Rolling Stone Magazine is becoming a source for provocative investigative journalism. 

Here is its most recent article (17 Aug. 2011) titled "Is the SEC Covering Up Wall Street Crimes?" by Matt Taibbi.

Also, here is a related Rolling Stone's article by the same author from earlier this year (16 February 2011) titled "Why Isn't Wall Street in Jail?"

Enjoy.

The chart provided by Financial Times yesterday regarding a "AAA Bubble" is mostly self-explanatory, although the article has some good off-links.  And, for those who want a refresher on credit ratings, a good starting point is this Wikipedia article.

The allegedly intentional misdirection of language in Silver Lake/Skype’s employees’ stock options agreement demonstrates the lengths that some firms and managers go to apparently cheat other people, clients and employees. 

For further reading about the behavior of aforementioned companies and managers, reference some of the links below.

Nevertheless, there are a couple of lessons that may help to mitigate perpetuation of unethical behavior by certain parties and individuals:

Lesson 1: The Devil is in the Details (ideally have an attorney vet one’s important agreements, or read thoroughly and ask questions)

Lesson 2: Asynchronous communication: unethical behavior that becomes transparent to more ethical employees, potential employees, and limited partners (public pension fund managers, foundations, etc.) generally ultimately wields a high cost to the alleged perpetrators (e.g., Enron, Lehman, Allied Capital, et al.).

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"Brian O'Shaughnessy." Luxembourg | LinkedIn. O’Shaughnessy is an alumnus of NYU and Merrick College holding a degree in “political science.” Currently Head of Global Communications at Skype and formerly worked for Google, who self proclaims not to do evil.  One wonders about the opinions of his alma maters and former employers regarding the option agreement topic. Web. 07 July 2011. <http://lu.linkedin.com/in/brianoshaughnessy>.

Davidoff, Steven M. "A Clash Between Venture Capital and Private Equity - NYTimes.com." Mergers, Acquisitions, Venture Capital, Hedge Funds - DealBook. 06 July 2011. Web. 07 July 2011. <http://dealbook.nytimes.com/2011/07/05/in-silicon-valley-a-culture-clash-sullies-a-romance/>.

Salmon, Felix. "Downgrading Skype and Silver Lake to ‘Evil’ " Wired.com. 25 June 2011. Web. 07 July 2011. <http://www.wired.com/epicenter/2011/06/skype-silver-lake-evil/>. 

Salmon, Felix. "Skype’s Options Plan and Silicon Valley Norms | Felix Salmon." Analysis & Opinion | Reuters. 07 July 2011. Web. 07 July 2011. <http://blogs.reuters.com/felix-salmon/2011/07/07/skypes-options-plan-and-silicon-valley-norms/>.

  Remember the good old days of leveraged buyouts (LBOs)?  

You know, buy control of a company by using a pile of debt, firing a lot of employees, and selling some hard assets.  Then, use the cash flow to pay capital providers and financial sponsors of the transaction through principal payments, interest and special dividends.  In the medium- and long-term, this behavior tends to destroy (read: bankrupt) companies due to reasons such as not adequately investing in maintenance and human capital and necessary SG&A.

Now, apply the old LBO model to a sovereign nation and what do you get?  [Well, besides the decline and fall of the Roman Empire.] You get a lot of debt, misallocation of taxpayer dollars to things like subsidies (corn, sugar, etc.), excessive global military presence, and lack of infrastructure maintenance.  

That said, an article titled “Life in the Slow Lane” by The Economist (April 30, 2011) indicates a red flag of not maintaining one’s infrastructure.  I suppose this is another data point that complements our blog from March 2011 titled “Remember the Off-Balance Sheet Shenanigans of Enron?”

According to Coller Capital, and highlighted by Jason Kelly at Bloomberg, investors’ newfound selectivity will help eliminate 20% of private equity firms. Just one of many reasons is alluded to by the June 13, 2011 bankruptcy filing by Perkins and Marie Callender's restaurant, a portfolio company of Castle Harlan, which will lose all of its $245 million investment.

This isn't new information or surprising to many deal-by-deal practitioners such as Coventry League, as we witness the level of talent (or lack thereof) on a continual basis (in public and private equity investing) and wrote about the upcoming debt overhang at over-levered portfolio companies (De-leveraged Buyouts; Nov. 2009).  Nevertheless, more transparency about these zombie-like private equity firms is positive for the industry since many of these below average firms and professionals tend to overbid and under-perform from a post-acquisition operating perspective. 

  Unfortunately, the investment and M&A industry is not like, say, professional sports.  In sports, athletes are continually evaluated mostly on an objective basis and are displaced by those who demonstrate better prospects and abilities.  Exceptions, to an extent, are made for legacy athletes (e.g., Brett Favre) – sometimes. In investing, especially at firms that don’t charge fees based on performance (think wealth management-type firms and mutual funds), many professionals exist not necessarily by their objective abilities and performance but rather mostly by subjective reasons that often include cosmetic aspects of one’s background, personal connections and whatnot. 

Additionally, the industry perpetuates a myth that it is practically impossible to consistently outperform market indices (read: collection of companies selected by preset screens) using similar risk (typically defined using price fluctuations with time horizons less than a year). 

Why apparently sophisticated investors, including high net-worth individuals and institutional investors continue to deploy capital irresponsibly is puzzling.  This is best addressed in a separate blog; however, we'll leave you with this: InkStop.  It was a retail chain outlet focused on selling ink cartridges for printers.  The business model was terrible (high fixed costs; low-priced products; market trend of low-cost, quick-delivery Internet options; etc.).   Yet, several "sophisticated" investors found this business model attractive enough to actually request an investment memorandum and subsequently invest in the company.  After the company's prompt fall to bankruptcy, some of these same investors amazingly cried foul.  Moral of the story: Stupid is as stupid does.  

Against the wishes of global banks and investors, but with the wishes of its citizens, Iceland allowed its too-big-to-fail institutions to default (i.e., no taxpayer-funded bailouts).  Guess what?  A Great Depression in Iceland didn’t occur.  Rather, its economy has stabilized  and is performing well, relatively speaking. 

Elsewhere, in contrast, leaders have been using fear-mongering and outright threats (if citizens don’t enable massive bailouts, then the equivalent of financial Armageddon will happen).  The latter is disturbing because leaders are essentially saying if citizens don’t permit bailouts, then civil-servant leaders will make things worse than otherwise (drastically reduce public pensions, services, etc.).  If these were company managers, their actions would be considered fraud by a rational Board of Directors and promptly removed from service. 

A good example of the aforementioned fraud and potential fraud on citizens can be gleaned from what is happening in Greece.  In short, Greece needs to restructure its debt; in other words, it needs to default.  However, global banks and investors (take your pick) that speculated in credit default swaps, and international institutions (IMF, central banks) intend to do whatever it takes to prevent Greece from formally defaulting. The most recent ploy is to frame a default as a “voluntary exchange;” doing so is deemed to not trigger a payout by the sellers of CDS.  However, a sovereign nation has no reason to play semantics with how it defaults, and is not beholden to sellers of CDS…unless there are implied threats against the country for doing what is best for its citizens.

So, as indicated in the blog by Automatic Earth titled “Honey, I Swapped the Greeks,” the concern is not with Greece defaulting and reducing the principal due to bondholders.  Instead, the concern is with the huge payouts that would be required by CDS sellers (think insurance companies and banks; hedge funds; holding companies like Berkshire Hathaway; et al.)…and the money is not there to payout.

                  Total Greek bond notional CDS: $5.4B 

                  Total Greek bond market: $374B

                  Total Greek CDS market: $455B (ergo the problem with a formal default)

And, if Greece proceeds to formally default and not engage in semantics, then one can estimate the carnage from contagion of CDS payouts as defaults spread to larger sovereign nations that are in similar financial straits…

UPDATE: 20 June 2011.  (*) Note: Bloomberg's values in chart, and figures highlighted in article do not sync.  It appears one of the sources does not use the appropriate currency.  The magnitude, ratios and schedule are apparent regardless. 

If Coventry League starts questioning practices of management or, even worse, is short a company’s securities, then it’s often a harbinger of things to come.  Please reference Coventry League (and its predecessor)’s shorts of Enron and Lehman.  We didn’t even make an effort to buy-to-close, and simply held through bankruptcy and elimination of the securities.

That said, if the following charts prepared by Mary Meeker in the document titled USA, Inc. were attributable to a company, rest assured Coventry League would be heavily short, albeit hedged.  In this case, the charts relate to a sovereign nation, which has unique alternatives versus a corporation – namely the ability to print money and create revenues (taxation).  Using these abilities to any meaningful extent exacerbates the problems, however. 

So, without further ado, please engage yourself with the referenced charts above and in the source file (or at Mish's blog) – but do so while on a ground floor office suite.

“Lend not unto him that is mightier than thyself; for if thou lendest him, count it but lost.”

We saw a comment about this Bible quote on Dealbreaker:

"UBS cites a well-documented case from 377 BC to 373 BC to illustrate how the ancient Greeks learned that sovereign defaults occur in clusters. In that case, 11 of 13 states defaulted on loans from the Temple of Delos…"

The Dealbreaker, in turn, references a post today by The Globe and Mail.  Essentially, the blogs relate to a citation by Costa Vayenas, an emerging markets analyst based in Switzerland at UBS AG, concerning sovereign debt defaults – in that they tend to occur in clusters.

Incidentally, we have negative views on municipal and some other debt generally…and are selective on issues, if any, in which to take action.

When comic relief is needed, the likes of Goolsbee, Bernanke and Fama is fine. However, if seriousness about a task or topic is warranted, then a genetic algorithm-based bot might be more useful, thankyouverymuch.

The cover story of Wired Magazine’s January 2011 issue is about artificial intelligence (AI).  I know, this topic might conjure up HAL 9000 from the 1968 science fiction film 2001: A Space Odyssey.  I suppose that’s not unjustified to do so.

Nevertheless, the initial story relates to how Kiva Systems set up a warehouse for diapers.com.  To a typical person, the inventory layout might have appeared haphazardly arranged, perhaps even to rational and efficiency oriented professionals such as finance and economics professors.  Yet, the organization of the warehouse was not based on human logic, but rather machine logic.  And, what is becoming exceedingly apparent, machine logic is excelling in many situations.

Furthermore, the cover story continues by including brief sections about Internet companies, financial markets, music, medicine, logistics, and fraud detection – essentially, a little bit of something to appeal to just about anyone.
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Sources and further resources:

●  Asimov, Isaac. I, Robot. Hardcover ed. New York, NY: Gnome Press, 1950. Print. The book is a collection of nine science fiction short stories. Find an edition at Powell's Books.

●  Gregory, John. "Robot Law." Slaw. 24 June 2010. Web. 01 Jan. 2011. <http://www.slaw.ca/2010/06/24/robot-law/>. Note: the blog article is a partial survey of interesting questions that have been asked about robots and the law, including several offlinks.

●  Levy, Steven, Felix Salmon, and John Stokes. "The AI Revolution Is On | Magazine." Wired, Jan. 2011. Web. 27 Dec. 2010. <http://www.wired.com/magazine/2010/12/ff_ai_essay_airevolution/>.

●  Singer, PW. "PW Singer on Military Robots and the Future of War | Video on TED.com." TED: Ideas worth Spreading. Apr. 2009. Web. 01 Jan. 2011. <http://www.ted.com/talks/pw_singer_on_robots_of_war.html>. Author shows how the widespread use of robots in war is changing the realities of combat. He shows us scenarios straight out of science fiction -- that now may not be so fictitious.

●  Vaughanbell. "Seeing the Mind amidst the Numbers." Mind Hacks. 22 Sept. 2009. Web. 01 Jan. 2011. <http://mindhacks.com/2009/09/22/seeing-the-mind-amidst-the-numbers/>. Blog article is about the Netflix Challenge that awarded a prize for the best algorithm that selects video suggestions for users. It also highlights the particular technique, called singular value decomposition (SVD).

Having worked in structured finance in the caverns of Wall Street, it is known that the structured finance market of CDOs and related securities can be explained and understood in a straightforward manner.  The complexity is mostly associated with the detailed mechanics of modeling and assessing risk to counterparties and investors.

Accordingly, included is a fine infographic presented by MortgageRates that helps illustrate the very basics of the CDO market.  Hat tip to Felix Salmon.