"They shoot horses, don’t they?" That line repeats itself methodically in my mind as I watch the House of Representatives financial services committee interrogating senior bankers in mid-February. "Barney Frank and the seven dwarfs," a source snorted. In fact there were eight dwarfs, and congressman Frank is a cross between a grumpy buddha and a garden gnome. Eighteen months ago, the chief executives of major financial firms were revered. We envied their elevated status – the jets, the bodyguards, the limousines and the layers of gatekeepers. Hedge fund managers might have been richer, but the combination of prestige and perks still affirmed Wall Street bosses as human deities. Now these men are reduced to squirming schoolchildren who’ve been caught stealing from the communal cookie jar.
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As the chief executives struggled to explain how munificently they had allocated the taxpayers’ Tarp money, they fell into a number of potholes. It did not inspire confidence to learn that since receiving taxpayer funds, wealthy men such as John Mack and Lloyd Blankfein have not purchased any shares in the companies that they run, despite bargain-basement prices. Vikram Pandit is definitely the class swot – but his eagerness to please is nonetheless endearing. Pandy burbled that he got the new reality and would work for one dollar a year until Citi returned to profit. Who would want to be a financial chief executive today? The upside is a mirage, the downside unlimited and the scrutiny is unacceptable. Congressman Paul Kanjorski spat at the financiers: "When you took taxpayer money, you moved into a fish bowl." Most of the chiefs travelled from Wall Street to Washington on public aircraft. Ken Lewis, however, undertook a nine-hour train pilgrimage. Schadenfreude, thy name is credit crunch. Is Ken sulking I wonder: defiantly trying to prove the point that private planes improve efficiency?
These are depressing times: even the most optimistic person despairs of rapid improvement; some sourpusses are stridently predicting an L-shaped recovery where the economy swoons and then bumps along the bottom for many years.
It is vital to laugh in these despondent days. I therefore urge you to watch on YouTube the flagellation of the contrite chief executives by congresswoman Maxine Waters. Mad Maxine prefaces her unintelligible rant with the ominous words: "All of my political life I have been in disagreement with the banking and... financial services’ community..." The Wall Street Warriors crumple cravenly in the face of her wrath. Ken Lewis can be seen nervously licking his lips. Waters demands to know whether the banks have "loss-mitigation" departments offshore. Lewis demurs that he is not sure where the departments are based but that Bank of America has 5,000 people working on these issues. "So you do have offshore facilities," Waters hisses, completely disregarding the senior banker’s response. Vikram Pandit attempts to deal with the dragon in a boyish but charming manner. He is slapped down. The more astute chiefs, such as John Mack and Jamie Dimon, decide to sit this one out and refuse to engage with the irate congresswoman. Scanning the faces of the eight dwarfs, I have to say all of them except for Perky Pandy look haggard and harassed. Not one of the chiefs seemed to be having a "good crisis". Obviously none of them had envisaged that the pinnacle of his banking career would effectively involve basking in the spotlight of public revulsion. Fearsome Frank summarized the venomous mood towards finance’s finest: "People really hate you," he said. "And they’re starting to hate us because we’ve been hanging out with you." Jo Sawicki, director of Ceres, a company that provides media training for senior executives, told me: "These chief executives are still doing what worked for them in the past: bravado and blustering. They need to show much more vulnerability and to realize that there is strength in vulnerability."
And while we are on the subject of the foibles of finance chief executives, former Merrill Lynch chief executive John Thain is in trouble because of allegations that he authorized the Merrill bonus payments to be paid earlier than usual. I saw a copy of the letter the New York state attorney general, Andrew Cuomo, sent to Barney Frank, chairman of the House of Representatives financial services committee, and the fallout could be nuclear. Cuomo grumbles that "in a surprising fit of corporate irresponsibility... instead of disclosing their bonus plans in a transparent way as requested by my office, Merrill Lynch secretly moved up the planned date to allocate bonuses and then richly rewarded their failed executives". Cuomo continues: "The vast majority of funds were disproportionately distributed to a small number of individuals. The top four bonus recipients received a combined $121 million."
Thain and Bank of America’s chief administrative officer, J Steele Alphin, have received subpoenas to testify before Cuomo and I sense that "Alf" will be hung out to dry on this one. Alphin, according to the Bank of America website, is a member of the senior management team responsible for "global human resources, global marketing & corporate affairs and corporate aviation functions". That is a big job, albeit that it will shrink as Bank of America is forced to dispose of its private jets. Alphin was one of Thain’s key Bank of America contacts during the transition period in late 2008. Bank of America has tried to distance itself from the Merrill bonus payments. However if it turns out that Alf knew all about them, doesn’t that mean Bank of America knew all about them? Cuomo might agree with my line of thinking as he has now subpoenaed Bank of America’s chief executive, Ken Lewis. "You’re wasting your time going after Thain," an impeccable source scolded. "You should dig deeper into the Bank of America board and the fact that after eight years of King Ken’s reign, there is still no obvious internal successor. Isn’t that an indictment of both Lewis and Alphin (who has been responsible for the group’s human resources since 1999)?"
Profits and losses
I am normally the first to criticize the failings and hypocrisy of the investment banking world. However, this month I would like to congratulate those big institutions that made a profit during the appalling conditions of 2008. The roll call of the successful includes Bank of America, Banco Santander, BNP Paribas, Barclays, Goldman Sachs, JPMorgan, Morgan Stanley and Société Générale. Some would argue, however, that profit has become a meaningless term in the banking world because the profit figure depends on the accuracy of each firm’s mark-to-market write-downs and accounting policy.
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The big Swiss banks were not profitable in 2008. UBS’s problems have been well rehearsed. Marcel Rohner has been forced to fall on his sword and has been replaced as chief executive by Ossie Grübel. I am not sure if Jerker Johansson, the head of UBS’s investment bank, will last another year. I am also certain that dismantling the investment bank has been discussed at the highest level. Bonuses for senior people were so meagre that sources expect a mass exodus in the next few months. The jewel in the crown, wealth management, is now a poison pill as the US authorities bay for blood. Net new money outflows from UBS wealth management and business banking divisions were a massive SFr58 billion ($50 billion) in the final quarter. The announcement in mid-February that UBS would pay fines of $780 million and reveal the names of some clients suspected of fraud to the US Department of Justice marks the beginning of the end not only for UBS but also for Switzerland’s status as a bastion of discreet and secure wealth management for the rich. And the irate US Internal Revenue Service is not finished yet: on February 19, it sued UBS for information about a substantial number of US client accounts held at UBS in Switzerland. A mole whispers that neither Peter Kurer, UBS’s chairman, nor Rohner had dared to set foot on US soil lest some malevolent immigration officer pounced on them in an intimidating fashion. As I said, the role of bank chief executive is fraught with difficulties these days. Where does all this leave Credit Suisse, Grübel’s former fiefdom? Three years ago both banks sang from the hymn sheet of an integrated one-bank model. UBS, as it has slithered from saint to sinner, has jettisoned this mantra and now talks about constituent units operating independently. But Credit Suisse is still a believer. In his fourth-quarter letter to shareholders, chief executive Brady Dougan wrote: "We remain committed to the integrated model which we believe enables us to most effectively deliver best-in-class service to our clients while realizing enhanced operating efficiencies."
Credit Suisse is one of the few banks not to have received government money during this crisis and it remains well capitalized, with a tier 1 ratio of 13.3%. Nevertheless the results for the final quarter of 2008 were disappointing and the bank reported a net loss of SFr8.2 billion for the whole of 2008. The investment bank fared badly, losing (before taxes) SFr7.8 billion in the fourth quarter. Some SFr3.2 billion of the fourth-quarter loss was attributed to net write-downs in leverage finance and structured products. Of course, Credit Suisse was not alone in feeling the pain. Most big investment banks lost money in the final months of 2008. "What was working during the fourth quarter?" a mole moaned.
Credit Suisse argues that it has aggressively reduced risk and shrunk troubled assets without any reclassification of assets on to accrual books. The firm’s exposure to legacy leveraged finance loans, commercial and residential mortgage-backed securities and sub-prime CDOs is put at approximately SFr14 billion, down substantially from a year earlier. In future, the investment bank will adopt a lower-risk, more client-focused strategy. "Look, we’re a responsible institution," a senior insider insisted. "We’re not champagne-swilling, jet-taking, limo-riding free-loaders. We even paid part of 2008 bonuses in illiquid troubled assets."
Huw van Steenis, the respected Morgan Stanley analyst, recommends that investors switch in to Credit Suisse shares: "While CSG has painfully de-risked positions, there is still risk as it seeks to shed SFr40 billion to SFr60 billion of investment bank RWAs but we think that the worst is probably behind it," he says. However, the tarnishing of the brand of Swiss private banking will not help Credit Suisse. It is interesting that net new assets to the wealth management division in the fourth quarter were a meagre SFr2 billion. Credit Suisse talks about: "Good contribution from collaboration revenues across the integrated bank: SFr5.2 billion in 2008." Dougan and Paul Calello, head of the investment bank, are clever and competent individuals. However, the sea of red ink has to part and we need to see green shoots of recovery. Otherwise, stakeholders might question whether or not the integrated model is the correct approach for the unforgiving years that lie ahead.
Carpetbagger capital
Charles Darwin allegedly wrote: "It’s not the strongest of the species that survive, nor the most intelligent, it is the one most adaptable to change." Undoubtedly, we are entering a new epoch. The old financial institutions that we took for granted might not be the future – in the same way that IBM had to cede to Microsoft. The incumbents are encumbered by lumpy baggage that they will find it hard to shift. Governments and regulators are struggling to find a solution to the toxic asset horror show but progress is painfully slow. That is why Bank of America’s decision to purchase Merrill Lynch might be the wrong road map. The record shows that the all-dancing, all-singing Citi was unable to benefit from its many tentacles and has been forced to unbundle itself in order to survive.
I have decided that the next few years will be the era of the carpetbagger. Following the American civil war , a carpetbagger was a Northerner who went South (with his belongings in a carpet bag) in order to profit from the troubles of the defeated Southerners. People are surprised when I say that huge fortunes will be made in the next few years. As a student of history, I know I am right. All you need is cash and, because of the market dislocation, there will be opportunities. Carpetbaggers profit from the misfortunes of others but they make fortunes for themselves. Significant wealth will be made in financial services. Everything is trading cheap – including people – and you can either buy or build. In three years’ time, you could be cackling while the incumbents are still caterwauling.
In particular, we might see a bigger divide between the providers of capital and those that offer advice. Someone who understands this is Michael Tory, the former head of UK investment banking at Lehman Brothers. Tory is a low-key Canadian with a high-grade mind. He sees things differently from others, which is a huge advantage in an industry where most people are sheep. Last October, Tory founded a new firm that will specialize in strategic advice. "This is a time of great change," he told me. "Clients are reviewing their relationships and talented bankers are reviewing their careers. We see a wave of fresh, next generation energy." Tory’s new firm will be an-old fashioned partnership. Other founding partners are Michael Baldock, former head of investment banking, Americas, for HSBC, and a Frenchman, Benoît d’Angelin, former chief executive of the hedge fund Centaurus Capital. I do not know Baldock but I think very highly of Benoît whom I once described as a cross between a koala bear and Alain Delon: in short a very charming creature.
And while we are on the subject of French bankers moving jobs, I was interested to see BNP Paribas announce that its head of investment banking, Jacques d’Estais, is swapping jobs with the head of asset management, Alain Papiasse. A mole whispers that this might be a promotion for Papiasse who is viewed as a protégé of Baudouin Prot, Paribas’ chief executive. Prot is in a pickle at the moment as the deal to purchase parts of Fortis swerves off track and BNP Paribas’ capital ratios look vulnerable. Nevertheless, some would say that BNP has outperformed the competition on the way down.
The future of hedge funds
It is not only investment bankers who are floundering. Behind the cactus hedges of self-imposed privacy, the hedge fund industry is in paroxysms of agony. Think about the performance of one of the boom time’s shiniest stars, hedge fund and private equity group Fortress. Fortress listed its shares on the New York Stock Exchange in February 2007. The shares closed the first day’s trading at $31, up some 65% on their issue price. Two years later, the stock is languishing at $1.30. If, as a salivating retail investor finally permitted to enter the hedge fund party, you had plunged in (and I warned you not to do that), you would have lost 95% of your capital. At the time of launch, I wrote: "Never forget it is a jungle out there. And for me, the furore surrounding the Fortress IPO is reminiscent of all those dot-com debuts."
Even sophisticated players have not done well out of hedge funds recently. A mole is outraged that he cannot retrieve his depleted funds because of the gate system. This is where managers impose a limit on redemptions on the grounds that free movement might cause a stampede and force them to sell illiquid assets at a loss. "You have the nerve to take management fees on my money which I want back," Mole berated the manager.
In future, hedge funds might face not only much tougher regulation but also calls for strong advisory boards and a reformulation of the fee structure. I saw a copy of a document issued by Utah Retirement Systems’ investments group entitled Preferred hedge fund terms. This stated trenchantly: "The hedge fund industry is at a crossroads where a decade-long sellers’ market for funds, buoyed by excess demand from all investor types, is grinding to a halt due to large performance related losses, structural changes to the investment banking model... and the exposure of an asset-liability mismatch (ie, strategy illiquidity meets investor demand for liquidity) that has created a spiral of redemption pressure and forced selling."
Managers might be forced to cut management fees. Originally meant to cover fixed overheads, the management fee became a source of profits (2% on, say, $5 billion is a large number – you do the maths!). Staff remuneration will have to be more in line with long-term performance and investors might demand clawbacks when losses occur.
"The mystique is gone," Mole told me. "If the industry doesn’t change, it will lose assets. The major endowments and the family offices will not be fobbed off any longer. I’m calling for a trade association and much greater transparency, and the regulators are listening." Oh dear, those years that we thought of as the naughty noughties (remember Blackstone chief executive Steve Schwarzman’s extravagant 60th birthday held at the peak of the bubble in February 2007) are turning in to the neutered noughties!
How was your month? Please send news and views to Abigail@euromoney.com