The Smartest Guys in the Room - Definitely smart by any standards

This is a definitely up there with the best of books that chronicles corporate disasters. Comparison with "Barbarians at the Gate" and "Den of Thieves" is fully justified. The best thing that you like in these books is that they rarely offer the authors perspective of the issue, preferring the reader to form his own opinion.



The characters, the plot and the unfolding of events has been well thought by the author. Issues regarding the structures of financial misrepresentation has been well reported. It is a well paced book, giving readers little room to reduce focus from the contents. The last few months of the final debacle has been well reproduced making it nearly impossible for any reader to put the book down and concentrate on anything else.

The book does lack in one key aspect. The attention to numbers / financials. It is very difficult to understand the extent of damage unless readers are continuously informed about the magnitude of damage through the book. EPS and market capitalisation was often used but one did not really know how much was the revenues and how much profits did it actually report. Infact, there would have been fewer than 10 times when the actual revenues and earnings were reported in the entire book. It was probably in the last 100 pages did one actually know the revenue, RoE, networth etc etc.

Overall, it is a wonderful book to read...much better than the earlier book on Enron. Read it...

Well..it is over...Liar's Poker

Well, I should be finally congratulating myself. I finally had the opportunity to finish Liars Poker. In the past five years, I would have at least attempted reading this book over 6-7 times only to finish the first thirty to fifty and dump it for the next time. I have read, albeit one partly, two other books of the same author: Panic, a wonderful book but a jolly evening time read and money culture where I could not understand the head or tail of the book (if there was any sarcasm in that book across chapters which my dear roomate found many, I for sure, did not find any).

Not that Liar's Poker is not interesting. Just that I have a differing opinion of the nature of the job compared to the author and simply cant accept his attempt to trivialize the whole work affair. It was basically this review that prevented me from completing this book.

Having completed this book, I should say that I liked the book. It is simple, good read and should take you less than 4 hours to read the book. If you really want to understand what happened at this time, there are definitely better books around : Den of Thieves, Barbarians at the Gate and the Predators' Ball (have not read this one).

There are a couple of things that should probably come as a few key take-aways from the book: the concept of treasury in a bank and its role, especially investment bank and the skepticism surrounding it. It clearly is difficult to understand when a house would actually keep a security in its book or downsell the same to its clients. If a treasury has the opportunity to make an IRR of 15-18% on its book and would need to compare this with a commission revenue of 1-2 bps on a trade, how would it balance the client and company's interest? Where does the company draw a line between the employee's interest and the shareholder as these banks are inherently employee focussed? How are risks/rewards measured?

A book to read during your travel time only.

Unfortunately, this book really showed disappointment beyond expectations. Not a good way to start a review either as you guys should ideally skip reading it beyond this line. If you have, then here is the reason. The book seriously lacks depth. Compared to his earlier work on "Once in Golconda", this book pales in comparison. Incidents, reasons and issues are sporadic across the decade and probably under-researched or there was little to say. The book has a lot of pages, so there is a lot of stuff written in it. However, most of these are issues which one can skip and still be a lot wiser. There is a 30-40 page discussion on churches, employee behavior etc which I failed to understand the significance to the story.

Does this book deserve to be a Wiley Classic? Resounding "Yes" because of only the last 60 pages. If one were to read this book perhaps a few years back, one would have thrown this away and said, "Yeah! those were the bad days unlikely to repeated ever". After being threw one of the toughest crisis, I can comfortably say that this crisis partly a combination of the 60s and the 1925-35 era. Here are probably two key reasons:

1. Capital : The last few chapters discuss the crucial element which went haywire in the 60s. The endless leverage at the broker level. In the 1929-35 era, customers were leveraged at an investment level using margin to finance their endless greed. Banks financed the greed and customers readily accepted the same. In the 1960's brokers were leveraged similar to what we have seen in this crisis. The only good part is that it did not affect the banking system. In the current crisis, everyone was leveraged : customers and brokers. What probably was marginally different was the extent corporate leverage. The 60s similar to the 80s seems to have unrelated mergers driving corporate leverage upwards, with the difference being debt was available much more freely than in the 60s.

2. Merger of entities: For a person who has just entered financial markets, the last year should have been a total surprise. The mergers that we have seen at such rapid pace should have thrown his entire theoretical knowledge out of the window. A regulator / group of financial institutions does not call few related parties over a few days/nights and co-ordinate a merger with whomsoever feasible. Yet, it all looks to have happened. This is nothing new in the U.S. In the 1960's as the book highlights, regulators took active interest in ensuring that systemic collapse does not occur. Hence, they were more than willing to help mergers at a rapid pace. Whether it is good or not, I am not sure. It is important for regulators to police the activities of its participants and prevent disruption of functioning. However, should it be actively engaged to this extent? I don't know if our regulator would ever involve themselves to such a degree.

Interesting, this crisis did not bring out any dubious companies like almost any other crisis seems to have.

The extent of crash and the impact is probably less understood in the 60s than in the period of the great depression or the 1987 crisis. We have well documented history for most of the other crisis barring this one, which is what makes the book interesting.

Dow Jones crisis periods

(Source: www.stockcharts.com)

At best, all these crisis keeps repeating the same problem: greed, leverage for investors and growth for corporates. I am almost famished after reading this book and looking at some of the other classics, I doubt I am going to find anything more interesting. However, it is increasingly getting difficult to get the rest of the books. Not one bookshop seems to have any of these classics, which is a definite read for any person in the capital markets.

Mr. Buffett...how did u survive these periods. Reading them is so exciting that living through them should have a world apart!

Capital raising - an exercise for whom?

I have been tracking stocks for the past few years and should say, through the ups and downs, it has been truly a wonderful experience. As an analyst, reading balance sheets, macro data, quarterly results and corporate actions has always been a delight.

Over the past few months, I have been getting increasingly perturbed with the concept of capital raising. It is a necessary exercise especially for companies that would like to grow beyond their current capacity. Capital is needed for companies for different reasons - funding growth or reduce risk residing in the balance sheet. Few examples

• Construction companies need higher networth to bid for bigger projects and fund their working capital.
• Banks need capital to fund balance sheet growth when internal accruals does not support them. Further, capital is raised when risk was mispriced leading to substantial erosion of profitability and raising threat of survival
  
• Capex driven industry (infrastructure) need higher networth to reduce risk in the balance sheet.

So, given this simple broad utilisations of networth, we need to understand the valuation behind raising capital and how should investors look at this exercise. We continue to see a capital raising activity to be extremely favourable to investors. Is there a logic to this argument.

To understand this, we assume that investors value companies in two broad valuation metrics: Price/Earnings and Price/Book.

Price/earnings can be dilutive to some extent to investors depending on the extent and price of dilution as investors play for growth more than return on equity (typically RoE in these industries are much higher than the cost of equity). Hence, I have not looked into this that deeply.

Price/Book
We take four specific illustration to understand this argument:
1. Raising at below book value: The book value per share declines depending on the extent of discount. This will be a poor policy, if implemented and can be done only when the possibility of erosion of networth is possible as the existing shareholders are not adequately compensated with the entry of the new investor.

2. Raising at book value: The book value per share remains constant and the new and old shareholders are not compensated with the change in shareholding structure.

3. Raising at fair book value: This is favorable to existing shareholders as there is an improvement in book value per share. The only assumption made here is that the new investors are bringing equity to the business which can impact the return on equity in the medium term. The reason is as follows.

• If price were to remain constant at the fair book multiple, the expansion in book value per share will depress the new price/book multiple.This is acceptable sometimes as it would take sometime for the company to sweat the new capital raised.
  
• If the price/book ratio were to remain constant, the price increases. However, this increase impacts both the existing shareholder as well as the new shareholder immediately, which should not be the case, as it gives endless arbitrage opportunity to keep raising capital.

4. Raising at exorbitant book value: This is the most puzzling and the most complex form to understand. Why do investors raise capital beyond fair multiple as the only person benefiting from it are existing investors? There are can be very few reasons for this.

Company like raising money by diluting as little as possible. This is not a valid argument as they are transfering risk to new investors. If this is a reason, then investors should be really wary of playing the game. New and old investors are banking on the ability of the existing company to keep bringing in new investor and artificially keeping their stock prices higher than the fundamentals warrant. Stock prices will be inherently volatile in these stocks as raising capital frequently and consistently will be a challenge.

New investors are not given immediate opportunity to play with the old investors. This is a much reasonable investment argument. The bulk of the risk was taken by the old investors and new investors are coming having seen the performance, which implies that new and old investors have two different cost of equity. The promoter and initial investors have borne the brunt of risk when they had invested while the new investors are just playing the final leg of the game. Hence, they are being punished for not entering early.

Investors understand that sustainable RoE can see further expansion but markets are unwilling to look at these factors. Hence the new investors are playing that risk.

There are arguments of scarcity premium, management premium, country premium etc etc but how much premium and where are these getting factored to the price is always the question.

Having written this, I have become no wiser than ever before. If anything, I seem to be as confused as ever.

The road well travelled

Here are two interesting books that one should read .... Once in Golconda by John Brooks and The great Crash of 1929 by John Kenneth Galbraith. Both these books are Wileys Classic. There are a few more books worth reading but it is extremely difficult to get these books. In India, barring the easy book of Common stocks and Uncommon Profits, not many books are easily available. I had to borrow these books who could buy it only outside India.

Coming to the two books. Both these books are set stage in the great depression era. Reading these books back to back makes a lot of sense as they fill vital gaps that is present between the two books. Further, read "The Partnership" discussing the Goldman Sachs era in this period.

The interesting part of these two books is that they give a historian...s perspective rather than an analyst/economist perspective. It is advantageous reading it this way as the bias of the author, whatever it may be, is lost and readers get pretty much what happened as it unfolds in time.

"Once in Golconda" spans the period before and after the crisis while "The great crash of 1929" is fairly elaborate till the start of depression. Both these books discusses in detail of the speculative bubble created by excessive leverage available to investors and the failure to understand that stock market at best can only allocate capital and not support an economy. Further, the insider trading, creating pools to move stock prices and the creation of leveraged investment trusts that is similar to mutual funds today is something that is described well.

Once in Golconda discusses the stock market (not economic impact) of the crisis. The endless period of denial by all investors, the subsequent gloom and the final acceptance. The part played by the various banks during the crisis. The two big characters of Albert Wiggin, Chase National Bank and Charles E Mitchell of National City Bank and their contribution towards the crash.

Post the crash, the book moves towards the central character played by Richard Whitney, the head of the exchange, his personal life and his imbalance with professional life and the subsequent "Satyam" like saga. The role played by the regulators/politicians/president has been well documented. The book loses out in the end as it focuses largely on Richard Whitney and less on the exchange. It is entirely silent on what was happening to the economy.

The great crash of 1929 discusses the period just before the crisis and discusses the aftermath in a very brief manner. You like this book as it traces the movement of the index and the mania associated to it. The confidence that investors/ would be investors/ company management / policy makers/ bankers show is an eye opener. It attempts to reduce a few myths associated with the level of participation by Americans, the aftermath suicide rates and the simple stuffs of investing. However, one is trully stunned by the level of participation by banks. I use the word stunned is probably because one always assume bankers to be a pessimitic sort of people who can only look at the negative side as they are the one lending the money. However, the level of participation of banks in lending money to investors to speculate and their peddling of securities through their subsidiaries (leading to Glass Steagall Act- seperation of investment banking and lending activities) makes the book an interesting read. Considering the amount of tight leash the regulator has in India, one has to be trully appreciative of their efforts.

You will definitely like both these books as they are easy to read, and what more exciting. As the famous saying goes..."Those who don...t learn from the mistakes of the past are destined to repeat them". I got the "The smartest Guys in the room" finally from the same person who recommended it and have just started. It surely does not look like a fast read seeing the font size. Lets hope it is as good as the readers recommend it to be.