Bonuses, Bail-Ins and Down Rounds

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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Bonuses and promotions.

"Bonuses in the financial industry this year are expected to fall 5 to 10 percent," sorry everyone. On the plus side, though, Goldman Sachs will promote analysts to associate after two years, and associates to vice president after another three and a half. I suppose one way to make up for lower pay is with fancier titles, though that does not seem to be the main motivation; the new young VPs will apparently be paid like VPs.

The goal of course is to compete with buy-side and tech firms that siphon off Goldman analysts after their first two years, and to try to encourage young bankers to build their careers at the bank. But one implication is that this really ought to de-value the MBA, at least at banks. (Or, at least at Goldman.) Now you can go from college to VP in five and a half years, while getting paid the whole time, and you'll be a first-year VP at the same age as a first-year associate coming out of business school with three years of pre-MBA work experience. In other news, only 14 percent of managing directors at Goldman have MBAs

And here is William Dudley on "Reforming Culture and Behavior in the Financial Services Industry."

TLAC.

"The Financial Stability Board (FSB) today issued the final Total Loss-Absorbing Capacity (TLAC) standard for global systemically important banks (G-SIBs)," and are there any more devoted users of abbreviations than bank regulators? We talked about TLAC a bit last week, and it makes sense as a concept to me: "The way to avoid financial crises is to clearly define the classes of people whom it is socially and politically acceptable not to pay back," and that's what TLAC is. The idea is to make a big bank's failure tidier, by clearly specifying in advance who is in line to lose money and in what order. Holders of bank capital lose first, but holders of TLAC debt -- basically unsecured debt issued by the bank holding company -- are on the hook next. The implication is surely that if you own something senior to TLAC debt -- insured deposits, say, or derivatives liabilities -- you should really expect to get paid back even if the bank fails. But, with luck, you'll get paid back out of a TLAC bail-in, not a taxpayer bail-out. Bloomberg View's editorial board is skeptical.

The main requirements are 16 percent of risk-weighted assets as of 2019 (18 percent as of 2022), and 6 (then 6.75) percent measured as a leverage ratio. There is apparently not yet enough TLAC debt, so banks will have to issue more of it. Bloomberg reports:

The shortfall banks face under the 18 percent measure ranges from 457 billion euros to 1.1 trillion euros ($1.2 trillion), depending on the instruments considered, according to the FSB. Excluding the three Chinese banks in the FSB’s 2014 list of the world’s most systemically important institutions, that range drops to 107 billion euros to 776 billion euros.

Here is the Quantitative Impact Study Report, which gets those numbers. Here are the TLAC principles and term sheet. Here is a cost/benefit analysis, which estimates among other things that TLAC-eligible securities will now be about 42.7 basis points more expensive for the median bank, which I suppose is a sort of estimate of the previous too-big-to-fail subsidy. Here is how the Basel capital rules will treat banks' holdings of other banks' TLAC instruments for capital purposes, which I include mainly as a reminder that bank regulation is complicated and interconnected.

Incentives.

Manhattan District Attorney Cyrus R. Vance Jr. "has secured a windfall of $808 million from criminal penalties against three international banks accused of violating United States sanctions" that he now gets to spend however he'd like. Some of it is going to "renovating the antiquated offices of his assistants at 80 Centre Street," some is going to buying stuff for police and prosecutors in New York and elsewhere, and some will be allocated to "programs aimed at preventing people from becoming criminals and helping convicts enter the work force when they are released from prison." "It’s going to be structured in some ways like a foundation," says the guy hired to run the foundation. 

Obviously if you have prosecutors who can use negotiated bank fines to make their own offices fancier and gain political clout by giving out millions of dollars to favored causes, you will expect to have more bank fines and more politically powerful prosecutors. I have to say that Vance's projects sound mostly pretty decent, though? "He has also given money to prosecutors in other boroughs for cybercrime labs," which is not encouraging; prosecutors, including Vance, are mostly a disaster when it comes to over-criminalizing anything that you can stick "cyber" in front of. Otherwise, though, there's a lot of fairly positive stuff like improving lighting in New York housing projects and "social engineering aimed at addressing early traumas that studies have shown lead to crime." Vance seems to want to set himself up as a leader in criminal justice best practices, though really one of those best practices is probably not letting prosecutors keep any fines they can negotiate.

Elsewhere: "Incentives Structures and Criminal Justice."

People are worried about unicorns.

On Friday, Square put out the pricing range for its initial public offering, "seeking a market valuation of as much as $4.2 billion in its trading debut, a significant cut from the $6 billion the company sought in its last funding round in 2014." That is obviously disappointing if you bought in the $6 billion round, though possibly not that disappointing:

Square’s I.P.O. is also a case study in ratchets, a type of protection that investors can use if a start-up they back does a subsequent round of funding at a lower valuation. In Square’s case, a ratchet will be triggered for Series E investors if the company goes public at anything less than $18.56 per share. If that happens, those investors will receive an additional number of shares to make up the difference, protecting them from taking a loss on their investment. This happens at the expense of earlier investors, whose shares will be diluted.

"A big name like Square going public at a down round paves the way to wonder what Silicon Valley unicorns will do so now," says a research analyst. I feel like you can have two models for the huge valuations and fundraising rounds in the private markets. One, which I have been pushing for a while, is that private markets are the new public markets, a well-funded multi-billion-dollar private company is not that different from a public company, and the IPO milestone is not that meaningful. If that's your theory, then this is just the story of a company going from a $6 billion valuation to a $4 billion valuation, which happens sometimes, though it's complicated by that ratchet protection.

The other model is that there is a unicorn bubble, as investors bid up private companies "because they think they can find someone else to sell to at an even more inflated price" in the IPO. The thing about true bubbles is that they pop: If it regularly becomes difficult to offload unicorns to the public, then the unicorn-creation ecosystem should collapse. If there keep being down-round IPOs, and unicorns keep getting funding, that may mean that we're not in a bubble but in a fundamentally transformed market for how companies are funded.

On the other hand, 93 percent of U.S. IPOs so far this year "have been by companies with less than $1 billion in annual revenue," up from 50 percent in 2012, when the JOBS Act became law. Which suggests, despite the unicorns, that U.S. public markets have become a friendlier place to fund small growing businesses.

Elsewhere in IPO news, Match Group, which owns Tinder and OkCupid, set its pricing range, valuing it at about $3.1 billion at the midpoint. I suppose Match is not technically a unicorn -- it is not venture-funded, but a unit of IAC/InterActiveCorp -- which is for the best. Unicorns are sweet creatures of innocence; Tinder, I gather, is not.

People are worried about stock buybacks.

Probably the most interesting and thoughtful advocate of the case against stock buybacks and corporate short-termism is J.W. Mason, who has a new Q&A out for the Roosevelt Institute. He makes the case that the current wave of dividends and buybacks from big public companies is mostly not being reinvested in innovative smaller private companies, and that those dividends and buybacks can't be justified just by saying that companies don't have any better uses of the cash:

But there are several reasons to think that the socially optimal level of business investment is substantially higher than the level preferred by financial markets. First, as long as the economy is operating below potential output, there is no real opportunity cost to higher investment. Second, investment spending often has positive externalities—meaning its social return is higher than its private return. Finally, most broadly, there is good reason to think that society as a whole places too little weight on future outcomes compared to present ones—that is, that we systematically apply too high a discount rate. So “excess” investment by prestige or growth-chasing managers may offset a pervasive bias in the opposite direction.

He also points out that "Despite popular perceptions, American law has never regarded shareholders as 'owners' of the corporation, and this view has only recently become widespread in the business world." 

Mason mentions Apple, which last year "paid out $56 billion in dividends and repurchases, more than twice as much as the next-highest corporation," and my question remains, "If you think Apple shouldn't be buying back stock, what should it be doing?" Conveniently, Mason, along with Mike Konczal and Amanda Page-Hoongrajok, has a companion paper on "Ending Short-Termism," which includes proposals to limit buybacks, reduce shareholder power and "expand government investment."

Elsewhere, Jeff Sommer scolds Microsoft for buying back too much stock, and I suppose there is a case that Microsoft could have spent more on innovation over the last 16 years? I don't know though, innovation is not strictly a matter of money, and it is notoriously difficult for dominant companies to disrupt themselves. Perhaps it is better for them to just run off cash to shareholders until their inevitable disruption by someone else.

And: "Nearly one-quarter of the companies in the S&P 500 that have reported results have shrunk their shares outstanding by at least 4% over the past year."

People are worried about bond market liquidity.

This is a bit of a stretch but here is an article about a Justice Department investigation into when-issued Treasury trading and collusion in Treasury auctions. This investigation seems to parallel some private lawsuits, about which I have expressed skepticism. Those lawsuits start from the premise that dealers should not make a profit intermediating bonds, and that premise is arguably how we got into our current sad state of bond-market liquidity worrying. But the Justice Department investigation, presumably, starts from a different premise -- presumably it started from the premise of "hey let's try to find some dumb e-mails that traders sent each other" -- so it might be more robust.

Elsewhere, there's a conference tomorrow on the optimal maturity and structure of Treasury debt

Me Friday.

I wrote about Exxon, and the possibility of converting corporate political speech (protected by the First Amendment) into securities fraud (not). One thing you might think about here is the campaign to make companies disclose their political spending to shareholders. This campaign has puzzled me a bit, since shareholders don't, qua shareholders, care. But perhaps the explanation is that, if you want to regulate corporate political engagement, putting that engagement in a securities disclosure gives you a good hook.

Elsewhere, here is a front-page New York Times story about how much presidential candidates lie (a lot). "Today, it seems, truth is in the eyes of the beholder," which is not a good line to use if you are defending a securities fraud case in court.

Things happen.

Takeover Loans Have Few Takers on Wall Street. "The positive overall effects of HFT on market quality are well-documented and appear by now pretty robust." Goldman's BRIC Era Ends as Fund Folds After Years of Losses. Yahoo Hires McKinsey to Mull Reorg, as Mayer Demands Exec Pledge to Stay. "Short Activism." What counts as operating cash flow at Valeant. What to do about dual class stock (if anything)? The Uberization of Money. 'I’m no crook,' declares MMM scamster, while claiming credit for the Bitcoin price spike. Eugene Fama makes fun of bitcoin to a bitcoin enthusiast. When Small Investors Make Tiny Stocks Move, Big-Time. Scottish Man Faces 25 Years in U.S. Jail Over Stock Tweets. Fire at Point72. Boss crush. Dog yoga. Happy 18 Brumaire.

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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 of this story:
Matt Levine at mlevine51@bloomberg.net

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