Four months after that promotion, Maounis had cause to celebrate. Hunter had continued to bet that winter gas prices might spike, and suddenly the mother of all weather shocks arrived: In August Hurricane Katrina slammed into the Louisiana coastline, flooding New Orleans and ravaging gas-production rigs in the Gulf of Mexico. The next month Hurricane Rita followed, and the nation’s gas supply was hit again. By the end of September, natural gas prices had hit a record, and the effect on Amaranth’s returns was dramatic. Having been down 1 percent in the first half of 2005 because of the sluggish performance of most of its strategies, Amaranth was up 21 percent by the end of the year, while the average hedge fund mustered a return of just 9 percent. Hunter and his gas trades earned $1.26 billion, accounting for just about all of Amaranth’s profits, and Hunter reportedly pocketed a tenth of that.9 Thanks to his performance, Amaranth’s assets swelled to about $8 billion, making it the world’s thirty-ninth-largest hedge fund. In its annual Christmas mailing, Amaranth sent clients toy gasoline pumps and a card that quoted Benjamin Franklin. “Energy and persistence alter all things,” the card proclaimed. Seldom had one of the Founders been taken so out of context.
On any reasonable reckoning, Hurricanes Katrina and Rita constituted freak events. But whereas Hunter had been ready to blame unforeseeable extremes for his Deutsche Bank losses, he was happy to take credit when unforeseeable extremes made him a hero. Maounis grew increasingly enamored of his young star. He seemed to view Hunter as a convertible arbitrage trader transported to a different space. He was generating profits while taking little risk: There was no way that winter gas would fall below the price of summer gas, so his potential losses appeared limited.10 Amaranth’s risk department only reinforced Maounis’s conviction; at one point, a member of the risk team responsible for natural gas assured Maounis that Hunter was the greatest commodity trader he had ever witnessed. Hunter had no difficulty persuading Maounis to allow him to move his family and trading team to his native Calgary. He commuted to his Canadian office in a Ferrari, though sometimes snowy conditions forced him to use a Bentley.
During the first months of 2006, Hunter’s successful run continued. His trades earned profits of roughly $2 billion between January and the end of April, again driving nearly all of Amaranth’s performance. At a time when the average multistrategy hedge fund was up just 5 percent since the year’s start, Amaranth was up roughly six times more; Maounis began to say that, although he had failed to strike gold in statistical arbitrage, he had discovered another secret weapon that was just as potent.11 And yet to some savvy observers, Hunter’s extraordinary profits were cause for alarm. There was no way that Hunter could be generating this sort of money without taking outlandish risks; and besides, there was a darker worry. With the rise of the new alpha factories, hedge-fund capital devoted to energy trading had soared from around $5 billion in 2001 to more than $100 billion in 2006: The trades were growing crowded. Thanks to this flood of capital, any strategy that made sense to energy specialists at hedge funds was almost bound to come good as others piled in. But it could also blow up if the stampede reversed itself.
In the case of Brian Hunter, an extreme version of this phenomenon seemed to be occurring. The weight of his own money might be driving his profits. Amaranth had allowed him to ramp up his positions in a niche market: By the end of February, Hunter held an astonishing 70 percent of the natural-gas futures contracts for November 2006 delivery on the New York Mercantile Exchange and about 60 percent of the contracts for January 2007. By means of this enormous position, Hunter was betting that November gas would fall in value and that January would rise; and so long as he added aggressively to his wager, his view was likely to be self-fulfilling. After all, it was not clear that his strategy was making money because market fundamentals were on his side. By early 2006, gas output had recovered from the devastation of the hurricanes, and mild winter weather was reducing gas demand, so that by April the quantity of gas held in storage was nearly 40 percent above the previous five-year average. Under these circumstances, the success of Hunter’s bet on summer/winter spreads seemed hard to explain—except when you looked at the astonishing growth in his positions. By around the end of April, Amaranth owned upward of one hundred thousand NYMEX contracts, or more than 40 percent of the total outstanding for all months on the exchange. Hunter was a momentum trader who traded on his own momentum.12
In May 2006, a team from the private-equity giant Blackstone visited Hunter in Calgary. Blackstone ran one of the longest-standing funds of funds, and it had invested $125 million in Amaranth. But now it was having second thoughts. Amaranth might be up a whacking 13 percent in April alone, but the size of Hunter’s profits showed he was taking dangerously large bets in a volatile market. Amaranth’s risk control department had calculated that because winter gas prices would never fall below summer prices, the most Hunter could lose in a single month was $300 million, a tolerable 3 percent or so of equity. But Hunter’s own trading had rendered this assessment obsolete: The spread between summer and winter gas had widened from $1.40 in mid-February to $2.20 in late April as Hunter had built his positions, meaning that there was plenty of room for the spread to shrink disastrously. Besides, the small size of the gas market—and the fact that the main buyer of Hunter’s positions was none other than Hunter himself—created a liquidity risk: Hunter would have nobody to sell to if he needed to get out of a position. Blackstone informed Amaranth that it would withdraw its capital at the next opportunity. There was a penalty fee for short-notice redemptions, but Blackstone was happy to pay it.13
Meanwhile, Maounis was finally reckoning with the fact that his star trader had overreached himself. He told Hunter to cut back on his risk, but this was easier said than done: Nobody wanted to buy Amaranth’s contracts, just as the Blackstone team had worried. The moment Hunter tried to unload some of his positions, the market turned, and the glorious results of April were followed by horrifying losses. By the end of May, Amaranth was down by more than $1 billion—nearly four times more than the risk department had deemed possible.
Maounis and his lieutenants scrambled to stabilize their operation. Traders in other strategies were told to cut back positions in order to free up capital, and Amaranth paid Morgan Stanley a large fee to shoulder some of Hunter’s exposure.14 But it was too little, too late. Hunter’s wild profits and losses had come to the notice of other gas traders, and it was clear that his positions were too big to hold on to. What’s more, there was no particular mystery about what these positions were: You just had to check which pairs of contracts had widened during March and April to figure out which ones Hunter had been piling into.15 Like Long-Term Capital caught in its bond trades, or like Julian Robertson caught in US Airways, Amaranth was trapped. “It was naïve to think that they could get out of the market with a size of 100,000 positions,” one rival trader later said. “I knew Amaranth would eventually implode. It was just a question of when.”16
Amaranth managed to hang on through the summer. Hunter was under instructions to reduce his positions, but since he could not do that without incurring crippling losses, he played a waiting game, hoping that something would let him out of his predicament.17 At the end of July, the rumor of another late-summer hurricane brought the old bravado back. Hunter jacked up his bets sharply, causing the summer/winter spreads to widen and triggering the implosion of a rival hedge fund named MotherRock that had the opposite bet on.18 In August, Maounis granted an interview to the Wall Street Journal, bravely declaring, “What Brian is really, really good at is taking controlled and measured risk” looking back on that extraordinary comment, one Amaranth veteran compared Maounis’s enduring faith in the young man to that of a jilted lover.19 But the moment of truth was approaching. Amaranth suffered losses at the end of August and faced a margin call from its brokers. The hurricane season ended uneventfully. Predatory rivals began to target Amaranth’s positions.20
ON A RAINY MID-SEPTEMBER DAY, MAOUNIS TOOK A LIMOUSINE ride fr
om his office in Greenwich to the Pierre Hotel in Manhattan. The traffic was bad; he should have taken the train; but managers of multibillion-dollar hedge funds are seldom at home on public transport. Maounis was on his way to a Goldman Sachs hedge-fund conference that was emblematic of the times. A ballroom was set up with dozens of tables, each manned by a team of hedge-fund chieftains; groups of institutional investors moved from stall to stall, listening to a pitch and then hurrying off to hear the next one. Maounis speed-dated his way through a couple of investor groups, repeating the patter that he knew by heart—Amaranth had a world-class fundamental equity team, a world-class credit team, a world-class quantitative team, a world-class commodities team, and all of this was wrapped up in a world-class infrastructure. Then an unwelcome e-mail arrived. There was trouble back at the office.
That Thursday, September 14, was effectively the end for Amaranth. The fund lost $560 million in a single day, as the spread on one of its key summer/winter positions collapsed to a third of its size at the start of September. At a tense meeting at Maounis’s home that evening, Amaranth’s top brass agreed they needed to raise capital immediately to meet margin calls. Maounis called Goldman Sachs to see if it would buy his energy portfolio. Other Amaranth officials reached out to other banks, desperately hoping for a bid from somewhere.
By Saturday morning, squadrons of investment bankers were descending upon the Amaranth office in Greenwich, jamming its parking lot with fancy cars and devouring the Pop-Tarts in its pantry. Teams of intense analysts conferred anxiously with bosses at country homes in the Hamptons; meanwhile, Amaranth’s positions hemorrhaged money in after-hours trading. Goldman made an offer, then Merrill Lynch made an offer, and early on Monday morning Amaranth thought it had a deal to stabilize the firm by selling a chunk of its assets to Goldman. It looked as though the Long-Term Capital plotline would repeat itself. A risk-loving hedge fund had blown up. The Wall Street establishment would pick up the pieces.
Maounis knew he had to get the news of Goldman’s offer out fast. The New York Mercantile Exchange would open soon. By now every commodity trader in the world had heard of Amaranth’s distress, and it would be open season on Hunter’s gas positions. Maounis sent out a letter to his investors, reporting that Amaranth had lost half the capital it had managed at its peak, but assuring them that a deal to raise fresh capital was “near completion.”
That Monday morning in Chicago, Ken Griffin, the boss of the multistrategy fund Citadel, was working out at home on an elliptical trainer. The contraption was rigged up with monitors so he could keep track of the news at the same time as his e-mail, and a message from Scott Rafferty, Citadel’s head of investor relations, popped up in Griffin’s in-box. The e-mail reported that Amaranth was down 50 percent. For a second or two, the number didn’t fully register; Griffin continued to pump the pedals up and down, thinking, It can’t say that. Then he stopped and hurried to the phone. He needed to speak to Rafferty.
“Fifty?” Griffin demanded. “Over what period?”
“A month,” Rafferty responded.
Griffin thought about what Vinny Mattone had told Meriwether when Long-Term Capital was failing. If you are down by half, you are not going to recover.
Meanwhile in Greenwich, Maounis organized a conference call to clinch the deal with Goldman. But when the two firms began talking, along with officials from the NYMEX, Amaranth’s clearing broker, J.P. Morgan, torpedoed the project. J.P. Morgan’s brokerage department had lent the firm money to finance its gas trades, holding the futures contracts as collateral; now that the value of this collateral was doubtful, the bank was uncertain of repayment. The law gave J.P. Morgan the right to pursue Amaranth’s assets through the bankruptcy courts, and even to claw back assets from other firms that bought them as Amaranth was going under. From Goldman’s perspective, the threat of a clawback created an impossible hurdle: It was hard enough to value Hunter’s gas book amid all the market turmoil, but legal uncertainty made the deal unthinkable. Goldman wanted Morgan to promise not to come after it through the bankruptcy courts. Morgan balked and the deal faltered.
As Wall Street’s banking titans wrestled one another to a stalemate, Amaranth’s chief operating officer, Charles Winkler, got a note from his assistant. He had received a call from Ken Griffin, and he hurried to his office to return it.
Winkler had worked for Griffin at Citadel, and the two men had been friends. But when Winkler got Griffin on the line, he found he was not in the mood for pleasantries. “Charlie, what can we do and how can we help?” Griffin demanded.
This was an audacious question. Amaranth’s gas positions had already bled $4 billion or $5 billion by Monday morning; how could a $13 billion hedge fund digest this radioactive portfolio? If the likes of Goldman had worked through the weekend without nailing a deal, what made Griffin think he could do better?
Winkler knew Griffin too well to write him off, so he answered his question forthrightly. “It’s real simple,” he said. “We need a bridge loan and a couple hundred million to stay in business.”21
Griffin began marshaling the resources of the firm that he had built around him. Buying a book that constituted a large chunk of the entire gas market would involve multiple risks: He needed to get his mind around the logic of the trades, how they were financed, who the counterparties were, whether Citadel’s computer systems were capable of handling them. The whole premise of a multistrategy hedge fund—that the edge lay in the efficiency of the platform—would now be tested to the full. If Griffin thought his firm was a potential rival to Morgan Stanley and Goldman Sachs, this was his chance to prove it.
Griffin arranged some forty Citadel staffers into groups to work on the transaction. He put two lieutenants on a plane to Greenwich, and the pair of them showed up looking half the age of their investment-banking rivals. Meanwhile, he got on a conference call with Maounis and his top advisers. By lunchtime the discussion had gone way beyond a bridge loan; Amaranth was losing money so fast that it needed to off-load all its energy positions, not just its gas positions. The more Amaranth’s positions unraveled, the greater Griffin’s advantage over his investment-banking rivals: For the banks, every movement of the goalposts required consultation up and down a chain; Griffin, chief executive and chief deal maker rolled into one, was free to react instantly. The same speed advantage applied at lower levels of the firm. Citadel’s technology chief knew how to get trade data transferred from Amaranth’s computers, loaded into Citadel’s system, and synced up with Citadel’s accounting and risk-management software: A larger bureaucracy might have required a committee or two to do that.22 In the Long-Term Capital crisis eight years earlier, Goldman Sachs had announced an interest in buying the distressed portfolio but had not pulled off a deal. This time a hedge fund had grown large enough to play in the big league, and it was proving relentlessly effective.23
By the evening, the talks between Amaranth and Citadel had eclipsed the talks with all the various investment-bank suitors. But one obstacle remained. Amaranth’s sale of its energy book might lead to bankruptcy, in which case the transaction might be subject to review by a court. Like Goldman Sachs earlier that day, Citadel could not value Amaranth’s book in the face of this uncertainty.
Griffin and his team worked through the night, looking for a way around this legal obstacle. Then, in a lucky break, a solution arrived on Tuesday morning. An executive from J.P. Morgan called to propose a deal: Morgan would waive its right to claw back assets in bankruptcy provided it could be the 50 percent purchaser of Amaranth’s positions. Griffin accepted, but then a new challenge arose: What if some other creditor pressed a claim on Amaranth that undermined Citadel’s calculations? Assessing this risk required understanding the nonenergy parts of Amaranth’s portfolio: Was there another broker that had financed trades that were now insufficiently backed by collateral? Griffin did not know the answer, and for a moment the deal seemed set to slip away. But then Bob Polachek, one of the two Citadel staffers who had camped ou
t in Greenwich, came up with the missing information. He had taken it upon himself to check all of Amaranth’s brokerage statements by working through the previous night. He assured Griffin that there were no undiscovered holes, and at 5:30 the next morning, the sale of Amaranth went forward.24
The sale was a triumph for Griffin and his investors. Partly thanks to J.P. Morgan’s offer, but also because Citadel’s execution platform had proved at least as good as those of the top banks, a hedge fund had stolen a deal that Wall Street had regarded as its own. The moment Citadel and J.P. Morgan took ownership of Amaranth’s portfolio, its value started to come back; predatory traders could see that the gas contracts were no longer about to be dumped, so they cut their bets and prices recovered. Citadel eventually earned a profit of about $1 billion from the transaction. Griffin’s plan to build the next Goldman Sachs had taken a significant step forward.
AMARANTH’S COLLAPSE CONFIRMED THAT HEDGE FUNDS had entered bubble territory. They had grown too fast for the available talent; under pressure to perform, they were capable of granting inexperienced traders the leeway to blow up spectacularly. The multistrategy format made this danger especially acute. Veterans such as Stan Druckenmiller or Louis Bacon understood risk because they traded every day, and they were determined to avoid a major loss because their own savings and reputation were bound up in their companies. But the new alpha factories were structured in a different way: They believed in delegation. The boss of a large multistrategy fund could not hope to be an expert in every risk his traders took, particularly when fast asset accumulation compelled equally fast adaptation to new styles. And once risk decisions were delegated down the chain, the multistrategy funds had to contend with a mild version of the problematic incentives that plague large banks and brokerages. Traders want bonuses; bonuses are won by betting big; and a firm’s central risk department seldom controls wizards who acquire an aura of invincibility. By the time Amaranth folded, $6 billion of its investors’ equity had gone up in smoke, a larger quantity than Long-Term Capital had incinerated.
More Money Than God_Hedge Funds and the Making of a New Elite Page 37