Saturday, May 30, 2009

Street Fighters and Their Pension Clients

Please take the time to read my update at the end of my last comment on CPPIB as the backlash is building to give back those outrageous bonuses.

One word of advice to the politicians in Ottawa. I know how hard it is to be a politician because my stepfather survived over 20 years in Quebec politics. It's easy to be cynical but being a politician is no barrel of fun, especially in difficult economic times like these.

But I hope politicians will stick to their principles and share some of the moral outrage that is being voiced out there concerning the payment of these bonuses. It's utterly ridiculous to pay anyone millions based on some four-year rolling return (which is based on questionable benchmarks) after a fund loses $24 billion in one year.

I know they will tell you to attract and retain "the best and brightest" we need to compensate them or else they will go to the private sector. I say let them go to the private sector because I guarantee you they will never find any private firm paying them based on a four-year rolling return. In the private sector, you do not perform, you are fired. Period.

Greed has permeated every facet of the financial industry, including public pension funds. This brings me to this weekend's topic.

A few weeks ago, I received a complimentary copy of Kate Kelly's new book, Street Fighters, which discusses the last 72 hours at Bear Stearns.

The book is a quick read and it is well documented. I enjoyed reading these accounts, but having worked on the sell-side and buy-side, I can't say I was surprised reading about the egos involved.

But Kelly's book is well worth reading, especially for those regulators who are trying to regulate these firms and every day investors trying to figure out what goes on behind closed doors. Unless they understand the culture of greed that permeates the financial world, they will always remain vulnerable to these sharks.

The L.A. Times' Tim Rutten wrote this review on Kelly's book:
A little more than a year ago, the fabled investment banking house of Bear Stearns was one of the pillars not only of Wall Street, but also of the global economy, widely admired for its daring innovations in managing and marketing new generations of asset-backed securities.

Today, to the extent Bear is remembered at all, it is for its collapse and forced sale to JPMorgan Chase, the first rock to fall in the risk management avalanche that triggered the current global financial crisis. As a reporter for the Wall Street Journal, Kate Kelly was the best of the financial journalists covering Bears' once-unthinkable descent into oblivion. Her admirably detailed three-part narrative of the firm's ultimate failure and dissolution was an important source for another account of the debacle, William D. Cohan's "House of Cards," which was published in March.

In "Street Fighters: The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall Street," Kelly has elected to undertake an hour-by-hour reconstruction of the three days in March of 2008 when Bear Stearns first realized it was collapsing, fought to save itself and, ultimately, agreed to a humiliating sale to JPMorgan. It overstates nothing to call Kelly's book brilliantly reported, and her narrative is grippingly propulsive and peopled with fascinatingly drawn characters. Notable among them are Bear's Hamlet-like CEO, Alan Schwartz, who wept in line at the nearby Starbucks on the morning he had to announce the sale, and Jimmy Cayne, the erratic and wildly eccentric cigar-smoking chairman, whose real passions appear to have been bridge and golf. There are terrific walk-on appearances by Warren Buffett; Bear's legendary ex-chairman, Ace Greenberg; Lloyd Blankfein (the Goldman Sachs honcho); and Chris Flowers, the engaging private equity investor who made a spirited run at Bear.

Kelly's meticulous reporting amply demonstrates that the locus of Bear Stearns' fundamental problems derived from the unique interplay of its distinctive internal culture with the deeply flawed and, often, unfortunately idiosyncratic men who ran the place in those last years. The result seemed to be an institution that -- at all levels -- was quick to display bare knuckles to the outside world, while behind its own closed doors a lot of sharp elbows were swinging. Perhaps the most telling of the interlocking portraits Kelly sketches so well is that of Bear's upper echelons, where executives were fiercely territorial and oddly inattentive to even critical operational questions. Bear Stearns was, in the end, an institution where denial was the executive suites' emotion of first resort.

Even so, the breadth of Kelly's reconstruction opens doors on other, structural questions. It's clear from her account that at some of the most critical junctures during the three days in which Bear Stearns writhed in extremis, the intervention of federal officials was critical. The deal with JPMorgan would have collapsed at the 11th hour had then-New York Fed Chairman Timothy Geithner, now secretary of the Treasury, not jumped in and proposed a federal guarantee of Bear's most problematic real estate-linked assets. The humiliating $2-a-share stock price at which the firm initially was sold was set by then-Treasury Secretary Henry Paulson, who reportedly felt Bear Stearns deserved to be punished for its recklessness. Similarly, if Paulson had elected to open the Fed's discount window -- which loans money to banks -- to investment banking houses just a day or two sooner, Bear might have been able to remain in business, at least for some time.

In her epilogue, Kelly reports on how most of the key characters in her drama have fared since Bear's Stearns' collapse. It will surprise only the catatonic that most landed firmly on their feet, that those who wanted to find other employment in their field quickly found it and that even most of those who remain traumatized and unhappy over their firm's fate mourn in considerable comfort.

At one point, Kelly catalogs the variety of implausible conspiracy theories that have been spun around Bear's fall. Then, she notes:

"Regulators may never know what really happened. But one thing is clear: Once confidence in a company falls away on such a grand scale, it can never recover. Bear started that week with more than $18 billion in capital, its largest cash position ever. Three days later, negative headlines, a stock drop, lender reticence and big withdrawals from client accounts had cut those capital levels in half. Eight hours later, it was nearly dead."

The tsunami-like pace of onrushing financial disaster was impressive, indeed. The introductory sentence to that paragraph, however, is deeply chilling and bears repeating -- "Regulators may never know what really happened." Yet this was a situation so threatening to the fabric and substance of global finance that Federal Reserve Chairman Ben Bernanke would subsequently insist that, absent government intervention to essentially force the deal with JPMorgan, Bear would have gone into bankruptcy, causing a "chaotic unwinding" of investments in all the American markets.

Yet regulators may never know what really happened.

That's the intolerable fact of public policy on which this whole mess turns, along with all the pain it set rippling through the nation's human economy, the one where ordinary people struggle to pay the deceptive mortgages that backed all those derivatives and where women and men who've lost jobs as a consequence of this calamity now scratch to find new livings.

There are timeless human failings to ponder anew in Kelly's artful narrative journalism -- ego, hubris, venality and folly, the whole sad crew. They, unfortunately, will always be with us, consequences of our fallen nature. What we need not tolerate is a federal regulatory structure that is blind to the operations of those who wheel and deal at the very center of the global economy and federal officials who are so uncertain of their aims and prerogatives that they fumble in the face of crisis.

By the way, many pension funds were investing these exotic derivatives based on shaky mortgages (CDOs) and some were selling insurance on CDOs (CDS) just like AIG.

I can also share with you that ego, hubris, venality and folly are still alive and thriving in the sell-side and buy-side. There is a pathological and symbiotic relationship between the sharks on Wall Street and their institutional clients. I was often disgusted watching individuals stroke each others egos as they figured out ways of profiting for themselves.

Not everyone in finance is ruthless and looking out for themselves, but having worked in this industry for a good part of my life, I can tell you that I have never seen so many hopelessly insecure and ruthless people with no sense of morality, and many of them are running these powerful institutions.

Finally, please take the time to listen to Kate Kelly's interview on CBC radio as well as her recent appearance on the Charlie Rose show along with William Cohan, author of House of Cards: A tale of Hubris and Wretched Excesses on Wall Street. (Note: you can read a review of Mr. Cohan's book here.)

I will come back tomorrow and write about why I think in the new era of investing, small is beautiful. Enjoy your weekend.

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