Commentaries

John Meriwether writes to investors (again)

This purports to come from the hedge fund investor John Meriwether but mysteriously carries a Nigerian postmark:

Dear friend,

Greeting,

Permit me to inform you of my desire of going into business relationship with you. I got your contact from the International web site directory. I prayed over it and selected your name among other names due to it’s esteeming nature and the recommendations given to me as a reputable and trust worthy person I can do business with.

My name is John Meriwether and I am a very wealthy financier in Greenwich, Conneticut, the economic capital of US. I have been managing investment funds for welthy business associates, taking advantage of relative value arbitrage strategies. This is 100 per cent guaranteed safe way to make double digit investment returns every year and was revealed only to me by internationally renowned Nobel prize winning economists. My track record – with LTCM and JWM Partners – speaks for itself.

I have now identified new investment opportunity, that has caused the need for another big transfer of funds. If you would assist me in this, it would be most renumerative to you.  Sir, I am honourably seeking your assistance. I need the funds as quickly as possible. I am offering a double digit return on these funds, net of my 2 and 20.

To provide a Bank account where your commission would be transferred to after the successful transfer of this fund to your designate account overseas, please feel free to contact ,me via this email address johnmeriwether1000@yahoo.com

Take the L out of LBO

In a perfect world, we would simply ban leveraged buyouts. The vast majority of these debt-laden corporate takeovers are no less predatory and value-destroying to a company than a loan shark who charges usurious rates of interest.

Realistically, a prohibition on private equity deals will never happen, given the big dollars involved in these transactions and the sizeable campaign contributions that private equity chieftains shower on politicians from both parties.

So here’s another way to prevent private equity firms from again saddling their corporate prey with too much debt: Prohibit banks from committing financing to any LBO where the private equity buyers are not willing to pony up at least 50 percent of the purchase price.

A 50 percent equity threshold would stop banks from giving in to their worst impulses, which are to do whatever they can to win favor with the private equity firms, in the hopes of rich fees and the promise of lucrative stock and bond underwriting deals down the road.

And it will force banks going forward to make more loans to companies looking to expand their operations and create jobs — not destroy jobs, as is often the end result of an LBO.

Requiring a private equity firm to put up a dollar for every dollar in a financing that a deal needs to get done is not as extreme as it may sound.

In fact, at the end of the two most recent LBO booms, it was not uncommon for the small number of deals that did get consummated to involve equity commitments in excess of 40 percent, according to data compiled by Standard & Poor’s Leveraged Commentary & Data.

from Rolfe Winkler:

When genius (finally) gets wise

The people who brought you the Long-Term Capital Management debacle want banks to get serious about cutting their own leverage, applying fair value accounting to a wider range of assets.

Writing with two colleagues in the Financial Times on Tuesday, Nobel Laureate Robert Merton said banks, their regulators and legislators are conspiring to conceal depressed asset prices in order to avoid dealing with the consequences of insolvency. He wants wider adoption of fair value accounting to force banks to fess up to losses and raise more capital.

Speaking on Bloomberg radio, Merton’s long-time associate and fellow laureate, Myron Scholes, concurred.

This is very refreshing, an honest appraisal of the disease still infecting the financial system---leverage---from two prominent economists who learned the hard way that leverage kills.

These days it’s de rigueur to declare that the worst of the recession has passed, that we’re on our way to “recovery.” Never mind that big banks remain insolvent. Take away the government guarantees that provide them cheap financing and protect the value of their assets and many would be at risk of collapse.

As I argued earlier this week, the fall in real estate prices implies huge losses for bank loan portfolios, losses that could wipe out what’s left of their meager capital.  We got another reminder on Monday of just how bad the losses might be. BB&T said it marked down loans acquired from failed Colonial Bank by 37 percent.

A loss rate half again as large, if applied to Citigroup, Bank of America and Wells Fargo, would wash away what’s left of their equity capital. In other words, despite recent capital raises, their leverage remains way too high.

from Rolfe Winkler:

Banks still need bigger cushions (Q2 TCE update)

It was a surreal moment two weeks ago when analysts on Goldman Sachs’ earnings conference call pressed CFO David Viniar to jack up leverage. They seem to think that the worst of the credit crisis is behind us, so Goldman should goose its risk profile to increase returns. This is remarkably short-sighted.

Yes, leverage is down, but only relative to the obscene levels reached a year ago.  Measured by tangible common equity, the biggest banks are still levered over 20 to 1. If banks learn nothing else from the financial crisis, it’s that they should err on the side of prudence, carrying substantially more capital than appears necessary.

(Click table to enlarge in new window)

Tangible common equity remains the crucial measure of bank capital because it’s the primary cushion to absorb losses. When that cushion gets low, creditors panic. Bank runs ensue and the financial system ceases to function.

A nickel of equity for every dollar of assets is a pathetically small capital cushion.  And today, banks substitute federal guarantees for liquid capital.  Policymakers are afraid to remove the guarantees because they don’t want to precipitate another collapse. The financial system can’t stand on its own until its capital cushion is rebuilt.