A risk too far

South China Morning Post  |  Oct 9, 2008

By Sin-ming Shaw

yline: As in the US, Hong Kong's mostly incompetent hedge-fund 'experts' threw caution to the wind, writes Sin-ming Shaw

The collapse of Wall Street as we knew it has revealed a fundamental flaw: the lack of competent oversight by the relevant authorities in the United States, particularly the Securities and Exchange Commission whose Republican chairman, Christopher Cox, has now admitted his shortcomings.

In Hong Kong, over the past 15 years or so, "hedge funds" focusing on the Greater China markets have appeared like the proverbial bamboo trees in the spring.

Their prospectuses touted their expertise and "experience" in Asia, their knowledge of the China market and their "long/short" strategies seeking absolute returns while managing risks prudently. Some even flaunted their "personal connections" to high-up government officials in China as part of their credentials as fund managers.

For that guanxi and other "hedging" services, they charge their clients a hefty fee (1.5 per cent to 2 per cent of assets) and 20 per cent of profits. Ordinary mutual funds do not share in profits and charge not more than 1 per cent. Many charge less.

Investors were willing to pay for their expertise and seeking "absolute returns" - meaning profits - because managing a well-run hedge fund requires skills most mortals do not have.

The old-fashioned way of managing money - known as "long-only" funds - was to buy good companies and hold them over long periods of time, come hell or high water. In the most pessimistic business environment, conservative fund managers simply sold stocks and sat on cash, lots of it, waiting for better times to re-enter the market.

But hedge fund managers claim they can benefit from bear markets by going "short". They do so by borrowing stocks they don't own, selling them and buying them back at a lower level, thereby making a profit.

At the minimum, hedge fund managers could hedge their portfolios by "neutralising" market downturns. They could do this by buying "put options" - contracts giving the owner the right, but not the obligation, to sell a security at a specified price within a certain time - on stocks or market indices. In this way, when these stocks go down, or the entire market goes down, these put options would increase in value, thereby making up for the losses in the portfolio.

This year, Hong Kong's managers of "absolute returns" specialising in the Greater China markets have proved to be mostly incapable of running a hedge fund.

With a handful of rare exceptions, all have lost money, based on figures at the end of August. Some 99 per cent of funds lost between 15 per cent and 40 per cent; some losses reached 60 per cent. The one that was boastful of its China guanxi lost over 30 per cent. Something is not right.

Did they not say they would "hedge" their portfolio of stocks if they didn't want to take a view of whether the markets would go up or down?

A hedge fund in its classical definition is a fund where no market risks would be taken and that, for each dollar of a better quality stock A bought, another dollar of a lesser quality stock B would be sold, so that, even in a bear market, stocks of better companies would go down less than the poorer-quality ones. And, in that process, money would be made.

A well-run hedge fund should not be losing money at the magnitudes seen in Hong Kong, unless they are essentially undisciplined speculative funds that are run incompetently.

Global financier George Soros has always been explicit: he is a speculator and he states that in his prospectus. Anyone who puts money with him knows that.

In Hong Kong, "hedge funds" are mostly leveraged speculative funds with a bullish bias. They are "directional" bets on rising markets. There is nothing wrong with such funds if the managers, like Mr Soros, have full disclosure at the outset instead of falsely claiming that they could manage risks while obtaining positive returns.

A good lawyer could easily build a case against quite a few of these managers.

The SEC in the US has belatedly admitted it had been asleep at the wheel. Hong Kong's Securities and Futures Commission should be proactive.

Taking away the licences of one or two particularly incompetent "hedge fund" managers who falsely advertised their expertise would be far more effective in protecting investors than following the advice of Secretary for Financial Services and the Treasury Chan Ka-keung. He said investors should read consumer reports regarding the risks of hedge funds.

Sin-ming Shaw is a former professional fund manager in Hong Kong

Race and the US Presidential Race

Project Syndicate  |  Oct 1, 2008

By Sin-ming Shaw

BUENOS AIRES – Three-quarters of Americans now disapprove of President George W. Bush’s performance. Given this, and the fact that the policies and values of John McCain and his vice-presidential nominee, Sarah Palin, are almost identical to those of Bush, you would expect Obama to be leading in the polls by a wider margin than he is.

The reason that he is not, I suspect, is racism. When polled, most older white voters overwhelming reject Obama, even if many of them are unhappy with Bush. Indeed, one-third of Democrats have at various times told pollsters that they will not vote for a black candidate. And a recent Associated Press/Yahoo News poll suggested that his race is costing Obama six percentage points in the polls.

Most of the time, this racism is covert, only hinted at through code words. The media, particularly the increasingly popular conservative media and talk radio, are particularly important here. Obama is consistently criticized for his “otherness” and his “arrogance,” terms that call to mind the image of the “uppity nigger” from the days of segregation, which are actually not so far in America’s past.

In a recent interview, Bill O’Reilly, the most popular TV talk show host at Fox News, America’s most watched news station, talked down to Obama in so condescending a manner that some viewers were reminded of the image of a slave owner in an old Hollywood movie putting a young black upstart in his place.

Sean Hannity, another star host at the Rupert Murdoch-owned Fox News, demanded repeatedly on air from one interviewee, Fareed Zakaria, a well-known columnist at Newsweek with a CNN talk show of his own, whether he thought America to be the greatest nation on earth. The dark-skinned Zakaria, a naturalized American from India with a Ph.D. from Harvard, felt compelled to affirm his loyalty for America twice. It is hard to imagine Hannity demanding such a public affirmation of loyalty from anyone with white skin.

So how much is race costing Obama? The problem is that pollsters cannot effectively measure the problem. They call it the “Bradley effect,” first noted during the 1982 governor’s race in California, when Tom Bradley, the then African-American mayor of Los Angeles, lost the race to his white opponent despite leading in pre-election polls throughout the campaign.

The idea behind the “Bradley effect” is that white voters won’t reveal their prejudices to pollsters. Instead, they lie and say that they will vote for the black candidate when, in fact, they have no intention of doing so.
Of course, many people now say that Obama has proven that the “Bradley effect” is a thing of the past. But his continuing difficulties with white working-class voters, who in the primaries went with Hillary Clinton, suggest that, perhaps, the “Bradley effect” is still alive and well.

Younger Americans accept inter-racial relationships as part of the normal social and sexual landscape. Yet, the very speed with which American society has progressed has threatened half of the country, older and mostly white, unable and unwilling to live in the present.

The moderate Republican Party of Dwight D. Eisenhower and the Rockefellers has been taken over by a radical crowd, with even Eisenhower’s granddaughter now openly backing Obama. So it boggles many non-Americans’ minds that so many in that great nation still do not wake up to the reality that four more years of Republican rule will further degrade and bankrupt the country.
In any civilized society, ignorance is not illegal and being moralistic is anybody’s inherent privilege. But what is alarming is how private religious beliefs and morals have increasingly shaped the secular agenda of America, whose Founding Fathers had specifically designed the Constitution to separate state and church.
Today’s radical Republican Party represents a large segment of the population that believes that abortions and same-sex marriage are immoral, God sent America to Iraq, and that bailing out Wall Street is “socialism.”

At the Republican Convention in August, the ear-splitting chants of “USA! USA!” and “Drill, baby, drill” sounded like cries of desperation, as well as of defiance against an enemy who threatens American’s divine right to remain supreme. Palin has since identified the enemy, proclaiming of Obama: “This is not a man who sees America like you and I see America.” Whether or not her judgment carries a racist undertone, as many observers believe, the polls indicate that many Americans agree.

Sin-ming Shaw is a former Visiting Fellow in History at Oxford and Princeton universities.
Copyright: Project Syndicate, 2008.

Expect a new order after 'blood flows in the Street'

Bangkok Post  |  Sep 29, 2008

By Sin-ming Shaw

When Warren Buffett speaks, the world listens. When he acts, the world better pay attention.

Mr Buffett has bought about 10% of Goldman Sachs. The market considered the purchase a sign of confidence in the company. Not everything Mr Buffett has ever bought worked out as planned, though most did.

In 1998 he bought General Re, an insurance company that turned out to be a can of worms giving him not only a close look at a mix bag of derivatives General Re executives had foolishly bought, but also got him into many legal tangles with the government because of what General Re had done.

Mr Buffett did not call derivatives "financial weapons of mass destruction" without good reason.

While we may feel a little reassured that the Man with the Golden Touch has put $5 billion into Goldman Sachs, we should wonder why Goldman Sachs, supposedly the strongest, the best, bluest chip of all the investment banks needed to sell and at the most favourable terms to the buyer no less.

The terms are extraordinary. According to a September 24 New York Times report: "Berkshire Hathaway [Mr Buffett's investment vehicle] will receive perpetual preferred shares in Goldman, which will pay a 10 percent annual dividend, or $500 million a year. Those dividends take precedence over other payments to common shareholders. Goldman has the right to buy back the shares at any time for a premium of 10 percent.

In addition, Berkshire Hathaway will receive warrants to buy $5 billion in common stock at a strike price of $115 a share, which can be used at any time in a five-year period. Those warrants are already in the money: Goldman shares closed Tuesday at $125.05, up $4.27, and rose to $134.75 in after-hours trading after Mr Buffett's investment was announced."

You don't need much financial expertise to realise it was a distress sale. Goldman needed capital badly to have had to agree to such terms. This also means the Wall Street meltdown is at present only on a holding pattern.

The urgency with which Hank Paulson, US Treasury Secretary and Fed Chairman Bernanke want the US Congress to hand them a blank check of $700 billion now takes on new meaning.

Underlying the urgency must be their realisation that without that check available right away, the alternative might be a catastrophe the shape of which one dare not imagine.

There is a risk that an order of an unpredictable kind will be imposed on policy makers around the world by a panicked world.

That new order we can only imagine is likely to have the following elements. The financial markets will have a lot further to fall. Dow at 8000 or lower is not out of the question, with the Hang Seng closer to 14000 than to 24000 within the next 12 months. There will be rising global unemployment, even in China where growth will be cut short by high inflation and low global demand. Gold could reach $1300 an ounce with oil approaching $200 a barrel before an inevitable collapse destroying more personal wealth and corporate capital, causing further global unemployment.

Right now the rest of the world is still sitting on their collective hands, either like the French sniggering at the collapse of US-style financial capitalism or like China keeping its views to itself.

The incident involving Bank of East Asia is only a tiny pre-appetiser taster of what could hit the major financial centres if the world does not rise up to the occasion.

Goldman and Morgan Stanley have already ceased to exist as investment banks, so it is no longer meaningful to use Wall Street as a symbol of American capitalism at its most creative or at its most destructive - like a neutron bomb that instead destroys assets without causing actual deaths.

Every major investment bank in the US has disappeared. Everyone is now a conglomerate bank such as HSBC with an investment banking department under the control of the Federal Reserve Board.

In the new order governments in Beijing, Moscow, Tokyo, a few multibillionaires such as Mr Buffett, oil-rich Arab sheiks, perhaps a couple of Hong Kong's super rich, will own Wall Street - after "blood in the Street".

That's not all. The radical Republican Party faction that has taken over the US political agenda since Richard Nixon's presidency replacing the traditional moderate, middle-of-the-road, fiscal conservatives represented by such leaders as Dwight Eisenhower and Nelson Rockefeller will finally be discredited as a bunch of crazy nuts on par with utopian but ultimately amoral, cynical Marxism that impoverished Eastern Europe and China for over half a century.

The deliberate and systematic dismantling by the Bush crowd of oversight expertise in the US government is criminal, if not by law, certainly by ethical standards.

What is clear that for a market to function properly as in soccer is this: mayhem will result on the field without a competent team of referees. And that means competent regulators and laws to ensure the proper working of the market. They are there not to suffocate the markets but to make sure they work well and stay open, fair and efficient.

For too long the new Republican Party has been replacing competent public servants with business lobbyists who in that dishonestly twisted logic would represent the best interests of the market.

Nonsense. They represented narrow financial interests without any regards to the greater good of the country.

Meanwhile the French will be laughing all the way to their chatty salons celebrating the demise of the "Anglo Saxon" model of economics. They think the Statist model is the way of the future. One day a swing away from Statism towards a free market will surely occur. As greed once again takes over, the world will begin once again a bull market.

Until then, prepare for more surprises. The only certainty right now is uncertainty.

Sin-ming Shaw is a former fund manager and visiting scholar at Princeton.

© Copyright The Post Publishing Public Co., Ltd. 2006
Privacy Policy

Ticking time bombs

South China Morning Post  |  Sep 27, 2008

By Sin-ming Shaw

Byline: It's little wonder Warren Buffett calls derivatives 'financial weapons of mass destruction', writes Sin-ming Shaw

Is the worst of the Wall Street meltdown over? If not, how bad could it get? Successful investors and speculators typically buy when the whole world panics. Conversely, they sell when everyone else thinks what goes up will go ever higher. Historians tell us the world hasn't seen a financial crisis playing out on Wall Street since the Great Depression in the 1930s. So, is this a once-in-a-lifetime opportunity?

The fallout from Wall Street is not quite settled. Many institutions around the world bought "hi-tech" papers designed by financial engineers trained at the best departments of maths and physics in the US.

What other esoteric papers are still buried deep in corporate balance sheets around the world that we don't know of? I'm not sure.

At Columbia University in New York you can earn a PhD in financial engineering at its School of Applied Sciences that still houses the first prototype atom smashing machine that helped in the building of the first atomic bomb. One of the star professors was the former head of Goldman Sachs' derivatives group. Financial engineering is serious stuff.

Warren Buffett has famously called derivatives "financial weapons of mass destruction". George Soros has expressed similar sentiments.

The varieties of derivatives are limited only by the imagination and ingenuity of the mathematicians. Try to read any advanced financial maths textbook in a bookstore and you would probably think you had mistakenly ended up in the nuclear physics section. Not all derivatives explode like neutron bombs, but most are inherently dangerous because they embody volatile mathematical properties beyond the grasp of most investors.

If two of the world's richest and most successful investors don't understand derivatives, how many in the mortgage business, insurance companies or salespeople at brokerage houses do?

Ask randomly any smartly dressed private wealth-management executives to write down the equation behind a derivatives product and you are likely to get: "Trust me. Our principals have their own money in this."

Many of these principals have brought down Wall Street. Not a few should be put behind bars.

Let's be honest. We are still not sure how big a hole the world is in. Experts tell us the credit-default swaps amount to over US$43 trillion, far bigger than the subprime exposure, while the total derivatives market size is over US$500 trillion. The imbedded leverage is large, and leverage always spells trouble. But no one really has any solid figures. The figure on the table at present is US$43 trillion.

Last year, the entire world's gross domestic product was US$54 trillion. The figure of US$43 trillion is almost four times that of America's GDP, and 13 times China's GDP. Am I getting your attention?

What happens when the toxic virus begins to spread to other kinds of papers? To other countries? Does anyone know? And that's perhaps why the gold market, always a barometer of fear, is acting like a yo-yo that the world hasn't seen in a very long time. This is after the announcement of an unprecedented US$700 billion bailout plan by US Treasury Secretary Henry Paulson, a former chairman of Goldman Sachs, the world's foremost blue-chip provider of derivatives.

What is worrying is that the world has not responded to an increasingly desperate call for help from Washington, albeit couched in less dramatic fashion. To trained ears, Mr Paulson and US Federal Reserve chairman Ben Bernanke are in a bind, flying blind.

The three largest holders of US Treasury bills are China, Russia and Japan. None has joined Mr Paulson to tackle what they consider to be mainly a US problem. Two of these three are geopolitical competitors. The largest economic bloc, the European Union, has stayed away, no doubt fretting about an explosion among its own financial institutions.

A multitrillion-dollar market caving in cannot be just a US problem. Unless the major economies stop thinking along nationalistic lines, Mr Paulson's US$700 billion plan could look like small change before the final curtain is drawn.

If you feel you are buying into a market bottom, first check your name. Is it Soros or Li Ka-shing?

By the way, Mr Li's warning remarks about the markets in May last year were prescient. Very few in the world are as clever, though many delude themselves into believing they are.

Developer Lee Shau-kee may have lost billions making disastrous market calls of late, but he still has plenty more to burn and many overpriced apartments to sell to Hong Kong's middle class. Do you?

Sin-ming Shaw, a former fund manager, has been a visiting fellow at Columbia, Harvard and Princeton