When Greed Is Good

For those of my generation, Gordon Gekko is the ultimate Wall Street caricature. Oliver Stone's movie Wall Street, in which Gordon is the main character, came out in 1987, just as I was getting out of business school and starting my career in venture capital. The big line in that movie is when Gordon says "greed is good."  Here's a ~3 min clip from the film and the whole thing is worth watching but the big line comes around 2:40 into the clip:

If you watched until the end, you also got to hear this line:

Greed, you mark my words, will not only save Teldar Paper, but also that malfunctioning corporation called the USA.

That's the first thing I thought of when I read this morning in the NY Times that the bank rescue plan that Geithner will announce tomorrow relies in part on private investors:

Administration officials said the plan, to be announced Tuesday, was
likely to depend in part on the willingness of private investors other
than banks — like hedge funds, private equity funds and perhaps even
insurance companies — to buy the contaminating assets that wiped out
the capital of many banks.The officials say they are counting on
the profit motive to create a market for those assets. The government
would guarantee a floor value, officials say, as a way to overcome
investors’ reluctance to buy them.

The smartest people I know have been saying this has to happen for over five months. Roger Ehrenberg has been pleading for the good bank/bad bank solution since the late summer early fall. In the good bank/bad bank scenario, the bad bank gets all the "toxic" assets and private investors are allowed to speculate as to their worth in an open and transparent market.

The single best comment I've received on this blog about the banking mess came last September from JLM, who was hanging around this blog community during the election but sadly seems to have left the conversation, at least he's gone silent.  JLM said:

Sometimes a bit of historic perspective is useful in trying to deal
with TODAY. Remember that quote about being doomed to relive the
history we ignore? Well we are not being very thoughtful about this. We
have actually seen this movie before though maybe it was a shorter
version.

Remember the S & L crisis and the Resolution Trust
Corp? I do because I hit a very, very good lick in purchasing
distressed properties from the RTC, pension funds, insurance companies,
banks and S & Ls. I bought them for $0.20-0.30 on the dollar of
replacement cost, fixed them up, owned them for about 5-7 years, had
the numbers audited annually and sold them all to institutions in 3
transactions in 1995 — 6,000 apartments, 100 warehouses, 7.5 MM sf of
offices.

My partners were the likes of GE Capital (for whom I
also fixed up some of their problems), Fidelity and private foreign
investors. BTW, GE Capital is the smartest bunch of real estate folks I
ever met and the best risk takers a partner could ever have hoped for.
And they made a ton of money in the deal while conducting themselves
like perfect partners and gentlemen. Private money jumped in big time!

I
trooped around Wall Street trying to raise money for a long, long time
and shared my contrarian investment strategy (and believe me the folks
were looking for the lobotomy scars all the time) with the likes of
KKR, Odyssey, Bear Stearns, Allen & Co, Leon Black — the usual
suspects. And guess what? They never gave me any money but they all
went into the business themselves. Capitalism was alive and well.

Here's
the bottom line: If the RTC had held every property and just injected a
bit of management they would have recovered every penny of principal,
every penny of interest at the default rate and they would have firmed
up the national commercial real estate markets more quickly.

This
is not some mythical academic theoretical tale. This is something that
a bunch of guys did the last time the markets crashed (then it was more
commercial than residential) and the government stepped in to bail out
the transgressors. This is reality.

BTW, the final price tag on
the RTC was about $200B last time around. How much would that be in
today's dollars? Oh, about $700B maybe?

Here's a suggestion based upon what was learned the last time around —

Let all the originators of the problem fail. Suck their capital dry. Punish them like a VC would punish the first round guys.

Don't
use a penny of government money. If pressed, use government loan
guarantees only. The only entity left with real credit is the US
government. Use it. This will make the markets tell us what this crap
is really worth. Right now the issue is the pricing.

Fix the
problems that created this mess quick and do it publicly. No 100%
mortgages even for Warren Buffet. No low doc mortgages. No financing of
closing costs in mortgages. Make all borrowers have skin in the game.
No leveraging capital 30-40 times for any financial instititions. No
mortgage based derivatives of any kind — why? Cause you cannot
collect mortgage payments when the mortgage is "embedded" and "divided"
by securitization. Teach the guys with mousse in their hair how to
collect a past due payment. No extraordinary compensation for
investment guys who are primarily salary men — let them take a piece
of their own deal if they want an equity style upside. No naked short
selling. Ban short selling for 24 months. Then reinstate the uptick
rule. Bring all hedge funds out of the woods and under the regulatory
umbrella. If you want American markets, tax laws, securities laws, etc,
then you have to be regulated. Lower the capital gains rate to 0% for
five years — because that's how long it will take to work this
through. The private capital will come to that lowered capital gains
rate like a moth to a flame and it will be immediate. Merge Freddie and
Fannie and obtain meaningful merger efficiencies.

Stop the
foreclosure process on residential real estate which can be salvaged.
If a borrower can pay anything — owes $100 per month but can pay $70
— keep him in the house because real estate plummets in value the
second it is empty and every foreclosure ever sold has been sold at a
deeper discount than the foreclosure price. Make a trade. Rework the
mortgage in return for a 50% equity slice above the mortgage amount.
There is a certain irony in allowing the public to solve their own
problems rather than just sending them the bill. It shortcuts the flow
of money and it has a social benefit. Can every deal be reworked? No,
but many can be and should be.

Oh, yeah, get rid of Barney Frank, Chris Dodd and Chris Cox.

That's even better than I remember it. I should print it out and mail it to every single legislator and policy maker in Washington. But my favorite part of it is this:

I hit a very, very good lick in purchasing
distressed properties from the RTC, pension funds, insurance companies,
banks and S & Ls.

It's time for America to get up off its ass and start looking for some "good licks". Howard Lindzon has it right.

This crisis of confidence will only be fixed by you and me

Greed is good when fear rules the roost and fear is good when greed rules the roost. Now is the time for greed.

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