Pixels Don't Breathe

As usual with de Kooning, the handling is wet-in-wet—high-keyed color worked with lots of white paint, which keeps things lively and advancing. There are screechy yellows, electric blues, boudoir pinks, and—as painter friends assure me—two of the most ungovernable hues in the painter's kit: alizarin crimson and thallo green. These are dyelike synthetic pigments, transparent like nail polish and viciously intense. They affect other colors the way garbage cans kicked downstairs would affect chamber music. They give the Dutchman no great difficulty.

— Peter Schjeldahl, The Hydrogen Jukebox ¹

Here's a fun project for you, children.

One fine, convenient day, close your laptop, shut down your monitor, mute your smartphone and slip it into a pocket, and go visit an art museum. Once inside, skip the bookstore, shun the gift shop, and eschew any special exhibitions of Blockbuster Anything or Super Duper Famous Artist retrospectives. Instead, find the painting galleries in the permanent collection and wander around until you find a nice piece that particularly interests you—preferably one with a bench commodiously arranged before it—and sit down. Just exactly what kind, vintage, or style of painting is entirely up to you. For what it is worth, for my purposes I prefer an abstract painting, but this choice is an entirely personal matter and does not impinge upon the value or effectiveness of the exercise. By choosing an abstract piece, I am not distracted by the narrative behind it, the physical beauty or attractiveness of the painter's subject(s), or the verisimilitude of his or her representation. But again, the choice is yours.

Now, here's the exercise: look at the painting. Just look at it. Look at it long and hard: 10, 15, 20 minutes at least. Stand up and go look at it up close. Back up and look at it from a distance. Look at it with squinted eyes, with eyes wide open, with a sideways glance. Try to take in the entire painting at one time (this is harder than it looks). Go up close to look carefully at individual passages or details to see how the paint has been applied. Is it smooth? Is is scumbled? Is it cracked or glazed with varnish? How does the surface of the painting—shiny, fleshy, or rough—work with the colors of the paint and the light of the room to create the images you see from a distance? Can you guess how the artist painted that particular passage? Try to understand why the light falls on it just so in that one intriguing corner.

If you are doing this right, you will need to take frequent breaks. Looking this intensely at anything is hard work. Use these breaks however you like: looking at other museumgoers (always interesting sport), glancing at other paintings, reading a snippet of catalogue, taking a brief stroll around the gallery. But always return to the painting. Try to look at it afresh each time, and try to see something new, or something you missed, or something you thought you saw before but now realize you missed entirely.

Go up and read the label, if you want, just to give yourself some context, but try not to let the label tell you what to think about the painting. Make up your own mind. Do you like it? Do you dislike it? Why? Are there particular parts or passages that you like or dislike? Why? Try to answer these questions for yourself, but if you cannot, do not get frustrated. Instead, examine your feelings and impressions about the painting. Try to decide what you think about it. After all, the painting is there for you. It will wait.

* * *

There is much, much more you could do, but I think you get the idea by now. The point is to experience an object in real time—in the flesh, as it were—unmediated by the lacquered page of a book or the reflections on a computer screen. An object which has been created out of canvas, and wood, and paint, and whatever else the artist chose to incorporate for the express purpose of being looked at in itself, as an object: here and now.

Given how much of my personal and professional life is conducted or mediated through the sterile arrangement and rearrangement of glowing pixels on a screen, I find an occasional such exercise to be a refreshing and even reinvigorating way to reconnect with the physical world. You could accomplish the same thing by contemplating a tangerine, or your belly button, I suppose, but I personally tend to find fine art more intrinsically interesting. Plus, there's the advantage that staring for 20 minutes at a painting in a museum will garner you fewer incredulous stares (although not none) than doing the same thing with a piece of fruit in a farmer's market.

For someone who likes and looks at art a lot, primarily on the printed page but increasingly online, I never fail to be amazed by the sheer physicality and scale of good paintings in real life. I remember being astonished years ago when I first encountered historical paintings by Rubens in a European museum: they were so damn big. Scale is integral to the experience of an art object, and that is something completely missing from photographic representations in whatever medium. As is the physicality of the medium itself. You simply cannot appreciate the sheer weight, texture, and fleshiness of the surface of a de Kooning painting—or the way its surface and scale can draw you in until you swear you begin to see it breathe—until you have stood before the actual object.

* * *

I am sure I could draw parallels between my little exercise and others you could perform to pierce the electronic veil before your eyes and reconnect with the world-as-it-is, but I will leave that project for you to contemplate.

After all, like most artists, I do not wish to dictate. I prefer to suggest.


¹ "Willem de Kooning." Berkeley, California: 1991, p. 133.

PHOTO CREDIT: Willem de Kooning, Easter Monday, 1956. Photograph by Renzo Dionigi, here. This is a very good, high resolution photograph of the de Kooning piece hanging in the Metropolitan Museum of Art in New York City. The color balance is a little too yellow, but this is a common problem in such shots.

© 2011 The Epicurean Dealmaker. All rights reserved.

Put Down Your Pitchforks

This opinion piece by BusinessWeek columnist and author Roger Lowenstein deserves not only the broadest possible exposure which can be afforded it, but also to be read by everyone and their brother carrying a pitchfork and torch towards the ramparts of Wall Street. There was a protest on Wall Street earlier this week wherein many of the demonstrators carried placards emblazoned with the slogan "Make the Banks Pay." If those people are truly interested in educating themselves about the sources of the financial crisis and perhaps even preventing another one in the future, they would have been far better served spending fifteen minutes reading this, instead of chanting slogans at a bunch of straw men.

The financial crisis was accompanied by fraud, on the part of mortgage applicants as well as banks. It was caused, more nearly, by a speculative bubble in mortgages, in which bankers, applicants, investors, and regulators were all blind to risk. More broadly, the crash was the result of a tendency in our financial culture, especially after a period of buoyancy, to push leverage and risk-taking to the extreme.

Mortgage fraud exacerbated the bubble—as did, among other factors, lax monetary policy, failure by Congress and successive administrations to rein in Fannie Mae (FNMA) and Freddie Mac (FMCC), and weak financial regulation, itself a product of the discredited but entrenched thesis that markets are efficient and self-policing. At the banks, overconfidence in "risk management" methods (which were mostly worthless) and ill-considered compensation practices were serious contributing causes.

As this list suggests, the meltdown was multi-causal. That explanation will be unsatisfying to armchair prosecutors, but it has the virtue of answering to the complex nature of the bubble. To prosecute white-collar crime is right and proper, and a necessary aspect of deterrence. But trials are meant to deter crime—not to deter home foreclosures or economic downturns. And to look for criminality as the supposed source of the crisis is to misread its origins badly.

But screaming "criminal," "bankster," and the like is far more satisfying—not to mention lucrative—to filmmakers like Charles Ferguson and polemicists like Matt Taibbi, who, after all, have tickets and magazines to sell. It also resonates nicely with the average American, who feels victimized by impersonal forces beyond his or her control or understanding. But it does nothing to help those Americans or their elected officials either understand or address the issues at hand.

As Lowenstein writes, the financial crisis resulted from the confluence of many different forces, which fell upon a system the checks and balances of which appear in retrospect to have been very badly designed and managed. But these flaws were evident before the fact to anyone who cared to look. They were hiding in plain sight. Nevertheless, almost everybody—bankers, regulators, politicians, ratings agencies, everyday financial consumers—decided to look the other way, because it suited our financial interest to do so. The pernicious fact about financial bubbles is that everyone has an incentive to prolong them, and almost everyone who participates in them profits from them, at least until the bubble pops and the last ones in are left holding a very smelly bag.

Writing about the ratings agencies, whose entire business model was designed to facilitate, support, and encourage the bubble, Lowenstein makes a point which applies generally to the entire crisis:

To call [this kind of behavior] criminal is to call the culture criminal, which is a point of rhetoric, not law.

Later, he states that

it's worth remembering that in the American legal system, people who merely act badly or unwisely do not do time. And people who contribute to a financial collapse aren't guilty of a crime absent specific violations that make them so.

The statutes which would have rendered the behavior most culpable for the financial crisis criminal—greed, stupidity, arrogance, willful recklessness—were not on the books in 2007 and 2008. Therefore, the people who committed those acts did not commit crimes. Period, end of story.

* * *

Now, if we want to reexamine our financial system in a measured, rational, determined way in order to actually fix the damn thing, let's do so. If we want to criminalize or enjoin certain types of behavior—formerly legal—which we now consider dangerous to the public weal, fine. That is what societies do. I am all for it, in fact.

But's let put a lid on the rabble rousers jumping up and down screaming "Criminals!" at the top of their lungs. They are nothing but a distraction to the proper focus and task at hand, and the energy and anger which they are stirring up among the public is getting frittered away in purchases of movie tickets, magazines, and overheated exposés of the crisis, not to mention increasingly unhinged and disconnected comments on blog posts and news articles.

Fixing the sources of the financial crisis will be long, hard, complicated work. Let's stop dicking around and get started.

© 2011 The Epicurean Dealmaker. All rights reserved.

Eight Reasons Not to Hire an M&A Advisor. And One Reason to Do So

It's always fun to read reactions in the press and blogosphere to big M&A deals. So much of what passes for informed opinion is ignorant twaddle, tendentious, misinformed bullshit, or thinly-veiled axe-grinding. Even people who actually know how the M&A sausage factory works can rapidly overshoot their skis if they start to speculate on dynamics which took place behind closed doors and over the phone over the course of the months or even years that a typical large transaction takes to close.

But your Humble Correspondent was struck by one fact which emerged from the brouhaha surrounding Microsoft's recently announced purchase of Skype: Microsoft did not use an advisor in the deal. It occurred to me that some among my Dedicated Readership might be interested in my unbiased opinion as to whether this was a good idea, and, to boot, whether I think that doing without an advisor on a large M&A deal is ever advisable. So, notwithstanding the paradox of a professional advisor giving advice on the advisability of professional advice, I thought I would share with you lovely people what I perceive to be the pros and cons of the matter.

Somewhat surprisingly, I have found it easier to itemize reasons why it makes sense to not hire an investment bank to advise on an M&A deal. (Never let it be said I am not subtle in advancing my own interests.) So, without further ado, here they are:

* * *

EIGHT REASONS NOT TO HIRE A BUY-SIDE M&A ADVISOR: ¹

1) You are a serial acquirer or dealmaker. This deal is not your first rodeo. In fact, it is simply one in a long series of deals. Your firm is an M&A machine, with experienced deal professionals, established procedures, disciplined processes, and the full support and backing of your firm's senior decisionmakers. Your firm's M&A strategy is crystal clear. You have done enough deals to have seen—if not it all—at least a hell of a lot. You have spent time, energy, and money on deals which never closed, where you were outbid, which you withdrew from. You know how and why the previous deals you did do succeeded or failed, and you can document this exhaustively. Your dealmaking system is so well-oiled that you can execute transactions in your sleep, but you don't, because you make it a practice to learn something new from every process. You may have more deal professionals working for you that most investment banks. You are Cisco Systems or General Electric.

Companies like this conduct mergers and acquisitions just like any other business line, and they get very good at it. Like many things, practice in M&A makes perfect—or at least really, really good—in part because every deal is different, and experience counts for a lot. There is another group of potential clients who do deals for a living, too: private equity firms, or "financial sponsors." Like experienced corporates, PE firms normally do not need help with tactical issues like process, negotiation, or valuation where investment banks commonly add value. With rare exceptions, when clients like these hire investment banks as advisors, they are really just renting our balance sheet to help finance the deal. Most of them won't even meet an M&A banker like me during the process, because they just don't need what I'm selling.

(Which is fine with me, by the way, because I really don't like most of those assholes anyway.)

2) Your target is not a big, unusual, or risky deal. The company you are acquiring is small relative to your own firm, it is in a business line you understand well, and integrating it into your own business should present no difficulties. In other words, the deal you are contemplating is not a bet-the-company transaction, or one that will dramatically transform your firm's current operations and future prospects.

3) The seller and/or its advisor is a sophisticated and experienced deal-doer. You might think that having a skilled counterparty across the negotiating table would necessitate bringing your own hired gun to the party, and normally you would be right. But often an unsophisticated counterparty can create a nightmare of a process, simply because they don't know how to behave or even how one goes about executing an M&A deal. Having an experienced M&A advisor at your side can ameliorate such situations by gently steering the doofuses you are dealing with onto the right path and running interference for their most egregious misbehavior before it ever interrupts your peaceful slumber. Never underestimate how clueless and irrational the members of a family-owned business can become when they decide to sell their company.

4) You want ideas as to which companies to buy and why. No. No, no, no, no, NO. If you are a Chief Executive Officer of a company who wants me to tell you which companies in your industry you should buy and why, you don't need an investment banker; you need a new job. And your Board of Directors needs a new CEO. Are you fucking kidding me? That is your day job, buddy; you're supposed to know this shit better than anyone. We investment bankers don't tell you Who and Why; we tell you How and When. That's our value add.

Now, if you have decided for whatever reason to diversify into a business line or industry with which you have little familiarity—or you are a private equity firm which wants to invest in an unfamiliar sector—it might make sense to hire someone like me to hold your pee-pee for you while you figure out how to urinate. But this is and should be a relatively rare occurrence in M&A. The throes of a hotly contested acquisition should not be the place where you decide what you want to be when you grow up.

5) You know you are the "natural buyer" of the property in question. In other words, you understand the competitive M&A landscape extremely well, and you do not reasonably anticipate being surprised by another bidder coming out of left field to gum up the process or beat you with a topping bid. This condition is pretty rare, however, especially in hot industries or when M&A is very active. You might think that a participant in a particular industry should know the strategic intentions and capabilities of its direct competitors well, but normally you would be wrong. Competitors do not talk to each other directly about strategy because—wait for it—they are competitors. On the other hand, it is the job and practice of any good investment banker not only to develop an informed opinion about how each significant competitor in a space thinks about strategy but also to have done so by talking directly with them, frequently if possible. This is simply not practical for most corporations. Investment bankers are normally far better informed about the strategic landscape of an industry than any one of its participants. This is a critical component of the network knowledge which investment bankers bring to the table for their clients.

6) You need someone to tell you when to stop bidding. If you need an advisor to tell you when to walk away from a deal—because it has become too expensive or the value you expected is no longer there—you do not need an investment banker, my friend; you need a testicle transplant. Investment bankers are trained, incentivized, and paid to close deals. If you're not completely sure that you want to close a transaction, don't hire an investment banker, because we will use all the honey-tongued blandishments at our disposal to persuade you, your counterparty, and anyone else who will listen that this deal here is a really, really good deal, and you should close directly. Ninety-eight percent of the time, we only get paid when a deal closes. How do you think that affects our ability to pull you aside and whisper in your ear that you should let this particular opportunity go?

Never forget, my friend: you are the ultimate decisionmaker in a deal. If you can't say no, you shouldn't expect to hire it done, either.

7.) You are supremely confident this will be an entirely "friendly" deal. In other words, you know the seller/buyer well, you judge that your interests are well-aligned, and you anticipate that your negotiating positions will not be that far apart. This means that, if all goes well, you will not find yourself at 3:00 am in some dingy conference room in Wichita, Kansas, screaming obscenities at your erstwhile friend and golfing buddy of 30 years because he will not budge from his demands for 18 months severance in case of termination without cause, whereas you only want to give 12. Good luck.

M&A deals are high stress affairs, because they are time-pressured, overrun by multiple third parties and advisors (e.g., lawyers) with multiple conflicting (yet eminently sensible) interests and demands, and put a great deal at stake. Even the strongest and oldest of friendships and business relationships can become frayed beyond repair in the negotiating room. That is often why otherwise sophisticated and competent dealdoers in their own right hire third party advisors to do their mud wrestling for them. That way, the investment bankers and lawyers can scream at each other as proxies for the principals, while the principals can walk away arm-in-arm after the fact with no hard feelings. Do not underestimate the value of this, especially if you intend to live and work with the person(s) you have negotiated against so hard for several years after the fact.

8.) You want some sort of guarantee that this deal will work out. Sorry, buddy. Investment bankers are agents. You hire us to help you do a deal. Whether that deal is a good one, or works out for you and your shareholders in the end, is your responsibility. We don't integrate your acquisition, we don't run your merged company, and we don't devise your business plan or operational strategy. All that stuff is your responsibility, and that is the stuff—in addition to exogenous factors like the general performance of the economy and your industry which are largely out of anyone's control, plus a healthy dose of sheer luck—which determines whether your acquisition or divestiture will turn out to be a good deal in the end. The terms of the deal you struck—price among them—are relatively minor factors in the ultimate success or failure of an acquisition.²

M&A is simply an accelerated, concentrated version of investment in your business by other means. It is capital expenditure. It's your plan. We investment bankers are just there to help you execute it. If it doesn't work out, don't blame the bat.

On the other hand, there is...

* * *

ONE REASON TO HIRE A BUY-SIDE M&A ADVISOR:

1.) At least one of reasons 1, 2, 3, 5, or 7 listed above is not true.

Any questions?

* * *

In conclusion, I will let you clever readers decide which, if any, of these conditions Microsoft violated when it chose to go solo on Skype. Heck, this could even become a parlor game.


¹ NOTE: These recommendations and remarks pertain primarily to the decision whether a client should hire a "buy-side" advisor to help him or her acquire another company. "Sell-side" advisory is an entirely different kettle of fish, in which an advisor runs a process for a client who wishes to sell an asset or business. The arguments against using a sell-side advisor are much fewer and weaker. As a matter of fact, most clients do tend to use sell-side advisors when they transact, and the percentage of deals with sell-side advisors is much higher than those with buy-side advisors. (Skype used sell-side advisors when it sold to Microsoft.) If you people are really, really nice to me, perhaps one day I will elaborate further on this.
² Please, please, please don't talk to me about whether or not a deal is "fair" to shareholders. I have eviscerated that legalistic canard quite definitively in the past.

UPDATE: This post is a replacement for the original item posted earlier in the week which Blogger.com vanished into the ether. (Just in case you were keeping track.) The folks at Blogger.com have been permanently removed from my Christmas card list. Fuckers.

© 2011 The Epicurean Dealmaker. All rights reserved.

Patience

Delay is natural to a writer. He is like a surfer—he bides his time, waits for the perfect wave on which to ride in. Delay is instinctive with him. He waits for the surge (of emotion? of strength? of courage?) that will carry him along. I have no warm-up exercises, other than to take an occasional drink. I am apt to let something simmer for a while in my mind before trying to put it into words. I walk around, straightening pictures on the wall, rugs on the floor—as though not until everything in the world was lined up and perfectly true could anybody reasonably expect me to set a word down on paper.

— E.B. White, "The Art of the Essay" (Interview), The Paris Review¹

Me, I tend to walk in circles, like a predator circling its prey, or a burglar casing a building. The metaphors and the methods differ, but the purpose is the same: it is not procrastination, but rather preparation. Each of us has his or her own little rituals and techniques to concentrate the mind.

The drinking sounds about right, however.


¹ The Paris Review Interviews, IV. New York: 2009, p. 138.

© 2011 The Epicurean Dealmaker. All rights reserved.

Twilight of the Übermenschen

This is the true joy in life, the being used for a purpose recognized by yourself as a mighty one; the being thoroughly worn out before you are thrown on the scrap heap; the being a force of Nature instead of a feverish selfish little clod of ailments and grievances complaining that the world will not devote itself to making you happy.

...

Beware of the pursuit of the Superhuman: it leads to an indiscriminate contempt for the Human.

— George Bernard Shaw, Man and Superman

* * *

Steven Davidoff opens a recent piece at The New York Times DealBook blog with the following words:

Reputation is dead on Wall Street.

This is powerful language. What does he mean?

Well, for one thing he means that the reputations of individual investment banks are no longer coterminous with the reputations of their executives and employees. He ascribes this to the tremendous growth in scale and complexity of financial markets over the past three decades:

Today’s Wall Street is not the Wall Street of 1907 when J.P. Morgan single-handedly used his reputation and wallet to stem a running financial panic.

Until the 1980s,... Wall Street was made up of traditional partnerships. These were small groups of investment bankers who represented companies in offering and selling securities and occasionally acquisitions. These bankers put their individual reputations on the line, because there were so few of them. Morgan Stanley, for example, had only 31 partners in 1970 and fewer than 1,000 employees.

But this began to change in the 1980s. Trading markets became much more sophisticated, and trading and brokerage became the investment banks’ primary business. This is a technology game. The better the technology, the better the trading and brokerage operation. Individuals became less important.

The growth of more complex capital markets and a global economy also created much larger financial institutions. Morgan Stanley now has more than 62,000 employees. These banks could use their assets and position to compete in the market for finance and trading. Again, individuals were less important as size dominated. A client now trades or does business with a bank based on its positions or ability to make a market or loan. The executive at the bank executing the transaction is unimportant.

In one respect, this is true. Lazard is no longer Felix Rohatyn. Goldman Sachs is no longer Sidney Weinberg. The First Boston Corporation is no longer Bruce Wasserstein and Joseph Perella. But this is old news. All those investment banks (or their successors) have become institutions in the sense that no one larger-than-life personality defines its image, its reputation, or its capabilities.

Professor Davidoff also points out the inverse: that an individual's reputation is no longer irrevocably tied to that of his or her current or previous employers. Both of these observations make intuitive sense. The tremendous scale of large global investment banks normally renders one individual too small and insignificant to make much of a difference. Rarely does a customer deal with one person when they transact with an investment bank nowadays; there are teams and teams of faced and faceless individuals who do a client's bidding. Even in the case of senior executives, who arguably should make a difference and presumably direct and/or set the tone of their firm's operations, the organization is too large and diverse to imbue most individual transactions with significant impact on those executives' reputation. Most customers nowadays are smart enough not to lay the blame for every botched JP Morgan mortgage at Jamie Dimon's feet.

In fact, investment banks have followed the lead of the rest of Corporate America and become brands. This is simply a natural evolution of the economy, in which people no longer purchase goods and services based on the local, individual reputation of a merchant known directly to them. Brands separate reputation from individuals and make it portable across geography, time, and whoever happens to be preparing your Jamba Juice across the counter. Some investment banks—notably Goldman Sachs in the 1980s and 90s—used to make a concerted effort to sublimate individual bankers' reputations and even identities to that of the mothership. Others cultivated the star culture, to greater or lesser success. But now, even a well-educated insider would be hard pressed to identify a material number of individual superstars on Wall Street. Every bank has become a brand first. In my business nowadays, the name on your business card that matters most is not yours; it's the name of your employer.

* * *

But the Professor's description of investment banking is incomplete. If superior technology and gobs of capital were all it took to compete, my industry would have been taken over years ago by the lumbering behemoths of commercial banking. They have always been bigger than investment banks, have much more capital, and have plenty of money to spend on technology and plenty of experience automating financial transactions. And yet the past few decades are littered with examples of huge commercial banks—mostly foreigners—spending lavishly to buy their way into investment banking, only to trip over their own genitals and transfer billions of shareholder euros or yen into the pockets of footloose investment bankers (and thence to their wives, mistresses, and Maserati dealers). Where investment banks and commercial banks have successfully merged, it has almost always been the case that the investment bankers came out on top.

Furthermore, if automation and capital were the only factors which mattered, we should expect to see much more price competition among investment banks than we do. For, as I have mentioned in these pages many times, virtually everything investment banks do is highly commodified. There is almost no transaction, product, or service that Goldman Sachs can deliver to their customers which Morgan Stanley, JP Morgan, or any number of competitors all over the globe cannot deliver that is indistinguishable in terms of perceived quality and actual price. This is particularly true in the areas which Professor Davidoff focuses on for his examples: capital markets lending, underwriting, and trading. We can't even distinguish our product offerings by flavor, like Coke and Pepsi can.

Finally, Professor Davidoff's image of global investment banks as well-funded, highly automated factories staffed by faceless automatons fails to answer a nagging question: Why do investment bankers make so much money? If labor is so interchangeable and replaceable, how come 50% or more of revenues in my industry has historically gone and continues to go toward compensation? If we bankers are so meaningless to our customers, how are we able to skim so much cream off the top? Do not forget that the average Goldman Sachs employee makes roughly ten times the median income of a family of four in this country. And there are plenty of clerks, washroom attendants, and janitors in that average. The average investment banking professional—supposed faceless cog in a vast financial factory—brings home pay which would make the average pasha blush.

If superior technology and vast capital were all that mattered, the Gucci-clad wage slaves would not be bringing home so much of the bacon. If something else wasn't at work, investment bankers who sell non-proprietary, commodified financial services like leveraged loans, equity underwriting, and, yes, even mergers & acquisitions advice would get paid like glorified bank tellers; that is, like corporate lending officers. The only ones who would make any serious money in such a firm would be the topmost executives and the shareholders, just like most of the rest of Corporate America.

Why isn't that the case? Because Professor Davidoff has missed the key, defining feature of investment banking which differentiates it from other financial activities, which provides the "value add" that our customers are so willing to pay so much for, and which explains why labor captures so much of the firm's value. He has missed the fact that investment banks are not factories.

Investment banks are networks.

* * *

I have made this point many times before.

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.

When our clients ask us to underwrite a debt or equity offering, they want access to our network of contacts among buy side investors and our network knowledge of the capital markets. When counterparties trade financial instruments like securities and derivatives with us, they want access to the breadth and depth of our trading network and the capital of our trading counterparties and our own proprietary books. When a client asks us to advise them on a merger or acquisition, they want access to our network of potential buyers and sellers and our network knowledge of the M&A markets in their industry. Networks are absolutely central to the power and value which investment banks bring to their clientele. It's what we're selling.

And networks lie at the nexus of the conundrum we have been considering. For having a differentiated network in a particular area can enable a bank to distinguish itself from its competitors. While any bank can underwrite an initial public offering, a bank which develops a reputation for being the best at, say, health care IPOs can attract new business and maintain market leadership in that area. The peculiar power of networks is well known: they derive their power and effectiveness from their completeness, breadth, and depth. And these features make it easier to attract new connections into the network to make it stronger. Network strength builds upon itself.

The other particular feature of networks is that they consist of interconnections made among nodes. A moment's thought will convince you that, in the case of networks comprised of constantly changing information and personal relationships, the nodes of an investment banking network are its people. Investment bankers are powerful—and get paid a lot of money—because they are custodians of their firm's power: its networks. You simply cannot automate the most interesting market knowledge or access to external aggregations of people and capital which are constantly forming and reforming, much less the personal relationships and insights which most of these are based on. Furthermore, that knowledge is portable. If a banker ups and leaves, he or she takes his or her network of contacts, knowledge, and relationships with him or her, usually to a competitor.

This is the source of the peculiar tension between individual investment bankers and the "platforms" from which they operate. Clearly, a proprietary trader or an M&A banker is more powerful and effective if he or she works at a great platform with outstanding network resources, like Goldman Sachs. He or she can do more, bigger, and more profitable deals because of it. But Goldman Sachs itself is more powerful and more valuable to its clients because they have that person (and his or her network(s)) in place. To the question, "Who is more valuable, the banker or the platform?," the answer is always "Both." Take one away from the other, and both are diminished.

* * *

So discussions like this one, where an individual who arranged a massively profitable trade for his bank expects far more compensation than the bank wants or is likely to give him, are an annual staple of my industry. Clearly the trader could not have done such a trade without the capital and resources of his employer, so a huge bonus is not merited. But the bank has incentives to make him happy, too, lest he leave with the special knowledge or relationships he employed or developed in that trade to replicate it—and the accompanying profits—at a competitor. Investment banker compensation is always comprised of some portion of reward for business won and profits made plus an option on potential future business and profits from that same banker. This insight helps explain the fact, puzzling to most outside the industry, that investment bankers can get paid tons of money even when they or their firms lose it: they are being paid for future potential results.

One last thing is worthy of note. The network of relationships and market knowledge which each investment banker carries is a local one; that is, it is limited in scope and power to the industries or markets he or she participates in. My knowledge of M&A, capital markets, and the participants and dynamics of Industry X is valuable to my clients in that industry, but it is largely meaningless to a proprietary trader on my firm's govvie desk or a structured products banker packaging and selling mortgage derivatives, much less to their clients or customers. This has always been true. What has changed is that banks have gotten so big, global, and interconnected that the network of any individual employee—no matter how prominent—has become incrementally less important to the overall picture.

Which is only to say that, were he to work at a big global investment bank today, living legend and networker extraordinaire Felix Rohatyn would probably be just another schmuck with a corner office.

Of course, he'd probably be paid a lot more, too.


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