Investment and finance

Relevant here are
three groups of people/organizations/institutions:
  1. investors,
  2. bankers and brokers (middlemen),
  3. borrowers.
Most of the news thus far (thru October 2008)
concerning America’s financial fiasco of the 2000s
have concerned the mistakes of the last two, bankers and borrowers.
But the bankers, at least,
could not have made the much-discussed errors that they did
without the concurrence of the investment class.
Who are they, and what choices did they overlook?

Well, leaving aside the large number of small investors,
prominent examples of large investors are,
pension funds (governmental and corporate),
endowments (university and foundation), and
insurance companies
and at the international level,
sovereign wealth funds (a fairly recent development).

The news in 2007 and 2008 has been about the “housing bubble”.
But that could not have happened, no matter what the policies of the Fed were,
if investors had not made the decision
to make their investments in housing
(all those mortgage-backed securities)
as opposed to other areas.
(The multi-trillion dollar losses we are now seeing
represent not just failed investments by investment banks of their own money
[they surely do not have that much]
but losses from much larger investment pools.)

Looking at the big picture, we see three major issues
concerning Wall Street’s investing patterns:
  1. its massive overinvestment in housing and
  2. its disinvestment in American industry,
    mitigated to some extent by
  3. foreign investors buying up whatever is left of America.
Some examples that spring to mind include:
the attempt of Dubai to invest in American ports,
foreign investments in American toll roads,
for example in Indiana, Illinois, and Virginia
(cf. “Lost Highway” by Daniel Gross),
the InBev purchase of Anheuser Busch,
a sizable part of the U.S. steel industry (cf.),
purchases of numerous banks and publishing houses by foreign investors.

My question is:

Why did foreign investors see bargains in all these domestic areas,
while American investors were blind to them

(for they did not outbid the foreigners)
but instead made their disastrous investments
in a housing industry
that any sane observer could see was ripe for collapse

(based on, for example,
the ahistorical divergence between median home prices
and median family income)?

Remember, the people running those investment funds are not ordinary people.
They have the most education, training, knowledge, and access to information
relevant to these issues of anyone in America.
Further, they, unlike the investment banks,
did not stand to (directly) gain commissions
from purchases of mortgage-backed securities.
We have all heard of how “Wall Street”
made commissions off the housing excesses.
But, supposedly,
those commissions would not have reached
the investors (pension funds, endowments, etc.) themselves.
Or did they?
The circumstantial evidence
(since the people running those investment pools
are as smart and well-informed as anyone)
is that, somehow, they were corrupted (that is the correct word)
into going along with such a disastrous investment policy.
The two most obvious sources of such corruption are:
  1. some form of kickback [e.g.
  2. that the people making the investments
    and the people making commissions off of the investments
    were not in fact independent, but linked in some fashion.
    I will leave it to your imagination as to
    what such a linking mechanism might exist.

You can talk about groupthink,
but Wall Street certainly, normally, has its share of contrarians.
I can believe
ordinary people in Holland, say,
would believe tulip prices would increase endlessly
and bet their life savings on that assumption.
I find it hard to believe that
those smart, savvy, hard-headed people on Wall Street
would fall into the same mania.
Surely something else is at work here.

Oh yes, some will say,
they believed those “credit default swaps” would protect them.
But did they?
They protected housing investors just as much as
that house of straw protected the three little pigs
(and maybe that’s not such a bad analogy).
That is, until the U.S. government decided to spend trillions of taxpayer dollars
bailing out the holders of those credit default swaps.

For an example of how even such an elite institution as the Harvard endowment
was swept up in the leveraging madness, see

And for a 2012-06-19 NYT article on precisely this subject,
click on the following!

Note added 2010-06-17

[In early 2010 Simon Johnson and James Kwak published their book
13 Bankers: The Wall Street Takeover and the Next Financial Meltdown.
On page 147 of that book is a paragraph dealing directly with
the above remarks of mine.
The next paragraph of this document is a copy of that paragraph in the book.
The emphasis is added by the current author.
By the way, note that the (back-) reference they give
is to a blog item published in 2009-10!]

The irony is that the Fed’s flood of cheap money [post 9/11]
did not even have the healthy effect that it should have had.
Ordinarily, businesses should take advantage of low interest rates
to make capital investments,
which contribute to overall economic growth.
In the 2000s, however, as Tim Duy notes,
business investment in equipment and software grew more slowly
than in the 1990s, despite the lower interest rates.
The problem was that
the cheap money was misallocated to the housing sector,
resulting in anemic growth.
That misallocation was due to
  • the new mortgage products
    that made it so easy to borrow large amounts of money,
  • the voracious appetite of Wall Street banks and investors
    for securities backed by those mortgages,

  • a decade of government policies
    that encouraged the flow of money into housing

    (Cf. the remarks of Sheila Bair here and reported here.
    Indeed, Ms. Bair seems to be practically the only financial regulator
    who has been consistently on the ball.).
And the more money that flowed into new subdivisions in the desert,
the less flowed into new factories where Americans could go to work.
Ultimately, the price of the housing bubble and the financial crisis
is not just
trillions of dollars of losses on mortgages and mortgage-backed securities,
a decade of poor economic growth and declining real household incomes.

[Footnote in the book:
Average real annual growth has been lower in the 2000s (through 2008)
than in any decade since the 1930s;
real median household income (in 2008 dollars) has fallen
from $52,587 in 1999 to $50,303 in 2008.]

An interesting graphic from the New York Times appears below
(its original source is crestmontresearch.com):

Miscellaneous Articles


Goodbye, Dollar---and Empire
By Patrick J. Buchanan
American Conservative, 2004-11-22

[An excerpt.]

The deindustrialization of America could be reversed
if we were willing to
return to Hamiltonian economics

Hamiltonian economic program,
American School (economics), and
American System (economic plan);

not to be confused with Hamiltonian dynamics or mechanics (different Hamilton)]
rewrite our tax and trade laws, and
dump the WTO into the Atlantic.
the transnational corporations that finance both parties will not allow it,
for their executives have grown royally rich
transferring factories out of the United States
into the low-wage countries of Asia and the Third World.

The dirty little secret of our era is that
the interests of Middle America
are now in conflict with
the interests of America’s corporate elites.
They are anxious to get out of the United States
and shed their American work force.


In Modeling Risk, the Human Factor Was Left Out
New York Times, 2008-11-05

[The complete article; paragraph numbers, emphasis and comments are added.]

Today’s economic turmoil, it seems, is an implicit indictment of
the arcane field of financial engineering
a blend of mathematics, statistics and computing.
Its practitioners devised not only
the exotic, mortgage-backed securities that proved so troublesome,
but also
the mathematical models of risk that suggested these securities were safe.

What happened?

The models, according to finance experts and economists,
did fail to keep pace with
the explosive growth in complex securities,
the resulting intricate web of risk and
the dimensions of the danger.

the larger failure, they say, was human —
in how the risk models were applied, understood and managed.

Some respected quantitative finance analysts, or quants,
as financial engineers are known,
had begun pointing to warning signs years ago.
But while markets were booming,
the incentives on Wall Street were to keep chasing profits by
trading more and more sophisticated securities,
piling on more debt and
making larger and larger bets.

[That line is all the rage now to explain what went wrong.
But financial managers have long also had such values as
prudence and fiscal responsibility (consider the name of one insurance company).
How such concepts were abandoned and
what that says about the sociology and psychology of the investment managers
awaits examination.]

“Innovation can be a dangerous game,”
said Andrew W. Lo, an economist and professor of finance
at the Sloan School of Management of the Massachusetts Institute of Technology.
[Perhaps all those now swooning over the idea of change
(due to the election of Barack Obama)
might take that comment to heed.
Perhaps there is a reason for the old ways of doing things.]

“The technology got ahead of our ability to use it in responsible ways.”

That out-of-control innovation is reflected in
the growth of securities intended to spread risk widely
through the use of financial instruments called derivatives.
Credit-default swaps, for example,
were originally created to insure blue-chip bond investors
against the risk of default.
In recent years,
these swap contracts have been used to insure all manner of instruments,
including pools of subprime mortgage securities.

These swaps are contracts between two investors —
typically banks, hedge funds and other institutions —
and they are not traded on exchanges.
The face value of the credit-default market
has soared to an estimated $55 trillion.

Credit-default swaps, though intended to spread risk,
have magnified the financial crisis because the market is
unregulated, obscure and brimming with counterparty risk
(that is, the risk that one embattled bank or firm
will not be able to meet its payment obligations,
and that trading with it will seize up).

The market for credit-default swaps has been at the center of
the recent Wall Street banking failures and rescues,
these instruments embody the kinds of risks
not easily captured in math formulas.

“Complexity, transparency, liquidity and leverage
have all played a huge role in this crisis,”
said Leslie Rahl, president of Capital Market Risk Advisors,
a risk-management consulting firm.
“And these are things that are not generally modeled as a quantifiable risk.”

Math, statistics and computer modeling, it seems,
also fell short in calibrating the lending risk on individual mortgage loans.
In recent years, the securitization of the mortgage market,
with loans sold off and mixed into large pools of mortgage securities,
has prompted lenders to move increasingly to automated underwriting systems,
relying mainly on computerized credit-scoring models
instead of human judgment.

lenders had scant incentive to spend much time
scrutinizing the creditworthiness of individual borrowers.

“If the incentives and the systems change,
the hard data can mean less than it did or something else than it did,”
said Raghuram G. Rajan, a professor at the University of Chicago.
“The danger is that the modeling becomes too mechanical.”

Mr. Rajan, a former chief economist at the International Monetary Fund,
points to
a new paper co-authored by a University of Chicago colleague, Amit Seru,
The Failure of Models That Predict Failure,”
which looked at securitized subprime loans issued from 1997-2006.
Their research concluded that
the quantitative methods underestimated defaults for subprime borrowers
in what the paper called
“a systematic failure of default models.”

A recent paper by four Federal Reserve economists,
Making Sense of the Subprime Crisis,” found another cause.
They surveyed
the published research reports by Wall Street analysts and economists,
and asked
why the Wall Street experts
failed to foresee the surge in subprime foreclosures in 2007 and 2008.

The Fed economists concluded that
the risk models used by Wall Street analysts correctly predicted that
a drop in real estate prices of 10 or 20 percent
would imperil the market for subprime mortgage-backed securities.
But the analysts themselves assigned a very low probability to that happening.

The miss by Wall Street analysts shows how
models can be precise out to several decimal places,
and yet be totally off base.
The analysts, according to the Fed paper,

doggedly clung to the optimists’ mantra that
nominal housing prices in the United States
had not declined in decades —

even though house prices did fall nationally, adjusted for inflation,
in the 1970s,
and there are many sizable regional declines over the years.

Besides, the formation of a housing bubble was well under way.
Until 2003,
prices moved in line with employment, incomes and migration patterns,
but then they departed from the economic fundamentals.

The Wall Street models,
said Paul S. Willen, an economist at the Federal Reserve in Boston,
included a lot of wishful thinking about house prices.
But, he added, it is also true that
asset price trends are difficult to predict.
“The price of an asset, like a house or a stock,
reflects not only your beliefs about the future,
but you’re also betting on other people’s beliefs,”
he observed.
“It’s these hierarchies of beliefs — these behavioral factors —
that are so hard to model.”

Indeed, the behavioral uncertainty
added to the escalating complexity of financial markets
help explain the failure in risk management.
The quantitative models typically have their origins in academia
and often the physical sciences.
In academia,
the focus is on problems that can be solved, proved and published —
not messy, intractable challenges.
In science, the models derive from particle flows in a liquid or a gas,
which conform to the neat, crisp laws of physics.

Not so in financial modeling.
Emanuel Derman is a physicist who became a managing director at Goldman Sachs,
a quant whose name is on a few financial models and author of
“My Life as a Quant — Reflections on Physics and Finance” (Wiley, 2004).
In a paper that will be published next year in a professional journal,
Mr. Derman writes,
“To confuse the model with the world
is to embrace a future disaster driven by the belief that
humans obey mathematical rules.”

Yet blaming the models for their shortcomings, he said in an interview,
seems misguided.
“The models were more a tool of enthusiasm than a cause of the crisis,”
said Mr. Derman, who is a professor at Columbia University.

In boom times,
new markets tend to outpace the human and technical systems to support them,
said Richard R. Lindsey, president of the Callcott Group,
a quantitative consulting group.
Those support systems, he said, include
pricing and risk models,
back-office clearing and
management’s understanding of the financial instruments.
That is what happened in
the mortgage-backed securities and credit derivatives markets.

Better modeling, more wisely applied, would have helped, Mr. Lindsey said,
but so would have common sense in senior management.
The mortgage securities markets, he noted, grew rapidly
and generated high profits for a decade.
“If you are making a high return,
I guarantee you there is a high risk there,
even if you can’t see it,”
said Mr. Lindsey,
a former chief economist of the Securities and Exchange Commission.

Among quants, some recognized the gathering storm.
Mr. Lo, the director of M.I.T. Laboratory for Financial Engineering,
co-wrote a paper that he presented in October 2004
at a National Bureau of Economic Research conference.
The research paper warned of
the rising systemic risk to financial markets
and particularly focused on
the potential liquidity, leverage and counterparty risk
from hedge funds.

Over the next two years, Mr. Lo also made presentations
to Federal Reserve officials in New York and Washington,
and before the European Central Bank in Brussels.
Among economists and academics, he said, the research was well received.
“On the industry side, it was dismissed,” he recalled.

The dismissive response, Mr. Lo said, was not really surprising because
Wall Street was going to chase profits in the good times.
The path to sensible restraint, he said,
will include not only better risk models, but also more regulation.
Like others,
Mr. Lo recommends higher capital requirements for banks
and the use of exchanges or clearinghouses for the trade of exotic securities,
so that prices and risks are more visible.
Any hedge fund with more than $1 billion in assets, he added,
should be compelled to report its holdings to regulators.

Financial regulation, Mr. Lo said,
should be seen as similar to fire safety rules in building codes.
The chances of any building burning down are slight,
but ceiling sprinklers, fire extinguishers and fire escapes
are mandated by law.

“We’ve learned the hard way that the consequences can be catastrophic,
even if statistically improbable,” he said.

Proceed With Care, Mr. Obama
New York Times, 2008-11-07

College, state pension funds, endowments are hurting
By Rachel Beck and Joe Bel Bruno, The Associated Press
USA Today, 2010-12-03


College endowments and state pension funds
plowed billions of dollars into hedge funds and private-equity investments
as a way to balance their stock holdings.
For a time, they got supercharged returns.

Those days are over.
From Harvard University to the state pension fund of California,
the values of those alternative investments are shrinking.

So far, the losses are mostly on paper,
but analysts say they could eventually lead to
reduced payouts to retirees,
higher taxes so state governments can fulfill their promises,
or less cash available for colleges to give out as financial aid.

“Everyone was in a desperate search to find returns,”
said Colin Blaydon, head of the Center for Private Equity and Entrepreneurship
at Dartmouth’s Tuck School of Business.
“Now they have to face the dirty little secret that
those investments aren’t in great shape.”

It’s too soon to know the depth of the damage from these investments.
Annual results won’t be in
until January for pensions and July for endowments.

But there are already indications that
the value of these alternative investments is falling:

•Harvard University announced this week that
its endowment fell about $8 billion, or 22%,
since July 1 to about $29 billion
and said that doesn’t fully capture its losses because
it doesn’t reflect declines in its private-equity and real estate investments.

It forecast total losses for its fiscal year ending in June 2009
could be as much as 30%, its worst performance on record.

•In California, public pension fund Calpers says
state, local and county governments may have to
chip in as much as an additional $45 billion
beginning in mid-2010 to cover its pension losses.
Its total assets had fallen from $260 billion last
fiscal year to just $178 billion on Dec. 1.

•The pension fund for public employees in Wisconsin
says it may have to cut monthly payments to retirees by as much as 3.5% —
the first reduction in its 26-year history.

Critics say the party had to end.

Doug Kass, president of Florida investment firm
Seabreeze Partners Management,
says hedge and private-equity funds overpaid for many takeovers,
used too much debt to finance the deals and
charged excessive fees.
So when bad times come and the now-private companies struggle,
those investors will be the first to lose
if companies go bankrupt or need restructuring.

“These funds relied on the kindness of institutional investors
who were intoxicated by hysterical returns,”
said Kass.

Managers of hedge and private-equity funds
are pressing investors to pony up more cash
to avoid having to sell assets at fire-sale prices.

The Madoff Economy
New York Times, 2008-12-19

[Krugman raises some very good points.
The full text; emphasis is added.]

The revelation that Bernard Madoff —
brilliant investor (or so almost everyone thought),
philanthropist, pillar of the community —
was a phony has shocked the world, and understandably so.
The scale of his alleged $50 billion Ponzi scheme is hard to comprehend.

Yet surely I’m not the only person to ask the obvious question:
How different, really, is Mr. Madoff’s tale
from the story of the investment industry as a whole?


The financial services industry has claimed
an ever-growing share of the nation’s income over the past generation,
making the people who run the industry incredibly rich.

Yet, at this point, it looks as if
much of the industry has been destroying value, not creating it.
[Actually, skimming investments.]
And it’s not just a matter of money:
the vast riches achieved by those who managed other people’s money
have had a corrupting effect on our society as a whole.

Let’s start with those paychecks.
Last year,
the average salary of employees in
“securities, commodity contracts, and investments”
was more than four times the average salary in the rest of the economy.
Earning a million dollars was nothing special,
and even incomes of $20 million or more were fairly common.
The incomes of the richest Americans have exploded over the past generation,
even as wages of ordinary workers have stagnated;
high pay on Wall Street was a major cause of that divergence.

But surely those financial superstars must have been earning their millions,
No, not necessarily.
The pay system on Wall Street lavishly rewards the appearance of profit,
even if that appearance later turns out to have been an illusion.
[E.g., the bonus system.]

Consider the hypothetical example of a money manager
who leverages up his clients’ money with lots of debt,
then invests the bulked-up total in high-yielding but risky assets,
such as dubious mortgage-backed securities.
For a while — say, as long as a housing bubble continues to inflate —
he (it’s almost always a he) will make big profits and receive big bonuses.
Then, when the bubble bursts and his investments turn into toxic waste,
his investors will lose big —
but he’ll keep those bonuses.

O.K., maybe my example wasn’t hypothetical after all.

So, how different is what Wall Street in general did from the Madoff affair?
Well, Mr. Madoff allegedly skipped a few steps,
simply stealing his clients’ money rather than
collecting big fees while exposing investors to risks they didn’t understand.
And while Mr. Madoff was apparently a self-conscious fraud,
many people on Wall Street believed their own hype.
Still, the end result was the same (except for the house arrest):
the money managers got rich;
the investors saw their money disappear.

We’re talking about a lot of money here.

In recent years
the finance sector accounted for 8 percent of America’s G.D.P.,
up from less than 5 percent a generation earlier.
If that extra 3 percent was money for nothing — and it probably was —
we’re talking about $400 billion a year in waste, fraud and abuse.

But the costs of America’s Ponzi era surely went beyond
the direct waste of dollars and cents.

At the crudest level,
Wall Street’s ill-gotten gains corrupted and continue to corrupt politics,
in a nicely bipartisan way.
From Bush administration officials like Christopher Cox,
chairman of the Securities and Exchange Commission,
who looked the other way as evidence of financial fraud mounted,
to Democrats who still haven’t closed the outrageous tax loophole
that benefits executives at hedge funds and private equity firms
(hello, Senator Schumer),
politicians have walked when money talked.

Meanwhile, how much has our nation’s future been damaged by
the magnetic pull of quick personal wealth,
which for years has drawn many of our best and brightest young people into investment banking,
at the expense of science, public service and just about everything else?

Most of all,
the vast riches being earned — or maybe that should be “earned” —
in our bloated financial industry
undermined our sense of reality and degraded our judgment.

Think of the way
almost everyone important missed the warning signs of an impending crisis.
How was that possible?
How, for example,
could Alan Greenspan have declared, just a few years ago, that
“the financial system as a whole has become more resilient” —
thanks to derivatives, no less?
The answer, I believe, is that
there’s an innate tendency on the part of even the elite
to idolize men who are making a lot of money,
and assume that they know what they’re doing.

After all, that’s why so many people trusted Mr. Madoff.

Now, as we survey the wreckage
and try to understand how things can have gone so wrong, so fast,
the answer is actually quite simple:
What we’re looking at now are the consequences of a world gone Madoff.


Endowment Director Is on Harvard’s Hot Seat
New York Times, 2009-02-21

[Derived from this article is a DealBook blog article.
Here is an excerpt from the original article; emphasis is added.]

The endowment was squeezed partly because

it had invested more than its assets,

a leveraging strategy that can magnify results, both good and bad.
It also had invested heavily in private equity and related deals,
which not only lock up existing cash
but require investors to put up more capital over time.

I am not an investment type, but I thought
an endowment’s investments were its assets, and vice versa.
I guess that approach wasn’t good enough or was too simple minded
for Harvard.]

Madoff Scandal Casts Light on Investment Advisers
New York Times, 2009-04-07

[This article is extraordinarly significant;
it is the first one I’ve seen
(not that I have much time or expertise to spend researching this topic)
on how so much money from institutional investors
ended up in
a) the hands of hedge funds and
b) in such risky strategies.

Emphasis is added.]

Kenneth A. Flatto paid a lot of money for expert advice
about investing the pensions of municipal workers in Fairfield, Conn.
Unfortunately, he says,
the experts never warned him about Bernard L. Madoff.

Fairfield was not snookered by some sharper peddling that old Madoff magic.
Instead, Mr. Flatto says,
the town was relying on
the skill of one of the nation’s largest investment consultants,
NEPC [New England Pension Consultants].

The name NEPC probably does not ring many bells.
But NEPC and businesses like it play a pivotal —
and at times controversial — role as
the gatekeepers of the investing world.
They stand between
trillions of dollars of public and corporate pension money and
investment professionals who want a piece of it.
And those professionals, it turns out, include the likes of Mr. Madoff,
who masterminded a global Ponzi scheme.

NEPC says
it urged Fairfield to reduce its investments in a Madoff-linked fund
before the scheme came to light.
But Mr. Flatto, Fairfield’s first selectman
and the trustee of its $300 million investment portfolio,
contends that NEPC did not do enough.
Fairfield paid NEPC $100,000 a year to help it pick investments.
The two sides are arguing in court over
who will bear the blame for $19 million in losses.

The Madoff affair is rife with finger-pointing.
Federal regulators,
banks that did business with Mr. Madoff
and even his investors
have faced criticism.

But the giant Ponzi scheme
and similar investment frauds coming to light in recent months
have also trained a spotlight on
pension and investment consultants like NEPC.
For years, troubling questions about these businesses
have percolated through the financial industry and the courts.
Now, calls for change are growing.

Some consultants, their critics maintain,
have conflicts in cases where
they collect money as consultants and
from the funds they recommend.
[Again, I am no financial expert,
but that seems like a prima facie conflict of interest to me.]

While others,
particularly those specializing in vetting secretive hedge funds,
are paid a bounty by the hedge funds
for steering investors’ money to the funds.
And then there are those, their detractors say,
who simply fall down on the job.
These consultants are hired to keep pension funds out of trouble.
But many blessed investments that turned out to be losers —
or worse, outright frauds.

Long a backwater,
investment consulting took off during the mid-1990s
as hedge funds, private equity funds and other so-called alternative investments
exploded onto the financial scene.
Big investors like pension funds and endowments wanted a piece of the action,
but many lacked the time, staff and expertise required
to sift through the growing list of investment options.

Enter the consultants.
On their advice, big investors shifted hundreds of billions of dollars
into investments like hedge funds,
the loosely regulated pools of private capital.
The idea was that hedge funds would provide the outsize returns
that pension funds needed to cover their obligations to retirees.

Now the hedge fund industry is going through an unprecedented shakeout.
Investors have lost many billions, and hundreds of these funds have closed.
Some public pension funds are considering reducing their hedge fund exposure
and have cut ties with those advisers who, they say,
gave them bad advice that led to losses.
Some federal officials and regulators have warned for years
about potential problems in the consulting business.

The Labor Department, for instance, started examining the industry in 2007,
and its inquiry is starting to bear fruit.
This month,
the department settled with Consulting Services Group, based in Memphis,
over conflicts of interest.
Last December,
it sued Zenith Capital Partners, a Santa Rosa, Calif., pension consultant,
claiming that Zenith had accepted payments from a hedge fund
for steering pension clients to it.

“What we are looking at are

pension fund consultants who are fiduciaries,
but who
use their fiduciary position for their own benefit,”

said Virginia C. Smith, director of enforcement at the Labor Department.
“We were a step ahead in looking at these issues before Madoff.”

[I am neither a lawyer nor a finance expert,
but it seems hard to believe that that isn’t both illegal and unethical.
A step ahead?
Four months after the Madoff scandal broke?
Where’s the enforcement?]

A common complaint is that
consultants shirked their responsibility to protect their clients
and pushed public pension boards into hedge funds to collect large fees.

“Yes, pension consultants pushed hedge funds onto pension funds,”
said Edward A. H. Siedle,
president of Benchmark Financial Services in Ocean Ridge, Fla.,
a company that investigates money managers on behalf of pension funds.
“They did this because
the fees they could garner are exponentially greater than
from a regular advisory retainer.”

Investors are discovering that some hedge funds,
and perhaps the consultants who vetted them,
are not all they were cracked up to be.

For instance,
on the advice of Wilshire Associates, another leading pension advisory firm,
the Iowa state pension fund,
as well as the University of Pittsburgh and Carnegie Mellon University,
poured millions into a hedge fund called Westridge Capital.

Westridge, the authorities now contend, was a fraud.
Iowa hired a law firm to try to recover
some of the $339 million it lost on Westridge,
and has recovered $35 million already.

Julie Economaki, a spokeswoman for the Iowa fund, declined to comment on
whether it would file suit against Wilshire,
which is based in Santa Monica, Calif.
Kim Shepherd, a spokeswoman for Wilshire, declined to comment,
saying that the business did not comment on matters involving its clients.

“What you’ve seen in the last five years is
a proliferation of pension fund consultants,”
said Ross B. Intelisano,
a securities lawyer who represents institutional investors.
“And, you’ve seen a failure of consultants to do proper due diligence.
The fact that any of these public funds are in a Madoff or a Westridge
is amazing to me.”

Fairfield conceded that NEPC had told the town that
Mr. Madoff advised a fund in its portfolio, the Maxam Absolute Return Fund.
But the town contended that NEPC had not mentioned that
Maxam was a Madoff feeder fund,
taking Fairfield’s money and investing it with Mr. Madoff.

The town says that
NEPC should have seen obvious red flags over Mr. Madoff’s securities business,
such as his use of an obscure auditing firm.

“We were in the dark as to what was happening,” Mr. Flatto, the selectman, said.

Sean Findlen, a spokesman for NEPC, said that
Fairfield’s investment in the Madoff feeder fund predated the hiring of NEPC
and that the firm had not recommended Mr. Madoff or any of his feeder funds.
In fact, Mr. Findlen said,
NEPC recommended that Fairfield reduce its exposure to Maxam,
but the town did not heed its advice.

N.Y. Pension Deals Seen as Focus of Wide Inquiry
New York Times, 2009-04-14


New York State prosecutors and the Securities and Exchange Commission
are investigating whether
the Carlyle Group,
one of the nation’s largest and most politically connected private equity firms,
made millions of dollars in improper payments to intermediaries
in exchange for
investments from New York’s state pension fund,
according to two people with direct knowledge of the case.

The inquiry,
which is examining the activities of a number of investment companies,
focuses on what has been

a widespread practice
among hedge funds and private equity firms —
paying so-called placement agents
to gain business
managing the pension funds run by states for public employees.

Such payments often raise questions about conflicts of interest
and concerns that they lead placement agents to bribe public officials.


Hedge Fund Executive Guilty of Securities Fraud
New York Times, 2009-04-15


A hedge fund executive has pleaded guilty to securities fraud
and is cooperating with New York State Attorney General Andrew M. Cuomo’s investigation of corruption at the state pension fund,
according to court records unsealed in Manhattan on Tuesday.

Barrett Wissman,
a Dallas business associate of the Hunt family,
is the first investment executive to be implicated in the inquiry
and will pay $12 million over several years
as part of a settlement under his felony plea,
people with knowledge of the investigation said.


Mr. Wissman received millions of dollars in fees as
an intermediary between the pension fund and other investment firms.
Such fees are not illegal,
but often raise concerns about conflicts of interest
and would be illegal if used to generate kickbacks to public officials.
Prosecutors suggest that Mr. Wissman did little for the money
other than trade on his access to the state officials.


Hedge Fund Executive Guilty of Securities Fraud
by Andrew Ross Sorkin
New York Times DealBook blog, 2009-04-15

Public Pension Managers Rethink Hedge Fund Ties
New York Times, 2009-04-15


From New York to California,
public pension funds staked billions in good times
on the highest of Wall Street high rollers:
hedge fund managers and corporate buyout specialists.

But for many of these pension funds —
and the millions of people who are relying on them for their retirements —
that gamble is not paying off as hoped.

Even before state and federal regulators began investigating
whether several prominent investment firms had made improper payments
to gain business from New York’s state pension fund,
public pension funds were backing away.
These private investments were supposed to outpace the stock market
but, in many cases, lost value instead.

Public pension funds that embraced these ventures —
which range from real estate to commodities to private equity funds —
have grown uneasy over the costs and secrecy typically associated with them,
as well as with their inability to withdraw their money quickly if needed.

Now news from New York is shining an uncomfortable spotlight
on hedge funds and private equity,
which helped define the boom years on Wall Street.


In State Pension Inquiry, a Scandal Snowballs
New York Times, 2009-04-18

The inquiry into corruption at the New York State pension fund
started simply enough.
Alan G. Hevesi, the former comptroller,
was accused of using state workers as chauffeurs for his ailing wife.

But by the time Mr. Hevesi resigned his office in late 2006,
investigators for the Albany County district attorney’s office
were examining a more troubling problem:
allegations that Mr. Hevesi’s associates
had sold access to the state’s $122 billion pension fund,
using one of the world’s largest pools of assets to reward friends,
pay back political favors
and reap millions of dollars in cash rewards for themselves.


Mr. Cuomo is chipping away at a mountain-size problem
afflicting public pension funds across the country.
Most of them
outsource the work of investing their assets to professional money managers,
who compete zealously for the work.
The fees paid to the money managers can be very lucrative,
even when there are losses,
and the fees tend to be higher for riskier strategies like hedge funds.

The problems usually begin
when a pension fund’s board is deciding
which money managers to award its business to.
Many members of these boards are elected officials,
like local comptrollers and treasurers,
or the appointees of mayors and governors,
who also need to raise campaign cash.
Money managers have repeatedly tainted the selection process
by making campaign contributions to these board members,
then walking away with the pension fund’s business.

Mr. Cuomo’s office is already considering proposing systemic reforms,
at least in the state and possibly federally,
most likely in conjunction with the S.E.C.
Those reforms could include
a ban on the use of intermediaries in pension transactions
and stricter limits on campaign contributions
made by investment firms, or their executives,
to public officials overseeing public pensions.


Pension Adviser Charged as Cuomo Inquiry Grows
New York Times, 2009-05-01

[New York Attorney General Andrew M. Cuomo] said his investigation,
which is continuing, had uncovered
what amounts to a conspiracy involving
politicians, professional investors and consultants
to defraud public pension funds in New York and other states
by paying millions of dollars in kickbacks
in exchange for access to the funds.

Investment firms reap lucrative fees by managing portions of the funds.

“I believe we are disclosing
a national network of actors
who often acted in concert and did this all across the country,”
Mr. Cuomo said.

More States Start Pension Inquiries
New York Times, 2009-05-07

In the printed “Washington Edition”, the article’s title and subtitle are:

The Pension-Go-Round
Networks of Friends Decide
Where the Money Is Invested

The sprawling investigation into New York’s pension investments hints at
a much bigger problem
than the handful of indictments so far would suggest.

What started as an investigation
by the New York attorney general, Andrew M. Cuomo,
into the state comptroller’s office —
where Mr. Cuomo says
favors were being exchanged for
contracts to invest pension money

has mushroomed into a broad look at more than 100 firms
by attorneys general in at least 30 other states.

A survey of practices across the country portrays

a far-reaching web of friends and favored associates:
political contributors, campaign strategists, lobbyists,
relatives, brokers and others,
capitalizing on relationships and paying favors.

These influential figures can determine
how pension funds are invested, as well as
state university endowments,
municipal bond proceeds,
tobacco settlement funds,
hurricane insurance pools,
prepaid tuition programs
and other giant blocks of public money.


“What has developed is a corrupt system,
where Wall Street, various fiduciaries,
politicians and corporate managers
are draining America’s savings,”

said Frederick S. [sic: E.] Rowe,
a hedge fund manager who serves on the Texas Pension Review Board,
an oversight body.



Brazil quickly becoming a player in the global economy
By Juan Forero
Washington Post, 2010-09-21


Perhaps the strongest sector for Brazil’s investments and clout is food.
In 2007, JBS Friboi bought Swift,
the U.S. beef and pork processor then based in Greeley, Colo.,
for $1.4 billion.
With other investments in Argentina, Britain, Egypt, Russia and Chile,
Friboi controls 50 percent of the world’s meat processing,
according to a report by the U.N.’s Economic Commission
on Latin America and the Caribbean.

[It seems remarkable to me that
foreign companies were seeing good investments in American companies
at the same time as
American investors were putting so much of their investment dollars
into a housing market that was at the top of its bubble.]


South Carolina’s Pension Push Into High-Octane Investments
New York Times Sunday Business, 2012-06-10


Hedge fund and private equity firms are selling,
and taxpayers —
in the form of public funds —
are buying, and buying big.

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