What Wall Street's CEOs Don't Know Can Kill You
Commentary by Michael Lewis
On March 14, a Friday, the market believed that Bear Stearns Cos. was worth $30 a share.
Say what you will about Bear Stearns on that day, you can't say that it was flying below the radar. It was as intently scrutinized as a public corporation can be, by some of the shrewdest people on our planet, and perhaps some smarter people from distant planets, too.
For nine months it had been in obvious distress; in just the previous three days its shares had fallen $30. A billionaire from outside the place — the sort of investor who has the power to know as much as it is possible for an investor to know about a Wall Street firm — was long the stock at $107 a share.
Three days earlier, on theStreet.com, Jim Cramer listed Bear Stearns common stock as a “buy” at $62. On his CNBC program that day, he showed his viewers a chart of Bear Stearns stock price and hollered, “Bear Stearns is fine! Do not take your money out of Bear.”
Over that weekend — days when the markets were closed and there was no material news about the company — Bear Stearns was believed to be worth $2 a share, so long as the Federal Reserve assumed the downside risk of almost $30 billion of its mortgage securities.
JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon obviously thought it was worth more than that, or he wouldn't have bought it. How much more is hard to say but the number now being floated, $10 a share, appears to sound about right even to the sellers.
TheStreet.com quickly removed Cramer's March 11 “buy” recommendation from its page devoted to Bear Stearns. (The Cramer-obsessed Don Harrold's YouTube account of all this is priceless.)
And Cramer went back on CNBC to explain that he never intended for anyone to go and actually BUY shares in Bear Stearns — only that, if they happen to bank with Bear Stearns, they shouldn't worry about losing their money (a public service to all those “Mad Money” viewers who use Bear Stearns as a bank.)
All of this raises an obvious question: If the market got the value of Bear Stearns so wrong, how can it possibly believe it knows even the approximate value of any Wall Street firm? And if it doesn't, how can any responsible investor buy shares in a big Wall Street firm?
At what point does the purchase of such shares cease to be intelligent investing, and become the crudest sort of gambling?
There is, of course, a reason that the market doesn't understand Wall Street firms: The people who run Wall Street firms, and who convey news of their inner workings to the outside world, don't understand them either.
Jimmy Cayne plays bridge, and Stan O'Neal golfs while their firms collapse, not because they don't care their firms are collapsing, but because they don't know that their firms are collapsing.
Across Wall Street, CEOs have made this little leap of faith about the manner in which their traders are making money, because they don't fully understand what their traders are doing.
Late last November, in a superb account of the demise of Citigroup CEO Charles Prince, Carol Loomis of Fortune magazine revealed that Prince resigned after he was informed of the consequences of liquidity puts — options that allowed buyers of complex and presumably safe mortgage securities to hand them back to Citigroup at par if they became hard to finance.
Liquidity puts were about to make Citigroup the new owner of $25 billion of crappy mortgage securities at par, cost Prince his job, and put the company into the hands of Robert Rubin. Rubin is an extremely smart man with keen instincts of self- preservation, and he sat closer to Prince than anyone else at Citigroup.
Rubin said he had never heard of liquidity puts.
To both their investors and their bosses, Wall Street firms have become shockingly opaque. But the problem isn't new. It dates back at least to the early 1980s when one firm, Salomon Brothers, suddenly began to make more money than all the other firms combined. (Go look at the numbers: They're incredible.)
The profits came from financial innovation — mainly in mortgage securities and interest-rate arbitrage. But its CEO, John Gutfreund, had only a vague idea what the bright young things dreaming up clever new securities were doing. Some of it was very smart, some of it was not so smart, but all of it was beyond his capacity to understand.
Ever since then, when extremely smart people have found extremely complicated ways to make huge sums of money, the typical Wall Street boss has seldom bothered to fully understand the matter, to challenge and question and argue.
New New Thing
This isn't because Wall Street CEOs are lazy, or stupid. It's because they are trapped. The Wall Street CEO can't interfere with the new new thing on Wall Street because the new new thing is the profit center, and the people who create it are mobile.
Anything he does to slow them down increases the risk that his most lucrative employees will quit and join another big firm, or start their own hedge fund. He isn't a boss in the conventional sense. He's a hostage of his cleverest employees.
At this point you have to at least wonder if Wall Street firms should be public companies. Their complexity renders them inherently opaque. Investors are right now waking up to this fact: They will demand to be paid for opacity, and also for volatility.
The firms have been revealed to be so treacherous in bad times that the only way they survive as public companies is to make outrageously huge sums in good times. That is, as public companies, to be economically viable they are likely to be socially problematic.
If they aren't about to go under, they are making so much money that everyone else hates them.
Something is about to give.
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