19. Investment Banks

All right. Today, we want to talk about
investment banking, which is different from commercial
banking. And today we have a guest, Jon
Fougner, who took this course almost 10 years ago and has
been working in investment banking since. I'll introduce him in a few
minutes, but I wanted to start with just the elements of
investment banking, and then I wanted to talk about changes
in it that came about after the financial crisis of
2007 through 2009. OK. The topic is investment
banking. And that is a term, a
20th-century term, that first became big and important, I'd
say, in the 1930s, but preceded that by some years. And it refers to a business of
helping other businesses create securities. If someone wants to issue
stock, they go to an investment banker
to help them. Or if you want issue
bonds, you go to an investment banker. It can be a corporation
that goes to the — for-profit, it can be a
non-profit corporation, it can be a government.

I suppose even an individual,
who is incorporated, can go to an investment bank. That's the investment
banking business. Now it's different — it shares something with the
consulting business, because investment bankers serve
often as consultants. A company will come to an
investment banker with a problem, and they want to raise
money by issuing new shares, for example, to
solve that problem. But if it's a good investment
bank, they will do more than just issue shares for them.

They'll talk about their whole
corporate strategy. So, in that sense an investment
bank looks like a consulting firm, but they don't
do pure consulting. That makes the distinction. Maybe, they're in many ways a
favored consultant, because they bring money. You can talk to a consultant,
who will bring you no money, and another consultant,
who has his hands on money somewhere. And that helps a lot. The advice and the money
together help a lot. So, investment bankers are
different from traders, because usually they deal with
creating something — about making a corporation or
a government — making it work, enabling them to
do something that they want to do. And then, being realistic about
it, and coming up with the money to do it. And so, that's how investment
banking differs from consulting
[correction: trading]. And it differs from commercial
banking in that a pure investment bank does not
accept deposits.

You can't go to your investment
bank and say, I'd like to open a savings
account. They don't do it. I'm talking about a pure
investment bank. But let me just give you
something about this business. I'm going to come in a moment
to pointing out that most investment banking businesses
are not pure investment banks. But let's talk about what a
pure investment bank does. It does underwriting
of securities. That means — suppose you're a company and
you want to issue shares. You need someone to go to bat
for you, someone who knows the kind of people, who might
buy your shares, and can vouch for you. So in some sense, it's
a reputation thing. The investment bank has contacts
among people who make big investments, and they manage
the issuance of your new shares, and that's called
an underwriting.

If it's the first time you're
issuing shares, it's called an IPO, or ''initial public
offering.'' So, you're a private company, it's just you
and a few friends own the company, but now you want to go
public, you would generally go to an investment bank,
and talk to them about how to do it. And the investment bank would
solve that problem for you by doing an underwriting. So, traditionally there's two
kinds of underwriting — Also, there's also something
called a ''seasoned offering,'' and that means, for
a company that has already gone public, and it already has
shares traded, so that the shares are seasoned, but you
want to issue more shares.

So, you can go to an
investment bank to do that, as well. OK. There's two kinds of deals. There's a ''bought deal,''
and then there's a ''best efforts.'' With a bought
deal, the investment bank buys your shares. They go in and say, you know, we
know that we can market for your shares. We will buy them ourselves and
resell them on the market. A best efforts offering is one,
where the investment bank doesn't buy it and doesn't
promise anything. They say, we'll make
our best efforts to place this offering. So, those are the basic
things that they do.

The methods that they use are
regulated by the Securities and Exchange Commission
in order to make — the SEC in the United States,
and regulated similarly in other countries. So, that's the basic investment
banking business. So, if you're thinking of where
to place yourself, I think investment banking suits
very well people who are — it's not good for
autistic people. If you're autistic,
be a trader. Then, you just get on the phone,
and you buy and sell all day, and you can be rude,
and you can have coffee stains on your shirt, and you don't
have to know anything about classical music. OK? But investment bankers
are a different — I see Jon is laughing. Tell me, what you know
what classical music.

I assume that was a part of
your training at Goldman. He says no. It's a whole different
industry. So, if you go to the symphony
and look around, you'll see lots of investment
bankers there. But you won't see any traders. You nod on that
[POINTING AT JON FOUGNER], maybe. We talked about moral hazard. I think that an important part
of what investment banks do is, solve a moral hazard
problem, and that problem is, that companies, who issue
shares, don't have a reputation. And so, what do I care, I'll
issue shares, right before we're going to go bankrupt. We know inside that we're going
to go bankrupt, so hey, let's just see, if we can milk
this company, before the public knows it, and
issue shares. That's a moral hazard. And the investment bank
is in business to prevent that moral hazard. They do the due diligence, they
check you out, and then after that, people are
more trusting of you.

So, I think investment banking
is built around trust, it's establishing trust. So, that's how it differs from
a lot of — that's why it's important that these people be
cultivated and impressive. They tend to be well-spoken. I can ask Jon, whether he agrees
on all this, but it's my impression, you can tell when
the investment bankers walk in the room. They dress differently,
they look differently. I don't know what it is. It's something about reputation
— it's what it's built around. The investment banking
industry — let me just — since I'm talking about the
nature of investment banking and since we have a Goldman
Sachs representative here. I put on your reading list a
book as an optional reading by Charles Ellis called The
Partnership, and it's a history of Goldman Sachs. Goldman Sachs was an investment
bank until just very recently, and we'll
talk about that. They're still in the investment
banking business, but now they're officially
a commercial bank.

It's an old, venerable firm, and
Goldman Sachs emerged in the early 21st century, as,
I think, the most highly respected and esteemed
investment bank in the world. Amazingly successful, and
amazingly well-respected. Ellis wrote a book just
a few years — Ellis is on the Yale
Corporation. He's a distinguished businessmen
and author himself, and he wrote a book
about Goldman Sachs, which is largely admiring. Like, how did this happen? How did this phenomenon of
Goldman Sachs come about? And I suggested — I didn't assign — I suggested, you read one
chapter, which was called Principles. And it says something about
Goldman Sachs, and it refers to, in that chapter, the
chairman of Goldman Sachs, John Whitehead, in the 1970s
wrote down a list of principles that guide
Goldman Sachs.

And Ellis seems admiring
of these principles. Not everyone would agree. It's a matter of taste,
I guess, if anything. Whitehead is now — I just looked it up — he's 88 years old, and is
retired from Goldman, must have retired some years ago. What kind of an organization? Ellis says, that the thing
that struck him about the organization is loyalty. But that's not alone, that
people feel a strong loyalty toward their company. That's not on Whitehead's
list. So, Whitehead's list.
What is his first principle of Goldman Sachs? "Our client's interests always
come first." These sound a little bit like bromides. I'm sorry, but I read them
thinking, it is the most successful investment bank in
the world, so maybe there's something beyond — I think, there is something
beyond platitudes here. Second, "our assets are
people, capital, and reputation." That's a coincident
with what I said.

"Uncompromising determination to
achieve excellence." Well, everybody says that, so maybe
we'll discount that. "We stress creativity and
imagination." Well, those are sort of bromides, maybe. Then, Whitehead issued
some guidelines — this is also in that
chapter later — for Goldman Sachs employees, and
these seem to be a little bit more candid. ''The boss usually decides, not
the assistant treasurer. Do you know the boss?'' That's
something I've learned from my own interaction with people — the boss really does decide,
and Goldman Sachs goes for the top. And maybe this is obnoxious, I
don't know — they don't want to talk with underlings. ''You never learn anything when
you're talking.'' That means, be a good listener. ''The respect of one person
is worth more than the acquaintance with 100.''
''There's nothing worse than an unhappy client.'' The
one thing that — I don't if it's on Whitehead's
list — but I think it says something
about investment banking, and that Ellis says, is that
they shun publicity.

They don't want to be in the
newspaper, they want to be known by the president. They want to be known by
a few prominent people. They're kind of social
climbers, in a way. But it's all built around some
basic principles of service, and they want to be talking to
the top guy, and they don't want to be in the newspaper. I'm going to quote
Ellis on this. Now I'm quoting Charlie Ellis. I call him Charlie. I know him. He's a friend of mine. "Making money, always and no
exceptions, was a principle of Goldman Sachs.

Nothing was ever done
for prestige. In fact, the most prestigious
clients were often charged the most. Absolute loyalty to the
firm and to the partnership was expected. Personal anonymity was
almost a core value. The real culture of Goldman
Sachs was a unique blend of drive for making money and the
characteristics of family, in ways that the Chinese, Arabs,
and old Europeans would well understand.'' So, I'm giving you a flavor of
what an investment bank is.

You might be repelled by it. You know, is making money
so important? And if you are repelled by it,
you probably don't want to work for Goldman Sachs. On the other hand, they're
kind of respecting some economic principles, right? Working for a firm like this,
you can make huge amounts of money, and then at the
end, you can give it all away to charity. And that's the new capitalism,
right? So, what's wrong with that? What are you going to
do with all this? If you make $100 million, what
are you going to do with it? You're going to give
it away, right? I mentioned at the beginning, I
mentioned Andrew Carnegie's book, The Gospel of Wealth. Maybe that's, what this
is all about. On the other hand, some of them
don't give it away, and some of them live lavishly. Different people have different
impressions of this business — but I want to make sure I have
time for our guest and I'm sort of running out of time. I wanted to talk about what has
happened in the crisis.

There's so much to say
about this topic. Maybe, I should talk first
about the first crisis. In 1933, the US Congress passed
the Glass-Stegall Act, which forced investment
banks — it prevented investment banks
from doing commercial banking, or commercial banks from doing
investment banking. It split them in two, and it
said you have to decide, are you a commercial back, or are
you an investment bank? The Glass-Steagall Act was the
act that created the FDIC, the Federal Deposit Insurance
Corporation, the first successful national deposit
insurance act in the world.

And part of it — it makes sense
— if you're going to insure the commercial banks, you
better watch what they're doing and prevent them from
doing dangerous business. So, the dangerous business was
investment banking, and they forced companies to decide. So, J.P. Morgan, which was doing
both investment banking and commercial banking in
1933 had to decide. What is it? Investment banking or
commercial banking? So, they picked commercial
banking, and that means, they fired all their investment
bankers. So, these guys regrouped and
they formed an investment bank, called Morgan Stanley. Stanley was a Yale graduate and
Morgan was, I think — not J.P. Morgan, it was
his grandson. Morgan died around 1911. And so, those were two
separate ones. J.P. Morgan, commercial bank. Morgan Stanley, investment

But since then, we've repealed
the Glass-Steagall Act, and that occurred with the
Gramm-Leach Act [correction: Gramm-Leach-Bliley Act] of — what was that — 1999. Well, Gramm-Leach[-Bliley] repealed Glass-Steagall, and
now these businesses, they generally do the same
business, both commercial and — yes, Gramm-Leach[-Bliley] was 1999. Since then, as you recall, we've
had a financial crisis. And in that financial crisis,
Glass-Steagall got brought up again, because it seemed that
the crisis was related to a number of shenanigans that
firms were undertaking. And the government had to bail
out commercial banks. We talked about this, and
it's very controversial. So, the question is, did these
banks get in trouble, because we repealed Glass-Steagall? A lot of people came
on saying that.

These banks were doing all kinds
of screwy things that were dangerous, and we're
insuring them, so it can't be. So, a lot of people said,
we have to go back. There was some inherent wisdom
in Glass-Steagall that we've lost. And this was debated. Now incidentally — I didn't mention this — Glass-Steagall was somehow
confined to the United States. Outside of the United States, I
don't know if there was any country, but as far as I know
the U.S. was the only one that did it. So, outside of the United
States they had what was called universal banking. And these banks outside of
the U.S. were doing both investment banking and
commercial banking. They sailed right through the
whole century without being divided up. So, the reason why we got
Gramm-Leach[-Bliley] was, that people started to
say, you know, we're at a competitive disadvantage. We Americans are at a
competitive disadvantage to Europe, because we can't do
both, and they have more freedom than we.

And so eventually, in 1999, we
said, they could do both, so that the U.S. also became a
universal banking country. But then problems arose. And the problems were — Paul Volcker, who was chairman
of the Federal Reserve Board in the late '70s, early '80s
proposed something called the Volcker Rule. And the Volcker Rule was
not a full return to Glass-Steagall, but — and this is now in the
Dodd-Frank Act.

It's Section 619. It doesn't say Volcker Rule
there, but that's what it is, and it prohibits proprietary
trading at commercial banks. And it also says, that
commercial banks can't own hedge funds or private
equity [addition: private equity funds]. So, that was the Volcker
Rule that was put in. There was also another rule
added, which is analogous to the Dodd-Frank Act [correction:
analogous to the Volcker Rule], also. And this is in the Dodd-Frank
Act of 2010. There was a senator. Her name was Blanche Lincoln, a
Democrat from Arkansas, who proposed the Lincoln Rule — unrelated to Abraham Lincoln,
as far as I know.

And the Lincoln Rule was — or Lincoln Amendment, and that
is Section 716 of Dodd-Frank. It says that — it doesn't prohibit banks
dealing in swaps, but it said swap dealers are barred
access to Fed window, discount window. And so effectively, it prevents
banks from dealing in swaps anymore. As a result of this, Goldman
Sachs has got to shut down — or it appears that — the Volcker Rule says
banks have until October 2011 to comply. So, it means that Goldman Sachs
has to shut down — Goldman Sachs had to become a
commercial bank, too, so it's no longer — it's an official commercial
bank now.

And because of the Volcker Rule,
it appears that it has to shut down its proprietary
trading, which was a huge part of its profits. And Goldman Sachs will never be
the same again, apparently. But it's not clear,
what will happen. It depends all on how Dodd-Frank
is enforced. I think, that the people that
are in the banking industry are going to try to claim, that
some of the activity that was done by their proprietary
traders — that is, people who were trading
the market on — true investment banking
shouldn't involve the investment banker buying and
selling securities trying to make a profit. That's not underwriting
of securities, that's proprietary trading. The Volcker Rule says, that you
pretty much can't do it anymore, unless you're a pure
investment bank, but if you're a commercial bank, you can't
do it anymore, and they're kind of forced to become
a commercial bank.

But they're going to try to
steer around these rules, and I think that maybe they can. They'll re-define something
that looks something like proprietary trading, and
then continue to do what they're doing. We'll have to see. These things are long
and arduous. You know, one thing that strikes
me about finance is, that it's so rules-based. There are so many laws, there
are so many lawyers, that nobody can grasp the magnitude
of the regulations that these people live under. And you see these landmark
bills, but none of us understands them, because the
real content of them is involved in hundreds of pages of
legal documents, that never cease to amaze me with
their complexity. Let me tell you something about
shadow banking, which is relevant here.

The term ''shadow banking,'' I
think of that as coming from a term that I first heard from
people at Pimco just within the last five years or so. Or maybe it goes back
further than that. It refers to a new kind of
semi-banking system. What are shadow banks? These are companies that are
acting like commercial banks, but they're technically not. So, they're not regulated
as commercial banks. And in many cases,
the investment banks were shadow banks.

I'll give you an example of
Lehman Brothers, which was a pure investment bank. It's now bankrupt, it's gone. It was a pure investment bank,
so it wasn't regulated as a commercial bank. This was before the Volcker
rule, before Dodd-Frank, and they went bankrupt in 2008, and
it was the worst moment in the financial crisis. Why did they go bankrupt? Well, there's a reading on your
reading list by Professor Gary Gorton here at Yale, who
argues that Lehman, like many other investment banks, was
financing a lot of proprietary investments by issuing repos,
or by dealing in repos. What is a repo? That's short for repurchase
agreement. The banking crisis, that we saw
in 2008, was substantially a run on the repo.

So, here's what happened,
according to Gorton and others who agree with him. Investment banks, like Lehman
Brothers, were not regulated like commercial banks, and as
long as they didn't accept deposits, they didn't
have to be regulated as commercial banks. So, they could do what they
want, and they were considered underwriters, so fine,
do whatever you want. Well, not quite, but they
weren't heavily regulated, the way commercial banks were. And what Lehman Brother started
to do is, to make heavy investments in subprime
securities and other securities by effectively
borrowing through the repo market. What is the repo market? It's a market, in which a
company effectively borrows money by effectively selling
some securities it owns with an agreement to repurchase the
security at a later date. They're short-term loans, and
in fact, collateralized by some security that they own. What it was, it was almost
the same as a deposit. They were short-term loans
that someone could withdraw at any time. The someone wouldn't be some
mother and father with their small savings account. It would be some bigger,
probably institutional investor. But these were acting like
banks, like commercial banks, because there could be a run
on these banks the same way there's a run on the
commercial banks.

If anyone starts fearing that
Lehman Brothers is going to fail, they all want to take
their money out, which means, they don't renew their repos. And so Lehman Brothers failed,
when the housing market declined, the value of its
subprime securities declined. People, who were lending it
money through repos, got wind of this, and they stopped
wanting to do it, so it was like a run on Lehman Brothers. And Lehman Brothers could
not be saved, if it weren't for a bailout. The government had already
bailed out Bear Sterns, and it had helped Merrill Lynch, which
was failing as well, and they decided not to bail
everybody out, so they let Lehman Brothers fail.

So now, the reaction to that is,
that we can't let shadow banking go unregulated,
and Dodd-Frank is part of that reaction. So now, investment banking
is substantially altered by these laws. And still, of course, it's a
very important business. The United States has
traditionally been the most important country in investment
banking, but it continues that Europe and Asia
are also important, very important participants in
investment banking. Growing, I think. The financial crisis has put
something of a damper on the business for a while, but
I think, it seems to be coming back. The latest news is, that the
investment banking business is starting to look more stable
and prosperous. So, what I want to do
now is invite — let me just do a brief
introduction. So, Jon Fougner took this class,
I think it was 2002, and then, he served as my
research assistant for a book I was writing, called The New
Financial Order, so I got to know him better. The important thing for this
lecture is, that you worked for Goldman Sachs, and got to
know people there, and now he's working for Facebook.

You've heard of this
company, right? I thought it would be
interesting to have him back to give his impressions of what
life was like after ECON 252, of what Goldman
Sachs was like — at least the old
Goldman Sachs. And I think, it's interesting
to hear about Facebook, too, because it's a different kind of
culture, and I'm interested in culture. It's more of a tech business. I'm interested to hear, if they
have anything like the Goldman Sachs principles,
or they enunciate them the same way. So, I'll bring Jon up, and
I'll let him continue. JON FOUGNER: Very well. Thank you Professor Shiller. And Professor Shiller has
promised, that I'll be well-spoken, and well-dressed,
and a bunch of other things, good, bad, or otherwise.

I'm not sure, if I'll live up to
any of those expectations, but hopefully I can
share a little bit about this business. How many of you are considering
going into investment banking? Maybe about 30%, or so. OK. And how many of you
are on Facebook? OK. And how many of you are considering working at Facebook? OK, so maybe we'll add
a few more to that by the end of this. The goal for the next half hour
is really to help you think about, whether banking
might be the right next step for you after college, and for
those of you who say yes, to share a few tips on
how to think about getting into the business. I'll give a little bit of my
background, kind of a context for my reflections on the
industry, so you can take them with a grain of salt, share some
anecdotes from banking during the debt boom, and then
also give a few tips, or steps that you could take today, if
you're interested in it. So, a little bit on
my background. Junior summer, I went to work
for a large investment bank, as Professor Shiller mentioned,
and I really enjoyed the work, knew that
I wanted to go back to it.

But I had never lived abroad,
because, as you all know, your junior year here at Yale,
there's a lot going on with extracurriculars, and so many
people don't go abroad. I went to see Charles Hill — now how many folks are familiar
with Charles Hill? Fabulous negotiator. And I said, Professor Hill, how
can I negotiate to go back to this job a year later,
so I can do a Fulbright in the meantime? So, he taught me all this
jiu-jitsu, and it ended up working out, and I did a year in
Norway, and then came back full time to banking.

Now, as you probably know,
a lot of analysts go into banking, they do it for two
years, maybe do private equity, hedge fund, maybe do
an MBA afterwards, and something like 15% might stay
on, get promoted, and become career-track bankers. When I was working on Wall
Street, this was the peak of the most recent private
equity boom and the associated debt boom. And so, recruiting to private
equity had reached such a fever pitch, that literally 16
months before the start date for these jobs, analysts were
getting calls from recruiters, doing interviews, and
actually making commitments to joining companies. And I knew, I was interested in
tech, and so I became very close to signing with a
technology private equity fund, that I admire still very
much to this day, but I actually decided that I wanted
to work in tech itself, and so the last three and a half years,
as you mentioned, I've been working at Facebook
working on our social advertisement strategy.

So, a little bit about inside
the banking role. It may sound a little bit
funny to talk about the investment banking division of
an investment bank, but that's what we'll do for the
next 15 minutes. And by that, I really mean, just
the part of the business that Professor Shiller
mentioned, giving advice to CEOs and CFOs about financing,
and mergers and acquisitions. So if you see this logo– and that makes you smile — I see a few smiles, maybe
a couple grimaces — if it makes you smile,
it's a good sign that banking may be for you. You think about two,
don't understand that. That's an Excel logo. JON FOUGNER: That's
an Excel logo.

What are you driving at? JON FOUGNER: That's an Excel
logo, and these are Excel models, and they go on and on. PROFESSOR ROBERT SHILLER:
You mean, they're going to be a nerd. Is that what you're saying? JON FOUGNER: Yes, if by that
you mean you want to feel comfortable with the technical
aspect of the role, yes, absolutely. Especially at the junior
level, where — you mentioned some of the
relationship aspects of banking, but at the junior
level, really your core responsibility is building
out these models. So, if you think about working
on that until 4 in the morning maybe two nights in a row, maybe
20 nights in a row, and that's exciting to you,
that's a good sign. So, how many of you have gone
online to Open Yale to see Stephen Schwarzman's talk
from this class from three years ago? One, two. Two enterprising users
of the internet. I would strongly encourage
everyone to do that.

One of the things, that he
talks about is that in banking, there's not a ton of
flexibility for getting the numbers wrong. As the analyst, you really
need to nail the details. And primarily, what we're
talking about there, is building operating transaction
and valuation models that describe your clients,
and other companies, and their industry. And then, the information from
those models, along with research you find by hook and by
crook on the internet, from your colleague, wherever you
can, kind of comes together into presentations, polished
pitch books to help win a piece of business. So, that could be an IPO, a
merger advisory, as you mentioned, and once you've won
that piece of business, then you as the analyst really are
the organizing principal for getting this deal across
the finish line. Dealing with the accountants,
working with the lawyers, other bankers, even competitors
who might also be working on the deal, and then,
of course, your client, and whichever counter-party
your client is selling to or buying from.

So, it's a fair amount
of responsibility. Typical investment banking deal
team, the core team is pretty lean. Maybe one each of an analyst,
associate VP, and MD, and if you decide to and are given the
opportunity to continue working in investment banking
on a career basis, then you will gain a little bit more
control over your week to week and month to month schedule
as you become more senior. But even at a senior level,
investment banking is really considered an always on-call
client service profession. Now, one of the advantages of
this very lean deal team is, that there's plenty of
responsibility to go around. So, if you raise your hand and
say, yes, I can take on some of this work, that might by
default fall to some of my associates, and you do it
without making mistakes, you're going to be able to get
more and more responsibility, learn more and more
on the job.

One of my favorite projects
that I worked on was a proposed venture capital
transaction, where we were looking at investing in eight
different operating companies, and because the team was that
lean, I was actually able to basically take on leading the
due diligence on these eight different companies. PROFESSOR ROBERT SHILLER: Before
you go ahead, why do the managing directors
have zero grey hairs? JON FOUGNER: Well,
I'm just assuming it's all gone by then. That's a median, the mean might
be a little bit higher. High variance. So, I would — Was that the nerdy comment
you were looking for? So, I might encourage you to
think about these roles as an investment in your career,
where what you put in, of course, is long hours — maybe
100 hours a week for a couple of years — and what you get out, is a
number of things, including a skill set that's really valued
and respected, not just in finance, but around the business
world, exposures to CFOs and how they think about

If you decide to continue on as a career banker,
participation and success that you'll help create
for your company. And then, of course, a network
of very smart, eager peers, like the folks in this room,
who then fan out across the finance industry. So, as I mentioned, I was in
banking during the debt boom, and there was such a peak in
transaction that people started calling it Merger
Mondays, this expectation that before the bell at the beginning
of the week, there'd be a $20 billion, or $30
billion, $40 billion transaction that would
be announced. And there was so much enthusiasm
for this sort of transaction that even financial
institutions, which, conventional wisdom told
us, couldn't be LBO'ed [clarification: LBO stands for
leveraged buyout], because their balance sheets were
already so levered, actually became considered targets
for leveraged buyouts.

And arguably the peak of this
was, when Blackstone themselves, one of the fathers
of the buyout industry, filed an S1, and in fact became a
publicly traded company, which they are to this day. Your final task as a banking
analyst is to create a deal toy, when you successfully
created a transaction. Now, this particular one used
to have water in it and glittering fish, and at the
time I thought it was very pretty, but I would just invite
you maybe, when you create your deals toys, don't
picture your client swimming with the fishes. Not the best idea. And then, this is a safe for a
bank, which, of course, is logical, safes are in a bank.

But this is actually an
especially fun toy, because you pull this handle here,
and then actually this one opens up. That was my idea of fun when I
was a banker, so you again should take it with
a grain of salt. This is a snow globe — you
shake it upside down, which is a lot of fun, as well. But again, just in terms of the
metaphor, and I have only myself blame — maybe I
was sleep deprived — I guess, maybe don't show your
client's capital structure literally under water, when
you design your deal toys. PROFESSOR ROBERT SHILLER: Are
you saying that investment bankers have a childish side? You say, deal toys. I was presenting them as
going to the symphony. What are you presenting
them as? JON FOUGNER: I can't claim, I
ever made it to the symphony, when I was an analyst, but a
number of my colleagues were on the boards, involved
philanthropically with those organizations.

But yes, I think that we have
this creative energy and creative spirit. I think, there's a lot of
creativity in finance that, as Stephen Schwarzman mentioned
in his talk, at the senior levels, when you're dreaming how
to combine companies, how to finance companies, how to
deal with new regulation, as you mentioned. But at the analyst level,
maybe not quite as much. So maybe, there is that creative
spark, that's just trying to find its way out, one mischievous way or another. But anyway, this was the landscape, when I left banking. That was September 2007. And then six months after that,
as Professor Shiller mentioned, Bear Sterns sold in
a fire sale to J.P. Morgan, and then six months after that,
September 2008, we saw Merrill Lynch narrowly avert
liquidation, become the asset management brand of
Bank of America, which it still is today. That same week, Lehman Brothers
collapsed under the weight of those mortgages,
suffered a bank run, and was not bailed out, was liquidated,
some of their investment banking and capital
markets assets sold to Barclays in bankruptcy.

A week after that, what a lot of
people thought would never happen, did happen, and Goldman
Sachs and Morgan Stanley went to the Federal
Reserve, and asked to become commercial banks, which
technically they still are today, as Professor
Shiller mentioned. Now, that having been said, if
you take Charles Gasparino's account of this era, this
was the end of an era for Wall Street. That having been said,
investment banking continued at firms all around the world,
some of these diversified conglomerates, and also at a
burgeoning slate of so-called independent advisory shops. So, these are folks like
Evercore, Lazard, Greenhill. And if you're interested in
learning about finance, investment banking is not the
only way to get into it. There are also, for example,
the so-called alternative asset managers, private
equity hedge funds. Folks like KKR, Carlyle,
Bridgewater, who I believe still recruits here on campus. And then, out where I live in
California, you have the heart of the venture capital industry,
especially around the information technology

So, folks like Kleiner,
Sequoia, Benchmark. They may not be recruiting on
campus, and they may not even be open to hiring
undergraduates, but some of their competitors are. So, if that's interesting to
you, maybe we'll just touch on a few steps that you
can take today. Obviously, you're already doing
plenty of this, without anyone having to remind you. Things like taking the right
classes, doing well in them, researching the firms you
want to apply to. Just three that I'll touch on. Taking advantage of the
incredible resource you have in the professors here today,
which you really don't want to take for granted. Learning a little bit about
yourself — and I know that sounds touchy-feely, but
I'll give a couple specifics around that. And then, of course, there's no
substitute for trying this hands-on to see whether
it suits you.

So, this is pretty much exactly
as I remember John Geanakoplos — genius mad scientist. You can
find him on Open Yale now, and if you have not yet taken his
class, and it's offered next year, I would strongly recommend
that you do so. David Swensen, I understand
you've had the distinct pleasure of hearing from
already, the most successful endowment manager ever, the
reason that we get to have nice things here at Yale. And I just keep coming back time
and again to Pioneering Portfolio Management, the
bedrock of core investing principles that he articulates
in that book. Even if you never become an
institutional investor and are only thinking as a retail
investor, it's still incredibly useful stuff. And he does teach a
senior seminar. And then, in addition to this
class, as you probably know, Professor Shiller has a graduate
seminar, which I think you have promised
to let students apply to, to get into to.

Yes, I had about eight last semester. JON FOUGNER: OK. And how did they do? PROFESSOR ROBERT SHILLER: That's
an embarrassing thing. They did pretty well, against
our graduate students. I won't rank them. Embarrassing to our
graduate students. JON FOUGNER: But flattering
to all of you. As Professor Shiller mentioned,
I got to work a little bit on The New Financial
Order as an undergraduate, and I just
still consider it such a rewarding experience, because
the tenets that you talk about in this book, around how finance
can be a technology for societal innovation,
everything from the micro level of personal income
insurance to encouraging people to take more risks early
on in their careers, to the macro level of GDP insurance
are some really visionary ideas.

I, of course, remain dismayed
that some of them have not been put into practice yet,
but that really is an opportunity for all of you who
are interested in Finance for Idealists to think about that as
a potential career option. Other useful courses, of course,
anything with math, probabilities, stats,
econometrics, Excel modeling, especially using the three
financial statements, computer science, computer programming
is going to serve you well, not just in investment banking,
which we're talking about this morning, but also
in those other aspects of financial services
like trading. Now, kind of switching
gears a little bit. How many you have either
done Myers-Briggs or Strengths Finder? A few. Maybe 20 — maybe 30% or so. So, these are tools that I think
have become a little bit more popular in recent years,
which are basically psychological inventories
where you spend an hour answering multiple choice
questions, then they literally spit out a profile of how
you like to work. Obviously, there's no right or
wrong answers, they're really just preferences. It's a pretty modest investment
of your time — maybe an hour each — to gain insight not just into
what you're good at, but also to helping you articulate to
potential employers really what you can bring
to the table.

And then, of course, where the
rubber meets the road, is actually applying for that
internship or that job, and getting your foot in the door. Career Services on campus are
a fabulous resource, but because of that they are very
scarce resource, because almost everyone is using them. So, if you want to find jobs
that don't get 200 other Yale resumes coming in their front
door, you want to look a little further afield. So, you've got things like lists
of investment management firms, from Institutional
Investors, American Banker, Hedge Fund Research.

There are plenty
of these lists. And I'd say, don't be shy
about cold calling, cold emailing — just kind of be persistent. We touched on professors here. I am incredibly grateful to
Professor Shiller, Ray Fair, David Swensen, folks who have
helped me in my career, even at this extremely early stage
in my career, and it was really just because I asked. And I would encourage you to
do the same thing, because once you've left campus,
it gets a lot harder to get that help. And then the alumni
directory — how many folks have been using
the alumni directory to reach out for jobs? Maybe 15%. I'd encourage you to do so, and
all I would add to that is, think about what you share
in common with the people you're reaching out to, think
about whether you can reciprocate the help that you're
asking for, even if that might not be obvious now,
because they're established in their career and you're
just starting out.

I had a student in this class
reach out to me three weeks ago interested in advice, and
I was happy to share that. And actually, he ended up being
really helpful, helping me understand in where you all
are in your decision making process and your career
right now. So, there are always ways that
you can help, and you'll find a much more welcome hand if
you're about to do that. And then lastly, recruiters. These large, so-called ''two
and 20'' funds, the alternative asset managers,
typically use third party recruiters to find the talent
that they want to interview. And they are typically targeting
current banking analysts and associates, but
there's nothing to say that, if you have a strong finance and
technical background as an undergraduate, that you couldn't
actually get on their radar and try to use them
for a placement.

The only caveat I would add to
that is, that you want to be really clear and confident when
you speak to them about what is that you're
looking for. Because if you go in there
waffling, asking them to sort of be your mentor and your
career coach, they're really not going to get that sense
of confidence for you, and they're not going to want to
put you in front of one of their clients, who are the
asset management firms. PROFESSOR ROBERT SHILLER:
We're having questions in just a minute. JON FOUGNER: Oh, great. Yes. [SIDE CONVERSATION] PROFESSOR ROBERT SHILLER: We're
going to open it up for questions in a minute, but
go ahead and interpose. STUDENT: It could probably also
come at the end, I was just wondering, who
is Keith Ferrazzi? JON FOUGNER: How many folks
are familiar with Keith Ferrazzi in the room? Some people are — their
arms are getting tired. Maybe 20%. So, Keith was the youngest
ever Fortune 500 CMO. And he's a fellow Yalie, New
York Times best-selling author, written a lot about the
role that relationships play in business.

And you hear this word
networking, which, I think, all of us now get sort of a sort
of unctuous feel around. It seems very, sort of,
superficial and self-serving, and what he's really helped
elucidate is, how the basic tenets of psychology — and in this respect, he reminds
me of Professor Shiller — applying the basic
tenets of psychology to how you actually build real,
meaningful business relationships, and breaking down
this artificial barrier between relationships
and business. Because business is
relationships. As Professor Shiller mentioned,
one of the things that investment bankers try to
do is, establish senior level relationships, because it's
ultimately individuals, not entire companies, who are
making decisions. So, just to share a couple of
anecdotes about my transition from banking, after banking, as
I said, I knew I wanted to work in tech, and I very
fortuitously got a phone call from a lifelong friend of mine
around that time, who was an engineer who had started
working at Facebook.

And what he convinced me was,
that I could help him and his colleagues change how
people communicate. I was pretty sort of anxious
about this, pretty intimidated by the prospect of being
a business guy doing engineering. And what he told me, and I
ultimately think this proved true, is that you don't have to
be an engineer in Silicon Valley to have an impact, you
just have to be able to think rigorously like an
engineer does. I think the training, that
you're doing here at Yale, and then the potential training at
investment banking, both have the potential to serve you
well in that respect. So, what we're trying to do at
Facebook is get people the power to share and make the
world more open and connected. Pretty simple, in principle. And our strategy for doing this
is mapping out what we call the social graph.

Now, we didn't create this. This exists out in the world,
all we're trying to do is draw a mathematical representation
of it, and that's basically who likes whom, and
who likes what? And then, we push information
as efficiently as possible along the edges of
that ground. So, this is kind of where I
spend most of my day, not just over here in FarmVille, but also
over here in ads-land.

And what my role is called is
''local inbound product marketing.'' So, to kind of
parse that out, what we mean is basically, I go and talk to
local businesses, restaurants, plumbers, understand what their
pain points are, what other advertising products they
use, what they're trying to accomplish as a local
business owner, and then basically synthesize that with
data analysis, and ultimately present it to the engineers as
a case for what we should build next.

So, these are questions like,
what do the ads that you see on Facebook look like? How should they interact with
the rest of the product? How can we target them to
make them more relevant? A whole bunch more. The real guiding precept here
is that, it's basically what Henry Ford said, right? He didn't want to build the
faster horse, even if that's what his clients might have
asked for, he wanted to build something that was dramatically
more useful, and for him that was a car, and for
us it's something that we call social advertising. I am happy to chat a little
bit more about that during questions, if folks
are interested. So finally, just to kind of
compare these two roles, and how one might have prepared me
for the other, I think the three things from banking that
have served me best working on internet products are: One, this
cross function of process management, which is a
ubiquitous part of the business world.

Two, building polished
presentations, this one notwithstanding. And three, being resourceful
about tracking down data points to help make the
right decisions. On the other hand, there's some
parts of the job that were totally new. Thinking from the mindset of the
CMO, the chief marketing officer, rather than the CFO,
the chief financial officer, just the pace of the
environment, banking is fast-paced, but the rate at
which products evolve in the internet is dramatically
faster. And the fundamental job itself,
which is basically creating new products, building
the business case for them, validating that case with
data, trying to actually mock them up — and I assure
you, I'm not good in Photoshop — and then actually use those
mocks and that case to inspire engineers and product managers
to want to build them.

So, it's an environment that
is much more ambiguous. The yardsticks for whether or
not you're going in the right direction, especially in
the short term, are not nearly as clear. But if that's actually something
that's appealing to you, then I strongly encourage
you to check out jobs around Silicon Valley, and especially
at Facebook. So, you can actually go to
facebook.com/careers — quick plug — to check out about the
internships and the full time jobs that we have available. So, Professor Shiller, did you
want to use the rest of the time for questions. PROFESSOR ROBERT SHILLER:
Well, yes. I'm opening it up to all
of you for questions. OK, you have a question
back there. STUDENT: Before you did your
junior summer in investment banking, how did you even
know you wanted to — JON FOUGNER: I caught some of
that, and then the screen caught some of it, so just bear
with us for one second, and then I'll be
right with you.

You said, before I did my junior
summer, what did I do? STUDENT: Before you did
your junior summer. Or how did you figure out that
investment banking was the field you wanted to be in? JON FOUGNER: Well, you know, I
knew that some of the stuff on the right hand column of the
ROI chart was stuff I was interested in. I was interested in the
technical side of the work, working on math, basically,
but also interested in the relationship side of it, the
strategic side, thinking about basically how you help
these companies vet the company decisions. And during the first week of
training, one of the partners of the firm came in — and we use this term partner
kind of as a term of art, because, as the professor
mentioned, it's no longer a partnership — but he came in and said, when
our clients want to do really important things,
they come to us.

And when they want to think
about important things, they come to fill-in-the-blank
name of top tier consulting company. And that kind of action, and
actually physically seeing the results that you create in
the world was really appealing to me. And I hadn't done Strengths
Finder yet at the time, but I did it subsequently, and found,
not surprisingly, that that's where my psychological
reward structure was kind of geared towards. PROFESSOR ROBERT SHILLER: Yes? STUDENT: So, Peter Thiel, who
was the first investor in Facebook, and is currently on
their board, is now offering 20 people under the age of 20
each $100,000 to drop out of school for two years and start
their own companies.

And since you actually work for
Facebook, I was wondering what you thought of that. JON FOUGNER: Yes, I think
that's fascinating. And obviously, I don't work
with Peter Thiel. Look, I think, whatever
we can do to promote innovation is great. Now, if you're sitting here in
this room and you're saying, well, do I want to take this
risk of sacrificing this signaling device of this college
degree, and also potentially sacrificing some
structured classroom experience, in order to rapidly
accelerate, how quickly I got into entrepreneurship, I don't know. That's a personal decision that
is for you to make, and I don't really have any
opinion on it. Ultimately, for me it'll come
down to, do these companies actually end up doing really
cool things and building really cool stuff? PROFESSOR ROBERT SHILLER: And
I'd add, it isn't as risky as you might think, because Yale
will take you back, if it fails in a couple of years.

JON FOUGNER: One of our very
early employees was a Yalie, who had had an undergraduate
experience somewhat like you're describing, where, I
think, he had actually taken some time off to work
on startups. I think he came back, finished
his degree, and is now a partner at Benchmark, one
of the firms that I had on that slide. PROFESSOR ROBERT SHILLER: Well,
while they're thinking, can I ask you — I emphasized the core values
at Goldman Sachs, and it strikes me that Facebook
is totally different. Maybe I'm wrong. Can you tell me, what are the
core values at Facebook? If I were to read that list
that I just gave you from Goldman Sachs, how would it
sound to the Facebook people? JON FOUGNER: Yes, so I think
there are similarities and differences. I think, each of us has a core
constituency, who we wake up thinking about them, go to bed
thinking about them, probably dream about them, and know that
whether or not we serve that constituency will determine
the success or failure of the company. And at Goldman that
was the clients. And at Facebook, our number one
focus is the users and the user experience.

And we care a lot about our
partners, we care a lot about our advertisers, we care a
lot about everyone in the ecosystem, but ultimately
we know we have to serve the user as well. So, each company, I think, has
almost a maniacal focus on serving one core constituency,
albeit they're different. Now, in terms of the day-to-day
experience, I do think they're quite different. I think that what
I'm doing now is quite a bit more creative. PROFESSOR ROBERT SHILLER: You're
not doing spreadsheets.

You're doing it, still. JON FOUGNER: Yes, not as much. And I really love the creative
side of the work. If you think back to Steven
Schwarzman's lecture, where he mentions that there's no
flexibility for getting the numbers wrong, I mean certainly
we feel the same way, all the analysis needs to
be correct, but there's almost an ominous tone, when he says
that, whereas the way that we operate is knowing that we have
to move really fast in order to continue to innovate,
continue to stay relevant. And so, that means that
sometimes you make mistakes, and it's no secret that we've
made mistakes, and some of them have been big mistakes.

And we just try to minimize
the number of times that happens, try to fix them as soon
as they do happen, and just be honest about them, and
admit them when we make them. PROFESSOR ROBERT SHILLER: Can I
ask a question of the class? You set the example. How many in this class are
engineering majors? Not many. Like 5% maybe. What about science majors? That looks like 10%. See, you're kind of in an
engineering company, right? I mean, I don't know exactly
what Facebook is, but is there some kind of division here? Why aren't there more engineers
in this class? JON FOUGNER: That sounds like
a question for the class.

Well, I can't ask them, because they're not here. JON FOUGNER: All the engineers,
who are not in the room, why are you
not in the room? PROFESSOR ROBERT SHILLER: But
I mean, is there a big cultural difference? I mean, are engineers
prejudiced against us finance people? You're there, so — JON FOUGNER: Look, I think
that product design and software engineering is at the
heart of the company, but as I mentioned, I was pretty
intimidated going in and saying, huh, I'm going to
be a business guy here. Am I not really going to be
able to have an impact? And I think the things that are
important for the business people are: One, to remember
what the core mission of the company is, which for us is
really all about the users. Two, to have a sense of
what is feasible. So, you don't actually have to
know how to write the code, or even necessarily how to mock up
the product, but if you're making recommendations that we
should build things that are simply technologically not
feasible, you're going to waste people's time and lose
credibility pretty quickly.

And then, three, I think, when
you do the analysis, engineers are going to want to see as
rigorous analysis as possible, quantitative analysis when
that's relevant, when that's possible, and to the extent that
you can bring that to the table, I think that's helpful. If you think about the business
world at large, one of the things, that's just
going to be increasingly important, is the ability to
design, conduct, and interpret statistically significant,
valid experiments. And this sounds like a pretty
straightforward thing, that you might learn by maybe
second or third year of college, and yet you get out
into the business world, and you'll find that many of your
colleagues, whether they're coming from MBAs or other
backgrounds, may not actually have that background. So, being able to bring that
sort of rigor to the table, whether it's at a consumer
internet company or an industrial company, anything
else, I think is very helpful.

know, I'm thinking, maybe I should change the name of
this course to Financial Engineering. That would bring
in the others. Because to me, engineering and
finance have a certain connection. They're both designing
devices. I think, we have another
question. STUDENT: Have you thought of
going back to graduate school, and how do you see that playing
into a career like investment banking? JON FOUGNER: Yes, I have thought
about going back to graduate school. I think that all of us want
to be lifelong learners throughout our career. There's a number of ways
you can do that. Graduate school is
one of them. Another is, going into
industries where you're just confident that everyone you're
working with is really smart, and they're going to push you
hard, and not settle for mediocrity, so you just know
you're going to learn by that pressure and that osmosis. And then, I think, there's
some kind of simple, structured things that
you can do, as well. I threw a slide up of a couple
that you can do in the comfort of your own living room
— the Meyers-Briggs and Strengths Finder.

But then also, you can leverage
having a workplace to do things like peer
coaching, career coaching, executive coaching. So, I kind of take a somewhat
agnostic point of view as to which of these tools I'm going
to use at any given time. I just know, that I constantly
want to be challenging myself and constantly want to
be learning more. PROFESSOR ROBERT SHILLER: OK. STUDENT: I've heard a lot
about issues with click-through rates on various
social networking sites, so if you could talk about, what you
think the putative value of Facebook should be, and whether
the current valuation is appropriate. JON FOUGNER: Yes, so, I'm happy
to share a little bit about click-through rates. I'll probably defer on the
question of how much the company should be valued at. Is everyone familiar with what
a click-through rate is? No, not everyone. OK. So, this is just
a simple ratio. Let's say, you show an ad some
number of times to users on the internet.

It's the ratio of the number
of times the user clicks on that ad to the total number
of times you showed it. So, if you show an ad 100 times,
and you get one click, you have a 1% click-through
rate. And if you think about, well,
why are people advertising? In marketing there's kind of
this concept of this marketing funnel, which is a little bit
silly, but it actually conveys a useful concept. Up here is everyone in the
world, and then here is the people we can actually make
aware of our product. And then here is the people who
we can actually make have an affinity for our product. And here is the people who we
can actually make consider purchasing our product. And then people who actually buy
it, and then repeat, loyal customers who buy it
more and more. So, we get to a narrower
and narrower pool. And what marketers are
constantly trying to do is, push people through this funnel,
so they can actually start with someone, who may not
know about the product at all, and then actually
get them to buy it again and again.

So, marketers use a variety
of different tools. Online advertising is one, but
that represents maybe 15% of the market, but it's a
relatively new one, and there's plenty of others that go
back decades or centuries. Things like television,
radio, print. These different media play
different roles in getting people through this
marketing funnel. And if you think about, where
online advertising originally grew up, it was really
towards the very bottom of this funnel. Of, OK, I am looking for a blue
iPod at the best price, that I can either order online
or that it's within five miles of my home. So, I search that on a search
engine, I see a list of vendors, and in that case, it's
really important whether I click through, because
that's basically the determinant of whether or not
we get them through the next stage in the marketing funnel. If you think about Facebook
advertising, that is one of the roles that it can play, but
it can also actually play throughout this entire marketing
funnel, where we have a reach of 500 million
people, and then you can target within that.

And then you can use things like
social context, telling you that your friend might
really love a product, to help build your affinity for it, on
through this whole funnel. So, for some of it,
click-through rate is relevant, for other of it,
click-through rate really isn't relevant, and you need to
think about other sorts of measurement. Things like companies
like Nielsen do. Like polling people and asking
them, OK, you saw this media, did it increase your likelihood to buy this product? Or did it make you aware of the
message, that the brand is trying to convey, that you
weren't aware of before? I think, it's one of a number
of metrics that go into assessing the health of the
business as a whole.

think we're essentially out of time, but let me just say,
click-through rates and marketing sound profit-oriented,
but it seems to me they have a social
purpose — one thing is that capitalism is
being transformed by this kind of thing, because it gets
people to buy things that they really need. It's like your Strengths
Finder or Needs Finder. And I have to applaud Facebook
and other companies. Finally, I'm going to invite you
back in another 10 years. This was great. JON FOUGNER: Thanks.

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