EMK RIP

Ted Kennedy died last week after a 15 month battle with brain cancer. I was really saddened by his death and had a chance to reflect back on the many times I spent weekends with him at the Cape. I won't go into all the stories here, but I would just like to memorialize that from my experience all the descriptions of him as he is being eulogized was as I knew him. A great guy, with flaws no doubt, but a lot of fun and very interesting to be around. He loved his family and was amazingly generous as a host.

I'll also say that his flaws were no greater than most people's, but for his opponents they loved to focus on those and ridicule him. Well if the last 10 years have taught us anything, it's that hypocracy always catches up with you. I think it's called Karma.

The Clayton chapter has closed

After 4 and 1/2 years, my time at Clayton has come to an end. It was not my initiative, but theirs. I was not really given as to why I was being offered the package, but I figured the deal would not be as lucrative in six months when the next RIF would be coming. The reality was, the firm is way below forecast, and while there were some "green shoots" coming from the surveillance business to oversee loan mods for FHM, I think the new sales head wants to bring in his own guy, and to do that he was going to have to let one of three of us go.

Anyway, I have mixed feelings. I certainly hated going in everyday, but I liked many of the people I worked with personally. And while I have no doubt that something better will come from this, one always likes these events to be on his or her schedule, not the company's. The truth is the fun had ended a long time ago there, because the work had lost its challenge. The company remains in a troubled mode, and I didn't see a lot of signals that the management team was up to the challenge.

To understand my tenure there, I'll first lay out the ownership and structural changes that occured. When I joined in 2004, the Clayton's founder was still running the firm but he had sold the company that summer to TA Associates, a venture firm. Their goal was to do a "roll-up" of companies that provide products and services in a dominant way to mortgage business. In addition to Clayton, they also bought MurrayHill (another firm run by its founder,), and they made a minority investment in CoreLogic. I know they were looking at others, such as Arc Systems, because I was part of the group to due diligence these potential acquisitions. TA's goals were very clear and firm, they wanted to consolidate what they could, and monetize quickly. Clayton merged with MurrayHill in 2005, and it became clear that CoreLogic did not want to be a part of us (they eventually sold themselves to First American. wise move). Immediately after the merger, TA brought in a new CEO for the merged company - Frank Filipps. Steve Lamando stayed on as President of Clayton, but he became less involved that year and eventually resigned at the end of 2005. In 2005 the two firms consolidated, if that's what you call it when you don't really rationalize any of the duplicative functions. Frank Fillips deserves his own chapter on corporate larceny, but I'll summarize to say that he lived in Philly and rarely made it to Shelton. He hired Keith Johnson in May 2006 as President to run the company day-to-day. Keith is also his own chapter, but while many people were not fans of Keith's style, I liked him overall because he always worked hard and was always looking for ways to make the company better.

At the same time, TA began its exit by borrowing a significant amount of money to redeem its Preferred Shares, and began the IPO process to raise equity to repay that debt and provide an exit for its common shares. Early in the process (Summer of 2005) the value of the entity was estimated to be high enough that the decision to issue shares (I think 20% of the authorized total) to repay all the debt and still leave plenty of cash in the coffers. By the time the process finally began with S1 filings, the IPO value had been cut by 75%. The IPO occured in March 2006, and with the proceeds a fair portion of debt was repaid, but there was still over $100mm in debt outstanding. Over the next 12 months the company did well enough that the stock reached its high of about $24 per share in Feb 2007, which translated into a market cap of roughly $400mm, plus the debt, for an enterprise value of about $500mm. It was all downhill from there. The business crested in Q1 2007, and after Q2, due diligence dried up to an after-thought. The stock kept falling along with the business until it hit about $4 in Q1. At the same time we were using every bit of dry powder we had to repay debt and stay that execution. We were given a "clean opinion" for fiscal 2007 audit only after we made a significant repayment on the bank debt and the bank agreed to waive convenant defaults through the year. Well we certainly knew that we could only do that trick once, so management began looking for an acquirer in earnest in late 2007, and much to my surprise a pidgeon came along by the name of Greenfield Partners. They not only agreed to pay a 50% premium for the outstanding shares, they also repaid the remaining bank debt, so their total investment has exceeded $170mm. That closed in

Beginning two and half years ago, Clayton was faced with an often fatal perfect storm in the market: The market went away for its two main products, and that market went away in general; one year after that its largest customers disappeared. Clayton's two main businesses were: performing loan due diligence to ensure adherence to underwriting guidelines and regulatory compliance; and servicing surveillance of the loans underlying private label MBS (mostly sub-prime). In addition, Clayton had a Conduit business that I ran and accounted for about 12% of the firm's revenue in 2006. This business began to wind down rapidly in early 2007, to the point where it was shuttered by Q4 of that year. In addition, the securization market that the company serviced evaporated, and many of its customers disappeared as "Wall Street" disappeared in 2007 and 2008.

Clayton was faced with a choice of how to proceed going forward, and ultimately I don't think it will succeed. The firm has never made the proper transition to a upgraded technology platform; and the management team (version 4) doesn't know the business well enough to make real decisions about which market strategies to pursue.

So now it's on to the next chapter. I will always be thankful to Clayton because it moved me back to New England from a fate worse than death: living in Florida. And I met good people. But in general it was a very dysfunctional time and I will hopefully take those lessons with me when selecting my next job.

Lee Child

Ureka! another non-political post! Today Joe and I went to hear and meet Jim Grant, a/k/a Lee Child. Obviously I am a huge fan and have read all 13 of his Jack Reacher thrillers. The event was held at the Mohegan Sun casino.

The setting was a small 200 seat theatre in the casino. Lee/Jim was on stage in a lounge chair, as was his questioner, who was a local journalist. Jim spoke for about 40 minutes as he answered questions from the journalist, and these ranged from how he got started to who based Reacher on, etc. All normal questions that any fan would be interested in. They then opened the questions to the audience for about 20 minutes. Jim/Lee couldn't have been nicer and he really seemed to be enjoying himself. Some of the interesting things discussed included:

it makes much more sense to launch a writing career in the US rather than the UK because we read much more and the normal word of mouth doesn't work there in the bookstore.

He spends about 5 hours a day from Sept to Mar each year writing book.

He hopes to top out at 21 Jack Reacher books.

He doesn't like to change the character too much because we have come to expect certain things about Jack Reacher.

etc

Anyway, we then proceeded to the book signing, which included about 80-100 people in line. Again, he couldn't have been nicer, as evidenced by him allowing me to take a picture with Joe.

Bethpage Black

What a relief! A post about something other than gloom and doom economics. Yesterday I played Bethpage Black - the site of this year's (2009) US Open. It is exactly one month from the Open and they will be closing the course in two weeks to finalize preparation, so this was as close as I ever expect to get to playing a US Open course.  

Before I get to the description, let me tell you about its history and difficulty in getting on. The course is part of a 5 course park complex in central Long Island that was built in the Depression, and it is still the largest governement owned golf complex in the country. The stated designer is A.W. Tillinghast, one of the pantheon of legendary golf course designers, but there seems to be some dispute as to who actually did the work. It was Tillinghast's last project and he died while it was being completed. The Black course is very difficult to get on because it is a public course with a very meritocracy-based rigor to the system. Basically, getting a tee-time is like winning the lottery.  The course was always well known in NY circles prior to it being selected by the USGA for the 2002 US Open (it was the first "muni" to host a US Open), but that award really put it back on the map. I remember hearing that over the years the condition of the course had devolved to the point near the end of the century it was in the condition of many Muni's. Sometime near the end of the century, the park hired a well-regarded greenskeeper from the Garden City Golf Club, and he restored the condition to its peak.

Anyway, I received a phone call the afternoon before from a client, asking if I would like to play. It goes without saying that if one is trying to get through a bucket list of golf courses, you grab every chance you can, since you never know if or when you will have another opportunity. I had other plans for Friday, but nothing that couldn't get rescheduled, especially when they heard what jumped their place in line. 

I have played a decent number of Top 50 golf courses in my life, and hope to play more. My zeal for completing the list has somewhat shrunk since I don't play golf as much as I used to, or really love it as much as I used to. I think that has to do with not being able to play with friends as much as I would like, and with clients instead. I think the list includes: PebbleBeach, Olympic, The Country Club, Inverness, Scioto, Muirfield, Oak Hill, Crooked Stick, Laurel Valley, Torrey Pines, Sawgrass, Pinehurst, and now Bethpage. I have also walked/seen during tournaments, Medinah, Shinnecock & Augusta. I can get on to Fishers Island Golf Course and Oakland HIlls, as I have been to the clubs, but haven't played. Actually, now looking at the list, I need to get back to completeing it. I thought I was going to play Cypress last year, but our connection was past due on his dues. At least five are accessible as resorts - Bandon & Pacific Dunes, Shadow Creek, Kiawah and Whistling Straights. A couple seem really in accessable - SF Golf Course, Sand Hills, and Seminole. Anyway, we'll see how many I get to.

Bethpage is walking only. You can use a caddy or a pull cart if you like. We chose the pull carts. We chose wisely. I generally prefer walking over riding because I like the exercise and I think people pay better if they handle their own ball, and aren't driving all over the course looking for their  partner's ball. Walking BB is tough, and by the time I got to #10 I was definitely re-thinking my theory. BB is very hilly (and you thought Long Island was flat), very long and a fair distance between holes. We played from the Blue's, which was sort of comical for four guys that didn't break 100, but never underestimate the power of pride.  What makes the course challenging besides the length, is the terrain, the traps, the long tee shot carries,  the layout (very serpentine, at times) and THE ROUGH. 

The rough really sets this course apart. Like many Open courses, this one is really about staying in the fairway. Missing the fairway by even a few feet means you may be hiking back to the tee to hit your provisional. I think I lost about 5 balls, so that was 10 strokes right there. Again, the key is leaving your pride and ego in the clubhouse.  I pared 3 holes but had snowmen on at least that many. I didnt hear what my total score was (the round lasted about 5+ hours so everyone was in a hurry to leave at the end, but I had a 52 for the first 9 , so I assume it was at least that for the back nine).  The track was exhausting. By the end of the first nine I commented that I felt like I was at mile 18 in a marathon. There was no more fun from here on in, just trying to finish.

Anyway the course is beautiful, tough, long and unbeliveably challenging. I feel lucky to have played it and look forward to watching the US Open in a few weeks

two years later

Ok. It's been nearly two years since I last blogged, and suffice to say all the things that I have been warning about since 2004 about the mortgage industry and the housing asset bubble have come to pass, and then some. Seriously, I was so spot on prescient it has been scarry. and it was 2004.  But frankly, even though I thought things would get bad, I didn't think they would get where we are today. Essentially my predictions stated that the housing bubble would take down all the financial institutions that were monoline mortgage banks, e.g. FNM, FRE, Countrywide, Bear, etc. But I didn't realize how that debt had been the underlying asset to write $60tn in CDS. Fuck that's huge. Also I didn't put two and two together to follow the trail of leverage that starts with housing as the asset and that winds its way through all of global industry. And that short sightedness I truly am chastened by; it won't happen again.

Just so eveyone fully connects the dots, let me explain: basically, a significant part of the globe's economy since about 2000 was bought and paid for by debt, and specifically the housing bubble allowed it to happen. Here's what I mean: As the housing values rose people came to believe their net worth was growing and would continue to go. The result was, they get buying more cars and high end goods, and when the bills came due they transferred the debt from their credit cards and car loans to their home equity lines. As a result, the normal circuit breakers -increased credit card debt, etc,  didn't go off. Once the bubble popped , people are stuck with houses with declining value, credit card balances that can't get rolled onto home equity, 401k's that have been decimated. So now everyone is feeling very poor. Then you combine that with baby boomers beginning to hit retirement, and what you will see for the next 20 years from that demographic is significantly less spending and a lot more saving, so they can repair their retirement outlook. It is not going to be pretty for many years.

Ok anyway, that's in the past and future. What are my new predictions for the future. I will try to bullet point as much of this as possible so it doesn't get too long winded. I will also tell you in advance, like the mortgage mess before, my predictions are more about what I see as a macro change rather than, hey buy this stock because it's in plastics and they are the future. SO here goes:

Financial Services will be a much smaller player 10 years from now. This seems obvious but let me explain. No single industry has benefited more from the last nearly 30 years of deregulation than the financial services business; mortgage debt, asset management, student loan debt, other consumer debt; etc. A big chunk of that will shrink from the private sector and the rest will look more traditional. Before June 30 of this year, I predict FRE and FNM will announce that they will merge and become full fledged government entitites. When you combine that with FHA, that means about 95% of the mortgages in the country will be owned by the gov't. The admin and funding of Student loans (which I will explain in a minute) will be taken over by the gov't. The banks and financial intermediaries in that business are truly just friction in the process. In addition the SL originators have been in a very cancerous but symbiotic relationship for years, which will now end.

(Here is an aside. If you read my last post from 2 years ago, it was an observation on the excessive cost of college over the last 20 years and how I couldn't explain the above average increase, and I thought it would be solved in the future by children going to colleges overseas and by colleges using on line education tools to make themselves more efficient. Well little did I know, that colleges and student loan purveyors, had their own little symbiotic thing going just as home builders and realtors did with the mortgage industry. In hindsight it all seems logical now. The colleges had no interest in reducing the costs. They wanted to increase revenues by hiking tuitions. Well how do you sell a home that used to cost $300k and now costs $400k but your target market's income hasn't increased? You just find more creative financing options. Everybody thinks they have won - the buyer, the seller and the financier - but in truth, only the seller and the financier did. The buyer thought he won because he could tell his friends that he know lived in a $400k house, but in fact it was still just a 3 br 2ba split level. Well the same thing was going on with the colleges , the students, and the parents, and the financiers. The college received more tuition, the student and parents didn't quite feel the pinch since they were either taking out student loans with deferred payments and/or increasing that same home equity line, and of course the financier won because now he has slapped a $50-100k lien on a college grad, and that lien can't be discharged in BK (only the IRS has similar rights).  

The next one the list is employment based retirement savings in the form of pension plans and 401k plans. These plans are totally controlled and administered by the private sector, whether it be the company or the employee, but the Federal gov't is the guarantor. And frankly all these adminstrators are just friction.  It only makes sense that if the gov't is the backstop, then they will conclude that they should be the adminstrator, and the investment manager. So sure, go ahead and offer an attractive retirement plan as a benefit Mr. Corporation, but don't expect that you will be able to use accounting gimmickry to get around funding and managaing it adequately. Expect the Federal government to admin the assets, dictate current funding, and detemine asset allocation strategy.  This is also a backstop to ensure that we can adequately means test Soc Security, which obviously is coming.

So net net, financial services will be much smaller (plus consider that as baby boomers retire they will begin to withdraw assets for living expenses, especially since now their house is worth less).  And you have half a generation of workers that have seen no benefit in investing in stocks and bonds, since the market is now below 1997 levels. Frankly anyone who started work in the 90's or later will conclude that the best strategy is to put their money in the bank account.

Ok next prediction: Microsoft is doomed (unless they blow up their current business model). The simple truth is open source software has gotten better and more reliable, and is really just as good for most apps.  If you combine that with corporate retrenching that is forcing every department to take a hard look at every expense item, you come to the conclusion that many CIO's will finally decide to ditch Exchange for Google apps, or Office for Open Office or zoho or google apps, or .net, SQL for LAMP. The only way Microsoft will survive will be if they embrace web and open source world, by skinning down Windows and making it cheaper, cutting the price of Office by 75% or more, and overhauling Exchange by dramatically expanding storage and getting a much better search feature.  

Any brand with luxury cache now and brand equity, will have a very tough time maintaining that equity over the balance of this depression. And when we finally do come out, a new, younger  generation will be ready to spend, and they will have their own ideas of what brands are valuable to them. So how do you make money on this? Identify brands that still have brand equity tied into their market value (that means the stock is trading at a premium to tangible book) and short it. 

What else? Oh I know. Health care. Of course we are moving to a single-payer model. We have to. I crack up when I hear these idiot Repubs talking about tax cuts as the solution to every problem. "Oh small business needs these tax cuts to provide employment" Please, if single payer results in a 25% cost cost reduction in health care premiums paid by small business, I think that will have a more positive effect.

And I guess lastly, the Repubs are toast as party for a long time, unless they abandon the whack job Christian wing. They are rapidly becoming the party of angry, redneck males.

TTFN

More musings from Cassandra

Among the many causes I take on that are clearly ahead of their time but prescient nonetheless, has been the cost of higher education in America. Essentially up to now we have not utilized technology to improve the efficiency of its distribution and as a result you have seen tuition costs rise well beyond the rate of inflation. If it isn't already, the cost of education will be priced beyond the reach of most Americans, unless something drastic changes. The factors that have driven this is fairly obvious - it is very labor intensive and the laborers demand (and can get) pay increase well beyond the rate of inflation. In addition, in order to attract the best students a virtual arms race has insued to build more and better facitities. Ironically the one area that has potentially checked the rate of tuition increase has been the ever larger revenues from collegiate sports, thanks to tv revenue. This has significantly helped a small number of consistent athletic powerhouses.

I have never believed the the Univ of Phoenix model was the solution for a number of reasons that I won't go into here, but I have posited that more Americans would look overseas for education since the cost to attend most of these fine schools is more reasonable, and the disparity in cost has never been greater. For example India Institute of Technology is arguable the finest engineering/science school in the world (perhaps only MIT or Cal Tech is better. perhaps), at a tiny fraction of the cost of the top tier in the US. On top of this is, to steal Tom Friedman's phrase, the World is Flat, and a student will likely be more prepared to compete globally with this typ of experience. Now it appears a new model is evolving (see link above) that may take the premier Univ in the world, and make their programs more accessible, and ultimately more affordable for those that attend in person. I'm not certain of the precise details of how this seachange will manifest but I am pretty sure that it has begun with the offering of complete coursework on-line. I have a few ideas on how it will unfold, essentially versioning, like software, and more work done by more people independently, who then come to the main campus for a short period to be tested and graded.

We'll see. Something has to change. When I started OSU in the Fall of 1978, the tuition was about $450 per quarter. It is now about $3,000 per quarter. To put this in real terms. I was a waiter and could work two weekends to generate enough tips to cover my tuition ( a Friday and Saturday night would typically result in at least $100 per night in tips, i.e. cash). I would now need to be a top notch stripper in LV (and not have any corresponding addiction problems) to generate that kind of cash in two weekends' time. In any event, you get the picture.

PCP in the 21st Century

What is the new PCP - post-coital protocol - for this communication age? A full length phone call filled with disingenous cooings the next day about how great and meaningful the sex was the night before (and there definitely couldn't be a latency of more than two days) was required as little as 10 years ago, if you expected to taste that again. Today you can get by with a quick text message. In fact texting and email has reduced the need for all kinds of conversations in the dating world. Text a few missives during the day, arrange the time and place, and then show up buy drinks and dinner and then hit the sack. Another win for mankind. And the beautiful thing is that now you can even claim to be avoiding the dreaded phone call by claiming that the reason you aren't one for much talking is because you only have a cell phone and you are doing your part to save the honeybees.