“Mr. Weinstein pleaded with the pension fund to allow him to pay it back in installments over several quarters, arguing that it would be difficult to get top dollar for some of the most illiquid assets – like corporate bonds – which would otherwise be valued at fire-sale prices…

…The pension fund said no. It wanted the money immediately. So Mr. Weinstein set about conducting an auction for the corporate bonds, but only three of nine dealers made bids. As might be expected, the valuations ascribed to the bonds were significantly less than their original value…“A liquidity drought can exacerbate, or even trigger, the next financial crisis,” Mr. Schwarzman wrote in The Wall Street Journal earlier this year. “Sellers will offer securities, but there will be no buyers. Prices will drop sharply, causing large losses for investors, pension funds and financial institutions. Additional fire sales will aggravate the decline.”…General Electric’s sale of its GE Capital unit could be described as a case study on what happens when you try to sell illiquid assets quickly.The company is in the process of selling down its GE Capital business, worth some $500 billion in relatively illiquid assets. It recently took a $16.4 billion charge. While it might not be directly analogous to the fire sale of illiquid corporate bonds, and that charge figure includes some accounting issues, it shows how difficult it is to sell large amounts of assets at one time.” Andrew Ross Sorkin, “The Perils of Forcing a Sale of Illiquid Assets”, The New York Times, September 29, 2015

“The ding dongs at the FDIC fire-sold IndyMac Bank in a matter of a few months in late 2008/early 2009, at the very worst and most illiquid time of the financial crisis, at a time when FDIC Chairperson Sheila Bair herself was quoted in the NYTimes saying that “market prices for assets were irrational”!!!! The Federal Reserve took years to wind down the assets it acquired from Bear Stearns, AIG, and others. So did Treasury with its GM and others, and so did the private trustees of Lehman’s bankruptcy. I believe the FDIC being a financially imprudent conservator, of IndyMac Bank and other banks it seized during the financial crisis, needlessly cost the deposit insurance fund tens of billions.”, Mike Perry, former Chairman and CEO, IndyMac Bank

September 28, 2015, Andrew Ross Sorkin, The New York Times

Dealbook Column                                                                                                     

The Perils of Forcing a Sale of Illiquid Assets

By ANDREW ROSS SORKIN

Boaz Weinstein, the hedge fund chief, in 2011. He is being sued by the Public Sector Pension Investment Board of Canada. Credit Brendan McDermid/Reuters

Boaz Weinstein, the hedge fund manager famous for betting against the JPMorgan Chase trader known as the “London Whale,” is being accused of his own accounting chicanery.

In a case that could have chilling lessons for investors in certain kinds of illiquid assets, Mr. Weinstein — a chess master who made his career exposing and gambling on mispriced assets — is being sued by the Public Sector Pension Investment Board of Canada, formerly the largest investor in his hedge fund, Saba Capital.

The pension fund sought to liquidate its investment in Mr. Weinstein’s fund earlier this year after he piled up a string of losses over the last two years.

The pension fund estimated it was owed $500 million and gave Mr. Weinstein less than two months to refund the money.

Mr. Weinstein pleaded with the pension fund to allow him to pay it back in installments over several quarters, arguing that it would be difficult to get top dollar for some of the most illiquid assets — like corporate bonds — which would otherwise be valued at fire-sale prices.

The pension fund said no. It wanted the money immediately.

So Mr. Weinstein set about conducting an auction for the corporate bonds, but only three of nine dealers made bids.

As might be expected, the valuations ascribed to the bonds were significantly less than their original value. Now the pension fund is claiming in a lawsuit that it got about $12 million less than it should have for those illiquid assets, contending that Mr. Weinstein “improperly manipulated the values of certain of the funds’ assets with the objective of artificially depressing the price paid” to the fund.

The lawsuit — and the valuation that the fund received — illustrate an issue that has been bubbling up over the last year: It is very possible that a liquidity panic could lead to the next financial crisis.

William H. Gross, the bond investor, sounded the alarm earlier this summer on “possible exit and liquidity problems in future months and years.” The potential for such a crisis isn’t restricted to large pension funds and wealthy investors.

“Mutual funds, hedge funds and E.T.F.s are part of the ‘shadow banking system,’ where these modern ‘banks’ are not required to maintain reserves or even emergency levels of cash,” Mr. Gross wrote in a letter to investors. “Since they in effect now are the market, a rush for liquidity on the part of the investing public, whether they be individuals in 401(k)’s or institutional pension funds and insurance companies, would find the ‘market’ selling to itself with the Federal Reserve severely limited in its ability to provide assistance.”

Whether Mr. Weinstein valued the assets in his fund properly or not will be up the court to decide. Many facts on both sides that are necessary to truly understand what happened have yet to emerge.

But what we do know from the lawsuit is that Mr. Weinstein had to value his portfolio as if it were being sold tomorrow, and it demonstrates, at least to some degree, that selling illiquid assets in a hurry usually results in sharply lower prices.

Stephen A. Schwarzman, co-founder and chairman of the Blackstone Group, is a Wall Street veteran who has been anxious that many regulations put in place since 2008 have made it harder for banks to act as intermediaries and stand in to buy assets if the markets seize up.

“A liquidity drought can exacerbate, or even trigger, the next financial crisis,” Mr. Schwarzman wrote in The Wall Street Journal earlier this year. “Sellers will offer securities, but there will be no buyers. Prices will drop sharply, causing large losses for investors, pension funds and financial institutions. Additional fire sales will aggravate the decline.”

Not everyone is convinced a liquidity crisis is upon us. Matt Levine, a columnist for Bloomberg View, calls it “the liquidity illusion,” which he defines as a narrative that “big investors buy a lot of bonds thinking that they’ll be easy to unload in a crash, but in fact they won’t be easy to unload, and there’ll be panicked fire sales that worsen the crash and lead to a real crisis.”

He asks: “How is that illusion tenable when everyone talks about it all the time? What big investor is suffering from the liquidity illusion? Presumably not all the investors who are quoted constantly in stories about the liquidity illusion, right?”

If Mr. Weinstein wins the case, the Canadian pension fund may have suffered the liquidity illusion.

Others have suffered the liquidity illusion, too. General Electric’s sale of its GE Capital unit could be described as a case study on what happens when you try to sell illiquid assets quickly.

The company is in the process of selling down its GE Capital business, worth some $500 billion in relatively illiquid assets. It recently took a $16.4 billion charge. While it might not be directly analogous to the fire sale of illiquid corporate bonds, and that charge figure includes some accounting issues, it shows how difficult it is to sell large amounts of assets at one time.

“The suggestion that Saba ‘shopped for lowball bids’ for two bonds in our portfolio is ludicrous and totally unsubstantiated,” Mr. Weinstein said in a statement. “On the contrary, Saba initiated an industry-standard auction process to determine the value of the two bonds. This allowed us to determine objectively the level of interest by real-life purchasers, instead of relying on subjective estimates for extremely illiquid instruments in which institutional trading was virtually nonexistent.” He added: “The suggestion that I manipulated the valuation of two bonds for my personal gain is utter nonsense.”

A spokesman for the pension fund, Mark Boutet, said, “Since this matter is before the courts, we are not commenting.”

We’ll see what the courts eventually have to say about all of this. But that could take years, and we might see a liquidity crisis — and many more cases like this one — first.

A version of this article appears in print on September 29, 2015, on page B1 of the New York edition with the headline: The Perils of Forcing a Sale of Illiquid Assets.

Posted on October 2, 2015, in Postings. Bookmark the permalink. Leave a comment.

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