Wednesday, February 3, 2010
Live By The Sword And Die By The Sword
Here is something I wrote to a friend the other day about TOO BIG TO FAIL.
Well, I have been reading this book and while I think Andrew Sorkin knows his stuff, or, should I say, I hope he does. The simple, the very simple, at times, goes unexplained. Leverage is another word for borrowing money. A corporation that is highly leveraged makes big money, or more precisely their return on equity is a bigger number, than a corporation that isn't so highly leveraged. You see, once you pay the "rent" on the money known as interest you borrow to make more money, the rest is pure profit after the corporation's expenses. So, if you borrow a lot and have a 30:1 ratio of borrowed cash to cash you own, you can make lots of money. But, what happens if you borrow a lot of money and you buy ice cream and your refrig goes bad and your ice cream melts? Now you have borrowed a lot of money and no ice cream to sell to pay the borrowed money back. Now substitute mortgage-backed bonds or real estate holdings for ice cream and instead of the ice cream melting, the bond market has a meltdown because no one knows what the bonds are worth because they ain't worth the triple-A credit rating they were given by the credit rating agency that rated them, or the real estate is not worth what the investment bankers paid for it. This shit is not complicated, but if you don't work in the field, it seems very complex. This complex bullshit is what the people on Wall Street want everyone to think.
The other big problem for investment bankers and their publicly traded corporations is short sellers. Those that live by the sword die by the sword. The firms make nice money when other corporations are being shorted by their hedge fund manager clients that trade with them, but when the shorts are directed at them, they cry foul. Well, you can't have it both ways. Either stand up for reform of the shorting of equities with the up tick rule, or, remain silent and await your turn to be stabbed in the back.
The other big problem for a publicly traded investment bank is the practice of mark to market. In the Super Bowl this Sunday, when a team commits a foul the yardage is walked off. Yes, you screw up and the ref walks off 5, 10 or 15 yards and now you have further to go for a first down and a touchdown. Simple. On Wall Street, mark to market of real estate or bonds that have no buyers is a ticklish thing. No one wants the yardage walked off against them. They want to commit capital to a "bad play" and not have to receive any penalty. Here is where the short sellers come in. They, the short sellers like a hedge fund, don't believe the books that the investment bank puts forward to reflect the financial condition of the corporation. And, before you know it, everyone is joining the party and selling that corporation's stock down to oblivion. At this point, the lights on the pinball machine go crazy and the hedge funds make lots of money. Game over.
Just for one second can you imagine, what a Super Bowl would look like if only say one ref took the field to call the game? What do you think the game would look like? I was watching an NFL game this past season one evening and I saw former Fed Chairman Alan Greenspan sitting in a box eating and watching the Washington Redskins. I wonder if he ever gave a thought to what football would look like if we took the refs off the field and let the teams "self-regulate" the game? I have already written my feelings about Mr. Greenspan's intellectual abilities more than a few times. Yes, I hope he enjoys soaking in his tub.