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by: Dear John Thain August 28, 2008 | about stocks: C / FNM / FRE / LEH    

Dear John Thain

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I haven’t had the opportunity, in a long time, to cobble together some real thoughts. However, here are a few quick takes on what is going on recently:

1. Citi (C) continues to shuffle deck chairs. Now, I don’t know what they could be doing right now to fix their situation. The problem they are facing is that they need to control costs in an environment rife with morale problems. As one commenter on Dealbook pointed out, I don’t know who believes that Jamie Forese is asking a subordinate to become his equal–indeed that’s probably not even within his power to do. I also don’t know why there is such a massive use of management consultants – in a large bank with an everything - needs - signoff - from - the - C.E.O. culture it’s hard to imagine someone who runs a department of 200 people can go out and hire McKinsey.

Those managers can’t even upgrade their own travel arrangements to first or business class! Anyway, the real issue with these measures is that the worst abusers are powerful and find their way around these policies and senior management’s time is better spent doing other things than approving new computers and offsite meetings.

IRONY ALERT: As I was writing this post, I saw this item from Research Recap:

 McKinsey sees considerable scope for investment banks to cut their noncompensation costs – possibly up to $2 billion in recurring savings.

…

McKinsey said its experience indicates that data, printing, supplies, delivery and professional services usually yield the fastest results; restructuring real estate and IT spending may take longer but generate much larger savings.

McKinsey said its analysis suggests that “executives can embark on this additional belt tightening without harming a bank’s culture and morale.”

Of course, morale at most investment banks is already so low that a further whack at expenses is unlikely to make it any worse.

 

(emphasis mine)

Honestly, you can’t make this stuff up…

2. Lehman (LEH) is approaching a deal to sell a stake in its asset management unit,  Neuberger Berman, to a private equity firm. This is a good start for a type of relationship (that I have already opined on) between Lehman and a business that should be looking for disintermediation. If I were Mr. Fuld, I would look to sell a stake in the asset management unit, get an equity investment in Lehman itself, and form a permanent J.V. with whatever top-shelf private equity firm will be winning the auction. Maybe Lehman can try cross-selling:

Mr. Kravis, I see you own a part of our asset management division, can I interest you in some cheap real estate debt? With gas prices so high who couldn’t use some hard assets?

Feel free to fo read my prior post–I go into a lot more detail there about the nuances of what the structure, in an ideal world, should look like.

3. Fannie Mae (FNM) and Freddie Mac (FRE) are falling … in slow motion! I have no idea, none at all, why the failing and bailout of Fannie and Freddie are both taking so long. Guess what? If Fannie and Freddie are woefully undercapitalized now then what’s the catalyst for things to get better? There is none. This whole situation doesn’t make sense. Are they waiting for the government sponsored enterprises [GSEs] to be insolvent? We already know they are leveraged institutions completely concentrated in markets that are dead, dying, or woefully sick. I guess I don’t understand the rationale for waiting to take action.

From the Wall Street Journal:

The Treasury probably doesn’t need to make a decision imminently unless the companies lose their ability to tap debt markets at reasonable costs, said Joshua Rosner, a managing director at research firm Graham Fisher & Co.

If the Treasury is forced to inject capital into Fannie and Freddie, though, that is likely to be part of a restructuring that would likely wipe out the value of previously issued common and preferred shares and lower the value of subordinated debt.

[Obligatory paragraph about what the stock did today.] …

Fannie increased its holdings of “liquid” investments, cash and short-term securities that can easily be sold, to $103.6 billion, up 43% from June. The move gives the company more flexibility to reduce its future borrowings if market conditions worsen, company officials said.

(emphasis mine)

In what world is $100+ billion of anything easily sold?  With the Fed pressuring the Treasury Department to ease up on wiping out certain equity holders because of the destruction wiping out parts of the GSEs capital structure would cause, this is simply stupid. Have any of these people ever seen markets function in the face of uncertainty? Oh, right … the last year or so. Well, at least that’s going well.

4. The next big problem is here: distressed companies. People expect that this will be the next set of losses and economic distress. Corporations have been resilient, as a sector, to this economic downturn. Part of this is the lag that corporations have from the time consumers start tightening the purse strings to the time that effect is seen on the bottom line. Nothing else to say, really, the numbers are all moving in the same direction.

5. A random assortment of other things:

  • Do you remember the rating agencies? Well, now one is going to sell you something that will tell you how much you’re going to lose on the C.D.O. paper you bought because they said was safer than it actually was after using its flawed ratings methodology… Apparently, the part of its suite that worked was the part that picked out the downgrade candidates.
  • In a slight nod to my political views, there is finally hard data that we, as a society, have a vested interest in investing in those amongst us that have the least.

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This article has 14 comments:

  •  
    Aug 27 08:23 AM
    When in doubt, hire an expensive nationally known consultant. Its a wonderful and costly CYA when you have no idea what to do and don't trust your staff.
    Reply
  •  
    Aug 27 08:49 AM
    Humm… You say that you have no idea how Fannie, Freddie are keeping a float? Perhaps a little more research on your part would present a more accurate picture of what the realities are…It is apparent that the Shorters continue to march with rumors and rumors of rumors…. I just read an interesting article on Bloomberg.com that says that Fannie, Freddie Mortgage Profit Reaches 10-Year High (new investments)…. Interesting article … “The sky is falling” said Chicken Little… I do not think so…

    bloomberg.com/apps/new...
    Reply
  •  
    Aug 27 09:55 AM
    Regarding Citi (and most banks) -- its standard MO for lame CEOs and their management consultants to suggest trimming costs by slashing the IT and back office budgets. What is really surprising is that anyone outside the company would give a shred of credence to the idea.
    1) It was the CEO and the "profit" centers who got over-levered on mortgage debt they didnt understand
    2) It was the CEO's earlier decisions to ignore risk management and not develop proper risk management software... its far from obvious how cutting these areas further will do anything but hurt
    3) Exactly how many traders does it take to go out and buy assets they clearly don't understand and on absurd leverage? Any janitor who dropped out of high school could lose billions just as fast -- and a lot cheaper
    4) Does Citi need thousands of securitization lawyers and deal makers considering the market is all but shut down? Do any of the banks need this?
    5) Why is management overly concerned with approving first class business airline tickets? If there was actual business activity occurring, a multi-billion dollar corporation really shouldn't care between $300 and $3000... the real question is "Why are you flying at all?" Since there is no business going on, don't fly at all. Get rid of the managers who want to fly first class -- and while you are at it, get rid of the manager who does the approving.
    6) This one is a no brainer: save millions by getting rid of all the McKinsey people or else all the Citi managers. If the Citi managers don't know what they are doing, why are they there? If they do know what they are doing, why is McKinsey there? Two completely redundant management structures

    But even with two redundant management structures, the best plan they can come up with is to make cuts in risk management and IT? How many McKinsey people did it take to conclude that firing people who had nothing to do with the mistakes that caused the bank's collapse won't result in lower staff morale?
    Reply
  •  
    Aug 27 11:57 AM
    Same game as in the early 1990's. Cut overhead, clamp down on expenses. Count the pencils. However, tell me that the senior people at Citi and other banks are flying commercial coach and I will believe it. Tell me the CEO and executive team will 1) cut their base pay to maximum $500,000 with no bonus until earnings reach a sustainably higher level and 2) no options at today's prices but a large amount at $35 a share and five year cliff vesting. I'm waiting! Disclosure: Long "C"
    Reply
  •  
    Aug 27 11:59 AM
    these consultans re management have always been a joke.cut all pay to top management.pay by dividend only.then see how many or fly 1st class.all corp. business should pay by dividend only.that would shake things up in the right direction.ever hear of a consulting firm say"ged rid of the top three exexcs?LOL
    Reply
  •  
    Aug 27 02:16 PM
    Gramps2

    Agree completely with what you wrote. Sounds like you may have actually managed something.
    Reply
  •  
    Aug 27 03:44 PM

    Does Congress have the foresight to follow our Constitution? It states there in only Congress has the authority to print our money supply(dollars)and based on only Gold and Silver. Both Presidents T.Jefferson and A. Jackson destroyed the Central Banks in their days, because they issued fiat money(non gold backed paper money),causing inflationary boom and bust cycles! The Fed is that today . The elite and Bankers love this as they have incredible cheap buying opportunities during these downturns paying pennies on the dollar for business and houses!
    Don Trumph admitted he'll have unforeseen opportunities during this period and the oil companies should be taxed on their excess profits on CNBC in June! Do any of our Statesmen or Reps(Congress0 have the cahones to even attempt this taxation?
    John, do you think that the present unfolding of such extreme problems are caused by recent events or have been brewing since U.S. Presidents in 1936 and 1971 forced us and the dollar off the gold standard without Congressional authorization and total disregard to the Constitution?

    Is fiat money responsible? Would a single world currency help?
    Please Reply,
    Cal
    Reply
  •  
    Aug 27 04:08 PM
    gramps2 for Secretary of the Economy! Especially poignant was # 6:

    "6) This one is a no brainer: save millions by getting rid of all the McKinsey people or else all the Citi managers. If the Citi managers don't know what they are doing, why are they there? If they do know what they are doing, why is McKinsey there? Two completely redundant management structures"

    I have *never* understood how management in *any* company get away with this! If not competent, show them the door! If competent, no consultants necessary!
    Reply
  •  
    Aug 28 09:42 AM
    Regarding the GSE's, your reporting of these agencies is less than honest at best. How someone can get a job writing garbage pieces covering any subject matter without having researched the subject continues to amaze me and many others.
    Reply
  •  
    Aug 28 10:37 AM
    'If Fannie and Freddie are woefully undercapitalized now then what’s the catalyst for things to get better?'

    why take credit for bailout when you can put it off for the next administration and political opponent.
    Reply
  •  
    Aug 28 10:44 AM
    As a consultant, I can tell you that consultants are used primarily for two purposes:
    1) Convince the Board of something you want them to do
    2) Outsource work that requires expertise or staff resources you do not have in house
    Reply
  •  
    Aug 28 11:25 AM
    Cal,

    In terms of increasing the tax on oil companies - the consumer, not the business would bear the majority of the burden as it would simply translate to higher gas prices. Just my 2 cents based on what I've read.

    In response to your single world currency idea I haven't the foggiest. I can only speculate on the outcome in terms of valuation in a global perspective.

    If something is confusing about my response or doesn't make sense - I apologize as I only recently started my MS-F and am trying to immerse myself in as much relevant material as possible even though I may not completely understand it.
    Reply
  •  
    Aug 28 03:33 PM
    The author says: "I have no idea, none at all, why the failing and bailout of Fannie and Freddie are both taking so long"

    Could it possibly be there is some controversy over whether a bailout is needed or not? A bailout would almost certainly leave Common and possibly Preferred shareholders with major, maybe complete, losses. Acting precipitously, if a bailout were not really needed, would be hard to defend. At June 30, 2008 Fannie Mae had assets of $886 billion and capital of $41 billion for a capital ratio of about 4.7%. That's a pretty good capital ratio for a residential lender. How could you support wiping out the Common shareholders in that situation?

    According to the GSEs regulator, the Office of Federal Housing Enterprise Oversight, "it is misleading to say the companies are undercapitalized and need a dramatic capital infusion".

    I have no investment position in Fannie or Freddie, but I am confused as to why there is so much noise about the need for a bailout. Is this just more of the "Short & Distort"?


    Reply
  •  
    Aug 28 08:18 PM
    so what do you do with your assets?
    Reply
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