Distressed Desks and Drug Problems
The Credit Suisse fallout.
Apparently people at Credit Suisse don't talk to each other? Chief Executive Officer Tidjane Thiam said yesterday that he hadn't known about a buildup in Credit Suisse's distressed debt and securitization positions:
“This wasn’t clear to me, it wasn’t clear to my CFO and to many people inside the bank” when the firm laid out a strategy in October, Thiam, 53, said Wednesday in a Bloomberg Television interview. “There needs to be a cultural change because it’s completely unacceptable,” adding that there had been “consequences” for some employees.
Then he walked that back a bit, saying that "the scale of the positions 'was a surprise to a number of people and was not a widely known fact' within the company," and then adding that everything was maybe fine:
Thiam, who took over in July, said at a conference in Zurich later on Wednesday that the positions that caused the writedowns were already in place when he joined, having been built up from 2012 to 2015 after an initial reduction. No traders breached limits, though with “hindsight” the limits may have been too high and traders’ judgment was questionable, he said.
But non-communication is a two-way non-street, and apparently as the traders weren't telling anyone about their positions, no one was telling the traders anything either:
Most damningly, there are allegations that Credit Suisse’s distressed debt traders weren’t fully briefed of the bank’s plan to pull back from distressed debt trading before Thiam announced it in an interview in February. This is said to have made the losses on the illiquid trades worse as buyers bid CS traders down in the knowledge that they needed to sell for strategic reasons.
None of this is particularly impressive? "To simply say ‘we were out of the loop’ is not acceptable," says a guy. "I wouldn’t fault the CEO for not completely understanding the ins and the outs, but the buck stops with the CEO," says another.
I feel like, if I ever got hired by an investment bank to be its CEO, I would spend my first week or two just sort of wandering around the trading floors, sidling up to people to ask questions like "so do you have any illiquid credit positions that might trigger oh say $1 billion of write-downs?" That seems even more important if the plan is to cut back dramatically on the trading activity. Like, what do you think banks do? Honestly I can understand the CEO being out of the loop on the private wealth manager who was allegedly misappropriating hundreds of millions of dollars from his clients. That's a weird thing to do! Who would have predicted that? But for Thiam to go on TV, almost a year after he started at Credit Suisse, and be like "I was shocked, shocked to find distressed debt on our distressed debt desk" does seem like a failure of due diligence.
The Valeant fallout.
Thiam is of course a McKinsey alumnus, as is J. Michael Pearson, the recently-returned-and-soon-to-depart CEO of Valeant Pharmaceuticals. Here John Gapper argues that "McKinsey's fingerprints are all over Valeant." On the one hand, I am always hesitant to ascribe specific operational problems and poor decision-making to vague societal worries like "shareholder value" and "short-termism." On the other hand, hoo boy, if you wanted to create an imaginary company to illustrate the evils of shareholder value, you'd probably end up with something that looks a lot like Valeant. Tax inversion to Canada! Raising drug prices to exploit insurance! Cutting back on research and development! Lots of leverage! Financial engineering and occasionally aggressive accounting! It is a greatest-hits album of distasteful corporate choices.
I suppose the expectation is that all the distasteful corporate choices increase returns, but I wonder if the increased returns just compensate for increased risk. The weird thing about Valeant is that all the risks have come due at once: The aggressive accounting exposed the controversial pricing practices, which led to a cutback in acquisitiveness, which makes the leverage a problem. Valeant is walking back every aspect of its McKinseyishness, all at once, which seems like uncharted territory.
Elsewhere, Robert Goldfarb is retiring as CEO of Ruane, Cunniff & Goldfarb and co-manager of the Sequoia Fund, Valeant's largest shareholder, after a very long, very good run that has ended very embarrassingly. "While we have beaten the market over the past decade, through the end of 2015, our investment in Valeant has diminished a record that we have built over two generations and in which we take great pride," said Ruane Cunniff. And Bill Ackman is down 25.2 percent so far this year, and apparently so broken up by his Valeant losses that he won't be speaking at the Sohn Investment Conference. Last year at Sohn he pitched ... yes ... irresistibly ... Valeant:
Of note: One of Mr. Ackman’s stock picks at last year’s Sohn conference was Valeant. He compared it to an early-stage Berkshire Hathaway Inc. and said shares could trade between $446 and $618 by January 2020. It’s trading at $32.68 Wednesday.
Here's a new Yale Law Journal article from Richard Epstein, a law professor at New York University, about how insider trading law should be. Epstein's thesis is basically that companies should be allowed to decide what to do with their information. This would mean getting rid of Regulation FD -- the Securities and Exchange Commission rule that prohibits selective disclosure of material nonpublic information -- and letting companies talk to investors all they want, while also punishing people who share information without their companies' permission:
Thus, as a matter of first principle, the best strategy for the law is to avoid both the personal-benefit issue and the knowledge and information question by making it clear that corporations may, through their directors and officers, allow firm employees to engage in the selective release of information to the firm’s general client list, and the problem goes away.
I assert that this is kind of how the law works anyway: No jury seems to care all that much about the "personal benefit" requirement in insider trading law, and if Regulation FD were strictly enforced all the private one-on-one meetings that companies do with analysts and investors would be kind of weird. So, sure, why not make the law line up with reality?
From my outside perspective, it looks like white-collar law in the U.K. is converging with U.S. law in its severity. Yesterday a London judge ruled that poor Navinder Singh Sarao should be extradited to face 380 years in a U.S. prison for using a computer to pretend to trade stocks, which his lawyers argue isn't even illegal in the U.K. Another judge ordered Libor manipulator Tom Hayes to pay back 880,000 pounds for his Libor manipulation, on top of his rather harsh 11-year prison sentence, which means that Hayes and his wife "will likely have to sell their seven-bedroom home outside London" and "might even have to sell their wedding rings." It is a bad time to use a computer to do sneaky financial things in the U.K.
But the U.S. does try to stay a step ahead:
States have taken the idea of the sex-offender registry and applied it to everything from kidnapping to animal abuse. Utah is expanding it into new territory: financial crime.
An early version of the White Collar Crime Offender Registry, which has been online since February, includes more than 100 people convicted of tax, credit-card or insurance fraud; thefts from employers or friends; and bilking investors.
There are mugshots. The example in the article is a guy who pretended his motorcycle had been stolen to get insurance money, who perhaps does not quite qualify as an international mastermind of financial crime.
Fannie and Freddie.
My longstanding view on Fannie Mae and Freddie Mac is that the status quo -- in which they are owned and operated by the government as instruments of housing policy, provide a government guarantee of the mortgage market that enables the U.S. to have 30-year fixed-rate mortgages, and make profits for the government -- is basically fine, though embarrassing, and no one has much interest in changing it. There's a new proposal to reform Fannie and Freddie -- written by, among other people, mortgage-bond inventor Lew Ranieri and two former Obama advisers -- that I think matches that intuition pretty well. The proposal is to merge Fannie and Freddie into a single quasi-governmental entity, keep using them to issue mortgage securitizations and guarantee repayment, and sell some more risk-shifting bonds to make the private sector take on some more mortgage risk. From the proposal:
Rather than winding the current system down and starting largely from scratch, we merely accelerate the steps that FHFA already has under way to transfer the GSEs’ risk to the private market and synchronize their activities, and then use their merged infrastructure to form the structure for the government corporation that replaces them. Fannie and Freddie would continue to build the common securitization platform; the current effort to synchronize some of the processes at the enterprises would be extended to all of them, from purchasing mortgages to securitizing them and overseeing their servicing; and their current risk-sharing efforts would be expanded so that all of the noncatastrophic risk on their new business would be sold into the market. Importantly, Fannie and Freddie, and ultimately the NMRC, will gradually shift their risk-syndication efforts to the mix of structures that prove most effective in maintaining broad access to affordable credit, a level playing field for lenders of all sizes, and resiliency against market downturns.
Basically it's the status quo, but less embarrassing. I suspect this is the most likely endgame for Fannie and Freddie, though I also suspect it will take approximately forever.
The Money Problem.
I mentioned it the other day, but I just finished Morgan Ricks's book "The Money Problem" and it is really good. (Disclosure: Ricks and I briefly worked together at Wachtell Lipton, and the book quotes me.) Ricks has a clear simple theory of the financial crisis that I think is more or less right: The crisis was in essence a financial panic, financial panics are always about runs on money-like claims, and the key problem leading up to the crisis was a rise in runnable money-like claims (repo liabilities, asset-backed commercial paper, Eurodollars, etc.) that were not government-guaranteed and that were often issued by entities ("shadow banks") that were not prudentially regulated. This view -- that the crisis was fundamentally about institutions and instruments rather than about evil individuals and fraud -- seems more interesting, and more correct, than many of the alternatives. Ricks's proposed solution is for the government to guarantee all the short-term liabilities of banks and prohibit anyone but banks from issuing short-term debt, which is perhaps a bit radical, but even if you don't agree with that the book is some of the clearer thinking about the global financial crisis and the design of financial institutions that I have read.
Here is a terrific Harper's story about a man who found hundreds of millions of dollars worth of emeralds in the ocean off Key West, except that they might not have been worth hundreds of millions of dollars, and also he might have put them there. (Apparently if you take some cheap emeralds and throw them in the ocean, or pretend to, they come back up valuable.) Come for the marine treasure-diving yarn, stay for the Delaware corporate governance battles between the guy and his New York hedge-fund investors.
There are basically two schools of thought about investing:
- It is war.
- It is something other than war.
Which is correct? Lloyd Blankfein has memorably endorsed view 2 ("You’re getting out of a Mercedes to go to the New York Federal Reserve. You’re not getting out of a Higgins boat on Omaha Beach."), but all in all the weight of authority comes down on the side of view 1. There are Ray Dalio's Navy SEALs, and Bill Gross's query "whether we are still marching three feet apace with 65-pound backpacks into the face of 1,000 machine guns," and now Crispin Odey has declared that recent turbulence and policy interventions left the market "no longer an investment market but a battlefield." Be safe out there, hedge-fund managers!
People are worried about dual-class share structures.
I am always skeptical of stuff like this:
Members of the Council of Institutional Investors voted to adopt a new policy that all investors in initial public offerings have equal voting rights among their shares, an official of the group said. They are concerned that dual-class share structures with unequal rights make management less accountable.
Or what? If the next sexy unicorn files for an IPO that gives its founders high-vote shares while selling low-vote shares to new investors, will all of CII's members stay home? No, of course not, they will grumble about the dual-class structure and then buy it anyway. It is a market, investors are grownups, and if they are willing to give up some governance rights in exchange for economic returns, then tsk-tsking from CII won't do much.
If you don't like dual-class share structures -- or covenant-light loans, or any other non-financial terms of publicly marketed financial instruments -- then the solution is to price them. Like, if every institutional investor told IPO bankers "we'll pay 25 times earnings for single-class shares, or 22 times earnings for dual-class shares," then companies will face a real economic tradeoff between diluting their founders' economic ownership and diluting their voting power. Maybe some companies will choose single-class structures to get a better price. But as long as investors' preference for single-class voting is expressed in grumbly policies, rather than in price, it seems unlikely to move issuers too much.
People are worried about unicorns.
Here's some good unicorn news: It turns out that Cruise Automation, which was bought by General Motors earlier this month, "is the equity crowdfunding market’s first-ever $1 billion exit." Cruise had raised about $18 million in funding, of which $200,000 came from AngelList crowdfunding syndicates. So it is the first ... crowdicorn? Unicrowd? Crowd of unicorns? Unicorn, but made out of crowds? Unicorn with a crowd of angels dancing on the tip of its horn? Please do not send me drawings of any of these things. Elsewhere, "The Uber Model, It Turns Out, Doesn’t Translate." And: "Tech Slowdown Seen in San Francisco's Commercial-Property Market." And watch the actors of "Silicon Valley" guess what startups do.
People are worried about bond market liquidity.
Look, the purpose of Money Stuff is not really to solicit weird drawings of quasi-financial concepts, but yesterday I did say that "nobody ever draws bond market illiquidity," so reader Kellon Lawrence did. Or rather, he drew this:
You may need to zoom. I object that he did not actually draw the illiquidity; it is just a footnote.
I think we are at a bit of an impasse here. I have to either ask everyone to hold off on sending me drawings for a little while, or start running a regular cartoon feature in Money Stuff. Anyway, here is Bloomberg Gadfly's Lisa Abramowicz with "Liquidity Death Spiral Traps Credit Suisse." Also Vanguard owns a lot of Treasuries.
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