June 10, 2011

"Nate Thoma stood up in a Delaware bankruptcy court last December in a sharkskin suit and delivered a 24-minute argument that changed the course of one of the largest bankruptcies in U.S. history."

The Wall Street Journal reports on the 33-year-old investor with no legal experience who had thought Judge Mary Walrath wouldn't listen to what he had to say:
"But halfway through, I noticed she was paying attention," he says. "I realized she was going to let me go on, and I went for broke."...

But this battle is likely to be his last. He says that despite his success, his experience has left him disillusioned.

"The thrill is gone," he says. "It's such a big game, [individuals] just can't compete. I'm picking up freelance Web work again."

14 comments:

edutcher said...

Well good for him, and her.

Too bad there aren't more people like that watching over the nation's finances and a lot fewer of the likes of the Friend of Angelo and Slobbering Barney.

AJ Lynch said...

Jeez I hate clicking on links to WSJ, Wash Post, Philly Inquirer, Fox News.

Can anyone explain why news sites like these take forever to load and tend to freeze your browser. "Freeze up your browser"? heh- maybe Anthony Weiner should have gone to these sites to cool off his browser.

EDH said...

"But this battle is likely to be his last. He says that despite his success, his experience has left him disillusioned."

Tell me, again, what "success" did this guy achieve?

A judge listened to him and ordered a probe?

The Drill SGT said...

EDH said...
Tell me, again, what "success" did this guy achieve?


The net result was a settlement between small investors and the hedge funds, which included Appaloosa Management and Centerbridge Partners. That deal has paved the way for the bank to exit from bankruptcy and gives the little guys a chance of recovering some of their losses.

edutcher said...

AJ Lynch said...

Jeez I hate clicking on links to WSJ, Wash Post, Philly Inquirer, Fox News.

Can anyone explain why news sites like these take forever to load and tend to freeze your browser. "Freeze up your browser"? heh- maybe Anthony Weiner should have gone to these sites to cool off his browser.


Depends on the site and the browser. Some browsers handle Javascript routines differently, as an example.

Also, some sites embed so many videos, loading each player adds to the delay.

LarsPorsena said...

"Mr. Thoma, who didn't finish college, says he taught himself to trade, much like he taught himself computer programming..."

Not a lawyer; not a graduate. He just gets stuff done. As the education system produces the credentialed but uneducated expect to see more of this type of person.

Scott said...

I've worked in the securities industry since 1998, documenting systems for managing portfolios and executing trades. I also traded options for awhile. And let me tell you: There are many people in the investment industry who consider small investors to be a large herd of sheep that need to be sheared periodically.

"[Thoma] bought trust preferred securities, a hybrid of debt and equity, which rank above common and preferred shares. That enabled him to essentially jump ahead in line for any money distributed from the bank's estate."

What the fuck is a "trust preferred security"? It was apparently one created by WaMu to raise capital from sophisticated investors who, unlike the small investor, could actually see how risky it was to invest in the bank. By placing this class of security ahead of the preferred shareholders, you could presumably offer a more attractive risk premium than preferred stock while at the same time mitigating some of the risk. Sweet, huh.

The problem is, the existence of this thinly-traded, hard-to-find security absolutely fucked the WaMu preferred stock shareholders, who thought they were buying the risk mitigation that the "trust preferred security" siphoned off. The effect of this was to cause the shares of preferred stock (which are much easier to trade) to be consistently overpriced on the market.

Who is the guiltiest party? WaMu. They created the "trust preferred security" to do precisely what it did: Arbitrage the risk mitigation of the preferred stock in a way that obscured the fact from the small investors.

What made this possible? Three things:

First, the United States of America. Unlike other countries, in the USA, anyone can create and market any weird-ass security, option, or debt instrument they want without prior approval from the government. (This is actually a beautiful thing for creating jobs and wealth when it's not abused. The trick for an investor is to identify abuse when you see it. Lack of transparency is the enemy.)

Second, the investment banker who created the idea for this particular weird-ass security and pitched it to WaMu; a bank that wanted the cash it would raise. The investment banker made an obscene amount of money for his bank from "advising" WaMu and creating a market for the security.

Third, lawyers and accountants on both sides of the revolving door between the SEC and the investment banks. In concert, they create a regulatory framework that pays lip service to protecting small investors, while muddying the waters with impenetrable words and balance sheets to obscure risk from those same small investors.

What's the answer?

Less regulation. Make the markets more dangerous, not less. Enrons and WaMus and Bernie Madoffs and investment bankers are aided and abetted when regulators pretend they are making the markets safer. In fact, they're not -- they're just increasing the minimum stake you need to get in the game. Ultimately you end up with crony capitalism; an economic system favored by many small Asian governments as well as the Obama administration. By making markets more dangerous, you push the risk premium downscale, which actually favors small investors. (But that's another rant.)

How to invest now? This is what I'm doing--and not doing:

I'm not trading anymore, because (unlike Mr. Thoma) I don't have the time to do it properly. If I buy a position, it's with the intent of holding it for a long time.

I limit my stake in any individual stock to 5% of my portfolio; or any individual mutual fund to 15%.

Generally (but not always), if I buy a position that subsequently loses 10% of its value, I sell it, and invest the funds elsewhere.

I never stay fully invested. Ideally I usually keep a chunk of cash on the sidelines, ready for the next good deal.

Enough rant. I'm off for blueberry pancakes and the gym. Cheers.

The Drill SGT said...

Scott said...The trick for an investor is to identify abuse when you see it. Lack of transparency is the enemy.)

But the initial point of the scam is that the risk didn't exist when the investor bought preferred stock early.

Later the hydrid shares were created that literally stole value from the preferred shares. Subsequently, what is to stop a firm from repeating the process indefinitely? Obviously, they will be able to steal less and less as the process becomes apparent.

In Mr homa's case, the instruments already existed and it's not clear what the precise mechanism of the swindle was. Clearly the hyrids held value. Was the bank issuing more, thus continuing the theft from shareholders/ or was there insider trading in the secondary market that did not disclose to the seller of these hyrids, that the market wasnt transparent and that his buyer was his own investment firm that was skimming off these undervalued hyrids by not making their sale fully public?

Scott said...

Good Morning Mr. Drill Sgt,

In the world of investing, small investors (like myself) don't do very deep analysis of an individual company's securities and debt instruments before investing. Rather, we expect certain classes of standardized investments to behave certain ways. Something called a "bond" acts like a bond, "common stock" acts like common stock, etc. And there is a triage of who gets paid first when bankruptcy assets are distributed -- generally, creditors, bondholders, preferred stockholders, and common stockholders are paid in that order.

What WaMu did was create something called a "trust preferred security" which was inserted in the triage ahead of the preferred stockholders. This is perfectly legal, and I think it should continue to be, because the cost of regulating this activity will cause more economic problems than leaving it alone. But they took advantage of the lack of transparency inherent in the regulatory framework to obscure the risk shifting from subordinate classes of investors. This is not ethical even if it is legal and widely practiced.

But how to improve transparency? Perhaps corporations should be required to determine and declare annually on their 10-K the classes of securities and debt instruments that lay claim on their assets; and the order in which each class would be paid in the event of a liquidation. It would increase transparency to investors, and would make bankruptcies immensely simpler. It would also contribute to fairer (lower) pricing of subordinate asset classes, such as the preferred stock.

Did WaMu do everything it could reasonably do to communicate to the preferred stock shareholders that they were siphoning off their asset protection with this new hybrid security?

Our purpose in life is not to make it easy for the rich to get richer. The rich and powerful use the lack of transparency to protect themselves. Lack of transparency is the enemy.

The Drill SGT said...

Scott said...Did WaMu do everything it could reasonably do to communicate to the preferred stock shareholders that they were siphoning off their asset protection with this new hybrid security?

to be clear, wasn't it value, not just risk protection being siphoned off?

with the hyrids inserted, the preferred stock lost value (real money that day) and of course much less value if there was a default.

Scott said...

Risk and price have an inverse relationship. Higher risk, lower price.

Preferred stock is generally considered a lower risk investment than common stock in part because if the company is liquidated, preferred shares are paid before common. That diminished risk is factored in when the market evaluates its price. In theory it makes preferred shares more valuable; although in reality it's harder to tell.

chuckR said...

To those grumbling about slow loading websites. I just did a clean install of XP Pro and getting rid of three years of digital barnacles made loading everything much faster. Assuming Windows is used, another option is editing the hosts file to dummy load the offending content. This is often done by spyware and anti-spyware programs too, so its good to know how to check the file. I don't mind ads - its how sites like Althouse can exist, but when some damn script or video locks my browser and/or computer, I try to send the offenders to the null site - 127.1.1.1

chuckR said...

A couple of books I think provide an introduction to some of the recent arcana and amorality of Wall Street - Quants, by WSJ reporter Scott Patterson, and Nobody Would Listen, by Harry Markopolos, who has become a financial fraud bounty hunter after trying to alert someone/anyone/SEC to Madoff's fraud.
Anything that NSFW's a hedge fund or investment bank is probably beneficial to the rest of us.

wv - snolego - its tinkertoys instead

ampersand said...

@AJ Lynch

Do you have some sort of safe search add on enabled?

I had one from AVG that slowed my browsing and I had to disable it.