• home
• tags
• Search
• Feed

How we got started

Alas, as I stated earlier, it is that truth that no one wants to hear. So if you are one of those "no ones" that don't want to hear the truth, cover your ears, cause here we go...

Bear Stearns is in Real trouble

The last year at the Bear hasn’t been a good one – a quick recap

Bear Stearns has a Level 3 assets (see Banks, Brokers, & Bullsh1+ part 1 ) worth $27 billion, investments in SIVs of $41 billion, and off balance sheet SIVs of $21.3 billion. Furthermore, Bear Stearns has counterparty credit exposure (Banks, Brokers, & Bullsh1+ part 2 ) towards Ambac which recently was downgraded from AAA to AA by Fitch Rating Agency. I have written extensively on Ambac – material that was quite controversial, and in hindsight highly prescient. I feel I have a handle on this company's situation, and it is not as positive as management and investors would make it out to (see Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion of Equity, Follow up to the Ambac Analysis, Monolines swoon, CDOs go boom & I really wonder why the ratings agencies are given any credibility, Ambac Management Should Read Blogs More Often, Ambac Now Has a Municipal Bond Issue to Worry About - I'm not going to say I told you so! , and Download a "Window" into Ambac's Problems). Faltering counterparties have further aggravated the company's credit position. Bear Stearns' 5 year CDS spread is also widening significantly, following concerns that the company will need to take additional write down on assets in the coming quarters. The deteriorating US credit situation has negatively impacted almost all the banks and brokers alike with $133 billion of asset write downs to date, with two of the biggest names in the industry, Citigroup and Merrill Lynch, leading the pack. We believe the amount of write downs taken by Bear Stearns as compared to other big investment banks seems insufficient. Moreover, the selling of stakes by some of the top executives at Bear Stearns validates the trouble at the company is far from over and is likely to get worse.

Back to the Basics: The Customer is Always Right

Bear Stearns’ most visible problem is probably its most basic as well. It has alienated its customer. With ex-clients lined up in court trying to reclaim their money from what was once their trusted advisor, to clients cooperating with the government in pursuing a federal indictment (no Wall Street firm has ever survived a criminal indictment), it is apparent the main source of revenue (the customer) is a tad bit disenfranchised with the Bear. This is a short and simple point, but it is probably the most poignant and underappreciated as well.

Money Making Talent Caught in a Bear Hug: Show Me the Money?

Would Bear Stearns be able to entice me for a gig (that is, assuming I am a hot commodity and I knew what I was doing with this finance and investment stuff)? Probably not, and this is how many worth their mettle will feel given the Bear’s current situation.

One of the key points that we have observed in the case of Bear Stearns is that compensation expense as a percentage of revenues has increased to 57.1% in 2007 compared to 47.1% in 2006. This was despite the compensation expenses coming down to $326 million in Q407 from $664 million in Q307 and $1,052 million in Q406. In addition, the executive committee has decided that they will receive no compensation this year (last year they made $156 million, or 3.6% of total compensation expense).

Now, if I compare this to some of Bear’s key competitors, the average increase for other investment banks’ compensation expense is in the range of 20-21% with Lehman Bros. giving a 10% increase, Goldman Sachs 23% and Morgan Stanley increasing the compensation expenses by 19%. In this scenario, it is likely to be extremely difficult for Bear to attract, and more importantly retain, people who will be able to make real money (and in the past have made real money) for them. This is a point that can’t be overemphasized. Intellectual capital service organizations, such as investment banks and consulting firms, have only their human capital as a primary, yet highly competitive resource, with financial capital being a commodity that is normally (although not the case recently) relatively easy to come by. Without competitive human capital, any services entity, be it an investment bank, investment fund or consulting firm is doomed to failure. Wall Street has created an environment where human capital is simply paid for, it flocks to the highest bidder with the highest cache in terms of stature and potential for future payout. Currently, in my opinion, Goldman Sachs takes this pole position here (although we feel they have some skeletons sporting big bones in their closet), with Bear Stearns at the rear in terms of major US investment banks. Without adequate financial capital to bid for and retain the human capital necessary to compete, Bear Stearns will find itself in a downward spiral that is self-reinforcing – the worse its performance, the harder it will be to attract and retain money makers, hence degrading its performance relative to its peers.