The Source of De Nile

[Scene: A therapist's office. A cellphone rings.]
Mrs. Ari: "Ari? I told you to turn that off."
Ari Gold: "I did turn it off, but this is the emergency line. This is the Bat Line, baby."
Therapist: "Do you need to get that?"
Ari: "I do need to take this, yeah."
Mrs. Ari: "No he doesn't. I ask for one hour out of the day. For his undivided attention. And I can't even have that."
Ari: "You can have it if you wanna live in Agora fucking Hills, and go to group therapy. But if you want a Beverly Hills mansion, and you want a country club membership, and you want nine weeks a year at a Tuscan villa, then I'm gonna need to take a call when it comes in at noon on a motherfucking Wednesday!

— Entourage

In case you hadn't noticed, the gravy train is over.

This is bad news for investment bankers, private equity moguls, and hedge fund professionals, of course. It is also bad news for the lawyers, accountants, consultants, and commercial and residential real estate brokers who depend upon them for their livelihood.

But it is even worse news for their wives and mistresses, and the largely parasitic community of wealth suckers who feed upon the steady flood of ill-gotten gains which these women¹ have been siphoning out of their husbands' bank accounts and pumping into the community for years. Luxury goods retailers, twee French bistros, personal drivers, personal trainers, personal shoppers, and the women manning the cosmetics counter at Henri Bendel should all begin to worry that theirs will be a much bleaker and more impecunious future.

I don't think the strappy Manolo sandal has dropped for everyone yet, though.

With few exceptions, Girlfriend and her "retail therapy" enablers seem to be in a state of denial similar to the one their Sugar Daddies passed through over a year ago. I don't care how many €150,000 crocodile Birkin bags Russian oligarch wives buy, Bernard Arnault didn't build LVMH into a €16 billion retail juggernaut by selling one-of-a-kind baubles to the ultra-rich. The €175 billion luxury goods industry depends on armies of women from the middle class on up not only to lust after its wares, but also to buy them.

You can understand why Mrs. Big Swinging Dick might be having a little trouble coming to terms with today's realities, though. The poor thing has been far too busy spending BSD's money for the last several years to worry about where it was coming from or whether it would continue indefinitely. Given that it now seems that hubby didn't have the answers to those questions either, it is a little much to expect her to have worried her immaculately groomed little head about it herself.

Besides, after years of telling her maid to wash the blood off the soles of her man's wingtips every night, I think she knew better than to ask.

* * *

It's not just the Ladies Who Lunch and their hangers-on who are going to have to bite the bullet.

In the same way, nightspots in Manhattan have become dependent on horny young investment bankers, dangling scantily clad Ukranian and Czech hotties as bait to draw in undersexed youngsters able to spend $300 on a bottle of Ketel One on the off chance they might get lucky before some Managing Director calls them back into the office to spread the S&P 500. A recent unscientific survey in the trendy Meatpacking District by Yours Truly revealed that the only things inhabiting the tables and banquettes reserved for bottle service were dust bunnies and a couple of Somali pirates. Likewise, art dealers and auction houses have gotten hooked on the crack cocaine of laundered hedge fund profits, and real estate developers seem to have built enough inventory in downtown Manhattan to house five times the total number of future employed junior investment bankers for the next twenty years.

It's not all grim, however. Felix Salmon thinks there will be a bull market in escapism. Journalists and bloggers alike—your Dedicated Bloggist included—are certainly long schadenfreude, but I feel compelled to remind everyone that this is a very rapidly depreciating asset. I think the average Joe and Josephine are getting close to their fill of industry exposés and critical profiles of the former Titans of Finance. There is only so much you can read (or write) about Dick Fuld or Ken Griffin before you collapse from sheer boredom.

I have high hopes for Hollywood, though. There's always the sequel to Wall Street to look forward to, although I imagine it could use a serious trip to the Rewrite Department about now. I don't know: perhaps we will even get our own big budget musicals, with Fred Astaire and Ginger Rogers dancing blissfully on the rooftop of 15 Central Park West while unemployed i-bankers and hedge fund traders down on the street burn CDO and SIV documentation in oil drums to keep warm.

In the meantime, though, retailers of aspirational goods and services are going to take it in the shorts.

Silk lamé or not.

¹ I make no apologies for the apparent sexism of my remarks. Notwithstanding my best efforts, the proportion of the fairer sex who actually hold professional positions in the finance industry (outside the Human Resources Department, natch) remains vanishingly small. Until and unless I see substantially more evidence that women are manning up and bringing home the big bucks themselves, rather than relying on their or someone else's hubby to do so, I will continue to assume that bankers, PE guys, and hedgies should be referred to with male pronouns. Go ahead, ladies, prove me wrong. As I have warned the missus from the beginning, I am more than willing to chuck her, the i-banking grindstone, and everything else to become some Amazon's boy toy if one ever shows up. To date, Mrs. Dealmaker has remained disappointingly unworried by my threats. (Memo to self: Next time, marry a dumb blonde.)

© 2008 The Epicurean Dealmaker. All rights reserved.

Holiday Tonic

November 27, 2008:

A truth that's told with bad intent
Beats all the lies you can invent.
It is right it should be so:
Man was made for joy and woe;
And when this we rightly know
Through the world we safely go.
Joy and woe are woven fine,
A clothing for the soul divine.
Under every grief and pine
Runs a joy with silken twine.

— William Blake, Auguries of Innocence

Happy Thanksgiving.

© 2008 The Epicurean Dealmaker. All rights reserved.

Graveyard Spiral

While descending turns are commonly performed by pilots as a standard flight manoeuvre, the spiral dive is differentiated from a descending turn owing to its feature of accelerating speed. It is therefore an unstable flight condition and pilots are trained to recognise its onset, and to implement recovery procedures safely and immediately. Without intervention by the pilot, acceleration of the aircraft will lead to structural failure of the airframe, either as a result of excess aerodynamic loading or flight into terrain. Spiral dive training therefore revolves around pilot recognition and recovery.

— "Aircraft Dynamic Modes," Wikipedia

I do not know whether you already know this, O Dearly Beloved, but apparently human beings are not well designed for powered flight. No, no, I am not pointing to the incontrovertible fact that few humans outside of the occasional Managing Director at Goldman Sachs possess either wings or the chest and back muscles to power them. Rather, I refer to the rather more subtle limitation that our internal mechanism for determining motion and orientation is not well suited to many of the maneuvers one can and does perform in three dimensional space at the controls of an airplane.

Especially when one does not have an external visual reference point to fix on, executing a gradual, sustained, or slow turn in flight can trick the inertial orientation system in your inner ear (and hence you) into believing that you are not turning, but are rather holding to a straight course. This can be disorienting when you attempt to change direction, since your body has no kinesthetic clues as to your current course. All sorts of spatially disoriented behavior can result, including my favorite, the "leans."

[While I have never piloted an aircraft myself, I have experienced a rather similar disorientation now and again when I have unexpectedly discovered myself listing to port or starboard on the perch of a barstool somewhere in the Midwest while plying clients with booze and other controlled substances. The bartender moves away, and suddenly you notice a thoroughly disreputable character, tilted thirteen degrees from vertical, leering at you from the mirror, with the tip of his Hermes tie swimming in his neighbor's Budweiser. It's not a pretty sight, and it's even less pretty when you realize that's your tie which now needs to be drycleaned. But I digress.]

Among the most dangerous maneuvers resulting from this disorientation, the cheerfully named "graveyard spiral" usually happens when a pilot loses sight of the visual horizon and enters a gradual turn. After 20 seconds or so, the pilot loses all sense that he is turning, but rather feels that the plane is descending in a gradual straight line. If the pilot does not consult his instruments to check whether he is indeed level or in a turn, he will likely try to pull out of the dive by pulling back on the stick and applying power. Unfortunately, if you are already in a turn, aeronautics dictates that doing this will only tighten and accelerate the turn, locking the plane even tighter into its downward spiral. Eventually, if the pilot does not correct, he gets trapped in a high speed spiraling dive that is almost impossible to pull out of.

The right thing to do instead, apparently, is cut the throttle to reduce acceleration, check your instruments, and gently turn out of the spiral. This will feel weird, but the point is that you have to trust your instruments, not your gut, the seat of your pants, or your inner ear.

* * *

As we witness the increasingly fast, increasingly narrow turns that Citigroup is making this week on its continuing spiral toward a sticky end, I wonder whether it is too late to give CEO Vikram Pandit a little in-flight training. Clearly he thinks the appropriate response to Citi's sinking stock price is to pull back on the stick and goose the throttle, proclaiming ever more strenuously that all is well and that he intends to stay the course. But Citigroup is not in a straight line level dive.

What Pandit does not seem to realize—and what Bear Stearns' Alan Schwartz and Lehman's Dick Fuld failed to realize before him—is that his company is experiencing a potentially deadly spiral of evaporating confidence. The more loudly he proclaims his own confidence in Citigroup's solvency and bright prospects—which may, for all I know, be objectively true—the more investors take a look at Citi's swooning stock price and rocketing default insurance premia and conclude he doesn't realize how desperate his situation is. They think management is in denial, or uninformed, or lying. This, in turn, destroys even more confidence, and the downward spiral speeds up. Trying to halt a slide in confidence by boosting confidence alone is not only futile: it is counterproductive.

No, what he obviously needs to do is slow things down, and begin acknowledging to his stakeholders that Citigroup needs to change course. (How he should do this, and what changes he should propose, are above my pay grade, although I might be persuaded to take the job for $25 million a year plus options.) Only these actions have a chance of persuading investors that Citigroup can last the weekend. Once they believe Pandit and the board acknowledge the seriousness of the situation, and are examining every alternative to correct it, they will stop running for the exits in panic. Confidence will stop evaporating, at least temporarily, and the company will have a few more days or weeks to pull some rabbits out of its hat.

(Of course, you still have to land the plane after you pull it out of a graveyard spiral, but at least you have more time, and a chance to do it without executing that charming maneuver, "flight into terrain.")

* * *

The real question of interest for me, Dear Readers, is what this promising but perhaps painfully extended metaphor means for the future management of highly leveraged, public financial institutions like commercial and investment banks. It is clear from the spectacle of Bear Stearns, Lehman Brothers, and other victims of the current panic that many if not most top managers of these firms were the rankest amateurs, in terms of management or piloting skills. Give them a clear, cloudless day, gentle supporting thermals, and no other traffic in the sky, and these panjandrums were more than capable of piloting their tricked-out Cessnas the five hours from Reno to Orange County. They got paid ridiculous amounts of money for flying under perfect conditions, too, almost as if they were personably responsible for the favorable weather.

But put them over unknown terrain, in fog, cloud cover, or at night, and let them drift into a gentle turn, and they fell apart. They had neither the sensitivity to tell when they were drifting into trouble nor the training and skill to recover from it. Their insensitivity to changing conditions, exacerbated by arrogance, swollen heads, and the echo chamber of handpicked loyalists in the executive suite put them all on the path to doom and destruction. They just kept listening to their inner ears and staying the course, never realizing they were steering directly into the ground until it was too late. Even now, most of these guys have absolutely no idea what they did wrong or how they should have acted differently to avoid cratering their once-proud institutions. Just ask Dick Fuld.

Fortunately, however, now that the United States government owns every financial institution larger than a piggy bank, we can make sure that this type of disaster never happens again. I recommend we institute a federally mandated Financial Institutions Piloting course for every executive with management responsibility over more than 10 people. Perhaps there could be a tiered license system, with candidate CEOs for large financial institutions only eligible to take the job after they have proved their skill by not cratering a regional bank and putting in 1,000 hours of Executive Committee flight time.

Either that, or we can conduct regular ear exams.

© 2008 The Epicurean Dealmaker. All rights reserved.

This Can't Be Good

Randolph Duke: "Exactly why do you think the price of pork bellies is going to keep going down, William?"
Billy Ray Valentine: "Okay, pork belly prices have been dropping all morning, which means that everybody is waiting for it to hit rock bottom, so they can buy low. Which means that the people who own the pork belly contracts are saying, 'Hey, we're losing all our damn money, and Christmas is around the corner, and I ain't gonna have no money to buy my son the G.I. Joe with the kung-fu grip! And my wife ain't gonna fu ... my wife ain't gonna make love to me if I got no money!' So they're panicking right now, they're screaming 'SELL! SELL!' to get out before the price keeps dropping. They're panicking out there right now, I can feel it."
Randolph Duke: "He's right, Mortimer! My God, look at it!"

— Trading Places

Citigroup below $7. Goldman below $56. Morgan Stanley below $11. Blackstone below $6. Fortress below $2.50.

I'm beginning to smell a black, black Christmas on Wall Street. Furthermore, I don't think we're going to see any babies born on the Upper East Side, in Greenwich, Connecticut, or in Mayfair next August, September, or October, either.

Get your G.I. Joes with the kung-fu grip while they're hot.

© 2008 The Epicurean Dealmaker. All rights reserved.

Confirmation Hearings

Congressional Committee hearings, like the one Rep. Henry Waxman held yesterday to survey five hedge fund managers on the current and future state of the financial industry, can be fascinating theater. With few exceptions, however, yesterday's proceedings turned out to be a disappointingly anodyne love fest, with grizzled populists and battle-scarred demagogues alike practically jumping over the dais to flatter and genuflect before the most concentrated source of potential campaign contributions ever assembled on Capitol Hill.¹

Such hearings can also offer interesting insights into the character and capabilities of those under the klieg lights. Not only do we get to see how the persons in question react under pressure, but we also get to read how they would like to present themselves, in the form of their prepared testimony. As is common with all such exercises in autoeroticism, one can often learn far more about a person from these voluntary revelations than that person ever expected or intended to reveal.

Among the advance remarks presented to the Waxman Committee, your Dedicated Correspondent was particularly struck by those submitted by Mr. John Paulson, renowned far and wide as a modern-day St. George, slayer of the fearsome Dragon of Subprime Mortgage Securities. Since I am sensitive to criticism that I am often unkind to persons whose pecuniary plenitude varies in inverse relation to their physical stature or the intrinsic interest of their personality, I thought it might be a useful exercise to share with you, my Faithful Readers, some of Mr. Paulson's own words (and, I must admit, a few more of my own).

* * *

With that in mind, let us see what kind of insights about Mr. Paulson can we glean from his prepared testimony.

First, we discover that he is not merely an obscenely rich financier in a tasteful suit. He is also a gentleman and a scholar:

Prior to founding the firm, I was a Managing Director in Mergers & Acquisitions at Bear Stearns. I am a summa cum laude graduate from New York University and graduated with high distinction, as a Baker Scholar, from Harvard Business School in 1980.

Modest, too.

Notwithstanding his documented brilliance, however, I get the sense he's a bit muddled as to the true reasons for his success:

We believe that our ability to protect our investors’ capital and generate positive absolute returns with low volatility over the long term is the reason we have grown to be one of the largest hedge funds in the world.

Actually, Paulson & Co. started in 1994 as an event-driven investment fund betting on M&A transactions and other corporate "events." This is a reasonably uncomplicated, well-understood strategy with a long pedigree and relatively low volatility, assuming you can handicap merger deals with any degree of success. Mr. Paulson enjoyed consistent but distinctly modest returns with this strategy for most of the early life of his fund. As late as July 2003, for example, his fund employed only nine people and controlled assets under management totaling a mere $700 million.

This is nothing to sniff at, mind you, but long-term, low volatility returns is not the primary reason current investors have entrusted 37 bajillion smackeroos to his care. No, I tend to think it has much more to do with the fact that Paulson made approximately 32% more money than God last year by betting on the complete collapse of the securitized subprime housing market.

Perhaps all those fresh billions bulging out of his safe deposit box have addled Mr. Paulson's memory. Or perhaps he thinks, secretly, that the Congressmen and women in the room—and the millions reading and watching at home—wouldn't respect him if they discovered he was just some washed-up, ex-Bear Stearns ambulance chaser who had a brain wave one morning in 2006 and won the investment lottery. They wouldn't respect his impressive college and business school degrees, or defer to his authoritative proposals on how to fix the current financial crisis, if they thought he was just some lucky schmuck from Queens.

Don't sell yourself short, John: You were right, and your timing was almost spot-on (if a little early). Rejoice in it, man! America loves a plucky, lucky bastard, and you were about the luckiest bastard in that committee room yesterday. Just ask Ken Griffin.

* * *

Most importantly, I think, we learn that Mr. Paulson is clever enough to wrap himself in the American flag when he is testifying before a Congressional Committee that is looking for someone to blame for the ongoing clusterfuck that is our economy and financial system. This shows some nicety of judgment, given that he and co-grillee Philip Falcone are two of the most prominent members of that tiny fraternity of investors who have profited personally and directly from the nuclear meltdown of the American Dream.

Either that, or he is a true patriot:

As Americans, we are proud of the leadership position the United States occupies in this industry, the jobs our industry has created, the export earnings we have produced for our country and the taxes we generate for the Treasury. For example, over the last five years, our firm has increased our employee count by 10x, creating numerous high-paying jobs for Americans.

Wow, John. You're a fuckin' force of nature, you are. That would be increasing your employee count to what, approximately 70 warriors for truth, justice, and the American Way? I guess we can all stop worrying about General Motors going bankrupt with that kind of job creation going on.

(As an aside, I always find it amusing to hear poobahs from hedge funds or private equity nattering on about their oh-so important "industries." They always seem to omit the critical modifier "cottage" in front of the word "industry." Christ, Citigroup fires more people in a week than work in hedge funds and private equity combined.)

* * *

But patriot or not, dissembling scoundrel or not, I think we can all agree that Mr. Paulson does not have a promising career awaiting him in international economics should he ever decide to hang up his investing spurs:

In addition, eighty percent of our assets under management come from foreign investors. The revenues we receive from foreign investors allow us to contribute to the U.S. economy like an exporter of goods, bringing in money from abroad.

What, exactly, does Mr. Paulson think his firm "exports" to all these eager foreign consumers in exchange for their foreign "revenues?" Why, last time I checked, that would be money. Hmm.

And where does this money come from? Why, from all those investors and institutions who were on the opposite, losing sides of Mr. Paulson's short trades in mortgage securities.² Of which, I presume, the vast majority were American investors and institutions.

So, let's say for each dollar of investment Mr. Paulson took in, he earned around ten dollars in trading profit last year. After taking his cut of $2, he shipped $8 back to his limited partners, $6.40 of which went to foreign investors. Eighty cents of cash into the US; $6.40 out. That doesn't sound like a very favorable input to the current account deficit to me. In fact, it sounds much more like a massive offshore wealth transfer from American investors, institutions, and pension funds into the pockets of foreign investors. It's a good thing for Mr. Paulson that the Congressmen and women he testified before yesterday didn't have a fucking clue the sense to press him on this issue.

Of course, looking at the situation more broadly, re-exporting American wealth may be the fair thing to do anyway, considering how many of those toxic subprime securities we sold to German banks, Norwegian municipalities, and other furriners in the first place. In fact, it may be a small price to pay to maintain international peace and cooperation in today's uncertain, multipolar world. Americans and foreigners alike should be grateful for Mr. Paulson's strenuous efforts on behalf of the United States in this regard.

Some people have gone so far as to propose John Paulson for Treasury Secretary.

I recommend him for Secretary of State instead.

¹ It always amazes me how the mere sight of a billionaire can turn Americans from practically every walk of life into cringing, tail-wagging puppies. Warren Buffett is Exhibit A in this respect. Rugged American individualism, my ass.
² Given that such trading is a zero sum game, naturally.

© 2008 The Epicurean Dealmaker. All rights reserved.