By Katie Benner

The death of the investment banks. The ban on short selling. The unrelenting pain for anyone who needs to borrow money. Chaos has descended on Wall Street, and at least one hedge fund manager isn’t going to take it anymore.

Cliff Asness, managing partner of AQR, a $30 billion hedge fund firm, produced a searing, angry, and hilarious piece for Joe Nocera at the New York Times that rails against the Securities and Exchange Commissions “temporary” ban on short-selling. God only knows how Asness fared when the ban, which prohibits investors from betting against a company’s stock, went into effect. But it forced funds to cover short positions (Wall Street speak for scrambling to buy shares of companies they hate and had therefore shorted). And quantitative funds that use computer models, like Asness’ AQR, undoubtedly did not have a “what if the government bans shorting” contingency built into their algorithms.

Unsurprisingly, Asness is hopping mad. He hits all the expected notes: The government greenlighted Wall Street greed and the residential real estate bacchanalia. The Federal Reserve under Alan Greenspan led the way by refusing to let the country go into a recession when it should have, creating a massive real estate bubble.

But he also includes zingers like, “So, what goes through the minds of the politicians and bureaucrats and what do they say to themselves? Perhaps it’s the following: ‘What this crisis absolutely requires is that a really futile and stupid gesture be done on somebody’s part and we’re just the guys to do it.’ It was funny when Bluto said it in Animal House. Appropriately if you stayed for the end of the movie you discovered he went on to become a senator. It’s not funny in real life.”

But you know Asness is a man at the end of his rope if you bother to click on the disclosure that accompanies the story. His views and opinions, of course, do not necessarily reflect the views of AQR Capital Management, LLC its affiliates, or its employees. But they are, he concedes, the work of a man who is “criminally insane.”

“Anyone trading on my advice, or a client, consultant, employee or Iraqi insurgent thinking he has been wronged by my attitudes or opinions can have a $250 out-of-court settlement right now if they’ll sign a waiver, otherwise we’ll break you. Oh, and we lied about the $250, but seriously, we will break you.

“Furthermore, if you read one guy’s opinion on a blog and do anything based solely on that, you are an idiot.”

As Nocera wrote at the top of the story, we too hope to hear from Asness as often as possible as this crisis plays out.

By Katie Benner

If you’re Lehman Bros. (LEH), the market has doubts about your balance sheet, your stock is down, and rumors say you’re going out of business or bound for the auction block. So forming a hedge fund that looks like nothing more than a place to dump unknown assets might not be the smartest idea.

But, reports Bloomberg, this seems to be exactly what Lehman has done. The firm has sold $4.5 billion worth of assets to a newly-formed hedge fund that counts Lehman as a significant investor; is run by seven recently-departed Lehman executives; and operates out of Lehman office space, three floors down from the office of Lehman’s corporate secretary, the report says. What’s more, Lehman is keeping its dealings with the fund, R3 Capital Partners quiet, and it isn’t mentioned in the firm’s Securities and Exchange Commission filings.

You don’t need to know much more about R3 to see that this could be cause for alarm.

Lehman investors will want to know how any transactions with the fund have affected the bank’s financial statements. R3 told Bloomberg that it is “an independently managed fund in which Lehman Brothers is a limited partner and holds a passive, minority stake in the general partner.”

Not good enough for a firm that wants to restore investor confidence, says Bloomberg. “That [statement] won’t keep investors from forming their own conclusions. If Lehman doesn’t like what they decide, it will have only itself to blame.”

By Katie Benner

Mergers and acquisitions were once as simple as a Hollywood romance. But bad capital markets, the threat of recession, and the horrible morning-after realization that you’re paying too much have made it harder for deals to live happily ever after.

The latest in the list of unions-not-consummated: hedge funds Fortress Investment (FIG) and Centerbridge partners are scrapping their $6.1 billion agreement to take Penn National Gaming (PENN) private.

Even though Fortress chief executive Wesley Edens said in March that the buyout firms “are committed to funding that transaction,” they’ve changed their minds, likely in a fit of buyers’ remorse. According to a company statement, casino and racetrack operator Penn will receive $225 million to terminate the takeover. The hedge firms agreed a year ago to buy Penn for $67 a share and Penn is trading 57 percent below that purchase price. Penn says “a re-negotiated, reduced purchase price was not a viable option.”

In a little twist, the hedge funds have agreed to loan Penn $1.25 billion over seven years. Penn can either repay the loan in cash or stock. If Penn can’t repay the loan, the hedge funds in the end will still have a lot of control over the company.

More trouble for Citi (C). The bank stopped investors from pulling their money out of a hedge fund that specialized in corporate debt after the fund, CSO Partners, posted an 11 percent loss for 2007, The Wall Street Journal reports. The Journal reports Citi injected $100 million to stabilize the fund, which has about $500 million in assets but faced an attempt by investors to withdraw 30 percent of the fund’s money.

Citi isn’t the only financial titan with hedge fund problems, though. The Journal reports that investigators are probing whether former Bear Stearns (BSC) fund manager Ralph Cioffi misled investors on an April conference call that was held just  months before the firm admitted that two in-house hedge funds had collapsed. On the April call, the Journal reports, Cioffi said he was “cautiously optimistic” about the funds, which made leveraged bet on subprime mortgage-backed securities - despite the fact that he had just pulled $2 million of his own money from the funds. Cioffi’s lawyer is considering making him available to prosecutors for informational interviews, the Journal adds. Perhaps he’ll tell investigators that he really needed to diversify his portfolio.

CNet (CNET) is under siege. Shares in the online media company were flat Monday after management told a group of hedge fund investors led by Jana Partners to go pound salt. The Jana group has taken a 10 percent stake in CNet and seeks to expand the company’s board so it can oust current management. Jana and its affiliates, Spark Management Partners and Velocity Interactive Management, also sued to invalidate CNet’s bylaws on the grounds that they limit shareholder control of the company. Complaints about CNet’s direction are nothing new: Disgraced securities analyst Henry Blodget suggested last year that a good project for a bored private equity firm would be to take CNet private.

CNet replied Monday that Jana’s proposal is “improper” and that its bylaws and governance processes aim to “prevent short-term stockholders without standing from using the company’s established governance procedures in order to further their individual agenda.” CNet adds that over the past year, it “has sharpened its focus on core brands, disposed of underperforming assets” and “recruited industry leaders to replace almost half of its executive management team.” Still, the company’s floundering makes you wonder if CNet didn’t replace the wrong half.

Goldman Sachs (GS) retains its status as the juggernaut of Wall Street. The firm this morning announced earnings of $7.01 a share which beat - again - analysts’ expectations. Not that it will earn Goldman any friends among investors: The stock declined in early trade Tuesday. A big chunk of the earnings growth came from Goldman’s investment banking unit, and it’s a reasonable bet that the deal flow will slow next year; presumably that assumption is behind Wall Street’s tepid response.

Does Goldman care? Probably not. In a stunning act of confidence, the firm is reportedly also launching a new hedge fund, with between $6 billion and $10 billion in funds; the latter figure would make it the largest hedge fund debut in history. Bloomberg got hold of the fund’s marketing material, which boasts that if the current fund “had operated since the beginning of 2004, it would have returned 18 percent a year on average through August 2007.” That’s an interesting cutoff point. As a writer at 24/7 Wall St. is rude enough to point out, the Goldman Global Alpha Fund lost 37 percent of its value through November 30.

The government’s first try at a housing bailout took another baby step this morning, when Treasury Secretary Hank Paulson sketched the outlines of a plan that could lead to an interest rate freeze on some adjustable rate mortgages. Paulson told an audience in Washington that along with  an industry-community partnership called Hope Now, the government aims to do three things to keep a lid on spiking foreclosure rates on loans to less-creditworthy homebuyers.

“First, we are increasing efforts to reach able homeowners who are struggling with their mortgages,” he said in prepared remarks for the national housing forum in Washington. “Second, we are working to increase the availability of affordable mortgage solutions for these borrowers. Third, we are leading the industry to develop a systematic means of efficiently moving able homeowners into sustainable mortgages.”

No formal agreement has been reached, and details are still lacking. But however the final plan shapes out, it will be hamstrung by one significant fact: ARM resets aren’t what has been driving the surge of foreclosures in recent years. Rather, the problem is that buyers came to see house price appreciation as a sure thing and stretched to buy houses they couldn’t afford on their income. That’s why defaults spiked on 2006 and 2007 subprime loans even before those borrowers faced resets.

As economist Dean Baker wrote in August, “resetting subprimes are just a single wave in an ocean of bad mortgage debt.” He says the spike in defaults on subprime mortgages over the last two years owes more to the borrowers’ tenuous personal finances than to any reset phenomenon. “Less well-situated borrowers are more likely to have taken out ARMs since the payments are typically lower than fixed rate mortgages,” he writes.

On that note, analysts at Portales Partners in New York estimate that any bailout plan will help just 10% of the roughly 1.5 million borrowers due to face a reset in the next year, though analyst Gary Gordon at Portales stresses that no one knows how any bailout effort will play out. He adds that he expects holders of subprime mortgages, ranging from hedge funds to overseas banks, to object to any solution that depends on investors forgoing interest income. That could mean a wave of lawsuits – the one result that would help absolutely no one.

Update: Maybe a legal free-for-all isn’t in the offing. “A bond-fund manager who sues over an attempt to mitigate the subprime mortgage mess,” Felix Salmon writes at Portfolio, “is going to be someone who calls attention to himself as a dupe of an investor and also an enemy of homeowners.” Even fund managers don’t want to look like weenies.

E*Trade (ETFC) tumbled again Monday after an analyst advised investors to sell the stock, citing deepening problems at E*Trade’s banking unit. Bank of America analyst Michael Hecht cut the stock to sell from hold, saying problems in E*Trade’s home equity loan portfolio could result in billions of dollars of losses. Adding to the company’s worries: online trading and retail banking customers have been fleeing E*Trade amid concern about its toxic mortgage holdings. Shares tumbled 14% to $3.94 — putting the stock down more than 20% since Citadel agreed last Thursday to pump $2.55 billion into the company.E*Trade also continues to look less than razor sharp on the disclosure front. This column wondered last week why E*Trade hadn’t filed its current report on form 8-K following the announcement of the Citadel transaction, which came as E*Trade announced a CEO change and a writedown of more than $2 billion. A spokesman indicates the company has four days following the announcement of the transaction to file those papers, and adds that E*Trade expects to make the filing in a timely fashion. It’s almost unheard of for a big company to fail to file an 8-K on a big transaction within a day of its announcement, but then again, this is E*Trade we’re talking about. In the meantime, the big question is how low can E*Trade stock go.

E*Trade (ETFC) continues to slide, a day after it announced a big bailout deal with vulture-oriented hedge fund Citadel. Much was made of E*Trade’s success in getting out from under a deteriorating $3 billion mortgage portfolio, albeit at the deeply distressed price of 27 cents on the dollar. But E*Trade stock fell Thursday and it continues to give up ground Friday as investors worry about assorted other issues, including the company’s still substantial home equity loan exposure. As Phil van Doorn writes on TheStreet.com Friday, E*Trade has $2.4 billion worth of home equity loans in which the loan-to-value ratio is above 90%. With house prices falling sharply, it’s all too likely that many of these loans will end up defaulting — and the potential for recovery appears low.

Meanwhile, E*Trade still hasn’t filed its current report on form 8-K with the Securities and Exchange Commission, which is unusual given that yesterday the company reported three separate events that would seem to call for that sort of disclosure: the departure of its CEO, a transaction that gives one shareholder 20% of the stock, and more than $2 billion in writedowns. E*Trade didn’t immediately return a call seeking comment.

Update: A Citadel spokeswoman says an E*Trade investor relations rep tells her he expects the filing to be made in the next day or so.

The housing mess has taken its toll on bond insurers Ambac (ABK) and MBIA (MBI), which have seen their shares fall sharply this year amid the collapse of the market for subprime mortgage securities. Accrued Interest says the companies can expect to raise billions of dollars in new capital to cushion the blow of coming losses. But now hedge fund manager Bill Ackman of Pershing Square Capital, who has been betting against Ambac and MBIA for years, is putting a happy holidays spin on the companies’ problems. He told the Value Investing Conference in New York Wednesday that he expects a bond insurer to fail, Bloomberg reports — an event that would surely pay off handsomely for Pershing’s short bets on Ambac and MBIA. On a cheerier note, the bond insurers’ shortcomings could turn into a boon for the less fortunate — as Ackman plans on donating his winnings to his Pershing Square Foundation. Why? “I don’t need the money,” Bloomberg quotes him saying.