WEBVTT - 22: The Unbearable Brightness of Being a Shadow Bank 0:00:06.080 --> 0:00:08.920 Welcome to odd Lots. I'm Tracy Alloway, Executive editor of 0:00:08.960 --> 0:00:13.920 Bloomberg Markets the Bloomberg News. Max joins me today because 0:00:14.000 --> 0:00:17.200 Joe is still off, but I think, uh, we're going 0:00:17.239 --> 0:00:19.880 to have a good show. Max. Have you been watching 0:00:19.960 --> 0:00:23.440 that new TV series Billions? You know a little known 0:00:23.480 --> 0:00:25.680 fact about me is that my girlfriend Annie and I 0:00:25.760 --> 0:00:30.120 do not own a television really, so no Billions for us. 0:00:30.280 --> 0:00:32.960 All right, then you're gonna find this interesting. It's a 0:00:33.000 --> 0:00:36.040 show basically about a high flying hedge fund manager who's 0:00:36.120 --> 0:00:39.080 dealing with regulators. Let's put it that way. Most of 0:00:39.080 --> 0:00:42.479 it is him wheeling and dealing in stocks, shorting things, 0:00:42.560 --> 0:00:46.760 making short term directional bets, going long or short. Uh, 0:00:47.080 --> 0:00:49.440 maybe it's easier if we just play a clip. Who 0:00:49.479 --> 0:00:51.920 said this deal is going to close? Ben said? This morning, 0:00:53.000 --> 0:00:57.279 Everyone's saying, who is this a new analyst? Well, if 0:00:57.320 --> 0:01:02.160 we hired you must be a genius. Yeah, Stanford, then Wharton, Okay? 0:01:02.160 --> 0:01:06.559 Stanford Warton Electric Sun is controlled by Casuwitz. He also 0:01:06.600 --> 0:01:09.320 owns nineteen point three of Luma Therm back Door through 0:01:09.319 --> 0:01:12.160 his stake in Southern Wind. You see that block trade 0:01:12.240 --> 0:01:15.080 last Thursday come out of Meryl. Yeah, that was Fortress 0:01:15.080 --> 0:01:19.039 cashing out their shorts before the merger, wasn't it traders 0:01:19.040 --> 0:01:21.160 A twelve fifty two when everyone was at lunch, which 0:01:21.160 --> 0:01:23.600 tells me they wanted it to be missed. You guys 0:01:23.640 --> 0:01:26.200 caught it, which is something I guess, but you're looking 0:01:26.240 --> 0:01:29.080 at it backward. Electric Soun's offer was just deployed to 0:01:29.120 --> 0:01:32.600 temporarily prop up Luma Therm. Typical Casuits played a bail 0:01:32.640 --> 0:01:35.759 on a Loseries and animal. The block trade was casuits 0:01:35.760 --> 0:01:38.880 getting out of Southern Wind getting out of Luma therm. 0:01:38.920 --> 0:01:40.840 He wrote the story now he's out, which means you 0:01:40.880 --> 0:01:43.560 need to be out. In fact short, it'll slight to 0:01:43.600 --> 0:01:48.280 thirty two and change after word breaks. Wow, is today's 0:01:48.320 --> 0:01:52.320 episode going to be your view of Billions? No, I 0:01:52.360 --> 0:01:56.400 will spare you all my opinions of Billions. I actually 0:01:56.400 --> 0:01:59.880 wanted to bring it up for two reasons. Um mostly 0:02:00.000 --> 0:02:02.800 because our guest today is Dan's Warren, and he's a 0:02:02.880 --> 0:02:06.400 really well known hedge fund manager, but he's never actually 0:02:06.440 --> 0:02:09.239 done the type of stuff that most people seem to 0:02:09.360 --> 0:02:12.280 think hedge funds do based on clips like the one 0:02:12.320 --> 0:02:15.560 we just heard. In fact, he made his career providing 0:02:15.639 --> 0:02:20.359 capital to thousands of companies with a few other financing options, 0:02:20.400 --> 0:02:24.160 basically going where banks fear to tread. Well, at least 0:02:24.480 --> 0:02:27.200 up until recently, banks were pretty brave about that kind 0:02:27.200 --> 0:02:29.800 of thing. So what he does must be interesting. Yeah, 0:02:29.800 --> 0:02:32.760 and we're going to talk about how that opportunity came up. 0:02:33.120 --> 0:02:35.440 And one of the reasons it is really interesting is 0:02:35.440 --> 0:02:38.400 because we often hear regulators and lots of other people 0:02:38.480 --> 0:02:43.840 talking about non bank financial institutions or providers of credit, 0:02:44.160 --> 0:02:47.760 which sometimes go by the label shadow banks. Right, And 0:02:47.800 --> 0:02:50.280 as soon as you hear the term shadow banks, you think, oh, 0:02:50.320 --> 0:02:53.800 this is a bad thing, it's risky, there's something nefarious 0:02:53.840 --> 0:02:57.520 about it. But actually, as we're going to hear, shadow 0:02:57.520 --> 0:03:00.760 banks can fill a gap, and some times that gap 0:03:00.919 --> 0:03:04.320 needs to be filled. I still get like a small 0:03:04.400 --> 0:03:07.960 shiver up like the small of my back, of my 0:03:08.000 --> 0:03:10.519 spine when I hear shadow banking. So I feel like 0:03:10.520 --> 0:03:13.639 I'm gonna need a little bit of convincing from Dan 0:03:13.720 --> 0:03:15.560 and from you that I that it's that it's you know, 0:03:15.680 --> 0:03:18.120 it's not a shadowy a thing as its name implies. 0:03:18.160 --> 0:03:19.600 All right, well, we'll see if we could do that. 0:03:19.639 --> 0:03:22.320 But before we do, there's one other reason I brought 0:03:22.400 --> 0:03:25.200 up billions. And that is because Dan had his own 0:03:25.280 --> 0:03:29.600 run in with regulators just before the financial crisis, right, 0:03:29.880 --> 0:03:34.600 And I remember that because of the wonderful Bill Cohan, 0:03:34.720 --> 0:03:37.280 my friend known to known to listeners and readers as 0:03:37.320 --> 0:03:41.480 William D. Cohan is violent. He wrote a really long 0:03:41.560 --> 0:03:44.560 and detailed and beautiful story about about those travails not 0:03:44.600 --> 0:03:47.560 too long ago in Bloomberg, right, and I urge all 0:03:47.600 --> 0:03:50.200 our listeners to go read that story. But in the meantime, 0:03:50.200 --> 0:03:53.720 I'm going to summarize very quickly. Basically, it's about how 0:03:53.800 --> 0:03:58.040 Dan's hedge fund ran into some accounting problems and then 0:03:58.080 --> 0:04:02.240 investors started pulling out money. Uh. Dan eventually closed it down. 0:04:02.280 --> 0:04:06.360 It used to have twelve billion worth of assets. Uh. Eventually, however, 0:04:06.400 --> 0:04:09.080 he was cleared of all wrongdoing by the U S 0:04:09.080 --> 0:04:14.320 securities regulator. And since then he's been busy rebuilding a 0:04:14.320 --> 0:04:16.880 different fund. And we're going to find out today what 0:04:17.040 --> 0:04:23.359 exactly he's doing. Let's get started. Dan, thank you so 0:04:23.440 --> 0:04:26.000 much for joining us, Thanks for having me. So let's 0:04:26.040 --> 0:04:28.560 get this out of a way. First. Back in two 0:04:28.560 --> 0:04:32.240 thousand and six, two thousand seven, you were this really 0:04:32.440 --> 0:04:36.080 high flying hedge fund manager. I saw one commentator who 0:04:36.120 --> 0:04:41.880 referred to you as hedge fund perfection. Uh, and then 0:04:42.480 --> 0:04:47.120 this sec thing happened. Tell us what exactly went down? Well, Look, 0:04:47.120 --> 0:04:49.560 we had a we had a wonderful business that made 0:04:49.560 --> 0:04:51.760 seven hundred million dollars in its last year two point 0:04:51.800 --> 0:04:54.320 seven billion dollars overall. We had six billions of equity, 0:04:54.360 --> 0:04:57.160 twelve billion of assets, three hundred good employees and another 0:04:57.200 --> 0:04:59.719 eight hundred associated employees around the world, and did business 0:04:59.720 --> 0:05:02.520 and twe five countries, financing a lot of the companies 0:05:02.560 --> 0:05:05.360 and assets and and consumers and real estate properties that 0:05:05.400 --> 0:05:08.400 otherwise couldn't have been financed. UM. So we were doing well, 0:05:08.440 --> 0:05:11.480 and I think doing good. And Uh, Unfortunately, we had 0:05:11.520 --> 0:05:16.440 a an internal bad egg that we're uh. Some folks 0:05:16.440 --> 0:05:20.000 that I had assigned to tighten the controls of our business, 0:05:20.240 --> 0:05:23.600 UH found out. I directed the firm to turn them in. 0:05:24.120 --> 0:05:28.360 And unfortunately, UM, the process by which it was made 0:05:28.360 --> 0:05:30.720 clear that neither I nor the firm had anything to 0:05:30.760 --> 0:05:33.080 do with that person's activities too longer than otherwise should have. 0:05:33.520 --> 0:05:35.919 And so while we never had any h and an 0:05:35.960 --> 0:05:39.200 audit changed or requalified or amended or any of those things. 0:05:39.640 --> 0:05:41.159 It took so long for that to clear up that 0:05:41.200 --> 0:05:43.400 we had to move along with the firm. Tell us 0:05:43.440 --> 0:05:46.560 what your fund actually did in order to achieve the 0:05:46.640 --> 0:05:50.360 returns that you're known for. Uh. Sure, well, we we 0:05:50.400 --> 0:05:53.240 refer to ourselves as a global chaser of illiquidity UM, 0:05:53.279 --> 0:05:56.960 and so fundamentally we wanted to liquidity being assets that 0:05:57.080 --> 0:05:59.240 might be hard to buy or sell or trade in 0:05:59.279 --> 0:06:02.880 some way correct correct And and it doesn't necessarily mean 0:06:03.000 --> 0:06:06.000 assets that don't trade on a marketplace, because at times 0:06:06.440 --> 0:06:09.360 even assets that are you know, that have an accusive 0:06:09.440 --> 0:06:13.119 number on and trade over bloomberg um, have very little 0:06:13.200 --> 0:06:15.800 bitter offer. And so we like to say that we'll 0:06:15.839 --> 0:06:18.240 we'll run into every house on fire and and stay 0:06:18.240 --> 0:06:20.719 in some of them. And ultimately we want to be 0:06:20.760 --> 0:06:23.719 in a position where both, as we say, both borrower 0:06:23.760 --> 0:06:26.000 and lender, or both buyer and seller have the exact 0:06:26.040 --> 0:06:28.520 same view on value, but the other guy just needs 0:06:28.520 --> 0:06:32.200 our money, as opposed to having a directional view on 0:06:32.200 --> 0:06:34.840 on asset prices. You said a second ago that you 0:06:34.880 --> 0:06:37.719 guys did both well and good, and it sounds like 0:06:37.720 --> 0:06:40.120 you definitely did well while while the going was good. 0:06:40.440 --> 0:06:43.360 Explain to us why you also feel like you were 0:06:43.360 --> 0:06:47.440 doing good? Uh, well, to be clear, unlike some other people, 0:06:47.440 --> 0:06:49.159 I'm not gonna claim to be have have done the 0:06:49.200 --> 0:06:53.960 Lord's work. However, the world is, within finances, a big 0:06:54.000 --> 0:06:56.560 have and have not world, and there are a lot 0:06:56.640 --> 0:07:03.400 of very viable consumers, properties, companies, assets that don't actually 0:07:03.440 --> 0:07:07.560 intrinsically have materially large amount of credit risk in them 0:07:07.720 --> 0:07:10.720 that for non value reasons might not be able to 0:07:10.720 --> 0:07:14.960 access credit. And you know other over time banks have 0:07:15.080 --> 0:07:18.440 done that. And what you find is there's a reflexive 0:07:19.160 --> 0:07:21.840 characterization that sometimes people have. Let's say, well banks aren't 0:07:21.880 --> 0:07:23.680 that smart at what they do and they can't really 0:07:23.680 --> 0:07:27.000 do this thing, etcetera, etcetera. But if you were scaling 0:07:27.240 --> 0:07:30.360 a bank in the level that banks are scaled, and 0:07:30.400 --> 0:07:32.960 you had to create a very set set of rules 0:07:33.280 --> 0:07:36.280 for thousands of employees to follow regarding who should get credit, 0:07:36.680 --> 0:07:38.960 you're necessarily going to have to make some pretty blunt 0:07:38.960 --> 0:07:42.320 instrument rules to allow yourself not to get into problems. 0:07:42.720 --> 0:07:45.920 And so that leaves all of these kind of idiosyncratic, 0:07:45.960 --> 0:07:48.720 funkier things that otherwise should get credit, and if it 0:07:48.720 --> 0:07:51.120 were done one by one would get credit out in 0:07:51.160 --> 0:07:53.440 the cold. So, in other words, you were lending where 0:07:53.440 --> 0:07:57.440 others were were fearing to go or by policy, etcetera, 0:07:57.480 --> 0:08:00.840 couldn't go right. So you might frequently see talk to 0:08:01.040 --> 0:08:03.640 folks at banks who would say, well, jeez, we would 0:08:03.640 --> 0:08:07.280 do this. I would do this, but our institution can't 0:08:07.320 --> 0:08:10.120 do this for some sort of rule that had very 0:08:10.120 --> 0:08:12.600 little do with the credit worthiness of the underlying asset. 0:08:13.240 --> 0:08:15.880 You know, I want to be honest with you and 0:08:15.920 --> 0:08:19.040 tell you where I sit in the newsroom is literally 0:08:19.040 --> 0:08:22.040 physically close to my very good friend Zeke Fox, who 0:08:22.040 --> 0:08:29.520 writes beautifully about the nuances and sometimes the criminality, and 0:08:29.680 --> 0:08:32.679 or at least just that the very gray area of 0:08:33.240 --> 0:08:37.160 hedge funds lending to small businesses sometimes the rates can 0:08:37.160 --> 0:08:40.040 get very very high. I remember in Cohen's piece he 0:08:40.080 --> 0:08:42.240 mentioned um that you lent to a company that least 0:08:42.240 --> 0:08:46.320 slot machines to casinos on Indian reservations. And just speaking 0:08:46.360 --> 0:08:49.360 honestly in the same way that we're gonna we're gonna 0:08:49.360 --> 0:08:51.600 talk about in a while, how shadow banking sometimes makes 0:08:51.600 --> 0:08:53.440 me nervous just from the mere sound of it. Also, 0:08:53.520 --> 0:08:55.760 just have to be honest and say it also makes 0:08:55.800 --> 0:08:58.200 me nervous, even though, mind you, I don't know too 0:08:58.280 --> 0:09:00.320 much about it. When I hear about hedge funds lending 0:09:00.360 --> 0:09:03.640 to things like, you know, Indian casinos and slots. Is 0:09:03.640 --> 0:09:05.959 that something that you felt comfortable with? Can you? Did? 0:09:05.960 --> 0:09:08.120 You have to deal with people who felt less comfortable 0:09:08.120 --> 0:09:12.200 with and explain why this was a good a good thing. No, 0:09:12.720 --> 0:09:14.040 you know, at the at the end of the day, 0:09:14.040 --> 0:09:18.560 Indian reservation gaming facilities are large money makers for those 0:09:18.720 --> 0:09:21.720 reservations in that case, and to the extent that there 0:09:21.720 --> 0:09:23.760 are machines that they have where they don't want to 0:09:23.760 --> 0:09:27.880 deploy capital, but there's you know, perfectly reasonable credit to 0:09:27.920 --> 0:09:30.040 be had. You know, folks like us could do it 0:09:30.040 --> 0:09:32.800 in that particular case. Because those slot machines were on 0:09:32.920 --> 0:09:36.920 Indian reservation property. You needed to have a gaming license 0:09:36.960 --> 0:09:40.720 for that reservation, uh, in order such that if you 0:09:40.800 --> 0:09:44.360 ever had to foreclose on the assets and operate them, 0:09:44.520 --> 0:09:46.920 you have a license to do so. And so we 0:09:46.960 --> 0:09:49.240 had to partner with a very specialized guy who happened 0:09:49.280 --> 0:09:51.160 to have such a license in order to be there 0:09:51.160 --> 0:09:53.520 and provide the capital that a bank wouldn't for them. 0:09:53.760 --> 0:09:57.120 And so to the extent that that gaming facility thrived 0:09:57.480 --> 0:10:00.600 and helped and benefited its tribe, it was a perfectly 0:10:00.640 --> 0:10:03.920 legitimate business. Uh, you know, we don't see an issue 0:10:03.960 --> 0:10:06.240 with that. It worked out in the end, it didn't. 0:10:06.880 --> 0:10:09.720 So your old fund was all about investing in liquid 0:10:09.760 --> 0:10:14.199 assets extending credit to all sorts of different businesses and companies. 0:10:14.559 --> 0:10:17.440 You have this new fund now essentially doing a very 0:10:17.559 --> 0:10:21.760 very similar thing. Walk us through the idea here, and 0:10:22.040 --> 0:10:26.200 if there is actually a bigger gap to be filled now, well, 0:10:26.280 --> 0:10:28.480 I think there's There's two different parts of the story. 0:10:28.760 --> 0:10:31.160 The first is, you know, where is the market today? 0:10:31.240 --> 0:10:33.640 And the answer to that is that, in fact, post 0:10:33.720 --> 0:10:37.120 the crisis, there is, you know, a much larger addressable 0:10:37.120 --> 0:10:38.760 market for the kind of things than we that we 0:10:38.840 --> 0:10:43.720 do then there perhaps ever has been, and arguably the 0:10:43.760 --> 0:10:46.880 people who are addressing that market um are as few 0:10:46.920 --> 0:10:50.360 as they ever have been when we had our prior business. 0:10:50.400 --> 0:10:52.840 The largest competitor we had competitors we had were the 0:10:52.880 --> 0:10:55.679 internal proprietary groups of the investment banks, which are all 0:10:55.720 --> 0:10:58.480 gone now. Which are all gone now. And that's not 0:10:58.559 --> 0:11:01.040 to say all of those people and assets are gone, 0:11:01.080 --> 0:11:04.000 because they a large number of them have migrated to 0:11:04.080 --> 0:11:07.400 a very small number of very large alternative investment firms, 0:11:07.880 --> 0:11:10.160 large in a way that we never dreamed possible at 0:11:10.200 --> 0:11:12.920 that point. Um, there was a time when ten billion 0:11:13.000 --> 0:11:16.400 dollars of assets was a big deal. Uh. And many 0:11:16.440 --> 0:11:18.800 of these folks with whom I competed with with whom 0:11:18.800 --> 0:11:22.920 I competed are now you know, thirty and twenty billion dollars. 0:11:23.440 --> 0:11:27.000 And so what's interesting is that in some ways the 0:11:27.080 --> 0:11:31.360 same gaps are available because they can only write checks 0:11:31.400 --> 0:11:34.440 that are you know, seventy million at a shot. And 0:11:34.480 --> 0:11:37.480 so in the absence of them, the investment banks and 0:11:37.480 --> 0:11:40.920 commercial banks, the number of the very large number of 0:11:40.920 --> 0:11:43.679 smaller opportunities out there to be financed is as big 0:11:43.720 --> 0:11:46.240 as it's ever been. So if you're looking for sort 0:11:46.240 --> 0:11:49.760 of smaller opportunities, how do you actually source your loans? 0:11:49.800 --> 0:11:51.920 Because you and I have spoken about this before, and 0:11:51.960 --> 0:11:56.880 it is an interesting on the ground sort of process. Well. Uh, 0:11:56.920 --> 0:12:00.520 to the extent that things are intermediated by brokers of 0:12:00.600 --> 0:12:04.120 various sorts, they almost by definition tend to be less appealing. 0:12:04.640 --> 0:12:08.120 And so no, it's not that it's just that they 0:12:08.160 --> 0:12:10.240 show with the lots of people because they're looking for 0:12:10.280 --> 0:12:14.000 the fastest path to that fee. Um. And so we 0:12:14.080 --> 0:12:19.400 have found that in the type of things that we do, UM, 0:12:19.440 --> 0:12:22.679 there are frequently people who have very specialized knowledge, whether 0:12:22.720 --> 0:12:27.679 that's sourcing, uh, analysis capability, or even servicing of assets. UH. 0:12:27.720 --> 0:12:30.440 They may not have all three of those, um, and 0:12:30.480 --> 0:12:34.560 they may specialized in very idiosocratic things, but they have 0:12:34.600 --> 0:12:37.160 a special skill. And we like to find those kind 0:12:37.160 --> 0:12:40.280 of folks UH and use that to supplement our our 0:12:40.360 --> 0:12:44.360 team on our our own teams UM where we can 0:12:44.600 --> 0:12:48.359 partner with them in a very highly financially aligned way 0:12:48.400 --> 0:12:50.520 where they're putting up significant amounts of their own money 0:12:50.800 --> 0:12:53.360 UH to go after this unique these unique assets that 0:12:53.440 --> 0:12:56.079 leverage their unique capabilities. I think you're going to find 0:12:56.160 --> 0:12:57.880 over the next few minutes, and our listeners will to 0:12:57.960 --> 0:12:59.760 that Tracy is gonna be the one asking the assistigated 0:12:59.800 --> 0:13:02.960 question because she's really good. You can do it. I'm 0:13:02.960 --> 0:13:05.920 gonna be asking. I have a basic question when when 0:13:05.960 --> 0:13:08.080 in the olden days, when the Wall Street banks were 0:13:08.120 --> 0:13:09.760 allowed to be doing some of the stuff that you're 0:13:09.800 --> 0:13:13.240 good at, do you think just looking at the system 0:13:13.320 --> 0:13:15.720 and worrying about its safety was it a good thing? 0:13:15.880 --> 0:13:18.880 When Golden Sacks, for example, I've written a little bit 0:13:18.920 --> 0:13:21.480 about their special Situations group, which had some brilliant people 0:13:21.679 --> 0:13:24.520 un familiar with them. Yeah, I assume they in those 0:13:24.520 --> 0:13:27.520 good old days are probably your rivals, rivals and partners. 0:13:28.720 --> 0:13:30.800 Was it a good thing that they had so much 0:13:30.800 --> 0:13:34.240 capital to play with? I think one could take the 0:13:34.320 --> 0:13:38.000 view that them having capital and deploying it and itself 0:13:38.120 --> 0:13:42.199 was not particularly problematic. UM. Where I think some people 0:13:42.280 --> 0:13:45.960 might have had issues were situations where it was not 0:13:46.040 --> 0:13:49.960 necessarily clear where they were acting as an intermediary and 0:13:50.000 --> 0:13:52.560 where they were acting as a principle. And in everything 0:13:52.640 --> 0:13:55.360 I've ever done, you know, there's no question we have 0:13:55.440 --> 0:13:57.920 only one thing to do, which is deployed capital and 0:13:58.000 --> 0:14:02.320 make a disproportionate return for unit of UM. So I 0:14:02.360 --> 0:14:06.200 would say, as an example, UM, there was a situation 0:14:06.240 --> 0:14:09.920 with a European bank in the early two thousands that 0:14:10.040 --> 0:14:12.880 had some assets that were a problem, and we went 0:14:12.960 --> 0:14:16.160 and met with them, and they were represented by their 0:14:16.520 --> 0:14:20.080 trusted advisors of golden Sacks, and those guys were in 0:14:20.080 --> 0:14:21.760 the room when we got to meet with the bank, 0:14:22.680 --> 0:14:25.360 and it quickly became clear that three of the four 0:14:25.400 --> 0:14:27.960 people in the room were in fact our competitors, not 0:14:28.000 --> 0:14:31.320 their investment bankers. UM. And so, needless to say, we 0:14:31.360 --> 0:14:33.120 didn't get a chance to do much with that bank, 0:14:33.600 --> 0:14:36.000 and so I think there was perhaps it was overblown, 0:14:36.000 --> 0:14:38.400 but there was a perception that there was a mix 0:14:38.600 --> 0:14:41.480 of principle and agent there that was not always clear. 0:14:41.960 --> 0:14:43.840 And in so far as that perception it was out there, 0:14:43.920 --> 0:14:47.080 it might have caused some issues. But you are talking 0:14:47.080 --> 0:14:51.240 about an incredibly well run business and firm, one that 0:14:51.560 --> 0:14:55.800 made it through the crisis much better than virtually everyone else, 0:14:56.240 --> 0:14:59.720 that had a huge number of really smart people, and 0:14:59.800 --> 0:15:03.160 I think, unlike virtually any other competitor that they had 0:15:03.520 --> 0:15:07.239 um created a culture where there was information flow, information 0:15:07.280 --> 0:15:12.280 sharing that was really unique. Whatever you may say about 0:15:12.480 --> 0:15:18.000 their goals, they were incredibly effective at pursuing them, all right. 0:15:18.080 --> 0:15:21.640 But we did have this confusion about principle versus agent, 0:15:22.120 --> 0:15:24.400 so whether they're doing this as a sort of financial 0:15:24.440 --> 0:15:28.000 intermediary versus trading for their own accounts profiting it from 0:15:28.000 --> 0:15:31.840 it for themselves. That really came to the forefront during 0:15:31.840 --> 0:15:35.360 the financial crisis and afterwards we saw regulators pile in 0:15:35.680 --> 0:15:39.440 all these new rules basically restricting and or making it 0:15:39.520 --> 0:15:42.800 more expensive for banks to undertake some of this activity. 0:15:43.080 --> 0:15:46.920 And simultaneously we saw guys like you and those asset 0:15:46.960 --> 0:15:50.680 managers you mentioned, or alternative managers you mentioned earlier start 0:15:50.720 --> 0:15:54.280 to get big as they picked business off of the banks. 0:15:54.840 --> 0:15:57.920 And then of course we heard from regulators that actually 0:15:57.920 --> 0:16:00.720 they were worried about the growth of the shadow banking 0:16:00.760 --> 0:16:06.040 sectary should we be worried well with any sorts of 0:16:06.400 --> 0:16:11.320 idiosocratic finance. Over time, there are clearly cycles, and I 0:16:11.320 --> 0:16:13.560 would argue that one of the biggest risks in any 0:16:13.640 --> 0:16:16.800 of these activities is the moral hazard that they bring. 0:16:17.520 --> 0:16:19.800 And part of their way we structured our business with 0:16:19.840 --> 0:16:23.080 these joint ventures allowed us to have an extremely variable 0:16:23.120 --> 0:16:26.920 cost of effective infrastructure. So there was nobody out there 0:16:26.960 --> 0:16:29.160 who said, well, I need to do things in order 0:16:29.160 --> 0:16:32.040 to get paid, right, And so we took away that 0:16:32.160 --> 0:16:35.280 moral hazard in our business and it and it importantly 0:16:35.280 --> 0:16:37.560 allowed us to find not only find good things to do, 0:16:37.600 --> 0:16:40.800 but even more importantly avoid things that were not there 0:16:40.880 --> 0:16:42.240 that we're not good to do. Can you give me 0:16:42.240 --> 0:16:45.560 an example of one of those types of things to avoid? Uh? Well, 0:16:45.640 --> 0:16:50.160 So as an example, um um. In the last energy cycle, 0:16:51.240 --> 0:16:55.280 when Enron and Merinth and Aquila and all those firms 0:16:55.320 --> 0:16:58.200 that many of whose names we don't remember anymore, we're 0:16:58.200 --> 0:17:01.680 blowing up uh, and oil and gas prices were low 0:17:01.760 --> 0:17:04.959 this is kind of a tish uh oh. Three, We 0:17:05.200 --> 0:17:08.879 ended up buying the onshore natural gas landing business of 0:17:09.400 --> 0:17:13.399 Mirrant at about sixty cents on the dollar and pretty 0:17:13.480 --> 0:17:16.280 much and so and again we're not macro people, all right, 0:17:16.320 --> 0:17:18.480 so we don't know about oil and gas prices. What 0:17:18.560 --> 0:17:21.919 we knew was that in the high one dollars we 0:17:22.080 --> 0:17:24.760 get our money back, in the low mid twos, we'd 0:17:24.760 --> 0:17:26.639 make a nice return, and beyond that it would be 0:17:26.680 --> 0:17:28.200 really good. And it turned out to be four bucks 0:17:28.240 --> 0:17:31.560 and so it was really good. Um. But more importantly, 0:17:32.480 --> 0:17:35.960 at that point, nobody in town in Houston was making 0:17:36.480 --> 0:17:39.160 on on balance sheet loans the energy companies, and so 0:17:39.240 --> 0:17:43.119 based on that knowledge, we stepped in and actually worked 0:17:43.119 --> 0:17:45.000 with a couple of local folks down there to create 0:17:45.040 --> 0:17:48.280 what then became the most significant on on on shore 0:17:48.359 --> 0:17:53.080 natural gas lender out of Houston. Once banks started to 0:17:53.480 --> 0:17:58.320 reaccustom themselves assuming that risk we couldn't really compete um 0:17:58.920 --> 0:18:01.480 or that those opportunit needs couldn't compete for our capital. 0:18:02.040 --> 0:18:04.200 Uh And so we ended up just doing less and less. 0:18:04.760 --> 0:18:07.280 And so now when prices are back where they are, 0:18:07.480 --> 0:18:10.719 we're now the fact third time around down in Houston 0:18:10.760 --> 0:18:13.200 and Dallas and other places looking at that stuff all 0:18:13.240 --> 0:18:17.040 over again. Um. You know, when I think about shadow banking, 0:18:18.240 --> 0:18:20.600 I think about because I'm a total nerd, I think 0:18:20.640 --> 0:18:24.080 about the repo market. Before two thousand eight, we've been 0:18:24.119 --> 0:18:27.120 talking about shadow banking in the context of non banks 0:18:27.200 --> 0:18:31.920 providing credit intermediation, but the definitions can get really muddled. 0:18:32.240 --> 0:18:35.640 Are there specific types of shadow banks that you would 0:18:35.680 --> 0:18:40.600 be more concerned about, for instance, say a liquid fund 0:18:40.960 --> 0:18:45.280 buying up the kind of illiquid assets that you specialize in. Well, 0:18:45.320 --> 0:18:48.600 I think yeah. First of all, I don't know that 0:18:48.600 --> 0:18:52.440 there's a dictionary definition of shadow banking, other than if 0:18:52.440 --> 0:18:54.639 there is, I'm sure it's a poor one. Yeah. What 0:18:54.720 --> 0:18:56.440 I would say is, if you want to think about 0:18:56.480 --> 0:18:59.639 what risks are significant now in the wake of the 0:18:59.640 --> 0:19:03.639 regular aation that happened, I think it's less about the 0:19:03.640 --> 0:19:07.840 market participants, less about Goldman Sachs participating the markets as principal, etcetera, 0:19:07.880 --> 0:19:10.840 and much more about the provision of liquidity. And so 0:19:11.160 --> 0:19:14.800 what has happened with the new regulations is that there's 0:19:14.840 --> 0:19:19.080 tremendous disincentive for anybody to provide liquidity of any sort. 0:19:19.680 --> 0:19:24.360 And so we have not yet remotely tested what it's 0:19:24.359 --> 0:19:27.120 going to feel like when people who have for many 0:19:27.200 --> 0:19:29.239 years been used to being able to get out of 0:19:29.280 --> 0:19:32.280 things um suddenly don't have a bid. And is that 0:19:32.320 --> 0:19:36.200 basil regulations or Dodd Frank. I think that's a combination 0:19:36.359 --> 0:19:41.400 of vasil, Dodd Frank, and importantly vulcan, because when insofar 0:19:41.520 --> 0:19:45.399 as you preclude what otherwise would be marketing making activities 0:19:45.440 --> 0:19:49.200 and over the counter products by investment banks, you preclude 0:19:49.240 --> 0:19:54.080 them from quote unquote proprietary trading um when you're trading 0:19:54.080 --> 0:19:56.840 for their own accounts. Correct, when you're making markets and 0:19:56.920 --> 0:20:00.399 over the counter products, you can't afford to be a 0:20:00.400 --> 0:20:03.280 willing buyer or seller at a price because your own 0:20:03.280 --> 0:20:06.520 customers will take advantage of you and you will quickly 0:20:06.560 --> 0:20:09.760 get you know, busted and and and put out of business. 0:20:10.080 --> 0:20:13.640 And so you have to have some directional views as 0:20:13.640 --> 0:20:16.880 to what's going on. And so to preclude them from 0:20:17.040 --> 0:20:19.760 quote unquote proprietary trading in the way that has been 0:20:19.800 --> 0:20:23.480 done has basically sucked the liquidity out of virtually every 0:20:23.480 --> 0:20:27.400 OTC trading market, and the effects of that have yet 0:20:27.440 --> 0:20:32.160 to be felt in a material way because since July thirteen, 0:20:32.640 --> 0:20:35.200 when kind of d dragging stepped in with his kind 0:20:35.200 --> 0:20:37.800 of job owning about rates being low forever. Uh. In 0:20:37.840 --> 0:20:41.800 the in the periodic times when that notion has been tested, uh, 0:20:41.840 --> 0:20:44.600 and then kind of we've seen recovery driven by central bankers. 0:20:44.840 --> 0:20:49.240 Since then, we've yet to really feel how utterly devoid 0:20:49.280 --> 0:20:51.520 of liquidity the markets are. Do you think there's a 0:20:51.640 --> 0:20:57.359 chance that what Paul Walker would call, uh, casino banking. 0:20:57.400 --> 0:20:59.679 You know that if there's anythings that by preventing the 0:20:59.680 --> 0:21:04.720 Walsh firms from trading on their own account, Yeah, casino banking, 0:21:04.800 --> 0:21:07.960 you would call that that that is nothing but a 0:21:08.440 --> 0:21:11.040 plus for for society, that that's going to protect tax 0:21:11.080 --> 0:21:12.800 barers from having to bail out banks again, and that 0:21:12.880 --> 0:21:15.680 the downside, the downside will be minimal as it has 0:21:15.720 --> 0:21:18.880 been at least so far, nothing horrible has happened because 0:21:19.520 --> 0:21:22.040 um liquidity isn't as lush as it once once. What's 0:21:22.080 --> 0:21:24.200 do and that's optimistic? Is there any chance things will 0:21:24.200 --> 0:21:26.320 play out that way? Or are you worried that something 0:21:26.359 --> 0:21:30.240 scary as can happen? Uh? I'm you know. Buffett says, 0:21:30.240 --> 0:21:34.000 in the long term, markets are are weighing machines, not 0:21:34.080 --> 0:21:38.000 voting machines, and so credit markets haven't been allowed to 0:21:38.040 --> 0:21:41.640 find their level yet UM, and they've been trying episodically 0:21:41.680 --> 0:21:45.800 for the last couple of years and so UM as 0:21:45.840 --> 0:21:47.840 you saw a little bit in the last little shock 0:21:47.920 --> 0:21:50.840 we had in December of January, what happened then there 0:21:50.840 --> 0:21:53.720 were a series of funds that were investing in corporate 0:21:54.000 --> 0:21:58.480 OTC product that had no liquidity in their assets, but 0:21:58.560 --> 0:22:00.879 had lots of liquidity on their lives ability side, right. 0:22:00.920 --> 0:22:04.639 They were mutual funds, structured funds, exchange traded funds, that 0:22:04.720 --> 0:22:07.560 sort of thing, well, specifically mutual funds that were open 0:22:07.680 --> 0:22:10.000 ended with daily liquidity that were invested in things that 0:22:10.040 --> 0:22:11.760