August 11, 2009

Getting Out of the Doghouse

Hey, finance professionals: we've got a problem.  Really we do.  In case you haven't noticed, the Great Recession of 2008/9 has a Villain (with a capital V) and it's you and me.  I know, I know, we did nothing wrong; we're generally decent, hard working, well-intentioned souls who humbly ply our trade in a peculiar, esoteric, and well-paying corner of the economy.  But we don't actually produce anything tangible, which makes us an easy target when a lot of people who do actually manufacture real "stuff" are out of work.

And, indeed, the demagogues swirl like turkey vultures seeking carrion.  Who is blameworthy for the sad state of affairs in this country?  The cry rises from the frenzied mob: Banks!  Private Equity Firms!  Mortgage brokers!  Investment banks!  Venture Capitalists!  Money Managers!  MBAs!  (Barney Frank busies himself handing out torches and pitchforks while Timmy G and the Treasury crew ready the shackles.)

But even our friends are enemies in this battle: over the summer I helped a cousin work through a mortgage refinancing.  Some Excel whiz-bangery did little to clear up a confusion born of too many options marinated in too many layers of uncertainty.  "Forget the spreadsheet; what's the best choice for me?" asked my cousin.  "It depends," I replied, dusting off an all-purpose answer.  "What do you think the future holds?  How long will you live there?  Are rates going up or down?  What will your tax situation be?" etc., etc.  "It's all so confusing," was the reply.  Then, my cousin's tone changed to bewildered frustration: "you finance people have made this stuff so complicated, and each choice seems like another opportunity for people to get ripped off."

And then it hit me: the average person doesn't want life to be an HBS case.  The Socratic method may work well in air-conditioned, wi-fi enabled classrooms with sage professors guiding a meandering discussion, but people live in the real world where decisions have consequences and costs — sometimes big ones, sometimes immediate ones.  And all of the optionality increases anxiety, not to mention adding complexity to once-simple account statements.  I know some pretty smart people who just don't understand their cell phone bills.  The dis-utility of complexity has exceeded the utility of choice optimization. 

But we can help, finance people!  And burnish our tarnished communal reputation at the same time!  Here's my modest proposal: what if everyone in finance, insurance, and real estate committed to doing a few hours a month of pro bono work?  Maybe we could participate in "office hours" for half a weekend day once a month?  We could use bank branches; after all, the government owns a lot of 'em now.

Sure, you'd have to pass some good Samaritan protections so that lawsuits wouldn't ensnare the well-meaning, but imagine the good (and goodwill) that would arise from an army of savvy people helping oldsters understand their cable bills, helping young couples think about their mortgage options, helping college graduates set up their 401k plans.  Anything that has to do with money and is even remotely intimidating would be fair game.  (Of course, it would have to be a marketing-free zone.)

You could even make it a continuing education requirement for the first five years after attaining professional licensing or designation like a CPA, CFA charter, Series 7, CLU, or CFP, with subsequent participation encouraged.  I suspect the idea of ongoing participation could elicit some chortles on the 5:26 out to New Canaan, but remember, guys: that cat next to you from Ropes & Gray's New York office could be coming back from a day at the NYC Family Court Legal Service Project.

My old buddy, the Prof, suggested making some threshold of pro bono activity a requirement for FDIC insurance.  He even had the idea of creating the equivalent of "patient advocates" for thornier cases.  Maybe we could establish industry-funded fellowships to support laid-off or on-sabbatical professionals.

You could even imagine some kind of clearinghouse for people that incorporated the best of Web 2.0: feedback ratings, maybe even a "bid system" for appointments or specialists.  Think of it as a mashup of Craigslist, eBay, Google Maps, and us.  You could even throw in Twitter for good measure.  We can fix this, we have the technology.

Now the last thing I want is to create more bureaucracy and regulation.  But we have to realize that the regulation train has left the station and is bearing down on us at full steam.  And indeed, there are a lot of folks in the chattering classes who would portray finance professionals as the looters that smashed the storefronts of the economy, cynically plundering from the earnest masses.  Maybe the best thing we can do for ourselves and the economy is to pick up a broom and start sweeping up the mess.  

July 21, 2009

Pain Points

Along the way, the kids on the block started calling old DiPietro “Boch.”  I didn’t know what it meant, but always guessed it was short for some term of endearment in La Bella Lingua.  And it was a great nickname for the generous old guy: whenever a Spaldeen would crack in two – a pretty frequent occurrence in our stickball marathons – the cry would rise up from the boys to his ever-open apartment window: “Aaayyyyy, Boch!  Yo Boch! Bocheroonie!  You got a spare Spaldeen up there?”  Sometimes it took a minute or two, but eventually, a pink rubber ball would fly out of that window on the third floor and go bounding onto East 2nd Street below.  I swear he bought those things by the case. 

Boch had seen a lot since boarding a ship for America all by himself in Palermo on his fourteenth birthday.  And he loved to tell us stories; his favorite was about how he snuck into a game at Ebbetts Field on the very day he cleared quarantine at Ellis Island.  But the thing Boch liked best was dispensing advice to the growing boys enjoying some post-stickball lemonade on his stoop.  “In life,” he often warned forebodingly, “someone’s always got you by the coglioni.  The only thing you can control is how hard they squeeze.”

It’s advice I ponder frequently, doing the voodoo I do. 

* * *

Lately, I’ve been a bit bummed out, though: “don’t waste a good crisis,” the new mantra goes.  So let me ask this: why aren't we using this epic downturn to fundamentally re-frame the relationship between GPs and LPs?  Instead, people are battling along the same lines across which LPs and GPs have been skirmishing for years.  It's like World War I: fierce battling yields a few acres of pockmarked muddiness.

But what if it doesn't actually matter if the fee offset is two-thirds or three-quarters?  What if it really doesn't make a difference whether the no-fault is triggered by 66% or 80% in interest?  Maybe the the LP-friendly/GP-favorable axis needs to be discarded in favor of some entirely new, orthogonal continuum that re-thinks how interests are aligned?   

Let me put a finer point on it: currently, LPs worry that the carry system grants GPs a free option in times of frothy markets; LPs ask: why pay an incentive to people who simply capture beta?  GPs on the other hand bellyache about how long-dated carry payouts can be; after all, those wacky hedgies get paid every year (watch those high watermarks, boys).  But what if we rethought the way in which carry is paid?  What if we instead paid people on a deal by deal basis, but only when they beat the opportunity cost of an appropriate public index?  And let's acknowledge that the public markets are a fast rabbit, so we should pay people a substantial portion (25%? 50%?) of the excess return above equity-substitute cost of capital.  You would have true-ups every couple of years to ensure that groups didn't get paid more than X% of the net profits on the fund.  

Something like that could be a win-win: LPs get a formalization of private equity's return enhancing essence while GPs pull carry forward (increasing the PV!) and could even get paid on flat (or down!) investments, as long as they exceeded public market comps. 

While we're at it, we could also get everyone on a budgeted fee (now I'm getting Pollyanna — sorry: I've exceeded my daily Diet Coke allotment).  Pay yourselves well, folks; this is America and there's a market for your services, but let's not be bonusing back millions of dollars in excess fees . . . let's focus on cap gains, not W-2 income.

Of course, there are a million reasons why we'll never see a radical departure from the status quo: the fundraising "haves" don't need to mix it up while the "have nots" may be perceived as desperate for offering something new.  And indeed, LPs find themselves trapped in a prisoner's dilemma.  Most perniciously, the legal and accounting costs of a new structure could be prohibitive.

But, unfortunately, the most difficult hurdle to surmount is that any out-of-box thought would "make people's heads hurt."  It's a common complaint.  The status quo is easy to support and difficult to dislodge.  Maybe old Boch was right?  Maybe by trying to avoid headaches, we're sealing our destiny to keep squeezing each others' coglioni?

But what if we used this juncture in the short history of the private equity business to do something extraordinary?  What if we tried something new to make us all better off?  Almost a half-century ago, President Kennedy exhorted us to go to the moon, not because it was easy, but rather because it was hard and surmounting the difficulties would bring out the best in us.  Maybe trying something new might beat the squeeze-off to which we've otherwise consigned ourselves?

July 16, 2009

Random Thoughts from Denver Airport

So, I've got a more fulsome post (at long last) coming later this afternoon, but in the interim, I had to get some things off my chest:

[insert rant here]

First: if we're going to have national healthcare, particularly a program that's paid for by a small subset of taxpayers, we need to ban the sale of cigarettes yesterday.  Either that, or tax 'em at like $15 per pack.  Anything less creates a huge principal-agent problem.  While we're at it, let's do something about Mixed Martial Arts.  Do we really want kids watching this stuff on ESPN and then going out behind the trailer and practicing a sport whose usual loser's outcome isn't graceful defeat, but rather a hospital visit?

Second: Why is anyone surprised that the savings rate continues to climb (some say it might soon exceed 10%)?  Sure consumers are de-levering, but savings rate is also a function of people's expectations of future disposable income, no?  And disposable income is a function of income and tax rate.  People may have differing expectations on income, but one thing we can probably all agree on is that taxes are going up, up, and away.  As we used to say in Brooklyn: BOHICA.

Last: no matter how low my expectations get, United Airlines never ceases to underwhelm.  Once, I expected courtesy, then I hoped for indifference, now I just want to get home without interacting with any more of their employees or having them bark at us over the intercom.  How does an airline that treats its customers so cynically stay flying?  Remember the old phrase, "one bad flight attendant can bring down an entire airline?"  When did people stop caring?  It's that pesky principal-agent thing again . . .

[end rant]

June 30, 2009

Systemically Important

It's been thrilling to watch the Green Revolution unfold on Twitter.  It reminds me of those sweltering days of Tienanmen long ago.  You see, back then there was a Chinese immigrant-owned business over on Church Avenue and the fax machine in the back groaned nonstop as it disgorged furtively-sent messages on curly-thermal parchment.  Unofficial word of officially-banned events crept out of the top of the machine as a half-dozen men crowded around, anxious for news of home and breathless at each pause in the transmission.  Every break in the traffic gave smoke-stained fingers the chance to tear off the latest pages, place them on the backup fax (connected to a telephone jack in an apartment upstairs by a hundred feet of frayed cord), and relay the fresh news on to another clutch of emigres in Boston, Honolulu, Vancouver.

Such was the Fax Americana.  Technology in the service of information, democracy and freedom.

So here we are again, two decades later, watching voices from the other side of the globe cry out.  And with each Tweet, it becomes more evident that the United States has outsourced the public face of its foreign policy to Silicon Valley.  Of course, this is happening just as the bureaucrats in DC are contemplating a raft of regulations aimed at the types of firms that fund the companies that allow the administration to exercise soft power.  Ironic, no?

There's even talk in some quarters of venture firms being tangled up in yet more onerous regulations targeted at firms that pose systemic risk to the financial system.  Funny: the way I see it, the only systemic risk that Silicon Valley poses is to opacity and oppression everywhere.

June 13, 2009

Picture of the Day: The Ruins of a Low Dishonest Decade

I think you'd be hard pressed to find a city whose economy offers a better tour through the American economy — with all its ups and downs — than Seattle.  From the once-vibrant sawmills along the muddy banks of the Wishkah to the cavernous airplane factory in Everett to the bucolic Microsoft campus over in Redmond, it's all there.  Driving around for an afternoon, you can take a journey through time from the resource-focused past to the post-industrial future. 

And on a sunny day, there may be no finer city in all the world.  I love walking around Seattle when the skies are blue; glimpses between buildings offer fleeting peeks at diamond-sparkling Puget Sound and the verdant isles beyond.  The occasional seaplane buzzes by, punctuating a steady line of Boeings flying back to the place they were born, an airborne metaphor for the salmon running in the crisp freshwaters nearby.

And there's this great sculpture on Second Avenue; I've always thought of it as a metallic version of the stone ruins on some sun-drenched Aegean isle.  Maybe the sculptors were making a point: sic transit gloria mundi; everything is fleeting, no matter how permanent the marble or metal may seem.  It's irony in steel.

But on Thursday I looked up and realized (not being a local) that these urban ruins stand (er, lie) on the grounds of the Washington Mutual Tower.  A sculpture of ruins before the old HQ of a ruined company.

And then it hit me: forget all this symbolism of paying back TARP funds.  Maybe WaMu's corporate heir, JPMorganChaseandFriends, should contact the sculptors and ask them permission to "fix up" the sculpture.  Maybe with enough (ahem) inducement, the artists could decamp (under cover of night) the askew original for a meandering sculpture garden somewhere.  In its place, they could deposit a new set of pieces that would snap together cleanly when righted.   Imagine the photo op: hardhat-clad, bullhorn-clutching Jamie Dimon directing cranes as they ressurect the columns.  The pillars of capitalism standing once more! 

Of course, if we've learned anything from the ruins of those ancient lands it's that disasters, natural and man-made, inevitably take their toll on temples and memorials.  Sometimes, it's what people do and how they act that resonates better than the monuments they build.

Ruins