Endowment Spending and Bank Earnings

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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Universities and private equity. 

Victor Fleischer points out that "Last year, Yale paid about $480 million to private equity fund managers as compensation," while only spending about $1 billion of its endowment on operations, of which "only $170 million was earmarked for tuition assistance, fellowships and prizes." (Disclosure: My wife works for Yale, though not as a fund manager.) He thinks that this is self-evidently bad, and you can see his point, but of course the private equity managers had a better year. Or I don't have the actual data for the year, but "over the past 20 years, under the brilliant guidance of its chief investment officer, David F. Swensen, Yale’s private-equity portfolio earned an astounding 36 percent per year." The private equity managers run about $8 billion of Yale's endowment; take 36 percent of that and you get an expected return to Yale from the private equity managers of almost $2.9 billion. Meanwhile "in 2014 Yale charged its students $291 million, net of scholarships, for tuition, room and board." Yale spent almost three times as much money on private equity managers as it did on students, but the private equity managers gave Yale almost ten times as much money as the students did. And Yale didn't need to feed, house or teach them. "Time for Yale to shed the declining legacy educating business," says Malcolm Gladwell.

I suppose Fleischer's point is really that profitability is not the right metric for a non-profit university. Fair enough! He wants universities with big endowments to be required to spend at least 8 percent of them every year; others argue that the answer is making university endowments taxable, on the theory that if you're thinking in terms of profitability maybe you should be treated like a for-profit entity. 

How much does bank equity cost?

Here is John Carney on the idea that banks have a cost of equity of 10 percent, a number that as far as I can tell has no basis in anything but which is treated with surprising literalism in many discussions of bank earnings. "Bank X had a return of 9 percent, which doesn't even cover its cost of capital," is a thing that people say, though it is hard to know what they might mean. Carney's point is that the new post-crisis banks are much safer than they used to be, and that investors should re-evaluate the 10 percent rule of thumb to account for a new, safer world in which bank returns are lower but in which bank capital ought to be cheaper. You should expect a lower return on a safer investment. (This theory is, among other things, a key piece of Anat Admati's argument for higher bank capital requirements: If you double bank capital, that capital will be safer and its cost will go down, so having twice as much capital won't cost the bank twice as much.) I tend to sympathize. Taking a very simple dumb view, doing financial stuff is a business that returns X percent a year on assets, and banking is the business of leveraging those assets. If you leverage those assets 10 times, you should expect a 10X percent return on equity; if you leverage them 20 times, you should expect a 20X percent return. As leverage goes down, return expectations should go down linearly with it. Of course I am old enough to remember when at least some bank investors expected a 20 percent return on capital.

What are Fannie and Freddie up to?

The endless conservatorship of Fannie Mae and Freddie Mac is sort of embarrassing, in that conservatorships are not supposed to be endless, but it otherwise seems like the first-best option politically. Like: Fannie and Freddie are profitable now, and provide profits to the Treasury. But they are still nominally private companies, so their debt is not exactly debt of the U.S. government. Returning them to their shareholders would be hard, since it would reward the hedge funds who've been agitating for that, who don't seem popular politically. Re-privatizing them with new capital would be hard, if the old shareholders were wiped out, plus it's hard to provide a government subsidy to mortgages while pretending that the subsidy comes entirely from private investors. And as long as Fannie and Freddie are instruments of the government, it's easier to use them to implement government priorities

The federal agency that regulates the mortgage finance companies Fannie Mae and Freddie Mac on Wednesday set goals for the next two years to nudge them to provide mortgages to more low-income borrowers and to landlords who offer low rents to poor people.

Would a purely private mortgage market generate similar nudges? What about a private-capital-backed-by-market-rate-government-guarantee one? Who cares, really, is the answer. If Fannie and Freddie are setting goals for two years out, privatization doesn't seem especially imminent.

So your colleagues committed adultery.

Don't look at the leaked user information about Ashley Madison, the hacked adultery website. Don't look up your ex. Don't look up your colleagues and clients. Don't, for the love of all that is holy, look up your dad, come on. But here we are on the Internet and I do feel like I would be remiss if I didn't tell you that MarketWatch searched the Ashley Madison leaks for bankers who (1) signed up for some adultery and (2) used their work e-mail, and got hundreds of results. Wells Fargo had the lead, with a whopping 175 accounts; Bank of America had 76, Citi 51, Goldman Sachs 45, JPMorgan only nine. Obviously the data could be fake, etc., but I do appreciate this deadpan quote from Wells Fargo on its adultery-on-company-time policies:

“While we cannot speak to the veracity of the data, as a matter of company policy we require that team members use personal email addresses to conduct personal business,” Wells Fargo spokesman Ancel Martinez told MarketWatch.

Here is AdvisorHUB on how financial advisers feel about the Ashley Madison hack. (Bad, is the answer, though the actual language is a bit more colorful.) And here is Quartz with "8 tips for dealing with embarrassed colleagues," though they mostly boil down to the one key tip, which is: Don't look.

Meanwhile JPMorgan is hiring data scientists to snoop into its employees' electronic communications.

Municipal arbitrage.

I mentioned the other day Citigroup's $180 million settlement with the Securities and Exchange Commission over its crisis-era municipal arbitrage hedge funds, a settlement that was curiously light on descriptions of actual misconduct. Here is a deeper dive into those funds by a consultant involved in the related private litigation, which I recommend if you're interested in understanding "municipal arbitrage." Such as it was:

The municipal arbitrage strategy was dependent on hedging large, leveraged, long-term municipal bond positions with taxable interest rate swaps. The correlation between these hedges was quite low making it likely that they would fail. As long-term municipal yields increased more rapidly than the swap rates over many months, the hedging strategy in fact did fail. 

People are worried about stock buybacks.

I realize that that category tag is sort of misleading, but the point is that a lot of people are worried about short-termism and "quarterly capitalism" and so forth, and stock buybacks are a convenient synecdoche for that. But there are other symptoms of quarterly capitalism, of which perhaps the most obvious is quarterly earnings reporting, which has "quarterly" right in the name, and which allegedly forces companies and investors to focus on quarterly results rather than long-term investment. Wachtell, Lipton, Rosen & Katz, the great law firm of board primacy, "called on the Securities and Exchange Commission to consider allowing U.S. companies to do away with the obligatory updates." (Disclosure: I used to work at Wachtell Lipton.) Here's a version of the memo, which dreams that "we may still achieve a capitalism in which long-term, responsible investors champion boards and management teams that resist pressures to maximize short-term stock prices at the expense of sustainable long-term investment and wealth creation." 

People are worried about bond market liquidity.

Did you know that Goldman Sachs has a podcast? Did you know that people are worried about bond market liquidity? Here's an episode of Goldman Sachs's podcast about bond market liquidity worries. It is balanced and insightful and probably the best discussion of bond market liquidity that I've ever heard, though also probably the only discussion of bond market liquidity that I've ever heard. If you like listening to sensible and thoughtful 25-minute podcasts about bond market liquidity, there you go. (Disclosure: I used to work at Goldman too.)

Meanwhile the New York Fed's series on Treasury market liquidity today features a post on the "workup" in the Treasury market, "whereby the execution of a marketable order opens a short time window during which market participants can transact additional volume at the same price."

With the broadening of the interdealer market to include hedge funds and proprietary trading firms, and the increase in trading activity, some market participants consider the workup to be somewhat of an anachronism that is destined to lose its relevance relative to the CLOB. Contrary to this notion, we document the continued important role played by the workup, show some ways in which trading behavior in the workup has evolved, and explain some of the observed changes.

I feel like people who are worried about bond market liquidity have this stuff pretty low on their list of worries.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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