Passive Investors and Dominant Bankers

Active, passive, etc.

We talked last month about a proposal to more or less ban index funds, based on a paper arguing that ownership of public companies by "large diversified institutional investors" reduces competition, because diversified mutual funds don't want the managers of their companies to compete for market share at the expense of the overall industry's profit margins. Like many readers of that proposal, I was skeptical. But I was also intrigued. So the other day, when Trian lost its proxy fight at DuPont, I mentioned in a footnote that DuPont's big index fund holders had voted against Trian's slate, and half-jokingly said that this was "perhaps because their mechanical diversification makes them less interested in putting pressure on managers to perform."

But yesterday Martin Schmalz, one of the authors of the original diversification-hurts-competition paper, made that argument more seriously. Schmalz notes that DuPont and Monsanto have largely overlapping shareholders, that Trian accused DuPont of overpaying Monsanto for a patent license, that Trian criticized DuPont for performance that "was satisfactory only because of a positive industry-wide trend, but not if measured relative to DuPont’s competitors" -- and that Monsanto's stock was up 3.5 percent when Trian's bid failed:

It appears that a dispassionate look at different shareholders’ economic incentives supplies a rather simple rationale for why the passive funds did not themselves enforce relative performance evaluation, protest the weakening of DuPont’s CEO’s incentives, encourage more R&D and gains in market share, and so forth. Doing so simply isn’t in their economic interest. Peltz’s campaign, by contrast, aimed at increasing DuPont’s value in isolation, by strengthening DuPont’s relative competitive position. Predictably, the mutual funds voted against him.

It's a clever post! I remain intrigued, but skeptical. Other large holders of both stocks voted with Trian, and it's not like Trian's proxy-fight platform was explicitly about cutting prices to compete more aggressively. More broadly, I just have trouble believing that index fund managers sit down and decide to vote for whatever will make industries less competitive. It's easy enough to believe that index funds underinvest in governance monitoring: Monitoring adds costs to a product advertised for its low costs, it can't really lead to outperformance (for an index fund), and every other index (and non-index) fund can free-ride on it. But once an activist is already running a proxy fight, it's also hard for me to believe that diversified funds -- and, here, index funds specifically -- actively vote to reduce competition. Still, I mean, in a certain light, this looks like evidence.

Elsewhere here is evidence that stock pickers can pick stocks.

Wall Street is back, bad, etc.

Congrats everyone, we did it

The number of people working in the securities business nationally has returned to 2007 levels, as has the gap between the compensation of Wall Street workers and that of everyone else. The financial sector as a whole is reporting profits that are as large a share of the overall economy as in the early 2000s and more than double their average level over the 70 years ended in 1999.

Average pay for securities-industry workers was 3.6 times the average pay of all workers in 2013, down from 4.2 times in 2007 but getting there. This all seems like good news if you work in the industry, but most people don't, and of course there are skeptics. Neil Irwin continues:

A dominant financial sector may actually crimp economic growth and living standards for most people. It can drain talented workers from the rest of the economy and create damaging boom-and-bust cycles. A large financial sector creates lots of new vehicles through which consumers and businesses can take on debt, and the rise of debt levels creates vulnerability in which small shocks to the economy can translate into huge swings. The central job of banks, investment firms and the like is to funnel capital toward its most productive uses, and there is scant evidence that the sector did that job better when it was a bigger share of the economy, as in the 1990s and 2000s, than in the preceding decades.

And Marshall Steinbaum argues that "much of finance is still detracting from rather than contributing to economic wellbeing," because the "paradoxical confluence of abundant capital for the well-connected and high corporate profits implies that corporations face little competition."

Also here is Andrew Ross Sorkin on a new survey of financial-industry workers, finding that "about a third of the people who said they made more than $500,000 annually contend that they 'have witnessed or have firsthand knowledge of wrongdoing in the workplace,'" and that "Nearly one in five respondents feel financial service professionals must sometimes engage in unethical or illegal activity to be successful in the current financial environment." I was a little skeptical about a prior version of the survey, but I guess the main question is the control group. Like: What do these numbers look like in other industries? What percentage of the journalists writing about the financial industry, or the politicians regulating it, "have witnessed or have firsthand knowledge of wrongdoing in the workplace"? 

Elsewhere here is a story about a broker who was barred from the industry after 69 customer disputes over 13 years.

Skip McGee is also back.

Former Lehman and Barclays energy banker Skip McGee is starting his own energy and power boutique, Intrepid Financial Partners, and man is he quotable:

“We’re connecting with some people that we’ve worked with in the past,” McGee said. “In the days that I have been in Houston, I have two or three breakfasts every morning.”


“Once you form a company the hardest thing to do is come up with a name,” McGee said. “Every cool Greek and Roman god? Gone. Every cool animal? Gone.”

Is that true? I don't know, there are a lot of animals, each cool in its own way, though I suppose hedge funds have eaten through a lot of the charismatic megafauna. The complaint about Greek and Roman gods is more plausible, though if I ever start an advisory boutique I will shop for a name among the chthonic spirits in Jane Harrison

Fannie and Freddie are not back.

Here is John Carney on the proposal for Fannie Mae and Freddie Mac to coordinate on a single form of agency mortgage-backed security:

Fannie would be giving up an important competitive advantage. The company itself says the single security would “adversely affect” its results by hurting its ability to compete to buy mortgages from banks.

So it is clear the single-security project isn’t something a private company would voluntarily pursue. But this only highlights the status of Fannie and Freddie as wards of the state and likely forecloses any scheme to restore the two to their precrisis status quo. Back then, the two were private companies and fierce competitors. The single security is a feature of a market in which they are more utilities.

This could also be a prelude to a more dramatic change. The single security could be opened up to private guarantors, perhaps backed by reinsurance purchased from Treasury. That would eliminate a critical barriers to entry into the mortgage-guarantor market: the liquidity advantage enjoyed by Fannie and Freddie.

And here are Jim Parrott of the Urban Institute and Mark Zandi of Moody's Analytics on proposals to re-privatize Fannie and Freddie:

Under any of these scenarios it would take a very long time to achieve the level of capitalization that would be required of the GSEs. Even under the low-cost recap and release scenario—in which the Treasury dividend is extinguished and the commitment fee is priced like deposit insurance—it could take as long as 18 years (see Table 2). And if they are required to pay the 10% dividend and a CoCo-like commitment fee, it is conceivable that the GSEs would never be able to appropriately capitalize themselves.

Apple is not making a TV.

We talked yesterday about Carl Icahn's financial model for Apple, which involves Apple making television sets and selling $52.5 billion worth of them by the end of 2017. "But after nearly a decade of research, Apple quietly shelved plans to make such a set more than a year ago, according to people familiar with the matter." Oops!

Apple had searched for breakthrough features to justify building an Apple-branded television set, those people said. In addition to an ultra-high-definition display, Apple considered adding sensor-equipped cameras so viewers could make video calls through the set, they said.

Ultimately, though, Apple executives didn’t consider any of those features compelling enough to enter the highly competitive television market, led by Samsung Electronics Co.

Guess it should just buy back some stock then.

A treasury of fake SEC filings.

We talked last week about the fake tender offer for Avon Products, and about how it's relatively easy to file things on the Securities and Exchange Commission's Edgar website. What I didn't know is that Broc Romanek of has a collection of fake Edgar filings, and they are excellent:

This latest incident is a cautionary tale for investors as it’s not the first fake takeover announcement. My favorite dates back to 2001, as noted in this piece, when a fake “blank check” company calling itself “Toks Inc.” filed a Form SB-2 with the SEC announcing plans to take over General Motors, General Electric, AT&T, Hughes Electronics, AT&T Wireless, AOL Time Warner and Marriot International – for roughly $2 trillion in “Toks” stock. The promoter – Ade O. Ogunjobi – didn’t give up even when the SEC issued a “Stop Order” to prevent the registration statement from going effective and suing him for selling unregistered securities, later launching a website to promote his wild ambitions and plans to then hold press conferences to announce his plans for these major US companies he was to take over!

Hard to believe, but those SEC filings by Toks are still on EDGAR.

Here are some more, including a guy claiming to own 999 billion shares of Microsoft, and a company whose "objective was to add an incremental value to the utility derived by the internet user something slightly different from what other companies are doing."

Things happen.

Are financial markets too fragile to handle a leap second? Goldman Sachs is not happy that its lead supervisor at the New York Fed "has quit for a job advising other financial firms." Euro-Area Bonds Climb as Coeure Says ECB to Expedite Purchases. Here's who's on the Ad-hoc Committee of Noteholders to Ukraine. "According to this metric you should have sold stocks every year of the current bull market." Morgan Stanley strategists think we're not at the top because they got an e-mail from a bad financial adviser. "Is Calpers missing the forest for the trees?" Lumber and gold. Crowdfunding a universal basic income. What VC Can Learn From Private Equity. There's another Patriarch Partners lawsuit. "Equity, a movie about a female investment banker whose IPO is in jeopardy." Soon you might be able to pump your own gas in New Jersey. Should you tweet that? Find out next week what Meat Loaf won't do for love.

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    Matt Levine at

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