Hedge Fund Nation

No doubt, by now you have come across the news of the arrest of Bernard Madoff. Madoff’s Hedge Fund managed to lose $50 billion (effectively all) of the money people entrusted with him to invest. That number is staggering! Many people have lost literally everything and their lives are forever changed.

Where Were the Regulators?
Bernard Madoff was the former Vice Chairman of the National Association of Securities Dealers (NASD).
Let me describe for you what the NASD is and what its functions are –The NASD (now FINRA – Financial Industry Regulatory Agency) was established under the Securities Act of 1934 to oversee all securities firms and licensed individuals who do business with the public. The goal was to set up a regulatory system to protect the public from crooks.
“NASD regulates trading in equities, corporate bonds, securities futures, and options, with authority over the activities of more than 5,100 brokerage firms, approximately 173,000 branch offices, and more than 676,000 registered securities representatives. All firms dealing in securities that are not regulated by another SRO are required to be member firms of the NASD.
NASD licenses individuals and admits firms to the industry, writes rules to govern their behavior, examines them for regulatory compliance, and is sanctioned by the U.S. Securities and Exchange Commission ("SEC") to discipline registered representatives and member firms that fail to comply with federal securities laws and NASD's rules and regulations.”
At FINRA, Madoff or his company now sit or sat on at least the following “FINRA Advisory Committees –

Compliance Advisory Group
National Adjudicatory Council
NASD Mutual Fund Task Force
NASD Nominating Committee

So it turns out that Madoff was one of the regulators responsible for protecting the public from the criminals.

What Happened?
Madoff set up a classic “Ponzi Scheme” - which involves paying abnormally high returns to investors out of the money paid in by subsequent investors, rather than from the profit from any real business.

His Hedge Fund had an exceptional track record of historical returns. Money goes where it is treated best, so investors plowed their money into Madoff’s fund. At some point you need to figure out that the definition of greed is chasing large returns after they already occurred.

It turns out that the scam was uncovered when a client wanted their $7 billion investment back and Madoff was unable to come up with the money. Even better, knowing he was under the gun, Madoff tried to pay bonuses early to employees such as his sons. The bonuses would have been from the excellent performance returns the fund had generated for clients. Un-freakin-believable. The criminals are unconscionable!

My Big Concern
There have been a lot of instances over the past two years where Hedge Funds and Money Market Funds have had to freeze their accounts and no allow investors to get access to their money.

My fear is that there are a lot of crooks cooking the books at Hedge Funds. What I am afraid of is that the Fund Managers have held assets that are difficult to price, and have been generously setting their values too high. This makes the price of the portfolio artificially high and allows those selling to get out at artificially inflated values. It also leaves the late sellers with the losses, amounting to the difference between the invented price and the actual price of the securities.

This occurred in Florida about a year ago. A Money Market Fund was set up to manage the cash of Florida Municipalities and Charities. Its returns were in excess of those of other funds. Some investors got spooked and wanted to cash out. When investors want their money, the fund has to sell holdings to cover the redemptions. They tried to prop up the price of the fund and paid out artificially high prices to the first group of redemptions.

Eventually, they stopped honoring all sell orders. It then became clear that they had bad investments and they were over pricing their holdings. Good people got hurt.

Money Market Funds
I think the Money Market Fund managers got bailed out when the Fed instituted the $540 billion Money Market Fund backstop on 10/21/2008 and the $1.3 trillion Commercial Paper backstop on 10/07/2008. So at least the vast majority of the investing public was spared harm and an effective run on the Money Market Industry was prevented.

When Bear Stearns went under (sorry, was married at gunpoint with JPMorgan), I read Prospectuses and Position Statements on 34 Money Market Funds. I wanted to make sure that the money I managed was not exposed to bad investments.

When Lehman went under, a $25 billion Money Market Fund lost money and investors saw their money market accounts trading at 97 Cents on the Dollar. That was the death of the Money Market Industry. I was positioned to avoid it, because I did my homework. Clearly others weren’t because 4 days later, the Fed set up FDIC style Insurance for the Money Market Industry.

People didn’t do their homework and could have lost everything. I was sitting in 1-month US Treasuries at 0% yields. I got berated for the poor yields, but we eventually proven right when it all hit the fan.

Hedge Fund Nation
Now the US Government is a $7 trillion Hedge Fund. The Government is printing money, leveraging up and hiding price discovery. They won’t tell us what they are buying, who they are buying it from and what these holdings are worth. You know that they will keep buying stuff on any future market weakness. Do you see how the only people getting screwed in this are the Taxpayers? We keep having to pay to clean up everybody else’s mess.

It’s your money. YOU are responsible for knowing what you own, or you are responsible for finding an advisor you trust who does the homework for you and is proactive in getting the information into your hands.

The regulators are nowhere to be found. The crooks are everywhere, and they are trying to steal your money each and every day. Be careful, and either work with a pro or hide your money under your mattress.