Wednesday, November 11, 2009

Lee Cooperman & Charlie Gasparino

I wanted to write this morning about Charlie Gasparino's interview with Ted Forstmann which appeared in Friday's Wall Street Journal. On the way to doing so, I happened to see Lee Cooperman's appearance on CNBC for a few hours this morning.

The contrast between the two seemed to me to be notable.

Last March, I wrote this post describing the dynamics of Cooperman, Michael Steinhardt and Mario Gabelli in a joint appearance on CNBC.

As I reread my post, I see that Steinhardt was, in retrospect, wrong about being long for the past six months. But simply reading my impressions of that morning quickly bring back my feeling of respect for Steinhardt's careful, measured remarks, the obvious product of much reflection.

In contrast, this morning's appearance by Cooperman was just as lightweight as that of last March. Amazingly, Cooperman carried on about the recession and alleged recovery as if it's no different than any other prior US recession/recovery combination. He rattled off statistics regarding average length of recession, and merrily forecast heady times for equities ahead.

For this reason, I checked back to that March post. It's hard to convey Cooperman's bubbly optimism. More to the point, it's hard to understand it in the face of 10.2% unemployment, a cratering US dollar, and federal debt and deficits of previously unheard of dimensions.

With this background, I turn to Gasparino's recent interview with Forstmann.

Yesterday, I wrote this post discussing hedge fund group owner Mark Spitznagel's recent Journal editorial which heavily cited Ludwig Von Mises' early twentieth-century book and theories. Spitznagel bored in on the folly of government manipulation of capital markets, and the damage which typically, consequentially follows.

In that vein, Gasparino's piece is great reinforcement. He begins with this statement,

"I recently sat down with legendary investor Ted Forstmann to discuss why, on the one-year anniversary of the financial meltdown, the press has largely ignored the role of government in creating the meltdown—and possibly setting the stage for another one—by allowing Wall Street to borrow cheaply and easily during the past three decades."

In that paragraph, Gasparino echoes my own sentiments in yesterday's post. It gives me mixed feelings about not being alone in my concern about this. Glad I'm not alone, unhappy about the observation itself. Gasparino continues,

"Mr. Forstmann knows a thing or two about greedy investment bankers: He's been calling them on the carpet for years, most famously during the 1980s when he fulminated against the excesses of the junk-bond era. He also knows that blaming banking greed alone can't by itself explain the financial tsunami that tore the markets apart last year and left the banking system and the economy in tatters.

The greed merchants needed a co-conspirator, Mr. Forstmann argues, and that co-conspirator is and was the United States government.

"They're always there waiting to hand out free money," he said. "They just throw money at the problem every time Wall Street gets in trouble. It starts out when they have a cold and it builds until the risk-taking leads to cancer."

Mr. Forstmann's point shouldn't be taken lightly. Not by the press, nor by policy makers in Washington. But so far it has been, and the easy money is flowing like never before. Interest rates are close to zero; in effect the Federal Reserve is subsidizing the risk-taking and bond trading that has allowed Goldman Sachs to produce billions in profits and that infamous $16 billion bonus pool (analysts say it could grow to as high as $20 billion). The Treasury has lent banks money, guaranteed Wall Street's debt and declared every firm to be a commercial bank, from Citigroup with close to $1 trillion in U.S. deposits, to Morgan Stanley with close to zero. They are all "too big to fail" and so free to trade as they please—on the taxpayer dime."

All true enough. But Gasparino does a real service to readers, similarly to the theme of his recent book and his comments in support of them, as I noted here. He clearly identifies federal government culpability for the recent financial mess. For example, I wrote,

"But I admire his honest and full exposition of how the mortgage-backed financial meltdown truly came to exist. And that is due to explicit, bi-partisan federal government manipulation and coercion of the financial system to make questionable mortgage loans to lower-income borrowers, then securitize those loans as if they were high-quality debt instruments.

Credit goes to Gasparino for mentioning clearly and loudly, in nearly every interview, the name of Massachusetts Democratic Representative and current chair of the House Banking Committee, Barney Frank, as a prime architect of the financial mess which exploded last year."

Gasparino, in his interview with Forstmann, then provides real value by linking recent events to something so far back that my own brief brush with it was early in my career at Chase Manhattan Bank.

"The conventional wisdom as perpetuated in the media is that these bailout mechanisms are unique, designed to ameliorate a once-in-a-lifetime financial "perfect storm." They are unique, but only in size. A quick look back at the past three decades will demonstrate what Mr. Forstmann meant when he said the government has been ready to hand out free money nearly every time risk-taking led to losses.

The first mortgage market meltdown of the mid-1980s, spurred by the Fed's supply of easy money, was among the most painful market upheavals in the history of the bond market. The pioneers of the mortgage bond market, Lew Ranieri of Salomon Brothers and Larry Fink of First Boston (the same Larry Fink now considered a sage CEO at money management powerhouse BlackRock), lost what were then unheard-of sums of money. (Mr. Fink concedes to losses of over $100 million.)"

I vividly recall attending a mortgage-backed bond conference at which all of the era's mortgage finance luminaries- Fink, Ranieri, Michael Mortara, and, if memory serves, Dexter Sfent (sp?), a name now not even found via Google- spoke. I'll save my own anecdotes for another post, but, suffice to say, my takeaway impression, which I conveyed to my boss, SVP of Corporate Planning, Gerry Weiss, was that these investment banks were taking a haircut for repackaging risk, but doing nothing to reduce it. They were merely spreading it among the many mortgage-backed bonds, sliced up by tranches of time and risk.

So, for taking a hefty underwriting fee, they 'solved' the S&L's problems of underwater mortgages by securitizing them, transferring risk to bond holders while pocketing a fee.

Gasparino continues, with the theme of warning that last year's extreme bailout of the financial services industry was no new thing,

"What happened then was a dry run of what was to come," Mr. Fink recently told me, as he looked back on the market he created, which would eventually lie at the heart of the most recent financial crisis. Wall Street took excessive risk in mortgage bonds amid the easy money supplied by the Fed—and lost. When the crisis began, the Fed under then Chairman Alan Greenspan slashed interest rates—as it would do after Orange County, Calif., declared bankruptcy in 1994 because of bad bets on complex bonds; and again in 1998 when the hedge fund Long-Term Capital Management (LTCM) blew up; and of course in the bond-market crisis of 2007 and 2008. The lower rates each time lessened the pain of the risk-taking gone awry, and opened the door for increased risk down the line.

A similar bomb exploded in 1998, when LTCM blew up. The policy response to the LTCM debacle is instructive; more than anything else it solidified Wall Street's belief that there were little if any real risks to risk-taking. With $5 billion under management, LTCM was deemed too big to fail because, with nearly every major firm copying its money losing trades, much of Wall Street might have failed with it.

That's what the policy makers told us anyway. On Wall Street there's general agreement that the implosion of LTCM would have tanked one of the biggest risk takers in the market, Lehman Brothers, a full decade before its historic bankruptcy filing. Officials at Merrill, including its then-CFO (and future CEO) Stan O'Neal, believed Merrill's risk-taking in esoteric bonds could have led to a similar implosion 10 years before its calamitous merger with Bank of America.

We'll never know if LTCM's demise would have tanked the financial system or simply tanked a couple of firms that bet wrong. But one thing is certain: A valuable lesson in risk-taking was lost. By 2007, the years of excessive risk-taking, aided and abetted by the belief that the government was ready to paper over mistakes, had taken their toll."

It's instructive to stop at this juncture and dwell on Gasparino's last sentence. By the end of 2007, Wall Street firms had benefited from a full 20 years of federal bailouts of their failures to manage risk adequately.

In the same vein that Congress and several administrations allowed the GSEs to pump inappropriate, too-risky, too-low-income mortgages through the US and, ultimately, global financial system, the federal government had also encouraged and abetted private, publicly-held commercial and investment bank excessive risk-taking through 20 years of easy money policy and loss mitigation.

Gasparino concludes,

"With so much easy money, with the government always ready to ease their pain, Wall Street developed new and even more innovative ways to make money through risk-taking. The old mortgage bonds created by Messrs. Fink and Ranieri as simple securitized pools had morphed into the so-called collateralized debt obligations (CDOs), complex structures that allowed Wall Street banks as well as quasi-governmental agencies Fannie Mae and Freddie Mac to securitize ever riskier mortgages.

Likewise, nearly to the minute he was forced to file for bankruptcy, former Lehman CEO Dick Fuld believed the government wouldn't let Lehman die. After all, government largess had always been there in the past.

All of which brings me back to Mr. Fortsmann's comment about policy makers helping turn a cold into cancer. What if the Fed hadn't eased Wall Street's pain in the late 1980s, and again after the 1994 bond-market collapse? What if policy makers in 1998 had allowed the markets to feel the consequences of risk—allowing LTCM to fail, and letting Lehman Brothers and possibly Merrill Lynch die as well?

There would have been pain—lots of it—for Wall Street and even for Main Street, but a lot less than what we're experiencing today. Wall Street would have learned a valuable lesson: There are consequences to risk."

Thus, after reading Gasparino's well-written history, with Forstmann's help, of the last 20+ years of US financial sector excessive risk-taking, with explicit federal government collusion and encouragement, it's difficult to understand how Cooperman can be so cheery about the current real US economic conditions and equity markets.

On one hand, you could say Cooperman is simply following Gasparino's/Forstmann's observations that this recent equity rally, too, will be sustained, and any subsequent damage repaired by easy federal policy.

On the other hand, as I've written in many recent posts, one senses that things are different now. The US is now essentially borrowing from abroad to conduct easy monetary policy. The fact that the US Treasury Secretary had to personally assure the Chinese government with respect to guarantees of GSE-issued debt suggests we no longer can simply inflate our way out of future financial disasters.

It's less a matter of proper US policy conduct, which is unlikely, than it is unaffordable costs of continuing on that past, as measured in rising rates on US debt, the rapidly depreciating US dollar, and potential problems selling more Treasuries into a global market already wary of US monetary and fiscal policies.

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