Insurance and Unicorns

A good trade is to exchange your IOU for someone else's IOU, sell the other guy's IOU for cash, and then wander away.

How to succeed in the insurance business.

This weekend's Wall Street Journal story about Alexander Chatfield Burns is a delight and I recommend it highly. Burns was the sort of teenager who "determined" that the Black-Scholes "options-pricing model 'was wrong' and 'he had a better idea,'" and he reportedly grew into the sort of twentysomething who had both a pretend Yale degree and a pretend Mayflower ancestry. He spent most of his time running a private equity firm called Southport Lane, which found a way to buy insurance companies with no money down, and then did weird things to them. Those weird things left the insurance companies in liquidation after he decamped briefly to Bellevue. Here's a follow-up from the Journal about how regulators seem to have missed all of this. And here's a weird thing Burns reportedly did, from a delightful Duff & Phelps valuation report:

On November 26, 2013, SSF acquired two classes of preferred stock from Metcom Affiliate Holdings, LLC (an affiliate of Metcom) with a face value of $100 million by the issuance of two promissory notes -- each with a face value of $40 million. The promissory notes each have quarterly interest payments due beginning on March 1, 2014, with their entire principal balances due December 1, 2019. The Metcom preferred stock was contributed to TIO V, which is owned by two separate Destra series in equal amounts. Units of those Destra series were sold to the Insurance Companies for value commensurate with the $100 million face value of the Metcom preferred stock. Similar to the Artwork, to date, we have not seen evidence to confirm of where the funds used to purchase those Destra units were applied.

A glossary:

  • SSF was Southport Specialty Finance LLC, one of Burns's private equity vehicles
  • Metcom seems to have been a company?
  • TIO V and Destra seem to have been -- well, Duff & Phelps refers elsewhere to Burns's propensity for "structures that include multiple intermediate holding vehicles that do not appear to contribute any economic value"; just ignore them.
  • The "Artwork" is a purported, but disputed, Caravaggio painting.
  • Duff & Phelps says that "the first interest payment may not have been made" on the promissory notes.

Get it? Southport got a $100 million IOU from Metcom, in exchange for an $80 million IOU from Southport. No money changed hands, and Duff & Phelps values the Metcom IOU at zero, "due to the risk of Metcom cancelling the preferred stock certificates due to the default of the Metcom notes that were used by Southport Specialty Finance to finance them."  That is: Neither side ever paid off its IOU. So Southport had just exchanged its worthless piece of paper for someone else's worthless piece of paper. But then! Southport contributed Metcom's worthless piece of paper to its insurance companies for actual cash money. That's the way to do it. 

Shadowy unicorns.

Here's a story about how big mutual fund companies are investing in big tech startups that aren't yet public, which I guess is somehow nefarious:

“I think it goes beyond what mutual funds were set up to do,” said Leonard Rosenthal, a professor of finance at Bentley University in Waltham, Mass. “It’s great for the portfolio manager, but it’s not necessarily in the interest of the shareholders of the fund. If investors are looking for a portfolio of risky securities, there are plenty of stocks to trade in the public market.”

Also it's "shadowy":

Those lofty valuations, combined with the eagerness investors show in bidding them up, have created a shadowy market for private stock issued to tech companies’ early investors and employees. 

And here is a story about how investments from hedge funds and mutual funds are pushing up valuations for private companies, from 10-12 times sales five years ago to 15-18 times now. 

So look: Stocks can trade on public exchanges, or in private transactions. There's no obvious reason to think that public stock is Good and private stock is Bad. The shadows are strictly metaphorical, and after all: "If investors are looking for a portfolio of risky securities, there are plenty of stocks to trade in the public market"! In fact, since public offerings often serve mostly to cash out earlier private investors in modern tech companies, if you are a fund manager who actually wants to allocate capital to growing tech businesses, the private market is a very reasonable place to look. Also: Measured by market capitalization, Airbnb is worth more than Hyatt; Uber is worth more than Hertz. If you want to give your investors exposure to the growth areas of the U.S. economy, it would be frankly weird to stand on ceremony and limit yourself to Hyatt and Hertz because Airbnb and Uber haven't yet filed certain pieces of paper with the SEC.

As for valuations, here is Aswath Damodaran on "Illiquidity and Bubbles in Private Share Markets":

Extrapolating from one experimental study may be dangerous, but if this study holds true, the fact that the private share market is less liquid than a public market may be a check on the market's exuberance, and especially so for young start-ups. Put differently, if liquidity adds to bubbles, Uber, Airbnb and Snapchat would be trading at even higher prices in a public market than they are in the private share markets today.

Citi gets a breather.

Here's a little good news: Citigroup is allowed to make two small interest payments on Argentina's local-law, U.S. dollar bonds in March and June, "giving it time to exit a custody business there that got stuck in the government’s legal battle with hedge funds." This grace period seems to have been worked out with Elliott Management's NML Capital, the holdout creditor that previously won a court order preventing Citi from making those payments. What NML gets out of the deal is that it "heads off the bank's appeal of the March 12 ruling," which was pretty controversial, and also I suppose NML is not actually in the business of needlessly harassing Citi. (It's in the business of harassing Argentina.) On the other hand NML does seem to be giving up some leverage on Argentina: Surely given a few months of lead time, Argentina can find someone to custody these bonds who is not subject to jurisdiction in New York and who can keep making the payments. I mean all you absolutely need is a person to sit in an office in Buenos Aires handing out duffel bags of dollars, right?

Some financial regulation.

Remember Libor? "Benjamin Lawsky, the New York regulator known for taking a hard line against overseas banks, has shouldered his way into the long-running Libor scandal," going after Deutsche Bank, and what regulatory purposes could that serve at this point? Libor manipulation has found its way into the jurisdiction of the U.S. Commodity Futures Trading Commission, the Department of Justice, U.K. Financial Conduct Authority, the European Commission, the Swiss Financial Market Supervisory Authority, and of course the private lawsuits of anyone actually or allegedly harmed by the manipulation. At some point you start to wonder whether the duplication is necessary, of if it's just a way for all the regulators to get some headlines and fund themselves.

Elsewhere Zions Bancorporation is having a tough time with modern financial regulation, which lumps big regional banks like Zions in with the massive Wall Street banks. "We see ourselves as a group of local banks," says the Zions chief executive officer, and can't you almost imagine Jamie Dimon saying that? Anyway the stress test is particularly stressful for Zions, which has the same problems with the tests as other big banks -- voluminous submissions, lack of Fed transparency -- but also seems to be a bit less, um, good at it than the Wall Street banks are.

And Paul Volcker has a plan to simplify financial regulation! 

Mr. Volcker said he and his think tank, the Volcker Alliance, will soon publish a paper calling for consolidating and reorganizing U.S. financial regulators, including creating a single agency to supervise financial institutions while leaving the Federal Reserve the authority to write regulations for them.

First of all, Volcker Alliance, great name. Second, remember the last time Paul Volcker had a simple idea? Somehow it got complicated.

Money books.

The New York Times Book Review had a whole issue on books about money this weekend. It covers both "God's Bankers" and "Heaven's Bankers," as well as the Beanie Baby bubble, and Jessica Pressler reviews a history of money written by an investment banker who calls people "bro." Elsewhere in the Times: What to Do in Dubai, and, of course, When the 13-Year-Old Picks a $14 Million Condo.

Dan Davies does things.

Here is Dan Davies on the Smurfs and secular stagnation, and on New Zealand:

The landscape has an extraordinary … generous quality to it. The desert in Jordan carried the constant fear of death to the unwary, and the fertility of Sri Lanka also had a sinister quality to it, as if something was going to start growing on you if you sat still for too long. And Australia, even in the temperate zones, is such an extraordinary collection of poisonous and hazarodus things (one episode of Peppa Pig has been banned by the ABC, as it involves Peppa learning that Friendly Mr Spider is nothing to be scared of, a message which is wholly inappropriate to teach Australian kids). But New Zealand – the countryside seems to be acting as if it is trying to kill you by throwing fruit at you.

Things happen.

People are worried about a bond bubble, and bond "investors are taking chances on assets and regions that few would have considered just months ago." Deutsche Bank may spin off its retail operations. AIG settled a shareholder class action for almost $1 billion. It's a big week for Greece. "Objective: Patient will verbalize the importance of education for employment and will state that Obama is not following her on Twitter." "You know what I do when I'm doing math and am stuck? I just stop being stuck and be awesome. True story." Pope Francis Accepts a Pizza While Riding in the Popemobile.

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    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

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