Re: Toxic Waste
I basically like the outlines of the banking bailout as it looks to be presented today but it is really going to be quite the highwire act... I like them trying to bring in private money and maintain the system as much as possible but it is a gamble and falls short of the more encompassing nationalization and keeps a lot of the original managment in place... Another interesting part of this is that they hope private equity firms will get into buying these toxic assets... such as the private equity firm that now owns IndyMac. Taleb has mentioned several times lately and he's not alone that private equity firms especially those that are highly leveraged are in much danger of being the next shoe to drop... So asking them to take over troubled bank assets and with the fed govt along for at least part of the ride could make for a very bumpy and dangerous roller coaster ride over the next few years... I don't see any easy solutions to all this.. A very difficult problem.. You pay your money and take your chances but the road will be slippery...
http://www.nytimes.com/2009/02/10/business/economy/10bailout.html?pagewanted=1&_r=2
Geithner Said to Have Prevailed on the Bailout
By STEPHEN LABATON and EDMUND L. ANDREWS
Published: February 9, 2009
WASHINGTON? The Obama administration's new plan to bail out the nation's banks was fashioned after a spirited internal debate that pitted the Treasury secretary, Timothy F. Geithner, against some of the president's top political hands.
In the end, Mr. Geithner largely prevailed in opposing tougher conditions on financial institutions that were sought by presidential aides, including David Axelrod, a senior adviser to the president, according to administration and Congressional officials.
Mr. Geithner, who will announce the broad outlines of the plan on Tuesday, successfully fought against more severe limits on executive pay for companies receiving government aid.
He resisted those who wanted to dictate how banks would spend their rescue money. And he prevailed over top administration aides who wanted to replace bank executives and wipe out shareholders at institutions receiving aid.
Because of the internal debate, some of the most contentious issues remain unresolved.
On Monday evening, new details emerged after lawmakers were briefed on the plan.
It intends to call for the creation of a joint Treasury and Federal Reserve program, at an initial cost of $250 billion to $500 billion, to encourage investors to acquire soured mortgage-related assets from banks.
The Fed will use its balance sheet to provide the financing, and the Federal Deposit Insurance Corporation might provide guarantees to investors who participate in the program, which some people might call a "bad bank."
A second component of the plan would broadly expand, to $500 billion to $1 trillion, an existing $200 billion program run by the Federal Reserve to try to unfreeze the market for commercial, student, auto and credit card loans. A third component would involve a review of the capital levels of all banks, including projections of future losses, to determine how much additional capital each bank should receive.
The capital injections would come out of the remaining $350 billion in the Troubled Asset Relief Program, or TARP.
A separate $50 billion initiative to enable millions of homeowners facing imminent foreclosure to renegotiate the terms of their mortgages is to be announced next week.
Some of President Obama's advisers had advocated tighter restrictions on aid recipients, arguing that rising joblessness, populist outrage over Wall Street bonuses and expensive perks, and the poor management of last year's bailouts could feed a potent political reaction if the administration did not demand enough sacrifices from the companies that receive federal money.
They also worry that any reaction could make it difficult to win Congressional approval for more bank rescue money, which the administration could need in coming months.
For his part, Mr. Geithner will blame corporate executives for much of the economic crisis, according to officials. He will announce rules that require all banks receiving capital from the government to submit plans that describe how they intend to strengthen their lending programs and generally restrict them from using the money to acquire other banks until the government money is repaid.
But officials said Mr. Geithner worried that the plan would not work ? and could become more expensive for taxpayers ? if there were too much government involvement in the affairs of the companies.
Mr. Geithner also expressed concern that too many government controls would discourage private investors from participating.
A spokeswoman for Mr. Geithner, Stephanie Cutter, had no comment.
In an interview on Monday Mr. Axelrod did not deny that there were differences of opinion as the policy was being crafted or that he had taken a harder line on issues such as executive pay restrictions, as other participants to the discussions recalled. But he said he was ultimately satisfied with the final product put forward by Mr. Geithner."We had a great and productive discussion and as a result we came up with a good set of guidelines and rules," he said. "I didn't come away disappointed in any way."
The White House is hoping that its rescue plan will be perceived as a more coherent rescue effort than the Bush administration's, and one whose breadth and scope are so vast that it begins to restore financial confidence in the battered markets and entices private investors to come off the sidelines.
The plan is calibrated to work on multiple fronts, with promises to invest billions of dollars in scores of ailing banks and creation of a new institution to relieve bank balance sheets of their most troubled assets.
It will also renew a legislative proposal giving bankruptcy judges greater authority to modify mortgages on more favorable terms to lenders and over the objections of banks.
Officials say that new rules encouraging transparency and limiting lobbying are intended to begin to restore political confidence in a program that has faced withering criticism in Congress, an effort that they view as essential because they expect to return to Congress for more money later this year.
But as intended largely by Mr. Geithner, the plan stops short of intruding too significantly into bankers' affairs even as they come onto the public dole.
The $500,000 pay cap for executives at companies receiving assistance, for instance, applies only to very senior executives. Some officials argued for caps that applied to every employee at institutions that received taxpayer money.
Abandoning any pretense about limiting the moral hazards at companies that made foolhardy investments, the plan also will not require shareholders of companies receiving significant assistance to lose most or all of their investment. Some officials had suggested that the next bailout phase not protect existing shareholders. (Shareholders at most banks that fail will continue to lose their investment.)
Nor will the government announce any plans to replace the management of virtually any of the troubled institutions, despite arguments by some to oust current management at the most troubled banks.
Finally, while the administration will urge banks to increase their lending, and possibly provide some incentives, it will not dictate to the banks how they should spend the billions of dollars in new government money.
And for all of its boldness, the plan largely repeats the Bush administration's approach of deferring to many of the same companies and executives who had peddled risky loans and investments at the heart of the crisis and failed to foresee many of the problems plaguing the markets.
In internal discussions, Mr. Geithner is said by officials to have raised the lessons of countries that forced banks to make loans and adopted other, more interventionist measures. Those strategies, he said, wound up costing more and undermining their governments' credibility. He concluded the wiser course would be to provide economic incentives to encourage lending.
Some Democrats in Congress who have been given previews of the outline of the plan said it struck the right balance.
"They want to make sure the plan is a balance of carrots and sticks, which are needed substantively and politically," said Senator Charles E. Schumer, Democrat of New York, vice chairman of the Joint Economic Committee. "They are using every tool in the book because the problem is so vast, but they are also tailoring their response to the individual needs of each institution."
For private institutional investors, the question of whether to invest alongside the government will depend on what kinds of carrots and sticks Treasury officials offer.
Managers of hedge funds and private equity funds are closely watching to see how much the government pushes banks to write down the value of troubled mortgages and mortgage-backed securities they want to sell.
There is no market value for most of those troubled assets because they are not trading. Investors want to buy them at the lowest price possible, but banks want to avoid selling them at rock-bottom prices and realizing huge losses.
The impasse is particularly serious for whole mortgages, which are loans that banks have kept on their own books instead of selling them to Wall Street firms, which bundle them into pools and resell them as mortgage-backed securities.
Under current accounting rules, financial institutions have already been required to write down the value of mortgage-backed securities to reflect their current market value. But banks do not have to write down the value of whole mortgages if the borrowers are still current, and many regional banks collectively hold vast numbers of those loans.
Under the category of sticks, private investment managers are closely watching how the Treasury rolls out its "uniform stress test" for grading the health of banks. If the government takes a tougher line with more banks, it could force them to sell off more of their loans and take their lumps sooner rather than later.
Under the category of carrots are various forms of financing and government guarantees
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http://www.vanityfair.com/politics/features/2009/02/wolff200902?currentPage=1
The Ultimate Bubble?
At a lavish conference in Monaco, the game was guessing which big private-equity firm will be first to go bust. But the smoke and mirrors that wrecked the global economy might actually save the likes of K.K.R. and Blackstone.
by Michael Wolff February 2009
Here's a parlor game, played best by the people who are in it: Which private-equity firm's going bust first? Carlyle? Fortress? K.K.R.? Cerberus? Apollo? Could it even be mighty Blackstone, with its vast real-estate holdings? Which of these one-word-branded enterprises (the word should emphasize strength, opacity, and preferably be culled from mythology?though no one in private equity, rest assured, reads his Bulfinch's) that make up what's been called the world's "shadow banking system" will collapse and, in the domino pattern of this financial crisis, take the other firms with it?
There's an urgency to this question because no big firm has actually gone bust?yet.
All of the behemoth investment groups that sit on top of trillions of dollars of the largest capital accumulation outside the public markets remain suspended over the global economy like awfully big shoes waiting to drop. The wait increases both the suspense and the bitchiness of the game: somehow every private-equity guy (private-equity guys have been among the most unpopular figures of the great bubble) feels he's been more prudent and responsible than all the others.
Given the credit crunch, no private-equity deals are getting done now?chances are that what you're doing with your idle hours as a P.E. man is trying to figure out who deserves to crash and burn before you.
For reasons that, at this particular moment in economic time, make little sense?and border on the totally embarrassing?I was in Monaco recently at a business conference that attracted many private-equity types who are still traveling grandly on the 2 percent fees private-equity firms pay themselves on the money they've raised. At my table in the ballroom of the H?tel de Paris, in Monte Carlo, at a dinner hosted by Prince Albert of Monaco, there was a gentleman whose company, backed by private equity, had gone public and risen to $130 a share, but had, through the terrible autumn, dropped to $17. To my left there was a gentleman from K.K.R.?the seminal name in the corporate-buyout business, having survived and profited off a quarter-century's worth of bubbles and busts. Actually, the gentleman joined K.K.R. after the collapse of Lehman Brothers, where he had been for many years. (By my quick calculation, in all that time of being compensated with Lehman stock, he probably lost between $30 and $120 million in the collapse. Still, he seemed to have homes in London, Dubai, and New York.) I asked, lowering my voice, "So ? who's on the brink?"
"Carlyle," he responded darkly. Indeed, Carlyle Capital Corporation, the arm of the Carlyle Group that invests in mortgage-backed securities, had defaulted last spring on more than $16 billion.
The gentleman on my other side was Norman Pearlstine, the former editor in chief of Time Inc., who'd gone to Carlyle, it was widely assumed, to lead a buyout of Time, but who had recently forsaken his adventure in private equity and gone back into the news business?this time as the chief content officer at Bloomberg.
Still another gentleman of my acquaintance, at an adjacent table to which I shortly hopped?a European manager of private-equity money, who'd taken in nearly a billion dollars in new investments just before the bubble burst?said in response to my question about the brink, "Oh, it's K.K.R. who's going to go over quickly." (I briefly thought of the K.K.R. man, having left Lehman and now with the prospect of going down on a second Titanic?that must keep you up at night, even in London, Dubai, and New York.)
"Well, who is O.K.?"
"If you have cash?if you're not fully invested."
"You're O.K. if you have cash?"
"Well, I wouldn't go that far."
"But if you are fully invested?"
"Oh, dead."
And yet, it seemed important to contrast the existential predicament of
private-equity funds?the most debt-ridden enterprises in the history of finance, with some $4 trillion due to lenders in the next year (it is mathematically impossible, given the downturn, for even a fraction of that to be paid back in a timely fashion)?with the fact we were sitting here in Monaco, in a scene that might well have occurred at the very top of the market. To the naked eye, nothing had changed.
When I was 11, my father, a businessman who, in his day, took a dubious risk or two, gave me a key lesson in finance and life which I knew was meaningful without understanding it.
"You're not bankrupt," he said, "until people know you're bankrupt."
By which he meant, I've come to understand, that money is a complicated reality. It's a master illusionist's game. The artifice is everything. Transparency is the enemy of making it really big?which is one reason the word "private" got joined to "equity."
This may have something to do with the message I got when I called up Stephen Schwarzman, the head of the Blackstone Group, and the most successful of all private- equity players. At the top of the market, in June 2007, when Blackstone went public (a top-of-the-market irony was to have firms specializing in taking companies private doing it with public money), he was, briefly, the richest man in New York, stepping over Michael Bloomberg, but now may be down to his last billion.
"Mr. Schwarzman's office," said the receptionist, "is no longer taking calls."
"Ever?"
"Not for the foreseeable future, I've been told."
This might seem to be a sort of going to ground, or holing up in a single room, as you are surrounded by creditors and police, the gun in your hand. Blackstone, which with Fortress Investment Group went public a year and a half ago, is now at a fraction of its former value?whereas K.K.R. has altogether failed in its efforts to go public.
And those other kinds of funds, hedge funds?which make short-term investments in securities rather than, like private-equity funds, long-term investments in companies?are, everywhere, shutting their doors. Investors in those funds are, sensibly, demanding their money back?or what's left of it.
And yet, even though you might not be able to get through to Mr. Schwarzman, the greater point is that he is still in his office. His thousand or so employees around the world are still there, too. Indeed,
few people in private equity?in the middle of the greatest financial crisis of the era, even as everybody in private equity awaits the collapse of everyone else in private equity?have actually lost their jobs. Even with no business to be done, it's business as usual. This is an extraordinary demonstration of denial, or of a dreamworld, or of an alternative reality?or of my father's dictum.
Nobody knows if the world's great P.E. firms are out of business?the guys who run these firms may not even know.
In the finance world in recent years, to work at an investment bank, to be part of the great, well-paid army of people who service financial transactions, was to be a schlub. A relative zero. A body. The brains were creating their own equity and growing it. The guys at Lehman and Bear Stearns deserved in a sense to lose their jobs because, well, they weren't in private equity?weren't bright enough or farsighted enough to be. In a never-ending re-invention of relative masters of the universe, it was private-equity guys who came to sit on top: David Rubenstein, at the Carlyle Group; Blackstone's Schwarzman; K.K.R.'s Henry Kravis; T.P.G.'s David Bonderman; Quadrangle Group's Steven Rattner. These are the master illusionists, the guys who combined social skills and salesman talents and media savvy and quickness with numbers and expensive suits to make vast personal fortunes and to redefine the craft or magic of modern finance.
But remember: histories of financial collapses are as much about who holds on to their money, or even who profits from the mess, as about who loses it. Nobody remembers my grandfather, who lost his fortune (in the cereal business) in 1932. Everybody remembers Joseph Kennedy, who held on to his and, given the great opportunities when you're the only one with money, vastly grew it during the Depression.
Indeed, if the private-equity business is, by all logic, looking at imminent catastrophe and ruination, it can also see the best possible environment in our time for investing?a world in which sound and necessary businesses have lost two-thirds or more of their value, a world in which public companies can be bought up by private money for a pittance. This is heaven on earth for the brave and the greedy.
It is also, in fact, the very model of private equity. Most of the powerhouse firms that, in the last five or six years, have come to dominate the corporate world were firms that found themselves with money in the bank when the market collapsed in 2001. In the private-equity formula, a $2 billion company which, at the bottom of the market, had lost half of its value?making it a $1 billion company?could be bought with $100 million in cash and $900 million in debt. When the market rebounded, and the company's value was restored, the private-equity firm, taking a billion in profit, would have a 1,000 percent return on its investment, keeping 20 percent of the profit for its troubles. (That's 2-and-20 in private-equity parlance?2 percent annual fee on the money that's been raised; 20 percent of any profit.) Since private-equity money is raised on the basis of how well your last deal (or last fund) performed, this became self-perpetuating?big returns got you more money. (The more you borrowed, the bigger your returns would be.)
This moment might be like that?vast private-equity funds eyeing, across the commercial landscape, nothing but devalued properties.
Except that, as much as that is the case, it is not the same at all.
Rubenstein, Kravis, Bonderman, Rattner, and Schwarzman, holed up in his office, could still?with many of us taking great satisfaction in this?go bankrupt.
For one thing, the modus operandi and reason for being of private equity is borrowed money, and there is none to be had? zilch. Gone. Even Schwarzman, practically speaking, can't get a loan.
For another, while firms have raised vast pools of capital?the success of a firm is judged largely on the amount of money it has raised?this capital is not actually in the bank. It's "on call"?and it's entirely unclear what happens if, for instance, the Carlyle Group, with $40 billion theoretically available, calls on someone (wealthy individual, pension fund, well-endowed university, or, in that hall-of-mirrors locution, a fund of funds) who has lost the will or wherewithal to meet the call. (Permira, the big U.K. P.E. fund, has voluntarily let some investors take money back.)
And, perhaps most important, the very premise on which a P.E. fund buys an asset?that is, a reasonable ability to ascertain its current value?is gone. Nobody knows what anything is worth?therefore you'd be a fool to buy it.
This last point is, unfortunately, germane not only to what you buy but also to what you own.
To wit: private-equity firms now own all these businesses which not only have dramatically declined in value but are, practically speaking, worthless?their value doesn't exceed their debt. What's more, as consumer spending plunges, there isn't enough business to support the debt.
Quadrangle, Rattner's firm, which specializes in media deals, bought Maxim magazine for $250 million a year ago?borrowing most of the money to do the deal. This was already a deal burdened by the hubris of private equity?that is, the company that owned the magazine (and specialized in publishing magazines) was unloading it precisely because it understood the market for laddie magazines had peaked (a year before, the company had spurned a much higher offer). But Quadrangle, even though it had no experience in the publishing business, assumed that with its business prowess (P.E. types who seldom have managed anything nevertheless believe themselves to be consummate managers) it could cut costs and raise cash flow and expand into new lines of business?Quadrangle envisioned Maxim-themed movies and restaurants and tchotchke shops. This general hubris and belief in business prowess come because, while P.E. firms have so often been Keystone Kop sorts of managers, the economy has over and over again proved their competence.
Or, at any rate, the rising economy meant that all sorts of mistakes would be covered by a rich resale price. In a sense, with the market constantly rising, you could do nothing wrong?until now. Accordingly, the Maxim business went from making $28 million to making $8 million annually, which is not enough to pay the costs of the debt it incurred. Hence, Quadrangle Group, which recently admitted defeat and closed its hedge-fund arm (sometimes called, confusingly, the Quadrangle Fund, which, when I was in Monaco, meant that a rumor swept the H?tel de Paris that Quadrangle itself had collapsed), is now trying to give Maxim back to its creditors.
At Apollo, Leon Black's troubled firm, they've lost $365 million on Linens 'n Things. And they're in trouble with more than $3 billion in other investments.
Still, that's nothing. After all, Cerberus paid $7.4 billion for Chrysler. Chrysler!
And Blackstone, at the top of the market?indeed doing the last big deal of the bull market?paid $26 billion for Hilton Hotels. (Hotels, where private-equity guys spend most of their time, form a big part of the P.E. mythology. Not only has Blackstone become the biggest hotelier in the world, owning at various times mass-market chains such as La Quinta and Extended Stay America as well as Claridge's, in London?reportedly Mr. Schwarzman's favorite home away from home?but the Carlyle Group is named after the Carlyle Hotel in New York, David Rubenstein's favorite hotel.) Actually, Lehman Brothers, Bear Stearns, and a few other banks paid $26 billion for Hilton?they lent Blackstone the money.
Or, in fact, because Lehman and Bear have collapsed and their debts have been bailed out by the U.S. government, you've paid for the Hilton hotels?with their dramatically devalued real estate on which their empty rooms sit.
This is bad. Private equity is in no better position than any bank or hedge fund or insurance company which has seen the values of its holdings collapse.
It would seem unfair then, to say the least, that this very situation that has brought the world to the brink of ruin?financial schemes founded on artifice and lack of clarity and someone else's money?could actually save private equity.
The same act of illusion that got us all into this mess could get private-equity firms out of it. (Actually, they might deserve their money if they can get out of this.)
Take the value, or the negative value, of the companies a P.E. firm owns. Hedge funds and banks have to re-state the value of their assets on a day-to-day basis. A private-equity firm heretofore concerned only with the trade?selling what it owns as soon as advantageously possible?suddenly becomes a benign owner. The very language of these guys changes, from "exit," their fondest word, to "managing for the long term," "patience," "building." "We're holders," they say. Their worthless companies become future jewels. "The market may be down, but we believe in the underlying value" ? blah blah.
Then there's the debt?the mountains of debt. The major private-equity firms are, with a little critical interpretation, like subprime-mortgage holders. In order for the banks to get the business of private-equity firms, they gave deals they should never have given. Actually, loans to P.E.-backed companies are, in many instances, far worse and far more risky than subprime loans, which at least can be foreclosed on. The major P.E. firms in the riskiest of deals have gotten the most liberal terms possible?they almost can't go belly-up. What's more, it is important to remember that, if the private-equity game is played correctly, you don't have that much money in any single deal. The lenders are on the hook. (The partners at Quadrangle can wash their hands of Maxim and still show up at work the next day.) You're not. If it does well, you benefit disproportionately; if it goes south, you suffer minimally.
What's more, unlike a hedge fund or a bank, which are only ever investors, a P.E. firm can suddenly become a manager (again ignoring the fact that these people know nothing about managing). They can slash, burn, reduce, maximize cash flow. Here too the language changes?from the glories of rates of return to the hard but satisfying work of management: "We've pulled on our boots."
Indeed, the complaint of all companies owned by private-equity firms is that, previously left alone by their remote investor-owners, they are now enduring the attention of the private-equity guys who have so much less to do (and no idea what they are doing).
As for the theoretically vast pools of capital that could, if you're not careful, evaporate before your eyes?and therefore expose you as a bankrupt and pull you down?the way to avoid that possibility is simply not to make the call. The Carlyle Group's $40 billion on call remains a $40 billion asset (which they brag ceaselessly about) if nobody has to deliver it up. Indeed, the only thing that you're really calling is your 2 percent?which, on $40 billion, is $800 million. In other words, you can wait it out. You have the luxury which no one else in a panic has?you can be patient.
And then not being able to borrow. That's tough. Except that, in a reversal of ironic magnitude, the debt that has supported private equity has so crippled the lenders that they are now selling that debt at a vast discount?and private equity is buying it. You know that $900 million I borrowed from you guys? I'll buy the obligation back for $400 million. You get the picture. K.K.R. has started a new fund dedicated to buying other people's debt.
What's more, it is possible to dispense with the very notion of the private-equity business?ownership itself. Steve Rattner's firm increasingly becomes no longer an investor but an adviser. (Quadrangle advises Michael Bloomberg and invests his money.) Rattner, in other words, having risen from the ranks of investment bankers to being an owner of corporate assets himself, is so masterful that he knows when to revert back to being a stockbroker.
The precariousness of it all is obvious to every private-equity manager?which is why they see their competitors imminently going down. One big front-page bankruptcy of a P.E.-owned company?say, Hilton, or the commercial-property company Blackstone bought from Sam Zell (enabling him to buy the Chicago Tribune, which has gone bust)?will create new demands for, and congressional oversight committees insisting on, fair accounting treatment for portfolio value. If the value of the private-equity market is re-stated like the value of the stock market (its mirror image), a reasonable panic ensues?Carlyle loses its $40 billion and everybody else can't get at what they themselves have got on call.
And yet, being comfortable with there being no there there is the talent. That's the private-equity genius: We've figured out how to buy companies without putting up the money; we've figured out how to run them without knowing anything about them. The situation has just gotten more fluid?the banks don't have money to give us, and God himself couldn't turn a profit at most companies now. But somewhere, sometime soon, if we can just bluff it out, there is opportunity. Amazing opportunity.
Michael Wolff is a Vanity Fair contributing editor.
