September 9, 2005
Katrina and American Business
It will take some time for the full economic effects of Katrina to sort out. The smart money is currently on reduced second quarter economic growth, a higher unemployment rate, a higher inflation rate and increased consumer prices across the board (due to higher energy and raw material prices). So why is the stock market up?? Some argue the government and private money that will be used to rebuilt will be, in essence, a giant urban renew plan, creating a economic stimulus with positive, leveraged ripple effects in the larger economy. Is this why the market it up? No, traders are believe that Katrina may cause the Fed to slow increase interest rate increases. We are too dependent on the discretionary, quarter to quarter decisions of the Fed.
Hedge Fund Regulation
Next year the Securities and Exchange Commission will register hedge funds. Funds must submit their address and attest that they are not run by those who have committed financial crimes. The SEC then has the power to perform discretionary audits on registered funds and presumable, if the SEC does not like what it finds, to suspend their operations. At issue is whether the new regulations are enough, given the recent proliferation of hedge funds and the two most recent spectacular failures, the Bayou Group and the KL Group, or whether they are too much, expanding SEC registration to what was formerly considered private investing activity. Regardless of registration, of course, hedge fund operators that defraud investors can be prosecuted criminally and pursued civilly for damages. The SEC, in pursuing these new regulations, have, in my view, put itself in a very difficult position. Bad operators will continue to take people's money and the SEC will take considerable heat for each new failure beginning next year. Defrauded investors will be angry that the SEC either did not audit the failed fund fast enough or that it did not catch the fund fast enough if it did. The SEC so chastised will be forced to conduct more thorough and searching audits with each new scandal. It is a recipe for eventual total regulation by the SEC of hedge fund activity.
September 7, 2005
Hedge Fund "Window Dressing"
The new revelations on the practice of hedge-fund "window dressing," the artificial inflation of performance figures for clients, are stretching the notion that hedge-hund clients are sophisticated enough to take care of themselves. Now there is news that some hedge funds trade at the end of reporting cycles in small volume stocks to increase temporarily stock prices in stocks they hold. See WSJ, 9/7, at C1. Why do sophisticated investors tolerate this stuff?
Microsoft v Google Continued
The dispute between Microsoft and Google over the services of Mr. Lee continues to entertain. Mr. Lee, in testimony, described a tirade by Mr. Gates in which the CEO of Microsoft disparaged the Chinese people and its government while attempting to outsource $100 million worth of jobs to China. Microsoft, on the other hand, came up with an e-mail from Mr. Lee to Google in which Mr. Lee trumpeted that he was "working on areas very related to Google (while at Microsoft)." Mr. Lee also recommended to Google, while on the Microsoft payroll, which people at Microsoft Google ought to hire. The trial is turning into a public relations disaster for both companies.
September 6, 2005
Google v Microsoft over Kai-fu Lee: Round Two
The local court heard arguments on a preliminary injunction (it has aready granted a TRO) restraining Mr Kai-fu Lee from working at Google after leaving the employ of Microsoft. The case is going to get interesting. We already have a description, in a sworn affidavit, of Mr. Ballamer throwing a chair and threatening to "bury" Mr. Schmidt (CEO of Google) when informed of another earlier defection. The high profile of the case may set the ground rules for future employee defections in the high-tech industry. Google has filed a countersuit in California that Microsoft removed to federal court. The hearing in this second case is set for October.
SOX and International Business
International corporations are finding that the new whistleblower rules under Sarbanes-Oxley are inconsistent with rules in other countries, particularly in Europe, that do not respect anonymous complaints. The French, for example, believe that an anonymous complaint procedure does not give adequate protection to the people accused of wrongdoing. Companies that do business in both the US and France will be conflicted. Eventually the SOX rules that conflict with foreign rules will have to be isolated to US operations. At present they are not.
September 5, 2005
Stock Market Prediction: Get out
Folks, I will make a prediction against my interest (I may look very foolish with this later -- and indeed, I hope I do). The stock market is due for a severe correction. It may not happen quickly -- it may take a while to develop -- but look for a 15% negative correction over the next year or so. Increased energy prices, Chinese and Indian products coming on line, the markets blase acceptance of low risk premiums, a slowing manufacturing economy, leveraged fund foibles (chasing the high returns; hiding the bad results), lower consumer spending, heavy short pressure (particularly in the EFTs) -- it all adds up to a correction. Minimize long positions in stock.
Disney Case Settles
The case against the board of directors of Disney for paying Orvitz excessive compensation for his 14 months of service has settled. The Delaware Court of Chancery recently ruled in favor of the defendants after a trial and the plaintiffs have opted to settle the case rather than appeal. The details of the settlement will be interesting. I do not yet know them and may never if the Court decides to keep them confidential.
Hedge Fund Shakeout Predicted
In a must read paper, Professor Andrew W. Lo of the Sloan School of Management at MIT had predicted a hedge fund shakeout in the near future. He found that when a hedge fund posts "smooth returns" that are too smooth to be realistic, it is a precursor to a hedge fund's reversal of fortune. Looking across current hedge funds, he has noted an industry-wide "smoothing" of hedge fund returns, similar to the situation just before the 1998 global meltdown of hedge fund returns. He speculates that hedge fund difficulties could create a "perfect storm." Hedge funds, he notes are highly leveraged and vulnerable to having lenders cut off credit in a downturn, forcing the funds to close out positions at the bottom. Multiple close outs would have ripple effects into the solvency of banks and brokerage firms that lend them money. His solution? A national crisis management team. Seeing the crisis management skills of the government at work in the Katrina disaster should remind us that government crisis management is a slender reed. I, as I have noted here, would force all lenders to tabulate and expose to public view their ongoing, open exposure to leveraged funds.