KKR Demonstrates Why Public Banks Don't Need Capital

Thursday's Wall Street Journal carried a detailed piece on KKR's preparation for a larger, broader role in the financial services sector.

For now, according to the article, the firm is adding syndication of its own investment assets and infrastructure finance as new businesses.

Whether the private equity shop actually goes public seems less material to me than that they demonstrate what I contended in this recent post.

Why should we think KKR will stop with these few new businesses? Once they build a larger infrastructure to manage a broader range of financial units, can basic loans, various types of equity underwriting, and asset management be far behind?

Having moved to wean itself from the simple leverage buyouts for which KKR became famous in the 1980s, there wouldn't seem to be a natural stopping point.

Of course, with each new business will come some more watering-down of returns, competition for capital and expense dollars, more resources spent managing the internal efforts of the businesses, etc. Which will gradually mean lower returns on a larger income stream for partners.

But in the meantime, wouldn't it make more sense for KKR to just hire the necessary people, raise capital and do the businesses which make sense, than to buy into badly-managed banks, commerical or investment, which are publicly-held and in bad shape?

The Mess at UBS- More of the Same

Yesterday's Wall Street Journal profiled the new chairman of UBS, Peter Kurer, and his putative "Legal To-Do list," which read,

"1. Write down more subprime sercurities by Aug. 12?

2. Turn over names of wealthy American clients.

2a. Try to limit fallout at private bank.

3. Defend bank against Massachusetts acution-rate fraud claims.

4. Split the bank in two?

5. Find four new board members.

6. Mollify activist investor Lugman Arnold.

7. Find time to complete strategic review by Oct. 2."

This bank is a mess!

I had forgotten the totality of its trouble.

The lawsuit regarding alleged tax evasion by American private banking clients. The auction-rate securities fraud case. And the end result of UBS's split over valuation of the same subprime CDOs for itself and customers.

The irony, though, is that, when you look at a five year chart of UBS compared to the major US commercial banks- BofA, Wachovia, Chase and Citi, plus the S&P500 Index- it just looks like one of the bunch.

Because I don't regularly follow UBS, it being a Swiss-based bank, I didn't realize how badly it had slipped, to the point of easily being confused, on a performance basis, for a large, mediocre bank.

In fact, it's right with the four large US banks on five-year price performance, just behind Chase. UBS actually outperformed the index and the other banks for 2005-06, but then the seeds of trouble sown then began to sprout, and it nosedived like the other banks over the past 18 months.

The next Yahoo-sourced chart shows the same players over the last two years.

In this timeframe, UBS is squarely in the middle of its fellow large banks, plummeting disastrously to lose more than 60% of its value in two years.

And, now, beyond the operating issues of the subprime assets, auction-rate securities mess, and tax evasion matters, it has to fix its own management and strategy.

With a new leader.

I guess maybe the good news is that it's clearly not just US banks that have performed so badly and gotten risk management so wrong in the past half-decade.

About Those Credit Default Swaps Prices....

A recent Wall Street Journal article bemoaned the high price of MBIA and GM credit default swaps.

As if, somehow, the world was coming to an end because holders of debt of these two antiquated, flawed companies were paying up for default protection. And that maybe this suggested an overall continuing credit crisis.

It doesn't.

These prices ought to be higher now. Both firms are clearly in danger of bankruptcy, not to mention it's unclear that either is any longer needed in the US economy.

Other than the usual Congressional suspects, and the local economies around their production facilities, would anyone really miss GM if it just died? The market share will be filled in by some other auto maker, meaning replacement jobs and facilities. Only, this time, they might be ones with prospects for growth, rather than fear of how much they'll be shrinking due to CEO Wagoner's continuing inept management of the firm.

As for MBIA, it probably has a very small footprint, economically. As Doug Dachille noted on CNBC some months ago, the model for bond insurance is no longer viable. Between better information access and fully-priced risks in the underlying instruments, the kind of 'guarantee' that MBIA and its ilk offer is simply worth less today, if its even credible.

Plus, the industry didn't help itself by plunging into a risky area, mortgages, to try to stoke growth, as I noted in this post.

Sometimes it seems like the sky is falling, when, in reality, it's just a small piece of it.

Why don't people just let go and acknowledge that companies die. They sometimes lose their reason for being. Their approach to the market is wrong and out of date. They have become irrelevant.

Currently, it looks as if the bond insurers and America's poorly-run, largest automaker, GM, are either already there, or very close.

But that doesn't mean the entire financial market, nor the economy, is in crisis.

It's Official.....Time To Go Short!!!!

I am very, very sorry to note that my proprietary equity allocation signal has finally gone to "short" for the first time since 2001.

Believe it or not, even January's rollercoaster ride and March's collapse didn't trigger it. Almost, but the April bounce lifted the S&P just enough to keep us long for a while.

For my partner and I, now, that means calls rather than puts, since we have moved on from straight equities. But the message from the underlying equity markets is still important, and not to be taken lightly.

June's S&P return of at best -9%, on first glance using a simple Yahoo-sourced price difference, is the worst in ages, and sends my proprietary market turbulence/allocation signal firmly into short/put territory.

It will take at least a +3% July S&P return to reverse this, based on my tools.

I don't predict the S&P, and I don't market time. My tools are more like hurricane warnings than daily weather forecasts. And right now, I'd be boarding up the windows and filling the bathtub with water. At least for the next few weeks.

More as conditions develop later this month. But for now, we are almost certainly going to be buying puts next week, when end-of-June Compustat data arrives to drive July selections and weights.

Why Should Private Equity Invest In US Commercial Banks?

There has been a lot of ink spilled recently on how the Fed and other related US bank regulators need to adapt various rules so that "private equity" can rescue crippled commercial banks by supplying new capital, but without the onerous current restrictions.

The Wall Street Journal devoted a front page piece to the topic on Friday, and gave space to two Carlyle group directors to opine on the same topic Thursday.

I think this concern over how to allow private equity to invest in commercial banks is misplaced. It's entirely the wrong solution.

Let's understand what the current situation among large commercial- BofA, Citi, Wachovia, Chase- and three of the four large public investment banks- Merrill, Morgan Stanley and Lehman- really mean.

These financial institutions committed grave and expensive errors of risk management and timing of investments and trades, resulting in very large and continuing losses. These operating losses, realized in ever-more regular fashion, have depleted capital among these eight large publicly-held US financial institutions.

Don't such losses imply excess capacity in the sector, which led to injudicious, risky behavior on the part of the competitors?

Isn't the obvious solution to consolidate the sector's participants? How much loan origination, underwriting and trading capacity do we really need? Surely not so much that it goes off in search of bad deals and blows holes in the balance sheets of the sector's competitors.

In fact, if/once you fence off simple deposit-taking activities, which are federally insured, all other banking businesses are quite competitive and, thus, subject to cyclical losses.

What we're seeing now is not really anything new, but, rather, a confluence of several bad financial bets by these large banks at once. Combining overly-aggressive mortgage financing with securitization resulted in them messing up both a real economic sector- housing- and the entire financial sector with it.

The result has been material losses of shareholder capital from these boneheaded moves on the part of the eight large firms mentioned above, plus, of course, the now-dead Bear Stearns.

But that's no reason to lament the availability of capital for publicly-held financial institutions.

You can bet your bottom dollar that private equity shops only want in because they think there will be a feast as economic and financial conditions recover, and probably a few regulatory sweeteners tossed in for good measure.

But why worry about the temporarily shrinking capacity of US commercial and investment banks? If private capital can buy into these institutions, to filter their capital into loans, etc., why can't they just enter the businesses directly?

Private equity shops could, if they chose, hire commercial and personal loan employees from publicly-held banks and go forward with their own fresh capital, replacing the questionable business practices and judgments of the commercial and investment banks.

Why throw good money after bad, and into the hands of inept CEOs and senior managements at the existing eight large commercial and investment banks?

I don't see a crisis here at all. In fact, I don't see a need for any regulatory intervention whatsoever. What I see is a need for mergers of weak commercial and investment banks. Or maybe just the death of the worst-performers.

There's nothing wrong with the financial sector that segregating deposit-taking and then allowing mergers of weak institutions won't fix. With less taxpayer 'help' and modification of regulations.

But letting private equity into the picture is just mistaken. Those guys are smart enough to just take on the businesses and do it themselves. They don't need to be buying into the management of inept commercial and investment banks.

Angelo Mozillo's Corporate Conduct

Back in the spring and summer of last year, Angelo Mozillo made several appearances on CNBC's morning program. At the time, he was viewed as a dynamic, informed and successful architect of the nation's largest independent mortgage lender.

The twenty-year price chart of Countrywide and the S&P500 Index nearby displays how well Mozillo managed to consistently create value for his shareholders during many of these years.

However, upon learning recently that he had formed a special "Friends of Angelo" group of influential industry executives and Senate members for whom he arranged sweetheart loans, my opinion of Mozillo has declined considerably.

The knowledge that past heads of Fannie Mae, as well as Democratic Senators Chris Dodd and Kent Conrad all knowingly received preferential loan terms from Mozillo's company clearly shows that the lender's CEO didn't want to leave his firm's fortunes to chance anymore.

He evidently bought Fannie Mae's allegiance to Countrywide, and its acceptance of the private-sector lender's low- and no-doc loans with bribes to the quasi-government loan packaging entity.

In the case of Senators Dodd and Conrad, Mozillo took care to buy the consent of two members of a key oversight committee to Countrywide's practices during the mortgage lending boom, and, even now, to the bailout of its worst loans during these challenging times for the industry.

It's hard to now view Mozillo as simply a hardworking CEO who built his firm from scratch and ran afoul of tough market conditions.

It's evident now that Mozillo must have known his firm was stoking growth via 'innovative,' a/k/a risky loans, for which he needed to grease some important institutional buyers and Senatorial overseers.

At this point, I hope Mozillo is charged with, and serves prison time for his actions. What he did, based on recently-disclosed evidence, is nothing less than bribery of business associates and government officials. I hope the executives and government office-holders who took the bribes, including Dodd, Conrad and Fannie Mae executives, are also charged, convicted and sentenced to serious hard time in prison for their misdeeds.

Ordinarily, I'm all for the market dispensing justice. But in this case, it appears Mozillo went far beyond what was ethical and legal in his operation of Countrywide. I hope he and those who collaborated with him all suffer for their betrayal of shareholder and public trust.

The Buschs' Shameful Behavior

Annheuser-Busch's and its CEO, August Busch IV's responses to InBev's offer to buy the firm and reward the American brewer's shareholders more richly than the current management has been able to do, have been disappointing and shameful.

Predictable, but disappointing.

Not only has the Busch family dug in its heels to claim the right to continue to impoverish their shareholders, as I noted in this recent post, but they have recruited various local government officials to aid them in this disgusting enterprise.

I've written more on the sorry Busch saga here and here. Holman Jenkins, Jr., of the Wall Street Journal, wrote an entertaining piece last week lampooning the Busch family's attempt to screw shareholders of the firm the family founded, but sold to the public years ago.

Wouldn't you like to see, just once, a family-founded firm which has gone public do the right thing for shareholders?

Oh, wait. One did. Bill Wrigley!

I suppose it's way too much to hope that August Busch IV would ever take inspiration from Wrigley and do the right thing for his shareholders, isn't it?

Steve Ballmer's Idiocy- "Pondering Change" at Microsoft

Friday's Wall Street Journal ran a rather curious article concerning Microsoft, entitled "Ballmer Ponders Changes at Microsoft."

The piece begins,

"As Bill Gates ends three decades in Microsoft Corp.'s top management, Chief Executive Steve Ballmer faces a major question: How do you make a 100,000-employee software giant much more agile?

There are no easy answers. But in a memo last summer to his top lieutenants, Mr. Ballmer drew lessons from two other U.S. business icons -- Wal-Mart Stores Inc., known for the central management of its retail outlets, and General Electric Co., known for businesses that operate autonomously. His conclusion: Microsoft needs more elements of both."

This is a joke. Ballmer is a pompous fool.

The nearby Yahoo-sourced price chart for Microsoft and the S&P500 Index tell a very clear story.

After an astounding performance for shareholders from its IPO in 1986 to 2000, the company has simply declined, then stalled for the last eight years.

Eight years.

Isn't it a little late for Ballmer to wonder what's gone wrong? Where were he and Bill in, oh, say 2002? After the stock price was falling through the floor much faster than the index.

The Journal article continues by noting,

"At the center of Mr. Ballmer's dilemma is ongoing tension over whether Microsoft's huge business divisions should have wide freedom to set their own course -- or be more centrally planned, a strategy that could meld expertise across the company in ways that provide an advantage over rivals with narrower technology portfolios. In the memo, according to Microsoft executives, Mr. Ballmer cites lessons from both the Wal-Mart and GE experiences.

"We're not a conglomerate, but we're not a monolithic operating company," Mr. Ballmer said in a recent interview. "The question is, 'are we always hitting the right balance?'" "

Let's humor Mr. Ballmer. After all, did he not also leave Harvard prior to completing his degree? No matter. Neither he, nor Gates have any sort of disciplined management education, and it shows in the way their company simply stopped performing after 15 years.

Here's another Yahoo-sourced price chart. This time, it depicts the past five year performances of Microsoft, the S&P500 Index, and Ballmer's choice of role models, Wal-Mart and GE.

It's just pathetic, isn't it? Not one of the three firms has managed to outperform the index at all for five years, nevermind doing it consistently.

Give Ballmer credit for knowing how to choose two other turkeys with which to compare his company.

I'm not going to go searching for contrary examples, but I think we all know that Google looks a hell of a lot better than any of these three firms.

My point is, Ballmer is missing the point!

As recently as in this post from earlier this month, I again called for Microsoft's breakup, as I first did in May of 2006. You can read through the many posts I've written about Microsoft to see how I have argued for its divestiture of the company's operations into four independent businesses: operating systems, desktop applications, online, and gaming.

GE has the same problems, and has been under fire for over a year now to be broken up, too. My posts on GE are now somewhat well-known for this view, only way before it became popular last year.

Wal-Mart is simply a retailer which has pretty much saturated its primary markets, and failed in its attempt to move upmarket. It is only doing better lately as the recent slowing of economic growth has brought some of its former customers back from stores like Target and Kohls.

However, the key point is that Ballmer chose, for companies to emulate, two other losers.

If that doesn't tell you all you need to know about Ballmer's and Microsoft's probable future performance, I don't know what else will.