Friday, March 30, 2012

From the Files: "Round Up The Usual Suspects"

Editor's Note: We've been asked to re-post the following column, published during the dark days of 2008 when the financial world as we knew it was coming to an end and then-Treasury Secretary Hank Paulson was pushing a bailout for his former friends and colleagues on Wall Street.  The reader making the request erroneously states that this post had been taken down, which it had not; and why he/she wanted to read it again, we can't say, but it's always worth looking back at a crisis, so here goes...

Sunday, September 21, 2008

“Bail Out the Drunks, O’Malley, and Round Up the Usual Suspects”

A party begins in somebody’s back yard. It is quiet at first, nothing out of the ordinary.

But as the night wears on, the music gets louder, the voices get more boisterous, and things begin to get a little out of hand. The neighbors can’t sleep, and one calls the police, but nobody comes.

The party gets louder, more out-of-control. A second neighbor calls the police. Again, nothing happens.

The party kicks into high gear. Drunks wander into backyards and urinate on the neighbors’ houses. A window is smashed. A fence is torn down. Neighbors call the police with lists of specific offenses, but are told the party-goers are all consenting adults, and the police have no reason to believe illegal drugs are being consumed.

In short, the policeman says, the partyers can handle themselves.

Suddenly, above the music and drunken singing comes a hysterical scream. A neighbor investigates and finds a fight has broken out, and somebody has been killed. The party-goers are in a stupor. They can’t agree on what to do.

911 is called and police cars come screeching to the scene of the crime. They discharge dozens of serious-looking cops who surround the premises, shine their flashlights in the faces of drunk and retching party-goers, count the empty liquor bottles strewn across the yard and throw towels over dazed, naked couples.

After carefully sizing up the situation, the officers make their move: they tell the drunks, “We’ll pay for the damages.”

And they arrest the neighbors.

So it is, we think, that the U.S. Government—which certainly shares responsibility with Wall Street for bringing the subprime mortgage mess down on the heads of the American people—acted on Friday when after years and months of ignoring the subprime mortgage crisis, or at least hoping it would go away, eagerly embraced a quarter-trillion dollar bailout fund for the very Wall Street firms that had promoted, securitized and distributed those subprime mortgages that brought the world to the brink of a financial precipice nobody could fathom…and banned short selling, to boot.

“Bail out the drunks, O’Malley, and round up the usual suspects” seems to be the word from Washington.

How else to describe it?

How else to describe a government whose Treasurer proposes a quarter-trillion dollar bailout for his friends and former competitors on Wall Street, and whose securities arm bans short sales in 799 stocks—many of which lie at the heart of the drunken orgy otherwise known as the subprime party—instead of taking action against the Wall Street firms that caused the mess in the first place?

One commentator this weekend, we think, got it right, when he wrote, in part:

Then again, maybe the S.E.C. is trying to cover up its own culpability in this crisis. Four years ago, the agency pushed through a rule that allowed the big investment banks to take on a great deal more debt. As a result, debt ratios rose from about 12 to 1 to more like 30 to 1. Guess what Lehman’s debt ratio was when it went bust? Yep: 30 to 1.

Joe Nocera, “Hoping a Hail Mary Pass Connects”New York Times, September 20, 2008

Joe Nocera was not, as we say here, making that up.

On August 20, 2004, the SEC enacted a rule called “Alternative Net Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised Entities.”

The effect of this rule, as Nocera pointed out, was that it allowed five firms to increase their use of leverage dramatically.

Those five firms were Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch and Morgan Stanley.

If the Federal Reserve is supposed to “take away the punch bowl” when the economic party is getting out of hand, with this rule change the SEC brought in a distillery and said “Here, boys, have fun.”

And did they ever have fun!

Lehman Brothers ramped up its debt-to-equity ratio from 21.4 in 2003 to 30.5 in 2007. Merrill Lynch jacked up its debt-to-equity from 16 to 31 in the same period; Morgan Stanley from 21 to 32.

Now, you can read the actual rule change here:

But we’ll save you some time.

After declaring that “The principal purposes of Exchange Act Rule 15c3-1 (the “net capital rule”) are to protect customers and other market participants from broker-dealer failures [emphasis added]” the SEC states:

“We are amending the definition of tentative net capital to include securities for which there is no ready market [emphasis added]…”

What goes around, as they say, comes around, for as we write this, the U.S. Treasury is proposing a near-trillion dollar fund to buy securities for which there is no ready market.

You would think somebody at the table of Government bureaucrats and sober Congressional “leaders” trying to cobble together a rescue package might think to invite in the short-sellers who tried to warn Wall Street that these companies were headed for trouble.

But no.

Instead, short sellers—many of whom got the subprime collapse absolutely right, without ever resorting to the kind of abusive tactics short sellers as a class are now being accused of wielding in this fear-crazed environment—are being banished not merely from the discussion of what to do now, but from their profession by government directive.

Oddly enough, nobody seems to have considered using a simpler and far less costly way to fight the negative forces that began to feed upon themselves in recent weeks: simply reinstate the uptick rule.

That rule, which very effectively limited so-called bear raids in stocks by requiring that stocks be sold short only on an uptick, was removed by the SEC in 2007...after lobbying by Lehman Brothers and some of the same Wall Street firms now seeking shelter from the storm.

All in all Friday was, we think, a black day for free markets: those who got it right are being punished; those who got it wrong are being rescued.

And the homeowners enticed to buy at the top of the market using financial instruments they understood even less than the Wall Street firms that pushed those instruments, are not being helped at all.

Jeff Matthews
I Am Not Making This Up

© 2008 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews.
Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice. It should never be relied on in making an investment decision, ever. Nor are these comments meant to be a solicitation of business in any way: such inquiries will not be responded to. This content is intended solely for the entertainment of the reader, and the author.

Thursday, March 15, 2012

Mr. Smith Goes to Wall Street

 The emails came pouring in yesterday, from friends and family, all with one, innocuous question: "What did you think of the 'Why I Am Leaving Goldman Sachs' editorial in the New York Times?"
 The fact is I hadn’t read it: the day-to-day utility of op-ed pieces in any newspaper are slim-to-none, and the Times—with its special brand of high-and-mightiness combined with the kind of straight-faced hypocrisy only a family-controlled institution can maintain in the public marketplace (the recently ‘retired’ CEO at that organization, which prides itself on a devotion to egalitarian causes such as unjust CEO payouts, recently received a $23.7 million exit package for leading the Times over a 7 year period during which its share price dropped 80%)—is no exception.
 Nevertheless, I did read the piece, and I am still scratching my head at why it got so much attention.
 After all, the odd mix of shameless self promotion [“I was selected as one of 10 people (out of a firm of more than 30,000) to appear on our recruiting video”] and playing-to-the-audience self-righteousness [It makes me ill how callously people talk about ripping their clients off”] sure sounds like a Goldman guy talking.
 Besides, did he think he was taking his “bronze medal for table tennis” to work for UNICEF?

  Anybody who has worked with, around and against Goldman Sachs (and I’ve been doing that, on and off, for almost 30 years) knows what apparently never crossed one man's noble mind: Goldman Sachs is, and was, and always will be, run for the benefit of its partners and shareholders.
 How otherwise to explain the fact that Goldman’s return on equity—the most basic measure of a company’s profitability—puts its peers to shame year after year (40% in a good year, 5% in 2008, the worst-year-since-the-Great-Depression)?
 More personally, I first became aware of Goldman’s clout well before Mr. Smith Went to Goldman Sachs.
 It was in the early 1990’s, and Robert Maxwell, “the Bouncing Czech,” was using company pension money to prop up shares of Mirror Communications Corp—a company I was short (betting against) because of its obvious financial shortcomings.
 So obvious were those shortcomings that the only wonder (in my mind) was the stock never seemed to go down.  The firm I was with—a client of Goldman Sachs at the time—eventually threw in the towel on our Mirror Corp short when the cost of borrowing the shares (through Goldman Sachs, I might add) made it too expensive to bother with.  While Mirror Corp eventually collapsed (after Maxwell was found floating dead in the Atlantic Ocean), it was too late to help: we had already moved on.
 But it was a great lesson that has stayed with me to this day: I learned, the hard way, that whoever was backing up Robert Maxwell had more money than we did...and in the end, money, rather than noble intentions, wins on Wall Street.
 Still, did I write an op-ed for the Wall Street Journal about how unfair the Mirror Corp short squeeze was?  No.  We bit the bullet, and moved on.
 That’s what you do on Wall Street.

 Now, in case you are wondering who was helping Robert Maxwell in those days, the answer is contained here, in the UK Department of Trade and Industry report on the Maxwell scam.

 For the record, the report states: “The investment bank with whom he principally dealt was Goldman Sachs.”

 Mr. Smith should have done his homework.

Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2011)    Available now at

© 2012 NotMakingThisUp, LLC
The content contained in this blog represents only the opinions of Mr. Matthews.   Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.  This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored.  The content herein is intended solely for the entertainment of the reader, and the author.

Monday, March 05, 2012

Bill Gates To Succeed Warren Buffett? Not A Chance…

 When it isn’t obsessing about the meaning of a meaningless number (“Dow 13,000”), the financial world loves to speculate about the name of the man Warren Buffett has identified as his successor at Berkshire Hathaway.

Editor’s Note To Politically-Correct Readers: Buffett’s successor will be a male, so there is no point writing “person,” or “man/woman,” or “non-gender-specific life-form,” rather than simply “man.”  Buffett employs female CEOs atop only four of the 80 or so companies in the Berkshire fold, none with the experience to step in as CEO of a company with more than a quarter-million employees and operations ranging from, as Buffett puts it, “lollypops to jet airplanes.” And while Warren Buffett may seem like the most liberated, open-minded uncle you ever knew, he is, at heart, strictly mercenary when it comes to business.  As for female “liberation,” Buffett has more of a ‘50s era Hugh Heffner sensibility than his female admirers might want to think: he once sent a holiday card with a photo of the Berkshire Board of Directors (including its female members) standing outside a Hooters, surrounded by the Hooters, er, staff—the jocular message inside the card being that the setting explains the high attendance at Board meetings.  And if you don’t believe me, you haven’t read “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett” (eBooks On Investing, 2012).”

 Getting back to the story here, Warren Buffett last Saturday announced in his shareholder letter that he had identified a successor as his CEO, along with “two superb back-ups.”
 While it was not new-news that Buffett had a successor, it was news that the individual has the Board’s seal of approval—a more formal-sounding arrangement than in years past when, for example, Buffett joked that there was simply a name in an envelope, along with instructions of how to proceed upon is death…the first being, “Take my pulse again.”
 Speculation as to the identity of Buffett’s successor began immediately—almost matching that surrounding who fathered Snooki’s baby—with one Berkshire shareholder in the Wall Street Journal picking Microsoft Chairman Bill Gates as The Guy (Buffett’s successor, not the father of Snooki’s baby…)
 After all, Gates is a close friend of Buffett’s, a Berkshire Board member, has run a large and successful company and is well known to Berkshire’s Board.  But there’s a problem with this angle that we’ll get to in a minute.

 By way of background, Warren Buffett actually wears three hats at Berkshire, each of which will be filled by different men: those hats are Chairman of the Board, Chief Investment Officer, and CEO.
 The Chairman of the Board hat will go to Buffett’s oldest son, Howard, so that a Buffett family member can oversee the family’s major asset while also making sure what Warren Buffett so lovingly and painstakingly built is not trashed by some scummy corporate raider in years to come.

Editor’s Note To Non-Politically-Correct Readers: Yes, Buffett is being entirely, completely, 100% hypocritical in annointing his son—a member of what Buffett himself disparages as “the lucky sperm club” when it comes to describing other rich peoples’ children—as his heir as Board Chair, but you’ll have to get over it: Buffett is smart enough to be able to rationalize anything, including this deal.  And his shareholders are fine with it.

 The second hat—Chief Investment Officer—is also publicly defined: hedge fund managers Todd Combs and Ted Weschler, recently hired by Buffett, will handle Berkshire’s stock investments and, in Buffett’s words, “be helpful to the next CEO of Berkshire in making acquistions.”
 The third hat—and the one all the fuss is about—is who, exactly, that CEO of Berkshire will be upon Buffett’s death or incapacity.

Editor’s Note to Anyone Who Thinks Buffett Will “Retire”: Warren Buffett, now approaching 82 years of age, will not “retire,” despite pesistent media speculation set off by a Berkshire press release that used the term when announcing the hiring of Todd Combs.  Buffett will run Berkshire until he drops dead, has a stroke, or otherwise can’t get out of bed—and even if he can’t get out of bed, he’ll probably run it so long as his mind works: he loves the job; it requires, as he likes to say, “no heavy lifting”; and besides, Buffett has no hobbies outside of making money except for playing bridge.

 So who’s the CEO going to be?
 The answer involves a lot of Kremlinology, which is fine with Buffett since he doesn’t want the focus to shift from himself to his successor before the time comes because, a) he likes the limelight, and b) he doesn’t want anyone distracted by the media attention from doing what’s best for Berkshire.
 While Buffett has insisted that former Berkshire top guy David Sokol was never actually The Guy, Sokol did appear to succumb to what Charlie Munger called “hubris” for precisely the reason that he was Buffett’s presumed heir-apparent, with frequent CNBC coverage and the kind of attention that can only go to one’s head—in a bad way.
 What we know for sure about The Guy is what Buffett wrote in his letter:
“Berkshire’s directors are at the top of the list in the time and diligence they have devoted to succession planning.  What’s more, their efforts have paid off…. Your Board is equally enthusiastic [as they are about Combs and Weschler] about my successor as CEO, an individual to whom they have had a great deal of exposure and whose managerial and human qualities they admire.”
 Reading between the lines—as opposed to jumping to conclusions, which is what much of the speculation involves—it seems clear that Bill Gates is not The Guy. 
 For one thing, Bill Gates is a member of the Berkshire Board (he’s in that unfortunate Hooters photo), and Buffett would probably not have written that description the way he did if a Berkshire board member was The Guy.
 For another thing, Gates is not a manager, and never has been.  He was a visionary who built one of the most valuable and world-changing companies in history, but he has never been known for or admired for his “managerial” qualities.  Finally, Gates happens to Co-Chair the Bill and Melinda Gates Foundation, which is the recipient of Buffett’s Berkshire holdings—making him, in effect, a fiduciary for Buffett’s heirs.  He can’t do both jobs at once.
 So who’s The Guy?
 Well, Barron’s—which a few years ago identified David Sokol in a cover story on the subject—now says it’s Ajit Jain, the reinsurance genius who has added more value to Berkshire Hathaway than anyone but Warren Buffett himself.   (Barron’s keys off Buffett’s statement that the Board has had “a great deal of exposure” to the guy.)
 And while it’s true Jain is familiar to everyone at Berkshire (he’s been making money for Buffett for 25 years) it ignores the fact that Jains runs the reinsurance business out of a small office in Stamford, Connecticut, without as much exposure to the Berkshire businesses that now drive the company’s growth (energy, railroads and manufacturing) as others.
 So while we’d bet Jain is one of the two back-ups, since he can step into Buffett’s shoes easily, if need be, the “managerial” aspect cited by Buffett suggests somebody running actual businesses, which leads to Tony Nicely, who has run GEICO brilliantly—and to big props from Buffett along the way—for decades, as well as Tad Montross of GenRe, Matt Rose of Burlington Northern, and Kevin Clayton of Clayton Homes—all of whom excel at what they do, and (except Nicely) are young enough to fit the bill…but may lack the broad experience of our pick: Greg Abel, the dealmaker and ace manager of Berkshire’s immensely important MidAmerican Energy unit.
 Well-liked, and presumably with plenty of exposure to the Berkshire Board since Buffett bought MidAmerican over ten years ago (back when MidAmerican’s executive offices were across the street from Berkshire’s in Omaha), Abel has the experience of operating regulated, multi-national businesses plus a healthy deal-making background that Berkshire will need over the long run.

 But whoever The Guy actually is (and the name may change before the time comes), Berkshire will be Berkshire after Buffett is off the stage thanks only to the fact that the company is no longer a collection of investments that will compound at staggering long term growth rates thanks to the genius of Warren Buffett’s investment capabilities, but a conglomerate made up of businesses that will rise and fall—but mostly rise, over the long term—with the overall economy.
 And in that sense, there is not, and never will be, a replacement.

Jeff Matthews
“Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett” (eBooks on Investing, 2011)

© 2012 NotMakingThisUp, LLC
The content contained in this blog represents only the opinions of Mr. Matthews.   Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.  This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored.  The content herein is intended solely for the entertainment of the reader, and the author.