Friday, May 29, 2009

Take Home Quiz

May 29, 2009
ECON 403: Elements of Modern Corporate Finance Theory
Section 4.2: Valuation

Please answer the following questions using the methodology we have been employing in this course. Make sure to show all your work. The use of financial calculators is strongly encouraged.

You may use the attached materials as examples.

1) What is the Net Present Value of a poem?

2) What is the Internal Rate of Return on a photograph?

3) What is the proper Debt to Capital Ratio for a concerto?

4) What is the Net Operating Cash Flow of a painting?

5) Extra Credit: To what reasons does the author of the following passage ascribe the collapse of Lehman Brothers in September 2008? Is he using Fama and French or Miller and Modigliani? Explain.

We shall not cease from exploration
And the end of all our exploring
Will be to arrive where we started
And know the place for the first time.
Through the unknown, remembered gate
When the last of earth left to discover
Is that which was the beginning;
At the source of the longest river
The voice of the hidden waterfall
And the children in the apple-tree
Not known, because not looked for
But heard, half-heard, in the stillness
between two waves of the sea.
Quick now, here, now, always—
A condition of complete simplicity
(Costing not less than everything)
And all shall be well and
All manner of thing shall be well
When the tongues of flame are in-folded
Into the crowned knot of fire
And the fire and the rose are one.

— T.S. Eliot, Little Gidding (excerpt)

This quiz will count for 25% of your semester grade. Good luck!

© 2009 The Epicurean Dealmaker. All rights reserved.

Thursday, May 28, 2009

Old Ideas Are the Best Ideas

I have been accused, from time to time, by otherwise Grateful Readers of these pages of focusing overmuch on the description, analysis, and criticism of many of the troublesome practices and behaviors in the financial industry which vex our peaceful commonwealth and which have led us down a ruinous path to our current sorry state. "Why," these plaintive supplicants beg, "does someone with your blinding grasp of the obvious not do your fellow citizens the signal service of providing a solution to the pesky problems you so trenchantly describe, rather than just ranting on and on about their vileness and injustice?"

This, I must admit, is a just critique.

Fortunately, a recent browser in my archives has reminded me of a piece I penned quite early in my career as a gimlet-eyed commenter on current events. While it is not entirely up to date, it could easily be refashioned to do service in today's less carefree environment. I wrote the post in question early in 2007, when I was yet a starry-eyed naïf on the serried field of financial bloggism, and when nary a cloud bedimmed the bright blue horizon of a world where everyone looked forward to an endless future of easy credit, excess liquidity, and consistently above-market returns.

The mere memory of those times makes me sigh.

Anyway, as I said, the post could do with some editing for fact and content, since some of its key premises—for example, the contention that private equity firms still have money to spend—are clearly artifacts of a time long since past. (Now, for instance, one might contend that the natural buyer is the US government, financed without apparent limit by complaisant taxpayers and clueless sovereign wealth funds. Stay tuned for further revisions.)

Nevertheless, I believe the problem I identified then continues to afflict us now, and the solution I proposed remains sound. Perhaps it could be extended to a broader class of commodities—for example, investment bankers, secured debt lenders in distressed companies, and reckless insurance company executives—but I will leave that as an exercise for the reader. When purveyors of pitchforks and torches struggle to meet demand from the general populace for their wares, I am certain that a well-thought-out, rationally designed solution along the lines of my proposal will meet with substantial public acclaim.

* * *

So, without further ado, I (re)present herewith



IT IS a melancholy object to those who walk through this great town or travel in the country, when they see the streets, the roads, and expensive restaurants, crowded with former Chief Executive Officers of public companies, followed by three, four, or six hangers-on, consisting of PR flacks, personal trainers and bodyguards, and second or third wives, all in furs and importuning passersby for the location of Charlie Rose's studio. These ex-CEOs, instead of being able to work for their honest livelihood, are forced to employ all their time in playing the 100 Best Golf Courses in the World, yachting in the New Hebrides, and giving interviews on "Larry King Live." Worse, they are routinely compelled by their straitened circumstances to author self-exculpatory autobiographies and tendentious management screeds (with the assistance of ghostwriters or third wives) and to promote same on nationwide speaking tours.

I think it is agreed by all parties that this prodigious number of former CEOs is in the present deplorable state of the nation a very great additional grievance; and, therefore, whoever could find out a fair, cheap, and easy method of making these individuals sound, useful members of the commonwealth, would deserve so well of the public as to have his statue set up for a preserver of the nation.

But my intention is very far from being confined to provide only for former CEOs; it is of much greater extent, and shall take in the whole number of current and former Chief Executive Officers of publicly traded corporations in this country and, by extension, the world.

The number of public company CEOs in this nation being usually reckoned five thousand, of these I calculate that there may be about fifteen hundred of consequence. The latest research by eminent scholars of executive pay indicates that these CEOs were paid an average of $4.9 million a-piece per annum in wages, benefits, and emoluments, thereby imposing upon the nation and upon the common shareholders of their employer companies an aggregate burden of $7.4 billion per annum. And yet this is not the worst of the imposition upon the population, since it is common for such CEOs to take with them substantial multiples of their current pay and benefits upon their retirement, voluntary or otherwise, from the post. A respected gentleman of my acquaintance, who himself is of the most unimpeachable character and honesty, even asserts that there have been some knaves and scoundrels among the ranks of former CEOs who have managed to depart their employers with amounts in excess of $200 million, although I can scarce credit such outlandish reports.

I shall now therefore humbly propose my own thoughts, which I hope will not be liable to the least objection.

I have been assured by a very knowing Frenchman of my acquaintance in New York, that a vigorous healthy CEO well compensated is at three years old a most delicious, nourishing, and wholesome food, whether stewed, roasted, baked, or boiled; and I make no doubt that it will equally serve in a fricassee or a ragout.

I do therefore humbly offer it to public consideration that of the fifteen hundred current CEOs already computed, those five hundred CEOs in their first year and those five hundred in their second year of service may be reserved for ongoing management, and five hundred CEO designates be identified for promotion to the post. The remaining five hundred currently in office may, upon the third anniversary of their employment as CEO, be offered in sale to the persons of quality and fortune though the nation; always advising the shareholders to let them suck plentifully at the corporate teat in the last fiscal quarter, so as to render them plump and fat for a good table. A CEO will make at least six dishes at a lavish entertainment for friends; and when the family dines alone, the fore or hind quarter will make a reasonable dish, and seasoned with a little pepper or salt will be very good boiled on the fourth day, especially in winter. I have reckoned upon a medium that a CEO newly appointed will weigh 190 pounds, and in three solar years, if tolerably remunerated with salary, options, restricted stock, and perquisites, increaseth to 260 pounds.

I grant this food will be somewhat dear, and therefore very proper for private equity partners, who, as they have already devoured most of the public corporations, seem to have the best title to the CEOs.


* * *

There is more, Dear Readers, much more. Please, read it at your leisure and discuss it amongst yourselves.

I pass these valuable thoughts on to you, my fellow citizens, as a general salve for these troubled times with no thought of personal reward, other than the cheers and praise of a grateful nation.

(Of course, donations to The Epicurean Dealmaker Memorial Library are always welcome. Please send all contributions to the address found on this website in the form of small, unmarked bills or credit vouchers to nationally recognized strip clubs. Thank you.)

1 As before, this author proffers fulsome apologies to Jonathan Swift.

© 2009 The Epicurean Dealmaker. All rights reserved.

Obviously, Alan Blinder Is Not a Golfer

Oh, Alan, Alan, Alan.

I love ya dearly, but clearly you need to get out more. Get a cup of coffee, see a movie, read a blog or two for chrissakes.
Despite the vast outpouring of commentary and outrage over the financial crisis, one of its most fundamental causes has received surprisingly little attention. I refer to the perverse incentives built into the compensation plans of many financial firms, incentives that encourage excessive risk-taking with OPM—Other People's Money.

What, you say, hasn't huge attention been paid to executive compensation—especially those infamous AIG bonuses? Yes. But the ruckus has been over the generous levels of compensation, or the fact that bonuses were paid at all, not over the dysfunctional incentives that inhere in the way many compensation plans are structured.

Well, I don't know. This guy seems to have been paying attention.

In fact, I might even say he has been beating the dead horse of perverse incentives in the finance sector rather convincingly for some time now.

Oh well, I guess there's no accounting for taste.

© 2009 The Epicurean Dealmaker. All rights reserved.

Wednesday, May 27, 2009

Life Imitates Art

This is my new favorite explanation for the complete and utter collapse of financial capitalism as we know it:
In the world of comic books any individual who has more than 5 million dollars in saving or assets immediately becomes bat-shit insane. It's a strange rule, but it seems that every independently wealthy individual in superhero comics decides that fighting/committing crime is the best way to spend their free time. They ignore possible hobbies like golfing, yachting, and collecting antique cars and go straight into wearing a mask and creating a global organization designed to save/destroy/conquer the world. The examples in comic book fiction are nearly limitless.


This persistent pattern of a wealthy individual building a financial empire through shrewd economic skill and then destroying it almost instantly through costumed antics shows only one thing. In comic books, all money is coated with a powerful hallucinogen. When you aquire enough of it you go crazy and then act accordingly.

So far, the authors have been too modest in assessing the explanatory power of their groundbreaking new theory by limiting it to the comic book universe, but I am sure a book deal or two and a couple of appearances on CNBC and Charlie Rose will cure them of their diffidence posthaste. If not, I know a couple of Ukranian hookers who can buff their confidence to a blinding shine.

Coincidentally, I already possess warehouses full of documentation proving that anyone in the real world who accumulates more than $5 million in wealth automatically and immediately turns into a raving lunatic. It just never occurred to me that we could have avoided global financial meltdown by distracting investment bankers and commercial bank CEOs with a lifetime supply of green spandex and a few hundred crates of pumpkin bombs.

Hindsight, as they say, truly is 20-20. Or, in this case, X-ray vision.

Hat tip: Felix Salmon

© 2009 The Epicurean Dealmaker. All rights reserved.

Tuesday, May 26, 2009


A good guide will take you through the more important streets more often than he takes you down side streets; a bad guide will do the opposite. In philosophy I'm a rather bad guide.

A serious and good philosophical work could be written consisting entirely of jokes.

Ludwig Wittgenstein

Illustration courtesy of xkcd.

© 2009 The Epicurean Dealmaker. All rights reserved.

My Kid Could Do That!

In a flash bulletin this morning from The Department of the Obvious Department—otherwise known as The Wall Street Journal—I was gobsmacked to learn that a crack team of Harvard and NYU academics has cracked the code to M&A valuations.

As I hastily toweled coffee off my keyboard and computer monitor, it occurred to me that, if said news were true, it could revolutionize the practice of corporate mergers and acquisitions, not to mention put a serious damper on my plans for early retirement to the Côte d'Azur with a couple hundred large and a stable of pliant young confidential secretaries. Naturally, I read the article with bated breath.

Having read the piece, however, I am pleased to report that investment bankers, private confidential secretaries, and French Riviera purveyors of vintage champagne, high-priced real estate, and paid police protection can all heave a gratified sigh of relief. There is nothing to see here. Move on, folks.

Of course, there will always be some number among my Worshipful Audience who will affect a slightly more skeptical air and demand to know names, dates, and the particular measurements of any confidential secretaries involved. For these tiresome busybodies, I will take valuable time away from my Tuesday afternoon pedicure to make the following remarks.

* * *

Sadly, the concierge for this little spectacle, the WSJ's own Dennis Berman, did not link to the original report by our intrepid researchers, so your Dedicated Bloggist is limited to commenting on the news article alone. Fortunately, there is adequate supply of folly in said piece to provide ample amusement for all.

For instance, Mr. Berman opens his piece with a sop to the cheap seats, taking a swipe at the supposed hypernumeracy of the media's current favorite whipping boys:

With their spreadsheets and teams of math geeks, investment bankers like to show their deal work as a kind of deep science.

While pithy and provocative, this little dig suffers from the slight rhetorical handicap that it simply is not true.

First of all, the mathematics used in M&A valuation, while admittedly more complicated than balancing the average American's checkbook, is decidedly not complex and bears absolutely no resemblance to the scary agglomerations of obscure Greek letters, self-referential operators, and nested gobbledygook in which the true "math geeks" of the investment banking world—derivatives structurers and traders—traffic. Sure, there is the all-important concept of the time value of money, the calculation of which is best handled within the confines of a computer spreadsheet, but most M&A valuation entails simple grade school math: addition, subtraction, multiplication, and division.

Second, any M&A banker worth his or her salt knows that valuation is an art, not a science. There is no one right answer to the valuation of anything as complex as a business. For one thing, while the mathematics of the relatively simple models investment bankers traditionally use to value companies—comparable company trading multiples, comparable transaction multiples, and discounted cash flow projections—are uncontroversial, their input assumptions are not. Which publicly traded companies do you designate most comparable to the firm you have on offer? Which valuation multiples do you weight most heavily in deriving an "appropriate" public valuation? Which M&A transactions do you pick to compare the proposed deal to, and why? Which discount rate do you use for your discounted cash flow analysis of the company's projected future results? What is the basis for the operating assumptions which underly those projections? Etc., etc.

Every single one of the important assumptions an investment banker makes in his or her valuation of a company can and will be challenged by the banker on the other side of the table. And this conflict over assumptions does not spring solely from the antagonistic positions the opposing bankers hold as advocates for their different clients. Even among bankers on the same side of a deal, honest disagreements can arise over the proper assumptions to make. Valuing a company is not like solving the Pythagorean theorem: there is no one right answer.

Given this, and given the competing objectives of the parties to a deal, it is clear that the determination of "value" in an M&A transaction—the purchase price to be agreed upon—is driven not by the unchanging precepts of cold, emotionless science or mathematics. It is determined by negotiation.

M&A bankers know this. I have written so, at length, before:

There is no "right" number in merger negotiations, just as there is no one, right number in valuing any for-profit enterprise. Valuation, whether in the market or in a deal, is well and truly—and ineluctably, now and forever—an art, not a science. But such gut instincts—rather more accurately described as carefully considered judgments—on the part of M&A advisors are or should be based on a mountain of careful, well-judged analysis, comparison, and argument. You never go to your counterparty in an M&A deal and say your offer of $100 million for his pissant company is based on gut instinct; you give him reasons. You show him where his company's peers are trading in the marketplace, you show him the levels at which other companies in his industry have been bought and sold, and you share your assumptions of the future value of his business enterprise with exhaustively analyzed and justified discounted financial projections. He, if he is not an idiot, will counter with his own exhaustive analysis showing why his gem of a company is really worth $500 million. And you're off to the races.

Therefore, I find Mr. Berman's transparent attempt to criticize an M&A straw man made up of imagined scientific rigor from the perspective of behavioral economics flatly unconvincing.

In other words, boards and bankers are just like the rest of us. They set aside their rational mind in favor of those anchors -- arbitrary and emotional points of concentration. It's the same process that we use when ordering dinner at a restaurant: That $50 steak can influence how we perceive the $25 chicken.

Of course M&A is subject to all sorts of emotional and psychological quirks. What person who actually does M&A for a living ever said it wasn't?

* * *

For another thing, I find the article's purportedly dramatic conclusion that there is a surprisingly high correlation of completed merger prices with the 52-week high stock price of the target company seriously underwhelming, on many levels.

First, there is the question as to whether Boards of Directors and investment bankers are in fact "fetishistic" about it:

The 52-week high stock price has always had a fetishistic role in merger discussions. By custom, boards are insulted if a merger offer doesn't breach this price level. Banker presentations focus on whether an offer is greater or lower than the 52-week high.

Well, look at it this way. The 52-week high, by definition, shows a demonstrable, concrete valuation for the target company, one validated in the public market sometime within the past year. It is a "real" price that directors can point to easily, unlike the smoke and mirrors valuations based upon a mountain of assumptions which their investment bankers assault them with in the boardroom. It is a price the other side cannot reasonably dispute. It is a clear, unequivocal, publicly-available reference point which the Board can direct their shareholders to, without making Aunt Millie or Cliff Asness dig through a 500-page proxy statement to find it. As anchors go, it is a damn convenient one: good, solid, and indisputable.

Second, unless the company has fallen on seriously hard times, or its directors believe its future prospects have been permanently impaired, their default starting point should be that they will not consider selling the company for anything less than a premium to the 52-week high. After all, even if the company is not trading at that level, it was worth that much less than a year ago (see above), and generally accepted corporate finance theory contends that an acquirer should be willing to pay a premium to the publicly-traded price of a widely held company to reflect the value of control for that asset. Therefore, it strikes me as no great surprise that the 52-week high holds such attractive power when it comes to M&A transactions.

The academics' study itself supports this idea with some rather unsurprising results of its own, results which Mr. Berman oddly chooses to characterize as "oddities":

Consider these oddities. More deals priced at exactly the 52-week-high than at any other price. About three-fifths of deals fall above the 52-week marker. And each deal that is priced above the high has a 76% chance of shareholder approval, while deals falling below the high succeed 69% of the time.

What's odd about any of this? (In particular, I fail to get excited that exactly 60 out of 7,500 transactions studied show final prices equal to the target's 52-week high, more than any other price. Sixty out of 7,500? Stop press!) Almost none of these results are remotely odd if you consider that there are probably tons of offers to purchase companies at prices well below their 52-week highs where Boards of Directors politely tell the suitor to go pound sand before the deal is even announced. Hostile suitors, of course, can announce offers well below their targets' highs, but such deals remain a substantial minority among all M&A deals even today.

Frankly, I find the study's results rather reassuring that Boards of Directors may in fact be less driven by emotion and unexamined behavioral tics than the authors seem to conclude. The mere fact that 69% of announced deals priced below the 52-week high water mark actually close demonstrates to me that directors (and shareholders) can make economically rational decisions quite often. For all the reasons the 52-week high acts as a positive benchmark for the selling company in negotiating a deal, it also imposes an extra burden on the selling company's directors to explain and justify the sale of the company for less to their shareholders and the market. I find the fact they pull it off more than two thirds of the time somewhat of a minor miracle.

* * *

For all this, there may actually be something there there. One could perform an interesting analysis with the professors' data that looks at anchoring around the 52-week high during different market environments. In particular, I would expect the correlation to be stronger—the 52-week high to be a stronger anchor to final pricing—during sellers' markets, when the selling company arguably has the upper hand in negotiations, and weaker during buyers' markets. Our intrepid academics would have to fine grain their analysis much more than their base period of 1984 – 2007 to pick up those patterns, though.

In the meantime, I would urge you to heavily discount the article's suggestion that anyone can take this study and go do M&A.

You don't need Goldman Sachs to do this math. Dr. Phil will probably do the trick: If you want to get a deal done, beat that 52-week-high. "These are the largest transactions that take place in the economy. If there's any place where psychology should be absent, it's here," said Mr. Wurgler. "But it's not."
Dr. Phil might actually be an asset at the negotiating table, but I guarantee you that completely clueless ivory tower M&A virgins like Professor Wurgler would not.

If there is any form of economic transaction where psychology does and must take center stage, large scale corporate M&A is it.

© 2009 The Epicurean Dealmaker. All rights reserved.

Thursday, May 21, 2009


Pfuel was one of those hopelessly and immutably self-confident men, self-confident to the point of martyrdom as only Germans are, because only Germans are self-confident on the basis of an abstract notion—science, that is, the supposed knowledge of absolute truth. A Frenchman is self-assured because he regards himself personally, both in mind and body, as irresistibly attractive to men and women. An Englishman is self-assured, as being a citizen of the best-organized state in the world, and therefore as an Englishman always knows what he should do and knows that all he does as an Englishman is undoubtedly correct. An Italian is self-assured because he is excitable and easily forgets himself and other people. A Russian is self-assured just because he knows nothing and does not want to know anything, since he does not believe that anything can be known. The German's self-assurance is worst of all, stronger and more repulsive than any other, because he imagines that he knows the truth—science—which he himself has invented but which is for him the absolute truth.

— Leo Tolstoy, War and Peace 1

Here's a fun new parlor game, kiddies. Match the famous Russian novelist's national psychological stereotypes from 200 years ago to current financial market participants. Here are some thoughts off the top of my head:

  • Frenchmen = Investment bankers; recent MBA graduates
  • Englishmen = Goldman Sachs employees; private equity professionals
  • Italians = Hedge fund managers; CNBC commentators
  • Germans = Economists; derivatives structurers

Naturally, I exclude the Russians from my analysis, because I am completely unaware of anyone currently operating in the financial sector who will admit to knowing nothing, much less take pride in it. (Actually knowing nothing does not count, since if we used that distinction 98.3% of all market participants would have to start wearing ushanki all year round.)

Your thoughts?

1 Leo Tolstoy, War and Peace. New York: Simon & Schuster, 1970, p. 709.

© 2009 The Epicurean Dealmaker. All rights reserved.

Wednesday, May 20, 2009

The Ant and the Elephant

PARENTAL ADVISORY: This post contains naughty language and inappropriate situations. It is not suitable for a family blogsite. Fortunately, you are not reading a family blogsite.

Once upon a time, a small ant was walking along a forest path in deepest, darkest Africa. The ant was searching for a new colony to join, because his fellow ants at the colony where he was born had kicked him out the day before. The ant was in a foul and fractious mood.

It seems that our diminutive hero had developed a reputation for arrogance, conceit, and self-confidence all out of proportion to the meager contributions he made to his colony's welfare. He irritated all and sundry with repeated demands for honors, special treatment, and extra rations based upon his inflated sense of self worth. The ant's conceit and arrogance were only matched by the disdain he heaped upon the other, "inferior" ants in the colony, who suffered from the apparently unpardonable sin that they were not him.

The last straw for the colony elders came the day he claimed credit for a brief rain shower which brought welcome relief to the drought-parched surroundings. The elders were unmoved by his increasingly strident assertions that he alone had summoned the shower by doing a particularly energetic and skillful waggle dance. They knew, of course, that rain only fell when the Great Anteater in the sky relieved himself. They escorted him out of the colony that very evening.

The next day, as the ant stumbled blindly along the woodland path, bemoaning his fate and cursing the shortsightedness and stupidity of the elders who had been too moronic to see just how special and deserving he was, he was brought up short by a strange sound.

Looking up, he was surprised to see a large female elephant sitting smack dab in the middle of the path, blubbering inconsolably and waving one of her front feet around. The ant stopped in a huff.

"Look. Do you mind moving out of the way?," he snapped. "I am a very important ant, and I am in quite a hurry to get down this path."

"Oh please, Mr. Ant," begged the elephant, "please can you help me? I stepped on a tiny thorn a ways back, and it has worked its way into my foot. It is too small for me to see or get out, but it is simply killing me. I just can't walk any farther. Do you think you could take it out for me?"

The ant was unmoved. "I'm sorry, but I just don't have the time. I must ask you to move aside."

"Oh please, please, kind ant," the elephant pleaded, "I am sure you could take it out in no time. There," she indicated where the thorn was embedded, "you see? It would be no trouble for you at all. I would be so grateful."

"Oh you would, would you?," mused the ant, calculating to himself. "Just how grateful? How would you pay me back?"

"I would do anything for you, anything at all," she averred.


"Yes, absolutely anything!"

"Okay," smiled the ant, "I want to fuck you in the ass."

"What?!," exclaimed the elephant.

"I want to fuck you in the ass."

"You're kidding me, right?," said the elephant. "That's a joke."

"No, I am absolutely serious. If you want me to help take that thorn out of your foot, a difficult and dirty job which will seriously inconvenience me and entail an unconscionable delay to my exceedingly important errand, then I expect to fuck you in the ass. Take it or leave it."

The elephant peered at the tiny ant, whose miniscule thorax was puffed up with self-importance, and back at her swollen, throbbing foot. "Oh, alright," she sighed, "do whatever you want. Just take out the damn thorn."

The ant laid down his little rucksack with a pleased expression on his face, and set to work removing the thorn. It was indeed a difficult and dirty job, but the ant worked diligently and eventually removed it. The elephant shuddered with relief and stood up to test her weight on the wounded foot.

"Okay," said the Ant, wiping his hands on a nearby leaf, "bend over."

"What?," asked the elephant.

"Bend over. I'm going to fuck you in the ass now."

"Oh, right," sighed the elephant. "Well, go ahead and climb on up there, Lothario. Just get it over with."

"I have to warn you," the ant announced smugly as he climbed the elephant's rear leg toward his destination, "that I am known among my own people as an exceptionally well-endowed ant. I fear that you will not find the sensation pleasant," he leered.

"Whatever," the elephant replied, as she peered at the tiny speck crawling up her leg. "Give it your best shot, big guy."

The ant placed himself in position and started banging away, encouraging himself with cries of "Go, Ant! Go, Ant!," and occasional taunts to the elephant to ask her how it felt to be dominated by such a puissant lover. The elephant, who could not feel a thing, ignored the ant and busied herself by considering where she would eat on her way back home.

Meanwhile, up in the forest canopy, a solitary monkey had silently witnessed this entire scene. Dumbfounded amusement had gradually led to helpless hilarity, and the monkey struggled to contain his laughter at the ludicrous scene below. As he writhed and twisted with silent guffaws, the monkey dislodged a large seed pod he had collected in the branches, and the heavy pod came tumbling down onto the unsuspecting elephant's head.

"Ow!," exclaimed the startled elephant. "That really hurt!"

"Yeah!," screamed the ant, in the extremity of his passion. "Take it, bitch!!"

* * *

Later, no amount of exasperated explanation from the elephant or strangled giggling from the helpless monkey could convince the ant that he himself had not caused the elephant's discomfort through his own exertions.

The incident had an unsurprisingly salutary effect on the ant's self regard, and it imbued him with such self-confidence and such a compelling story to tell that he was promptly crowned king of the next ant colony he encountered. After a long and lucrative career as a tyrant, the ant lived very comfortably in retirement on the speaking fees and book deals he was able to garner on the basis of his adventures. Later, the ant embellished his rather slender repertoire by doling out opinions on pachyderm podiatry, interspecies sex, gravitational acceleration of seed pods from the forest canopy, and other topics which a neutral observer might expect him to know little about.

The elephant, who might have told a different story to interested listeners, sadly fell into a poacher's trap a week after the incident and was butchered for her ivory.

The monkey, who could have corroborated the elephant's story, choked to death a month later on another seed pod in the middle of a fit of laughter brought on by remembrance of the story.

The ant, however, lived happily ever after, to universal admiration and acclaim.

* * *

MORAL: Never underestimate the ability of a self-absorbed egomaniac to make a career out of a couple of lucky breaks. (Especially if he is willing to fuck a few people in the ass.)

COROLLARY: There is no justice in the world.

DISCLAIMER: No ants, elephants, monkeys, or seed pods were harmed in the writing of this parable. Resemblance to any characters or situations living or dead is purely unintentional and entirely coincidental. The author of this parable disclaims any and all responsibility for these words, and maintains steadfastly that it was not he who mailed Jack Welch that parcel full of monkey poop a week ago Thursday. Hyperlinks which may or may not be embedded in this article are entirely the result of random computer error. The reader is encouraged to draw his or her own conclusions.

© 2009 The Epicurean Dealmaker. All rights reserved.

Monday, May 11, 2009

More of a Kickin' Sitcheyation

Pappy O'Daniel: "I signed that bill. I signed a dozen aggeyculture bills. Everyone knows I'm a friend of the farmer. What I gotta do, start tendin' livestock?"
Junior O'Daniel: "We can't do that, Daddy. We might offend our constitchency."
Pappy: "We ain't got a constitchency! Stokes got a constitchency!"
First aide: "Well ... it's a well-run campaign. Midget and broom an' whatnot."
Second aide: "Devil his due."
First aide: "Helluvan organization."

Junior: "Say, I got an idee."
First aide: "Whassat, Junior?"
Junior: "We could hire us a little fella even smaller than Stokes's."
Pappy: "You slump-shouldered sack o' guts! Why, we'd look like a bunch of Johnny-come-latelies. Braggin' on our own midget. Don't matter how stumpy. An' that's the goddam problem right there. People think that Stokes got fresh ideas. He's au courant and we're the past."
First aide: "It's a problem of ... uh ... uh ..."
Second aide: "Perception."
First aide: "At's right."
Second aide: "Reason why he's pullin' our pants down."
First aide: "Gonna paddle a little behind."
Second aide: "Ain't gonna paddle it. Gonna kick it. Real hard."
First aide: "No, I believe he's gonna paddle it."
Second aide: "I don't believe that's a proper description."
First aide: "Well, that's how I'd characterize it."
Second aide: "I believe it's more of a kickin' sitcheyation."

— O Brother, Where Art Thou?

After several days of holding my peace and refusing to engage in a pointless pissing match with spokespeople for the militant wing of the Salvation Army, the card-carrying socialists at The Wall Street Journal have rallied to my rescue. Today they published a page one article which described exactly what happened during the negotiations over debt recovery before and during the Chrysler bankruptcy. I am pleased to report, Dear Readers, that their investigation has thoroughly confirmed the argument I made in these pages over a week ago.

Attentive readers will remember that I asserted several substantive points1 in my tirade. First, the negotiations over debt recovery by Chrysler's secured lenders in the company's restructuring were just that, negotiations, not a cookbook allocation of value according to rigid, unvarying legal precedents. Second, while acting unequivocally like the schoolyard bully throughout, the Obama Administration did nothing fundamentally wrong or even unexpected by pushing hard to further its own political objectives. It certainly did not run roughshod over the rule of law or undermine the bankruptcy process, as some wilder-eyed commentators have claimed. Third, it completely failed to surprise me that the administration wiped the floor with the dissident creditors in both private and public, given its vastly superior negotiating position. And finally, I personally found the whiny, martyred tone of the public pronouncements from said dissidents both morally and aesthetically repugnant.

Begging your indulgence for a moment, I will repeat the summation from my prior piece here:

Here's a clue for the novices in the room: It's called politics, you fucking morons. Stop being such a bunch of whiny pansies.

* * *

Now, thanks to the crack reporting of a newspaper which all right-thinking troglodytes will henceforth consign to the ninth circle of capitalist hell, along with other traitors to kith and kindred, we learned just how badly Chrysler's creditors judged their chances, and how thoroughly the government spanked their little bottoms:

President Barack Obama's auto task force heard a blunt message early this spring from J.P. Morgan Chase & Co., the largest lender to Chrysler LLC. In any deal to remake the troubled auto maker, Chrysler would have to repay its lenders all $6.9 billion it owed.

"And not a penny less," said James B. Lee Jr., vice chairman at the bank, in a call to auto task-force boss Steven Rattner on March 29.

The next day, Mr. Obama called the banker's bluff. The president stepped before a podium to announce that Chrysler could face a disorderly bankruptcy or even liquidation. His meaning was clear: If that happened, the lenders would get nowhere near $6.9 billion.

A few hours later, Mr. Lee called Mr. Rattner back. "We need to talk," he said.

The banker's about-face was a vivid example of the government's tightening grip on a humbled financial industry. Pulling a trick from the hedge-fund playbook, the government used its leverage as the sole willing lender to Chrysler, either in bankruptcy court or out, to extract deep concessions from some of the country's biggest banks.

My, how the worm turns.

Notwithstanding the concerted attempt by certain creditors and third-party commentators—whose passion and outrage seemed to vary inversely to their closeness to and understanding of the actual situation—to portray the dissident lenders as saintly defenders of widows and orphans unjustly crushed beneath the hobnailed boot of an overweening Executive Branch, it appears that almost everyone involved understood exactly what type of game they were playing:

Many of the lenders believed the administration wouldn't let Chrysler file for bankruptcy. "The plan was to call the government's bluff. The game was to game the government," said a manager of a distressed-debt fund.

In retrospect, perhaps that wasn't the best of plans. It's hard to win a gun fight when all you bring is a penknife.

In the following days, the lenders began to realize their leverage was small and dwindling. Only the government had the ability or willingness to finance a bankruptcy reorganization of Chrysler, while also supporting its warranties and suppliers and recapitalizing Chrysler Financial. None of the lenders, some of which had consumer operations in the Midwest near Chrysler plants, had any desire to take over and liquidate the company.

Anyway, we all know the outcome. The large secured lenders folded, smaller dissident creditors balked, and the Administration threw the company into bankruptcy court, where a judge was charged with dividing the baby. As soon as the dissidents saw there were enough votes among the capitulating creditors to cram down the government's restructuring plan, and the judge was not inclined to block it, they threw in their cards and walked away. No matter what their ideological attitudes were, I think they eventually realized the fiduciary duty they defended so loudly in the press could come back to bite them if they continued to waste their investors' money in fruitless battle.

* * *

Now the good news in all this hullabaloo is that the system worked exactly as it should. Stakeholders in a financially troubled company always have the right to negotiate a restructuring solution outside the courtroom, and Chrysler's did. There are indeed extensive precedents for the division of value among various stakeholders, including a normally preferential position for secured creditors. These provide useful guideposts for negotiation, but they are neither absolute and unvarying in every situation, nor are they the only legal principles which govern a corporate restructuring.2

Furthermore, bankruptcy case law makes allowance for occasions when contending parties have such lopsided negotiating leverage that the solutions proposed can be unfair. In these instances, an independent judge has discretion to revise or even scrap a plan in favor of minority and other interests where appropriate. This is exactly what happened: the government attempted to ram down a plan adverse to the interests of secured creditors, a small, determined subset of those creditors screamed bloody murder, and a bankruptcy judge considered the facts and nonetheless ruled against them. Due process and the rule of law had their day, the sun rose in the east and set in the west, and everyone went home to watch American Idol on flat screen television. Case closed.

Far from representing evidence that the Administration has set out sub rosa upon a course of stealthy expropriation, creeping socialism, or outright fascism, the final outcome in the Chrysler case simply represents the triumph of bare knuckled negotiation from a position of overwhelming strength, within the settled confines of existing law and practice. The government simply did what any hedge fund driven by fiduciary duty and self interest would have done if it held the reins: it dictated the terms it wanted to see, and it told the creditors to pound sand if they didn't like it. The creditors, on the other hand, seemed to sally forth onto the field of battle without fully considering who was supplying their reinforcements (the Treasury), where they were fighting (in the forum of public opinion, as well as the arena of commerce), and the outside chance that their primary opponent might be smarter than a bag of hammers (and therefore realize and exploit its advantages). In return, they got schooled, but good.

I see little reason to give credence to those alarmists who see the Chrysler case setting a dangerous precedent. With the admittedly substantial exception of General Motors—whose existing creditors should be busy stocking up on Vaseline, ball gags, and Motrin—I cannot fathom why the government would want to get more broadly involved in corporate restructurings. The process causes massive amounts of brain damage, absolutely nobody likes the result—with the possible exception of the lunatic fringe on the left—and it sets up the Administration for all sorts of political pain in the future. There is absolutely no upside and tons of downside, which is a situation so anathema to politicians that most of them spend their entire careers dodging difficult decisions that would land them in such soup. Obama cannot be happy about it, unless he is an idiot or a nut. I will hazard an educated guess that he is neither.

Listen, I'm all for sanctity of contracts, the rule of law, and a stable, predictable bankruptcy process. I think they are critical underpinnings to our current system, which I happen to admire, warts and all. Undermining any of them would be a serious mistake, with long-term deleterious consequences both to the economy and the political fabric of the country.3 Should I see any real evidence that ne'er-do-wells from any branch of government are moving demonstrably down that path, I will don my cammo fatigues, grab an AK-47, and join Equity Private and her fellow Objectivists on the barricades toot sweet. (My first act of insurrection would be to pick off any Aeron Chair Socialists I happen to see tampering with the traffic signals.)

But the system we have is strong. The strongest defense against accidental or intended overreach by the government in any bankruptcy situation will be the swift and decisive ruling of a bankruptcy judge. Call me naive if you will, but I have seen enough grinning, pointy-toothed restructuring advisors in my day to know that any judge capable of swatting them down will be more than up to the task of telling Steven Rattner where to get off. Most of those judges can bite the ass off a grizzly bear.

* * *

Which leads me to my final remarks.

I continue to find the whinging and apocalyptic fear-mongering from certain quarters of the finance and business community about the government's present involvement in economic affairs despicable. For chrissakes, people, what did you expect? The bloody economy has gone off the rails, the global financial system is in tatters, and millions of citizens are seething on the unemployment line. (2010 election motto: I'm unemployed, and I vote.) The market failed. Deregulation didn't help. And the only economic actor with the will and the financial wherewithal to borrow heavily enough from the future—our future, natch—to fix this shitstorm is the government. Did you really think you were going to get government help without a government (read political) agenda? What are you smoking?

It doesn't take a masters degree in political economy to realize that when you go up against the government in a financial negotiation where it holds all the cards—including some of yours—you are going to get your head handed to you on a platter. Deal with it. Buck up, and move on. Find a less lopsided game to play in.

Because I can guarantee you the government and 95% of the people who elected it to power don't give a rat's ass that you're going to lose money on your Chrysler bonds.

1 If, in fact, I failed to make any of the following points, or failed to make them clearly, consider them made here. Honestly, I can't be bothered to treat these pages like a fucking Freshman debate class.
2 Readers who are open to learning something about this—as opposed to continuing to tilt at real and imaginary windmills—could do much worse than to consult The Bankruptcy Litigation Blog here, here, and here.
3 George Akerloff and Robert Shiller contend that real and perceived government interference in the economy helped depress business investment and was a serious contributing factor to the general loss of confidence and malaise they credit for the length and depth of the Great Depression. Animal Spirits. Princeton: Princeton University Press, 2009, pp. 69—70.

© 2009 The Epicurean Dealmaker. All rights reserved.

Sunday, May 3, 2009

You Realithe, Of Courth, Thith Meanth War

"Consequences, Schmonsequences, as long as I'm rich."

"I may be a craven little coward, but I'm a greedy craven little coward."

— Daffy Duck (attributed)

Apparently unlike many of my fellow citizens, I freely confess that I harbor no morbid fascination for car crashes. Many people seem unable to draw their eyes away from the spectacle of thousands of pounds of hurtling vehicle rearranging itself into a smoking pile of mangled metal and broken bodies. For my part, I prefer to look away, both before and after the fact. I feel no great compulsion to remind myself that when metal and flesh collide at speed, flesh is always and everywhere the loser. I claim no moral superiority for my behavior, simply a finely tuned squeamishness and a certain intellectual distaste for repeated demonstration of the obvious.

Hence, you should not be surprised when I admit I have not devoted more than cursory attention to Chrysler Corporation's developing bankruptcy. The multifarious sources of the crash have long been evident to any sentient being with a pulse. In addition, the looming bankruptcy itself has been unfolding for so many months it resembles the slow motion pile-up in Talladega Nights, which takes so long the TV announcers break to a commercial in the middle of it. A bloggist less honest than myself might claim he saw the wheels coming off the LeBaron almost two years ago. Fortunately, your Dedicated Correspondent is above such petty credit-jumping.

But now that the patient has been wheeled into the operating theater, where a bankruptcy judge will soon commence the drawn-out and delicate procedure of reconstituting Chrysler into a viable new company which will magically produce vehicles irresistible to all those consumers previously inured to their temptations, I have begun to take notice of a certain strain of commentary which I feel compelled to address.

This commentary seems to issue primarily from Chrysler's secured creditors and their supporters, apologists, and fellow travelers. I believe one can fairly characterize the essence of this commentary as

"Waaah! The Government is Picking on Me!"

To be perfectly honest, I find this intensely amusing.

* * *

The first indications I received that all might not be well in the temples of untrammeled commerce came from a self-described group of Chrysler's smaller secured creditors, who objected in print and in public last week to what they perceived as President Obama's rather shabby treatment of them in the whole mess. In their communiqué, they whined about being shut out of direct negotiations with the government, groused about dramatically lower recoveries on their debt than secured lenders at General Motors, and wrapped themselves in the saintly robes of Sanctity of Contracts and Fiduciary Duty. And, knowing full well that the government would do it for them, they pompously proclaimed that they would never push Chrysler into bankruptcy.

The fact is, in this process and in its earnest effort to ensure the survival of Chrysler and the well being of the company’s employees, the government has risked overturning the rule of law and practices that have governed our world-leading bankruptcy code for decades.

Heavens to Betsy! Save the Bankrupcty Code!

The next little goodie to cross my consciousness was the allegation by White & Case lawyer Tom Lauria, subsequently denied by the White House and Mr. Lauria's client Perella Weinberg, that the White House has been playing very hard ball indeed in the Chrysler negotiations:

"One of my clients was directly threatened by the White House and in essence compelled to withdraw its opposition to the deal under threat that the full force of the White House press corps would destroy its reputation if it continued to fight...That was Perella Weinberg."

Finally, to cap it all off, we received this little bulletin from the front lines of capitalist hysteria1 late Saturday night:

This (as yet unproven) yarn goes exactly like this:

Confronting the head of a non-TARP fund holding Chrysler debt and unwilling to release it for any sum less than that to which it was legally entitled without compelling cause, this country's "Car Czar" [Steven Rattner] berated the manager of said fund with an outburst of prose substantially resembling this:
["]Who the fuck do you think you're dealing with? We'll have the IRS audit your fund. Every one of your employees. Your investors. Then we will have the Securities and Exchange Commission rip through your books looking for anything and everything and nothing we find to destroy you with.["]
Faced with these sorts of threats, in this environment, with valued employees in the crosshairs and AIG a fresh, open wound upon the market, the fund folded.

Fuck the Bankruptcy Code, and Betsy, too! Save us instead!

* * *

Now, I would like to make a few remarks in reaction to this.

First, while I have no particular knowledge of the facts and circumstances surrounding the negotiations over Chrysler's restructuring prior to its bankruptcy filing—and no eager little beavers are sending me real or imagined transcripts of inflammatory conversations which may or may not have taken place—I have no reason to doubt that these conversations or ones similar to them did in fact take place. In fact, I would be surprised if they had not.

Think about it. The political stakes for the Obama Administration in the Chrysler fiasco are monumental. Barring the ongoing clusterfuck in the finance industry—which is arguably a legacy problem inherited from the previous bumblefuck administration—Chrysler is Obama's first big test to fix an incredibly hairy political, social, and economic dilemma. I would be shocked—shocked!—if every member of the Administration charged with its resolution was not under tremendous personal and professional pressure . In such circumstances, I think it is the height of folly not to expect a great deal of vituperative language, threats, and other nastiness to come spilling out of the mouths of such individuals. Is such behavior right, proper, or even polite? Of course not. Should allowances be made for it? Yes indeed.

Saying awful, hurtful, or even threatening things under conditions of high stress is normal human behavior. Anyone who has not been on the giving or receiving end of such treatment from another human being at least once in his or her life is either a) lying, b) staggeringly obtuse, c) certifiably autistic (see (b)), or d) incredibly immature.2 The proper response to such an attack can be any number of things: defuse it, ignore it, deflect it, or retaliate. How one responds depends on the situation at hand.

This leads to my second point. The negotiations over carving up claims to Chrysler Corporation prior to bankruptcy were just that: negotiations. Notwithstanding whatever principles of Truth, Justice, and the American Way the Chrysler non-Tarp lenders would have us believe undergird their positions, they were simply one party among many to a very complicated negotiation over the proper distribution of value of a very large and troubled company. Yes, there are general principles and precedents concerning the division of spoils in a corporate bankruptcy which normally guide such processes. Yes, many of these have been laid down over decades of contested and uncontested bankruptcies prosecuted through our court system.

That being said, none of these precedents are Holy Writ.

The parties to the Chrysler negotiation tried to agree to a prepackaged division of spoils which they could present to a bankruptcy judge and thereby speed the company's restructuring. They failed. Did someone—the government, the UAW, the non-Tarp secured lenders—overreach? Maybe. Does it matter who? Not in the least. A pre-agreed deal was not struck, so the distribution of claims to Chrysler will be determined in court, by a judge, who will listen to advocates for each group argue their case. The process will take longer, and perhaps introduce additional stresses and strains that Chrysler can ill afford, but everyone will have their day in court. Even those poor, put-upon non-Tarp lenders. In fact, even though they would likely be loathe to admit it publicly, everyone may be happier that the company has fallen into Chapter 11. That way, each can say to their own constituents that they tried as hard as they could, but were unable in the end to get everything they wanted. (Chief among these, by the way, I would place the Administration.)

The corollary point of negotiations is this: they are hard, and often unpleasant. Parties to a bankruptcy say hard, unpleasant things, they threaten and cajole, and they use all their powers of persuasion, soft and hard, to convince the other parties to the deal to give them what they want. In this context, why should anyone be surprised that agents of the government threatened recalcitrant lenders with IRS audits, excoriated their behavior in populist press conferences, or promised to destroy their institutional reputations in the public eye? The government was simply using the real and imagined powers at its command to browbeat its counterparties into agreement. This is standard operating procedure in high-pressure negotiations.

Had I advised the government on Chrysler, I would have encouraged them to use the very same tactics.

Of course, anyone on the other side of the table during such outbursts who had half a brain or any sort of experience in such matters would have recognized them for what they were: bluffs. And they would have countered with their own hard and soft power, and their own real and imagined levers of persuasion—"fiduciary duty," for example, and David and Goliath press releases would have worked (and did work) nicely—to push back in turn. Furthermore, if threats and bullying appeared to cross the line, the affected party was always free to politely remind the offending official that there are such things as limits to power in this country, and very nasty things tend to happen to public figures who abuse them. Every corporate and individual citizen in the United States is legally subject to an IRS audit at any time. But precedent, tradition, and most Americans' innate fear and hatred of the IRS reassure me that any official who was discovered to have triggered one on a purely political basis would face blowback of career-ending proportions.

* * *

Now I assume the non-Tarp Chrysler lenders actually brought someone to the restructuring negotiations who knew what the fuck he was doing. (If they didn't, too bad for them.) They clearly have learned they need to work the press as hard as the Administration, if only so they do not appear to concede the government's talking points by their own silence. Sad to say, this will be a Sisyphean task, since hedge funds and finance companies of every stripe have a reputation with the general public only slightly less awful than that of drug-dealing child molesters. I personally understand and am sympathetic toward their argument of fiduciary duty, but vulture funds wrapping themselves in the banner of widows and orphans won't do them much good. In all but the most hardened capitalist cadres' hearts, working mens' paychecks and the Public Weal still trump the profit motive, even if it is Aunt Millie's profit.3 They also play better on national TV.

Lastly, I fear I will disappoint my card-carrying capitalist comrades by remaining defiantly unconcerned that the Obama Administration is playing hardball in the current economic crisis. After all, the President and yea, even the US Congress, have their own fiduciary duties to prosecute and uphold. Many of the people to whom they owe their duty have few or no other advocates in economic affairs. Call it my stubborn American sense of fair play, but I cannot see why everyone with a stake in the outcome shouldn't have a competent and committed representative on the field of battle.

Perhaps some financiers feel a little miffed now that they have to fight for what they think is their due, after having had the field to themselves for so long.

Here's a clue for the novices in the room: It's called politics, you fucking morons. Stop being such a bunch of whiny pansies.

1 Editorial note to Equity Private: Stressed out, hyperaggressive former investment banker and private equity professional reaming hedge fund guy a new asshole during bankruptcy negotiation : Deliberate government swerve toward "Fascism" :: Bouncing a check to your local laundromat : Lehman Brothers' bankruptcy. I don't care how many academic or pseudoacademic definitions of fascism you provide, you have well and truly jumped the shark with this post.
2 And any professional dealmaker who does not recognize this is either a) brand new to the business or b) headed toward the unemployment line.
3 Especially if, as I suspect, a majority of these "widow and orphan" funds picked up their Chrysler secured debt at pennies on the dollar, with the express intent to profit from its pull toward par in a bankruptcy proceeding. A little harder to spin that story in Middle America, ain't it?

© 2009 The Epicurean Dealmaker. All rights reserved.