The Demise of a Giant Hedge Fund

KESSLER, ANDY

The Demise of a Giant Hedge Fund The old Wall Street is dead. Long live the new Wall Street! BY ANDY KESSLER Before the last of Wall Street gets sold off as day-old fi sh on Fulton Street...

...Those who have a nose for making money will join other fi rms, or hedge funds, or start their own shop...
...Firms generate sales, and employees get half the money...
...What a perfect use for all that capital on their huge balance sheets and cheap fi nancing from low interest rates...
...You can blame the Fed for low interest rates, rating agencies for putting AAA ratings on garbage loans, the SEC, short sellers, monoline debt insurers, lying borrowers, mark to market accountingóheck, letís blame the Chinese for lending us our own dollars...
...AIG in the penalty box...
...And Silicon Valley...
...Deleveraging a balance sheet leveraged at 30 to 1 is not easy or pretty when everyone is doing it along with you...
...And the new Wall Street...
...And man, it was a lucrative trade...
...And they have no idea what they are doing...
...More capital was needed to fund the growth of great companies Think of all the technology companies that didnít even exist in 1983...
...They ate their own dog food, if you will...
...With the Fed forcing low interest rates in 2002-2004, the higher the yield the better...
...Thanks to Dick Grasso and CNBC, most of us think of Wall Street as balding men in ugly solid-colored suits yelling at each other and throwing litter on the fl oor of the New York Stock Exchange...
...And horror of horrors, Goldman Sachs and Morgan Stanley are now bank holding companies...
...Take íem public, bank íem, and grow with íem...
...WaMu too, into the belly of J.P...
...They traded stocks and made good money...
...From 40,000 feet, Wall Street is about access to capital...
...They offered advice on mergers and acquisitions and got paid handsomely...
...The neat thing about derivatives is that no one but the person who created them knows what theyíre worth, so you can sell them at huge markups...
...Wall Street, en masse, started buying all these high yielding derivatives for their own account...
...A very subtle change ruined the party...
...His most recent book is The End of Medicine...
...But no one on Wall Street did...
...Or maybe Wall Street is stockbrokers, calling you at dinnertime, trying to put you into a few shares of some hot IPO...
...Pretty cool...
...Is this the end of Wall Street...
...They needed to tap those same public markets, and so went public to raise huge buckets of capital to help their clients...
...BY ANDY KESSLER Before the last of Wall Street gets sold off as day-old fi sh on Fulton Street or washed into the East River altogether itís worth asking, what is Wall Street these days anyway...
...If you want to know why Wall Street CEOs made so much, it wasnít from trading your 1,000 shares of Apple stock...
...With a lot less capital, sit on the edge of the stock market and provide access to capital for the next set of great companies...
...Bear Stearns gone...
...Meaning instead of just borrowing a dollar for every two dollars of assets they owned (which by the way, thanks to the 50-percent margin requirement, is the amount of leverage that you and I are allowed to buy stocks from these same fi rms), they borrowed 20 to 1, 30 to 1, and even 50 to 1, if they could get away with it...
...Itís nice to be needed...
...The spreadsheets fl ashed green...
...The buck stops at the management of these fi rms for chasing a bad trade and not sticking to their bread and butter businesses...
...Fannie and Freddie are the new U.S...
...There is plenty of fi nger pointing to go around...
...On the street level, of course, Wall Street is a lot nastier...
...I ran a hedge fund for a lot of years and learned rather quickly that if a trade was too good, if everyone was doing the same trade, then I should absolutely turn around and run for the hills...
...economy took off...
...Andy Kessler is a former hedge fund manager turned author who writes on technology and markets...
...They might as well be holograms from Disneylandís Haunted Mansion, just a hangover of years gone by...
...So what is it...
...And rightly so...
...The one group making money were these weird guys with math Ph.D.s creating exotic securities, derivatives, pieces of paper backed by pools of assets, maybe airplane leases, or home mortgages...
...It was nobodyís fault but mine...
...Morgan...
...Wachovia into Wells Fargo...
...Still, those profi ts werenít enough...
...The rest, after expenses goes to shareholders...
...Yeah sure, free toaster jokes are fl ying, but the net effect is they will now be restricted to 10: or 12:1 leverage, instead of 30...
...Traders at fi rms were being replaced by electronic trading systems that were faster, cheaper, and donít show up late for work after taking clients out to Smith & Wollenskyís...
...Sweet deal...
...Because all of a sudden, Wall Street is no longer a business of traders or stock brokers or investment bankers, itís a giant hedge fund...
...It may not be as exciting as the last few years, but it beats getting dumped in the East River...
...Wall Street partners had to pay for memberships in Greenwich country clubs, so partnerships couldnít retain much earnings...
...More like the start of a new one...
...When running money, I bought plenty of stocks only to see the company screw up and the stock drop...
...Subprime home mortgages, because of higher risk (ooh, donít say that word), had high yields and moved to the top of the list...
...And a massive service economy...
...And this is not the customer panic-selling and paying fees to Wall Street, itís Wall Street doing the selling, pushing prices into the irrational range and turning companies belly up overnight...
...There were great people at Lehman and Enron, Bear Stearns and AIG...
...Iíll tell you why not...
...At the end of the day, Wall Street is not about the names on the door, itís about the people inside...
...By 2002, Wall Street fi rms, despite being fl ush with huge balance sheets of capital to generate returns with, were no longer making money in their bread and butter business of stock and bond trading, investment banking, and money management...
...Merrill Lynch is a subsidiary of Bank of America, which barely survived their purchase of Countrywide Mortgages and, the word is, they wonít change their name to Lynch America Countrywide...
...Wall Street is really just a compensation scheme...
...Or sleek bankers, guys (mostly) in gray Armani suits, blue shirts with white collars, and Herm?s ties, jetting off to London to close some important deal...
...Borrow at 3 percent and make 6 percent or 8 percent or 10 percent...
...Itís back to basics...
...No one needed a broker anymoreóyou could do it all online...
...Department of Mortgages and are closing their K Street offi ces...
...Risk was a four-letter word best not said in polite company...
...Not even close...
...The stock market, which is really you and me, does the dirty work of hiring and fi ring managers and green-lighting or killing projects...
...Their customers were making great money buying Wall Streetís derivatives...
...But in August 1983, the stock market and the U.S...
...Wall Streeters became hedge fund cowboys and loved the spoils, until a tiny little downturn in housing sent everyone rushing to get out of the pool at the same time...
...Back in the days of private partnerships, White Weld or Brown Brothers or even Morgan Stanley, that was fi ne...
...Lehman is dust in the wind...
...When not enough of these loans could be bought from banks, fi rms like Bear Stearns and Lehman set up entire loan-origination subsidiaries, and in true Wall Street style were aggressive and rose to the top of the market-share tables...
...The same PC and Internet technology that was sweeping corporate America and getting rid of tellers and travel agents and secretaries and typesetters was also invading Wall Street...
...You may not even realize it, but magically, the value of companies with great prospects goes up, meaning they can raise capital much more cheaply to hire smart programmers or build another solarpanel factory...
...It was the easy trade...
...Woo-hoo...
...The stock market trades every weekday, and sometimes slowly, sometimes violently, picks the economyís winners and losers...
...But why should banks and pension funds and hedge funds have all the fun...
...Thereís only one direction...
...Not quite back to the old white shoesblue blood partnerships of the past but certainly that business model...
...Yes, half...
...So why not...
...And biotech...
...The fl ip side is that the price of companies doing all the wrong things (think General Motors and now Lehman Brothers) goes down, starving them of capital, a punishment for screwing up, until they disappear or do something to turn themselves around...
...Actually, itís not the market, itís you and me, our mutual funds and pension plans, the collective ďwe,Ē that do the picking via our buying and selling...
...So did mutual funds...
...After 20 years in the business, when I think of Wall Street, I think of alpha dogs generating revenue however they can: getting deals done, fi ghting for market share against all the other fi rms, and then at the end of the year, on the inside of their fi rms, unsheathing the political knives to carve up the ever growing bonus pool, and maybe also carve up each other...
...They liked it so much, they levered up...
...Not anymore...
...I could try to blame the company, but my investors would blame me...
...None...
...Still, Iím pretty sure that half of those employed on Wall Street in 2007 will be doing something else by January...
...What a great 25-year run...
...They should...
...Mammoth departments were created all over Wall Street to securitize everything that moved...

Vol. 14 • October 2008 • No. 5


 
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