Roughly a century ago, the American writer Ambrose Beirce compiled The Devil’s Dictionary. In his celebrated lexicon, Bierce displayed a profound understanding of finance, which he defined as “the art or science of managing revenues and resources for the best advantage of the manager”. Below are several other of his definitions touching on the subject of money:
Debt: An ingenious substitute for the chain and whip of the slave-driver.
Mammon: The god of the world’s leading religion. His chief temple is in the holy city of New York.
Riches: The savings of many in the hands of one.
Wall Street: A symbol of sin for every devil to rebuke. That Wall Street is a den of thieves is a belief that serves every unsuccessful thief in place of a hope in Heaven.
While Wall Street’s ethos has not changed since Bierce’s time, it is time to update and enlarge The Devil’s Dictionary of Finance for the world of hedge funds, private equity, structured finance, subprime equity, etc.
Part 1: A through M
AAA: A credit rating which indicates a company has very little likelihood of default and therefore carries too little debt. By a process of financial alchemy, this rating now covers most of the riskiest corporate and consumer borrowers, which have too much debt. See rating agencies and CDO.
Alternative investment: The lucrative process of repackaging traditional equity investments. An ingenious marketing technique of the investment industry devised to boost earnings after the stock market collapse at the turn of the century. See Hedge Funds and Private Equity, also Illiquidity.
Asset-gathering: The method by which investment firms maximize the value of their businesses, normally at the expense of clients. Formerly associated with traditional investment firms, but now frenetically practiced by alternative investors. See Blackstone.
Bankers: People who lend other people’s money in exchange for a fee. Formerly concerned about the return of principal, but now only interested in the fee. “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional and orthodox way along with his fellows, so that no one can really blame him.” (John Maynard Keynes)
Bear: A stopped clock which is right not twice a day, but merely once a decade.
Bear Stearns: A Wall Street firm with a “savvy” (Wall Street Journal) understanding of the bond markets; produces unique investment results. See High-Grade Structured Credit Strategies Enhanced Leverage Fund.
Bezzle: “At any given time there exists an inventory of undiscovered embezzlement in—or more precisely not in—the country’s businesses and banks. This inventory—it should perhaps be called the bezzle—amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times, people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances, the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression, all this is reversed. Money is watched with a narrow and suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks.” (John Kenneth Galbraith, The Great Crash)
Blackstone: Private equity firm run by former investment banker Steve Schwarzman. In a recent interview with the Wall Street Journal, the billionaire emphatically denied he was a “marauding, low-class, low-brow inflictor of random damage”. See Lucky Fool.
Bridge loans: Temporary loans provided by banks to finance leveraged buyouts. A financial hot potato. But as the head of Citigroup, Chuck Prince, recently observed, “As long as the music is playing, you’ve got to get up and dance.”
Bull: Politely speaking, the stuff and nonsense of Wall Street’s daily conversation.
Carry trade: The act of borrowing cheaply and lending at a higher rate. Popular with hedge funds when short-term rates collapsed after the dotcom bust, viz. Charlie Munger of Berkshire Hathaway, “Never have so many people made so much money with so little talent.” See Greenspan.
China: A Communist country bent on undermining its capitalist enemies by gorging them on debt. In furtherance of this policy, the People’s Bank of China has recently taken a sizeable stake in Blackstone.
Collateralized Debt Obligation (CDO): A dumping ground for loans off-loaded by banks, which are pooled, sliced up and stamped with investment-grade ratings.
Covenant-lite: Loans for leveraged buyouts, which have many of the risks of equity without any of the upside.
Credit: Long ago, when she first appeared amongst us, “Lady Credit” was said to be attracted to a person’s character, probity and trustworthiness. With age, she has become less choosy.
Credit default swaps: A means for transferring risk. Lenders can now insure against the risk that a borrower goes bankrupt. Instead, they are now exposed to the risk that the seller of default protection, in an unregulated $30 trillion market, goes belly up.
Croupier’s take: The annual charge for managing institutional money, which includes fund managers’ fees and brokerage commissions. Conservatively estimated by Charlie Munger at roughly 3% of principal p.a.
Debt: A lingering disease left behind after Lady Credit has taken flight.
Delinquencies: The inevitable consequence of providing money to those who can’t afford to pay either the interest or principal on a loan.
Dividend deal: A debt-funded dividend paid shortly after a buyout. Serves to boost private equity returns at the expense of creditors.
Downgrade: A reduction in the quality of a credit rating. Normally occurs after the deterioration of fundamentals, but before the event of a default. This action protects the reputation of the rating agencies but not the wealth of bondholders. See subprime.
EBITDA: Earnings before interest, cash, depreciation and amortization. The maximum cash flow available to finance a buyout. When all EBITDA is used for debt service, nothing remains to invest in a company’s ongoing operations. See Zombies.
Equity tranche: The riskiest part of a CDO which takes the first loss in the event of default. Popular with hedge funds which pick up performance fees from investing in equity tranches right up to the moment they blow up. See incentives.
Fees: The raison d’etre of Wall Street. The means by which wealth is transferred from its owners to those entrusted to manage it. See investment banks, private equity, hedge funds, rating agencies, money managers, etc.
Financial engineering: Whereas conventional engineering seeks to take weak structures and make them solid, financial engineering aims at the opposite.
Financial Journalist: While most journalists are illiterate, financial hacks are also innumerate. “When you stand at the summit of financial journalism, you are at sea level.” (James Grant, editor of Grant’s Interest-Rate Observer)
Fund of funds: The loading of fees upon fees. Institutions which speed up the transfer of wealth from owners to managers, as described above.
Greater fools: Wall Street’s ever expanding clientele.
Greenspan: The patron saint of carry traders.
Hedge funds: A lucrative compensation scheme for professional investors, who get to charge roughly 10 times as much as traditional money managers while generating, in aggregate, similar returns. See loser’s game.
Home: A building constructed on weak financial foundations. See delinquencies.
Initial public offering: An exit route for alternative investment managers who expect the jig is up.
Implied equity: A measure employed by private equity to forgo investing any real equity in a buyout.
Incentives: The incentives of most Wall Street professional involve asymmetric pay-offs. Known less formally as heads-I-win, tails-you-lose. See Where are the Customers’ Yachts?
Institutional investors: Simple-natured fellows possessed of an incurable tendency to extrapolate from past performance.
Interest cover: The ratio between a company’s debt servicing requirements and its cash flow. Buyout borrowers have recently driven interest coverage ratios to “barely 1.Ox” (Moody’s).
International carry trade: The practice of borrowing cheaply abroad to fund investments at home. Popular with Hungarian and Polish home-buyers and unpopular with central bankers in Switzerland and Japan.
Investment banks: Wall Street firms that find clever and original ways to bring the financial system to the brink.
Investment bankers: Financiers who find clever and original ways to put their own interests before those of their clients.
Junk: Riskier corporate bonds are known as “high yield” during the early part of the credit cycle. But as the cycle progresses, both their credit quality and yield diminish, at which point they are properly designated “junk.”
KKR: The original buyout firm. Founder Henry Kravis says he shouldn’t be congratulated on buying a company but on selling it. Unfortunately, Kravis has been so busy taking other companies private this year that he missed the chance to sell his firm to the public when the opportunity beckoned. See Pulling the IPO.
Leverage: The substitution of debt for skill in order to enhance investment performance or profitability. In theory, any gains from leverage are offset by a commensurate increase in risk. In practice, this theory is ignored.
Leveraged buyout: The debt-funded purchase of a company. Immensely profitable to private equity firms when profits and valuations rise and, owing to management and other fees, still very profitable to private equity when valuations and profits decline.
Leveraged loans: The rocket fuel that powers the LBO industry. Originated by banks but quickly passed on to hedge funds and stuffed into collateralized debt obligations.
Liar loans: Mortgages provided to those who economize with the truth. See mortgage brokers.
Liquidity: A vogue term which provides an aura of financial sophistication to its user, as in, “an excess of liquidity drove the market higher, today” or “a lack of liquidity drove the market lower, today.”
Loser’s game: The recognition that investors, in aggregate, are engaged in a zero-sum game—one person’s gains are equal to another’s losses, less the cost of transactions. Those who make fewest mistakes and have the lowest management expenses end up winning the loser’s game. The irrefutable consequence of this finding is that institutional funds should be largely invested in low-cost index funds. It is a tribute to the marketing power of the Wall Street that this isn’t the case.
Lucky fool: A person who owes his success to luck rather than skill, but is unaware of the fact. As it takes several decades of performance data for statisticians to distinguish luck from skill in the investment game, the number of lucky fools on Wall Street must always remain indeterminate. See Steve Schwarzman.
Mark-to-model: The use of a mathematical model to value complex securities, such as CDOs. “The combination of precise formulas with highly imprecise assumptions can be used to establish practically any value one wishes” (Ben Graham). Particularly useful to investors who wish to delay the recognition of a loss. See CDOs.
Master Limited Partnership: A clever corporate structure favoured by private equity and hedge funds on going public. Provides investors with few of the traditional governance safeguards, while allowing alternative asset managers to avoid paying corporation tax on their earnings.
Mortgage-backed securities: A former blue chip of the Wall Street casino which on becoming tarnished is rapidly losing currency. See withdrawals.
Mortgage broker: A person who, in exchange for a fee, will exaggerate the income of a mortgage applicant.