We start today on a sad note.
Mr. John Devaney is an idiot. But without idiots, the graveyards and barrooms would be empty; and then, what kind of a world would it be? Thank god for them all.
And so, we sympathise when an idiot runs into trouble…fully aware that we could be the next ones to do so!
Poor Mr. Devaney is selling his 142-foot yacht for $23.5 million. But that is not the source of the discomfort. There are only two happy moments in a boat-owner’s life, or so it is said – the day he buys his boat…and the day he sells it. So, may Mr. Devaney will probably enjoy getting rid of the thing.
Especially since the boat’s name is “Positive Carry,” and therein lies a tale. For the reason that Mr. Devaney is in the news is precisely because his carry went negative…and his hedge fund, United Capital Markets, went into losses.
This is not the first time the man has made the news. He was quoted in the papers as describing people who took out subprime mortgages as “big idiots.” A moment’s reflection might have brought the opprobrium closer to home, for Mr. Devaney’s fund was buying up these big idiots’ subprime mortgages, on a grand scale.
That is the problem with today’s markets; it is so hard to figure out who is the biggest idiot. Surely, the fellow who buys a trashy barrack in a bad part of town using a subprime ARM is an idiot. Buying more of a house than he can afford, he’s just asking for trouble. But so is the fellow who buys a whole inventory of these packaged mortgages – collateralized debt obligations – asking for trouble. If they were bad for the borrower, sooner or later they’re going to be bad for the lender too. Making a loan to a guy who can’t pay you back has never been good business. But then, in order to buy more CDOs than he can afford, the hedge fund sharpie borrows money. Often, he’ll get even more leverage by means of the carry trade – borrowing yen or Swiss francs at a low rate and using the money to buy high-yielding subprime debt. As long as everything works out as planned, he’ll have “positive carry.”
And then, along comes an investor who puts his money in the hedge fund! And, get this, he pays the manager fees of “2 and 20” for the privilege of taking part. Is this guy an idiot, or what?
The mathematician, Daniel Bernoulli, described why he was sure to be a loser, hundreds of years ago. On even odds, 50/50, if you keep betting you’ll win sometimes and lose sometimes. If you go double or nothing each time, sooner or later you’ll be wiped out.
If the hedge fund manager were merely making 50/50 wagers…he’d win some, lose some. Each time he won, he’d join you in the winnings. Each time he lost, you’d be alone. Eventually, you’d have nothing left. But hedge fund managers have an incentive to take much bigger gambles. Because, the bigger the bet, the more he stands to win…and you stand to lose. If it goes right…he’ll get 20% of the pot. If it goes wrong – which it will, sooner or later – you’ll take all the loss.
We don’t know exactly what went wrong with poor Mr. Devaney. Sounds like he was a bigger idiot than most; he seems to have invested in his own preposterous fund. Word is, he’s put his house in Aspen up for sale too. For only $16.25 million, all 16,000 square feet of it can be yours.
What happens to these guys? Our friend, Nassim Taleb, took up the question in Vancouver.
“Don’t worry about them,” he said. “A hedge fund manager who blows up his fund isn’t out of work for long. He just takes a vacation. The bigger the blow-up, the longer the vacation. Maybe he goes for a hike in the Alps if it is a small fund. A medium fund manager who blows up goes to climb Kilimanjaro. And a really big fund manager has to go to the Himalayas. But he has already sent out his resume, telling of all the great success he has had…blemished by only one mistake. Usually, he gets a call to come back to work at another fund before he ever leaves the base camp.”
So…don’t worry about the idiots. As long as the credit boom is still going on…Mr. Devaney will be all right.
But don’t worry, dear reader…it’s only money.
Markets and Money