Most investment analysts tend to look at the corporations they cover through rose-tinted spectacles. You just have to look at the preponderance of "buy" and "hold" notes, as opposed to "sell" notes detailed in my earlier blog post 'Anonymous takes aim at the cozy world of investment analysis', to see how and why this happens. In this comfortable world of mutual back-scratching, CLSA's Mike Mayo stands out as the leading heretic.
While many of his peers appear to see their role as being to flatter the egos of over-weaning chief executives, and enable their colleagues in M&A, corporate finance, investment banking, etc. to win lucrative advisory work from the corporates that they cover, including the underwriting future IPOs and share offers, Mayo sees his role as being to tell it as it is.
Given the frame of mind with which it is written, it is unsurprising that much of the sell side research churned out by Wall Street and the City isn’t worth the paper it’s printed on (often, it simply regurgitates what management tells the analysts to write). It is, therefore, hugely refreshing that there is one banking analyst who has retained his integrity.
Mayo The Prophet?
Mayo – named as "One of Eight Who Saw The Crisis Coming" by Fortune magazine – was fired by former employers Credit Suisse in 2000 after writing a scathing 1,000 page overview of the banking sector, Banks and the Red Queen Effect, in which he advised investors to dump all their bank stocks.
Now he has written a more literary effort chronicling his two decades as one of America's leading investment analysts. Called Exile on Wall Street: One Analyst's Fight to Save the Big Banks From Themselves, the book describes Mayo's interactions with the likes of Jamie Dimon, of JP Morgan Chase and Chuck Prince, of Citigroup, and makes for fascinating reading. In it, Mayo summarizes his "simple as ABC" solution for resolving the banking sector's problems: (1) fix the Accounting, (2) put insolvent banks into Bankruptcy, and (3) reduce the Clout of banks.
In the book Mayo expresses outrage about the rewards for failure on Wall Street, and the damage these create for the broader economy. "That's not capitalism, that's entitlement," he said.
In an interview with Pundit Review Radio Mayo was particularly critical of Citigroup's pay policies, which he described as “reckless and rigged." In the interview Mayo said that:
"Because pay is based on earnings that can be manipulated, the threshold for incentive comp is ridiculously low, and if you get to 2014, they keep everything, just like what happened during the crisis. This encourages imprudent risk-taking. Citigroup should change this compensation programme immediately … I’m on my third cycle with Citigroup but still we’re seeing the same bad practices that should have been fixed a couple of crises ago.”
To me, it’s astonishing that institutions classified as G-SIFIs by the G20 - global systemically important financial institutions - are still pursuing similar goals and still incentivizing executives and traders, in the same way that they did before the last and previous crises. Mayo believes that the "see no evil" approach of other analysts played a big part in the stoking up of "excess in the markets” -- in that imperious and headstrong managers went largely unchallenged.
Mayo is, like me and many many others, more than a little disenchanted with the economic illiteracy of most bankers and the complicity of third parties including government, the accountancy profession and credit rating agencies in creating an environment where a blind eye was turned to risk taking. He outlined some of these issues in his remarkable testimony to Congress in January 2010. In his inaugural research note at CLSA in 2009, he detailed what he saw as the "Seven deadly sins" of the sector:
“The seven deadly sins of banking include greedy loan growth, gluttony of real estate, lust for high yields, sloth-like risk management, pride of low capital, envy of exotic fees, and anger of regulators.”
“I believe in the idea that we should have more alternatives within our capitalist system than what we’ve had, that we should not just accept the status quo. Enough already with what hasn't worked.”
Mayo also said that there are plenty of other people on Wall Street who want to see change.
“A lot of people on Wall Street are very frustrated with parts of Wall Street. Different operators operated on steroids -- and some of those operators blew up and tainted the industry."
Mayo is not infallible. Even though he made good calls by downgrading Bear Stearns and Citigroup in 2007, he did issue a "buy" note of Dick Fuld’s Lehman Brothers at the same time, and did not change his stance until the investment bank's stock lost 70% of its value. Soon afterwards Lehman was bankrupt. That caused interbank funding to completely freeze over, ushering in one of the worst phases of the current financial crisis.
For the sake of completeness, here are the edited highlights of an interview Mayo gave to Associated Press
Q: Are you on the same side as the Occupy Wall Street protesters?
A: I'm as outraged as them. I've been on the inside protesting for 20 years … The key difference between me and the protesters is that I believe in capitalism -- a capitalism that works.
Q: What's your view of capitalism?
A: Capitalism works when rules are put in place and strictly enforced, not when government looks the other way when rules are broken and then steps in to protect banks that cannot deal with the consequences of their bad decisions. Capitalism works when executives are rewarded for performance, not when the rules are written so that they walk away with fat pay checks even when things go wrong.
Q: Your employers wanted you to write positive reports about banks that your investment banker colleagues were courting for business. So they enticed you with lavish experiences. You write about having lunch in Credit Suisse's private dining room with delicacies prepared by celebrated chef David Bouley.
A: Yes. Here is the menu I saved from that day. [Mayo takes out a laminated copy of the gold vellum paper menu of the meal 12 years ago. It lists Chatham lobster, foie gras in poppy seed Armagnac sauce, and a dessert called tophenstreusel cloud with wild berries. In the book, Mayo says: "As I wiped the tophenstreusel crumbs from my mouth after events like this, I was increasingly conflicted, because I knew the source of these perks."] That was the best meal of my life.
Q: You say in the book that the former chairman of the Federal Reserve Paul Volcker is your hero. Why?
A: Paul Volcker was a harsh disciplinarian of the U.S. government when he made the incredibly difficult move of raising rates to kill inflation in the early 1980s. He didn't back down to political pressure at that time because he wanted to defend his ultimate goal. It was pain in the short term for a better end. Today, no one has that kind of guts. We need a Tiger Mom in charge of our economy. Paul Volcker was a Tiger Mom.
Mayo said that in a low-growth environment, such as the one we're currently living in, there is a big, big risk that other bank managements will follow the example of commodities derivatives brokerage MF Global and push for organic growth with crazily leveraged, risky bets. That's scary.
Further reading on Wall Street and how to reform it:
- It was not lack of regulation, but lack of ethics, that killed The Street by Ian Fraser
- Bringing Trust Back to Wall Street by Bill Hambrecht
- Hell hath no fury like a Wall Streeter scorned by Ian Fraser
Tags: accountancy , Accounting , Anonymous , Anonymous Analytics , capitalism , Chuck Prince , Citigroup , CLSA , Congress , corporate finance , Credit Suisse , David Bouley , Dick Fuld , G-SIFI , interbank funding , investment analysis , Jamie Dimon , John Wiley & Sons , Lehman Brothers , Los Angeles Times , MF Global , Mike Mayo , Occupy Wall Street , Paul Volcker , Pundit Review Radio , sellside research , underwriting , US Congress , Wall Street