Wednesday, April 30, 2008

Follow-up: Move over eagle ...

I was remiss in neglecting one key component of the Bear Sterns fiasco in my earlier post: what's in it for the government.

Uncle Sam isn't just all warm-fuzzy altruistic here. True, their action drips with populism, but that's not their biggest bennie. Mark my words - the Treasury, and Federal Reserve, in orchestrating this, has effectively bought themselves greater involvement in the financial markets, especially corporate finance. Their take is most likely increased oversight, probably including approval authority in financial M&A transactions and OTC product markets.

This might have appeared to be an opportunistic grab had it not been one of a growing pattern of strategic moves by the Bernanke house to expand their pervue. Opening the discount window to i-banks and brokers was clear back scratching. See, currently the Fed has no involvement with these firms - it's the SEC's job. Over the past decade, with the relaxation of Glass-Steagal regulations, i-banks have weaseled their way into being allowed to carry credit on their alance sheets (=make loans in exchange for other juicier business). Basically, i-banks are acting more and more like real banks. The Fed's had their knickers in a bunch for years over this because they don't think the SEC understands how to regulate banking activities (more on this in my next blog). So the Fed does i-banks the "favor" of letting them borrow from the Fed cheaply (although they're not member firms) but the price of admission is that the i-banks must pledge collateral for those loans .... and (here's the juicy part) ... the Fed gets to scrutinize the collateral .... which is almost always .... (drum roll) ... loans. Through this keyhole, the Fed will be able to project a large portion of what goes on inside the firm. They can let the i-banks get hooked on cheap discount window money, and then progressively tighten the screws of oversight ... and eventually regulation. For one thing, this will give the Fed the data-driven ammo to prove that the SEC is clueless, at which point they can swoop in and save us all.

Tuesday, April 29, 2008

Follow up: Triple Play in the FT Today

Good to see great minds are interested in some of the same topics I've been writing about. The FT Comment page today carries pieces on not one, not two, but three of my recent blog topics:

  • Abbie Hofman writes about i-bankers and their role in our recent credit market problems ("The binge culture of banking must be changed") just as I did in "Levers, Gears, Pulleys..." She's better with the word than I about those topics common to her piece and mine. For example, I listed "clouding" as one of the i-bankers bag-o-tricks. She uses the more formal "obfuscation." She goes beyond just agreeing with me, though. She astutely points to compensation structures and Jones-man-ship ("if another bank sells the product, so must we") as areas which must change in order to avoid another period of i-banking pain. She correctly points out that we need more directors who come from the industry and can understand the concepts being bantered about in board meetings. Here's a great quote-of-a-quote: "...we have been told that bankers were paid so much because you were cleverer than the rest of us. Now it turns out you were not..."
  • Leszek Balcerowicz talks about the natural tension between collectivists and free-marketers ("Free marketers must fend off the statists"), very much in the vein of my recent blog on the government interference behind the Bear Sterns work-out ("Move Over Eagle ..."). I particularly appreciate his Eastern European viewpoint. He and his generation are probably the world's best experts on the topic of statism vs. capitalism. It's no surprise he's such a staunch advocate of the latter.
  • And finally staff writer Gideon Rachman takes on the SWF issue ("Do not panic over foreign wealth") summing up the message that I had provided background for in my "Yabba Dhabi Doo" series. His take is spot-on: these guys are not going to invest billions in a US firm only to topple it, or the US economy at large. To the contrary, I would argue that they, by investing their national treasure in global companies, will finally and perhaps unwittingly cure one of the major causes of their cultures' historic religiously-based and paranoia-fuelled stances toward the rest of the world -- the haves vs. the have nots -- the evil empires hell-bent on domination -- the imperialists looking for conquest -- the hell-bound hedonists who must be slaughtered. By participating in the world economy, they suddenly have a very direct and clear motivation to do what's in its best interest, thus aligning their national interests more closely with ours. As he says, "... if governments ... have large investments in the US and EU, then they also have a direct stake in the continuing prosperity of Ameria and the EU ... it surely must make it less likely that political differences will escalate into conflict..." It's also nice to see that a British FT staff writer agrees with Dubya: protectionism in the West is a cloud on the horizon ... one of locusts to be taken very, very seriously.

That "other" airport in DC

There are two airports in DC: Dulles and Reagan. If you're gonna be a socialist idealist and insist on the name "National" then you better also call that big NY airport Idlewild, not Kennedy.
In fact, if you're gonna go there, then go all the way. Please memorize the following:

  • Orchard Field, not O'Hare
  • North Beach, not Laguardia
  • Great Western Aerodrome, not London Heathrow
  • United Airport, not Bob Hope Burbank
  • Aéroport de Paris Nord, not De Gaulle
  • Orange County, not John Wayne
  • Pan American Field, not Miami International

Sunday, April 27, 2008

Euro Vibe

Gosh darn that Rick Steves. He's just so jolly and fop-ish and humbly bumbling and lucky to trollop around the Continent for a living. He makes me jealous every weekend when I flip on PBS and find him in České Budějovice sampling Pilsners with the bearded, weathered locals or donning lederhosen to mountaineer with some sehr gesundliche Swiss retirees in Zermatt.

I wish I was on the Continent. with a fast car and a cappuccino, but alas I've put my Spanish summer vacation plans on hold. Since I no longer work for a European firm, I don't even have a business excuse to go pay ten bucks for a Coke and a newspaper at De Gaulle.

I can't even justify buying a good Châteauneuf-du-Pape, although the silver lining of that one is that I've found some nice Argentinian Malbecs and California Central Coast Syrahs.

The dollar will come back, and then I'll go. Europe always lags the US and everything is always in slow motion there. Let's say we have a sorry 2009 but in 2010 the US grows by 4% for a year and then settles back to 1% for 3. Europe will show up in 2011 with 3% growth and stay there through 2012, after which they'll have a protracted 10 years of no growth in response.

Friday, April 25, 2008

Compensating to Evolve

Humans are probably not unique in perceiving their inadequacies and trying to do something about it. One of the beauties of mother nature's genius is the elasticity of animals' behavior. Some more than others, but those of us critters who have survived a few hundred thousand years are pretty good at changing our behavior in response to our environment. It's all to further the species. We're each an experiment in the drive for survival. Those of us who make successful choices (survivalistically) are, on average, more likely to propagate their genetics and learned behaviors to the next generation of experiments.

We humans are particularly elastic in our behavior ... to a fault. We get so neurotic over our deficiencies (real or perceived) that we end up choosing remedies which make no sense at all.

Ever see a guy at a party make a totally bonehead move with a chick? One that would never, in a million years get him laid? What goes through your mind? Yup, "Desperate."

Ever seen a chick with more piercings than teeth? Maybe some tats and a bad attitude to go with it? "Desperate."

      How about the sexy Hollywood type who makes a hundred mill in a couple years and then spends the next decade shuttling between court, rehab, and bed? Same word comes to mind for me. Desperate.

        Your annoying brother-in-law with the constant need to best your every story. "You think YOU had it bad - I was raised by alligators!" Desperately desperate.

          Or the guy whose whole identity is performing ridiculous death-defying stunts ... the bloodier the better. You know the dude: he was the one at the bar last night showing everyone his scabs and scars. Or maybe your little sister brought him to the family picnic. Double desperate.

However counter-productive one's choices end up being, if we take an evolutionary view, I don't think we can fault any individual for them. In them, we are switnessing one tiny slice of the overall attempt by the species to further survival. One's choices may seem illogical, harmful, or otherwise counter-survivalistic on an individual level. We can blame them on uncontrollable forces, our genes, or our parents. However, looked at from a macro species perspective, they are quite useful. Perhaps the likelihood of their success is low, but it's quite possible that one of these wacky, counterintuitive choices could lead to a whole new evolutionary branch and extend the extinction countdown timer by another few hundred thousand years. Otherwise, how would we ever get bizarre-o critters like the dancing Bird of Paradise or the Anglerfish or the Bloodbelly (see pics).

Frankly, even at an individual level, I see legitimate (dare I say rational?) reasons for such actions. Freaks and grumpy moments aside, humans are a social species. In fact, we've evolved down that track to the point that we are inter-dependent. In order to live the lives we are accustomed to, we need the support and cooperation of many, many other members of society. We need to be allowed to be part of the clan, which means we need to be relevant to it. We're not comfortable unless we "carve out our place" by making our own unique contribution. Like Peter Gabriel, we all "want to be wanted ... need to be needed ... love to be loved" If one of us perceives that he's not desired by the group, he changes himself. If that doesn't work, he tries something else a bit further "out there." He's barking up the wrong tree, but instead of trying a different one, he just barks louder and more desperately. Eventually, if he never feels that warm fuzzy comfort zone, he's off doing things that are horrifically bizarre and destructive.

Bottom line, he's trying to compensate. Just as we all do.

The straight-A student who cries at not getting to be editor of the school newspaper.

    Those boisterous inner-city teens on the subway who vomit a steady, 100-decibel stream of profanity until they reach their station ...

    The Chinese immigrant's daughter who started ballet at 4, piano at 8, tennis at 12, Harvard at 16 and coke at 20.

    The un-athletic momma's boy who ends up wearing skirts and high heels, getting groped by men in dirty clubs by the time he's 21.

    The bond trader who drops fifty grand on an inside straight draw with his co-workers in Vegas. Weekly.

    The 80-year-old bazillionaire who is still at the office by 6am daily.

    The kid-of-a bazillionaire who can't but anounce that fact to everyone he meets.

    The gay guy who's been to 50 countries on 5 continents (and had a conquest in each) by the age of 30.

    The governor who gets caught with the ten-grand hooker (finally)

    The chick who keeps going back to her abusive husband.

All desperate for something. All trying to compensate. All trying to overachieve in their own right in a desperate, breathless race for relevancy. I understand; I sympathize ... 'cause I'm a lot like 'em, and neither are you.

Photo credits:
Bloodbelly, Anglerfish -

Monday, April 21, 2008

Corporate Newspeak 3

A Long Road: (n) A lengthy sequence of bad decisions and mistakes (usu. by the speaker) which could likely have been avoided with some forethought.

Gave It His/Her/Their All: (v) Tried to fix one's own mistakes and failed

Worked Hard: (v) Finally took the time to fix one's own mistakes

Put in Long Hours: (v) See Worked Hard

Ran 24/7: (v) See Worked Hard

Gave 110%: (v) See Worked Hard

We: (n) You (when referring to blame or work to be done)
Usage: "We should investigate who to blame on this one."

Also: I (when referring to opinions or mistakes)
Usage: "So, we're saying that we didn't fully think this through."

Also: Everyone but me (when referring to hard work)
Usage: "Oh boy, we put in long hours and worked weekends to deliver!"

Went Above and Beyond: (v) Took the time to fix someone else's mistakes
Usage: "It was a long road, but we did it. We gave it our all; Suzie and Terence gave 110% over the weekend; Thanks to Gerald for going above and beyond to bring us in on time."

Sunday, April 20, 2008

What Will Tomorrow Bring: The Gay Gene

Brace yourself now, I'm about to say something not-so-PC. Let me just say I'm not judging, I'm not criticizing, nor am I condoning.

Okay, here goes. We will someday find scientific proof that there is a gay gene. Actually, we'll probably find more than one. We will further discover that these genes appear in the DNA of more than just the members of the Ten Percent Club who actually experience the same-sex desire. We'll discover that it's a spectrum, not a lightswitch. We'll discover that some people work harder to push themselves toward one end or the other. But most powerfully, we'll discover that environmental factors such as upbringing, role models, social experiences, sexual experiences all influence whether (or how many) gay genes gets expressed. By this, I mean someone could have a fairly "strong" set of gay genes but legitimately never experience the associated desires because nothing in that person's past has "opened the door" for the genes to step out.

One day, when medicine has stepped into the 21st century (more about that soon), this will be science, not conjecture.

Friday, April 18, 2008

Move over eagle, our new national symbol is the Bear

Even brash libertarian capitalists can be made to admit that government plays certain necessary roles in order to underpin a free market society. The most irrefutable among them is preserving private property rights. This is commonly elaborated to comprise two spheres:

  • Providing physical security for the country from external threats (= a defensive-only military)
  • Protecting one's property rights from the rest of the populace (= an internal system of property laws and law enforcement)
The first is pretty self-contained. Namely, don't let the wily Canadians come down here and change or subvert that system of laws and enforcement that underpins the second sphere. The second is what really makes the world go 'round. On face, it's straightforward: it's not okay to steal my stuff; I need it to get rich off of ... but I can't, by myself, keep the whole world from knocking down my door. I need the whole society to collectively and reliably enforce.

With these in place, an idealistic capitalist would say, government has satisfied it's purpose and should go no further. Motivated, self-interested individuals will act to maximize their happiness, wealth, or whatever measure of "utility" more effectively than any external body, however altruistic it may be. This is guaranteed to achieve the highest possible "gross national utility" (GNU) and thus the highest average utility per capita.

Unfortunately, sometimes what I do with my property infringes on yours. Say I start dealing drugs out of my house. I get rich. The rest of my yuppie neighbors get furious that the neighborhood is going to shit, what with all the druggies and crime moving in. Meanwhile, I've enabled a bunch of potentially productive people to get high and become lumps of useless flesh. Say my meth lab keeps catching fire and burning down the neighbors' houses. Do these things still result in a maximized GNU? Nope, only mine. My neighbors are suffering from the "externalities" of my actions.

Examples of externalities are endless:
  • A factory pollutes a river and makes the downstream residents sick, increasing their healthcare costs.
  • An bank makes risky investments and goes belly-up, zapping the savings of its depositors
  • A management team pays themselves royally while driving the business into the ground, rendering worthless shareholders' stock, as well as the incomes, healthcare, and retirement funds of employees.
  • A small group corners the market on an essential good and then sets a ridiculous price, effectively transferring wealth from consumers to themselves.
  • A bar opens up in an apartment building and makes so much noise nobody can sleep ... or sell their apartments.
  • A con man sells knock-off products that don't perform as promised. Buyers have no recourse other than to go elsewhere; fine with the con man - he makes a whole career of duping first-time buyers.
  • A drug company sells medicines which perform as advertized, but 10 years later cause cancer
  • An investment bank borrows heavily and throws the funds into risky investments. The investments go south, the bank can't pay its loans, and the whole market panics, making it impossible for other, sound banks to continue their activities
Whether the above are textbook externalities, bad luck, or criminal is a matter of perception, but these examples make clear that my property protection needs protection from the externalities of your property protection ... which has to be codified in our laws. Suddenly we're back to the drawing board to better define our original point two above. Enter government expansion, as they write tomes about what is and isn't allowed.

Could it be simpler? Could we simply say that a property owner is flatly responsible for any externality from his property and actions? Freaky, I know ... but what if we had universal externality insurance? Enough questions. The benefit of this is that it gets government back out of the economy, since they consistently screw it up. This, of course, creates a whole new set of complexities to be worked out, disagreements to be arbitrated, and missing precedent. If done correctly, though, it would have several nice side effects:
  • reduction in government
  • reduction in litigiousness
  • restoration of a personal responsibility
And that last one is perhaps what I've been driving at from the beginning. One cannot be omniscient about the future consequences of one's every action. We'd be in permanent "analysis paralysis" afraid to do anything. One need not be. In this context, people can simply be responsible and intelligent about choices ... and insure themselves against those unanticipated consequences.

Now, what does this have to do with Nationalizing Bear? It is this: ensuring Bear is a viable concern on any given day is not my responsibility or interest. Nor is it yours. Nor is it our collective responsibility. And in no conceivable way is it the government's. Replace "Bear" with "all of Wall Street" and my answer is the same ...

... Trouble with that is the externalities. I've been glibly relying on the positive externalities of Wall Street's efficiency and ingenuity for years. We all have. They've figured out ways to fund all kinds of cool businesses, reduce transaction costs so small fish like me can buy into those cool businesses and partake in the culture of capital. The idea that Wall Street might implode and stop providing those benefits (which neither you nor I pay for) is supposed to cause panic and hysteria. "Can't have that ... gotta intervene" some argue. Were each of those I-banks insured against caused externalities, we wouldn't be so scared. Were I also insured against experiencing externalities, I'd be all warm n fuzzy inside. We just might end up being a more sane and rational society.

I anticipate this solution will get criticized as a mere transfer of liability to big corporations who will, in turn, just leave the henhouse to the foxes. My response is that insurance companies are designed to transfer liability. They are the experts at finding investors willing to take the risk in return for either a steady stream of payments or the chance at a big payout. They mitigate, they distribute, they hedge. These are the wonders of modern finance. The genius of Wall Street ... not Capitol Hill. Whereas Wall Street responds to challenges like this using an analytical, profit-seeking, quantitative, risk-minimizing approach, politicians have a different tack. Bail out. Fear-monger. Stump speech. Borrow and tax. Wrong-footed at each step, the government's response increases risk (via increased leverage) and has no promise of maximizing profit.

Nationalizing is bad when Chavez and Castro did it. Bad when Musolini and Mao did it. Why, then, should it be any different for us?

Sunday, April 13, 2008

Levers, Gears, Pulleys ... and some Bailing Wire

Had I been drinking milk at 8:17 last Wednesday morning, I might have shot it out of my nose, and not for laughing, I promise. Admittedly, only a few other econo-financial dorks would have found the FT Lex column headline so ridiculous but it just summed up so concisely (as the "pink paper" is wont to do) our current financial crisis ... how we got here, what's wrong, and how the crazies running the asylum are trying to get out of their current mess by using the same tricks which got them into it.

The article started "CITI OFFLOADS $12BN LEVERAGED LOANS TO PRIVATE EQUITY FIRM TPG" or something to that effect.

First off: leveraged loans? C'mon people. What is that supposed to mean?

I can just picture it ... Pandit berating his CFO committee ... saying without saying that they better find a better way to cook the books this time around. They all know their last 3 quarters have looked like pig shit ... and they're hoping that they can put enough lipstick on the producer of it to avoid becoming bacon, themselves. When in doubt NY I-banking types always fall back on their oldest tricks, hoping for new results. Their actions are so predictable that I am convinced the following must be scrawled on bathroom walls all up and down the Street:

I-Banker's bag-o-tricks:

  • Clouding: Nobody can justify mega-million dollar Wall Street compensation for something as mundane as "buying something, waiting a little bit, and then auctioning it off, hopefully at a higher price." Let's face it, an IPO is just "putting your company on e-Bay." The only way you can justify charging 6% of the value of the company for this is to talk in circles so nobody can understand. It makes you sound smart for inventing something so complicated. Smart sells at a huge premium in the Wall Street job market. This takes many, many forms. Here are a few:
      • Arcane, fabricated (usually compound) terms ... leveraged loans, anyone?
      • Arcane, fabricated (usually shaky) math ... by bigshots. LTCM ring a bell?
      • Pretending to reduce risk through "hedges" (usually based on fallacious precepts) ... guess what - LTCM again.
      • Pretending to reduce risk through "collateralizing" (usually with a "Trust us - It's good!" asset)
      • Sleight-of-hand accounting
      • Bazillion-page prospectuseses
  • Making Sausage: Layering, Packaging, Blending, and Slicing. Just like baloney, the ingredients are magic and secret and most likely you really don't wanna know. As long as it tastes good, people don't bother to figure it out ... Your secret recipe is worth its weight in ... well, baloney I guess.
  • Offloading: It's scary to own something. That thing might spoil. That thing might go out of style. The value might go down. You might have to sell it at a low price in a pinch. I-bankers are afraid of commitment. Plus, it's just sitting there occupying your money; much more fun to have cash to play with. Much better to "manage" someone else's assets for a fee than actually taking the responsibility of managing your own. The fees you earn can't get taken away, even if you manage the asset right into the shitter. You can even sell your asset to someone and then borrow it back. And I love the irony as these i-bankers and brokers go pitch their wares: "well, I wouldn't own it ... but you TOTALLY should!"
  • Leveraging: This must be the oldest trick in the bag. No investor or i-bank likes sticking their neck out and actually making a bet with their own money. When in doubt, borrow to take risk. Even better - use the fail-safe "steroids for investments": borrow some money and dump it into your wimpy underperforming investment. Suddenly your measly 1% return on initial investment looks like 10%. As long as the interest you pay is less than the return you make, you look like Midas. See, i-bankers and other investors are measured based on "return." It's their job to figure out how to squeeze the most profit out of the least amount of money. Those who make the biggest returns get fat bonuses. The rest get canned.

Let me boil the CITI situation down for you: CITI loaned shaky companies money. The companies blew the dough and suddenly found themselves with liabilities exceeding their assets. Rather than just foreclose on the companies, CITI swooped in to save their initial investment using the ole leveraging trick. They joined with TPG, Apollo, and other private equity firms to loan the ailing companies more money, this time at elevated rates (since now the companies are considered "junk"). This is what they really mean when they resort to clouding by calling it a "leveraged loan" but don't tell 'em I told you. Of course, everyone got fees and probably a chunk of equity. CITI doesn't actually expect to get the money back 9 out of 10 times. Their plan is to package the leveraged loans (for another fee) and sell them off in little pieces (for yet another fee) aka making sausage and offloading. Unfortunately, nobody will buy this crap anymore, so CITI and the PEs resort to hot potato. Stay with me here. CITI gives the PEs new super-cheap loans (more leveraging). PEs use the money to buy (from CITI) the loans CITI made to them initially ... at above-market, yet helpfully below-book prices (more sausage and offloading). CITI's books are now much tidier. The mess is moved to the PEs books ... which are secret (clouding). CITI continues to mange the loans (hilariously, bankers prefer the term "service the loans") for a fee, meaning in accounting terms they've turned an ugly string of write-downs (=negative profits) into a nice stream of pure-profit fees. Those are the facts.

Now let me speculate: CITI also loaned TPG the money to pay a bunch of structuring fees on that cheap loan. CITI also sold TPG some insurance (in the form of credit or other derivatives). There was assuredly a buy-back clause saying if too many of the companies (remember them?) go belly-up, CITI will buy back the loan at a discount (note to TPG: you'll be in the courts for years if you try to exercise this). Finally, the kicker: to finance the whole thing CITI borrowed from the Federal Reserve discount window at rock-bottom rates by pledging questionable collateral. With that, the risk of the whole thing gets swallowed up in the big black hole of the Federal Government. Because of the prevailing "too big to fail" philosophy, not to mention the prevailing populist politics, the Fed would never actually try to collect on this loan should CITI stop paying.

What's in it for the PEs you might ask. If there's anyone in this mix you should not feel sorry for, it's them. They have their own bag of time-tested tricks ... Err ... well OK, they only have one trick, a doozy called "gearing" which is pretty much the same as leveraging. They have ownership in the struggling companies. They pump these companies up with as much debt as humanly possible in a game of corporate Jenga. They force the companies to use that money, not to invest in the future, but rather to artificially pump up revenues. The PEs extract as much in interest and fees as possible without totally bleeding the company out. Then they put thne lipsticked pig back on the market at an inflated price. They whip out fancy valuation math which takes the (new and inflated) growth rate of revenues and pretends this will continue into the future forever (the famout and ubiquitous "hockey stick" chart).

So, the end state is this:

  • The ailing companies now have debt FAR exceeding their assets. Should they ever make a profit, it would get swallowed up in either loan payments or "special dividends on preferred shares" to the PEs. One or two of them might turn into the next Google, but the other 90% will eventually go bankrupt or get gobbled up by the competition ... just AFTER the PEs have left the building.
  • The PEs have a huge new chunk of cash to play with from CITI. They have their talons ever deeper into their struggling companies. Water from a stone comes to mind.
  • CITI has a nice new performing loan on the books, backed by a cheap government loan so it looks profitable on the books. Plus, of course, fees everywhere.
  • The Fed has a no-recourse loan to CITI at a below-market rate. Thankfully, the Fed has no profit motive since the US taxpayers are ready and waiting to hand it some of our hard-earned tax payments.