Diary of a Very Bad Year

Interviews with an Anonymous Hedge Fund Manager

Hedge Fund Manager, n+1, Keith Gessen

" Diary of a Very Bad Year is a rarity: a book on modern finance that's both extraordinarily thoughtful and enormously entertaining." —James Surowiecki, New York Times–bestselling author
 
A profoundly candid and captivating account of the economic crisis and subprime mortgage collapse, from an anonymous hedge fund manager, as told to the editors of New York literary magazine  n+1.
" Diary of a Very Bad Year does something few of the books written about the crisis have accomplished: It delivers an insider perspective on the events in real time, rather than dwelling on conclusions reached after the fact." — BusinessWeek
"HFM does a good job of teaching the reader how mortgage-backed paper, money-market funds, and credit-default swaps work, while offering up juicier tidbits about the ethics and legalities of his sector." — Time Out New York
"A highly readable refresher on the financial crisis . . . Amazingly—and largely because of the anonymity he's granted—the nameless hedgie gives straight answers . . . the book is packed with plenty of humor." — The Wall Street Journal
"A short, illuminating set of interviews with one savvy, articulate Wall Streeter . . . A penetrating, educational and at times harrowing play-by-play." — Time magazine

"A great read . . . HFM offers a brilliant financial professional's view of the economic situation in real time, from September 2007, when problems in financial markets began to surface, until late summer 2009." — Booklist

AFTERMATH

HFM VI

POPULIST RAGE

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April 15, 2009

Dow: 8,029.62

Liquid Universe Corporate Index Spread over Benchmark: 427

U.S OTR ten-year: 2.76 percent

Unemployment: 8.9 percent

Foreclosures: 341,180

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n+1: You were in China.

HFM: I was in China, mostly Beijing, a couple of weeks ago, checking on a property investment. The property sector is important: A lot of the pressure on raw materials prices supposedly coming out of China was related to the property sector, to construction. The amount of building that had been going on was enormous and visible, all over Beijing. I saw one luxury housing development after another, most of them just in the process of construction, or recently completed, and…sales had last year just come to a halt. It was amazing, the physical reconstruction of that city. A lot of it had to do with the Olympics, but a lot of it also had to do with property speculation.

And Beijing really is not the city that had the most residential property speculation. The optimism that pumped up that sector was pretty incredible. Here you have a provincial city where there was maybe one 4-star hotel—suddenly there are four 5-star hotel projects under construction, and you just wonder who the heck is going to stay in them. A city that really didn’t have much in the way of luxury housing suddenly has tons of luxury projects sprouting up, a lot of those getting sold to speculators, with nobody at the end of the chain. Toward the end of last year people realized just how far supply had outrun real demand, and how far prices had run up.

When I visited, it seemed like reality had set in for the developers and they finally started cutting prices. And unlike in the U.S.—it was interesting to see—in the U.S., where prices had run up, I don’t think buyers had in their mind a measurement by which they would decide that if prices fell by x percent, property would be fairly valued. But it seemed like in China, people really did have a price target in mind. “I know what rents are, and this is what the rental yield should be, and if prices fall by a certain amount, then I’m ready to buy.” And a number of developers just when I was there were cutting prices, and the statistics that came out for February and March showed that there was suddenly a rebound in property sales.^* And that’s created some optimism about the property sector of China, which spills over into more optimism broadly.

The other thing that’s going on in China is that there is a—not unlike in the U.S.—a very concerted effort at fiscal stimulus and a loosening of credit conditions. Lending has really picked up in China. You’re starting to see people starting to believe that that’s going to lead to China hitting growth targets, maybe even 8 percent this year.^† At the same time, you’re starting to see the Chinese run down a lot of the inventories of commodities, so they’re having to replenish those inventories. People are starting to get optimistic about China, about the effect of China on the global economy. It’s a little bit puzzling…China, we talk a lot about it, it’s a lot of people. But as an economy, it’s still quite small relative to Europe or the U.S. But it looms large in the imagination of the investor class.

n+1: Isn’t the main issue that they are a manufacturing country?

HFM: They’re an exporter, and exports have suffered in China. You actually have seen drops in exports, not merely a reduction in the rate of growth, and that’s something that would have been inconceivable eighteen months ago. But there’s no way that China’s going to be a supportive factor to the global economy via exports. The imbalances in the global economy related, to a large extent, to the fact that China was oversaving and therefore was running a very large surplus, the flip side of which was the unsustainable borrowing in the Anglo-sphere economies: the U.S., the U.K., Australia, New Zealand. We were running up current account deficits and borrowing a ton. Those imbalances have to unwind, which means that China’s supportive factor is going to be a story about domestic consumption and about domestic investment in China. And so the property sector’s a big part of that. It’s not about exports; it’s about absorption in China, spending in China. If you believe the Keynesian story, that we have suddenly a shortage of demand, well, the place that was underconsuming relative to its potential was the place that built up a trillion dollars of reserves, that had a domestic savings rate in excess of 40 percent. That’s China. China needs to consume.

n+1: They’ll get us out of this thing?

HFM: I don’t think the Chinese economy is big enough to save the global economy by itself. But if China were to fall into a recession, and Chinese demand were to fall off a cliff, or if the Chinese were to attempt to stimulate their economy by depreciating their currency and try to export their way out of the situation—that would be very damaging to sentiment. And if China manages to grow at 8 percent, and if there is a jump in domestic demand in China, that will have a positive impact at the margin of the global economy. But that effect will be multiplied, in a sense, by the positive effect on sentiment. You know, “Oh gosh, at least there’s a source of growth somewhere. China is growing.”

n+1: What do we mostly buy from the Chinese? We buy T-shirts and sneakers and stuff?

HFM: Technology too. And even some semiprocessed goods. The Chinese make a lot of steel. They import steel, but they also export steel. So it’s not only low-value stuff anymore: Haier refrigerators and air conditioners, Huawei telephone switching equipment. They’re all up and down the value chain; it’s not just knickknacks anymore. A lot of things that are built under the American brands. Some of the biggest exporters in China are big multinational companies that are maybe headquartered in the U.S. or Europe and just do a lot of manufacturing there. It’s the workshop to the world.

n+1: And are there now a lot of Americans and Europeans there with duffel bags selling sneakers and stuff? To even the current account deficit?

HFM: No, not yet. It’s still Chinese guys saying “Copy watch!” The thing that I always get propositioned for is “Copy watch!” I thought at first it was a watch that makes copies, but in fact it’s a knockoff watch. DVDs too. “Copy watch! DVDs!”

n+1: Why would they tell you it’s a copy watch? I guess they knew you could tell the difference.

HFM: Well, they know that you know nobody is going to be selling Rolexes out of a duffel bag on the corner of a street in Beijing. They offer that courtesy out of respect for your intelligence.

n+1: So the Chinese aren’t going to go off the dollar? This is not something we’re worried about?

HFM: Will the dollar lose its status as a reserve currency? This is an interesting question. I don’t believe the dollar will lose its reserve status anytime soon for a variety of reasons. But the reason people overlook is that a lot of reserve buildup is precautionary, not in the sense of being able to buy goods and things if your country has a problem, but in terms of the ability to repay debts that come due if there’s a sudden stop of capital flows, and most of the debt outstanding, the international debt outstanding in the world, is denominated in dollars. That’s not something you can change overnight. This is debt that’s been issued over years and years and years, so if you happen to be indebted in dollars, your economy, the private agents in your economy, not to mention the government, are indebted in dollars, then the monetary authority needs to hoard dollars as a precautionary measure. Hoarding euros isn’t necessarily going to help if what you owe is dollars and your goal is to know that your economy can deal with a year-long sudden stop in capital flows. You need to have a reserve, and a composition of reserves, to match up with the composition of your obligations. Most of those are dollars.

Now, if the dollar is to lose its reserve currency status, the first thing you need to see is cross-border borrowing denominated in other currencies. That means the loss of reserve currency status will be a slow process. Why would companies in emerging countries, or governments in emerging countries, seek to borrow in currencies other than dollars over time? Well, that’s really where you get into the more standard story about what makes a reserve currency. You’re going to borrow in a currency that matches the currency in which most trade flows are denominated, and that means if the U.S. is not a big importer and exporter anymore, well, then maybe people don’t denominate their trade flows in dollars anymore. Or if the currency no longer functions as a stable store of value, or people don’t want to denominate intertemporal transactions in that currency anymore, and if the dollar were facing, you know, a lot of inflation or the threat of a lot of inflation, or instability in its value, a company isn’t going to want to denominate a long-term import contract or export contract in dollars. And so that interferes with the use of the dollar in trade flows, and...

Table of contents

• Cover
• Title Page
• Contents
• Introduction
• Before the Collapse
• The Collapse
• Aftermath
• Epilogue
• Bibliography
• Searchable Terms
• About the Author
• Copyright
• About the Publisher