Bonfire of the vanities

The meltdown in the credit markets has humbled theself-styled masters of the universe behind Cheyne Capital. No one understood what they did, but a year ago they were being feted as the high priests of global capital. Now they are cast as its villains. By Danny Fortson
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The Independent Online

An inevitable by-product of any financial crisis is the schadenfreude that wells up among a populace that for years has had to swallow hard at the steady stream of stories about multi million-pound City bonuses and the lavish lifestyles led by those inhabiting the highest echelons of the financial universe.

So as the body count of high-flying financiers laid low by this summer's global credit crisis increases, it is not surprising to find a pervading satisfaction at the fabulously remunerated being served some piping hot servings of humble pie (even if the most hard hit will still be left infinitely better off than most).

Few have a fuller plate these days than Stuart Fiertz and Jonathan Lourie. Not long ago the former Morgan Stanley bankers were being feted as financial alchemists, the proverbial smartest guys in the room. After all, Cheyne Capital, the hedge fund they started in 2000 with just $200m – a relatively modest amount in the $1.9trn global hedge fund industry – had achieved phenomenal success, a shining example of the new breed of financial innovation that produced big returns for investors and, supposedly, little risk that it could all go "poof".

By this summer, the cash pile they controlled from their St James's offices had ballooned to more than $12bn, with another $8.8bn held in a structured investment vehicle, or SIV, called Cheyne Finance that they set up with help from their old chums at Morgan Stanley.

Things were going very well indeed. Mr Fiertz, a 43-year-old American who has lived in the UK for 17 years, accumulated a fortune of more than £110m according to the Sunday Times Rich List. A graduate of Dartmouth College, the Ivy League university in Hanover, Connecticut, he also found time to branch into philanthropy.

Mr Fiertz is a trustee of the Club of Three, which despite the forboding name is a non-profit outfit dedicated to promoting "broader understanding of pol-itical, social and economic dev-elopments within and between the three countries." It does so by convening meetings in different European capitals of businessmen, academics and journalists from the UK, France and Germany.

The Club of Three is chaired by Lord Weidenfeld, the former journalist and publisher whose firm made a name for itself for publishing Vladimir Nabokov's provocative masterpiece Lolita. Lord Weidenfeld is also chairman of Cheyne Capital. Mr Lourie, a 44-year-old naturalised British citizen, lives in Kensington, not far from the firm's offices.

Like most of their hedge fund peers, Mr Fiertz and Mr Lourie operated in relative anonymity from the general public. Within the opaque hedge fund industry, however, the pair were making headlines, and oodles of money. Last year, the magazine Euro-money named Cheyne "Best CDO Manager", intoning that the firm had "rewritten the rule book in structured credit this year thanks to breathtaking pace of innovation". In 2004, Eurohedge dubbed Cheyne "Firm of the Year".

Of course, that was all before the credit crunch took hold this summer. This week, Cheyne Finance, the SIV set up by the mother firm, found itself in the press for a very different reason. The $8.8bn vehicle handed itself over to the receivers, Deloitte – the latest and perhaps largest victim of the global liquidity crunch thus far in the UK's hedge fund community.

The development thrust Mr Fiertz and Mr Lourie into the harsh spotlight now being shone on banks, hedge funds and the other financial wizards. Specif-ically, questions are being asked of SIVs, the arcane instruments which have been revealed as a crucial piece of the global credit system yet were virtually unknown – or at least ignored by most – until just a few weeks ago. Indeed, Cheyne's entry into receivership came on the same day that Moody's, the credit ratings agency, slapped a negative outlook and downgrades on $14bn worth of bonds held by half a dozen SIVs (including Cheyne) around the world due to what the firm termed "unprecedented price volatility."

So just what are SIVs? The first of these highly specialised funds was created by Citibank in 1988 in response to what Moody's described as investor appetite for "steady returns" with little risk of losses. They rely on the ability to sell short-term debt, called commercial paper, to investors in order to then buy into longer-term investments that produce better returns. Their initial growth was gradual: by 2001, there were only ten around the world. Yet in the recent boom years of the market, their popularity skyrocketed. Today, there are 30 SIVs, plus another six SIV-lites, a legally simpler version that are often less diversified. In practice, some are focused almost solely on residential mortgage-backed securities, which are packages of US loans made to individual borrowers. Between them, this handful of little-understood funds have grown to control $412bn – $400bn of which is held in SIVs, the remainder in SIV-lites. The biggest single fund controls more than $55bn.

When the market was running smoothly, few voiced concerns about these funds. Yet when the market began to get indigestion earlier this summer, investors began to take a closer look at what it was they had been happily buying into. Many were not quite sure what they were looking at. Add to this the revelation of the hundreds of billions that investment banks have built up in conduits – opaque, heavily leveraged off-balance sheet vehicles – and the landscape of the global credit market all of a sudden looked quite hazy. The upshot has been a widespread crisis of confidence. Credit markets have ground to a halt. Banks won't lend to each other, and investors previously eager to get their hands on commercial paper – the short-term debt that is the lifeblood of SIVs – have completely turned their backs on the sector.

Worse, Moody's and Standard & Poor's, the credit ratings agencies the market relies on to deem the creditworthiness of such vehicles, only began downgrading the offending SIVs once much of the damage had already been done. Moody's downgraded some Cheyne Finance bonds, for example, yesterday – the same day it was put into receivership.

Cheyne Capital is at pains to explain that Cheyne Finance, the SIV, is entirely separate from the mother company, which is still operating normally. The former was forced into receivership after its net asset value dropped to levels that triggered automatic asset sales. Yet even a week ago Mr Fiertz was still hopeful that there were other options. He was reported to have said: "We think chances are good for a recapitalisation. Because the Cheyne Finance debt holders are sophisticated, large institutions, they are looking at this sensibly."

The problem is now one of perception. None of the assets underlying the more than $400bn controlled by SIVs have experienced defaults. But in the current market, that doesn't seem to matter. It is a fact that SIV managers – facing a make-or-break moment next week when more than $100bn worth of commercial paper will have to be refinanced – know only too well.