Archive for the ‘History of Finance’ Category

Soros Says the U.S. is Already in a Double Dip Recession – Defining Balance Sheet Recessions

Sunday, September 25th, 2011

Soros recently asserted that Europe could be more dangerous to the global financial markets than the default of Lehman Brothers in 2008, because of the political stubbornness of European policy makers.   He has been saying this for over two years now, while government officials continue to ignore him, focusing instead on making bold statements and causing riots.  In a brilliant move, Soros returned investor capital at the end of July to avoid the eyes of the public.  I am sure he is now short sovereigns via CDS, currencies, and synthetic instruments, while he continues to donate to the poor in Eastern Europe like a modern day Robin Hood.  Since March, Italian CDS has more than doubled, and French and Belgian CDS spreads will continue to creep higher as the sovereign crisis persists.  How are Greece, Italy, Spain, and Portugal supposed to grow their way out of debt, as deficit cutting reduces European GDP growth to less than 1%?

The public doesn’t trust officials to make timely decisions to protect the EU.   The PIIGS (Ireland and Italy included) pose an insurmountable task for the region, as the combined nations have far greater GDP and net leverage than Germany, the only country that will be supporting the EFSF with a AAA rating. Italy itself has €1.2 trillion of debt, which is  more than Germany, and France may be downgraded in the next 6 months, which is evident in how much its CDS spread has widened over the past 2 months.  France also cannot print money like the United States, and certainly should have been downgraded beforehand, sharply decreasing the effectiveness of the stabilization facility in the EU. A French downgrade would not only endanger French banks, it would create counterparty risk for its U.S. partners as well.  Soros has already claimed that the U.S. is currently in a double dip recession, which I personally think to be true.

Both the majority of the EU and the United States are in a global double dip already not only because of policy mistakes, but due to unsustainable leverage, overspending, broken healthcare and education systems, and corrupt governments. Recent real estate, manufacturing, and confidence numbers, along with revisions down in the earnings of major metallurgical coal and transportation companies in developed countries support my thesis (look at tickers ANR, WLT).  Alpha Natural Resources recently cited a sharp decrease in coal demand for steel production in Asia, reflecting weakness in both its U.S. and ex-U.S. clients.  In the U.S., real estate usually contributes 15% to GDP growth, and it is showing no chance of recovering (HOV), as most sales over the past two years have been distressed sales driven by investors, not families or single buyers.  Developed economies are slowing down quickly, as elected officials argue over who is more important than the other.  The S&P 500 ex-dividends is at the same level it was in 1998, the FTSE MIB in Italy is down 30% on the year (40% from April), and the emerging market index (EEM) just broke its 2010 lows.  Many European financial institution equities are down 60%+ to date.  Markets are broken, as the CME has to raise margins every other day to bring down the prices of precious metals, which are rising in the face of fiat destruction and future inflation risk.  Poverty has reached 15% in the United States, unemployment is over 9.2%, underemployment is about 17%, and local government cuts have resulted in the layoffs of countless public employees, like the recent 3,000 teachers who were fired in Providence, Rhode Island.

There are 44 million people on food stamps in the United States, which is supposed to be the wealthiest nation, and the land of hope for many immigrants.  Over 30% of the U.S. population pays more than half their gross income on rent, since incomes (adjusting for inflation) have not increased since 2000.  With rents projected to increase 3-4% in metropolitan areas over the next year, even the educated poor may be driven out of cities or on to the streets. The land of hope? Why don’t you ask my hardworking university friends about hope, who are much more qualified than some of their U.S. peers, but cannot get jobs and improve the quality of our economy due to the difficulty of obtaining visas.  This country was built by immigrants, who are now blocked out of entering the nation. Teen unemployment also hit decade lows this past month.

According to New York-based Economic Cycle Research Institute (ECRI), which tracks some 20 large economies contributing about 80% of the world GDP and provides critical information about upturns and downturns of economic cycles to money managers, we will know within the next 60 days whether we are in a recession or not.  ECRI’s Lakshman Achuthan has been one of the most accurate forecasters for economic cycles over the past decade.   He argues that the 2008/2009 recession was different than the sharp recession of the 1980s, “This is very different than the early 1980s. The issues that ail the U.S. economy and the jobs market today are not things that result from nearby events. What we’re living through and dealing with now has been building for decades,” he says. “If you look at the data, you see that the pace of expansion has been stair-stepping down ever since the 1970s, on all counts — on production, how much can we produce, how many jobs can we create, how much money do we make, how much do we sell. These are all trending down.” In the deep recession of the 1980s, GDP growth was 5%+ coming out of it…our growth in Q111 was revised down to 0.4%, and will be less than 2% for the year. Don’t believe me? Check on your own.

“If we do have a double-dip recession, Achuthan says, the people who are already having trouble finding work and paying bills are already in a depression and that they “are going to suffer more.”  ”It poses massive problems for policymakers because a new recession automatically increases all of these expenditures out of the public sector, while at the same time dramatically decreasing all their revenue,” he says. “So there’s even less ability to help the people who are hurting the most.”

Although I am not a fan of Roubini for his sensationalist gloom and doom scenarios, he does do decent research and predicted a 60% chance of a double dip in the U.S. three weeks ago.  The United States is in a balance sheet recession, as the economist Richard Koo, a strategist at Nomura, predicted may happen back in 2009.   Most of the growth we have experienced has been the result of continued fiscal and monetary stimulus from the United States government over the past three years, as well as inventory restocking.  The biggest driver of this slow and painful recession is that more stringent underwriting standards for real estate lending and small business lending are slowing down aggregate demand and GDP growth.  Koo argues that once you have a balance sheet recession, people focus on paying down debt, making the situation much worse over time.   The government has to increase fiscal stimulus for the entire duration of the private credit contraction cycle to overcome private deleveraging.  Unfortunately war and internal conflict has made this impossible in the United States as our debt to GDP nears 100%. Since the private sector has moved away from profit maximization to debt minimization, newly generated savings and debt repayments enter the banking system but cannot leave the system due to a lack of borrowers.  The economy here will not and cannot enter self-sustaining growth until private sector balance sheets are repaired.

If the government tries to cut spending too aggressively in 2012-2013, Koo thinks that we would fall into the same trap President FDR fell into in 1937 and that Prime Minister Ryutaro Hashimoto fell into in 1997.  The deflationary gap created by a lack of credit creation and fiscal stimulus “will continue to push the economy toward a contractionary equilibrium until the private sector is too impoverished to save any money.”  The economy will collapse again, and the second collapse will be worse than the first.  It will be difficult to convince people to change their behavior in this scenario.

In a typical recession, private sector balance sheets are not hurt very badly, and most still express profit maximizing behavior.  People borrow money and spend as interest rates are lowered.  In a balance sheet recession, consumers refuse to borrow even if rates are at 0%.  This results in asset prices collapsing and banking crises.  Banks then cannot lend into the private sector, and the government becomes the borrower of last resort, at extremely low rates, because banks don’t need to hold capital against government loans.  When people use money to pay down debt, they withdraw money from their bank accounts and pay it back to the banks, so both deposits and the money supply shrink, which actually caused the Great Depression.  For example, 88% of Obama’s tax rebates have been used to pay down debt.

Let me put it in perspective:

According to Koo, “The Board of Governors of the Fed in 1976 estimated that deposits lost in Depression-era bank closures and through increased hoarding of cash outside of the banking system explained just 15% of the almost $18 billion decline in deposits during the period. Meanwhile, bank lending to the private sector plunged 47%, or by almost $20 billion, from 1929 to 1932. The conventional wisdom is that lending fell because banks panicked in response to dwindling reserves and forcibly called in loans. But that same Fed study shows that bank reserves did not actually fall during that period, when borrowings from the Fed are taken into account. In addition, a survey of almost 3,500 manufacturers, undertaken in 1932 by the National Industrial Conference Board, showed that fewer than 15% of the firms surveyed reported any difficulty in their dealings with banks.”
If bank closures, cash hoarding and heartless bankers didn’t cause the Depression, what did? ”There’s only one possible alternative explanation for that era’s dramatic shrinkage in deposits and loans — or, at least, for the 85% of those shrinkages that can’t be attributed to the traditional villains. And that is that firms were reducing their debt voluntarily. At that time, the Fed tried to increase money supply by pumping reserves into the system, but with everyone paying down debt, the multiplier was actually negative, so it produced no results whatsoever.”
And companies became hellbent to pay down debt because — “The price of assets purchased with borrowed funds (as most had been, during the Roaring’20s) collapsed after the stock market crash, and companies’ leverage had already gotten extremely high before the Crash. In other words, companies in the 1930s faced the same balance sheet problems as Japanese firms confronted in the 1990s. The lesson we learned from our experience in Japan is that with the government borrowing and spending money, the money multiplier will stay positive, and that’s basically how Japan kept its GDP growing throughout its Great Recession. So we have a situation where fiscal policy is actually controlling the effectiveness of monetary policy. It’s a complete reversal of what almost everyone alive today learned in school — that monetary policy is the way to go. But once everyone is minimizing debt instead of maximizing profits, all sorts of fundamental assumptions go out the window.” Just like a severe asset price crash on leverage caused crises for the U.S. in the 1930s and for Japan in the 1990s, our real estate driven recession is more than just a manufacturing slowdown or a simple policy mistake.
In the U.S. we had over 150 bank closures last year, and have had 72 in 2011.  Banks are reticent to lend, but the real problem continues to be that there is less demand for money, and deleveraging will continue to weigh on growth for years. There are many parallels Koo describes with the Japanese crisis as well, which I will discuss in another article.
The worst part of our current situation in the U.S. is that new bank capital adequacy standards are making it even more difficult for banks to encourage private lending.  So banks do not wish to lend, lending standards have increased dramatically, and citizens don’t want to borrow…and now with a flat yield curve, I don’t understand how financial institutions are going to dig their way out of this mess with profits either. Thank you Ben Bernanke.  Your “operation twist” policy has eroded all profit potential for financial institutions in 2012.  Let the deleveraging continue…

Cheers, Singh

“As I said there is nothing wrong with failing. Pick yourself up and try it again. You never are going to know how good you really are until you go out and face failure.”
-Henry Kravis

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Glencore Considering $19.5 Billion Bid for ENRC…

Monday, June 13th, 2011

You thought you had heard the last of Swiss based Glencore, the famed diversified commodities trading firm, with the news of its multi-billion dollar IPO.  Now rumors of a nearly $20 billion takeover?  Looks like Glencore’s management team is taking advantage of its new currency.  According to ENRC’s 3 founders, Alexander Mashkevitch, Patokh Chodiev and Alijan Ibragimov, who control 45% of the company, Glencore’s CEO recent discussed a possible merger.  ENRC, a Kazakhi miner, trades at a 15% discount to its peers, using a trailing P/E multiple, and is down almost 30% this year.


Glencore, headquartered in Baar, Switzerland, is the world’s largest commodities trading firm, which a 60% market share in the trading of zinc, and a 3% market share in the trading of crude oil.  The company is also the biggest shipper of coal in the world.  Glencore’s 485 traders own and run the company today.  It was formed by a management buyout of Marc Rich & Co AG in 1974.  Marc Rich, now a billionaire commodities trader at the time was charged with tax evasion and illegal business dealings, fleeing to Iran.  Years later, he was pardoned by President Bill Clinton.

In 1994, after failing to corner the zinc market, the company lost $172 million and nearly went bankrupt, forcing Rich to sell his share in the company back to the firm, which was renamed Glencore.  It was run by Rich’s inner circle, including Willy Strothotte and Ivan Glasenberg.

Over the years, Glencore has also been accused of illegal dealings with rogue states, including the USSR, Iran, and Iraq (under Hussein).  It has a history of breaking UN embargoes to profit from corrupt regimes.

The company owns stakes in Rusal, Chemoil, Xstrata, Minara Resources, PASAR, Evergreen Aluminum, Katanga Mining, Windalco, OAO Russneft, and many other firms.


With its initial public offering weeks ago, Glencore was valued at about $60 billion, and raised about $10 billion.  Each of the 485 traders received average payouts of $100 million through the flotation.

I highly recommend reading, “Secret Lives of Marc Rich.”

Bank Stocks Beware: Bernanke & Fed Support Increasing Capital Requirements

Tuesday, June 7th, 2011

U.S. bank indices fell 2% yesterday after fears that capital requirements would increase as much as 7%.  Bank of America (NYSE: BAC), fell below $11.00, the lowest since last year.  The discussion came about after the Basel Committee on Banking revealed how levered large financial institutions still were, and tried to reconcile levels with future recession risks.  A 7% equity capital raise for most banks would be catastrophic and dilute equity by 50%+, but a 3% raise seems manageable in a functioning economy.  The problem is that the U.S. economy is on life support, and that life support is called Quantitative Easing 2.  Once this support fades on June 30th, how will U.S. banks (at their already low valuations due to real estate risk and put backs) raise new equity capital?  A replay of 2009?  You be the judge.

According to Bloomberg, “The Fed supports a proposal at the Basel Committee on Banking Supervision that calls for a maximum capital surcharge of three percentage points on the largest global banks, according to a person familiar with the discussions.

International central bankers and supervisors meeting in Basel, Switzerland, have decided that banks need to hold more capital to avoid future taxpayer-funded bailouts. Financial stock indexes fell in Europe and the U.S. yesterday as traders interpreted June 3 remarks by Fed Governor Daniel Tarullo as leaving the door open to surcharges of as much as seven percentage points.

“A seven percentage-point surcharge for the largest banks would be a disaster,” said a senior analyst at Barclays Capital Inc. in NY. “It will certainly restrict lending and curb economic growth if true.”

Basel regulators agreed last year to raise the minimum common equity requirement for banks to 4.5 percent from 2 percent, with an added buffer of 2.5 percent for a total of 7 percent of assets weighted for risk.

Basel members are also proposing that so-called global systemically important financial institutions, or global SIFIs, hold an additional capital buffer equivalent to as much as three percentage points, a stance Fed officials haven’t opposed, the person said.

Bank Indexes Fall

The Bloomberg Europe Banks and Financial Services Index fell 1.45 percent yesterday, while the Standard & Poor’s 500 Index declined 1.1 percent. The KBW Bank Index, which tracks shares of Citigroup Inc., Bank of America Corp., Wells Fargo. and 21 other companies, fell 2.1 percent.

In a June 3 speech, Tarullo presented a theoretical calculation with the global SIFI buffer as high as seven percentage points.

“The enhanced capital requirement implied by this methodology can range between about 20% to more than 100% over the Basel III requirements, depending on choices made among plausible assumptions,” he said in the text of his remarks at the Peter G. Peterson Institute for International Economics in Washington.

In a question-and-answer period with C. Fred Bergsten, the Peterson Institute’s director, Tarullo agreed that the capital requirement, with the global SIFI buffer, could be 8.5 percent to 14 percent under this scenario. A common equity requirement of 10 percent is closer to what investors are assuming.

‘Across the Board’

“I think 3 percent is where everyone expected it to come out,” Simon Gleeson a financial services lawyer at Clifford Chance LLP, said in a telephone interview. “If it is 3 percent across the board then it will be interesting to see what happens to the smallest SIFI and the largest non-SIFI” on a competitive basis, he said.

U.S. Treasury Secretary Geithner, in remarks yesterday before the International Monetary Conference in Atlanta, said there is a “strong case” for a surcharge on the largest banks. Fed Chairman Bernanke is scheduled to discuss the U.S. economic outlook at the conference today.

“In the US, we will require the largest U.S. firms to hold an additional surcharge of common equity,” Geithner said. “We believe that a simple common equity surcharge should be applied internationally.”

Distort Markets

Financial industry executives are concerned that rising capital requirements will hurt the economy, which is already struggling with an unemployment rate stuck at around 9 percent.

Higher capital charges “will have ramifications on what people pay for credit, what banks hold on balance sheets,” JPMorgan Chase & Co. chairman and chief executive officer Jamie Dimon told investors at a June 2 Sanford C. Bernstein & Co. conference in New York.

The Global Financial Markets Association, a trade group whose board includes executives from GS and Morgan Stanley, said the surcharge may apply to 15 to 26 global banks, according to a May 25 memo sent to board members by chief executive officer Tim Ryan.

Dino Kos, managing director at New York research firm Hamiltonian Associates, said the discussion about new capital requirements comes at a time when banks face stiff headwinds. Credit demand is weak, and non-interest income from fees and trading is also under pressure.

Best Result

U.S. banks reported net income of $29 billion in the first quarter, the best result since the second quarter of 2007, before subprime mortgage defaults began to spread through the global financial system, according to the Federal Deposit Insurance Corp.’s Quarterly Banking Profile.

Still, the higher profits resulted from lower loan-loss provisions, the FDIC said. Net operating revenue fell 3.2 percent from a year earlier, only the second time in 27 years of data the industry reported a year-over-year decline in quarterly net operating revenue, the FDIC said.

“You can see why banks are howling,” said Kos, former executive vice president at the New York Fed. Higher capital charges come on top of proposals to tighten liquidity rules and limit interchange fees, while the “Volcker Rule” restricts trading activities. Taken together these imply lower returns on equity, he said.

“How can you justify current compensation levels if returns on equity are much lower than in the past?” Kos said.

Martin J. Whitman on Distressed Investing – A Legend and Founder of Third Avenue

Monday, June 6th, 2011

Over the past two years, I have become a staunch follower of Martin J. Whitman, a legend in deep value investing and founder of Third Avenue. I have read his book, Distress Investing twice now, and wanted to share some excerpts with you. Hopefully you will pick up a copy too!

According to Whitman, there have been three major trends that have shaped the credit markets since the innovation of the high yield (junk bond) in the late seventies through 2008:

1)      Financial Innovation

2)      New Laws & Regulations

3)      2007-2008 Financial Meltdown

1)      New credit instruments, capital structures, and financial institutions grossly inflated the size of the credit and derivatives markets from the 1980s to 2008.  The shadow banking system (SIVs, SPEs) and securities this system issued like CLOs were part of this trend.  Credit default swaps eventually allowed banks and hedge funds to make highly levered bets against issuers, directly influencing market perceptions about credit worthiness.

New primary and secondary markets improved liquidity for below investment grade issues in the late 80s and early 90s.  Leveraged loans that one would have paid 40 cents for in the 1980s, investors were paying 85-90 cents for in the early 90s through the 2007/2008 meltdown.  Almost 70% of leveraged loans were held by nonbank institutions like hedge funds, CDOs, CLOs, etc.

2)      After Gramm-Leach Bliley passed in 1999, commercial banks also began to act more like underwrites, completely eschewing credit risks, and collecting fees on originating loans, bonds, and ABS.  Securitization allowed for the transfer of risk off of bank balance sheets.

BACPA, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 imposed new time limits for filing a plan of reorganization (POR) and shortened the amount of time required for business bankruptcy filings.  It additionally shortened the time over which investors could decide to curtail payments on property and reject non-residential real estate losses.  Finally, it curtailed executive pay for firms under Ch. 11 and enhanced vendor rights, so trade vendors were pari passu with the unsecured creditors.

Many of these innovations drove litigation costs so high, that today most of the reorganizations done today are prepackaged or prenegotiated filings.


According to Whitman, since 1950, credit market debt has grown at 4.1% in real terms, while GDP grew at 2.7%.  In the 1970s, more of the below investment grade debt was classified as “fallen angel,” and was originally investment grade credit.  Originally issued high yield bonds, which were unsecured and had much less restrictive covenants than loans, were quite rare.  They took the form of Rule 144A securities (unregistered with the SEC).

Junk bonds were unsecured claims usually subordinate to senior loans and senior unsecured debt.  But by the 1980s, they were the preferred security for driving LBO and M&A transactions.  By 1989, high yield debt consisted of 20%+ of the non-financial bond universe. (to be ctnd…)

Cheers, Tom Rendon

Wall Street’s Annual Frat Party

Wednesday, January 19th, 2011

Alan Breed – President, Edgewood Management

Peter Georgiopoulos – Chairman and CEO, General Maritime Corp.

Jane Gladstone – Senior Managing Director, Evercore Partners

Pam Goldman – Vice President, Invemed Associates

Joseph Goldsmith – Founder and Managing Partner, Goldsmith & Co.

Candace King-Weir – President, C.L. King & Associates

Steven Langman – Managing Director, Rhone Group

Robert Lindsay – Co-Managing Director, Lindsay Goldberg

Roberto Mingone – President, Bridger Capital

John Miller – Managing Director, Barclays Capital

Seth Novatt – Managing Director, Alliance Bernstein

Mitch Rubin – Managing Director, RiverPark

James Sampson – Senior Managing Director, Lebenthal & Co.

Peter Schulte – Managing Partner, CM Equity Partners

Michael Tennenbaum – Senior Managing Partner, Tennenbaum Capital Partners

Andy Walter – Managing Partner, Blue Orchid Capital

Meredith Whitney – CEO, Meredith Whitney Advisory Group

For members of Kappa Beta Phi, an exclusive, secretive Wall Street fraternity, plunging stock prices, the waves of layoffs and bank failures have yielded a dividend in punch lines.

“I feel like the mayor of New Orleans after Katrina,” quipped Alfred E. Smith IV, the group’s leader, or “Grand Swipe,” at the opening of its annual black-tie dinner last week. “Today, the FBI put out a warning that Al Qaeda was planning an attack to cripple the U.S. economy,” inductee Martin Gruss joked later in the evening. “I’ve got news for them, Congress has already done that.”

Though a number of the society’s luminaries — including former Bear Stearns Cos. Chief Executive James E. Cayne, Lehman Brothers Holdings Inc.’s Richard S. Fuld Jr. and ex-Merrill Lynch & Co. Chief Stanley O’Neal — have faced rebuke and were conspicuously absent, members still standing haven’t lost their sense of humor. This year’s attendees gave a rare standing ovation to a rendition of Don McLean’s “American Pie,” rewritten to read: “Bye, bye to my piece of the pie.”

Established before the stock-market crash in 1929, Kappa Beta Phi meets just once a year and always at the St. Regis, the more than a century-old Beaux Arts hotel on Fifth Avenue. The society, with its grandiose titles and playful rituals, dates back to a time before television when societies and clubs were big sources of entertainment. It also dates to when the term “Wall Street” referred to the warren of streets around the New York Stock Exchange and not to the complex, global network of hedge funds and structured derivatives it has become.

Kappa Beta Phi continued to meet through the depression — a 1932 Wall Street Journal story about the gathering carried the headline “Wall Street Chapter to Revive Ghosts of ‘Good Old Days’ Tonight” — but its annual dinner was suspended for a few years during World War II.

Kappa Beta Phi’s membership remains a roster of Wall Street power brokers past and present, including New York Mayor Michael Bloomberg and New Jersey Gov. Jon Corzine, two more no-shows at this year’s dinner. Mary Schapiro, President-elect Barack Obama’s nominee to head the Securities and Exchange Commission, is also a member, as is former Goldman Sachs & Co. Chairman John C. Whitehead. About 15 to 20 new members — eminent all — are inducted each year, having been nominated by members and approved by the group’s leaders.

But Kappa Beta Phi, whose name is a play on Phi Beta Kappa, the academic honor society, is more about cornball comedy than high finance. Its Latin motto “Dum vivamus edimus et biberimus” is freely translated as, “While we live, we eat and drink.” Like Phi Beta Kappa inductees, members of Kappa Beta Phi also receive a fob, or key. Phi Beta Kappa’s key includes a hand pointing at three stars that symbolize the society’s principles: morality, friendship and learning. Kappa Beta Phi’s key has images of a hand, a beer stein, champagne tumbler and five stars. The stars represent Hennessy cognac and the hand is there to hold a glass.

Under the painted clouds and gilt chandeliers of a room called the St. Regis Roof, this year’s attendees, including Alan Schwartz, the ex-Bear Stearns president and chief executive, and Sallie Krawcheck, the former head of Citigroup’s wealth-management arm, enjoyed an evening of ribald humor and old-fashioned hazing.

The material was choice, since in the year since the group last met, all five of Wall Street’s major independent investment firms have been taken over, have failed or have been transformed into commercial banks.

Society members, some wearing the society’s key on a red ribbon around their necks, started with cocktails then moved on to dinner of beef tenderloin and cheap wine — $10 bottles of Chilean cabernet sauvignon. About 150 members showed up, fewer than usual. Some, including BlackRock Inc. Chief Executive Laurence Fink and Gregory Fleming, who resigned as Merrill Lynch’s No. 2 executive the day of the dinner, only stayed for a drink.

Part Friar’s Club roast, part “Gong Show,” Kappa Beta Phi’s annual dinner is held for the official purpose of inducting new members, who sit at a long table with a black tablecloth at the front of the room. The inductees, “Neophytes” in Kappa Beta Phi parlance, must perform a variety show for the old crowd. Mr. Smith, a Wall Street veteran and great-grandson of legendary New York Gov. Al Smith, served as the evening’s master of ceremonies.

Neophyte Mr. Gruss poked fun at a fellow investor. “There’s Wilbur Ross over there,” Mr. Gruss said at one point, referring to the member who recently became the society’s “Grand Loaf,” one of Kappa Beta Phi’s four offices. “Doesn’t he look like a visitor from another planet? That’s the reason brothers and sisters shouldn’t marry.”

“There’s a need for Wall Street to have a little bit of humor,” Mr. Ross said this week. “If anything, people needed a little more cheering up this year.”

The group’s humor is anything but politically correct. One crude joke took aim at Rep. Barney Frank’s treatment of the U.S. taxpayer, with a reference to Mr. Frank’s sexual orientation. Mr. Frank is the first openly gay member of Congress.

Together with professional coaches, the Neophytes stage Wall Street’s version of pledge night. This year, at the suggestion of last year’s class, the male Neophytes appeared in falsies and pigtail wigs, some in gold and bright pink. The men, some sporting a dab of blush, also wore cheerleader skirts and shirts bearing the society’s Greek letters.

This year’s crop of 17 Neophytes included Don Donahue, chairman and chief executive of the Depository Trust & Clearing Corp., J. Tomlison Hill, vice chairman of the Blackstone Group, Peter Scaturro, former chief executive of U.S. Trust and Goldman Sachs Group Inc.’s private-wealth arm, and James S. McDonald, chief executive of Rockefeller & Co., a wealth-management firm that advises the Rockefellers and other families.

The female members of the class, dressed as male cheerleaders, wore short-hair wigs and tights. The three female Neophytes were Sarah Cogan, a partner of Simpson Thacher & Bartlett, the Wall Street law firm, Sara Ayres, managing director at New Providence Asset Management, and Marianne Brown, chief executive of OMGEO LLC, a firm that handles the post-trade details of securities transactions.

Backed by a five-piece band, the Neophytes performed renditions of musical standards, from Bing Crosby’s “White Christmas” to the Beatles. There was at least one attempt at rap, by Mr. Hill, who was quickly jeered offstage. Rockefeller’s Mr. McDonald tried to sing a version of “Joshua Fought the Battle of Jericho,” renamed “Treasury Fought the Battle of Lehman Bro.” and met a similar fate.

In one ditty, a play on Dr. Seuss’s “You’re a mean one, Mr. Grinch,” the performers took aim at several of Wall Street’s fallen stars. One target was Kappa Beta Phi member and former Grand Swipe Mr. Cayne, absent though he was. The song’s lyrics included the line, “You’re an odd one, Mr. Cayne,” and made light of his reported use of “ganja.” He has said he didn’t engage “in inappropriate conduct.”

Treasury Secretary Henry Paulson, a former Goldman Sachs CEO who is not a member, also made it into the Grinch tune: “Where’s the TARP money, Mr. Hank? Did any of it fall through the cracks? You let Lehman go under but not your beloved Goldman Sachs.”

The hit of the evening, however, was this new take on “American Pie” performed by Mr. Scaturro:

A long, long time ago…

I can still remember

How the Dow Jones used to make me smile.

And I learned my trade and had my chance

The music played I did my dance

And I made seven figures for a while.

I can’t remember if I cried when they pulled the plug on Countrywide…

It sucks that Iceland is out of ice….Bye, Bye to my piece of the pie…Now I travel coach whenever I fly…Maybe this will be the day that I die.

Lehman Brothers Whistle Blower Letter

Tuesday, March 30th, 2010

The letter below is a shocking account of Matthew Lee’s findings at Lehman Brothers in May of 2008.  Enjoy the read.

Letter by Lehman Whistle Blower Matthew Lee, Dated May 16, 2008

Greed & Fear on the Repeal of Glass-Steagal

Friday, March 5th, 2010

Greed & Fear on the Repeal of Glass-Steagal

Greed & Fear – Volcker (CLSA)

First Credit Crisis – Ricciardi Family (1294)

Monday, February 15th, 2010

Vox recently published this article on the first credit crisis recorded in history.  Many economists tend to think that this phenomenon is a recent development, but throughout history, sovereign debt and credit contagion have been major issues. ~I.S.

It is widely believed that the current credit squeeze, leading to bank failures, is a modern phenomenon arising from the interplay of a historically unique set of circumstances that could not have been foreseen. But a team of academics – a finance professor and two medieval historians – at the University of Reading’s ICMA Centre has documented a medieval credit crunch that bears remarkable parallels with the current crisis.

The Ricciardi & Edward I

Before 1272, English kings had occasional dealings with Italian merchant societies, mainly in purchasing luxury goods for the household and arranging for balance transfers overseas. During the reign of Edward I (1272-1307), however, the king entered into a close financial relationship with one particular merchant society, the Ricciardi of Lucca (Kaeuper 1973). From 1275, the Ricciardi collected the newly-created customs duty on exports of wool, hides and wool-fells, worth around £10,000 per year, as well as receiving money from other sources of royal revenue. In return, they advanced significant sums in cash to the king and made payments to third parties on the king’s behalf, as and when ordered by royal letters. In total, between 1272 and 1294, the Ricciardi were involved in the collection and disbursement of around £20,000 per year, equivalent to roughly half of the king’s ordinary annual income. We could perhaps compare this arrangement to a modern current account, complete with extensive overdraft facilities (interestingly, Edward was usually overdrawn by £10,000-£20,000).

This relationship had great advantages for both parties. It allowed the king to anticipate royal revenues and so smooth the seasonal fluctuations in his income. Edward also enjoyed regular access to credit, allowing him to respond to unexpected events or undertake expensive projects without the burden of maintaining a large cash reserve. In return, the Ricciardi received some financial return on their advances, although this is usually hidden in the sources because of the religious prohibition on usury. We have calculated that, before 1294, Edward was probably able to borrow at rates of around 15% per year (Bell, Brooks and Moore 2009). Furthermore, the Ricciardi benefited from royal favour in their business dealings.

How were the Ricciardi and other merchant societies in a position to make such loans and investments? Their initial funding came from the partners of the society, who pooled their capital and received proportionate shares of any profits. Such involvement could be risky, because the partners could be held personally responsible for any debts owed by the society. They also received deposits, mostly from wealthy citizens of the Italian city-states (Hunt and Murray 1999). In addition, the Italian merchants profited from the management of papal taxes collected in England, and we would argue that this played a vital role in capital formation. In 1274 the pope had levied a tax on the clergy across Europe to support a new crusade, which raised a total of around £150,000 in England alone. The Ricciardi were one of several Italian merchant societies to act as papal bankers and were responsible for holding a portion (worth around £10,000) of the monies collected in England (Lunt 1939). This would have covered much of the king’s overdraft with them.

At any one time, most of this capital was committed to various ventures, including loans to governments and private borrowers, as well as investment in goods for trade. This was normally profitable, since this money was earning a good return, but it meant that the merchants only retained a small buffer of liquid capital. This was not ordinarily a problem, since most transactions could be carried out through credit, offsetting or balance transfers between merchants. When actual cash was needed beyond their own reserves, it could be raised from other merchants, either as a loan or by selling assets. For instance, the Ricciardi often acted as brokers raising loans for the king from a cartel of their fellow merchant societies (Kaeuper 1973). We can perhaps describe this as an early variant of the ‘Northern Rock’ business model, in that the Ricciardi relied on wholesale or interbank lending to fund their loans to the king.


The trigger for the global credit crunch starting in 2007 has been traced to the ‘sub-prime crisis in the US, as the resulting uncertainty meant that banks were unwilling to lend to each other, thus removing liquidity from the market. In the early 1290s, there was a similar crisis of liquidity, as the papal tax discussed above was gradually called in by the pope and the French king exacted large sums from the Italian merchants in his kingdom, leaving the merchant societies under-capitalised.

Initially, it seemed as though the Ricciardi may have been escaped the worst of this. In 1290, Edward had finally agreed terms with the pope to lead a new crusade and, in return, was granted access to the proceeds from clerical taxation in England. As a result, the merchant societies with whom the tax had been deposited were ordered to deliver a first instalment of 100,000 marks (£66,667) to the Ricciardi on Edward’s behalf (see Lunt (1939) and Kaeuper (1973). It is unlikely, however, that any money physically changed hands, since it would have been more logical for the merchant societies simply to transfer their liabilities from the pope to the Ricciardi. On paper, the Ricciardi would have been credited with the extra money, but there was a corresponding danger should Edward seek to withdraw this tax revenue at short notice.

Unfortunately, this was precisely the situation that arose in 1294, when war broke out between England and France. As he had before, Edward turned to the Ricciardi for money to fund his armies. Although, in theory, the Ricciardi should have been well-capitalised, it seems that, in reality, the greater part of their resources was tied up and, fatally, the wider lack of liquidity meant that they could not raise money on the interbank market. These difficulties were exacerbated by the Anglo-French war, which effectively cut communications between Italy and England and left the merchant societies unable to update the account books of their various branches across Europe.
In their defence, the Ricciardi, much like banks today, would argue that their difficulties resulted from a short-term liquidity squeeze and that, overall, their assets matched their liabilities. In practice, however, the Ricciardi were unable to provide the English king with the financial support that he desperately needed. In response, Edward removed the Ricciardi from their position as collectors of the wool custom and ordered the seizure of the assets (mainly wool but also loans to private individuals) held by the Ricciardi and other merchant societies. This dealt a mortal blow to the Ricciardi’s finances and effectively marked the end of their long-standing relationship with the English crown.


The Ricciardi initially sought to recover their position through a series of ‘credit swaps’ and netting between their creditors and debtors (Kaeuper 1973).1 They requested a new accounting with Edward, in the belief that his ‘overdraft’, combined with the proceeds of the confiscated wool and debts, would offset most of the outstanding papal tax. Their other main creditor was the pope, and the merchants tried to persuade him to take over the debts owed to them in France and in Italy, on which he was better-placed to collect. To draw another parallel with more recent events, we can compare this to government intervention, exchanging Treasury-backed bonds for the more illiquid assets held by the banks.

Unfortunately for the Ricciardi, they were unable to convince governments to support them.

In the short term, Edward’s decisive actions succeeded in recovering around £50,000 from the Ricciardi. However, the fall of the Ricciardi had significant costs in the medium-term, since Edward still needed to raise huge sums of money to pay for his armies, now fighting in Gascony, Scotland and Wales, as well as the subsidies that he had promised to his allies in the Low Countries and Germany. As a result, Edward was forced to turn to moneylenders who both lacked the resources of the Ricciardi and charged much higher rates of interest (we have found examples of annual rates at 40% and 150%) (Bell, Brooks and Moore (2009).

Applying this experience to the current crisis, it is clear that taking punitive action against the banks today would have much more serious economic consequences, given modern reliance on credit. Edward himself may have come to the same conclusion. By 1299 he had entered into another long-term financial relationship with the Frescobaldi of Florence. When the Frescobaldi complained that news of this had led to a run on their bank, Edward promised them £10,000 sterling in compensation.2 Relative to the English crown’s ordinary annual income of about £40,000, this commitment is in fact greater than the initial £50 billion bank recapitalisation proposed by the British government in 2008.

Furthermore, deprived of access to credit, Edward was forced to rely on heavy taxation and his prerogative rights of purveyance and prise (compulsory purchases of goods). He also over-issued wardrobe bills (essentially government IOUs) to pay for wages and supplies. All of these measures aroused political opposition in England, and contributed to a major constitutional crisis in 1297 (Prestwich 1988). By contrast, Edward’s opponent, Philip the Fair of France, sought to raise money by debasing the French currency, reducing the silver content of the coins by as much as two-thirds. The income (seigniorage) received from these recoinages meant that Philip did not have to resort to direct taxation to the same extent as Edward or incur the same level of debt (Favier 1978). It is possible, however, that the long-term consequences of the expanding money supply for the French economy were more damaging that the medium-term pain of high taxation and debt in England. We would argue that this has considerable modern resonance, as today’s governments begin to grapple with the problem of how to pay for the obligations that they are currently undertaking.


This essay arose from the findings of an on-going three-year research project with the aim of investigating the credit arrangements of a succession of English monarchs with a number of Italian merchant societies.The study, based at the ICMA Centre, Henley Business School, University of Reading, is funded by the Economic and Social Research Council (ESRC) under grant RES-062-23-0733. For more information see:


1 This is based on a number of internal Ricciardi letters that survive in The National Archives (TNA E 101/601/5) and have recently been edited in Lettere dei Ricciardi di Lucca ai loro compagni in Inghilterra,1295-1303, A. Castellani and I. del Punta (eds.) (Rome, 2005).

2 The original letter survives in the National Archives, TNA SC 1/47 no.120 and has been translated in R. J. Whitwell, ‘Italian bankers and the English Crown’, Transactions of the Royal Historical Society, New Series, 17 (1903), pp.198-9.


Bell, A. R. C. Brooks, and T. K. Moore, ‘Interest in Medieval Accounts: Examples from England, 1272-1340’, History (forthcoming, Oct 2009).

Favier, Jean (1978), Philippe le Bel, Fayard

Hunt and Murray (1999) A History of Business in Medieval Europe (Cambridge, 1999)

Kaeuper, R. W. (1973) Bankers to the Crown: Edward I and the Ricciardi of Lucca (Princeton).

Lunt, W. E. (1939) Financial relations of the papacy with England to 1327 (Cambridge, Mass.), pp.311-46.

Prestwich, M. (1988) Edward I, London

Whitwell, R. J. (1903) ‘Italian bankers and the English Crown‘, Transactions of the Royal Historical Society, New Series, 17 (1903), pp.198-9.

For more information, please visit VOX…


Volcker Speech on Regulatory Reform Fails to Inspire

Tuesday, February 2nd, 2010


Today, Mr. Volcker spoke out about his reform against U.S. investment banks and proprietary trading.  After the speech, it looks likely that the rule will not go forward in its original form.

The former Federal Reserve Chairman called out recently to limit bank’s proprietary trading, principal investments, hedge funds, and private equity divisions.

On the opposing end, Senator Richard Shelby (Republican) opposed both the Volcker Rule and President Obama’s decision to levy a $90+ billion tax on U.S. large cap banks.  Although the Leverage Academy team does not feel that these two rules will be approved of in their original form, a tax or some form of penalty for using taxpayer funds for principal investments may still be passed by the House and the Senate.

Since Democrats do not have the necessary 60 votes needed to enforce this reform package, it will only pass with Republican support.

Even the House Financial Services Subcommittee Chairman Paul Kanjorski told the Financial Times that he was only 80% to 85% in agreement with the Volcker rule and that many issues raised by Volcker were already included in his amendment passed by the House.

According to the Financial Times, one of the most outrageous demands today was from Warner, who said he is proposing that US banks set up a USD 1trn fund to invest in US infrastructure projects as a way to avoid the USD 90bn bank levy.  When probed, a staffer said that Warner is not calling for the banks to place USD 1trn in cash, but to raise such an amount through leverage…

Below is a live blog of the speech by the Wall Street Journal…

Text begins here:

So Mr. Volcker, what is prop trading anyway? It is the $64,000 (make that the multi-billion dollar question) for Wall Street.

So far, the former Federal Reserve Chief, who is now spear heading the Obama administration’s effort to overhaul the banking system, has been pretty vague on exactly what constitutes proprietary trading — or trading on behalf of a bank, rather than its customers. A copy of Volcker’s prepared testimony is more specific about what Volcker thinks banks should do, rather than what he thinks they should not do.

Other key issues that Volcker is likely to address in his testimony before the Senate Banking Committee are proposing capital and leverage restrictions on large banks.

Deal Journal is live blogging the hearing.

    • 2:36 pm
    • by Michael Corkery

    Chairman Chris Dodd is opening up the hearing, just as President Obama has finished his remarks at a town hall meeting in Nashua, NH. This is like the well-oiled Obama presidential campaign when everything was highly orchestrated.

    • 2:40 pm
    • by Michael Corkery

    Sen. Shelby: He’s “disturbed” by the way Obama has sneaked in the Volcker rule seven months after it first proposed financial reform that it called “sweeping.”  Is Shelby suggesting that politics may have played a role in the timing of Obama’s latest proposal? No. Really?

    • 2:41 pm
    • by Michael Corkery

    That said, Shelby says he supports the Volcker Rule…

    • 2:43 pm
    • by Michael Corkery

    Volcker is Up: Right off the bat he goes to Prop Trading…He says it’s not an issue of whether prop trading is bigger risk than others. It is a risk. Period. And taxpayers shouldn’t backstop that risk.

    • 2:49 pm
    • by Michael Corkery

    Volcker: This is about two big to fail.  We have to limit banks and non-banking institutions from engaging in activities that could require a bail out…He references AIG and GE Capital…

    • 2:52 pm
    • by Michael Corkery

    Volcker: Bank supervisors with “strong legislative direction” sould be able to contain excess in trading. Wait a second. Is Volcker proposing to leave it to the banks to decide what is risk and not risky? Um, that didn’t really work too well.

    • 2:55 pm
    • by Michael Corkery

    Volcker hasn’t looked up once from his prepared testimony.

    • 3:00 pm
    • by Michael Corkery

    This is dry stuff. Bring Back Geithner or Blankfein.

    • 3:02 pm
    • by Michael Corkery

    Volcker: Trading “incidental” to customer interests would be OK. Trading that is not explicitedly done on behalf of the customer is not OK.

    • 3:07 pm
    • by Michael Corkery

    Dodd asks but isn’t “hedging” good for bank? Couldn’t that be seen as propreitary behavior?

    Volcker brings up a good example: AIG had credit defaualt swaps which were designed to be hedges, but when AIG doubled down on CDS they were no longer hedges, but an added risk.

    • 3:07 pm
    • by Stephen Grocer

    Dodd asks: If the U.S. adopts the Volcker rule and other don’t, has U.S. left its institution in a weaker competitive position?

    • 3:09 pm
    • by Stephen Grocer

    Volcker counters that the plan has receive support elsewhere, especially London.

    • 3:10 pm
    • by Michael Corkery

    Shelby: There is no evidence that prop trading fueled the losses that contributed to the credit crisis. Plus, Bear and Lehman were not commerical banks yet were more interconnected and posed systemic risk. So why so much focus on prop trading

    • 3:11 pm
    • by Michael Corkery

    Volcker is not really answering the question.

    • 3:15 pm
    • by Michael Corkery

    Volcker just compared ‘too big to fail’ institutions to pornography…”you know it when you see it.”  That’s a new one.

    • 3:18 pm
    • by Michael Corkery

    Grocer, Volcker says he’s not naive and he’s been around for a long time, but does he really think that he can get other countries, like the UK and France, to agree to enact similar restrictions?

    It’s hard enough to get the U.S. Congress to agree to these rules.

    • 3:24 pm
    • by Michael Corkery

    Volcker: It’s not theoretical the conflicts of interests inherent of prop trading. It’s inenvitable that you will trade against the interest of your customers. But he has no specifics.

    • 3:28 pm
    • by Stephen Grocer

    Corkery: If the Conservatives are elected in the U.K., London might get a version of the rule.  But EU has indicated that it is unlikely to follow the U.S. lead if it passes the Volcker rule. That would definitely put U.S. institutions at a disadvantage.

    • 3:28 pm
    • by Michael Corkery

    Volcker just joked that he’s always thought that a “Chinese Wall” is actually permeable. “It didn’t keep out the Huns, did it?”  Banks have said that there is a chinese wall between depository and prop activiity. Economist humor.

    • 3:32 pm
    • by MIchael Corkery

    These Senators are going easy on Volcker. I guess it wouldn’t look good to gang up on the elder, grandatherly academic. But the former Fed chair is admitting to a lot of unknowns in his proposal.

    • 3:37 pm
    • by Michael Corkery

    Volcker is finally showing  a little animation.  Sen. Corker is telling him that commerical banks cannot move money from the commerical side of the bank to another part of the bank. “You don’t think they can do that,” Volcker says.

    • 3:40 pm
    • by Michael Corkery

    Dow has stayed up 115 points.  Looks like the market thinks the Volcker Rule is a dead on arrival in the Senate.

    • 3:43 pm
    • by Michael Corkery

    Volcker: If Goldman wants to keep prop trading they have to give up banking license and access to cheap capital at the Fed window.

    • 3:47 pm
    • by Stephen Grocer

    Volcker declines to rank which of the activities — private equity, hedge funds or proprietary trading — is riskiest.

    • 3:52 pm
    • by Michael Corkery

    Sen. Mike Johanns: “I get more confused as you testify. You are not clearing it up.”
    Finally someone said it.

    • 3:54 pm
    • by MIchael Corkery

    Volcker: “I am puzzled why I am losing you.”

    • 3:56 pm
    • by Michael Corkery

    Volcker says his rule wouldn’t have stopped AIG or Lehman. But the “comprehensive” reforms by the Obama administration would have stopped those problems.

    • 3:57 pm
    • by Stephen Grocer

    Sen. Johanns is raising the question of the day: How will the Volcker rule have prevented the financial crisis. It would not have solved the problem with AIG or

    Volcker responds: That rule was not designed to solve the problems of those firms.

    • 3:58 pm
    • by Michael Corkery

    Best quote of the hearing.

    Volcker: The issue is look ahead. I am telling you if banks are protected by tax payer and given free rein to speculate. There are going to be problems. “I may not live long enough to see the next crisis. But my soul is going to come back to haunt you.”

    • 3:59 pm
    • by Stephen Grocer

    Volcker points out his rule is designed to solve future problems, not just the regulatory gaps laid bare by the current financial crisis.

    • 4:12 pm
    • by MIchael Corkery

    Sen. Jim Bunning: Wait, I thought your goal was about preventing banks from getting too big to fail. But this proposal does nothing to require banks to shrink.

    • 4:18 pm
    • by Michael Corkery

    From the sounds of the senators skeptical questioning, Volcker’s rule looks to be on thin ice. The hearing was not a total wash out: Volcker warned that his ghost will come back to haunt the Senate if they don’t listen to him.  That will be a quote that will no doubt be pulled out years from now for that inevitable “I told you so” moment.


  • For more information, please visit WSJ…

The Jackson Laboratory: Founded in a Recession

Sunday, January 17th, 2010


For discouraged entrepreneurs and VCs alike, the story of The Jackson Laboratory is bound to spark some enthusiasm.  The Jackson Laboratory was founded in 1929, during the Great Depression,  by Clarence Cook Little in Bar Harbor, Maine.   Today, it is the world’s most diverse lab mouse breeder and supplier with over 1, 360 employees.  The Jackson Laboratory was founded using money raised from wealthy CEOs in the auto industry, including Edsel Ford and Roscoe Jackson.  George B. Dorr donated land for the laboratory in Bar Harbor.

During the Depression, the employees of the lab used to fish and grow vegetables, acting like a commune to sustain themselves.  Thomas Roderick, a retired staff scientist recalls the staff growing its own vegetables until 1958.  He says that the lab ran on the founder’s charisma and scientific genius.  Little and his crew wrote many papers on cancer and genetics.  They noticed that the genome of mice is almost identical to that of humanes.

Today, the Jackson Labs have over 4,500 mouse models available for sale to other labs.  It is now an internationally known research lab with an annual budget of $169 million.  It has attracted funding from the American Cancer Society, the National Cancer Institute, and the national Institutes of Health.

For more information, please refer to Mass High Tech…