Friday, July 31, 2009

Andrew Cuomo Is a Cheap Pander, and Other Observations

Carol Connelly: "Hey, we all have these terrible stories to get over, and you—"
Melvin Udall: "It's not true. Some of us have great stories, pretty stories that take place at lakes, with boats and friends and noodle salad. Just no-one in this car. But a lot of people, that's their story: Good times, noodle salad. What makes it so hard is not that you had it bad, but that you're that pissed that so many others had it good."

As Good As It Gets

Envy, Dear Readers, is an ugly thing.

It may be a powerful, ancient motivator for people to improve their station and situation in life—as real estate brokers, car salesmen, and cosmetics companies from time immemorial can attest—but it is corrosive, base, and potentially destructive as well. It can transform a person who otherwise feels content with his life into a shrill, grasping, dissatisfied shrew, just because he notices that someone else has something he does not. It can lead to all sorts of chronic social ills, like celebrity magazines, reality shows, and regularly recurring profiles of Donald Trump on national television.

It is usually blind and farcically selective, as well. We envy our neighbor's new Ferrari without realizing he bought it with life savings after learning he has six months to live. We envy the thin, wealthy, and fabulously connected Upper East Side socialite without knowing her hedge fund manager husband is an abusive, philandering stranger and her children hate and despise her. We envy the famous, the rich, the beautiful, and the better or more [insert your preferred adjective here] than us without understanding either the price they pay for such gifts or the gaping holes in their lives where we possess advantages they can only dream about. We envy advantages for which we do not understand the price, and we envy possessions and qualities which we would not be willing to sacrifice what is necessary to achieve them even if we knew what it was.

Envy is the weak and lazy sister to its hardworking sibling, ambition. It is a futile, foolish, and low emotion. And it is a favorite target for populist demagogues and pandering politicians alike.

Which brings me to the Attorney General of the State of New York, the Honorable Andrew M. Cuomo.

* * *

Writing as The Deal Professor at The New York Times today, Steven M. Davidoff takes gentle umbrage at Mr. Cuomo's laughably obtuse report on the 2008 bonus compensation of the nine largest banks receiving TARP bailout funds:

I thought that this was the hard-hitting government study we needed into investment bank compensation and its relationship, if any, to the financial crisis. But I was ultimately quite disappointed.

Instead of an in-depth report on the compensation practices at Wall Street firms, both past and future, the only thing we got was compensation porn.

And uninteresting porn at that.

Echoing Professor Davidoff, I have to admit that I was similarly unimpressed. Although I realize most lawyers have difficulty writing numbers larger than "$500 per hour" on paper, I was staggered to see that over three quarters of the 21-page report were devoted to double spaced itemizations of random bonus trivia and cursory historical financials for each of the nine banks. This is the type of work a suitably trained investment banking Analyst—or, for that matter, a slightly brain-damaged monkey—could have knocked out in one evening after downing a couple of Red Bulls and some Adderall.

For this we waited nine fucking months?!

Anyway, the Professor correctly criticizes the Attorney General for failing to investigate or address key elements of his self-proclaimed brief, namely the relation of 2008 bonuses to compensation in prior years, the methodology the TARP recipients put in place to determine 2008 bonuses after they received government support, and the banks' justification for any bonuses they did pay last year. Other than collecting numbers from each bank in arbitrarily defined buckets—why, for example, look at the aggregate bonuses for the top 14 executives, exactly?—and doing a rudimentary and meaningless comparison of total compensation at each of the banks in relation to their historical net income, of all numbers, it doesn't look like the crack troops at the AG's office did much of anything with their vaunted access and limitless powers of subpoena.

But this is ridiculous. These are all empirical questions, questions which could have been investigated and addressed with each of the banks in turn without so much as breaking a sweat. It's not like the AG didn't have enough time, or his steely-eyed investigators couldn't get access to the trembling CFOs and Human Resource heads who were busy pissing their pants in fear of having Mr. Cuomo and his minions up their asses with a flashlight for the next ten years. Where are the answers to these simple questions? Did you just not do the work, Mr. Cuomo, or did you just decide to omit these results from your report, in fear they might portray a more nuanced and less politically marketable picture of Wall Street greed and excess?

* * *

I, for one, would have been very interested to learn exactly what percentage of these bankers' pay was granted in the form of non-cash compensation, like shares and options. It would have been even more illuminating to learn how much of the non-cash pay took the form of deferred compensation, pay which was locked up in the stock or options of the employing bank and which could not be claimed for years after its grant. Pay which, in my experience, a banker usually forfeits if he leaves the bank voluntarily before it vests, and pay which exposes a substantial portion of the banker's net worth to the risk and fluctuation of his employer's stock price. Risk the banker shares equally with public shareholders, with the niggling little exception that shareholders can sell their stock at any time, and the banker cannot. Of course, it would have been more illuminating to see this data broken down by level of pay, too, since it is usually the senior bankers making the big bucks who get stuffed with toilet paper, not the lowly-paid worker bees.

But I guess I see why you didn't publish that data for all the banks. It would have diluted the message to disclose for everyone what Goldman Sachs insisted you report for them: that 953 Goldman employees earned bonuses of $1 million or more, but no-one at the company took home more than $885,000 in cash. Sorta undercuts the image of fat cats dining freely on the shareholders' and taxpayers' dime, doesn't it? Joe Sixpack might not get so worked up about a banker's $10 million bonus when he learns that over $9 million of it is tied up in his firm's stock for up to five years, huh?

And while Professor Davidoff also expressed disappointment that you did not address bigger issues surrounding investment bank compensation, like the tension between individual performance and the performance of his or her firm or the potential mechanisms for clawing back previous pay, learning just how much bankers' and executives' pay is tied to the share price performance of these TARP banks—how many billions of dollars of employees' wealth is at risk along with that of shareholders and taxpayers—might just have answered both of those questions. Heaven forbid that we find investment bankers have been "playing the casino" with their own money, in addition to ours. Kinda muddles the populist message of outrage, dontcha think?

* * *

Anyway, I cannot get too outraged about this, I guess. After all, you are only a politician, and as such still reside somewhat lower on the scale of public approval and trust than investment bankers and other pond scum. In addition, your role as Attorney General makes you the chief prosecutor for the State of New York, and hence an advocate for the pursuit, discovery, and punishment of all criminals, real or perceived. It is not in your remit to be balanced and fair, or to use your powers of subpoena and investigation to discover the truth about anything. It is your job to build a case, and throw the bums in jail if you can. It is up to defense lawyers to offer up an opposing interpretation, and for judges and juries to arrive at a more nuanced and balanced vision of the truth.

And you are following a long tradition in New York, from Rudy Giuliani to Eliot Spitzer and beyond, of pursuing your version of justice—and a promising and lucrative political career, as well—in the kangaroo court of uninformed public opinion. Why befuddle the poor people with unsightly and confusing facts, when you can wrap yourself in the cloak of sanctimony and popular outrage to pelt a few fat cats in the stocks of public opinion? It's worked before, and you seem to be doing an excellent job.

So, while we are on the subject of accountability and pay for performance, Mr. Cuomo, I guess I would be interested to learn just exactly how much of my New York State income taxes was used to produce this disingenuous excuse of a marketing pamphlet for your upcoming gubernatorial campaign.

The fine and upstanding people of the State of New York deserve to know.

© 2009 The Epicurean Dealmaker. All rights reserved.

Thursday, July 30, 2009

The Fish Stinks from the Head

Benedick: “And, I pray thee now, tell me, for which of my bad parts didst thou first fall in love with me?”
Beatrice: “For them all together; which maintained so politic a state of evil that they will not admit any good part to intermingle with them.”

— William Shakespeare, Much Ado about Nothing

Heidi Moore 1 published an interesting counterpoint to all the recent Goldman Sachs-bashing at Slate’s The Big Money yesterday, entitled “Will Everyone Please Shut Up About Goldman Sachs?” Notwithstanding its title, the article seems to be less a defense of the orcish vampire squid threat to humanity everybody loves to hate and more of an encomium to its unique culture.

Ms Moore points out the fact that, for all its reputation as “a devastating hive mind that can control any institution it touches, including the U.S. government,” and as a gathering of the smartest minds, human and machine, on the planet, Goldman Sachs employees have proved singularly inept outside of the hive. I have made a similar argument—characteristically with fewer examples but many, many more words—in the past.

I have also described in these pages my experience of Goldman bankers over the course of my career and their almost uniform, as Ms Moore terms it, “lack of magic or voodoo.” For such a successful firm, Goldman Sachs seems to have a remarkable dearth of superstars, whether in my exalted realm of corporate finance and M&A or the sordid cesspits of sales and trading. Almost no-one there dazzles you with their sheer genius, overwhelming salesmanship, or scintillating personality. Nevertheless, the firm has a preternatural ability to persuade past, current, and future clients that it is the best of the best on Wall Street, no matter how badly it may have fucked up any one client’s particular transaction in the past. This is a truly admirable capability, and one which I and many other Goldman competitors continue to try and replicate, so far with less than complete success.

* * *

Taking her cue from the “current and former Goldman bankers and officials” she interviewed 2 for the article, Ms Moore lays credit for the firm’s success firmly at the feet of its vaunted culture. Goldman encourages their bankers to express their opinions and disagree freely over important decisions, she says, but discourages dissent and second-guessing once decisions have been agreed. She notes that bankers are rotated freely among positions and functions, as part of developing general management experience. She cites the legendary Goldman focus on dense and high frequency internal communication via voice mail, and she posits that the firm's system of “360-degree reviews,” wherein “everyone is evaluated not only by their managers but also their underlings and peers,” not only encourages homogenization but also discourages some of the more disagreeable political shenanigans found at many other banks.

The interesting thing about this litany—which is widely known across the Street—is that few of these practices are unique to Goldman Sachs. In fact, I can confidently assert that the only really unusual practices at the firm are the near psychotic intensity devoted to communication by voice mail and the rotation of bankers through different areas and positions. While many banks are indeed noted for surface consensus belied by subversion, undermining, and open backstabbing, managerial decision making by open disagreement is not that unusual.

The fearsome old troglodytes at Salomon Brothers, for instance, prided themselves on a culture which encouraged open and voluble disagreement among bankers in pursuit of robust and thoroughly examined decisions. A correspondent remembers Solly bankers proudly explaining at an NYU recruiting function years ago that the firm did not tolerate backstabbing. Instead, if someone disagreed with you they promised to “break down the door and come at you [directly] with an axe.” Friends and colleagues from the house of Liars Poker confirm this tale: bankers would beat the crap out of each other over important decisions, and then go grab a beer or ten together afterwards. The system worked remarkably well.

Likewise, 360-degree reviews are now common across Wall Street. They have been almost universally adopted because they make sense, for all the reasons Ms Moore relates. However, I have worked at two big banks which used 360-degree review systems, and I can tell you from personal experience that they did not make a damn bit of difference. At both shops, bankers went through the motions of reviewing bosses, subordinates, and peers, but everyone knew that top management paid no attention to them. Banker pay and promotions were determined the old-fashioned way, through political patronage, budgetary infighting, and whoever screamed the loudest and most convincingly over deal revenues. No-one had any incentive to give honest reviews or constructive criticism, because anything negative could be seized upon by one's enemies or schemers among senior management as reason to reduce a bonus or even fire someone. Accordingly, all reviews became subject to massive grade inflation, and the category comprising bankers who were supposed to be rated in the top 10% of their peers magically grew to include 40 to 50% of everyone at the firm. It was a joke.

Now, maybe Goldman Sachs has figured this out, and these systems actually work for them. But if so, it is not due to the processes and procedures they have in place. It is the firm’s culture, and senior executives’ complete commitment to that culture, which makes these mechanisms successful. 360-Degree review systems, 24-hour response voice mail, and rotation of bankers through different departments only work when senior managers refuse to make exceptions to the rules. There are a nauseating number of investment banks which profess an undying commitment to teamwork and a dedicated focus on cultivating client relationships rather than chasing transactions. But these banks fall short time and time again because they do not enforce these principles. If Mr. Big Swinging Dick Managing Director who brings in a billion dollar IPO or a ten billion dollar merger throws a hissy fit and threatens to stomp out the door if he has to share credit, or a successful M&A banker refuses to manage a group in Capital Markets, or a Group Head inflates the review scores of all his subordinates to boost their pay and his power, senior management can either hold firm and preserve the culture, or they can cave. If they hold firm, everyone else at the bank hears about it, and they learn that the rules and the culture will be enforced. If they cave, everyone knows that too, and it’s off to the bad old races of “what’s in it for me.” Sadly, most investment bank executive teams cave.

* * *

Now, for all the folderol in the press about how “brilliant” this or that banker or group of bankers is, I have always maintained that individual talent and originality are highly overrated in investment banking. With few exceptions—which always have extremely limited shelf lives, as competitors reverse engineer innovations within weeks or days—there is almost nothing new under the sun in my business. Notwithstanding what they like to tell you, investment bankers don’t really sell “ideas.” They sell connection, and access, and they are successful to the very extent they can maintain themselves in the flow of market information. Investment banks derive their market power and importance by maintaining dense and robust information networks across the numerous markets they participate in. This makes them better traders, better investors, and better advisors.

In the overall scheme of things, a successful bank should prefer to have strong networks, rather than strong bankers. Take a banker with excellent network connections out of his or her supporting environment, and he or she becomes dramatically less effective. Allow individual bankers to weaken the network by hoarding clients, refusing to communicate, or actively undermining their rivals within the firm, and you weaken the bank materially. Encourage the hiring and creation of “superstars,” and you shift power away from the bank into the hands of individual mercenaries. All of these things make an investment bank less valuable to its clients, as well.

So, a bank which can subsume individuals into a cohesive mass, which can preserve and encourage the development of internal and external networks, and which can build a stable platform has a long-term advantage. Maintain a stable platform, and you remain in the flow of information and deals over the long term. Remain in the flow, and you build a credible and trustworthy brand. Do it long enough, and you just might become Goldman Sachs.

Of course, Goldman Sachs is not unique in the history of investment banking for having developed a distinctive and stable culture. A long litany of culturally distinct and successful organizations graces the rolls, including such standouts from my early days in the industry as JP Morgan, Drexel Burham Lambert, First Boston, DLJ, Salomon Brothers, Morgan Stanley, Merrill Lynch, Bear Stearns, and Lehman Brothers. The distinguishing feature of almost all of these firms, however, is that they diluted, destroyed, or squandered their distinctive cultures through a series of ill-advised mergers or acquisitions, in the benighted industry-wide pursuit of growth.

Culture grows organically, and slowly, over time. Introduce a foreign culture into an existing institution—particularly one built entirely on the back of assets who walk out the front door every evening—and you almost always destroy what you have. The glue which binds colleagues and potential rivals into a cohesive whole dissolves, and the mantra becomes every man for himself. You can rebuild a culture, or build a new one, but it takes a long time and an almost superhuman dedication from the very top of the organization. JP Morgan is a good example of a firm with a formerly distinct and powerful culture which lost its way through acquisitions and which has now rebuilt itself to a near facsimile of its former self, largely on the back of Jamie Dimon’s personality. It is still absorbing the Bear Stearns virus, but early indications are that the House of Morgan will survive the infection.

* * *

All of which helps explain why Goldman Sachs enjoys such prominence in the industry and the broader financial markets today. If nothing else, they have succeeded by being too smart—or too timid, or too insular—to buy anybody else in the last two decades. They have thrived by remaining the same—while admittedly swelling like a tick on a dog—while everybody else engaged in an orgy of corporate combination and lost or weakened their distinctive identities, franchises, and platforms.

Goldman’s integrity and cohesiveness certainly make it admirable in my eyes. But that does not necessarily mean it is not evil. A powerful culture creates a powerful divide in the minds of its members between what is inside and what is outside. Goldman employees’ dedication to the firm does not necessarily extend to its clients, its regulators, or the society it operates in. One can legitimately question whether Goldman behaves like the traditional stereotype of the mainland Chinese: if you are on the inside, and connected, you will be treated with respect and honesty; but if you fall outside the inner circle, you are fair game to be cheated and taken advantage of.

In the realm of fiction, the Borg are admirably focused, cohesive, and successful, too. That doesn’t mean they are the heroes of the story.

“We are the Borg. Lower your shields and surrender your ships. We will add your biological and technological distinctiveness to our own. Your culture will adapt to service us. Resistance is futile.”

Remember, Dear Reader, that old saw: Just because you’re paranoid doesn’t mean that Goldman Sachs isn’t out to get you.

1 Yes, that Heidi Moore.
2 I have no idea what Ms Moore's experiences were in said interviews, but I suspect that her description of these immensely wealthy and powerful individuals as drab, colorless nebbishes may prove the exception to the rule of women interviewing powerful men I elaborated earlier. I have to suspect that interviewing your off-the-rack Goldman banker generates about as much sexual tension as watching oatmeal congeal.

© 2009 The Epicurean Dealmaker. All rights reserved.

Wednesday, July 22, 2009

H is for Hedge Fund

“Were the judgments we made reasonable ones?” a former top Harvard administrator asked me, rhetorically, addressing the sharp increase in expenses and capital commitments of the last decade. “At the time, I think they were reasonable judgments. It turns out, with the benefit of hindsight, you might have preferred less ambitious plans.” (Which is not to say that the administrator in question accepts a grain of responsibility for those judgments.) ...

“Apparently nobody in our financial office has read the story in Genesis about Joseph interpreting Pharaoh’s dream—you know, during the seven good years you save for the seven lean years,” remarked Alan Dershowitz, a professor at Harvard Law School since 1967. “And now they’re coming hat in hand, pleading to the faculty and students to bear the burden of cutbacks. It’s a scandal! It’s an absolute scandal, the way Harvard has handled this financial crisis.”

— Nina Munk, "Rich Harvard, Poor Harvard," Vanity Fair

At one point in her gripping account of the endowment train wreck and its aftermath at Harvard University, Nina Munk characterizes Harvard as "a distinguished, high-minded research university, arguably the greatest university in the nation." This is just the sort of a by-the-by assertion that makes Harvard partisans nod their heads and murmur "Of course" and the rest of us grind our teeth in various degrees of dismay, disbelief, and envy. Harvard itself makes no effort to dissuade people from this view, and its public mission seems to center around preserving and extending its reputation, legacy, and importance.

Which is why I am puzzled that Harvard has landed in the mess it has so loudly, sloppily, and apparently unexpectedly. You would think a university founded almost 375 years ago would take the long view in everything it does. You would think that it would be cautious, circumspect, and conservative, and that, in the words of that arch traditionalist, Rudyard Kipling, it would have learned to treat those two imposters, triumph and disaster, the same.

You would think that a mere setback of 25 or 30% in the endowment account—after years of outstanding, market-beating returns—would have been reserved for, or at least anticipated as theoretically possible. You would think that such a university would have made provisions for just such a rainy day. Apparently, you (and I) would be wrong.

* * *

Of course, there are other contenders for the throne of greatest university in the world, some of which have the unbridled temerity to site themselves outside the United States. So I thought it would be instructive to conduct, investment banker style, a quick comparable analysis of the leading hedge fund universities in the US with the oldest English-speaking university in the world, Oxford. The comparison, if I say so myself, is revealing.

 Harvard Yale Oxford 1
Year founded 2163617011096/1167
Total students20,32011,44620,014
Total staff12,95012,7958,427
2008 FYE expenses (mm)$3,465$2,294£749
Staff costs as % of expenses47.9%58.4%53.8%
2008 FYE endowment (mm) 3$36,927$22,686£654
% Expenses funded by endowment34.7%37.1%4.5%
% Expenses funded by government 415.4%19.7%30.4%
Net fixed assets (mm)$4,951$3,200£844
2008 FYE capital spending (mm)$591$569£114

1 Oxford's numbers do not offer a true apples-to-apples comparison to its American rivals, since the vast majority of the University's residential colleges are independent financial entities whose numbers are not reported in the University's consolidated reports. However, one can get a sense of the size of the omitted entities by noting that the colleges had aggregate income of £267 million in fiscal 2008 and aggregate endowments totaling £2.67 billion.
2 Oxford states: "There is no clear date of foundation, but teaching existed at Oxford in some form in 1096 and developed rapidly from 1167, when Henry II banned English students from attending the University of Paris." Way to stick it to the French.
3 As of fiscal year end 2008, before everybody and their brother shit the bed. Current size estimates for Harvard's and Yale's endowments are $26 billion and $16 billion, respectively. No-one really cares how much Oxford's pissant little endowment lost since July 2008, except perhaps Oxford. It is worth noting that Oxford is currently undertaking an unprecedented capital campaign to raise—wait for it—another £1.25 billion. Woo-hoo!
4 The percent of last fiscal year expenses paid for with direct national government support and grants.

For one thing, the figures do little to persuade me that Yale pays much attention to the productivity of its labor force. More interesting, and more to the point, it appears that the oldest university manages to eke out its continuing reputation as one of the best around with a much smaller endowment than its competitors. Even adjusting for the unconsolidated endowments of Oxford's independent colleges, the University manages to educate over 20,000 students to some of the highest standards in the world using a mere $5 billion in treasure. Sure, Oxford relies on the UK (and, to a much lesser extent, the EU) government for a larger proportion of its operating expenses than the Yanks, but Harvard and Yale demonstrate no rugged go-it-alone individualism when it comes to Uncle Sam's largess. Again, adjusting for the Colleges' endowment income, it is not clear there is much difference at all.

So what's the difference? Cathedral building. Consider this, from Nina Munk:

Over the 20-year period from 1980 to 2000, Harvard University added nearly 3.2 million square feet of new space to its campus. But that’s nothing compared with the extravagance that followed. So far this decade, from 2000 through 2008, Harvard has added another 6.2 million square feet of new space, roughly equal to the total number of square feet occupied by the Pentagon. All across campus, one after another, new academic buildings have shot up. The price of these optimistic new projects: a breathtaking $4.3 billion.

In Allston, a Boston neighborhood just across the Charles River from the school’s main campus, you can view Harvard’s billion-dollar hole in the ground, a vast construction pit. It’s the foundation of Harvard’s most ambitious project of all: the sprawling Allston Science Complex, once scheduled to be completed by 2011 at a cost of $1.2 billion—but now on hold.

And this proud recitation, from Yale's fiscal 2008 report:

Capital spending on facilities in 2008 totaled $568.9 million. This represents a 52% increase over the 2007 spending level and the highest level of spending in the University’s history. This significant increase in capital spending reflects the University’s commitment to renovating its existing facilities while adding strategic new facilities to meet teaching, research, and residential needs.

The accompanying graph is a thing of beauty.

It seems that Harvard and Yale are in a race to determine which of them has the biggest edifice complex.

* *

This is Part 3 in a continuing series on the cost and funding of higher education in America.
Part 1: Et in Arcadia Ego
Part 2: VA • NI • TAS

© 2009 The Epicurean Dealmaker. All rights reserved.

Tuesday, July 21, 2009


In the days when Harvard’s endowment provided only a fraction of the university’s operating budget, a loss would have been unfortunate, but not tragic. In recent years, however, Harvard’s soaring endowment has become the engine fueling the university’s growth. In 2008 alone, so-called distributions from the endowment were $1.2 billion, representing more than a third of Harvard’s total operating income, up from only 16 percent two decades ago.

During the boom years, it was assumed without question that the value of Harvard’s endowment would keep rising. Trusting in that false certainty, the already profligate university went wild, increasing its annual operating budget by 67 percent, from an inflation-adjusted $2.1 billion in 1998 to $3.5 billion in 2008—this, even as the number of students remained constant. While I was reading through Harvard’s financial reports from the past decade, the word “delusional” sprang to mind. So did “unsustainable.” It was like feeding an addiction, having access to so much quick and easy money.

— Nina Munk, “Rich Harvard, Poor Harvard,” Vanity Fair

Reading Nina Munk’s generally excellent and entertaining piece in Vanity Fair on the fallout at Harvard University from the spectacular implosion of its endowment, I was struck by a particularly confusing passage.

In it, Ms Munk explained that Harvard’s apparently panicked sale of $2.5 billion of bonds in December of last year—possibly the worst time in the last few decades to try to sell new debt in the marketplace—was necessitated because “it needed immediate cash to cover, among other things, what [her] sources say was approximately a $1 billion unrealized loss from interest rate swaps.” Swaps, Ms Munk explained, which “were put in place under Harvard’s then president, Lawrence ‘Larry’ Summers, in the early 2000s, ... to protect, or hedge, the university against rising interest rates on all the money it had borrowed.”

But this makes no sense. As of June 30, 2008, Harvard had no more than $1.6 billion identified as variable rate debt on its books, and no more than $4.1 billion in total. If Harvard’s swaps were designed to pay fixed and receive floating—which is the simplest and most common way to hedge existing variable rate bonds against increasing interest rates—those must have been some enormous fixed rate payments to trigger a $1 billion loss on the swaps.

In fact, it turns out that Harvard had to raise new funds last December for two primary reasons. First, it faced around $1 billion in margin calls on the depreciated value of the investment positions in its endowment portfolio, positions it either did not want to or could not sell into the falling market. Second, it faced mark-to-market losses on swaps covering not only the $1.6 billion in floating rate debt already on its books but also an additional $2 billion of debt it planned to issue in the future. Bloomberg explains:

Harvard had 19 swap contracts with New York-based Goldman Sachs; JPMorgan Chase & Co.; Morgan Stanley; Charlotte, North Carolina-based Bank of America Corp. and other large banks, according to a bond-ratings report by Standard & Poor’s.

The agreements required Harvard to pay banks fixed interest rates on a total underlying amount of $3.52 billion in exchange for receiving floating-rate payments. Some of the swaps were used with existing floating-rate bonds, essentially converting the school’s cost to fixed rates.

Most of the swaps, signed when Summers, 54, was Harvard’s president from 2001 to 2006, were intended to lock in rates for debt that Harvard expected to issue as far off as 2022, for a 340-acre campus expansion, according to Moody’s Investors Service. In 2006 and 2007, Moody’s warned of risks from those so-called forward swaps, though it said the school’s finances and management experience mitigated them. Summers declined to comment on the record about the matter.

The value of the swaps dropped as the fixed rates charged by banks in exchange for floating rates on new contracts fell below what the university was paying. By Oct. 31, its swaps were worth a negative $570 million, meaning that’s how much Harvard needed to pay to get out of them, S&P said. The losses widened from $330.4 million on June 30 and $13.3 million a year earlier, according to Harvard’s annual report.

Given the continuing plunge in swap prices from the end of October to December 2008, it is not hard to believe that Harvard’s cost to exit its interest rate agreements ultimately approached $1 billion.

Now forward swaps, or forward start swaps—which behave like normal swaps except the offsetting fixed and floating rate payments are scheduled to start at a date certain in the future—by themselves count as little more than rank interest rate speculation, specifically in this instance as a bet that short-term interest rates will rise in the future. They can make a great deal of sense when an issuer intends to sell bonds in the relatively near future and when the issuer wants to hedge against budgetary uncertainty by converting floating rate obligations into fixed rate debt. That being said, I have rarely encountered a corporate client who feels confident enough about both their absolute funding needs and current and impending market conditions to enter into a forward swap starting more than nine months into the future. Entering into a forward start swap for debt you do not intend to issue for up to 20 years in the future sounds like either rank hubris or free money for Wall Street swap desks.

Of course, the entire article recites a litany of stupidity, arrogance, hubris, greed, and backstabbing bureaucratic infighting which makes the average investment bank look like a Montessori preschool.

It’s reassuring to see that Wall Street doesn’t have the market for organizational dysfunction cornered, after all.

© 2009 The Epicurean Dealmaker. All rights reserved.

Friday, July 17, 2009

Where's That Goddamn Ringing Coming From?

Nobody listens to me.

Were I not a charter member of Ye Ancient and Hoary Order of Pompous, Arrogant, and Misogynistic Assholes—more commonly known in this day and age as investment bankers—I might take this state of affairs amiss. But my ego, like my checkbook, is constructed of seamless cast iron, so no little absence of sustained attention to my pearls of wisdom can disrupt my customary bonhomie, especially on such a pleasantly sweltering Summer Friday as today in New Jack City.

But this afternoon, as I surveyed the crater-strewn landscape outside my window that used to be the gleaming crossroads of international finance over the remnants of a particularly satisfying cigar, I became filled with magnanimous concern for those among my brethren who perhaps are not in as comfortable a situation or as equable a mood as I.

I speak, of course, about such friends and colleagues as those who man the 24-hour money spinning machines at Goldman Sachs and JPMorgan. Poor, sad, pitiful wretches. For surely, even as they labor valiantly over the swelling piles of filthy lucre in the engine rooms of the global economy, sweating buckets into their custom-made shoes and staining their $5,000 suits with unsightly streaks of salty perspiration, these poor creatures know that appreciation and admiration among the general populace for their selfless acts of daily heroism are nowhere to be found.

On the contrary, jibes, epithets, and scurrilous abuse are what they encounter. No "Thank you, Sir, for sacrificing your weekends in St. Barts and daily visits to the manicurist to shovel ever greater piles of gleaming coin into your shareholders' and senior executives' bank vaults, whence surely they will eventually trickle down to water the parched and thirsty lips of a grateful nation." No, instead they get called "vampire squid," and are castigated for having blood funnels.

As if that's a bad thing.

* * *

Apparently there is some small concern that, after having been thrown several government-issue lifejackets and buoyed upon a flood of free taxpayer money to preserve the illusion that they were no better off than perennial basket cases like Citigroup and Bank of America, Goldman et al. are displaying a striking tone deafness when it comes to the recompense of their toiling hordes. They are accruing bonuses according to the old "halfsies" rule, which history tells us was first formulated in the late Pleistocene when a natty Cro-Magnon investment banker promised to help acquire a particularly troublesome Mastodon for a gormless bunch of Neanderthal cubicle dwellers in exchange for half the choice steaks.

Sadly, tradition is no substitute for judgment in these troubled times. Accordingly, out of deep charity and the everlasting goodness of my heart, I am more than happy to share again some thoughts I transcribed on this very subject a mere 8 1/2 months ago, which the executives of the surviving investment banks might find useful. I will not take offense that my previous advice seems to have been ignored, since I am sure that last October Messrs. Blankfein and Dimon were far more concerned with swatting piranhas and alligators away from their submerged testicles than with fine-tuning the optics of a politically acceptable and competitively workable compensation model.

For any of you who are too lazy to click through to the original, plus those (like Lloyd) who have been charged by Timothy Geithner with itemizing every surplus hyperlink they have taken on the taxpayers' dime, I offer the core of my measured advice here:

Pace the structural changes in the industry, which all point toward a long-term decline in both the absolute and relative levels of investment banking compensation, the CEOs and Boards of Directors of major commercial and investment banks are under severe short-term political pressure to reduce pay. Because this is true for the entire industry, senior management at the leading banks may take this opportunity to cut their wage bill in tandem from, say, the traditional 50% of net revenues to 40%, or lower.

I can think of many senior executives who would love to stick it to their restive, pain-in-the-ass bankers and traders who are never happy with their pay, no matter how high it is. This crisis could provide the industry great air cover for a structural change in the level of pay to employees. "It's not us," they will cry, "Congress made us do it!"

Nevertheless, even at reduced payouts the absolute level of pay for the typical bog-standard Managing Director will still be plenty large enough for Henry Waxman to string him up with piano wire on the steps of Capitol Hill and be applauded for doing so. Panicky, resentful voters who can only dream of making enough money to break into Obama's higher tax bracket and who are worried about keeping their homes, their jobs, and their three large-screen plasma TVs will not look kindly on anyone making over $1,000,000 this year. Even in a shitty year like this one, there will be plenty of those to go around.

So i-bank management better start getting pretty clever about justifying, explaining, and structuring its compensation practices and payouts in the glare of public scrutiny. For what it is worth, I think most people could accept even high pay packages if it were shown that bankers were not walking away with the family silver after the public has saved their house from burning down. Limit maximum cash compensation for everyone to less than $1 million, and make up any excess in the form of long-dated options and long-vesting restricted stock. I imagine even Joe the Plumber could accept an MD earning $10 million this year if he knew that $9 million of it was in the form of company stock he cannot touch for five to 10 years. That way, the banker will thrive or suffer in tandem with his firm's other shareholders and the US taxpayers who have rescued his cookies, and Messrs. Waxman and Cuomo will take comfort in knowing that TARP's billions have not flown straight out the door to fund cocaine and hooker binges on St. Barts this Christmas.

There you have it. Put on the hair shirt, don the mucking boots, and just wade right into the Augean Stables. You have the best excuse in the world right now to screw over your employees. All you have to do is point out the window and show them the snarling crowds of Congressmen, auto machinists, and Rolling Stone readers waving pitchforks and torches on the sidewalk to persuade them that yes, perhaps just this once, they might forgo squealing like little girls if they receive less than half of the total, crisis-inflated dollars rolling in the front door and defer most of their cash compensation to another day.

As usual, you can soften the blow by reminding them that most citizens outside the charmed circle of investment banking have all the basic understanding of finance and accounting of Maxine Waters and frontal lobes which are easily distracted by the shenanigans of John and Kate or the Jonas Brothers. This too, as as our colleague and mentor the Devil himself has maintained from time immemorial, shall pass.

* * *

But Lloyd, Jamie ... Guys.

I'm a businessman, too, you know. I figure my advice will save you and your firms billions of dollars in current compensation, and, what is more, garner you a priceless trove of positive publicity and political capital that will just keep on giving into the future. (As long as you continue to water it with ongoing campaign contributions, of course.) I think I deserve to be compensated for my critical contributions to your firms' value creation, don't you?

Whaddya say we split the difference, and I take 5% of your combined 2009 annual revenue as a fee. That's fair, right?

Oh, and by the way, I want top billing on the deal tombstone. Tossers.

© 2009 The Epicurean Dealmaker. All rights reserved.

Thursday, July 16, 2009

Do Not Forget to Specify, When Time and Place Shall Serve, That I Am an Ass

"Dost thou not suspect my place? Dost thou not suspect my years? O that he were here to write me down an ass! But, masters, remember that I am an ass; though it be not written down, yet forget not that I am an ass. No, thou villain, thou art full of piety, as shall be proved upon thee by good witness. I am a wise fellow; and, which is more, an officer; and, which is more, a householder; and, which is more, as pretty a piece of flesh as any in Messina; and one that knows the law, go to; and a rich fellow enough, go to; and a fellow that hath had losses; and one that hath two gowns, and everything handsome about him. Bring him away. O that I had been writ down an ass!"


"Who have you offended, masters, that you are thus bound to your answer? This learned constable is too cunning to be understood. What's your offence?"

— William Shakespeare, Much Ado about Nothing

Late yesterday, I published on this site a post commenting on an article by one Julie MacIntosh of the Financial Times concerning the rise of boutique advisory shops. I thought the article was well-balanced, informative, and well-written, and I said so. However, in addition to a rather lengthy disquisition on a couple salient points which I thought Ms MacIntosh had missed or underemphasized in her piece, I chose to sprinkle a few jibes and asides into my post that focused on certain possible aspects of Ms MacIntosh's putative appearance. While you may question my judgment, I thought they added a little harmless and humorous spice to my essay.

If professional journalist Heidi Moore's rapid Twitter messages to me are any indication, however, she, for one, did not agree:

moorehn @EpicureanDeal "Either that, or she has really nice tits." That's in bad taste. She's a professional journalist and that's demeaning.
about 17 hours ago from web in reply to EpicureanDeal

moorehn @epicureandeal Not to mention that the only spur for your idiotic leering seems to be that she wrote an article that you read.
about 16 hours ago from web

moorehn @epicureandeal This isn't the old days at the client with a Solly AmEx card in the strip club. Get over yourself and get into this century.
about 16 hours ago from web

And, if I had any doubts as to her meaning, I suppose they must have been allayed by the following direct message:

moorehn You really come off like a tremendous asshole in that piece. Maybe rethink the whole "demeaning any female who dares write abt IB" thing.
about 17 hours ago


* * *

I suppose I could try to defend myself by pointing to the long tradition of using unreliable, unintelligent, and even despicable narrators to relay comic messages, or to the fact that to underline the inanity of my "idiotic leering" I footnoted the most egregious aside in my post with a ludicrous industry joke older than dirt. I suppose I could point to previous writings on this site which undermine a casual perception of me as an unrepentant sexist or chauvinist. Finally, I suppose I could point to the barrelfuls of vitriol, invective, and naughty language I have spilled here in pursuit of countless idiots, stooges, and scoundrels—virtually every one of them male. But that would be a waste of time. It's hard to convince someone you were trying to be funny when they don't believe you were.

So let me make a couple brief points.

The intersection of female beauty and male power is one of the most ancient themes in the never ending Battle of the Sexes. The attraction of older, successful men to young and physically attractive women, and the complementary attraction of young women to powerful, wealthy, and successful men, are powerful physical and emotional forces that operate somewhere near the level of our cells. They will never be domesticated out of our beings, no matter how feminized our culture may become. For proof, I only have to look at the 50 to 70-year-old squillionaires squiring 30-year-old wives and children young enough to be their grandchildren to school every morning around my neighborhood. (Or, for those of you farther from the center of the universe, Donald Trump.)

Layer on top of that substrate a situation wherein a young, fresh faced female journalist—no matter how professional—eagerly interviews a wealthy, powerful, testosterone- and hubris-soaked Captain of Industry for his wisdom, insight, and experience, and you have a combustible combination. The man—unless he is dead, or on estrogen therapy—cannot help but be flattered to have an intelligent, attractive young woman hanging on his every word and nodding and laughing in vigorous agreement to every bon mot, joke, and opinion he cares to regale her with. The woman—unless she is dead, or on testosterone therapy—cannot help but sense the power and charisma radiating off her distinguished interviewee, and be highly conscious of his wealth, power, and eagerness to please and impress her. This is heady stuff, for both man and woman. Just ask Suzy and Jack Welch.

To deny that this tension occurs in such a situation, no matter how suppressed it may be in any particular instance, is just foolish. It is also foolish to deny that some female journalists over the ages have been more than happy to use what my grandmother used to call their "feminine wiles" to squeeze just a little more juice out of the lemon than their interview subjects would normally care to share. (Not that these horndogs aren't more than capable of defending themselves, mind you. I ask for no pity for powerful men.)

So when I noted that Ms MacIntosh authored a piece incorporating interviews with many of the most powerful, distinguished, and wealthy investment bankers on the planet—bankers who, by dint of their position at the top of their own firms, are in control of their own destiny to a degree not shared by other, equally wealthy peers at larger firms—my subliminal antenna perked up. I have never met Ms MacIntosh, and did not know what she looks like before this morning, so she was a tabula rasa, so to speak, for the fevered imaginings of my brain. I sensed the potential tension inherent in the situation, and I shamelessly exploited it for comic intent. So shame on me.

* * *

But honestly, Dear Readers, I really don't feel any shame. I suppose I am sorry that Ms Moore took offence, and I would be genuinely sorry to learn Ms MacIntosh suffered any distress from my puerile scribblings. I hope that she has developed a tough enough carapace to withstand any paper bullets of the brain that naturally wing their way toward her in her role as a public commentator and journalist, but I take no particular pride in adding to the shell, if I did so.

But let's get real for a minute. This is a blog, people. This is a blog written by a pseudonymous investment banker who curses, exaggerates, and generally takes any and all liberties available in pursuit of an (admittedly confusing) agenda of both entertaining and informing his Dedicated Yet Quite Tiny Audience, usually not at the same time. It is a vanity project. It is a labor of love. It is something to do when I am bored, which has been happening with distressing frequency during these last several months. If you come here looking for evenhandedness, balance, and facts, I have to ask you just one simple question: What the fuck are you thinking?

So if my volatile ramblings insult, annoy, or offend you, do what countless others before you have done. Cut me off, drop me from your RSS feed, unfollow me on Twitter, and do anything else you can to erase the knowledge that there is someone as cutting, uninhibited, and uncivilized as me wandering about the intellectual landscape, or at least the little corner of it demarcated by Wall Street and Broad. Don't worry: I won't take offense if you leave.

In the meantime, I will soldier on regardless, happily unconcerned what the disapproving classes think about my maturity, sexual politics, and preferences in female body parts.

Besides, anyone who really knows me knows I'm a leg man.

© 2009 The Epicurean Dealmaker. All rights reserved.

Wednesday, July 15, 2009

It’s Not the Meat, It’s the Motion

Julie MacIntosh has a nice piece over at the Financial Times today on the resurgence of boutique investment banking. The article is generally pretty even-handed, and she seems to have navigated the treacherous shoals of towering egos and savage self-promotion endemic to the sector pretty well. As one well versed in the difficulties of such, I admire the delicacy and diplomacy she must have employed to interview the self-anointed Grand Old Men of investment banking without getting her nose snapped off.

Either that, or she’s really attractive. That always gets the attention of pompous old geezers with more money and self-regard than self-restraint. (It sure gets my attention, I can tell you.) 1

Anyway, I’m guessing the FT’s editors decided to run the article based on the rather slender premise that boutique advisers have rocketed from the 11 to 12% share of global M&A revenue they have enjoyed for the last six years to an eye-watering 14% in the first half of 2009. Never mind that, as Ms MacIntosh reveals, M&A activity is by its very nature rather lumpy, and hence ill-suited to supporting conclusive projections of long-term trends based on short-term fluctuations. No, missing from the entire premise is the understanding that M&A activity so far this year is so thin on the ground, and so concentrated in a few mammoth transactions mostly centered on resuscitating the moribund financial sector itself, that your Uncle Vanya himself might have shown up on the list had he gone ahead and sold his beet farm outside Lodz.

Missing as well from the analysis is the fact that private equity sponsors—who at their height in the M&A market of 2007 accounted for as much as a third of all transaction volume and who now are so inactive and penurious they would be lucky to get Uncle Vanya to return their phone calls—are clients who almost always use large, integrated investment banks with bulging balance sheets to “advise” on their deals. The PE guys want folding money, not “intellectual capital” from their bankers. (Having mostly been M&A bankers themselves, private equity professionals have a well-founded disdain for the probity, intelligence, and personal hygiene of M&A advisors. Besides, they will tell you unasked they are too smart to need advice. That’s why they left banking.) Any outfit which offers advice unalloyed by mountains of cheap, filthy lucre is unlikely to receive any love from these cowboys when activity picks up. Accordingly, I expect boutiques’ share of the spoils to have reached its zenith for the foreseeable future.

* * *

That being said, I do have a couple of quibbles with Ms MacIntosh’s work. (Did you expect otherwise?)

First, I would note that our charming journatrix makes a repeated to-do about the supposed compulsion for boutique advisory shops to grow, grow, grow; viz., e.g.:

Opinions are mixed on whether these firms will flourish or whether today’s aggressive land-grab mentality will lure some to sow the seeds of their demise through rapid growth.


Growth is vital for those seeking longevity.

But “Why?,” say I.

In fact, I would argue that investment banking’s obsession with growth, as an industry, has contributed immeasurably to the enormity of the systemic clusterfuck in which we currently find ourselves entangled. Growth for growth’s sake has been driven either indirectly by the blind pursuit of market share in an expanding market by ultra-competitive banks intent on sticking it to their hated competitors or directly as a response to the incessant demand for ever-expanding earnings streams from their incontinent public shareholders.

It seems pretty clear in retrospect that the financial markets expanded for all the wrong reasons: excessive financialization, unrestrained asset inflation and increasing velocity of capital driven by over-lax monetary policy and a global savings glut, and a society-wide abandonment of prudence, caution, and common sense when it came to the formerly hoary relationship between risk and return. Without any empirical data whatsoever, I have posited before that investment banking and the financial sector in general grew to such an outsize portion of the total economy in part because the industry required so many more worker bees just to push the damn money inflating the global asset bubble around properly. No-one has yet proved me wrong.

In like vein, others smarter than me have asserted that finance should shrink as a percent of total activity from its current inflated level, and should over time average a relatively steady 7% or so of total GDP. Why, then, should one assume that financial entities of whatever sort should grow at a rate faster than nominal GDP growth anyway?

Of course, the unreconstructed optimists among us—I am looking at you, Mr. Boutique CEO—will assert they can grow at a heady clip simply by taking market share from larger banks and other boutiques. To such as these, I would remind them that the iron laws of economics apply to investment banking services just as much as to Ukranian hookers, vintage champagne, and alluring young journalists: if everybody pursues increased market share, margins, and the means to purchase any of the foregoing, will decline. Quelle horreur!

Fortunately, a careful reading of Ms MacIntosh’s opus leads me to believe that at least some of the grizzled veterans profiled in the article understand this very well. Many of them argue implicitly or explicitly against the growth-is-all mantra, which gives me some comfort that not all these majordomos had their brains and hormones addled by the charismatic young Scotswoman. In fact, the poobahs who seem to agitate hardest for growth through diversification or the acquisition of comprehensive capital markets capability all seem to come from the publicly-owned, bulge bracket investment banks of the 1980s who started us down this path to perdition. Pompous old fucks.

Lastly, it is important to note that these boutiques’ supposed core market—advising corporate clients on buying and selling other businesses—is not a market which is particularly susceptible to bubble behavior. M&A is cyclical, sure, but a cycle is the furthest thing from a bubble. (For one thing, you never say “It’s different this time” when you believe you’re in a cycle.) I can foresee no fundamental shift in the conditions or underpinnings to the M&A market which will compel a sustained secular change in the volume of companies buying and selling each other. Taxes? Regulation? Technology? Nope. (Of course, I could be wrong. But if I am, I will already be swilling champagne on the barricades by the time you find a pair of suspenders and a garish Hermes tie, so don’t press it.)

* * *

Second, our lovely Caledonian completely fails to mention, in her otherwise comprehensive catalog of the potential pitfalls and bugbears to success in Boutiqueland, the central issue at hand.

This, for those who missed the earlier memo, is the fact that most of these boutiques boil down, at the end, to vanity projects for their excessively well-endowed (Rolodex-wise) founders and principals. With few exceptions, Ms MacIntosh’s catalog of boutique heavyweights reads like a Who’s Who of investment banking circa 1985. These (admittedly impressive) characters first made their names and reputations during the wild, land-grab years of RJR Nabisco, Campeau Stores, Oliver Stone’s Wall Street, and the like, when “M&A” and mysterious, slightly repellent characters called “investment bankers” first came to the attention of society at large.

After milking all they could from the mainline firms, these free agents mostly gravitated toward their own gigs, where they hired a raft of solid B-players to carry their bags and write the pitch books while they monetized their two to three decades of relationships into neatly stacked piles of leafy simoleons. But monetizing a legacy of relationships is far different, and far easier, than building an advisory institution which will outlast your own pathetic mortal coil. I have laid out the dilemma, and the prescription, before:

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.

And, pace Ms MacIntosh’s no doubt impressive achievements, I fear that a one-page profile of the whole lot of them in the Financial Times does not quite make the grade.

Anyway, that is a problem for wrinkled old plutocrats trying to seduce a fresh young journalist to work out, not one for me. I have my own strategy and tactics to worry about, and the current environment has given me plenty to think over.

Besides, me ol’ gran always told me Scotswomen were mad as snakes.

UPDATE February 20, 2013: Upon rereading this otherwise interesting and informative article in the context of reviewing my back catalogue, I have come to the conclusion that a certain prickly journalist of the distaff persuasion was correct, and my original embellishments of a sexual nature to this article were puerile, superfluous, and distracting from my underlying argument, which I believe remains worthy and sound. Accordingly, I have bowdlerized my own work under the theory that 1) nobody can remember the original silliness, 2) no-one will miss it, and 3) you can never be sure that you won’t find an angry radical feminist manning the Pearly Gates when you finally arrive there. So go ahead: call me cowardly if you will. I am hedging my bets.

1 Which inspires me to relay a very old investment banking chestnut: A senior Managing Director is interviewing two female candidates for an entry-level Associate position. The first candidate is a nationally-ranked biathlete with a dual degree in Plasma Physics and Macroeconomics and a 4.0 GPA from Harvard undergrad who is graduating from Harvard Business School as a Baker Scholar. The second candidate is a summa cum laude graduate in Political Economy from Yale with an MBA with high distinction from the Wharton School who rows for the US Olympic team in her spare time.

Q: Which candidate gets the job?
A: The one with the best body.

Yes, sad to say, it’s true: we investment bankers really are that awful.

© 2009 The Epicurean Dealmaker. All rights reserved.