On Family

I often harp on how often important or advantageous family connections are in Asia, and wonder why most Western analysts, financial or economic, miss the point. When I really want to understand a local economy in Asia, I try (very tough without a few years of experience in the market) to draw a rough family tree connecting the characters. Unless you understand how players interact, you will often end up puzzled by why certain things are happening. When you do have this understanding, then some of the bewildering news reports that make you scratch your head will then seem like mere levers in game of influencing the public opinion.

An Indian example

When I visited a couple of weeks ago, I heard an interesting story from a friend of mine. It was about an airline called Paramount Airways, a 4-5 year old airline with a premium domestic service. Paramount, unlike Kingfisher or Jet Airways, which had grown from existing businesses, was a startup from a guy who had no prior experience in any business at all, let alone the airline business. So how the hell did, Thiagarajar, the thirty-something entrepreneur who owns Paramount, set it up?

Well, my friend told me, to understand that you have to go back to Thiagarajar College, a small university set up Mr. Paramount’s grandad. India being India, the College had been a source of favors for almost fifty years. If you had a smart kid, but were too poor to afford to send him or her to college elsewhere, you would go plead with the Thiagarajar family, who although they were not wealthy by Western standards, were still the trustees of the College, and they would make arrangements for a scholarship of some sort.

That’s just one example of course. Over time those favors get traded, someone needs some help with government, and the family once helped a government officials’ daughter get into university, so they arrange a favor exchange.

After fifty or so years of that, when young Mr. Thiagarajar goes to the local bank to get a loan for Paramount, the bank officer literally rolls out the red carpet for him. The loan applicant is regaled with tales of how the bank officer used to know Mr. T’s father and even grandad. How he is so thankful that his eldest sister’s son was able to go to College and is doing well now. And how can he help Mr.T now?

That buildup of social capital over decades is what is irreplaceable, and unfakeable. It is what we as Western investors will never have in the local market.  Where a Western investor has to dot the i’s and cross the t’s and even that is no guarantee that you won’t get ass raped when push comes to shove, the local guys often get by with much less. People voluntarily watch out for them, government officials warn them of regulation changes ahead of time, tax officials warn them of audits before they are done. No money changes hands most of the time. It is pure influence.

Even when they make mistakes, they are forgiven. The amount of time before the mistake gets papered over depends on the severity and if it hit the papers in a big way, but in general, few people (who aren’t competing with them) want to see these guys fail, and lots of people are rooting for them.

You see, the guys like the Thiagarajar family, the Bakries in Indonesia, any number of Malaysian political families, Communist party elites etc, Lee Kuan Yew and family, have been building influence for decades.They were providing jobs and livelihoods when there were none, education when schools were few and out of reach of middle class poor. They were rationing these scarce commodities according to their whims before these markets opened up, and the people who received those favors, and their kids, and grandkids remember.These guys were helping people in the dark old days when Asia was a proper third world kind of place. So in the modern era, when they call their favors in, many are glad to do what they can.

This is what confounds most Westerners about Asia. Even when there is no explicit corruption, these guys are like Teflon. They never go bankrupt even if they make the worst business decisions. They never go to jail even when they commit egregious crimes, unless the public opinion demands a sacrificial goat.

I have seen more than one tycoon snatch his wealth back from the jaws of bankruptcy. His Western lenders get screwed, but local lenders are almost always made whole. If his bank goes bust because he’s been embezzling money, the government steps in and saves him. A couple of years in the tank, and he’s out smelling like roses again, running for office even.

Citadel, Bloomberg and the perils of stale news…

Bloomberg today morning kicked off with a puff piece on Citadel, which will no doubt appear in Bloomberg magazine later in the month…

Oct. 29 (Bloomberg) — Rohit D’Souza was on vacation with his family in India in May 2008 when he got a call from Ken Griffin, founder and chief executive officer of Citadel Investment Group LLC. Griffin wanted the banker, who had just quit his job as head of equity trading and sales at Merrill Lynch & Co., to help him do something no other hedge fund had ever tried.

Less than two months earlier, Bear Stearns Cos. had disappeared, swallowed by JPMorgan Chase & Co. after losing billions on subprime mortgages. Griffin asked D’Souza, a 45- year-old native of Mumbai, if he would be interested in running a full-service investment bank.

6 hours later, WSJ reported the following

The Chicago firm also confirmed that a banker it hired last year to build an investment bank, Rohit D’Souza, was leaving.

The developments showcase the challenges facing the firm that manages $14 billion in assets as it tries to recover from a grim 2008 for its hedge funds while diversifying into other businesses.

Upon which, Bloomberg had to Update the article and add the following

Oct. 29 (Bloomberg) — Rohit D’Souza was on vacation with his family in India in May 2008 when he got a call from Ken Griffin, founder and chief executive officer of Citadel Investment Group LLC. Griffin wanted the banker, who had just quit his job as head of equity trading and sales at Merrill Lynch & Co., to help him do something no other hedge fund had ever tried.

Less than two months earlier, Bear Stearns Cos. had disappeared, swallowed by JPMorgan Chase & Co. after losing billions on subprime mortgages. Griffin asked D’Souza, a 45- year-old native of Mumbai, if he would be interested in running a full-service investment bank.

The two men talked through September as Lehman Brothers Holdings Inc. declared bankruptcy and rumors swirled that Chicago-based Citadel, whose gross assets had reached $145 billion earlier that year, would fail. The firm’s biggest funds, Kensington and Wellington, lost 16 percent that month and started exiting unprofitable businesses. In October, as the funds tumbled another 22 percent, D’Souza said yes. D’Souza said yes.

On Oct. 29, 12 months later, Citadel said D’Souza is leaving the firm and will be replaced by Patrik Edsparr, president of Citadel Europe and head of the company’s fixed- income business. The departure suggests that Griffin’s attempt to graft an investment bank onto a hedge fund firm won’t be easy.

Hilarious… at least Bloomberg is lucky the news wasn’t delayed a couple more days, then in would be in hardcopy in the Bloomberg magazine. However, they certainly couldn’t change the thesis of the article… that Citadel was building an investment bank, without deleting the entire piece… so they just ran with it, regardless of how irrelevant the entire story had become:

His latest enterprise may well be his most audacious, at least since starting his own hedge fund. Grafting an investment bank onto a hedge fund firm won’t be easy. Unlike large banks, Citadel doesn’t have a big balance sheet, so it can’t offer loans to clients to purchase companies or make investments.

On the Ground in India

I’m on vacation in India this week, covering mostly southern India, namely the states of Kerala, Tamil Nadu and Andhra Pradesh. We’ve been getting in a mix of the cities and the villages, and I’ve had a chance to touch base with some old colleagues who have moved here. I just wanted to fire off some initial impressions from the ground.

Power
The power situation here is abysmal, but that has created some advantages that will serve the economy well in the future. India has about 120 gw of generating capacity, compared to the UK which has about 80 gw. This is ridiculous. The UK is now contemplationg a power shortage in about 5 years, yet it already has about 1.3 gw per million people, India has 0.1 gw per million.

What this means is that power is now unavailable from the market at the regulated official rate. In order to get power you have to pay off officials, and the unofficial rate is as high as 20 US cents per kwh. In comparison a developed market, with all its regulations and carbon taxes normally has tariffs at about 4 to 5 US cents per kwh (France for eg).

The reserve margin, or excess capacity beyond peak demand is at -20%, officially, and unofficially as high as -50%. Beyond the capital city of each state, electricity is rationed with planned power outages of between 2-4 hours each day.

The southern states plus maharashtra are the wealthiest states with a concentration of manufacturing and IT services. But power is so short that any manufacturer has to either build his own power plant or have a generator at hand to support operations. Indians have turned to distributer power generation because they have no choice. Some companies like Suzlon and Vestas have built these enormous wind farms across the barren landscape of the south. A manufacturer can buy a windmill, feed in to the grid, and take out an equivalent amount at his plant.

The nuclear power plan in India has gotten much further along than I expected. While at a diplomatic level, India has just received unanimous approval from the Nuclear Suppliers Group to buy materials, at the local level, land acquisition, design, and the political debates around the issue are well advanced. I passed by the Kudankulam Nuclear Power site, an existing site where the Russians will add 4 more reactors, and the area had ready been cordoned off, with heavy trucks starting to go in.

The electrical grid has imporoved dramatically since I was last here 3 years ago, with all the wind farms connected by high voltage transmission lines, something which is cauisng the US issues with wind development. the local grids have now all been connected and the Power Grid Corporation is working on the final North-South interconnect. This is probably the only area where the Indians are ahead of the Chinese, but the advantage seems to stem from the inherent bicoastal geography and more distributed population than any focused effort.

Power distribution reform is still at its early stages, with some cities having privatised their grids, and some still under state goverment control. Distribution is probably the most controversial area because you actually have to cut off millions of slum dwellers who have illegally tapped power lines. The more expensive but less troublesome way is to bury overhead copper cables rather than actively policing areas with distribution losses.

Roads
The road infrastructure has improved dramatically in the last 3 years, with 2,4 and 6 lane highways on many major routes. If there is one sector of the economy which is printing money right now, it is the toll road operators. Unlike transportation infrastructure in many other developing nations which are basically pork barrel-soft loan-slush fund projects for local politicians with overestimated traffic numbers, a unique tax incentive has made road developers here underestimate numbers (but of course the pork barrel element still exists!). Basically the goverment waives value added taxes when developers show low revenue numbers due to the low tolls they are required to charge. The volumes when the road is built is so much higher than the projections that the developers make out like bandits.

Metro
All the major cities are builidng metros. The Japanese are providing soft loans and technology for the Chennai metro which is currently being built. The Indian government no longer provides sovereign guarantees to any of these projects, as India is now an investment grade destination. I believe the last project they provided a guarantee to was the ill fated Enron Dhabol project.

Finance and banking
Finance is largely in the 1920s here. Bank loans are obtained by bribing bank officers for small loans, and being friends or family with the head of the bank for larger loans.

There is no concept of limited recourse, and loan applicants typically have to assign all personal and family assets to the bank.

The stock market is purely an insider’s game at the local level. The larger local investors receive tips from the tax offices, accountants, consultants, and other people in the know. In fact, trading on pure analysis without as inside edge is regarded as ludicrous. All the big brokerages are essentially stock pools which exist to manipulate stocks up and down. On a daily basis, brokers from IndiaBulls and Edelweiss and other brokerages send text messages to the millions of small investors under their wings, directing them to sell or buy particular stocks, while leading their clients. It’s really the 1920s out there.

There is no bond market for local issues, and hence there is no concept of bankruptcy. Instead all the bank lenders club together to put the company through a Corporate Debt Restrucuring process, which typically involves paying some upfront fees to lender (and bankers as well presumably), in return for an indefinite maturity extension.

This process has created literally hundreds of companies under perpetual restructuring. No one will sell when distressed, because they can always make a deal with the bank. This process only gets disrupted when there is significant external borrowing from foreign sources, one reason why the Reserve Bank of India is a predatory hawk when it spots this.

Agriculture
If the indian economy has an Achilles heel, it is agriculture. 700 to 800 million people depend on it, but the variabily of the monsoons, groundwater depletion and overfarming are driving desertification of large areas of the country. The south is in severe drought right now, and in the afternoon the temperature hits 40 degrees C. Inter state disputes and local politics have delayed many of the water projects. Lack of power has also been a significant hurdle.

Having said that, the agricultural sector produces an immense amount and variety of products here, This may simply be a by-product of the smallholding system, or it may be that there is enough local variations of climate and conditions to support a wide variety of plants.

Poverty and the Naxalites
India still has the kind of grinding sub-saharan africa kind of poverty that has disappeared from the south east asian ecenomies. Farmers who have taken 5000 rupees or about USD100, end up going into indentured servitude and shipped off to stone quarries and coal mines. All absolutely illegal, and civil society groups try to expose and prevent the worst of the atrocities, and yet it happens.

While a huge number of people live on less than USD5 a day, it is amazing how much you can buy for that amount in India. A college educated non-engineering graduate would probably make USD200 a month. A good meal at a local diner would set you back maybe 50 US cents.

The Naxalites are a more recent development. I think the best way to describe them would probably be a slightly Communist tinged Project Mayhem type organization. There does not seem to be a central leadership, but more than two thirds of Indian districts are supposedly under their control. They pop up randomly, extort small amounts of money or oppose some project by kidnapping someone. Their victims generally know who they are, and in fact live side by side with them in the villages. Most of the Naxalites don’t know who their leaders are, but simply follow the instructions they receive, show up here, pass this package to a person who gives you this signal. It seems like a classic uprising of the lower classes against the stratified and protected elite.

Fund Info: Matchpoint Asia

Well,  looks like Raaj Shah, he of the first Och Ziff partner to get fired after the IPO fame, has bounced back, somewhat…

Sets up Matchpoint Asia with Sean Debow,  another hedge fund firee. The size of the fund USD50mm, indicates that it’s probably primarily partner’s funds. They probably put in USD20-USD30mm on their own, and got some Chinese entrepreneur to pump in USD20mm in return for a cut of management and performance fees. The problem with new fund raising these days, is that it takes at least 3 years to establish a track record as a new fund and get on the radar screens of the typical institutional investors, all of whom were badly burned in the last 18 months.

I’m still waiting for a Chinese oligarch backed fund, with money from a Chinese family and a cutthroat CIO to show up and start doing big things. I would envision something like Barakett’s Atticus Capital, where a HBS ice hockey cowboy was paired with an European playboy fund raiser. Atticus was such a play on concentration, leverage and sheer luck. No diversification of bets whatsover.

Getting back to Matchpoint, their strategies seem to be to trade whatever equities, bonds, and convertibles they can. There’s a lot of smoke on their strategies, but that’s what it’s going to boil down too.

On another note, neither Raaj nor Sean is Chinese or even North Asian, and yet they focus markets are North Asian. I always wonder why these guys think they can make it out here. Here’s a piece of advice, it you want to be the smart money in Asia, you better damn well have family connections into the oligarchies that run stuff. Or you will get you ass handed to you everytime.

Oct. 7 (Bloomberg) — Raaj Shah, an ex-partner of Och-Ziff Capital Management Group LLC, co-founded a hedge fund last month trading under-researched and mispriced Asian securities affected by events such as mergers, tax changes and forced selling.

The almost $50 million Matchpoint Asia Fund Ltd. targets annual returns of 15 percent to 17 percent without betting on market direction, Sean Debow, chief operating officer and co- founder of its adviser Matchpoint Investment Management Asia Ltd., said in an interview. Hong Kong-based Matchpoint’s nine- person team has the capacity to manage $700 million, he added.

“We see arbitrage opportunities in Australia where there are a lot of takeovers and tender offers,” Debow said yesterday. “We see a substantial number of securities that are mispriced and not as well understood in India, Taiwan and China.”

——

Shah, Matchpoint’s 34-year-old chief investment officer, spent 12 years with Och-Ziff, the New York-based hedge fund firm led by Daniel Och. He co-managed Och-Ziff’s Asian operations before leaving in December. Debow, 42, was most recently Asia research director and Asia business head of Los Angeles-based Ivory Investment Management LP.

‘Turning Point’

Och-Ziff’s then $16.4 billion OZ Master Fund lost 16 percent last year. The $2.4 billion OZ Asia Master Fund fell 31 percent, according to the annual report.

“We’re at the turning point right now in terms of the availability of talent for the hedge-fund industry in Asia,” said Charles Stucke, Chicago-based global chief investment officer of Guggenheim Investment Advisors LLC, which manages more than $50 billion of assets.

Matchpoint will use a so-called bottom-up approach to select its investments, Debow said. The bulk of its holdings will consist of listed shares of companies. About 10 percent of the assets would be listed securities incorrectly priced because of forced selling by investors, short-term changes in the issuers’ cash flows, or other types of corporate distress events, he said.

It will invest in securities whose prices are expected to be affected by “hard catalysts,” including publicly announced corporate actions such as mergers or events with a number of possible outcomes. Matchpoint will exploit mispricing of those securities before the events are completed, Debow said.

Distressed Prices

Company executives are shifting their focus from “firefighting” during the financial crisis back to growing their businesses through strategic investments amid “the calm after the storm,” Debow said.

Matchpoint will also trade securities with “soft catalysts,” meaning they will be affected by short-term changes in factors such as consumption patterns, taxation rates, regulatory environment, or costs of goods sold, he said.

A third category of investments will be securities trading at distressed prices, hit by forced selling by investors, or events such as material changes in near-term costs and selling prices of their products, Debow said.

The Matchpoint fund will focus on Hong Kong, China, Australia, Japan, Taiwan and South Korea, and to a lesser extent, India, Singapore, Indonesia and Malaysia, he said.

Och-Ziff, Ivory

Och-Ziff invested about 20 percent of the $27 billion assets under management at the end of December in Asia, according to its annual report.

The company in December cut at least 10 jobs in the region as its funds lost money amid falling markets and investor withdrawals, people said then. Shah departed that month to “do something more entrepreneurial,” Debow said.

Debow left Ivory, which decided in December to close down the Asian operations to focus on U.S. securities, he said.

He declined to give his and Shah’s earlier investment performances, saying the track records are owned by their former employers.

Infrastructure Investment Of the Year Award!

This would be pitched so:

———————

ELAN INVESTMENTS presents unique investment opportunity in Asian infrastructure. The Company is the owner of the exclusive right to develop a transportation network in a prosperous Middle Eastern democracy. The network will be used for the transportation of all goods to be used by the territory in question, and hence would have a monopoly on transportation of materials into the territory. The economy of the territory in question is estimated at USD12 billion for a population of 2.5 million, for a GDP per capital of USD5,000 per person, which is higher than India and slightly lower than China.

The license obtained by Elan does not limit tolls in any way, and hence the Company will be able to charge whatever the traffic will bear. Cost of construction of each link in the network will cost approximately USD100,000.  The Company has been encouraged by the sponsor government to build as many links as possible. The Company envisions an initial investment of USD100 million in the form of Redeemable Assumed Preferred Exchangeable Receipts  paying a coupon of 120% per annum. The sponsors of the Company will own all equity in the firm, and hope to make a return in excess of the RAPES.

Political risk insurance on this investment in not available.

———————–

Elan by the way, in Arabic would translate to Hamas.

Inshallah they get restitution.

Investment opportunities are rare in the Gaza Strip. So when Nabila Ghabin saw one last year, she pawned her car and jewelry and put $12,000 into a network of tunnels that brought in supplies smuggled from Egypt.

She was one of about 4,000 Gazans who gave cash to middlemen and tunnel operators in 2008 as Israel blocked the overland passage of goods. Then Israeli warplanes bombed the tunnels before and during the Dec. 27 to Jan. 18 Gaza offensive and the investments collapsed.

Now investors, who lost as much as $500 million, want their money back from Hamas, which runs Gaza.

The imbroglio over the 800 to 1,000 tunnels has deepened Hamas’s decline in public opinion in Gaza and highlights the Wild West nature of the underground economy that supports this jammed enclave of 1.4 million people.

————-

Digging and operating a tunnel, typically about 50 feet (15 meters) deep and 250 feet long, costs as much as $100,000, according to Shaban.

With Israel restricting the flow of goods into Gaza after Hamas took power in 2007, tunnel owners began seeking funds for more tunnels. They built under license from Hamas: Four operators who declined to be identified said they each paid 11,000 shekels ($2,950) to Hamas for a digging license.

According to investors Ghabin, Mohamed Shurab and Shadi Qishawi, the financing worked this way: In exchange for their money, investors were promised monthly dividends of 10 percent. They were not owners of the tunnels. The returns came from the profits of smuggling as well as new investments, Shaban said.

—

Temasek/GIC Tracker

This just in, looks like SingGov is going to have a piece of one of the largest single property real estate defaults in the world: the Stuyvesant Town and Peter Cooper Village in New York. This is what you get for participating in real estate mezz loans in 2007, taking equity risk with capped return.

To be honest, this worked out unfortunately for Tishman Speyer and Blackstone more because of local NY politics. Their calculations about converting rent control apartments seem to have been sound, but they underestimated how socialist the US has become lately.

Numbers time:

At Stuyvesant Town, there is a $3 billion first mortgage, or commercial mortgage-backed security, and a $1.4 billion second loan, known as “mezzanine debt” held by SL Green, the government of Singapore and others.

Finally, there is $1.9 billion in equity put up by Tishman Speyer, BlackRock and their investors. Tishman Speyer, which generally earns development and management fees from the properties, has about $56 million of its own money in the deal.

USD3.0 b first lien
USD1.4b mezz
USD1.9b equity
——————————-
USD6.3b total purchase price
——————————-

Current estimated value of property, drum roll please USD2.2b.

All of the equity, all of the mezz and 30% of the first mortgage has been wiped out. But Tishman Speyer only put in USD56mm and received management rights. It was basically call option premium plus purchase of a cash flow stream for them. If the other investors syndicated widely, it probably ended up being NYC real estate call options for all of them.

Abax Global Capital: Redux

Abax just announced they are opening up a global macro fund. This must be where their paths diverged with founder Chris Hsu last year. A switch from special sits to global macro makes sense if you are an investor, but I’m not sure it makes sense if you work for the firm. I mean, did they just dispose of all their corporate finance people and hire traders instead.

Tudor, the $10.5 billion Greenwich, Connecticut-based hedge fund company founded by Paul Tudor Jones, contributed the majority of the initial capital for the Asian macro fund, with the rest coming from Abax partners, Yong said. Abax raised $300 million at inception and now oversees $455 million.

Tudor is known as a good macro guy. So the fact that they raised money from him is great. But why did he fund them? They might have some market access or knowledge on Chinese currency movements.

The world’s biggest carry trade…

It’s occurred to me that the US and the Fed are now officially engaged in the world’s biggest carry trade. They’re borrowing money at the risk free rate and pumping it to the economy, whether it’s through the TARP or the Fannie or Freddie.

Here’s a thought, you don’t think Citi, or Goldman or BofA are good enough credits to lend them money at say 5% interest, so instead you lend money to the US government at 2%, and the government then onlends this to the banks at 5%. Ludicrous. All that money has to come from somewhere, so first you borrow it, and then you print paper money till the real value of those debts that you incurred is impaired.

Sooner or later the rest of the world is going to wise up to this. TANSTAAFL

If Vikram Pandit was honest….

I was thinking of what Vikram Pandit might have said when he took over leadership of Citigroup. If he had been really honest, he might have said the following:

Date: Dec 11, 2007

Transcript of speech by Vikram Pandit

Thank you Win Bischoff and Robert Rubin.

Dear Colleagues,

Citi has been through a trying time in the last 12 months and indeed in the last few years. While I am a relative newcomer to Citi, I am extremely proud of this institution’s history and aware of the tremendous responsibility that comes with assuming the mantle of leadership.

First, it is necessary for me as incoming CEO to make a thorough assessment of the current state of our business, and outline my plans for the firm.

I think of our business as a combination of several advisory firms with a large portfolio of securities. In order to have an honest reckoning of the state of the firm, it is necessary to value the portfolio under a global recessionary scenario which may last as long as 2 years, and a decrease in global GDP by about -1%.

Under this scenario, combined with a real estate bust in major Western markets, we see significant impairment in our securities portfolio. In all, we expect to take in excess of USD500bn in losses over the next two years or approximately 25% of total assets. These losses will occur across all portions of our business including subprime mortgages, prime mortgages, Alt A mortgages, small business loans, bonds, leveraged loans, lines of credit and consumer loans such as credit cards, auto loans.

As of today, our market capitalization stands at USD167bn, and our total long term debt stands at USD427bn. Over the course of the next 24 months, I expect that out equity will turn out to be worthless, and in addition our debt will be worth 78 cents on the dollar.

In addition, Citi is the counterparty to millions upon millions of trades, including repos, rehyphothecations, credit default swaps etc. We do not have an effective way of gauging losses on these trades in response to market movements. It is within the realm of possibility that we have additional billions of losses that we are not aware of yet.

We also do not know what terms lie in the hundreds of contracts we sign on a daily basis. Under what conditions do we have an obligation to consolidate our off balance sheet entities? When would we have to post collateral on our CDS contracts? As the machine which is the contract grinds forward, we are as susceptible as anyone to surprises.

I propose from this day forward to cease paying dividends indefinitely, this would increase cash available to debtholder USD11bn annually. I also propose to pay all bonuses in the form of restricted stock which will have to be held for 5 years.

I propose from this day onward to cease making new loans of any sort until capital position is sorted out. If the government wants us to make loans, it better give us the money.

I propose to split Citigroup into 4 different parts: a retail and corporate bank providing loans, an investment bank providing advice, a brokerage and wealth management firm, an insurance firm. The hedge fund, private equity and proprietary trading desks will be allowed to buy themselves out, sold or terminated. They will no longer have access to the bank’s capital.

I will ask for the US, EU and other national governments in each jurisdiction that Citigroup has operation in to participate in a global bailout. The capital received will be senior to all existing equity and debt, but junior to customer deposits in order to avoid a bank run. Each national government will be asked to guarantee every penny of customer deposits. This action, combined with writedowns of assets to realistic market values, will result in the nationalization and loss of control of most of Citi’s international businesses.

Our board is composed of highly respected individuals who are not really that interested in our business. If Chuck Prince, who spent every moment looking at our business did not completely understand it, then what hope is there for luminaries such as Richard Parsons, who couldn’t tell a CDO from a good HBO episode of Sopranos? Bob Rubin is a great man, but he’s our schmoozer in chief, not a manager of our business. The last time Win Bischoff actually did anything in banking, derivatives were something you did in calculus.

In short, I am in complete control, and rule the board through fear of exposing their incompetence.

I could have come up here and done the usual CEO rigmarole. Oh yeah business is great, things are looking up, the music will start and we’ll keep dancing… Our portfolio has been cleansed and has now top notch securities… Great franchise, we’ll never break up.. our board is stunning… etc etc.  But in fact this would only give some meagre support to shareholders and fleece sovereign wealth funds into buying our worthless shares.

No, I care more for being honest, and keeping it real. In 12 months, I want to be able to say I was right, rather than going on the Charlie Rose show and saying how when the facts change, I change my mind.

This speech also ensures that I won’t lose my job for poor performance next year, because I’ve already revealed exactly how abysmal performance really is right now. So all you fools who just think I’m a seatwarmer who’ll announce the bad results and then be axed, this’ll show you..

Ya Trick Yar!

The reaction to that honest speech should have been Citi’s share price plummetting immediately to below USD1, all other banks suffering the same fate. No financial institution would have been able to raise capital for the next year, and there would have been riots on the street as banks stopped lending.

Contrary to the tone of the letter above, this piece is actually a defense of Vikram Pandit. Sometimes you need liars and cheats to get us through the bad times by telling us its not really that bad.

Credit Suisse Bonuses: Better than a stock award?

The news that Credit Suisse is going to pay bonuses using its troubled assets has been viewed with glee, both restrained at the NYT and unrestrained at Dealbreaker. But I’m not totally sure that this actually disadvantages the senior bankers in anyway.

Here’s why. Let’s say that the troubled asset pool is currently marked at fair value on the CS balance sheet. Firstly let’s think about this, how do you identify high risk assets? Is it just the interest rate/risk premium on the asset? Nope, let’s say its trading at 30 cents on the dollar, but you bought it (or its marked on your book) at 15 cents on the dollar, then the asset is actually in the money, and hence not troubled. Now I doubt they know what the fair value of the assets really is, but let’s just assume management actually has genuine faith in the statements they’ve been putting out to the market saying that their marks are reasonable.

Now let’s compare handing out bonuses in terms of stock awards versus a slice of the troubled asset pool. What is stock? Shareholder’s equity is the residual value after all other claims have been paid. Hence if the firm were handing out stock awards, each recipient is receiving a portion of the remainder of the hypothetical value of the firm if all assets were sold and the proceeds used to pay off all liabilities.

Now if you hand out a slice of the troubled asset pool, what is the analogy? You look at the asset side of the balance sheet, identify the high risk assets, section them off, and hand them off to a trust to administer them. In theory, this is actually better for the recipients than the stock award. Why? Well let’s say the assets are valued at a distressed but fair market value. In effect what is happening is that a portion of the assets is getting carved out of the benefit of the recipients, who then have a collateralized position. Ie the recipients are actually now have a senior claim on the firm with reference to the shareholders. In the same theoretical value liquidation exercise, they will receive their money before shareholders do, and in effect this reduces the value of the stock.

This is even before the identification problem. How does the bank know which assets are troubled? Let’s say the bank has taken writedowns on its leveraged loans and these are piled into the bonus facility. But then perhaps the bank did not forsee a problem in the commercial mortgage market and leaves these on the balance sheet. The shareholders are still exposed to the commercial morgages as residual claimants, while the leveraged loans, if they have been written down far enough, might eventually be worth more than their written down value, and the shareholder no longer have a claim on them.

Of course most of us know that the assumption here is wrong. Those assets are not marked at fair value and CS knows it. Why no one calls them on this shit, I have no idea. Plus they’re supposedly providing leverage to the facility. So what they’re saying that the recipients are going to take first losses. Which means more of less that CS is paying bonuses using stuff that they already know is worthless.

Why an accounting or regulatory body doesn’t call these guys out on this shit is beyond me. But, Dealbreaker is right, CS bankers are getting screwed worse than their counterparts at any other bank.