Bronte Capital calls for a new French Revolution

Credit Agricole SA is a bank which obsesses me – and on which I have lost some loot.

The problem is that it is a bank with very good bits and very bad bits. And the good bits are excellent (and mostly outside Paris) – and the bad bits are atrocious.

Charlie Munger observed that if you mix turds with raisins you still have turds.  Charlie was right and it shows in Credit Agricole SA’s stock price.

The bank is controlled by a bunch of regional mutual banks who – for reasons that are not apparent to me – have never got around to closing the bad bits.  Those regional mutuals are in turn controlled by five million voting mutual certificate holders – a reasonable proportion of French households.

The super-bad bit is their investment bank. It’s a mathematical finance type investment bank in the French mould. As has been noticed by more than a few people – the market recently has not been too kind to mathematical finance.

I just want to extract the results – quarterly – for just investment banking business.  Please click for detail...

These numbers really deserve looking at. The first observation is that revenue can go very strongly negative at an investment bank. That is nothing that Lehman et al have not discovered before – but the trading revenue was negative for several quarters in a row. You might conclude the traders were not much better as traders than say the average French farmer.

The second thing is that the costs line doesn’t seem to move much. Now when I was young and naïve – say 2006 – I thought the investment banks would have a very rough trot – but that the staff would take a fair bit of it in the hip-pocket. The argument being that the very high salaries were at risk – and you could at least assume that when time got rough for an investment bank the staff would be paid salary without bonus. Capital risks were lower than it would appear because at least variable expense would go close to zero.

Now I read lots of stories about how children are getting less allowance due to the credit crisis. Such stories always seem to wind up high in big-media’s “most read” and “most emailed” lists. And that is only because we – dear readers – are doing it to our own kids.

And if it is good enough for our kids it is surely good enough for our investment banker!

Anyway – it is noted that Wall Street bonuses remain stubbornly high – but this is France with all its equality and fraternity. And they can’t control this crap either.

But with numbers like these – if the investment bank were not owned by the rich French parent (Credit Agricole SA) then it would be bust – and the children (sorry investment bankers) would be out on the street.

But bust is better than it would have been in 1792. In those days – faced with a class as egregiously and hypocritically greedy as investment bankers they would have set up the guillotine in the Place de la Concorde and we would be treated to the public spectacle of mass beheadings.

These days of course it is easier. The French farmers and middle class all have a vote – its their mutual share. Executing a vote may be less grizzly than executing investment bankers – but it might be just as effective (though somewhat less theatrical).

Now how do you organise a new French Revolution?

John Hempton

By no means the scale of Madoff

This is one of then first posts I made on this blog... in light of the issues that have been exposed in the last week I thought I would repeat it.

A similar check on Madoff would have exposed him as questionable (has anyone ever heard of the auditor?)

I argued that any fund of funds that got suckered into a single fraud as per the one detailed below did not deserve to exist. I guess we are about to get the test of that... but a test I would prefer not to have. The original post is here.

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Forgive me for a non-stock post. But it will cover the dubious goings on off Wall Street - and is fun.

A while back I went looking for a new name for a fund. In passing I came accross New World Capital Management - the most intriguing hedge fund you have never heard of. The fund was run by someone who called themselves Greg Duran - and who hailed from New Mexico.

Their record was unbelieveable. Below I have extracted from their marketing materials the records for their two funds. The equities fund monthly return is below:



The return for the multi-curreny fund is below:




In both cases you should click for more detail - just to show how truly extraordinary these returns are. In July 2007 the multi-currency fund claims to have scored a 66% month.

The first cockroach

It is sometimes said there is never just one cockroach. But the first cockroach I found was a doozy. The annual returns in this table are not consistent with the monthly returns!

In particular the monthly returns in the 2007 currency fund compound to more then the stated annual return. Similar mathematical errors exist throughout their documentation.

Some due diligence

Given the very attractive returns listed I figured maybe I could give up the game altogether and put my money with Mr Duran. But of course I would need to do some due diligence.

Mr Duran made this fairly easy. His literature listed (for the currency fund) the Prime Broker as Ikon Global Markets, the auditor as Spicer Jeffries LLC, the legal council as Pillsbury Winthrop Shaw Pittman.

As a basic due diligence I thought that I would approach these firms. In particular the auditor is expected to stand behind the accounts that they sign - so they would be good people to approach.

The Prime Broker's less than Prime response

The Prime Broker's (reasonable) response is repeated below:

Mr. Hempton:

Thank you for contacting us regarding this situation. As per our privacy rules, we cannot disclose details regarding client’s of the firm unless directed by the client. IKON is a prime broker for FX trading and acts as a counterparty for FX trades. In this capacity, we do not endorse, verify or audit the returns or claims of any client (individual or fund). If the fund is rated, then you can research their results through the rating agency. You can also ask to speak to their auditor, legal advisor or request further information. I am sorry we cannot be for further assistance and I recommend that you do thorough research and due diligence before you select any money manager.

Thank You

Diwakar Jagannath

Managing Director/CEO

IKON GLOBAL MARKETS, Inc.

99 Wall Street, 11^th floor

New York, NY 10005

What Ikon did next however staggers me. They contacted Greg Duran - and I received an indignant email from New World. [If it is a fraud - why tip-off the perpetrator? Confidentiality applied to the customer but not to me.]

The auditor

The auditor was at least polite - but at first had never heard of New World. It turns out that a partner had discussions with Duran about becoming his auditor - but that no appointment had been made and Spicer Jeffries had never audited any New World accounts. [This was despite New World literature asserting that Spicer Jeffries had conducted such audits.]

I would have assumed that an auditor would want to protect the integrity of the statement "audited by us" and called the police. No such luck. I think they were interested in protecting a potential client.

Further conversation with Greg Duran

As Duran now knew I had contacted his Prime Broker he might as well know that I had contacted his auditor as well. This led to the following fascinating exchange:

I started the fund in 2005 with myself and two small investors. We built up a track record up till April of 2007, when we launched the fund LP. We started taking clients accounts in November of 2007. In November of 2007, we hired on Spicer Jeffries to do our audits. Because it is an LP, we have a choice of whether to do an audit at the end of the 2008 or do an audit now. We are in the midst of getting feedback from our current investor base to determine if they want to wait to do the audit or, if they want to do it now. The investor pool has to decide since they are paying for the audit. Now, we started a relationship with Dranger Capital, whom is our CTA and who also gave us notice to the contact you had with IKON's Manager so that they can speak on our behalf.

The plot is thickening here. Note this email has him starting the fund in 2005. He gives (above) records for the 2003 and 2004 years. Peculiar.

Does the fund exist?

This is a good question. Greg Duran seems to exist. Indeed he was often good for a quote in the Santa Fe New Mexican - by a journalist called Bob Quick - who seemed to put his stories out that way. Here is an example where Greg Duran is seen (in January this year) backing the solidity of Thornburg Mortgage. (He got that wrong.)

Indeed Quick quotes Duran more than once. Lazyness is the nicest explanation I have - though I rang Bob Quick up and suggested to him that - just perhaps - Greg Duran was the local story. There was no follow up.

Who was suckered?

I do not know how many people were suckered by New World - but one New York based fund-of-hedge-funds gave him money. They were kind of embarrassed when I spelt out the problems. I do not know whether they have recovered some or all of their funds.

Duran quite quickly realised I was doing a proper due-diligence - and he realised that maybe New World was not a "good fit [for me]". I do not know anyone else who was suckered.

Their website has now gone dead. The phone number that they gave me now rings through to someone called "Dranger Capital". Dranger Capital might be a legitimate operation - but they woud hate to know that the number of New World is being forwarded to them.

Prosecution

I didn't just tip off Bob Quick. I went to journalists with some leading publications. I copied full details to the SEC and to the New Mexico AG.

Nothing seems to have happened.

Lessons

Due diligence - just a little digging - will save you most errors.

Obvious frauds are not prosecuted. (This was an obvious fraud - and the authorities were told.)

Just because it is not prosecuted doesn't mean its not fraudulent. If you can't verify you should not put your money there.

Postscript

The website may be gone. The phone may ring to a new venture. But you can still see their logo here.

Full disclosure: this is for amusement only. Had the fund checked out I would have given them some money. But it didn't check out and that was that.

My main interest here is how easy it appears to get away with it. Unless that is changed then the capital markets will remain unsafe and deserve lower valuations.

Must read Cassandra - on Madoff

I don't do links much... this is great.

http://nihoncassandra.blogspot.com/2008/12/bernie-comes-out-of-closet.html

Oh, and this...

http://nakedshorts.typepad.com/files/madoff.pdf

A post-script: climate change from the left and another plea for investments...

I think it is fairly obvious that nuclear is part of the solution to climate change.  

The impression I get is that some on the right think of climate change as some kind of left-wing conspiracy to get a government controlled economy implemented on basis of scientific fraud.  (I know I shouldn't focus on the wing-nuts - but the wing-nuts are everywhere.)  

But the left has also had to suck it up.  I know a few people who have changed their mind about nuclear - but I have seen very little rational debate about nukes on the left.  

But politics is not the purpose of this blog... investing is...

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The investing idea I had however was that if the governement was going to restrict investment in certain carbon emitting activities those who had protected investments in place would win big-time because they had competition restricted.   Don't invest in the solution - invest in the problem!  (As Charlie Munger says: "invert - always invert.")

The right investment in Europe was not windmills but big nasty polluters.  That may wind up being more general.

And if I did that the right might think I was some kind of "greenhouse believing socialist fruit-loop" and the left might think I was a sell-out.

Hey - if I get it right I make a lot of lucre.  And that is my cynical purpose...

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I have a few unethical investments in my day.  I am a liberal with a large stock holding in News Corp.  You should hear me cheer Fox News.  I have owned tobacco companies in Indonesia.   And those were companies that chopped down rainforest to get timber to smoke-cure their cancer-causing drug of addiction.

If the right investment is a polluter in China whose western competition go away then I am all-too-happy to make the unethical investment.  

I just want ideas guys - not debate on politics.  

John

Conservatives, climate change and investing

I didn’t mean to start a debate by the religious fanatics of climate change. And I will not do so here. But I will state my position and I do want to talk about the investing implications of climate change.

My position on the political and practical debate (and on the science on which I have limited expertise)

Conservatives have had a funny set of positions on climate change. First they argued that it didn’t exist. That seems to have fallen by the wayside. There is little factual doubt that the world is warmer than it was say 50 years ago. In Australia – where the climate is doing quite strange things – popular opinion says the strange things (sustained drought) are caused by greenhouse effects. I have my doubts about that…

Then conservatives argued that the observed warming was not caused by human driven changes in the CO2 in the environment. That is possible – but I am happy to accept that it is highly likely that humans have caused it. I am far less convinced by the human cause step than the existence step – but I still think that the bet on climate change is having human causes is pretty strong.

It is not clear what conservatives are going to argue next. Starting by arguing with the preponderance of scientific opinion doesn’t bode well…

I was always more impressed by Charlie Munger’s view – which was intellectually honest – and did not start by denying the science. His view – which I believe arguable – is that climate change is real, is caused by humans but that it is essentially unstoppable at any reasonable cost (you simply can’t administer any plausible program to reduce greenhouse gas emissions). He then argues that the cost of the world being marginally warmer are not too high.

I really have no idea at that point. I do not know how big the cost of the world being a few degrees warmer will be and I have no idea whether a system to ameliorate climate change is even practically possible. I have some idea how you would design quotas and taxes to try ameliorate greenhouse emissions and I personally think it worth trying, however I am very unsure as to whether it would be successful.

More generally I think the conservatives without strong relevant scientific skills and who start by denying the preponderance of scientific opinion do themselves disfavour. If they lose the scientific debate they look stupid – and just as importantly – they deny the fundamental intellectual strength of conservatism.

The appeal of conservatism as an ideology is that it is based on a practical observation about the world – decentralised market systems work pretty well on the whole and governments stuff up lots of things. That observation – loosely stated – is grounded in fact. Nobody is responsible for the distribution of bread in New York or Sydney – but it works very well. Someone was responsible for the distribution of bread in Stalingrad and it worked dreadfully. The appeal of conservatism in this regard is that the core part of the ideology is based on observable fact.

I do not understand why conservatives want to latch onto very minority scientific positions (which are probably wrong) on climate change or onto positions which are completely scientifically untenable on evolution (six days, recent origin).

Conservatives have a perfectly defensible ideology – why give up the intellectual high ground for obscurantism? It is not my ideology – but when the facts suggest that I am wrong I am very happy to retreat. If you are not happy to retreat then you count yourself out of serious discussion.

But this is a practical investing blog

I think we can assume (on the strong balance of probability) that CO2 emissions cause global warming. I am not sure we can assume that something effective will be done about it – or even that it is possible within a modern global economy do to anything effective about it. But there is a good probability that governments will try.

How they try is going to dramatically change the investment horizon – and it might do so in strange ways. For instance in Europe greenhouse gas quotas were given to large carbon emitters – and for a while the way to make money was to buy the company with the worst emissions problem. Why? Because the quotas were worth more than the industrial base they had to shut.

I do not want to provoke a debate about whether the human caused greenhouse effect is real – I think that is pretty likely – but this blog is entirely unlikely to contribute in any meaningful way to the debate. I am not a relevantly trained scientist and nor are most my readers.

What I do want to provoke is a debate about how the governmental reaction to greenhouse will change the investment horizon. I may not like it – but if the incentives are for me to buy the ugliest most polluting industry because it is a beneficiary of government action then I will do it. I will not let ideology get in the way of investing. That would be even more stupid than believing in six day creationism – because the belief in creationism is largely personally harmless – but letting ideology get in the way of investment decisions is personally costly.

So this is a plea: let us discuss what really matters to my clients and my readers – which is how do we make some filthy lucre from all of this – rather than argue about science about which we can make little contribution.

And just to make sure the discussion is focussed I am going to break this blog’s policy on censorship of comments. I will censor any comment on the science of greenhouse unless it has an investing implication. I will however let through any comment with investing implications generally or discussions on the practicality of things governments might (try to) do to ameliorate greenhouse gas emissions.

John Hempton

Is this the seriously smart money?

It pains me to say anything nice about Exxon Mobile management.  They are the most notorious climate change sceptics for instance, something I rank along with believing that the world was created in six days about 6000 years ago.  

The belief might be politically convenient for Exxon, just as it might be politically convenient for some conservative politicians – but otherwise it dumb and possibly dangerous.

But – putting my politics aside I am going to say something really nice about Exxon.  They look a lot smarter than me – and a lot smarter than most of the rest of us.

Remember the super-spike in oil.  Remember how it was going to remain high forever.  It was only a few months ago.

You would think that Exxon believed it too – and ramped up their capital expenditure to take advantage of the super-cycle boom to come.

You would think…

But you would be wrong.  

Here are the capital expenditure numbers for the company by year in millions:

2002 11,437

2003 12,859

2004 11,986

2005 13,839

2006 15,462

2007 15,837

Now anyone who followed this industry knows that the cost of building new plants, pipes and drilling new holes skyrocketed during this period – so the physical amount of capex done by Exxon probably reduced during this period.  It reduced whilst the cash flow from operations went from 21 billion to 52 billion.  

Sure capex went up a little in the first nine months of this year but even that increase was disciplined.  

The conclusion you have to come to is that Exxon did not drink the kool-aid.  They were at the centre of one of the biggest booms out there – and they were not sucked in.

So – if you want to know who the smart money were – look no further.

John Hempton

PS.  There is another hypothesis consistent with the data – one which paints Exxon in a very poor light.  The alternative hypothesis is that they did little capex because they did not have worthwhile projects to do – that is that their reserves are stuffed.  I see little evidence for that hypothesis but hope to entertain it in the comments.

However I should note that I know so little that it is entirely possible that the PS bear case is correct.  Knowledgeable comments much appreciated.  

J

Weekend edition: iphones and Galileo

The comments have proved to my satisfaction that the effect noted here is an artifact of the lens and not a crescent of Venus.  So the discussion here is faulty.  

Thanks to the person who put up the comment.  The issue is that there are simply too many pixels in Venus...

However I am left perplexed as to why Venus pixelated as a crescent - with the lit side tilted towards the sun (as you would expect) and Jupiter and the Moon look like circles (the moon) or squares (Jupiter).  If someone is able to give a good optical explanation I would appreciate it.  

Meanwhile I will try to replicate the Brad Delong picture with a mobile phone camera and a 10 megapixel SLR.  

John

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Brad Delong has a photo on his blog taken with an iphone of the moon, Jupiter and Venus.

It is impressive – and through it – looking at the individual pixels – you can tell that Venus is a crescent.

Now all Galileo did – which marks him as one of the greatest minds of all time – was look at Jupiter through a simple telescope and plot the four moons (I have never been able to resolve more than four moons).  And if you do this regularly – certainly every evening for two or three weeks – you will come to the conclusion that the moons circle Jupiter.  Galileo’s letter to the Prince of Venice is here and an English translation of the text attached to the diagrams is here.

Galileo did not distinguish between the moons and stars – the notion that the sun was just another star far out in the uncharted backwaters fo the unfashionable western spiral arm of the galaxy was beyond him.  But he did work out that the “Medici Stars” revolved around Jupiter and that was a major challenge to the authorities.

The second great Galileo experiment was to work out that Venus revolved around the sun – and for that he took observations in the morning and the evening for considerable time – observing the crescent shapes.  

And Brad Delong has shown you can do that with an iphone.

Here is Brad’s image

 – and here is an expansion of the pixels of Venus.

When technology that good is easily available the excuses for basic scientific ignorance are becoming thinner and thinner.

Now to take the eight year old out with an iphone and teach him some real science!  There are few excuses...

John Hempton

The bull in the china shop

Well I am relieved.  It has been my contention that Sheila Bair is the bull in the china shop.  She confiscated Washington Mutual because it might cause a problem for her agency.  There is little evidence that WaMu was illiquid or insolvent at the time – and indeed if the losses were only what JP Morgan has assumed then the bond holders (which she wiped out) would have received considerable value – probably par.  

I contend she did this based on the narrow and short-dated assumption that it would make a potential headache for her agency (and her agency alone) go away.  

The confiscation of WaMu caused the rapid collapse of Wachovia – which she insisted could only be saved with a government guarantee when within a few days she had a hard offer involving no government money.

Her actions destabilised Citigroup as well.

There is plenty of evidence she made these mistakes all on her own and she should resign.

Press reports indicate that Geithner wants her gone.  Geithner is no political hack wanting to get rid of the Republican.  He just wants to get rid of the dangerous and irresponsible bull in the china shop.

Some press indications are that Sheila Bair will be hard to remove.  She is a statutory appointment after all – and her position will survive a change in government.  And if she puts up a fight she will be even more destabilising.

A change in administration is the perfect opportunity for Sheila to resign.  Then she can do it without disgrace.  But my contention is that every day Sheila is in the position is another day added to the end of the financial crisis.  She, more than anyone, makes it clear that intermediate funding in banks is insecure – and fixing that perception is the first and most important thing needed to make this crisis go away.

So Sheila, you are going to be asked to resign anyway.  Please make it quick, give your successor time to undo the damage you did and help get this crisis over with.  

John Hempton

Great interviews in finance

Sorry - YouTube has mangled the video and the sound is stuffed.  I can't seem to fix.  

Mish alerted me that Land America had filed bankruptcy.  Its a company I used to follow - but I never shorted.  

This is a gem - an interview from only 18 months ago.

The money quote: "the United States real estate economy is the envy of the world... the ability to create value out of real estate by taking mortgages and securitising them..."

And this was the seemingly boring business of title insurance!

Goodbye Tanta - I will miss you...

Doris Dungey (Tanta) - a really competent blogger in the mortgage area has died at an unfortunately young age.  

I am not much into obits...  I would rather praise the living when they can enjoy it.

But I will give you one blog post - an absolute gem which shows the quality of the woman:

http://calculatedrisk.blogspot.com/2007/03/unwinding-fraud-for-bubbles.html

John Hempton