Monday, September 29, 2008

It's a Great Time to Invest!

It's the end of the world as we know it.
It's the end of the world as we know it.
It's the end of the world as we know it, and I feel fine.

— R.E.M., It's the End of the World as We Know It (And I Feel Fine)

Hat tip: Mrs. Dealmaker

© 2008 The Epicurean Dealmaker. All rights reserved.

Tuesday, September 23, 2008

Live and Let Die

La guerre! C’est une chose trop grave pour la confier à des militaires.

— Georges Clemenceau

Say what you will about the United States Congress, Dear Readers—and I know I am not alone in having said many things about it over the years which are unsuitable for publication in a family newspaper—but I must say that I am heartened by what is transpiring under the klieg lights at the Dirksen Senate Office Building this morning. The same authorities who tell us that secrecy begets tyranny are the ones who reassure us that sunlight is the best disinfectant. I am quite happy to endure some populist demagoguery and partisan grandstanding from the lunatic fringe of the Senate Banking Committee if it allows us to shine a light down the rabbit hole Ben Bernanke and Hank Paulson are desperately urging this nation to jump down into.

I am also delighted that Senator Dodd and Congressman Frank have taken the lead in negotiating with Messrs. Bernanke and Paulson over exactly what form the massive bailout they have requested will take. Clearly, the Treasury's first draft of the proposed bailout suffered from a number of minor deficiencies, including the relatively trivial one that its demand of immunity for itself—

"Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency."

—was egregiously unconstitutional on its face. (Nice try, Hank.) It is reassuring that a few of our brave elected representatives have chosen to smack the Hammer on the snout and try to come up with something more in keeping with truth, justice, and the non-fascist way.

[As an aside, I have to say that I hope the final proposal does include some provision for the Treasury to take an equity stake in any financial institution which elects to participate in the bailout by selling toxic assets to the fund. Given that we have what almost everyone acknowledges to be an intertemporal asset valuation problem—in which the current fair value of these assets and firms is opaque, widely believed to be artificially depressed, and just as widely expected to recover over time when taken out of the glare of current market pressures and mark-to-market accounting—it strikes me that the best solution is one where the bailer—that's you and me, Ladies and Gentlemen—and the bailee have neatly aligned incentives to participate in the market's eventual recovery. There is a nifty, time-proven financing method to accomplish such ends, which is called equity. Frankly, it was the height of stupidity, carelessness, and/or disingenuousness for the Treasury to have made their initial proposal without incorporating such a mechanism, especially since it has been done successfully before.]

* * *

But whatever final form this bailout proposal takes, and however it is implemented by this Administration and the one to come, I think it is absolutely critical to maintain a clear distinction between saving the American (and global) financial system from catastrophic lockup or breakdown—which should be the point of the whole exercise—and pulling any one (or more) particular financial institution's bacon out of the fire, which should not.

As an economy, and as a country, we will suffer losses. Sacrifices will have to be made. And, like in any war, it should be the soldiers on the front line who bear the brunt of the damage.

Let me be clear: financial ruin and calamity for some, if not many, market participants should be completely understood as a likely and perhaps even desirable outcome from this godforsaken mess. There is no reason on God's green earth why Goldman Sachs, Morgan Stanley, or even Citigroup cannot and should not be allowed to fail completely, utterly, and without a trace. (And to reassure you I am not being partisan, I would remain unmoved if outfits like Cerberus, PIMCO, and KKR went down the tubes as well. I just tend to think they are at far less risk that the traditional financial intermediaries currently on the firing line.)

These firms, and the people who run them and work for them, have been living by the sword for a long time. It would be no great American tragedy if some of them died by the sword today.

Would there be a great big smoking crater in our financial system from the impact of one or more of these failures? Yes. Would there be collateral damage to apparently innocent bystanders in the markets and the broader economy? Of course. Would the smoking rubble of the institutional assets and liabilities of such firms require a huge clean-up effort by regulators, lawmakers, and other market participants over a period of many years? Very much so.

Would tens of thousands of lives be ruined, just like the tens of thousands of lives which have already been ruined by the wholesale collapses and takeovers of Bear Stearns, Lehman Brothers, and other market casualties? Absolutely.

You know what I say to that? So the fuck what.

War is hell, mister.

Goldman Sachs is not more important than the national interest.

© 2008 The Epicurean Dealmaker. All rights reserved.

Friday, September 19, 2008

Simple Jacks

"You went full retard, man. Never go full retard."

— Kirk Lazarus, Tropic Thunder

So which is it?

Did Christopher Cox of the SEC and Hector Sants of the FSA simultaneously go "full retard" yesterday in temporarily banning short sales of financial stocks, or is there a secret government plot to use the markets to attack financial terrorists?

Almost every commentator and market pundit I have read this morning who has any fucking clue about the markets or what they are talking about in general has registered stunned disbelief at the SEC's and FSA's actions. The common reaction seems to be a mixture of: a) what do Cox and Sants think they're going to accomplish with this?; b) the relief/short covering/apotheosis-of-the-morons rally will be very short-lived and followed by a very long and ugly aftermath; and c) they went full retard.

Barry Ritholtz does provide some comic relief over at The Big Picture this morning by relating a conversation with a fund manager who does not think Jim Cramer was batshit crazy when he speculated that "financial terrorists" were behind the waves of selling of financial stocks over the past few weeks, but you can tell he is just casting around for some flotsam to cling to as the S.S. Capitalism goes under the waves. He doesn't want to believe her captain and first mates blew up the ship from within simply because they went full retard. I have to sympathize: it's a bitter pill to swallow.

Interestingly enough, crack financial reportrix Bess Levin at Dealbreaker puts some data out there that can be viewed by a sympathetic reader as both a) providing corroborative evidence that the War on Terror may have moved into the financial markets already and b) short sale restrictions don't make one damn iota of difference. After all, Pakistan is a key front in said WoT, and it is easy to imagine its market regulators trying to stop perceived bear raid attacks on market integrity by Islamists hostile to the government (and capitalism in general, natch), just on the off chance any hostile Islamists with sufficiently large margin accounts really exist.

What is sad to contemplate, however, is not only was banning short sales insufficient to keep the Pakistani market from continuing its long-term slide, but also one can argue that the short-selling Islamofascists—if there are any—may have actually surpassed their goal of weakening Pakistan's financial system by getting the country's own government to undermine the very principles of unrestricted trading and unhindered price discovery that system is built upon. It is beyond depressing to imagine that our market regulators may have handed financial terrorists a similar victory with their own boneheaded moves.

Let's hope, instead, that Cox and Sants simply went full retard. While it is scary enough to contemplate the two leading overseers of modern financial capitalism simultaneously having spontaneous frontal lobotomies, it is somehow less disturbing than thinking we have cut off our own heads to avoid the guillotine.

Roger: "I don't like the games you play, Professor."
The Professor: "War is hell, Mr. Thornhill, even when it's a cold one."
Roger: "If you fellas can't lick the Vandamms of this world, without asking girls like her to bed down with him and fly away with him and probably never come back, perhaps you ought to start learning how to lose a few cold wars!"
The Professor: "I'm afraid we're already doing that."

North by Northwest

© 2008 The Epicurean Dealmaker. All rights reserved.

Thursday, September 18, 2008

Burn Before Reading

Some days, Dear Readers, when the world is crashing down around your ears, your livelihood and net worth is going up in smoke, and your dealer is calling to say he is out of Xanax, it becomes hard to resist the impulse to push back your chair, rub your temples in dismay, and stare uncomprehendingly at the carnage playing out before your eyes.

Today is one of those days.

I have seen one or two others like it.

I remember in the halcyon days of my youth, when but a tender sprout reasonably fresh out of university, I decided to investigate this intriguing business known as "Wall Street" to see what I could find out about it. Naturally, my first impulse was to visit a friend of mine who held gainful employ within the hallowed halls of one of the mysterious practitioners of the financial arts. This ancient and hoary firm went by the since-remaindered name of The First Boston Corporation.

Since my friend worked in equity capital markets at the time, I sauntered through security one fine Monday morning up to the massive, open trading floor where hundreds of salesmen, traders, and support staff performed the various arcane rituals and sacrifices which seemed to be entailed in the institutional equity business. I had seen one or two movies and read one or two books about the industry, so I fully expected to be greeted with a wall of sound when the elevator doors opened onto the trading floor.

Instead, I was met with silence. Deathly, hushed, creepy silence.

It was Black Monday, 1987.

As he showed me around the trading floor, my friend tried to explain to me a little of what was going on and point out some of the various departments within Institutional Equities that were scattered about in different locations, but I must admit I paid more attention to the people and their behavior than his words. I could easily distinguish between the traders, who gaped at their terminals with the thousand-yard stare of shell-shocked infantry, and the salesmen, who were talking in hushed tones to clients over the phone. The latter sounded for all the world like crisis hotline personnel trying to talk a suicidal caller off a ledge. It wasn't pretty to listen to.

There was some sound on the floor, of course. The occasional ring of a phone, the occasional sob of despair (did I imagine that?), the occasional snort of disgust as the traders tried to read the tape, which was running about three hours behind the actual trading activity at that time. The only lively activity anywhere was in the pit, where in-house Nasdaq traders tried to reach their counterparts at other investment banks to execute or confirm trades. Since most of these counterparts were not answering their phones that morning, there was a lot of cursing and slamming of phone receivers to be seen there.

But probably the scariest part to me was the silent corner off the main floor where the risk arbitrageurs sat behind a Chinese Wall of soundproof glass. These few traders managed some of the largest true proprietary positions in equities at First Boston, and normally they cut themselves and their activity off from the main floor in order to prevent compliance breaches. That day, their glass door was open, and you could see the traders sitting silent and motionless at their desks, doing nothing but looking at the terminals before them. They sat straight and grim-faced, and their stillness was not the stillness of men who feel either confidence or serenity, nor was it the peacefulness of opportunity seen and realized. That little tableau frankly scared the pants off me, and I still see it clear as day more than 20 years later.

* * *

Today, the litany of woe seems to be neverending, and the causes for despair keep multiplying like rabbits.

I see as of this writing that the pathetic, naive little investors who pushed the market up this morning on the hopeful news that governments around the world were printing more money opening their pocketbooks to ...—do what exactly?—are giving up the ghost.

Goldman Sachs is back down around the lows of yesterday, where I pointed out the franchise-killing effects one can expect from that sort of stock price.

Morgan Stanley has decisively breached $17 per share as well, notwithstanding the desperate news that they might be selling themselves to fellow walking-wounded Wachovia or flogging a big stake to China Investment Corp. (By the way, who among you feels comfortable entrusting the long-term future of an important global counterparty to sovereign investors who hail from a culture where it passes as business as usual to spike baby milk with toxic melamine to hide protein deficiencies and then conceal the reason for recalling the milk for weeks because some fat ex-athlete in a spandex suit is pretending to fly up the side of a stadium to light a friggin' torch? I, for one, do not.)

Meanwhile, on the political front, we face a restive Congress and a couple of economically illiterate Presidential candidates, about whom the most charitable thing one can say is that they appear less foolish when they keep their mouths shut. Our standing President has decided to forgo his previously welcome silence and kick in his one and a half cents worth, which will no doubt frighten the market into another swoon once investors remember he remains the Decider in Chief for another four months.

On the M&A front, even the tumbleweeds are getting bored with inactivity, and any client who hasn't suffered sunstroke in the last three weeks is hunkered down in a fallout shelter behind sacks of rice and beans toting a loaded shotgun. A few of these will call me from time to time, to check whether it is safe again to come out and play, but they really don't expect me to say yes.

* * *

So where do we go from here?

I will venture out a brief distance onto an anonymous limb and make a few irresponsible predictions as to what might happen over the next several months. Let us hope I am proved wrong.

We have not seen true capitulation in the markets yet. When it comes, it will come in the form of one or more days with stocks declining closer to 10% a day than 5.

Volatility is going to the moon, with the result that a lot of short sellers are going to get slaughtered, too. There will be no safe haven in this storm.

Morgan Stanley: gone. Goldman Sachs: gone, or mortally wounded.

Timothy Geitner of the New York Fed: Interim Dictator of the United States, or dead in a ditch from a terrorist bomb thrown by someone who has finally figured out who actually runs this country.

Dick Fuld, John Thain, John Mack, and Hank Greenberg: strung up in Times Square with piano wire by rampaging mobs of disgruntled shareholders.

Having fun yet?

* * *

Normally, I am a firm believer in the maxim that it is unwise to yell "Fire!" in a crowded theater. Nevertheless, when the stage and proscenium are on fire, the orchestra is embroiled in a knife fight with the stagehands, and four of the six exits are blocked, I feel that prudence compels me to issue a measured warning to my fellow members of the audience:


© 2008 The Epicurean Dealmaker. All rights reserved.

Wednesday, September 17, 2008

Remain Calm ...

Further to my extended woolgathering post yesterday on the potential future of the investment banking industry in general and the only two large remaining independent i-banks in particular, I would be remiss if I did not call your attention to the stock price performance of Morgan Stanley and Goldman Sachs today.

As of this writing, GS stock is trading down approximately 25% on the day, near $100 per share, and MS is sucking moose titty to the tune of minus 35%, around $18 per share.

This is important, Dear and Beloved Readers, because over the past five years Goldman Sachs' stock price has ranged from a high of $248 per share to a low of $84, with an average over the period of $146.78. The comparable figures for Morgan Stanley are $74, $18 (today), and $50.48, respectively. Given that investment bankers are usually paid a substantial portion of their mouthwatering annual bonuses in the form of restricted stock, options, SARs, and other stock-related funny money which typically vest in stages over a period of three to five years, this means that GS and MS bankers are looking at the evaporation of somewhere in the neighborhood of one- to two-thirds of their nominal deferred compensation from the last five, highly lucrative years.

I don't care how much cash you have in the bank, that'll leave a mark.

Furthermore, the percentage of funny money in your paycheck usually increases quite substantially the higher up in the organization you go and the more successful you become. Top-earning bankers can get stuffed with 60%, 70%, or sometimes even more company toilet paper in place of officially approved government tender. Therefore, you can just imagine the senior executives and big swinging dicks at these two shops probably feel like they have just undergone (another) bris today without anesthesia. Most of these will also realize later this afternoon as they pack up to go home that they're going to get another kick in the balls from their adoring spouses when they share the news that little Missy can't have a $500,000 Sweet Sixteen party at the Rainbow Room this year, after all.

So while it is probably too early to say that the majority of senior bankers at GS and MS are irretrievably disgruntled with their situation, it is far from clear that they are or will remain sufficiently gruntled for any length of time.

Further to my aforementioned thesifying, I would speculate that today's events—unless they are reversed quickly and handily in the very near future—will only accelerate the hemorrhaging of experienced investment bankers from these two remaining bastions of integrated capital markets and advisory services. Whether these bankers drop out completely and toddle off to St. Barts to squander their (diminished) accumulated wealth on hookers and blow or elect to sign up with the roving packs of predators known as advisory boutiques will depend, in large part, on how large a hole has been blown in their personal balance sheets. (Also how expensive and painful Sweetie-pie can make the potential alternative of divorce.)

Of course, there always is a more socially responsible alternative:
"Christ. Seven years of college down the drain. Might as well join the fucking Peace Corps."

— Future Senator John Blutarsky

I would vote for that.

© 2008 The Epicurean Dealmaker. All rights reserved.

Tuesday, September 16, 2008

The K-T Boundary

Okay, boys and girls, today we start a new class project.

Now that Lehman Brothers and Merrill Lynch have disappeared as independent investment banks over the past few days, it is time to determine whether the investment banking industry as we know it is entering a new era. The vaporization of Lehman Brothers at the point of impact of the Chicxulub subprime meteor1 and the absorption of the Thundering Herd into the gaping maw of Ken Lewis's petty cash account have left us with only two independent i-banks of any materiality, Goldman Sachs and Morgan Stanley. Those two were last seen limping around the tropical forests of southern Wyoming, so it is presumed by knowledgeable commentators that they have survived the weekend's events.

Never one to avoid a swift roll in the hay with conventional wisdom, certain elements of the chattering classes have already begun to speculate that Goldman and Morgan are not long for independence. These pundits speculate that the once-fearsome predators will be consumed by giant, lumbering herbivorous dinosaurs, some of which have been eyeing the carnivores' ecological niche covetously for, oh, about 40 million years or so. The rationale, of course, is that GS and MS will need to shelter under the protective wing of a commercial bank in order to have access to less volatile sources of funding for their huge sales and trading operations. How such unnatural inter-species combinations might be accomplished, and whether they can be done without entailing the utter destruction of one or both of the presumptive mergees—questions one might legitimately pose concerning the merger of BAC and Merrill, by the way—seem not to have attracted too much attention from these budding eugenicists.

Alternatively, there is a countervailing "Small is Beautiful" argument developing around certain other watercoolers. This crowd is yammering on about how the new order will be taken over by swarms of little furry advisory boutiques, who will survive the impending nuclear winter by sheltering in the moldering corpses of the reptilian behemoths and raise their multitudinous young on the detritus of integrated investment banks past. Certain advocates of this scenario contend that this will truly signal the end of the Age of Dinosaurs and the rise of the Age of Mammals. In contrast, others insist that, once free to run about, the little boutiquers will gradually reaggregate—like scattered globules of mercury—into great big "multi-product, multi-geography" investment banks again. Should this happen, we will likely learn that all those so-called "mammals" were really devious little reptiles in disguise, who donned fake fur and whiskers to confound hostile regulators and lawmakers while they secretly rebuilt the Age of Dinosaurs, Version 2.0.

As I am an exemplar of those few bankers who crossed the reptilian-mammalian divide into boutiqueland some years ago, I must admit that I have a predilection for the SiB-ers' position. (I know my partners and I would certainly not mind being able to pick up a passel of disgruntled former Lehmanites on the cheap.) Nevertheless, I am clear-eyed enough to know that there are many hidden forces at work in the ecological woodpile, and I could make a credible case for either of these theories, plus the as-yet unconsidered one exemplified in the status quo.

In any event, I am a realist when it comes to industry structure, not an idealist. I believe people and firms will try all sorts of ways to exploit the current market upheaval, including utilizing different (and the same old) organizational forms. As you might expect, Goldman Sachs' CFO insisted today on their earnings call that it does not want to buy a commercial bank or sell itself to one and that all is for the best in this best of all possible worlds for the Teflon Investment Bank. (Although he would have to say that, wouldn't he?) Other than plummeting stock prices, there seem to be few hints that Morgan Stanley or Goldman Sachs are not long for the planet. As far as anyone can tell, they are not insolvent or illiquid, but one could have credibly said the same about Bear Stearns or Lehman a few days before they kicked the proverbial bucket.

Only time—as I have heard it said, somewhere or other—will tell.

* * *

So how did the investment banking industry get itself into this pickle, and where does it go from here?

I must say that John Gapper of the FT—he of the permanent small furry animal hypothesis, above—does a creditable job capturing the key developments in the recent history of the industry which have led us to this pass. In his view, it was "May Day"—the elimination, in 1975, of fixed commissions for stock trades—which launched the industry onto the path of relentless growth in capital, people, and profits we have seen up until recently.

Stockbrokers such as Morgan Stanley were pushed out on their own by the 1933 Glass-Steagall Act, which enforced the separation of banks and investment banks. Their fate was probably sealed on May 1 1975, when fixed commissions for trading securities were abolished, setting off a squeeze on broking revenues.

“To stockbrokers, May Day means nothing less than the abolition of the system that has enriched them in good times and pulled many of them through during long periods of market slack,” Time magazine noted that year. Investment banks had relied on these commissions during the financial doldrums following the 1973 oil crisis.

Investment banks went on to enjoy 30 years of prosperity. They grew rapidly, taking on thousands of employees and expanding around the world. The big Wall Street firms swept through the City of London in the 1990s, picking up smaller merchant banks, such as Warburg and Schroders, on their way.

Under the surface, however, they were ratcheting up their risk-taking. It was increasingly hard to sustain themselves by selling securities – the traditional core of their business – because commissions had shrunk to fractions of a percentage point per trade. So they were forced to look elsewhere for their profits.

They started to gamble more with their own (and later others’) capital. Salomon Brothers pioneered the idea of having a proprietary trading desk that bet its own money on movements in markets at the same time as the bank bought and sold securities on behalf of its customers.

Banks insisted that their safeguards to stop inside information from their customers leaking to their proprietary traders were strong. But there was no doubt that being “in the flow” gave investment banks’ trading desks an edge. Goldman Sachs’ trading profits came to be envied by rivals.

Investment banks also expanded into the underwriting and selling of complex financial securities, such as collateralised debt obligations. They were aided by the Federal Reserve’s decision to cut US interest rates sharply after September 11 2001. That set off a boom in housing and in mortgage-related securities.

The capital markets business—securities sales and trading activities—has always been a key component of the investment banking model. Unlike the advisory side of the business, however, maintaining a credible and effective capital markets operation has always been an expensive proposition. It requires a lot of people, information technology, dedicated real estate, and other doodads that cost a lot of money to install and a lot of money to maintain. (The air conditioning bill alone to cool a trading floor full of computers on a New York summer's day would set a small Somali village up for life, for example.) In contrast, your typical M&A banker requires very little in the way of infrastructure. Outside of a nice wood-paneled conference room or two to entertain clients in, the advisory banker can usually get by with a suitcase, a cell phone, and a charter membership in the Emperors Club.

So when fixed commissions were eliminated, the huge capital markets business of a typical investment bank could no longer support itself financially. Banks needed to find another use for all that investment in infrastructure. Pace the supposed genius of the innovators at Salomon Brothers, it was only a small and intellectually undemanding step from using relatively small amounts of in-house capital to support underwriting and market-making activities to using a much larger amount of money trading for their own account, on a proprietary basis. Because they were "in the flow" and saw the securities markets from the privileged position of market makers, "prop desks" at investment banks started making money hand over fist. In other words, they started acting like hedge funds.

Add in the ballooning federal deficits of the Reagan years (and the resulting huge trading volumes in fixed income securities and related derivatives), the explosion in equity trading which accompanied the internet boom, and Alan Greenspan plying the financial markets with liquidity like a whorehouse madam plies shore-leave sailors with booze, and you can readily see that capital markets operations became the dominant business line of all major investment banks over the past couple of decades.

Of course, there was trouble in paradise. Trying to incorporate a volatile principal-oriented business like proprietary trading into an organization that was otherwise focused on agency business like M&A advisory, capital raising, and underwriting caused all sorts of problems. When the prop traders made a bundle betting for the firm, they brought home annual bonuses that struck even the highly overcompensated bankers in M&A and corporate finance as nothing short of obscene, and when their trades blew up in their faces everybody else at the firm suffered big cuts in compensation regardless of how good their individual years had been. Bankers off the trading floor began speaking bitterly about the "trader's option," while the unlucky traders got fired and sauntered across the Street to another prop desk at another bank.

For their part, the prop traders began to chafe that they were making hundreds of millions—or, occasionally, billions—for their banks but were not getting paid adequately for it. This was the genesis of Long Term Capital, which formed from a nucleus of prop traders who decamped from—you guessed it—Salomon Brothers in the mid-1990s. LTCM's fate aside, Wall Street trading desks have been the farm teams for serious hedge fund traders ever since.

The compensation systems at investment banks could not deal with this development, either. Proprietary traders, CDO structurers, and derivatives specialists began taking and holding positions with longer and longer risk tails, but still got measured and paid based on systems designed to measure the annual production of a banker conducting traditional agency business, like M&A or equity underwriting. Imbalances built up, risk and return became misaligned, and various pieces of shit began hitting various fans. Paying traders, corporate financiers, and M&A advisors with long-vesting restricted stock did create some sort of alignment with the firm's and shareholders' interests, but it was too blunt an instrument to contain and control the stresses building up in the new hybrid hedge fund-investment banking model.

You know the rest of the story.

* * *

Now the cleverer among you might have already questioned why the investment banks didn't simply abandon the securities sales and trading business when it became unprofitable after May 1975. There are three reasons, two of which are relatively trivial, but one of which goes to the heart of the question of what will happen to the industry business model going forward.

For one thing, commissions did not vanish in one fell swoop after May 1, 1975. Competition was introduced, and commissions shrank gradually over a number of years. Investment banks did not necessarily see the writing on the wall for quite some time, and by the time they realized that pure agency capital markets was now and forever a loss leader business, it was in many respects too late to change. (Gimlet-eyed financial entities or not, investment banks are subject to the same irrational commitment to sunk costs and legacy businesses as our friends in the real industrial economy.) Second, capital markets businesses were always large, controlling roughly half the resources of a typical investment bank and sometimes more. Human psychology and organizational theory tell us that it is very difficult to kill a business line with so much human, psychological, and political capital committed to it, plus sharp-elbowed leaders who are committed to fight for it.

But most importantly—and perhaps surprisingly—the capital markets business has always been an integral part of an investment bank's advisory business. This may be obvious for corporate finance activities like selling bonds to raise capital for a railroad or underwriting an initial public stock offering for a technology company. Raising capital for corporate clients has always been an extremely important business line for investment banks. In fact, it was really the only business investment banks conducted for many years after their separation from commercial banks in the 1930s after Glass-Steagall, until the emergence of a new business in the late 1970s which came to be known as mergers and acquisitions advisory. All those "client bankers" to Ford Motor Company, CSX Corporation, and Netscape did and do rely heavily on their buddies on the capital markets desk to gauge investor demand, structure attractive security offerings, and help sell their clients' securities to new investors.

But what is really interesting is that M&A bankers rely heavily and often on their capital markets colleagues, too. I am not speaking, by the way, of private equity-led buyouts, where M&A bankers get dragged along to "advise" the PE clients in name only. In such deals, the PE firms hire "financial advisors" solely for their prowess and ability to raise leveraged finance to fund transactions, not for any putative real advice from an industry or M&A banker. The private equity guys couldn't care less what some guy like me has to say. They just want the money.

But in the case of corporate clients, there is all sorts of useful intelligence an M&A banker can glean from his capital markets partners which bears directly on the approach, feasibility, and potential price of doing a deal. There are shareholder and bondholder lists to parse, market chatter to channel, and potential financing terms to suss out. Publicly traded corporations want to know how the markets will react to the announcement of a transaction, and CEOs want to know who are the top 20 critical investors they should talk to to explain the rationale for selling a division or buying their biggest competitor. Once the deal is announced, the capital markets bankers become the client's direct channel to Mr. Market, with all the positive and negative feedback that entails. This is real-time information, of the most critical kind, filtered with skill and intelligence by people who know what the hell they are talking about. There is no better definition of market-based advice, and no better example of the type of added value an integrated investment bank can bring to its client.

Not all clients need or value this type of advice, so independent pure advisory firms like Greenhill, Evercore, and the like can survive and even prosper on M&A business alone. But an important number of companies do, and such companies form a durable and defensible client base for integrated investment banks which can deliver such capabilities. Not to mention that Goldman, Morgan, and even the Frankenstein hybrids of universal banks like Citigroup, JP Morgan, and Deutsche Bank have the leveraged finance capability to deliver deal funding to private equity buyers and other financial derelicts in need of other peoples' money.

Pure advisory boutiques cannot deliver this sort of advice, because they do not have the capital markets arms to deliver it. But capital markets operations of any consequence (i.e., those which can deliver good market intelligence) are too expensive to support solely with the revenues a successful M&A practice brings in. Here is your Catch-22, if you like. Advisory practices cannot compete with fully integrated investment banks in all situations without capital markets capabilities, but capital markets capabilities cannot pay for themselves without proprietary trading operations. We seem to be stuck with the integrated i-bank model, whether we like it or not.

* * *

"So what the fuck is your conclusion, TED?," you think to yourself. Good question.

If I had to venture a guess—you didn't think I wouldn't, did you?—I would say that we will see a repopulation of the middle of the industry over time. At the top end, in size and revenues—but not necessarily prestige or reputation—we will continue to see hedge fund-i-bank hybrids flinging their balance sheets about and trying to be all things to all people. Most of these will be combinations of commercial banks and investment banks, but there may still be a place for a Goldman Sachs or a Morgan Stanley if they remain religiously devoted to careful risk control.

Such firms should be successful, at least among the clients who truly need the services they deliver. The current market environment, and the current systemwide flight from risk, may mean that these banks will have to settle for lower returns on equity, and their bankers will have to settle for lower compensation, than they have been used to in the recent past. If this is the case, you will see higher-profile investment bankers—"rainmakers" who can write their own ticket (or persuade others they can)—bleed out of such leviathans into smaller, more prestigious advisory boutiques, where they can eat what they kill.

You may see some independent boutiques grow in size, and become credible competitors to Lazard and the in-house M&A factories of larger banks. But for this to happen, we will need to see an institutionalization of advisory boutiques which has been lacking to date. So far, the named boutiques we read about all depend on one or two serious, named founders who generate all the revenue, and a bunch of lesser-known, competent bankers who carry their bags. For boutiques to truly thrive and prosper, you will need to see firms that can field 10, 20, or even 50 senior partners who can slug it out toe-to-toe with the best that Goldman, Citigroup, or JP Morgan can offer. And you will need to read about them in the pages of Institutional Investor and The Wall Street Journal.

Where this leaves me, and where I fit into this picture, I prefer not to say. But I will say that I expect the next several years to be very interesting ones for the investment banking industry.

Fasten your seat belts, comrades.

1 Or its absorption into the gaping maw of Bob Diamond's petty cash account. It matters not: the result is the same. You should know, Dear Readers, that I have never been willing to sacrifice an entertaining metaphor for the trite and uninspiring vagaries of the truth.

© 2008 The Epicurean Dealmaker. All rights reserved.

The Garden of Forking Paths

"The explanation is obvious: The Garden of Forking Paths is an incomplete, but not false, image of the universe as Ts'ui Pên conceived it. In contrast to Newton and Schopenhauer, your ancestor did not believe in a uniform, absolute time. He believed in an infinite series of times, in a growing, dizzying net of divergent, convergent and parallel times. This network of times which approached one another, forked, broke off, or were unaware of one another for centuries, embraces all possibilities of time. We do not exist in the majority of these times; in some you exist, and not I; in others I, and not you; in others, both of us. In the present one, which a favorable fate has granted me, you have arrived at my house; in another, while crossing the garden, you found me dead; in still another, I utter these same words, but I am a mistake, a ghost."

— Jorge Luis Borges, The Garden of Forking Paths

To Whom It May Concern:

I will not insult your intelligence by offering career advice. I will, however, offer the following. Perhaps some of you might find it helpful.

In the midst of the Garden, which is Time, you find yourself on a path, which is your fate to follow to the next forking. You may not have chosen the path you are on, and you may not like it or the choices you think you see before you, but you cannot go back. You cannot unwrite your own history. You cannot unlive your own life.

You must go forward. And because you must, you should go forward boldly, to the next fork in the path, and see where it leads you.

As Mrs. Dealmaker is fond of saying, "Life is what happens to you while you are making plans."

Forkin' A.

© 2008 The Epicurean Dealmaker. All rights reserved.

Irony of Ironies

What do you think I discovered when I opened my e-mail in-box this morning, O Dearly Beloved?

Why, nothing less than this timely little gem:

I guess Dick Fuld didn't get the research report on subprime mortgage CDOs in time.

Gives new emphasis to the phrase "eating your own cooking," doesn't it?

© 2008 The Epicurean Dealmaker. All rights reserved.

Thursday, September 11, 2008

Dick Fuld, Excitable Boy

For my homies at Lehman Brothers:
I went home with the waitress
The way I always do
How was I to know
She was with the Russians, too?

I was gambling in Havana
I took a little risk
Send lawyers, guns and money
Dad, get me out of this ... Hyah!

I'm the innocent bystander
Somehow I got stuck
Between the rock and a hard place
And I'm down on my luck
Yes I'm down on my luck
Well I'm down on my luck

I'm hiding in Honduras
I'm a desperate man
Send lawyers, guns and money
The shit has hit the fan

All right
Send lawyers, guns and money ... Huh!
Uh... Send lawyers, guns and money ... Uhh!
Send lawyers, guns and money ... Hyah!
Send lawyers, guns and money ...

— Warren Zevon, Lawyers, Guns and Money

Peace out, bra. Chill.

© 2008 The Epicurean Dealmaker. All rights reserved.

Wednesday, September 10, 2008

T-Bone the Metaphor

Ya gotta love this country:
MISSOULA, Mont. (AP) — A middle school teacher suffered some bruising and a big scratch on his back after he struck a bear while riding his bicycle to school.

Jim Litz said he was traveling about 25 mph Monday morning when he came upon a rise and spotted a black bear about 10 feet in front of him. He didn't have time to stop and T-boned the bruin.

He tumbled over the handlebars, his helmet hit the bear's back and the two went cartwheeling down the road.

The bear rolled over Litz's head, cracking his helmet, and scratched his back before scampering up a hill above the road.

Litz's wife drove by shortly after the crash and took her husband to the hospital. He hoped to be able to return to teaching science at Target Range Middle School on Friday.
* * *

NEW YORK, NY (AP) — Troubled investment bank CEO Dick Fuld suffered a bruised ego and a black mark on his resume after he struck a bear while riding his limousine to work.

Mr. Fuld said he was traveling about 30 mph Wednesday morning when he came upon the intersection of Wall Street and Broad and spotted David Einhorn about 10 feet in front of him. He didn't have time to stop and T-boned the bearish investor.

He tumbled out of the limo, his Blackberry hit the activist's back and the two went cartwheeling down Wall Street.

Mr. Einhorn rolled over Fuld's briefcase, scattering his restructuring documents, and scratched his Gucci loafers before scampering into a Starbucks across the road.

Bart McDade drove by shortly after the crash and took Mr. Fuld to the Fed's Discount Window. He hoped to be able to return to scowling menacingly at creditors and rating agency executives at Lehman Brothers on Friday.

* * *

WASILLA, AK (AP) — Vice Presidential candidate Sarah Palin suffered some jovial ribbing and a big dent to her reputation after she struck a moose while ferrying her children to soccer practice.

Ms Palin said she was traveling about 85 mph Tuesday morning when she came upon a school crossing and spotted a sleeping moose about 10 feet in front of her. She didn't have time to stop and T-boned the herbivore.

She tumbled out of her Expedition, her AK-47 hit the moose's back and the two went cartwheeling down the road.

The moose rolled over Palin's skinning knife but escaped without a scratch before scampering down a hill into the Arctic National Wildlife Refuge.

John McCain drove by shortly after the crash and took Ms Palin to the taxidermist. She hoped to be able to return to field-dressing Barack Obama in Virginia on Wednesday evening.

* * *

WASHINGTON, D.C. (AP) — Treasury Secretary Hank Paulson suffered a bruised balance sheet and a knock to his Teflon image after he struck a sour note while rescuing the federal housing agencies.

Secretary Paulson said he was spending about $200 billion Sunday evening when he came upon the wobbling GSEs and spotted a moral hazard about 10 feet in front of him. He didn't have time to stop and T-boned the metaphor.

He tumbled over the podium, his plan hit taxpayers and GSE shareholders in the pocketbook and the three went cartwheeling into uncharted territory.

The conservatorship rolled over Americans' sensibilities, undermining self-discipline, and cackled and scratched its balls before scampering down the corridor back to K Street.

Ben Bernanke drove by shortly after the crash and took Secretary Paulson to Capitol Hill. He hoped to be able to forget his stint in Washington as quickly as possible.

© 2008 The Epicurean Dealmaker. All rights reserved.

Monday, September 8, 2008

Plan Ahead

"We say to the management of companies: ‘You are here today. Where do you want to be five years from now, and how are you going to get there?’”

— Henry Kravis

Andrew Ross Sorkin and Julie Creswell authored a lengthy piece this past Sunday in the New York Times, entitled "What Does Henry Kravis Want?" Good question.

The gist of the article seems to be some extended head scratching about the private equity honcho's continued interest in taking his General Partner management company—the "KKR" which most people think about when they think about "KKR"—public through an initial public offering, notwithstanding the currently crappy market conditions for IPOs, leveraged buyouts, and bobbleheaded dolls bearing his own likeness or that of his partner George Roberts.

Like the Economist and other mainstream media reporters before them, Mr. Sorkin and Ms Cheswell profess to be confused by the fact that a private equity company would even entertain the thought of exposing its inner workings and private cafeteria menu to the withering gaze of the public markets and other riffraff. I, on the other hand, am confused by their confusion.

Perhaps they concluded that a gentleman of Mr. Kravis' abbreviated stature would naturally be particularly afflicted by the proverbial hobgoblin of consistency and were nonplussed when they failed to find it in his words and actions. But I could have told them that—"tiny eighties relic" or no—Mr. Kravis is by no means possessed of a little mind, and he and his partners and competitors in the institutionalized rape and pillage private equity industry have always had a complicated and situation-contingent love-hate relationship with the public markets.

Talented reportage or not, what amuses me is that the writers seem to have missed the very clue which could have enlightened them in the first place, a clue which they themselves drew attention to in the article. I speak, of course, of the quote from Mr. Kravis which adorns the top of this post, in which he alludes to KKR's standard practice of having their partner management teams develop extensive strategic, operational, and financial plans for the businesses which KKR buys with them. Surely Mr. Sorkin and Ms Cheswell did not think that a clever man like Mr. Kravis would fail to conduct the same simple planning exercise in his own personal and professional life?

Although, to be fair, reporters like Mr. Sorkin and Ms Cheswell would be unlikely to pursue this line of inquiry—even if it had occurred to them—without some sort of documentary evidence to back it up. Fortunately, your Dedicated Correspondent has access to a number of carefully screened, disgruntled current and former employees of KKR and other major PE houses to call upon for the manufacture discovery of titillating pieces of inside dope. A couple of phone calls and a kilo of cocaine later, and my sources delivered me a particularly revealing goody which shows just how far Mr. Kravis takes his own personal planning process.

The document is fragmentary, being just the first page of what appears to be a longer list, but I believe it speaks for itself:

Question answered, no?

Next time, Andrew, give me a call first, and I'll save you some shoe leather.

© 2008 The Epicurean Dealmaker. All rights reserved.

Monday, September 1, 2008

Molon Labe

Ω ξειν’, αγγέλλειν Λακεδαιμονίοις ότι τηιδε
κείμεθα, τοίς κείνων ρήμασι πειθόμενοι.

Go tell the Spartans, stranger passing by,
that here, obedient to their laws, we lie.

— Simonides of Ceos

For some reason, Dear Readers, I have been spending a significant portion of my leisure time recently reading about King Leonidas, his 300 Spartans, and their suicidal stand against Xerxes' Persian hordes at Thermopylae in 480 BC.

I trace my current interest to the 2006 release of the sword-and-sandals epic, 300, which I personally found to be a more enjoyable piece of comic book art than the original Frank Miller creation itself (Gerard Butler's clotted Scottish accent notwithstanding). My interest has unquestionably deepened as I traversed the slippery slope of increasing realism, historical accuracy, and scholarship from Steven Pressfield's fictional Gates of Fire to Paul Cartledge's Thermopylae: The Battle That Changed the World.

Psychologically, the reasons for my current fascination with the topic are less clear to me. Perhaps it has something to do with the story of a small band of elite, hand-picked warriors battling hopelessly against overwhelming odds to preserve their freedom and way of life. One need not be too grandiose to draw parallels with the predicament of a shrinking band of highly trained investment bankers struggling desperately against a relentlessly rising tide of inactivity and an actively hostile society to preserve their right to three Lamborghinis in the driveway of a Hamptons potato mansion. Pathologically self-absorbed and massively egotistical, yes, but not grandiose.

Human psychology is such that we all like to imagine ourselves at the center of a dramatically coherent and meaningful story, whether we work in a Dilbert-style cubicle zoo or commute to weekly Executive Committee meetings on the company G550. And, pace the current wisdom concerning the evolutionary origins of investment bankers, the best scientific evidence available seems to indicate that most of them are indeed human. Investment bankers do have the same hopes and dreams as the rest of society. It just so happens that our dreams contain more champagne, caviar, and expensive Russian hookers than yours do.

Besides, the closer you look into this Thermopylae business, the more eerily exact and disturbing the parallels become. The battle itself is believed to have happened in the dog days of August, traditionally the nadir of capital markets and M&A activity and hence the scariest period on the investment banking calendar. This August in particular has been so dead that the typical jumpy, underemployed i-banker can be forgiven for seeing crouching Medean warriors—or HR associates armed with pink slips—lurking behind every Starbucks counter and Southampton hedgerow.

And notwithstanding the common man's perception of the Spartans as the Western World's first freedom fighters, marching bravely off to certain death for God, for Country, and for Yale, Spartan society was a deeply weird and rather repellent concoction, at least by current standards. The justifiably intimidating standing army of Sparta—which was composed of every adult Spartan male, for whom the role of full-time soldier was the only profession allowed—was in fact established and maintained primarily to control a vast underclass of enslaved Greeks known as Helots, upon whom the full-fledged Spartan citizens, male and female, relied to do all their labor.

Throw in officially sanctioned pederasty, fearsome women who expected their husbands to come home draped in glory or in a body bag, and the educational system of the agoge, which taught young boys to steal, lie, and do whatever it took to come out on top, and Spartan society begins to look disturbingly similar to investment banking culture. (I'll let you figure out where the pederasty comes in.) By many accounts, the Spartans were an arrogant, anti-intellectual, and unpleasant bunch, and their festival days must have looked a lot like the Hampton Classic horse show, minus the Ralph Lauren togs.

But the bugger(er)s were principled; you have to give them that. And, whether you believe it or not, most investment bankers are too. We just don't adhere to the principles most of the rest of society holds dear (or at least the principles the political correctness police loudly tells society it should hold dear). Cigar smoking, misogyny, excessively foul language, and a scornful disrespect for the meek and downtrodden are central to the Darwinian world view of your typical investment banker, and dearly held beliefs, too. On the plus side of the ledger, investment bankers do tend to hew to a punishing work ethic (at least the junior ones, before they learn the tricks of the trade from slacker MDs like me), and they clean up real nice. Some of them even—in a moment of weakness, I grant you—donate to charity. Who knew?

And, like the Spartans at the Hot Gates, the true threat to investment bankers' way of life does not really come from collapsing markets, vengeful regulators, or rioting shareholders: it comes via treachery from within. If any force has the capability to destroy all that is unique and special in investment banking culture, it is the bog-standard Human Resources department of your typical investment bank. Now—when banks are groaning under the pressure of plunging revenues and dousing smoking craters where their balance sheets used to be—is when the craven HR weenies crawl out from under their rocks and start swaggering around the halls waving sheaves of termination notices in their hands. They resort to each and every trick in their book to cull the bloated ranks of former Masters of the Universe, including enforcing the banks' internal PC behavior codes which normally remain dormant and unenforced when said MoUs are raking in the legal tender.

Therefore, we witness senseless little tragedies like the recent termination of fellow bloggist and investment banker 1-2 for the heinous crime of blogging while employed at some nameless über-bank. 1-2 seems to be taking it well, but his fate definitely casts a pall over the rest of us who undertake the occasional character assassination or fierce excoriation of some hapless boob in the industry from behind the comfy firewall of anonymity.

It is at times like these, with the PC Empire bearing down on the narrow defile where Yours Truly and a select few bloggers man the Phocian Gate in defense of truth, justice, and the Investment Banking Way, that my mind turns toward King Leonidas' laconic response to Xerxes' demand that the Spartans give up their weapons:

"Come and take them."

That—plus a few choice Anglo-Saxon epithets of rather more earthy persuasion—is what I mutter to myself whenever I sense the threatened approach of the nannies-that-be to confiscate the laptop, smoking jacket, and case of 20-year old Scotch which comprise the bulk of my blogging tools. They haven't caught me yet, but it may just be a matter of time.

Well, gotta go. Sounds like someone's banging on my office door with a battering ram, reciting the text of the Americans with Disabilities Act over a bullhorn. I guess they're coming for me.

I think I'll sit down, smoke a cigar, and comb my hair.

© 2007 The Epicurean Dealmaker. All rights reserved.