Monday August 13 – No precedent, no rescue, no clue?

COPYING AND DISTRIBUTING ARE PROHIBITED WITHOUT PERMISSION OF THE PUBLISHER: SContreras@Euromoney.com

By:
Peter Lee
Published on:

For reporters on the call, Goldman CFO Viniar unwittingly supplies the headline: 'This is not a rescue'. Grateful sub-editors simply take out the word 'not'. The market has the same fear after the call that it had before: that somewhere out there lies a very large fund that the market disruption will bring down.

The week Wall Street went into meltdown

The other big news over the weekend had been the departure of Karl Rove, political fixer for president George W Bush. Fixated on their own worries, Wall Streeters simply ignore this, focusing instead on a rare unscheduled announcement from Goldman Sachs.

Goldman kicks off the week by declaring that it is partnering with a group of outside investors including CV Starr, Perry Capital and Eli Broad, as well as others that do not wish to be named, to inject $3 billion of new equity into the $3.6 billion equity long/short quantitative hedge fund Global Equity Opportunities (GEO), which Goldman manages but had not previously invested in.

If it hasn’t been much of an opportunity before, it certainly is now, Goldman CEO David Viniar tries to argue. "Our collective belief is that the fund is suffering from a market dislocation that does not reflect the fundamental value of the underlying stocks." He goes on: "The events of recent weeks have been unprecedented in their speed and intensity." But, he concludes: "We have seen market dislocations in the past and know they present opportunities."

It’s a brave effort but the market is far from convinced. Everyone is far too used to hearing disappointed investors complain, as a Goldman source does later to Euromoney, that the market valuation of their assets is irrational. And everyone can quote the relevant saying about how long the market can stay irrational compared with how long the investor can stay solvent.

The encouraging aspect is that Goldman is boldly putting down $2 billion of its own money on this bet that markets will mean revert and the fund’s positioning will come right. This is naked exposure. If Goldman is wrong, it loses that money. This is not a firm coming in to prop up a fund carrying its brand name as a senior secured lender, laying claim to the collateral and seeking an orderly unwind. "The debate we had," says the Goldman source, "was if somebody else came to us with a portfolio that looked exactly like this, would we buy it? The answer was ‘yes, in a heart beat’. These were stocks of really good companies, with no bad news, that had yet been losing 5% a day, day after day. It’s unbelievable."

But it’s not unbelievable at all. It’s what happens when investors are forced to de-lever, raise cash, meet margin and sell what’s good and liquid to prop themselves up. Goldman reveals that GEO is down 30% for the year, all of that fall coming in the prior week, and that its more famous Global Alpha hedge fund is down 27% for the year, half of that decline coming in the prior week. The managers have been busy de-risking and de-levering, a process now roughly three-quarters complete. The GEO fund had previously been operating at six times leverage and is now down to 3.5 times.

Goldman can as yet give no details on redemptions and outflows from longer-standing institutional and high-net-worth investors in the GEO fund, with month-end, still three weeks away, being a key moment. Perhaps this timetable explains Goldman’s decision: invest in GEO now, lest mass redemptions at month-end scupper it.

Is this setting a precedent and will Goldman put equity into other hedge funds it manages if their valuations get beaten down? "You should not look at this as a precedent," comes the answer and, "note, we are not investing in Global Alpha".

Market disruption brings turmoil to financial stocks

Goldman Sachs share price (13 to 17 August 2007)

Source: Yahoo Finance


For reporters on the call, Goldman CFO Viniar unwittingly supplies the headline: "This is not a rescue". Grateful sub-editors simply take out the word "not". The market has the same fear after the call that it had before: that somewhere out there lies a very large fund that the market disruption will bring down.

Monday August 13 –
No precedent, no rescue, no clue?


Tuesday August 14 –
Out of control


Wednesday August 15 –
Skin in the game


Thursday August 16 –
Crescendo of panic


Friday August 17 –
No one leaves unscathed


Lessons of the market seizure
They said it
And what of the broker-dealers’ own prop desks – what losses will they eventually report, assuming they will be too large to be swept under the carpet? Euromoney recalls a parting exchange with one Wall Street CEO in June, when the market fever was just breaking out. Was his firm hedging in expectation of losses to come and could it position to escape the worst of a big sell-off. "No," came the blunt reply, "it would be really bad." Central banks reduce the scale of cash injections, with the Fed supplying just $2 billion of cash, compared with $38 billion on the previous Friday, and the ECB €47.7 billion. Late selling takes the Dow Jones Industrial Average back to flat for the day. No one Euromoney talks to is prepared to say the markets are returning to normal. "The key risks now are liquidity and credit risk, which is why we’re keeping high cash balances," says a senior Wall Streeter. "There’s a high degree of cooperation between firms now, lots of joint working parties." He declines to go into details, other than: "It’s in no one’s interest for anyone to go bust."

In Canada, it emerges that Coventree, a niche investment bank specializing in credit arbitrage that funds portfolios including mortgages and CDOs by issuing asset-backed commercial paper, has been unable to roll over short-term funding, has had to pay up to extend certain notes and is looking to its backstop bank credit lines.

Bankers are nervous about the potential impact on the wider asset-backed CP market.

Tuesday August 14 – Out of control
This is a week in which some of the brightest, best educated, most eloquent – who can normally argue three different and contradictory positions at once on the economy, the markets and their own industry – discover that they've somehow lost track of how the new financial markets work. They know it's somewhere, but they have no idea where and in what measure they have distributed the risks. Some of the usually vociferous don't want to talk at all, fearful that if they say something today and the markets move the opposite way tomorrow, they'll look stupid. But no one looks terribly clever.


Wednesday August 15 – Skin in the game
"It was PIKs and toggles," he rolls his eyes, as if someone else had forced him to do this deal or cheekily agreed it in his name. "It was covenant lite and even what covenants there were were rubbish ones." After weeks of wrangling over how to bring the senior secured portion of the financing to market, his own banks' team and that of the LBO sponsor were barely on speaking terms.

Thursday August 16 – Crescendo of panic
We've got hedge funds who are saying, 'Look, we have been in business for ten years and we've paid $500 million in fees and commissions to Wall Street and you can't give us a couple of days?' We are getting a lot of blunt decisions made by people far away from these markets and some of them are bad decisions. If someone comes down from the 40th floor and tells us not to accept a certain class of collateral or counterparty, we're not going to disagree"

Friday August 17 – No one leaves unscathed
"It's really troubled. Everything is being tarred with the same brush and investors in funds that buy commercial paper are ringing and asking: 'You're not in that asset backed CP are you?' And if funds have bought ABCP, investors don't want to hear about whether it's good ABCP or not, they're out of there"

Lessons of the market seizure

They said it