Tuesday, September 23, 2008

On Leverage, Investment Banks and Incompetence

"Don't kick a guy when he's down?
Shit, that's the best time."
-a trader to your correspondent, some years ago.

As this story from the New York Sun pointedly states:
...The SEC allowed five firms — the three that have collapsed plus Goldman Sachs and Morgan Stanley — to more than double the leverage they were allowed to keep on their balance sheets and remove discounts that had been applied to the assets they had been required to keep to protect them from defaults....
The most leveraged, Bear Stearns failed first. The second most leveraged was Lehman.
On last weekend's McLaughlin Group, Mort Zuckerman identified* the leverage of the investment banks as half the problem (see below).

From Infectious Greed:

What is truly disgraceful is that investment banks could only manage returns on equity of 15-25% with a balance sheet that was often leveraged to the sky.

-- Niels Jensen and Jan Wilhelmsen, of Absolute Return Partners

Another view of the average Wall Streeter:

...no wonder so many marginal people make money on the street - it is like the special olympics out there.
- anonymous commenter at DealBreaker
*From the transcript of The McLaughlin Group, September 19, 2008:


MR. ZUCKERMAN: Well, the single greatest contributor to the housing bubble was Fannie and Freddie. And everybody knew that Fannie and Freddie was -- they were two institutions, two government- sponsored enterprises, that were out of control in terms -- they made over $600 billion of investments in subprime mortgages in the first six years of this century, and that contributed mightily to what we are all now having to deal with. And Paulson, when he said the core of the problem was the collapse of housing, that's where it all started, in the subprime field. And in fairness, Obama did nothing on that.

However, Cox, the SEC commissioner, was the man who sat there while they doubled and even tripled --


MR. ZUCKERMAN: -- the ability of financial houses to use leverage. They went from a maximum of 12 to 1 to as high as 40 to 1.

MR. BUCHANAN: This was what -- MR. ZUCKERMAN: And this was the core of what happened on the other side, which was the overuse of leverage --

MR. BUCHANAN: (Inaudible.)

MR. MCLAUGHLIN: Let him finish.

MR. ZUCKERMAN: -- overuse of leverage that compounded the problem in the housing world, and vice versa. That's what we're dealing with. There are two problems....