Let’s start with some bank accounting ...

You’ve got a bank, its assets are $100 of loans, and its liabilities are $90 of deposits. Shareholders’ equity (assets minus liabilities) is $10, for a capital ratio (equity divided by assets) of 10%. Pretty normal stuff.
Then the assets go down: The loans were worth $100, but then interest rates went up and now they are only worth $85. This is less than $90, so the bank is insolvent, people panic, depositors get nervous and the bank fails. It is seized by the Federal Deposit Insurance Corp., which quickly looks for a healthy bank to buy the failed one. Ideally a buyer will take over the entire failed bank, buying $85 worth of loans and assuming $90 worth of deposits; borrowers and depositors will wake up to find that they are now customers of the buyer bank, but everything else is the same.
How much should the buyer pay for this? The simple math is $85 of assets minus $90 of assets equals negative $5: The buyer should pay negative $5, which means something like “the FDIC gives the buyer $5 of cash to take over the failed bank,” though it could be more complicated.
But that simple math is not quite right. If you pay negative $5 to take over a bank with $85 of assets and $90 of liabilities, you effectively get a bank with $90 of assets, $90 of liabilities and $0 of shareholders’ equity. That doesn’t work. The bank, in the first paragraph, in the good times, did not have assets that equaled its liabilities; it had assets that were $10 more than its liabilities. Banks are required — by regulation but also by common sense — to have capital, that is, shareholders’ equity, assets that exceed their liabilities. The buyer bank also has to have assets that exceed its liabilities, to have capital against the assets that it buys. If it is buying $85 of loans, it will want to fund them with no more than, say, $75 of liabilities. If it is assuming $90 of deposits, it will have to pay, like, negative $15 for them, which means something like “the FDIC gives the buyer $15 to take over the failed bank.”
This is a little weird. You could imagine a different scenario. The FDIC seizes the bank and sells its loans to someone — a hedge fund, or a bank I guess — for $85, which is what they are worth. Then the FDIC just hands cash out to all the depositors at the failed bank, a total of $90, which is the amount of deposits. At the end of the day there’s nothing left of the failed bank and the FDIC is out of pocket $5, which is less than $15.
The FDIC mostly doesn’t do this, though, for a couple of reasons. One is that usually banks, even failed banks, have some franchise value: They have relationships and bankers and advisers that allow them to earn money, and the buying bank should want to pay something for that. The value of a bank is not just its financial assets minus its liabilities; its actual business is worth something too. Selling it whole can bring in more money.
Another reason is that this approach is far more disruptive than keeping the bank open: Telling depositors “your bank has vanished but here’s an envelope with your cash” is worse, for general confidence in the banking system, than telling them “oh your bank got bought this weekend but everything is normal.”
Also there is a capital problem for the banking system as a whole: If the FDIC just hands out checks for $90 to all the depositors, they will deposit those checks in other banks, which will then have $90 more of liabilities and will need some more capital as well. Selling the whole failed bank to another bank for $75 will cost the FDIC $15, but it will recapitalize the banking system. The goal is to have banks with ample capital, whose assets are worth much more than their liabilities; the acute problem with a failed bank is that it has negative capital; the solution is for someone to put in more money so that the system as a whole is well capitalized again. Sometimes the FDIC puts in the money.
This morning the FDIC seized First Republic Bank and sold it to JPMorgan Chase & Co. My best guess at First Republic’s balance sheet as of, you know, yesterday would be something like this:
Assets: Bonds worth about $30 billion; loans with a face value of about $173 billion but a market value of about $150 billion; cash of about $15 billion; other stuff worth about $9 billion; for a total of about $227 billion at pre-deal accounting values but only $204 billion of actual value.
Liabilities: Deposits of about $92 billion, of which $5 billion came from JPMorgan and $25 billion came from a group of other big banks, who put their money into First Republic in March to shore up confidence; the other $62 billion came from normal depositors. About $28 billion of advances from the Federal Home Loan Bank system. About $93 billion of short-term borrowings from the Federal Reserve (discount window and Bank Term Funding Program). Those three liabilities — to depositors, to the FHLB, to the Fed — really need to be paid back, and they add to about $213 billion. First Republic had some other liabilities, including a bit less than $1 billion of subordinated bonds, but let’s ignore those.
Equity: The book value of First Republic’s equity yesterday was something like $11 billion, including about $4 billion of preferred stock. The actual value of its equity was negative, though; its total assets of $204 billion, at market value, were less than the $213 billion it owed to depositors, the Fed and the FHLB, never mind its other creditors.
Here is, roughly, how the sale worked:
Assets: JPMorgan bought all the loans and bonds, marking them at their market value, about $30 billion for the bonds and $150 billion for the loans. It also bought $5 billion of other assets. And it attributed $1 billion to intangible assets, i.e. First Republic’s relationships and business. That’s a total of about $186 billion of asset value. JPMorgan left behind some assets, though, mainly the $15 billion of cash and about $4 billion of other stuff.
Liabilities: JPMorgan assumed all of the deposits and FHLB advances, plus another $2 billion of other liabilities, for a total of about $122 billion. (Of that, $5 billion was JPMorgan’s own deposit, which it will cancel.) The subordinated bonds got vaporized: “JPMorgan Chase did not assume First Republic Bank’s corporate debt or preferred stock.” That effectively leaves the shell of First Republic — now effectively owned by the FDIC in receivership — on the hook to pay back the roughly $93 billion it borrowed from the Fed.
Payment: JPMorgan will pay the FDIC $10.6 billion in cash now, and another $50 billion in five years. It will pay (presumably low) interest on that $50 billion. So the FDIC will get about $60.6 billion to pay back the Fed, plus the roughly $15 billion of cash and roughly $4 billion of other assets still left over at First Republic, for a total of about $80 billion. First Republic owes the Fed about $93 billion, leaving the FDIC’s insurance fund with a loss of $10 billion or so. “The FDIC estimates that the cost to the Deposit Insurance Fund will be about $13 billion,” says the FDIC’s announcement, though “This is an estimate and the final cost will be determined when the FDIC terminates the receivership.”
Equity: JPMorgan is getting about $186 billion of assets for about $182.6 billion ($122 billion of assumed liabilities, plus $10.6 billion in cash, plus $50 billion borrowed from the FDIC), meaning that it will have about a $3.4 billion equity cushion against these assets.
JPMorgan was the highest bidder in the FDIC’s weekend auction for First Republic; Bloomberg reports that its bid “was more appealing for the agency than the competing bids, which proposed breaking up First Republic or would have required complex financial arrangements to fund its $100 billion of mortgages.” And this is a pretty high bid: JPMorgan is paying $182.6 billion, total, in cash and assumed liabilities, for a bank with about $180 billion of loans and bonds at their current fair value; it is paying a bit extra for the other assets and the intangible value of the First Republic franchise. Still, it is acquiring the total package of assets for less than they are worth. That discount is required so that JPMorgan can properly capitalize the assets, so that it can have enough capital against them. And that discount is paid for by (1) First Republic’s shareholders, preferred stockholders and bondholders, who are getting wiped out and (2) the FDIC, which is also taking a loss on the deal.
Another point of the deal is that the FDIC is entering into loss-sharing agreements with JPMorgan, in which the FDIC will agree to bear 80% of the credit losses on First Republic’s mortgages and commercial loans. You can sort of imagine a simple story here: First Republic is a failed bank, it made some bad choices, who knows if its loans are toxic, JPMorgan had only a weekend to review them, it is not comfortable taking the risk, so it demanded that the FDIC share in the risk.

@AndyJ, I was responding your comment while commenting on a broader context. Sorry that I should have link to your earlier post. In the last few months, the 1 and 2 yr treasury’s have been volatile, especially in March with the SVB and Signature. There was only 2 days when 2 yr Treasury went over 5.0% in March and it stays below that ever since.
The inverted yield curve makes prediction challenging beyond 2 years. As for fixed income investing, I like these bond funds:
Vanguard short term treasury index, ETF, VGSH, Avg effective maturities -2.0 years, 30 days SEC yield - 4.43%.
Taking on a bit more on credit risk,
Vanguard short term corporate index, ETF, VCSH. Avg effective maturities - 3.0 yr, 30 days SEC yield - 5.22%.
I like your approach for potential cap gain for longer duration bond finds such as BND and BOND. Since the beginning of this year, I have invested back into BND and DODIX on dollar cost verage basis. If the FED is near the end of rate hike, bonds in general will do okay. If the FED starts to cut rate, the intermediate-term bonds will be in good position to have good capital gain.

Next week, the FED is likely to hike another 25 bps rate. In light of the banking turmoil, that may be the last rate hike the rest of the year. I think it is too optimistic to expect the FED to cut rate soon unless the economy falls into s severe recession.
I think that's right. About the rest of your post:
I'm holding intermediate-term junk.
Effective duration on PRCPX is down to 3.41 years. I just checked. The portfolio manager has moved shorter than before. Yield = 6.03%.
TUHYX effective duration =4.15 years. Yield = 6.62%.
I'm still enjoying the ride. Share price has crept up, too.
Source: Morningstar.

I was personally affected when in 2015 Prospect Medical Holdings ( owned by Leonard Green a PE firm) bought our CT hospital after two previous publicly traded companies "suitors" ( hoping to buy both hospitals in town) had been chased off by the left wing Democratic Governor. The hospital was close to going under.
The two previous offers were to build an entirely new hospital and combine both institutions, so they would not longer undercut each other in our small city. These offers were far superior and could have been much better monitored because they involved public companies and a pension fund. Unfortunately, the CT governor was beholden to our hospital union and threw up all sorts of crazy conditions, so they backed out.
We got all sorts of promises about capital infusions etc from Prospect but none materialized.
We sold our practice to the hospital/Prospect in 2018. At the physician level Prospect was fairly benign, although they refused to buy any new equipment like scanners and computers. I retired, in 2019 after 40 years of practice that I loved, because the electronic medical record required me to work to 9PM just entering data. They refused to pay $20 an hour to hire a scribe to help me. It was apparently far more efficient to make a physician do the work of a clerk. Both of my replacements have quit in less than a year.
Since then, Leonard Green had Prospect to borrow $1.2 Billion in 2019. Prospect paid Green and the chief executive a $675 million dollar dividend. Prospect CEO alone got $90 million. To pay the loan back, Prospect sold all their hospitals to Medical Properties Trust (MPW) and then leased them back. By 2021 they had stop paying rent, and MPW stock is down to $8 from $25.
Two Prospect hospitals in Delaware ( one the only source of care for 80,000 people I think) and three in Texas have closed completely. Rhode Island AG refused to let them sell the two there until they put up $80 million in escrow.
MPW is unloading the CT hospitals to Yale New Haven Hospital for the amount it paid for them in 2020, because Yale doesn't want the other big CT system, Hartford Hospital to get them. The hospitals in Delaware and Texas are closed for good.
As I have posted before, ProPublica has done an excellent series on Prospect documenting the millions Green got, but Prospect didn't have cash to buy gas for the ambulances.
https://www.propublica.org/article/rich-investors-stripped-millions-from-a-hospital-chain-and-want-to-leave-it-behind-a-tiny-state-stands-in-their-way
Another excellent source on the abuses of PE I have found is
https://pestakeholder.org/

The movement of the short and long duration yields is independent to each other. The longer end is determined by the market while the short end is controlled by the FED’s rate. It is counterintuitive to extend duration toward the intermediate duration, ~5-7 years. Treasury yield curve is still inverted and the probability of having 2yr yield at 5% is nearly nil. However, IG bond funds with short- and intermediate- duration are yielding 5%.
Next week, the FED is likely to hike another 25 bps rate. In light of the banking turmoil, that may be the last rate hike the rest of the year. I think it is too optimistic to expect the FED to cut rate soon unless the economy falls into s severe recession.

/3
In 2017, Snap Inc. went public by selling non-voting stock; only founders and insiders would get any votes at all. Investors complained, and also bought the stock, because they didn’t want to miss out on a hot initial public offering. (It’s down more than 40% since its IPO, oops.) But then some index providers — FTSE Russell and S&P Dow Jones — changed their rules to exclude or limit dual-class stocks from many of their indexes. The investors had solved their collective action problem; they had found a way to impose economic penalties on companies with dual-class stock.
It didn’t work. Companies kept going public with dual-class stock. They didn’t care that much about missing out on the indexes; their founders were willing to pay the economic price to keep control. (In particular, companies don’t generally get added to the S&P 500 the day they go public; a lot of index demand is not for shares in the IPO but later on, meaning that it doesn’t directly affect the IPO price.) This means that the investors’ solution ended up being bad for them: They credibly committed to not buying dual-class stock of hot companies, hot companies kept going public with dual-class stock, index funds couldn’t buy those stocks, and they were sad.
The solution was to give up. Last week S&P Dow Jones announced that dual-class stocks are fine again: “Effective April 17, 2023, all companies with multiple share class structures will be considered eligible candidates for addition to the S&P Composite 1500 and its component indices,” including the S&P 500. Here’s a Davis Polk & Wardwell LLP client memo from last week:
In response to Snap Inc.’s IPO in which only non-voting shares were offered to the public, the Council of Institutional Investors and others had lobbied the major index providers to bar non-voting shares from their indices, arguing that absent this change, passive investors such as index funds would be forced to invest in non-voting shares that erode public company governance. As a result, since July 31, 2017, S&P Dow Jones has excluded companies with multiple share classes from the indices comprising the S&P Composite 1500.
The decision to revisit index eligibility criteria comes after a consultation process that S&P Dow Jones ran with market participants from October to December 2022.
In 2017, investors noisily complained that they were being forced to buy dual-class stocks, so S&P kicked the dual-class stocks out of the indexes. In 2022, investors noisily complained that they were being forced not to buy dual-class stocks, so S&P let them back in.
Oil rigging
I loved Liam Vaughan’s and Lucia Kassai’s Bloomberg Businessweek story last week about corruption in Venezuelan oil auctions, in part because it is two almost entirely separate stories of corruption. For starters, there are the Venezuelan oil auctions. Venezuela’s state oil company, Petróleos de Venezuela SA, would sell various oil products in auctions, and big oil trading firms would hire a consulting firm named Helsinge, run by a guy named Francisco Morillo, to help them win the auctions. The way he allegedly helped them win was (1) he bribed PDVSA insiders to tell him about the other bids, (2) he shared those bids with his clients, (3) the clients topped those bids by a penny and (4) they paid him enough to cover the bribes with some profit for himself:
In one series of chats from March 14, 2006, Morillo, using the screen name George White, guided three prominent commodity traders—Maarraoui at Vitol, Gustavo Gabaldon at Glencore and Maximiliano Poveda at Trafigura—through auctions for fuel oil and a product called vacuum gas oil, which is used to make gasoline. At 9:51 a.m., nine minutes before the offers were due, Morillo shared details of the bids PDVSA had received for the vacuum gas oil—information PDVSA says is supposed to be confidential. Five minutes later he informed the three traders, via separate chats, of a late bid for the fuel oil.
The traders didn’t enter every auction, but when they did bid, the information Morillo had provided let them know at what price to do so. On March 20, 2006, after learning about offers from BP Plc and two other companies, Maarraoui placed a bid to buy gas oil at 0.8¢ per gallon more than the next-highest bidder. Two days later, Poveda won a liquefied petroleum gas auction after being told about two rival offers and besting them by a cent.
These conversations, a handful among thousands, demonstrate how valuable Helsinge’s service was to its customers—and how potentially devastating it was to the Venezuelan people. If Morillo’s clients had been forced to enter the market blind, they likely would have placed some bids at $5 or $10 per metric ton higher than they needed to, as the chats show their competitors did. Instead the traders were able to win auctions they entered by a dollar or less, saving as much as $1.5 million on a typical 150,000-ton cargo. According to the Boies complaint, they’d pay Helsinge about $300,000 on a shipment of that size. PDVSA declined to provide data to Businessweek on the outcome of its auctions, or to comment for this story, but given that the company conducted dozens of auctions each month as buyer and seller, and that Helsinge was in business for 15 years, it’s conceivable Venezuela lost out on several billion this way.
Also, if you keep doing this, eventually you’re going to drive everyone else out of the auctions, further depressing prices:
Traders from two oil companies told Businessweek that they’d stopped participating in PDVSA’s auctions because they were sick of losing to the same players. “Putting together an offer takes time. You need to figure out the economics, freight, insurance, the hedge, then submit to your compliance, get signatures from God knows who before you’re able to submit a number,” says one of the individuals, who asked not to be identified. “After a while we just gave up. It became clear to us that something funny was happening.”
This part of the story includes some classics of the “don’t put it in writing” and “don’t refer to bribes by cutesy nicknames” genres:
As well as routinely passing along information, [PDVSA commercial and supply unit manager Rene] Hecker talked to Morillo about the need to encrypt their conversations and about an offshore company he’d set up in Panama. In one message, Hecker sent Morillo banking information for his father-in-law, known as Gigante, writing in the subject line, “chamo elimina estos archivos despues please” (“dude delete these files later please”). Before Christmas 2004, Gigante received two payments totaling $400,000, Morillo’s bank statements show.
/3

/2
I said above that the few hundred million dollars that Bed Bath raised by selling 622 million shares of stock since it started preparing for bankruptcy “was not enough” to solve its problems, but it’s actually a bit worse than that. Bed Bath’s bankruptcy filing tells a story in which the company got into a bad place due to a combination of pandemic/supply-chain issues and its own management mistakes; in particular, its former chief executive officer pushed private-label brands instead of the well-known brands that its customers wanted. Bed Bath realized its mistakes and began correcting them — that CEO “was excused on June 29, 2022” — but that takes money; “the Company needed real runway to turn around its inventory and liquidity position.”
But the story is not that it then went out and raised several hundred million dollars to build up its inventory and make its business more attractive. No, the story is that it went out and raised several hundred million dollars to hand directly to its creditors:
Unfortunately, under the terms of the Second Amended Credit Agreement, the Debtors were required to use the net proceeds from the initial closing of the [Hudson Bay] Offering, along with the FILO Upsize, to repay outstanding revolving loans under the Debtors’ Prepetition ABL Facility, including repayment of the nearly $200 million overadvance. At this point the Company’s sales had dropped 60% on a comparable store basis, resulting in substantial ongoing losses from operation; therefore, the remaining Offering proceeds went to cover operational losses rather than to restoring inventory levels. …
The net proceeds from the B. Riley ATM Program were used to prepay outstanding revolving loans under the Debtors’ Prepetition ABL Facility and cash collateralize outstanding letters of credit, resulting in new credit under the Debtors’ Prepetition ABL Facility. ...
The Debtors’ cash burn continued while sales further declined due to lack of incoming merchandise, thus, preventing the Debtors from implementing their anticipated long-term operational restructuring while satisfying their restrictive debt obligations.
That is, Bed Bath had an asset-based lending facility (its most senior debt) and a first-in-last-out term loan (effectively its second-most-senior debt); as of November 2022, it had borrowed $550 million on the ABL (plus $186.2 million of letters of credit) and $375 million on the FILO. As of Sunday there was $80.3 million outstanding on the ABL (plus $102.6 million of letters of credit) and $547.1 million outstanding on the FILO.[3] Since this all began, Bed Bath has raised a bit more than $400 million from shareholders and handed about $300 million of it directly to its lenders, while the business collapsed and it had no money to fix things. Now it will hand the rest of its money over to the lenders.
I don’t know what to say? All of this was quite well disclosed. Back when Bed Bath did the Hudson Bay deal in January, it said in the prospectus that it intended to use all the money it raised to repay debt, and that if it didn’t raise a billion dollars in that deal (it did not) then it “would not have the financial resources to satisfy its payment obligations,” it “will likely file for bankruptcy protection,” “its assets will likely be liquidated” and “our equity holders would likely not receive any recovery at all in a bankruptcy scenario.” All of the legal documents were pretty clear that Bed Bath was raising money by selling stock to retail investors, that it was handing that money directly to its creditors, that the money probably wouldn’t be enough, that Bed Bath was probably going bankrupt, and that when it did the stock that it had just sold to those retail investors would be worthless. And things have worked out exactly as promised. No one can be surprised!
And yet it is one of the most astonishing corporate finance transactions I’ve ever seen?[4] The basic rules of bankruptcy are:
When a company is bankrupt, the shareholders get zero dollars back, and the creditors get whatever’s left.
The shareholders don’t get less than zero. They don’t put more money in.[5]
Here, I mean, Bed Bath was kind of like “hey everyone, we went bust, sorry, but our lenders are such nice people and they could really use a break, we’re gonna pass the hat and it would be great if you could throw in a few hundred million dollars to make them feel better.” And the retail shareholders did! With more or less complete disclosure, they bought 622 million shares of a stock that (1) was pretty clearly going to be worthless and (2) now is worthless,[6] so that Bed Bath could have more money to give to its lenders when it inevitably liquidated.
I have over the past few years been impressed by AMC Entertainment Holdings Inc.’s commitment to the meme-stock bit. In particular, AMC’s management was early and aggressive in realizing that being a meme stock could be a tool of corporate finance, that when people on Reddit are bidding up your stock for no clear reason, the correct reaction is not to chuckle in disbelief but to sell them stock. But AMC at least has a story; AMC is using its meme investors’ money to pay down debt, sure, but also to keep its theaters open and buy a gold mine.
No, this is the peak of meme stocks. Bed Bath & Beyond sold 50 million shares a week for three months with, as far as I can tell, no story, no plan, nothing but “a troubled financial situation and nostalgia value.”[7] Bed Bath saw that its retail shareholders wanted to throw their money away, and that its sophisticated lenders wanted to get their money back, and realized that there was a trade to be done that would make everyone, temporarily, happy. So it did the trade. It’s amazing. The lawsuits are gonna be great.
Dual-class stock
Most investors would prefer not to have dual-class stock. If a company has two classes of common stock, one of which has a lot of votes and is held by the founders and the other one of which has fewer votes and is sold to the public, then that’s bad, for you, as a big public shareholder. If you’re buying 5% of a company you’d like to get 5% of the votes, so that if you get dissatisfied with management you can push for change and they’ll have to listen to you.
But it can be a little hard to insist on this preference. Most of the time, if things work out well or even adequately, your voting rights just won’t matter very much. If some hot tech company is looking to go public with dual-class stock so that its visionary founder can keep control forever, and you like the visionary founder, you will want to own the stock even with no voting rights, and if you insist on voting rights, the visionary founder can say “well I don’t need your money anyway, lots of other people want to invest.” There is a collective action problem: Most investors would like voting rights, but it’s not at the top of their list, so anyone who refuses to buy dual-class stock will end up missing out on a lot of hot deals.
This means that, if you are a visionary founder looking to go public, there’s not much downside to having dual-class stock. “Investors won’t like it,” your bankers will tell you, and you will ask “well how much less will they pay for the stock if it’s dual-class,” and the bankers will be forced to reply “well they’ll pay the same price but they’ll grumble about it to the press.” Who cares? If there is no visible economic penalty for having dual-class stock, lots of founders will want it.
There is, however, at least one way for investors to act collectively to address this problem. Sort of. Companies, and founders, want to be in stock indexes, because there is a lot of money there: Trillions of dollars are managed in indexed strategies, and trillions more are in funds that are benchmarked to indexes and tend to invest in companies in indexes. So there is an economic penalty for companies that are not eligible for the indexes. And index eligibility rules are set by index providers like S&P Dow Jones Indices and FTSE Russell. Those companies can change their rules if they want. Those companies’ clients are investment managers who use their indexes. And the index eligibility rules are, to some extent, a matter of customer service and marketing: Index rules are not just about the abstract pursuit of truth (“What does it mean to be a large-cap company in Europe, the Middle East and Africa? How do we make sure all of those companies are in our index?”), but also about providing a useful product for your customers (“What list of large-cap EMEA companies do large-cap EMEA index fund managers feel like they should invest in?”).
And so if all the investment managers hate dual-class stock, they can quietly call up the index providers and say “hey it would be helpful for us if you ban dual-class stocks from the index, because then none of us could buy them and our collective action problem would be solved.”
/2

"Mr. Ballou is an attorney and the author of the forthcoming 'Plunder: Private Equity’s Plan to Pillage America,' from which this essay is adapted."
Not to be confused with: "Financial journalist Gretchen Morgenson explain[ing] how private equity firms buy out companies, then lay off employees and cut costs in order to expand profits. Her new book is These are the Plunderers."
Fresh Air interview with Gretchen Morgenson, April 26th, transcript and audio:
https://www.npr.org/2023/04/26/1172164997/how-private-equity-firms-are-widening-the-income-gap-in-the-u-s
Morgenson's book was released one week before Ballou's. Curious timing and similarity of titles. Both authors use the same ManorCare example in their excerpt/interview.
If the MOs of these firms sound familiar, there's a reason. It's a rebranding. Morgenson says: "Private equity firms are what used to be called leveraged buyout funds and firms". Yes, it's still going on, and has been going on for decades.
The revolving door that Ballou describes in the excerpt quoted swings both ways. It's not just PEFs hiring " former chiefs of staff, counsels and legislative directors".

Gross: [Trump] appointed Jay Powell to head the Federal Reserve. What's Jay Powell's connection to PEFs?
Morgenson: Jay Powell was an executive - a high-ranking executive at the Carlyle Group in Washington for several years. So he definitely has, you know, the mindset of private equity. Donald Trump also had, as a very high-level adviser to him, Steve Schwarzman, who is the co-founder of the Blackstone Group. You would often see Steve at Donald Trump's, you know, right or left hand when they were having meetings about business. So, you know, these firms do have a lot of clout and power in Washington.

@BenWP- well, at least you're in good company- @rono, @hank, and @Catch22 for starters. And I have to tell you that when we were younger, over a number of years we covered a huge swath of Europe with a good sized group of Michiganders and Michigeese, and they were just great people.

@Old_Joe - He was an investor, not a saint. But I agree with you that religion’s a funny thing. Templeton wore his religion well. Was it genuine? I believe so, but who knows? And the comments above about Bhopal haven’t escaped me. I suspect that today (50 years later) he might be scoffed at for being so overtly religious. Different periods and cultures.
Among the giants that appeared often on Rukeyser’s show in the ‘70s & ‘80s were Templeton, Peter Lynch and Henry Kaufman. What Templeton lent was a belief / message that over long periods individual investors would be rewarded for saving and investing for the future. In the long run the country and mankind worldwide would prosper and investments in equities were a road to participation in that wealth - a way to raise the living standards of the masses. Of course, it hasn’t turned out that way for various sundry reasons. But that was the message, and I think he really believed it.
Geez - Have another book about Templeton loaded into my Audible library. Generally fall asleep nights absorbing either finance or astro-physics, both of which I find intriguing. Have listened to Howard Marks a lot and to a nice biography on Buffett. I try to glean what wisdom I can from any source, even though I might loath some aspects of their lives.
PS - Thanks for commenting.

First Republic, Part 2:

The other option is “do nothing.” First Republic reported earnings on Monday, and they were legendarily awful:
Across the industry, First Republic’s quarterly earnings report on Monday has come to be regarded as a disaster. The firm announced a larger-than-expected drop in deposits, then declined to take questions as executives presented a 12-minute briefing on results.
But First Republic reported a profit. The problem, for First Republic, is that lots of its low-interest deposits have fled, and it has had to replace their funding by borrowing from the Fed, the FHLB and the big banks at much higher rates. Meanwhile it still has lots of long-term loans made at low interest rates. If you borrow short at 0% to lend long at 3%, and then your short-term borrowing costs go up to 5% while your loans stay the same, you will be losing 2% a year on your loans, and that is roughly the state that First Republic finds itself in. But it is not exactly the state that First Republic finds itself in: It still has some cheap insured deposits, some short-term assets, some floating-rate assets, some fee income, and in fact it has managed to scrape out a profit even as rates have moved against it. Can that last? I mean, maybe not:
The deposit run has forced First Republic to rely on other, more expensive funding. That makes it hard to generate interest income, and at some point it might not be able to.
“They’ve never been super profitable,” said Tim Coffey, managing director and analyst at Janney Montgomery Scott. “Now you’re not growing and you’re layering on really high borrowing and funding costs.”
But a bank can stay in business even with some quarterly losses, as long as it remains well capitalized, and as a technical matter First Republic has enough capital to withstand some unprofitable quarters. And if you muddle along for long enough, the situation can right itself: The long-term low-interest loans will roll off and be replaced with higher-interest new loans, and First Republic’s interest margins will start to expand again. It might work! If you are a First Republic shareholder, “do nothing and hope the business recovers” is clearly the best option.
Of course deposits might keep flowing out, but so what? First Republic is now funded in large part with loans from the Fed and the FHLB, and I suppose they could just lend it some more money. When Silicon Valley Bank failed, the Fed put in place a new Bank Term Funding Program that was designed for more or less this purpose: The BTFP lets banks borrow against their assets without taking into account interest-rate losses, so that they can replace fleeing deposits with loans from the Fed. US regional banks spent years in a low interest rate environment, they were caught out by a rapid rate hiking cycle, and the Fed responded to that problem by lending them money to smooth out the transition.
The advantage of doing nothing is that nobody has to take any losses now. But the regulators seem to want to move. Bloomberg again:
The clock for striking such a deal began ticking louder late last week. US regulators reached out to some industry leaders, encouraging them to make a renewed push to find a private solution to shore up First Republic’s balance sheet, according to people with knowledge of the discussions.
The calls also came with a warning that banks should be prepared in case something happens soon.
And one way for something to happen soon is if the Fed stops lending to First Republic:
As weeks keep passing without a transaction, senior [FDIC] officials are increasingly weighing whether to downgrade their scoring of the firm’s condition, including its so-called Camels rating, according to people with direct knowledge of the talks. That would likely limit the bank’s use of the Fed’s discount window and an emergency facility launched last month, the people said.
Why? Why close a bank and take billions of dollars of losses if you don’t have to? The consequences of doing something are obvious and bad; the consequences of doing nothing are a bit more diffuse.
But let’s talk about some of them. One is that there are legal limits on the Fed’s ability to keep propping up First Republic. I mentioned the BTFP, the Fed’s post-Silicon Valley Bank program that lends to banks at 100% of the face value of their collateral, even if that collateral has lost money due to rising interest rates. But only US Treasury and agency securities are eligible to be BTFP collateral, and First Republic’s assets are mostly loans. Those loans tend to be pretty safe — they are mostly mortgages to rich people — but they are very exposed to interest-rate risk, so they have lost a lot of value. And it can’t use them to borrow from the BTFP.
Meanwhile these loans are eligible collateral at the Fed’s discount window, its more standard lending program, but the discount window lends against the market value of collateral, and these loans have lost a lot of value. If deposits keep fleeing from First Republic, its ability to replace those deposits with Fed loans depends on the market value of its assets, which means it might run out of capacity. If the FDIC is worried about that happening sometime soon, then there is some urgency to do something first.
More generally, the theory of central banking is that central banks should lend to solvent banks, but not prop up insolvent banks. The Fed’s statutes limit its ability to lend to undercapitalized banks. In some obvious economic sense, First Republic is undercapitalized — its assets are worth less than its liabilities, which is why we are talking about this — but legally it is fine and has plenty of regulatory capital.
But at some point, if the regulators conclude that First Republic is not viable, it is at least, like, embarrassing for them to keep lending it money. In the limit case, if all of First Republic’s deposits fled, you could imagine the Fed lending it $210 billion (up from its current $105 billion of Fed/FHLB money) so it could continue to limp along. But that’s bad! You don’t want a bank out there doing business, making loans, paying executive salaries, that is entirely funded by the Fed. You need some private-sector endorsement of the bank for the Fed to keep supporting it.
Also: The losses have already happened. First Republic made loans at low interest rates, now interest rates are higher, and so its loans are not worth what they used to be. As an accounting matter, those losses don’t have to be recognized yet; First Republic’s balance sheet is still technically solvent, and it can muddle along for a while. But economically the difference between “the banking system reports billions of dollars of losses today and then normal profits afterwards” and “the banking system bleeds these losses into lower accounting profits for the next few years” is not that great, and the former is more clarifying.

Annual pace decelerates to just 1.1% as fears of recession this year grow despite strong consumer spending
Following is a current report from The Guardian:

US economic growth slowed sharply in the first quarter of the year, despite strong consumer spending resilient to interest-rate rises designed to tame historic inflation.
The latest GDP figures released by the US commerce department show that the world’s largest economy slowed sharply from January through March, to just a 1.1% annual pace as businesses reduced inventories amid a decline in housing investment. The abrupt deceleration from 2.6% growth in the final three months of 2022 and 3.2% from July to September came in significantly under economists’ expectations of a 2% increase.
The figures indicate that aggressive interest rises designed to tame inflation are beginning to produce what US central bankers desired – a slowing economy coupled with reduced wage increases and a tighter job market without tipping it into outright recession.
“The data confirm the message from other indicators that while economic growth is slowing, it isn’t yet collapsing,” said Andrew Hunter, chief US economist at Capital Economics. “Nevertheless, with most leading indicators of recession still flashing red and the drag from tighter credit conditions still to feed through, we expect a more marked weakening soon.”
Resiliency in consumer spending, which rose 3.7%, reflected gains in goods and services and came as business investment in equipment recorded the biggest drop since the start of the pandemic in 2020 and inventories dropped the most in two years.
The Federal Reserve has indicated that while it has slowed the rate of interest rises, it expects commercial lenders, buffeted by the collapse of two regional banks this year, to tighten lending standards.
Many economists say the cumulative impact of Fed rate hikes and tighter lending requirements have yet to work their way through the system, presenting central bankers with a dilemma over whether to continue raising rates.
“The last thing the Federal Reserve wants to be doing is raising rates as the economy begins to grind to a halt and potentially exacerbating the situation,” said Marcus Brookes, chief investment officer at Quilter Investors. “The coveted soft landing is looking increasingly difficult to achieve and we are now getting towards a position where the market may become concerned that stagflation could be a likely possibility.”
There is widespread skepticism that the Fed will succeed in averting a recession. An economic model used by the Conference Board, a business research group, puts the probability of a US recession over the next year at 99%. That expectation is compounded by political risk, given congressional Republicans could let the US default on its debts by refusing to raise the statutory limit on what it can borrow. Wider global economic conditions are also in play.
Earlier this month, the International Monetary Fund downgraded its forecast for worldwide economic growth, citing rising interest rates around the world, financial uncertainty and chronic inflation.
The IMF chief, Kristalina Georgieva, said global growth would remain about 3% over the next five years: its lowest such forecast since 1990.

”Keys to Investment Success” - from John Templeton
This audio book sounds like it was recorded in the 1980s. A one-on-one interview, very “rough around the edges” - perhaps conducted over the phone. I bought it for $3.99 and have listened to the first half so far. About an hour long. Templeton was my first fund manager when I was just starting to contribute to my workplace plan in the 70s. The fund was TEMWX. He was also founder and head of Templeton World Funds.
- He’s big on Union Carbide
- U.S. Steel has fallen in price, but is still too expensive for his taste
- “Do-it-yourself” small investors don’t have a chance compared to a good mutual fund with its depth of research and analytical capabilities.
- He thinks no-load funds should not be allowed. His reasoning is that without the assistance of “dedicated professionals” (salespersons) retail investors would make poor decisions in buying funds that don’t meet their individual needs. And also, having not paid a load would entice investors to jump from fund to fund and forsake the rewards of long term investing.
- He thinks 5 years is the reasonable time frame to expect to profit from a good equity fund. He says it would be extremely rare not to make a profit in one of his firm’s investment portfolios over a 5 year period, based on historical averages.
- His style sounds deep value. The best investments are those whose price has been trashed and which have long been out of favor / shunned “by everyone else.” However, he’s more than willing to grab off a quick profit and sell a recent acquisition if the price rises quickly.
- He doesn’t like bonds / bond funds for long term investment, being quite adamant that equities will outperform over longer periods.
- He and the investment committee move from investing style to investing style in an attempt to stay ahead of the crowd. Once everyone adapts a successful style of investing, it ceases to be effective. He refused the interviewer’s request to detail any one new style under consideration, saying that if he revealed it, it would be less effective as others moved to mimic it.
- He prays frequently for guidance in making correct investment decisions and leads off staff meetings with prayer.
- According to the intro, Sir John resides (resided) in the Bahamian Islands while running Templeton Funds.
An interesting look back in time. Some of Templeton’s views may provoke ridicule or ire among today’s investors. For his time, Templeton was a giant in the mutual fund world. Templeton Funds were later acquired by Franklin. ISTM that’s also about when their earlier years stellar performance ceased.

Amazon Link
”Money magazine in 1999 called him "arguably the greatest global stock picker of the century". Templeton attributed much of his success to his ability to maintain an elevated mood, avoid anxiety and stay disciplined.” Wikipedia

@catch22 - Agree. As you know, I dwelt in the Detroit metro / Pontiac area near 30 years. There was an added degree of safety in wearing a cheap wrist watch, a pair of trousers from K-Mart and driving an inexpensive vehicle. There was a common wisdom back then that said don’t stop for red lights at night in and around Detroit.
Well, I was wishing for some activity in markets. More movement today. Wrong direction in most cases. Metals & miners very weak in the AM. Recovering some lost ground in afternoon.

"In talking with Vanguard leadership, they feel like they’ve heard that and they’re trying to become known for best-in-class customer service. That is a goal of theirs, and they say they’ve made progress in that. It remains to be seen. We hear a lot of comments from that here at Morningstar. "
There have been customer service issues at Vanguard for years.
The firm was aware of these issues yet customer problems continue.
I seriously doubt Vanguard will be able to provide anything resembling best-in-class customer service.

Comment from Mr. Lucas (Vanguard):

Lucas: Customer service complaints have always been sort of a feature of Vanguard’s history. If you go back to the days when Bogle led the firm—this is a point that I made at that conference—there were lots of complaints over the years about Vanguard’s customer service. I like to compare Vanguard to, say, those of you who shop at Aldi. If you go to Aldi, you have your quarter, you get your grocery cart, you bring your own bags or you put it in boxes. I would say Vanguard has got more customer service ethos than that, but it is something where it’s not necessarily been known for high-touch customer service. And it is trying to become a leader in customer service and to really improve its technological offer.
So, what Vanguard is trying to do is, because it has experienced over the course of its history and continues even in this first quarter, experienced such asset growth, it’s trying to enable investors to do as much as they can as simply as they can online, so without talking to a human advisor. And they’ve really made investments in technology. They’ve modernized their technology platform, and they’ve seen increased resiliency and increased customer service scores.
The big snafu they made in 2020 was—this is Vanguard, they’re always thinking about investor assets and costs and trying to save money on behalf of investors—so, in 2020, when the market turned down, they stepped back and they looked and they saw that historically when the market falls, client communications sort of fall off a cliff. So, they actually slowed their hiring of customer service representatives right at a time when—in fact, what happened with the lowering of interest rates is that investor demand shot up and that caused, I think, significant wait times and lots of frustration. They have normalized that, and I think are committed to sort of being a little bit more, call it, I don’t know if cautious is the right word, but they’re going to be more prone to overspend and I think on what they expect they will need to try and improve customer service. In talking with Vanguard leadership, they feel like they’ve heard that and they’re trying to become known for best-in-class customer service. That is a goal of theirs, and they say they’ve made progress in that. It remains to be seen. We hear a lot of comments from that here at Morningstar. But the big thing always to keep in mind is that Vanguard serves a lot of customers. So, you’d expect that some of them would be frustrated. And I’ve heard both success stories and stories of frustration, and we’ll see if the stories of frustration are minimized over the coming years.

Seriously, Vanguard has to catch up to where they were in terms of customer service. There is no replacement to having human touch in communication of their needs. Having a robust interface on the website is one thing, but not everyone can fully take advantage of that feature. So Vanguard still have a way to go in order to catch up with Fidelity and Schwab.

Difference between short and long-term thinking. Banks CEOs like most CEOs of publicly traded companies often only think from quarter to quarter. To accept zero yields in 2020 and 2021 as Buffett did would be unacceptable to such CEOs trying to hit quarterly earnings estimates in 2020 and 2021 and collect their sizable bonuses for hitting those quarterly numbers. Ultimately, such short-term thinking is bad for everyone but the CEOs and the analysts setting the earnings targets. Investors suffer as Buffett rightly pointed out. But society suffers as well. Banks go bust, we bail them out, people lose their jobs, etc.
Vanguard’s John Bogle called this the “agency society” in which the agents of investors, i.e., executives are the only ones who benefit. This problem could be alleviated if CEO bonuses and other compensation were shifted from short- term ones to long-term ones based on, say, a company’s three-year or five-year profitability and if analysts and Wall Street in general stopped being so short-term oriented. Raising the taxes on short-term capital gains from 20% to 30% or even 40% and lowering the taxes on long-term gains for stocks held 5 years to 15% or even 10% might “inspire” or incentivize Wall Street analysts, traders and money managers to think differently.
Importantly, most of Buffett’s wealth comes from his long-term ownership of Berkshire stock. His salary is minimal and I don’t think he receives a quarterly bonus.

”In a recent CNBC interview, Berkshire Hathaway (BRK.A) CEO Warren Buffett criticized banks for investing in mortgage securities at historically low yields, calling them a ‘very dumb holding for banks.’The problem for mortgage securities holders is that effective maturities lengthen when interest rates rise, the opposite of what the banks want. It leaves banks with relatively low yielding portfolios for potentially long periods. BofA's bond holdings yield about 2.6%, which could weigh on its returns, particularly if it has to pay more for deposits. The portfolio has an estimated average life of eight years. Unlike the banks, Berkshire chose to invest its cash of over $100 billion largely in short-term U.S. Treasury bills. It accepted rates near zero in 2020 and 2021 but is now getting 5% on its holdings. If Bank of America had taken more of a Berkshire-type approach, it now could be earning twice the current rate. Berkshire is Bank of America's largest investor, with a roughly 13% stake—some one billion shares. It's notable that Buffett has decided against putting new money into Bank of America this year even after the stock's weakness.”
Excerpted from Barron’s April 24, 2023 (Print)
Article: “Bank of America’s $99 Billion Bond Problem” - Andrew Bary

In the lead/feathers test, I bet people are quite sensitive to the inertia (both linear and angular) when lifting the two supposedly identical boxes and the experimenters neglected this.

Linear inertia is the resistance of a body or collection of bodies to altering its linear motion. That is, linear inertia is mass. It doesn't matter whether a box is filled with a single lump of lead or a collection of many feathers. So long as the total mass of each box is the same the linear inertia of the two boxes is the same.
Angular (rotational) inertia, more commonly called moment of inertia (which you mentioned in the pre-edit version of your post), plays the same role in rotational motion. But unlike linear inertia, angular inertia depends on the location of the individual bodies constituting the total mass. It is calculated as the sum of each mass times the square of its distance from an axis of rotation. It's that second moment (squaring) that makes the difference.
Think about the two boxes. Assume that the feathers are uniformly distributed in one box and that the lead mass is held in position at the center of the other box. Further, assume that the axis of rotation we are considering is through the center of the box.
Then the angular inertia (moment of inertia) is greater for the box with feathers. Equivalently, the box with lead has lower angular inertia.
You are suggesting that the box with lower angular intertia (easier to rotate, i.e. needing less torque to achieve the same rotation) will feel heavier. That strikes me as counterintuitive. Even if the lifters were rotating the boxes.
I bet ... the experimenters neglected this

Weight illusions--where one object feels heavier than an identically weighted counterpart--have been the focus of many recent scientific investigations. The most famous of these illusions is the 'size-weight illusion', where a small object feels heavier than an identically weighted, but otherwise similar-looking, larger object. There are, however, a variety of similar illusions which can be induced by varying other stimulus properties, such as surface material, temperature, colour, and even shape. Despite well over 100 years of research, there is little consensus about the mechanisms underpinning these illusions.

Getting a grip on heaviness perception: a review of weight illusions and their probable causes, https://pubmed.ncbi.nlm.nih.gov/24691760/ (cited on the originally linked page)
I'll take that bet :-)

Off to a good start in 2023, but arguably one of the very worst SCG funds over the past 5 years.
Period: % in Category
1-yr: 92%
3-yr: 99%
5-yr: 95%