Special Situations

Sweeping changes are taking place at the state level as pension trustees and legislatures push for higher monthly contributions to pension plans, a later retirement age and lower annual cost-of-living adjustments for current and retired workers. Unions (those that don't make Twinkles, in any event), are making the concessions because they can see the future absent shared sacrifice — the termination of defined benefit plans in favour of defined contribution plans. Be that as it may, employee contributions are going up — a de facto tax hike. And this will work directly against any upturn in consumer spending when you consider that the state and local government sector employ nearly 20 million people or 15% of the national job pie. So we will have less government, fewer entitlements and more whisperings that it isn't just the $250,000+ high-income households that are going to experience tax increases and diminished disposable income growth. This is shared sacrifice. To think that the nation could have ever gone to war in Iraq and in Afghanistan under the Bush regime, putting our troops at great risk not to mention the emotional scars on their families, while here at home civilians would be allowed to enjoy tax cuts and a debt-financed consumption binge.... One has to wonder what events could provide positive momentum to GDP growth, push corporate earnings to record highs as the consensus predicts as early as next year, or generate any lasting inflation, for that matter.  It's the people that make these pricing decisions. Businesses can only price up to what consumers are willing to pay. It is households that determine whether or not we have inflation, not some bureaucrat in Washington who believes he has control over some printing press.

The BOJ pioneered QE in March 2001, with two objectives. The first was to eliminate deflation, which took hold in the mid-1990s; and the second was to shore up Japan’s fragile financial system. Did it work? Yes, for the second objective - the BOJ arguably bought time for banks tied up in NPL disposal; but, unfortunately, QE was not successful in combating deflation. The BOJ’s intended policy transmission mechanism was so-called portfolio rebalancing. Ideally, the buildup in banks’ deposits at the BOJ that earned no return (but carried zero risk) should have prompted banks to seek higher returns (with higher risk) and thus increase their lending. But portfolio rebalancing did not kick in for several reasons; most of which are the same as are occurring in the US currently. More fundamentally, however, Japan's demographics hindered any hopes of a capex-driven recovery - and policy can do little to affect that. While the US faces a less dismal demographic picture, the Japanese experience highlights that other policies (as Bernanke himself admits) are required for any sustained benefit in the real economy.

Lately, it has become particularly fashionable to bash private equity, especially among those workers in the employ of the state. The argument, in as much as capitalism can be summarized in one sentence, is that PE firms issue excess leverage, making bankruptcy inevitable (apparently those who buy the debt are unaware they will never get their money back), all the while cutting headcount to maximize cash flow (apparently the same PE firms don't realize that their investment will have the greatest terminal value to buyer if it has the highest possible growth potential, which means revenue and cashflow, which means proper CapEx investment, which means streamlined income statement, which means more efficient workers generating more profits, not less). The narrative ultimately culminates with some variation on a the theme that PE firms are responsible for offshoring jobs. While any of the above may be debated, and usually is especially by those who have absolutely no understanding of finance, one thing is certain: when it comes to bashing PE, America's public workers should be the last to have anything negative to say about Private Equity, and the capital markets in general. Why? Because when it comes to fulfilling those promises of a comfortable retirement with pensions and benefits paying out in perpetuity, always indexed for inflation, and otherwise fulfilling impossible dreams, who do America's public pension fund administrators go to? The very same private equity firms that have suddenly become outcast number 1.

Game Over for the once high flying hedge fund manager: "“Today’s charges read like the final exam in a graduate school course in how to operate a hedge fund unlawfully,” said Robert Khuzami, Director of the SEC’s Division of Enforcement."

Just because Solyndra was not enough of a humiliation for the president, not to mention MF Global where inquiring minds are wondering when the president and vice-president will refund any and all campaign donations received by Jon Comminglerzine, here comes the next public fiasco for the administration, as the broader public shifts its attention to LightSquared by way of owner Harbinger capital, and its flamboyant head (and wife) - Phil Falcone. As has been just released in an SEC filing, Harbinger has received a Wells Notice from the SEC. Now in a time long, long ago, or about three years ago, before market criminality and manipulation became wholly endorsed by the US government, getting a Wells Notice was a death sentence for any hedge fund. Alas, it still is: "The Wells Notices state that the staff intends to recommend or is considering recommending that the Commission file civil injunctive actions against HCP, Harbinger Capital Partners Offshore Manager, LLC, Harbinger Capital Partners Special Situations GP, LLC, Mr. Falcone, Mr. Asali, and Ms. Roger alleging violations of the federal securities laws’ anti-fraud provisions in connection with matters previously disclosed and an additional matter regarding the circumstances and disclosure related to agreements with certain fund investors." And whether the Wells Notice is merely an inquiry into Falcone previous shady hedge fund-dipping practices described here, or a preamble to a full blown public spectacle-cum-humiliation on Harbinger's LightSquared remains to be seen. One thing is certain: Mrs Falcone will milk the newly found notoriety to its full extend, prenup firmly in gold-braceleted hand.

RAB Capital, once the poster child of the London credit bubble, whose assets peaked at $7 billion in 2007, has seen its shares tumble over 30% in afternoon trading, following an announcement that the firm will delist after a terminal surge in redemption requests. From the FT: "RAB, which at the beginning of the year oversaw assets of just over $1bn – a far cry from its peak of $7bn in 2007 – has seen its remaining assets evaporate in recent weeks. Investors pulled $370m from RAB’s flagship $470m Special Situations fund last month when a three-year moratorium on withdrawals finally expired....Since then, clients – fearful of the RAB’s viability – have abandoned the company’s other strategies. The firm’s $120m Cross Europe fund has been swamped by redemption requests, say people familiar with the company. In addition, one of RAB’s remaining star money managers, Gavin Wilson, is to retire from the firm. Mr Wilson’s $250m Energy fund has been one of RAB’s best performing offerings of late." Well, if other, much better managed hedge funds are any indication, Mr. Wilson's Energy Fund likely got annihilated last week, putting the final nail in the 4 year public stint of this vehicle to bring leverage to leverage.

With everybody presenting their ideas and themes for 2011, most of which are replete with crayon drawing of rainbows, koolaid and unicorns, here is David Rosenberg's list of 10 thoughts for what to look for in 2011.

One of the biggest hedge fund "fall from grace" stories last week, was that of Phil Falcone fund Harbinger, which has seen major redemptions from key LPs including Goldman Sachs and the New York State pension fund after his withdrawal of capital from a locked up fund made headlines (having made headlines previously in March, although with a 5 month delay). Today, via Reuters we learn that Mrs and Mr. Lisa Marie Falcone continue to have key major cash needs, after posting some of their "fine art" as collateral for a secured five-year loan from Bank of America public records show. And while "the two-page document does not specify the amount the couple borrowed, the terms of the financing package or exactly what the "certain items of fine art" posted as collateral are" neither is the "uses of funds" disclosed, the amount is hardly paltry and is surely needed for more than mere renovations of the couple's $49 million town house, which just happens to be Bob Gucciones's Fifth Avenue former stomping ground. Regardless, ongoing scrutiny and an unwelcome public spotlight will make Harbinger's future ever more problematic: already the fund has lost nearly 75% of its value, peaking at $26 billion in 2008, and now down to just $7 billion. As the fund is down 15% YTD, the only money coming in is from the 2% management fee: a paltry $140 million which has to cover overhead and expenses, and a far cry from the billions Falcone made a few years ago.

Nope...just some normal profit taking and another opportunity to load up on stocks...

The one-two punch is complete: first Goldman pulls it capital, now the SEC and the US Attorney's office are investigating Harbinger. Is this the proverbial curtains call for Phil Falcone? Accusations are one thing. Accusations accompanied by major LPs pulling capital are usually the last thing.

Markets will do whatever they have to do to screw the most people. In every election since 1950, markets rallied for six months after the midterms, setting up for a nice yearend rally. One more flush in the indexes, and a 950 SPX gives you a PE multiple of 10, the lowest it has been for years. After firing people to boost productivity and profitability, the end September earnings reports should be pretty good. (SPX), (ECH), (TF), (IDX), (EPOL).

Michael Burry, who needs no introduction, was on Bloomberg TV earlier discussing his latest investment allocation, which no longer focuses on shorting real estate via the cheapest possible instrument, and instead is going long cash assets in the form of farmable land (oddly enough, not multi apartment commercial real estate), small tech, and, yes, gold. “I believe that agriculture land -- productive
agricultural land with water on site -- will be very valuable in
the future. I’ve put a good amount of money into that.” Burry, just like Zero Hedge, laments the surge in cross-asset correlations, which makes all hedging strategies virtually impossible, and is a primary reason for why so many rational investors have decided to depart from the market: "I’m interested in finding investments that aren’t just
simply going to float up and down with the market. The incredible correlation that we’re experiencing -- we’ve
been experiencing for a number of years -- is problematic." Lastly, Burry agrees with the Paulson-Greenspan view on gold, but not any of the other Paulson "Recovery" themes we presented in extreme detail over the weekend: "Paulson's big in gold, and that's something that is interesting to me given how I see the world playing out, but other than gold I haven't really bought into any of the other theses." (And no, you still can't eat it, dammit).

What are the top hedge funds buying and selling?

As was pointed out yesterday, Morgan Stanley's massive Real Estate empire is starting to unravel building by building. With a building here, five buildings there, the shareholder pain, and the writedowns start accumulating. But it was not always makeshift tears and walking away from buidings when your equity is underwater. In those long ago days of 2005 it was hope and bubblemania. Which is why we dug up various Morgan Stanley Real Estate Fund documents and materials, exposing the firm's delirium just as the peak in the real estate bubble was about to set in.

Many big hedge funds (and private equity funds) become asset gatherers, collecting 2% on huge assets. When you see more marketing personnel than investment professionals visiting you, pull the plug fast!