis, The New New Thing: A Silicon Valley Story (New York: W. W. Norton, 1999), p. 165.

  27. Einhorn, Fooling Some of the People All of the Time: A Long Short Story, p. 37. It should be noted that Einhorn’s other short positions generated a large profit in 1999, a rare case of a hedge fund successfully bucking the bubble.

  28. The Fed’s monetary looseness featured in Druckenmiller’s thinking. Druckenmiller interview.

  29. An academic study of hedge funds in this period confirmed that their portfolios were heavy with tech stocks, especially in the third quarter of 1999. Technology stocks went from 16 percent of their equity portfolios to 29 percent in just three months, even though the tech sector accounted for just 17 percent of all U.S. stocks at the end of September. See Brunnermeier and Nagel, “Hedge Funds and the Technology Bubble.”

  30. John Griffin, interview with the author, November 29, 2007.

  31. Oppel, “A Tiger Fights.”

  32. Julian H. Robertson, letter to the limited partners, December 8, 1999.

  33. Julian H. Robertson, letter to the limited partners, January 7, 2000.

  34. Julian H. Robertson, letter to the limited partners, March 30, 2000.

  35. Druckenmiller interview. The role of Celera Genomics as a trigger is suggested in a detailed reconstruction of Quantum’s last weeks, which quotes Druckenmiller as saying to a trader, “This is insane. I’ve never owned a stock that goes from $40 to $250 in a few months.” See Gregory Zuckerman, “Hedged Out: How the Soros Funds Lost Game of Chicken Against Tech Stocks,” Wall Street Journal, May 22, 2000.

  36. Druckenmiller interview.

  37. Ibid.

  38. Zuckerman, “How the Soros Funds Lost.”

  39. Druckenmiller interview.

  40. Thinking back on Druckenmiller’s mood, Soros says, “He was torn because he felt loyal; he was engaged. And on the other hand, he felt it was too much. He couldn’t bring himself to actually follow through and leave, so because of the inattention he created a situation where he blew up and then he could leave. An expensive way…” George Soros, interview with the author, June 10, 2008.

  41. Steven Drobny, Inside the House of Money: Top Hedge Fund Traders on Profiting in the Global Markets, (Hoboken, NJ: John Wiley & Sons, 2006), p. 28.

  CHAPTER TWELVE: THE YALE MEN

  1. Sean Driscoll, interview with the author, October 27, 2009. Driscoll is the manager of Glorious Food, the caterer.

  2. Roger Lowenstein, When Genius Failed: The Rise and Fall of Long-Term Capital Management (New York: Random House, 2000), pp. 103–104. See also Chrystia Freeland, “I Love Competition…I Love Winning,” Financial Times, October 10, 2009.

  3. Marcia Vickers, “The Money Game,” Fortune, October 3, 2005.

  4. Day after day during one five-year period, Steyer wore the same vibrant plaid tie to the office, desisting only when an assistant seized it, stains and all, and mounted it in a display box as though it were a deal trophy. See Loch Adamson, “Steyer Power,” Alpha, January 2005.

  5. Robert Rubin says flatly of Steyer, “He doesn’t care what he can buy.” Steyer and his wife used some of their wealth to support a community bank, One California, which they founded in 2004. Robert Rubin, interview with the author, June 10, 2008. See also Francine Brevetti, “New Bank Welcomes Clients That Others Shun,” Inside Bay Area, October 4, 2007.

  6. The partner was Katie Hall, who had known Steyer at Morgan Stanley and at Stanford.

  7. Steyer recalls, “I got no full night of sleep for six months after the crash. I would go to sleep and wake up and then lie there. After the crash, my wife and I would come in at like three and just walk around. No market was open. We’d just hang around the halls, waiting for the market to open…. I have a nice wife. I think she thought I might open the window.” (Tom Steyer, interview with the author, July 25, 2008.) Steyer’s colleague Katie Hall recalls, “Tom is a very, very, very, very focused guy, and if he can’t sleep he goes into the office.” (Katie Hall, interview with the author, August 28, 2008.) Likewise, Meridee Moore recalls, “Sometimes you’d be right there with Tom trying to talk to him and he would pick up the phone. I used to go into a conference room and call him on the phone sometimes because it would be easier to get his attention. He would always take the phone call. I think that’s an arbitrage thing. What if the phone call is from somebody saying the deal’s about to break?” (Meridee Moore, interview with the author, July 24, 2008.)

  8. Meridee Moore emphasizes the similarity in approach between merger arbitrage and distressed-debt investments. In bankruptcy, distressed debt is often converted into equity, and the payoff from that conversion is akin to the payoff from the deal premium in a merger: In both cases there is an expected return in a fixed time frame. Moore interview.

  9. Meridee Moore recalls distressed debt investing in the early 1990s: “There were really three buyers, and all the regulators were putting pressure on the banks to sell their debt. So we have this wonderful supply-demand imbalance.” Moore interview.

  10. Steyer recalls that the conventional wisdom after Drexel’s bankruptcy was that “everything Drexel’s ever done was fraudulent, nothing they own is worth anything, these companies are all a joke. Everybody knew that, but it just didn’t happen to be true. So if you could bid—which is what we were doing too—against that underlying absolutely accepted lie, then you can make a phenomenal amount of money.” Steyer interview.

  11. Swensen explains why event-driven funds have a systematic edge in David Swensen, Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment (New York: Free Press, 2009), p. 183.

  12. Swensen, Pioneering Portfolio Management, p. 252. Reflecting on what motivated Steyer, Meridee Moore says, “You get to research different things every day. You get to work on whatever you want. You’re predicting outcomes. And if you’re right, there’s nothing more rewarding. It’s the ultimate challenge. That’s what keeps people going; it’s not the money.” Moore interview.

  13. Steyer also wanted Farallon employees to have
their liquid savings in the firm because otherwise they would expend precious energy on managing their personal portfolios elsewhere, and Steyer could not abide such a distraction. Steyer interview.

  14. When Swensen started negotiating seriously with Steyer, he demanded a further refinement on the standard performance fee—Yale preferred to pay a slightly higher than usual rate, but the fee would kick in only after Farallon’s returns exceeded the risk-free yield on Treasuries. Steyer could see the purity of this model. But he warned Swensen, correctly, as it turned out, that Farallon would end up earning more from Yale under the Swensen formula. Steyer interview.

  15. Steyer interview.

  16. The Yale Endowment Web site reports that its first allocation to “absolute return” was in July 1990. Data for 1995 allocations come from Josh Lerner, “Yale University Investments Office: August 2006” (Harvard Business School case study 9-807-073, May 8, 2007).

  17. Lerner, “Yale University Investments Office.”

  18. In 2000, event-driven funds accounted for $71 billion in assets, or 14 percent of the industry total, according to Hedge Fund Research. In 2005, they accounted for $213 billion, or 19 percent. In 2007 they accounted for 436 billion, or 23 percent.

  19. For example, Mark Wehrly, Farallon’s general counsel, reports that Farallon borrows about $25 for every $100 in equity. Mark Wehrly, interview with the author, July 25, 2008.

  20. Robert Howard and Andre F. Perold, “Farallon Capital Management: Risk Arbitrage” (Harvard Business School case study 9-299-020, November 17, 1999). According to this HBS study, the Sharpe ratios for two Farallon funds between 1990 and 1997 were 1.38 and 1. 75. The S&P 500 had a Sharpe ratio of 0.50.

  21. Enrique Boilini, who led Farallon’s investment in Alpargatas, recalls that Gabic, a similar textile company, did not attract the interest of a foreign hedge fund, with the result that its factories were liquidated and all its workers lost their jobs. In turning Alpargatas around, Farallon worked with Texas Pacific Group, another U.S. investor. Enrique Boilini, interview with the author, August 8, 2008.