Friday, May 29, 2009

Remoras or suckerfish are commonly found attached to the skin of whales or sharks. The remora's diet is primarily leftover fragments from its host. The host they attach to gains nothing from the relationship. Over centuries the remoras emerged from the primordial depths and began to work on political campaigns. Post the political campaign they enter a lucrative dormant state known as "tokenus job privatus market" before bursting from their chrysalis as either an appointed government employee or as a "moneyfinder", a seller of access to public retirement money. Before sailing from the Galapagos, Darwin observed many whales errantly swimming into large rocks as contact with the remoras seemingly deprived them of their ability to make sensible choices. This trait of infecting the host persists on land today and is known as "politicial contributions."

Dominating the recent headlines has been the unsurprising tale of government pension funds hiring money managers, who have made payments to money finders for no apparent purpose other than to buy influence at the pension fund. Ironically, these payments are made in parallel to the monies being paid to legitimate placement agents for providing marketing services. In order for these schemes to work, three parties need to be complicit: a pension fund manager, the money finder and the manager. Note that there is no actual placement agent in this Bermuda Triangle of cash. Yet, in response to the recent NYS Scandal, what solution was determined by the Controller and the Attorney General of NYS? Ban the placement agents. Applying that logic, their solution to the Spitzer scandal would have been to leave the Governor in office and to ban women.

Other equally Solomon-like action has taken place in Private Equity regulation. Rather than have a trial regarding the largest payments made by one firm to a "money finder," the firm bought absolution by writing a check valued at less than two years' fees earned off the NYS commitments and agreed to disavow future use of placement agents. Despite this being the third state scandal involving said firm in the last ten years, they were permitted to issue a press release stating their agreement with the AG "would set a new standard of ethics for the industry." They also announced they would sue their placement agent for "deceiving them." Their public relations effort is beginning to rival OJ Simpson's pursuit of the real killer.

The fine wrinkle that keeps this whole scandal a chapter short of a Mickey Spillane novel is the additional side payments made by various firms, including one run by a current member of the White House auto industry team, to finance a movie being produced by the brother of the NYS pension manager, David Loglisci. To give you a sense of its cinematic value, several scenes were shot at the Stamford pizza place from which we order lunch on Fridays. To hear an explanation that these payments were a normal part of a pension fund solicitation sends eyebrows toward Hubbell. The title of this movie, Chooch, Italian slang for knucklehead, is a fitting label for all the players.

Despite our continuing economic slump and the bizarre attempts at leadership offered by the political, business and journalist class, we are fortunate to still see examples of selfless leadership such as that shown by Captain Richard Phillips in the recent skirmish with Somalian Pirates. He traded his own safety for the lives of his crew as his actions revealed his priorities. Juxtapose his behavior with our political leadership's: Senator Grassley "Resign or kill yourselves," our business leadership's: Chrysler's Bob Nardelli "I feel good about getting us here" or our journalists' fixation with Michele Obama's right to bare arms. Meanwhile the faux outrage vented over AIG bonuses was completely absent for the same event at FNMA, yet neither the press nor the White House harped on that inconsistency.

The latest impulse out of Washington is to regulate compensation - a plan likely to be as successful as the Egyptian pig slaughter was in halting swine flu. To date, the lowest common denominator populist approach has led to TARP banks removing their brand name from multiple sporting events where they had already paid non-refundable millions for the privilege. Nor did the banks bring any clients to the events. If one assumes that advertising can lead to sales and profits then how does throwing away money on advertising by banks the government is already supporting help the banking system? Despite the outrage over the sums lent to the banks now there is a pause over letting them repay the money. In a Bizarro world's "Brewster's Millions" banks have reduced expenses, written off loans and raised capital to be told they may need to hang onto the "excess" TARP funds. One other nuance of the Chrysler bankruptcy is yet to be explored. The apparent abandonment of hundreds of years of contract law regarding senior creditors has been amply explored, but what is the implication for the cost of future secured borrowing for large "too big to fail" unionized companies? Certainly a senior lender would not be foolish enough to think its security interest will compensate for its true risk, so will secured lenders to such companies demand equity-like returns to lend? If so, what are the implications for those companies? Will they become permanent wards of the federal government to stay financed?

In addition to the denominator effect that has been amply discussed in the press, another factor is looming as a further hindrance to liquidity for private equity investors. Interpolating the December 31, 2008 Cambridge Associates benchmark data for vintage years 2003-2005 suggests that nearly 100 Funds (70% of their universe), formed in those years have a net IRR of less than 8%. Any reasonable assumption about 2009 and 2010 will have growth in the economy or the value of financial assets at less than 8%, greatly reducing the Fund's chances of beating 8%. Consequently, the Fund term designed to align interests, the preferred return, usually set at 8%, is having the opposite effect. For those 100 funds the economic incentive is now to maximize management fees by retaining assets rather than seeking liquidity to earn carried interest. No quarter would be complete without another Citicorp theatric. After first defying all financial conventions by reporting they had a profitable eight weeks earlier in the quarter, Citicorp released its actual first quarter "earnings." They reported earnings of $1.6 billion. However, $2.5 billion of the earnings were due to accounting gains due to the decline in the market value of Citi's issued bonds. Apparently, Citi is able, for accounting purposes, to account as if they bought back (they didn't) the declining bonds and booked the difference between the low price due to their deteriorating financial condition and par as a gain! Rod Serling advised on the accounting. By this standard the Madoff victims are the nouveau riche!

I’m Rob Morris and I approved this blog.

Remoras Or Suckerfish Are Commonly Found Attached To The Skin Of Whales Or Sharks...