http://www.slate.com/id/2200917/
The End of the BSDA Wall Street icon falls.
By Daniel Gross
In New York, happiest among the financial alpha males is the big
swinging dick. The term entered the lingua franca via Michael Lewis'
Liar's Poker. (Relevant quote: "If he could make millions of dollars
come out of those phones, he became that most revered of all species: a
Big Swinging Dick.") BSDs are the perennial winners of the game of
conspicuous earnings (giant bonuses), conspicuous consumption (giant
co-ops and summer homes), and conspicuous philanthropy (giant plaques on
public edifices). In recent years, with the explosion of wealth
triggered by the credit and housing boom, a large number of BSDs were
minted by the Holy Trinity: hedge funds, private equity, and investment
banking.
Players in these arenas had clearly succeeded in the most difficult and
competitive of environments. But these industries were all easy-money
businesses—great, sexy, and wonderful to be in when credit is plentiful
and cheap but considerably tougher when the lending climate turns nasty.
The dirty little secret of the late boom? Many of the people who
succeeded most flagrantly did so not because they were great at figuring
out ways to make huge amounts of money. Rather, they scored because they
were great at figuring out ways to make small amounts of money and then
magnified their returns through the massive use of debt. But now the
credit crunch and a new market and regulatory climate are turning BSDs
into NSBSDs (not such big swinging dicks).
Hedge funds thrived on the use of debt. Find a stock that's doing well
in a bull market, borrow money to buy it, reap outsized returns when it
rises, and keep 20 percent of the returns. Investment banks eager for
stock-trading commissions were keen to provide the liquidity. Today, not
so much. Hedge funds were willing to use leverage in part because they
hedged; they sold stocks short to protect themselves from being wiped
out if the market moved down. But as part of an effort to protect the
CEOs of financial institutions from their fellow BSDs at hedge funds,
the Securities and Exchange Commission this week issued an order banning
the short selling of several hundred financial stocks. As a result, many
hedge funds are pulling in their horns and running for safety. As the
Financial Times reported Thursday: "Citigroup estimates that hedge funds
have now placed $600bn in cash, and that $100bn of this is held in money
market funds." The BSDs are investing like grannies who survived the
Great Depression. Riding out the storm by parking assets in cash is a
smart strategy for a hedge fund that has already scored big gains for
the year. But most hedge funds haven't. Earlier this week, it was
reported that, globally speaking, only one in 10 hedge funds is earning
performance fees—i.e., the 20 percent of the fund's gains that the
managers keep as compensation. Performance fees are what make hedgies
BSDs. (What's 20 percent of nothing? Zero.) Fortress Investment Group,
one of the few publicly held hedge funds, just canceled its dividend for
the third quarter.
Private equity firms, which have a compensation structure similar to
that of hedge funds, have also seen their returns wilt. During the boom,
private equity firms could rack up big gains by buying a company with
little or no money down, and then having the company issue debt to pay
the new owners a healthy dividend. (They called it investing.) Or they
could profit by selling it to other private equity firms or by selling
shares to the public. Just as homebuyers now must make larger down
payments, private equity firms in the post-credit-boom era have to pony
up more cash to buy firms. Issuing bonds to pay dividends is passé, and
the market for IPOs is limp. The slim list of recent IPOs is heavy on
Asian firms. The upshot: Private equity firms are having difficulty
consummating exit transactions. In the second quarter, Blackstone
reported that performance fees were actually negative, compared with
$453 million in the second quarter of 2007.
Investment banks have suffered a triple whammy. Many of the biggest of
the BSDs, like former Lehman Bros. CEO Richard Fuld and former Bear
Stearns CEO Jimmy Cayne, have seen their massive fortunes evaporate as
their stocks plummeted. Thousands of lower-level BSDs have suffered
alongside them. (Check out Gabriel Sherman's New York piece on the
lament of a former Lehman Bros. $3 million man.) And there's not much
hope for the near future. Investment banks funded themselves through the
capital markets, which meant they could rack up as much leverage as the
market would permit—up to 25 or 30 times the amount of capital. Higher
leverage means greater returns when you have a good idea and the climate
is forgiving (viz. 2002-06). But it's a killer when the weather turns
nasty (viz. 2008). At some investment banks, bonuses this year will be
slim to nonexistent. Earlier this week, Goldman Sachs and Morgan
Stanley, seeking more stability, received permission to transform
themselves into commercial banks. They can now accept deposits and enjoy
regular access to credit from the Federal Reserve. In return, they'll
have to submit to more regulation and use much less debt in their
operations. For decades, investment bankers looked down on commercial
bankers—with their shorter hours and lower profits and salaries—as
nerds, putt-putting along in Oldsmobiles while the I-bankers drove
Ferraris. But now investment banks will have to operate less like hedge
funds and more like the First National Bank of Podunk, with commensurate
changes in compensation.
Among investment banks, Goldman Sachs was the ultimate big swinging
dick, the firm that could do no wrong, that was more profitable than
anybody else, that was just better. But this week, Goldman, needing
cash, turned to Warren Buffett, the biggest of the BSDs. He agreed to
help but extracted pretty onerous terms: 10 percent annual interest rate
plus an equity kicker. In other words, Goldman is paying a double-digit
interest rate and giving up a piece of the house in exchange for a
measly few billion dollars. Goldman Sachs CEO Lloyd Blankfein, lord of
the BSDs, is now a subprime borrower.
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