I was reading Paulson Funds latest client letter (hat-tip Kedrosky). It is an enviable list of the things he got right this year. However one section jumped out at me – a hand grenade thrown at about 100 hedge funds:
Redemption policyAs a firm, we have not imposed any gates or other restrictions on clients withdrawing their assets. While we recognize the difficulties of the current environment, we think it’s a manager responsibility to raise liquidity to meet the needs of their investors. There is plenty of liquidity in the markets. Even in opaque areas of the markets such as in bank debt, mortgage backed securities and other distressed securities, we see hundreds of millions of dollars trading every day. We are especially surprised that many managers have restricted client withdrawas when: 1) the total redemptions are manageable (15-25% of AUM); 2) the managers have the cash; and 3) one of the stated reasons for restricting withdrawals is so the manager can continue to invest in new opportunities. Emphasis added.
I read this as John Paulson saying that there are funds which have easy enough to mark to market assets and where the assets are sufficiently liquid are refusing to give money back. Theft or fraud. Or maybe both. Moreover the liquidity according to Paulson is sufficient that funds almost never should have stop withdrawals – even in opaque areas of the market.
Now I guess it is up to John Paulson to name names – or perhaps some enterprising WSJ reporter can do it for us. Whatever – this is a big story.
John Hempton
Might they be restricting withdrawals in order to perpetuate the level of capital on which their management fee is calculated?
ReplyDeletePrecisely. The motto - we won't give you your money back so we can keep taking fees from you.
ReplyDeleteOk - is it theft or fraud?
Two crimes.
ReplyDeleteTheft, they are clearly depriving another, "the client" of the use of their money.
Theft or extortion when they then charge fees on that money.
Fraud would be dependent on the firm and the client, and any agreement between the the two.
Mens rea would be the hardest part of any criminal prosecution in the US. Civil courts would have a much easier time with that.
John,
ReplyDeleteThree grenades, perhaps?
The second one lobbed at banks that have put their perhaps-not-so-illiquid-after-all "illiquid" assets into the Level 3 accounting bucket.
The third at the idea that pricing this stuff is so difficult that some murky TARPish mechanism is needed in order for banks to get rid of it.
Richard Smith is getting the gist of this proposal. I think Paulson is telling the truth that this stuff is NOT hard to value.
ReplyDeleteSo the TARP should be no problem. Banks that say the valuation are had - they are lying.
And yes - the criminal fraud would be hard to prosecute - but I think it should be done. On a grand scale...
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The Paulson quote is a total bomb.
J
Paulson possibly benefits if more funds go down (they might get more business) and more banks go down (shorting financials is probably their killer trade), he possibly doesn't lose anything by whatever he said.
ReplyDeleteTanmay suggested that Paulson suggested that his competitors are mass fraudulent because it is in his interest to drop bombs.
ReplyDeleteI doubt it. The rest of his letter is very soft. The quote is right at the end - so you need to be a reader like me to get to it.
But yes - it would be nice for him if the competition went away.
J
Also, Tanmay, if Paulson can see 100s of millions in daily volume in opague assets, then others must also be able to.
ReplyDeleteHis claim is checkable! I hope someone does just that.
I would have thought that he stands to profit much more from being proved to be truthful, than he would by going short and spreading a rumour.
1. This is not the first time Paulson has criticized other funds for bringing down gates. Furthermore, I don't see how a letter which is supposed to be private communication can be considered a "bomb." Correct me if I am wrong- was this letter released to the press? Paulson repeats in private what he has earlier said in public, and that's news?
ReplyDelete2. If you subscribe to a hedge fund which offering document explicitly states that the manager has the right to impose a gate at his own discretion, what is the case here? I'm sure you could get a lawyer to handle your "case," so long as you paid him up front in cash. Don't expect the judge to give you much of his time though.
3. Again, we need to recall that this letter is a private communication before we begin having fevered dreams about it being used as a forum to persuade investors in other funds to pull their money out (oops, it has already been gated) and invest with Paulson. The people who didn't invest with Paulson in '08 are regretting it enough without Paulson reminding them that they should have.
"I read this as John Paulson saying that there are funds which have easy enough to mark to market assets and where the assets are sufficiently liquid are refusing to give money back. Theft or fraud."
ReplyDeleteMaybe both, maybe neither. Rules governing redemption are spelled out clearly in the subscription agreement. Who cares why the manager holds the fund if he is legally allowed to do so? A fool and his money, if the investor failed to read the agreement before investing he deserves what he gets. I'd be shocked if there is a thing for a WSJ reporter to report here. I read Paulson's comment as: Funds can allow redemptions, but they are not legally obligated to do so. Given the high water marks they will hold every dollar under management possible. That's the game, if you hate it do not play.
Paulson is playing a dangerous game, payback is a bitch. Ask Cayne.
I am not sure where the theft or fraud is. As an investor in a hedge fund that has been gated, I am extremely angry, but upon rereading the private placement memorandum, it is clear that this particular fund has wide latitude in their ability to gate. Abuse of trust? Yes. Possiblity to get relief in court if the judge exercises his or her equitable powers? Yes. Violation of contract law? Depends on what the private placement memo says. If anyone has relevent sections from Citadel or some of the other major gated funds, please post.
ReplyDeleteJohn - Great post. I hope Paulson's comments cause a bit of noise next week.
ReplyDeleteOne point I would like to address - is it really in Paulson's interests if the rest of his competitors go down? I doubt it - he is unlikely to have the sort of capacity to really take a flood of new money. I suspect there is an upper limit for his strategy to make returns and he is probably not far off from that sort of AUM already. I suspect Paulson is more motivated by making sure that the Hedge Fund Industry's credibility does not go completely down the drain during this crisis.
Of course the banks are not being very straight forward in their marking of the troubled assets. If they were marked at anything close to market - they would be illiquid. So much easier to claim that they have no idea what the price should be and hope there is a net transfer of money from the taxpayer to the banks. No wonder Paulson had a big short position on Barclays quite recently, as they seem to be the worst offenders.
I really hope his comments get more coverage especially as the "bad bank" idea is still on the table and this would certainly give some food for thought to the decision makers before they screw the taxpayer and reward the banks(I live in hope).
I agree with you about pricing and buying. Paulson and other investors have been buying since November when TARP looked to be out of the Toxic Asset business and the price fell. My theory was that the holders of these assets want and are waiting for government intervention of some kind. In fact, Liddy said just that. He considers AIG's money to be a bridge loan in order to avoid selling assets at a fire sale price.
ReplyDeleteI understand you to be saying that one way to avoid being caught up in a Calling Run is to say that you can't fulfill the calls. This would be fraud, and would also go some way to explain the supposed lack of liquidity in this market. If this is true, you have certainly seen a very important point.
Don the libertarian Democrat
you have to do the math. i'm speaking generally, without reference to any specific fund.
ReplyDeleteif all a fund had to do was sell down 15-25% of their assets to meet redemptions that would probably not be a problem for most funds. however, funds have had to do that AND delever. funds have had to sell broadly even to maintain constant leverage ratios (mtm asset prices have gone down 50% or more in some categories); further, repo and other counterparties are much less willing to extend leverage to hedge funds so leverage ratios have needed to drop in addition.
you could make a case that funds should remain as leveraged as possible so as to return investor money now rather than later. but that is a somewhat more difficult case to make.
Cerberus and Fortress - two major funds that restricted redemptions last year
ReplyDelete