When options have negative value: Part 3, money being Manny
[Continued from the previous Part 1 and Part 2.]
Yesterday, we saw that in his role as sponsor, former Red Sox left fielder Manny Ramirez, perceiving that his current contract had gone on ‘too long,’ was engaging in a time-honored if not time-endorsed strategy of the deniable strike, probably at the behest of his new agent, Scott Boras:
A reputation as a total flake comes in handy sometimes J
Mr. Ramirez was doing this because the Red Sox had two more option years they could exercise, and their exercise price was by now below market value, at least for first-rank free agents of the kind Mr. Boras often represents (and which Mr. Ramirez, for all his eccentricities, surely is – he is a beautiful hitter with a swing like a lash uncoiling).
As I posted throughout:
Some contracts are too long for their own good.
A contract too long for its own good becomes a liability for the beneficiary …
and ends up getting retraded.
We’ve now arrived at Part 3, where the Sox had a potential surprising move they could have made – if they thought of it, which I’ll bet they did.
3. A contract too long for its own good ends up getting re-traded
By the last few days of July, the Red Sox knew they were facing an untenable situation, and would have to re-trade their arrangements with Mr. Ramirez. Knowing this, they had a move different from the one they made: they could have voluntarily renounced their extension options, in the days and weeks before the trading deadline. “Go ahead, Manny,” that move would have said. “Show us the very best you have, and if you’re worth more because of that, so be it.”
Do this often enough and I’m worth a fortune
Such a move is really bold – it gives up a benefit previously negotiated for, and for no consideration. Yet the Red Sox paid Mr. Ramirez’s salary on the way out of town (true enough, levering their weak cards into a very good replacement player). But if their sole focus was this season, there is little doubt that two months of Mr. Ramirez’s hitting production would be more valuable than two months of Mr. Bay’s.
The Red Sox management consists of very smart folks – they must have realized the renunciation was feasible. So in realizing it, they rejected it. Why? They had to be thinking longer-term than just the next two months – and when we look at the longer horizon, the capital provider’s horizon as opposed to the sponsor’s, we can identify several reasons why they might have rejected the option-renunciation:
1. ‘Acceptable losses.‘ The Red Sox might have figured they were likely to make the playoffs anyhow, so the near-term loss from swapping Mr. Ramirez for Mr. Bay was mild enough to bear.
Happy to be in
2. ‘Better than nothing.’ Although the Red Sox paid a large financial price to rid themselves of this troublesome beast, by acting now they levered his availability into getting a player they liked, could count on (Mr. Bay’s contract has 1½ years to run), and could very likely sign longer term. In other words, they swapped a third of a year of Mr. Ramirez for one and a half years of Mr. Bay. Had they waited until year-end, they could have tried again to trade Mr. Ramirez, or perhaps been forced to decline their options, losing him as a free agent. Acting now may have been the best they thought they could get.
3. ‘Addition by subtraction.’ Once Mr. Ramirez had proved himself a scoundrel – which, much though I have liked him during his time in
Manny did what?
4. “Stand on principle; it’s easier to remember.’ Any given player negotiates a maximum of 3 or 4 contracts per career; a club negotiates twice that many per season. Reputation matters much more to the club, therefore, than to any given player. The Sox might have concluded that if they once truckled with passive-extortion, they would be vulnerable to every other free agent and in every other contract negotiation.
In any event, Mr. Ramirez is gone. He traded his good image in Boston (despite numerous bilious columnists, most fans I encounter though him well worth putting up with) for almost certainly more money and a fresh start in AL East Exile, aka the Los Angeles Dodgers, who now have Nomar Garciaparra, Derek Lowe, and Mr. Ramirez, all members of the 2004 Red Sox, plus former Yankee manager Joe Torre, canned last season for not doing enough, in ownership’s eyes, with the talent he had.
Y
End-of-lease effects. Here’s another useful rule highlighted by the Ramirez tale:
Anyone who ever graduated from college knows about end-of-term effects. Once the sheepskin is secure, all else seems rather pointless. Discipline goes by the board. Behavior changes, whether to sloth or bacchanal according to choice. The sooner the students get out of the college, and the sooner the college flushes this crop of seniors, the better for all concerned.
I’ve encountered this in real estate, with ground leases and long-term use restrictions, such as those arising from the military’s Wherry and Capehart programs, or its Section 801 leases, and more prosaically in the Section 2211d3 and Section 236 prepayment options. Real estate sponsors will sign up for a twenty-year hitch with the expectation of residual value, and while this is too long – the LIHTC’s fifteen years is closer – it served well for most of the 221d3/236 portfolio. Thirty years – the LIHTC extended use period – is definitely too long, particularly so after the LIHTC recapture has phased out in Year 15. I wrote about this in discussing tax credit zombies, another example of a ‘too long’ contract:
Collectability works in the LIHTC’s early years because investors who consume large amounts of tax credits are by definition financially robust (or they wouldn’t have gone looking to buy credits against their annual income taxes). Once the recapture period is over, these investors have no further interest in the property – and their typical partnership agreement will have allocated most of the cash flow and sale/ refinancing proceeds to the sponsors – so they want out. Incoming investors, lacking tax motivations, needn’t be so financially large, and are seeking basically to get a cash-on-cash return.
In short, after Year 15, a property is very likely to be sold from a better capitalized investor group to a worse-capitalized – and probably, less professional – one.
I
After writing that post, I found a walking zombie, the distinguished chancellor of Texas Tech University, who gives all appearances of being a slumlord:
Hance said he feels a moral obligation to maintain Cornerstone.
Had you walked away five years ago, Mr. Hance, your investors would have suffered substantial tax recapture. You get no moral credit for staying in the face of recapture, interest, and penalties. […] Mr. Hance has no inner qualms about his ownership:
“I don’t feel I ought to make it like living in
I’ve previously written about the disgusting mentality which says that ‘those people’ do not deserve quality affordable housing. After all, we don’t need to give ‘those people’ anything too comfortable to live in, do we?
“At this festive season of the year, Mr. Scrooge,” said the gentleman, taking up a pen, “it is more than usually desirable that we should make some slight provision for the Poor and destitute, who suffer greatly at the present time. Many thousands are in want of common necessaries; hundreds of thousands are in want of common comforts, sir.”
“Many can’t go there; and many would rather die.”
“If they would rather die,” said Scrooge, “they had better do it, and decrease the surplus population.”
Mr. Hance wishes no such ill upon his tenants:
“I don’t think you could find anyone else who would put that kind of money in a project,” Hance said during a phone interview.
Rapes, shootings, break-ins, rats, water bugs, leaks. They’re not your problem, Mr. Hance.
You’re only the owner.
`Or would you know,’ pursued the Ghost, `the weight and length of the strong coil you bear yourself? It was full as heavy and as long as this, seven Christmas Eves ago. You have laboured on it, since. It is a ponderous chain!’
But Manny Ramirez, bless his heart, is no Kent Hance. He has departed for Lotusland, where he probably will not even make the playoffs, but will reappear somewhere next year, most likely in the National League. Meanwhile the Red Sox head toward their own independent future.
Housing morals to this story abound:
1. Very long contracts with level payments are usually balanced only in the middle; at the front end, the sponsor is over-compensated, while on the back end, the capital provider or government has the better of the bargain. See Wherry, Section 608, and Section 236.
2. When a sponsor is undercompensated toward the end of a contract, the sponsor always has ways of taking the property hostage. See Flexible Subsidy.
3. The potential for residual optionality is a motivating factor long before a contract is over; indeed, the mere prospect of an opt-out has a salutary effect. See Section 236, LIHPRHA, rent supplement conversions to Section 8 LMSA, and the original 15-year LIHTC lock-in.
4. There is a temptation for capital providers or regulators to demand the longest possible affordability period as the price of their up-front resources. See LIHTC 30+ years,
5. Lock-in periods that are ‘too long’ (defined as Justice Oliver Wendell Holmes would define it J ) are self-defeating, and it is usually worthwhile for the regulator/ capital provider voluntarily to surrender some of the extra affordability bargain in exchange either for a change of sponsor or a change of sponsor behavior.
6. Don’t negotiate for things you will never use. You cannot renounce them, so you have to trade them away, and if you have nothing to trade for, the counterparty can actually hold you hostage.
7. Very long contracts should never expire; they should be renegotiated about a quarter of the way from the end. If not sooner.
See the value of renegotiation?
And don’t forget:
Some contracts are too long for their own good.
A contract is no thing of Aristotleian perfection: it is a thrown terra-cotta pot, serving a purpose for a while and then, one day, cracking and outliving its use. When that happens, what’s cracked can seldom be repaired: you have to let go what you thought you bargained for, realistically appraise what you now have, and use the shards to form the new vessel.
You got two World Series and another outfielder out of me, what more do you want?
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