His fund used credit default swaps, which depend on the solvency of the institution issuing them. He closed it a few days after the Paulson rescue plan was unvieled. Washington Mutual then failed, the bailout was defeated and then passed, and the stock market had its worst week in 75 years.

It’s been about a month since he’s closed the fund, and on Friday his retirement letter was unvieled. Let’s just say it’s worth a read. Here’s the highlight:

Other interesting parts include who’s at fault for the subprime debacle,

First, I point out the obvious flaws, whereby legislation was repeatedly brought forth to Congress over the past eight years, which would have reigned in the predatory lending practices of now mostly defunct institutions. These institutions regularly filled the coffers of both parties in return for voting down all of this legislation designed to protect the common citizen. This is an outrage, yet no one seems to know or care about it.

his views on world government, and the role of hemp. Here’s the letter in it’s entirety. The original PDF can be found here.

October 17, 2008

Today I write not to gloat.  Given the pain that nearly everyone is experiencing, that would be entirely inappropriate.  Nor am I writing to make further predictions, as most of my forecasts in previous letters have unfolded or are in the process of unfolding.  Instead, I am writing to say good-bye.

Recently, on the front page of Section C of the Wall Street Journal, a hedge fund manager who was also closing up shop (a $300 million fund), was quoted as saying, “What I have learned about the hedge fund business is that I hate it.”  I could not agree more with that statement.  I was in this game for the money.  The low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA, was there for the taking.  These people who were (often) truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government.  All of this behavior supporting the Aristocracy, only ended up making it easier for me to find people stupid enough to take the other side of my trades.  God bless America.

There are far too many people for me to sincerely thank for my success.  However, I do not want to sound like a Hollywood actor accepting an award.  The money was reward enough.  Furthermore, the endless list those deserving thanks know who they are.

I will no longer manage money for other people or institutions.  I have enough of my own wealth to manage.  Some people, who think they have arrived at a reasonable estimate of my net worth, might be surprised that I would call it quits with such a small war chest.  That is fine; I am content with my rewards.  Moreover, I will let others try to amass nine, ten or eleven figure net worths. Meanwhile, their lives suck.  Appointments back to back, booked solid for the next three months, they look forward to their two week vacation in January during which they will likely be glued to their Blackberries or other such devices.  What is the point?  They will all be forgotten in fifty years anyway.  Steve Balmer, Steven Cohen, and Larry Ellison will all be forgotten.  I do not understand the legacy thing.  Nearly everyone will be forgotten.  Give up on leaving your mark.  Throw the Blackberry away and enjoy life.

So this is it.  With all due respect, I am dropping out.  Please do not expect any type of reply to emails or voicemails within normal time frames or at all.  Andy Springer and his company will be handling the dissolution of the fund.  And don’t worry about my employees, they were always employed by Mr. Springer’s company and only one (who has been well-rewarded) will lose his job.

I have no interest in any deals in which anyone would like me to participate.  I truly do not have a strong opinion about any market right now, other than to say that things will continue to get worse for some time, probably years.  I am content sitting on the sidelines and waiting.  After all, sitting and waiting is how we made money from the subprime debacle.  I now have time to repair my health, which was destroyed by the stress I layered onto myself over the past two years, as well as my entire life – where I had to compete for spaces in universities and graduate schools, jobs and assets under management – with those who had all the advantages (rich parents) that I did not. May meritocracy be part of a new form of government, which needs to be established.

On the issue of the U.S. Government, I would like to make a modest proposal.  First, I point out the obvious flaws, whereby legislation was repeatedly brought forth to Congress over the past eight years, which would have reigned in the predatory lending practices of now mostly defunct institutions.  These institutions regularly filled the coffers of both parties in return for voting down all of this legislation designed to protect the common citizen.  This is an outrage, yet no one seems to know or care about it.  Since Thomas Jefferson and Adam Smith passed, I would argue that there has been a dearth of worthy philosophers in this country, at least ones focused on improving government.  Capitalism worked for two hundred years, but times change, and systems become corrupt.  George Soros, a man of staggering wealth, has stated that he would like to be remembered as a philosopher.  My suggestion is that this great man start and sponsor a forum for great minds to come together to create a new system of government that truly represents the common man’s interest, while at the same time creating rewards great enough to attract the best and brightest minds to serve in government roles without having to rely on corruption to further their interests or lifestyles.  This forum could be similar to the one used to create the operating system, Linux, which competes with Microsoft’s near monopoly.  I believe there is an answer, but for now the system is clearly broken.

Lastly, while I still have an audience, I would like to bring attention to an alternative food and energy source.  You won’t see it included in BP’s, “Feel good.  We are working on sustainable solutions,” television commercials, nor is it mentioned in ADM’s similar commercials.  But hemp has been used for at least 5,000 years for cloth and food, as well as just about everything that is produced from petroleum products.  Hemp is not marijuana and vice versa.  Hemp is the male plant and it grows like a weed, hence the slang term.  The original American flag was made of hemp fiber and our Constitution was printed on paper made of hemp.  It was used as recently as World War II by the U.S. Government, and then promptly made illegal after the war was won.  At a time when rhetoric is flying about becoming more self-sufficient in terms of energy, why is it illegal to grow this plant in this country?  Ah, the female.  The evil female plant – marijuana.  It gets you high, it makes you laugh, it does not produce a hangover.  Unlike alcohol, it does not result in bar fights or wife beating.  So, why is this innocuous plant illegal?  Is it a gateway drug?  No, that would be alcohol, which is so heavily advertised in this country.  My only conclusion as to why it is illegal, is that Corporate America, which owns Congress, would rather sell you Paxil, Zoloft, Xanax and other additive drugs, than allow you to grow a plant in your home without some of the profits going into their coffers.  This policy is ludicrous.  It has surely contributed to our dependency on foreign energy sources.  Our policies have other countries literally laughing at our stupidity, most notably Canada, as well as several European nations (both Eastern and Western).  You would not know this by paying attention to U.S. media sources though, as they tend not to elaborate on who is laughing at the United States this week.  Please people, let’s stop the rhetoric and start thinking about how we can truly become self-sufficient.

With that I say good-bye and good luck.
All the best,
Andrew Lahde

First, let’s back up a bit and describe how the market for gasoline works. Gasoline is a commodity (gasoline from Shell is effectively the same as gasoline from Exxon), and everyone knows the price (due to those giant signs on the side of the road). This means that we can model the gasoline market using basic economics and we should be able to draw some reasonable conclusions. Ready?

Supply and Demand Curves

Let’s talk about supply and demand. We all know that the “law of supply and demand” somehow determines prices apparently – but what exactly is happening? Well, let’s start with a “demand curve”.

This describes how much consumers would want (demand) for a certain price. A typical gasoline demand curve can be seen on the right – if the price is really high (Point A), we’ll only use a car for essential trips (low demand). If the price goes down (Point B), we’ll use more and more until we’re driving everywhere. Sound reasonable?

Now let’s look at supply curves. These curves describe the behaviour of the other side – the guys that produce gasoline. If the price of gasoline is really low (Point C), you’ll only sell it if you can cover your costs (generally). As the price of gasoline increases (Point D), more and more supply is available. This is a result of higher prices allowing higher cost methods to be effective. If a new extraction method costs 50 bucks a barrel, you better be able to sell it for more than 50 bucks or else there’s no point. An example supply curve is on the left.

Market Price

So we have a supply curve, and a demand curve – so what? Well, now we know what the price of gas is! How exactly? Well, let’s put the supply curve and the demand curve overtop of each other. We can see this on the right – any ideas of what the price of gas is?

If you guessed where the two curves cross, good work! Where the two curves cross gives us:

1. the price of gas
2. the amount of gas sold

It’s the single point where consumers demand the exact same amount that producers want to provide. If the price was lower, consumers would want too much and producers wouldn’t produce enough (scarcity). If it was higher, consumers wouldn’t want as much gas and producers would produce too much (surplus).

Now we know how to determine market price. Now ask yourself – what happens if someone (perhaps the government creates a law) says “Nope! That price is wrong! Change it!”.

Price Ceilings

There are a few different terms for this, but we’ll limit ourselves to an enforced maximum price – called a price ceiling. There are two different ways a price ceiling can be implemented.

The first is rather boring – called a nonbinding price ceiling. For example, if gas was currently selling at 3$ and a law was made saying the maximum price is 4$, what do you think would happen? Well, not much is right. It would really only come into effect if prices continued to rise.

So what’s the other type? It’s called a binding price ceiling. Suppose gas was currently selling at 3$ and a law was made saying the maximum price is 2$ – clearly something is going to happen. From our previous discussion about supply and demand curves we know two things happen when price decreases:

1. consumers can afford more, so demand goes up
2. producers make less money, so supply goes down

Wait a second… that doesn’t seem to make sense. We have more demand, and less supply? That seems to mean that prices would go up. But they can’t because the law says they can’t. So what happens?

Excess Demand

Well, not much can happen. It’s the law after all. Prices will stay at the price ceiling, but look at the graph on the right. The quantity demanded by consumers used to be the same as that provided by producers – but now consumers want far more and consumers provide far less. This difference is called “excess demand”.

So what happens if you have excess demand in a market? Well, let’s ask the Nintendo Wii.

Nintendo Wii

First off, the situation with the Nintendo Wii isn’t purely a result of a price ceiling. It’s very similar however (limited production capacity combined with a price ceiling). Let’s create the supply curve for Nintendo Wiis. Assume we sell at a constant price (suggested retail price), and the factory can produce up to a certain number of units – but no more.

Now let’s put a consumer demand curve over that (right) – we can see that the curves cross and an equilibrium price is produced. Consumer demand at equilibrium is less than the factory capacity, the suggested retail price is appropriate and everything works out wonderfully.

Now suppose that your executives completely underestimated consumer demand, and are now so far behind that they cannot possibly build a factory in time to satisfy this demand. The demand curve shifts to the right significantly (for a given price there is now much more demand). The Nintendo Wii factory can only produce so much however, and we can see excess demand in the graph on the left. Now we have a problem – if you’re going to make something cheap, there better be a lot of it!

Why you don’t want the gasoline market to act like the Wii market

Both situations involve excess demand. And the problems that occur are effectively identical. For instance:

• If you’re first in line, you’re golden! No problems, you get your (Wii/gasoline) for a cheap price. Unfortunately, if you’re at the end of the line, no (Wii/gasoline) for you! The market chooses based not on willingness to pay, but on willingness to screw around and hunt for a scarce item.
• People try to play the system. If they’re at the front of the line, people will buy (a Wii/gasoline), and then try to sell it for a higher price to those at the end of the line.
• The excess demand still hasn’t gone away. Everyone still wants (a Wii/gasoline). Now it’s just a huge pain to find.

For instance, you could be working a 9-5 job, which requires gas to drive to. You don’t have time to figure out what stations have gas – so you end up buying gas on the black market at a ridiculous price from a seedy guy who spends his entire day wandering around finding gas stations that actually have gas. Not exactly a shining example of capitalism.

So what has the Nintendo Wii taught us in regards to gasoline pricing?

Lessons

Price caps on markets like gasoline don’t solve a damn thing. They sound like a good idea at the start – but the very act of regulation changes the way the market works, and causes an unintended result, shortages. These shortages then tend to reward speculation instead of real investment and progress.

In short, gasoline is expensive because we can’t live without it, and continue to pay whatever price is demanded. Real solutions for transportation and infrastructure aren’t as simple as saying “gas should be cheap, always!”.

“Those who cannot remember the past are condemned to repeat it.” -George Santayana