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INEFFICIENT MARKETS - Devil's Dictionary
A selective guide to what's happening in today's markets.
Roughly a century ago the American writer Ambrose Bierce compiled The Devil's Dictionary. In his celebrated lexicon, Bierce displayed a profound understanding of finance, which he defined as "the art or science of managing revenues and resources for the best advantage of the manager." Among his definitions touching on the subject of money:
Debt: An ingenious substitute for the chain and whip of the slave driver.
Mammon: The god of the world's leading religion. His chief temple is in the holy city of New York.
Riches: The savings of many in the hands of one.
Wall Street: A symbol of sin for every devil to rebuke. That Wall Street is a den of thieves is a belief that serves every unsuccessful thief in place of a hope in Heaven.
Although Wall Street's ethos has not changed since Bierce's time, it is time to update and enlarge the Devil's Dictionary of Finance for today's world.
A* AAA: The credit rating that indicates a company has very little likelihood of default and therefore carries too little debt. By a process of financial alchemy, this rating now covers most of the riskiest corporate and consumer borrowers. See collateralized debt obligation and rating agencies.
Alternative investment: The lucrative process of repackaging traditional equity investments. An ingenious marketing technique of the investment industry devised to boost earnings after the stock market collapse at the turn of the century. See hedge funds and private equity.
Asset gathering: The method by which investment firms maximize the value of their businesses, normally at the expense of clients. Formerly associated with traditional investment firms but now frenetically practiced by alternative investors. See Blackstone.
B* Bankers: People who lend other people's money in exchange for a fee. Formerly concerned about the return of principal but now only interested in the fee.
Bear: A stopped clock that is right not twice a day but merely once a decade.
Bear Stearns: A Wall Street firm whose leveraged adventures suggest that stopped clocks may at last be giving the correct time.
Blackstone: Private equity firm run by former investment banker Stephen Schwarzman. In a recent interview with the Wall Street Journal, the billionaire Schwarzman emphatically denied he was a "marauding, low-class, low-brow inflicter of random damage." See lucky fool.
Bridge loans: Temporary loans provided by banks to finance leveraged buyouts. A financial hot potato. But as the head of Citigroup, Chuck Prince, recently observed, "As long as the music is playing, you've got to get up and dance."
Bull: Politely speaking, the stuff and nonsense of Wall Street's daily conversation.
C* Carry trade: The act of borrowing cheaply and lending at a higher rate. Popular with hedge funds when short-term rates collapsed after the dot-com bust. Per Charlie Munger of Berkshire Hathaway, "Never have so many people made so much money with so little talent." See Greenspan.
China: A communist country bent on undermining its capitalist enemies by gorging them on debt. In furtherance of this policy, the People's Bank of China has recently taken a sizable stake in Blackstone.
Collateralized debt obligation (CDO): A dumping ground where banks off-load loans, which are pooled, sliced up and stamped with investment-grade ratings.
Covenant-lite: A type of loan used for leveraged buyouts that has many of the risks of equity without any of the upside. See AAA.
Credit: Long ago, when she first appeared amongst us, "Lady Credit" was attracted to a person's character, probity and trustworthiness. With age, she has become less choosy. See liar loans.
Credit default swaps: A means for transferring risk. Lenders can now insure against the risk that a borrower will go bankrupt. Instead, they are exposed to the risk that the seller of default protection, in an unregulated $30 trillion market, will go belly up.
Croupier's take: The annual charge for managing institutional money, which includes fund managers' fees and brokerage commissions. Conservatively estimated by Charlie Munger at roughly 3 percent of principal per annum. See asset gathering.
D* Debt: A lingering disease left behind after Lady Credit has taken flight. See credit.
Delinquencies: The inevitable consequence of providing money to those who can't afford to pay either the interest or principal on a loan.
Dividend deal: A debt-funded dividend paid shortly after a buyout. Serves to boost private equity returns at the expense of creditors.
Downgrade: A reduction in the quality of a credit rating. Normally occurs after the deterioration of fundamentals but before the event of a default. This action protects the reputation of the rating agencies but not the wealth of bondholders. See subprime.
E* Ebitda: Earnings before interest, taxes, depreciation and amortization. The maximum cash flow available to finance a buyout. When all ebitda is used for debt service, nothing remains to invest in a company's ongoing operations. See zombies.
Equity tranche: The riskiest part of a CDO, which takes the first loss in the event of default. Popular with hedge funds that pick up performance fees from investing in equity tranches right up to the moment they blow up. See incentives.
F* Fees: The raison d'être of Wall Street. The means by which wealth is transferred from its owners to those entrusted to manage it. See hedge funds, investment banks, private equity and rating agencies.
Financial engineering: Whereas conventional engineering seeks to take weak structures and make them solid, ®≠nancial engineering aims at the opposite.
Fund of funds: The loading of fees upon fees. Institutions that speed up the transfer of wealth from owners to managers, as described above.
G* Greater fools: Wall Street's ever-expanding clientele.
Greenspan: The patron saint of carry traders.
H* Hedge funds: A lucrative compensation scheme for professional investors, who get to charge roughly ten times as much as traditional money managers while producing, in aggregate, similar returns. See loser's game.
Home: A building increasingly constructed on weak financial foundations. See delinquencies.
I* Implied equity: A measure employed by private equity to forgo investing any real equity in a buyout.
Incentives: The incentives of most Wall Street professionals involve asymmetric payoffs. Known less formally as "heads I win, tails you lose." See yachts.
Initial public offering: An exit route for alternative investment managers who suspect the jig is up.
Institutional investors: Simple-natured fellows possessed of an incurable tendency to extrapolate from past performance. See alternative investment.
Interest cover: The ratio between a company's debt servicing requirements and its cash flow. Buyout borrowers have recently driven interest coverage ratios to "barely 1.0 x," according to Moody's Investors Service.
International carry trade: The practice of borrowing cheaply abroad to fund investments at home. Popular with Hungarian and Polish home buyers and unpopular with central bankers in Switzerland and Japan.
Investment bankers: Financiers who find clever and original ways to put their own interests before those of their clients.
Investment banks: Institutions that find clever and original ways to bring the financial system to the brink. See leveraged buyout, subprime.
J* Junk: Riskier corporate bonds that are known as "high yield" during the early part of the credit cycle. But as the cycle progresses and their credit quality diminishes, they are properly designated "junk."
K* KKR: The original private equity firm. Co-founder Henry Kravis says he should be congratulated not on buying a company but on selling it. Unfortunately, KKR has been so busy taking companies private this year that it missed the chance to sell itself.
L* Leverage: The substitution of debt for skill in order to enhance investment performance or profitability. In theory, any gains from leverage are offset by a commensurate increase in risk. In practice, this theory is ignored.
Leveraged buyout: The debt-funded purchase of a company. Immensely profitable to private equity firms when profits and valuations rise and, owing to management and other fees, still very profitable to private equity when profits and valuations decline. See incentives.
Leveraged loans: The rocket fuel that powers the LBO industry. Originated by banks but quickly passed on to hedge funds and stuffed into collateralized debt obligations. See institutional investors.
Liar loans: Mortgages provided to those who economize with the truth. See mortgage brokers.
Liquidity: A vogue term that provides an aura of financial sophistication to its user, e.g. "an excess of liquidity drove the market higher today," or "a lack of liquidity drove the market lower today."
Loser's game: The recognition that investors, in aggregate, are engaged in a zero-sum game. Those who make the fewest mistakes and have the lowest management expenses end up winning. The irrefutable consequence of this ®≠nding is that institutional funds should be largely invested in low-cost index funds. It is a tribute to the marketing power of Wall Street that this isn't the case. See overconfidence.
Lucky fool: A person who owes his success to luck rather than skill but is unaware of the fact. As it takes several decades of performance data for statisticians to distinguish luck from skill in the investment game, the number of lucky fools on Wall Street must always remain indeterminate. See Stephen Schwarzman.