Wolf
Richter www.testosteronepit.com www.amazon.com/author/wolfrichter
We
don’t know what hedge fund manager Steven Cohen will do with the
money he’s borrowing from Goldman Sachs’s GS Private Bank. We
don’t even know how much he’s borrowing. But it’s a lot, given
that the personal loan is backed by his collection of impressionist,
modern, and contemporary art estimated to be worth $1 billion. The
only reason we know about the loan at all is because Bloomberg dug
up a notice Goldman filed with the Connecticut Secretary of the
State, claiming he’d pledged “certain items of fine art” as
part of a security agreement.
Goldman and Cohen go back a long ways. It
provided prime brokerage services to his hedge fund, SAC Capital
Advisors that pleaded guilty last year to insider trading charges and
agreed to pay $1.8 billion in penalties and stop managing money for
outsiders, which will reduce the fund to a family office managing $9
billion to $11 billion of Cohen’s personal fortune.
Cohen
made $2.4 billion in 2013, according to Institutional
Investor’s Alpha
List of
hedge fund managers, in second place, behind David Tepper ($3.5
billion) and ahead of John Paulson ($2.3 billion). Wouldn’t that be
enough without having to borrow more? And what might he be doing with
all this borrowed moolah? He won’t need that much to make ends meet
when his electricity bill comes due.
In the rarefied air where these art loans take
place, they have unique advantages: clients get to keep their art on
the wall, and interest rates are about 2.5% – thanks to the Fed’s
indefatigable efforts to come up with policies that enrich this very
class of success stories. This is where the Fed’s otherwise
illusory “wealth effect” is actually effective.
So why borrow money?
“A number of hedge fund guys who manage their
money wisely, they look to put their art collections to work,”
explained Michael Plummer, co-founder of New York-based consultant
Artvest Partners and former COO at Christie’s Financial Services.
“If you can get liquidity out of your collection and pay only 250
basis points,” he said, “it just makes sense.”
So Cohen will invest it. Cheap leverage, the
holy grail these days. It’s the driver behind the asset bubbles all
around. It’ll goose otherwise minuscule returns. He might invest
this borrowed money in his fund, which might for example buy
Collateralized Loan Obligations. Banks that carry them on their books
have to dump them to satisfy new regulations. But prices have
dropped, and so banks are lending hedge funds cheap money so that
they buy these CLOs. Some banks are offering to lend as much as nine
times the amount that the hedge fund itself would invest. More
massive and cheap leverage.
CLOs
are similar to subprime-mortgage-backed Collateralized Debt
Obligations that turned into toxic waste during the financial crisis.
But they’re backed by junk-rated corporate loans, some of them
malodorous “leveraged loans” that private equity firms use to
strip-mine their portfolio companies. These already overleveraged
companies borrow money from banks and pay it out as a special
dividend to the PE firms. It pushes the company deeper into the hole,
loads up the PE firm with cash, and saddles the bank with a dubious
asset, the “leveraged loan.” The bank can then package it with
other low-rated corporate debt into an enticing CLO [read.... Banks
And Hedge Funds Make Curious Deal On New Structured
Toxic-Waste Securities].
So Cohen, using these multiple layers of
leverage, might earn a return of 8% a year on his art loan that costs
him 2.5% a year. Multiply that out to a billion, and it’s a money
machine. That would be on top of the art itself that has seen
phenomenal increases in value under the Fed’s money-printing binge.
Absurd? Sure, but this sort of absurdity, an
outgrowth of the biggest credit bubble in history, has become the
lifeblood of the US economy and its lopsided income distribution.
It’s
not just a few people at the top that can benefit from multiple
layers of leverage. After the run-up in home prices over the past two
years, many homeowners have equity. So it didn’t take the financial
media long
to encourage them to leverage that equity – through home-equity
lines of credit or “cash-out refinancing” – and buy stocks with
the proceeds (always buy, buy, buy!).
A
homeowner might cash out $100,000 and put it into a brokerage
account. To goose his returns like Cohen, he might buy $150,000 worth
of securities, with the remainder coming from margin debt. And the
security might be IBM, a highly leveraged outfit with $123 billion in
debt and tangible stockholder equity of minus $18.3
billion [read.... Stockholders
Got Plundered In IBM’s Hocus-Pocus Machine].
Absurd?
Heloc originations soared
42% in
the fourth quarter. The average credit line for “super-prime”
borrowers was $120,000. Even “deep subprime” borrowers got an
average credit line of $60,000. And “cash-out refinancing” is hot
again, making up about
25% of
all new refis in the first quarter, according to Quicken Loans.
Strung-out consumers might blow this money on a
car and food and other things and some might consolidate debt and pay
off their maxed-out credit cards so that they can charge more in
their heroic effort to keep consumer spending from collapsing
altogether. But the gorgeously mediatized stock market gains over the
last few years, and especially last year, seduced many people to step
back into the this craziness, all guns blazing, after having missed
the entire run-up. And they’re doing it at precisely the worst
possible moment.
This kind of hidden leverage pervades the
investment scene at all levels. When multiple layers of debt are used
to finance a chain of speculation, with very little equity involved,
returns on equity can be eye-popping, as long as everything soars
without ever as much as hesitating. But once progression beings to
totter, and many feverishly hyped stocks, like Twitter, lose more
than half their value in a matter of months, the bloodletting starts
and margin calls go out, and banks are suddenly worried about their
collateral, and some of the art gets dumped into a market with no
buyers, and junk bonds plunge, and “leveraged loans” default, and
it kicks off another bout of forced selling into an illiquid market,
and the cross-connections and tie-ins and the whole counterparty
spaghetti of these layers of leverage get knotted up, and all heck
breaks lose. And as the whole construct tumbles down, Cohen and his
ilk will once again press their cronies at the Fed and the Treasury
to bail out their investments just one more time.
For
years, nothing could slow the tsunami of junk debt. But suddenly,
something happened, and investors in leveraged-loan mutual funds,
where the crappiest junk debt accumulates, ran scared and started
pulling their money out. Consequences were immediate. Read….Biggest
Credit Bubble in History Cracks, Trips Up The Smart Money
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