Risking Our Returns

No real surprise here, but most of the world hates America. You don’t think so? Really? Well you’re wrong, simple as that. The majority of the world’s population (outside the United States, that is) hates us for any number of reasons. Let us begin to count thy ways:
1. We swim in pools that hold thousands of gallons of perfectly drinkable water
2. We sleep indoors every night we want to
3. When we sleep indoors, we often do so with animals; we call those animals “pets;” others throughout the world – nearly all of Africa, a great deal of Asia, and big chunks of Central and South America – would call those same animals “livestock”
4. We actually spend money to feed those pets of ours, all the while much of the world struggles to feed their children
5. We have skinny, blonde celebutard actresses who actually dress their pets in tiny clothes
6. When we turn 40, our mid-life crisis entails internal debates of “Corvette or Mercedes convertible;” elsewhere, if they’re lucky enough to turn 40, it’s the muni bus or maybe a less stinky yak
7. We have pizza delivery

That list can go on and on, and it does. I haven’t even brought up big screen TVs, high speed internet porn, booze, or really any of the seven deadly sins – although admittedly this sentence toes the line. But, when you dig deeper, all those reasons are “symptoms” of the hatred; the “root cause” is really just one. The Typhoid Mary, so to speak, is money. We’re rich. We’re swimming in it. And, as such, we are afforded the luxuries that so many in world do without. They’re jealous, and that’s not a fault. Who wouldn’t be?

Now, we’re rich primarily because we’re willing to take risks. It’s a basic tenement of a free market, entrepreneurial, capitalistic society – the greater the expected risk, the greater the expected rate of return. The good ol’ risk/return ratio. And, watch out – we’re in danger of screwing the whole thing up.

Note: That loud noise you’ve heard since October is Adam Smith, John Maynard Keynes, and Milton Friedman rolling over in their graves.

It’s in vogue these days to rip Wall Street – the beacon of greed and excess in the storm that is the world-wide recession. We tend to forget that those losses are inextricably tied to Main Street. The reason those collateralized debt securities of Wall Street are in default? It’s because people – not just companies, but people – over-extended themselves. Typical scenario in a typical town – for argument’s sake, let’s call it Phoenix – goes something like this:
1. Dude, whose job is cutting grass, buys a $200,000 house, putting a down payment of 10% or $20,000
2. Real estate market goes mad, and house has a market value of $400,000
3. Dude refinances his house, putting no more money in, but taking out a big chunk of equity, say $100,000
4. Dude buys a Lexus and a Range Rover
5. Real estate market goes mad again, and house goes up in value to $600,000
6. Dude refinances again, takes out another $100,000 – vacations in Europe and buys a Porsche
7. Real estate market collapses. House is worth $220,000. Dude has a mortgage balance of $380,000. Oh, and he also has a used Lexus, a used Range Rover, and a used Porsche, now collectively worth $18,739.
8. Dude loses his job and mails his house keys into the bank – after first flushing 18 bags of concrete down his three house toilets.
9. Dude drinks beer at the bar and bitches at the AIG bonuses and blames Wall Street for his troubles.

Yep, always someone else’s fault.

That’s when things go sour. But, what if things go like they did in numbers 1-7 above, only this time the dude doesn’t get greedy and hog material, tangible assets (like luxury automobiles)? If he doesn’t take equity out, he’s still paying on an original $180,000 mortgage on a house now worth $220.000. Dude has doubled his equity, and doubling ain’t bad.

He took a risk, and was hoping it would turn out to pay big bucks. For a while, it did. In the end it hurt him. Who’s fault? His. Just playing the game, he was, and that’s cool. More risk, more potential return. But, keep in mind, the ante of the game is more risk. Risk. Dude, look it up in the dictionary.

In battling out of the recession, we have to be sure not to take the risk premium out of the market. Any market, for risk brings the promise of potential high returns. Not a promise of guaranteed returns, mind you, but potential returns. And potential returns are enough to drive bold creativity, innovation, entrepreneurial spirit, ingenuity, and that good old “just freakin’ get it done” mind set. It’s the promise of riches that helps us advance and evolve as a society; without it, we’d have one step in the cave, another on a banana peel. Simple proof: Russian automobiles of the mid-70’s. ‘Nuff said.

I said we’re in danger of screwing things up, and we are. We have to be super careful with bailouts. Said differently, not everyone can get one. We saw it with the investment banks in the autumn. Why were some helped and others (Lehman, anyone) left to die? Because, if we bail out everyone, there’s no threat of failure, that’s why. No threat of failure leads to taking hugely irresponsible risks in a game of “one upmanship” to make the highest of all possible returns and allow us to build over-the-top, glass and steel skyscraper phallic symbols to our greatness (see dude in Phoenix, above). Bail out enough to stave off panic from the masses. Let enough fail to keep the game in check.

Okay, investment banks down, automobiles up next. GM will get a lifeline, just to save some jobs. But, jobs be damned – and you heard it here first – Chrysler gets hung out to dry (that’s after being ridden hard, hard into the ground). Two shaky U.S. auto manufacturers are better than one shaky company and two shitty ones. To keep the risk/return ratio relevant, someone has to hurt. Cerebus Capital, how’s that $7.4 billion investment in Chrysler paying off for you? You took the risk to potentially make billions. It didn’t work out. Don’t bitch about it. You knew what you were doing. [Oh, and Bob Nardelli, don’t expect a golden exit package like the one you swindled from Home Depot.]

Speaking of bitching, here’s one final word. Words, rather. Quit bitching about the AIG bonuses, people. You want to make big bucks too? Here’s a prescription. Get off your lazy, pompous asses and take a risk. You can always quit your relatively safe job in a cozy corporation and jump into the shark-filled waters of the American dream – start your own business, draw nothing in salary for years, work your ass off daily – every day. And maybe, just maybe, you’ll be the next Famous Amos. Or Ben and Jerry. Or Merrill, Lynch, Pierce, Fenner, and Smith. There’s no different rules for the elite and the rich. Only opportunity, and there’re the same opportunities for everyone. Take the risk. It will pay off big for a few, and it will crush a few on the way. It’s our game. If you don’t like the rules, there’s still a handful of socialists regimes around – have you tried the good life of Boliva lately?

Hey, that’s just this guy’s opinion is all.

If you like what you read, follow me on Twitter @RayHartjen.

Pay for (under) Performance

Interesting read in The Wall Street Journal today – front page, right hand side. AIG (American International Group Inc.), now 80% owned by the U.S. government after receiving a series of monetary aid packages (the the tune of just north of $173 billion, thank you very much), is paying out bonuses of about $165 million. The best part? The bonus payments are planned for employees at AIG’s Financial Products business unit, which was responsible for about $40.5 billion in losses last year.

You read that right. $165 million in bonuses for losing $40.5 billion.

Losing $40.5 billion!

WTF?

One can only imagine what the bonus payment would have been if the unit had stepped up and worked its way to a $50 billion loss. Makes one wonder what their goal is for this year.

Of course, bonus shenanigans are nothing new in the finance community. I’ve even benefited from some of the absurd practices, so who am I to spout off about it? Naturally, that’s not going to stop me, as I’ve never been one to be short on giving opinions.

One thing everybody needs to know right away is this: In the investment business, the people always find a way to carve out their more-than-fair share of the money. Oh, and when I say “people,” let me clarify – that’s not the customers or even the rank and file employees, but rather the “rain makers” that make the deals happen. It simply doesn’t matter if the deal makes money or loses money, whether it’s a buy or a sell, a bearish position or a bullish position, the market goes up or down; the “chop” is always there for the taking. In fact, in the business, they even personalize it and refer to it in almost human terms – my dearest and bestest friend, “Max Chop.”

Don’t get me wrong, there’s incentive aplenty for making some money. But, making money is certainly no requirement. Ever hear of State Street Corp.? Of course you haven’t – it’s a money management business that provides services to the securities industry, but it does provide us a neat little tale. You see, State Street’s CEO, Ronald Logue got a raise in 2008. State Street’s “accomplishments” over the year included taking $3.6 billion in losses, receiving $2 billion in TARP funds from the government, and seeing its stock price fall from $83 to $ 22. Those “highlights” are, admittedly, not that great, so it’s no real surprise to find that Logue’s raise was a measly 1.4%. That’s the bad news for Logue. The good news is that the 1.4% raise equated to $400,000, raising his pay from $28.3 million to 28.7 million. Hey, a guy has to eat.

Such tales of regal compensation are not just recent phenomenon either. You might remember one Stanley O’Neal, former CEO of Wall Street stalwart, er, rather, former Wall Street stalwart and now Bank of America subsidiary, Merrill Lynch. In October 2007, in a “how the hell did I miss that” precursor to the financial crisis that hit the fan a year later, Merrill took a write down of some $8 billion due to losses on crappy subprime mortgage investments. [Hello! Big clue! Bloody knife found on the floor! That and Bear Stearns a couple of months later? If I only had a time machine!] Merrill posted a big loss for the period, and the stock sagged. In the age of accountability, heads had to roll, and the company decided to make a big statement and sever the head at the top. The even reported out publically, almost thumping their chests – O’Neal was not going to receive any additional severance or bonus beyond his $161.5 million package.

Sucka, wha?

Remember, that was for losing a couple of billion. A billion here, a billion there – pretty soon, it adds up to some real money.

It’s not only investment banking, you know. Home Depot paid Robert Nardelli over $200 million to leave, also in 2007 (otherwise known as “the year of the golden parachute”). Interesting to note how that might have been a wise move by Home Depot, as Nardelli has done such a bang up job since then in his new post at the helm of Chrysler. Now, I don’t begrudge these kinds of compensation practices. If we’re stupid enough to tolerate it and pay that kind of money, kudos for them stepping up and cashing those paychecks. Remember, we’re the same society who will actually nod our heads in agreement when hearing a $20 million plus actor bemoan about the “brutal,” “grueling,” and “exhausting” shoot of a feature film. Hey out of touch actor, you’re hardly scrubbing toilets or picking cotton.

No, free enterprise and capitalism will ensure you are paid relative to the value the market places on you. The higher the perceived value, the higher the pay, and that’s a nice correlation that fits so snuggly together, like peas and carrots. The dudes above who got PAID? Good for them, either for having the foresight to write such terms into their employment contracts or for having the good fortune to work for a bunch of knuckleheaded bosses and shareholders. We don’t need to get mad, or for that matter, to get even. We just need to learn from the experience and ask ourselves one little question – How do I get my piece of this seemingly big pie before there’s nothing left but crumbs?

That’s just this guy’s opinion.

If you like what you read, be sure to follow me on Twitter @RayHartjen.