Stress and Performance

Also: pharma M&A, white-collar offender registries, oil trading, electric lawsuits, and in the long run we are all activist investors.

Stress tests.

Aren't you happy for Citi? Not only did it pass the stress test, but it "got the cleanest approval from the Federal Reserve among top Wall Street banks, a year after the firm failed the regulator’s annual stress tests." So the ritual sacrifice of chief executive officer Michael Corbat and his entire management team has been cancelled, good job everyone. After all the ostentatious knife-sharpening over the last few weeks, I was pretty comfortable that the sacrifice was not actually going to go forward, but still it's a relief to see that confirmed.

On the other hand, "Bank of America exhibited deficiencies in its capital planning process," including "weaknesses in certain aspects of Bank of America’s loss and revenue modeling practices and in some aspects of the BHC’s internal controls," which did not warrant a failing grade but did warrant a stern talking-to and a requirement to resubmit its capital plan. Goldman, Morgan Stanley and JPMorgan all had to revise their capital plans after their first efforts scraped below the minimum requirements.

And the U.S. units of Santander and Deutsche Bank failed outright on qualitative grounds -- Deutsche for "numerous and significant deficiencies" in various areas, which sounds bad, and Santander for "widespread and critical deficiencies," which sounds even worse. So they will not be allowed to return capital to their European parents this year. Which they had not asked to do anyway -- compare pages 44 and 72 of yesterday's CCAR stress test with pages 88 and 116 of last week's DFAST test -- so I'm not exactly sure what it means that they failed the test? Like, the Fed "objected" to their capital plans, but the plan was to do nothing, and now they're going to do nothing. It's not like the Fed is requiring them to raise capital; in fact, by most measures Deutsche's U.S. unit is the best capitalized bank in the test. I guess they have to go fix all those deficiencies, but they should probably do that anyway.

Pay and performance.

Here is a Bloomberg News article arguing that Larry Ellison's $103 million in 2014 pay from Oracle is a bargain: It "equates to 2.1 percent of Oracle’s three-year average economic profit," and, according to one analyst, "economic profit is just about the best single measure of company performance" because it lets you "pay executives for the results under their scope." Is that right? It's a measure of "after-tax operating profit minus the cost of capital," so for instance it doesn't penalize executives for research and development spending, but on the other hand, "Exxon CEO Rex Tillerson’s $28.9 million pay in 2013 is 0.4 percent of his company’s $7.4 billion three-year average economic profit through that year," and the price of oil isn't entirely under Rex Tillerson's control. I don't know. It seems very hard to figure out how much a CEO is worth: It's entirely plausible that a good CEO adds many multiples of his paycheck in shareholder value, though it is never clear to me how you answer the "compared to what" question. But I suppose that if you replaced Larry Ellison with a CEO who cost half as much and was 90 percent as good, that would be a huge loss for shareholders: Ellison provides 50 times as much value as he costs, and that trade would save $50 million in comp but lose $500 million in economic profit.

Elsewhere in pay and performance, the New York State Comptroller's annual report on Wall Street bonuses is out:

The average bonus paid in New York City’s security industry rose by 2 percent to $172,860 in 2014, according to an estimate released today by New York State Comptroller Thomas P. DiNapoli. Even though the industry was slightly less profitable in 2014, it added 2,300 jobs in New York City, the first year the industry has added jobs since 2011.

So that's pretty cheerful. Average bonuses grew at a faster clip in 2012 and 2013, but slow bonus growth combined with actually adding jobs might be a more sustainable model. And companies that are good places to work perform well in the stock market.

Pharma mergers.

Just last week, when AbbVie swooped in at the last minute to snatch Pharmacyclics out of the grasp of Johnson & Johnson, I asked why the pharmaceutical industry has all the fun mergers and acquisitions activity these days. And now Endo International lobbed in a topping bid for Salix Pharmaceuticals, which had already agreed to a $158-a-share cash deal with Valeant Pharmaceuticals. Here's Endo's letter, proposing per-share consideration of $45 in cash and 1.4607 shares of Endo stock, a deal worth $175 at the time of the letter though only $173.19 by yesterday's close. That is still more than $158, though the stock component and greater uncertainty (unlike Valeant's bid, Endo's requires its own shareholders to approve) make it a real contest. Ronald Barusch wonders why Endo couldn't get its act together to make this offer before Salix agreed its deal with Valeant, which is a fair point. Maybe it just wanted to keep things exciting. Here's Valeant's rather whatever response ("We are firmly committed to our all-cash agreed transaction, which delivers immediate and certain value to Salix shareholders"); perhaps it is waiting to see whether it will be forced to raise its bid. Or perhaps Valeant's "new business model is to generate cash from breakup fees": It stands to get $356 million if its Salix deal is scrapped, a bit less than the approximately $389 million that it made for losing Allergan to Actavis. 

A registry.

Does the Utah Legislature's plan to have a new white-collar offender registry, where you can browse the names and photographs of people convicted of financial crimes in Utah, make sense? On the one hand, it at least makes more sense for white-collar criminals than for, like, muggers: You get to sit at your computer and decide whether to give your money to a financial scammer, so if your computer had a way to tell you not to, that would be useful. On the other hand:

“You’re adding one more punishment without any real showing that it’s needed,” said Susan Brune, who represents white-collar defendants at Brune & Richard in New York. “Enough already.”

Since white-collar cases typically garner outsize media attention, Ms. Brune remarked that “Google is already a pretty effective registry.”

Also, I feel like the people most likely to fall for financial scams are precisely the people least likely to go on the state's "don't fall for financial scams from these people" website first. 

How to hedge oil volatility.

Here is a delightful story about how some of the oil majors -- BP, Royal Dutch Shell and Total -- are "the world’s biggest oil traders" and are likely making a lot of money in their trading businesses, because trading businesses thrive on volatility:

“We’re in a very strong commodity trading position,” Shell CFO Simon Henry said in a call with analysts on a Jan. 29. “Our ability to take advantage of volatility is some protection to mitigate the low price environment.”

The traditional way for oil producers to hedge oil prices is to go out and buy oil-price hedges. But this is expensive and boring, and also only sort of a first-order hedge: Eventually your hedges roll off, and if they do that in a low price environment, you have to re-hedge at lower prices (or higher expense). Doesn't that all seem tawdry and second-best compared with building a business that just profits directly from oil-price volatility? Meanwhile, the glut in oil means that the U.S. is running out of places to put oil.

An electric lawsuit.

There's a new lawsuit against JPMorgan for "racketeering and manipulation of California's electricity market." You can read the complaint here, though you will not find much that is new in it if you've been following JPMorgan's California electricity exploits since its Federal Energy Regulatory Commission settlement in 2013, as I have. If, on the other hand, you are new to the story of JPMorgan's California power plants, you are in for a treat:

In April 2011 JPM Ventures began submitting negative Day-ahead bids of -$30/MWh for the hours at the end of a particular day (day one). It also submitted near maximum Day-ahead bids of $999/MWh (the Tariff maximum is $1,000/hour) for the hours between 12:00 a.m. and 2 a.m. of day two.

JPM Ventures’ manipulative strategy took advantage of the limitations of CAISO’s automated bidding system, which only evaluates bids during a single calendar day. The minimum negative bids for day one resulted in bid acceptance because the system did not take into account the market consequences of accepting those bids for day two.

CAISO was thus obligated to pay JPM Ventures $999/MWh for electricity produced while ramping down after midnight. While this was a staggering rate by itself, the manipulation was all the more egregious because the market price of electricity between midnight and 2 a.m., when the demand is low, was typically around $12/MWh.

As the second paragraph of that quote implies, all of this was allowed by the rules of the California Independent System Operator Corporation, which runs California's electric grid. The rules were very stupid, and JPMorgan figured that out and ruthlessly exploited the stupidity. This landed it in trouble with the FERC, and in this lawsuit, but I have some sympathy: It's not exactly JPMorgan's fault that the rules were dumb. These plaintiffs should really be suing the people who made the rules, for malpractice.


Honestly my eyes glaze over at stuff like this but some people are into it:

A group of executives and investors sought the answer to the “scourge” of short-term thinking on Wall Street, Washington and across businesses in a New York conference room overlooking Central Park on Tuesday.

The group, calling itself Focusing Capital on the Long Term, batted around ideas on what concrete steps they and their powerful organizations can take to give executives breathing room to make the kinds of decisions that may drive growth down the road but might also draw flak from investors wondering about the here and now.

Sure okay great. Larry Fink is a co-chair. Here is Cliff Asness on the link between maximizing shareholder value, efficient markets, and the long term. Obviously there is something to the idea that shareholders focus more on near-term gains than on long-term ones, but it doesn't seem very theoretically sound, and also I mean Amazon is a $170 billion company. This notion that shareholder capitalism is all about tearing down companies and selling them for parts seems a little overblown. Here is a discussion of Delaware Vice Chancellor Travis Laster and the short and long terms:

Vice Chancellor Laster extended his Trados conflict of interest analysis to other situations in which directors represent stockholder constituencies with short-term investment horizons, including directors elected by activist stockholders seeking immediate steps to increase the near term stock price of the corporation. He states that such directors can face a conflict of interest between their duties to the corporation and their duties to the activists.

The activists are shareholders, remember, so the question is whether you can have a conflict of interest between your duties to a corporation and your duties to its shareholders, based on those shareholders' time horizons. But shouldn't the current price of a stock incorporate expectations about oh never mind.

Things happen.

Who's the next Jack Bogle? The new carry trade is borrowing euros to invest in "India and Indonesia and in some cases the Philippines and Sri Lanka" and also U.S. Treasuries (related?). Snapchat Is Raising Money From Alibaba at a $15 Billion Valuation. Noah Smith on bubbles. Jaber George Jabbour, hero of the Libya-versus-Goldman and Portugal-versus-a-snowball derivatives controversies, is running for parliament in Inverclyde. Greece is talking about World War II reparations again. Montel Williams clarifies that he still endorses payday lender MoneyMutual, except in New York. Investment bankers priced out of Mayfair and Knightsbridge will be living in the City of London. Group Of UBS Ladies Slated To Attend Networking Party For “The Sexual Elite” This Weekend: Report. A fake Winklevoss. It'll get cold again.

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    Matt Levine at

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