Wednesday, May 30, 2012

As Long as the Right People Get Shot

Do ya feel lucky, punk?  Well do ya?
“A man’s got to know his limitations.”

— Magnum Force

I like John Hempton, O Dearly Beloved. I truly do. The man is smart and principled, and he has attracted a global audience as a direct result of his fearless application of these two qualities to the analysis of investment opportunities and economic realities. I do not link to his work more often here because 1) macroeconomic topics and specific trading opportunities are not my focus or concern, either in these pages or in my professional life, and 2) accordingly I do not pretend to an expertise in such matters which would enable me to judge the quality of his analysis and advice. I value his reputation on the recommendation of others whom I respect.

But every man has his limitations. I am sad to say that, with his latest post, Mr. Hempton has overstepped his. This is what he says:

In an IPO an investment bank takes a fee from a business to place that stock in financial markets.

Or, more precisely, they take a fee from a business to sell part of that business.

Their customer is the company doing an IPO and they have a legal and moral obligation to get the highest price for the company they are selling. No more. No less.

However investment bankers have, as a practical matter, a desire to expand and improve their franchise. Their franchise consists of a huge number of buy-side investors (some retail, some institutional) who will buy from them whatever they sell so long as it comes in a prospectus.

Investment bankers expand that franchise by making sure the things sold in a prospectus have excess demand. If they can sell for $38 they chose to sell for $33 to guarantee a stag. Every time they do so they build their own franchise as an investment bank at a cost to the client to whom they owe a legal and moral duty and who is paying them fees.

The buy-side customers of investment banks have got used to playing in this little game of theft. We – as buy-siders – like to be able to buy IPOs and have instant stag profits. Indeed in the 1990s the game of giving favours to investment banks in exchange for instant stag profits became the way business was done on Wall Street.

The moral corruption of investment banks not only became accepted but we redefined morality around what investment banks did rather than what they should do. We though the process of systematically ripping off the sellers of IPOs in order to build the buy-side franchise of the investment bank was right-and-proper.

It is not right-and-proper and it never was right-and-proper.

Bullshit, John. Bull. Fucking. Shit.

* * *

Now for what it’s worth, the principal target of Mr. Hempton’s post seems to be buy-side investors who are screaming bloody murder in and with the eager support of the press that they did not receive what they appear to hold as their god-given right to a substantial IPO price “pop” once Facebook’s shares were released to trade freely. And in this I am in full agreement with him. Nowhere is it written that the price of an initial public offering must appreciate by a certain percentage after the offering, nor indeed that it must appreciate at all. It is even true that—heaven forfend—there is no divine prohibition that the price of an IPOed company’s stock cannot decline after the offering, as Facebook’s has done. As I will explain below, investment banks which underwrite IPOs normally prefer most IPO stock prices to rise modestly post offering (because their clients do), but nowhere is it written that any such outcome must occur.

So in this respect I agree with Mr. Hempton’s larger point: that the buy-side, institutional and retail alike, have no leg to stand on to criticize lead underwriter Morgan Stanley, Facebook’s CFO, or indeed anybody involved in Facebook’s IPO that the stock price has declined as precipitously as it has. Facebook’s IPO—as the most anticipated and hyped initial public offering in years—was a possible/potential/highly likely train wreck long in coming, and any moron who bought on the offering, or, worse, in the aftermarket, deserves every heart palpitation and shooting pain that’s coming to him. Caveat fucking emptor, people. Jesus. I have absolutely no sympathy for you.

However, where I do take extreme umbrage and exception to Mr. Hempton’s scribblings is in his characterization of Morgan Stanley’s purported acquiescence to Facebook’s CFO’s request to upsize the offering and price it at the top end of the indicated (revised) range as uniquely or particularly “ethical”; in contrast to what he styles as Wall Street’s typical “theft” and “moral corruption.” For it is clear that Mr. Hempton’s moral judgments hinge critically upon the ineluctable fact that, in this instance at least, he doesn’t know what the fuck he is talking about.

* * *

Virtually all IPOs in the modern era are done on a “best efforts” basis. This means exactly what it sounds like: underwriters contract with an issuer and selling shareholders (if any) to place its newly issued shares in the marketplace at a time, a price, and in a quantity which they are able to secure by exerting their best efforts to sell same to potential investors. IPO underwriters do not have any obligation—legal, moral, or contractual—to deliver any final terms to the issuer. Our job—the job which every potential IPO issuer hires us to do—is to help them take their offering to market and achieve the best possible outcome, which includes and is entirely contingent on the market accepting the final offered terms and buying the IPO. Nowhere in this arrangement, understanding, tradition, or even the contractual Underwriting Agreement which governs the underwriters’ and issuer’s mutual obligations to each other is anything said, guaranteed, warranted, or promised about the “highest price.” For what it is worth, by the same token nowhere it is contractually required that the issuer must agree to the final terms which the underwriters are able to deliver. If the issuer doesn’t like the final deal offered, it can tell the underwriters (and public market investors) to pound sand. No deal, no offering. Buh-bye.

Now there is a longstanding tradition, rule of thumb, heuristic—whatever you want to call it—in IPO underwriting that issuers should sell their shares in an IPO at a discount to intrinsic or fair value. In normal, healthy markets, this discount is normally discussed in a range of 10 to 15%. In today’s unsettled, Facebook-/Europe-/Presidential-election-addled markets, this discount can be as wide as 25 to 30%. The intended purpose of the IPO discount is twofold: 1) to help place the relatively large bolus of shares which an IPO represents with investors who have alternate potential uses for their money1 and 2) to bolster positive demand in the marketplace for follow-on buying. You see, an issuer of an IPO is not, unlike a company which is selling 100% of itself, trying to maximize total proceeds for existing shareholders (and fuck the newcomers). It is trying to attract a new set of shareholders who will be co-owners of the company for at least some non-trivial period of time. An IPO issuer only sells a minority of the total ownership position in the firm, and it wants to develop a positive, receptive marketplace for future stock sales in the public markets. (After all, how can the company raise future equity finance money and inside shareholders sell down their holdings in the future if public market investors are hostile to them? Oops, Facebook.)

As I’ve argued before, the IPO discount—which is well and truly disclosed, discussed, and argued over from the very first day competing investment banks pitch to underwrite an issuer’s proposed IPO—is the cost of going public. It is no secret. The issuer knows about it, understands its purpose, and agrees to it from the very first moment it agrees to proceed with the offering.

So here’s the deal, John:


It’s pretty fucking simple.

* * *

Now that you understand why IPOs are typically priced at a discount to intrinsic or fair value, it is no burden for me to admit that underwriters are not unhappy that we have these bargains to pass around to our friends and relations. Of course giving access to IPOs at 10 to 15% discounts to fair value is valuable currency for us to share with investors who trade with us, direct business to us, and generally bolster our bottom lines. We are in business, after all, and we have every right to treat some customers better than others if it promotes our own welfare. This is not moral corruption, it is business. But it falls out of the marketing imperatives which drive the successful placement of IPOs; it does not drive them.

And investment banks’ business, for those of you, like Mr. Hempton, who seem to get confused about the matter, is to be a middleman. We straddle the markets for issuers and investors of capital, and both issuers and investors are our clients. We are unavoidably riddled with conflict of interest because we serve two masters, and the masters we serve have conflicting interests. Other things being equal, issuers would like to sell shares high; investors would like to buy shares low. Our job, as underwriters, is to make those desires clear in the middle, and execute a transaction that equally satisfies—or equally dissatisfies—both parties. That’s our job. Everybody knows this.

So, if, on the other hand, you own a company and want to receive the highest possible price for your ownership stake, you should stay the hell away from the IPO market. Because I and my peers will be the first ones to tell you you can get a better price in the M&A market.

And we can help you with that transaction, too.

Oh. And Chesterton’s fence.

Lieutenant Briggs: “You’re a good cop, Harry. You had a chance to join my team, but you decided to stick with the system.”
Harry Callahan: “Briggs, I hate the goddamn system! But until someone comes along with changes that make sense, I’ll stick with it.”

Related reading:
Jane, You Ignorant Slut (May 21, 2011)
Dan, You Pompous Ass (May 22, 2011)
Chesterton’s Fence (March 5, 2012)

1 Forget the novelty of an IPO, which represents a new stock in an unknown company without an active trading market or established market price. IPOs usually represent a substantial amount and percentage of the issuer’s stock being offered all at one time. (Facebook’s IPO totalled $16 billion.) For established public companies, the analog would be a secondary offering or a very large block trade. Guess what, bubeleh: each of those clear the market at a material discount to the existing market price, too. When you’re trying to place a big block of stock—newly issued or not—you’ve got to offer a discount. Think WalMart, or buying in bulk. It’s really not that complicated.

© 2012 The Epicurean Dealmaker. All rights reserved.

Sunday, May 27, 2012

Out of Office Autoreply: Where Are You, Dammit?!

I am out of the office until further notice and will have limited access to email and voice mail during my absence. For assistance with creative inspiration or questions of technical artistic execution, please contact my assistants Calliope or Thalia at (212) 555-1212 during office hours of 500 to 323 B.C.


TED’s Daemon
Direct: (212) 555-1212

Elizabeth Gilbert wants you to fool yourself.

Of course this is a psychological dodge. A trick an artist can use on him- or herself to externalize the mysterious, elusive creative spark which offers and even more rarely delivers true transcendence. You don’t really think there is an invisible daemon who lives in the walls of your studio and sneaks out after you’ve gone to bed to breathe genius into your work, do you? An independent personality dispensing musical melodies who levitates over Los Angeles freeways while Tom Waits drives to the grocery store?

Well, no matter. Even if you do, this strategy is a clever ruse you can play on yourself. Identify an independent, capricious external entity with beauty and genius in her gift whom you can persuade, flatter, trick, and cajole into giving you what you want. A person whom you can negotiate with. This is something almost all of us know how to do, and it neatly avoids the desperate and fruitless struggle which modern artists feel they must make to wrest genius and inspiration from the tortured depths of their own soul. It also opens up a psychological space for failure, which is the daily accompaniment of every working artist. It’s not that you, personally—through sheer laziness, incompetence, or lack of talent—have been unable to deliver the inspiration which should be bubbling up merrily from your own unconscious. Instead, the problem is your flakey muse has split town again with that hipster loser from the gas station, just when you needed her most. Damn minx.

Strangely enough, this psychological model from ancient times may be closer to the truth than we realize. More and more research in neuroscience and the science of consciousness is implying that the unitary model of intentional consciousness—best visualized as a little homunculus sitting at the control panel of our brain, pulling levers and flipping switches in full awareness and with fully articulated intent—is a naïve and misleading fiction. More and more of what we have traditionally considered to be in the purview of our fully conscious, intentional mind, including conscious physical activity, judgment, and even decision-making, is being discovered to happen at pre- or subconscious levels in our brains. Even our personalities, which we like to pretend are stable and fully articulated identities, are likely to be more evanescent, contingent, and multifaceted things than we imagined, and certainly more so than most of us would like to imagine. It may be more accurate and useful to think of our mental life as a collection of impulses, reactions, thought, and intentions which cooperate with varying levels of input and intensity as we make our way in the world. A loose alliance of conscious, semi-conscious, and unconscious actors. A bundle of “me”s, as it were.

So who is to say that one or more of these fractious homunculi isn’t the very muse we are looking for? Who is to say the very genius of inspiration we chase after doesn’t already live in our heads, just as we have imagined him to do for the last 500 years? The only difference is he doesn’t really work for us, we have no way to communicate with him, and he only shows up if and when he damn well pleases.

I just hope my daemon genius isn’t that damn hipster loser at the gas station. Now that would be depressing.

© 2012 The Epicurean Dealmaker. All rights reserved.

Saturday, May 26, 2012

Your Village Called...

More slack-jawed, cinnamon soy latte drinkers
Villager: “Wor, she turned me into a newt!”
Sir Bedevere: “A newt?”
Villager: “I got better.”

Monty Python and the Holy Grail

You might be surprised to learn, O Dearly Beloved, that your Humble Blogosopher actually enjoys the jeremiads which periodic bank mugger and professional angry man Matt Taibbi publishes intermittently in Rolling Stone Magazine. The man is a talented and inventive writer, an excoriating polemicist, and usually funny to boot. Thanks to Mr. Taibbi, Goldman Sachs will forever be known as

a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.

For that phrase alone, the surly assassin deserves some sort of permanent recognition, even if it is only a lifetime ban from Lloyd Blankfein’s country club. Of course, I rarely agree with him on the substance of many of his accusations, and I take real issue with the way he blatantly and unapologetically cherrypicks and alters facts to support his prosecutorial agenda, but there is no denying the force of his outrage on the page. Plenty of people did some really stupid shit in the years leading up to and including the financial crisis, and some peoples’ stupidity clearly shaded into criminal or near-criminal fraud, so I tend to agree with Mr. Taibbi that there is a lot of blame to spread around. I part ways with him when he tries to accuse entire firms and industries of premeditated bad behavior, and I reject his blanket attack on all investment bankers as irredeemable fraudsters and criminals. But I also believe my colleagues and I are big enough—and, ultimately, culpable enough—that we should be able take his pummeling (and occasional below-the-belt punches) without whining.1

On occasion, however, Rolling Stone chooses to give less talented and intelligent writers than Mr. Taibbi a platform from which to launch missiles at various targets in finance. This often has the unfortunate consequence that the magazine casts itself as one of the funniest self-parodies on the web, (apparently) populated and read by hairshirted, Birkenstock-sandal-wearing, cinnamon-soy-latte-drinking Upper West Side Starbucks Communists who wouldn’t recognize a stock ticker on a dare and who last balanced a checkbook in 1968 to figure out whether they had enough money to buy $50 of weed from their anarchist roommate at Berkeley. The latest example of this comes from somebody named Josh Kosman, who has written a gem entitled “Why Private Equity Firms Like Bain Really Are the Worst of Capitalism.” It’s so hairshirt shreeky it’s hilarious.

Apparently Mr. Kosman is the author of a book on the topic of private equity, too, about which one may presume he says many unflattering and unsupportive things, if this article and the book’s title are any indication. Based on some of the whoppers, special pleading, and flagrantly partisan contents of his article, I would not advise any of you Dear and Long-suffering Readers to part with your hard-earned cash to confirm my suspicions of the book’s contents further. It is not my wont to thwart the beneficent machinations of Commerce, but I suspect you would find more entertaining and informative reading on the back of a cereal box.

* * *

The faults with Mr. Kosman’s article are many, and I presume your patience is as short as mine, so I will try to be (relatively) brief. Mr. Kosman first trips my WTF-O-Meter five sentences into his piece, when he asserts, without further evidence or elaboration, that

[private equity is] a predatory system created and perpetuated by Wall Street solely to pump its own profits.

Huh? Doesn’t this clown realize that private equity is a financial industry separate and apart from investment banking? That private equity was created independent of investment banks, sometimes by former investment bankers and sometimes not, and that it is almost without exception populated by firms which have no owners other than their own partners and professionals? Private equity firms—aka financial sponsors—are clients of Wall Street. Wall Street works for them, not vice versa. Seriously, it’s like this putz just wrote “WalMart creates and perpetuates 300 million American consumers solely to pump its own profits.” Take a closer look, Mr. Kosman: the cart usually gets hooked up behind the horse.2

And, like every sustainable industry and company in history, private equity did not will itself into existence as a means to make profits and support its members’ lavish lifestyles simply because its founders wanted it to. Private equity arose in response to a real emerging opportunity in the market for corporate control which began to manifest itself in the late 1970s and early 1980s. Private equity seized upon the opportunity to buy companies using newly available sources of debt financing alongside their own and limited partners’ equity, work with management to transform those businesses, and sell them for substantial profits. In the beginning, because competition among private equity firms (and from outside the industry, in Corporate America) for businesses to buy was limited, most of the investment profits to be made came from financial engineering. Financial sponsors tended to buy stable companies with strong, predictable cash flows using very little equity and lots of debt, and then use those cash flows to pay down debt and boost the value of their equity. (This was the model very much in effect when Mitt Romney ran Bain Capital decades ago.) Nowadays, however, that simple leverage play is almost nonexistent. There is plenty of competition for businesses, which pushes purchase prices up, and most lenders now refuse to finance buyouts with less than a 30% or even 40% equity contribution by the sponsor. Nowadays, private equity has to improve the value of their portfolio companies in order to make any returns.

Second, it is clear that Mr. Kosman—much as it might surprise a reader who might rationally presume otherwise from someone who has researched and written a book on the private equity industry—has a very shaky grasp of what it is that private equity actually does. Here is his “explanation” of LBO financing for his latte-sipping, hemp-wearing audience:

Here’s what private equity is really about: A firm like Bain obtains cheap credit and uses it to acquire a company in a “leveraged buyout.” “Leverage” refers to the fact that the company being purchased is forced to pay for about 70 percent of its own acquisition, by taking out loans. If this sounds like an odd arrangement, that’s because it is. Imagine a homebuyer purchasing a house and making the bank responsible for repaying its own loan, and you start to get the picture. [emphasis his]

Uh, no, Josh. The company pays interest and any required amortized principal to its lending banks and other lenders out of its own operating cash flow. Unlike your typical owner-occupied, unrented house, you see, companies tend to generate cash from the conduct of their own businesses. That’s what a company is supposed to be. It’s an LBOed company’s cash-flow-generating capability that lenders lend against in the first place, numbnuts, not the private equity owner’s ability to make a mortgage payment like a homeowner.3

Lastly, Mr. Kosman displays his ignorance of the actual behavior of financial sponsors nowadays with this embarrassing display:

that’s when the fun starts. Once the buyout is completed, the private equity guys start swinging the meat axe, aggressively cutting costs wherever they can – so that the company can start paying off its new debt – by laying off workers and cutting capital costs. This process often boosts operating profit without a significant hit to the business, but only in the short term; in the long run, the austerity approach makes it difficult for companies to stay competitive, not least because money that would otherwise have been invested in expansion or product development – which might increase revenue down the line – is used to pay off the company’s debt.

It takes several years before the impacts of this predatory activity – reduced customer service, inferior products – become fully apparent, but by that time the private equity firm has generally resold the business at a profit and moved on.

I have countered this naïveté before, with the simple and verifiable notion that private equity firms have to not only preserve the value of the companies they buy but more importantly improve it if they have any hope to make the kind of profits their limited partners, ex-wives, and girlfriends expect and depend upon. With your kind forbearance, I will quote myself at length:

... remember: the private equity firm and its investors only make money if they take more money out than they put in. And starving a company of resources it needs to sustain and grow future earnings destroys value. Think about it: the next buyer of the company is almost certain to be a sophisticated buyer itself, and they will figure out pretty quickly if [the financial sponsor] has permanently weakened [its portfolio company’s] earnings power. If so, it will pay less, and the reduced debt balance will likely be more than offset by the lower value it offers for the entire business. Levering up businesses with huge amounts of debt and making your equity returns primarily from the paydown of debt with excess cash flow was the old model of the leveraged buyouts of the 1980s. It only worked then because private equity firms could get businesses cheaper than they can now. Fierce competition has shut this sort of financial engineering down.

So the only reliable model for private equity to make the returns it promises to its [limited partners] is to increase the earnings of its portfolio companies. And that is what they all try to do. Sure, a lot of this involves cutting costs, and labor costs are often one of the biggest line items in company income statements which can be trimmed. But private equity also looks to improve the sales and margins of its companies, and this often entails increased investment in productive assets, company infrastructure, and, yes, employees. Many financial sponsors invest additional cash in their portfolio companies over the life of their investment, in order to support increasing sales, improved productivity and margins, and occasionally add-on acquisitions. Their objective is to make the company stronger and healthier than it was when they first bought it, and hence more valuable. Financial sponsors frankly don’t care whether increasing EBITDA and free cash flow comes from cost-cutting or revenue and margin increases—a dollar is a dollar is a dollar, after all—but most of them are fully aware that the latter is normally sustainable in a way the former is not.

In contrast, Mr. Kosman seems to believe that private equity’s fundamental business model depends on selling portfolio companies to Greater Fools who do not bother to do due diligence on the past investment, current asset quality, and future business prospects of these very large, very expensive investment opportunities. This assertion is stupid on its face for sophisticated institutional investors (many of which include other private equity firms which buy companies from their peers and competitors) and—pace the embarrassing folderol surrounding the recently botched IPO of Facebook—very rare even in the case of a sale via public markets.

* * *

In closing, I will not address directly Mr. Kosman’s list of failures, near-failures, or potential future failures of private equity deals both in the industry and during the tenure of Mr. Romney, other than to note he highlights a particularly small sample set for an industry which transacts hundreds if not thousands of mostly successful deals every year. As I am sure Mr. Kosman will admit, no human enterprise admits of 100% success. There are always stinkers in every bunch. Even, one might note, among articles of financial reporting and opinion.

I will also not quibble with Mr. Kosman’s observation that private equity has taken aggressive advantage of the government- and tax-code-sanctioned deductibilty of interest expense on corporate debt for tax purposes. This is a real and meaningful subsidy from taxpayers, and private equity has always (wisely, in my opinion) taken full advantage of it. I will only note that private equity is not alone in being eligible for this treatment: all corporations are eligible for this deduction. And, given that private equity-owned companies constitute a rather small minority of all taxpaying corporations in this country, it is worth noting that taxpayers subsidize far more debt owed by non-PE-owned companies than by those which are.

I have asserted elsewhere and often that private equity is a natural, productive element in our current system of financial capitalism. It is neither evil nor saintly, but rather plays an important specialized role which no other class of financial institutions is capable or willing to perform. It screws up occasionally, as we all do, and its failures and negligences should by no means be given a special pass just because somebody who used to do it years ago—when it was a very different industry—happens to be running for office. By the same token, we should not encourage ill-informed, underresearched, ignorant attacks on the entire industry for the very same reason.

Anyway, it’s time for me to go: I hear the phone ringing.

Oh... It’s for you, Josh.

Related reading:
The Rape of Persephone (January 29, 2012) — A rather thorough and relatively clear (for me) primer on private equity
J’accuse, Part Deux (June 27, 2007) — Private equity and the tax deductibility of corporate interest expense
We Didn’t Start the Fire (December 7, 2009) — A rant on the non-role of private equity in the recent financial crisis, and links to posts on the issue of carried interest

1 Fisking Mr. Taibbi’s various attacks on my industry alone would constitute a full-time job, and I have a day job to consider. Furthermore, the man is no idiot (unlike, say, above), so a comprehensive response to many of his accusations would require careful research and closely argued reasoning. It is no task for a hobbyist commenter, and that is without question what I am.
2 Which is not to deny what I will (here) charitably assume is Mr. Kosman’s real point: that private equity’s activities—buying and selling companies, doing IPOs, and raising debt to finance acquisitions—are immensely profitable for Wall Street. Financial sponsors, as a class, are the largest fee payers to investment banks around. Believe me, we are very happy that they exist and require our services as often as they do. But we did not create them, and we thrive upon their sufferance, not they on ours.
3 Another unheralded toxic legacy of real estate’s implication in the latest financial crisis: overmatched, undereducated prognosticators using stupid, poorly-conceived housing analogies to explain complex financial topics. Please make it stop.

© 2012 The Epicurean Dealmaker. All rights reserved.

Sunday, May 20, 2012

J.P. Morgan and the Marlboro Man

Git along, little doggies
“I don’t wanna join your goddamn union, alright? Loner. Lone gunman. Get it? That’s the whole point. I like the lifestyle, the image. Look at the way I dress. Why don’t you become a cop or something? You can have coffee in the morning with friends.”

— Grosse Pointe Blank

It is patently obvious from last Friday’s page one article in The Wall Street Journal that J.P. Morgan granted reporters extensive access to Jamie Dimon and key bank officials to help create a blow-by-blow account of the implosion of the bank’s “London Whale” over the past several weeks. There is no other way to explain the appearance of Mr. Dimon’s pillow talk with his wife at the climax of the crisis, or the humanizing details of top executives downing vodka and wine in the midst of a confessional bull session.

It is also clear that, whether or not Mr. Dimon had a hand in directing this public relations exercise himself, one of its clear purposes was to help rehabilitate the image of the formerly Least Hated Banker in America to an approximation of his former regard. The gruff, no-nonsense quotes, brusque take-charge leadership, and self-deprecating assumption of responsibility for the cock-up are all we can and should expect from Mr. Dimon, based upon his meticulously constructed and maintained public image.1

But notwithstanding the industrial-strength fact spinning and image polishing being spoonfed to an adoring public in the Journal’s piece, I take away a rather dimmer view of Mr. Dimon’s character and capabilities from the exercise than I suspect the J.P. Morgan public relations department intended to impart. For one thing, we learn later in the piece that Mr. D. is an exhaustively hands-on manager, prone to grilling his department heads in three-hour monthly business reviews which drill down all the way to minutiae like Blackberry roaming charges. And yet this was the same man who spent increasingly little time over the preceding three years reviewing the risk profile and operations of a Chief Investment Office purportedly responsible for reducing firm risk as it delivered ever larger gains, even up to 10% of the total profits of the entire firm. This was an executive self-consciously famous for having sailed through the Great Financial Clusterfuck of 2008 with nary a scratch on his corporate hide, who now unaccountably and unforgiveably failed to perceive that the line officer responsible for the CIO’s biggest and most opaque bets unilaterally “dropped risk-control caps that had required traders to exit positions when their losses exceeded $20 million.” This is a man whom the article paints as a hyper-demanding micromanager who unaccountably developed a massive blind spot and a cavalier disregard for risk in the one area of the firm which he had explicitly encouraged to take on more risk.

Also missing from the article is the story of how Jamie’s handpicked, loyal, and diligent lieutenants—who, in the cavernous multi-trillion dollar global financial edifice which is J.P. Morgan Chase ought to have some pretty big and important jobs—instilled the discipline and diligent attention which Jamie himself demanded from them into their own subordinates and departments. Nor did any of these high-powered, massively compensated executives successfully challenge Mr. Dimon’s increasingly lackadaisical oversight of the CIO in Operating Committee meetings or bring to his attention disturbing warning signs of impending disaster like the scrapping of risk limits.

I read the Journal article, in other words, as a classic case study of an overpowering, imperious CEO who has built such a cult of personality around himself and his firm that he will not suffer anyone to challenge him. Pardon my Harvard Business School French, but why the fuck is the CEO of one of the largest commercial and investment banks on the planet personally conducting three-hour departmental operating reviews every month? Why did word that the CIO’s New York and London offices had devolved into vicious internecine warfare after the semi-retirement of Ina Drew not reach Mr. Dimon’s ears? Or—what is possibly worse—if it did, why didn’t he smash some heads together and fix it? The yawning gaps and omissions in the Journal’s tick-tock scream loudly to me that Mr. Dimon has built an executive rank at J.P. Morgan which is not only overly dependent on him and his excessively involved attention to the operational minutiae of his far-flung empire, but also one which seems incapable of effectively challenging him when he is wrong. Pardon my perhaps naive presumption, but it does not seem unreasonable to me that the Chief Executive Officer of a global financial services holding company with over 261,000 employees scattered all over the world should fucking delegate a little.

The irony in all this, of course, is that Jamie Dimon built his considerable and well-deserved reputation as a top notch manager in financial services primarily through his 16-year stint as Sandy Weill’s lieutenant at American Express, Citigroup, and elsewhere. Jamie earned his spurs and the respect of almost everyone who worked with him for exactly the kind of reliable, forceful, and intelligent hands-on work which Sandy relied on him to deliver. Yet Jamie was no pushover: he could and did deliver both good news and bad both up and down the chain of command, and he got into more than his fair share of knock-down, drag-out fights with his boss and mentor, too, when he thought he was wrong. Sandy relied on him to do so. That is what made him invaluable. And yet it seems Mr. Dimon has forgotten or maybe never learned the primary lesson of his own career: a CEO is only as successful as his lieutenants are powerful and independent, as well as loyal.2

In conclusion, Dear Readers, it does not reassure Your Humble Yet Fretful Bloggist that Jamie Dimon appears to have decisively seized the reins of the runaway horse and rescued the day. At $2.3 trillion in assets and over a quarter of a million employees, Mr. Dimon’s ranch is big enough that this writer believes he needs to hire a few more capable cowhands.

Climb down off the palomino, Jamie-boy, and start paying attention to the payroll.

1 If you are one of those charming naïfs who believe Jamie Dimon’s public image as a gruff, no-nonsense straight shooter is not meticulously constructed and maintained, I can only imagine you also believe Donald Trump to be a self-made billionaire with a slightly unfortunate natural hairline who just happens to be staggeringly good in bed. Congratulations. You are a public relations person’s wet dream.
2 I have heard some speculate that Jamie forced Bill Winters out of the firm because the latter became too powerful and independent himself. The departure of his other longtime lieutenant, Steve Black, a year later, is also suggestive. It is probably overly simplistic to draw a straight line between these two events and the collapse of the CIO, but one does wonder.

© 2012 The Epicurean Dealmaker. All rights reserved.

Saturday, May 19, 2012

Behind the Wall

Pull harder, lads
“All visible objects, man, are but as pasteboard masks. But in each event—in the living act, the undoubted deed—there, some unknown but still reasoning thing puts forth the mouldings of its features from behind the unreasoning mask. If man will strike, strike through the mask! How can the prisoner reach outside except by thrusting through the wall? To me, the white whale is that wall, shoved near to me. Sometimes I think there’s naught beyond. But ’tis enough. He tasks me; he heaps me; I see in him outrageous strength, with an inscrutable malice sinewing it. That inscrutable thing is chiefly what I hate; and be the white whale agent, or be the white whale principal, I will wreak that hate upon him. Talk not to me of blasphemy, man; I’d strike the sun if it insulted me.”

— Captain Ahab, Moby Dick

Of course Captain Ahab was insane. Completely bonkers. This should be well and truly understood.

But what, after all, is an insane person but someone who has once and for all dropped the pretense the rest of us cling to, day after day, that the world does not make some sort of horrible sense after all?

© 2012 The Epicurean Dealmaker. All rights reserved.

Tuesday, May 8, 2012

Occupy Galt’s Gulch

“Each of us in this room has warmed ourself at fires we did not build, and each of us has drunk from wells we did not dig.”

Mark Shields, as heard, October 1997

I am not ashamed to confide, O Dearest and Most Equable of All Readers, that I have had a version of this particular post marinating in my brain for more than five years, from almost the first time I began laying finger to keyboard at this modest opinion emporium. Lord knows I have had numerous opportunities to release it over the intervening period, what with, in sequence, 20-something investment bankers, 30-something hedge fund traders, and 50-something private equity mavens each trumpeting to the stars the overweening brilliance and talent of their professional accomplishments to any and all who would listen, and to many who would not. For those among you who have noticed, the exposure and ridicule of hubris among the Great and Good, the not-so-great and not-so-good, and the patently pathetic yet surprisingly lucky has been an overarching concern and even gleeful entertainment in these pages. It is somewhat of a hobby of mine, undertaken and cultivated, if for no other reason, than to remind Your Humble Servant that he should indeed try strenuously to remain as humble as he can. Because he sure as shit isn’t anywhere near as clever or accomplished as he would like to pretend to be.

To date, what has typically stayed my hand is an acknowledgement that any efforts to puncture the iron-clad self regard of the self-appointed financial elite would be doubly futile. First, because they would blink stupidly at me (metaphorically) for completely missing the point of their unquestionable magnificence, and second, because it has always seemed to me that the only people impressed by these individuals’ autofellation have been themselves. In other words, my targets have historically been both too impervious and too self-evidently ridiculous to bother.

What has tipped my hand at last has been the appearance, at Megan McArdle’s blog site, of a really excellent guest post by entrepreneur and investor Jim Manzi. Mr. Manzi’s capitalist credentials are indisputable, so I was both impressed and heartened to read the words he excerpted there from his newly published book:

Many entrepreneurs hold the opinion that “I did it all on my own,” which may be well adapted to leadership success in certain situations, but it is objectively myopic. The entrepreneur relies on an ecosystem of venture capitalists, risk-taking purchasers, and so on. This ecosystem itself rests on a deeper foundation of collective, government-led enterprise. The delivery of our software, for example, depended on the existence of the Internet, which is the product of a series of government-sponsored R&D efforts, in combination with subsequent massive private commercial development. Government funding has been essential to much of the university science that entrepreneurs have exploited. Honest courts and police are required for functioning capital markets and protection of assets; physical infrastructure is required for the roads and running water without which we would not spend much time thinking about artificial intelligence software. At the absolute foundation, national armed forces protect the whole system against external aggression. All of our exciting technical and economic innovations ultimately require men to stand watch all night looking through Starlight scopes mounted on assault rifles—and die if necessary—to protect our commercial, law-bound society. Would you do this to protect a billionaire hedge-fund manager who sees his country as nothing more than lines on a map?

Add to this, in my world, the foundational infrastructure of global financial institutions and markets, the extraordinarily complex socioeconomic web of laws, regulations, and conventions which protect, foster, and enable investment and speculation, and the enormously capable and complex bureaucratic platforms from which most traders, investment bankers, and investors operate, and you begin to appreciate that these self-proclaimed supermen resemble Prometheus wresting fire from Mount Olympus for the benefit of mankind far less than spoiled rich kids born on third base who grow up convinced they hit a triple. (Not to mention that most of these clowns got rich on a flying trapeze constructed over a free safety net composed of the taxes, retirement savings, and future debt repayment powers of tens of millions of their otherwise completely uncompensated and unrewarded fellow citizens.)

So let me just say that I remain completely unpersuaded that traders, bankers, and private equity investors who have made fortunes over the last ten years deserve to be unconstrained, unregulated, and untaxed because they did it all themselves. Bull—if I may be so bold—fucking-shit. Go pull the other one, sweetheart. I’ve worked in finance for more than two decades. You can’t fool me.1

* * *

Now don’t get me wrong, children. I think America, for all its various and distressing faults, is a remarkable country. In most countries in most ages of the world, the rich made their money the old-fashioned way: they stole it or they inherited it. For the last 200 years or so, we have run an experiment here and in a few countries abroad where capitalists have been allowed to create vast wealth for themselves and others based on sheer effort, talent, and—undeniably—loads of good luck. This is a remarkably heartening history. It is the unyielding bedrock for the Rawlsian contract which we all seem to enter into at birth, a contract which states that we will not unnecessarily constrain or prevent the great accumulation of wealth in our fellow citizens, as long as we have, ab initio, some non-trivial reason to believe we ourselves could be such a winner.

Jim Manzi puts it well (emphasis mine):

the fundamental tension of democratic capitalism [is that] winners... require shared resources produced by the losers. That is, the market economy requires broad social consent. Why should those who lose out in market competition give it?

Why indeed? Because they hope and expect that they, too, have some chance to be winners. If society evolves in such a way that winning becomes hereditary, or winners can rig the game in their favor, or losers have no chance to become winners because the gap is too wide, watch out. Social contracts are only worth the paper they are written on. And paper can be torn up.

The Mark Shields quote featured above remains graven on my brain, more than 15 years after I first heard it at an otherwise forgettable conference. It is true on its face, to anyone who will admit it. The rich and the successful in any society enjoy their spoils and their comforts at the sufferance of those whose lives, sweat, and blood have helped them earn it. This is what makes the Randian fantasy of capitalist übermenschen living self-sufficient lives in a remote canyon in Colorado—or, for the less self-reliant, modern titan, a condominium on Lake Geneva—so ridiculous. Most of the fat, pampered hedge fund managers and private equity moguls I know couldn’t survive a week without access to Whole Foods’ prosciutto bar, much less potable water, heat, and edible foodstuffs.

The complex, modern, secure, comfortable, and predictable society which we all enjoy at this time in history comes at a cost. It is expensive. And yet that cost, at least in this country, is subsidized for the rich by millions of fellow citizens who charge them less than market rates solely in the hope that they, too, might win the lottery of hard work and success.2 It would behoove you sundry Masters of the Universe—tech entrepreneur, corporate executive, and financial titan alike—to remember this fact. Because the rest of us have not forgotten it.

And we vote.

1 And don’t try to pull the “self-made man” shit on me, either, bubeleh. I’m one, too. It’s not any kind of excuse.
2 Would you deny this? How else do you explain that the aggregate tax burden in this country is so low compared to other advanced Western economies with comparable or superior standards of living? Please.

© 2011 The Epicurean Dealmaker. All rights reserved.

Sunday, May 6, 2012

Prolegomena to Any Future Life

His vision, from the constantly passing bars,
has grown so weary that it cannot hold
anything else. It seems to him there are
a thousand bars; and behind the bars, no world.

As he paces in cramped circles, over and over,
the movement of his powerful soft strides
is like a ritual dance around a center
in which a mighty will stands paralyzed.

Only at times, the curtain of the pupils
lifts, quietly—. An image enters in,
rushes down through the tensed, arrested muscles,
plunges into the heart and is gone.

— Rainer Maria Rilke, “The Panther” 1

Here’s another didactic little story. There are these two guys sitting together in a bar in the remote Alaskan wilderness. One of the guys is religious, the other’s an atheist, and they’re arguing about the existence of God with that special intensity that comes after about the fourth beer. And the atheist says, “Look, it’s not like I don’t have actual reasons for not believing in God. It’s not like I haven’t ever experimented with the whole God-and-prayer thing. Just last month, I got caught off away from the camp in that terrible blizzard, and I couldn’t see a thing, and I was totally lost, and it was fifty below, and so I did, I tried it: I fell to my knees in the snow and cried out, ‘God, if there is a God, I’m lost in this blizzard, and I’m gonna die if you don’t help me.’” And now, in the bar, the religious guy looks at the atheist all puzzled: “Well then, you must believe now,” he says. “After all, here you are, alive.” The atheist rolls his eyes like the religious guy is a total simp: “No, man, all that happened was that a couple Eskimos just happened to come wandering by, and they showed me the way back to the camp.”

— David Foster Wallace, This Is Water 2

We cannot know his legendary head
with eyes like ripening fruit. And yet his torso
is still suffused with brilliance from inside,
like a lamp, in which his gaze, now turned to low,

gleams in all its power. Otherwise
the curved breast could not dazzle you so, nor could
a smile run through the placid hips and thighs
to that dark center where procreation flared.

Otherwise this stone would seem defaced
beneath the translucent cascade of the shoulders
and would not glisten like a wild beast’s fur:

would not, from all the borders of itself,
burst like a star: for here there is no place
that does not see you. You must change your life.

— Rainer Maria Rilke, “Archaic Torso of Apollo” 3


Du mußt dein Leben ändern: You must change your life. That much is certain.

But I cannot tell you the way; you must find it yourself. For I am not a wise old fish, either.

Nel mezzo del cammin di nostra vita
mi ritrovai per una selva oscura,
ché la diritta via era smarrita.

1 Rainer Maria Rilke, The Selected Poetry of Rainer Maria Rilke, ed. & trans. Stephen Mitchell. New York: Vintage International, 1989, pp. 24–25.
2 David Foster Wallace, This Is Water: Some Thoughts, Delivered on a Significant Occasion, about Living a Compassionate Life. New York: Little, Brown and Company, 2009, pp. 16–23.
3 Rilke, op. cit., pp.60–61.

© 2012 The Epicurean Dealmaker. All rights reserved.