We fret about this no original thought thing a lot -- agonize over it, really -- so last week when we shouted “hoo-fucking-ray!” on the 4-5-6 line downtown on reading that ex-Goldman supremo Jon Corzine went belly up at MF Global and took millions of Chris Flowers's dollars with him, we were pleased because we were sure it was our first.
It didn’t take long to find out that we were wrong. In fact, it seems like much of Wall Street shared that exact same thought –hoo-fucking-ray – and most of them beat us to it, especially the dusted-off and moved-on bunch from Long Term Capital Management. Roger Lowenstein, the only Wall Street writer we know who can tell financial stories without using swear words, recounted in his excellent When Genius Failed why this might be. Long-Term, you’ll recall, made huge returns for a few years skimming the nickels, as they called it, using highly quantitative historical models to find spreads between pairs of securities around the world that were out of line with their historical norms. A common trade was to buy the relatively cheap one, short the relatively overpriced one, and wait for the spreads to return to normal. If the spreads widened even more on a trade they liked, they’d double down. They were so successful in their first three years that they gave $2.7 billion back to investors at the end of 1997 to bring their capital base "more in line with its risk and liquidity needs."
In the summer of 1998, this came back to haunt them. Global markets were a mess and Long-Term’s partners were watching their capital evaporate almost daily. They were looking for investors and time was running out. Corzine and his boys from Goldman were making sweet noises about coming to the rescue. From Lowenstein:
The [Long-Term] partners still had Goldman Sachs and [Goldman’s chairman] Corzine, who now, in mid-September emerged as Long-Term’s one best hope.
Of course, Goldman was also a competitor of Long-Term. Lowenstein goes on to describe a bit about Goldman’s move into prop trading in the ’80s and early ‘90s:
The leadership duo of Stephen Friedman and Robert Rubin, later of Treasury fame, confidently expanded into trading and as Goldman’s bankers removed their white gloves, conflicts with customers became common.
With a conditional deal to invest $1 billion of their own and find another billion for Long-Term, the Goldman due d team arrived:
In Greenwich, Goldman’s sleuths, who had the run of the office, left no stone unturned. Long-Term’s staff couldn’t keep track of who the Goldman people were, so many were rummaging through the hedge fund’s files. … According to witnesses, [one of Goldman’s traders] appeared to be downloading Long-Term’s positions, which the fund had so zealously guarded, from Long-Term’s own computers, directly into an oversized laptop (a detail that Goldman later denied). Meanwhile, some of Goldman’s traders in New York sold some of the very same positions. At the end of one day, when the fund’s positions were worth a good deal less, some Goldman traders in Long-Term’s offices sauntered up to the trading desk and offered to buy them. Brazenly playing both sides of the street, Goldman represented investment banking at its mercenary ugliest. To [John Meriwether] and his partners, Goldman was raping Long-Term in front of their very eyes.
Lowenstein’s best line in the book though is what makes Corzine’s blow up so delicious. Long-Term got in a squeeze when bond spreads around the world, which they saw were at or near all-time highs relative to Treasurys and bet would converge, diverged even more when the Russians defaulted on their own ruble bonds. (Don't say we didn't tell you about the Russians.) Before then, most big swinging dicks around trading rooms said the possibility of the Russians defaulting was about as high as Raj Rajaratnam bunking with Lindsay Lohan in prison. Chanting “nuclear powers don’t default” traders eschewed their spreadsheets and held firm to losing trades. Lowenstein:
Long-term Russian bonds fell to half their price of only two months earlier, when Goldman had happily floated them.
As the world waited for a ruble devaluation, which the government still insisted would not occur, the Communist-dominated Duma, the lower house of Parliament, rejected reform measures urged on it by the IMF. The members then went on vacation. When the government begged the Duma to reconvene, the members refused – but by then many government leaders, including President Boris Yeltsin, were also at seaside dachas, leaving the country to sort out its misery.
It was a hard thing to model.
Did we mention that Long-term’s balance sheet was 97% debt?
Most of Long-Term's trades eventually worked out, but for the 14 Wall Street banks who bailed them out, not for Meriwether and his partners. When you’ve got all that leverage you have to hope for a smooth ride. If trades go south along the way, you had to have the capital to weather the collateral top-ups. Corzine knows this well. Yet as John Carney of CNBC describes the MF Global trades, he seems to have forgotten. Collateral calls killed them.Corzine is reported to have told his underlings at MF Global essentially to trust him on the European trades, that the European Central Bank would take care of things. While that’s not looking so great right now, maybe they eventually will. But somehow being a governor of New Jersey with an Italian-sounding name made him think he knew what Bunga Bunga Berlusconi bonds were going to do. So, another really smart guy undone by one of these once-in-a-century storms that come along every five years mixed with too much leverage, maybe not all of it willingly provided. W don't believe Corzine has broken any laws, by the way, and we’re not at all worried about finding the $600 million MF Global seems to have misplaced on the way to bankruptcy court. The freaks at Olympus have it, and all those tycoon wannabes at Zucchini Park preparing to decamp to Tokyo will bring it home.
Update: The MF Global story gets even better. Lisa Du of Business Insider wrote a headline we wish we had thought of: “ Three Of Corzine's Goldman Colleagues Are Getting Screwed After MF Global's Bankruptcy .”
Motley Fool's excellent "What really killed MF Global."
http://www.wewerewallstreet.com/Corzine-what-goes-round.html
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