Dreyfuss, Hedge Hogs

Unlike its namesake “eternal” flower, the Amaranth hedge fund was all too mortal. It opened its doors in May 2000 and, in an epic downfall, shuttered them in the fall of 2006. “At its peak in August, Amaranth LLC had assets totaling $9.668 billion. But four weeks later, more than $6 billion had vanished.”

Barbara T. Dreyfuss investigates the “high stakes battle” that led to the fund’s demise in Hedge Hogs: The Cowboy Traders Behind Wall Street’s Largest Hedge Fund Disaster (Random House, 2013). It’s a gripping tale of two natural gas traders whose activities roiled energy markets, “costing utilities, small companies, schools, hospitals, and homes millions of dollars,” and whose “contest ended when one collapsed a multibillion-dollar firm and the other became a billionaire.”

Prior to joining Amaranth Brian Hunter had had a rocky career at Deutsche Bank where, after losing $53 million in two weeks, he was demoted from head of natural gas trading to research analyst and “due to his lack of integrity and immaturity” got no bonus. But Amaranth, eager to expand its commodity business, scooped him up nonetheless. Two and a half years later, when news of Amaranth’s demise became public, executives at Deutsche Bank felt vindicated. As one said, using a reference to cricket players practicing before a game, “he was merely playing in the nets when he was here.”

Hunter’s bête noir, John Arnold, was one of Enron’s most profitable traders in its heyday; his VAR was one-fifth to one-third of Enron’s entire limit. After Enron imploded he set up his own hedge fund, Centaurus. In 2006 Centaurus earned a 317% return and Arnold’s personal income surpassed that of T. Boone Pickens, Steve Cohen, and Paul Tudor Jones.

Dreyfuss’s story also has a supporting cast, starting with Nicholas Maounis, who founded Amaranth and who rewarded outsize returns with outsize trading capital. In 2005, for instance, Hunter’s trades turned around what would have been a losing year for the fund. And so “capital allocations were cut for some portfolio managers and traders in order to funnel more money to Hunter.” Maounis turned a blind eye to the potential risks in Hunter’s huge, concentrated positions.

And regulators placed few limits on Hunter’s activities. ICE was exempt from government regulation and had no trading limits. NYMEX set only loose guidelines. “The only firm limit set by NYMEX, under CFTC guidance, was on how many expiring contracts a trader could hold during its last three trading days: one thousand. But traders did not have much trouble getting permission to exceed these limits. Indeed, in September 2005, Amaranth’s limit for such trading was raised to twenty-five hundred.”

Hedge Hogs is a cautionary tale but not a finger-wagging one. Since the plot is so compelling, Dreyfuss doesn’t have to be preachy. Of course, one knows in advance how it ends, but that doesn’t interfere with the trading drama. The book’s a page turner.