Saturday, January 29, 2011

A Terrible Beauty Is Born

I have met them at close of day
Coming with vivid faces
From counter or desk among grey
Eighteenth-century houses.
I have passed with a nod of the head
Or polite meaningless words,
Or have lingered awhile and said
Polite meaningless words,
And thought before I had done
Of a mocking tale or a gibe
To please a companion
Around the fire at the club,
Being certain that they and I
But lived where motley is worn:
All changed, changed utterly:
A terrible beauty is born.

— From W.B. Yeats, "Easter, 1916"

The current situation in Egypt is, as they say, fluid. There is the remote possibility that the Egyptian people will achieve their apparent ends relatively peacefully, without further loss of life. But while the power of authority arrayed against them—the police, internal security apparatus, and perhaps the army—relies for its ultimate effectiveness upon the credible threat of violence, the power of protest and resistance relies in the last instance upon a people's willingness to die for their cause.

This is what it means to be courageous: to place yourself in the path of irresistible force, certain of your own destruction, for a cause higher than yourself and your petty concerns. Flesh arrayed against bullets, bodies against tanks. Lives willingly offered for beliefs and aspirations. Without sacrifice or the threat of sacrifice, there is no courage.

And bullets and tanks are so much more powerful than flesh and bodies, are they not? But here's the trick: once the credible threat of violence by a government against its own people tips over into the actual use of force, the balance shifts. The government forfeits all legitimacy, and the people assume the mantle of moral and political authority over their own destinies. By sacrificing their blood and their lives, the people themselves can seize power from the men with bullets and machines. For there are always more people than there are bullets or machines.

Ammunition runs out. Machines break down. But ideas, and ideals, are inexhaustible.

Let us hope the Egyptian people feel the power in their own hands, and use it.

Creedy: "Die! Die! Why won't you die?... Why won't you die?"
V: "Beneath this mask there is more than flesh. Beneath this mask there is an idea, Mr. Creedy, and ideas are bulletproof."

— V for Vendetta

© 2011 The Epicurean Dealmaker. All rights reserved.

Sunday, January 23, 2011

Standup Physics

Everybody needs a hobby, Dear Readers. Everybody. Even I have to take respite from high-level global financial parasitism on occasion, in order to maintain my keenly honed intellect and razor-sharp sarcasm.

One of my hobbies is collecting books on the history and philosophy of science, especially physics. I have developed quite an impressive library, which glowers ominously from my bookshelves like a mathematical reproach to my ignorance and wooly-headedness. For make no mistake, My Skeptical Friends, I have read very few of these weighty tomes and understood even fewer. Nevertheless, I like the way they look, the graceful, incomprehensible equations which crowd their dense pages, and the mistaken impression they create among visitors to my home, who naturally believe I have read and understood them all. They also tend to set conversational expectations somewhat higher than the latest shenanigans on The Jersey Shore, which obviates the necessity of me punching my houseguests in the nose should they sink so low.

Anyway, I have absorbed enough of the issues and concepts of physics that when @__phlox tweeted a clever joke earlier today on Twitter, I felt both compelled and inspired to reply in kind. Herewith, for your entertainment and edification, is what followed.

The action:
@__phlox: a neutron walks into a bar, orders a drink, and asks how much. the bartender says, "for you? no charge."

My unequal and apposite1 reaction, with explanatory links:

A Higgs Boson walks into a bar. The bartender says, "Hey! Where've you been? Everybody's been looking for you."

A neutrino walks into a bar and just keeps going.

A proton says to another proton, "You repel me!" "Are you sure?," asks the other. "I'm positive."

An electron says to a neutrino, "I really like you, but I just can't get a reaction out of you." She replies, "Aww, don't be so negative."

A photon asks another photon, "So, which slit are you going through?" The other replies, "Dunno. The experimenter hasn't decided."

An electron on vacation asks a photon for a date, but she replies, "I'd love to, but I'm already entangled with someone back home."

A mother neutrino calls upstairs to her son, "Junior, where exactly are you?" He replies, "Sorry, Mom, I'm not completely certain."

And the capper:

"Thaaaaat's all, folks!," exclaimed the particle, as he waved goodbye.

* * *

So, never let me hear you say that TED cannot sink to the lowest level of cheap, nerdy humor when he wants to.

And let that be a lesson to you, too. Mess with me, and I just might trot out my Émile Durkheim jokes. Then you'd be sorry.

1 Sic. You didn't really think that was a mistake, did you? Really? I'm disappointed in you.

© 2011 The Epicurean Dealmaker. All rights reserved.

Saturday, January 22, 2011

Bar Nothing

Every man I knew went to bed with Gilda... and woke up with me.

— Rita Hayworth

I laugh and laugh, O Dearly Beloved, whenever some yabbo alleges that investment banks have their clients wrapped around their impeccably manicured fingers. I laugh because it's almost never true. I laugh because investment bankers are hired guns, client service professionals who are employed on an ad hoc basis to help companies raise capital by issuing securities or do mergers and acquisitions. Clients hire us. We work for them. Not the other way around.1

Sometimes we will in fact suggest or bring a company a deal idea, but in almost every instance our idea has more to do with How and When to do a transaction, rather than What and Why. The clients themselves provide those answers, based upon their own self-determined need for capital or strategic objectives.

Now it's true that a wise client will never hire an investment banker to help execute a transaction unless the client really, really wants to do that transaction. For one thing, investment bankers are pretty good salespeople, and we will use our sales wiles on our own clients when we think it's necessary. Accordingly, we will try to overcome any objections (like price, terms, etc.) a client may come up with that may stand in the way of closing a deal. For another, investment bankers are highly motivated to close deals, because in almost every instance that's the only way we get paid. A client should never hire an investment banker for pure, unbiased advice as to whether it should do a deal, because often the right answer to that question is no, and that's just not what we're selling.2

* * *

But if you really want to understand the true nature of power relations between investment banks and their clients, it helps to examine the extreme example of a hot deal or client. Then you see the sordid truth: nervous, sweaty multimillionaires in expensive suits stacked five deep in a waiting room, desperate to get in and pitch for some juicy piece of business every Managing Director needs to win to make his revenue quota. Five, six, or more presentation books from different investment banks, each with exactly the same "ideas," exactly the same credentials, and exactly nothing to distinguish each from the other other than different bank logos at the foot of every page. Investment bank teams which vary directly in terms of number and seniority of members with the size and prominence of the client and piece of business at hand. (Of course, the prominence of those members varies inversely with their relationship to the client, understanding of the deal, and actual participation in its execution if the bank wins the mandate. Notwithstanding who is in the room, Ladies and Gentlemen, Jamie Dimon or Lloyd Blankfein will never actually do anything for your pissant little IPO or divestiture.)

These are the Gildas of the investment banking world: clients so sexy and compelling that every schlub and Casanova who can get into the casino will make his pitch to bed them. These are not clients whom you try to advise on the best course of action. They have probably already decided what they want to do, which usually involves making as much money as possible for themselves and, if there's any left over, some scraps for free-riders like shareholders and other riff-raff. If you want a piece of the deal, and the mouthwatering fees and bragging rights that come with it, you will suck up as shamelessly as possible to the beautiful lady and tell her anything she wants to hear. To hear tell in one of these Boardroom meetings, there is no supermodel or film star in the world more intelligent, attractive, and downright fuckable at this very moment in time than Acme Widgets and Social Networks, Inc.™

The client holds all the cards in these situations, and the most an investment banker can hope to do is hop a ride on the gravy train and ladle off as much as he can. It is not a scenario which encourages or supports professionalism, integrity, or carefully weighed judgment. It encourages blatant prostitution.

* * *

For an excellent example of just such a situation, let us turn to James Altucher, who has continued his recent spate of confessional blog posts from the past with this little gem:

So we closed on thirty million dollars and bought our first company. Then we bought a second company. A consulting company called Katahdin. They had nothing to do with wireless but they had profits. We’d bury them in the IPO story but make use of their profits. Then we bought a third company. I can’t even remember their name but they were a spinoff from MIT. Right away we were getting calls. Aether Systems wanted to buy us but we said no. They only wanted to pay fifty million for the company. A banker at CS First Boston told us he could get us seventy five million no problem. But we didn’t even listen to him. In the elevator we laughed at him. What an old fool! We were going for an IPO.

Every bank came in with a powerpoint and a team of young people to pitch us. Goldman, CSFB, Merrill, Lehman, etc. CSFB was the front runner because Frank Quattrone was an investor but Merrill made a strong pitch. The pitch was funny. The top Merrill banker was there. He said to the associate on the deal, “John, walk them through the numbers.” And John said, “uhh, my name is Roy”. Two other things I remember from the pitch. The first was, “Henry Blodget will be the analyst on this deal. He loves wireless.” Which made no sense to me since he was an Internet consumer analyst.

The other thing I remember was the back page of the presentation. The beautiful back page. The only page that mattered. It had what my networth would be if we IPOed and the market valued us similar to Aether Systems. I would be worth something like nine hundred million dollars.

Yes, you may laugh at the pathetic, drooling investment bankers in this story. I certainly do. But you must understand why they behave this way in front of hot clients. They do so because—notwithstanding everything you may have read and heard about my industry—there is immense competition among investment banks for this kind of business. I laugh even harder than I do above when I hear my industry described as an oligopoly or cartel, because that is undeniably untrue. Ever since I started in the business as a mere bag-carrier, my superiors and peers have complained about the excessive and relentless competition in investment banking. Part of it boils down to the fact that, on any given day, any investment bank with a broker-dealer license can probably execute your securities underwriting or M&A transaction just as well as the other thirty-two. Goldman Sachs and Morgan Stanley do not boast superior resources or better quality bankers than anyone else on the Street. In fact, I have experienced just the opposite my entire career and said so in these pages many times. If they want in, they've got to strap on knee pads and warm up the Vaseline just like the rest of us.

It is a strange feature of my business that, despite such intense competition, investment banks rarely compete on price. I have addressed this conundrum in the past, but I think it simply boils down to the fact that most of our clients simply aren't that price sensitive when it comes to fees for capital raising or M&A. Instead, banks mostly compete on how abjectly they can grovel in front of the boobs and knuckleheads populating the Boardrooms and executive suites of desirable clients. And this usually entails declaring the ridiculous, half-assed strategies devised by these lucky fools the smartest and cleverest ideas we have ever heard in our professional lives.

So, if you want to preserve some modicum of professional dignity and integrity as an investment banker, I would recommend you steer clear of hot clients, hot sectors, and hot deals. Leave those to the tech, consumer, and retail bankers, who would raise a billion dollar IPO for a company that makes Chia pets if they thought they could sell it. Join me in one of the many comfortable backwaters of the industry, where we try to add actual value to our humdrum clients with sensible, well-reasoned advice and well-executed transactions.

But if you want klieg lights and fame, get ready to sell your soul and your dignity. And get ready to recite, along with Gilda:

If I'd been a ranch, they would've named me "The Bar Nothing."

1 I do not speak here, O Attentive Ones, of the dark side of investment banking known as sales and trading, or capital markets, wherein banks act as middlemen in securities and derivatives trading markets. Nor do I speak of capital markets' evil half-brother, proprietary trading, nor its idiot second cousin, in-house private equity funds. I speak here of traditional investment banking: securities underwriting and M&A for third parties. You know, the good kind. Try to keep up. Thanks.
2 Which is not to say, mind you, that some of us don't recommend against doing ill-advised deals on occasion. Good investment bankers always try to put their client's interests before their own, because we're playing a long game, in which the client trust and reputation a banker builds from advising against bad deals should redound manyfold to our benefit in the future. But you should not be naive about bankers' economic motivations and incentives, which push us strongly toward doing this deal, right now. Bad investment bankers—which, sadly, are legion—have no such scruples.

© 2011 The Epicurean Dealmaker. All rights reserved.

Wednesday, January 19, 2011

A Good Start

Q: What do you call 10,000 lawyers and 10,000 investment bankers chained together at the bottom of the sea?
A: A good start.

— (Apologies to) Anonymous

Not content with instigating a racial and cultural bar brawl over the only proper way to raise children in the United States, Rupert Murdoch's Wall Street Journal now appears determined to create news any way it can. In the most recent instance, the Journal's editors seem to have taken a look around and asked themselves, "Which are the two most-hated groups in America, and how can we pick a fight between them?" Given that Republicans and Democrats seem to being doing a fine job bashing in each other's heads without the media's help (and an even better job with it), the WSJ appears to have settled on everyone's favorite serial kitten killers: lawyers and investment bankers.

Accordingly, they have lined up Mean Street's Evan Newmark, former Goldman Sachs banker [hiss] and current gadfly about town, and former M&A deal lawyer Ron Barusch to do the honors. Sadly, it is a bit of an unequal contest, since Mr. Newmark, whom this blog has gently mocked in the past, delivers an effort which is a distinct weight class or two lighter than that of Mr. Barusch. Evan's piece seems to boil down to asking why anyone would want to work on Wall Street without making as much money and as much fame as possible. Suffice it to say only a banker—and a not particularly reflective one at that—would find that a compelling argument or even a very interesting question.

On the other hand, Mr. Barusch turns in a clever and funny piece which mostly takes investment bankers to task for character and behavior quirks that he and his fellow deal lawyers find irritating. His roast is recognizable to anyone who has worked with or across the table from an investment banker on a deal. Even I, paragon of well-behaved reasonableness that I am, recognize myself in the counselor's portrait.

Were I a less disputatious man, I might let Mr. Barusch's good-natured ribbing lie. But then I would not be true to myself. And, if you are honest with yourselves, Dear Readers, you would be disappointed if I did. Am I right?

Well then.

* * *

Mr. Barusch titles his piece "6 Ways Bankers Drive Lawyers Nuts." He enumerates these irritations and offers explanatory commentary on each. I thought it would be amusing to address his criticisms directly, while responding to his points with countercriticisms which investment bankers commonly level against lawyers.

1. Bankers are wimps. Mr. Barusch complains that investment bankers never say anything substantive about the deals they work on on the record. This is absolutely true, whether the remarks appear in public filings or on the witness stand. Read simply from their public statements, investment bankers are mealy-mouthed purveyors of empty, meaningless, convoluted verbiage, which conveys nothing of the true drama of real dealmaking or the actual force and substance of any recommendations they make to their clients in the course of a transaction.

Counterpoint: Lawyers are castrating Bowdlerizers. Mr. Barusch alludes to the source of this curious irritant himself: lawyers themselves prevent bankers from saying anything. Bankers' public disclosure documents and courtroom testimony read like Vogon VCR manuals for the simple reason that all substance, spirit, and fact has been thoroughly and religiously bleached out of them prior to their release by an army of lawyers: bankers' in-house lawyers, client counsel, and even attorneys on the other side of the deal. No-one involved in an M&A deal has any incentive to recount its ups and downs and dirty details, nor what was said, whispered, or screamed in Boardroom deliberations. It's just too messy and confusing. Give me a partial transcript of one negotiation or an internal discussion of a merger or acquisition and even I, a lowly legal virgin, could construct the plaintiff's suit to end all plaintiff's suits.

Furthermore, it is not investment bankers' primary task to be opining on anything in public. Our job is to help a client find and execute a transaction. If a deal is done, it is the client's deal, not the bankers'. (Remember, bankers don't live with a deal: the client does.) The only reason bankers do opine is because Boards of Directors demand such legal bubblewrap to cover their asses in the case of subsequent shareholder or third party lawsuits. We do this reluctantly, with extensive provisos, carve-outs, and weasel words for the very reason that we want to attract as little as possible of the litigious ire and consequences directed at a deal and its principals—the companies and investors involved—to ourselves. Banks do offer standalone fairness opinions when they can't get a piece of more lucrative advisory assignments, because they usually get paid some fee to do so and also league table credit, but it is not a preferred business line for us.

Conclusion: Fight fire with fire, Mr. Barusch, and lawyers with lawyers. If the world were not populated with flesh-eating securities litigators chomping at the bit to prove malfeasance because a banker was caught on record alleging the sun is hot, we bankers wouldn't have to wrap our every public utterance in 50 pounds of cotton wool. Physician, heal thyself.

2. Never get between a banker and his fee. Are you serious? This is a gripe? You might as well complain that sharks like to eat things.

Counterpoint: Never come between a lawyer and a billable hour. I mean, if we're gonna take cheap shots, let's take cheap shots. Oh, and Mr. Oh-So-Valued Corporate Client, don't even dream of not paying your devoted counsel's bill timely and in full, unless you would like to see your former consigliere unleash the slavering hounds he keeps in the back room for just such an eventuality.

3. Bankers are quick to volunteer unreasonable schedules—for others. And? Where do you think the time pressure comes from, buster? It comes from deal dynamics, competitors and regulators breathing down our collective necks, and from the client CEO's looming, uncancelable plans to take the mistress skiing in Gstaad. Dealmaking is client service, buddy, and bankers are more often the messenger than the instigator.

Counterpoint: Unreasonable schedules make for more billable hours. See #2 above. We're just trying to help you send Junior to Harvard Medical School, pal. Cut us some slack.

4. "We are working on the model." I'm not quite sure what Mr. Barusch finds irritating about this, actually. Helping frame the valuation of the company is, at the end of the day, one of the primary ways an investment banker helps his or her client come to a reasoned conclusion about whether or not to accept or pursue a particular deal. "Working on the model" is also an integral part of the way bankers do due diligence: we come to understand our client's business and financial prospects by detailed investigation, testing, and discussion of each financial line item with company management. This bears directly on the determination of value.

We transfer the company's figures into our own models because ours are typically more powerful and flexible in analyzing different business and capital structure scenarios. And, yes, investment bankers often encourage company management to revise and clarify their own projections because we challenge them in ways potential buyers do. Many is the company which has modified its financial projections during the course of a deal based upon a more realistic and market-tested view of their assumptions. But at the end of the day, the projections belong to the company. If the client does not sign off on the projections, we do not use them. We can't, and we won't. Financial projections are the responsibility of company management, and no-one else. Whose model or format they happen to be in is beside the point. Finally, unlike the activities of certain other advisers in a deal process [ahem] (see below), the model is almost never the bottleneck in terms of timing.

Counterpoint: You want delays? I'll give you delays. Meanwhile, 25,000 pages of constantly wordsmithed, constantly changing, constantly argued-over supporting legal documents later, the clients and the bankers are still sleeping on couches in the law office waiting room while counsel for each side kickbox over semicolons. And the press release announcing the deal is due to hit the tape in 20 minutes. Delays? Hah!

5. Where did they all come from? I have seen this phenomenon with bankers, too. Usually it comes from large firms, where the only person on the banking team who actually knows what's going on is the second year Financial Analyst. The senior client Managing Director, the senior M&A Managing Director, and their respective Vice Presidents and Associates are just there to schmooze the client and get credit. All I can say is, work with better firms and smarter MDs who actually know what they're doing. Like me.

Counterpoint: Where are all the lawyers who showed up on the billable hours summary? Cause you sure won't see them in the room. Or anywhere else during the deal. Hmmm...

6. Bankers are eternal optimists. Uh, duh. That is the most critical component of our job. If we weren't, no deals would ever get done. As Mr. Barusch points out, bankers are only paid if the deal closes, so we have complete incentive to make it happen. That's why clients hire us. Besides, someone has to counteract the lawyers (see below).

Counterpoint: Lawyers are eternal pessimists. Which is their job. Lawyers are there to protect their clients, to say no, to anticipate and plan for the worst. They are paid by the hour, which means they have no disincentive to cratering a deal and, interestingly, every incentive to drag out negotiations as long as possible. Unfortunately, if they got their way all the time, no deals would ever get done. Mergers and acquisitions are risky business: financially, strategically, and legally. All business is. Lawyers are professionally and genetically disposed to hate risk. So eventually, if a client really wants to take a risk and do a deal, he or she has to overrule their attorney. I've seen this time and time again, when company counsel goes along with something against his or her better judgment because the client insists. It's how deals get done.

Conclusion: Every deal needs a Yin and a Yang, a good cop and a bad cop, a saint and a fool. Lawyers and bankers are both necessary to a successful process, but our working methods, incentives, and personal predilections all conspire to put us in tension, if not opposition, all the time. This is a good thing.

For without this Hegelian dialectic, who would feed the fishes?

© 2011 The Epicurean Dealmaker. All rights reserved.

Monday, January 17, 2011

When You Are Old

When you are old and grey and full of sleep,
And nodding by the fire, take down this book,
And slowly read, and dream of the soft look
Your eyes had once, and of their shadows deep;

How many loved your moments of glad grace,
And loved your beauty with love false or true,
But one man loved the pilgrim soul in you,
And loved the sorrows of your changing face;

And bending down beside the glowing bars,
Murmur, a little sadly, how Love fled
And paced upon the mountains overhead
And hid his face among a crowd of stars.

— W.B. Yeats, "When You are Old"

Happy Martin Luther King, Jr.'s Birthday.

© 2011 The Epicurean Dealmaker. All rights reserved.

Sunday, January 16, 2011

Some People Never Learn

Beatrice: "I wonder that you will still be talking, Signior Benedick: nobody marks you."
Benedick: "What! my dear Lady Disdain, are you yet living?"
Beatrice: "Is it possible Disdain should die while she hath such meet food to feed it as Signior Benedick? Courtesy itself must convert to disdain if you come in her presence."

— William Shakespeare, Much Ado About Nothing

Honestly, Dear Readers, sometimes I just don't know why I bother.

I drone on and on in these pages about the nature, dynamics, and economics of my industry—purely out of the fulsome charity of my solid gold heart, mind you—and it doesn't seem to make one damn bit of difference. Pundits, prognosticators, and pettifoggers continue to attack investment banking with the most ludicrous assumptions, laughable claims, and lunatic suggestions I have seen in a family newspaper. It's enough to give a bloggist the vapors.

* * *

The latest doofery on offer comes from Sebastian Mallaby, whom the editors of the Financial Times describe as

the Paul A. Volcker senior fellow for international economics at the Council on Foreign Relations, and the author of More Money Than God: Hedge Funds and the Making of a New Elite.

In other words, one presumes, a reasonably smart man.

Mr. Mallaby utterly fails to cover himself in glory, however, in the jeremiad that follows. He starts off reasonably enough, excoriating both the SEC for its ill-conceived and ill-prosecuted suit against Goldman Sachs for fraud in connection with the ABACUS fiasco and Goldman itself for its mealy-mouthed efforts at self-defense and ultimate cave-in settlement to make the charges go away. He also takes well-merited pot shots at the insipid exercise in corporate pablum Goldman evacuated in the form of a report by its crisis-spawned Business Standards Committee.

But these are easy targets, products of hive-mind corporate ass-covering and the lack of courage endemic to large, bureaucratic organizations of every stripe. Goldman Sachs and big investment banks in general are no less prone to this kind of hand-waving, smoke-spewing obfuscation that any other large corporation on the planet. Beyond a certain size, a company's internal spine of principles and conviction is almost always eaten away from the inside by rapidly metastasizing cowardice, usually spreading outward from the General Counsel's office.

No, where Mr. Mallaby rapidly runs off the rails is with the following:

A bank’s first loyalty is to its profits, not those of its customers – it’s us-against-them, not zen and om. Despite claims to the contrary, banks frequently play customers for patsies, keeping the best investments for themselves while selling leftovers to clients. They exploit knowledge of their customers’ order books to make money on proprietary trading.

These sentences, and their immediate followers, are shot through with such silly assumptions, assertions, and insinuations as to make me despair Mr. Mallaby is more than recently arrived at a command of the English language, much less any concept of rational argumentation.

Mr. Mallaby correctly skewers Goldman's corporate-speak piffle by pointing out "a bank's first priority is to its own profits,"1 but he quickly loses the plot. With the phrase "us against them," he implies that banks' pursuit of profits comes exclusively at the expense of its customers. In other words, that it is a zero sum game. But this is only even potentially true of proprietary trading, where a bank's profit or loss on a trade may be a mirror image of its counterparty's loss or profit.2 All the other businesses a modern investment bank operates in—M&A, securities underwriting, private placements, derivatives structuring, and securities market making—are to a greater or lesser extent agency businesses, where the bank earns a fee or margin for executing a transaction for its client. In other words, it is the client's deal or trade to do, which the middleman investment banker is merely hired to help effect. Agency business is not "us against them," it is the bank for its client. This is pretty basic stuff.

The rest of Mr. Mallaby's indictment seems to rest on a vast overestimation of investment banks' power and position in markets and with their clients. Even in their proprietary investment operations—like proprietary trading and in-house private equity funds—investment banks almost always compete with other traders and financial sponsors for deals. Let's be clear here: almost all of these trades and private equity investment opportunities come from third parties, who naturally want the best price and terms for their business. When a bank competes as a proprietary investor, its money is no greener than anyone else's. It only wins because it offers a higher price or better terms to the seller.3 The only time a bank has an edge in a proprietary investment is the rare instance when its parent investment bank originates the trade itself and is willing to accept a lower price to keep it in house. You wanna guess how often that happens? Yeah, not much. Where does Mr. Mallaby think these "best investments" come from, the Tooth Fairy?

Hence, I find his narrative of Goldman's recent Facebook deal laughable on its face. He claims Goldman's internal private equity arm "turned down" the deal because it couldn't get the terms it liked, then after injecting $450 million of its own capital, the bank turned around and marketed participations to wealthy clients on worse terms. Where, Mr. Mallaby, is Facebook itself in your little story? Is it not more likely that Facebook laughed Goldman's PE arm out of the room because they wanted to buy too cheap, then told Goldman if they wanted to earn commissions by selling Facebook shares to its high net worth clients it would have to pay to play? Do you realize how difficult it is for investment banks to put their own capital at risk to earn an underwriting or placement mandate? We hate, hate, hate it, Mr. Mallaby. It goes contrary to everything we aspire to do. Goldman only did it because it thought it could make great fees on Facebook's eventual IPO. Facebook got a great deal to raise over $2 billion without having to go public, and Goldman's wealthy clients got a chance to buy shares in the hottest company since Google. So which client, exactly, did Goldman Sachs puts its interests before in this little drama? That's right, buster: no-one.

Next, Mr. Mallaby trots out the old canard that investment banks use insider knowledge of their trading counterparties' order books to make money, presumably by implication at their customers' expense. But if said information is gained via agency work, and is true insider stuff, there are laws against that (as well as strict confidentiality agreements), and investment banks which want to stay in business (all of them, natch) have very strict internal controls to prevent it. If, however, a client publishes a list of securities with bids and/or offers to the Street—and it is always done to more than one investment bank—how would Mr. Mallaby propose that such information is not public and fair game for anyone who discovers it? Moreover, it is far more common (and effective) for clever traders to suss out counterparties' trading books by inference: monitoring their actual trades and behavior to infer weakenesses, biases, and opportunities. But this is done by hedge funds unaffiliated with investment banks all the time; in point of fact, by every successful trader out there. More often than not, investment banks themselves are the objects and victims of such reverse engineering.

But the last accusation Mr. Mallaby levels is the purest hokum of all:

[Banks] also advise corporate clients to merge, acquire rivals, and issue copious securities – activities that generate handsome fees but don’t always benefit companies in the long run.

What utter fucking bullshit.

I have eviscerated this conceit in the past too many times to mention, but it still pops up with annoying regularity from educated people who should know better. Let me be clear: investment banks advise on mergers and acquisitions and underwrite securities for their clients because their clients hire them to do so. It is pure agency business, and we bankers take a cut off the top of each deal we conclude successfully (we do not normally get paid for failure here). But it is absolute horseshit to claim, as Mr. Mallaby seems to imply, that investment banks somehow bully or cajole corporate clients into doing deals or raising capital that they didn't otherwise want to do. Who the fuck does he think we are, Mephistopheles? Who the fuck does he think huge, sophisticated global corporations like BHP Billiton, Oracle, and Google are, willing sheep eager to be sheared? Get a grip, Mr. Mallaby. If M&A deals or corporate capital raising do not work out so well down the line, perhaps you might adopt the maturity and insight to discover that the blame for such failure—if blame indeed there be, rather than bad luck, changes in the market, or shifting economic fundamentals—lies with the CEOs and Boards of Directors charged with making such decisions who hired the goddamn bankers to do their pissant deal in the first place.


* * *

Of course, Clever Readers will no doubt anticipate that I am not a fan of the childish proposal Mr. Mallaby advances to correct my industry's perceived failings. He suggests we split investment banks along functional lines, with M&A advisory, securities underwriting, and trading conducted by separate boutiques. But this misses the critical point I have mentioned many times in the past, that investment banks derive their value to their clients exactly from the fact that they straddle markets. Having conflicts of interest is the best evidence that investment banks can help their clients in M&A, capital raising, and trading. We derive our institutional value from the information networks, market knowledge, and corporate and financial relationships which these very conflicts of interest reflect. Investment banks trade in information. That is the value we add, and the value we bring to our various clients across all business lines and sectors. Because of that, managing conflicts of interest has been a core competency—believe it or not—of investment banks since Year One.

And the thought that hedge funds, private partnerships, and boutiques can replace large, multi-line investment banks is ludicrous, too. For one thing, independent, focused, privately held hedge funds have only grown in size, number, and market importance because there are large, integrated investment banks which can act as counterparties, intermediaries, and brokers across multiple global securities and derivatives markets and lend them the money to trade with and clear their trades in their role as prime brokers. There is an important, natural niche in the global financial ecosystem for large, multi-line, highly interconnected investment banks. If you broke us up into our functional components, some other entities would merely spring up to take our place.

* * *

In any event, it is patently obvious to this Correspondent that Mr. Mallaby has been working without tools. His analysis is wide of the mark, his proposals are deeply flawed, and his understanding of my business is less than rudimentary. If only these credentials would encourage him to keep silent on the subject.

But, like Wile E. Coyote, I suspect Mr. Mallaby will be right back at the overpass, strapping on his Acme© Rocket-Powered Roller Skates™, just as soon as he recovers from his recent plunge into the canyon. To be honest, my fellow roadrunners in the industry and I would be disappointed if he didn't. We need a good laugh nowadays.


1 It is a tautology to say that a for-profit enterprise's first loyalty is to its own profits, rather than those of its customers. Last time I checked, Coca Cola, Walmart, and Microsoft—much less your local drycleaner or delicatessen—were principally concerned with making money for themselves and their owners, not maximizing the profitability or net worth of their customers. Making money (profits) is why they are in business. Banks are no different in this regard, and certainly not unusual. Often, of course (but not always), a business will sell its products and services on the basis they will help customers save or make money, but this is marketing, not the primary corporate objective. I wish I did not feel compelled to state this obvious fact, but I fear far too many readers among Mr. Mallaby's audience may have read this statement of economic fact as an indictment of investment banks in general.
2 Of course, people say this all the time, but reflection will show that the situation is not quite so simple. At the time of the trade, the value is that at which the trade was transacted: there is no instantaneous profit or loss between the counterparties. The selling party may have made a profit or a loss, but that is only in relation to the price he or she bought the security or derivative at previously. The buyer may make a profit or a loss in the future, but that is subject to many things out of its control, and certainly out of the seller's control. So how can we say trading is a zero sum game? Based on potential forgone profits or losses? But the buyer only makes those profits or losses by assuming exposure to risk which the seller has disposed of. Perhaps we can call trading a zero sum game in total because it does not create any value in and of itself—the same old pieces are paper are just passed from hand to hand—but it is far too simplistic and almost certainly wrong to claim that each trade of necessity has a winner and a loser.
3 Now mind you, there are several investors in the marketplace—particularly private equity firms, which are large customers of the agency side of investment banks and which pay Wall Street a hell of a lot of money in the form of deal fees—who are not particularly pleased that some investment banks have proprietary investment arms which compete independently with them for deals. This is an ongoing source of tension between some banks and their customers, but it's because their competition raises prices and reduces available investments, not because banks somehow get sweetheart deals. On the prop trading side, most hedge funds don't seem to mind much: they like having big, well-connected trading counterparties. (And most hedge funds think they're better traders than investment banks' in-house traders anyway.)

© 2011 The Epicurean Dealmaker. All rights reserved.

Saturday, January 15, 2011


He who hopes to grow in spirit
will have to transcend obedience and respect.
He will hold to some laws
but he will mostly violate
both law and custom, and go beyond
the established, inadequate norm.
Sensual pleasures will have much to teach him.
He will not be afraid of the destructive act:
half the house will have to come down.
This way he will grow virtuously into wisdom.

— C.P. Cavafy, "Growing in Spirit"

© 2011 The Epicurean Dealmaker. All rights reserved.

Wednesday, January 12, 2011

From Tiny Acorns, Mighty Oaks Doth Grow

Notwithstanding my sustained, inventive, and diligent efforts to the contrary, Dearest and Long-Suffering Readers, it appears that Your Humble and Elusive Blogosopher simply cannot escape the leafy laurels of misdirected fame. Today's latest unearned encomium wings its way to these unworthy shores via UK-based social network investment site MindfulMoney, which has amazed the room by publishing a report it entitles "Social Finance: The New Influentials."

The premise of this report is in fact sound and quite intriguing:
Most investors would acknowledge that social media is playing an increasing role in their investment decisions. Yet no-one has mapped the emerging network of influence likely to be playing a crucial part in those decisions.

... Some professional investors believe that many of the sites in this loose network have proved a better source of information than the traditional media, especially and crucially in the run up to the financial crisis.

Clearly, a new and significant source of information is available to investors. One with an audience of over 38 million. However given that this is the case, it is also important to understand who the main players are, how they interact with the Government and other sectors and how they influence each other.

The results this study presents, however, are puzzling in the extreme, if for no other reason than this site is ranked #13 on a list which includes such internet traffic and page-click—if not critical or intellectual—giants as Naked Capitalism, Zero Hedge, and Dealbreaker. I mean shit, homey, I get fewer visitors in a year than any one of those link monsters get in a week. Whassup?

The other puzzlement, which diligent consumers of this site will appreciate immediately, is that I have never offered one ounce of actionable investment advice among the billions of words I have tortured into existence here since the beginning of 2007. Unless professional investors count verbal disembowelment of Goldman Sachs executives, merciless ridicule of excessively short, excessively rich private equity plutocrats, or scathing satire of flag-waving, chest-thumping idiocrats among the hedge fund community as timely investment advice, I must say my writings have no more use to them than a lunchtime visit to Gawker or TMZ. (Which, by the way, I would consider a flattering comparison. We all have to get our freak on occasionally.)

The answer to this conundrum lies, of course, in MindfulMoney's methodology, which they do not elaborate to any great extent in the published report. One might assume inbound and outbound links have something to do with the calculated importance of any one node or blog within the social network, but even so, this site is characterized more by the number of other sites on the list it has linked to, rather than the number of inbound links it has received therefrom. Anyway, Mrs. Dealmaker Mère always told me never to look a gift cheval in the mouth, so there I will let the mystery lie.

* * *

From a broader perspective, however, one can raise interesting questions. Why, for example, does the arguably most heavily trafficked and influential site in the econoblogosphere, Felix Salmon's site at Reuters, not show up on MindfulMoney's social network? Surely, Felix does not offer prepackaged investment tips, but neither do I (see above), and neither do a number of prominent blogs on MindfulMoney's list. Why, also, do extremely popular and well-frequented investment sites such as The Reformed Broker and absolutely essential finance information aggregators such as Abnormal Returns or Alea not make the cut?

More importantly, I think MindfulMoney has seriously missed the mark on realtime investment influence in the social network of the investment world by ignoring Twitter. After a year or so, Twitter has replaced most of the methods (like RSS) I used to use to aggregate and collect links to information on economics and finance into one frenetic, unmoderated, and absolutely essential knowledge stream. While I do not use it this way myself, I am aware of countless individual and professional investors who use Twitter as a realtime forum for the analysis, exchange, and promotion of actionable investment ideas. Then there is the burgeoning StockTwits network, which I, being a staid and heavily regulated investment banker avoid like the plague, but which boasts a fast-growing and extremely passionate membership of money managers small and large.

The recommendation I would therefore leave you with, O Dearly Beloved, would be to take this latest "Best of the Web" compilation by MindfulMoney with a heaping helping of salt. It offers an intriguing window onto one interesting corner of the finance econoblogosphere, but it fails utterly to capture the whole of the developing finance information ecosystem in all its febrile, sweltering, and frenetic glory. Information, like water and money, is promiscuous, mobile, and free, and I expect the social network of the finance and investing world to continue to metamorphose as frantically as Proteus struggling under the grasp of Menelaus.

In the grand scheme of things, my friends, Your Faithful Correspondent will likely continue to offer little more than faint and feeble commentary from the cheap seats. The good news is that I've always liked the peanut gallery.

© 2011 The Epicurean Dealmaker. All rights reserved.