Paulson Apologizes for His Hedge Funds’ Performance

Wall Street Journal

Hedge-fund manager John Paulson apologized to his investors, saying performance at his funds this year is "the worst in the firm’s 17-year history." John Paulson, president and co-fund manager of Paulson & Co. Inc.

In his third-quarter letter dated Oct. 28 to investors, Mr. Paulson, who won fame for reaping billions of dollars by betting against the U.S. housing market, said "we are disappointed and apologize." Two of Paulson & Co.’s largest funds—Advantage Fund and Advantage Plus Fund—posted declines of 29% and 44% this year through October, according to a person familiar with the funds. Mr. Paulson said performance of funds were affected by the European sovereign-debt crisis, slowing economic growth and disagreement over the debt ceiling in the U.S.

"As the year progressed our assumptions proved overly optimistic and net equity exposure too great," he said in the letter, which was seen by a person close to the funds. At this rate, Mr. Paulson and his staff aren’t likely to earn incentive fees or a cut of profits. "We have learned from the 2011 experience," Mr. Paulson said, adding that the firm is "committed to returning investors to high-water marks." In the letter, Mr. Paulson said he has added Harvard economics professor Martin Feldstein to the firm’s advisory board, joining former Federal Reserve Chairman Alan Greenspan, New York University’s Stern School of Business finance professor Edward Altman and economic forecaster Christopher Thornberg.

Nouvelle Orientation – Une Europe monétaire à plusieurs vitesses

Philippe Waechter

Selon une note de Reuters parue dimanche 27 novembre après midi, les allemands et les français sont en train de réfléchir à un moyen d’accélérer l’intégration au sein des pays de la zone Euro afin de faire face aux tensions qui s’observent sur les marchés financiers et fragilisent la construction européenne.

 Trois aspects sont mis en avant selon une logique simple

1- une plus grande intégration fiscale

2- Cette intégration fiscale donnerait la plus grande cohérence nécessaire à la zone Euro pour mettre en œuvre des Eurobonds

3- La BCE pourrait alors intervenir et réduire les tensions qui s’observent sur les marchés financiers en achetant ces Eurobonds.

Dans la note de Reuters on doit comprendre que la plus grande intégration fiscale est davantage un mécanisme portant sur la discipline budgétaire pour les pays signataires que sur une problématique de transferts fiscaux au sein de la zone euro.

Chart of the day, Morgan Stanley bailout edition

Reuters – http://blogs.reuters.com/felix-salmon/2011/11/28/chart-of-the-day-morgan-stanley-bailout-edition/

Ladies and Gentlemen, this is what a lender of last resort looks like. What you’re looking at here are three lines. The black line is Morgan Stanley’s market capitalization, which tends to hover in the $40 billion range but which fell as low as $9.8 billion in November 2008. The orange line is the amount that Morgan Stanley owed to the Federal Reserve on any given day — an amount which peaked at $107 billion on September 29, 2008. And the red line is the ratio between the two: Morgan Stanley’s debt to the Federal Reserve, expressed as a percentage of its market value. That ratio, it turns out, peaked at some point in October, at somewhere north of 750%. Many congratulations are due to Bloomberg, for extracting this information from the Fed after a long and arduous fight. It couldn’t have come at a timelier moment: if the ECB wants to avert a liquidity crisis, charts like this give a sobering indication of just how far it might have to go, and how quickly it might have to act.

Are Corporate Balance Sheets Really the Strongest in History ?

John P. Hussman, Ph.D.

http://www.hussmanfunds.com/wmc/wmc111128.htm

Let’s begin with a few notes on continuing credit strains in Europe and elsewhere.

The Greek 1 year yield shot to 270% last week, with Greek debt of every maturity trading at 35% of face value or less. The prospect of limiting writedowns to 50% is increasingly unlikely, which I suspect will put much greater strain on European bank capital than anyone is willing to admit. As expected, we’re beginning to see negotiations pushing for deeper restructuring than 50%. On Friday, Reuters reported:

"Greece is demanding harsh conditions from its creditors as it starts talks with lenders about a proposed bond swap, a key part of Europe’s plan to reduce its debt pile and save the euro… The Greeks are demanding that the new bonds’ Net Present Value — a measure of the current worth of their future cash flows — be cut to 25 percent… a far harsher measure than a number in the high 40s the banks have in mind… It is increasingly likely that Greece will force bondholders who do not voluntarily take part in the bond swap to accept the same terms and conditions, something that is possible because most of the bonds are written under Greek law."

Should we care? Given the extremely high leverage ratios of European banks, it appears doubtful that it will be possible to obtain adequate capital through new share issuance, as they would essentially have to duplicate the existing float. For that reason, I suspect that before this is all over, much of the European banking system will be nationalized, much of the existing debt of the European banking system will be restructured, and those banks will gradually be recapitalized, post-restructuring and at much smaller leverage ratios, through new IPOs to the market. That’s how to properly manage a restructuring – you keep what is essential to the economy, but you don’t reward the existing stock and bondholders – it’s essentially what we did with General Motors. That outcome is not something to be feared (unless you’re a bank stockholder or bondholder), but is actually something that we should hope for if the global economy is to be unchained from the bad debts that were enabled by financial institutions that took on imponderably high levels of leverage.

« L’histoire risque de mal se terminer »

Les Echos

HANS WERNER SINN, PRÉSIDENT DE L’IFO, INSTITUT DE RECHERCHE ÉCONOMIQUE

Que devraient faire, selon vous, les gouvernements pour réduire leurs dettes ?

Les Etats-Unis devraient augmenter les impôts et la France réduire ses dépenses publiques, qui représentent plus de 50 % de son PIB, un niveau record en Europe et même au sein de l’OCDE.

Angela Merkel souhaite renforcer l’intégration de l’Union européenne. Est-ce la bonne solution ?

Créons une Europe forte et unie en abandonnant notre souveraineté et commençons par mettre en place une armée commune, et pourquoi pas un gouvernement commun sur certaines compétences. Mais, à mon avis, chaque Etat devrait rester responsable de sa dette. Je ne suis pas pour la mutualisation des dettes publiques.

Why the ECB Won’t (and Shouldn’t) Just Print

John P. Hussman, Ph.D.

http://www.hussmanfunds.com/wmc/wmc111121.htm

Over the past week, we’ve heard all sorts of propositions that the European Central Bank (ECB) "must" begin printing money to bail out Italy and other countries, because "there is no other option." There are three basic difficulties with this idea. The first is that ECB buying might help to address immediate liquidity issues of distressed European countries, but it would not address long-term solvency issues, and would in fact make them worse. The second is that the ECB, under existing European treaties, has no such authority, and the prohibitions against it are very explicit. Changing that would be far more difficult than many market participants seem to believe, because it would require an explicit and unanimous change in the EU Treaties that AAA rated countries such as Germany and Finland vehemently oppose. The third difficulty is that even if the ECB was to buy the debt of distressed European countries with printed money, the inflationary effects would likely be far more swift than anything we’ve seen in the United States. This would not "save" the euro, but would simply destroy it by other means.

Investors are not likely to be treated with a "surprise" announcement that the ECB is going to expand its purchases of distressed European debt. Any significant ECB intervention would likely follow a formal revision of EU treaties that trades greater ECB flexibility in return for more centralized fiscal control.

Let’s cover these points individually.

On attend la France sur l’Europe fédérale

Les Echos – Eric Leboucher

Mais où sont passés les Français militants de l’Europe ? Les Monnet, les Schuman, les Giscard, les Mitterrand, les Delors ? On entend les eurosceptiques, les Chevènement, les Le Pen. Les infatigables euro-bâtisseurs de naguère semblent, eux, avoir disparu. En tout cas ils, se taisent. Remarquez le silence, opoosé en France, aux propositions d’ « union politique » faites par Angela Merkel, lundi 14 novembre, à Leipzig, devant le congrès de son parti chrétien-démocrate. « Le devoir de notre génération est de compléter l’Union économique et monétaire et de construire une union politique en Europe, étape par étape [...] Cela ne signifie pas moins d’Europe, cela signifie plus d’Europe. » Qui, en France, a bondi sur ces propos fédéralistes pour les applaudir, les commenter, les compléter, pour accompagner l’Allemagne, pour la dépasser sur la voie fédérale ? Qui ? Personne. Ni à droite. Ni à gauche. On a dit l’Allemagne de moins en moins européenne. Le contraire est vrai. C’est la France qui freine ! L’esprit national l’habite.

Hokey Pokey

John P. Hussman, Ph.D.
http://www.hussmanfunds.com/wmc/wmc111114.htm

The repeated waves of fresh crisis and temporary hope in Europe are starting to look a lot like the Hokey Pokey. Last week, Italy briefly put its right foot in. Then, thanks to purchases of Italian debt by the European Central Bank, it put its right foot out. Meanwhile, everyone is calling on Germany to turn itself around, and Greece is still just shaking all about.

Until last week, much of the concern about European debt focused on relatively small countries with high debt/GDP ratios. In particular, Greece, Ireland and Portugal have debt/GDP ratios of 166%, 109%, and 106%, respectively. But Italy actually comes in at 121% debt/GDP, the highest of any European nation next to Greece. Far worse, Italy has a GDP that is 7 times the size of Greece, and is 3 times the size of Greece, Ireland and Portugal combined. So Italy’s debt is not just huge relative to its own economy – it is just plain huge, at about $2.5 trillion in dollar terms. This is a terrible problem for France, whose banks are the largest single creditor to Italy, holding Italian debt worth about one-fifth of Italian GDP.

With Italian yields pushing past 6% and briefly passing 7% last week, Italy is actually very much in the situation that Greece was in about 18 months ago, when it was hoped that new "austerity" measures would shrink the deficit by forcing painful cuts in government spending. They didn’t. The effect of austerity policies in weak economies is generally to damage the economy even more, causing a significant shortfall in tax revenues, so deficits don’t materially improve despite the reduced spending.

Quote of the day / citation du jour

From Rudiger Dornbusch, MIT economist  (who was a professor to the new head of the ECB, Mario Draghi):

"The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought."

Sortir du nucléaire, à quel prix ?

Les Echos

Le premier point est que le risque nucléaire ne s’accommode pas de demi-mesures. Si l’on pense qu’une catastrophe nucléaire est à la fois possible et absolument insupportable, il ne sert à rien de diminuer de 30 % ou de 50 %, ou même de 80 % la production d’électricité d’origine nucléaire, et on doit penser que seule l’interdiction totale est acceptable. Le risque nucléaire est défini par la probabilité très faible d’un dommage très grand. On pourrait même dire : la probabilité infinitésimale d’un dommage infini. Le danger est le produit de la probabilité par le dommage. Réduire de moitié le parc nucléaire réduit de moitié la probabilité, mais pas le danger, car la moitié de l’infini reste l’infini. La logique du risque nucléaire est donc par nature dichotomique. Les extrémistes qui ne se contentent pas d’une sortie partielle mais exigent une sortie totale ont la logique pour eux.

European equities – trick or treat?

FT Alphaville

In keeping with the bearish mood this Monday morning, we present selected lowlights from the latest Graham Secker note. Morgan Stanley’s European strategist has downgraded equities to “underweight” following the double-digit rally, to reflect the inadequate policy response to the Eurozone debt crisis, weakening economic growth, falling margins and some technical gubbins.

Now, we should make clear, Secker’s not forecasting a big fall in stocks in the near term. Rather his downgrade reflects the fact that the overall macro environment in Europe is becoming tougher, equities are not particularly cheap and no big policy breakthrough appears to be imminent. (Indeed, one of the things that would make Secker turn positive on equities would be QE from the ECB).

But he still thinks investors should be looking to preserve wealth by selling into the recent rally.

October’s rally unlikely to be sustainable
To use seasonal parlance, we believe the market’s strong bounce in October will prove to be more of a trick than a treat. While the market may hope this is the start of a longer-lasting rally into year-end, we suspect this is just a traditional counter-trend rally in an ongoing bear market. We believe investors should look to use any residual strength in stocks and sectors as an opportunity to construct an even safer and more secure portfolio – at this time the prime goal of investors should be wealth preservation rather than wealth generation. In this regard, we are making some changes to our European model portfolio, increasing our underweight in Financials, and putting more funds into defensives.

Quote of the day

From Pimco’s Mohammad El Erian:

"The big exposure to Americans is the general exposure to the equity market. You cannot be a good house in a bad neighborhood, that’s just a fact. The equity market is the house, and the global economy is the neighborhood. So if the global economy takes a leg down, the equity market is going to take a leg down too."

Reduce Risk

John P. Hussman, Ph.D.

http://www.hussmanfunds.com/wmc/wmc111107.htm

A quick note on Greece – as of Friday, the yield on 1-year Greek debt has soared to 212%, up from 144% a week ago, just after the grand "solution" to the crisis was announced. Over the past week, the price of 1-year Greek debt has plunged by 20%, to 38.4 (bid 35.81, ask 40.97 to be exact). Which begs the question – if everyone has agreed that Greek debt will only be written down by 50%, why is the 1-year note trading at just 38% of face value, with longer maturities trading below 30% of face? This sort of incongruence isn’t inspiring.

Much of the reason Greece is seeking a voluntary exchange of debt from its bondholders is that an "involuntary" exchange would be a default event, which would trigger payments on credit default swaps. But across the global financial system, there are only about $3.7 billion in credit default swaps outstanding against Greek debt, and even in the event of an "involuntary" exchange, the actual amount of payouts would be less than that notional value.

One of the greatest advantages Greece has is that about 90% of its debt is governed by Greek law. The terms of any debt exchange, voluntary or involuntary, are more than simply technical details, as any restructuring should significantly reduce the discounted value of the new debt, and I suspect that the next stumbling block is that Greece will change its laws to impose "collective action clauses" on its debt, sufficient to restructure the debt more easily, given the consent of some supermajority of its bondholders. That would help to avoid any holdouts to "voluntary" restructuring, but it would also allow the possibility of a larger haircut. Little of this has been worked out, so even widely publicized "final" deals are not final until the details are settled. In any event, a 50% haircut still puts the Greek debt/GDP ratio above 100% by the end of the decade, so it’s possible that Greece will pursue a further haircut, even if it triggers CDS payments. We’ll see soon enough whether the widely accepted 50% figure actually holds up.

Citi: "The Bear Market Rally Is Behind Us; We Anticipate A Move To 1,000-1,015"

Zero Hedge

to sum it up:

"While we are the last to put much weight in the predictive power of technical analysis, lately it has become all too clear that the only thing more worthless than technicals is fundamentals. Which unfortunately means that with the lowest common denominator (and marginal price setter) in the market being robots, in turn programmed by 20 year old math Ph.Ds who only know charts, it may be time to revise our skepticism. Enter Citigroup’s Tom Fitzpatrick, who together with Goldman’s John Noyce, are the two best sellsiders in this particular field. In short, neither has much good to sayl in fact when it comes to near-term bearish sentiment, it will be hard to find someone as pessimistic as Fitzpatrick, even among the Janjuahs and Rosenbergs of the world. Citi’s conclusion from a just released note should be enough to scare anyone who believes that the bear market rally started just about a month ago will persist: "While we respect the October monthly close on the S&P 500, we did not close above the 12 month moving average…we believe the bear market rally is behind us and anticipate a move towards the 1,000-1,015 target over the weeks and months ahead." And while charts will never be a good guide as to what words may come out of G-Pip’s mouth next, with so much market action these days being purely backward looking, we would urge caution."

Not liking those odds of a China hard landing

FT Alphaville

A new Nomura report puts the odds at one-in-three of a hard landing in China in the next three years, which they define as four consecutive quarters of sequential GDP growth at 5 per cent or less. It’s a pretty epic paper, with numerous authors, charts, and historical references, so we’ll focus here on their key six reasons why they’re becoming more wary of a hard landing. Before we get into that, though — one interesting point made early in the report is why economists are more optimistic than investors on China; despite a sell-off in Chinese equities and bonds, they point out, the IMF is forecasting 9 per cent growth in 2012 while Consensus Economics’ latest survey came up with 8.5 per cent next year and 8.4 per cent in 2013.

Nomura’s strategists see it like this:

The way we would reconcile this gap is that economists forecast the modal, or most likely, outcome, whereas the financial markets tend to take a weighted-average probability of different possible outcomes. If we apply our baseline and hard-landing probabilities to the market method {(8.5*0.66)+(5.0*0.33)}, it gives a weighted-average GDP growth forecast of at most 7.3% in 2012-14. In other words, like-for-like, our forecasts are probably not that dissimilar to what the market is pricing in – the key will be whether the risk of a hard landing rises or falls going forward (…)