CREATIVE ACCOUNTING 101

09 August 2007: DJIA 13,270; C 46.90; MER 76.25

Merde! Who would have thought that a boring old French bank could make such a complete mess of its hedge funds (that I didn’t realize anyone actually bought, apart from some overfed French farmers looking to invest all the subsidies they get for sitting around drinking wine and eating cheese all day). You just don’t expect a French bank to have such a major impact – a 387-point impact, to be precise – on our market. But the toxicity of those four words – ‘complete evaporation of liquidity’ – was enough to send us into meltdown. Merci beaucoup!

Which is a shame, just as we were coming off the back of a little rally, the resignation of Warren Spector, Bear’s co-president, notwithstanding. The bulls were back, helping us all to some serious gains just a couple of days ago. Then these damn Frenchies come and bust up the party. No wonder nobody likes them. I’m never eating French fries again.

When I think of Europe, I think of England. Over there it’s all positive. They’ve had Tony Blair doing a fine job, helping us to try and tame those terrorist towelheads, whilst Gordon Brown has been masterful at running the economy and letting the finance sector get on with its primary task of making money without too much interference. No wonder old Gordie said that this was the start of a ‘golden age’ for those boys in London. I envy them.

Thinking of Mr Brown reminds me that we’ve not made much progress with our London operation. There are plenty of frustrations, even though they reportedly speak the same language as us. We want some nice offices, but the realtors are asking too many questions, trying to make us disclose far too much about us and our business plans. Hey, I only want to sit at a desk, not be the father of your children! What’s all this caution about? We’re a good, decent, honest firm. Trust me.

We’re also hearing the first stirrings of doubt about whether UK pension plans really want to go any larger into alternatives. Consultants say that they are all pretty troubled by mortgage-backed securities, and this French news certainly won’t help any. They cannot see past this little blip to the bigger picture: volatility is good. We love it. You can only make truckloads of cash when there’s volatility. Stability is for politicians and economists. Give me boom and bust any day (which is where I part company with Gordon, who claims to have abolished it. Yeah right – not if old Larry has anything to do with it.)

I wish we had a Treasury Secretary with a much gravitas as Brown. Hank Paulson is so inarticulate he can hardly put one word in front of another. Add in the fact that nobody believes he does anything unless it’s going to benefit Goldman’s and you have a guy who is pretty much a joke from where I’m standing. Fortunately it doesn’t matter too much as he doesn’t really have a lot to do. He makes some speeches and issues reassuring statements about how strong the economy is, but the real power lies elsewhere. He just takes the flak when it all goes wrong.

The question we have to answer is: is it all going wrong? Paulson says no and, more importantly in my view, the Fed sounds confident. All the bets on it having to ease the Fed Funds rate turned out wrong. It said that it reckons the economy is likely ‘to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.’ Thanks, Mr Bernanke – I’m with you on that one.

That said, central bankers don’t sound too confident today. What I’m hearing is that all the big central banks are going to start pumping liquidity into the system. That’s good and bad, but not necessarily in that order. Paribas has got this whole market spooked, and what with Bear and Countrywide, people are starting to wonder if we aren’t reaching a tipping point.

I sure hope not. I haven’t exactly been meeting my job description as a hedge fund manager recently. I’m not too hedged on anything. I really would like this bull to run a little more, just until I can close, adjust, burn or lose some of my positions. In this business, they say that timing is everything. The people who say that don’t know how right they are. It’s not just about when you sell or buy – there’s also a real skill to knowing when to book the profit (or loss) to the clients’ accounts. That really can make all the difference. And a few more months of upward momentum would certainly help me to get the performance numbers looking just peachy. Knowing how to account for that performance is just as critical as the performance itself, if you want my opinion.

Take the Thai Baht position. As of today, that looks excellent. At 31.10, we’ve made 34 million and change. Now, you give that back to the clients – less, of course, our 20pct performance fee – and they are as happy as hogs in dirt. It therefore follows that so are we. But that’s not necessarily where it ends for us. Say we still felt bearish about the Baht. Clients have their profit booked, so they’re made up. But were we to run the position until year-end, and it got down to, say, 29 or so, we’re looking at additional profit of 16 mill. That’s for the firm. We close it out, net off the interest cost of the 250 mill we’ve had to borrow because we needed to give back the original client money that funded the transaction, and the rest is all ours. That’s the beauty of performance accounting. We manage it.

Compliance guys and other back-office lamebrains just don’t get it. For them, it’s all about process. But, as I keep on telling them, this is a dynamic business. If we are constantly worrying about the paperwork and the niceties of accounting conventions, we’ll never have any time to make money. At the end of the year, when we’ve earned that huge pot of money, we go hire some hotshot accountants to put all the right transactions into the right buckets. Everyone’s happy, and everyone’s richer than when we started. Do you really need an MBA to work that one out?