The Lehman Bankruptcy proceedings are taking a dramatic turn with accusations that rumors helped speed along the troubled investment bank’s collapse. Lehman has requested that the New York hedge fund Och-Ziff “should respond to its demand for information as it investigates investors who may have helped push the bank into collapse by selling short its shares”. The alleged rumors suggested that Lehman hid its leverage within external hedge funds which it ultimately controlled. How this soap opera is resolved is anyone’s guess, but I think it provides an interesting reflection point.
The fact is that when there are troubled financial companies, hedge funds, investment banks and asset managers smell the blood in the water and try to act as opportunistically as possible. The investment world is the guttural carnation of capitalism with all of its selfishness, egotism, and cannibalism. It is well known that many investors copied Long Term Capital Management’s investment strategies in trying to replicate their success. It is less well known that those same investors puked the positions and then they went against them by taking an opposite position under the premise that when LTCM would be liquidated, the prices would go even further in their favor….
When Amaranth had massive losses from its natural gas positions, it is rumored that Ken Griffin, the founder of Citadel, called the heads of Amaranth and threatened to push natural gas prices against them even further unless they sold out to Citadel at rock bottom prices. Jamie Dimon from JP Morgan and Ken Griffin ultimately profited from that transaction. I wonder how far they pushed the prices before they made that call?
The bottom line is that those with few ethical standards and desires for fat bonuses will always prey on whatever situation could make them outsized profits. The only question is whether the reward compensates for the legal risk. The interesting aspect of this last financial crisis is that the OTC markets provided oodles of opportunities for corrupt actions. The headlines have hit on predatory lending and bad securitized CDO transactions. What has not been explored is the profit motives in the demise of companies like Lehman, Bear Stearns, Countrywide, Wachovia,AIG, etc. The OTC markets provide a venue to make completely opaque bets on the viability of companies while having outsized control of that same viability. The language surrounding Och-Ziff and Lehman rumors is old-hat. Unethical asset managers have always been interested in spreading rumors to move stock prices. Let’s take it into the 21st century – what about being a controlling stakeholder in a company but having negative economic interest in that same company through the use of derivatives? If you own 20% of the outstanding shares and/or outstanding bonds, what is to stop you from buying put options on twice that amount or buying CDS protection on two times the company’s outstanding debt? The answer is nothing….and no one would know except for your counterparties. I am wondering if or when a story of that magnitude will emerge. Imagine having a majority voting right in a company, intimate knowledge of their operations and financials alongside a negative economic position on that very same company…