Felix Salmon

The SEC comes round to private markets

Felix Salmon
Apr 8, 2011 13:12 UTC

Jean Eaglesham has a big piece of news today: yes, the SEC is looking into the private share dealings in Facebook. But not necessarily with any kind of enforcement in mind. Instead, it’s thinking about raising the 500-shareholder limit which marks the point at which companies need to start making public filings.

A move in this direction would be a huge ratification of private markets by the SEC, which was created to protect investors. I guess that one way of protecting investors is to ensure that they never get an opportunity to invest in the first place:

The move could potentially delay or derail IPOs by tech companies that want to grow but would rather avoid having to disclose vast amounts of information. It could also shut out many ordinary investors from one of the fastest-growing market sectors, since shares in private companies are generally available only to investors whose individual net worth is at least $1 million. And at a time when investors are seeking more market transparency, it would lessen the amount of publicly available data about those companies.

The point here is that there is literally an opportunity cost to such a move, which is almost impossible to calculate. How much diversification (in the technical sense) and diversity (in the more colloquial sense) are the public markets going to miss out on if important, fast-growing companies stay private rather than going public?

But I have to admit I don’t understand this:

The possible changes come amid concerns about a dearth of U.S. stock listings, which politicians on both sides of the aisle worry could hurt American competitiveness with the rest of the world.

I don’t know which politicians Eaglesham is talking about (Tim Geithner, perhaps?), but in what sense are stock listings a sign of international competitiveness? There might be a vague correlation there, but I can’t see much in the way of causation. Indeed, there’s a strong case to be made that US companies can be more competitive internationally if they’re free to concentrate on running themselves as best they can, and don’t need to use up precious management cycles dealing with analysts and journalists and people second-guessing all of their actions on the basis of how their share price is moving that day.

The sourcing on the story is about as annoying as it possibly can be: Eaglesham says that the SEC review was “disclosed in a letter to a lawmaker,” without saying who did the disclosing, posting a copy of the letter, naming the lawmaker in question, or even explaining how the letter came to be written. This kind of coyness does nothing to advance the public interest; instead it looks like little more than a petty way of jealously guarding Eaglesham’s Capitol Hill source so that her competitors can’t find the same letter. Come on, WSJ, your job is to make news public, not keep it to yourself.

Eaglesham’s story comes in the wake of two very different takes on the prospects facing private markets. Evelyn Rusli has the bullish view from Silicon Valley, where entrepreneurs are turning down millions of dollars in funding and indeed are cashing out long before any IPO.

“By taking money off the table, you’re expunging a big source of risk, allowing you to focus on the interests of the company you’re building instead of your own,” said Andrew Mason, the 30-year-old founder and chief executive of Groupon. He said he was able to sell some of his shares in D.S.T. Global’s initial Groupon investment, a $135 million round last April.

Meanwhile, Gregory Zuckerman has the more bearish view from Wall Street, where Goldman Sachs’s attempts to put together a private stock exchange called GSTrUE have gone absolutely nowhere.

Goldman has largely stopped working on GSTRuE, merging it into the Portal Alliance, a fledgling network developed by Nasdaq, Goldman and Wall Street firms to act as a single market. That effort hasn’t attracted any new listings, either.

“When everyone ran for the door in the crisis it changed people’s desire to invest in things that aren’t listed” on an exchange, says Anton V. Schutz, manager of Burnham Financial Funds, who says he no longer buys issues that aren’t listed. “Even deeper markets than this haven’t come back after the crisis.”

Why was GSTRuE a failure while SecondMarket and SharesPost are much bigger successes? I suspect that the answer might have something to do with the fact that GSTRuE was set up to mimic a public exchange, with a common set of rules for every company looking to list and every investor looking to trade. The auction sites, by contrast, are happy approaching every deal on a case-by-case basis, structuring auctions to exactly the specifications of the company in question. And, of course, there’s also the fact that there’s a Web 2.0 bubble right now, while GSTRuE launched mainly with asset-management firms which are much less hot.

In any case, it looks very much now that all the current shareholders in SecondMarket were quite right to hold on to their shares rather than sell them on SecondMarket. (There have never been any SecondMarket trades in itself, because no one wanted to sell.) Today’s news has surely increased the value of the company substantially, and you can probably add SecondMarket founder Barry Silbert to the list of people who is politely telling would-be investors that sorry, he has no use for their money right now.


Seriously, Felix, how can you say that
“there’s a strong case to be made that US companies can be more competitive internationally if they’re free to concentrate on running themselves as best they can, and don’t need to use up precious management cycles dealing with analysts and journalists and people second-guessing all of their actions on the basis of how their share price is moving that day.”

There is a reason that listing on U.S. stock exchanges is so highly sought after. And shares of U.S. companies (as well as German and U.K and no doubt others) are desirable for investors. That reason is “disclosure requirements” and GAAP (or international GAAP for Germany UK others). If U.S. companies didn’t have disclosure requirements, they would also be a lot less attractive to international investors!

Private stock, restricted stock, whatever, is not appropriate for everyone. It is particularly inappropriate as an investment for those who don’t have access, or time, to do the sort of research necessary to estimate valuation with a pro-forma. Most non-institutional investors have their hands full with investing and following exchange traded equities.

I have an account with SharesPost, have had one for over a year. SharesPost has very explicit disclaimers and warnings about lack of transparency and liquidity. I think well of SharesPost, I am not disagreeing with your assessment of them, as they offer a service, along with disclaimers that any analysis or research reporting provided is based on limited information about these private companies. This is not investing for the general public, and SharesPost makes that very clear.

I think that spiffy76 (the previous comment) is right on the mark in his assessment.

Trying to turn private markets into “semi-public” ones, as spiffy76 said, subverts the whole concept of SEC disclosure requirements, and will result in an even less equitable IPO market. Right now it isn’t great, but at least we know how it works.

One other thing. I’ve been wondering about this for awhile, would be appreciative if anyone addressed: Why DOES Facebook want to do a semi-private IPO, or any sort of IPO at all now? Why would they want to give up any amount of ownership in this company? It is hard for me to believe that they lack for funds so much that they would want to sell equity.

As a private company, Facebook isn’t burdened by disclosure, public scrutiny, shareholder accountability. That is the benefit of their status as a privately held concern. Why change now?

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Why private equity markets are on the rise now

Felix Salmon
Apr 2, 2011 06:17 UTC

I got some predictably super-smart reactions to my questions about private equity markets at the Kauffman Bloggers Forum today.

Matt Yglesias said he couldn’t see what the fuss was all about: the SEC was created to protect small individual investors from having access to super-risky companies that disclose highly limited amounts of information, and that’s exactly what it’s done. It’s a good point, especially in the context of another idea, from Steve Waldman, which was echoed in the comments to my post by absinthe.

It’s the concept of the winner’s curse: that it’s maybe no coincidence that the Russian clients of Goldman Sachs who are falling over each other to bid ever-higher prices for Facebook shares are much the same people as the Russians paying $100 million for trophy Picassos, or Los Altos mansions.

The theory here is that Goldman Sachs, SecondMarket and the like have identified a group of buyers who are willing and able to pay through the nose for assets which are rare and special and which few other people can have. So long as companies like Facebook and Zynga meet those criteria, the winners in any auction for their shares are likely to be cursed — or, to put it another way, the final auction price is likely to significantly overvalue the company.

Looked at in this way, the market in private equity is less an opportunity for plutocrats to get excess returns, and more an opportunity for intermediaries to extract large profits by selling them overpriced equity in overhyped tech stocks.

As for the timing of all this, Virginia Postrel said that maybe all it took was one or two companies going this route successfully, and then everybody — both management and investors — wanted to join in the fun. A catalytic event is by its nature unpredictable, but once the idea got out that there was a lot of money and attractiveness in private markets, it became self-fulfilling. It’s important not to use Facebook as an example of what can happen when companies go the private route — especially since recent news implies that it might go public early next year. It really is sui generis. But Facebook can still be an important catalyst, inspiring many others to take a serious look at alternatives to expensive and stressful public markets.

On which subject, many of the bloggers in Kansas City were convinced that Sarbox really is an important reason why public markets have become less attractive. The year 2001, in this view, saw not only the 9/11 attacks, which gave birth to the security theater of the TSA; it also saw the Enron scandal, which gave birth to the regulatory theater of Sarbox.

Finally, Tyler Cowen had a good point: now that the rich are getting richer, it’s easy to see how there might be no need for companies to tap the power of millions of small investors any more. If you can get all the equity capital you need from a handful of plutocrats instead, that’s surely a preferable route to go down. In this view, the rise of private equity markets is correlated to the rise of the international plutarchy. Which makes sense to me.

Update: Here’s the talk, for those of you who want to see the questions as well as the answers:


This is a misapplication of the concept of winner’s curse, which would apply in any auction scenario whatsoever. The problem, of course, is how a bidder can limit the harm from being seen by others to have won the auction at an inflated price. One solution, in fact, is to limit the number of bidders who participate in the auction. Private markets like Goldman’s Facebook deal solve that problem, whereas a public floatation would bring in the entire universe of potential investors. So the truth is that private market investors may be willing to allow Goldman an excess participation in the deal in return for keeping out everyone else on the planet (until later).

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Brazil’s love of equity

Felix Salmon
Mar 29, 2011 13:44 UTC

About the same time that “junk bonds” became “high yield” and shortly after “third world” became “emerging markets,” the finance industry quietly engineered another rebranding: “leveraged buyouts” became “private equity.”

So as Andrew Ross Sorkin notes today, the idea of a private-equity shop without debt is fundamentally at odds with the genesis of the industry. This is private equity done the old-fashioned way, where “old-fashioned” means “unprecedented.” But in Brazil, it makes perfect sense: rates there are simply too high to be able to make LBOs profitable, and meanwhile there are lots of efficiencies to be found turning smallish family-owned companies into much larger professionally-run operations.

Brazil is particularly suited to this model, as it has a lot of family-owned companies, and it also has a large elite professional class which is more than capable of taking them on and running them efficiently.

Sorkin is a bit credulous when he wonders at how Brazilian private-equity shops can “make such huge profits,” citing returns of “more than 20 percent annually.” The fact is that many of these family-owned companies, if they’d simply waited two or three years and gone the IPO route instead, would have seen bigger returns than that on the amount of money that they actually sold for. The IPO market in Brazil has been white-hot for a while now, barely taking a breather for the global financial crisis to come and go. Brazilian private-equity shops fund themselves with 100% equity not just because debt is expensive, but also because equity is extremely cheap.

That said, it does make a certain amount of sense for a deep-pocketed investor to buy a good but small franchise and spend the money needed to get it big and efficient enough to IPO effectively: private-equity firms are probably a good way of shepherding companies to the promised land of an IPO, or some other big exit. Effectively, private equity in Brazil is behaving more like US venture capital than it is like US private equity. Except it’s more interested in old family-owned companies than in young technology start-ups.

All of this is a welcome development, in a world with enormous systemic risks associated with debt finance. Private equity might not be as good as public equity, from a public-policy point of view. But it’s still better than debt.


leveraged buyout investing is a class of private equity. so is venture capital (assuming the VCs buy equity and aren’t making some sort of loan). private equity is just what it sounds like – equity that is not publicly traded.

“the idea of a private-equity shop without debt is fundamentally at odds with the genesis of the industry.” this is not true. the idea that PE in Brazil is done with no/very little debt is only surprising/interesting/profound to people who do not understand finance very well (sorkin included).

private equity done the “old-fashioned way” was just people investing in businesses that couldn’t get bank loans…something more comparable to VC today and something akin to PE in Brazil right now. not something “unprecedented.”

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More worries about companies staying private

Felix Salmon
Mar 23, 2011 20:43 UTC

It’s not just me worrying about the implications of fewer companies going public. Tim Geithner thinks the same way:

At the earliest stages of funding, small companies have become more reliant on angel investors, universities, or sector-specific investment shops.

And as these small companies find their footing, they are waiting longer than ever to go public – financing themselves instead through multiple rounds of private equity or venture capital.

The number of IPOs in the U.S., for example, has decreased during the last two decades. And even though IPOs have picked back up in the wake of the financial crisis, an increasing number of U.S. companies are going public in other countries, or even deciding to stay private and access different sources of funding.

The reaction to my piece has been illuminating. Stephen Bainbridge, of course, blames Sarbox, citing survey data, among other things. I’m unconvinced, although I do agree that it’s a boon for accountants. Derrida, in the comments on my post, reckons that a stock-market transaction tax would help. I like that idea more: liquidity can be a bad thing, and throwing sand in the wheels of the stock market would almost certain bring correlations there down, thereby reducing the diversification benefit to investing in private equity. It would also, of course, make buying and selling stocks more expensive — and that’s arguably a good thing too, if we want shareholders who act like owners rather than short-term speculators.

The most interesting pushback came from Ryan Avent. It’s worth taking his points one at a time:

Mr Salmon hasn’t managed to convince me that this recent trend is actually a threat to American capitalism. For one thing, he’s argued persuasively that private ownership is likely to be advantageous for firms that don’t need to raise money in public markets. It spares them the need to deal with pushy, impatient, litigious shareholders, allowing the firm to focus on its private goals and long-term growth. From a public policy perspective, the incentives facing firms are of some consequence.

Well yes: which is why it’s a good idea to nudge incentives more towards public markets and less against them. In America for pretty much all of the 20th Century, and in the rest of the world even today, public markets have shown themselves to be a really good thing when it comes to value creation. Before we simply come to the conclusion that we were doing it wrong all along, and that the rest of the world is still doing it wrong, it might be worth asking whether public markets shouldn’t by rights be more attractive than they are. It’s also worth asking whether pushy, impatient, and litigious shareholders are creating or destroying value. I genuinely don’t know the answer to that one.

Ryan continues:

I’m also not convinced that this trend is likely to leave private investors shut out of capital ownership. If millions of Americans want to invest their savings in equity of some sort, and if firms are out there looking for funding (and if there aren’t firms out there looking for funding, the economy has a bigger problem than stock ownership), is it really plausible that the financial system won’t find ways to match the two? There are many things to be said by way of criticism of the financial system, but its inability to exploit a profit opportunity is not one of them. And letting trillions in small investor savings trickle into low-yielding bonds would represent a massive missed profit opportunity.

I’m not for a minute saying that individual investors are going to wind up in low-yielding bonds as a result of all this. I’m saying something worse: that individual investors are going to wind up in low-yielding stocks as a result of all this. The US stock market is still worth some $17 trillion — there’s no shortage of stocks to invest in. But I worry that individuals investing in the stock market are just going to be buying and selling stocks to each other, while being gamed all the while by high-frequency traders. The more important work of capital allocation, meanwhile, is being done by private equity and venture capital shops.

The point here is that while demand for stocks to invest in might well be a profit opportunity for Wall Street, firms are smart enough now to realize that things which make lots of fee income for Wall Street aren’t necessarily good long-term ideas. So given the choice between a Wall Street investment banker who says “I can make you rich in an IPO”, and a Silicon Valley VC who says “you’re already rich, I can give you all the money you want, I can personally help you become even richer, and you won’t need to worry about being public,” the latter looks a lot more attractive. Does that VC dream of an exit-via-IPO at some vague point in the future? Maybe, maybe not. But a delayed IPO is still better than one tomorrow. Meanwhile, individual investors will continue to invest in the stocks that already exist. They just won’t make that much money from them. Which brings me to Ryan’s final point:

A different question is whether small investors will earn a lower rate of return than the big, rich, connected guys. I’m going to go ahead and ruin the suspense: they will. Now, Mr Salmon wants to make the point that defined-benefit retirement plans can earn better returns than defined-contribution plans, because managers of the big plans can play on the same field as the rich, well-connected investors who get to put money in Facebook. Perhaps that would remain the case, or perhaps that premium would disappear if a larger share of workers invested in defined-benefit plans. I can’t say. But that’s a fundamentally different question from whether falling numbers of public stock offerings threaten to end ownership of capital by the masses.

Ryan forgets, here, that a larger share of workers did invest in defined-benefit plans, for most of the stock market’s heyday. And that during those years, defined-benefit plans did pretty well, considering.

I’m not worried that falling numbers of public stock offerings threaten to end ownership of capital by the masses. What I’m worried about is that the masses will end up owning the dregs of the capital world — the overpriced stocks which nobody else wants, and which they get automatically when they buy their index funds. Meanwhile, private companies will be owned by plutocrats, and will comprise an ever-increasing share of the US economy. Which might be good for both the companies and the plutocrats. But it’s clearly not so good for those of us with 401(k)s.


Wow, I never thought of it that way, y2kurtus. That makes perfect sense!

The real value of a company — as long as you own it — is in the cash flow. Market price is only relevant when you sell it (or transfer it to your heirs).

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The downside of companies staying private

Felix Salmon
Mar 22, 2011 20:42 UTC

I had a pretty involved Twitter conversation with TED today on the implications of the fact that fewer companies are going public. We’re both agreed that from a corporate-finance perspective, the trend makes perfect sense: the all-in cost of private equity is lower than the cost of going public. (For reasons why that might be the case, see here or here for starters.) But broadly speaking, from a public-policy perspective, is this a good thing or a bad thing? My thesis is that it’s a bad thing.

There are a few different reasons for this, but they basically boil down to the idea that it’s a good idea for stock ownership to be as broad as possible. What we don’t want is a world where most companies are owned by a small group of global plutocrats, living off the labor of the rest of us. Much better that as many Americans as possible share in the prosperity of the country as a whole by being able to invest in the stock market.

I’m not saying that individual investors should go out and start picking individual stocks. But I am saying that equities provide bigger returns, over the long term, than other asset classes. And that therefore it’s not good public policy for the ability to invest in an increasingly large part of the equity universe to be restricted to an ever-shrinking pool of well-connected global plutocrats.

Historically, this wasn’t much of an issue. Yes, there were private companies, but once they reached a certain size, they generally went public. Even after private-equity firms started becoming important players, those firms were largely funded by pension plans which were ultimately invested on behalf of relatively small individuals.

Nowadays, however, things have changed. There’s much more equity capital available for investment in the private markets than there has ever been in the past — which means there’s much less need for private companies to go public. On top of that, most of us aren’t invested in big pension funds and never will be: the country has moved from that model, based on defined-benefit pensions, to a model of defined-contribution pension plans where individuals invest their own money for retirement. And those of us with 401(k) plans or IRAs don’t have any real way of investing in private equity: our mutual funds and ETFs invest only in public equity and debt.

This is one of the important ways in which defined-benefit plans are better than defined-contribution plans: they give individual investors access to the kind of sophisticated pension-plan managers needed to be able to invest in private equity successfully. I’m not a big fan of the idea that middle-class individuals should be encouraged or allowed to invest directly in private equity — the risks and fees are too large, and invariably the real money ends up getting made by someone else. As for TED’s suggestion that we should just buy stock in Blackstone — well, for one thing Blackstone is a public company, not a private company, so it suffers from all the same problems of high correlation with other public stocks. And for another thing it’s pretty obvious that there’s a world of difference between buying a stake in a publicly-owned asset manager, on the one hand, and buying a stake in a privately-owned company, on the other.

My point here is one that Michael Kinsley has been making for a while:

Look. Small businesses are businesses like any other, and small business owners are people just like others—except that they tend to be wealthier…

There is an anthropomorphic fallacy here. Big businesses are not owned by big people, and small businesses aren’t necessarily owned by small people. The typical shareholder in a big business is a worker in some other big business whose pension fund has chosen to invest in that company. Or a retiree who has bought this stock as his or her nest egg. Or it’s somebody’s 401(k).

Broadly speaking, there are two ways of building wealth: returns to labor (work hard), and returns to capital (invest wisely). If you work for a company with a defined-benefit pension plan, then it will invest wisely on your behalf. If you’re stuck with a defined-contribution plan, however, the onus of investing wisely is on you — whether you’re qualified to do that or not. And the universe of asset classes that are available to you significantly smaller than the universe available to pension plans. As a result, defined-benefit investors outperform defined-contribution investors significantly (by about 3 percentage points per year, if I recall correctly; my internet connection right now isn’t good enough for me to get the exact number).

So American workers are facing a double whammy here: they’re losing access to private equity at exactly the point in time where private equity is becoming a very large and important part of the international capital markets. Meanwhile, it’s the rich foreign clients of Goldman Sachs — the global rentier class — who are getting that coveted access to equity in Facebook.

It’s not just Goldman Sachs, either. SecondMarket (a private company itself) now has a platform designed to match buyers and sellers of private equity in more than 12,000 companies; the company has also registered some 55,000 participants who are qualified to take part. Needless to say, those participants are not exactly representative of middle-class America.

So how do we put the brakes on this trend? Should we force companies to go public when they reach a certain size? Should we allow individual investors to have much more access to private equity and venture capital than they have right now? No: both of those are bad ideas, I think. The reasons for staying private are good ones, and the reasons for restricting investment in illiquid private companies are also good.

How about making a public listing more attractive by relaxing rules like Sarbanes-Oxley? Again, I’m not a fan: the literature is far from compelling that Sarbox was a significant contributor to the decline in public listings.

Indeed, I’m not putting forward any policy prescriptions at all here. I’m just pointing out a problem, while noting that it doesn’t seem to be an issue in the rest of the world. Maybe this move will just be an extra nudge pushing American investors out of the US market and into more international diversification. Which might not be a bad thing after all.


This would be less of a problem if all the nations of the world agreed to impose sufficiently progressive taxation that the wealth of the plutocrats was also funding a proper social safety net, including a defined benefit pension along the lines of that thing Matt Yglesias was talking about ( http://yglesias.thinkprogress.org/2011/0 2/they-could-call-it-social-security/ ).

At a fundamental level, if there simply weren’t enough people with sufficient wealth to fully fund significant sized companies — if the ONLY way to raise IPO-scale amounts of money was to ask for money from the top 10% richest, because there just wasn’t enough wealth available from the top 0.1% — then more companies would IPO.

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Why Facebook’s investors want it privately-traded

Felix Salmon
Jan 6, 2011 17:36 UTC

John Abell asks a very good question about a privately-traded Facebook:

Aren’t all the people investing at this moment assuming that a $50 billion valuation is a bargain? What will drive a higher valuation — let’s limit it to the Goldman Sachs Golddiggers — that makes the investment savvy?

Can a relatively illiquid market (one open to only ultra-high net worth individuals) do that? Or are these new investors buying at what they hope will be pre-IPO bargain prices? Would they otherwise, i.e., would they put up $2 million to get a upside potential based solely on privately-reported earnings?

For the answer, it’s worth looking to Justin Fox. Yes, public markets are much more liquid and transparent than private markets. But, as accounting firm Grant Thornton says,

Generally speaking, economists and regulators have maintained that competition, and reduced transaction costs are of great benefit to consumers — but only to a point. When it comes to investments, higher front-end or transaction costs and tax structures that penalize speculative (short-term) behavior can disincent speculative behavior and incent investment (buy-and-hold) behavior that may be essential to avoiding boom-and-bust cycles and maintaining the infrastructure necessary to support a healthy investment culture. As markets become frictionless (i.e., when there is little cost to entering into a transaction), it becomes easier for massive numbers of investors to engage in speculative activity.

Goldman is requiring that investors in Facebook commit to holding their shares for an indefinite period of time: the bank does seem to be making a good-faith effort to find long-term investors rather than people looking to flip their shares the minute there’s an IPO. And for those people, the speed and efficiency of public markets, where the average stock is held for just 22 seconds, looks much more like a bug than a feature. It means that stocks become highly correlated with each other, and that the value of a stake in Facebook becomes much more a function of the performance of the stock market as a whole than it is a reflection of the value of Facebook.

Goldman’s clients are looking for uncorrelated investments, and Facebook will become much more correlated to other stocks the minute it becomes public. That’s why the clients will be happy with Facebook remaining privately-traded. After all, private markets have already bid the value of Facebook up to $50 billion: there’s no reason why they can’t bid it higher still.


Based on the links that Danny black and hsvkitty have provided, it look’s like Facebook’s forward PE does in fact rival the 1980′s dot.com’s. How long of a shelf life do you really think that Facebook has? Selling a social network service to advertisers seems extremely vulnerable to the next best thing that comes along. Odds are that Facebook has already peaked! Goldman is a genius (or evil, depending on your perspective) at selling worthless crap (Abacus also comes to mind) to people who somehow came across huge sums of money in spite of their lack of intelligence.

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Facebook doesn’t care where Goldman gets its funds

Felix Salmon
Jan 6, 2011 07:29 UTC

The NYT is reporting that Goldman Sachs only made its $450 million investment in Facebook after its in-house private equity fund, Goldman Sachs Capital Partners, passed on the deal.

Many people — including the NYT — have been talking a lot in recent days about the “ancillary business” that Goldman is likely to get as a result of this investment, including fees from any future IPO and wealth-management fees for looking after Mark Zuckerberg’s fortune. There’s no formal agreement about any such things, I’m sure, but the general understanding seems to be that if Goldman scratches Facebook’s back by raising a couple of billion dollars for it now, then Facebook will scratch Goldman’s back in future with various lucrative bits of investment-banking business.

Goldman, it seems, would have loved to get all those fees without having to put its own money into the deal — and then when GSCP said no, it ponied up the requisite cash itself.

But that means something important: that from the point of view of Facebook, Goldman’s client, there’s really no difference between Goldman investing and GSCP investing — whether the money was borrowed from the Federal Reserve or invested by rich clients. Goldman Sachs and GSCP are two faces of the same company and either way Goldman is likely to end up with those ancillary fees.

That, in turn, makes a mockery of all the talk about Chinese Walls between banks’ sell-side and buy-side operations, or the idea that speculative trading is fine, the Volcker Rule notwithstanding, just so long as it takes place in the asset-management arm rather than the bank itself. (Ask Bear Stearns just how insulated a parent bank is from losses at a subsidiary fund.)

If an investment from a bank’s asset-management operation gives that bank all of the relationship-based upside of a principal investment by the bank itself, then it’s clearly silly to think of those investment subsidiaries as being divorced from the investment-banking business. It’s something regulators should think hard about, as they put together clear rules and guidelines about what kind of activity is acceptable where.


If the purpose of the Volcker rule is to impede a highly-leveraged entity with a Federal Reserve backstop making risky investments, it would seem to matter enormously to regulators where the money came from. It appears here that it matters to GSAM as well; GSAM apparently didn’t feel under sufficient pressure from the bank itself to make the investment. And naturally Facebook doesn’t care who the ultimate investors are; it doesn’t affect them.

I guess it hadn’t occurred to me that the purpose of the Volcker rule might be to put fed-regulated entities at a competitive disadvantage; to the extent it did that, I figured it was epiphenomenal, and not the ultimate purpose. Perhaps I misunderstood.

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Rattner’s rabbi

Felix Salmon
Dec 8, 2010 18:21 UTC

At the bottom of the NYT‘s long and fascinating account of the feud between Andrew Cuomo and Steve Rattner, there’s a startling kicker:

After earning millions from managing Mr. Bloomberg’s fortune, Mr. Rattner now advises the billionaire mayor without pay, as the terms of his S.E.C. settlement require, reducing a onetime Wall Street titan to a volunteer.

This is news, I think, and fascinating, to boot. In its press release, the SEC said only that Rattner had “consented to the entry of a Commission order that will bar him from associating with any investment adviser or broker-dealer with the right to reapply after two years”; when Dan Primack called Bloomberg for comment, he was told that “Mr Rattner is a friend whose advice the Mayor has and will continue to rely on.”

Why is Rattner working without pay for Bloomberg? A few possibilities present themselves:

  • Bloomberg is somehow paying Rattner under the table, or in kind, or with some kind of nod-and-a-wink understanding that Rattner will somehow be able to invoice for services rendered at some point in the future, a bit like Mike Milken managing to charge $50 million in M&A advisory fees even after he was barred from the securities industry for life.
  • Rattner is hopeful that he’ll be able to charge for his investment-advisory services once he’s able to reapply in two years; obviously it’s worth staying in charge of Bloomberg’s multi-billion-dollar portfolio for a couple of years unpaid if you get to start charging for managing it in the foreseeable future.
  • Rattner loves the idea that he’s found a loophole in the SEC agreement he made, and can continue to manage Bloomberg’s money for him even though it would seem that the SEC agreement prevented him from doing that.

I suspect that the real reason, though, is hinted at a bit earlier in the NYT story, when it says that Bloomberg is Rattner’s “most coveted and prestigious client,” and that Rattner’s relationship with the mayor “has conferred credibility and stature on Mr. Rattner despite the legal pall that hangs over him.” Rattner needs a rabbi to protect him, and Bloomberg is the best possible rabbi he could have, with the possible exception of Barack Obama himself.

Earlier in the piece, there’s this:

The attorney general was known to be especially galled that in February 2009, in the midst of the investigation, Mr. Rattner had accepted the high-level post in the White House, overseeing a task force reorganizing the American automobile industry, and later announced he would write a book about the experience.

Cuomo clearly thinks that Rattner was hoping to protect himself with Obama’s coattails, and generally bolster his reputation as much as possible through public service. When that didn’t work, Rattner turned from Obama to Bloomberg for protection. I wonder how much that’s worth to him—how much Rattner would be prepared to pay in order to retain his connection to Bloomberg.


“When that didn’t work, Rattner turned from Obama to Bloomberg for protection.”

Rattner had been close to Bloomberg for many years before he went to work for Obama, and Rattner’s former firm was already managing Bloomberg’s money before Rattner became the auto czar. So it is far from accurate to say that Rattner “turned from Obama to Bloomberg for protection.”

Posted by ChasNY | Report as abusive

Who deserves the credit for GM?

Felix Salmon
Nov 16, 2010 17:45 UTC

Andrew Ross Sorkin loves private equity.

Sorkin finally get around to responding to Malcolm Gladwell today, and he’s unimpressed. Here’s how he frames the question:

Can financiers ever do anything beyond financial engineering?

With General Motors planning an initial public offering for Thursday that values the once-left-for-dead company at more than $50 billion, the answer to that question is more than theoretical.

How did G.M. become one of the greatest turnaround stories, at the moment at least, in history?

You can guess where Sorkin ends up. While Gladwell gives a lot of credit for GM’s current health to Rick Wagoner, Sorkin dismisses Wagoner as the CEO under whom GM went bankrupt. Instead, he says, “the GM turnaround is ultimately an act of financial engineering”—the financial engineering that Steve Rattner takes lots of credit for in his book, and which Sorkin is happy to ratify as one of the greatest turnarounds in history.

The financial engineering at GM was difficult and impressive. But in principle it’s neither difficult nor praiseworthy to take an insolvent company, put it through bankruptcy, and let it emerge under the ownership of its former creditors and people who provided DIP funding.

Bankruptcy, in theory and in practice, is essentially just a change of ownership. It’s not easy, and it carries non-negligible costs; Rattner did a good job of minimizing those costs and therefore maximizing the value of the post-bankruptcy GM. But you don’t need PE honchos to orchestrate a bankruptcy filing and rid a company of its liabilities. And the main thing that Rattner did with GM was to lubricate the process with something over $50 billion in US taxpayer money, most of which went to pay off GM’s creditors, and much of which is unlikely to ever be repaid.

Rattner deserves praise for what he did. But so does Wagoner, and so do all the workers who have worked and who continue to work to actually make the cars that GM sells. The financial engineering might have been a necessary part of the turnaround process. But it wasn’t remotely sufficient.


GM is a typical example of a US company forgetting the rest of the world exists.

Once the US market had saturated, the only place to look for growth over and above replacements was the rest of the world. But what US focussed GM had not done for decades was notice that the rest of the world made cars too, and better ones than GM made.

So now GM has lost it’s early provider advantage in overseas markets. That means just one thing: there’s no more easy money. Management need to change their way of thinking fast or we’ll be revisiting this situation just a few more years down the line.

http://fifthdecade.wordpress.com/2008/12  /05/saving-the-american-auto-industry/

Posted by FifthDecade | Report as abusive