SEC Probe on Insider Trading Is Getting Interesting

At first I thought it was nothing more than a "wag the dog" operation by the SEC to divert public attention from a much bigger mess (mortgage/foreclosure fraud), but it may get traction as more prominent hedge funds get subpoenaed.

First, it was these smallish three on Monday:

Diamondback Capital Management ($5.8 billion assets in management)
Level Global Investors
Loch Capital Management ($2 billion assets in management)

Then today, much bigger funds got ensnared:

Janus Capital Group Inc. ($161 billion assets in management)
Wellington Management ($598 billion assets in management)
SAC Capital Advisers
Citadel Asset Management

Why is the SEC going after hedge funds? Fines of few million dollars? Peanuts. Or is the SEC using these funds as bait to catch much bigger fish on Wall Street?

Now, Zero Hedge's Tyler Durden, citing FOX's Gasparino, says Goldman Sachs may get roped into the insider trading probe, via Diamondback. Now we are talkin'....

However, as soon as the investigation gets close enough to Goldman Sachs, it will be inexplicably shut down, if the past is any indication, and we are supposed to forget anything about insider trading. By that time, the foreclosure fraud, securitization fraud, and mortgage fraud will be all forgotten. Oh, so it IS a "wag the dog" operation after all...

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Obama Wants to Ban Proprietary Trading

as expected. But wait, there's more. He also wants to ban investment in hedge funds by the banks. The stock market dives. Thank you Mr. President.

In the statement released by the White House this morning:

The proposal would:

1. Limit the Scope - The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit.

2. Limit the Size - The President also announced a new proposal to limit the consolidation of our financial sector. The President’s proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits.

The number 2 item is interesting. I'd love to see the detailed proposal. How is he going to limit the size of liabilities, other than levying a 0.15% tax which he already proposed this month? When does a growth become "excessive"? Who's to decide? Paul Volcker?

If Obama really wants to "put an end to the risky practices that contributed significantly to the financial crisis", he should first fire Ben Bernanke and Timmy Geithner, shut down Fannie and Freddie, stop making subprime loans via FHA, and reign in his runaway spending.

Cynics are saying that Obama wouldn't do anything that would anger one of his biggest sponsors (financial industry, particularly Wall Street banks), and this proposal was already agreed to by Wall Street.

I am not so sure. If Obama had gone to Larry Summers or Timmy Geithner and come with the proposal, that's one thing. But he went to Paul Volcker, whom he hadn't bothered to consult much till this issue. Volcker may genuinely believe that banks should go back to the ways he knew when he was the Fed chairman (1979 to 1987), before all the innovations (like algo trading) and proliferation of hedge funds took place (more later).

Currently, Dow Jones Industrial is down more than 220 points (over 2%) to 10,384 at 2:24 PM EST. Many of the same cynics are saying this is just Wall Street's way of scaring investors and scaring the government so that this proposal won't be enacted, just like Wall Street supposedly did (as they say) in September 2008. Back then, the banks deliberately tanked the market during the TARP discussion in Congress so that Congress would be scared into passing the bailout bill.

One thing these cynics seem to ignore: the market tanked in earnest AFTER the bailout bill was passed.

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"The latest casualty of the economic crisis is the rule of law."

... is the opening sentence of a piece in Vanity Fair by Edward Jay Epstein ("The Czar's Rules Apply at Chrysler"). (Hmmmm, even Vanity Fair writes about this topic...)

"Consider the sad case of Chrysler. Its troubles became manifest in 2007, when it was owned by the German auto giant, Daimler, and it was unable to come to terms with the United Auto Workers labor union (UAW). Rather than suffer more losses from an unfavorable union contract, Daimler decided to rid itself of Chrysler by handing over 80 percent of its ownership to Cerberus Capital Management....

"Chrysler then borrowed $10 billion from a banking syndicate, led by J.P. Morgan Chase, Citigroup, and Goldman Sachs, to fund its operations. The loan was secured by mortgages on Chrysler’s real estate, manufacturing plants, patents, and highly profitable brand licensing rights. (Jeep alone earned $250 million a year licensing its name to toys, clothes, and other products.)

"The lenders assumed (incorrectly, as it turned out) that their secured loan, which was senior to any other Chrysler debt, would be protected even if Chrysler went bankrupt, since the iron rule of bankruptcy held that secured loans get fully paid before unsecured loans. Without this rule, financiers would be reluctant to lend money to corporations on their assets."

WRONG! (That was before this administration came in. We are in a new era now.)

"... the creditors were confronted with a take-it-or-else offer of 29 cents on the dollar, substantially less than the unsecured creditors would receive. (The UAW’s fund, for example, would receive an implied 55 cents on the dollar.) The “or else” turned out to be what President Obama described as a “surgical bankruptcy” for Chrysler in a pre-selected U.S. bankruptcy court."

Fiat is the clear winner, who is not putting any money and getting 20% stake. The next in line is UAW, with UNSECURED claims (pension fund) and still ending up with 55% stake

"But the consequences of upending the rule of law, even if it was done with the best of intentions, may prove far more serious than whatever befalls Chrysler in the Rustbelt. For one thing, it will undoubtedly become far more difficult for an American corporation to borrow money on its assets, since even a senior secured lender can no longer be sure his claim will take priority over those of labor unions and other unsecured creditors.

"As one savvy investment banker told me, “Now that we live in a banana republic, secured lending is anything but secure.”"

Money will flee.

By the way, according to Zero Hedge, none of the Chrysler's senior debt holders (non-TARP lenders, mind you) has CDS on their debts. They thought, as this article points out, they were protected by the bankruptcy law.

"Fiat" is such an appropriate term for this sorry saga. It means in original Latin "Let it be". In modern usage, it means "an arbitrary order or decree".

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Hedge Funds Capitulate in Chyrsler Debt Restructuring

Oppenheimer withdraws opposition to Chrysler plan, according to Reuters.

"Oppenheimer Funds was among the group of holdout creditors that own a combined $295 million of the automaker's $6.9 billion in distressed debt and which rejected a deal that offered them only 29 cents on the dollar."

There were about 20 such holders of Chrysler's senior secured debts when Judge Gonzalez started to hear the case on May 1. However,

"President Barack Obama called the dissenters "speculators" in public criticism for refusing to join Chrysler's biggest banks in a government-brokered deal to wipe out Chrysler's $6.9 billion debt and move forward with the Fiat alliance. "

So Mr. Rattner (car czar)'s eloquent persuasion has clearly worked.

Combine that with the bankruptcy judge's order on May 5 that all the names of the funds who oppose the debt restructuring are to be made public despite some death threats to the funds, and the fiduciary duty goes out the door quickly. Fiat gets the goods for practically nothing.

"More than half of the parties that had opposed Chrysler's plan have already dropped out of the group as public and political pressure grows to restructure the automaker quickly."

I wonder if Mr. Clifford S. Asness's fund is still opposing.

For all Chrysler bankruptcy related posts so far on this blog, click here.

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Judge OKs Chrysler Bidding Procedures Despite Protest

Judge Gonzalez Greenlights 363 Process, Redlights Justice (Zero Hedge)

Well it didn't take very long for the judge to capitulate. Super-fast dismantling, just like Lehman Brothers.

"What is notable is that during a witness testimony in court today, a Chrysler staffer under oath said that Chrysler had previously been in discussions with Nissan, GM and Fiat for alternative value enhancing programs, which had a Net Present Value of $11 Billion, $36 Billion and 4 Billion, respectively. And yet per the Sale Motion, Chrysler creditors (TARP and Non-TARP) will receive a mere $2 billion from Fiat now, in exchange for the Dodge-maker's good assets." [emphasis mine]

And

Judge OKS Chrysler bidding procedures, dissident lenders protest; identities to be disclosed (AP)

"Bids for all or part of Chrysler's assets must be submitted by May 20, and a determination of the lead bid made by May 26. A final sale hearing would be held on May 27 and the sale could close in as little as 30 days after that."

The judge also ordered the identities of the lenders to be disclosed, despite public threats to the lenders (with loudest threats coming from the White House and the car czar).

If you are performing fiduciary duty to your firm and your clients, you are now a "dissident".

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More on Hedge Funds vs Government over Chrysler

Hedge Funds Outraged At Obama Bullying But Also Cowering In Fear , from Business Insider (they say picked it up from Zero hedge).

It is a letter distributed by Clifford S. Asness, Managing and Founding Principal of AQR Capital Management, LLC.

The following are his concluding paragraphs:

"Last but not least, the President screaming that the hedge funds are looking for an unjustified taxpayer-funded bailout is the big lie writ large. Find me a hedge fund that has been bailed out. Find me a hedge fund, even a failed one, that has asked for one. In fact, it was only because hedge funds have not taken government funds that they could stand up to this bullying. The TARP recipients had no choice but to go along. The hedge funds were singled out only because they are unpopular, not because they behaved any differently from any other ethical manager of other people's money. The President’s comments here are backwards and libelous. Yet, somehow I don’t think the hedge funds will be following ACORN’s lead and trucking in a bunch of paid professional protestors soon. Hedge funds really need a community organizer.

"This is America. We have a free enterprise system that has worked spectacularly for us for two hundred plus years. When it fails it fixes itself. Most importantly, it is not an owned lackey of the oval office to be scolded for disobedience by the President.

"I am ready for my “personalized” tax rate now."

Well I'm sure Mr. Rattner is ready to give him the rate, but he may be too busy with the new project on GM...

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