Monthly Archives: December 2012

Economic theory can’t tell us much about the single most important economic fact of the past three decades: how the world has become split between an increasingly wealthy elite, and an increasingly impoverished majority.

Paul Tudor Jones after an especially lucrative day of trading commodities and equities, circa 1986.

Paul Tudor Jones after an especially lucrative day of trading commodities, equities, and currencies, circa 1986.

People who study Wall Street with an academic lens often say one or another thing about the idea of the “smart” investor who can pick winning stocks, buy them at key moments, and hold them just long enough to harvest big returns. Half say it’s poppycock. Markets are efficient, information is readily available, trading is liquid, and share prices adjust virtually in real time to any change in expectations. You can’t beat the market, they say. Burton Malkiel summed the view up saying a blindfolded chimpanzee throwing darts at the Wall Street Journal’s tables could pick stocks with the same success rate as any of the professionals. Malkiel and others have trotted out data sets to prove just this point. Over decades-long time frames professional portfolio managers at the big mutual funds and boutique houses have failed to beat the average rate of return. What’s implied in a lot of this, is that markets are also fair. Nobody really has an advantage. Transactions and assets are transparent processes and things, and when someone does make an absolute killing, it’s either through risky strategies that will sooner or later backfire on them, or some sort of insider crime.

Then there’s the economists who think that some crafty investors can beat the market, but not for the most reassuring of reasons. This camp points to evidence that markets aren’t efficient. Instead markets are ruled by irrational forces buried deep in the popular psyche. Stock trading happens between human beings whose expectations are as much emotional and superstitious as they are educated guesses about the future values of assets based on sober facts. Keynes was the big ideas man who first popularized this view of markets and made it into a proper subject for his colleagues to talk about. Subsequent behavioral theories of markets are summed up by the notion of “irrational exuberance,” the famous utterance of Fed Chairman Alan Greenspan to describe the mid-90s stock market bubble in an otherwise boring speech. Yale economist Robert Shiller used the phrase for a book that warned of the dot com bubble which popped in 2000. He recycled the book with some new material to talk about the irrational bear market for housing in the 2000s. Shiller saw these bubbles coming and made a fortune selling timely book-length criticisms of the macro economy’s fantasy ride. Numerous financiers also saw the bubbles and made killings by shorting housing, equities, bonds, and other over-priced securities. Here again a lot of shenanigans are implied, but so is the basic fairness of the market.

John Paulson, head of the Paulson & Co. hedge fund, circa his "big short" bet against US subprime housing securities in 2006.

John Paulson, head of the Paulson & Co. hedge fund, circa his “big short” position against US subprime housing debt in 2006.

So are markets rife with under and over-priced deals fit for the taking? The market is certainly systemically inefficient because it’s a big messy human drama, but does this at least provide wiggle room for brave, crafty, and patient investors to beat the average rate of return? Maybe that’s the gloss over the warning the behavioralist school of thought is really trying to impart; financial markets are intrinsically unstable and prone to bubbles and deflations that grow from a bi-polar collective consciousness. If that’s true, there are moments when real value can be seized at discounted prices, and over-priced assets can be shorted by the cognoscenti. The herd perishes before the ubermensch hunters who can smell the beastly fear and stay a step ahead. Is this what we should believe about the few elite investors who continually post massive profits while the pack stagnates?

In wondering about “the market” as a totality this debate between the efficient markets school and the behavioralist school misses the trees for the forest. Yes, I turned that phrase backwards. The problem here is big picture thinking. Too many economists start from the wrong level of analysis. Economists are rightfully concerned with the forest —the economy as a whole unit— but they make the mistake of launching straight into theorizing about “the market” as a whole, and the big forces that drive it. They’re looking too much at aggregate sets of data.

The question of whether markets are efficient or not, and how some investors beat the average returns, has too often proceeded from a ten thousand foot level where individuals and firms and governments and laws and historical events disappear into a noise of statistical data, where returns are averaged, and actors are lumped into vast populations and categories, or else they’re lumped into psychological categories, and all the action is reduced to something akin to ravenous locusts or panicking wildebeest. Specific trees disappear, and we’re left with the abstract jungle of either efficient markets allocating capital and rewards in seemingly random ways, no matter an individual’s efforts, or wild-thing markets swung around by animal spirits, devouring the slow herbivores who feed on the buy or sell ratings of analysts.

If you look at the major studies that bolster the efficient market hypothesis and the behavioralist views you’ll notice that they’re short on micro case studies that focus in on particular investors, firms, and business stratagems. These sorts of accounts are ridiculed anyways as “journalism” or the niche sub-field of “economic history,” which is considered more of a member of the field of historical arts than the “science” of economics. This is largely because economics has pretended to be a rigorous science for over 100 years now. In emulating the rex of science, physics, economics has actually fled from reality and built a world around logical models set spinning into equilibrium with mathematical methods.

There are political reasons for this, of course. It’s too much to get into here, but the short of it is that getting away from concrete reality that could be revealed through detailed case studies of economic activity helps mask some politically damaging realities for those who have managed to accumulate big shares of the world’s wealth.

rbpieMost economists never got the memo from the other social sciences that detailed ethnographic, comparative, and historical study is just as rigorous, and can often produce much richer theory than abstractions based on big quantitative data sets. Or they saw the memo, but chose to ignore it. After all, economics serves two purposes. One is to attempt to understand how the economy sets prices, meets demand, grows, and allocates capital, whatever all that means. The other is to attempt to legitimate the way the economy actually functions by telling a value-neutral story about a fair and natural system, using fancy equations and hard to envision categories like gross domestic product and marginal income, when what’s actually being discussed is a not so happy tale of power and conflict.

When I read the best of contemporary business journalism what jumps out are the details, not the big sets of data showing market trends, price movements, or average portfolio returns. It’s the people, firms, and the tactics they use to amass fortunes from securities markets that appear in high fidelity and get my mental gears spinning. All the advanced theories of markets and finance add little value to these tales, serving only to wash away the reality.

To be clear, I think both the efficient markets hypothesis and behavioralist theories can offer some useful guidance in understanding part of the big picture. They’re not entirely without some truth to them. It is incredibly rare for someone to best the market by simply picking the best stocks, bonds, and making smart bets in derivatives markets. In this sense the EMH is good at describing the odds a normal person, acting without any special access, information, and with just a modest sum of capital, can beat the market. You can’t really. Additionally, of course the markets are irrationally driven by emotions, and prone to bubbles, recessions, and depressions. People lose their shirts all the time, especially the little investors and the weaker institutions like pension and mutual funds.

What do these theories really help us understand about our lives though? What do they tell us about the truly pressing questions of our era? Not all that much. The infatuation that the economists have had with their own insular debates about markets reveals more about the function of economics in veiling power relations than anything else.

Another big picture, derived from a decidedly ethical concern, is how the world is becoming polarized between a wealthy elite and an increasingly impoverished majority. Today’s elite, the rentiers and creditors who exert disproportionate influence on our political systems and control most of the world’s capital, and thus our collective future, many of these rainmakers obtained and maintain their positions of power precisely by “beating” the markets and surviving periods of irrational exuberance. Somehow, against both the notion that markets are efficient and impossible to beat, and markets are volatile and dangerous, today’s one-percenters used stratagems to squeeze capital from markets that are otherwise impossible to gain much from because of their efficiency, or their volatile irrationality.

So how did the contemporary elite do this? That, I think, is the real question to be asking about markets. It doesn’t invalidate what’s obvious or useful about other theories, but it does allow us to bust free from the limits of “scientific” economics and finance theory, and concern ourselves with a more social and anthropological study of the economy as a system of power relations. I think it requires attention to specific cases of accumulation on detailed levels.

Getting away from the forest views where actors are all just individual data points and the market is a vast plot of variables moving in impossibly complicated ways is a good place to start. Let’s start instead by looking at the so-called masters of the universe who have done quite well for themselves against the market’s efficiency, and against the noise of volatility and random catastrophe.

Hedge funds and private equity firms seem like great places to start.

Private equity fund Kohlberg Kravis and Roberts has been around since 1976 and throws weight at over $40 billion in assets. KKR has been an astoundingly successful firm when it comes to obtaining returns on investments that beat the average market participant. Or take Bain Capital, the most well known private equity fund in the world now thanks to that guy who ran for president in 2012. Bain pounced on the markets when it was founded, and grew at a phenomenal rate, posting profits that year after year showed acumen far above and beyond what other businesses were capable of, including most other PE firms.

Among hedge funds there are plenty of examples of winners who defy the standard economic theories of how markets work. Bridgewater Associates, the world’s reigning zeus of the hedge fund pantheon, was founded in 1975 and has grown rapidly into an overseer of $122 billion in assets. A new hedge fund outfit, the Brevan Howard firm, with $36 billion under management, has repeatedly bested the market, posting huge gains even in macro-economic downturns. In 2008 and 2009 Breven Howard posted gains of 20 percent and 18 percent respectively.

How do firms like these beat the market time after time? Sure, some blow up. Those that do, like Long Term Capital Management, get sliced up by their creditors, and the quants or dealmakers running the show go gently into the night, into semi-retirement in their Gold Coast mansions, but more often into business under another name. What’s amazing is that so many of the top hedge funds and private equity groups have such staying power. If we’re to believe in efficient markets or take on a cynical behavioralist viewpoint, all these firms should be out of business, or at least not growing at double digit rates into entities with wealth surpassing many sovereign nations. How do they survive the irrational explosions of turbulence that roil asset prices every three to five years? Indeed, how do they often post their biggest gains at precisely the moment the efficient markets are efficiently destroying everyone else’s wealth because the crowd psychology tipped from glee to gloom?

Here’s a hint: it’s not due to their super-human intelligence, secret sauce market models, protestant work ethic, or sobriety. It boils down to power. The contemporary financial elites use power through politics, the law, and sometimes even the raw power of the huge pools of capital they control, to make markets move, or else to get around the other efficient and fair mechanisms that most other market participants must abide by.

This will guide a couple future posts here. I’ll explain some of these strategies, but unlike the dismal scientists, I’ll be focusing in on specific cases to reveal how the top dogs accumulate wealth. These will be tales of non-efficient markets where power relations are masked behind prices, information, and access.


An Oakland native-turned New York hedge fund operator, and several Oakland-based foreclosure-to-rental mills bracket the the the boom, bust, and ‘recovery’ of the US housing market

Picture 4Between 2007 and 2011 over 10,000 homes in Oakland, California were foreclosed on. Of home loans originating between 2004 to 2008 within the city, nearly 1 in 10 have gone into foreclosure. Most of these foreclosures threw Black and Latino residents out of their houses, leaving specific neighborhoods in West and East Oakland’s flatlands devastated by vacancy and blight, to say nothing of the hardships facing displaced families. Some streets saw multiple emptied houses deteriorate, often several on the same block. Empty homes quickly became dump sites and health hazards, further depressing surrounding property values and draining community wealth. The process hasn’t stopped. According to RealtyTrac 399 homes went into foreclosure in Oakland in October of 2012.

It didn’t take long for those with capital to take advantage of this crisis. As the Urban Strategies Council has reported, wealthy investors have snapped up 42 percent of completed home foreclosures in Oakland at auction, or from bank sellers, between 2007 and 2011. The goal of these investors is to turn these properties, 93 percent of which are located in Oakland’s low-income flatlands, into rental properties. In the lingo of the Wall Street banks and hedge funds hoping to cash in on this trend, foreclosed homes that can be converted quickly into large portfolios of rental properties are a new “asset class” that promises “higher yields” than almost any other investment out there today.

The result is that ownership of Oakland’s housing stock in Black and Latino neighborhoods, and thousands of homes in parts of the Bay Area, especially the East Bay suburbs, are quickly being transferred from local residents to absentee landlords. It is nothing less than a vast transfer of wealth and power.

For the Bay Area, the origins of the foreclosure crisis are both global and intimately local. In many ways Oakland sits at the center of the foreclosure wave that is itself at the center of the global financial crisis. The unequal impact upon particular communities of the local housing market’s meltdown mirrors national trends. Black and Latino communities have been seriously harmed by predatory lending, the financialization of consumer credit and housing debt, and the resultant crash. Some neighborhoods in Oakland are as devastated as any of the worst hit regions across America — Atlanta, Las Vegas, Phoenix. Now the morphing of the housing bust and foreclosure epidemic into a lucrative multi-billion dollar opportunity for major investors is also uncannily centered upon Oakland and the greater Bay Area, where companies flush with hedge fund cash are buying up homes by the thousands.

The entire sweep of the US housing bubble, financial crisis, and foreclosure wave can therefore be told by looking at persons and companies with intimate links to Oakland and the Bay Area. What follows is one account.

Central to this story is an ex-Goldman Sachs trader, raised in the East Bay’s exclusive Oakland Hills, who helped the mortgage industry create the nationwide housing bubble by underwriting the complex mortgage-backed securities and credit derivatives that eventually exploded, causing a near meltdown of the whole economy. This whiz kid emerged from the crisis as a wealthy hedge fund operator who is now making huge bets on a housing “recovery.”

Alongside Goldman’s ex-golden boy are several hedge funds, some of them based in the Bay Area, and a growing list of corporations, also a few with headquarters here in Oakland, all of them busy buying up foreclosed homes across the region and country, and transforming them into rental portfolios so as to extract value from US families that have been driven from home ownership by the crisis.

Financial operators such as these profited from the housing bubble. Some of them profited doubly from its collapse. All of them are now tacking backward to make billions more on a housing “recovery.”

This recovery, however, won’t involve the salvation of low-income homeowners still struggling to keep their houses, or to obtain new homes on fair terms. Rather, it’s simply about “spreads,” the changes in price differences between different debts and assets traded by powerful banks, hedge funds, and private equity firms. Like the “jobless recover” that appeared in 2010 with corporations and the wealthiest stratum of America posting record profits and incomes, the housing recovery that has commenced is characterized by the absence of middle and working class persons and families keeping their homes, or obtaining mortgage loans for new housing opportunities.

Having run much of its course, a consolidation is occurring at the bottom of the foreclosure crisis, with homes and the wealth of working families being transferred into the portfolios of a few elite investors.

From the Oakland Hills to the Bubble’s Epicenter

In his account of “how Goldman Sachs came to rule the world,” William Cohan says that Josh Birnbaum dreamed from an early age of working on Wall Street.

Head Royce, Oakland's most elite private high school.

Head Royce, Oakland’s most elite private high school.

“His interest in finances was encouraged by an uncle—whom  he greatly admired—and who one day showed his nephew the Wall Street Journal’s options table. His fascination with options and how much money potentially could be made from them grew out of that moment. He was twelve years old.”

In 1990 Birnbaum graduated from Head Royce School, the elite K-12 private institution in the Oakland hills where tuition currently costs $31,000 a year. He had his sights set on becoming a business executive and financier. He left the East Bay for the University of Pennsylvania’s Wharton School of Business, one of the top colleges for aspiring investment bankers.

Before Birnbaum even graduated from Wharton he was already working summers for none other than Goldman Sachs. The bank gave Birnbaum a demanding job that required on-the-fly math skills and on-your-toes negotiating chops. His task was to purchase mortgages from originators, companies like Countrywide and Fremont General, companies that were then beginning to market sub-prime and Alt-A loans on vast new scales thanks to historically low interest rates influenced by federal economic policymakers.

Birnbaum would pool together mortgages into relatively new financial products called collateralized mortgage obligations (CMOs). Goldman and other investment banks were just beginning to ramp up production of these and other hyper-complex debt securities for sale to all types of investors seeking higher yields than government bonds, but less risk than corporate stocks. The biggest buyers were insurance companies, commercial banks, and hedge funds. Credit ratings agencies signed off eagerly on the products.

Oakland’s Birnbaum soon took a full-time job at Goldman Sachs and carried on with the work of securitizing home loans, but he also expanded into trading other products related to mortgage debt, including credit default swaps (CDSs). CDSs are basically insurance agreements against the possibility that a debt obligation (like a CMO) would fail to be repaid. CDSs became a modest-sized market, but so long as the housing bubble continued to expand there wasn’t too much demand for them. Few thought insurance was necessary on mortgage-backed securities. In the world Birnbaum inhabited it was commonly remarked that the last time US home prices declined was the 1930s, the Great Depression, an unthinkable possibility given the supposed sophistication and risk management of the new globalized financial economy.

Birnbaum’s career took off with the housing bubble, but what really made him a star within the bank was his idea for how to make billions off the coming crash that was supposedly unthinkable. Birnbaum and a few other key players orchestrated one of the biggest killings in Wall Street history by betting against the very products they had spent almost two decades creating and selling: mortgage-backed securities.

From the Big Bubble to the Big Short

In 2006 Birnbaum was trading through the ABX.HE Index, a securities index that referenced housing equities in various CMOs, including those that Goldman had structured and sold. ABX.HE was created by Goldman Sachs and a handful of the other Wall Street investment banks that served to make the markets for CMOs, CDSs, and other housing derivative products. Goldman even owned part of the holding company that controlled the administrator of the ABX.HE Index, MarkIt, the London-based data shifter.

Home prices steadily rose for decades, shooting rapidly upward in some regions of the country like California, only to plummet in 2007.

Home prices steadily rose for decades, shooting rapidly upward in some regions of the country like California, only to plummet in 2007.

One of Birnbaum’s clients asking for ABX.HE trades was the Paulson & Co. hedge fund. Paulson & Co. was unlike other clients. In 2006 when few suspected anything was wrong with the US housing market, the Paulson & Co. hedge fund was asking Birnbaum to make bets that were extremely contrary to the prevailing market sentiment.

Paulson & Co. was making a multi-billion dollar bet that US housing prices would decline, that these declines would be large enough to cause millions of home owners to default on their mortgages, and that these defaults would cascade through the financial system, through the CMOs assembled from countless mortgages, thereby triggering credit default swap payouts linked to lower tranches of mortgage bonds. All this would mean enormously big gains for those buying protection through the ABX.HE market. By buying protection through the ABX.HE Index, Paulson & Co. were said to be gaining synthetic exposure to the US mortgage market. The fund wasn’t hedging a bullish bet on one sector of the housing market, or some other investment strategy in corporate stocks or commodities futures with a bearish position on subprime. Rather, they were massively speculating on a crash.

Birnbaum appearing on CNBC in 2012 promoting his views about housing's 'recovery' as an asset class for investors.

Birnbaum appearing on CNBC in 2012 promoting his views about housing’s ‘recovery’ as an asset class for investors.

It was a trade that Birnbaum and a few colleagues soon convinced Goldman’s higher ups to adopt. In little time Goldman Sachs, through Birnbaum’s desk, was also betting massively against the US housing market.

Various accounts of the “big short,” as the strategy has been called, claim that Goldman’s employees were thinking there would be a modest to serious event leading to big market disruptions and a big profit for the bank. Few Goldman employees admit to thinking the entire financial system was speeding toward a cliff. If they did, none of them took action to prevent a crisis by, for example, verbalizing their concerns to federal regulators at the Treasury Department, SEC, White House, Federal Reserve, or elsewhere. In fact, the sell-off of their own mortgage-back assets, their “warehouse” of mortgage bonds awaiting securitization, and their aggressive moves to bet against the market, all amounted to a small, but significant force that actually sped up and worsened the coming crash for everyone but themselves.

Goldman’s traders quietly leveraged their bets for even bigger profits. They were dealing with a universe of equations, numbers, models, far removed from the human toll that would be exacted when their models played out in the real world. Nowhere was the “big short” so devastating as California where more subprime, predatory mortgages had been issued than any other state.

While the most severe consequences of the coming crisis and foreclosure wave would be concentrated in the Central Valley, Inland Empire, and portions of LA, Oakland’s flatlands would endure a serious spate of foreclosures, many of them prompted by declines in home prices. Stockton, and the smaller suburban towns off the I-80 between Sacramento and Oakland have been among the most damaged by foreclosures in the entire country. Goldman Sachs and hedge funds like Paulson & Co. were therefore not just minting money off their sophisticated peer counterparties like Lehman and AIG who were stuck in long positions (betting on US home price appreciation and continuing payments being made on subprime debt), rather, these short sellers were making money off the human crisis of families losing their homes. The more people who found their debts impossible to pay, and were forced out onto the street, the higher would be Goldman Sachs and Paulson & Co.’s profits.

Conflict of Interest

As has been widely reported, Goldman Sachs was making the bet of the Century against the very same products they had earlier structured and sold to investors. This became one of the most scandalous revelations of the financial crisis, something the Senate Permanent Subcommittee on Investigations called a “conflict of interest,” and “abuse,” and for which the Securities and Exchange Commission would fine Goldman $550 million in 2010. Even though it was a record fine, the SEC’s half billion penalty was just a small percentage of the profits the bank made on their bets against mortgage-backed securities, some of which they had assembled and sold.

The deal that led to the half-billion SEC penalty is known as the ABACUS 2007-AC1 collateralized debt obligation. Goldman put the ABACUS CDO together specifically so that the Paulson & Co. hedge fund could short sell hundreds of million in subprime mortgage debt, a strategy designed to siphon billions in profits from counterparties that were willing to be on a continued housing boom.

Goldman duplicitously sold the ABACUS CDO to IKB, a German bank that was too hungry for mortgage income streams, and too far away, or, like many US investors at the time, still too enamored with the fairy tale of never ending economic boom times to realize the mortgage debts being sold their way were some of the most toxic and dangerous on the market.

After buying the ABACUS 2007-AC1 CDO, IKB turned around and sold financial products that depended on the ABACUS CDO’s cash flow to various customers, including non-other than the city of Oakland and the Oakland Redevelopment Agency.

In 2006 Oakland bought $6 million in commercial paper issued by “Rhineland Funding,” an obscure offshore entity controlled by IKB which was financed with the ABACUS CDO. As late as 2007 the Redevelopment Agency had a $25.7 million investment in Rhineland. Oakland government was parking money with Rhineland, as the city and other local governments routinely do, to ensure tax dollars or bond proceeds don’t lose value to inflation.

When the market began to crash in late 2007, Rhineland hemorrhaged value. Luckily for Oakland the city had already been paid back on its $6 million investment, and the Redevelopment Agency got its money back too. Other investors were not so lucky. Paulson & Co. reaped hundreds of millions off bearish swap payments as the ABACUS CDO’s value plummeted. IKB faced massive and growing liabilities and dwindling funds to settle them. It was just one among thousands of major deals struck between some of the world’s largest financial corporations, all based on complicated contracts with values derived ultimately from the ability of US homeowners to pay their mortgages. In a feedback loop process, as mortgages went into default, financial companies began to fail, liquidity dried up, interest rates went haywire, the entire economy slowed and stumbled, reaching back to homeowners in the form of job layoffs, spiking interest rates, and other hardships, causing mortgage defaults, ad infinitum.

Birnbaum, who was at the center of Goldman Sachs’ larger plans to short numerous mortgage securities through the ABX.HE and by other means, escaped unfazed, even emboldened by the big short. He seems to have kept clear of the specific ABACUS CDO deal tailored for Paulson & Co., working instead on Goldman’s own proprietary position against housing prices.

Birnbaum, now a star trader at the world’s most powerful investment bank was, however, reportedly disappointed when Goldman’s partners offered him a paltry $10 million bonus for his services. Soon after Birnbaum left Goldman Sachs to start his own hedge fund, one that would trade you guessed it – mortgage backed securities.

Tilden Park

Tilden Park Capital Management’s web site says only that the hedge fund is a “multi-strategy fixed-income-focused alternative asset manager” that specializes in trading “structured products and mortgages, fixed income relative value and related corporate credit and equity strategies.” Although the fund’s offices are in Midtown Manhattan, the firm takes its name from Tilden Park, the forested regional park in the hills above Berkeley. A picture of Tilden and Lake Anza serves as the fund’s banner image on its web site. Oakland-native Birnbaum presumably chose the name for the hedge fund which he created with Jeremy Primer, another Goldman employee who worked closely with Birnbaum on the big short deal.

Screenshot of Tilden Park Capital Management's web site, Lake Anza appears set amid the rolling hills and oak forests of the East Bay.

Screenshot of Tilden Park Capital Management’s web site, Lake Anza appears set amid the rolling hills and oak forests of the East Bay.

Birnbaum’s official bio on the Tilden web site explains that he’s more or less a mortgage securitization guru. Before founding Tilden he served as the head of Goldman’s Structured Products Group, “which trades all securitized products including RMBS, CMBS, ABS and CDOs. During his career at Goldman Sachs, he served as desk head or lead trader across a wide spectrum of mortgage products including: mortgage credit, mortgage derivatives and mortgage passthroughs.”

No details are known about Tilden Park Capital’s current investment positions. Like other hedge funds, Tilden trades in securities and derivatives that aren’t disclosed in regulatory filings, and the fund has no obligation to disclose any of its trading activities. Birnbaum has been eager to make media appearances over the last year, however, talking about what he sees as the future of the US housing market, and new strategies he has devised to make yet another fortune.

In October of 2012 Bloomberg News reported that Birnbaum’s Tilden Park Capital is posting a return as high as 30% this year, which would amount to roughly $300 million in gains on the fund’s $1.1 billion in capital. Citing Birnbaum himself, the report says that the hedge fund’s largest positions are bets on the value of US subprime mortgage-backed securities.

Birnbaum’s big bet that home prices will recover, that is rise from their current levels, is being made through the same ABX.HE Index he used while at Goldman Sachs to short the US housing market. Goldman Sachs is also currently promoting protection-selling positions through the ABX.HE as the housing market is expected to recover.

This “recovery,” and the opportunities for hedge fund operators like Birnbaum to profit from it, is due primarily to two factors.

First is the federal government’s intervention in the housing market to buy up government-backed mortgage securities. This pushes yields on mortgage bonds down and keeps lending rates lower than they would otherwise be. It is effectively the creation of artificial demand for mortgage bonds, mimicking a healthy housing market with widespread buyer demand.

The second factor helping to push up US home prices is the emergence of a whole new class of investors buying up billions of dollars worth of foreclosed single family homes to turn into rental properties.

Both of these forces have had the effect of bolstering home prices and driving down lending rates, even though there remain millions of homeowners delinquent, or nearing delinquency on their mortgage payments, and there remains a shadow inventory of foreclosed properties that are glutting a market that is already bereft of demand. Neither the federal government, nor the major investor activity should be confused for a program or development that will benefit those who have experienced declines in income and/or spiking interest payments on their debts that has lead to foreclosure.

Hedge Fund Landlords and the New Long Position on US Home Prices

The rise of hedge fund investors taking direct ownership of US housing stock is especially troublesome. Just as home prices are set to stabilize and possibly grow again, partly a result of federal intervention to buy up distressed mortgage debt, wealthy investors are seizing ownership of single family homes to obtain the gains in equity previously promised to many first time home buyers. Oakland is again very much a center of action.

A screenshot of Waypoint Homes' online, map-based rental searching tool. As of December 7, 2012, Waypoint lists eleven homes for rent in East Oakland.

A screenshot of Waypoint Homes’ online, map-based rental searching tool. As of December 7, 2012, Waypoint lists eleven homes for rent in East Oakland.

One company that is credited with innovating the financial and technology platforms to scoop up foreclosures on a bulk level and transform them into rental investments is Waypoint Homes. Waypoint, which is headquartered in Oakland, began buying foreclosed homes in 2008 at the beginning of the foreclosure and financial crisis. The company has focused on single family houses in the East Bay suburbs, especially areas like Antioch. Waypoint now reportedly owns more than 1,800 homes, mostly in California and Arizona. The company is incredibly ambitious, with plans to take their model nationwide, and is already advertising rentals in suburban Atlanta and Chicago.

Propelling Waypoint is the Menlo Park-based GI Partners private equity firm. GI Partners focuses on real estate and manages money for CalPERS, among other big institutional clients. In January of 2012 GI Partners announced a $250 million investment in Waypoint to speed up the company’s acquisitions of homes. GI Partners plans to spend another $750 million to expand Waypoint’s holdings by the end of 2013. On Waypoint’s web site the company lists homes for rent in East Oakland’s flatlands between 55th and 104th Avenue, Black and Latino sections of the city hit especially hard by foreclosures and where Waypoint has been able to obtain properties for half their pre-crisis prices.

Waypoint is reportedly earning large profits. Richard Magnuson, the head of of GI Partners, seems pleased with the results so far, but told a reporter for the Wall Street Journal that he’s wondering, “can you scale it to 5,000 or 10,000 homes, because the supply is there.” That supply of foreclosures is expected to last for several more years due to the stagnant US economy, job losses, and other factors that have caused many low-income, or highly indebted homeowners to default on payments.

Other companies getting in on the foreclosure-to-rental mill model include McKinley Capital Partners, a real estate investment specialist, which has its offices in Oakland’s Kaiser Center high rise. Like Waypoint, McKinley Capital has looked for funding from the world of private equity. New York’s Och Ziff, one of the world’s largest hedge funds, reportedly supplied McKinley with financing to buy up thousands of homes in California (but the hedge fund may be backing off now). As of January, 2012, McKinley reportedly owns $400 million worth of residential housing in the region.

Below this elite level of regionally and nationally focused companies are relatively smaller investors who are also making big plays for foreclosed housing in the Bay Area. In Oakland, as is detailed in the Urban Strategies Council’s report “Who Owns Your Neighborhood,” a small group of real estate speculators have been purchasing a large share of the city’s overall foreclosures. Their business model, and ultimate aims, aren’t as well publicized as Waypoint and McKinley’s, but they stand to profit doubly from displaced homeowners who have been turned into renters in search of housing, and the coming rise in home price values that seems set to occur in the next few years.