Ackman goes to town on Target

On Monday, William Ackman, president of hedge fund Pershing Square, held a "town meeting" in Manhattan and broadcast on the Internet to present his case to shareholders of Target and encourage them to elect new directors that he called more experienced and more independent than current members of Target's board who are up for reelection.

In his hour-long presentation, Ackman says that Target does not have the proper structure for its credit card operation and that the company should offload the credit risk to a bank or other financial institution. He also notes that among retailers, Target owns the most real estate and claims that the company has several options to monetize its real estate assets. Third, he points out that Target missed the boat on grocery sales and, as a result, cannot challenge Wal Mart in that category. The directors endorsed by Ackman has extensive operating experience in those three key disciplines.

What's innovative here is Ackman's use of the town hall format. The meeting was open to anyone interested and during Q&A questions were fielded from the audience and from those viewing the webcast. This degree of transparency is fairly unique in the realm of proxy fights and marks a continuation of Ackman's earlier pledge to be more public about issues facing his business and the hedge fund industry.

From a communications perspective, Ackman dedicated part of his presentation to systematically countering recent claims Target has made against him. He also took pains to praise Target's management and positioning his beef with the board as one focused on independence and receptivity to new ideas intended to enhance shareholder value. Most noteworthy, he was clear that shareholders have a choice among directors and that voting for one or more of those endorsed by Pershing Square does not require them to vote for Ackman himself, who is also on the alternative slate.

In all, it was an effective presentation of a business argument and the event went a long way to refuting Target's claim that this proxy fight is all about Ackman and his fund's short term interests.

Update: In a move that The New York Times calls "unusual tactic in proxy fights, but one the company feels it must make in order to win over shareholders," Target is fighting back by issueing its own presentation that tries to discredit the nominees supported by Pershing Square.

Hedge funds need a community organizer

"Hedge funds really need a community organizer," quips Clifford Asness, managing partner at AQR Capital Managment, in a strongly-worded letter rebuking the administration's comments about secured investors opposing the reorganization plan for Chrysler. When asked about the 16 or so bondholders who were not willing to accept the government's terms President Obama said, “I don’t stand with those who held out when everyone else is making sacrifices.” Mr. Asness, rightly, tries to set the record straight.

Certainly there are plenty of targets for bondholder ire in the Chrysler case -- even for funds, like AQR, that are not invested. The sanctity of contracts, the government intrusion in the economy, the package offered to the UAW, the merits of bankruptcy court are all at issue here. However, the size of the auto companies and their historical importance to the econmy make it easy to tar as un-American those who would see Chrysler in bankruptcy.

In the economic crisis, there is a broad perception that, as the President suggests, we are all in this together and we need solutions that require cooperation from all parts of society and business. This puts Chrysler's dissident bondholders in the same uneviable position as those investors who oppose restructuring mortgages because of ripple effects into the bond market. The complexity involved in both of these situations and Main Street's lack of understanding of the rules of bankruptcy and the financial system in general contribute to the reputational risks associated with taking a principled but massively unpopular stand on hot-button issues like automakers and mortgages.

Of the Chrysler holdouts, The New York Times writes, "this bit of brinkmanship — which many characterized as a game of chicken with Washington — has become yet another public relations disaster for Wall Street...What is striking to many in financial circles is how much Chrysler’s reluctant creditors gambled for what is, in the scheme of this bankruptcy, a relatively small amount of money."

Yes hedge funds need a community organizer. Job one would be to unify the industry and develop a sense of, well, community based on shared business interests. Job two would be to become more effective at advocating common sense on critical issues facing hedge funds' ability to operate freely in the marketplace. Job three would be to know which fights, like Chrysler, cannot be won.

TCI switches tracks on CSX campaign

London-based hedge fund The Children's Investment Fund has sold its position in railroad operator CSX and will resign the board seat it gained after a long court battle last year. This "defeat" for TCI demonstrates the difficulty investors of all stripes, even the most sophisticated and deep-pocketed, have in advocating change at traded companies.

BreakingViews writes, "the top brass at CSX demonstrated an unwillingness to take criticism or suggestions from a substantial shareholder — the kind of parochial response that other investors should find worrying." Agreed.

However, BreakingViews goes on to say "if hedge fund activism is indeed on the wane, then shareholders looking for a more enduring advocate for their interests may need to do the job themselves. Come to think of it, that wouldn’t be such a bad outcome after all." Disagreed.

If hedge funds cannot be effective activists, how in the world can anyone on Main Street be an effective voice for change? What are individuals supposed to do? Show up at annual meetings and grab the microphone? Yeah, right.

View the story from BreakingViews.
View the story from The Journal of Commerce.
View the story from DealBook at the New York Times.

Springing forth: Op-eds by hedge fund managers

April showers have brought a bloom of recent op-ed articles by prominent hedge fund managers. Mark-to-market accounting, regulation of financial services, executive compensation and corporate governance are the subject of articles written by the likes of James Chanos, Carl Icahn and Paul Singer in the Wall Street Journal and New York Times.

These are high-profile and important pieces because they demonstrate how the interests and opinions of the hedge fund industry are aligned (in these cases) with the best interests of the country. Icahn argues that shareholders should have more influence and that it should be easier to replace corporate boards. Who would disagree? Chanos writes that while mark-to-market accounting isn't perfect, it is an important contributor to integrity of financial statements. Seems logical. Paul Singer, head of Elliott Management, writes that "private responsibility and practical government regulation will help ensure that the capitalist system continues to be a source of opportunity and prosperity throughout the world." Sounds reasonable.

Articles like these, appearances on CNBC, and meeting with lawmakers are important steps in publicly aligning the interests of the hedge fund industry with the economic recovery and the creation of a well-functioning marketplace that this blog calls the New Financial World Order.

See also Andy Kessler's op-ed on bear raids that provides good perspective on the shorting of financial companies.

Media misses demand side of hedge fund equation

Think about what you read about hedge funds. What makes "news?" It's the AUM for the industry -- way up and now way down. It's the activists, the larger-than-life manager, the lavish hedge fund affairs. It's the flame outs, the frauds, the gates and the side pockets. It's the compensation. It's shorting and "black boxes."

All of this is the supply side of the industry. Nobody is writing about the demand side of the industry -- the source of those trillions in AUM and those willing to pay the notorious two and twenty for performance.  This lack of focus on the demand side is central to the the poor state of the reputation of the industry.  

The result is a situation in which the media criticize hedge funds without asking the simple question, "why do hedge funds exist?"  

They exist to serve the needs of their investors. Plain and simple. If they fail in what Dan Strachman in his new book calls the "hedge fund promise" (the ability to use all the arrows in Wall Street's quiver without taking on significantly more risk than the market as a whole to deliver alpha), hedge funds cease to exist. Everything about hedge funds is completely elastic. No performance, no assets. No assets, no hefty fees.

The people stretching (or not) that elastic are the investors, mostly large institutions. But hedge funds reporters are not talking to those people and, as a result, don't understand the demand for hedge funds and the ways good investors work with hedge funds on the key management issues like risk management, governance and reporting.

If I were advising a major fund or the MFA, I would work to have the fund's investors do much of the talking (to the media) for the fund. A company's customers are always the best evangelists and it is no different in the hedge fund industry. In fact, it's even more important in the hedge funds business because the demand side has received so little attention. Think about it. What's more credible to a reporter's ears? Having a hedge fund say that they allow investors free access to their books or having an investor tell the reporter that his auditors spend several days a year poring over the books with the hedge fund CFO and COO.

A recent profile of megafund Bridgewater Associates in Fortune takes steps in that direction. Here's an excerpt: "I view them [Bridgewater] more as a partner than a vendor," says John Lane, the director of Eastman Kodak's $7.5 billion pension portfolio, which has had money with the firm since the late 1980s. "We don't make a major change here in strategy without calling Bridgewater to get their view...Of all the investment firms we work with," he says, "they're the most trusted."

That is powerful. Any manager worth his or her salt, though, should be able to get similar endorsements from their clients.

The media and the public need to better understand why hedge funds exist. The answer comes from the demand side and the industry needs to figure out how to get those voices out there.

The rocky shoals of regulation and reputation

It's time to set the record straight about short selling. The media doesn't get it. Congress, certainly, doesn't get it. And the hedge fund industry is at risk of getting it right where it hurts, if short-sighted regulation is the result of misplaced concern about short selling. A recent column on Bloomberg blames naked short selling for the collapse of Lehman Brothers. The column begins with this shrill statement, "the biggest bankruptcy in history might have been avoided if Wall Street had been prevented from practicing one of its darkest arts." Fraud, dark arts, and collusion are among the charges levied against hedge funds in the piece.

An effective counter-argument can be found on Portfolio.com, but just because a debate on short selling exists, doesn't mean that people are hearing both sides.  The critics are much more vocal and their claims play on the concerns people have about everything Wall Street.  Experts say that people need to hear something between three and five times before they believe it.  Believe me, people have heard that short selling is bad, dangerous, even un-American lots of times.  They are writing their congressmen. Congressmen (and there are not many bankers and securities lawyers in the House), in turn, are turning up the populist rhetoric against the industry.  

What's at stake here is license to operate.  When I worked for Texaco, license to operate was the primary PR concern of the company.  The energy industry understands that reputation is central to winning contracts with foreign governments, executing acquisitions and preventing over-regulation.

Ensuring that short selling does not come under unreasonable regulation should be taken as seriously as the energy sector takes regulation on offshore drilling ,CO2 emissions, double-hulled tankers and other aspects central to its operation and profit.  

Right now, the hedge fund industry is running a proverbial oil tanker onto a reef and they don't even know it.

What can be done?  Here are some tactics:

Get independent third party experts, like academics or former regulators, to set the record straight. 

Sponsor and promote independent research that documents the effects of short selling on the market.

Get involved in the debate online.  The blogs listed (see right hand column) on this site all feature intelligent comment and debate among readers.

Become more vocal in the media.

Educate key lawmakers.

The blog on Portfolio.com listed above suggest creating an official panel (like the 9-11 Commission) to investigate (and hopefully vindicate) short selling.

Jon Stewart swings and misses in showdown with Cramer

Jon Stewart flopped Thursday night in the final battle of his much-hyped "war" with CNBC and Jim Cramer.  Stewart was neither funny nor insightful in his attempted grilling of Cramer.  The only comedy was watching two non-journalists talking about the presumed guilt shared by real financial journalists in not foreseeing the financial crisis (see March 4 post).  In his attempt to be serious, Stewart lost the art of what makes him so effective -- the ability use humor to point out the serious, even insidious hypocrisy in politics, business and society.   

Stewart has interviewed people with whom he has more philosophical differences than Cramer.   John Sununu, Mike Huckabee, Dana Perino, Bill O'Reilly, Bill Kristol, Ari Fleisher, to name a few.  But he reserves the long knives for Cramer and despite his domination of the conversation (Cramer doesn't get too many words in edgewise), completely whiffs.  The result is an interview that is just as superficial and farcical as the CNBC body of work Stewart was lampooning in the first place.

I don't blame Cramer for agreeing to the interview, but he was unprepared and let Stewart set and dominate the agenda.  Poor media training.  Maybe he was blindsided, expecting Stewart to be more like his playful real self.  Maybe he didn't know what he wanted to achieve in agreeing to the interview.  Bottom line is that Cramer hasn't learned his lesson from his longer-running, much more serious feud with Barron's.  The bad blood there began to be spilled in 2007.  Barron's won't let go of this "story" and recently revisited its critique of Cramer's stock picks.  

Cramer's problem is that he doesn't know what his show is really about and has not found an effective way to put his stock "picks" into perspective.  He needs to admit to himself that his picks and pans are NOT what the show is about.  His show is about speaking to (mostly) young investors about how the market works and how to do research on investments.  It's not a stock picking show, stupid!  On The Daily Show, Cramer should have said, "Jon, I don't think you understand my show" and taken control over the interview from there.  

Cramer needs to understand that what he does is not very serious and very serious at the same time.  Not serious because he cannot have an informed micro-level opinion about all of the equities covered in the Lightening Round and very serious because he is communicating with an audience ignored by the financial community in a way they understand and connect with (could Suze Orman fill the basketball arena at any university like Cramer routinely does?)  

In response to the most recent salvo from Barron's, I wrote as much to the editors of Barron's.  Scroll half way down the page.

Oh, in my ranting, I almost forgot:  Bank of America (one of the institutions supposedly coddled by CNBC and Cramer) advertises on The Daily Show.com. How's that for irony?  

Hedge funds silent on "golden coffins" and other governance issues

Apparently its not enough for some CEOs to get massive compensation packages, lavish corporate perks and a golden parachute when they get fired for mismanaging their enterprise.  Now there are "golden coffins" too.  According to the Wall Street Journal, golden coffins are generous posthumous payouts to senior management and dozens of corporations offer generous death-benefit packages that might include allowing heirs to collect unvested equity, posthumous severance payouts, supercharged pensions and/or years of postmortem salaries.

With executive pay coming under intense scrutiny in the wake of the banking crisis, corporate governance issues are moving to the forefront.  Hedge funds -- except Carl Ichan -- are surprisingly silent on the matter.  This is a mistake.  Corporate governance is a non-controversial issue, but one of great importance.  Fighting the good fight right now are a couple of pension funds, academics and proxy advisors.  These are mostly passive players, however, and corporations are not under meaningful pressure.  

That could change if hedge funds enter the fray.  Aligning with other governance activists would demonstrate that hedge funds are a responsible part of the modern capital equation.  It would also show that hedge funds can be watchdogs and enforcers of fair play in the markets in what this blog calls the "new financial world order."  Lastly, it would advance their business interests as shareholders in corporations that are less wasteful, have better boards, and are less protected by poison pills and other anti-shareholder defense mechanisms.

Organizations that hedge funds should cooperate with on the issue of corporate governance include:

The Corporate Library

RiskMetrics Group (ISS)

The Weinberg Center for Corporate Governance (U Delaware)

GovernanceMetrics International

CalPERS

Hear no evil, see no evil, speak no evil.

"How could 9,000 business reporters blow it?" asks Dean Starkman, a former Wall Street Journal reporter and current writer for the Columbia Journalism Review, in a recent essay that examines how the media missed the warning signs in the run up to the credit crisis.  According to Starkman there are several factors to consider:

- Shrinking newsrooms and increasing financial pressure on media as factors that have reduced investigative reporting.  

- The rise of M&A reporting, in effect, made media Wall Street "insiders" dependent on Wall Street for information and potentially coopting independence

- An editorial focus on outsized CEOs was a distraction from the real business stories underfoot

Starkman makes good points but sensibly does not entirely indict media for missing the boat.  Indeed, many in the media were asking the right questions and reporting about smoke in the real estate market.  As early as 2005, Ruth Simon and Bob Hagerty of the Wall Street Journal were asking my clients hard questions about subprime lending practices and default rates.  It is clear to me that they knew something dangerous was happening, but they never could get their suspicions confirmed by the right people.  The complexity of mortgage securitizations and CDS and CDO markets made it almost impossible for journalists to identify what was going on, much less "expose" anything with confidence.  (See a more complete defense of financial media at The Deal.)

The big question is how can the media (or regulator or other whistle blower) focus on bad news when the market is going up and up?  Not easy.  Ask Harry Markopolos.  Indeed, there were examples of stories that identified exactly what the risks were.  In September 2005, the Wall Street Journal wrote an in depth piece on the limitations of the Gaussian coupola, the formula at the heart of the models evaluating mortgage securities and derivatives.  The piece explains how the formula was being applied to gauge risk of CDOs and synthetic CDOs.  Read today, the article is truly scary.  Back then no few paid attention.  The Gaussian coupola is the subject of the cover story in Wired this month.

Of course, there were many who figured out at least some of what was happening.  Steve Eisman of Front Point Partners (see the December cover story of Portfolio) and John Paulson made fortunes shorting financial firms.  It's just that their voices were not heard over the din inflating the bubble.  Why be a sourpuss when everyone is getting rich?

Someone, though, always seems to know the truth.  Even in the Bernie Madoff scandal, certain private banks refused to allow their clients to invest in the Madoff funds.

It appears that, especially during bubbles, it takes more than one voice to show that the emperor has no clothes.  It can't be media alone, or short selllers alone, or a noble minded whistle blower, like Markopolos, alone.  

In the wake of the banking crisis, hedge funds should choose to be more vocal, utlizing the media and other means to expose unsound unsound business practices, accounting sleight of hand and fraud.  Speaking up and getting people to listen, even when they don't want to hear the truth, is good for hedge fund business, the economy and our society.

Short sellers: "The real financial detectives"

James Chanos, president of Kynikos Associates, recently did an eleven-minute interview with PBS' Nightly Business Report.  Similar to William Ackman's recent appearance on Charlie Rose (see previous post), this was a thoughtful exchange about key issues facing capital markets. Veteran reporter Darren Gersh did not pull any punches in the interview, querying Chanos on short-selling, vetting of qualified investors, and transparency issues.  So, this was no puff piece.

The important fact though, as Chanos demonstrates, is that there are credible, logical answers to just about any question a responsible hedge fund might face from the media.  Moreover, reasonable people watching at home are likely to agree with those answers.  If hedge fund managers did more of these interviews there would be far less confusion about the roles hedge funds play in the market, the institutional investment needs they seek to fill and how they make money.

Some notable quotes by James Chanos during the interview:

Short selling "should be encouraged, not discouraged."

Short sellers are "the real financial detectives.  Regulators are the financial archaeologists."  

Regarding accusations by bank CEOs that short sellers imperiled their banks: "It's easier to point fingers at others, when you've screwed up."

On Bernie Madoff and whether there is such a thing as a "sophisticated" investor: "people will always do stupid things with their money, when greed takes over."

On the effectiveness of regulation, the largest "financial disasters happened among regulated firms."

Click on the image below to view the interview in a new window.

I trust you. NOT!

Edelman's annual trust barometer study suggests that the financial industry has a long road to travel before it can rebuild the trust it requires to operate. It also suggests that intelligent media relations might provide much of the solution that will once again win the industry the support of the public and regulators.

First a few grim statistics from the study:

- While trust in all industries in the U.S. declined last year, banking suffered the most, with a 35% decline in the trust metric. Banks and insurance companies are among the three least trusted industries in the U.S.

- Only 49% of Americans think the free market function is sufficient to prevent future financial crises

- 61% of Americans think that government should impose stricter regulations on business and people were evenly split on whether the government or business should be most responsible for ending the credit crisis

- CEOs were the least trusted of all expert spokespeople and people cited excessive compensation as the number one reason they had less trust in corporations (When President Obama spoke about demanding new accountability from CEOs, the MSNBC audience reaction meter went into the stratosphere of approval ratings... even higher than it did than when he outlined a new commitment to cure cancer!)

What's a bank or hedge fund or private equity firm to do? Ramp up the public relations. The study shows that using media to win back third party validation of a company's mission and merit is the best way to rebuild trust. Importantly, old media remains a key component of influencing opinion and creating trust. According to the study, traditional media (analyst reports, articles in business magazines, newspaper articles, and radio and TV news) are the most credible information sources, even for young people (age 25 - 34). In fact 55% of those age 25 - 34 and 43% of those age 35 - 64 find business magazines the most credible of all media. After media, people find conversations with company employees highly credible, meaning that employee communications need to also be a priority.

Ok, no problem, right? Not so fast. Part of the challenge is that people need to get information from multiple sources, multiple times to believe it. The study says that 60% of people need to hear or see something (positive or negative) about a company between three and five times before they believe it to be true.

This means that there are no shortcuts on the long road back to trust. The journey is worth it, though, as trusted corporations have greater license to operate and receive the benefit of the doubt when things inevitably do go wrong in the future. Heidi Moore, DealJournal columnist at the Wall Street Journal says, "You can call on trust when you need it."

Where are the good apples?

Portfolio.com argues that the private equity industry doesn't produce real returns for investors. According to the article, "private equity firms generally don’t make their money by choosing good investments. They make it on an amazing Technicolor array of fees: management fees, deal completion fees, consulting fees, performance fees, special events fees, fees of every kind and stripe. Chalk it up to yet another racket of the bubble years."

The entire spectrum of alternative asset management is under attack. Much of it is deserved and we are in the early phase of a shakeout. In the meantime, the good apples are tainted by the bad and they are not doing much about it.

Are there hedge funds that are delivering for investors even now as so many funds are making excuses instead of money? Yes. Are there private equity firms that are truly creating value instead of paying themselves out by further saddling their portfolio companies with unnecessary debt? Yes.

The problem is that no one is talking about the good apples in the alternatives arena. No one is making the case that hedge funds and private equity are valuable, even important, vehicles for institutions, like pension funds, that should reasonably expect to make money even when the market is down. This should be an easy argument to make, but no one is actively taking it on.

No one ever got fired for buying IBM, for making the safe choice. The question at hand is will the alternative arena become perceived as the patently unsafe choice for institutional managers? And if so, will it go down without a whimper?

Hedge funds aim at bird in the hand

With raising assets becoming more difficult, hedge funds need to focus on retention. Funds need to realize that institutions of all sizes have suffered losses and are scrutinizing all of their managers. The spectrum of communications, including investor letters, meeting with investors, and media relations need to be stepped up as part of a broader effort to compete for allocations.

Investors need more detail of how funds are managing in the current environment, which opportunities they are targeting and why. Some funds are choosing to share more information about specific investments. See previous post. 

A few funds with significant losses are thinking creatively about management and incentive fees. This is a good strategy because it recognizes the fact that investors have been hurt across the board, not just in one fund. For example a single stock fund run by William Ackman's Pershing Square Capital Management is down 90%. Pershing Square is helping investors recoup losses by suspending incentive fees on their investments in other Pershing funds until they are whole. It might not satisfy all investors, but demonstrates the degree to which Pershing will go to retain investors. See shareholder letter from Pershing below.

Hedge funds have always competed aggressively for assets. The battle now is to keep assets from walking out the door.

Pershing Square IV Letter to Investors

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Reactionary forces continue to oppose hedge funds

Martin Lipton, founder of the venerable law firm Wachtell, Lipton, Rosen & Katz slammed hedge funds at a recent New York Bar Association conference.  In his keynote address, Lipton accused activist hedge funds as being motivated by short-term gains instead of long-term value.  Ironic, since Lipton is credited with the creation of the poison pill -- a strategy used by corporations to prevent takeovers, even takeovers that offer premiums to shareholders.

Hedge funds need to plow through this reactionary bluster and step up their activist strategies, not curtail them.  In the new financial world order (see previous post), activists and short sellers are an important part of the marketplace of ideas that enforces good corporate governance and compels CEOs to explore all alternatives to create value for shareholders -- even at the expense of their own jobs.  

Poison pills and break-up fees are nothing more than anti-shareholder defense mechanisms designed to preserve the status quo and the lucrative relationships law firms maintain with corporations.  

Clearly Wachtell, Lipton, Rosen & Katz is part of the problem, not the solution, and hedge funds need to identify the forward looking law firms, PR firms and other service providers to help them with constructive activism.

Hedge funds must be part of the new financial world order

Could hedge funds be part of the solution? Could short-selling hedge funds be doing the market and regulators a valuable service? Surely you jest. However, that's exactly what ex-Wall Street Journal columnist Jesse Eisinger hints at in his story about restructuring the financial system in the current issue of Conde Nast Portfolio.  

"We need more dissidents.  We need to make the world a safer place for short-sellers to criticize companies.  Regulators should publicly praise short-sellers, rather than periodically ban their activities.  Critics and whistle-blowers, no matter how self-motivated, should be regularly consulted about suspicious companies, not dismissed as cranks once they expose wrongdoing."  Really.  Page 47.  

For hedge funds to be a respected part of a new financial world order, two things need to happen.  Regulators, analysts and shareholders need to aggressively seek the opinion of independent parties and be much more skeptical of corporate claims and the CEO bully pulpit.  That shouldn't be too hard.

Second, short-sellers and hedge funds of all stripes need to admit they are part of the system and behave like they have an interest in stability in the market, preventing fraud and encouraging financial fair play.  Once they take their positions, they must go public in cases where systemic risk, fraud, or deceptive accounting is afoot.  Profits will still be made, but full-blown crises might be averted.

What hedge funds cannot do is sit on the sidelines grinning like the Cheshire cat.  In a new financial world order, it is not sufficient to be the smartest guy in the room.  You also need to be responsible.  

In the same issue of Portfolio, John Paulson, whose funds made $15 billion in 2007 by betting against homeowners, banks and mortgage companies in 2007, is scrutinized along these lines.  "Left unexamined is the uncomfortable moral dimension of Paulson's achievement.  If he saw all of this coming, was it right for him to keep his own counsel, quietly trading while the financial system melted down?  Do traders who figure out a way to profit from our misery deserve our contempt or our admiration, however grudging?" 

Financial firms risking more than reputation by continuing lavish spending and bonuses

Wall Street bonuses have always drawn the attention of journalists. In the best of times, the topic of bonues at investment banks has been covered much like auctions at Christie's -- phenomena to behold, but not quite believe. These are not those times and the issue of bonuses at Merrill Lynch was toxic enough to send John Thain into retirement. How can Citigroup buy a new corporate jet on the heels of more financial support from the government? How can AIG pay $450 million to workers at the unit that brought down the firm? It is hard to fathom that the culture of compensation and the perception that it requires bags and bags of money to retain talent in the financial sector is so pervasive that the same hand that is begging for taxpayer-funded relief is signing whopping bonus checks.

Bankers need to look at the case of Detroit for a reality check. Automakers were denied a government bailout partly because public sentiment was against them. Financial firms will lose political support in hurry if they continue to enrich their own at public expense.

By comparison, the 2/20 compensation system for hedge fund managers, long criticized by media, seems aligned with the interests of investors. Not that you are going to read that anywhere soon!

Maureen Dowd turns her wit on John Thain and Wall Street bonuses in today's New York Times.

Bloomberg outlines $450 million in payments at AIG's financial products unit.

A former Merrill banker writes about the bonus culture on Wall Street in an op-ed in the New York Times.

Wall Street paid $18.4 billion in bonuses last year, the sixth biggest bonus year on record, according to the New York Times.

John Thain's$1.22 million office renovation is detailed on the DailyBeast.com.

Of course the antique commode purchased by Thain for his office at Merrill is too tempting for the Daily Show to pass up.  The first three minutes of last nights intro segment lampoon John Thain.

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Classic IR tactic not working for banks

Insider buying by CEOs and other top executives is a classic tactic to signal that the market has the wrong perception about a company.  The problem is that it is simply not working for banking CEOs these days.  Confidence is just too low in the financial sector and would-be investors simply don't trust banking CEOs.  Trust in CEOs overall might be at an all time low and companies need to understand that and adapt to a new communications environment where new efforts are required to earn trust. 

Earlier this week Ken Lewis and other chiefs at Bank of America purchased more than 513,000 shares.  It won't make a difference.  The Wall Street Journal writes "credibility is a series of small, successful gestures [and] bank executives must see that their gestures are being read by the market as empty ones."  In fact, research by InsiderScore.com and other analysts suggest that buying by insiders should be a strong sell signal for everyone else.  Turns out that execs, of late, have been wrong more often than they have been right.

BreakingViews.com writes, "given how erroneous the public statements on Wall Street's top banking executives have proven to be, it would be hard to take their prognostications seriously."

Unfortunately for bank CEOs, the market is not doing as they say nor, when it comes to insider buying, is it doing as they do.  The herd is going the other way.

Communicating with current investors is job one

The New York Times' DealBook blog profiles JHL Capital Group, a Chicago-based hedge fund run by James Litinsky.  While JHL returned up to 18 percent to investors last year certainly bucks the current trend, it is not the only thing notable about the fund.  From his quarterly letter to investors, Mr. Litinsky clearly realizes that resting on the laurels of exemplary performance is not sufficient in today's environment.  Good returns alone might not prevent newly risk-conscious investors or investors who have suffered losses elsewhere from cashing in their chips.  Managers must give investors compelling reasons to stay in the fund or risk redemptions.  

In the case of JHL, Mr. Litinsky uses his quarterly letter to reinforce his investment philosophy and detail the business case for two primary investments, the bonds of The New York Times Company and Lamar Advertising.  For each, the fund explains its view of why the debt was undervalued, but secured.  It also explains why neither company is likely to default in the near term and goes on to give worst-case scenarios for both investments.

Mr. Litinsky writes: "In both the NYT and LAMR situations, we modeled out the path to paydown.  We not only had asset coverage well in excess of our basis but also had a priority interest on family heirlooms.  If conditions deteriorated further, the management teams would likely be most focused on maintaining long-term control of the assets rather than extracting an extra dividend or attempting something more overtly hostile.  Those are the kinds of borrowers we like."

This level of transparency is one way to give investors the confidence to maintain or even increase their commitment to a hedge fund.  Right now, getting the right information to current investors is job one, superseding any new marketing and fundraising.

 

Hedge fund "convergence" is good for embattled industry

All About Alpha.com writes about "convergence" in the asset management industry.  Citing recent examples of Putnam launching an "absolute return" mutual fund and quant fund manager AQR starting its Diversified Arbitrage mutual fund, the story discusses how hedge funds are morphing into diversified financial institutions that are providing traditional asset management and investment banking services among other offerings not typically associated with the hedge fund business.

While this trend is good for hedge fund business, it is also good for the reputation of the industry.  The media don't appreciate the extent of the role hedge funds play in the global capital equation, particularly now, as commercial banks are severely constrained and the investment banking options reduced.  Why can't hedge funds and private equity firms be a driving force behind recapitalization of the banking industry and the broader economic recovery?  By stepping into the breach created by troubled banks, new institutions can be part of the solution -- and maybe, just maybe get credit for it.

See a previous post about hedge funds and their importance to the broader market.

As early as 2005, the New York Times was writing about hedge funds getting into corporate lending.

Read the Wall Street Journal's account of the new AQR fund.

Read the FT's story on hedge funds morphing into investment banks.

Transparency at issue in bank system fix

The New York Times writes about the Obama administration's options in dealing with the ongoing banking crisis.  The story notes that one of the main differences among options being discussed is the level of transparency about the ultimate cost to taxpayers and the degree to which banks would be required to disclose the true magnitude of likely losses.  

According new analysis by the Congressional Budget Office, costs to taxpayers are highest when bailouts involve opaque transactions that are difficult to understand.  TARP is the poster child for a program with limited transparency.  The CBO estimates that taxpayers will end up absorbing 26% of $247 billion in disbursements to financial institutions through December.  The AIG bailout, another complex program, is estimated to cost taxpayers more than $20 billion.  November's decision to guarantee $306 billion of toxic assets on Citgroup's books is estimated to cost the public $5 billion.  

The new administration must do a better job in disclosing the real costs and real value behind its plans for the banking system.  More transparency and better communication with voters and the media are needed to both ensure the best solution is reached and help stabilize reeling bank stocks.  In addition, more transparency will increase the likelihood that hedge funds and other private investors buy some of the assets in question and invest in the banks themselves.

The Times notes, however, that "banks may not want that kind of openness, because accurately valuing the toxic assets could force many to book big losses, admit their insolvency and shut down."