Long-Term Capital: It’s a Short-Term Memory

Market amnesia..... The following article comes from ROGER LOWENSTEIN the author of When Genius Failed: The Rise and Fall of Long-Term Capital Management. I recommend to read the entire peace.

Manchmal könnte man wirklich meinen das der Markt an unheilbarer Amnesie leidet..... Der nachfolge Bericht kommt von ROGER LOWENSTEIN der den Bestseller When Genius Failed: The Rise and Fall of Long-Term Capital Management verfasst hat. Ich empfehle den kompletten Report zu lesen. Bleibt zu hoffen das der auch den Weg zu den Aufsichtsbehörden, Zentralbanken usw findet........


Long-Term Capital: It’s a Short-Term Memory NYT

A FINANCIAL firm borrows billions of dollars to make big bets on esoteric securities. Markets turn and the bets go sour. Overnight, the firm loses most of its money, and Wall Street suddenly shuns it. Fearing that its collapse could set off a full-scale market meltdown, the government intervenes and encourages private interests to bail it out.

The firm isn’t Bear Stearns — it was Long-Term Capital Management, the hedge fund based in Greenwich, Conn., and the rescue occurred 10 years ago this month.

AS striking as the parallel is to Bear, Long-Term Capital’s echo is far more profound. Its strategy was grounded in the notion that markets could be modeled. Thus, in August 1998, the hedge fund calculated that its daily “value at risk” — meaning the total it could lose — was only $35 million. Later that month, it dropped $550 million in a day .....

Rather than evaluate financial assets case by case, financial models rely on the notion of randomness, which has huge implications for diversification. It means two investments are safer than one, three safer than two. .....

The fund’s partners likened their disaster to a “100-year flood”— a freak event like Katrina or the Chicago Cubs winning the World Series. (The Cubs last won in 1908; right on schedule, they are in contention to repeat.) But their strategies would have lost big money this year, too.

John W. Meriwether, the fund’s founder, later organized a new fund, which suffered big losses early this year, according to press reports.

If 100-year floods visit markets every decade or so, it is because our knowledge of the cards in history’s deck keeps expanding. When perceptions change, liquidity evaporates quickly. Indeed, the belief that one can safely get out of a “liquid” market is one of the great fallacies of investing.

This lesson went unlearned. Banks like Citigroup and Merrill Lynch felt comfortable owning mortgage securities not because they knew anything about the underlying properties, but because the market for mortgages was supposedly “liquid.” Each firm would write down the value of its mortgage investments by more than $40 billion. .....

....the notion that a private hedge fund with but 16 partners and fewer than 200 employees could cause lasting harm was never truly examined. It was simply accepted.

The concept of too-big-to-fail, exceptional in 1998, is now a staple in the regulators’ playbook. Bear Stearns and, by implication, other troubled investment banks have been taken under Washington’s protective skirts; Fannie Mae and Freddie Mac, too. The Federal Deposit Insurance Corporation is pushing for easier terms for millions of homeowners; auto companies are demanding loan guarantees.

....Incredibly, six months after the Long-Term Capital affair, Mr. Greenspan called for less burdensome derivatives regulation, arguing that banks could police themselves. In the last year, he has been disproved to a fault.

LTCM: Lessons Learned? via iTtulip!

I think i know the answer......Too bad that this time the problem is not "contained" to hedge funds......Big hat tip to Rajiv and iTulip for a reminder of this important history lesson of the fall from LTCM

Ich glaube die Antwort zu kenne......Dumm nur das heutzutage nicht nur die Hedge Fonds betroffen sind....Großes Kompliment an Rajiv und iTulip um uns dieses "Mißgeschick" mit dem Namen LTCM in Erinnerung zu rufen

Kass: 'Don't Fight the Fed.' How Quaint

'Don't Fight the Fed.' This phrase will from now on put on the table almost every day from CNBC, Cramer, Wall Street etc. And with the macro news getting worse days by day it it probably their only argument for a long time to come. Remember that this new "Mantra" will be coming from the same guys that didn´t see the housing bubble, then said housing is contained, talked about a "Private Equity Put", said the market is cheap, there is cash on the sidelines, will come up with the Fed Model...

So it is good that Doug Kass is providing some "anti spin". The only thing that might dampen the slump a little bit is that the world economy is much stronger than during the past. But this won´t save the US from going into a recession.

'Don't Fight the Fed.' Diese Redewendung wird uns die nächsten Monate unweigerlich jeden Tag von Seiten CNBC, Cramer, Wall Street usw. begegnen. Und da sich die Marcodaten Tag für Tag verschlechtern bleiben aus Bullensicht natürlich auch nicht mehr allzu viele Argumente übrig. Man sollte dabei jedoch bedenken das dieses neue "Mantra" von denselben Leuten kommt die erst keine Immobilienblase erkannt haben, dann das Immobilienproblems als isoliert bewertet haben, die einen "Private Equity Put" gesehen haben, die steif und fest behaupten der Markt wäre günstig (trotz 30-40 % Finanzgewichtung), die Tonnen von Cash an der Seitenlinie vermutet haben, die das sog.Fed Model bemühen.........

Da tut es gut wenn Doug Kass wie üblich zum "Anti Spin" ausholt. Das Einzige was evtl. den Verfall etwas abmildern könnte ist die noch immer rund laufende Weltwirtschaft die sich so stark wie noch nie präsentiert. All das wird aber die USA nicht vor einer happigen Rezession schützen.

On Friday night, I appeared on CNBC's "Fast Money" and was asked a critical question: Why fight the Fed in maintaining a cautious market view? After all, the markets soared after the Fed eased in response to the Long Term Capital Management (LTCM) bailout in 1998.



I'll answer that question now.

Back in 1990-1992 and 2001-2003, the Fed lowered interest rates 100 basis points, secure in the belief that it had thwarted a recession. Both times, the Fed was wrong: A recession commenced, and a bear market in equities followed. For example, the DJIA soared nearly 3% with the surprise January 2001 interest rate cut. Three months later, the markets made new lows and ultimately fell 20% from the highs.

Seven years ago, the economy was soaring with real gains of about 4%, productivity was unprecedented, technology was in the midst of a renaissance, and the consumer was in fine shape. The LTCM issue was fairly contained; it was an isolated liquidity crisis in a hedge fund that was forced by the misuse of leverage and the insolvency of a relatively small economy, Russia.

The result was a 75-basis-point reduction in the fed funds rates, which restored calm in the financial markets in a matter of weeks.

Things are far different today.

Today, we face an economy that has far less promise with participants (consumers, hedge funds and borrowers of all kinds and shapes) all hocked up. Unlike 1998, today's housing market is in a sustained downturn, which will not likely recover until 2010. The consumer is at a tipping point, hedge funds don't hedge, and the world's economy faces a broad credit crunch. What was a liquidity issue seven years ago is both a liquidity and solvency issue today.

I have argued that, in the current credit cycle, nontraditional lenders have proliferated by circumventing Regulation T and banking reserve requirements, serving to soften or even dull the Fed's role in monetary policy. In turn, this systemic change has led to unusual borrowing in the form of interest-only and teaser adjustable-rate mortgage loans and levered quant hedge funds.

Furthermore, growth in the derivative market ran amok, serving to underwrite the sale of a broad-based group of products (such as motorcycles, automobiles, furniture, etc.) and also serving to brighten the markets for private equity.

This added liquidity from nontraditional lenders also buoyed the credit market, allowing companies that should have failed to tap large sums of equity and bonds. This created the feeling that all was well with the business world as stock markets rallied around the globe and corporate default rates hit all-time lows in 2006.

> Here are more charts that shows how deep the US consumer is in trouble

> Here mehr Charts die eindrucksvoll zeigen wie tief der US Konsument inzwsichen im Schuldensumpf steckt

But this was an illusion.

With credit being extended to everyone, the consumer -- already having ponied up to the Credit Bar Saloon -- went further into hock by loading up on ARMs and "no-money-down" durable (and nondurable) purchases. The hedge funds, in this period of mispricing of risk, got into the act by levering up in order to capture unsustainable returns. (According to Merrill Lynch hedge fund assets now approach $10 trillion, which is supported by less than $1.5 trillion of equity.)

The "hot money" provided by nontraditional lenders eventually led to what we have today and what I have described as a tightly wound financial system vulnerable to any interruption or negative event. The subprime mess was the event that triggered a chain reaction and a reassessment and repricing of risk; it was a ticking credit time bomb that most ignored -- until recently.

Pushing on a String
Pushing on a string means that the positive impact of lower interest rates is overwhelmed by the reduction in credit availability and the desire to borrow, as lenders try to improve the quality of their loan book and repair their balance sheets.
> I think the chart for corporate loans in 2006-2007 is looking similar

> Ich denke das der Chart für gewerbliche Kunden in 2006-2007 wohl ähnlich aussehen dürfte

The 50-basis-point reduction in the discount rate will likely be followed by further easing by the Fed, but it will do little good

The combination of stressed and stretched individual mortgage holders, a consumer levered far greater than in 1998, crippled nontraditional lenders, grossly extended hedge funds and debt-heavy subprime companies will exacerbate the downturn in the domestic economy in a far more severe manner than during the LTCM crisis. The two periods, quite frankly, are not even comparable in terms of how secure or shaky the economic foundation is.

Regardless of the Fed's actions, the odds favoring a 2008 recession have been increasing daily and until recently have been almost entirely ignored.

Political Consequences
After the LTCM mess in 1998, the Republican Congress was firmly in control and so was the security of lower taxes for both individuals and corporations. This is not the case in 2007, as the rising odds of a recession and the possible perception that the Fed is working as an agent for corporate America to bail out the hedge funds and troubled lenders already follows the Democratic midterm election victories of 2006.

Also, the growing schism between the haves and the have-nots in 2007 over 1998 will likely serve to give the Democrats the 2008 presidential election on a silver platter -- and with it, the headwinds of rising trade protectionism and higher taxes.

"Don't fight the Fed," a phrase promulgated by Marty Zweig, is one of those nonrigorous "truisms" that may no longer be useful. The markets in August 2007 have had the expected and Pavlovian reaction by immediately soaring; this is just what occurred on Jan. 3, 2001, after another surprise rate cut.

Back then, the Fed and the markets briefly thought that the threat of recession had been eliminated. It had not; we entered a recession soon thereafter. Today, the financial system is far more levered (and stressed) than in 2001, and a reduction in interest rates would simply ease a small portion of the pain of the debt excesses since 2000.

Our investment eyes need to be washed by tears once in a while so that we can see the markets and economy with a clearer view again. From my perch, we are in one such period. Everybody is going to hurt.

Fight the Fed.

The Biggest Dollar Diversifiers Are American / S. Jen

While i not agree that the US $ is sound Stephen Jen puts up some excellent points why the Greenback is facing some "hidden" headwinds. The obvious problems like a slumping US economy, the diversification from Foreign Central Banks away from the $, deficits etc are well known ... He points out several others reason why the $ is losing faith..... He blames the Fed and its "bailout" mentality under Greenspan and probably under Bernanke.... On top of this it isn´t helping the $ when the Fed is the only Central Bank that is targeting the useless "core rate" when others are fighting the headline CPI. Both are not very successful...... But the key point is that the big guys are fleeing or as Wall Street and others would say "diversifying" out of the dollar holdings at a accelerating pace........Make sure you read also this piece from Brad Setzer

Obwohl ich nicht mit der These übereinstimme das die Fundamentaldaten für den $ immer npch gut sein sollen macht Stephen Jen hier einen sehr guten Job und weist auf einige nicht so offensichtliche Punkte hin die einen Teil der aktuellen Dollarschwäche erklären. Die offensichtlichen Probleme des $ wie eine abschmierende Volkswirtschaft, Diversifikation der Notenbanken aus dem $, Defiizite usw. sind inzwischen selbst auf CNBC angekommen. Jen aber arbeitet andere nicht so offensichtliche Punkte heraus, wie z.B. das die Fed dank Greenspan zurecht eine Mentalität unterstellt das im Falle einer Krise immer die Geldschleusen großzugig geöffnet werden. Dazu kommt dann noch das die Fed die einzige Notenbank ist die lediglich die alberne "Core" Inflation "bekämpft". Der wichtigste Punkt aber ist das die Amis selbst aus dem $raum flüchten oder vornehmer ausgedrückt "diversifizieren"..... Kann Euch in diesem Zusammenhang noch empfehlen das von Brad Setzer zu lesen.

The dollar is very weak relative to most currencies. While cyclical factors have played an important role, I don’t believe that cable is trading at 2.05 and EUR/USD at 1.38 due only to these rather innocuous cyclical factors. Other structural factors may be at play. One possible structural reason for the dollar to have had a gradual downward trajectory since 2002 is, I suspect, portfolio diversification by US real money managers.

Cyclical explanations for the weak dollar
There are ample cyclical reasons for the dollar to have underperformed recently. First, the US economy is weaker than almost every other economy in the world. Though we may have seen the trough in the US business cycle in 1Q, the recovery trajectory is likely to be modest, after a surge in 2Q. The rest of the world, however, continues to surprise to the upside, showing no sign of lagged effects of the softness in the US economy from 2Q06 to 1Q07. No longer do investors doubt the ‘de-coupling’ thesis. Monetary policy between the Fed and other central banks is in direct correspondence to this expected divergence in economic growth. As a result, the dollar may sag as long as other central banks remain in motion.
Second, in addition to these central case expectations of the US and the rest of the world, due to the problems with the sub-prime market and the housing sector, the risk to the US outlook is biased to the downside, with limited spillovers expected for the rest of the world. Investors have the collective memory that the Federal Reserve eased interest rates by 75bp in 1998 in response to the failure of LTCM, despite the fact that the general macro conditions were positive and inflation was drifting higher. With this track record, investors believe that the Fed may have difficulties raising interest rates if the sub-prime problem persists.
Third, higher oil prices are positive for EUR/USD. Not only do oil exporters have a marginal propensity to consume European goods that is twice as high as that for US-made goods, but the fact that the ECB targets headline inflation while the Fed targets core inflation may also have encouraged investors to expect EUR/USD to rise with oil prices. ....

Diversification by US real money accounts
While the cyclical factors I mentioned above may help explain why the dollar has depreciated recently, they don’t give a satisfactory explanation as to why the current level of the dollar is so extremely low. In retrospect, since 2002, the dollar has had its ups and downs, but the underlying trend has been downward. I have long argued that the dollar is structurally sound, and provided reasons (such as the ‘de facto dollar zone’, valuation, geopolitical hegemony, dominance in the global financial markets, etc.) justifying why the dollar’s hegemony will be preserved. I am still convinced by many of my arguments. However, I am now taking more seriously the thesis that US real money investors have been steadily diversifying away from USD assets since 2003. ...The dollar may thus still be structurally sound, but not as sound as I had thought.

US real money accounts consist of four key categories of funds: mutual funds, private pension funds, state and local pension funds and life insurers. The Fed’s Flow of Funds data track the sizes of these funds. As of 1Q07, the total assets under management by these four categories reached US$20.7 trillion, up from US$12.6 trillion in 1Q03. At more than US$20 trillion, real money under management in the US is close to four times the size of the world’s official foreign reserves. Any signs of diversification by these real money accounts would have great implications for the dollar. While I don’t have a breakdown of the asset allocation of all four categories, the Boston Fed’s Monthly Mutual Fund Report shows that mutual funds’ allocation to international equities has risen from around 15% in 2003 to 22.5% now. This trend diversification is gradual but determined.

If we apply this outward investment allocation ratio to the total stock of mutual funds, the cumulative outflows of mutual fund investment since 2003 are around US$400 billion. But if we apply this outward investment allocation ratio to the entire stock of real money accounts, the cumulative outflows since 2003 total US$1.16 trillion: US$190 billion in 2003, US$295 billion in 2004, US$324 billion in 2005 and US$352 billion in 2006. These outflows are indeed massive.

Bottom line
Contrary to popular presumption, US real money mangers are the biggest dollar diversifiers, not the Asian central banks. Controlling assets that are four times the size of the total global official foreign reserves, US real money managers have been steadily diversifying out of the US since 2003. My calculations show that cumulative outflows may have totaled US$1.16 trillion in the past four years. This may help explain the downward drift in the dollar in recent years, and why the dollar is so weak now.

Bear Stearns Plans $3.2 Billion Bail Out / Largest Since LTCM

How long can they avoid the inevatable? I can smell fear......

Wie lange noch kann das nicht vermeidbare hinausgezögert werden ? Ich kann leichten Agnstschweiß reichen....

Bear Stearns Plans $3.2 Billion Fund Rescue to Halt Fire Sale

Bear Stearns Cos. plans to take on $3.2 billion of loans to stop creditors from seizing assets of one of its money-losing hedge funds in the biggest fund bailout since 1998, people with knowledge of the proposal said.

Largest Since LTCM
``The problem is not what we see happening, but what we don't see,'' said Joseph Mason, associate professor of finance at Drexel University in Philadelphia and co-author of an 84-page study this year on the CDO market. ``We don't know the price of these assets. We don't know which banks are exposed to this sector. These conditions are the classic conditions for financial crises across history.''

The bailout of the fund would be the largest since Long- Term Capital Management LP, which received $3.625 billion from 14 lenders in 1998. After Long-Term Capital, run by John Meriwether, lost $4.6 billion, lenders including Merrill and Bear Stearns agreed to take a stake in the Greenwich, Connecticut-based fund.

The Bear Stearns funds had borrowed $9 billion and made bets of more than $11 billion, one person said. Aside from Merrill, Lehman and JPMorgan, other creditors included Goldman Sachs Group Inc., Citigroup Inc. and Cantor Fitzgerald LP, all in New York. Bank of America Corp., based in Charlotte, North Carolina, Barclays Plc in London and Frankfurt-based Deutsche Bank AG were the other lenders.