Lieutenant Island Views : Commentary About Finance, Politics and Baseball

A Tale of Two Cities-Red Sox/Yankees Economics in the 21st Century

March 31, 2009
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The last five years have been the best of times for Red Sox fans. Starting with their infamous collapse in 2004, they have been the ugliest, if not the worst, of times for Yankee fans.

One could argue that the performance dichotomy is the result of two disparate economic strategies. The Yankees continue to follow strictures established by Col. Jake Rupert in 1920: spend significantly more than any other team to hire away the biggest names in the majors. The Red Sox operate with a hybrid version of Money Ball relying heavily on home grown talent, making strategic bets on reclamation projects like David Ortiz, Bill Mueller, Mike Lowell, Brad Penny, John Smoltz et al. and using Sabremetrics to execute on the field as well as in drafting players.

The two strategies are also seen in their approaches to free agents. The Yankees tend to use muscle to outbid others for big name free agents regardless of the cost. In dealing with free agents, their own and other teams’, the Red Sox tend to have price limits and stick to them (this even was true with Daisulke Matsuzaka). The Yankees hardly ever are outbid in auctions unless it is a onetime sealed bid process where they do not have a chance to up their offer (this is how they lost Daisulke Matsuzaka). This year, the Yankees out did themselves with signings of CC Sabathia, AJ Burnett and Mark Texeira. The Red Sox made a run at Texeira but would not match the Yankees bid. Their real focus was to add four reclamation projects (Takashi Saito, Brad Penny, John Smoltz and Rocco Baldelli) for a combined annual compensation level less than any one year salary of the three big Yankee additions.

Surprisingly, though the Yankees are the huge spenders, they exhibit less alacrity than the Red Sox at jettisoning stars or exploring new strategies. Mid-season trades of Manny Ramirez and Nomar Garciaparra were bold moves by the Red Sox which improved team chemistry without significantly reducing run generating firepower. The Yankees seem less willing to adopt new approaches. Perhaps this is why they still stick with the almost 90 year strategy of Jake Rupert.

The sad reality is that, since 1978, their high priced players strategy has been a bust. The Yankee championship teams of the late 90s were built along the lines of the Red Sox model. This happened during a period when George Steinbrenner was banned from baseball. In Steinbrenner’s absence, Gene Michel and Buck Showalter were able to develop home grown players like Derek Jeter, Bernie Williams, Jorge Posada, Mariano Riveira and Alphonso Soriano who took them to the promised land. As those players aged, and Steinbrenner was reinstated, it was “déjà vu all over again” with more spending, off the charts payrolls and diminishing performance.

One has to wonder what goes through the Steinbrenner’s heads. If there is a proven strategy to win more games win with less expense, why not try it? It could result in less gut wrenching failure and greater profitability. Red Sox fans regularly thank the lord that George and his boys have not figured out the new paradigm. They do this because they know that God IS a Red Sox fan!!!

For another take with some interesting statistics, check out Alex Speier’s piece, “A Different Shape to the Red Sox-Yankees money Wars”.

The End of the Beginning or the Beginning of the End of Hedge Fund and Private Equity Economics?

March 30, 2009

Saturday’s Wall Street Journal has an interesting article (“Calpers Tells Hedge Funds To Fix Terms-Or Else”) which details the California Public Employees’ Pension Fund’s (“Calpers”) attitude toward hedge fund and private equity compensation. Calpers is the nation’s biggest public pension fund. It has seen its hedge fund and private equity portfolios decimated this year along with its myriad other equity oriented investments. This is necessitating a reallocation of their portfolio which will mean substantial cuts in funding for “alternative investments” like hedge funds and private equity. Calpers’ reallocation issues has done more to put the fear of God into heathen PE and hedge fund managers than would any overzealous preacher! Loss of Calpers money can put a dent into any fund’s asset base and be a harbinger of incremental losses as other funds follow Calpers’ lead. Reallocation also gives Calpers extraordinary “muscle” to demand favorable terms from those with whom it chooses to invest. As the article points out, some of the modifications in terms that it is looking to achieve include:

• Reduction in annual fees (now 2-3% on avg.) and carry from 20% to something significantly less
• Recoupment of fees paid in good years to cover subsequent bad performance
• Managed accounts solely for Calpers to reduce the impact of redemptions by other investors
• Greater disclosure of assets and potential limits to leverage

Implementation will come primarily with the deployment of new money rather than amendments of existing fund investments. While it will take some time to implement the changes desired, they will have a chilling effect on the compensation and operations of many hedge funds and PE shops. Because so many institutional fund investors follow Calpers example it is likely that some fund managers will opt for dissolution or be forced to that decision by an inability to raise adequate capital. If Calpers succeeds, the face of alternative investments will look very different in the coming years. It also won’t help the value of homes in the Hampton’s or large apartments on Park Avenue.

It is quite possible that the fund business will follow the example of Major League Baseball. Top performers like Paulson and Soros may still be able to demand their terms because of their stellar track records in the recent downturn. Others will see a dramatic change in life and pay because they did not measure up in the clutch. There won’t be many Johan Santanas or Albert Pujols in the fund world. To make matters worse, Calpers is signaling that they have no intention of spending as freely as the Steinbrenners!

Paul, We Love You But Get a Grip!

March 27, 2009

The same guy who says that the Obama Administration should be spending trillions more on everything does not like the government’s plan to liquify toxic bank assets. He also seems to hate the capital markets. I guess he thinks that the incremental trillions he wants us to spend come from the printing press rather than the global markets.

What is the real source of his problem? He is is a truly smart guy but today’s piece in the New York Times really lacks clarity. His article “The Market Mystique” fulminates on multiple topics but never really specifies the underlying sources of his problems.

He clearly sees a need for more regulation of markets and then grudgingly admits that the Obama Administration is moving to significantly increase regulation. He dislikes markets and won’t come to grip with the fact that they can’t be ignored. He seems to forget that even in his favorite generation, the fifties, the government used markets to finance its operations. Maybe he thinks that in that era, America was like the Fonz and always had money but did not have to do anything to get it! Only the Fonz failed to realize that there is no free lunch.

It is less clear what Krugman wants other than for banks to admit that the assets have a low value. The argument comes down to what is fair value. If banks follow Krugman’s draconian solution, it could be Lehman redux, unless mark to market rules are eliminated, which his logic would argue against. Forcing big markdowns triggers capital inadequacy issues and, probably, government takeover (s) of some big banks. In this scenario, the FDIC gets to own the assets and probably lots more as a result of a collapse in market confidence (remember what happened when Lehman fell). The government would have to step in and, like it or not, figure out how to finance everything it acquired. It would have to go to the markets. The fellows who make up the markets might not have a Krugmanesque point of view (those Chinese fellows, in particular, have no sense of humor when it comes to losing money in American assets). The elegant thing about the Geithner plan is that it does not deny the valuation issue and provides government funding. The difference in the plan versus Krugman is that it does it by attracting outside capital and reigniting trading in the assets. Krugman’s plan lays it all on the government’s shoulders to finance after triggering a very negative series of events. We saw this with Paulson at the helm. do we want to watch it again?

Paul, please take a bite of a reality sandwich. You can’t avoid markets so use them for our benefit. Obama, Geithner and equity investors get the joke. Why can’t you?

Survival Guide for Red Sox Fans in New York City

March 26, 2009
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While New York is a truly interesting and dynamic city, the months from April until the end of October can be difficult. Native New Yorkers, with exception of die hard Met fans, can be hard to endure when it comes to baseball. They have yet to learn that in the new millenium the baseball firmament has been reordered. Yankee fans are particularly obnoxious in October, which has been a very cruel and empty month for them this century. Freud would call their nastiness toward Red Sox fans in New York a “wicked bad” case of projection. The good news is that there are multiple places and ways to avoid them and surround yourself with the more cultured, educated and amusing species of New Yorkers know as the Blohards (Benevolent Loyal Order of Honorable Ancient Red Sox Diehahhhhhd Sufferers of NY). The folks can be found at their semi-annual meetings at the Yale Club when our team comes to town as well as some truly extraordinary watering holes around Manhattan. If you are such a cultured, educated and amusing individual, please check out the attached list of “Life Lines” as well as the general site of the Blohards

Spitzer for Treasury Secretary? Are You Joking Katrina?

March 25, 2009
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Recently Katrina Vanden Heuvel, Editor of the the Nation, has been suggesting that Treasury Secretary Tim Geithner should be replaced by Elliot Spitzer. We know that she and her husband have been his friend since their days at Princeton but her suggestion is an embarrassment. Perhaps she is letting friendship cloud her judgment. Aside from the fact that Spitzer pleaded no contest to several of the crimes (Mann Act violations, illegal currency wire transfers, aiding and abetting prostitution etc.) that he often used to coerce his targets when he was New York Attorney General, he may have been the root cause of AIG’s demise. His actions, which forced out AIG’s long time CEO, Hank Greenberg, led to new management which took the company in the wrong direction. Greenberg’s successors had a difficult time maintaining his earnings record. They went for what they saw as easy money in credit default swaps and other esoteric insurance products. This was a large and real deviation from the way Greenberg ran the company. We all know the rest of the story.

The laws of unintended consequences really can be punishing when you act in a vindictive manner rather than as a result of a deliberate strategy.

As a secondary question, does Katrina expect an easy confirmation for her friend Elliot? Larry Summers was kept away from the Senate confirmation process because he spoke out about the gap between women and men in scientific fields of study. Imagine if he had broken multiple laws to hire $5,000 per hour hookers! At least Elliot paid his taxes.

If Goldman Returns its TARP Funds, Will Others Follow?

March 24, 2009

Given that Wall Street functions largely as a “Land of Lemmings” where one idea, regardless how good or bad, is usually criticised and then copied if it is seen as potentially beneficial to either personal pecuniary interests or corporate revenue generation. Right now, many on Wall Street believe that repaying TARP money certainly addresses the first point and could serve the second (or give a competitor a leg up if not followed). The article attached goes into detail on many of the implications of possible paybacks. One that seems to be missing is details on how many of the banks can raise the capital quickly. One needs only look to a bank’s loan book for the answer. To the extent that a bank can find a way not to “roll” a large revolver, use a technical covenant default to reduce exposure, not reapply toxic loan sales to new credits or generally accellerate a cutback in corporate lending (because that’s where the large loans are and Congress is not focusing on corporate liquidity), it can free up capital for repaying the government. Unfortunately, the casualty of this is a major reduction in corporate credit just when we need to help corporations make it through the downturn with available loan capital. In no small way is this part of the “unintended consequences” we addressed in our earlier piece on Congress’ compensation legislation. Even if the bill does not become law, the simple passage by the House has put the fear of God into banks. The really bad news is that the Lemmings of Wall Street may march their corporate clients into the sea to rid themselves of the yoke of TARP!,%20will%20others?&st=Search

Did Andrew Cuomo Read Our AIG Compensation Post?

March 24, 2009
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From the attached article, one can see that Attorney General Andrew Cuomo is using a little gentle persuasion along the line of thinking we suggested earlier this week. Let’s hope he is not afraid to push harder and work with the leaders of the New York congressional delegation to develop a Black List that makes it tough for those who do not pay back to find gainful employment with any firm that does business with TARP recipients. Punish the guilty, not the innocent who must stay at their jobs to clean up the mess!

Top Beers at the World Baseball Classic

March 24, 2009
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Call me silly but I loved this little entry from Kevin Kernan of the New York Post. It highlights all of the great foreign beers he consumed at the recently completed classic!!

Whither the Dollar?

March 24, 2009
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Whither the dollar? That is the question. As the attached article points out, the Chinese government is worried. If they are worried, we should be too! A cheaper dollar certainly debases their investment in dollar denominated securities, particularly the Treasury obligations which they already own. Equally significant, a cheaper dollar will likely force us to pay higher rates on the Treasuries which we will sell to finance the large stimulus package that will be unfolding in the coming months. The only silver lining is that China is as addicted to a high dollar as we are. As we are their largest market for all sorts of goods, and because their currency is basically pegged to ours, their income and purchasing power erodes as the dollar declines. One answer for them is to allow their currency to trade more freely like other currencies do. While it sounds reasonable, they know that freeing their currency to trade on a “market basis” is the proverbial slippery slope. It is a slope that they will find pock marked with speed bumps and other hidden dangers that they have, to date, assiduously avoided. This is a relationship that bears watching closely and must be handled with deft skills by the Obama administration

An Iconic Pitcher Hangs Up His Cleats

March 24, 2009
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Yesterday Curt Schilling announced his retirement from baseball. Baseball will be poorer for his absence. While many, the author included, disagreed with his political positions, these are the reflection of an American with a point of view. They don’t make him a bad guy, they add to his story. He was a special player in so many on and off the field ways that you can only shake your head and say: WOW! As a pitcher, he was the biggest of the Big game pitchers we have seen since Bob Gibson and Sandy Koufax. If you don’t believe it, look at the records or ask members of the ’01 or ‘04 Yankees!

His detractors will tell you that he definitely had a “big mouth”. It is absolutely true and even he would admit it. Unlike many pros, however, when he made outlandish predictions or comments, he usually delivered. On Arriving in Boston in ’04, he said he was “coming to overturn the Curse”. He Delivered. What red blooded Red Sox or Yankee fan can forget his famous comment prior to the ’04 ALCS about his expected effort: “I can’t think of any scenario more enjoyable than making 55,000 people from New York shut up.” He Delivered. In that respect, he more than Karl Malone, was the true Mailman!

And then there was the famous “Bloody Sock”. Unlike so many high paid players who will avoid anything that would jeopardize their ability to keep playing and being paid, Schilling took a huge career risk and submitted to an unconventional surgical technique to pitch in Game 6 of the ALCS. Pain and pressure be damned. Bloody Sock and all, Schilling pitched seven innings of one run ball against the mighty Yankees in their home park. He scattered a meager four hits over the seven frames; something very difficult for any pitcher regardless of his physical condition. Was he insane, a total unselfish team player, an ego maniac or one of the most courageous players in the history of the game? He was probably all of the above. The performance now ranks in baseball history with Babe Ruth’s called shot and Bobby Thompson’s home run off Ralph Branca as the three most memorable acts in baseball history.

Off the field, Schilling was as intense and driven as when in uniform. We have already mentioned his political activism. Though he has a different political perspective, he rightly should be compared to film icons Sean Penn and Susan Sarandon, who are both exceptional actors who bring out their best in the most difficult roles. Without making judgments about anyone’s specific political views, the important thing is that he thinks about issues and is committed to using his celebrity in a positive manner to support such ideas. Can one think of many other ballplayers who have thought about US foreign or economic policies (other than their own tax rate)??

In charitable endeavors, Schilling was a tireless advocate for fighting ALS (Lou Gehrig’s disease). He has raised millions and been a strong advocate for increasing American awareness of this terrible disease. Less well known are his activities to fight skin cancer. As with his politics and on field bravado, he follows up his outspoken comments with action, energy and commitment.

While all of the above make put Schilling in a small cadre of professional athletes, perhaps most unusual is the fact that he has no agent, choosing to represent himself in contract negotiations. Some might say his choice is “penny wise and pound foolish” yet he has been among the highest paid pitchers in baseball for more than the last ten years. He has kept the 10-15% that would otherwise go to an agent (read that as tens of millions of dollars) without hurting his relative position in the compensation firmament. It is also worth noting that, compared to a number of Scott Boras clients, including Johnny Damon, Jacoby Ellsbury and Derreck Lowe, one cannot find Schilling’s name on a roster of investors swindled by Stanford Capital.

Whether or not he makes it to the Hall of Fame is for the sports writers to decide. Regardless what happens, he will be missed!

for another take, please link to the following

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About author

Mr Thaler is currently the Managing Partner of Lieutenant Island Partners, an organization providing corporate finance advice and general consulting to corporations and not-for-profit organizations. Mr Thaler retired as Vice Chairman of Deutsche Bank Securities in early 2008. His background includes experience as an investment banker, senior manager, business builder, college professor, not for profit board chair and trustee. In his thirty plus years as an investment banker for Deutsche Bank and Lehman Brothers, he has been involved in numerous significant debt and equity financings, mergers & acquisitions, leverage buyouts, restructurings and cross border transactions. Of particular note, Mr Thaler has been one of the most active participants and strategic advisors to the homebuilding industry. In a period of significant turmoil and losses, he was one of the few active bankers to the industry who did not have either a loss or credit write down. He is currently advising several public builders on strategic matters and is an adjunct professor of finance at Morehouse College in Atlanta, Georgia. Though he lives in New York, he is a life long Red Sox fan!