n+1: So this is a hedge fund.
HFM: This is a hedge fund. Now you’ve seen what a hedge fund looks like: a lot of flat screens, a lot of people staring intently into them, and not a lot of noise. We’re quite quiet for a hedge fund. We don’t have TVs. That’s probably one of the big differences between this trading floor and a typical trading floor—I got rid of TVs some time ago. I don’t have a TV at home, and I thought it was ironic that I had gone through all this effort to resist having a TV at home and then I would spend all day watching Squawk Box on CNBC, so then we decided, we’ll just get rid of the volume, we’ll kill the volume, but then I spent my whole day inventing dialogue for Maria Bartiromo, and new texts for the—well, there was this foot fungus commercial that would play on CNBC all the time which was really disgusting, and we were coming up with new variations of foot fungus. So we decided finally we really had to get rid of TVs. Other than that it’s pretty standard.
n+1: So how are things going?
HFM: It’s been a really turbulent couple of weeks. Obviously the market has been in some, uh, degree of crisis since the last time we spoke, but what’s new is that it’s really been spreading. I’ve been doing this for over a decade and I’ve seen asset prices generally more distressed than they are today, the equity market has been much more distressed than it is today. The particular market that I trade, I’ve seen prices much more distressed than they are today. But I’ve never seen the financial system as a whole more distressed. Banks, the sense of panic and despair at the major banks, I’ve just never seen it before.
n+1: When we talked a few months ago, you seemed OK with things, you thought everything was going fine, America was going to win this.
HFM: Well, I didn’t want you to start a bank run with your vast readership at n+1. I felt it was my responsibility as a member of the financial community to keep all of literary New York from lining up at the bank or at the ATM the next day.
I still think things will be fine, but I overestimated the degree to which the subprime risk had been off-laid by the banks. I think a lot of it was off-laid—we talked about European buyers and Asian buyers who were the ultimate underwriters of the risk, but as it turns out much more of the risk than I expected was still on the books of the big investment banks. So when you hear about write-downs related to subprime mortgages taking place at Merrill Lynch, Citibank, Bear Stearns, that’s a consequence of their having retained risk related to these assets on their books. We thought it had been sold on to Europeans. And it was: the Germans lost a lot of money, and some of the Chinese banks are announcing earnings in the next weeks and the speculation is that a lot of them will have to announce write-downs related to subprime. But Citibank had a ton of this stuff on their books and had to write down a tremendous amount. Almost all of the major banks have.
At the end of the subprime orgy, it became difficult to place a lot of this debt. So the banks would end up warehousing it. They had a profitable business in purchasing and securitizing these assets, but it was ten minutes to midnight and they didn’t know it. They thought they would be able to place it and securitize it when things calmed down. But it turned out the clock struck midnight and these assets turned into—pumpkins. And they couldn’t move them, and while all these assets were sitting on their books the real estate market started to deteriorate, and the value of these subprime mortgages started to deteriorate with it.