Llewellyn
King
Read Llewellyn's bio and previous columns
September 22, 2008
Investment Insanity:
When Peer Pressure Took the Hand Of Greed
I
once asked the chairman of Wells Fargo how his bank had gotten sucked
into dubious Third World loans. Greed, he responded. Just greed.
He
might have added another motive peer pressure. We think of peer
pressure as the force that gets kids into trouble, but business is as
subject to it as teenagers are.
When a lot of states deregulated their electric utilities in the 1990s,
these formerly conservative companies went on an international binge.
They started buying up utilities around the world with a passion a
passion often fed by the fear that they were being left out of the great
global bonanza. Some believed that they would not be able to hold up
their heads at the meetings of the Edison Electric Institute unless they
could discuss their latest acquisition in a faraway land. From Brazil to
Indonesia, American electric utilities were into globalizing and loving
it.
Of
course, most of these investments went sour. The expected profits were
as often as not consumed by currency variations, confiscatory local
taxes and dishonest politicians, who sought to extract bribes from the
operators as soon as the ink was dry on the contracts. Many American
executives did not know anything about local conditions. For example,
they were unaware that in much of Latin America, and parts of Asia, up
to 50 percent of the electricity is stolen. Governments are powerless to
stop the theft for fear of social upheaval.
Helping the electric utilities make their mistakes were the investment
banks. Mergers and acquisitions are the mother's milk of investment
banking. The banks often found the deals, researched them and took them
to the American companies. Their reward giant fees.
One of these investment houses was the now-bankrupt Lehman Brothers. At
the height of the madness, as the publisher of The Energy Daily,
I was invited to give a lecture to Lehman clients. The audience was half
Lehman executives and half newly-minted internationalists. I told them
the truth about investing in other people's infrastructure: It looks
good on paper, but it does not work in practice because you will be
resented as an absentee landlord. Populist politicians will run against
you.
On
the face of it, this was not what they wanted to hear. They wanted
wilder music and stronger drink. One major utility executive who was
also something of a king-maker in the Democratic Party told me I did not
know what I was talking about. He was invested in Pakistan, and thought
it was a great place to do business.
Yet privately, the Lehman executives were glad I had called for a
reality check. One managing director told me: We should take their
passports away.
As
investment after investment went south, many of the utility travelers
came to wish they had stayed at home. Lehman, other investment banks and
their lawyers knew better, but those lovely fees were irresistible.
The utility madness was not earth-shaking, but it was symptomatic of how
investment banks regarded money itself as the client, not the
fee-payers.
About this time the world became aware that an obscure and arcane branch
of finance, derivatives, was growing and attracting not financiers, but
mathematicians and physicists to slice and dice away from prying
regulators, troublesome politicians and curious journalists. The linkage
between collateral and loans was obscured. A change in the regulations
in 2004 enabled investment banks to borrow or leverage their assets by
30-to-1 when it had been 12-to-1. No worries. The market would
discipline itself, said the players.
Mortgages were the new financial manna. You could package them and sell
them around the world. But Wall Street was not satisfied with the volume
of mortgages being written in the old-fashioned way, and thousands of
mortgage brokers started loosening the criteria, until there was really
no threshold for getting a mortgage.
Now the party is over and the administration of George W. Bush, a
conservative, is nationalizing a large chunk of the financial markets.
He is also tying the hands of the next president, and there is still no
transparency. The only thing that is clear is that the taxpayer will
pay.
© 2008 North Star
Writers Group. May not be republished without permission.
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