My Pop was an Economist; Harvard and MIT trained, and taught there in fact… Purty prestigious, huh? So, that said, it is telling to me that Dad, when explaining things economic, he used pretty plain English. His Doctoral dissertation at Harvard was entitled, ‘Some Economic Implications of Modern Personnel Management and the Situational Approach.’ Now, we might not understand the intricacies of the concepts, but what that was about is perfectly evident, ain’t it?
So, it was with some disdain I listened to a story on NPR this morning wherein economic pundits tried to explain why the market is tubing, even after the greatest two day rise in twenty one years. I heard analysts explain that the market “Was in liar phase,” and “Decoupled from the economic environment.” Now I don’t know about you, but that sounds more like a bunch of idiots trying to emulate Greenspan’s semantic gymnastics than somebody honestly trying to explain the situation to the masses…
The gist of the report focused on the supposition that the market was largely being pushed by the vagaries of “Huge multi-billion dollar hedge funds.” Bemoaning “forced sales” and margin calls, the pundits stated that “Perfectly good stocks were being sold to pay for other stuff.” Now I don’t know about you, but this kind of obfuscation genuinely pisses me off; as such, I’d like to take just a moment to go ahead and call a spade a fucking shovel…
“Liar phase,” and “Decoupled” are akin to using the word ‘Parse’ to mean ‘explain’; The fact is, ‘parse’ has a specific meaning pertaining to language usage, to dissect a phrase into its components and describe them grammatically; it is not a generic term for ‘describe’. ‘Liar phase’ means nothing, but it is a very dangerous throw away solipsism;it implies that times when the market reflects nothing but its own lack of fecundity are de rigueur and perfectly OK; fact is, they’re not, and it’s not OK. ‘Decoupled’ shouldn’t be used when one means ‘dislocated’. Decoupling implies the elimination of a relationship, not a temporary displacement; if one is implying the entire economy is in the toilet, one should say so and not employ doublespeak. The fact is, the last time the market did not reflect reality this badly was in ’29, and that’s not good, but if that is in fact the case then let’s bloody say so and get after it; being cute analyzes and explains nothing…
Now as for hedge funds; do you know what they are? If you say yes, I think you’re fooling yourself; what we know is what the media tells us they are. Most folks think of a hedge fund as a little exclusive club of the super-rich, designed to make them more so. Yet if these analysts are firing off statements about “Multi-billion dollar hedge funds,” messing up the whole market, how small and exclusive are they? Forbes magazine alternately described hedge funds as, “The sleaziest show on earth… A business rife with exorbitant fees, phony numbers and outright thievery.” Now that floats my boat higher than that other balderdash… Mark my words, friends and neighbors; something that’s only been around for maybe a dozen years that has such a pervasive reach is to be feared and squashed, not admired and encouraged.
The fact is that there ain’t no clear cut definition of what a hedge fund is: They are generally speaking, some kind of business entity that manages investments, but the key component thereof seems to be the fact that they are almost always highly leveraged entities. Now, it is real important to understand what ‘leveraged’ means in this context, and it’s real simple: ‘Leveraged’ means ‘borrowed money’ plain out and simple. Now where that concept began I don’t know, but it was somewhere around selling swamp land and bridges to carnival goers, I can guarantee you that… You see how this works? I am a financial wizard, but I don’t have shitloads of money, (Yet, I’m gonna soon though, and it’ll be yours by the way), but you do, so loan it to me and I’ll make you one hell of a return!!! Whether the investment is equity, debt, foreign exchange or derivations thereof, this is what these jokers do, fundamentally.
Now, do they do this out of altruism, just to make their investors more dough? I don’t think so… They get paid, in fact, at both ends of each transaction. Up front, there’s the matter of a Management fee; see, I’m the expert, remember, so you gotta pay papa, right? And of course after my alchemy turns your lead into gold, I get a cut, ‘cause that’s only fair, right? So the Incentive Fee comes into play at the back end to cover that. And down the middle, there might be some Administrative fees here and there, all par for the course of course… All told, I will easily skate with 20% to 30% of your money before it’s all through; pretty good return, huh? Wow, you think, those guys rake it in, huh? Well yeah, but to protect your interests, they’ll likely have a Hurdle rate built into the deal too.. Huh, you say, a what rate? A hurdle rate means I gotta perform at a certain level, or I don’t get the full Incentive fee, which is where the lion’s share of my dough is gonna come from. That’s a good protection for you, huh? Sure, except that the hurdle rate’s gonna be tied to some conservative measure of success, like the LIBOR fer instance, the London Interbank Offered Rate; today’s read on the 1 year LIBOR rate is 2.74%: If I can’t make you 2.74% on your money, uhhhh, I’m in the wrong business, or you’re really fucking dumb, or some viable combination thereof, ya know? Oh sure, there are other safeguards, like High Water marks, which are quite common, and are tracked for each investor individually; basically, that just says I only get full fees for what I make above and beyond the high point that existed when you got in, as opposed to the full fund value… Hoopty doo! I mean, if that wasn’t there, they wouldn’t be called Hedge Funds, they’d be called Wall Street Muggings and we’d all know how things really work, right?
OK, let’s get back to that one little word, ‘leveraged’ AKA borrowed. So, you ask, what’s so bad about that? I do that shit too, I mean, I bought a house and I owe $100,000 on it and I only put $5,000 down? Well sure you did and when times are good, you’re good too; that house might be worth $150,000 then and if you sold it, you’d pay off the bank, pocket $40,000 and be an arrogant ass at the bar: But campers, times ain’t good… What if the house is only worth $75,000 and your friendly bank ain’t so friendly anymore and they want to make sure their full investment is covered; what happens then? Well, frankly, you’re gonna hear a knock on the door and Guido and Vinny are gonna be there looking for their twenty five large, capice? And when your house is a “Multi-billion dollar leveraged hedge fund,” there ain’t enough muscle to collect on that shit, dig?
While the concept of the hedge fund has been around quite a while, (This is basically what A. W. Jones & Co did in the 70s), they’ve modernized, AKA obfuscated their concepts and strategies appropriately for the 21st century: Clearly, they don’t want this stuff to be simply explained, because if it was, the smoke and mirrors would be set aside and folks would no longer pay any attention to the dudes behind the screens. They call their schemes things like ‘Directional Strategies,’ AKA betting on big picture market trends and investing accordingly; ‘Market Neutral Strategies,’ AKA picking a specific market and trying to take advantage of specific changes therein while avoiding being steamrollered by the big picture; and ‘Event Driven Strategies,’ AKA taking advantage of a single companies fortune or demise by betting on the aftermath of a merger or divestiture, that sorta thing: Notice all of these are basically betting on stuff and hoping you’re right? You can have all the computers and models and heuristics you want, but the fact is, Texas Hold ‘em is still poker gang… Now the way all this bullshit really works is much simpler yet; what these funds do is infuse massive amounts of liquidity, AKA cash, into the market. And of course, the market likes that a great deal and therefore respects said funds in the morning, if you catch my drift… Now that’s all nice and good, but just providing bucks to the market and getting a spread therefore ain’t gonna make me a billionaire, so there’s gotta be more to it, and there is, and that is… Leverage again.
And that, friends and neighbors is the essence of how these funds make ridiculous money: They get dough for providing dough, and then they leverage all of that, all of it, and make more dough. Sounds easy, right? Well in fact, it’s not rocket science; it’s pretty basic stuff for folks that know what they’re doing. The problem is that this doesn’t work so great when overlaid on the Big Picture Boom and Bust cycles that we all know too well. I used to sell mortgages; the fact is, trained weasels can sell mortgages when a boom’s on. What’s not so easy is selling them when times suck. I know, I did it through a couple of those cycles too… The problem with this hedge fund Ponzi scheme is that doing this stuff is very, very risky indeed. When the shit hits the fan, you are hanging out a mile and a half: When it all goes to hell, you in fact are the one left holding the bag, and everybody wants theirs back, now… Now go back to what I just said about mortgages. In the booms, anyone can sell and believe you me, they do… You get fucking arrogant idiots with a GED who don’t give a flying rats ass about their clients, they just know you can make shitloads of money doing this and they want in: So Citi and Countrywide and Ralph’s Pretty Good Mortgages hires these morons and off they all go… And then the wind changes, and lo and behold, things suck, bad, really bad. Welcome to today… It is not unusual at all for these funds to lose everything, and I mean everything they had; and remember gang, it ain’t my money, it’s yours! This has in fact happened to large funds throughout the time they have existed; there is case after case to be cited. We notice now because this is a big down and they’s all circling the big drain.
Now there’s one more concern you need to be aware of before we’re done and it has to do with the folks running these things; remember what I said about folks selling mortgages in the good times? Welcome to the GED boys… There’s also fraud, you see, just like Forbes warned us about. From plain ol’ greed to amazing personal excess and outright criminal stupidity, amazing wealth can and does lead to amazing wrongdoing. From Lipper to Beacon Hill, and Lancer to Maricopa, billions have been lost and more will follow…
Most recently, hedge funds figured out that they could market themselves to somebody other than wealthy individuals; they began to go after institutional clients, like state retirement systems and educational entities. So tell me, as I wind this up; with that last point in mind, they’re only doing that out of altruism, right, to help those kinds of clients make bigger bucks, right?
I mean, it couldn’t have anything to do with deeper pockets and more suckers, could it?
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