Prem Watsa On The Uptick Rule

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Prem Watsa of Fairfax Financial –  one of several targets of short-selling attacks – in an interview with financial editor Diane Francis in the National Post:

“Q What stock market rules contributed to the meltdown?

A Eliminating the uptick rule [can only short on upticks in stock prices] was a mistake and so is short selling without borrowing the stock first. The ban on shorting financial institutions is lifted again and the SEC is debating whether to bring back the uptick rule again. What we need more of is transparency in all markets, including with respect to shorting and derivatives.

Q What of the role of boards of directors?

A In a bubble it’s difficult for boards of directors. Compensation should be long term. It should be stock-based and not cash. Our company’s compensation system is focused on the bottom line, not top line, and is long term. The Romans built strong bridges because their engineers had to stand under them as the army crossed them for the first time. Responsibility brings better results and aligned interest with partners.”

My Comment:

Watsa is an interesting figure to listen to on the financial crisis. Born in Hyderabad and educated in Chemical Engineering at the Indian Institute of Technology, he is the founder, CEO, and chairman of Toronto based Fairfax Financial, as well as a director and member of the risk committee at ICICI Bank in India. He’s been called India’s Warren Buffett and he did handsomely for Fairfax investors, turning shareholder equity from $2 billion in 2006 to $6.5 billion in 2009 by betting against credit default swaps.

Besides specific rules like the uptick rule, he cites the emphasis on ratings (versus due diligence or prudent risk management) and an increasingly short-term bias in the way companies, shareholders, and money managers act.

What does that amount to? A concern with the way things look, rather than the underlying reality.

It was the focus on labels and not reality that did the capital markets in.  At least, that’s my generalization

Zerohedge On Banning Credit Default Swaps

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Zerohedge has a technical discussion of why hedge fund manager David Einhorn’s call to ban Credit Default Swaps is essentially a call to dismantle the entire fiat money system. Some of the details elude me, as they’re very technical, but the rest seems right to me. There’s no inherent difference between a credit default swap and, say, an interest rate swap, of which there are many more. So Einhorn’s demand is in effect a demand to ban all derivatives…

“Remember the liquidity pyramid?

As the graphic shows, derivatives account for 1,000% of world GDP, in essence allowing the world to believe fiat money is worth something only courtesy of financial sleight of hand which involved derivatives and securitizations. Yet all those calling for an end to CDS also have to realize that due to CDS intertwined nature, the world fiat system would need to do away with all derivatives (not just CDS), and when you do that you basically eliminate the other hybrid asset classes: securitizations being chief among them. What this would leave us with is a liquidity pyramid which ends with bank loans, which are much more manageable and whose risk can be controlled. It would also leave the world with a fiat currency system, which would lose about 10x of its value overnight, thereby leading to an instantaneous and global unwind of fiat money, and rolling waves of domestically denominated hyperinflation. A spectacular race to the bottom of the asset pyramid. And who will rather commit suicide than see that happen: why the Federal Reserve of course.

Which brings us full circle: an attack on CDS is an attack on excess liquidity, which is an attack on the global asset/liability imbalance (as world GDP and otherwise output has no chance of catching up with the liquidity that is currently available), which is an attack on fiat money, which is an attack on the perpetually low price of gold (because if and when derivatives and securitizations are done away with and tangible assets regain their true value, gold would go up by at least the same magnitude that fiat currencies are devalued), which is an attack on the heart of our broken financial system itself, and, an attack on the Federal Reserve, the Fractional and Central Banking System in principle. Well done David.

We hope Einhorn is successful in bringing more people to understand not just what the risk implications of CDS are (while also demonstrating the positive value that they do in fact provide in a rigged and broken capital market), but also what the underlying thematic subject of his attack really is: a busted fiat system. In essence, David believes in a fresh start. So do we, because on a long enough timeline…”

My Comment

Just to make it clear – I am myself not in favor of banning all derivatives. Why? Not because I think they´re profound innovations..or vitally necessary. But I think it´s the wrong way to go about tackling the problem. Banning one set of financial instruments will only prevent the smaller players from using them. The largest and best connected players will game the ban in some way, or make use of other sorts of compensating structures.  A better way would be to undo the fiat money system altogether…

So my agreementis with Zerohedge´s assessment of the situation and not necessarily with Einhorn´s recommendation on that point.

Besides, Einhorn, who made his money off of CDS´s, is an odd person to be pushing a ban.

Janet Tavakoli Faces Off With Goldman On AIG CDOs

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Janet Tavakoli in Market Watch

“Earlier, Goldman denied it could have known this was a problem, yet acknowledged I had warned about the grave risks at the time. If Goldman wants to stick to its story that it didn’t know the gun was loaded, then it is not in the public interest to rely on Goldman’s opinion about the greater risk it now poses to the global markets.

Goldman excuses its participation by saying its counterparties were sophisticated and had the resources to do their own research. This is a fair point if Goldman were defending itself in a lawsuit with a sophisticated investor trying to recover damages. It is not a valid point when discussing public funds that were used to bail out AIG, Goldman, and Goldman’s “customers.”

Goldman claims the portfolios were fully disclosed to its customers. Yet at the time of the AIG bailout, Goldman did not disclose the nature of its trades with AIG, and Goldman did not disclose these portfolios to the U.S. public. If it had, the public might have balked at the bailout.

The public is an unwilling majority owner in AIG, and public money was funneled directly to Goldman Sachs as a result of suspect activity. The circumstances of AIG’s crisis were extraordinary and without precedent. I maintain that the public is owed reparations, and it would be fair to make all of AIG’s counterparties buy back the CDOs at full price, and they can keep the discounted value themselves.”

Shadow Stats’ Williams Says Hunker Down For Depression

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John Williams of Shadow Stats says the gig is up:

“Atlhough the hyperinflation is going to be limited largely to the U.S., the economic downturn will affect things globally. I can’t tell you how things will go with a hyperinflationary Great Depression, which is where I see things going.

It’s the type of thing that will tend to lead to significant political change. People tend to vote their pocketbooks. You could have the rise of a third party. You could even have rioting in the streets. I’m not formally predicting that — anyone can run these different scenarios. For the individual, what you need to do, from an investment standpoint, look to preserve your wealth and assets. Don’t worry about the day-to-day fluctuations in the markets. What I’m talking about here is over the long haul…

[Gold is] going to be highly volatile, as will the dollar, over the near term, but longer term, physical gold I would look at as a primary hedge for preserving the purchasing power of your wealth and assets. Maybe some physical silver. Get some assets outside the U.S. dollar. I might even look to move some assets physically outside the United States. The key here is to look at a longer range survival package, battening down the hatches, and preserving your wealth and assets during a very difficult time. Once you’re through that, you’ll have some extraordinary investment opportunities, and I can’t tell you what it’s going to be like on the other side of this crisis.”

My Comment

In response to a reader, I added my comment (Dec 28):

This is the way I see it.

1. There is asset price deflation going on (house prices falling), since the prices reflected unrealistic future projections of housing growth driven by derivatives built on the mortgages.
Now that those projections have been called into question, the derivatives have been repriced as junk, and the underlying securities, the homes, have to return to a more appropriate price leve.

2. This means that all artifical economic activity associated with the housing bubble also has to decline. So there´s economic contraction. That has taken down the commodity markets with it (except for gold, which is up as a hedge against the dollar and as a speculative play right now)

3. I don´t pay too much attention to individual figures coming out on the economy that seem to indicate an improvement in things, because

a. Many of the numbers are inaccurate or deliberately misleading.
b. Economics is not a mathematical science.  It´s an art. Static numbers cannot tell you about the social mood, political factors and gestalt that  drive the market.

Now, market prices are bit more reflective of those things because they´re dynamic, so the prices of commodities and stocks can be  good indicators. But there again, which prices -the price of gold, the price of money in the US, the price of commercial borrowing?

c. There´s also market manipulation..very severe manipulation. So again, the market indicators have relevance but its upto individual analysis how to tease out the relationships.

4. That said, and despite the fact that we have a credit contraction going on (a decline in the monetary base) that doesn´t mean that at some point the money pumped into the banks won´t find ways of entering the economy….if it hasn´t already, in some disguised fashion. (I realize the word ´money´ is being used in different ways here, as it is through out the debate, which is the reason for so much confusion..but that´s a long story..)

5. It´s highly probable that as the slowdown shows its true face, governments everywhere are going to be simultaneously devaluing..leading to local inflation.

6. Searching for hard assets, funds are again going to drive prices of certain essentials upward..leading eventually to commodity prices soaring even while there is a general economic contraction

Thus you could have simultaneously a high level of inflation – perhaps not hyperinflation, I would guess around 15%’20% – as well as a depression

Reverse Midas: SAC Spin-Offs Fail Even When They Succeed

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Reading this report about SAC Capital by Reuters, I was struck by a few things.

But first, here’s the chronology (skip below for my argument):

  • 1980s: Steven Cohen allegedly involved in insider trading at Gruntal
  • 1999-2004, 2004-2007, 2007-2009: Insider trading at Spherix (ex-SAC trader Richard Lee’s own firm); and possibly at Stratix (founded by Goodman and Grodin in 2004, also ex-SAC traders, with SAC as a sizable investor); and (again, possibly) at SAC itself, by Richard Lee and Ali Far, also an alum of SAC.
  • 2006: SEC investigates SAC and two other firms for manipulation of Fairfax Financial stock. Investigation dropped in 2007
  • 2007-2009: Agent Kang investigates 20 hedge funds for insider trading
  • 2007: SEC investigates SAC over Andrew Tong’s sex charges. Case sealed in 2008. Reopened in Nov. 2009, this time focusing on insider trading. About this time, Richard Grodin’s and Ian Goodman’s firm Stratix (where Lee and Far worked) closes. Grodin then begins Quadrum, which also closes
  • Oct-Nov 2009: Galleon Group charged by Kang with insider trading and 14 traders arrested, including former SAC traders, Richard Lee and Ali Far
  • Nov-Dec 2009: Cohen’s ex-wife alleges insider trading when Cohen was at Gruntal & Co. in the 1980s
  • Dec. 2009: Ex-SAC trader and founder of Stratix Richard Grodin subpoenaed

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Now that you have that in mind, here are the things that struck me:

1. The high number of SAC traders who seem to have gone off into their own businesses.

You’d think with all that money and the fund’s record as the most consistently successful in the business (only one bad year on record), their traders would stay forever. Quite the opposite.  People seem to have been leaving all the time to form their own businesses.

But SAC was also said to be a very tough environment. You produced, or you left.

So maybe that’s why Lee and Far, Grodin and Goodman, all left to found their own firms?
Could be. But I’m not convinced.

2. None of the spin-off firms seems to have been very successful.

Why not? Why couldn’t these hot-shot traders make money on their own?

The Reuters piece suggests that perhaps the SAC experience didn’t foster business ability. And that perhaps SAC traders flounder without SAC’s huge supporting cast.

But those things are likely to be true of other firms as well, not solely SAC.

Still not convinced.

Furthermore, consider this.

3. A spin-off fund that didn’t get money from Cohen ended up quite successful:

“Healthcor, a healthcare industry focused fund, had raised $3.2 billion by June 2009 since launching four years ago. The fund returned 25 percent in 2006, 18 percent in 2007, and was up 4 percent last year, when the average hedge fund lost 19 percent. In the first 10 months of 2009, Healthcor was up 7 percent.

Healthcor, founded by Arthur Cohen and Joseph Healey, opened without any financial support from SAC. In fact, soon after Cohen and Healey struck out on their own, SAC sued the pair, accusing them of breaching their employment contracts. The matter ultimately was settled. (Healthcor’s Cohen is not related to SAC’s Cohen).”

4. Even spin-offs that were doing well were shut down.

When Stratix started in 2004, it had $60 million given to it by SAC. When it shut down, in 2007, it was up 17% and had $530 million under management. Yet it shut down. Why did it shut down? Those numbers sound pretty good.

Another spin-off, Fontana Capital, started out in 2005 with $50 million of SAC money. It grew to $325 million by 2006.  But sometime in 2007, Cohen pulled out all his money. And in 2009, Fontana was down to $16.1 million, despite being down only 7.69%, compared to the average S&P Financial index loss of 57%. Again, that sounds like it wasn’t doing all that bad.

Reuters quotes someone familiar with the record of ex-SAC traders:

“So many of the ex-SAC people seem to have this model where they attract you with fantastic returns in the first year but in year two or three or four you get annihilated,” said a person who is familiar with several former SAC employees’ records.

Shades of Bernie Madoff….

Someone need to look closely at what happened to the money at these firms…

SEC Subpoenas Former SAC Trader Grodin

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El Economista carries this Reuters report, dating from yesterday, Dec. 24, on the SEC´s subpoena of a former manager at Steven Cohen´s SAC Capital hedge-fund:

“Federal prosecutors in the Galleon Group case have sent a subpoena to a former employee of Steven A. Cohen’s SAC Capital Advisors, a sign that the scope of the problem into the largest hedge-fund insider trading case in history is expanding, the Wall Street Journal reported, citing people familiar with the matter.

The subpoena seeks trading records from a former SAC hedge fund manager, Richard Grodin, who employed a cooperating witness in the insider trading case announced last week, the Journal said.”

My Comment

It’s all getting pretty tangled, so first let me try to bring some order into the picture.

  • I blogged, via Terri Buhl, that hedge-funds are going SAC-remote, deleting their email records and changing their trading positions so they don´t look too similar to Cohen´s, in anticipation of a probe. And now here come the subpoenas.
  • The subpoena to Grodin arises out of the two-year FBI investigation of twenty hedge-funds that became public in October 2009 with the Galleon arrests.
  • The investigation is headed by FBI agent B. J. Kang.
  • Kang also led the probe into the alleged stock manipulation of Fairfax Financial in 2006, in which SAC was one of three hedge-funds involved.
  • The two traders, Richard Choo-Beng Lee, and Ali Far, have admitted that they were involved in insider trading not only at their own fund Spherix, but  going back to 1994. This makes it highly probable that they were also trading illegally at SAC, where Lee worked for about five years.
  • Specifically, the agreement Far and Lee signed with the US Attorney’s Office charges conspiracies to commit insider trading from 2007-2009, from 2004-2007, and from 1999-2004.
  • Galleon chief Raj Rajaratnam’s brother Rengan, who was investigated for insider trading at his firm Sedna, also worked for SAC in 2003.
  • Lee is also going to be testifying about any insider trading he might have done at another firm, Stratix, which was founded by former SAC trader Richard Grodin, and yet another SAC alumnus, Ian Goodman.
  • Stratix, whose investors include SAC (is your head whirling?), shut down in 2007.
  • Then Grodin began another firm, Quadrum, which also shut down (“abruptly”, says Reuters).
  • Also, in November, we had the bizarre revelations of Andrew Tong, who claims he was sodomized and forced into oral sex, cross-dressing, and the ingestion of female hormones (to make him the perfect androgynous trader) by his boss, SAC trader Ping Jiang. Investigated in 2007, the case was dismissed as lacking in substance. The records were sealed, leaving many people feeling that the SEC, as a Harvard paper recently confirmed, tends to go after smaller rather than bigger fish.
  • But in November ’09, the Tong case was opened again and given wide attention on the internet, this time with more attention to Tong’s claims that Ping Jiang forced him to into illegal trading that led to a $3 million loss. The loss was the reason SAC gave for Tong’s firing. But Tong himself claims that that was just an excuse and that the sexual harassment was the real reason. He also claims that Cohen knew what was going on and didn’t care, as long as money was being made. In keeping with the firm’s reputation for secrecy, Cohen made everyone sign confidentiality agreements and kept even top officers in the company out of the loop.
  • These revelations have been followed by new charges made by Cohen´s ex-wife Patricia that her husband had cheated her out of money in their divorce settlement. Some of that money, she now claims, was hidden from the government and came from illegal insider-trading by  Cohen was he was a young trader in the 1980s at Gruntal & Co., a shady brokerage with a history of embezzlement and scandal.

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NOTE:

**If you want to understand the modus operandi of one of these insider trading deals, read Deep Capture´s latest analysis. It displays some of the emails sent by certain hedge-funds that colluded with SAC in the manipulation of the stocks of Fairfax Financial, Jim Chanos´Kynikos and Third Point among them.

The Fairfax investigation (opened in 2006) petered out, but Deep Capture’s email collection nixes any chance that the record can be wiped clean by any of the funds involved (you can also see Bagley´s piece posted at Seeking Alpha).

Oscar Wilde On Incarnation

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Oscar Wilde in De Profundis

“Who never ate his bread in sorrow, Who never spent the midnight hours Weeping and waiting for the morrow, – He knows you not, ye heavenly powers.’

They were the lines which that noble Queen of Prussia, whom Napoleon treated with such coarse brutality, used to quote in her humiliation and exile….

Clergymen and people who use phrases without wisdom sometimes talk of suffering as a mystery. It is really a revelation. One discerns things one never discerned before. One approaches the whole of history from a different standpoint. What one had felt dimly, through instinct, about art, is intellectually and emotionally realised with perfect clearness of vision and absolute intensity of apprehension. Continue reading →

A Real Investigative Journalist: Gary Webb

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This is a what a really great reporter looks like – Gary Webb, author of “Dark Alliance,” the book that blew open the CIA-crack cocaine connection. (Webb eventually committed “suicide” after the media trashed his career, although he had once been the recipient of a Pulitzer).

Here is Webb explaining media inertia and resentment in a 1997 interview:

“Webb: It’s been incredible, and it’s been amazing, and it’s been disgusting at times.

You’re referring to the media?

Well, first of all, I think the public’s response was fairly amazing, just the public outcry. I mean, it’s not like something you write about and [expect] people start marching in the street. That was a fairly amazing reaction. And I think some of the media follow-up’s been fairly disgusting.

Why do you think the media reacted the way they did?

Well, I think there’s a couple of reasons. One is that the big papers in this country have sort of an institutional history of sitting on this story. You go back and you look at what was written back in the ’80s by the three big papers in this country about this Contra-cocaine topic, and most of it was just a pack of lies. And they have continued that sort of “There’s nothing here” attitude up until now. So I think that one of the reasons is that they had an institutional history of covering this story up, and this [series] sort of exposed that for what it was. I think the other part of the problem is that you have most of the people that wrote these stories for most of the papers are establishment organs, they are mouthpieces a lot of the time for the government. And I think that’s what they’re being used for in this case, is the government’s side of the story.”

Rogue American Agent Key Suspect In Mumbai Bombing

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We always suspected that there was something odd about the Mumbai bombings. Something “stagey.” And we have been biting our tongue wondering when some bright-eyed reporter was going to turn over a few stones:

Times Online:

“A key terror suspect who allegedly helped to plan last year’s attacks in Mumbai and plotted to strike Europe was an American secret agent who went rogue, Indian officials believe.

David Headley, 49, who was born in Washington to a Pakistan diplomat father and an American mother, was arrested in Chicago in October. He is accused of reconnoitring targets in India and Europe for Lashkar-e-Taiba (LeT), the Pakistan-based terror group behind the Mumbai attacks and of having links to al-Qaeda. He has denied the charges.

He came to the attention of the US security services in 1997 when he was arrested in New York for heroin smuggling. He earned a reduced sentence by working for the US Drug Enforcement Agency (DEA) infiltrating Pakistan-linked narcotics gangs.

Indian investigators, who have been denied access to Mr Headley, suspect that he remained on the payroll of the US security services — possibly working for the Central Intelligence Agency (CIA) — but switched his allegiance to LeT.“

My Comment

Rogue he might be, but it´s odd that, once again, when you dig deep enough….you find a CIA link.

How big is that outfit anyway?

At least, the FBI is on the case.

Second Journalistic Dude Who Can Read Correctly

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I got my Christmas present early this year, from Graham Rankin, who is now enshrined in my writerly heart:

“For the role of a modern-day Luther and his 95 Theses, we could suggest to the historians Matt Taibbi and his article on Wall Street bankers Goldman Sachs for Rolling Stone magazine, ‘Inside The Great American Bubble Machine,’ which caused such a huge fuss in July, as long as we remember a lot of similar points had already been made in 2006 by Lila Rajiva in a piece that should have won an award for prescience, and hopefully one day still might. No doubt the historians will debate that role for some time to come.”

Thanks Graham, and if you´ll check on my blog for my articles and books, you will find the rest of Taibbi´s thesis there too. Plus some of my language and one-liners, I do believe.  You get dinner on me some day, buddy.

The other dude who can both read and tell the truth is Robert Wenzel, who´s also cited me on that.

There is hope.