Chapter 6
When news of the proposed private equity takeover of the airline broke the share price soared immediately. The problem for Peter and Jim was to try to project the timetable before the private equity players were to commence their own short selling and then pack up their marbles and go home. Too early in selling down would risk having to repurchase before the share price dropped. Worse, it might mean having to repurchase before the shares had fully peaked and thereby suffering a potential loss.
The cash was readied and the wait began. In the event, it did not take more than a few weeks to reach a point where the upward rise of the share price was pretty well stabilized and brokers were beginning to question the sustainability of the take-over proposal.
Bad news often comes in three’s. This is what Peter had often said to Jim, and he said it again the day he called to suggest they start selling some of the airline’s shares that they didn’t own. First, the airline had had a mid-air incident that forced an unscheduled and scary landing. Second, the private equity partners were voicing demands and raising issues that made it quite evident that the deal would not succeed. Third, the price rise in aviation fuel had just become much worse.
When Jim and Peter commenced selling down the shares in the airline there was no obvious competition from other short sellers. Quietly at first with small parcels, the share sales slipped along as every small dip produced more enthusiasts who wanted the shares despite the talks publicly failing to resolve some key outstanding matters.
A month of protracted negotiations slipped by. Peter and Jim had unloaded over 4,000,000 of the company’s shares and both were becoming a little concerned that this time they might have got it wrong. Peter had even fielded a call from his broker requiring additional security on the size of the outstanding parcel of shares. He had supplied this margin call but knew he would not be able to do so again.
When the telephone rang on a Monday afternoon Jim was startled but soon relaxed at Pete’s tone.
“It’s soon going to happen mate” said the younger brother.
“What do you know?” asked Jim.
“I know someone who knows someone who says that the flight stewards are going on strike for a 20 percent pay rise” said Peter.
“They can’t do that, there’s an enterprise agreement in place” said Jim.
“It expires next week.”
“Oh, joy,” said Jim “so now it’s about to happen?”
“Yep, I think so. I also think the private equity group is showing its true colours as well. They’ve started requiring all sorts of unsustainable guarantees from the airline before they sign off on anything” said Peter.
“That’s a good sign” said Jim. “How long have we got to go on the contracts before we have to start acquiring the stock?”
“About two more weeks, but we might be wise to pick up a few next week even if the price is only 10 or 15 percent down to spread the load” replied Peter.
They didn’t have to worry. Before the week was over the consortium was talking publicly about the deal being far from done. There were also two more mid-air incidents that collectively were raising investor concerns about cost cutting in relation to the airline’s maintenance program. The share price had begun to slide and the rate was accelerating. By week’s end, the shares had fallen more than 35 percent from the average price at which Peter and Jim had short sold them and they moved in to cover their position. The volume of shares coming onto the market was sufficient to allow them to repurchase all they had sold within a further three days. After allowing for taxation, brokerage expenses and interest they were just short of seven million dollars in profit from the enterprise.
When the group again convened at their favourite restaurant Jim proposed a toast to his brother and Peter returned the compliment by saying how pleased he was to have such cooperative partners as Jim and Peg. Peter then announced that he and Angie were to marry in a month’s time at a local registry office and asked Jim to be his ‘best man’.
For the next few weeks, including the week of the wedding, things were quiet on the investment front, but Peter said to Jim one evening when they were again together at the Point Piper apartment:
“According to my information we are about to run into a mighty storm on the market. It’s all about risky lending practices at major US banks, and as you know when America sneezes the rest of the world catches pneumonia.”
“Let me guess” said Jim. “We have a little more work to do across the Pacific?”
“Got it in one buddy” said Peter.
“Still got your little arrangement in San Francisco?” asked Jim.
“Of course” said Peter.
“So what’s the essence of the crisis that’s brewing?” asked Jim.
“Well at the core, but by no means the only thing that’s gone wrong in the States, is an unbelievably stupid practice on the part of lending institutions that has traded on the American dream of home ownership” said Peter.
“Sub-prime mortgages?” said Jim.
“Yes, but do you really know how dumb these home lenders have been?” said Peter.
“I have read a little here and there. Apparently, they paid the guys lending money according to how much they could lend without a thought as to whom they were lending it to” said Jim.
“Yes” said Peter “that’s essentially it. But just consider that whole suburbs outside most major American cities are now populated with millions of families who have these McManshions with every conceivable mod con that cost hundreds of thousands to build and yet the vast majority of these families don’t even have enough income to cover the interest on their mortgage before you get to normal living costs.”
“Did they ever try to find out if they could pay their mortgage interest?” asked Jim.
“Apparently not. Much of the lending was done by mortgage providers, you know rather like the ones we have here in Oz that tell you they’ll lend you up to 105% of the home’s valuation. The difference is at least as far as I know they do require some proof of income here” Peter replied.
“But not in the USA, eh?” said Jim.
“No. They seem as though they were content as long as they got a signature on a piece of paper. The mortgage broker got a fee, the bank put up the money and the broker moved on to the next easy commission” Peter replied.
“Then didn’t the banks on-sell the debt to other unsuspecting institutions as triple-A rated debt?” said Jim.
“All around the world you know” replied Peter.
“So now the turkey is coming home to roost?” said Jim.
“Exactly” said Peter.
“I can almost read your mind now, mate. We are going to get a little action as the bank shares go into freefall” replied Jim.
“There are some mortgage providers that have set the banks up for a fall, but now that the game is up no-one is going to allow them to write any more mortgages” Peter advised.
“Haven’t they already gone into freefall?” asked Jim.
“No. The market is a funny thing. There’s still this element of disbelief over there. They know something has been wrong for years but they can’t conceive of the logical outcome yet. So we have a little time to move” said Peter.
“Can we do the selling down from here?” said Jim.
“Yes, but it’d be better if we’re in the States to do it so as not to attract too much attention. I think we’ve got a few weeks left before the meltdown begins. Perhaps we should all get over to New York and spend a week or two working out which companies are most vulnerable. What do you think?” Peter asked.
“Okay by me. What do you think Peg?” said Jim.
A raised eyebrow and nod from Peg was all that was required to signal her willingness to go to the Big Apple. But then she followed with:
“I’ve not been to New York. We could take in a play on Broadway, and go to some of the great museums there, like the Museum of Natural History. I’d love it.”
&nbs
p; “I’ll get my legal friend in San Francisco to deposit your stake again in your own trading account under the assumed name you used last time and check again that you are registered for taxation in the USA. Let’s keep on the right side of the US Tax Office eh?” said Peter.
“Sounds fine with us Pete” said Jim.
“We’ll go on separate flights as well. The more low profile we keep it while we have a go at shorting the US banks the better. I’ve a contact who can organize an apartment overlooking Central Park where we can all stay for a month or more if needed” said Peter.
Jim and Peg flew via Honolulu to San Francisco where they stopped for a day and Jim was able to reconfirm the details for his own trading account, guarantee funds having been forwarded and held in trust by George Kuidel. Peter and Angelique flew via London and after a stopover they were in New York within a day of Jim and Peg. The trading platforms in order, all they had to do was check out the news from brokers and others along Wall Street and surrounds. They set out to talk to as many people as they could buttonhole about the underlying nervousness on the markets and by the end of the day were comparing notes on possibilities.
“I think” said Peter “that the problem firms fall into two broad camps. There are the mortgage brokerage houses and the merchant banks that have done most of the lending to them. In the first list I’d put these three home lenders” he said, putting their names in block printing to the left on a list. “I also think these four banks are likely to go way down in price if not fail altogether.” He placed a second list to the right of the first.
“Close to my list” said Jim. “I’ve got the first three, and one more” and he proceeded to name a fourth mortgage lender. “As for the banks, I had more trouble sorting them out but I agree about two of them and am not sure about the third.”
“Alright” said Peter, “why don’t we take all four mortgage lenders and the two banks we both agree on, put them into the system and sell them all down?”
The coming financial storm was yet to do more than rumble a little and by the following day when they sat down and logged into their trading houses the market was actually showing a slight upswing. Selling the mortgage brokers was slower than was the case with the merchant banks but within a few hours they had achieved about fifty percent of their target sell-down. By market close they were well into the second half.
Before the market opened the following day the first collapse of a broking house took the market by storm. Panic set in and everyone was a seller. Part way through the morning Peter called a halt and suggested they all go out for lunch. The shares they had sold the previous day had already tumbled enough to make their trip worthwhile and selling now was becoming difficult. Lunch was relatively subdued as there was an undertone of worry from the many banker and broker types who joined the buffet queue.
Peg suggested she and Angie would do a shopping run in the afternoon and they were left to their own devices after some advisories on safe taxi protocol in New York and making certain they had the address of the apartment securely in hand.
Over an endless coffee, Peter said to Jim that he sensed a major market correction if not a meltdown was about to occur. “I’ve never seen anything quite like this Jim” he said “Today there didn’t even seem to be a bottom to any stock and every time I put in a sell someone went lower and then ten others went lower than that. I’d hate to have had real shares that I was unloading.”
Jim responded in similar terms and asked Peter if he thought they could short sell any more during the trip. Peter was not sure but he felt it was time to try further up the pecking order with some of the larger more reputable banks.
“I don’t mean to suggest the mortgage brokers and merchant banks we’ve been selling aren’t reputable but they’re the ones most people named as pretty heavily into mortgage lending” he said.
“I wouldn’t like to have funds in any of them” said Jim. “It’s just as if cowboys have been running this economy for years now.”
“They have” said Peter. “The incumbent president is a Texas rancher. He probably knows lots about cows but he sure as hell knows little about finance.”
“One of the big banks that was mentioned by a few people was Boar something” said Jim.
“Boar Simes” said Peter. “Yes, they’re big but they could be worth a look. Size doesn’t always mean they’re well run you know.”
“They have a branch just up the road. We passed it coming down from the apartment. Why don’t we just bowl in and check out their lending ability? See if they could lend us a few million for a new block of apartments we are thinking of building upstate. We won’t tell them exactly where for commercially confidential reasons” Jim proposed.
“Alright. Great thinking mate. We might just get an idea of how things look with them” said Peter.
They finished their coffee, paid for the meal and made a quick trip up the avenue to the indicated bank. Security commenced outside. Upon trying to enter they were confronted with a uniformed security guard who asked them very politely with whom they had an appointment. Upon being told that they did not, he said he could make an appointment but that they would not be admitted until they had one. He used a cell phone to talk to someone inside. Never before had Jim experienced security taken to this extent just for a bank but Peter was not surprised.
They waited a while until the security guard finished his conversation and he then told them to come back in one hour to see a Miss Michaelson on the fifth floor. He also asked if they could leave their personal contact details with him. Being non-citizens seemed to confuse him for a moment but they wrote their current address on the back of Peter’s card and he was more mollified.
An hour later, on the fifth floor, a discreet knock on the door marked Sophie Michaelson produced a warm ‘come in please’.
Sophie Michaelson exchanged cards with both men and then asked them how long they had been in the United States. They needed to think on their feet without contradicting each other so Peter took the lead in responding. After a little Sophie asked them the purpose of their visit. When they indicated that they had some investment money and were looking to develop some real estate Miss Michaelson looked at them as though they must indeed have come from another planet.
“You know” she said suggestively a little understated, “residential real estate is not doing well right now in the US. I’m surprised anyone would come all the way from Australia to get into something that seems to be in oversupply right now.”
“Yes” said Peter, “but don’t these things move in cycles? Isn’t it the right time to get in when everyone else seems to be getting out?”
“That’s fine if you think the cycle will turn” Sophie responded.
“And don’t you think it will?” asked Jim in a most naïve way.
“Well most of my colleagues think not. At least for a decade or so” she responded.
“That long?” said Peter in mock shock.
“At least” she responded. “In fact, many people think we have enough housing stock now for fifteen or even twenty years without building one more house.”
“So what will banks like yours lend money on in the period when no houses are being built?” slipped in Peter, and she fell for it.
“Well we’re all very worried about that too,” she said. “Even in this bank that survived the Great Depression, and has survived since the 1880’s, there’s concern that we may not have the funds to survive.”
“So a five million dollar mortgage would be out of the question?” intoned Jim as if he were asking for another helping of apricot pie.
“Absolutely” said Sophie. “I couldn’t even take such a proposition to the Board right now. No, I’m afraid these are difficult times gentlemen. Thank you for your visit. I’ll have someone see you to the door” at which she undoubtedly buzzed a silent alarm because her office door opened and a uniformed security guard was waiting to show them from the building.
“No sign of any money
or tellers anywhere but did you notice the holstered guns on the security guy?” said Jim, as they walked back towards their apartment.
“You should get an Oscar for that little episode Jim” said Peter. “I knew there was reason for teaming up with you.”
“Do you think she cottoned on to what we were really up to?” asked Jim.
“Nah” said Peter “but what would it matter even if she did?”
“What’s a bank doing in business if it cannot lend money to secure customers?” said Jim. “That’s really what she was saying. It would not have mattered how much money we had, they had none to lend.”
“Guess where our next sell down will be?” said Peter.
“Right. It’s too late today. First thing in the morning” replied Jim.
The following day they awoke to the news that experts were saying yesterday’s little wobble was unwarranted and all the panic was unnecessary. An isolated event did not make a crash and so on. The market began to rise on opening and continued a subdued and fluctuating upward trend for most of the day. Half the previous day’s losses were recovered by day’s end. Peter and Jim sold to the maximum of their trading limit, all on the one bank. In all, they sold over twenty-eight million dollars worth of shares in the one bank. Jim’s stake was two and a half million dollars.
“I hope the boar roars soon” said Jim.
“Don’t you mean the bear?” said Peter.
“As long as it wobbles, eh?” said Jim.
“Not too much of a wobble on the upside, mate. That we don’t need. But they’ve got to be headed down soon, I’m sure” said Peter.
“Okay. So now all we have to do is enjoy New York for a few weeks and see how our little stocks go” said Jim. “Let’s go and get some good Canadian rye whisky.”
The girls arrived back at the apartment by cab with shopping in evidence and praised the helpful attention they had received at Maceys and elsewhere.
“Everyone seemed willing to help” said Peg. “You don’t often get that sort of assistance back home.”
New York offers so much of the visual that the first few weeks seemed to fly by just becoming familiar with the landmarks including the pathways around the lakes in Central Park and the architectural wonders of buildings like the Chrysler and Empire State buildings as well as the UN building and other famous landmarks that told the story of the metropolis as a repository of the history of several centuries of architectural and transport innovation. Peter had been in New York before and had a working knowledge of the building styles and history and was only too happy to be able to pass on his knowledge as they strolled the streets and avenues.
Towards the end of their third week in the city Angelique suggested they deserved a meal at somewhere special and she mentioned a restaurant named ‘21’. A telephone reservation was made and a cab called for the appropriate time. The restaurant was good, but it was difficult not to make comparisons with the waterfront eateries of Sydney. Not that 21 is actually a waterfront restaurant, but they did serve some excellent swordfish. Jim was fascinated by the memorabilia on the walls. There were autographed photos of many famous customers including several former prime ministers of Australia and well known entertainers like Fred Astair and other showbiz celebrities. There were also old war toys and model airplanes suspended from the ceiling, a particular interest of Jim who could hardly be dragged away to eat his meal.
They got chatting with mine host who suggested that the two gentlemen might like to be his guests at the Metropolitan Club the next afternoon while the ladies were undoubtedly occupied by more shopping. Peg said that she and Angie were going to the Museum of Natural History the next day and might also take in the Museum of Modern Art.
The next day was spent as planned. The Metropolitan Club boasted the largest wooden chandelier that Peter and Jim had ever set eyes upon. It was also clearly a gentleman’s retreat; not a female in sight. Mine host ordered both individual massage and sauna in the gym, at the end of which they could not believe they felt so invigorated with years taken off their collective ages. They made a point to invite their host for the best that Sydney could offer should he make his way there, to which he responded that he had always wanted to visit Australia and see the kangaroos.
Jim commented later to Peter that he was not sure their host really knew where Australia was or how distant from New York At one point he had tried gently telling his host that the most direct way to Australia was vertically beneath his feet from his current position in New York. But Peter distracted the conversation from something so pedantic.
The markets remained uncharacteristically unaffected by the wobbles of the previous week and their third week-end rolled around with no discernable downtrend. On the Monday, almost 12 hours ahead of New York, the Australian share market unexpectedly rose quite solidly as did the Asian markets. It looked like New York might take its lead from here and it did. New York pounded ahead and bank stocks recovered all their earlier losses and added some here and there.
The whole week saw slight upward trends followed by very slight downswings and all things appeared ‘rosy’ in the garden.
“Just one of the little quirks you’ll come across when you try to pick the market mate” said Peter to Jim by the following Friday when nothing else untoward had occurred.
Peter could see that Jim was also beginning to fret. Time was dragging.
“Have you any tricks that might spark a downturn Pete?” asked Jim on the Sunday night.
By this time the results of Monday’s opening in Australia showed nothing too far from normal trading conditions.
“Yes” said Peter, “we could start phoning brokers and asking if there’s any truth in the rumour that Boar Simes is in financial trouble. That might do it.”
“Okay” said Jim. “What say we get started when the market opens tomorrow?”
“No, leave it another day. Monday is not a good day to suggest there’s a rumour in the market” replied Peter.
“Why not?” asked Jim.
“Because for a rumour to be about over a week-end there’d be plenty of people already in the know. But a mid-week rumour can be started and fired up and not quashed over several days that we need to do our stuff. Tuesday morning after the markets opened, Jim and Peter set to work. They had listed all the stockbrokers in New York and decided to split the list, one working from the bottom and the other from the top. They called and said they were clients, feigned a loss of memory if asked for their client identification number and just asked to speak to a broker about buying some shares. As soon as they got to each broker they just said that they’d heard something about Boar Simes being in trouble and was there any truth to it? Then they dithered a few moments and suggested they’d consider selling their shares.
The persistence paid off. By mid-day, they were getting responses such as ‘yes, we’ve heard that too’, and ‘Unable to confirm things but it might be wise to sell some of your holdings’ and so on. By mid-afternoon the share price was moving downwards. Many brokers also had other clients they were now advising to sell. The bank was not responding to the rumours. That was what Peter and Jim wanted. The broad truth was, all the banks could be considered to be in some sort of difficulty. Making the market select just one at a time was the key. By the day after, the overall market was in decline but the Boar Simes bank was in virtual free-fall.
The bank’s market spokesman came out and said there were no particular reasons for concern about the health of the bank. But his statement merely added fuel to the fire.
Jim wanted to start picking up the stock when the shares had tumbled more than thirty-five percent. But Peter argued for another day’s delay and he turned out to be correct. Real panic had set in by day four. Peter and Jim set out to cover their short positions as the market continued to crumble. By the end of Friday’s trading they had repurchased most of the short sold shares for a discount of over sixty percent. Over the week-end the bank declared that it was indeed in trouble and filed
for Chapter 11 administration. The share buying came to a halt when Peter and Jim were still a few thousand short of the final tally.
“We probably won’t even have to purchase those now,” said Peter, “at the moment we can’t, but we’ll leave funds in the account should the sell be called. Not a bad result. Tomorrow we should be able to start buying back the shares in the mortgage brokers.”
On the Monday the market was much lower with all of the mortgage related brokerage firms in steep decline or at the point of failure. Peter and Jim quietly moved to acquire all the short sold stock and had finished the task by day’s end.
In just under six weeks they had accomplished what they came over to do. They now had more than 150 percent profit on the enterprise. For Peter that was over twenty-seven million dollars and for Jim it was something over four million dollars. Peter reminded Jim that the funds first had to go back to their legal representative who would arrange US Federal taxes and brokerage deductions, as well as his fees and charges, and then forward the respective balances to the designated accounts back in Australia.
“You’ll still make well over two million dollars on the trip mate” said Peter to a somewhat shell-shocked Jim. “Not bad for a boy from little old Summer Hill eh?”
Back at the apartment the four of them celebrated with some rather fancy champagne. Jim said he’d still prefer a good Aussie beer and took one from the fridge. He’d located an outlet selling James Boag’s Premium and duly bought them at an outrageous price of near twelve dollars a bottle.
“Never thought I’d be quaffing this stuff in New York” he said. “What a dream run.”
“We’ll need to stick around for a few days until all the trades settle and check the accounts” said Peter. “Why don’t we plan some sightseeing?”
“Yes,” said Peg, “and we haven’t been to a Broadway show yet or to the ballet.”
“You didn’t mention the ballet before” said Jim.
“I am now” she replied. “I picked up a flyer in the foyer downstairs and Tchaikovsky’s ‘Swan Lake’ is still on for two more weeks. And I want to go and see Madam Butterfly as well.”
“Well, what about a trip to Statten Island and the Statue of Liberty? asked Peter. Who’s interested in that?”
“That’ll do me” said Jim, and Angelique and Peg also assented.
The taking in of culture and sights of the greatest metropolis in the world could have gone on for weeks more but they decided to bring their flights forward to the following Wednesday and head for the cooler climes down under. New York in a summer heat is not the best place to be with humidity often around the ninety percent mark.
Peter and Angelique flew back to London then on to Singapore where they took a couple of days off from the flying before their return to Sydney. Jim and Peg took the long flight to Los Angeles then an Air New Zealand flight that went via Auckland where they had a one week stopover and did some hire drive touring around the North Island before flying on to Sydney.