Wednesday, September 10, 2008

Gotta Know When to Fold 'em

Sorry guys, I know this is a poker blog and of course I am all about writing about poker, but this Lehman stuff is really on my mind today and I'm going to write some more about it today. This is actually stuff that's been swirling around my head for some time over the past couple of months, and me writing this all down is really much more for me than for you guys, so bear with me. I promise this will not turn in to a Lehman Brothers blog or a stock market blog or anything. But if you're at all interested in my perspective on things with the biggest debacle in the stock market right now, feel free to read on for my thoughts.

So I just hung up from listening in on the big conference call this morning that Lehman Brothers held for the investing public regarding its future plans and the truly hideous quarter it reported today. My lord what a clusterfuck. The company lost more than $5.60 a share in Q3, more than basically all of the analysts were predicting even after the company obviously leaked information to various parts of the market over the past month or so that the quarter was going to be truly fugly. One of the highlights of the quarter included an astonishing $7.8 billion of gross writedowns, by far the worst quarter yet in the company's history -- surpassing Q2 of this year and now marking only the second time in the company's history as a public company that it has posted a loss -- and bringing the company's total asset writedowns in the past year to around $14 billion. The total loss so far in 2008 is nearly $7 billion for the firm as a whole, and who knows where things go from here, as fiscal Q4 which just started Sep. 1 has not exactly begun with a bang in the financial markets, so say the least.

But the more disturbing part of this morning's announcement from Lehman management is the lack of any concrete new news regarding the company's plans to fix the problems it faces going forward. Obviously the company needs excess capital -- 8 to 10 billion dollars worth by some analysts' estimates -- to cover the huge losses it has experienced and continues to experience this year. And yet, there is no word of any stock sales, to foreign investors in Asia, the Middle East or otherwise. No news of a concrete sale of the asset management business that has been rumored and now appears to be true according to this morning's conference call. And no word of sales of any of the troubled mortgage assets held by the company, in the small sum of, oh, just another $70 billion worth.

Read that again. Seventy billion dollars of troubled mortgages held by Lehman Brothers on its books right now. Still. One of my favorite parts of the company's plans to deal with this mess is the new idea to spin off these mortgage assets into a separate company called Real Estate Investments Global. Now tell me, who the fizzity fuck is gonna want to own that piece of doggie turd? They couldn't find people to invest in that pig no matter what they tried. So what are they going to do to find buyers for that separate public company? Simple! They're going to spin it off to the existing shareholders of Lehman Brothers stock. Basically force the creation of a market of buyers for this garbage by spinning it for free directly to the existing shareholders. Most of whom who have a single brain cell in their fucking heads will immediately sell the shit, I'm sure, but if it allows Lehman to get the troubled assets off of their books, then hey, just go for it. This is very similar to a move Lehman made earlier this summer when it spun off a couple of new entities it called "hedge funds", and basically funded them with a bunch of risky, hard to value, overvalued and troubled assets that Lehman itself desperately wanted to get off of its own books. Never mind the fact that these two spinoff entities were all composed of Lehman employees, using Lehman computers, networks and other assets, and all sat in Lehman's office space. But with those moves, the troubled assets got off of Lehman's books, and that's all this quick-fix CEO was looking for at the time. Well now it has all come home to roost.

One thing that Lehman specifically denied all through its conference call this morning is that the company is not seeing capital outflows from its asset management business and that counterparties are still perfectly willing to trade with it despite its recent troubles and despite the company's stock literally plunging 50% in Tuesday's trading action. Well you know what? I'm gonna have to call a big fat fucking bullshit on that one. You tell me -- if you had $10 million invested in Lehman Brothers before this week began, you tell me, is that money still sitting with Lehman now? To be more realistic, what if you had ten billion dollars with Lehman, as many of the large money managers, pension and hedge funds have under management? Is all $10 billion still sitting in Lehman's coffers somewhere? When there are plenty of other, more stable financial institutions out there where you could keep that money and not have the completely constant worry of whether your money will still be there tomorrow, and whether the company will still even be in business tomorrow? Of course not. For the company to say they're not seeing any outflows is not surprising, and I can't blame them for lying. They have to lie on this one point. If the CEO gets on the phone and tells the world that customers are taking their money out, then suddenly this is Bear Stearns, and the company will be gone -- yes, gone -- in two days just like Bear was. But for anyone to believe this story is preposterous to a significant degree. Of course people are taking their money and running from Lehman right now. And they would be fools not to, given what's gone on with the stock over the past year, over the past six months, over the past 3 months, over the past month, and now especially over the past few days.

Moreover, Goldman and Merrill and Morgan Stanley can come out all they want like they did after the close of trading on Tuesday and claim that they are all still willing counterparties to trades with Lehman Brothers on the other side. Suuuuuuuuure they are. Goldman and Merrill and Morgan may be a lot of things, but they aren't stupid, and they don't just throw money down the toilet when they clearly know that's what it is. I'm sure, thanks in no small part to extreme pressure from the Federal Reserve over the past 24 hours and over the past several months, that these other three large-cap investment banks are still willing to do some trades with Lehman, generally speaking. But if you think after Tuesday's trading action that this morning, Goldman is lined up to enter into, say, a 10-year interest rate swap with Lehman Brothers worth $15 billion, then you my friend are a jackass. What these companies will do, while still being willing to enter into small, short-term trades with Lehman, is they will immediately begin pulling in their exposure to Lehman by limiting the number of large trades, and certainly the number of long-term trades they will enter into with the company. They have to. They could arguably be sued by shareholders for not doing this, given how obvious and prevalent and public the problems with Lehman's future have become now this week. So sure they all say the right thing, the thing the Fed I'm sure coerced them all into proclaiming publicly yesterday after the market closed, but behind closed doors these companies are acting to preserve their own capital as much as they can, which is exactly what they should be doing. If you were a shareholder in Goldman Sachs right now, would you want them taking $15 billion of exposure to Lehman's troubles in a 10-year swap transaction? Think about that one for about 0.00005 seconds.

I've never written about this before here, but one of the saddest things that's gone on at Lehman Brothers during the past year as the credit crunch has deeply impacted business at the bank is the paralysis among so many of the employees there, who know deep down they should be looking for employment elsewhere but who simply cannot get themselves to unfreeze and take the plunge. And I say "sad" because that's just what it is, people who are simply paralyzed by fear, or by circumstances, or both into inaction. I personally know it to be a fact that most of the people at any real level of seniority at Lehman have been making way way more money than they are otherwise worth in the marketplace. This is a cold, hard fact coming from someone who has implicit knowledge of exactly what I speak about here. My old boss, for example, I know what he does and I know what those jobs pay elsewhere outside of the investment banking world, and I can tell you with absolutely no hesitation at all that he has made a good 200, 250k more a year at Lehman over the past couple of years than he would ever make at any job he could ever get if he leaves right now. Ever. He probably makes a lot more there right now than he will ever, ever make again in any job in the rest of his life. No joke and no exaggeration there. I also know that his boss makes about 350k to 400k more than he could ever make if he left Lehman Brothers right now, doing what he does. I mean it, I am talking about hundreds of thousands of dollars more than what they are really worth. And that guy's boss, whom I also personally know, makes a good 500k or more above what he could expect to make anywhere else.

Now putting aside the obvious problems associated with the fact that this company who is quickly running out of cash is somehow paying all of its employees two to three times or more than what they're actually worth, this mass overpayment of the senior-level people has contributed more than anything else to the paralysis among employees that I personally observed over the past year at the bank. Take the first guy I mentioned above as an example. He's known for a while that things are bad -- beyond bad even, horrible is probably a better word -- at the company for some time. For months, literally. He knows that the prospects for the company recovering to any semblance of its former self, and the prospects for him continuing to make the money he's been making there these past few years, are very low. He knows this. But he has been making literally $250,000 more than he could make if he leaves for any other company on the earth. Period. So in his mind, if there is even a 1% chance that his job at Lehman Brothers might persist, and that he might be able one day in a few years when things have calmed down and perhaps Lehman finds a way to survive to get back to making that kind of redonkulously inflated compensation again, he feels like he simply cannot leave. He can't bring himself to give up this ridiculous cash cow that's been dropped in his lap over the past few years. Think about it -- the thought of him willingly leaving that 250k a year on the table and taking a job for the "measly" money that he is actually worth for what he does, while someone else gets his grossly overpaying job, makes him want to throw up in his mouth. He can't face it. His boss can't face leaving his 600k a year job for the 200k he is worth anywhere else in the world, if there is even the slightest chance that he could have stayed and kept making 600k a year (and more) for the rest of his life if things turn around. The thought of giving these ridiculously over-inflated incomes up is making all the people making any kind of big bucks at the firm freeze in their tracks. And I have to tell you, sitting around and watching that go on with everyone around me as clear as a bell, that has to be one of the saddest things of all to me given my own perspective on things. These people just can't bring themselves to leave, even though they've seen the writing on the wall for quite some time.

Which takes me to I guess my last point for today, and after all this there actually is a poker point to it all. It's like the famous Kenny Rogers song, "The Gambler" -- what does he say in that? "You've gotta know when to hold em, know when to fold em." Maybe my poker experience helps me to see these things more clearly than some others out there, I don't know. But as a rule I know when I'm beat. I know when to hold em, and I also know when to fold 'em. Now it's true, I'm not making as much money as a lot of the people I mentioned earlier in this post at Lehman, and maybe my thought process would have been different if I were. But I don't think so, and I know it shouldn't have been. I know the people I mentioned above will never again make the kind of money at Lehman that they'd gotten used to over the past few years. As the absolute best case scenario -- something which I would rate as maybe a 5-10% chance at this point, nothing more -- maybe Lehman somehow finds a way to remain independent through all this bullshit and maybe in some number of years -- and I don't mean anytime real soon -- these guys could be making some real money again. But for me, I'm not interested in waiting five years or more for that, a 5-10% shot as it is, and I knew I had other options. So I got out, found a better job at a far more stable company at this point, in a far more stable industry, and in the end I will clearly make more money at the new place over the next few years than I would staying in the investment banking world. But so many of the people I spent the past three years of my life working with just don't get it. They've got down the part about knowing when to hold 'em, but they just dont know when to fold 'em. But just like I can lay down those pocket Tens on the board of TJQ when I've got two allins ahead of me and one player still to act behind me after there was a raise and a reraise already before the flop, I hung 'em up at the bank and have moved on to better things. I can only hope most of my old friends at Lehman can do the same soon.

"You got to know when to hold 'em, know when to fold 'em,
Know when to walk away and know when to run.
You never count your money when you're sittin' at the table.
There'll be time enough for countin' when the dealin's done."

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Blogger VinNay said...

I have to imagine that if you were making a few hundo grand more than you could make somewhere else you would have stayed.

I only say that because its what I would do. It's a fucked up situation, but if I'm gettin 2-500K more than I could make somewhere else - I stick it out. Even if that means just going in to work and sitting at my desk while I play online poker.

It's a +EV situation. Does quitting get you anything other than a worse paying job? I guess it might be a happier life. However, it looks like your old company is going to go under, but to me that makes it even more appealing. It means I won't be bored for the rest of my life, only for a little while and I might as well grab the cash while I can.

11:01 PM  
Blogger VinNay said...

BTW - I still give you props for leaving. It was the right call. I left a miserable job 2.5 years ago, and went to what I thought would be a great job, but for 15% less salary.

Turns out it is a great job, and 2.5 years later I am making 50% more than my previous job.

If you love what you do, and are good at it, the money will come.

11:06 PM  
Blogger Bayne_S said...

If I am making more money than I will ever make in future AND it is 3x what market rate for my skills are than every additional day I stay on job gets me 2 days more to find job after company goes under.

It has been 6 months since Q2 reporting so he has already bought himself a years additional pay vs. job switch after Q2.

Admittedly there isn't any satisfaction to going to work when riding a company down but I think "pot odds" are right to ride.

Would just hope they are already making lifestyle adjustments for market pay rate.

11:09 PM  
Blogger Mr Subliminal said...

Fuld should fold.

11:10 PM  
Blogger Hammer Player a.k.a Hoyazo said...

Keep in mind guys, a big portion (i.e., well more than 50%) of the compensation these guys are making in the bank comes in a year-end bonus. And that bonus won't be there this year. Or next year. Or the year after that.

So these people aren't making all that extra money while they sit there this year. The base pay is far under what they could expect to make at another non-investment-bank job, with the huge overcompensation coming in a bonus at year end. I should have been clearer about that in the post.

11:19 PM  
Blogger Bayne_S said...

then of course you bolt.

bonuses come from profits

12:41 AM  
Blogger Irongirl01 said...

is Fuld still in charge of lehman? i remember him from my AMex years. albeit I was aligned with the Weill/Dimon and then cohen regimes. I got out in 1988 right before/during the Barbarian at the Gates melodrama

The Compensation Committee of the Board of Directors is to blame for excessive pay. Wonder how much they pull in for meeting a few times a year?

1:25 AM  
Blogger Irongirl01 said...

as an aside. Fuld and I share an undergraduate alma mater. per forbes he's ranked 11th on 2008 CEO compensation

Total Compensation
$71.90 mil

5-Year Compensation Total
$354.03 mil

Obscene amounts for sure

1:30 AM  
Blogger Hammer Player a.k.a Hoyazo said...

Yeah IG, no way the job Fuld has done at Lehman is worth a penny more than $352 million over the past five years. lololololol

What a joke.

1:48 AM  
Blogger NewinNov said...

According to IndustryWeek, out of a survey of 3,000 U.S. companies, average board compensation was $1M. About a 1/3 got less than $500K. Extreme cases: Nine companies paid more than $2 million in cash director fees. So probably about $140K or so per individual per year for about 4-7 meetings.

3:04 AM  
Blogger Hrbek said...

Interesting callout here big picture calls out fuld

11:09 PM  

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