'Reckoning' begins for prophet of doom
http://www.theglobeandmail.com/servlet/ ... y/BusinessDEREK DeCLOET
July 28, 2007
For investors, this has been one rude interruption to a glorious summer. In the space of five days, the Dow was trashed, the FTSE fell, the Nasdaq went into a nosedive, and the TSX had its worst week since September, 2001. From Mexico City to Dublin to Bucharest to Sydney, it was nasty.
In a tiny office in midtown Manhattan, Nandu Narayanan (pronounced nar-EYE-uh-nan) ate it up. He loved it and had one of the best weeks of his career as an investor. He's been waiting for this. Did you see that Blackstone Group, the new cover boys for excess and greed in the private-equity age, has plunged 21 per cent since it completed its initial public offering, oh, about two hours ago? That the vultures at Cerberus Capital can't sell bonds to finance their big Chrysler deal? That Wall Street bankers are waking up at 3 a.m. in a cold sweat, having just dreamed of subprime loans? "The reckoning has started," he says.
Mr. Narayanan, who runs a shop called Trident Investment Management, might be the most unusual investor you've never heard of. He could have been a scientist, a famous economist, or a CEO. (His older sister, Indra K. Nooyi, is the chairman and top executive at PepsiCo and arguably the most powerful woman in Corporate America.) He graduated summa cum laude from Yale, studied under Paul Krugman at the Massachusetts Institute of Technology and acquired an MBA and a PhD in finance and economics from that institution. "He is the single smartest guy I've ever met in my life," says CI Financial's Bill Holland, which you could dismiss as fund-company marketing spin, except he's put $10-million of his own dough in Mr. Narayanan's hedge fund.
Instead of rocket science, he chose a different vocation: prophet of financial doom. Mr. Narayanan makes Eric Sprott look like a cheerful optimist. The credit squeeze that has put a deep-freeze on leveraged buyouts in July and forced this little stock market correction - this is just the beginning, he says. "I would say we're probably in the second or third inning." The best-case scenario? A replay of the summer of '98, when the Dow lost about 20 per cent in a month-and-a-half. The worst? "More like the Great Depression of this century."
If it gets really ugly, blame Wall Street and its obsession with inventing ever more complicated financial products. Mr. Narayanan is something of an expert on this. His first job out of Yale was for Smith Barney, working on earlier versions of mortgage-backed securities - mortgages that are packaged together and resold to investors.
Now, the big lenders and brokerage firms repackage almost everything this way - not just plain-vanilla mortgages but credit card debt, corporate loans, leveraged buyout debt, home loans to deadbeats who can barely fog a mirror, let alone make their payments on time. Slap 'em together, put a shiny wrapper on them, mix-and-match, give them a new name, doesn't matter what you do. Just sell them and get them off the bank's books, fast. That's the new Wall Street.
It worked, for a while. But the web of collateralized debt obligations (CDO) and mortgage-backed securities and credit default swaps and other esoterica is undermined by a fatal flaw, Mr. Narayanan reckons: "You've broken that critical link that tied the borrower to the banker." Someone lends you money to buy a house knows you and can estimate the value of the property. But a bank or a hedge fund that buys a CDO that's made up of other CDOs that are backed by subprime loans made against homes in California that have dropped 15-per-cent in value - well, how the hell can they really know what that piece of paper is worth?
"All of these credit instruments and these fancy things that Wall Street has provided these people have really been predicated on one thing, which is that markets are orderly and everything is fine," Mr. Narayanan says. And when they aren't? Then you can't sell them because there are no buyers. Ben Bernanke, the U.S. Fed chairman, estimated last week that losses on subprime loans may turn out to be $100-billion (U.S.). Mr. Narayanan's view of things is less tidy: When a real credit crunch hits - and we have not seen it yet - some banks and hedge funds won't even be able to figure out for months what their losses are on high-risk debt.
So they'll be paralyzed. And then? Lending activity dries up overnight, which leads to a U.S. recession, which brings on a global recession. "This could potentially make Long-Term Capital [whose collapse helped fuel the '98 crisis] look like some kind of walk in the park," Mr. Narayanan says.
You could easily dismiss the guy as too apocalyptic, and perhaps you'd be right. On the other hand, while your portfolio was getting savaged, his fund, which is short-selling "everything we can get our hands on" related to the U.S. lending industry, went up 10 per cent this week. If there's any truth to his doomsday predictions, this will prove to be a great time to buy gold and government bonds. And to build a bunker in your backyard.
::soapbox::