Category Archives: Other People’s Money

Other People’s Money 4 – Can’t Say it Better Myself

Great reporting from Sunday’s New York Times. Read the whole story here.

The average investor left out in the cold again. (Photo by Канопус Киля, via Wikimedia Commons.)

The average investor left out in the cold again. (Photo by Канопус Киля, via Wikimedia Commons.)

In many ways, what private equity firms did at Simmons, and scores of other companies like it, mimicked the subprime mortgage boom. Fueled by easy money, not only from banks but also endowments and pension funds, buyout kings like THL upended the old order on Wall Street. It was, they said, the Golden Age of private equity — nothing less than a new era of capitalism.

These private investors were able to buy companies like Simmons with borrowed money and put down relatively little of their own cash. Then, not long after, they often borrowed even more money, using the company’s assets as collateral — just like home buyers who took out home equity loans on top of their first mortgages. For the financiers, the rewards were enormous.

Twice after buying Simmons, THL borrowed more. It used $375 million of that money to pay itself a dividend, thus recouping all of the cash it put down, and then some.

A result: THL was guaranteed a profit regardless of how Simmons performed. It did not matter that the company was left owing far more than it was worth, just as many people profited from the mortgage business while many homeowners found themselves underwater.

Investors who bought that debt are getting virtually nothing in the new deal.

Attention Citizens: Your 4th of July Has Been Cancelled

Photo by Timothy K. Hamilton, Creativity+

Photo by Timothy K. Hamilton, Creativity+

As we continue to live with the consequences of the anti-public onslaught visited on our society these past decades by the radical reactionaries who have been calling themselves “Republicans” and “conservatives,” towns and cities across the United States have been forced to cancel their 4th of July fireworks — and sometimes their entire 4th of July observations — due to a lack of public funds.

Cancel the 4th of July? Think about it.

Thank your local “conservative” for working so hard all these years to “starve the beast” of government. As the man said, “Wave that flag; wave it wide and high!”

Of course, if you live in a large-enough city, you can still enjoy a fireworks show this July 4th. One brought to you through the “benevolence” of the executive overlords at your local, global corporate entity, like Macy’s in New York, or Target in Detroit. The national fireworks show, on the mall in DC, is itself brought to you as a good deed by a consortium of defense contractors (Base Technologies, Inc.) lobbyists (Tell America; The International Webcasting Association), and the usual corporate citizens, like Boeing and American Airlines. This, in our executive-overlord dystopia, is the way things are supposed to work: our government is supposed to be beholden to the “benevolence” of corporations. Have some municipal initiative? Better get your private funding and the chamber of commerce on board, boys. Anything else would be socialism.

Of course, when your country is up for sale to the highest bidder, attractive properties like the DC Mall, or the West Side of Manhattan garner the most “investor” interest. Meanwhile, hundreds, if not thousands of smaller towns and municipalities have cancelled their 4th of July, including my home town of Yonkers, NY. A cursory Internet search gives you an idea of the scope of this “patriotic” farce; towns cancelling their 4th of July include:

Yonkers, NY; Parma, OH; San Jose, CA; Charlottesville, VA; Hialeah, FL; Mesa, AZ; Colorado Springs, CO; Niceville, FL; Garland, TX; Gwinnett County, GA; Miami-Dade County, FL; Flint, MI; Montebello, CA; Nixa, MO; Bristol NH; York, ME; Methuen, Peabody, Randolph, Abington and Bridgewater, MA; Roseville, CA; Gurney, Elgin, Berwyn, North Riverside and Harvey, IL; Newton, IA; Loxley, AL; Rahway, Milville and Ridgewood Park, NJ. This is a representative sample from 5 minutes on Google News, not an exhaustive list.

Plymouth, Massachusetts — you know, as in “Plymouth Rock” — cancelled its 4th of July parade and celebrations altogether; after many years of being funded by private citizen donations, this year the contributions just dried up.

 As for me — I’ll be out riding my bike this weekend as usual. And despite my memories of wonderment at the little fireworks show that used to be staged at Ft. Totten in Bayside, NY when I was a kid, as I enjoy the unusual quiet this weekend, I’ll know who to thank.

Here They Go Again: “Morgan Stanley Smith Barney”

MSDW_MarkOur large financial institutions simply refuse to learn the lesson that large, M&A-driven investment shops, and retail investment firms, cannot comfortably coexist. There are simply too many inherent conflicts of interest, and most so-called “firewalls” are observed mostly in the breach. Deregulation, and most important, Graham-Leach-Bliley, removed the last remnant of common sense in this arena: you just can’t mix oil and water. 

MS_MarkNevertheless, the brilliant minds that brought you “Morgan Stanley Dean Witter” — a merger that cost billions, that cost untold millions to “brand,” and then just a few years later cost shareholders untold millions more to “un-brand” — now bring you “Morgan Stanley Smith Barney“.

MSSB_markGee, and to think, they could call it “Morgan Stanley Dean Witter Smith Barney & Co.” Hey, why didn’t I think of that?

’cause that’s where the money is

Willie Sutton at Eastern State Penitentiary

Willie Sutton at Eastern State Penitentiary

My dearest brother sent me a link to yesterday’s New York Times story detailing how hedge fund investors are circling the country’s small banks like raptors after particularly tasty chipmunks.

Published: May 5, 2009

CAINSVILLE, Mo. — No one seems to want to own a business in this dusty, windswept corner of rural America, population 370, with its crumbling sidewalks and boarded-up storefronts.

First National, with its boarded-up second story and $17 million in assets, is worth about a third of what its owner, a New York investor, paid for an Upper East Side town house in 2006. It is an unlikely launching pad for a new American banking empire. Except, that is, for J. Christopher Flowers, a media-shy New York billionaire who last year bought the First National Bank of Cainesville, one of the United States’ smallest national banks.

With that charter in hand, Mr. Flowers plans to take over a handful of large struggling banks, casualties of the economic crisis. In some cases, he hopes, the federal government will help.
Mr. Flowers, a private equity manager, has no particular love for rural Missouri; in fact, he has never set foot in Cainsville. Rather, he wants to use the national bank charter he picked up in this farm town to go on a nationwide buying spree.

My brother’s comment was telling:

Hello sucker— how the vulture capitalists will pick your pocket with the help of their lobby and the same connivers in the congress!!
M.C. Escher in Lego by Andrew Lipson and Daniel Shiu

M.C. Escher in Lego by Andrew Lipson and Daniel Shiu

And it’s hard to argue that he’s not right. Parties that hold “toxic assets” are going to unload them to other parties who also hold “toxic assets,” who in turn will unload their “toxic assets” to other parties who also hold “toxic assets” in a scheme to make would-be M.C. Escher’s the world over jealous. And all with underwriting from the government and the Fed.

But, as hard as it is to believe, there is method in the madness. And that method derives from the timeless logic and priceless American wisdom of Willie Sutton.
Sutton, as we’ll all remember, was among the public enemies number 1 of his day (almost as fatal as being “Al Qaeda’s No. 2” today I suppose) who, when asked why he robbed banks, famously replied, “because that’s where the money is.”
Which brings us back to the question, why are “vulture capitalists” (and their firms) being allowed to “pick our pockets [again]?” The obvious answer to which is “’cause that’s where the money is.” Having recently put my wallet through the washer, I can say beyond a shadow of a doubt that passing “distressed assets” from dirty hand to dirty hand is an act any money launderer can be proud of. But, given the way the world works, this miracle of accounting legerdemain (or should that be “ledger-demain“?) will probably have the desired effect, over the long run, of rinsing away the sins of the B- tranche, and restoring the appearance, if not the actual fact, of health to the financial sector.
The Whos Roger Daltry

The Who's Roger Daltry

And since this is a game that requires an enormous amount of money to play, why waste our time being aggrieved that the same Masters of the Universe who drove the bus off the cliff own the tow truck that’s come to drag us out? It’s American as Willie Sutton. Or in the words of the immortal poet, Roger Daltry: “Meet the new boss [baby]; same as the old boss.

Second Wave of Bad Economic News is Here

The New York Times is reporting that General Growth Properties, the largest retail mall operator in the country, is declaring bankruptcy, largely because of its inability to refinance its existing mortgage debt.

“Our operational model is sound,” Thomas H. Nolan Jr., the company’s president and chief operating officer, said on a conference call early Thursday morning, citing “the unprecedented disruption in the real estate financing markets and the need to extend maturing debt” as the reason the company filed.

“We made extensive efforts to modify existing maturing debt outside of bankruptcy,” he added.

More and more commercial properties, property owners, and the banks that provided highly aggressive financing based on questionable valuations, are going to find themselves going down this path in the coming months. In my opinion, that is one of the reasons the Obama administration is encouraging banks to keep TARP funds, and otherwise fortify their balance sheets. This is potentially a tsunami compared to what happened in the residential markets. On the other hand, there was not nearly the amount of re-leveraging and re-packaging of these loans into derivatives as there was on the residential side, so the effect may not be as widespread.

We have one more wave to come after this – of credit card defaults. The commercial real estate mortgage market collapse will be a bellwether of whether larger banks will survive. It is both a threat and an opportunity, because commercial real estate assets will be available at once in a lifetime bargain prices, and their owners and the banks that hold the notes will be more likely to bail on the current arrangements than individual homeowners ever could or would be. It’s going to look very strange, but large banks are going to be playing both sides of this market simultaneously. If the private banking industry pulls through this in the coming months, it will easily survive its credit card problems.

Hope Is a Thing that Blings

“It’s premature to conclude the economy has turned,” said CFO Howard Atkins in an interview with The Associated Press.
Atkins did say the bank was seeing a clear benefit from the government’s actions to bring interest rates down. “All I can tell you is, we’re seeing a lot of business.”

$3 billion buys a lot of bling. That’s the net revenue Wells Fargo expects to report for the first quarter. Suddenly, the debate on the economy is focused on whether Wells Fargo’s results are representative, or an anomaly. The President, understandably, is looking on the bright side:

President Obama emerged from a meeting with his senior economic advisers on Friday to say “what you’re starting to see is glimmers of hope across the economy.” But there were also signs of growing tensions between the White House and the nation’s banks over the next phase of the financial rescue.

Currency speculators the world over seem to share the President’s optimism.

April 11 (Bloomberg) — The dollar posted the biggest weekly gain versus the euro in more than two months on optimism the worst of the financial crisis in the U.S. is over.

Still, plenty of people are out there offering more dour assessments.

Wells Fargo announced today $3 Billion in profits. It was fantastic news and it sent the stock market soaring.

However, one thing that didn’t get talked about was why they made so much money.
Wells Fargo CFO Howard Atkins discusses the banks $3 billion reported first quarter 2009 earnings. Atkins hypes the impact of mortgages to the bottom line, due to low interest rates and foreclosure selling no doubt, but shockingly admits at the 7:45 mark that with the writedowns that would have been required by Mark to Market the bank actually lost money on the quarter.

To put it another way, Wells Fargo made money because the government allowed them to play “let’s pretend your assets are worth something”.

But what if that’s exactly what’s going on, and it’s working? What if instead of creating some toxic asset merry-go-round, banks are just allowed to hold toxic assets off their balance sheets long enough for rationality to return, and sensible valuations to emerge?

Just to be clear: I believe the market in mortgage backed securities and their derivatives, is as “undersold” today as it was “oversold” in the middle years of the decade. The herd mentality and “animal spirits”  are every bit as evident in this economic climate as they were in the giddiest days of the Internet, commodities and real estate bubbles. Only everybody’s running to the exits, blocking the aisles, so to speak.

Taking a quick look at “Unbossed’s” graphs of monthly default notices; yeah, sure there’s a spike coming, and defaults on both residential and commercial mortgages are going to double in the coming weeks and month. But double from what basis?


If the baseline rate of default a year ago was say somewhere in the neighborhood of 1% or 2% (which would have been historically typical), and is anticipated to double based on NODs, then the expected total rate of default will rise to between 2% and 4%. If defaults peak in this range, then portfolios of mortgages will still be worth 75 to 80 cents on the dollar, not the 25 to 30 cents the market values them at today.

Most banks will be able to “ride out” a 2% to 5% rate of default in either commercial or residential mortgages, especially with generous amounts of cheap cash available from the Fed to shore up balance sheets.

In short, everybody has an interest in “staying put” for as long as possible, then capitalizing their losses after the panic subsides. This includes property owners. If the “results” from Wells Fargo are representative – even if they were goosed by new leniency in mark-to-market accounting – it is a sign that the middle-ground bailout and TARP strategy adopted by the Administration is working, It may involve a bit of “accounting magic,” but doesn’t all banking? And in the circumstances, the pessimism that dominates the zeitgeist may in hindsight come to be seen as hysterial (in every sense of the word) as yesterday’s notion that no investment is as safe as real estate.

There’s another trend to look out for. Banks and other financial market makers understand that the current under-valuation of residential and commercial real estate, and the even greater discounts of mortgage portfolios, is the best opportunity for profit they’ve seen in years. They don’t want to partner with other investors or the government, or sell out their interests at all, if they don’t have to. Conditions have been created in which, if they can weather the storm, there is a quick, profitable path to a major windfall.

The bling at the end of the rainbow for many of these institutions is going to turn out to be the very same mortgage-backed securities and collateral debt obligations that got us into the crisis in the first place. When they finally do start trading, they are going to trade significantly below their true long-term asset values. And the smart money is going to snap them up. The Administration is right in limiting the government’s upside potential in all of this, because in the end there is going to be a backlash that buyers and the government took advantage of the original holders of these instruments, and underpaid for them. Put that in your pipe and smoke it, Mr. Roubini.

The Shower as Class Metaphor

Despite the fact that America has become the most class stratified, the least socially and financially mobile, society in the developed world, we still cannot talk about class transparently. We don’t even have an accepted language for dicussing social and economic class in this country. And merely raising the issue almost assures that you will be characterized as a Leninist class warrior.

Or maybe we have a language emerging. Complete with soap.

This week, social class in America emerged from the shower:

Here’s Ed Schultz, a new MSNBC host, describing his politics:

I’m gonna be the guy who represents people who take a shower after work. I’m gonna be that guy who’s gonna be there for the working folk of America. I’m a staunch supporter of unions. 

And here’s United Steelworkers President Leo Gerard complaining this week on Huffington Post about the structure of the federal bailouts:

The message here could not be more clear: Washington will bailout out those who shower before work but not those who shower afterwards.

So. Stay clean America! I suppose this conversation has to start somewhere. Even in ridiculous and obfuscating metaphor.

Other People’s Money 3 – The Credit Crisis

The real point of this thread is to discuss how, at the heart of the current economic crisis, is our habituation to other people’s money.

What is credit, of course, but other people’s money? Would you really buy the 52-inch flatscreen and the Quatrroporte with your own money? Sure, first  Hyundai, and now GM, are offering to take some of the risk out of buying a new car. But what was the choice to finance these items to begin with, but a way of sharing the risk of the purchase with a bank or finance company? If you knew for certain that you could afford it, shouldn’t you have just bought it?

That’s the crux of the banking and credit crisis as well. Incentives and rewards for top executives at financial service firms have not aligned with the long-term institutional interests of those firms for decades now, undercutting the very philosophical basis of arguments in favor of outsize executive compensation. Alan Greenspan, as we all now know, was “shocked”:

As I wrote last March: those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity (myself especially) are in a state of shocked disbelief. Such counterparty surveillance is a central pillar of our financial markets’ state of balance. If it fails, as occurred this year, market stability is undermined.

Really, dude? You didn’t see this one coming? That the executive overlords in the too-big-to-fail tranche weren’t accountable to anyone but their great-grandchildren? That on the basis of some Ayn Rand-ian fantasy you set a bunch of free radicals loose with trillions of other people’s money and somehow, by the laws of the universe — under some universal law of the origins of specie — it was all gonna’ work out for the best?

At least in the days when financial institutions were held, either by law or by custom, to some size where they couldn’t single-handedly risk trillions of dollars, they were accountable to each other. They’d have to build syndicates, and Bear Stearns wasn’t going to let Salomon Brothers drag them into a deal that smelled. No one on Wall Street wants to change someone else’s diapers.

Likewise the Clintonian and beyond “Fair Isaac Deal” that’s been foisted on the American middle class: In the end, American workers really didn’t need better credit scores, although their entire financial lives were overdetermined by this calculation; what they needed were better wages and a health care system that properly insures against financial calamity in the face of long-term or catastrophic illness. But we too fell sway to the lure of other people’s money.

So, in the coming months, as we slowly unwind this horrible mess, let’s look to these benchmarks:

  • Financial firms need to get smaller, not larger. They need the participation and countervailing force of multiple-firm involvement in deals large enough to threaten, or that might even remotely threaten, the overall stability of financial and credit markets.
  • We need more shareholder reform and activism. Executives at financial firms need to be held to account, every day, for how they handle the corporate assets with which they have been entrusted. This very much includes how much they pay themselves and each other.

Lastly, let’s all wean ourselves off our habt of living off other people’s money. Start a savings account. Pay with cash. You’ll be a better person for it.

P.S., while I’m on a rant, why does this guy (see video) have to be a cyclist? Just as the cycling community started to recover from the negative impressions created by John Kerry?

Other People’s Money 2 – “Permanent Upside Bias”

Recent oil prices and forecast

Recent oil prices and forecast

It seems to me that more contrarian-minded investors have been successful over the long term than common wisdom would suggest. Take a long hard look at where the crowd is headed, and run as quickly as possible in the opposite direction. Bet against MBS’s? You betcha! Sell into a rally? Gotcha covered!

Which begs the question: why is every position in your (and my) portfolio long?

Last year, with the Dow treading water and oil at $145 a barrel and seemingly heading north forever, I was occasionally asked if there was anything I would invest in. I repeatedly said I only had one suggestion: if I had the nerve, I would short oil. Putting aside the relative complexity and expense of futures trading, did I do it? Did anyone I spoke with? Of course not.

I was reminded of my prep school days in Rhode Island. A fortune was to be made any time the Rangers played the Bruins, or the Knicks played the Celtics. Kids from New York would beat my door down to bet FOR New York, kids from Boston, FOR Boston. Not once did some kid from New York ever say, the Knicks are going to get their butts kicked, give me Boston and 5. There’s no joy in betting AGAINST something. Only money. Which is why I was happy to bet against both the Knicks and the Celtics, getting points or favorable odds from both sides. (A nice little business; kind of like selling lottery tickets.)

Retail investors – and I suspect American retail investors in particular – have what I call a “permanent upside bias.” We want to invest in things we believe in, that will grow, that will make us happy and rich and skinny and “the new 30.” On top of that, we don’t want to “sell” things we don’t believe in anymore. Where’s the fun in that? We don’t believe in dumping (as a society, we won’t even dump waste). So not only do we never take short positions, we never sell soon enough either. It’s one of the major reasons experienced institutional investors and “insiders” beat retail investors all the time. They’re unsentimental, and they’ve learned when and how to sell.

Being long in equities is the ultimate herd mentality. I’m not saying that learning to love your inner short will be like taking candy from a baby. I’ve just always been curious why the same irony and skepticism that pervades our view of all the other aspects of our modern American lives doesn’t also inform our view of our investments. Made a profit in last week’s Obama mini-rally? Maybe you should think about taking the profit for a change.

Other People’s Money 1

Recent DJIA, courtesy, My Side of the Coin

Recent DJIA, courtesy, "My Side of the Coin"

Read “A Decade of Dow,” by My Side of the Coin here.

Famous personal financial advisors – Suze Orman and Jim Cramer come most easily to mind – keep giving people the same bad advice: if you have ten or more years to retirement, invest heavily in equities. The implication being, over any given 10 year period, you can’t lose.

Well, here’s the reality check.

Friday’s close on the Dow was 7,776.18.

On March 30, 1999, the Dow closed at 9,874.41.

That’s a 21.2% loss for that 10-year period.

Granted, there are 10-year periods in which you would have done fine in equities. If you had invested everything you owned in stocks on the day Bill Clinton took office, you’d be wondering what all the recession fuss was about, too. (To wit: see my post “Whatever happened to the ‘Barack-Olypse.”)

But there are abundant examples of 10-year periods in which you would have lost a bundle in the market. Investing in the equivalent of indexes or index ETFs anytime between 1965 and 1973, for example, you would more than likely have had a 10-year loss. And investing in equities at any point in the last decade, as we see above, was treacherous.

Unless you were timing the market – which we are repeatedly advised not to do – or picking individual stocks AND timing the market – which we are repeatedly told is too dangerous for the average investor – you would have been much, much better off over the past decade with CDs and T-bills. Hell, you would have been better off with an ING Savings Account!