This in from Pete, Managing Director of Citibank Thailand –in response to my posted views on Wall Street

“I can tell you banks don’t make anything near the fees quoted. Not even  on the wildest and most in demand Chinese IPOs.

“I know it is fashionable to take shots at Wall Street and unfortunately there is too much ignorance and lack of appreciation out there as to the importance of Wall Street in keeping America strong and ultimately free.

“The equity markets are critical as a means, other than debt, for companies to raise funds to make investments, hire staff, etc.  Companies require capital.  Banks and the bond market will not lend to companies that are not well capitalized. Or at least they shouldn’t.

“Unlike debt, the beauty of capital is it has no maturity and dividends are voluntary.  Investors are owners.  Investors tend to forget the risks of ownership when a company’s valuation goes up (stock price rises), and then cry against Wall Street when a stock price declines. Well, welcome to capitalism…And a stock price is what the market values a company at a point of time and is the “price” at which a company may raise additional capital. No ponzi scheme, and at the heart of an efficient capitalist market where the cream always rises to the top, and the nonsense goes to the bottom. There are crooks that mismanage debt and equity, but that should not condemn all capitalism and America’s preeminent equity markets.  Wall Street has made America in to a great free market nation.  The Soviet Union did not have a stock market, and look where that got them…”  Pete

Here were my responses:

“I can tell you banks don’t make anything near the fees quoted” in a narrow Citi view this may be true, of conventional banks anyway, but it runs a wide gambit and the second tier bankers and bottom feeders who make up the majority of the US industry are greedy opportunists and regularly pocket proceeds in the ranges I described…I give examples below.

“Not even  on the wildest and most in demand Chinese IPOs” probably because China’s capital markets have tight controls to prevent obscene profiteering…they have a command economy that will go the distance because it keeps evolving forward…while ours has been deregulated and regressed backward.

“I know it is fashionable to take shots at Wall Street and unfortunately there is too much ignorance and lack of appreciation out there as to the importance of Wall Street” I agree on this part

“in keeping America strong and ultimately free” I don’t agree on this comment…it’s just old mantra…comfort speak. We’ve all become slaves to Wall Street…too many are jobless and too many have lost their retirement savings and too many have lost their homes for this notion to be credible any more. Waving the “freedom” flag in the current environment only makes one look foolish and out of touch.

“The equity markets are critical as a means, other than debt, for companies to raise funds to make investments, hire staff, etc”. I agree

“Companies require capital.” I agree

“Banks and the bond market will not lend to companies that are not well capitalized.” I agree

“Or at least they shouldn’t.” I strongly agree

“Unlike debt, the beauty of capital is it has no maturity and dividends are voluntary” this is what needs to change…free capital incents the wrong behaviors and has dangerous consequences.

“Investors are owners.” This is a fallacy, all they own is a piece of paper that only has value if another gambler will pay more for it in the secondary markets than they paid for it.

“Investors tend to forget the risks of ownership” true, but there’s no real ownership, so let’s stop telling people that there is…does the gambler at a casino own the cards he’s playing with, or own some real stake in the casino simply because he’s holding their cards to play? All secondary market financial instruments are simply gambling props

“Investors tend to forget the risks when a company’s valuation goes up (stock price rises),” always true

“and then cry against Wall Street when a stock price declines” always true, but that’s why in its early days you had to be a “qualified investor” to play in the stock markets.

“Well, welcome to capitalism”..amen! .

“And a stock price is what the market values a company at a point of time” no, that’s part of the mythology fed to the public…stock price is just what the last gambler paid on the speculation that another gambler wanting into the pool, or wanting to increase their stake in the pool, will pay more for it than you did…it’s important that the language starts to describes the reality or we can’t see the problems in order to fix them.

“and is the “price” at which a company may raise additional capital.” A myth for public consumption and not true for most companies. As an example, in a secondary public offering in 1999 my stock was trading between $9-$12 on good volume and the offering was oversubscribed, but when one institutional player placed a $7 limit on his buy order, all the others followed suit…we needed another round so had to hold our noses and do it at $7…or not get the money; the bankers had us over a barrel. We closed the day prior to the offering above $9 and went out the next morning at $7; it soon climbed back to $12…the bankers involved made a killing

“No ponzi scheme,” then Pete doesn’t understand the dynamics that qualify an activity as a pyramid (Ponzi) scheme, or won’t say the words because it’s his bread and butter, and saying the words might send him to jail…Wall Street qualifies as a pyramid (Ponzi) scheme in every dimension…but it’s Wall Street…you get in trouble for saying the words (the Emperor has no clothes) because a pyramid scheme can’t work if confidence is damaged.

“and at the heart of an efficient capitalist market where the cream always rises to the top,” Not true, many top stock market performers are just gambling props, ponies that first tier investment bankers pick from the masses to put on the track so gamblers can bet on them. Epiphany where I was SVP/CIO/Executive Committee was a prime example. Their bankers are ‘preeminent’ players who I deeply respect, so I won’t name them. They picked this little dinky start-up called Epiphany out of their portfolio and gave it some legs by rolling up another dinky little startup called Right Point in a paper only transaction that they ‘valued’ at $400 million—the combined companies only had two rudimentary software products (marketing analytics and customer relationship management), few customers, only $19.4M in revenues between them, were years away from breakeven or profitability, and were trying to squeeze into a crowded market space where Siebel and others were already dominant—so I have no idea where that valuation came from. They hired a ‘flash and dash’ CEO, the deputy-chairman and COO at KPMG Peat Marwick (my boss) who made it to the top by building up KPMG’s tax practice in silicon valley…a god on Wall Street. They then took Epiphany public selling 4.15M shares at $16 per share grossing $66.4M and netting the company $50M…Pete, that’s a 25% rake-off for the bankers up front. A few months later Epiphany bought Octane for $3.2B…yes billion…a software company with barely $3M in revenues and a single product that didn’t work—it had to be re-written. Yet the stock climbed to $317 per share during that transaction on pure speculation, not on any rational market value—it rose on the updraft created by these first tier bankers, nothing more—anything they did was golden, so analysts and investors follow them like sheep. They then did a secondary public offering raising a billion(?) and allowing many of the principle actors to pull out huge amounts of cash…my research hasn’t turned up total proceeds for the secondary or what the rake was, but Epiphany had $465M in post-tax cash sitting in the bank when I got there in January 2001…not bad for a little company with no profits and fewer than 125 customers. By April 2001 the stock was trading below $10 per share…the bankers and principle players had all made huge fortunes and were soon gone, moving on to place new ponies on the track and start the process anew. This is not atypical; it’s the standard transaction profile for first tier players…the best of the best on Wall Street. Now, no one was printing money, so whose pockets do you think the fortunes that were raked off from these transactions really came from? That’s right—you and me and the retirement funds we were counting on.

“and the nonsense goes to the bottom.” Hmmm…I’m not sure…there’s nonsense in all quadrants, as I’ve just demonstrated

“There are crooks that mismanage debt and equity,” always true… but what I’ve described above was perfectly legal…the daily practices of Wall Street…fleecing the sheep..

“but that should not condemn all capitalism” agree, but all capitalism is not Wall Street…Wall Street is only one component and needs to be re-regulated…I’m not saying to do away with it, just get it back in harness.

“and America’s preeminent equity markets” I once would have proudly agreed with this sentiment, but now  I’m embarrassed by the comment. We’ve exported those ‘preeminent equity markets’ to the rest of the world over the past thirty years to expand our speculative base, and now look at the mess they’re all in as well. The global reaction when all is said and done may be a move away from capitalism and I’d hate to see the alternatives they’ll come up with, so let’s fix capitalism before it’s too late.

“Wall Street has made America in to a great free market nation.” up until 1980 (before deregulation) I would have agreed with Pete, but we’ve since lost our way and the hole just keeps getting deeper

“The Soviet Union did not have a stock market, and look where that got them”…Pete is mixing metaphors here…and such a comment is simply a negative emotional appeal that distracts from meaningful problem solving. I don’t want anyone mistaking my views as anti American or anti capitalist. I’m as proud as any American…twenty-six years in the Air Force and Army Reserves serving my country…half that time with a challenging full-time executive job on the side. And I’m a capitalist through and through; but we need to pull off the blinders and fix the system before it devours the world. I’m worried for my kids’ future and what we’re leaving them. All paradigms have a classic ‘S’ curve; eventually you reach the top of that curve and the solutions that worked before don’t work anymore…American capitalism has reached the top of its curve and is hitting the classic stall point that all paradigms hit before they collapse—that’s if they don’t figure out how to make a paradigm shift resetting the curve. We’re headed toward a similar ending as the Soviet Union experienced  if we’re not careful. Their economy didn’t collapse because they had the wrong ideology; it collapsed because their paradigm was worn out and they didn’t evolve forward to deal with the tough fiscal realities of an over-the-hill economy. Our ‘free market’ paradigm is also worn out; just look at the current economic landscape—it’s over heated and coming apart. Ideological rhetoric isn’t going to fix it; more of the same isn’t going to fix it; waving the American flag isn’t going to fix it.  All parties meeting in the middle of the aisle for meaningful dialog, with a paradigm engineer like myself facilitating, is the only way we’re going to reverse this trend and find a path back to prosperity.

Peace…and thanks Pete for providing a foil so I can get some of this out of my system and down on paper…I hope we’ll continue the dialog. I’ll buy you a drink and dinner if you’re ever out this way. I really enjoyed my time at Citicorp/Citibank back in John Reed’s time. I’d be interested in your views of how it’s changed since then.