Paul Singer runs Elliot Management, a $17 billion hedge fund which has a phenomenal investment record. It is one of those “almost-impossible-to-get-into-funds.” I used to get his letters every now and then and found his investment philosophy interesting and accurate. This article on his latest letter to investors came from the NY Times. Note that they call it a “screed.” I am looking for the original letter they mention and if I can get it, I will put it online.
Mr. Singer has a way with words and I think you will find yourself agreeing with most of what he has to say. It is well worth reading.
Note the Times knee-jerk reference to him as a “hard core conservative.” I don’t think I’ve ever heard them refer to leftists as “leftists” or “hard core.” In fact, a brief search on their site of the word “leftist” only got me South American politicians. The word “hardcore” yielded only one reference to politics and that was to the Tea Party freshmen in Congress.
“Stability is not the way of the world.”
That is how Paul Singer, founder of the $17 billion hedge fund Elliott Management, describes the current environment in his latest letter to investors, a 14,000-word screed that attacks government officials in the United States and Europe for their fiscal recklessness and portends an end to American hegemony should the ship not soon be righted.
In the colorful and often angry letter, Mr. Singer takes particular aim at the Federal Reserve (a “group of inbred academics,” in his view) for its use of artificially low interest rates and quantitative easing to stimulate the economy. The approach, he said, has distorted the price of just about everything.
“The distortions in public policy in the U.S. and Europe have introduced extraordinary undercurrents which are hidden from sight, but they are entirely capable of changing the landscape very quickly, and probably not for the better,” he said in the letter, which was obtained by DealBook.
Mr. Singer, whose fund gained 1.1 percent in the second quarter, released the letter several weeks before Capitol Hill reached a compromise on the contentious debt ceiling issue. That battle does not fully account for the country’s long term insolvency issues, he wrote, nor what he calls the “unpayable Big Three” — Social Security, Medicare and Medicaid.
“In both the U.S. and Europe, the budget and balance sheet numbers do not work,” the letter said. “When ‘off-balance sheet’ promises are taken into account, the U.S. and most countries of the Euro zone are insolvent.” And by extending reams of credit, the developed nations, he explained, are undermining their credibility, an erosion that — once complete — will exact untold consequences.
“As this is written, the prices of financial assets do not seem to take into account the risk of a history-altering reversal of confidence in paper money, the U.S. dollar, the American economy and its political leadership, or the Euro currency block.”
“Yet poor policy and incompetent leaders are creating massive systemic risks, and modern markets can concentrate and change their focus instantly — for all the right reasons, for no apparent reason, or for some combination of the two.”
Given the Fed’s “increasingly cavalier attitude” toward monetary policy, Mr. Singer said, it is up to the markets to “take away its freedom of action.” In that event, Elliott expects a “collapse” in the dollar’s exchange rate, a busted bond market and surging commodity prices — all accompanied by extreme volatility in the equity markets.
And as for how to extract the economy from the depths of whatever reckoning is to come, history does not inspire confidence in the eyes of Mr. Singer. Calling the government’s management of the financial crisis “horrendous,” Mr. Singer said the stimulus plan was a failure that led to a uniquely feeble recovery and an employment situation that “is simply putrid.”
“Instead of addressing the unsound financial system by deleveraging the banks, making them understandable and transparent, and modernizing the regulatory scheme, the bulk of the actions taken by the new government, starting in early 2009, consisted of an ideological wish-list and cronyism. Very little was oriented toward supporting the private sector, except for the surviving banks, which were nursed back to ‘health’ (that is, mostly as highly-leveraged trading shops) with lavish dollops of close-to-free money and blanket guarantees.”
So what would it take to fix the current dilemmas outlined by Mr. Singer, a hardcore conservative?
“Some are consumed with guilt and cry plaintively, ‘Tax me more, it feels so good!’ But many others will take their jobs, projects and ideas elsewhere, to places where they are not just thought of as sheep to be fleeced. The world, in terms of choices available to educated, ambitious workers and entrepreneurs, is way bigger than just the United States, Japan and Europe.”
Instead of raising taxes in a futile attempt to pay for burdensome entitlement programs, Mr. Singer said legislators should be focused on slashing obligations. He admitted that restructuring the health care system would require complex solutions, but Mr. Singer said there were also some easy fixes to trim costs, like lifting the retirement age or changing the way benefits are calculated.
And what to do about the Federal Reserve and its chairman, Ben S. Bernanke, whose confidence in the Fed’s ability to control inflation seems “more like careless talk radio rants than expressions containing the prudence and conservatism needed from the guardian of the value” of the dollar? Mr. Singer wants the Fed to ease off the gas pedal and change directions.
“The Fed should state that it has done more than enough, and that fiscal and regulatory policy needs to pick up the responsibility for growth and job creation.”
“We should demand that the Fed start commenting — in their beautiful prose — on the value of the dollar. They also need to start normalizing interest rates carefully, while developing intelligent policies to deal with the possible resultant decline in many asset prices (possibly balanced by optimism in the increased probability of sound money policies in the future). Until interest rates are normalized, capital will continue to be misallocated throughout the economy, real investment ‘risk’ will be almost impossible to determine and a firm foundation for solid growth in the American economy cannot be created.”
His most bitter medicine is perhaps reserved for Europe, which he chides for propping up Greece — “a hopelessly insolvent country.” Mr. Singer’s solution is simple: let Greece fail. He argues that Germany and France can only write so many checks before “elected officials are dragged out of the Reichstag by voters, or until German credit is on the verge of collapse.” Although the countries have become the informal lenders of last resort for the continent, Mr. Singer warns that they too are on shaky ground.
“The appropriate course is for Greece (and perhaps others) to have as controlled a default as possible and to exit from the Euro. The ’strong’ European countries will then have to ameliorate the severe economic shock which the defaulting countries will suffer, and they will also have to control and limit the damage to their own banking systems which presently hold a significant amount of the ‘bad’ debt.”
So what to make of all the volatility? Mr. Singer shies away from hanging up the Doomsday clock. With a healthy dose of uncertainty, he says he’s not sure if the “current market volatility is the start of something big or just a spooky episode.” However, if the next financial crisis is indeed brewing, Mr. Singer says, it will not enter as a lamb:
“You should expect surprising transmission mechanisms, the tearing apart of vulnerable market connections and assumptions, and a whole new set of insolvencies and problems. There is no way to predict the shape and timing of it, except our guess is that when the next real crisis (not just a head fake) starts, it will play fast, very fast.”
Yet for all the bearish musings in the letter, there is one thing Elliott is bullish on: itself.
The fund said it is still finding significant opportunity in “structured products, readily available at cheap prices from banks that are still under pressure; securities related to distressed real estate in the U.S., Europe and Japan; and discounted claims in the Madoff bankruptcy.”
In defense of its size, Mr. Singer says its returns have not suffered as it has grown. Based on an in-house statistical analysis, the fund achieved its best performance in 2007 and 2009, when it was at its biggest.
It is also getting bigger. The firm, the letter said, is “currently in the process of raising additional capital.”