Montrose Journal: Summer 09
Triumph of Mammon: Masters of the Universe Unbowed?
I recently received my annual fundraising letter from the Harvard Business School. While it is hard to think of an institution with less pressing financial needs than the Harvard Business School, its letters are always worth reading. This one was written by a classmate of mine who now works at Blackstone, the private equity group. It began: “Wow. Who could have guessed that since my last letter in September of 2008, the world would have gone from bad to totally depressingly awful? Here in NYC, one feels the change in funny ways – for example, the ‘hot’ day to go out for brunch and drinks appears to have shifted from Saturday to Wednesday afternoon!“
The letter vividly captured the narcissism of some in the financial services industry, their assumption that the pains of their particular world must be shared by everyone. If they’re feeling awful at Blackstone, well, of course, everyone must be feeling awful.
After wading through yards of worthy predictions about the future of finance, however, I came across an item on a financial gossip blog, which offered a very different view. It reported a sighting of David Rubenstein, the founder of the Carlyle Group, having dinner a deux with Rahm Emanuel, the White House Chief of Staff, on the day that General Motors filed for bankruptcy. They were said to be sitting outside at a restaurant in Washington D.C., both wearing the American capital’s uniform of blue suits and red ties.
Rubenstein began his career as an aide to Jimmy Carter, moved into private equity in the mid-1980s and has built his firm across countries and continents, thriving ry different political settings and in varying financial conditions. But he has always built. Even last year, when Carlyle declared itself “humbled” by the chaos in the global economy, it still added to its funds under management, brought in new investors and deployed $12.6 billion in equity.
Emanuel’s career has taken him from Congressional aide to the Clinton White House, into the private sector where he made some $16 million for himself in just two years as an investment banker, then back to Congress as a Representative and now into the White House as Chief of Staff.
The sight of them having dinner the night of GM’s bankruptcy indicated that whatever storms are raging, at the very highest level there are always deals to be done, conversations to be had and investments to be made. In fact, the greater the storms, the greater the opportunities are for those strong or nimble enough to survive them. Whatever may be happening at Blackstone, not everyone’s having brunch on Wednesday.
While the effects of the recession continue to gnaw away at the lower levels of the economy, higher up, the purge appears to have taken place. Arguments are still going on over the effectiveness of the Obama administration’s response to the banking crisis. Some say mission accomplished. Look at the banks raising money in the bond and equity markets to pay back the government loans they received last year. That would not be possible if there were still deep doubts about their futures.
Others, notably David Einhorn, the hedge fund manager who made his name by telling investors to short Lehman Brothers several months before it collapsed, says that the bank bailout has not dealt with the underlying problem of bad loans, the reason that debt continues to crush large sectors of the US economy. Obama, he claims, has simply punted the problem downfield, in the hope that it will go away before he has to deal with it.
But elsewhere in the financial galaxy, business has resumed, gingerly in some places, robustly in others. At three of the banks felt to have best dealt with the crisis, Goldman Sachs, Barclays and JP Morgan Chase, business never really stopped. Goldman became a bank holding company in order to receive government funds, JP Morgan Chase snapped up Bear Stearns and Washington Mutual on the cheap and Barclays vacuumed up Lehman’s North American business for a steal. Look at the share prices of all three, and it is almost as if the past 12 months did not happen. The strongest have emerged stronger.
The crisis was also an opportunity to cut costs, mainly by firing thousands of financial services workers. The firms which did this quickly now find themselves leaner, extracting more work from fewer employees. Whether this new efficiency will last depends on how quickly their businesses recover.
Of course, it would be dangerous to hand out premature laurels to any bank executive. John Thain, the former CEO of Merrill Lynch, was a hero one minute for selling Merrill to Bank of America over one fevered weekend in September, but a villain the next for spending $1200 of his ailing firm’s money on a wastepaper bin. Dick Fuld at Lehman Brothers and Jimmy Cayne at Bear Stearns know even more acutely how quickly public sentiment can turn from fawning to vicious. To paraphrase Solon, call no bank executive happy until they are several years into retirement and a proper view can be taken of their work.
There are some surprising survivors of the past few months. After Bear and Lehman collapsed, many feared Macquarie, the Australian bank, would soon follow because of the extent of its leverage. But after its share price tumbled, it has since recovered and is now raising capital with apparent ease. The Citadel Investment Group of Chicago, one of the largest and most successful hedge funds of recent years, seemed close to the edge last year as the value of its main fund fell by over 80%. But this year, thanks to rallies in the distressed debt, bond and equity markets, it is up over 20% through May. It has a long way to go to get back to even, but the firm is off life support.
Elsewhere, hedge fund managers with good records continue to attract funds. Redemptions have hurt many funds, but in many cases the redemptions were the result of clients’ liquidity problems, not necessarily bad performance. The crisis certainly exposed those funds which were simply tracking the indices, but charging 2 and 20 to do so.
But it also revealed the really good ones, the Paulsons, Lansdownes and others who did what hedge fund managers are supposed to do: profit abundantly from extreme volatility.
So what, if anything has changed? Was the past year a nightmare which we will all soon forget? Or will it have lasting consequences?
Some of the changes are obvious. Investment banks which moved aggressively into proprietary trading and derivatives have had their wings clipped. The new regulatory frameworks in the United States and elsewhere tend to favour commercial banks which are supposed to take fewer risks. The range of exotic products will be limited in the future, as will the credibility of the ratings agencies which failed so dismally to apply reasonable risk assessments to the credit derivatives market. After the Bernie Madoff scandal, there will have to be much closer scrutiny of investment firms and one is likely to see a flight to quality, away from anything smelling even faintly off.
Smaller advisory firms which eschewed the rapid expansion and wide range of activities of the big investment banks are thriving. As are bankruptcy and turnaround specialists. These are golden days for corporate lawyers. Private equity firms have some $400 billion in capital waiting to be deployed, the promise of an investment boom to come.
Even the machinery of the junk bond market is creaking back to life. Firms are desperate to refinance or roll-over their debt and they are now discovering the prices at which they can do so. Companies including Ford, Harrah’s Entertainment and MGM Mirage sold more than $23 billion in junk bonds in May, the most for a single month since mid-2007. Distressed debt has been one of the best performing asset classes this year, having been beaten down to absurd levels late last year amid talk of an economic apocalypse.
But elsewhere, things have changed dramatically and perhaps permanently. Tens of thousands of financial services workers in New York and London have lost their jobs in recent months. And many are unlikely ever to be employed in similar work again. The past three decades of financial revolution created a broad class of Masters of the Universe, who made hundreds of thousands of pounds a year doing very specific work. Suddenly, they are no longer needed, and their skills cannot easily be transferred. They are like typewriter makers at the advent of the personal computer. In Manhattan and the suburban swathes of Connecticut and New Jersey, thousands of households are facing a painful readjustment. They hope that the cuts in their industry are temporary. But there is a good chance they are permanent. The banks may no longer need fleets of traders and salespeople as their product range shrinks. If, as many suspect, finance is undergoing a secular rather than cyclical set of changes, these employees will never get their old jobs back. They will discover how difficult it is to make anything close to what they made before by doing something outside finance. What is happening in these communities is deeply melancholy and it will take a modern Arthur Miller to capture the emotional drama.
One curious aspect of the downturn is the number of emails I receive from people I haven’t heard from in years. They’re not asking for anything. But it does seem as though the shake-up has forced people out of their narrow focus on work and reminded them of the importance of friendships and networks in carrying them through.
Consumers are already finding it much harder to borrow. Credit card lines have been cut and with house prices falling, the home equity loan market is quiet. Psychologically, no one wants to buy anything these days. Once you get away from Wall Street, people are extremely mistrustful of the financial system which promised them everything in good times – and now seems to want it all back. It would not be at all surprising to see calls for reform of the US pension system, since millions of people have seen the value of their invested retirement plans crash. There will be a willing audience for any politician trying to create more stability around pensions. This, of course, would be bad news for the many investment funds which invest pension money and may now face more rules and limitations.
When I graduated from Harvard Business School in 2006, some 60% of my year went into financial services and management consulting, two professions pole-axed over the past 18 months. For those who sat at the top table throughout the crisis, it has been an extraordinary education. They have seen members of the business elite fall and others thrive. For others, those who took these jobs simply in the hope of making some decent money, it has been a fraught, stressful time. It has given them a dispiriting view of human nature.
Hard times have revealed the truths about the firms they joined, their tough-minded view of people as costs, the greed of those at the top, the depression which sets in when people realise that without money, they are nothing. These were truths which were covered up when money seemed to gush effortlessly out of the ground.
It will take a while for the financial services industry to regain its bloodied reputation. But it will. For all of the regulatory thunder coming out of Washington, there is nothing to suggest financial innovators won’t do what they have always done, slip through the economic universe like water, finding the paths of least resistance. We thought they were dead after the insider trading scandals of the 1980s, and after the dotcom bubble burst. But they keep coming back, finding myriad ways to profit from the system.
The only lesson to be drawn is that you don’t want to be on the wrong side of their ambitions.
Philip Delves Broughton is the author of “What They Teach you at Harvard Business School: My Two Years Inside The Cauldron of Capitalism”, published by Viking.
Philip Delves Broughton is an author and journalist. His writing in the Wall Street Journal, As Fracking Keeps Pumping, A Qatar Grows on the Bayou details the shale gale and its impact on the global economy. He is also the author of Life’s a Pitch and What They Teach You at Harvard Business School and writes regularly on Myanmar.