I bought Jefferies bonds last week, specifically the JEFFERIES GROUP INC NEW Cusip 472319AD4 with a coupon of 5.875 and maturity 06/08/2014.

I bought them on Tuesday (the 22nd Nov 2011) at 84.8 face value, yielding 13%, just the day that the letter to reassure investors was published by its CEO, I bought them an hour after it was public, that same day they went up to 87 and next day to 93 and have traded lately up to 96, they yield around 8 to 9% now.

The company seems to be one of the most conservative among investment banks. But given the market situation and specially after the bankruptcy of MF Capital it suffered an attack of rumors, probably motivated by short sellers, specially by one hedge fund and an analyst claiming it was exposed to European sovereign debt and the stock tanked. They promptly answered showing a list of all their investment and proving that their net positions in sovereigns was basically nothing. They also replied to every rumor, they took same days to reply and the stock tanked in between.

At current levels its valuation metrics are as cheap as ever, Leucadia has been buying enormous amounts of stock very recently, Ian Cummings, appart from being it’s owner, and a seasoned businessman who has done several businesses with Warren Buffett (Berkadia 1 & 2), is also a director of Jefferies, so that makes him an insider buyer, and in huge amounts, he is also the major owner now.

My knowledge of investment banking is quite small, so when I was informed by a fellow investor (who loves focusing on distressed and hard hit stocks) several days before, of this opportunity, I started reading the 10Ks, blogs, conference calls and news. I also decided then to read about investment banking in general, specially because it is hard to get a grasp on the business by studying the typical information. So I devoured the book “Liar’s Poker” from Michael Lewis. Great book by the way. That book is written by an ex Investment Banker about his experience in Salomon Brothers. It shows how investment bankers work, how immoral they are and how they care immensely more about their profits and bonuses than about their clients. If they have good investments they keep it to themselves, if they make a mistake, no problem, they make a priority to sell it to their clients, so that they take the hit. They are the ones who invented the infamous callateral mortgage obligations. By slicing and dicing mortgages into tranches to sell them as bonds and making billions in the process. They modified and lobbied for new laws in order to do it, helping to create the biggest recession in the latest years. Once the law and the rating agencies were on their side they sold trillions of those mortgage bonds, they created the market, a market that was inexistent before and that got the USA in the mess where they are now, and its hard to see how they can get out of the mortgage debt without losing trillions or massively inflating. The debt is in hands of the government, conveniently accounted as off balance sheet debt, in organizations like Freddy and Fanny. The debt, however you account for it, is real, represents a big percentage of the GDP, and it acts as a big inflation incentive for the government in order to pay it back. It dwarfs the problems in Europe. Thanks to “Banksters”, helped by their politicians associates, your mortgage is underwater. If housing prices had to be marked down to its real prices banks would have to write down trillions and would go bankrupt in the process.

It was also investment bankers, specifically Milken, from Bears Sterns that popularized the massive sell of junk bonds and used them in order to finance hostile leveraged buy outs.

The book is great, it shows with many examples how investment bankers make money, their lack of ethics, and how just a bunch of guys with an average age of 25 years and with less knowledge about managing money than the average blogger are entitled with billions from institutions to allocate it and move it around for their benefit. Most of that money comes from the average Joe who saved it with his hard work. At the end of the day it falls into the hands of these guys, who more than anything care about their year end bonus, which is 3 times more than what their daddy earned at 65. It is amazing to see how desperate they are about that bonus, that’s very nicely illustrated in the book. It is also nice to see how everytime that they make a mistake they rush to call their clients in order to sell them their mistake, saying that it’s a great investment. That’s how they cut their losses. They strive to get rid of their bad investments by passing the losses to institutions. Once they manage to sell to the client their losing positions they celebrate and the seller who did it is considered a hero, a hero for having managed to screw a client in order to save money for his firm, but of course, he could not care less about his firm, he does it to assure his bonus. Of course the client gets pissed off and the seller has to endure his angry phone calls and misery, but they care more about their bonus than about the complaining client. I understand better now why investment bankers are called “Banksters”. It is also interesting to see the average time they work at a company, which is really almost nothing because they jump from company to company to the one who pays better. An investment banker who remains more than 1 year in a company is almost considered an old timer, at 2 or 3 years he is almost a veteran.

Jefferies in general seems to be more conservative, at least his CEO has been working there for several years and they are in less risky lines of business, specifically in fixed income products. But nonethelss the nature of the business in general is risky, there is no way of knowing what they have in their assets. I am talking about investment banking in general, only one mistake can screw up the whole company. And the reason is because they use an enormous amount of leverage, just like banks, but even worse. So if their assets just shrink a bit in relation to their liabilities their equity is wiped out, confidence is lost, customers are lost and fly away to competitors, and even their employees run away to the next investment bank. In a few days the business goes bankrupt when that happens, and a small investment bank like Jefferies might not be bailed out by uncle Sam (or better said, by you, the tax payer). It does not take too much in order to achieve that, only one trader who was not correctly supervised (not rare) can manage to destroy his company. Like Salomon Brothers, where Paul Mozer, a primary dealer treasuries trader, managed to almost bankrupt the firm by dealing fraudulently with government treasury bonds. Salomon was saved with a lot of work from Buffett. Buffett had invested in Salomon a few years before, 700 millions at the time, quite more than now, and he was not interested in losing that money, so he made a huge effort to help the firm, and succeeded. He had to step in, even move to New York and stay there working and going to several trials, for a very long time, until the situation was resolved.

Given the risk I see in investment banking, but recognizing also that Jefferies is quite cheap, and that the possible profit is huge once the rumors calm down, and that there is a lot of insider buying from a very respected investor and owner I decided to jump in and invest, but definitely not in stocks, so I opted for something safer: bonds. I also hate to invest in stocks in industries where stockholders are not valued and where employees receive obscene bonuses with stock from the company which dilutes the number of stocks constantly. That’s why I opted for bonds, it is also reassuring to see that they do not have to pay their bonds until several years in the future, and since their cost of debt is already quite high they will maybe call out some of it and buy them at face vale or in the secondary market, boosting their face value. From what I read, officially from the CEO, they have already been buying back their bonds (and stocks) just now. It is still a risky investment, but the yield compensates and also the fact that it is certainly the stockholders that will suffer the most in case of persistent troubles. Another possibility I was thinking of was to buy some calls instead of stocks, like that you can have a big return and limit the possible losses. Whatever you decide to do, you should be quite careful before investing your money in an industry whose members are called “Banksters” :).

Cheers!

jrv