Friday, May 28, 2010

The Golden Fleece was once part of a Greek myth, but now it has become national policy. The 750 billion euro loan to provide eighteen months of breathing room to Greece is what Everett Dirksen would have called the waste of “real money.” The domino theory that underpins this loan presumes that the other dominoes stand still while Greece exhumes Midas to balance its books. Is there reason to believe all the other weak European economies will suddenly swerve to prudence any more than we would have expected or seen similar behavior by U.S. banks after Bear Stearns was saved? Certainly the 400% increase in the interbank overnight swap rate in the last two months is an indication the markets are not comforted by the European fiscal poultice.

The recent quarter produced the peculiar case of the government suing Goldman Sachs for lack of disclosure on a synthetic securities trade. This is the same government that owns and permits General Motors to announce they have repaid money owed to the government, but fails to disclose the repayment was made by other money provided to GM by the government. The internal email trail at Goldman by Fabulous Fabrice does not make Goldman look classy, but when did it become a requirement to disclose the names of parties who do not agree with the buyer? The Congressional hearings involving Goldman executives further exposed the risks of transparency as the elected officials were both clueless about the law and about the actual transaction. Despite all their faux outrage it was telling that no purchasers of the securities, the supposed victims, were at the hearing. It would have been interesting to see them complain that after reviewing every security and its rating before they purchased, that they felt unfairly treated or to hear if they ever knew the identity of a seller in other trades they made.

The private equity market seemed to have simultaneously experienced a rebirth and amnesia. The rebirth has been seen in the frantic recent activity level. The amnesia is detected clinically when analyzing the multiples being paid, the leverage being used, and the liberal incentive plans pointing to a long term memory deficit being experienced by lenders and by buyers. What factors are creating this bull market? Using the fictional Scorched Linen Partners, L.P., where money is burning a hole in their pocket, as an example, we see several motives. Scorched Linen has not made an investment in two years, so they and their investors are antsy. Scorched Linen has only fifteen months left in its investment period and does not want to waste their call option on their investor’s money. Scorched Linen has a mediocre track record, so this may be their last chance to try to earn a carried interest. Scorched Linen is also dropping down in investment size as inadequate debt capacity exists for their traditional investments.

Watching the rapid return of 2007-style investment behavior raises the provocative question: Does one need to experience a true economic depression to learn prudence? Certainly the generation that grew up in the 1930’s knew the importance of saving for a rainy day and the consequences of default. Perhaps it is not an accident that neither our private nor our public institutions approached the level of leverage recently attained when veterans of the 1930’s depression ran them. Nevertheless, despite all the loud, shallow speeches delivered about the need to avoid another depression, the actual solutions being legislated, including a post disaster tax on banks and bundles of more reports being sent to incapable bureaucrats, are reactionary not thoughtful.

Three simple ideas should be considered in private, by Congress, with the vote posted afterward but no press conferences, upon pain of sanction, permitted.

The Congress should consider a bill to:

1) Limit leverage in financial institutions to 7/1, 8/1 or whatever level they like but not near the 33/1 leverage that we saw at Bear Stearns.

2) Allow our financial institutions to fail, or mandate that if bailed out by the government all security holders are wiped out which would create an incentive for security holders to avoid not rely on bailouts.

3) Auction bankruptcy assets, as they do in Sweden, within sixty days, with no advantage to the “incumbent” equity.

Post World War I, anti-German sentiment ran deep in the US, but manifested itself in bizarre ways: Playing Beethoven was banned in Boston, liberty cabbage became the new name for sauerkraut. Now bankers have become the poster children for the recession in the cartoonish “Fat Cat” label that fairly describes less than 1% of the people that work in banks. No label has been attached to those that perpetrated the policies leading to no document, no verification mortgage loans and the black holes that FNMA and Freddie Mac, accepting $137.5 billion in aid, have become, but a little federal introspection might help put sensible policies on the table.

I’m Rob Morris and I approved this blog.

The Golden Fleece Was Once Part Of A Greek Myth, But Now It Has Become National Policy.