Is the Macquarie Model Dead?

What about the financial economy? In the U.S., Lehman Brothers (NYSE: LEH), Merrill Lynch (NYSE: MER), and Goldman Sachs (NYSE: GS) all report earnings this week. If you are a Sovereign Wealth Fund that decided to recapitalize Wall Street in the last six months, we recommend a cheap bottle of Scotch to go with your wasted capital. Wasted and wasted.

In fact, let us raise the prospect that the entire model of making money by managing and flogging assets is now in jeopardy. Case in point, Macquarie Capital Alliance Group (ASX: MCQ). Three years ago the investment fund raised a $1 billion from investors and had itself listed on the ASX. Now Macquarie is buying it back for $830 million and taking it private.

Macquarie took a $295 million write down earlier this year on its listed Australian real estate investment trusts, according to Brendan Swift in yesterday's Australian Financial Review. Some of its listed funds are selling at nearly 35% discounts to net asset value, according to Swift. Does that mean the assets are worth less than what Macquarie says they are, or what it paid for them?

Well, it could mean there's a lack of confidence in the listed fund model and that it's a great time to pick up Macquarie funds for a song. Or it could mean that using debt to finance asset purchases and earn money on fees and underwriting works really well when interest rates are low, and not as well when rates are high. You but assets with borrowed money, earn money on the assets, and fees on packaging them up and selling them again.

Babcock and Brown (ASX: BBC) made the mistake of financing much of its asset growth with short-term debt. When the debt had to be rolled over at higher interest rates, the flaw in the model was exposed. You can be the best asset manager in the world. But if the asset doesn't generate enough income to cover your debt payments, you have a problem.

Is the Macquarie model dead? No. But it is not an easy model to replicate either (or make work when borrowing money is no longer cheap and easy). You have to be discrete about the assets you buy and not over pay for them. And frankly, not many people can make money trying to be like Warren Buffett, buying assets and managing them better than people who work in the business full time.

Wall Street operatives invaded the boardrooms of global corporations over the last ten years, preaching the gospel of aggressive financial management. This meant selling "lazy assets" and stripping down companies to basic functions, shedding jobs and vertically integrated supply chains.

It worked very well for the investment banks that generated fees from the spin-offs, which they might later put together in some new shape. But did it work so well for the businesses? Probably not. An economy driven by the fee-making potential of asset managers does not necessarily end up being more competitive, efficient, or productive.

Dan Denning
The Daily Reckoning Australia

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