The Irish Independent reports that average earnings rose by 6pc last year, according to a new comprehensive study by the Central Statistics Office - a rate of pay increase which will add to worries about competitiveness.
The earnings figures for industry, utilities and the financial sector include payment not made at the regular pay date, such as annual bonuses, as well as non-pay labour costs such as pensions and benefit-in-kind. These were not included in previous surveys.
Workers in the State-dominated electricity, gas & water sector are the highest-paid. The survey found that clerical, sales and service workers in this sector earned more per hour than managers and professionals in industry.
Reduction
The figures show that total labour costs rose by 5pc in industry during last year, but by only 1.6pc in finance. There is no detailed breakdown on why this happened but there will be speculation that it represents a reduction in share options in the financial industry.
Alan Barrett, senior researcher at the Economic and Social Research Institute (ESRI), said the figures for industrial earnings were surprising, given the presumed pressures from global competition.
"We had thought that manufacturing earnings were rising by less than 4pc a year. In the euro area, they are going up by 2.6pc, so increases of 5.5pc are really hard to understand. Our view was that there are competitiveness concerns even at our lower figures."
IBEC director of economic policy Danny McCoy welcomed the new figures, but said they would have to be matched with productivity to get the important figure of the rise in unit labour costs.
"But the pay rises look to be well in excess of what we know about productivity. However, we do know that labour markets have been tight, with staff hard to find and retain."
The figures show that workers in the electricity, gas and water industries are the highest paid, with hourly earnings of €33.43 in the last quarter of 2006. Other costs, including PRSI, added €6.20 and hour to the employer's bill.
Workers in finance earned and average €27.60 an hour, with extra costs of €7.17, and manufacturing workers got €19.15 an hour, with just €3.89 in other costs.
Low levels of PRSI compared with most EU countries have helped keep total Irish labour costs down relative to elsewhere. The main difference between manufacturing and the other industries is likely to be employers' pensions contributions, which are included in "other social costs".
These represented just 98c in manufacturing, but €3.87 an hour in electricity, gas & water, and €2.90 an hour in finance.
Managers and professionals earned €32.38 an hour in industry, €51.41 in electricity, gas & water and €40.47 in finance.
Production workers in industry are the lowest paid, at €18.40 an hour, compared with €35.36 and 19.10 in the other two sectors.
The Irish Independent also reports that RQB, the property investment vehicle of financiers Paddy Kelly, Paul Pardy and Niall McFadden has joined forces with Seán Mulryan's Ballymore Homes to develop a 16-acre site in London.
The deal will see the two sides build 153,000-sq-ft of apartments in a scheme which will be valued at more than £1bn.
Under the terms of the deal RQB has agreed to buy a 50pc stake in the site, located on Thames Road, Silvertown in the Royal Docks area of London.
It is not know how much they paid for the stake, but property sources put a £260m price tag on the site, suggesting RQB handed over about £130m.
The details of the deal will emerge in about a week, when RQB approaches potential investor for the deal.
It is understood the company will seek to raise over £50m in equity to fund the deal. RQB has already build up an impressive portfolio of deals.
Last year, the group paid $200m (€150m) for the Sawgrass Marriott Resort & Spa, which owns 85pc of the tee slots on the associated world-famous golf course. Earlier this year it announced plans to develop 230 apartments on a 340-acre site adjacent to the course.
Leisure
RQB was also one of the investors in The Club Company, a chain of 11 British golf course and country clubs with associated leisure facilities. RQB raised £32m late last year to pay down debt associated with the acquisition and to redevelop many of the facilities.
The value of the residential element of the latest addition to the RQB portfolio, known as the Unex Site, will be considerably enhanced by its Thames-side location.
The site, which is about 1.5km from London City Airport, is 10 minutes from Canary Warf by train.
Aside from apartments it understood the RQB team, which is led by Mr Pardy, is planning 13,000 sq ft of commercial development for the site. The Ballymore team assigned to the project is led by Tim Farrow. Savills HOK is the property advisor to the scheme.
It is understood RQB will begin fund raising for the project within a fortnight. It is not known ifr RQB and Ballymore plan to develop the site themselves or sell it on once planning permission for the scheme is secured.
The Irish Times reports that global stock markets are likely to remain volatile this week as investors wait for further intervention from European central banks and the US Federal Reserve to calm nerves.
European central banks are standing ready this week to stem the turmoil in money and credit markets after the Fed moved on Friday to cut the discount rate it gives on loans to banks and hinted at a cut in its main interest rate.
Financial markets rallied after the announcement and, if the move calms US nerves this week, European central bankers are likely to follow.
With normality far from being restored, central bankers insist they can take further action if circumstances merit. Short of changing rates, the European Central Bank (ECB) can lend at longer maturities, reducing the need for its banks to access more expensive funds in the markets.
Central banks' willingness to act follows three weeks of turmoil, with the panic sparked by problems in the US subprime mortgage market leading to a global "credit crunch" and the third major sell-off of equities in just over a year. Although the Fed's decision to cut its discount rate led to a rally in world markets, US stocks were driven down late on Friday night after cash management firm Sentinel filed for chapter 11 bankruptcy protection.
Fears of further financial bombshells rose as a second German state-owned bank, Sachsen LB, was bailed out after its off-balance-sheet investment vehicle, Ormond Quay, failed to secure finance in the commercial paper market.
The crisis claimed its first Irish casualty last week with the collapse of the Dublin-based firm, Structured Credit Company (SCC), with liabilities of $350 million (€259.5 million).
Investors have also been left bruised, as the Iseq index of Irish shares underwent its worst period since 2001-2002.
The index is down almost 14 per cent since the start of the year, with some €19 billion wiped off the value of Iseq companies since the index reached a record high on February 21st. The decline has been more severe than in other markets because the Iseq was already suffering from concerns about the Irish housing sector when the subprime storm hit global markets.
But despite the lack of visibility, some investors may look at the decline of almost 9 per cent in the market since August 8th as an opportunity to buy stock at low prices. The fundamentals of Irish companies now look attractive if investors return to them, Davy stockbrokers said. "It now seems that the market has moved to a point where it is effectively discounting significant earnings downgrades going forward," said Davy economist Robbie Kelleher.
But market sentiment worldwide remains fragile, with investors wondering if the Fed will follow Friday's cut with an early cut in the main US interest rate, ahead of its official interest rate policy meeting on September 18th.
"If the move does not alleviate the liquidity problems gripping the markets this week, then the Fed can be expected to introduce an emergency cut in the Fed funds rate, probably within a matter of days," said Paul Ashworth of Capital Economics.
The ECB governing committee is due to make an interest rate announcement on September 6th, with the chances of it going ahead with a planned hike in its base rate receding.
The Irish Times also reports that Irish firms are generating annual spin-off sales of €25 million from technology developed for use in space under contracts with the European Space Agency (Esa), according to Enterprise Ireland.
Some 19 of Enterprise Ireland's client companies, including the Cork firm Sensl, which is designing a detector to be used in an Esa mission to Mars, won contracts worth a total of €5.7 million with Esa last year. Contracts secured by multinationals based in the Republic takes the value of European civil space business up to €7 million. Irish firms' involvement in the space sector will expand this year and will be driven by partnerships between optoelectronics companies and large European space companies, according to Tony McDonald, head of the Esa programme at Enterprise Ireland.
Sensl, which is a commercial spin-off from the Tyndall Institute in Cork, is developing a detector for a laser range-finder that will allow a planned Esa probe to Mars to find the best surface to land on. Under its technology, a small laser pulse is emitted, bouncing off the surface of the planet and coming back to hit the detector. The process is timed, allowing the probe to work out how rough the surface is, according to Dr Carl Jackson, Sensl's chief commercial officer.
Sensl's technology can also be used to measure pollutants in the atmosphere and has other potential applications on earth, for example in so-called "smart cars" with built-in anti-collision detectors and in biomedical devices that can use the technology to examine DNA and protein samples with greater sensitivity.
Another company, a telecommunications firm called Intune, is working on "tunable" laser technology for weather sensing systems that will help Esa measure water concentration levels in the earth's atmosphere.
"Esa take a 10-year view of technology that is at the research stage now and give 100 per cent funding, so they are an excellent support," said John Dunne, chief marketing officer at Intune, which has just completed a fundraising of almost $18 million (€13.3 million) from a consortium of international investors. Each ESA contract can be worth anything up to €500,000 to a firm, Mr Dunne said. But the real value to Irish companies lies in the additional commercial opportunities for the products they develop. Around 50 Irish companies and research organisations in the telecommunications, software, electronics and precision engineering fields have participated in Enterprise Ireland's space programme since 2000.
Proving that their technology is space-worthy is the problematic part, according to Mr McDonald.
"A lot of these technologies are at a very early stage of development. They have to prove that it can be used in space and that is very expensive."
Esa, which describes itself as Europe's gateway to space, has an annual budget of around €3 billion.
The Irish Examiner reports that Aer Lingus pilot representatives will this morning decide whether to accept an olive branch from the airline and call off their 48-hour strike, due to start tomorrow morning, which would ground more than 35,000 passengers.
In a letter to pilot’s union the Irish Airline Pilots Association (IALPA) last night, Aer Lingus chief executive Dermot Mannion called for talks over union concerns that staff in its new Belfast base will be exposed to inferior terms and conditions to those enjoyed by pilots in the Republic.
Dermot Mannion made the call after it emerged industrial relations mediator Phil Flynn, who had previously recommended the airline be allowed to open new bases elsewhere in the world under local terms, had not been aware the base could be in Belfast.
Mr Flynn’s initial recommendation, made months ago, to the parties in the Flynn Report contained the clause: “One is conscious of a very real fear on the part of IALPA that the company would use a recommendation of this nature to undermine the conditions and bargaining capacity of Irish-based pilots including the possibility of Irish Shipping-type circumstances. Accordingly, it is further recommended that joint discussions take place on how these concerns might be allayed.”
However, at the weekend Mr Flynn wrote to the airline to clarify that point.
“You raise the further question ‘If Belfast had been tabled as a base, how would you have addressed it?’,” he said. “This is a hypothetical question as it was not. However, it is unlikely that I would have approached it differently than set out in the final sentence of the above quotation: joint discussions designed to find solutions to pilots’ anxieties.”
In his letter to IALPA last night Mr Mannion said he welcomed Mr Flynn’s clarification.
“We also note his acknowledgement of concerns IALPA may have regarding the effect such a base outside the Republic may have on existing terms and conditions for those working within the Republic.
“I confirm we accept his recommendation we engage in discussion to explore how such concerns could be alleviated.”
However, Evan Cullen of IALPA would give no commitment to withdraw the strike action, saying there were “glaring inaccuracies” in Mr Mannion’s interpretation.
Meanwhile, it emerged Taoiseach Bertie Ahern has asked senior officials to examine the ramifications of the airline’s decision. He wants the findings reported back to him within weeks.
The Financial Times reports that European central banks are standing ready this week to take further steps to ease the credit squeeze following the US Federal Reserve’s unexpected move on Friday to stem the turmoil in money and credit markets.
Financial markets rallied after the Fed made direct loans available to banks on favourable terms and hinted at an interest rate cut. If the move calms US nerves this week, European central bankers are likely to follow to ensure a similar effect is achieved across the Atlantic.
One policy lever the Europeans are considering is the extension of more credit to banks for longer periods than are normally available in an attempt to bring market interest rates closer to the central banks’ main interest rates.
Fed officials do not expect a quick recovery in credit market conditions, and another volatile week on the stock markets is thought to be in prospect.
Mohammed El-Erian, chief executive of Harvard Investment Management, said the Fed’s action had helped but more volatility probably lies ahead. The question was no longer whether the Fed was prepared to counter market disorder, he said, but “whether it is able to do so”.
The world’s central bankers are also nervous that their powers to stem this crisis of confidence are limited, as even good quality credit cannot find ready purchasers. One noted the veracity of a comment by a market observer who said in these circumstances, any action by a central bank “doesn’t affect s***”.
At the weekend, the fear of continued small financial bombs going off was heightened as Sachsen LB, a second German state-owned bank, was bailed out after Ormond Quay, its off balance sheet investment vehicle, failed to secure finance in the commercial paper market.
Also late on Friday, Sentinel, the US cash management group, filed for Chapter 11 bankruptcy protection after freezing its clients’ accounts last week.
Signs of banks’ difficulties in raising credit were evident at the end of last week when European three-month interbank rates were much higher, at 4.65 per cent, than the European Central Bank’s 4 per cent policy rate. The ECB’s actions so far only stabilised the very short-term overnight market.
In London, where the Bank of England has so far avoided any intervention, interbank rates were 6.3 per cent overnight and 6.7 per cent at a three-month maturity, well above the central bank’s 5.75 per cent main rate of interest.
Although the Bank of England is trying to avoid being the first port of call for banks, if unusual market rates persist, it would act to secure its objective for “overnight market interest rates to be in line with the Bank’s official rate”.
The FT also reports that Smurfit Kappa, Europe’s largest cardboard box manufacturer, has thrown down the gauntlet to industry rivals, warning that it will no longer help maintain paper prices by shutting its factories if others are opening new mills.
Speaking after the Dublin-based company reported it’s first interim results since its initial public offering in March, Gary McGann, chief executive, says the sector is seeing improved profitability.
But he adds: “People need to examine why. This is a unique situation on the cost side, with energy, chemicals, starches, recovered fibre costs all rising and yet people are getting pricing and getting returns. The reason? Because there is a reasonably disciplined supply demand balance out there.”
Historically, when paper prices rise, producers commission new plant adding to capacity, and ultimately depressing prices.
Mr McGann said Smurfit Kappa was “not going to be the sweeper-upper or lender of last resort for the industry” by closing its factories in order to keep supplies tight.
The company, created by the 2005 merger of Jefferson Smurfit and Kappa Industries, a Dutch rival, has together with SCA of Sweden taken the lead, with 2m tonnes of factory capacity, or slightly less than 10 per cent of European paper production, closed down since 2005. Smurfit Kappa has shut down 700,000 tonnes of capacity, representing about 14 per cent of its output.
The measures have allowed the industry to announce six successive paper price increases during that period, something not seen in years.
But since the IPO, three rivals – Mondi, which was recently spun out of Anglo American mining group, and two German companies Prowell and Hamburger, a privately owned German paper maker, and Hamburger – have revealed plans for new mills.
With demand for paper and packaging products expected to increase by 10.2 per cent between now and 2010, Mr McGann estimates there is room for an additional 1.7m tonnes of net new capacity in Europe.
“The industry does need new capacity but it needs to be managed in an orderly fashion. We will be a player but we will not be an underwriter of everybody else’s problem,” he says.
John Sheehan, analyst with NCB stockbrokers, says given the paper industry’s poor self-discipline in the past, investors remain hypersensitive about any announcements of capacity increases.
Smurfit Kappa has about a 24 per cent market share of the European paper market. It is an integrated producer, meaning it makes both paper and the finished corrugated product that makes up a cardboard box. It manufactures two paper products – the higher value kraftliner (or facing board, used on the outside of a box) made using wood chips, as well as the cheaper recycled containerboard product, which is made from old boxes and other waste paper products.
Kraftliner prices have been held back as US dollar-euro weakness has encouraged US producers to ship product to Europe, thus boosting supply.
But in containerboard making the Chinese mills have been buying up recovered fibre for their own paper production, pushing up input costs for Smurfit and other producers. Mr McGann says recycled paper costs went up €20 a tonne in June and a further €30 (£20) a tonne in July after the European Commission announced it planned to apply stricter rules on what could be exported, prompting the Chinese buyers to step up their purchases.
However, on the back of this, Smurfit has been able to announce two successive price increases this year, with another due next month. Box prices are also rising, although with a time lag.
“This industry is a growth industry,” says Mr McGann. “Demand growth is robust. It needs new capacity. But it needs an orderly introduction of new tonnage and that can happen only if people behave sensibly. But if everyone wants to be the new kid on the block, with the biggest, best and fastest, most modern machine, it will just be a mess.”
The New York Times reports that for the last month, the stock market has gyrated as every other day seemed to bring more bad news about the housing and credit markets. Traders awaited a signal from the Federal Reserve and its chairman, Ben S. Bernanke, now in his sophomore year at the helm of the central bank.
On Aug. 7, Wall Street got its first answer. The Fed said in a statement that it was watching the housing meltdown with concern, but that it believed the broader economy was on a steady path of growth. The words did nothing to calm the markets.
Ten days later, the Fed significantly changed its tone. In an extraordinary action between board meetings, the Fed lowered one of the two interest rates it controls and issued a statement expressing concern about the markets and the possibility of a downturn in the economy.
The hand of Mr. Bernanke was clearly behind both statements, and some economists and traders shook their heads at the apparent flip-flop. But Mr. Bernanke, a student if not necessarily a devotee of the British economist John Maynard Keynes, was probably mindful of a remark by Keynes after he was accused of reversing his views on government intervention in markets during the Great Depression.
“When the facts change, I change my mind,” Keynes said. “What do you do, sir?”
Mr. Bernanke, grappling with his first crisis since taking over as Fed chairman in February 2006, is being intently watched to see how he handles the reins of the economy. Some accused him of dawdling and then acting with an excess of caution (“Bernanke’s baby steps” was the headline of a Merrill Lynch analysis published Friday).
David A. Rosenberg, North American economist at Merrill Lynch, wrote that the Fed noted that the risks to the broader economy had increased “appreciably.” If that is the case, Mr. Rosenberg asked, why are Mr. Bernanke and his colleagues not acting more boldly?
“It does indeed leave one wondering why the Fed didn’t bite the bullet and get more aggressive today by cutting the funds rate outright if the Fed has altered its risk assessment over the economic outlook that much,” Mr. Rosenberg wrote.
Others saw Mr. Bernanke as handling the upheaval with aplomb.
“The way he has handled this is completely in character,” said Mark Gertler, chairman of the economics department at Columbia University and a longtime colleague of Mr. Bernanke’s. “What’s going on is in many ways a textbook financial disturbance and nobody I know understands these things better than he does.”
Mr. Gertler endorsed both Mr. Bernanke’s early restraint in dealing with the crisis and his recent moves to address it. That said, he added that Mr. Bernanke, the markets and the economy are still in peril. “It’s a tightrope and they’re still up there on the tightrope,” Mr. Gertler said.
Although a Republican who served briefly on President Bush’s White House economic team, Mr. Bernanke has shown himself to be no laissez-faire ideologue or partisan gunslinger.
A fellow member of the Fed’s board of governors, speaking on background, called Mr. Bernanke “a technocrat of the highest order,” which he meant as the ultimate praise. He said that one of the missions that Mr. Bernanke has set for himself is to end the cult of personality that grew up around Alan Greenspan, who preceded him and served as chairman for 17 years.
In that he appears to have succeeded. He and his wife, Anna, a public high school teacher in Washington, lead a low-key private life, in contrast to Mr. Greenspan and his wife, the television correspondent Andrea Mitchell, who for years have been fixtures on the Washington social circuit.
Mr. Bernanke came to government from one of the tallest spires of the ivory tower, the chairmanship of Princeton’s economics department. He earned his doctorate at the Massachusetts Institute of Technology, where his adviser was Stanley Fischer, now the governor of the Bank of Israel and the former No. 2 at the World Bank.
But to understand Mr. Bernanke’s worldview, one must go back to his hometown, Dillon, S.C., which sits athwart Interstate 95 about halfway between North Jersey and South Florida. Dillon is known as the home of South of the Border, the Tijuana-themed tourist stop and a Mecca of American roadside kitsch.
Mr. Bernanke, 53, grew up in Dillon in the 1950s and ’60s, the son of the local pharmacist and a member of one of the few Jewish families in the largely agricultural region. He says his home was the only kosher household in a 50-mile radius. His mother had meat delivered from a butcher in Charlotte, N.C., where his parents live now.
Being a member of a minority taught him about discrimination and prejudice. “There was more than one request to see my horns,” he said years later.
He also watched the struggles of small farmers, who drove mule-drawn carts down the main street of town and had trouble paying their bills even in good years. His father granted credit for purchases at the drugstore, keeping records on small cards he kept in a drawer. Many of the debts were never repaid. As Mr. Bernanke grew older, the textile mills that had supported the area closed and moved overseas in search of cheap labor.
Mr. Bernanke worked construction jobs and waited on tables at South of the Border during the summer while an undergraduate at Harvard University.
“I was impressed by these experiences,” Mr. Bernanke said last fall at a ceremony in his honor on the steps of the neoclassical courthouse in Dillon, “and I think they were an important reason I went into economics, which a great economist once called the study of people in the ordinary business of life.”
He has written extensively about the Great Depression and the policy blunders made by the Federal Reserve that spread the distress. Asked to explain his fascination with the Depression he said, “If you want to understand geology, study earthquakes. If you want to understand the economy, study the Depression.”
Ed Yardeni, president of Yardeni Research, said that Mr. Bernanke’s studies of the Depression and other financial catastrophes have taught him that the Fed’s role is not only to keep inflation in check, but also to deal with upheavals in the markets.
But Mr. Yardeni said Mr. Bernanke might have misread the market’s signals and acted too timidly at first. He said the Aug. 7 statement gave too rosy an outlook. “That’s really where there was a credibility issue,” he said. “At that point, most observers had already come to the conclusion that things were coming unglued pretty rapidly and the Fed had to act.”
Mr. Bernanke’s compassion for the common man has not made him a populist or a protectionist, nor even a Democrat. His study of economics has led him to believe that free markets and unfettered trade offer the greatest opportunity for the greatest number of people. But in a speech on growing income inequality earlier this year, he endorsed programs to provide job retraining for displaced workers and new laws to improve the portability of health and pension benefits between employers.
As central banker of the world’s largest economy, Mr. Bernanke’s freedom of speech is circumscribed by custom and by the magnified effect his words have on global markets. He will not talk about the value of the dollar or future interest rate decisions or specific tax or budget measures. Less than three months into the job, Mr. Bernanke stubbed his toe by casually telling CNBC that Wall Street had misread the Fed’s signals, touching off a market frenzy.
Mr. Bernanke now refers to his first few months as a “break-in period,” and has been much more circumspect in his remarks since.
Still, it is possible to discern something of his roots and inclinations from his speeches and Congressional testimony. In a speech last fall in Washington, he expressed worry that the short-sightedness of the current generation will weaken Social Security and Medicare for their children and grandchildren.
In a commencement address at M.I.T., he delivered a rather dry lecture on the relationship between technological change and productivity growth. But he also told graduates “the world has more to offer than money” and encouraged them to pursue offbeat careers, charitable work and public service jobs.
In June, in remarks on the troubles in the housing and subprime lending markets, Mr. Bernanke voiced sympathy for homeowners who had been foreclosed or unable to obtain new loans. He said that it was difficult to predict how widely the problem would spread, but expressed confidence in the underlying economy.
“At this point,” he said on June 5, “the troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system.” The Fed held to that position, publicly at least, for two more months.
Kenneth R. Manning, a professor of the history of science at M.I.T. who graduated from high school in Dillon four years before Mr. Bernanke, predicted that his friend would excel as Fed chairman, in part because he has not forgotten where he came from.
“A lot of times, you have good theorists in economics but they don’t have a feel for the world, they don’t have a feel for politics,” Professor Manning said. “He has that.”
Mr. Bernanke’s mother Edna recalled the tribute to her son last autumn with a bit of embarrassment. “They put up a huge tent and they had about 500 people there and the governor came,” she said in a phone interview. “I think they were just excited that someone from Dillon went somewhere.”
The NYT also reports that as summer neared, investors in Sowood Capital Management, a $3 billion hedge fund, had little to complain about.
The fund was up 16 percent over the previous 12 months. Blue-chip management was in place, and any risk was well-hedged with a comfortable cushion of financing in place, the fund said in a letter to investors.
But a rocky June turned into a calamitous July, and by the end of the month, Sowood was on the brink of collapse. As the credit market tightened, Sowood had to sell stocks to meet margin calls from skittish banks and add hundreds of millions in cash reserves.
Sowood’s manager, Jeffrey Larson, sold the rest of the portfolio seemingly overnight — at a fraction of its initial value — and embarked on what he would later describe as a “deeply painful” process of returning the remaining money to investors and shutting the funds.
As problems that began in subprime mortgage lending have expanded into the broader markets, hedge funds like Sowood have come face to face with the ghost of past financial crises: the one-two liquidity punch from banks and investors.
On the one side, Wall Street banks and brokerage firms, as they did with Sowood, have stepped up their demands for more cash and collateral as they restrict the money they are willing to lend.
On the other, jittery investors seem ready to flee at any sign of trouble, as they did from the Bear Stearns Asset-Backed Securities Fund. The fund had a solid track record, no leverage and little exposure to subprime mortgages, but after it reported losses in July, investors demanded their money and Bear Stearns was forced to suspend redemptions.
Liquidity — the ability to quickly sell an asset at a reasonable value — is the linchpin to markets functioning effectively, and its absence in recent weeks has led to substantial losses in many highly leveraged hedge funds.
“For hedge funds, illiquidity is their Achilles’ heel,” said one fund investor who was not authorized to speak to the media.
Pressure from banks to raise margin levels as well as pressure from investors could not have come at a worse time for hedge funds; the prices of the debt instruments they hold continue to fall, if they trade at all. Stocks widely held by hedge funds, from small-cap value stocks to potential targets for leveraged buyouts, have been pummeled. And with volatility in the markets, banks and hedge funds are scrambling to reduce risk and sell those securities that can be easily sold.
“It’s not that suddenly everyone is out of cash — they just don’t want to lend it or invest it,” said Frederick H. Joseph, a head of investment banking at Morgan Joseph & Company, a boutique investment bank, and the former head of Drexel Burnham Lambert, the investment bank that survived an insider trading scandal but collapsed two years later when banks shut off financing.
A liquidity vacuum is scary for any market player, but it can be particularly hazardous to hedge funds that try to make money by spotting anomalies in the market. When liquidity dries up and fear takes over, prices start to behave abnormally and the funds’ bets go haywire.
“Hedge funds can withdraw liquidity rapidly, particularly when facing mounting losses, and this can cause severe market dislocation on the rare occasions when they all head for the exit door at the same time,” said Andrew W. Lo, a professor at the M.I.T. Sloan School of Management.
The dash to sell has been exacerbated by the interconnected nature of the players in the market and the securities they hold.
Because of problems in subprime mortgages, large “multistrategy” funds, those that trade many different kinds of securities or use diverse strategies, faced increased margin calls on their mortgage- or credit-related portfolios.
As banks demanded more collateral, the funds sold stocks. But many funds held the same stocks, including shares of companies known to be headed for a leveraged buyout, or others seen as targets for one.
With no ability to sell risky loans or slices of collateralized debt obligations, the funds started dumping stocks they owned and buying back stocks they had borrowed.
As a result, “high quality” or value stocks, plummeted while popular shorts — stocks that managers bet would fall in price — soared. This phenomenon ran counter to computer-driven or quantitative trading models, and created major losses in the first half of August in funds using those models, including some owned by Goldman Sachs, AQR Capital and D.E. Shaw.
Rumors shook the marketplace about imminent doom for various hedge funds. Some funds facing extensive losses looked to secure additional liquidity.
After steep losses in the first two weeks of August, three Goldman Sachs funds were severely under water. Its Global Equity Opportunities Fund fell 30 percent in one week; Global Alpha, a multi-strategy fund, doubled its losses in a week and ended last week down 27 percent, continuing an 18-month run of poor performance. The North American Equity Opportunities Fund was down more than 40 percent by Aug. 10, according to the HSBC Private Banking report.
With redemption notices approaching, Goldman orchestrated a major injection of liquidity. On Monday, before the market opened, the investment bank said it would team with some prominent investors including Maurice R. Greenberg, the former chairman of the American International Group who now runs C.V. Starr, and Richard Perry of Perry Capital, to inject $3 billion into the Global Equity Opportunities Fund ($2 billion of the total came from Goldman).
According to one investor, by the end of the week the Global Equity Opportunities fund faced “single digit” drawdowns from redemptions, suggesting that Goldman had, for the moment, dodged a bullet. (Investors are allowed to withdraw their money only once a month from the Global Equity fund, so the issue will arise again in mid-September). A spokesman declined to comment.
“The winners will be those who have liquidity and can extend it to those who crave it,” said Alan H. Dorsey, alternative investment strategist at Lehman.
But not everyone has access to capital. And when funds run into problems when liquidity is not available, investors can get nervous and run for the exits.
At United Capital Asset Management, John Devaney, a well-known manager who is selling his yacht, the Positive Carry, said in early July that the fund had received an “unusually high number of redemption requests,” including one from its largest investor that accounted for nearly a quarter of the firm’s assets under management.
As a result, he said, the firm suspended redemptions in several funds “in order to protect the interests of our investors.”
Regulators have for years emphasized to banks, which they oversee, as well as to investment banks and hedge funds, which they do not, the importance of managing “liquidity risk,” or the risk that hedge funds or banks wake up one day and cannot sell or borrow.
Yet those warnings often go unheeded. Long-Term Capital Management, for example, collapsed in the late 1990s when securities that the best computer models in the world predicted would not move in a certain direction did just that.
More recently, executives have blamed very unusual events — known to experts as 25-standard deviation moves, things expected only every 100,000 years — for the disruptions that computers could not predict.
And yet such unpredictable movements seem to pop up every few years. And when they do, they cause severe damage, even for big diversified funds with long track records.
SAC Capital’s multistrategy fund is down 6 percent for August, one of its worst months ever, one investor said.
Toward the end of the week, Tudor Investment’s Raptor Fund was down 7 percent for the year, and Highbridge Capital Management, owned by JPMorgan, was down 4 percent for the month at midweek and up 2.5 percent for the year. Representatives from those firms declined to comment.
Waiting in the wings are the opportunists. Goldman Sachs, in spite of the abysmal performance of its major funds, is raising money for a fund to capitalize on assets that have been beaten down by fear, but whose fundamental value should spike when more normal markets reappear.
It will be Goldman’s third Liquidity Partners fund: the first two were raised in 1998 and 2001, two other periods of extreme market conditions. According to a marketing document, Goldman will contribute 10 percent or up to $100 million and the fund will look for “tactical market opportunities” in fixed-income sectors rattled by dislocations.
“Liquidity used to be opportunistic,” said Stewart R. Massey, of Massey Quick, a consulting firm. “Now it’s predatory. Many savvy investors are sitting on cash or lines of credit waiting to pounce on distressed sellers.”
