August 11, 2007
Quants and Stock Prices
Any doubts that individual "stock pickers" should stay away from short term trading strategies had to be dispelled last week. The "quants," hedge funds with market neutral strategies dependent on the execution of historically based trading programs, rolled the market last week. Companies with weak performance data had their stock prices increase and companies with strong performance data had their stock prices decrease. Why? The quants' programs were unwinding positions, automatically, to account for market situations that programs had heavily discounted as very rare occurrences. Apparently the quants' programs were negatively affected by stock selloffs required by liquidity crunches. These hedge fund trades dominate the market, accounting for up to 60% of the volume on any given day. It is impossible for those on the outside, individual stock pickers, to make sense of such a market. It is a recipe for huge losses for such folks. Yet another example of why individuals should not try short term trading strategies.
August 10, 2007
"Freezing Hedge Funds"
The action by the French bank to "freeze" several of its hedge funds has confused many. What the bank did was to block "terminations." withdrawals, by fund investors. Hedge funds allow for liberal withdrawal rights to encourage investors to invest. Once a fund becomes insolvent it can no longer respect terminations, they are illegal preferences. So a "freeze" is a declaration that a fund is insolvent, must wind up and will pay investors whatever they can.
Cramer After Lockhart Now
Having failed to intimidate the Fed into balling out credit speculator, Cramer has turned his attention to the OFHEO, the agency that regulates Fannie Mae and Ginnie Mae. He wants the chair, Jim Lockhart, to allow the government charted banks (particularly Fannie Mae and its cousin Freddie Mac) to accept more delinquent loans so as to bail out the mortgage markets. "He is responsible if people lose their homes." I am not longer amazed that those who labor in the financial side of capitalism demand government bailouts when their speculative schemes collapse. They are "fair weather" capitalists. What economists know, however, is that predictable and frequent government bailouts will destroy the system in which they operate. Financial markets work only if unfettered and go down as well as up.
BackDating Criminal Cases
On Tuesday, a jury convicted Gregory L. Reyes, the ex-CEO of Brocade Communications, of criminal securities act violations for backdating compensatory options. He tried all the classic defenses: I did not know it was wrong; Everyone was doing it; I did not profit, my employees did; And, it was just a minor bookkeeping disclosure error with no victims. He lost. The interesting part of the case was the decision of not to call any witnesses from the Sonsini law firm to buttress the claim that Reyes thought it was legal. I have blogged earlier about how law firms have to draft and file documents to make backdating work. I suspect the law firm had in its firms enough CYA paper to give it "plausible denial" and not help the defense. The Supreme Court opinion in the Charter Communications fraud will put all this in issue. How much aid can professionals give a fraudulent scheme before they themselves are liable. I hope that the Court uses a "red flag" test to catch those involved that will enable prosecutors to look behind the CYA documents in the file.
August 7, 2007
Jim Cramer's Meltdown
On Friday's "Stop Trading" show, stock picker Jim Cramer had a meltdown when discussing the actions of the Fed and its chair Bernanke. Cramer demanded that Bernanke "open the gates", lower the discount rate, to save the hide of fixed-income speculators who were losing money in the current credit markets. Not long ago Cramer was blasting Greenspan for "attacking home prices." Contrary to Cramer's pleas, the chairman of the Fed is not in office to bail out speculators when they get over-extended. This fixation with actions of one man, and its significance to the markets, should give us all pause. We need a market based mechanism for setting discount rates.
Nardelli Takes the Reins at Chrysler
There has been universal surprise at the selection, by Cerberus Capital Management, of Robert Nardelli to run Chrysler. Recent management history has taught us 1) that the identity of the CEO is very, very significant to a company's success and 2) that, for a CEO, character matters. Given Nardelli's poor performance as CEO of Home Depot and as the chair of the compensation subcommittee of the board of directors for the NYSE, it seems that Cerberus has made a very unfortunate choice. As CEO of Home Depot he hurt the company, arrogantly abused its shareholders and investors, and then took excessive executive compensation for his troubles; on the NYSE board he facilitated the excessive compensation of its controversial CEO, Grasso (who single-handedly blocked technological innovation), which Nardelli later vocally defended. The new CEO of Chrysler will have to boost the public confidence in Chrysler's products (to buyers), in its financial position (to lenders), and in its labor relations (to the union) while reorganization the company's operations. He will have to be part diplomat; Nardelli is not diplomat.