Dimon, Munger, Rohatyn: No More Vegas - By Robert Lenzner

<blockquote>"Even more radical is Berkshire Hathaway's vice chairman. Munger wants Wall Street balance sheets reduced by 70% and insists that the firms "be a market maker, a broker, an underwriter and a custodian of securities but not the hedge funds they have become." He wants to restrict leverage to 50% on every securities transaction except for the Treasury trading desk where "you're dealing with the safest securities around."


That 50% margin level, incidentally, is the maximum that ordinary investors can obtain from their broker when they purchase common stock. Before their respective demises, Bear Stearns and Lehman Brothers were leveraged to the tune of $30 of debt for every $1 of capital.

To rid Wall Street of its Las Vegas tone, Munger suggests leveling the options exchanges in Chicago and New York, and banning completely all derivatives contracts, a rather impossible vision but one that's true to his spirit. He's also furious with the accountants, in particular for letting Wachovia report actual profits on accrued interest from risky mortgages when, in fact, the interest wasn't paid but added to the principal amount due on the mortgages."</blockquote>


Dimon, Munger, Rohatyn: No More Vegas

By Robert Lenzner
10.13.08
Source (Charlie Munger: Leash and Collar Wall Street)

Wall Street giants Jamie Dimon, CEO of JP Morgan Chase; Felix Rohatyn, recently senior adviser to Lehman Brothers; and Charles Munger, Warren Buffett's curmudgeonly sidekick, predict the end of huge leverage and the return of Wall Street to an earlier era when investment firms were mainly "advising corporations and individuals globally and making solid profits overall," says Dimon, whose bank just acquired the troubled Washington Mutual and positioned itself as perhaps the strongest institution on the Street.

The expected Treasury investment of $250 billion in the major firms of Wall Street means government ownership for the first time in history. The investment in Citigroup, Morgan Stanley, Goldman Sachs, JP Morgan, Merrill Lynch, Bank of America and State Street and others will stabilize their capital. It also means the compensation of the top five officers of each bank must be reduced to no more than $500,000 a year. The landscape of Wall Street has never experienced such a major revolution.

"The big proprietary desks with huge leveraged positions will be diminished," says Dimon. "Some hedge funds will find it harder to make the same level of profits," he adds.

Rohatyn, who was the merger and acquisition investment banker at Lazard Freres for decades, goes further: "Our objective must be to reduce risk. We have to get the gambling out of the system and to encourage investment. Personally, I'm inclined to ban off-balance sheet vehicles and get better control of the computer-driven systems that are a major force in markets. Perhaps we need an automatic trigger that limits trading when the danger gets too great."

Even more radical is Berkshire Hathaway's (nyse: BRK) vice chairman. Munger wants Wall Street balance sheets reduced by 70% and insists that the firms "be a market maker, a broker, an underwriter and a custodian of securities but not the hedge funds they have become." He wants to restrict leverage to 50% on every securities transaction except for the Treasury trading desk where "you're dealing with the safest securities around."

That 50% margin level, incidentally, is the maximum that ordinary investors can obtain from their broker when they purchase common stock. Before their respective demises, Bear Stearns and Lehman Brothers were leveraged to the tune of $30 of debt for every $1 of capital.

To rid Wall Street of its Las Vegas tone, Munger suggests leveling the options exchanges in Chicago and New York, and banning completely all derivatives contracts, a rather impossible vision but one that's true to his spirit. He's also furious with the accountants, in particular for letting Wachovia (nyse: WB) report actual profits on accrued interest from risky mortgages when, in fact, the interest wasn't paid but added to the principal amount due on the mortgages.

As for the future structure of Wall Street, Rohatyn, former U.S. Ambassador to France, is calling for a Bretton Woods conference like the one that created the International Monetary Fund, the World Bank and a global currency trading system 64 years ago.

"Heads of state, finance ministers and central bankers should meet to decide what kind of a regulatory system we must have to reduce risk and protect retirement benefits across the globe. We must deal with this today as if it's a global problem, not just an American one," says Rohatyn.

Indeed, coordinated efforts across Europe over the weekend were far more system-wide than what took place in the U.S. French President Nicolas Sarkozy said he would summon leaders from European states to meet with President Bush soon to work out a necessary cooperative structure.

As to the bailout in the U.S., JP Morgan's Dimon believes "the taxpayers could get back all the $700 billion and perhaps even make a profit on the rescue. I also think the Fed could very well make money on both Bear Stearns and AIG (nyse: AIG)." What's the risk of this, we asked. His answer: "All of this depends on the great unknown, how deep and long the recession will be."

So ad hoc, improvised and inconsistent the solutions to each crisis have been leading up to this moment, the issue of moral hazard has been given short shrift. Each solution has had serious ramifications that clearly no one in the Treasury or the Federal Reserve intended. Bailing out Bear Stearns made Lehman overconfident that it, too, would be protected in some way.

The conservatorship of Fannie Mae (nyse: FNM) and Freddie Mac (nyse: FRE) shut down the entire market for preferred shares, since Fannie suspended cash dividend payments. Taking over 80% of AIG in return for an $85 billion loan (now above $120 billion) triggered runs on Goldman Sachs (nyse: GS) and Morgan Stanley (nyse: MS), who were forced to become bank holding companies and to raise capital. The seizure of Washington Mutual on behalf of JP Morgan led to the run on Wachovia which had to be absorbed by Wells Fargo (nyse: WFC).

The road map to Wall Street's future is unclear and very much a work in progress. The probable necessity of Treasury aid, even government ownership, in part, is the price for being Las Vegas for so long. It is an enormous black eye for Wall Street.

One thing is sure: The abhorrent excessive compensation on Wall Street is bound to be severely reduced. If Wall Street firms can only be leveraged 10 to 1 instead of 30 to 1, then the excessive gains made on borrowed funds will be reduced by two-thirds. So the path to $5 million to $10 million annual payoffs will be more reasonable but still in the millions. Hamptons summer homes will be reduced in price. Private jets will be out of range for many. Applications to law school should go up. The buyside will have their choice of the brightest business school graduates. And forever more we’ll all wonder what a meltdown would have been like with the attendant chaos.

There will be an international conference dealing with global finance that will place such restrictions in order to prevent such a close brush with Armageddon and systemic collapse ever again. It cannot be left to the free market.