Private equity is ill-understood by the general public because it is private.? They don’t have to file statements with the SEC, all they have to do is inform their limited partners on how they are doing.
Jason Kelly gives us a neutral view of what is going on in private equity.? I think he is neutral, because he does not come across as a fan or a critic.? Personally, I think that is hard to do with private equity, because 1) it is easy for some to become amazed at the success of some incredibly wealthy and clever businessmen, or 2) it is easy to take offense at these shadowy capitalists that have produced bankruptcies, fired many people, and have been very clever at using the tax code to pay minimal taxes.
Both of these views are caricatures and the truth does not lie in-between but embraces both views.? Indeed, in many cases,? jobs have been preserved or created through private ownership of firms.? Many firms might have died without private equity restructuring the company, leading to the loss of all jobs.
Jason Kelly takes you through all aspects of private equity:
Fundraising
Leverage
Dealmaking
Operations
Exiting (Selling)
He also introduces you to all of the major private equity shops, and their leadership.
One thing the author highlights in the book is the pervasiveness of private equity.? He notes how many businesses are managed by private equity.? In general, these are businesses with steady cash flows that can service the debt that the private equity funds borrowed to buy them.
Some private equity firms are passive, and don’t try to improve operations.? Others make a great effort to grow the companies, hiring new people in the process, and taking risks to create a better company.? It depends on the philosophy of the private equity owners.
The book does note the favored tax status of carried interest, but takes the position that the private equity investors are following the law, and that they will follow the law should it be changed.? (My simple idea is that interest should not be taxed, or be a tax deduction.)
The book does note trends:
Private equity is becoming more public, as more large private equity firms go public.
Complexity inside private equity firms is growing as they broaden the scope of services that they provide.
The owner/founders are moving on, and a new generation of management is taking the reins.
Returns may be falling as private equity gets larger.
In all, a good book, but one that may leave partisans unsatisfied.? It does not demonize or engage in hagiography.
Full disclosure: The author?s PR Flack sent me a preprint and a copy of the book.
If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)
Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.
I was talking with two new friends of mine today regarding money market funds.? Surprising me, on asked whether the proposal that I made to the SEC covered only credit events, or whether it covered interest rate risk as well.
I all too easily commented that movements of short rates don’t happen fast enough to affect a money market fund, causing the shadow NAV to break the buck (i.e. drop below $0.995) — that we would need a banana republic scenario for that to happen.
But it bugged me that I did not know that for sure, so I pondered on how I could answer the question.? Then it hit me.? Use commercial paper rates to estimate a net asset value for a hypothetical money market fund with an average maturity of 45 days.? Using data from FRED, it took me roughly one hour to complete the analysis, and what I learned surprised me.? (Note: being surprised is good, because it means real learning is taking place.)
From 1971 to the present, money market funds without defaulted securities would have a shadow NAV below 0.995 15.4% of the time.? Here’s a histogram that details the shadow NAV versus par.
Thus I would modify my recommendation to my friends, and say that so long as there are no defaults, ignore the discounts to par.? If there is a default, then follow my recommendations, because that loss is certain.
Looking at the history, there are some ugly periods.? Let me describe them.
In late January 0f 2009, liquidity dried up for short-term unsecured bank debt the NAV of my hypothetical MMF got down to 96 cents on the dollar.? It was back to par in one week.? That could just be bad data.
In early December 1980, when I was celebrating my 20th birthday, and having my first truly “happy birthday” in three years, the shadow NAV got to 97% of par, but three weeks later was back at par.
I am embarrassed regarding my assertions.? Money market funds vary far more than I imagined, and I am only dealing with averages here.
But I think there is a rule here for intervention: do not intervene over interest rate moves.? Money market funds are resilient enough that credit events should only happen when a security has defaulted.
That said, if one wanted to run my rule when money market funds’ shadow NAV dropped below 0.995, it would not matter much to holders.? The loss of units would be recouped within 60 days or so.
Without a default, there is no reason to impose a credit event on money market funds, because in all past cases, the situation will right itself with time.
I do not claim omniscience here — things could be different in the future, particularly with low rates.? But absent defaults, money market funds have generally returned to par amid otherwise tough situations.
Ugh.? I have learned over the years that posts that verge onto politics give me the most negative mail.? My politics are more complex than most, and I can tell you I am not voting for Romney or Obama.? So please, do not take what I say as advocacy for either party.
As this article from Bloomberg points out, it’s not easy to answer whether you are better off.? Like the article, I also think of Ronald Reagan in 1980 posing the same question.? Now a Vulcan would have said, “Of course I am better off.? 1977 & 1978 were great years, more than offsetting the problems of 1979 & 1980.”? A human says, “I’m uncertain about the future, things don’t seem good now, so no, I am not better off.”
Note the difference: forward-looking vs backward-looking.? It is not a question of how income has changed, but how prospects for income have changed.
Thus the question should be: “Do you feel better off?”? But the politicians don’t say that because it is too touchy-feely.
Both fiscal policy and monetary policy are unsustainable.? That does not engender a sense of confidence about the future, and as such many of those that think about this end up saying they are not better off, even if their income is higher over the last four years.
There is another way to view it, which I know is unpopular, but I think people implicitly deduct the growth in government debt from GDP growth, because they realize that much of what the government spends money on does not grow the economy.
This is another way of being forward-looking.? When people are asked if they are better off, they do not look at past improvement, but whether the future looks better than it did four years ago.? Now that you know what Obama is like, do you really have any confidence that the future will be better if he is re-elected?
Don’t get me wrong, I think the Republicans are full of hot air.? I don’t think they would deal with entitlements the way they should be reduced.? Further, I don’t even see them making any dent in current budget imbalances.
But if you feel less certain about your prospects now than four years ago, odds are when someone asks you if you are better off than you were four years ago, your answer will likely be “No.”?? We look forward, not backward.
Before I begin this evening, let me simply say that where I find intelligence, I appreciate it, whether I agree with all the ethics of the situation or not.? Buffett is a bright guy, brighter than most.? I have *not* been shy to criticize Buffett when I thought there were ethical lapses — whether it was retroactive reinsurance, life settlements, David Sokol, or anything else.
The fifth way that Buffett is different is that Buffett was comfortable managing a company, rather than a pass-through vehicle like a mutual fund or a hedge fund.? That may sound trivial, but it is significant, because few investors do that.? The advantages are considerable.? You have permanent capital to work with, so you can focus on the distant future when times are bad.
The article that prompted this piece talked about how Buffett would “bet against beta,” and would invest in quality stocks.? These are the strategies that one can take advantage of if one has sufficiently long-term capital.? But I differ from the article, because value, betting against beta, and an emphasis on quality are not risk factors if you have a sufficiently long time horizon.? They are sources of alpha.? I disdain everything from MPT.? Real investing is finding companies that can compound free cash flow at above average rates.
I think that is a part of the problem with academic consideration of investing.? Typically they embed an idea that the investment horizon is short, which makes their ideas useless for long-term investors.
The sixth way that Buffett is different is that Buffett uses leverage (“float”) from the insurance companies to fund much of his assets.? The float has grown, but in an era of low interest rates, P&C insurance companies focus hard on making an underwriting profit.? In one sense, the low interest rate environment has made the P&C insurers and reinsurers to not be financials; they compete on underwriting, not investing.
The seventh way that Buffett is different, is that he doesn’t care what form the investment takes.? Buffett might say: “Stocks, great.? Convertible preferreds, even better.? Convertible bonds, yes.? Credit default swaps, only if I get to structure it, and same for selling options.? Private equity is fine; I will leave them alone, and capture the private equity niche of those who care about their corporate culture.” And more… he is a flexible guy, because he has a strong balance sheet behind him.
As for the robo-Buffett the academics create, well, hindsight is 20/20.? Who could have seen the relatively placid economics of the past 30+ years?? With that much foreknowledge, some private equity investors could have gone wild and done far, far better than that.
But Buffett had no roadmap.? He faced the same fog that we all do, but made robust choices that would do well against a fuzzy future.? As such, he deserves attention for his clever investing, because Buffett is different from the rest of us.
How cynical are you? How close have you been to politics in DC?
I know a lot of people who work for the US Government directly or indirectly, and they are astounded at the waste and fraud.? They are honest people, and it weighs on them.
The more I watch it, the more I think that power needs to come back to the states, and slim the Federal Government.
Now, I’m a libertarian of sorts, but what if you come to discover this as a “true blue” member of the Democratic Party?
Most people initially come to politics idealistically, and so did the author, inspired by… Joe Biden.? Now, with Mr. Biden, I did not see the thrill when I was younger.? Yes, there was more complex rhetoric, but nothing materially different then compliance with the particulars of the coalition backing the Democrats.
Be that as it may, the author went through many changes in supporting Biden and the Democratic Party.? Here’s his bio:
Jeff Connaughton holds an MBA with honors from the university of Chicago and a JD from Stanford Law school. He worked for four years as an investment banker, first at Smith Barney and then at E. F. Hutton. in 1987, he joined Joe Biden?s presidential campaign as Deputy national Finance Director and thereafter became his special Assistant when Biden chaired the senate Judiciary Committee. After graduating from Stanford, Connaughton clerked for Chief Judge Abner Mikva of the united states Court of Appeals for the DC Circuit, then followed Mikva as his special Assistant when Mikva was appointed Counsel to President Bill Clinton. in 2000, along with Jack Quinn and Ed Gillespie, Connaughton founded Quinn Gillespie & Associates, one of DC?s premier lobbying firms. He lives in Savannah, Georgia.
That’s a lot of change in 20+ years.? The book takes you from his early days, interleaving the recent versus the past, until we get to the financial crisis, at which point, the author’s faith in the Democratic Party is severely tested.? He never abandons his principles, but he grieves for his party.
His real crisis comes after Barack Obama is elected with Joe Biden as VP, and he and his boss are excluded because they have been lobbyists.? But the boss is appointed to fill the Senate seat of Joe Biden, and the author comes along as his senior aide.
They have two years to do what is right, uncorrupted by the money of politics, because he isn’t running for re-election.
They take on High Frequency trading.? Regardless of tighter spreads, is the amount offered at the spread similar-sized, or smaller?? Further, what happens in a crisis?? Do the market makers and specialists hold to their roles, or conveniently abandon them, amid crisis.? The latter seems to be true.? The philosophy is: to the degree that we have laws providing structure to markets, so that many people can trade easily, knowing that things are basically fair, we must review all practices that give unfair advantages to some.
In the process of trying to reform HFT, Ted worries that something like the “flash crash” will happen in advance of its occurrence, further burnishing his reputation as a thinker on markets.? Ted Kauffman asked: who is served by ever-greater liquidity? (P. 185)? From my angle, studies need to be done studying “percentage liquidity” seeing how spreads divided by average bid/ask size have to be done — narrow spreads don’t mean much if you can’t do much volume there.
On pages 204-5 of the book, it describes the gamut of Ted’s ambitions regarding the financial crisis:
Back in the senate, Ted had three great insights.? First, this wasn?t a time for vague legislation that kicksthe can back to the very regulators who?d failed in the lead-up to the crisis; Congress needed to draw hard statutory lines, just as it had during the great Depression. Second, Wall street?s inherent conflicts of interest had to be resolved through structural reform, such as by reinstating Glass-Steagall or imposing size and leverage limits. Third, he wanted to take the fight straight to the megabanks on too-big-to-fail, makingWall street defend against structural reforms it opposed,at least to increase the chance that other provisionsopposed by the banks, like the Consumer Financial Protection Bureau, would pass.
One thing he knew that I knew then and now.? The banking regulators did not use the tools that they had to do their jobs.? They were quiet accomplices as the leverage bubble built.
On page 228, Ted introduces “…the safe Banking Act of 2010, the Brown-Kaufman amendment would have put limits on the
size of and leverage used by megabanks by:
imposing a strict 10 percent cap on any bank holding company?s share of the united states? total insured deposits;
limiting the size of non-deposit liabilities at financial institutions (to 2 percent of U.S. GDP for banks, and 3 percent of GDP for non-bank institutions);
setting into law a 6 percent leverage limit for bank holding companies and selected non-bank financial institutions.”
The most radical of the proposals is the middle one, which aimed to limit repo financing at financial institutions; it would have been much more effective than the Volcker Rule.? Most of the problems in a financial crisis stem from short-term liabilities financing long-term assets.? This attempts to address the short-term liabilities that do not stem from deposits.
As the author comments on page 229:
Remarkably, although there is a prudential cap on the amount of deposits the largest banks can hold, nothing limits bank liabilities like repos, which often must be rolled over every day.
This is insightful, and the insight should be extended to securities lending, and derivatives, where margining must be adjusted day-by-day.
As Ted proposes breaking up the too big to fail banks, he runs into a lot of resistance.? This includes pseudo-intellectuals like Larry Summers who argues on page 234:
Summers?s [sic] second argument was that, if we broke up the megabanks into smaller banks, ?it would actually make us less stable. Because the individual banks would be less diversified, they would be at greater risk of failing because they wouldn?t have profits in one area to turn to when a different area got in trouble.?
What Summers didn’t get is that complexity creates more risks than diversification erases.? Complex banks are typically not well-managed as far as bad times are concerned; diversification disappears during the crisis.? And if we had a lot of small banks, yes, we would have more failures, but no, the system would be more secure.? The system is at risk from the 4 to 20 banks that are so large that the US Government must bail them out.
As it was the Brown-Kauffman amendment failed, and a pity that it did.? Would that it had become law, as opposed to the watered-down “Volcker Rule.”
At the end the author leaves DC after his patron leaves office, and restarts his life in Savannah, Georgia.? He adjusts to the happiness of life outside the Beltway, and realizes that a life outside of politics can be pleasant.
Quibbles
Page 149 — there is no way that short-selling is behind 50% of trading on a normal basis.? If that is true, I have to rethink a lot.
Page 152 — Even with naked short selling, it is really difficult to move a stock’s price down.? I would encourage the SEC to try some experiments where they nakedly short a stock, and see if they can make money off it.? I bet they can’t.
Page 179 — spelling error: peak s/b peek.
Who would benefit from this book: ? This book will tell you how much DC is in thrall to the power of money.? Doesn’t matter which party, their ideals are up for sale.?If you want to, you can buy it here:?The Payoff: Why Wall Street Always Wins.
Full disclosure: The author’s PR Flack sent me a PDF file of the book.
If you enter Amazon through my site, and you buy anything, I get a small commission.? This is my main source of blog revenue.? I prefer this to a ?tip jar? because I want you to get something you want, rather than merely giving me a tip.? Book reviews take time, particularly with the reading, which most book reviewers don?t do in full, and I typically do. (When I don?t, I mention that I scanned the book.? Also, I never use the data that the PR flacks send out.)
Most people buying at Amazon do not enter via a referring website.? Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.? Whether you buy at Amazon directly or enter via my site, your prices don?t change.
One of the following maps is the current gerrymander of Maryland’s Congressional District, and the other is my attempt at fair districts for Maryland.
Map 1
Map 2
I’ve written before on how to create fair districts.? Let a computer do it, minimizing the lengths of internal borders, subject to the districts being roughly the same size.? In response to that idea, the late Ron Smith of WBAL radio said,
“That’s an interesting idea. The problem is that it would defeat the very purpose of gerrymandering, which is one of the rewards for gaining the upper hand as a political party.?Pols probably wouldn’t?relinquish that very easily.”
My reply was:
I have no illusions on something like this.? This could not come from inside the system, it would have to come around the system through a constitutional amendment process.? What?s worse, is that I don?t think there are any interest groups with money that would back such a proposal.
Now, I decided to trying an experiment.? I can imagine someone making the following argument:
What? Are you crazy?? Leave it to a computer?? Computers don’t respect the unique culture of political subdivisions within a state!? People on opposite sides of the street could be in different districts!? A large city could be split in two or three, with no respect for the various subcultural groups, which would lose their voice!? Haven’t you heard of the Voting Rights Act!?
Well, okay. Let’s try doing something a little different.? Let’s start with the next largest subdivision in states — counties.? Let’s try to do a few things:
Have districts that are roughly equal-sized.
Have districts that come from similar geographic areas of the state.
Divide up counties as little as possible.
When dividing counties use straight lines.
Three counties were larger than the amount needed for a seat — Montgomery, Prince George’s, and Baltimore County (not city, which is its own county).? That’s where I drew three short lines, giving bits of those counties to other districts.
The top map is my creation.? Given the odd geography of Maryland, I think it does a good job of creating equal districts amid the diverse cultural geography of Maryland.
Western Maryland (rural)
The Eastern Shore (rural)
Southern Maryland along the Chesapeake Bay (suburban/rural)
Montgomery County near DC (urban)
Prince George’s County with Charles County to the South (urban)
Baltimore County less its southern fringe (suburban/urban)
Baltimore City w/Baltimore County’s southern fringe (urban)
Central Maryland (suburban/rural)
When I look at the second map, I can’t see how any of the districts are fair.? They are discretionary, jagged, concave to the max.? Why anyone should rule that these districts are fair is beyond me.
To those who live in Maryland, which is maybe 2% of my audience: what would it take to get a ballot measure together to change the way that we set districts?? To those living in other states, maybe you want to consider a similar shift.
Looking at my map, I suspect the congressional composition would be 3-5 Democrat to 4-4 Tied, versus the 2-6 we have today, and the 4-4 that existed when I first moved here in 1998.
If representatives were elected proportionately, Maryland would be 3-5, blue as the state is.
These are just my musings, but I will be passing them on to my friends in Maryland.
Update: Microcap made a good comment, I’d like to highlight the start of it here:
David: this is my ?hot button? issue for 2012.
I am very surprised you missed that there IS a ballot question that got enough signatures to be on the fall 2012 ballot. The measure would overturn the current map.
This isn?t a permanent fix but at least it?s a start.
I’m glad that’s on the ballot.? I guess I don’t follow state & local to the degree I follow national & global.? We can vote down the current gerrymander, but we need something to replace it with.? Maybe my proposal could be a ballot initiative next time.
