Stress Tests and Succession

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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That seems stressful.

"If you asked Corbat himself, he would tell you outright that the entire executive-management team is on the line," says an analyst about Citigroup chief executive officer Michael Corbat's job prospects if his bank fails the Federal Reserve's stress test this month. Why ... why would he tell you that? Everyone at Citi seems to be running around threatening that Corbat is gone if Citi fails again like it did last year, which seems pretty undermine-y. Unless the audience for these threats is not Corbat, or shareholders, but the Fed. The message to the Fed might be, one, we take this stuff seriously and are very sorry about failing last year, and, two, please don't fail us again or the dog gets it. The Fed is full of reasonable people; they don't want to get anyone fired. Here's another analyst:

"A second consecutive fail on qualitative grounds would be seen as a direct condemnation by the Fed of Citi’s business model and management team, which we do not believe the Fed wants to signal," John McDonald, an analyst at Sanford C. Bernstein & Co., said in a Feb. 27 research note. "We would be surprised if Citi does not pass."

Warren Buffett Warren Buffett Warren Buffett.

Warren Buffett's celebration of 50 years running Berkshire Hathaway is tinged with sadness insofar as he knows his actuarial tables and probably can't expect another 50 years at the helm. So much of the focus in his Golden Jubilee letter was on his successor, whom he didn't name, but whom he's picked, and who will have to "fight off the ABCs of business decay, which are arrogance, bureaucracy and complacency." His succession seems to be down to Ajit Jain and Greg Abel, though vice chairman Charlie Munger's successor is also important.

Buffett also had mean things to say about investment bankers in his investor letter. But here is an investment banker who sees an ulterior motive in Buffett's attacks:

Mr. Buffett needs no help financing and never intends to sell the companies he buys. Accordingly, he despises investment bankers and employs his considerable folksy charm to scare potential business sellers away from using us for the plain and simple reason that we make his job harder and more expensive. For sellers of companies, investment banks level the playing field.

How capital markets mandates work.

Here is a story about how big banks hire each other to underwrite their capital raising deals. Banks give each other these underwriting mandates "partly based on how much business they will receive in return." A guy is surprised:

“I was very surprised that this existed,” said Douglas Ferrans, the former chairman of the Investment Management Association, a U.K. trade group of money managers, who has studied the ballooning number of investment banks hired for routine underwriting assignments. “In all my years as an investment manager, I believed banks pitched for underwriting business and it was won on price and ability to execute. What I discovered was some form of cartel operating.” 

How did he manage money professionally without having any idea what was going on? Let's break this down:

  1. It's not that hard to underwrite stock and bond offerings for seasoned big-name issuers.
  2. Underwriting fees are more or less set by custom, rather than being competed down to the marginal cost of underwriting.
  3. So underwriting mandates are in part a lucrative reward for past services, not just a contract to provide fair payment for current services.
  4. So a big way banks win those assignments is by being good friends to the issuer -- lending it money, doing free work for it, whatever -- rather than just by being good at underwriting.
  5. This is doubly true when the issuer hires 25 banks as underwriters, as Deutsche Bank did in the article's leading example.
  6. It is quadruply true when the issuer is a giant bank and could pretty much sell its shares on its own.

"Won on price and ability to execute," come on. Come on! On price? Equity offering fees are not competitive -- everyone produces fee runs that say "the average fee is X," and then they charge X, which is not how competitive pricing works. Anyway European regulators are worried about competition in banking, and this "reciprocity" is one thing that they're worried about, and I suppose you could make the case that it's not particularly competitive, though I'd argue that the competition is in forming long-term value-added client relationships rather than in price-based bidding for specific deal mandates. But competitive or not, surely it's not a surprise.

How private equity pay works.

Here is Will Alden on the ways in which Steve Schwarzman gets paid. Mostly, Blackstone gets performance (and management) fees from its funds, and pays out a portion of those fees in dividends to its shareholders (er, distributions to its unitholders), and Schwarzman, as a significant owner of Blackstone, gets a big chunk of those dividends. But also it pays some of those fees to him directly as part of his compensation. Also he has some investments directly in Blackstone's funds, which generate sort of a surprisingly small percentage of his vast income. Pay at levels like this is largely about aligning incentives; it seems fair to say that Schwarzman's incentives are aligned pretty directly with Blackstone and its shareholders, but perhaps more indirectly with Blackstone's funds' limited partners. Though of course those performance fees are themselves supposed to align incentives.

In other news, NXP Semiconductors is buying Freescale Semiconductor for $11.8 billion in cash and stock, representing "a total enterprise value of approximately $16.7 billion including Freescale's net debt." Freescale is, of course, a Blackstone portfolio company:

Freescale had been a part of Motorola until being purchased in 2006 by the Blackstone Group, the Carlyle Group, TPG Capital and Permira for $17.6 billion, including the assumption of debt.

So that's a small drop in enterprise value over almost a decade, though: "At the initial deal price, Freescale’s private equity backers will roughly recoup their initial investment."

The police state of Bitcoinia.

"Whenever someone starts talking about the 'free market,'" says David Graeber, "it's a good idea to look around for the man with the gun." Here is Henry Farrell on the man with the gun behind the libertarian market utopia of Silk Road, who, in keeping with the spirit of Silk Road, was probably a bot with a fake gun. Still:

Ulbricht began as an idealist, setting out to build a market free from what he described as the ‘thieving murderous mits’ of the state. He ended up paying muscle to protect the bureaucratic system that he had created.

Elsewhere here is a story about how blockchain technology is finding uses beyond processing bitcoin payments, like, good lord, this:

“A diamond is forever, a marriage is forever, but when was the last time anyone looked at their wedding vows?” Mr. Mondrus said. “This technology allows us to get that data and store it in a way that is retrievable and noncorruptible.”

That's a guy who, with his new wife, "used a Bitcoin automated teller machine to record their written vows on the currency’s so-called block chain," super. Also I guess there are some real uses.

Uber, but for Twitter Ponzis.

Here is the story of a man who, according to the Securities and Exchange Commission, raised money from investors to buy pre-IPO shares of Twitter, couldn't get enough shares, and so paid off the Twitter investors using money he took from another fund he'd raised to buy pre-IPO shares of Uber. There's a part of me that thinks if you're investing in a fund that's supposedly buying Uber, you deserve to have your money stolen and given to people who thought they were buying Twitter, or vice versa, or, I don't know, I give up. The lesson is, never invest.

Things happen.

Bob Benmosche, who turned around AIG after the financial crisis, died on Friday; here are obituaries from Bloomberg News and the New York Times; here is Jessica Pressler's 2012 profile. Dennis Kozlowski is out of prison and getting mistaken for Steve Ballmer. How Billionaires in London Use Secret Luxury Homes to Hide Assets. Bond exchange-traded funds are popular. Here's a fund that's owned the same stocks for 80 years. Here's a group of Wall Street workers who eat burgers. Use your RadioShack gift cards quick! Terror owl. Wayne Rooney trying to peel a potato.

To contact the author on this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor on this story:
Zara Kessler at zkessler@bloomberg.net