HEDGE FUNDS: THE GLORY DAYS OVER?

It was one of the greatest, greediest parties in global finance while it lasted. A handful of hedge funds, led by a Hungarian billionaire philanthropist and wannabe social philosopher raised a few billion dollars from secretive offshore clients, leveraged their funds assets with colossal credit lines from banks in Wall Street and used their financial power to bet on anything from Swiss francs and Treasury bond options to silver and cattle futures. These funds were known as the global "macro" hedge funds because their managers made leveraged bets on currencies, interest rates, stock market indices, oil and commodities. The golden age of the hedge funds was in the early 1990's when the currency markets were abuzz with the financial fallout of the Berlin Wall and the ERM, while the stock markets of the US and Europe were listless.

In September 1992, George Soros became a financial celebrity overnight when his flagship fund Quantum took on the Bank of England and John Major during the ERM crisis with a huge leveraged bet against sterling. While Chancellor of the Exchequer Norman Lamont tried to borrow $15 billion to defend sterling, the Quantum Fund's 10 billion dollar short position in sterling forced HM Treasury into the most humiliating devaluation by Britain in modern times. Soros not only broke the Bank of England, he bragged about it in public, thus creating a personality cult that resonated across the high tech dealing rooms of Wall Street and the world financial markets. He was embraced as the ultimate in "smart money", a philosopher-king in the Platonic mold who even looked the part of Wall Street's Henry Kissinger, complete with a Central European accent, cerebral justifications for his jet set speculations that nobody really understood and a mass global following.

Investors all over the world rushed to invest in hedge funds who boasted the pedigree of George Soros, Julian Robertson of Tiger Asset Management and John Meriwether's Long Term Capital Management. The mid-Nineties was the apogee of global macro investing. The dollar sank to 79 yen. The ERM withstood bouts of speculative attacks. The US Treasury bond market became the plaything of hedge funds devoted to the arcane art of leveraged international interest rate arbitrage. Even though hedge funds skinned their investors alive with huge management and performance fees, (heads I win, tails you lose and since all the action is offshore, you have no clue how I make or lose money for you!), minimal disclosure and even selective arrogance, there was no shortage of lambs willing to be led to the slaughter as long as the fund manager was a media superstar. George Soros himself epitomized this new breed of leveraged financial buccaneers. He gave interviews to the Financial Times that moved the markets in gold and currencies. He jetted around the world to meet Kings, Presidents, Prime Ministers and Central Bank Governors. He dominated the international debate on issues as diverse as the fate of the Euro, the finances of post Cold War Russia, ethnic carnage in Bosnia and, bizarrely, even the need to curtail anarchistic speculators in the capital market! Soros no longer managed money. He pontificated on Big Ideas as the undisputed king of the new world financial order.

The hedge fund parade hit an iceberg in the fall of 1998, when Russia defaulted on its sovereign debt and the Asian tiger currencies became pussycats en masse overnight. Malaysian Prime Minister Mahathir Mohammed blamed Soros and his ilk for the chaos in the Southeast Asian financial markets. Unfair. The Southeast Asian markets were Casinos filled with sleaze, debt, borrowed dollars, phony asset bubbles, Rip Van Winkle regulators and self-serving croupiers. But Soros got tagged with the same brush as an earlier generation of British socialists who fulminated against the "Gnomes of Zurich" for the international crises of the pound sterling. Mahathir blamed Soros, the IMF, the World Bank and the tooth fairy for the Asian currency meltdown. Yet amid the international uproar, a volcano was poised to erupt in the playing fields of international finance - and the epicenter of this volcano was not in Kuala Lampur but Greenwich, Connecticut.

Salomon Brothers had a star trader named John Meriwether who made zillions in the bond market. He formed his own hedge fund LTCM after being forced to resign from Solly in a T-bond auction scandal. LTCM was no run of the mill hedge fund. Its partners included Nobel laureates, ex-governors of the Federal Reserve Board and finance professors from Harvard and Wharton. It used complex mathematical models to make money from spreads among dozens of credit markets, from Danish mortgages to Japanese off the run public papers. The world's biggest banks were so enamored of Meriwether that they allowed him to leverage LTCM capital 400 times over. When Russia exploded, so did Meriwethers portfolio. The bankers rushed to Mommy to help protect the System. Mommy (i.e. Fed Chairman Alan Greenspan) obliged. The world financial system survived after history's first central bank rescue of a hedge fund. If the System was at risk, Mommy will invariably bail the bankers out. In central banking jargon, Mommy is known as the Lender of the Last Resort.

This spring, the era of the hedge funds came to an end. Julian Robertson's Tiger Fund decided to liquidate after painful multi-year losses. George Soros also had to swallow a bitter pill this week. Stan Druckenmiller and Nick Roditi, the managers of the Quantum and Quota Funds, both resigned after a 25% hit in tech stocks. Soros said he is going to become "conservative". There is a lesson in all this. One, who cares about a hedge fund superstar's 25% performance record when NASDAQ doubled in less than a year? Two, the biggest hedge fund kahuna found the Net bubble as irresistible as the humblest Datek Online jockey. Three, mystique and marketing may raise billions for a fund manager. But it performance goes woosh, so does his reputation. Poor Soros. He became a victim of his own media mystique. Believe me, the markets humble us all in the end!