Askin Capital Management owned three hedge funds that sustained significant losses in 1994, Granite Partners, Granite Corporation, and Quartz Hedge Fund. Vinod Kothari details the Askin fund implosion as a "Sad episode of Global securitisation" in his Hall of Shame as follows:
Askin Capital Management is a case of wrong investment priorities by investing in mortgage-backed securities and speculating on interest rates. David Askin was a mortgage trader who had floated investment funds, investing in high-quality mortgage securities. On the promise of liquidity high and leverage low, "risk neutral" investment strategies, investors handed over some USD 630 million to Askin's hedge funds - Granite Partners, Granite Corporation, and Quartz Hedge Fund.
Askin invested in PO strips of CMOs.
However, in 1994, interest rates, especially short-term rates, rose dramatically. As is the feature of PO strips, when interest rates rise, prepayments come down and the value of PO strips falls.
Four Askin funds with $600 million in assets filed for bankruptcy when the rising rates drove down the market values of POs. Investors lost virtually everything, and the collapse stopped the MBS market in its tracks, generating a string of lawsuits, some of which are still pending. Askin was barred by the SEC from the securities industry for two years, and agreed to pay a $50,000 fine without admitting or denying guilt.
It should be recalled that in the 1990s, Kidder Peabody investment firm had built up, and took a controlling share in the market for instruments which were the precursors to MBS, called collateralized mortgage obligations (CMO); they worked on similar principles as MBS. Kidder Peabody dominated the CMO market, controlling approximately 25% of it. Kidder Peabody had five smaller firms, that functioned as "satellite firms" to Kidder Peabody, buying CMOs from and selling them to Kidder Peabody, and thus making the market in CMOs. The most important of these "satellite firms" were three hedge funds owned by Askin Capital Management, run by David Askin. Askin Capital Management often bought the most risky of the CMO instruments, which were known as "toxic waste," and packaged them and disposed of them to other firms.
During the first quarter of 1994, the interest rate on new 30-year mortgages had averaged 6.93%; Kidder and its satellites made a financial killing in the CMO market. But then during the second quarter of 1994, the interest rate on new 30-year mortgages jumped to an average of 7.45%, an increase in interest rates from the first to second quarter of half a percentage point. The CMO market, which was heavily leveraged, did not adjust well to the sharp increase in interest rates, even at only half a percent. At the end of March of that year, the three hedge funds controlled by Askin Capital Management were liquidated; but the Askin firms had $2.5 billion in CMOs, much of it on borrowed money. This set off a shock wave, which collapsed the more than 100-year-old Kidder Peabody, and bankrupted the CMO market. The Fed had to intervene to stem the crisis. In 1994, the size of the total CMO market was approximately $150 billion.
The Askin Capital Management implosion is a great example of how a seemingly small change in the markets can lead to a massive market implosion. As noted above, the interest rate change that set off the implosion was a mere 52 basis points. Further, Askin's share of CMOs was less than 2% of the entire market.
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Important: This fund is on our list of hedge funds that have "imploded" (see also ailing lenders). However, please note that "imploded" is a somewhat subjective. The "imploded" list contains hedge funds (or other unregulated and autonomous speculative investment funds) which have gone through some sort of permanent adverse change. This is a somewhat subjective call, and does not necessarily mean total shutdown or bankruptcy. It can also mean steep and rapid mark-downs in net asset value; or abnormal "bail-out" by corporate parents or peers in order to avoid write-downs and provide liquidity. The funds are of any type and sector.