Mayfair, the heart of London’s hedge-fund industry, was the home to Nassau Asset Management; a fund manager that functioned out of a luxuriously appointed suite of offices on Curzon Street. Hedge fund offices had sprung up across Mayfair like mushrooms. They attracted investments from banks, pension funds, endowments, foundations, insurance companies, money managers, wealthy individuals, municipalities and governments. The list was long; the profits had been huge with managers and traders enjoying spectacular salaries and bonuses.
Those happy times were now gone and Nassau Asset Management, the keystone of Nassau Investment Holdings, specialised in selling credit default swaps, was in very deep trouble, the market had imploded and its largest insurer, AIG, was on the hook for tens of billions of dollars.
Nassau Investment Holdings had its registered office in George Town, the capital of the Cayman Islands. It was one of Caribbean’s many tax havens where at the end of 2007 half of all the world’s hedge funds were registered. A scattering of Caribbean islands, which included the Caymans, the British Virgin Islands and Bermuda, were the relics of the European empires that had fought for the control of the Americas in the centuries that followed Columbus’ arrival in the new world. At the beginning of the third millennium hundreds of billion of dollars of lost taxes found their way to those happy islands’ shores every year.
It is worth noting, especially for the less privileged subjects of Her Majesty Elizabeth II, that many of the most prosperous offshore tax havens were British or ex-British territories, playgrounds for the rich, often British and British non-doms, where they could conveniently bank their money in offshore accounts. The same tax havens had also a more sinister role, besides being specialized in tax avoidance they were also centres for the laundering of dirty money, the proceeds of criminal activity, drug trafficking, gambling, prostitution and corruption.
In a modern five storey building, not especially remarkable, overlooking the Caribbean, not far from the centre of George Town, an incredible thirteen thousand companies were officially registered. Amongst these were Nassau Investment Holdings and Nassau Asset Management. The building, Ugland House, situated on South Church Street, was a sanctuary used by most leading international banks to register numerous offshore companies. The offices were there for all to see, everything was above board and perfectly legal and all activities were carried out in accordance with the laws of the small territory, carried out daily by ordinary though aptly qualified office staff, all of which caused Barack Obama to remark: That’s either the biggest building in the world or the biggest tax scam on record.
Under Cayman law these companies were barred from actually doing any business in the Caymans, which meant that shares, bonds and cash could technically be owned in the Caymans, but in reality were held in London, Greenwich in Connecticut, Frankfurt and Zurich. Many companies registered there, including Nassau Asset Management, were specialized in securitized trusts or derivatives. In total more than three thousand hedge funds had registered offices the Caymans. In addition major British banks held hundreds, perhaps thousands of accounts there, where it was estimated more than a quarter of all US foreign deposits, a total of almost two trillion dollars, were held in 2009.
As far as the man in the street was concerned the sub-prime crisis commenced in August 2007, although its roots evidently went much further back in time. Some six months later, after Bear Stearns had been absorbed by JPMorgan in a government brokered bailout, the world mistakenly believed the sub-prime crisis had bottomed out. In reality the bailout was a warning shot announcing the start of a crisis of much greater magnitude; the first episode of a tragedy to come that reached its first dramatic moment with the collapse of Lehman Brothers in September 2008, when fifty percent of share values were wiped out in the greatest stock market collapse since the days of the Great Depression.
In the past, US households had been the primary source of capital for the country’s economy, through savings and investment. The period of unprecedented expansion, which commenced at the start of the new millennium, was however, funded almost entirely by foreign money. The US went from being a lender to a borrower as foreign money provided the bulk of new capital.
During the boom years Americans for the first time, taking advantage of easy credit, took more money from the financial system than they put into it to finance an unprecedented spending spree, fuelling imports and world economic growth.
As manufacturing and commodity exporters’ earnings grew, countries such as China, Russia and Middle Eastern countries sought safe investments for their dollars and placed their money in US Treasury bonds, sub-prime mortgage-backed securities, shares and hedge funds. Wall Street and the City of London channelled foreign capital into hedge funds and bonds backed by credit default swaps that provided insurance in the event of default.
With the collapse of Lehman Brothers foreign bond holders were hit, but precisely who and to what extent their losses were was unclear because of the difficult in determining the value of derivatives and bonds they held, without taking into account the lack of transparency of many foreign banks. What was clear was all major investors held vast quantities of toxic assets.
The real problem arose when a hedge fund could not pay the claims and the derivative had to be written down. Investors who had hedged their bets could not collect or pay their losses, with the result other investors defaulted on their bets. This led to a chain reaction of defaults that contaminated the entire banking system, prompting the legendary investor Warren Buffett, head of the one hundred billion dollar Berkshire Hathaway mega fund, to call derivatives weapons of financial mass destruction.
Dubai