Social Loans and Creeping Fraud
I am old enough to remember when companies like Social Finance Inc. were referred to as "peer-to-peer lenders." The idea was, there was an online platform that made loans to people and then sold those loans to other people. It was a return to the most basic principles of finance: People with money get to invest, people without money get to borrow, and all the encrusted layers of intermediation that the financial industry had built up were stripped away and replaced by a computer program matching borrowers and investors.
But turned out that a lot of the investors were not regular people -- not "peers" of the borrowers -- but hedge funds and banks. This makes sense. People have jobs! Why would they spend a lot of time evaluating which small-business or consumer loans are good risks? Instead they give their money to professional managers (as hedge-fund investments, or as bank deposits), and the professionals make those decisions. It also turned out that even the professionals don't necessarily want to spend their time choosing which loans to buy, so companies like SoFi package their loans into securitizations and sell different risk tranches to different investors. The encrusted layers of intermediation build back up. "SoFi is a modern finance company that's fueling the shift to a bankless world," says SoFi, but that world is looking increasingly like the bank world.
The latest news is that SoFi is starting its own hedge fund:
The unusual move by SoFi, as the company is commonly known, is an attempt to get around waning investor interest that is threatening online lenders’ growth. The sector lacks the deposits needed to fund its loans like traditional banks, so it relies on being able to sell the loans to investors to free up capital to make new ones.
The new hedge fund, called SoFi Credit Opportunities Fund, has “a real chance to solve the balance-sheet problems facing the industry," said SoFi Chief Executive Mike Cagney in an interview.
The model to keep in mind is the basic one from the beginning: There are people with money looking to invest, and people without money looking to borrow. If online lending platforms face "waning investor interest," that means people with money are looking to invest less of it (with SoFi). SoFi's solution to that problem -- "the balance-sheet problem" -- is to repackage the way those people invest: If you can't sell your loans to hedge funds, build your own hedge fund, and then sell shares in that hedge fund to investors. You still rely on investor interest -- all financing relies on investor interest -- but you are at least presenting a different package to different pools of investor money:
Closely held SoFi is setting up the new fund to tap investors that don’t want to buy the firm’s whole loans or asset-backed securities directly. This includes some wealthy individuals, funds of hedge funds and even some institutional investors.
When I said that I am old enough to remember the term "peer-to-peer lenders," I was talking about, like, a couple of years ago. SoFi's name is "Social Finance," not, like, "Captive Hedge Fund Securitization Finance." Lending Club is a "club." You can witness ontogeny recapitulating phylogeny. A social club for regular people to lend money to other regular people becomes a securitization platform with its own in-house hedge fund while you watch. The whole history of modern finance recurs, sped up, right before your eyes. It is kind of beautiful.
Elsewhere, here are some slides from Andrew Haldane on "Finance Version 2.0?" "Finance is a market in information -- information technology should matter!" writes Haldane, and he discusses the "distributed/peer-to-peer model" for things like payments, lending and insurance. And Chris Skinner asks, "Will the Blockchain Replace Swift?"
Come on, Firrea.
The Financial Institutions Reform, Recovery and Enforcement Act gives prosecutors lots of extra power (most notably, a longer statute of limitations) to go after fraud affecting financial institutions. The idea, back when Firrea was passed in 1989, was that if you defrauded a savings and loan, the government would come after you. But times have changed, and prosecutors love power, so Firrea has been pushed into new and awkward service. (For instance, when banks sold shoddy mortgages, that was Firrea fraud against themselves.) But the Justice Department's potential use of Firrea against Volkswagen in its emissions scandal is a little ridiculous:
Using Firrea, the department’s civil division is now exploring whether lenders were harmed by financing customers’ purchases of the cars under inflated values, the people said. The law permits investigations of potential fraud “affecting” financial institutions. The resale value of the diesel cars has dropped since the software use became public last September.
"This has become a competition among enforcers, and you’re now getting a free-for-all without much coordination," says John Coffee.
Look, I get it: It's conceivable that lenders were harmed by financing cars that are now worth less than they were. But obviously Volkswagen's intention wasn't to defraud lenders, and that was nowhere near the main harm that it did. The harm to auto lenders is a weird tangent, a minor third-order effect that we are only talking about because it gives prosecutors more jurisdiction and more power. That's not how the law should work! The law should make sense! If you lie to customers in a way that harms them and damages the environment, you should be punished for that. You shouldn't be punished for reducing the credit quality of those customers' car loans. I know that this has been a minority view ever since Al Capone was sent away for tax fraud, but it seems to me that Volkswagen's essential problem was that it treated the law -- the emissions-testing regime -- as a game to be played, a puzzle to be solved as aggressively as possible, rather than a moral obligation. The Justice Department does too.
Are you excited for the United Continental Holdings proxy fight? As proxy fights go, it is unusually dramatic: Two shareholders, Altimeter Capital and PAR Capital, launched the campaign "days before its new chief executive, Oscar Munoz, is slated to return to work after a January heart transplant that followed a heart attack he had shortly after taking the job." They are trying to kick half the board and put in a new slate led by former Continental CEO Gordon Bethune, who is unimpressed by Munoz's lack of airline experience:
“If you don’t know anything about this business, it’s hard to know why you lose bags and why you get [customer] complaints,” said Mr. Bethune, who added that he owns an “insignificant,” amount of United shares. “I don’t think Oscar can’t learn it,” he said of Mr. Munoz, but investors “want something large to happen quickly.”
Also, though, we have talked a bit about governance in the airline industry specifically. There is a theory going around that, because the same group of mostly passive diversified mutual funds own large chunks of shares in all the major airlines, those airlines tend not to compete that hard against each other, leading to high ticket prices and possible antitrust violations. That theory has been received with ... some skepticism. But if it's true, the cure for it is activism: Shareholders like Altimeter and PAR who have concentrated positions in one airline will push for that airline to outperform its competitors rather than sit back and allow the whole industry to collect above-market profits. (Umm, I guess. As its name implies, Altimeter has a number of airline investments, including Alaska, American and Delta, and while PAR's biggest holding is United, its holding of Delta is almost as big, and it also owns several other airlines. But just go with it.) And so their proxy fight announcement complains of "many years of substantial and inexcusable Company underperformance relative to United’s competitors." If they run on a platform of increased competitiveness, and lose the index-fund vote, will that tell us anything?
Elsewhere, here is a story about how activist investors don't have much of a track record of nominating women to board seats:
Since the beginning of 2011, five of the biggest U.S. activist funds have sought at least 174 board positions and landed 108, yet nominated women just seven times, according to data compiled by Bloomberg. The women candidates got five seats, or 5 percent of the total.
One thing I think about here is the increased importance and institutionalization of activism. Once upon a time, if you were a lone corporate raider in a proxy fight, you could just nominate some combination of your buddies, your activist-fund employees and former executives from the target's competitors, all of whom might skew male, without worrying much about what people thought. Everything was a one-off fight for control; your board nominees had no broader societal meaning. But the bigger the role activism plays in the business world, the more important choices like this are. Incidentally, two of PAR and Altimeter's six United nominees are women.
Here is the story of Don Wilson, who is going to trial against the Commodity Futures Trading Commission on claims that he manipulated an interest-rate futures market. I am sympathetic to Wilson. The crux of the case is that Wilson thought he had valued the futures right, so he bid what he thought were the right prices for the futures, even though no one agreed with him. This pushed up their price. Then he turned out to be right and everyone agreed with him. This, this is manipulation? I don't see it.
Elsewhere, a JPMorgan broker who stole client money to gamble was sentenced to five years in prison. And here is a Securities and Exchange Commission case alleging that a fund manager "deceived investors by spreading false and misleading fund information while doing everything possible to bury his criminal history and troubling financial record." I keep waiting to read an SEC case where a fund manager hid his criminal past but was totally accurate in reporting his financial performance, which was great.
And then there is this guy:
An inventive and presumably muscular employee of Brink’s — the armored-car company — has been charged with stealing almost $200,000 worth of quarters that the company was storing for the Federal Reserve. An FBI investigation found that Stephen Dennis, a money-processing manager in Alabama, swapped bags of quarters for similar bags he'd filled with beads disguised with a thin layer of coins, and hauled out $196,000 — nearly five tons' worth — over a couple of months in early 2014. Dennis pleaded guilty to the charges and pledged to repay Brink’s, which has already reimbursed the Federal Reserve Bank of Atlanta.
Justice Department people lined up around the block to get their puns into the press release. ("Now he carries a heavier load," "nickel and dime theft," etc.) I hope he pays them back with bags of pennies.
Meanwhile in the U.K., the new financial conduct regime probably will not be "putting heads on spikes," but it is still scaring people:
“This is [already] a difficult industry to recruit non-executive directors into . . . If you terrify them with that level of evidence; you make their job almost impossible,” said Jon Pain, head of conduct and regulatory affairs at Royal Bank of Scotland.
It's possible that having a head of conduct and regulatory affairs named Jon Pain sets a bit of a scary tone too, though.
Happy birthday, Mr. Bull Market!
"The bull market that celebrates its seventh anniversary today has restored $14 trillion to stock values, pushing up the Standard & Poor’s 500 Index by almost 200 percent," so congratulations everyone. Market psychology is founded on paradox so, here, have some paradox:
Yet if history is any guide, that very cynicism provides a compelling case for the run to persist, at least by traditional market analysis. Bull markets usually die amid excessive optimism, and that’s nowhere to be found.
“This pervasive pessimism, skepticism and unwillingness to invest in equities anywhere near the degree we’ve seen in past bull markets has been a very unique characteristic,” Liz Ann Sonders, chief investment strategist at Charles Schwab & Co., said on Bloomberg Radio. That contrarian sentiment constitutes “the wall of worry that stocks like to climb,” she said.
Here is Bloomberg's Keri Geiger on the battle between art dealer Yves Bouvier and oligarch-collector Dmitry Rybolovlev, who bought, among other things, a Leonardo da Vinci masterpiece from Bouvier and then complained about the markup:
He purchased the painting, via Bouvier, though a trust. According to the Monaco complaint, the billionaire paid $127.5 million for the work, which was roughly $50 million more that he later said the seller had received, alleging Bouvier pocketed the difference.
That is a big markup! And Leonardos don't Trace; it's not easy to see what the last trade was. Nor, I suspect, is it always clear what the norms are: Was Bouvier acting as an agent-fiduciary for Rybolovlev, or as an arm's-length counterparty? In an unregulated international market, what rules and norms apply?
Elsewhere, we seem to be living in a small golden age of art shows about the stock market. There is Sarah Meyohas, of course, and now this: "Want to making a killing on the stock market? Hallucinate and consult the kabbalah."
Like the other sandwiches, the Bodega arrives alongside a grilled hot pepper on an irregular block of wood. This is both affected and counterproductive; a boring old plate would do a better job of keeping food off the table. (What’s going to happen to all these fancy boards once they stop being cool and everybody admits what a pain they are?)
Perhaps they could be warped into bowls? Elsewhere: Brew Buddies.
People are worried about unicorns.
Proskauer Rose LLP did a review of the 2015 class of initial public offerings that is surprisingly upbeat, finding, for instance, that "the stigma against insiders buying in an IPO has been lifted," "investors don't balk at multiple-class structures," and "material weaknesses also don't matter much." Sounds like a pretty robust IPO market! Of course a statistical review like this will always be backwards-looking: In 2015 as a whole, it was fairly easy to get IPOs done, even with some hair, but "by year-end, stocks that debuted in 2015 traded below their offering price on average," and you could forgive investors for thinking that the hair might have had something to do with it.
Elsewhere: "As mutual funds continue to mark down the value of their private tech holdings, venture capitalists say they are facing more questions from their investors about how they are valuing the same companies on their books." And people in San Francisco are rooting for a unicorn extinction:
“It’s practically a ubiquitous sentiment here: People would like a little of the air to come out of the tech economy,” said Aaron Peskin, perhaps the most prominent leader of the opposition. “They’re like people in a heat wave waiting for the monsoon.”
People are worried about bond market liquidity.
I mean, they probably are, but that doesn't mean that Warren Buffett can't get a bond deal done:
Investor orders for a piece of a $9bn Berkshire Hathaway bond sale eclipsed $30bn on Tuesday, as the conglomerate headed by Warren Buffett sought to repay bank loans used to finance its $36bn takeover of Precision Castparts.
In grimmer news, "the multiyear decline in trading shows that many of the challenges facing big Wall Street banks are secular, not cyclical, as many bank executives have hoped." And here is a study from the Office of Financial Research on interconnections in the credit default swaps market.
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