Hedge funds: Goldmans stumps up the cash

Goldman's has had to find some friends to help it bail out the Global Equity Opportunities (GEO) fund which it manages - the total amount needed was USD 3,000 million. That, to put some scale into the issue, is 75% of the total assets under management of one of the inter-governmental funds run by several UAE countries.

Goldman's didn't say what the extent of the problem was - indeed, its statement was almost politician-like in its vacuous double-speak: "Given the market dislocation, the performance of GEO has suffered significantly. Our response has been to reduce risk and leverage."

In English, that means the excreta had hit the whirling thing in the messiest possible way but someone was using the world's biggest roll of tissue paper to try to disguise the damage.

Of course, it's not surprising that Goldman's didn't want to say anything that might be interpreted as indicating that there was a widespread problem in the US economy - for its top job is now held by one of the beneficiaries of Washington's revolving door - Henry Paulson - the former US Treasury Secretary and he's not about to dump on his former colleagues on the Hill - after all, those connections are precisely why he was in demand on Wall Street.

But Goldman's wasn't entirely reticent - announcing the bail out, president and co-chief operating officer Jon Winkelried indicated the scale of the problem and where the blame lay. But it didn't lie with Goldmans or the US Treasury or the Fed - at least, not overtly. GEO was worth about USD5 milliard last December. But in the past few weeks, it had lost 20% of that, he said. But it was his next statement that indicated the depth of feeling in a bank that is trying not to say bad things about the government: The losses because world markets have been destabilised as a result of fears over the US housing market and tightening credit.

Time for another translation into the English the rest of us understand: the US economy is in a mess because of a period of disastrously bad lending decisions leading to a substantial amount of unsustainable personal and - to a lesser extent - commercial debt a disturbing proportion of which is or is on the verge of being classified as bad or doubtful or, in modern banking language non-performing.

The last time we heard that was when analysts were explaining the reasons behind crisis in Korea and Japan. And that, dear reader, was in 1997.

Time for the hard hats, lads. This might be a very bumpy landing.

After all, as the US has wavered, property prices in the UK have started to fall except in the most in demand places where rises have all but stopped. This morning's RTE broadcast Morning Ireland had a feature with Pat McArdle, an economist with Ulster Bank who tried to explain why the Irish construction sector has suddenly had the parachute pulled. In Hong Kong this week, we have seen estate agents posting adverts inviting offers below the advertised rental value - and rental values in parts of HK have fallen - according to our own surveys - by up to 20% in the past six months. We are also seeing some falls in purchase prices in some of the areas bordering the most desirable.

Last week, in Germany, hedge fund Frankfurt Trust, owned by BHF Bank, told investors in their FT ABS Plus fund they couldn't have their money back: around 1/3rd of investments had been withdrawn since the end of July as subscribers began to fear fallout from the US crisis. A statement on the company's website said "The situation for the asset-backed securities and CDOs market has become much worse in the last few days because of the U.S. real estate crisis.'' It went on to say that the result was that the fund faced having to liquidate assets to meet "redemptions" (i.e. claims by people who wanted their money back) and that the fund was, in effect, facing falling prices in a fire sale. In short, the fund decided to hold onto the assets it has, hoping that the market does not fall significantly and that it will come back sufficiently to recover the full amount of investments and charges. But the ripples don't stop there for BHF Bank was bought from ING in 2004 by Germany's largest independent private bank - Sal. Oppenheim Jr. & Cie KgaA. If Frankfurt Trust fails, the vertical shock waves could result in a major crisis in the German financial sector. And The Financial Times German edition reported that two other "Asset Backed Securities" funds - Union Investment and HSBC Trinkaus - closed their funds the previous week, although those primarily attracted institutional investors.

In the same week, BAFIN, the German financial regulator, warned that bad news from IKB was scary: if the bank collapsed, the regulator said, it could trigger the worst crisis in Germany since before WWII. Yesterday, German banks put euro3.5 milliard into a fund to rescue IKB. Whether it is enough depends on just how badly performing IKBs portfolio is: the total exposure is USD26.5 milliard. The German banks are therefore gambling that only about 15% of IKB's debts go bad.

This is all going to come back to haunt the battling bidders for ABN AMRO - for one of the issues at US unit LaSalle - they had a massive compliance problem in which staff were found to be signing off on loans without passing them before an actuary (in fact they forged the actuary's signature) as required by regulators. They said at the time that the default rate on the improperly signed off loans was no different to properly passed loans, and that the only reason was pressure of work. The work was to pass vast numbers of sub-prime lending deals. At the time, it was estimated that no more than 20% would go sour. But in March this year, the American Mortgage Lenders' Association said that in December last year - before the crisis began to bite - more than 5% of borrowers were already subject to foreclosure proceedings.

The Bundesbank joined the chorus of increasingly unlikely sounding promises that it's all OK really. Bundesbank President Axel Weber said "The exposure of German banks in the U.S. real estate market is manageable and limited overall." He suggested that IKB's problems were isolated. There are bunches of bankers in Frankfurt who know that's not so - and that even insurance companies are now being dragged into the crisis as indirect owners of the top slice of increasingly uncollectable debt.

And the contagion is increasing: two weeks ago, Sydney hedge fund Absolute Capital, substantially owned by ABN AMRO (note how often that name is cropping up?) announced that it was freezing redemptions: Absolute says that less than 5% of its AUD210 million Yield Strategies fund assets are in the US sub prime market but even so it lost 5% of its value in July. The company says that the cause of the problem is debt markets that have "ceased to operate normally". That rather depends on one's view of normal: it could be argued that someone has finally realised that the US debt market was based on assets with inflated prices, and that the reason for the current crisis is that someone noticed and blew the whistle.

Certainly, the crisis is in fact going global: some Macquarie Bank funds have fallen by some 9% in the past month, according to Australian media reports. And last week, Basis Capital's AUD320 million fund, Basis Yield was closed with an announcement that investors would be fortunate to see 50% of their money back. The company has appointed US investment company Blackstone to negotiate with creditors to try to prevent a rapid sell-off at a heavy discount.

As heads of central banks all circle the wagons, their pleas are becoming increasingly desperate. They want to be believed. They know that the only thing that has propped up markets in the past two years has been confidence as, with the notable exceptions of China, London's invisibles market and Japan most economies have not had significant structural strength. The speed with which money has rotated has given the illusion of wealth.

But the money go round is at risk of crashing as the wheels fall off.

And increasingly, it's looking as if that will happen if just one central banker goes off message.

BISfaculty and The Chief Officers' Network host "When America Sneezes..." in Singapore on 24 - 25 September 2007.

Details at BISfaculty.Com