So, Exactly How Serious Is JP Morgan About This Clawback Business???

Reggie Middleton's picture

JP Morgan is now calling for a clawback of INA Drew's excessive compensation. OF course, Sheila Bair (one of the few regulators whom I actually respect) declaresJamie Dimon's compensation should face a claw back as well. Well, it's apparent that Dimon's lobbying and influence reaches a bit farther than Ina Drew's, no? Ahhhh, regulatory capture at its best (as in How Regulatory Capture Turns Doo Doo Deadly).

BoomBustBlog readers remember this scenario from several years ago, to wit: Even With Clawbacks, the House Always Wins in Private Equity Funds. In said article, I explained that althought Blackstone instituted a clawback that returned funds to investors, the investors still got RIPPED OFF!!! Don't believe me? Read the following excerpt and keep in mind that private equity and LLP investors are easily replaced by public equity investors in the JPM scenario!

I have written extensively on this topic. For one, the CRE bubble was obvious, but funds plowed ahead because they receive fees for deals done as well as performance fees. I warned about Blackstone and the Sam Zell deal blowing up back in 2007 as it was being done (see Doesn’t Morgan Stanley Read My Blog?). It was quite OBVIOUS that the top of the market was there , but it doesn't matter if you get paid for both success AND failure, does it? They are often in a win-win situation. On April 15th, 2010 I penned “Wall Street Real Estate Funds Lose Between 61% to 98% for Their Investors as They Rake in Fees!” wherein I espoused much of my opinion on market manipulation and the state of CRE. I will excerpt portions below in an attempt to explain how REITs and the bankers that they deal with get to add 2 plus 2 and receive a sum of 6, or worse yet have 4 subtracted from their 6 and get to sell 5!!! Straight up Squid Math!

Oh, yeah! About them Fees!

Last year I felt compelled to comment on Wall Street private fund fees after getting into a debate with a Morgan Stanley employee about the performance of the CRE funds. He had the nerve to brag about the fact that MS made money despite the fact they lost abuot 2/3rds of thier clients money. I though to myself, “Damn, now that’s some bold, hubristic s@$t”. So, I decided to attempt to lay it out for everybody in the blog, see ”Wall Street is Back to Paying Big Bonuses. Are You Sharing in this New Found Prosperity?“. I excerpted a large portion below. Remember, the model used for this article was designed directly from the MSREF V fund. That means the numbers are probably very accurate. Let’s look at what you Morgan Stanely investors lost, and how you lost it:

The example below illustrates the impact of change in the value of real estate investments on the returns of the various stakeholders – lenders, investors (LPs) and fund sponsor (GP), for a real estate fund with an initial investment of $9 billion, 60% leverage and a life of 6 years. The model used to generate this example is freely available for download to prospective Reggie Middleton, LLC clients and BoomBustBlog subscribers by clicking here: Real estate fund illustration. All are invited to run your own scenario analysis using your individual circumstances and metrics.


To depict a varying impact on the potential returns via a change in value of property and operating cash flows in each year, we have constructed three different scenarios. Under our base case assumptions, to emulate the performance of real estate fund floated during the real estate bubble phase,  the purchased property records moderate appreciation in the early years, while the middle years witness steep declines (similar to the current CRE price corrections) with little recovery seen in the later years.  The following table summarizes the assumptions under the base case.


Under the base case assumptions, the steep price declines not only wipes out the positive returns from the operating cash flows but also shaves off a portion of invested capital resulting in negative cumulated total returns earned for the real estate fund over the life of six years. However, owing to 60% leverage, the capital losses are magnified for the equity investors leading to massive erosion of equity capital. However, it is noteworthy that the returns vary substantially for LPs (contributing 90% of equity) and GP (contributing 10% of equity). It can be observed that the money collected in the form of management fees and acquisition fees more than compensates for the lost capital of the GP, eventually emerging with a net positive cash flow. On the other hand, steep declines in the value of real estate investments strip the LPs (investors) of their capital. The huge difference between the returns of GP and LPs and the factors behind this disconnect reinforces the conflict of interest between the fund managers and the investors in the fund.




Under the base case assumptions, the cumulated return of the fund and LPs is -6.75% and -55.86, respectively while the GP manages a positive return of 17.64%. Under a relatively optimistic case where some mild recovery is assumed in the later years (3% annual increase in year 5 and year 6), LP still loses a over a quarter of its capital invested while GP earns a phenomenal return. Under a relatively adverse case with 10% annual decline in year 5 and year 6, the LP loses most of its capital while GP still manages to breakeven by recovering most of the capital losses from the management and acquisition fees..


Anybody who is wondering who these investors are who are getting shafted should look no further than grandma and her pension fund or your local endowment funds…

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General Debility's picture

"Straight up Squid Math!" Hahaha Love you Reggie!!!

Rearranging Deckchairs's picture

Read Reggies piece re Pennsylvania Real Estate Investment Trust (PRE) - enjoyed it. Noticed then when he brokeout the different returns for Lenders, GPs, and LPs ( investors). The management and performance fees definitely seem to hedge the insiders interests and "rig the game."

At least those management fees are taxed as ordinary income to the GPs and not as carried interests, I can only hope.


Only problem is option chain only goes out until Jan 13 ( no 30 month LEAPS d'oh ). And unlike General Growth which was in the $60 range when Regie called it out, PRE is only in the Teens. Would require continuous buying of out of the money puts for extended periods. That's fine for professional doomsayers like Michael Burry but too difficult for amateurs like myself. I want to at least have option duration beyond the announcement of  full FY12 results. I guess I will have to keep an eye on this play as a possible opportunity.



Rearranging Deckchairs's picture

Also curious if Reggie has looked at AGO - Assured Guaranty - regarding the municipal bond insurance market.  Besides the fact that AGO's subsidiaries supposedly insure  some $400,000,000,000.00 worth of municipal bonds with something like $13,000,000,000.00 of Assets available. While defaults are currently low they seem to be increasing. 

Then the structure of the company as a holding company receiving dividends from its subsidiaries seems opaque and overly complex. Makes me wonder if they are hiding things. This could increase the perceived value of the insurance they underwrite but it seems like they also face increased risks and demands to pay out.

One of its susbsidiaries also insures "structured finance"  which means the worse the residential real estate market gets the worse these RMBS trusts could get. But also depends on how the litigation with the Banks continues just like with MBIA.

So far Meredith Whitney's prognostications haven't borne fruit but I wonder if its just a difficulty in timing things. Most of the municipalities in this country will face enormous pension funding crises.

Frankly have tried looking into it but its a very opaque marketplace for an individual investor. 

Mr Lennon Hendrix's picture


silverserfer's picture

just bought 3 oz. Are they dead yet?