3. Bryan Burrough, “Bringing Down Bear Stearns,” Vanity Fair, August 2008; Andrew Ross Sorkin, Too Big to Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System—and Themselves (New York: Viking, 2009), p. 15.
4. In an interview on September 21, 2009, an SEC spokesman confirmed that, eighteen months after Bear’s failure, nobody had been prosecuted for conspiring to drive Bear Stearns down.
5. There is no evidence of a conspiracy to bring down Bear but plenty of evidence that Bear made mistakes that, coupled with high leverage and a reliance on short-term funding, sealed its own fate. The loss of confidence in Bear seems to have been brought on by the knowledge that it held huge mortgage positions and that other institutions holding similar positions were reporting major losses. On February 14, UBS had written down the value of its mortgage book, including “Alt-A” loans to wealthy borrowers. This had dire implications for Bear Stearns, which held a $6 billion portfolio of Alt-A mortgages and had used these as collateral to fund itself. On March 10, Moody’s downgraded mortgage bonds that Bear had underwritten and hinted that further rating downgrades would be forthcoming. Given all this, the notion that Bear collapsed because of a short-selling conspiracy seems too simple. Moreover, when Bear was bought by J.P. Morgan, Morgan’s analysis of Bear’s mortgage book suggested that the bank’s latent losses exceeded recognized ones by a wide margin, which is one reason why Morgan almost refused to buy Bear and eventually did so for a fraction of the $54 per share at which Bear had closed on Friday, March 14. Again, the point is that the shorts had good reason to be short. For the chest-bumping image, I am indebted to a hilarious post by Bess Levin on the Dealbreaker blog, July 1, 2008.
6. Hugo Lindgren, “The Confidence Man,” New York, June 15, 2008.
7. Interviews with two ex-Lehman Brothers officials. See also Sorkin, Too Big to Fail, pp. 79 and 100.
8. In an e-mail analysis, value investor Whitney Tilson credited Einhorn with having made Lehman face facts: “The losses are the losses—Einhorn certainly isn’t causing them. But thanks in large part to his questions, the company is selling assets, deleveraging and raising capital, all of which makes it more likely that the firm lives to fight another day rather than imploding and shaking the world financial system to its core.” On his New York Times DealBook blog, Andrew Ross Sorkin put it more bluntly: “Few people had more reasonable claim to vindication on Monday than David Einhorn.” See Hugo Lindgren, “The Confidence Man,” New York, June 15, 2008.
9. Chrystia Freeland, “The Profit of Doom,” Financial Times, January 31, 2009 (weekend supplement).
10. This threat is recalled by Werner Seifert, the Deutsche Börse chief executive, who tells his side of the story in his book, Invasion of the Locusts: Intrigues, Power Struggles, and Market Manipulation (Ullstein Taschenbuchvlg, 2007).
11. Michael J. de la Merced, “A Hedge Fund Struggle for CSX Is Left in Limbo,” New York Times, June 26, 2008.
12. Gillian Tett, Fool’s Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe (New York: Free Press), 2009, pp. 160–62.
13. Paul Tudor Jones, internal Tudor e-mail, June 28, 2008.
14. “I just thought even though one was a weekly and one was a daily, the chart patterns were so similar and the backdrops were so similar—two huge credit bubbles with enormous overcommitment to a variety of asset markets, real estate and stock market bubbles happening simultaneously.” Paul Tudor Jones, interview with the author, April 15, 2009.
15. Ibid.
16. After the fact, policy makers argued that they let Lehman fail because they lacked the legal authority to do otherwise. But policy makers had successfully stretched the legal bounds of their authority in other cases, and they acted aggressively again in the following days with respect to AIG, and then with respect to Goldman Sachs and Morgan Stanley, which were hurriedly granted full access to the Fed’s emergency loans. Moreover, the policy makers’ claim that the Fed could not lend to Lehman because it lacked adequate collateral is weakened by the fact that in the three days after Lehman’s bankruptcy, the Fed did actually lend Lehman’s broker-dealer unit $160 billion to tide it over until its sale to the British bank Barclays. It seems overwhelmingly likely that the government would have found a legal way to save Lehman Brothers if it had guessed in advance the consequences of its failure.
17. Paul Tudor Jones, interview with the author, April 15, 2009.
18. Jones interview. Jones adds, “From a trading perspective, fear is a much stronger emotion than greed, which is why things go down twice as fast as they go up. And that’s also just the law of nature. How long does it take for a tree to grow, and how quickly can you burn it down? It’s much easier to destroy things than to build them up. So from a trading perspective, the short side is always a beautiful place to be because quite often when you get paid, you get paid in vertical no-pain type of moves.”
19. Eric Rosenfeld, interview with the author, April 16, 2009. Echoing Rosenfeld, Louis Bacon recalls, “I grew my hedge fund within Lehman initially, and they were one of our closest counterparties, physically as well, since their headquarters was thirty paces from ours. Watching Lehman go under produced a foreboding nausea that was for me the financial equivalent of the horror of watching the World Trade Center go under, which I could also see clearly burning from my office. (I had worked for two years on the 102nd floor of Tower 2 for Shearson/Lehman, by the way.) It was not just the cold-sweat fear for the initial victims and your own safety, it was the instantaneous recognition that an entire American protective edifice had collapsed and that a longer-term downfall was inevitable.” Louis Bacon, interview with the author, July 21, 2009.
20. Jones says of the $100 million trapped in Lehman, “We actually tried to get out on the Wednesday before. They were supposed to wire it out on Friday. They did not, so we were one day late on that.” Jones interview.
21. The precise magnitude of Tudor’s losses is unknown, but traders at other firms estimate that emerging-market loans fell by at least two thirds, and given that the portfolio was leveraged, Tudor’s $2 billion presumably fell by more than that. Meanwhile, Paul Jones explains, “What I missed was the tail risk associated with something that for the prior eight years our manager had risk managed through in an excellent fashion. And also something that all of a sudden took on characteristics that heretofore it had never taken on, which was one hundred percent correlation with the U.S. stock market.” Jones interview.
22. Jones interview. Jones adds, “What I was thinking was here’s a guy who prides himself on being able to be liquid in relatively short order, and yet I had forty percent of our fund exposed to a strategy where liquidity had conveniently, totally disappeared.”
23. Jones interview. Jones adds, “I guess it gets back to this old saying that my grandfather, who was a Depression baby, told me. He said, ‘You’re only as wealthy as what you can write a check for tomorrow morning.’ I never understood it when he told that to me. I was really, really young—I was in my teens when he told that to me. I understood it for the first time last October when I saw the whole world crashing and when I saw within our BVI fund a variety of illiquid investments that we could not exit. I thought, ‘Oh my God. I know exactly where that statement came from and what it means now.’ And I will never ever violate that again.”
24. Jones interview. The end-year losses would have been substantially larger without offsetting gains from macro trading.
25. James B. Stewart, “Eight Days: The Battle to Save the American Financial System,” New Yorker, September 21, 2009, p. 74.
26. In 2006 Citadel reported in its bond-offering documents that its leverage was thirteen to one. By mid 2008, the ratio had fallen to eleven to one, according to Citadel officials.
27. Daniel Dufresne, Citadel’s treasurer, affirms, “One reason why markets targeted us was we were the only hedge fund that had a credit-derivatives market active in
our name because we had issued debt in 2006.” Daniel Dufresne, interview with the author, June 30, 2009.
28. Ken Griffin, interview with the author, July 9, 2009.
29. Stewart, “Eight Days,” p. 78.
30. Sorkin, Too Big to Fail, p. 438.
31. Steve Galbraith, “A September to Remember (Even if we would like to Forget),” Maverick Capital Management, letter to investors, October 9, 2008.
32. The convertible portfolio was losing money even before the short-selling ban. Lehman’s failure triggered the fire sale of an estimated $2 billion of convertible bonds, which hit Citadel’s holdings. But the short ban was an additional blow.
33. By way of illustration, Ken Griffin recalls, “We took all our energy derivatives and said, ‘Guys, we don’t want to face you. We want to face the clearinghouse instead, so let’s transfer all the OTC positions we have to cleared positions. Let’s reduce our bilateral exposure.’” Griffin interview.
34. This is the exchange as recalled by James Forese. James Forese, interview with the author, June 25, 2009. See also Marcia Vickers and Roddy Boyd, “Citadel Under Siege,” Fortune, December 9, 2008.
35. This passage is based on interviews with Ken Griffin, Gerald Beeson, Adam Cooper, Dan Dufresne, and Katie Spring of Citadel.
36. Loch Adamson, “Rethinking Chris Hohn,” Alpha, October 2008.
37. “Hedge Funds and the Financial Market.” Hearing of House Oversight and Government Reform Committee, Panel II, 110th Congress, Session 2, November 13, 2008.
CONCLUSION: SCARIER THAN WHAT?
1. The account of the Douglas Aircraft episode is based primarily on research in the SEC archive by Chad Waryas of the Council on Foreign Relations. See “In the Matter of Investors’ Management Co. Inc.” Administrative Proceedings, file no. 3-1680. Securities Exchange Act Release no. 8947, Investment Advisers Act Release no. 268, July 30, 1970.
2. Brimberg appears as “Scarsdale Fats” in Adam Smith, The Money Game (New York: Vintage Books, 1976), pp. 190–91. Banks Adams, interview with the author, April 16, 2007.
3. “The State of Public Finances Cross-Country,” IMF Staff Position Note, November 3, 2009. See in particular Tables 3 and 4. The numbers given for debt as a percentage of GDP come from the same publication.
4. Anna Fifield, “Obama in tough talk to ‘fat cat’ bankers,” The Financial Times, December 15, 2009, p. 2.
5. Piergiorgio Alessandri and Andrew Haldane, “Banking on the State,” paper based on a presentation to the Federal Reserve Bank of Chicago, November 2009.
6. See Dean P. Foster and H. Peyton Young, “Hedge Fund Wizards,” The Berkeley Electronic Press, January 2008.
7. See for example Russ Wermers, “Mutual Fund Performance: An Empirical Decomposition into Stock-Picking Talent, Style, Transactions Costs, and Expenses,” Journal of Finance 55, no. 4, August 2000.
8. Roger G. Ibbotson, Peng Chen, and Kevin Zhu, “The A, B, Cs of Hedge Funds: Alphas, Betas, and Costs” (Yale working paper, 2010). An earlier version of this paper showing similar findings appeared in 2006.
9. The three studies finding these returns for private equity are: Steven N. Kaplan and Antoinette Schoar, “Private Equity Performance: Returns, Persistence, and Capital Flows,” Journal of Finance 60, no. 4 (August 2005); Jones, Charles, and Matthew Rhodes-Kropf, “The Price of Diversifiable Risk in Venture Capital and Private Equity” (working paper, Columbia University, 2003); Alexander Ljungqvist and Matthew Richardson, “The Cash Flow, Return, and Risk Characteristics of Private Equity” (NYU Stern Working Paper Series, 2003). On the returns of buyout funds, Jones and Rhodes-Kropf estimate annual alpha of 0.72 percent per year, while Kaplan and Schoar are more negative. Ljungqvist and Richardson find stronger alpha for buyout funds, possibly because they focus on funds that were raised in the 1980s, when returns were higher.
10. Paul Tudor Jones II interview with Stephen Taub, “Alpha Hall of Fame,” Alpha, June 2008, p. 66.
APPENDIX I: DO THE TIGER FUNDS GENERATE ALPHA?
1. This S&P 500 return excludes dividends. Including them would bring the return up to about 15 percent per year, not a material difference.
2. For this phrase and for many of the calculations in this appendix, I am indebted to my Council on Foreign Relations colleague Paul Swartz.
3. The Tiger Cub index fell 14.8 percent in the last four months of 2008. This was a lot less awful than the market index, which was down 29.6 percent.
PHOTO CREDITS
Page 1: Courtesy of Dale Burch (top left, top right); courtesy of Commodities Corporation (bottom)
Page 2: Courtesy of Commodities Corporation (all photos)
Page 3: Courtesy of George Soros (top); © Peter Morgan/REUTERS (bottom)
Page 4: © 2007 Brad Trent (top); © Michael JN Bowles (bottom)
Page 5: © American Enterprise Institute (top); © Michael Mellon (bottom)
Page 6: © Michael Marsland/Yale University Press (top); © Linda Russell (bottom)
Page 7: © David Eisenbud (top); © 2010 D. E. Shaw & Co., LP (bottom)
Page 8: © Shirin Neshat (top left); © Greenlight Capital, Inc. (top right); © 2009 Citadel Investment Group, L.L.C. All rights reserved (bottom).
ABOUT THE AUTHOR
Sebastian Mallaby is the Paul Volcker Senior Fellow in International Economics at the Council on Foreign Relations and a Washington Post columnist. He spent thirteen years at The Economist magazine, covering international finance in London and serving as the bureau chief in southern Africa, Japan, and Washington. He spent eight years on the editorial board of The Washington Post, focusing on globalization and political economy. His previous books are The World’s Banker (2004), which was named as an editor’s choice by The New York Times, and After Apartheid (1992), which was a New York Times notable book.
More Money Than God_Hedge Funds and the Making of a New Elite Page 59
