Saturday, April 19, 2014

Assume a Can Opener

Which ball will you be?
Once upon a time, O Dearly Beloved, a cruise ship carrying a convention of scientists and social scientists collided somewhere in the South Pacific with a floating shipping container full of remaindered Greg Mankiw textbooks. The textbooks had been bound for the newly founded Jack Welch School of Neverending Business in Shenzhou before the container fell off a freighter during a storm. Sadly, the cruise ship foundered and sank to the bottom with almost all hands and passengers on board, with the exception of one physicist, one chemist, and four economists.

Being practical, quick-acting folk, the physicist and chemist salvaged a shrink wrapped pallet full of Principles of Economics (4th ed.) from the open container to float upon in the open sea, where they were shortly joined by one of the economists. The other three economists swam to another pallet floating nearby, which happened to contain Denver Broncos Super Bowl XLVIII Champion t-shirts, and were able to climb onto that. Eventually, the drifting current separated our two little bands of survivors, and a few days later they each washed up on small, isolated atolls about five miles apart.

Upon their atoll, as luck would have it, the three economists found a large cache of perfectly preserved canned food, left no doubt by local fishermen for just such an eventuality. Unfortunately, however, the fishermen had forgotten to provide can openers or indeed tools of any kind to open the food, and of course the survivors had carried nothing off the ship with them but their clothes. After considering the situation, the three economists agreed to separate and come up with solutions to their predicament which they could discuss and agree upon. The economists spent some time wandering the beach in thought. Then they reconvened to discuss their ideas.

The first economist stated that, based on his calculations, the joint probability of the three of them surviving the shipwreck, landing on a habitable atoll in the middle of thousands of square miles of empty ocean, and finding a cache of edible foodstuffs was so infinitesimal they might as well curl up and starve to death, content in the knowledge they had beaten the odds spectacularly so far. The second economist countered that, based on his proprietary DSGE model, the normalized incidence of unopened canned foodstuffs in an economy in equilibrium should comprise no more than 17.2% of all available consumables. He therefore proposed a thorough exploration of the 500 square meter atoll to find the remaining edibles—theoretically consisting of canned goods already opened and uncanned foods edible without the aid of openers—which his model predicted were just waiting to be discovered. The third economist demurred, contending that, even if they were able to find some means of opening and cooking the canned food, eventually the stores would run out and they would starve to death. He argued that expending tremendous amounts of effort trying to extend their lives in the face of certain death was foolish. Instead, he proposed the three spend their remaining days in relative ease and comfort, arguing about Paul Krugman’s latest op ed in The New York Times.

Naturally, being economists, the three could not agree on which solution to follow, so they parted company and went their separate ways. The first economist, true to his word, curled up under a palm tree and waited to die, taking comfort in his distress from the even more unlikely fact he could shelter under a blanket made of Denver Broncos Super Bowl shirts. The second economist set off on an expedition around the atoll to look for the missing food his model predicted. Within minutes, he stumbled into a sinkhole and broke his neck. The third decided that, since he was now alone, going for a pleasant swim would be easier than attempting to discuss a Krugman piece with himself, so he waded into the ocean and was promptly eaten by a large shark.

* * *

Meanwhile, five miles away, the physicist and the chemist killed the fourth economist with a rock, roasted and ate his body over a bonfire of economics textbooks, and waited for a ship to respond to their smoke beacon. After they were rescued, they got married, got tenure, and lived happily ever after.

So who said economists are useless?1

Related reading:
Bryan Caplan, Try Harder or Do Something Easier? (EconLog, April 16, 2014)

1 As someone who has made giving advice his living, this kind of nonsense irritates me no end. Advising people to take or forgo risks based on averages isn’t good advice. It’s lazy advice. Good advice includes a clear discussion of the odds of success—or what you think might be the odds (which are normally not quite so clear cut in most instances)—but it doesn’t stop there. You discuss the risks, the odds, and the special talents and resources your advisee intends to bring to the situation to come to a specific, tailored recommendation. “Don’t start a restaurant, because 60% of them fail” is lousy advice. “You realize on average 60% of new restaurants fail, right? What makes you think you can succeed?” is a better start to advice that might actually do the advisee some good. Notwithstanding many economists’ predilection to think in aggregates and averages, virtually nobody lives an average life. And a hell of a lot of outliers contribute to socioeconomic averages.

Consider the quincunx.

© 2014 The Epicurean Dealmaker. All rights reserved.

Thursday, April 17, 2014

We Have Met the Enemy, and He Is Us

As is usually the case, natch
Creditocracy and the Case for Debt Refusal by Andrew Ross1
OR Books, 280 pp, $17, February 2014, ISBN 978-1-939293-38-1

“Creditocracy (n.)
1. governance or the holding of power in the interests of a creditor class
2. a society where access to vital needs is financed through debt”

— Andrew Ross

If the book currently under review is any indication, Andrew Ross, a professor of social and cultural analysis at New York University, has never (or very, very rarely) met a creditor he really liked. This reader, no stranger to debt or creditors himself, is quite certain that similar attitudes are held by approximately 99.27% of all human beings extant who have undergone the experience of borrowing money. Accordingly, Professor Ross, a social activist who was instrumental to the creation of Occupy Student Debt and the Strike Debt forgiveness program, should have a very receptive audience for his message, which basically boils down to the assertion that debt is very, very bad.

What makes Ross’s tome different from advice dispensed by Suze Orman and dozens of other personal-finance mavens of greater or lesser credibility is his characterization of the socioeconomic institution of credit and his prescription for it. With respect to the former, he spends a great deal of time and effort outlining how debt and credit are inextricably intertwined with our lives and society, including personal consumption, housing, labor, climate, and long-term growth. As for his prescription for it, his message is bracingly simple: repudiate it.

Did I mention that Professor Ross thinks debt is very, very bad?

For if I did not, or if you forget between reading this article and picking up the book, you will recall it very quickly once you do. Ross is no fan of debt. He sees the current pervasiveness and economic and political power of what he has termed the creditocracy to be corrosive of our social fabric, destructive of participatory democracy, and particularly oppressive of the working poor. For the latter, he contends the current system of consumer and personal debt is but the newest incarnation of compulsory social and economic indebtedness for the poor that extends from and encompasses feudalism, indentured servitude, slavery, sharecropping, company scrip, and loan sharking. He has bad things to say about Wall Street, banks, hedge funds, payday lenders, the IMF, the World Bank, the Troika, the Club of Paris, advocates of austerity, politicians, lobbyists, Sallie Mae, Fannie Mae, college administrators, unpaid internships, student debt, revolving credit, compound interest, economic growth, Kenneth Orr, for-profit higher education, securitization, and colonialism. Did I mention debt?

Now lest you think I sport with Professor Ross or your intelligence, let me reassure you I found his book an interesting and, in places, a compelling read. He takes pains to declare that he is neither an economist nor an expert in all things credit or financial, and he makes no effort to offer up specific policy prescriptions or economic analysis to back up his arguments. He does cite reasonably extensive secondary sources throughout, which should enable diligent readers to check his facts and draw their own conclusions about his evidence. He leavens his narrative with the occasional fact or figure, some of which are well chosen to drive home his point. He employs a serviceable and not unpleasant writing style, which makes his book more readable than a run-of-the-mill polemic. He does shoehorn the intermittent left-wing shibboleth like “monopoly capitalism,” “high interest loans,” “high carbon industrialists” (the Koch brothers), and “Wall Street” into the flow of his text, but, as one would expect, these throwaway non sequiturs seem mostly placed to remind his readers of his (and their) political bona fides rather than carry any argumentative weight.

Ross also offers up interesting historical background on the use of debt as an instrument of political control by the IMF and the World Bank in developing economies, the development of the housing mortgage market in the United States after World War II, and the source and growth of the student loan market for higher education. He avoids many basic mistakes of fact or emphasis, and the occasional slip—like the comparison of stocks (bank assets) to economic flows (GDP)—is usually not so serious as to derail his arguments. He flubs the central premise of his chapter contra economic growth, contending that lending requires growth to function. (That this is not so can be illustrated with a simple auto loan.)2 He offers an entire chapter on what he titles climate debt to those of you who find such topics interesting. Sadly, this reviewer is not one of them.

However, he does make a compelling argument that the struggle between debtors and creditors has, for most people, replaced or superseded the struggle between labor and capital:
in societies that are heavily financialized, the struggle over debt is increasingly the frontline conflict. Not because wage conflict is over (it never will be), but because debts, for most people, are the wages of the future, to which creditors lay claim far in advance. Each new surrender of a part of our lives to debt- financing further consumes the fruit of labor we have not yet performed in the form of compensation we have not yet earned. Now that this condition has become inescapable, it is easier to imagine that the struggle between creditor and debtor is much older than the face-off between capital and labor that Marx proposed as a common sense explanation for economic life. After all, exploitation through debt long predates the era of wage tyranny, and its recent restoration as the most efficient means of wealth accumulation suggests that credit is a more enduring, all-weather organ of economic power.

His description of the endless treadmill of high interest, predatory lending suffered by the poor and less fortunate is believable and harrowing, and his description of the student loan market and its parasitic for-profit segment is eye-opening, and not in a good way. There is much to praise here.

* * *

And yet, given all these positives, this reviewer cannot help but feel that Ross has missed the mark. His foreground focus on the instruments and practices of debt has blinded him to an essential, incontrovertible fact: Debt is merely an instrument of economic interrelationships. A careful reader can see that Ross dances around this revelation every now and then, and even nods in its direction and alludes to its implications, but he retreats too soon to tackle the thorny fact directly. Missing this fact puts too much emphasis on the mechanism and history of the use of debt to sustain consumption in the face of stagnant or declining real wages for the majority of Americans, rather than the reason for it. Which, this reviewer believes, is ineluctably tied up with the issues and mechanisms of income distribution in the past several decades. (But that is another essay for another time.)

Ross is also not the first to confuse banks, which have increasingly taken on the role of intermediaries and originators of loans, with the holders of wealth who actually lend it out. But this is not true. Look at any bank’s balance sheet, and you will observe—as Ross correctly does at other places in his text—that banks borrow the lion’s share of what they lend out from other people: depositors, bondholders, other banks, the Federal Reserve. It’s not their money. Banks are conduits for transforming certain kinds of assets (money, investable funds) into others (loans, securities). More often than not, they transform short-term loans they borrow from their creditors into long-term loans to their debtors. This key bank function is called maturity transformation, and it is a critical, highly valuable socioeconomic service lending banks perform.

The real holders of wealth in the economy are not banks, which are only servants. The real holders of wealth are rich individuals, corporations, and institutional investors which manage trillions of dollars of their own and others’ wealth. The lion’s share of such wealth is and has always been invested in the fixed-income markets: sovereign debt, corporate loans, high-yield debt, municipal debt, and, yes, individual consumer debt in the form of securitized credit-card, auto, and student loans and mortgages. The complication, which Ross ignores, is that much of the institutional investment in fixed income is done by and on behalf of pension funds, retirement accounts, and mutual funds managed for individuals. Individuals—people, us—are the creditors we fear and loathe. Even someone with a simple passbook savings account is a lender: first directly to the bank she deposits at, and second indirectly to the debtors who borrow from her bank.

This is a critical point to understand. For it means that it’s not always so clear just whose ox is going to get gored if we go about repudiating debt wholesale. Ross makes a big deal about the retired city workers of Detroit being asked to reduce their pension benefits in the restructuring of the city’s debt. But Detroit’s municipal debt has been bought for years by, among others, professional fund managers on behalf of firefighters, policemen, nurses, and other public and private workers to support their pensions. By the same token, non-wealthy individuals have directly and indirectly purchased the loans and securitized debt of other individuals—i.e., made loans—to provide sources of income for their own futures. Who gets screwed if we start repudiating our credit card debt, student loans, home mortgages, and auto loans? Firefighters? Teachers? Our parents? Ourselves?

And waving one’s hands and saying the government should pick up the tab—as Ross suggests in the case of debt incurred for public higher education—just begs the question in another way. For who both lends money to government and pays taxes to pay its bills? We do, of course, directly and indirectly, in a thousand ways. Of course, we all have different exposures, both as creditors and debtors, to our governments. That, plus the fact we have different economic and political interests and preferences means we will have different opinions as to what debt, if any, should be repudiated and for whom. In other words, by focusing on the allegedly inherent evil of debt instruments, Ross elides the critical point that what needs to happen in our society is a political debate about power and inequality, not a technical debate about the mechanics of a debt jubilee.

This is the Gordian Knot we face when it comes to the problem of debt. I am sympathetic to the plight of the poor, I am outraged at the behavior of predatory lenders, and I am a firm believer in heavy regulation of consumer finance and a much heavier hand in prosecution of financial chicanery than we have yet seen. But the threads of debt shoot through our society and economy in such myriad patterns and interlinkages that it would be practically impossible for anyone to trace them all. Ross wants citizens to audit lenders for “bad” or “illegitimate” debt. But is he truly sure he or we can tell the difference? Is he truly certain repudiating “bad” debt will be good for everyone except lenders? Does he truly know who the lenders are? Who is going to pick up the tab?

Ross states he wants a “moral economy of debt.” He wants the privatization and financialization of basic human wants and needs—shelter, education, health care—reversed and taken out of the hands of private lenders, presumably to be put in the hands of government or, what is another word for the same thing, our common hands. But this is not a moral decision. This is a political decision.

And the last time I checked, we made those decisions through the ballot box. If Ross intends his book to be a call to action and a spur to political discussion of the transformation of our economy, all the better. We need more individual citizens involved. But he and they might find the answers they seek are not quite as obvious or acceptable to the rest of us as he contends they are.

1 This review first appeared in The New InquiryMoney” issue, published April 2014. It differs in minor cosmetic details from the published article, the online version of which can be found here. Any unexpected clarity and concision which has crept into my writing in this piece can be attributed to the excellent work of TNI’s editors. By the by, I recommend those among you who enjoy challenging your assumptions about the proper role of finance in society go check out the other thought-provoking articles therein by Steve Randy Waldman, Izabella Kaminska, Mike Konczal, and others. As is usual and proper among such econoblogospherical heavyweights, my piece was included for comic relief.
2 Should, for example, Ross decide to purchase a new Honda Accord for $22,000, he could finance it for 48 months at 4% interest for 48 level monthly payments of $495 each. Self-amortizing debt at fixed interest rates—which comprises a very large percentage of consumer and housing debt—does not require or depend on incomes or anything else growing. In fact, in general creditors tend to prefer a static or even deflationary economic environment, since inflation, which is usually associated with growth, erodes the real value of their fixed claims.

© 2014 The Epicurean Dealmaker. All rights reserved.

Sunday, April 13, 2014

In Loco Parentis

Kids: can’t live with ’em, can’t sell ’em for theater tickets.
“You know, Mrs. Buckman, you need a license to buy a dog, or… drive a car. Hell, you need a license to catch a fish. But they’ll let any butt-reaming asshole be a father.”


One of the advantages of being a sole pseudonymous proprietor of an obscure online opinion emporium—insulated from the interference of officious editors, hypersensitive advertisers, and unhinged commenters still seething over the unflattering piece I posted about their dipsomaniac uncle six years ago—is the freedom to write whatever I will. Periodically then, this freedom licenses me to post explanatory articles which illuminate often obscure features or issues about my chosen profession which, to be perfectly honest, will be of little interest to most of you Charming Visitors.1 So unless you would like to learn a little bit more about the current regulatory environment surrounding mergers & acquisitions, I suggest you skip over this entry and revisit the latest internet outrage du jour on Gawker or Slate, instead. Or better yet, read a book.2

The impetus for this post is the release, this January, of what is known in the trade as a “No-Action” letter by the SEC in response to a formal inquiry by a gaggle of M&A lawyers. Now in layman’s terms, a no-action letter is simply a formal statement by the SEC that, under a certain limited set of circumstances as laid out in exhaustive detail by the petitioners, it will choose not to enforce existing securities laws. In the particular instance under consideration, the no-action letter effectively eliminates the existing requirement for advisors who participate in mergers and acquisitions involving private companies to be registered as broker dealers with the SEC.

Now Charming Visitors like you, I am sure, can just imagine how this news was received among certain shouty quarters of the internet and associated environs:
“Wall Street Banksters Celebrate
SEC Trashcanning of Investor Protections
Over Lavish Meal of Roast Baby Seal,
Fricasséed Retirees’ Dreams”

Fortunately—or unfortunately, perhaps, if you are one who prefers to keep her mental map of the financial system conveniently colored in morally unambiguous shades of black and white—I am here to reassure you that baby seals and investor dreams face no greater threat than they did before, and this particular instance of deregulation running, as it were, against the tide of increasing regulation in the brave new world of Dodd Frank makes eminent and prudent regulatory sense.

* * *

It will help me make my case if you understand the historical background of the existing regulation which the SEC has decided to waive enforcement of. Historically, as you might expect from an organization entitled the “Securities and Exchange Commission,” the SEC has been particularly concerned with the regulation of anything and everything to do with securities. Simplifying greatly for the non-lawyers in my audience, the SEC has traditionally said that any financial intermediary who participates in the origination, solicitation, negotiation, marketing, or general fricaséeing of a security and gets paid a fee for doing so (i.e., all of us) is required by law to register as a broker-dealer. In other words, if you make money assisting the transfer of securities from one party to another–whether by making a market in secondary shares, underwriting a new bond issue, or selling companies—you need a license. What may not have occurred to you is that the securities of private, non-publicly-traded companies count as securities under the SEC’s purview, too. And M&A transactions, which usually involve the purchase, transfer, or exchange of securities for cash and/or other securities, definitely count.

Given the SEC’s mandate to protect investors, this makes eminent sense when M&A involves companies with publicly-traded securities. After all, if there are public securities involved, somewhere or other a widow or an orphan is likely to get caught up in the deal, and nobody—least of all the SEC—wants nefarious unregulated doings clouding the pale and fevered brows of said Ws and Os. At least not publicly. Of course pure M&A advisors almost never handle customer funds or securities—a big hot button for the widow and orphan protection unit—and they rarely provide financing for the transaction, unless they are one of the monster integrated investment banks intent on sucking more fees out of their clients’ wallets by lending their own balance sheet to the equation. But the overarching presence of public securities is as probably as good a reason as one can muster for the licensing of M&A advisors who participate in transactions involving public companies, even if it might be considered, for various reasons, a bit of overkill.

But the inclusion of M&A deals involving purely private companies under this licensing requirement has never made much sense. I will allow the helpful lawyers at Morrison & Foerster to explain:

The application of the broker-dealer regulatory framework to private company M&A advisers has always been somewhat awkward. Much of that framework is designed to protect customers against abusive sales or trading practices and to ensure that customer funds and securities are safeguarded. However, in the typical private company M&A transaction, the terms of the deal are negotiated directly by the principals with assistance from their financial and legal advisers. Unlike the customer who buys or sells stock based on a brief conversation with his broker, the owners of a private business are generally very involved in the negotiation process, which may take place over a period of weeks or months. Moreover, the financial intermediary never touches the customer’s funds or securities. The “broker” in private company M&A transactions functions essentially as an adviser to its client and its role bears little resemblance to more traditional broker-dealers.

This, I can tell you from long and painful experience, is absolutely true. The principals in a private company transaction are either other companies or financial sponsors, all of whom tend to be very experienced in doing M&A themselves and/or are protected by the advice and counsel of armies of very experienced lawyers, accountants, and professional M&A advisors like me. We take oceans of time for due diligence and negotiate the everloving crap out of every possible term of these deals six ways from Sunday. The notion that an average billion dollar corporation or financial sponsor with a three billion dollar fund needs the indirect, implicit investor protection that a broker-dealer license from the SEC purportedly conveys to its M&A advisor when it purchases a $25 million dollar business is patently ludicrous.

But historically the SEC has been a big fan of one-size-fits-all legislation: what’s good for Aunt Millie is good for Steve Schwarzman. I have complained in the past that the conflation of retail and wholesale finance under one legislative rubric structurally designed to protect the widows and orphans of 1933 and 1934 from boiler room operations is just silly. Financial transactions among professionally advised, intimately involved, professional principals like corporations and financial sponsors just should not be treated in the same way as Aunt Millie’s purchase of a mutual fund from her stockbroker Chuck. And M&A deals, both public and private, definitely count as the former.

* * *

The prior restrictions were not without negative effects, by the way. In order to satisfy the rules, M&A brokers who wanted to actively advise their clients often had to twist the transaction structure into an asset sale, thereby avoiding the requirements triggered by the involvement of securities, whether that was the most financially efficient structure or not. Or they simply ignored the law, in the hopes that the SEC would look the other way. In the latter case, their clients usually shrugged indifferently, since they knew they were fully protected by intensively negotiated legal engagement contracts and fully applicable anti-fraud provisions under the law anyway. Most aficionados of jurisprudence will tell you a law which only encourages scofflaws or evasion is bad legislation.

Lastly, the prior regime enforced a very inefficient structure in the market for private company M&A. In order to comply with the law, many individual advisors or small boutiques which could do M&A either had to associate with an existing licensed broker-dealer or apply for a license and maintain ongoing registration themselves. This, for smaller outfits, was not trivial, costing potentially hundreds of thousands of dollars up front and entailing substantial ongoing reporting obligations, dedicated compliance and administrative personnel, and non-trivial financial expense. It likely substantially curtailed the establishment of small independent advisors who otherwise wanted to and could provide professional advisory services to privately held companies. The outcome of this regulatory barrier to entry, of course, has probably been higher prices for customers who want to do M&A.

So I congratulate the SEC for finally seeing the light of intelligent market regulation in the M&A world. No true investor protections have been lost, and barriers to entry in a high cost service industry have been lowered at a stroke. Who knows, maybe this is the start of a new era of intelligent regulation of financial markets, not more regulation.


Related reading:
United States Securities and Exchange Commission, No-Action Letter Dated January 31, 2014
Morrison & Foerster LLP, Private Company M&A Brokers Don’t Need to Register With the SEC as Broker-Dealers (February 6, 2014)
You’re Doing It Wrong (October 22, 2011)

1 This, of course, incorporates the perhaps heroic assumption on my part that anything I write here is of interest to more than zero of you. But, since this is my website, I can damn well assume as much such nonsense as I choose. So take it as given.
2 I hear some mid-range Princeton author has an inflammatory new book out about Wall Street traders who like to expose themselves in public that’s getting a lot of press. Flasher Boys, or something like that.
3 In the isn’t-it-interesting-what-a-coincidence department, the SEC no-action letter comes at a time when legislation is currently wending its way through Congress that would enshrine the exemption of M&A advisors from broker-dealer registration requirements in actual law. The original bill, H.R. 2274/S. 1923, and the omnibus bill which incorporates it, H.R. 4304, incorporate virtually the same exemptions from registration as are included in the no-action letter, with the slight addition of size limits for transactions. Note that neither the no-action letter nor the proposed legislation lets M&A brokers off the hook from registration if they do public company M&A or normal securities financing work, like private placements. Any investment bank which aspires to the full range of agency services, even if they do not have capital markets trading activities, will still have to register. Relax, Aunt Millie: the dogs of war are not completely off the chain.

© 2014 The Epicurean Dealmaker. All rights reserved.

Thursday, April 10, 2014

The School of Hard Knocks

My GPA is Fuhgeddaboutit
Power Figure, Kongo Peoples, 19th C.
I am no student (We’re going down to meet
Feel those vibrations) Of ancient culture
(I know a neat excavation)
Before I talk
I should read a book
But there’s one thing
That I do know:
There’s a lot of ruin
In Mesopotamia

— The B-52s, “Mesopotamia

Megan McArdle penned an impassioned plea last week for the (presumably elite, corporate, Bloomberg-View-reading)1 employers of America to consider hiring more ex-slackers. Notwithstanding her acknowledged bias as a self-described ex-slacker herself, Ms McArdle argued this made sense for two reasons: first, young slackers do not necessarily stay slackers as they age, and second, hiring the alternative—highly professionalized, directed, ambitious careerists—tends to result in fragile corporate monocultures which are subject to their own risks and flaws, including social and intellectual conformity and groupthink.

I am less persuaded by Ms McArdle’s first rationale. In my experience there are all kinds of slackers, including potentially promising ones who dicked around in their youth because they were restless and bored by the cookie cutter path of adolescence and completely irredeemable ones who dicked around because they were lazy bastards who preferred (and will always prefer) to get high on tasty weed rather than do their homework or take out the garbage. I guess the operative screen is ex-slacker, since someone who actually gets her shit together and tries to make something of herself does deserve a real opportunity. Like Ms McArdle, though, ambitious ex-slackers have a lot of proving to do.

Her second rationale resonates strongly with me, however. Over the course of my more than two-decade long career in investment banking, I have read the job applications and interviewed hundreds of young candidates for entry level Financial Analyst and Associate positions at a number of firms of different size, prestige, and culture. Over that same period, I have seen an increasing convergence in the kinds and qualifications of these candidates: predictably good or stellar grades in unobjectionable mainstream majors like finance, business, or economics, predictably hyperactive extracurricular activities centered around “leadership” building opportunities, and predictably careerist charitable and community service activities which only Scrooge could object to. My typical reaction to such candidates is ably captured by David Brooks:
When you read these résumés, you have two thoughts. First, this applicant is awesome. Second, there’s something completely flavorless here. This person has followed the cookie-cutter formula for what it means to be successful and you actually have no clue what the person is really like except for a high talent for social conformity. Either they have no desire to chart out an original life course or lack the courage to do so.
Now normally this is not these children’s fault. It is what they have been told to desire and groomed to accomplish their entire lives. But, with all due respect to Megan McArdle’s Harvard friends with 4.0 GPAs, my God these people are boring.

Most of them, if they ever had a personality or original thought in their head in the first place, have hammered it down so deep into their subconscious they couldn’t summon it on pain of death. Their résumés, their bearing, and their polished interview patter render them about as distinguishable and interesting to talk to as Brooks Brothers mannequins. Nothing in their conversation or revealed background indicates any appetite for adventure, risk, or enlightenment. Nothing they can relate indicates they have tried something they didn’t know they could succeed at, risked failure for a good reason (or any reason at all), or simply gave themselves up to powers greater than themselves—love, fate, chance—just because. They haven’t lived at all. They’ve followed a career path.

I call them carbon sinks.2

* * *

Now the more charitable among you (as well as the helicopter parents who spawned these pathetic simulacra of humanity) will object I am being too harsh on these special snowflakes. You will remind me they are young, and hence pathetically stupid and naïve about the world and their true opportunities in it. Give them time and space, you plead, and these button-downed zombies will blossom into fulfilled and meaningful personalities. You will scold me for dismissing naturally interesting and unusual individuals because they are too wise (or afraid) to run up their freak flags in an interview with a curmudgeonly old white man at a potential future employer. You will complain that I only seek for such adventurers and renegades because I miss my own long-lost adventuring, and I want to relive my halcyon youth in these eager tyros’ stories for the space of a half an hour.

And you would be right. A tiny, tiny bit. But not much. Because I am experienced and clever enough to know how to winkle most such secrets out of the prepackaged dross of most college and business school graduates, if they exist. But they usually don’t. The polished husk you see is usually all there is. And my youthful gallivanting is not something I need or want to recapture in the glazed eyes of some nervous, dissembling twenty-two year old.

No, I look for evidence of intellectual independence, untrammeled curiosity, and adventuresomeness because these are really, really valuable traits in a professional investment banker. A young person who has deviated from the beaten path, who has taken risks, who has ventured to explore something unknown is far more likely to develop the mental flexibility, toughness, and adaptability that will make him or her a valuable counselor and advisor to his or her clients. Sure, these traits are largely useless in the beginning of any investment banker’s career, when they are and must be suppressed in order to satisfy the pressing demands of intellectual drudgery and unimaginative detail work that investment banks expect of their indentured chattel. But they re-emerge later on, as a young banker increasingly grows into the role of a pure salesman who must earn the respect and trust of his or her clients, colleagues, and peers.

And when you do this, a youth spent stretching the envelope and taking risks comes back to pay dividends all out of proportion to its actual extent. For one thing, you have a lumber room of stories which you can share with your clients and colleagues over dinner and drinks that will make them laugh and look at you admiringly. You will not be boring. For another, you are likely to genuinely appreciate these very clients’ and colleagues’ own youthful peccadilloes, which will only endear you to them as a non-judgmental, non-asshole, which is a sadly rare commodity in my business. Most importantly, taking risks and exploring the unknown—whatever form that may take—will likely increase your store of that deeply unfashionable and socially awkward characteristic: wisdom. As Ms McArdle herself avers,

When the prodigal sons return to the fold, they often bring with them valuable information about the outside world.
Wisdom is nothing to sneer at in a professional advisor, much less in a normal human being.

* * *

So what does this mean for the average ambitious youngster reading these words? Well, it means I heartily recommend taking a flyer or two, mixing it up, and actually trying to explore who you are and what you want out of life other than a prestigious, well-paying job at Stereotype Brothers, LLC. For one thing, you may find out to your chagrin after 22 years of prepping for Goldman Sachs that you really want to be a professional chef. Or a skydiver. Or a paleobotanist. Your whole life is ahead of you. I’ve asked this before: why should you put all your youthful energy, curiosity, and enthusiasm into a basket you’re not sure you want to carry?

Plenty of college students nowadays—perhaps too many, in this old man’s opinion—spend all their time and energy in college acquiring what they believe to be marketable skills, without considering for a minute whether the employment to which they aspire is right for them, will exist in a meaningful form in the future, or even will hold their interest for more than a few years.

But don’t get me wrong, either. Taking risks, avoiding the beaten path, and cultivating adventure is not an easy road. It’s certainly no guarantee of success.3 But is conventional success all you want out of life? Please say no.

It is the brave ones who are not afraid to expose themselves to risk, earn scars, and take hard knocks who make the most interesting humans. And even if you stick to the halls of commerce, I bet you’ll find a lot more risk takers and nonconformists among the ranks of the truly successful than Harvard 4.0s.

Guess who they’d rather talk to over a beer at 3:00 am.

Related reading:
The Standard Model (February 18, 2012)
No Country for Young Children (October 21, 2012)
Curriculum Vitae (March 10, 2013)

1 As opposed, say, to the vast unwashed non-elite, non-Bloomberg-View-reading firms who have to compete for their employees in less exalted realms.
2 As in somewhere a carbon atom goes to wait for 30 to 60 years before it can do something interesting, like get sucked into a supernova. Or become a charcoal briquet.
3 For one thing, if you do decide you want to get into investment banking, you’re going to have to run a gauntlet of dozens of junior bankers who are just as blinkered and one-dimensional as the straw men I have been eviscerating in this post. And very few of them, by definition, will be able to appreciate your non-conformity to the career model and professional values they have staked their entire young lives upon. I can’t tell you how many polite arguments I’ve had in group recruiting meetings with tyros who only want to hire (really smart, really accomplished) cardboard cutouts like themselves. And I don’t always win. Caveat interviewee.

© 2014 The Epicurean Dealmaker. All rights reserved.

Saturday, March 1, 2014

This Situation Absolutely Requires a Really Futile and Stupid Gesture

I am shocked! Shocked!
Bluto: “Hey! What’s this lyin’ around shit?”
Stork: “What the hell we supposed to do, ya moron?”
D-Day: “War’s over, man. Wormer dropped the big one.”
Bluto: “What? Over? Did you say ‘over’? Nothing is over until we decide it is! Was it over when the… Germans bombed Pearl Harbor? Hell no!”
Otter: [aside] “Germans?”
Boon: “Forget it, he’s rolling.”
Bluto: “And it ain’t over now. ’Cause when the goin’ gets tough…”
Bluto: “…”
Bluto: “…”
Bluto: “The tough get goin’! Who’s with me? Let’s go!”

Animal House

Hamilton Nolan posted a really stupid piece on Gawker this past week.1

Apparently the editor of our culture’s preeminent forum for snark and sarcasm was so outraged by Forbes’ annual encomium to the highest-earning hedge fund managers that he burst a gasket. I guess the shock was so great Mr. Nolan dropped a slice of gluten-free artisanal toast buttered with the tears of free range lambs raised on an anarchosyndicalist commune in Vermont face down on a rug woven by one-armed Peruvian orphans from the frayed fibers of their broken dreams. Or so I presume, given the fulsomeness of his resulting vitriol. Unfortunately for this forum, at least, Mr. Nolan’s righteous indignation was not matched by a similar zeal to get the most basic facts about the situation correct.

So the unsuspecting Whole Foods customers who read Mr. Nolan’s work were subjected to howlers like this:
Here is what George Soros’ fund did last year to earn him $4 billion: it underperformed the S&P 500 index by 8%. In other words, Soros charged his investors fees that are well over 1000% higher than what they could have paid for a simple index fund that would have earned them more money.
Which is amusing since, as Mr. Nolan subsequently appended in a parenthetical correction to those very words, George Soros only manages his own money. I mean, I suppose it is shocking Mr. Soros had the audacity to charge himself and his charitable foundations zero dollars for the privilege of earning only four billion dollars when he could have earned significantly more, but I suspect even the meanest intelligence would find the towering indignation inspired by the preceding sentences dissipating somewhat once he realizes exactly what that means. (Perhaps Mr. Nolan counts on his fellow snark and outrage aficionados to miss the embarrassing reveal…)

But this failure to do the most basic fact checking—i.e., reading the goddamn Forbes article he cites—is not the worst of Mr. Nolan’s sloppy misrepresentations. Even he seems to shrug off the fact that thousands of rich institutions and individuals seem content to pay billions of dollars in fees to hedge fund managers for results which, in aggregate, have underperformed the general stock market.2 No, what really pisses Hamilton Nolan off is the notion these greedy plutocrats are stealing food out of the mouths of hungry refugees by paying preferentially low tax rates on their filthy lucre. He points out, correctly, that alternative asset managers like hedge fund managers benefit from the treatment of their performance fees as carried interest. Carried interest, for those of you ignorant of it, enables the managers of certain investment partnerships to treat the performance fees they earn (typically 20% of the positive returns they earn for their limited partners) for tax purposes as capital gains, presumably on the theory they are returns to the “sweat equity” (i.e., not real money) that managers contribute to the partnership. This can be advantageous to the extent these managers, like those in private equity and venture capital partnerships, generate returns over a period of several years, which can then be taxed at preferentially low long-term capital gains rates.

But what Mr. Nolan fails to recognize is most hedge funds earn the bulk of their returns by rapid trading of liquid investments and assets like stocks, bonds, commodities, derivatives, and anything else for which a willing counterparty can be persuaded to part with a bushel of folding money. They are trading vehicles, which means most of the capital gains they earn via performance fees are treated as short-term capital gains. And short-term capital gains, under our current tax code, are taxed at the same rates as ordinary income.

Which means, technically speaking, that Hamilton Nolan is full of shit.

* * *

Now this is not to say the treatment of performance fees for alternative asset managers as capital gains via the mechanism of carried interest makes much sense or is good tax policy. I have argued strenuously in the past that performance fees earned by professional managers with no underlying capital at risk should be treated as what they clearly are: ordinary income for services rendered. The current tax regime is patently unfair, and the counterarguments offered by interested parties involved are weak and self-serving. But this does not invalidate the fact that, under the law, hedge fund managers who trade their clients’ money actively (that is, most of them) pay the equivalent of ordinary income rates on their performance fee income.3 Private equity plutocrats—who, interestingly enough, tend to make less money every year and have lower net worth than the best hedge fund managers—are the ones who benefit disproportionately from the current biases of the tax code. But Mr. Nolan is not attacking them.

Nor is it to deny that hedge fund managers, like any other person richer than Croesus, have the money and means to pay legions of lawyers and accountants millions of dollars to structure elaborate tax shelters and help them defer or evade billions in taxes. But this is not limited to hedge fund managers: it is a privilege enjoyed by any rich and politically powerful person who is willing to spend a tiny fraction of their income to shield the bulk of it from the taxman. You may thank the complexity of our tax code and the ingenuity of clever men and women willing to delve deep in its bowels for that.

* * *

At the end of the day, O Dearly Beloved and Excessively Tolerant Readers, what really annoys me about Hamilton Nolan’s poorly researched and badly premised hit piece is that its own strongest feature—a deep suspicion of and revulsion toward enormous sums of money flowing to tiny numbers of human beings while billions struggle to make ends meet—is almost completely undermined by its almost comical disregard for the facts. Growing wealth and income inequality around the world is engendering serious sociopolitical conflict, but attacking the wrong people for the wrong reasons with the wrong arguments will do nothing to address it.

Polemics can focus the mind wonderfully, but they must be based in truth if they are going to persuade anyone. One of my favorite non-finance bloggers about academia and culture, Freddie deBoer, wrote an illuminating essay about this very issue in academia not long ago:

This is the problem with speaking the “emotional truth,” a common invocation for adjunct essayists and part of a lot of rhetorically counterproductive strategies that, I’m sorry to say, creep into this genre a lot. The emotional truth is invoked on the ground in the day-to-day discussions I have with adjuncts. People will make claims that I know to be factually inaccurate, or will advance ideas that I find politically misguided, and I will push back. When confronted, they will say something like “I am entitled to my anger,” leaping back and forth from a position of making a dispassionate economic analysis to a position of emotional truth that I am therefore, in their minds, obliged not to contradict. There are all sorts of ways bad arguments and misleading information get excused in these debates– “it’s agitprop! it’s not intended to be factual! it’s meant first to provoke!”– and I think each of these, while certainly understandable, are ultimately unproductive. And they have made this argumentative space one of bullying and rejection.

To extend Mr. deBoer’s analysis, most of the people involved in the analysis, practice, and regulation of finance “are people who think that facts matter, and so when you are loose with the facts, you make it harder to get their support.” Yeah, like impossible. Most of us—even those who might otherwise be sympathetic to your analysis or agenda—just throw up our hands and ignore you. If you can’t argue from the facts, you are simply pandering to your own anger and the prejudices of the uninformed elements in your audience. You may be penning compelling polemics, but you are wasting every serious person’s time, and you certainly aren’t convincing them. In addition, you make it easier for them to discard everything you write or say, because your argument is riddled with silly, obvious omissions, misrepresentations, and untruths. Your potential allies think you’re a harmful idiot, and your enemies gleefully disregard any valid points you might make because you are a careless, misleading boob.

Polemics are fine, but don’t neglect the foundation of facts you must build them upon. Otherwise you’ll become like Matt Taibbi:4 beloved by those who don’t know anything and scorned by those who do.

Related reading:
Tax Breaks for Everyone! (June 14, 2007)
The Taxman Cometh (July 11, 2007)

1 “Gawker?!”, you gasp. Yes, yes, I know: most of you do not visit these pages with the view to enjoying the spectacle of me beating up the feebleminded, but I do have a larger agenda. Besides, it’s fun to go slumming on occasion. I promise I won’t make a habit of it.
2 A more intellectually honest and curious journalist might explore why so many presumably silly rich people allocate so much money to hedge funds and other alternative investments. That same journalist might find it revealing that the class of such assets allows one access on occasion to consistent outperformance which handily trumps average market returns. That journalist might also find it suggestive that rich folk such as Mr. Soros and his former clients are happy to trade volatility and uncertainty of investment returns for the opportunity to make tons of money when their manager is right. Finally, that journalist might discover that hedge funds invest in a much broader and more diverse universe of asset returns than simple stock market indices, which can be handy when the latter are pissing the bed. But I suppose we must not hold Mr. Nolan to such unrealistic standards.
3 And on the distributed returns they earn on the personal capital they invest in their own hedge funds. It is quite common in hedge fund land for managers to have very large portions of their personal net worth invested in their own funds. This is one good reason to admire these swashbucklers: they eat their own cooking and put their own capital at risk alongside that of their investors.
4 Or Matt Taibbi Junior. Say what you will about Mr. Taibbi, who also undercuts his own far more effective polemics with a highly tendentious style of argument that runs roughshod over the truth, at least he tends to do research. I very much doubt he would have stumbled over the elementary source of Mr. Soros’s income.

© 2014 The Epicurean Dealmaker. All rights reserved.