Lotteries, Index Funds and Lawsuits

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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Of course nothing in this newsletter is ever investing advice, but I will say as a personal matter that I tend to take a Pollanesque approach to the lottery: Buy lottery tickets, not too many of them, mostly when the jackpot is enormous. Not everyone agrees. Fox News's advice is apparently "BUY AS MANY TICKETS AS YOU CAN AFFORD," which is ... not correct.

But the Internet is also full of scoldy advice to the effect that you shouldn't buy any tickets at all, even when the Powerball prize is $1.4 billion, or #NUM. (Here is a blog post suggesting that instead of buying a lottery ticket you "buy yourself a cup of coffee and sit down to do some freelance writing for blogs that pay for guest posts," which is actually worse advice than Fox News's.) This Business Insider video is typical of the genre, and the error is always the same: conflating money with utility, or just assuming that utility is linear with money. Now, look, I don't know what your utility function looks like. But for me, being two bucks poorer (with probability .999[lotta 9s]) would not impact my quality of life at all, while being $1.4 billion richer (with probability .000[lotta 0s]1, and yes I know there are taxes and a lump-sum haircut) would impact my quality of life really quite a whole lot. I could buy a big house, and The New Republic. This is not an argument for playing every week, or for buying as many tickets as I can afford, but I for one have a deep intuitive feeling of the positively skewed utility of wealth. (Here is a paper on the subject.) 

Elsewhere in Powerball news, I enjoyed this New York Post article about how you can't guarantee that you'll make money on the Powerball by buying one ticket for each number combination, even with a $1.3 billion jackpot. This too is a popular type of scoldsplainer, and the Post dutifully plods through the math (taxes, lump-summing, risk of splitting), but then it goes the extra mile by pointing out how tedious it would be operationally:

The hardest part, though, would be the physical act of buying 292.2 million lottery tickets.

There are no special arrangements for mass ticket buying, so a market-cornering lottery player would need to have a lot of time and pencils to fill out slips at the local bodega.

So many beautiful arbitrages work great in theory, but in the real world are undone by a lack of time and pencils.

Elsewhere in legal-ish gambling news, a New York state appeals court will let DraftKings and FanDuel keep taking bets -- sorry, sorry, "deposits" -- from players in New York during their dispute with Attorney General Eric Schneiderman about whether daily-fantasy-sports gambling is gambling.

Banks and index funds.

I've mentioned several times my baffled fondness for the theory that mutual funds (or at least index funds) ought to be illegal because they drive anticompetitive behavior: If all the companies in an industry are owned by the same overlapping group of diversified passive mutual funds, then it's almost as though they're all the same company, and are therefore a monopoly. This theory sprung from a paper by three economists (José Azar, Martin Schmalz and Isabel Tecu) finding that mutual-fund cross-ownership of airlines led to higher ticket prices, which led Eric Posner and E. Glen Weyl to call for legal restrictions on mutual-fund ownership in order to keep down ticket prices. People pointed out that airlines are an odd industry to focus on: Virtually every industry, in our modern age of financial capitalism, has a lot of mutual-fund cross-ownership, and "airlines seem like a bad example of anticompetitive pricing, since they go bankrupt all the time."

So Azar and Schmalz, along with Sahil Raina, moved on to another industry. Their recent paper is on banks, and they find that a measure of concentration of ownership correlates with "higher maintenance fees, fee thresholds, and deposit rate spreads" on bank deposit products. They conclude that ownership by mutual funds might be reducing bank competition, and they triumphantly combine that finding with the airline thing:

A second implication is that antitrust regulators should consider studying the effect of ownership structure on market outcomes more broadly. We don’t base this recommendation on only the present study. Common ownership has been shown to increase prices in other industries using different techniques (Azar et al., 2015). The fact that the finding of anti-competitive effects of concentrated ownership is robust across industries and identification strategies suggests that it could be generally beneficial to allocate attention of antitrust agencies to the largest owners of most publicly traded firms: a small set of large asset management companies.

So watch out BlackRock. Eric Posner again takes up the cause, arguing that "breaking up the banks will not solve the problem" (of high fees), because "the real villains are not the banks but their owners."

John Carney is skeptical:

If this were true, bank profitability should have risen with common ownership. But the opposite has occurred. Between 2002 and 2013—the years examined by the paper—the average return on equity at the six biggest commercial banks has fallen from 15.55% to 9.68%, below the theoretical cost of equity for a bank.

The focus on deposits, where the lack of competition is easily explained by the rise of excess deposits in the banking system, may be a mistake. Looking at loan pricing, particularly loans to businesses, shows much more competition that in some instances is quite fierce.

Indeed, while interest paid to depositors has fallen, interest collected on loans has fallen by even more—which is why net-interest margins at banks have been severely squeezed.

I am also skeptical. Numbers aside, it seems odd to base any theory of big bank behavior on shareholder desires, especially the implicit desires of diversified passive shareholders. Everyone knows banks are run for the benefit of bankers, right? I suppose that might be part of Azar et al.'s point -- without shareholder pressures to compete, bankers don't -- but bankers seem to be an intrinsically competitive lot.

Law stuff.

If you invested in Ruane, Cunniff & Goldfarb's Sequoia Fund, a concentrated value equity fund that bought a lot of Valeant shares, you will naturally be unhappy that Valeant stock went down a lot last year, and keeps going down. In some circles "be unhappy" is more or less synonymous with "sue," and so some Sequoia investors have sued the fund's managers for putting too much money in Valeant. Some of this seems like silly second-guessing (arguing that Sequoia didn't sell Valeant even when, as a value investor, it should have), while some of it seems like a more legitimate argument about fund restrictions (in particular, the plaintiffs argue that Sequoia violated its "policy of not investing more than 25 percent of assets in one industry" by putting 32 percent of its money in Valeant). In general, though, I feel like if you invest in an actively managed concentrated equity fund, and the manager makes a concentrated bet, and that bet loses, it's a bit unsporting to sue him. If you want an index fund, those exist. (For now!) 

Elsewhere in lawsuits, Joseph Nacchio won a $14.2 million verdict against David Weinstein, his former financial adviser, and Ayco (now part of Goldman Sachs), for negligently selling him some life insurance. Nacchio is the former chief executive officer of Qwest, and spent 4 1/2 years in prison for insider trading; Weinstein testified against him at his insider-trading trial. So this is I suppose a bit of sad revenge.

And "U.S. prosecutors are asking whether two law firms gave Standard Chartered Plc improper advice as they steered the bank through a sanctions-violations investigation," which raises my former-lawyer hackles. Law firms are supposed to be on their clients' side against government investigations, but the imperialism of modern bank investigations is such that deference is demanded, and if lawyers take their clients' side too vigorously then they get in trouble too. 


"Oil prices fell to their lowest level in 12 years, with futures of West Texas intermediate crude for February delivery settling at $31.41 a barrel." This is bad for energy producers, whose debt loads are getting more worrying; "Morgan Stanley issued a report this week describing an environment 'worse than 1986' for energy prices and producers," and Cullen Roche writes that "the energy space has already experienced its 2008." It is also not great for Russia. On the other hand, the end of the energy boom seems to be good for tugboats.


Lucy Kellaway argues that millennials don't go in for workplace pranks, though her evidence comes mostly from the media industry, and I prefer to believe that the culture of pranking still lives on at investment banks. Even there, though, it is under attack; remember that poor kid at Barclays who somehow lost two jobs for sending out a pretty innocuous joke e-mail to the summer interns? O tempora etc. Kellaway attributes the shift partly to millennial attitudes toward work -- contrasted with an older generation that "sloped into jobs and never felt any particular need to behave in a professional fashion, except when strictly called for" -- but also partly to changing attitudes toward the seriousness and permanence of the Internet. "Most younger people have learnt that there is no such thing as a private joke on email," she writes, and "young professionals do not think it is OK to pretend to be someone else online."

One FT trainee explained that their internet personas are so much a part of them — their whole lives are online — that it counts as a serious betrayal if anyone, especially a colleague, tries to mess with that.

I would add that, in the U.S. at least, it is possibly a bad federal felony to pretend to be someone else online, which I suppose would cut down on the appeal of online pranks.

People are worried about unicorns.

Private tech companies spent 2015 raising tons of private money and not going public, and a lot of people are hoping that 2016 will see a bit of a shift back to going public. (Some of those people may work at, which advertises its going-public services, and its toll-free number, on CNBC.) The first tech initial public offering of 2016 will likely be Elevate Credit, which filed an amended S-1 with a pricing range yesterday, and Bloomberg has a list of 14 more possible tech IPOs to watch for in 2016. Meanwhile one of last year's big tech IPOs, Etsy, closed at $7.44 yesterday, its lowest level since IPOing at $16 last April, as its lockup expired, in possibly not the most encouraging news for other tech companies interested in going public. Meanwhile in companies interested in staying private, Uber will be raising money from high-net-worth Morgan Stanley retail clients, apparently at a $62.5 billion valuation.

People are worried about bond market liquidity.

A confession: Last week I gave serious thought to retiring "People are worried about bond market liquidity." It has been going on so long. It's a new year. And of course right after the new year there were not a lot of people worrying about bond market liquidity, or anything else, in print. What if, I thought, bond market liquidity was a worry of 2015, and in 2016 other worries -- oil prices or Chinese circuit breakers or the anticompetitive effects of index funds -- would take its place?

But I should know by now that any time I allow myself to entertain thoughts like that, a deluge of bond-market-liquidity worrying will soon follow. So here is Euromoney's "Bond liquidity: special focus." And the Securities and Exchange Commission released its list of 2016 examination priorities, and of course "New initiatives for 2016 include an evaluation of broker-dealers’ and investment advisers’ liquidity risk management practices." Bloomberg explains:

The Securities and Exchange Commission said in an annual statement on its exam priorities released Monday that it plans to scrutinize how mutual funds, exchange-traded funds and hedge funds value these less-liquid holdings and manage the risk that they can’t be sold when managers need the cash. The SEC said its examiners also plan to review the role of brokers that match buyers and sellers for less liquid investments.

And here is more from DealBook on the collapse of Third Avenue's Focused Credit Fund, and the SEC's related interest in bond-fund liquidity mismatches.

Things happen.

Chinese Official: Bets Against Yuan Are ‘Ridiculous and Impossible.’ Did China Change the Way It Fixes the Yuan? "Large funds managed by King Street Capital Management, CQS, Pine River Capital Management, Metacapital Management, DW Partners and Libremax Capital were among those that lost money, or were on track to, in 2015 for the first time." Silicon Valley: We Don’t Trust FICO Scores. Meet the Investors Willing to Bet $300 Million on Dov Charney. A profile of Tinder CEO Sean Rad. Chinese gaming company buys 60% of Grindr. Consumer Financial Protection Bureau Roughly Doubled Caseload in 2015. JPMorgan’s head of US government bond trading leaves bank. Credit Swaps Panel Adopts Rules to Mitigate Conflict of Interest. Shire Sidesteps the Taxman. "In categories such as 'prestigious,' 'upper class' and 'glamorous' the Trump name has plummeted among high-income consumers." Donald Trump's economic plans are obviously ridiculous. Hillary Clinton has a tax proposal that will obviously never happen. Keynes was not a great currency trader. Naked Pants Part II. Workplace sensors. Subway dogs. English trains delayed by sunshine. "Hi, I'd like to add you to my professional network on LinkedIn." 

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

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Matt Levine at

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