17 Floyd Norris, “The 1994 Honor Roll (of Sorts),” New York Times, 25 December 1994.
18 Benjamin Graham, The Intelligent Investor (New York: Harper & Row, 1973), 96.
Chapter 4: The Insatiable Curiosity to Know Nothing Worth Knowing (Oscar Wilde Was Right)
1 Anita Raghavan and Mitchell Pacelle, “Buffett Has Renewed His Talks to Acquire Long-Term Capital,” Wall Street Journal, 27 October 1998.
2 Roger Lowenstein, When Genius Failed (New York: HarperCollins, 2002), 128-129, 224-225.
3 Claudia H. Deutsch, “Edson Mitchell Dies at 47, Executive of Deutsche Bank,” New York Times, 26 December 2001. Edson Mitchell died in 2001 at the age of 47, after the twin-engine Beechcraft flying him to Rangeley, Maine to join his ex-wife and his children for the holidays, crashed into a mountain. He had left Merrill Lynch in 1995 to run global markets at Deutsche Bank.
4 Anita Raghavan, “Long-Term Capital’s Partners Got Big Loans to Invest in Fund,” Wall Street Journal, 6 October 1998.
5 “A Top Trader Quits Salomon,” New York Times, 22 December 1994. Hufschmid was head of Foreign Exchange at Salomon in 1993; his foreign exchange trading group reportedly made more than $200 million.
6 Edward Wyatt, “Profits of Hedge Fund Insiders Appear to Be Off but Still Big,” NewYork Times, 26 September 1998.
7 Sandra Hernandez, “Two-Year Notes Have Biggest Weekly Decline in 2008 on Fed Cut,” Bloomberg News, 21 March 2008.
8 Gregory Zuckerman, “Shakeout Roils Hedge-Fund World,” Wall Street Journal, 17 June 2008. Estimates varied from as low as 6,000 to 8,500 globally, depending on who was counting. That number does not include managed offshore entities that looked a lot like hedge funds but are called by a variety of structured finance labels, structured investment vehicles (SIVs), and special purpose acquisition vehicles (SPACs). Many of them invest in leveraged bets on tranches of collateralized debt obligations.
9 Gregory Zuckerman, “Shakeout Roils Hedge-Fund World,” Wall Street Journal, 17 June 2008.
10 Josh Hamilton, “Warren Buffett’s Berkshire Salary Remains $100,000,” Bloomberg News, 17 March 2008.
11 Jenny Strasburg, “Tudor Investors Pull More than $1 Billion from Raptor,” Bloomberg News, 14 December 2007.
12 Carrick Mollenkamp and Ian McDonald, “SEC Plumbs Money Firm’s Files,” Wall Street Journal, 24 March 2006.
13 Kenneth M. Krys and Christopher Stride, et. al. v. Christopher Sugrue, Mark Kavanagh, et al. Supreme Court of the State of New York, County of New York, Index No. 08600653, filed May 5, 2008.
14 Greg Newton,“Serve Him Right: SPhinX Liquidators Sue Angolan Resident,” Naked Shorts, 3 April 2008.
15 See note 13 in Chapter 3.
16 W. W. Meissner, S.J., M.D. Ignatius of Loyola: The Psychology of a Saint (New Haven:Yale University Press, 1992), 26.
17 Gary Belsky, and Thomas Gilovich, Why Smart People Make Big Money Mistakes and How to Correct Them (New York : Fireside, 1999), 118.
18 Lowenstein, When Genius Failed, 123.
19 Berkshire Hathaway 2007 Annual Report. 17.
20 Nassim Taleb, Fooled by Randomness (New York : Random House, 2001) xxvi. Emphasis in original.
21 Janet Tavakoli,“Dead Man’s Curve,” Client Note, 21 September 2006. A longer version of this client note was published in HedgeWorld.com, 22 September 2006 (printed with permission of TSF, which retains the copyright). The following is an excerpt for those interested in more detail:
If we use the model for a normal (Gaussian) distribution, a five-standard deviation credit event should only happen once in every 7,000 years. But in the market place, we see this happen once or twice in a decade. Amaranth was short fall natural gas futures contracts and long winter natural gas futures contracts in sequential years from 2006 through 2009, among other trades. But just as too much money flowing into these trades can collapse spreads in the treasury market, too much leveraged money flowing into the much thinner commodities market undid Amaranth’s trades. Spreads tightened by five to ten standard deviations in the September/December natural gas spreads depending on which time period you use for your data. In September, Amaranth lost more than half of its value, skidding from $9 billion to only $3 billion in assets (according to the Wall Street Journal) having put on the classic “Dead Man’s Curve” trade. These trades don’t follow a normal curve or even a historical spread pattern, and even if historical patterns eventually return, in the meantime, one is merely “dead” right.
22 Warren Buffett to Janet Tavakoli, e-mail correspondence, 27 September 2006.
23 Ianthe Jeanne Dugan, “Failed Hedge Fund Haunts Celebrities,” Wall Street Journal, 22 August 2006.
24 Richard Esposito, “Police Investigating Possible Suicide by Hedge Fund Cheat,” ABC News, 9 June 2008.
25 Ibid.
26 Greg Newton,“Surfacing Scammy,” Naked Shorts, 10 June 2008.
27 Ianthe Jeanne Dugan, “Manhunt is Launched for Trader in Big Fraud,” Wall Street Journal, 11 June, 2008.
28 Ibid.
29 Greg Newton,“Show Me the Corpse!” Naked Shorts, 9 June 2008.
30 Carlyn Kolker and David Glovin, “Bayou’s Samuel Israel to Forfeit Bail, Begins 20-Year Sentence, Bloomberg News, 3 July 2008.
31 Christian Boone and Bill Rankin, “Marietta Man in Hedge Fund Fraud Commits Suicide,” Atlanta Journal-Constitution, 25 May 2008.
32 D. H. Lawrence, “The Rocking Horse Winner,” in The Woman who Rode Away and Other Stories (1928), edited by Dieter Mehl and Christa Jansohn (Cambridge, U.K.: Cambridge University Press, 1995) 230-243.
33 Benjamin Graham, The Intelligent Investor New York: Harper & Row, 1973), 98.
34 Richard Heckinger to Janet Tavakoli, e-mail correspondence, 22 August 2006. Heckinger is now the senior policy advisor in the Financial Markets Group of the Federal Reserve Bank of Chicago.
35 Gregory Zuckerman, “Shakeout Roils Hedge-Fund World,” Wall Street Journal, 17 June 2008. The calculations on the number of hedge funds controlling assets is from Tavakoli Structured Finance Inc. based on market share data from Hedge Fund Research, Inc. sourced in this article.
36 Tom Cahill, “HFR Hedge Fund Index Rebounds in April after Decline in March,” Bloomberg News, 30 April 2008.
37 Matthew Lynn, “Hedge Funds Come Unstuck on Truth-Twisting, Lies,” Bloomberg News, 9 April 2008.
38 Tom Cahill, “Hedge Fund Outlook Is ‘Much Worse’ Than 1998, LTCM Veteran Says,” Bloomberg News, 8 August 2008. Hans Hufschmid became the chief executive officer of GlobeOp Financial Services LP.
39 Neil Weinberg and Bernard Condon, “The Sleaziest Show on Earth,” Forbes, 24 May 2004.
40 Ibid.
41 Ralph Cioffi (former managing director of Bear Stearns Asset Management) in a conversation with author, 30 March 2006. (This is not proprietary information).
42 Berkshire Hathaway Inc. 2007 Annual Report, 17.
43 Carol J. Loomis,“Buffett’s Big Bet,” Fortune/CNNMoney.com, 9 June 2008.
Chapter 5: MAD Mortgages—The “Great” Against the Powerless
1 Berkshire Hathaway 2003Annual Report, 5.
2 OHC Liquidation Trust, et al v. Credit Suisse First Boston et al., U.S. Bankruptcy Court, Delaware. Civil Action No. 07-799 JJF (Chapter 11 Case No. 02-13396) Memorandum Opinion June 9, 2008. (Partial Summary Judgment) Oakwood provided both mortgage loans and retail installment sales contracts (RICs) to buyers of its homes. Credit Suisse First Boston and subsidiaries (CSFB) provided Oakwood with a warehouse facility. CSFB received a warrant to purchase just under 20 percent of Oakwood’s common stock and earned fees for the warehouse facility and for structuring real estate mortgage investment trusts (REMICs) backed by Oakwood’s loans. CSFB was also the underwriter and marketer. CSFB bought the REMIC Certificates and sold them to investors. On November 15, 2002, Oakwood filed for protection under Chapter 11 of the Bankruptcy Code. From 1994 to 2002, CSFB underwrote $7.5 billion of Oakwood’s securitizations, of which $1.3 billion were done in 2001-20
02. In 2001-2002 alone CSFB earned around $21 million in fees. Oakwood’s liquidator wanted $50 million for the decline in its value while it was sinking and to get back $21 million in fees it paid in 2001-2002 to Credit Suisse. In 1999, one of CSFB’s credit officers had written that Oakwood posted “real/immediate bankruptcy risk issues/concerns,” and that Oakwood “is the weakest company in its [industry]” 5. Oakwood’s liquidator was unsuccessful in its claim.What applied here is in pari delicto potior est condition defendentis. It is an equitable defense barring someone from profiting from his own wrong.
3 Berkshire Hathaway 2003Annual Report, 5.
4 Housing Vacancies and Homeownership (CPS/HVS), U.S. Census Bureau. In 2002, 67.8 million U.S. (and region) residents owned homes; in 2004, 68.6 million owned homes; in the first quarter of 2008 the number of homeowners was back down to 67.8 million, and at 68.1 million in the second quarter of 2008.
5 Eliot Spitzer, “Predatory Lenders’ Partner in Crime,” Washington Post, 14 February 2008.
6 “Roland E. Arnall, 68; Founded High-Risk Lender Ameriquest,” Washington Post, 20 March 2008. Roland E. Arnall died in March 2008.
7 Gerri Willis discussed 2007 foreclosures during an interview with Jon Stewart on Comedy Central’s The Daily Show on January 30, 2008.
8 Gerri Willis, Andy Serwer, Paul Krugman, Janet Tavakoli, and Peter Dunay, “Busted! Mortgage Meltdown,” CNN, March 28, 2008 (first airing).
9 Ibid.
10 Aaron Krowne, entrepreneur and head of Planet Math, started this website (http://ml-implode.com) in late 2006 to chronicle unfolding events in the troubled US mortgage lending market.
11 “New Century Financial Corporation to Restate Financial Statements for the Quarters Ended March 31, June 30 and September 30, 2006,” PR Newswire, 7 February 2007.
12 Amanda Beck, “KPMG allowed fraud at New Century, report says,” Reuters, March 27, 2008.
13 Vikas Bajaj and Christine Haugney, “Tremors at the Door,” New York Times, 26 January 2007.
14 Warren Buffett’s to Liz Clayman, CNBC interview,13 March 2007.
15 Tom Hudson and Janet Tavakoli, “Fed’s Role in the Subprime Meltdown,” First Business Morning News, 19 March 2007.
16 Berkshire Hathaway 2003 Annual Report, 5.
17 Floyd Norris, “Color-Blind Merrill in a Sea of Red Flags,” New York Times, 16 May 2008.
18 Ibid.
19 “Subprime Winners and Losers,” Squawk Box, CNBC, 3 August 2007. Segment with Janet Tavakoli, Joe Kernen, and Becky Quick.
20 Antonin Scalia to Leslie Stahl, 60 Minutes, CBS, 27 April 2008.
21 David Enrich, “Banks Find New Ways to Ease Pain of Bad Loans,” Wall Street Journal, 19 June 2008. Thrift holding company Astoria Financial Corp’s non-performing loans were $106 million at the end of 2007, but the following quarter, it changed its internal policy to define “non performing” loans as missing three payments instead of two. Wachovia and Washington Mutual started using OFHEO data for first quarter results.
22 Betsy McKay, Wells Fargo’s Net is Better Than Expected, Earnings Decline But Beat Estimates; Stock Rallies 33%,” Wall Street Journal, 17 July 2008.
23 Robin Sidel, “Banking’s Winners and Sinners Part Ways,” Wall Street Journal, 19 July 2008.
24 “Remarks by Chairman Alan Greenspan, Consumer Finance,” at the Federal Reserve System’s Fourth Annual Community Affairs Research Conference, Washington, D.C. April 8, 2005. Greenspan said the following:
With these advances in technology, lenders have taken advantage of credit-scoring models and other techniques for efficiently extending credit to a broader spectrum of consumers. . . . Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in subprime mortgage lending.
The full text is available at http://www.federalreserve.gov/BoardDocs/speeches/2005/20050408/default.htm.
25 Janet Tavakoli and Thalia Assuras, “Making the Most of the Market,” CBS Evening News, 4 August, 2007.
26 Janet Tavakoli to Warren Buffet, e-mail correspondence, 15 August 2007. The following is the gist of my remarks:
Asset-backed conduits that issue commercial paper have been investing in very risky credit linked notes (CLNs). The risk is linked to leveraged structured products including subprime and other mortgage loan debt. Some are also linked to corporate leveraged loans (private equity buyout debt and other debt).The credit linked notes employ credit derivatives technology. [This is related to my comments about super senior mark-to-market manipulation. Many firms put leveraged super senior linked notes (CLNs) in the conduits to avoid the unpleasantness of marking them to market.] . . . Investors can be left holding the bag, because entities that provide the liquidity facilities sometimes refuse to buy the paper based on “technicalities (foreseen technicalities).” Nice kids. I call this the “Wiffelwaferdooper Exception.” It appears in many forms in many documents. This is what seems to be happening right now in Canada.
27 “Bracing for Regulation,” CNBC, 13 August 2007. Segment with Steve Forbes, Janet Tavakoli, Carl Quintanilla, and Eugene Ludwig,
28 Becky Quick, “Buffett Eyes Countrywide,” CNBC, 21 August 2007.
29 Katherine Graham, Personal History (New York: Random House, 1997), 534.
30 Harlan Levy, “The Finger Is Pointing toward the Underwriters,” Journal Inquirer (Connecticut), 9 October 2007.
31 E. Scott Reckard, “Countrywide Financial Chairman Angelo Mozilo’s e-mail sets off a furor,” Los Angeles Times, 21 May 2008.
32 James R. Hagerty, “Rainmaker Mozilo Exits under a Cloud,” Wall Street Journal, 28 June 2008.
33 David Wighton, “Reputations to Restore at Unforgiving Merrill,” Financial Times, 10 October 2007.
34 Janet Tavakoli, “Subprime Mortgages: The Predator’s Fall,” GARP Risk Review, no. 35 (March-April 2007). This article was published on April 13, 2007. I wrote the original draft in February 2007.
35 “Inside Merrill Lynch,” Squawk Box, CNBC, 24 October 2008. Segment with Janet Tavakoli, Joe Kernan, Jack Welch, and Charlie Gasparino,
36 Stan O’Neal, “Risky Business,” Wall Street Journal, 24 April 2003.
37 “More than 400 Defendants Charged for Roles in Mortgage Fraud Schemes as Part of Operation ‘Malicious Mortgage’ Federal Bureau of Investigation Press Release,Washington, 19 June 2008.
38 Ruth Simon, “Countrywide’s Pressures Mount,” Wall Street Journal, 26 June 2008.
39 Andrew Harris, “Countrywide Sued by Florida Over ‘Deceptive’ Loans,” Bloomberg News, 1 July 2008.
40 Illinois Attorney General Lisa Madigan made these comments when Tom Hudson interviewed her for a segment, “Countrywide in the Crosshairs,” on First Business Morning News, which aired June 25, 2008.
41 Ruth Simon, “Countrywide’s Pressures Mount,” Wall Street Journal, 26 June 2008.
42 Damian Paletta and David Enrich,” Crisis Deepens as Big Bank Fails,” Wall Street Journal, 12 July 2008. Senator Charles Schumer (D. N.Y.) had written to the Office of Thrift Supervision about IndyMac’s solvency and depositors withdrew around $1.3 billion in following 11 days.The largest two bank failures before 2008 were Continental Illinois National Bank and Trust (Chicago) in 1984; it had $40 billion in assets, and First Republic Bank (Dallas) in 1988; it had $32.5 billion in assets.
43 Michelle A. Danis and Anthony Pennington-Cross, “The Delinquency of Subprime Mortgages,” Federal Reserve Bank of St. Louis (Working Paper 2005-022A), March 2005, 15.
44 AP New York,“S&P: Subprime delinquencies continue to climb,” 22 May 2008.
45 James Tyson, “Fannie, Freddie Surplus Capital Requirement Is Eased,” Bloomberg News, 19 March 2008.
46 James R. Hagerty, Ruth Simon, and Damian Paletta, “U.S. Seizes Mortgage Giants,” Wall Street Journal, 8 September 2008.
47 Dan Levy, “U.S. Foreclosures Hit Record in Augu
st as Housing Prices Fell,” Bloomberg News, 12 September 2008.
48 Gretchen Morgenson and Charles Duhigg, “Loan Giant Overstated the Size of Its Capital Base,” NewYork Times, 7 September 2008.
49 Caroline Baum, “No Limit to Greenspan’s Once-In-A-Century Events: Caroline Baum,” Bloomberg News, 18 August, 2008.
50 Berkshire Hathaway 1999 Annual Report. 15.
51 Berkshire Hathaway 2000 Annual Report. 12.
52 Berkshire Hathaway 2003 Annual Report, 5.
53 Ibid.
Chapter 6: Shell Games (Beware of Geeks Bearing Grifts)
1 Matthew Goldstein, “Bear Stearns Shakes the CDO Honey Pot,” TheStreet .com, 5 August 2005.
2 Ibid.
3 Elizabeth MacDonald, “Did the SEC Miss Warning Signs at Bear Stearns?” FoxBusiness.com, 23 June 2008.
4 Floyd Norris, “A Lesson in Fraud for Chris Cox,” New York Times, 29 July 2005.
5 Ibid.
6 Ibid.
7 Aaron Johnson, “TABS CDO Auction Recoups Just 3% of Total Debt,” Securitization News, 4 April 2008.
8 Michael Mackenzie, “Credit Vehicle Defaults Reach $170 billion,” Financial Times, 24 April 2008.
9 Jody Shenn, “State Street, BlackRock Manage Some CDOs in Default,” Bloomberg News, January 4, 2008. This is excerpted from the Tavakoli Structured Finance, Inc. client note of December 7, 2007.
Adams Square Funding I had collateral consisting of both cash and synthetic (pay-as-you-go credit default swaps) of ABS CDOs on mezzanine subprime among other items. The conflicts of interest between the collateral manager, Credit Suisse Alternative Capital (CSAC), and other affiliated entities, including the Leveraged Investment Group (LIG) of Credit Suisse Securities (CSS) are [disclosed in the prospectus]. This is the kind of moral hazard from which I stated investors should walk briskly away [See p. 194 Collateralized Debt Obligations (John Wiley & Sons, 2003).] Rating agencies models do not capture the risks of moral hazard, and the rating agencies even failed to capture the obvious magnitude of the collateral risks. . . . Monolines rated “AAA” are not laughing, however, nor are the lower rated monolines. Writing guarantees on super-senior tranches seemed fine according to generic models, but many of these tranches have substantial principal risk. . . . [and] would require substantial capital increases.
Dear Mr. Buffett: What an Investor Learns 1,269 Miles From Wall Street Page 27
