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How Good an Investment Were the Bailouts?
Posted By Barry Ritholtz On September 25, 2012 @ 7:00 am In Bailouts,Investing,Really, really bad calls | Comments Disabled
The Treasury Department (and their defenders) insist the bailouts were good investments. The following almost true story might provide some insight into how true that argument is.
George and Martha, a wealthy older couple, comes into my office. They are not happy with their current stockbroker. Concerned about their future, they ask if I would have a look at their portfolio.
Certainly, we do these reviews all the time. As it turns out, this review would be very different from what I am used to. We sit down to discuss their investments, and perusing their 12-figure account, I almost fall out of my seat. The portfolio is festooned with every risky stock of the past five years. I have to restrain myself from sarcastically asking “What, no Facebook IPO shares?”
Instead, I simply say “Please tell me a little bit about yourselves.”
“We grew up hardscrabble, were self-reliant, always helped out our neighbors.” They are hard working people, and their wealth was accumulated after the war. They tell me they diligently built a portfolio of hard assets – gold, real estate and bonds. They took appropriate risk, were frugal in their spending, and diligently saved money.
It was perplexing. What they were describing about their approach to saving and investing was nothing like the portfolio mess I was looking at.
And oh, what an unholy mess it is: Many of the highest risk, lowest return assets ever to grace a broker’s pitchbook fills their portfolio. Sketchy private equity deals, dubious preferred stock, low rated corporate bonds.
I could see why they are not happy with their returns. The pattern that emerges from my brief review reveals their holdings were the biggest names from the financial crisis: AIG, General Motors, Citigroup, Bank of America, GE Capital, Fannie Mae, Freddie Mac, GMAC. There’s even a venture capital deal in the mix, some solar energy firm named Solyndra that had gone bust.
“Can you tell me something about the brokers who put together this portfolio?” I ask them?
Their portfolio was created by the firm of Paulson & Geithner Capital Management. The approach takes lots of significant of risk, but has hardly generated any payoff for these investors.
I ask them “This is a risky portfolio for folks like you. What was the thought process behind this?”
Things changed a bit after the dotcom crash, they said, but they really went off the rails during the financial crisis. Their broker then was a Mr. H. Paulson, and he oversaw the major changes to their holdings. In late 2008, he began pushing lots of private deals with banks and finance companies. He warned them that this was absolutely necessary, and if they did not do this, there might be serious consequences.
“He really scared us into these investments. We never wanted to get involved with these positions. Initially, we turned him down. But he told us that all sorts of terrible things could happen if we didn’t do this. We deferred to his expertise.”
George and Martha eventually relented, and Paulson made wholesale changes to the portfolio. He was very reassuring, and kept insisting this was painful but necessary, and it would all work out for the best.
Only, not so much. Their portfolio imploded.
Soon after, Paulson retired. Then the new kid came in. His name was T. Geithner, and he took over as their broker, managing their assets. He was younger and much slicker than Paulson. He seemed to be “fast-talking” them, insisting they were making huge profits on Paulson’s investments.
They couldn’t see what he was talking about. “No, no you are doing great” Geithner kept insisting. But the numbers never seemed to add up. If this was such a great investment, why hadn’t they even reached breakeven yet, nearly 4 years after Paulson stepped down?
“Look, this isn’t going to be pretty.” I said. “But let me give you the straight dope.”
I began to go over the ugly details.
“You’ve been tag-teamed – it’s an old school technique, and its still effective. The old man sold you high risk junk, the new kid come in, keeps insisting it’s a great investment.” The handoff is a classic sales con, and these folks were slowly realizing they had been had.
“Let’s start with the good news: this isn’t the worst portfolio I had ever seen.” Its just that it isn’t particularly good.
First up is their bank holdings – a collection of preferred stocks, corporate loans and private equity deals. Through a series of negotiated transactions, they owned Goldman Sachs, Morgan Stanley, PNC, US Bancorp, Suntrust, Capital One – the list went on and on. Hundreds of investments in various banks and insurers. In nearly every case, the bonds had been called, the outstanding principal repaid. Most of these showed modest single digit profits.
None were particularly good deals. The returns were mediocre on their face. Once you factored in risk, there were pathetic deals. I didn’t tell them I suspected a conflict of interest was why the deals were so generous to the banks and so poor for the investors.
“Understand what you did here: You made very high risk loans to very shaky banks at a time when no one else would have done these deals. An honest fiduciary could have negotiated a very advantageous deal, demanding both a high interest rate and a healthy chunk of equity. These trades should have been 5 or 10 baggers, but instead, your broker cut deals that was barely better than breakeven.”
To put that into context, over the same period, the S&P 500 was up nearly 100%, Gold more than doubled and Bonds were having their best decade ever. Even worse, these breakeven trades were their best investments.
We continued down the portfolio. “You own enormous amounts of Fannie Mae and Freddie Mac. These are giant losers, and the bleeding continues even today. I would never have bought these, and I would recommend you jettison them right away.” A bizarre note structure worked like were open-ended Futures contracts that never expired. They had no limits on the losses – like shorting a stock that goes up forever, the losses here were potentially limitless.
We went down the list. Chrysler (big loser). General Motors (even big loser). Bank of America and Citigroup (enormous risks for only a modest gain). GE (Breakeven).
We moved on to the next holding: AIG. This was an extremely reckless investment that came with accounting shenanigans. “The paperwork makes it appear that you made a profit on this investment, but look at this footnote. You waived a significant dividend from them so they could take a phantom tax loss.” What appeared to be a modest profit was in actuality a giant loss. “Whoever prepared this statement was not being honest with you. You still are off about 25% of the original investment.”
Oh, and there was another problem with some of these investment: Liquidity. “You guys are buried in your General Motors and AIG holdings. You own about 26% of the float of GM, and nearly half of AIG. If you needed to sell this quickly you would crush the stock.” It was 4 years later, and he had barely worked out of half their position.
The enormity of what occurred begins to register on their faces. It was time to deliver the bad news.
“Look, let me bottom line this for you. These accounts made extremely risky investments, at a time when no one else was willing to put up this kind of money. You put an enormous amount of capital up for very little returns. Your brokers failed to negotiate half decent deals – its as if they were working for the banks, not you. You should have been paid handsomely for this, and you are not even break even across most of this junk you bought. Had you simply put your money into an index fund or bought bonds, you would have significantly outperformed all this stuff – with appreciably less risk.”
The meeting ends, and they get up to leave. I share one final thought with them:
“I don’t know what the original goal of this portfolio was supposed to be, but generating a return on investment does not seem to be its objective. The nicest thing I could say, is given the circumstances, it could have been much, much worse.”
With that they thank me, and leave my office.
Its fair to say that the massive liquidity the bailouts provided helped stabilize a financial system about to fall into the abyss. It is not accurate to in any way call these good investments. This narrative was designed to counter that silly argument amongst the bank apologists .
George & Martha (as in Washington) represent the American taxpayer, in case that was too subtle.
To track out all of the money returned on these “investments,” check out Pro Publica’s Bailout Tracker .
Article printed from The Big Picture: http://www.ritholtz.com/blog
URL to article: http://www.ritholtz.com/blog/2012/09/how-good-an-investment-were-the-bailouts/
URLs in this post:
 bank apologists: http://dealbook.nytimes.com/2012/09/10/plot-twist-in-the-a-i-g-bailout-it-actually-worked/
 Pro Publica’s Bailout Tracker: http://projects.propublica.org/bailout/list
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