"Altruistica": Seeking a return to full financial disclosure and regulatory oversight. A financial market analysis blog for "entertainment purposes" only by an experienced CFA seeking new hedge fund engagements for investment writing and analysis. The author has experience investing internationally, running a hedge fund, making angel investments, and helping launch five startup companies. Investors should do their own due diligence.

30 November 2006

Paulson Balks on Hedge Fund Regulation

Anticipate-Hedging on Hedge Funds
Published: November 30, 2006

In October, a month after the Amaranth hedge fund lost $6.6 billion — the most ever by a hedge fund — Henry Paulson Jr., the Treasury secretary, spoke with Bloomberg News about the importance of “transparency” at hedge funds and “liquidity” in the system. His remarks were interpreted at the time as a warning, perhaps even a harbinger of more oversight.

What a difference a month makes.

In what was billed as a major economic address last week, Mr. Paulson devoted less than one-tenth of his speech to hedge funds, leaving the impression that he is basically satisfied with the regulatory status quo.

No one wants the Treasury secretary to be an alarmist. But other officials, notably at the Federal Reserve Bank of New York and the Securities and Exchange Commission, have gone further than merely acknowledging “potential risks” and pledging more “deliberations,” as Mr. Paulson did in his speech. Without pushing any panic buttons, they have broached the need for more collateral and better risk controls at banks that deal with hedge funds and greater oversight of hedge funds that solicit investments from pension plans.

Currently, some 9,000 hedge funds manage $1.3 trillion of investors’ money and control trillions of dollars more through their use of loans and derivative financial tools. They invest in all major sectors and operate through banks and securities firms, affecting the economy as a whole. And yet, they remain largely beyond the reach of federal overseers, a holdover from the days when they were much less ubiquitous. In 1990, only a handful of hedge funds existed, and altogether they managed just $39 billion.

Opponents of regulation routinely note that hedge funds are indirectly supervised because the banks they do business with are regulated. According to that logic, banks guard against excesses by their hedge fund clients to protect themselves from losses and regulatory problems. That reasoning also assumes that bankers are free of conflicts that might impair their judgment. But as hedge funds have grown, banks have earned increasingly larger commissions, fees and trading profits from them, a development that could induce some bankers to err on the side of recklessness.
There’s also an issue of practicality. As hedge funds become more numerous and complex, it is simply not feasible for banks to stay on top of their activities. And then there’s the matter of responsibility. It’s not a banker’s job to protect the public interest. It’s the job of regulators.

But, what's more ominous is this- Another GS Exec becomes the US Chief Trading Officer

The Fed’s new Chief Trading Officer, William Dudley, while addressing the NBER Conference in May, made what I think is an outstanding insight into the cause of market crashes. The trigger for collapse is typically unexpected.
Dudley said:

“Oftentimes, the trigger for the collapse of an asset bubble is some event that calls into question a widely-held market belief. For example, one trigger for the LTCM debacle was the decision of Russia to default on its ruble debt. This was unexpected because market participants thought the worse-case scenario was that Russia would just print more rubles to service its debt. Another example is the role of portfolio insurance in the 1987 stock market crash. Portfolio insurance works to limit risk if market prices adjust continuously. In 1987, prices gapped lower and portfolio insurance played an important role in making prices move discontinuously. After the fact, the flaws of portfolio insurance were self-evident. But when it occurred, it was unanticipated.”

Mr. Paulson was right when he noted in his speech that the need for regulation must be balanced against the benefits of flexibility. But the challenge of striking a balance is beginning to sound like an excuse for delay. It’s time to move the discussion beyond whether hedge funds require more regulation to how they should be regulated.

And look who got a nice boost from the Cerberus deal to buy out GMAC, former Treasury Secretary John Snow !! Funny how these great deals just work out...

Kerkorian Dumps Entire GM Stake
Move Clouds Prospects
For Auto Maker's Revamp
Of North American Unit
December 1, 2006

Billionaire investor Kirk Kerkorian Thursday afternoon unloaded his entire investment in General Motors Corp., according to a person familiar with the matter. The move clouds the outlook for a restructuring program intended to stanch red ink in GM's core North American operations and could mark the end of a 19-month-long battle over the fate of an icon of industrial America.

A person familiar with the matter said Mr. Kerkorian's Tracinda Corp. investment vehicle sold 28 million shares of the world's largest auto maker by output, at $29.25 a share. The shares were sold to Bank of America Corp., a key lender to Mr. Kerkorian, and represented Tracinda's remaining stake. Earlier Thursday, Tracinda said in a filing with the Securities and Exchange Commission that it had agreed to sell 14 million shares for $28.75 per share in a private transaction.
[Kirk Kerkorian]

The two transactions would bring Mr. Kerkorian's investment in the Detroit giant to zero. Tracinda last week sold another 14 million shares in a private deal for $33 a share. Before the sales, Mr. Kerkorian held 9.9% in GM, the world's largest auto maker by output.

At 4 p.m. in New York Stock Exchange composite trading Thursday, GM's shares were down 27 cents, or 0.9%, to $29.23. A sale of a block of 28 million shares moved Thursday afternoon, but it wasn't clear before markets closed that Mr. Kerkorian was selling his stake.

GM spokeswoman Gina Proia declined to comment. Tracinda spokeswoman Carrie Bloom also declined to comment.

Mr. Kerkorian's GM sales come at a point when the 89-year-old investor is ahead on his investment in the auto maker by less than $100 million, when dividends and gains from his recent stock sales are factored in. The gain represents a modest return on his $1.6 billion investment, falling well short of the multibillion-dollar profits he has reaped in the auto industry in the past.

The sales came as GM said it closed a deal to sell a 51% stake in its GMAC Financial Services unit, formerly known as General Motors Acceptance Corp., to a group led by Cerberus Capital Management LP. The transaction means GM will receive $14 billion over three years that it can use to help finance restructuring of its North American auto business. (Related article on page C5.)

"Successfully completing the GMAC transaction has been a key priority for the company, and an important step to further support GM's turnaround," GM Chairman and Chief Executive Officer Rick Wagoner said in a statement.

Mr. Kerkorian's decision to abandon his GM stake amounts to a no-confidence vote in Mr. Wagoner's strategy.

Doubts about the health of the U.S. economy and concerns about cash flow at GM have led other investors to pull money out of GM shares in recent weeks, depressing GM's stock price 19% from its 52-week high of $36.19 in October.

Mr. Kerkorian and adviser Jerome York have a history of activism and fought a battle with the management of the former Chrysler Corp. in the mid-1990s, when Chrysler rebuffed their demands to return more cash to shareholders. Mr. Kerkorian sold GM shares at the end of 2005, citing tax purposes, only to repurchase shares early this year.

Since making his initial investment in GM shares in June 2005, Mr. Kerkorian and Mr. York repeatedly put pressure on Mr. Wagoner to take more aggressive restructuring actions at GM. In January, prior to taking a seat on GM's board, Mr. York called on GM -- which lost $10.6 billion in 2005 as U.S. market share skidded and U.S. labor costs rose -- to take several drastic measures.
[Richard Wagoner Jr]

While the company followed Mr. York's guidance to cut executive pay and halve the dividend to shareholders, it didn't follow through on a suggestion it should abandon certain brands.

Mr. Kerkorian and Mr. York also were frustrated when Mr. Wagoner and other GM directors this year opposed their proposal that GM forge an alliance with rival auto makers Renault SA and Nissan Motor Corp., both run by Carlos Ghosn, whose turnaround of Nissan Mr. York cited as a model for GM.

Mr. York held a seat on GM's board for about eight months this year, but he quit in October after the talks with Renault and Nissan collapsed.

Wednesday, following a speech at the Los Angeles Auto Show, Mr. Wagoner indicated he wasn't overly concerned about Mr. Kerkorian's moves.

He said the company's management is focused on eventually posting positive cash flow and improving earnings.

"I think that's what shareholders, all of them, really care about," he said.

GMAC, one of the country's biggest automotive and mortgage lenders, said it expects to benefit from access to a lower cost of funds as it steps out of the shadow of its parent, which is hobbled by junk debt ratings. "The prospects for GMAC look quite promising as we now combine our existing business strengths with improved credit ratings, a more competitive cost of funds, and a strengthened capital base to support profitable growth," said GMAC CEO Eric Feldstein.

As part of the transaction, GMAC has a 10-year deal under which it will remain the exclusive provider of GM-sponsored auto loans.

Japan's Aozora Bank Ltd. is part of the Cerberus group. The New York firm resurrected Aozora, formerly Nippon Credit Bank, and still has a stake in the bank. Now it is using Aozora to help fund its investment in GMAC.


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