Citadel Chief Denies Rumors of Trouble

<blockquote>"...We’ve seen a near collapse of the world’s banking system."
-- Kenneth C. Griffin</blockquote>


Citadel Chief Denies Rumors of Trouble

By LOUISE STORY
October 25, 2008
Source

The hedge fund manager Kenneth C. Griffin christened his company Citadel — a name that conjures images of ancient strongholds.

But now his fortress is coming under siege from some of the most dangerous weapons on Wall Street: rumors.

As the stock market tumbled again Friday morning, the Citadel Investment Group, which rarely discusses its business affairs publicly, took the unusual step of issuing a statement to deflect rumors that it might be in trouble. The talk, Citadel said, was “categorically false.”

Hours later, Mr. Griffin held an emergency conference call that transfixed Wall Street, where some fear that troubled hedge funds might dump investments into the already-shaky markets.

But Citadel, Mr. Griffin said in the call, is sound. The firm, which is based in Chicago, has ample cash and financing facilities on hand, and its investors have withdrawn only a small amount of their money, he said.

Still, Mr. Griffin, who started trading out of his dorm room at Harvard in the 1980s, acknowledged that these were tough times in the financial world.

“I’ve never seen a market as full of panic as I’ve seen in the last seven to eight weeks,” Mr. Griffin said. “To call it a dislocation doesn’t go anywhere near what we’ve seen. We’ve seen a near collapse of the world’s banking system.”

Citadel runs some of the largest and best-known hedge funds, and its pain is a sort of bellwether for the broader industry, which is having its worst year on record. Hedge funds lost an estimated $180 billion during the last three months and some are near collapse. Investors are demanding their money back, and Wall Street is bracing for a shake-out in the $1.7 trillion industry.

“The reason we worry about something like Citadel is that it’s so large that you’d worry about systemic risk,” said William Goetzmann, a finance professor at the Yale School of Management, who has studied hedge funds.

The industry has grown fivefold in size since 1998, when many funds hit trouble, most notably Long Term Capital Management. A group of banks bought Long Term Capital Management’s assets to prevent its losses from cascading through the industry.

This time around, however, it is less likely that banks have the strength to stabilize the financial system if a big hedge fund hits trouble. It is unclear what role, if any, the government might play.

There is no evidence that Citadel will collapse, and Mr. Griffin’s remarks in the conference call may ease some of the doubts in the market. But Citadel has been in the position of fighting daily rumors, much like some investment banks. Investors are still debating what role rumors played in the deaths of Bear Stearns and Lehman Brothers.

“This is a game as old as organized stock markets,” said David Salem, the president of the Investment Fund for Foundations, which invests money in hedge funds for nonprofit organizations. “Traders know if they spread rumors and cause Citadel to unwind, that they can put wind in their own sails.”

For Citadel, the trouble began in September, when its largest funds lost 16 percent because of a divergence between prices on derivatives and related cash assets. Problems have continued this month, and Citadel’s flagship fund is now down 35 percent for the year. The rumors on Friday included word that Citadel was down 60 percent and claims that the Federal Reserve officials had arrived at the fund’s headquarters in Chicago.

Mr. Griffin did not refer to the rumors in the call Friday, but the fear in the markets generated frenzied interest in his remarks. Though the call was directed to Citadel’s small set of bondholders, about a thousand people dialed in. Scores of others tried to listen in, but the lines were busy.

“I’m less concerned about where the rumors are coming from, but certainly concerned about what is being said,” said Gerald Beeson, the company’s chief operating officer, in an interview. “And we took steps today to set the record straight.”

Mr. Beeson tried to dispel fears that Citadel could have trouble financing itself. He said the firm worked with a variety of prime brokers and had credit lines with commercial banks. Citadel has not tapped $8 billion of that credit, and the company has 30 percent of its capital in cash.

Citadel is leveraged just under 3 to 1 in its equity and credit-related businesses, which means it borrows $3 for every $1 it has in capital. That is a decrease from past levels.

Citadel also repurchased some 10 to 20 percent of its own debt in the last few days when approached by bondholders, according to a person with knowledge of the matter. Its bonds were put on negative watch by the ratings agencies in recent weeks. Mr. Beeson said that most of the funds’ losses were mark-to-market losses, which he thought were caused by a lack of liquidity and not by weakened assets. Earlier this year, investment banks said their losses were being caused by similar liquidity problems. Asked how Citadel’s paper losses differed, Mr. Beeson said, “This is not a portfolio of illiquid real estate assets. It is a portfolio principally consisting of bonds, equities and related assets.”

Citadel in the past has been strong when others were weak. Mr. Griffin has often called his competitors at their weakest moments and offered pennies on the dollar for their portfolios. Some of his recent winnings came from trouble at E*Trade, and the collapse of the hedge funds Sowood Capital and Amaranth Advisors.

When quantitative hedge funds tumbled in the summer of 2007, Mr. Griffin reportedly called Clifford S. Asness, managing principal of AQR Capital, looking for a deal. Mr. Asness, who survived the squeeze, described his reaction to the call to a reporter by saying, “I looked up and saw the Valkyries coming and heard the grim reaper’s scythe knocking on my door.”

Mr. Griffin is not only famous for buying assets cheaply, he is also known for picking off talented workers. JPMorgan Chase stopped trading with Citadel for one day in September to protest Mr. Griffin’s hiring from its ranks.

In 2005, the hedge fund manager Daniel S. Loeb of Third Point Capital wrote a widely circulated e-mail message to Mr. Griffin about Citadel’s poaching. Any attempts to hire his or his friends’ workers, Mr. Loeb wrote, would be considered “an act of war.”

The two hedge fund managers reportedly made up in recent years, when Mr. Loeb mailed Mr. Griffin a book on diet and exercise. Mr. Loeb said in an e-mail message Friday that he had “come to respect Ken for his intellect, competitive spirit, relentless drive and energy.”

“I’m sure he views this chaotic environment as a chance to demonstrate his impressive skills,” Mr. Loeb said.