Risk makes a comeback
Jeffrey Larson was a star of the Boston hedge fund world who made $17.3 million in a year managing money for Harvard not long ago. Kim and Stephen Martinelli were like the rest of us, just trying to pay their bills. Master of the universe or struggling homeowner, underestimate risk at your peril. Things don't always work out the way you plan.
The story of Sowood Capital Management was in all the papers yesterday, the biggest example yet of a hedge fund firm going bust in the tightening credit markets. The story of the Martinellis of Lawrence, told well in yesterday's Globe by business reporter Robert Gavin, is the human side of the same story. There will be many more Sowoods and Martinellis before the markets correct.
What began at the bottom of the financial food chain, subprime lending to those with problem credit histories, is spreading into the broader markets, including the financing of the frenzied leveraged buyout business. Larson, who managed $3 billion for Harvard Management Co. before starting his own firm three years ago, illustrates yet again that even the smartest people can get it wrong.
And when they do, it can all come apart at amazing speed. The Martinellis got in trouble when their adjustable mortgage payments jumped more than $900 a month in a year. Larson saw the value of his funds collapse by more than half in a month. Leverage is a wonder on the way up, and frightening on the way down.
The shakeout in the credit markets is a legacy of a long period of cheap money, lots of liquidity, and risk rarely being penalized but instead imbedded in the complex financial structures that are sliced, diced, and resold many times over. The scariest part about the current debt bubble is that unlike the dot-com bust, which largely involved public companies that reported their troubles quarter by quarter, the credit markets are far more opaque. Who owns what and how much is just beginning to unwind.
"There is going to be some blood in the streets," one hedge fund manager told me yesterday. "It may take awhile or it could be fast, as Mr. Larson just found out."
The problems in the hedge funds will cost a lot of rich people and institutions a bundle. (See Harvard, Sowood's first investor.) But the meltdown in the much larger mortgage markets is ultimately a greater risk to the economy. Rescue plans like the one being assembled by the Patrick administration for subprime borrowers can help around the edges, but basically the market needs to correct itself, which is what is happening.
If there was a silver lining in yesterday's stories it was this: Sowood is going out of business, but the foreclosure of the Martinellis' home was stopped after a nudge from the Globe. Jeff Larson can take care of himself; people like the Martinellis don't have that kind of cushion.
Neighborhood news. In June, I told you about former Reebok chief executive Paul Fireman's attempt to sell Willowbend Country Club, the ritzy club he built in Mashpee, to the members. Things are not going well if a recent letter from Fireman to members is any measure: "Some of you have been very vocal and negative about this transition and have voiced opinions in a less than appropriate way. Some of these conversations have been brought to my attention as well as overheard by my family members. Hearing this and having others bring this to my attention is making both me and my family feel like villains. This is upsetting since I have noticed members that I have known for years avoiding me or turning their heads the other way. I know the vast majority of members are not like this, but this has already done damage, and I implore you not to allow this to continue."
Steve Bailey is a Globe columnist. He can be reached at bailey@globe.com or at 617-929-2902. 