Financial Times discovers that something's wrong with hedge funds - 21-Jan-07 - Generational Dynamics

Gillian Tett, a senior economics writer for Financial Times, says in an article on Friday that she received an e-mail message from a "senior banker":

"Hi Gillian. I have been working in the leveraged credit and distressed debt sector for 20 years . . . and I have never seen anything quite like what is currently going on. Market participants have lost all memory of what risk is and are behaving as if the so-called wall of liquidity will last indefinitely and that volatility is a thing of the past.

I don't think there has ever been a time in history when such a large proportion of the riskiest credit assets have been owned by such financially weak institutions . . . with very limited capacity to withstand adverse credit events and market downturns.

I am not sure what is worse, talking to market players who generally believe that 'this time it's different', or to more seasoned players who . . . privately acknowledge that there is a bubble waiting to burst but . . . hope problems will not arise until after the next bonus round. ...

The degree of leverage at work . . . is quite frankly frightening. Very few hedge funds I talk to have got a prayer in the next downturn. Even more worryingly, most of them don't even expect one."

The first paragraph says, "Market participants have lost all memory of what risk is...." This is wrong. Today's market participant were born well after the Great Depression, and so they never had a memory of what risk is. This is something that analysts and journalists don't understand: what's happening today is caused by generational changes.

What he's essentially describing is a pyramid scheme, which is what I've been saying for years, and as I recently described in detail.

However, I want to call your attention to a few sentences that I'm repeating here:

"I am not sure what is worse, talking to market players who generally believe that 'this time it's different', or to more seasoned players who . . . privately acknowledge that there is a bubble waiting to burst but . . . hope problems will not arise until after the next bonus round. ...

Very few hedge funds I talk to have got a prayer in the next downturn. Even more worryingly, most of them don't even expect one."

This text makes very clear that there are two kinds of investors: Those who don't know that there's a crash coming, and those that do know, but are still earning commissions by convincing the first kind to keep buying into the bubble.

This is out and out fraud. Ms. Gett doesn't seem to realize this, but what her article shows is that hedge fund managers in particular are committing fraud. They are making promises of / hinting at big returns when they know that those promises / hints won't be met.

Managers and advisors have a fiduciary duty to their clients to give them the best professional advice available. Any advisor or manager who makes money by purposely giving incorrect advice is committing criminal fraud.

These advisors and managers think that they're safe, because all their clients have signed multi-page small print contracts that say that the client is responsible for all losses. But those contracts won't protect the managers and advisors from charges of criminal fraud.

Furthermore, no contract in the world will protect these managers and advisors from angry investors when they find out that the advisors protected themselves financially but didn't protect their clients.

I've pointed this out before, but it's worth repeating. Do you remember what happened in 2001 after the Nasdaq crash and the Enron scandal? People wanted to put CEOs in jail -- ALL CEOs, even perfectly honest ones. People were going crazy. Well, it's going to happen again.

The Enron scandal is one historical example, but a better example might be the bankruptcy of the French Monarchy in 1789 that led to the French Revolution. In the Reign of Terror that followed, any person who was an aristocrat, a relative of an aristocrat, a friend of an aristocrat, a servant of an aristocrat, or even had a resemblance to an aristocrat, would be tried and quickly convicted and sentenced to the guillotine.

So I have some advice for the economics experts, journalists, professors, investors, central bankers, pundits and politicians that have been telling us that everything OK and getting better: You'd better have your underground bunker picked out, because people are going to be coming after you, and the guillotine is going to seem mild compared to the punishment that they're going to want to inflict on you. (21-Jan-07) Permanent Link
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Financial Times discovers that something's wrong with hedge funds

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Generational Dynamics Web Log for 21-Jan-07 Financial Times discovers that something's wrong with hedge funds

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Generational Dynamics Web Log for 21-Jan-07
Financial Times discovers that something's wrong with hedge funds