Money Stuff

Folksy Wisdom and Credit Ratings

Also robot financial analysts, the mystery of accounting, IEX vs. Citadel, oil prices, unicorn jousts etc.

Happy Buffett Letter Weekend!

Berkshire Hathaway's annual report is due out tomorrow, and if 50 years of precedent is any guide it will include an insightful yet folksy letter from Warren Buffett, probably with one or two sexual metaphors that will make you squirm a bit. So today is a day for Warren Buffett previews and retrospectives. Here, for instance, is a roundup of his past sexual metaphors, which were probably never intended to be taken all together in such a high dosage. (If you have a strong stomach, here are some more, from Bess Levin in 2008, and yet more, from Matt Zeitlin last year, and none of them even mention fondling the cube.)

In chaster Buffett news, here are some worries about what oil prices will do for Berkshire Hathaway, whose BNSF Railway Co. "makes a lot of money hauling oil and other commodities," and whose Geico auto-insurance business might have to pay out more claims as cheaper gas leads to more driving and more accidents. Doug Kass worries that Buffett's "underperformance is getting conspicuous. He must address it." Buffett, though, seems untroubled, judging by this anecdote from his right-hand man Charlie Munger:

“He has a lot of time to think,” Munger told investors in Los Angeles on Feb. 10. “Warren is sitting on top of an empire now, and you look at his schedule sometimes, and there’s a haircut. ‘Tuesday: Haircut Day.’”

Do you think that means he's getting like eight hours worth of highlights and extensions?

Credit ratings.

My toy theory of the Justice Department's lawsuit against Standard & Poor's for mis-rating mortgage-backed securities is that S&P made its ratings more generous in order to compete with Moody's, and so generated a lot of written evidence that that's what it was doing. Moody's, whose ratings had already been more generous, presumably wouldn't have generated as much evidence that it didn't believe its ratings. But does that mean that Moody's was better than S&P (no embarrassing e-mails!), or worse (its ratings were even more inflated!)? S&P settled its suit for $1.5 billion, and "the U.S. Justice Department will decide in the next few months whether it will sue Moody’s Corp. for allegedly inflating ratings on mortgage bonds at the heart of the 2008 financial meltdown." And the difference between Moody's and S&P may well come down to the relative quantity of dumb e-mails:

One challenge for the government is that the volume of evidence is less than that in the S&P case because Moody’s didn’t retain e-mails for as long as S&P did, one of the people said.

Again: Is that better, or worse? The other day I asked whether "banks and regulators might be over-investing in stamping out dumb e-mails," and you can see here that "doing bad things" and "generating and retaining bad e-mails" are not synonymous.


The main job at an investment bank is high-touch sales. The pitching and winning of business is what drives everything, and because the sales are often big-ticket items, the human connection, flying to meet the client and shake her hand, tends to be important. If you are an investment-banking analyst, you might sit around in a cubicle tinkering with spreadsheets and pitchbooks for 100 hours a week, never seeing the light of the sun, never mind a client -- but your job is still high-touch sales. Partly because some of those pitchbooks may one day be seen by clients, but also because one day you yourself may grow up to be a managing director responsible for pitching business, and when you do reach that exalted position, your background in formatting pitchbooks and building Excel models will make you better at soliciting and advising clients. Or that is the theory. It is actually kind of a weird theory and no one entirely believes it, which is why I am sanguine that computer programs that automate the Excel models and pitchbooks won't really put that many bankers out of work. Anyway here is Nathaniel Popper on Kensho, the financial-analysis company that might be putting lots of bankers and traders and analysts out of work:

Kensho’s main customers at Goldman so far have been the salespeople who work on the bank’s high-ceiling trading floors. In recent months, they have used the software to respond to incoming phone calls from investors who buy and sell energy stocks and commodities, wondering how they should position their portfolios in response to, for instance, flare-ups in the Syrian civil war. In the old days, the salespeople could draw on their own knowledge of recent events and how markets responded, with all the limitations of human memory. For a particularly valuable client, the sales representative might have called a research analyst within Goldman to run a more complete study, digging up old news events and looking at how markets responded in each case. The problem with this approach was that by the time the results came back, the original trading opportunity was often gone.

Now you just put it into Kensho and it bleeps and bloops for a bit, and then tells you what to tell the client. That sounds nice! That saves you time and effort and gets you more trading opportunities! They're gonna give you a raise, not fire you! Everything is fine.

In other news:

Royal Bank of Scotland Group Plc’s chairman said his firm doesn’t pursue highly paid investment bankers anymore, as it cut the number of million-euro earners and its bonus pool amid the continued shrinking of its securities unit.

“We are not seeking to recruit M&A rainmakers in the City, we don’t do that kind of business any more,” Howard Davies said when asked about pay on a call with reporters Friday.

RBS reported "its eighth consecutive annual loss" along with those comments, driven by restructuring and past misconduct though also, I suppose, by the lack of rain. 


Here is a reminder that U.S. generally accepted accounting principles are forever a work in progress, an imperfect human attempt to get as close as reasonably possible to an elusive economic reality through black-and-white rules:

Accounting rule makers made their overhaul of lease accounting official on Thursday, issuing a new rule that will require U.S. companies to add huge amounts of leases to their balance sheets and thus make many companies look much more leveraged.

So, implies the Financial Accounting Standards Board, last year's balance sheets don't accurately reflect economic reality, because they don't include operating leases as liabilities. (Next year's balance sheets won't reflect reality either; the rule "will take effect for public companies in 2019.") "The FASB’s new rule culminates more than a decade of work," because accounting is hard. 

Here's another article about how bad it is that lots of companies report (often higher!) non-GAAP earnings alongside (often depressing!) GAAP earnings:

The implication: Even after a brutal start to 2016, stocks may still be more expensive than they seem. Even worse, investors may be paying for earnings and growth that aren’t anywhere near what they think. The result could be that share prices have even further to fall before they entice true value investors.

The implication of that paragraph is that the GAAP numbers are real and the non-GAAP numbers aren't. It's entirely plausible that the GAAP numbers would be more real -- the incentives to report non-GAAP figures are not all good, and non-recurring items often keep recurring -- but it is worth constantly keeping in mind that no accounting numbers are purely real; no set of rules can ever capture the undistorted economic reality.

Market structure.

I wrote yesterday about IEX, Citadel, high-frequency trading, and retail investors, which always makes people mad. I want to mention two points that I did not give enough attention in my post. 

First: If (like me) you are concerned mostly about institutional investors, who after all invest most normal people's retirement money, then the fact that wholesale market-makers like Citadel siphon off retail orders from public exchanges might bother you. The simple intuition is that if all the uninformed, small, no-adverse-selection retail orders go to wholesalers, then exchanges like IEX will be left only with informative institutional flow, and market makers will need to charge higher spreads to those institutions to deal with adverse selection. (Also, the institutions will never get to interact with uninformed retail flow themselves.) If everyone traded together, uninformed retail traders would subsidize institutions' trading costs, which would probably be good for the world (and, disclosure, for me, since I invest through mutual funds), but bad for those retail traders. But since retail order flow is mostly handled separately, retail traders get a good deal, but that comes at the expense of mutual funds and pension funds. Here is a report from Canada on the topic:

We show that by combining a randomized speed bump for marketable orders only with an inverted fee structure, the new TSX Alpha overwhelmingly attracts uninformed order flow, leaving other venues to absorb relatively more informed trading. Despite its modest 8 percent market share, this segmentation negatively impacts liquidity on other Canadian trading venues, increasing costs for liquidity demanders and lowering profits for liquidity suppliers, but increasing profits for liquidity providers on TSX Alpha. Our paper has implications for market quality in the United States, where virtually all retail and uninformed order flow is segmented away from lit exchanges.

Second: I joked that the Securities and Exchange Commission "is being asked to approve IEX's exchange application, not its marketing campaign." But Citadel's objections to IEX's marketing campaign to retail investors are not trivial. Here is a page on IEX's website urging investors to send a letter to their broker demanding that their orders be routed to IEX. "Your firm is not required to make a best execution determination beyond this specific instruction," acknowledges the letter, and you can see why urging retail investors to demand execution on IEX, even if it's worse for them, might be a controversial marketing campaign.

Elsewhere, here is sort of a strange comment letter from Direct Match, "the first all-to-all venue for the trading US Treasury securities," opposing IEX's exchange application. The gist of the letter is that Regulation NMS is good, Direct Match wishes there were something as good as Reg NMS in the Treasury market, and so the SEC shouldn't undermine Reg NMS by approving IEX's application.

People are worried about the energy industry.

I'm not going to make a habit of this, but man, people are worried about the energy industry. Here you can "Watch Five Years of Oil Drilling Collapse in Seconds." (In the animation, I mean; the real-world collapse took slightly longer.) Here "Halliburton Cuts Another 5,000 Workers to Cope with Oil Downturn." Here "the two largest oil producers in the Bakken formation of North Dakota," Continental Resources and Whiting Petroleum, "are giving up bringing new wells into production." Here "Energy MLPs Are Talking About Collateral" as investors worry about the creditworthiness of their oil-producer counterparties. Here is the story of Energy Transfer's acquisition of the Williams Companies last year, which five months later "has become a nightmare"; the story features this "tortoise-like quote" from Tortoise Capital:

“The deal, long term, is going to make sense,” said Matthew Sallee, a portfolio manager and managing director at Tortoise Capital Advisors, a firm based in Leawood, Kan., that specializes in energy investments. “It’s just hard to watch in the meantime.”

And there is this:

Outside the energy industry’s premier conference in Houston this week, a qualified petroleum engineer, immaculately dressed in suit and tie, has been holding up a sign saying: “Please hire me!”

That's not the saddest part of that story, which is about how "oil companies are working to put in place lower cost bases that will enable them to survive in a world in which crude prices could remain at about $50 per barrel for many years to come." The saddest part is that oil prices are currently in the mid-$30s. Even Exxon isn't safe: "ExxonMobil, one of only a handful of US companies with a triple A rating, has had its outlook changed to ‘negative’ from ‘stable’ by ratings agency Moody’s." In very marginally happier news, Goldman Sachs has four reasons that "The Energy Collapse Isn't Even Close to the Subprime Crisis." And the U.S. may start exporting liquefied natural gas to Europe "as part of a broader effort to challenge Russian domination of energy supplies and prices in this part of the world."

People are worried about unicorns.

Many a unicorn is born in the Enchanted Forest, but fewer make it out: In "2015, 70 members were catapulted into the exulted 'unicorn' club of startups with valuations of $1 billion or higher, but only 11 such unicorns exited through IPOs or acquisitions in the same year." What happened to the rest? Are they wandering the forest, lost, looking for a way out into the light of the public markets? ("It remained a lot easier to raise at a billion dollar valuation than to exit at one," says a research firm.) Or is there something evil lurking in the forest, some unspeakable menace that is murdering the unicorns and leaving a trail of rainbow gore everywhere? Honestly today's tech-startup market would be the worst animated children's television show ever. 

Elsewhere, "Didi Kuaidi Joint Co. is planning to raise about $1 billion from investors on terms that would value the Chinese car-hailing company at more than $20 billion," to prepare for its coming battle with Uber in a clearing in the Enchanted Forest. They will fight to the death, horn to horn, and the rainbow bloodshed will be terrible. Next week, on that terrible children's show! Here is my Bloomberg View colleague Noah Smith urging "Don't Strangle Uber and Airbnb," though thankfully his post is not illustrated with a vivid picture of a strangled unicorn. And here is "The Case Against Startups Raising As Much Money As Humanly Possible"; given the gothic nightmare that is the Enchanted Forest these days, that case seems pretty easy to make.

People are worried about bond market liquidity.

How long have we been worrying about bond market liquidity? I first mentioned it in Money Stuff almost a year ago, and even then it was a very old worry. But in all that time I have never noticed anyone worrying about being sued about bond market liquidity, that great meta-worry on top of any American worry. But now here is a Skadden Arps client memo titled "Potential Regulatory and Litigation Risks Relating to Fixed-Income Market Concerns":

If market concerns regarding high-yield open-end funds continue to escalate, investors in all open-end funds, including hedge funds, could seek to bring federal securities claims (either individually or on behalf of a putative class of investors) based on alleged misrepresentations or omissions in public disclosures and marketing materials regarding the funds’ risks, including whether and in what circumstances investor redemptions could be halted. 

Once people start suing over bond market liquidity, does that mean it's time to stop worrying about it?

Meanwhile, "electronic trading now accounts for more than 20 percent of transactions in high-yield bonds and 40 percent of dealing in single-name credit-default swaps." And here is "JPMorgan Has New Theory About What Really Caused the Flash Rally" in Treasuries on October 15, 2014. The theory is that "the cash market broke first" and "futures were playing catch-up, to some extent."

Things happen.

Goldman Struggling to Sell $2 Billion in Bonds Backing Solera Buyout. Deutsche Börse and London Stock Exchange Offer Details on Merger Talks. The Tale of the Swiss Coco. Lynn Tilton's ambulance company is bankrupt. MetLife "is in talks to sell a network of about 4,000 sales people to Massachusetts Mutual Life Insurance Co." The Election War on Hedge Funds. "Billionaire investor William Ackman has managed to erase his entire 40% return of 2014." Analyst to Valeant’s Michael Pearson: We Want You Back. Deutsche Bank Says German Regulator Closes Several Audits. NationStar Mortgage is "changing its name to Mr. Cooper." A Big Bet on Gold Is Getting Crowded. Deutsche Bank: It’s time to buy gold. Richard Thaler's Undiscovered Managers Behavioral Value Fund "beat 99 percent of its Bloomberg peers over the past three and five years." Fannie and Freddie: Recap and Release Is Still Just a Dream. Diageo pays $75m to Vijay Mallya to step down from United Spirits. Here is an interview with Dan Neff about how good Wachtell Lipton is (disclosure-brag: I used to work there, and it is good). Lloyd Blankfein slashes price of Hamptons home by $4M. Is your 401(k) too big? Twitter's missing manual. Maker of Skee-Ball Game Sold to a Wisconsin Rival. Meetings are bad. Eating lunch at your desk is bad. Barclays analyst arrested on charges of cat torture. Which rats are fake? Which conspiracies are real? An oral history of February 26, 2015, on the Internet. Smell map of Gowanus. World's loudest burp.

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