Wednesday, August 01, 2007

Floyd Norris: Notions on High and Low Finance

August 1, 2007, 3:18 pm
Liars Can’t Be Trusted

The news that Bear Stearns has halted withdrawals from a third hedge fund — one that sounds much less risky than the two that collapsed — is a reminder what happens when people suspect lies.

The two Bear funds that collapsed did so suddenly, as seen by their investors. The valuations given to investors did not indicate the end was near, but it was. In hindsight, those valuations appear to have been a tad optimistic. So now investors may be tempted to check out before there is proof of troubles.

With the Bear fund doing this, will investors in other funds run by different sponsors be tempted to follow suit?

Yesterday was July 31, and hedge funds that issue monthly reports will have to estimate the value of their holdings. “It is likely,” says Richard Bernstein, the chief investment strategist at Merrill Lynch, “that many hedge funds will be shocked by how low their marks are. The combination of a down market and liquidity drying up in many debt instruments is likely to make many intra-month evaluations now appear quite rosy.”

Some hedge funds routinely do not allow withdrawals, and thus will escape the pressure of immediate withdrawals. But others, particularly those that invested in fixed-income markets and derivatives, face a real risk: If they put out rosy numbers, will investors see that as a chance to bail out before bad news is admitted? On the other hand, if they put out gloomy figures, will investors see that as proof of a decline so severe it could not be finessed away with valuation techniques, and see that as a reason to flee?

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July 31, 2007, 6:16 pm
Volatility Is Back

The Dow today, at its high, was up more than 1 percent from yesterday. At its low, it was down more than 1 percent.

It was the first such day in more than four years. The last one was April 9, 2003, another day on which, as today, the bears prevailed at the close. But not for long. The Dow ended that day at 8,197.94. It has not been that low since.

Over the last 20 years, those days have come in spurts. There were 12 such days in 1987, the year of a soaring stock market that ended in a crash, and there were 22 in 2002, the year the market hit bottom after the 2001 recession and the bursting of the technology bubble. But no other year had more than nine.

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July 31, 2007, 5:12 pm
American Home Collapses

It made money until it failed.

So goes the story of American Home Mortgage, which today disclosed that it is having a liquidity crisis. The stock fell about 90 percent. It will not be able to come up with the money to fund hundreds of millions in loans.

For those who sold the stock in recent weeks, the New York Stock Exchange and the S.E.C. may want to ask just what they knew and when they knew it. We are told today in the release that the company has been getting margin calls on its mortgage securities for about three weeks. During that period, the stock fell from around $17 to $10 without any announcement from the company. Today it is around $1.

On June 29, the company had disclosed that it would report a loss for the second quarter, but promised to keep paying dividends and said its net worth would actually go up in the quarter. (Now there is a wonder of modern accounting.) When it made that announcement, it did not mention that its chief investment officer had resigned the day before. We learn that from an S.E.C. filing today.

Why did he quit? And how did the company decide that fact was not worth mentioning then?
This may not be a subprime issue, by the way. In his last earnings conference call, in April, Michael Strauss, the chief executive, said most of the company’s delinquency problems were coming from people with high credit scores, who had been received high loan-to-value loans and had not had their income verified.

I would, by the way, love to talk to anyone who had a loan commitment from American Home, and now will not be able to borrow the money.

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