Too Big to Fail and Too Weird to Finance

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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Is GE small enough to fail yet?

On Wednesday, MetLife escaped -- at least temporarily -- from the clutches of the Financial Stability Oversight Council's designation as a "systemically important financial institution." Yesterday, General Electric asked to do the same. But whereas MetLife de-SIFI'ed by fighting the designation in court and convincing a judge that the FSOC had been "arbitrary and capricious" in declaring it too big to fail, GE wants to de-SIFI the old-fashioned way: by getting smaller.

Thursday’s application detailed how GE has “substantially reduced its risk profile and is significantly less interconnected to the financial system, and therefore does not pose any conceivable threat to U.S. financial stability,” according to the statement.

GE Capital assets have shrunk 52 percent since 2012 to $265 billion, while financing receivables, loans to consumers and loans secured by real estate have dropped substantially, the company said. Once the top issuer of U.S. commercial paper, GE Capital reduced its total outstanding by 88 percent to $5 billion. The division said it won’t issue incremental debt for the next four years.

The MetLife decision counts as a loss for the post-crisis system of trying to create systemic stability by prudentially regulating (and/or shrinking) too-big-to-fail firms. The GE application surely counts as a victory. I suspect that a lot of people who like the SIFI regulatory regime would say that actually regulating SIFIs is a second-best outcome of that regime: Even better would be encouraging institutions to shrink until they are no longer systemically important.

Incidentally, yesterday when we talked about MetLife, I took a sort of Morgan Ricksian approach, arguing that the thing that really makes you a SIFI is having lots of runnable short-term debt (or related semi-runnable things, like contingently collateralized derivatives), and that MetLife probably isn't a SIFI because it is basically an insurance company funded with maturity-matched policy premiums. I got some perfectly fair pushback on that: MetLife is mostly an insurer, but then so was AIG in 2008; AIG's securities lending portfolio (which does create runnable short-dated liabilities) helped do it in, and MetLife has its own $30 billion securities-lending program. MetLife has other forms of runnable debt, too; for instance, it sells short-term debt to money market funds, and "the FSOC found that, should MetLife experience material financial distress, anywhere from eleven to as many as sixty-five MMFs could 'break the buck' and go below that critical one dollar per share level." John Crawford of the University of California, Hastings law school suggested by e-mail that "MetLife is arguably a large-ish shadow bank coupled to an insurer"; my view is that it is probably more like a medium-sized shadow bank couple to a giant insurer. His formulation makes it probably a SIFI, mine makes it probably not.

Reasonable people can disagree, which is perhaps enough reason to doubt that the FSOC's designation was "arbitrary and capricious." But to return again to the Morgan Ricks approach, his book argues that the government should simply ban non-banks from issuing runnable short-term debt (and guarantee the short-term debt of heavily prudentially regulated banks). Here, that would mean that MetLife couldn't issue commercial paper, and probably couldn't raise cash by lending out securities overnight. But in exchange, financial stability regulators would otherwise leave it alone. "In a panic-proof system" with short-term debt issuance restricted to regulated banks, argues Ricks, "we could worry far less about a lot of other things: 'excessive debt,' 'debt-fueled bubbles,' 'excessive risk taking,' 'disorderly failures,' 'too big to fail,' 'interconnectedness,' 'systemic risk,' and so forth." I am inclined to find a ban on short-term debt issuance rather draconian. But on the other hand, surely that approach to MetLife is cleaner and simpler than the current arguments over the quiddity of a SIFI?

Not with Anbang.

When last we discussed Anbang Insurance Group's bid for Starwood Hotels, I linked to an article pointing out that Anbang offered to buy Starwoods three times last year, and each time Anbang melted away after it was "pressed by Starwood and its bankers for details on how they would pay for the deal." Make it four times:

An investor consortium led by China’s Anbang Insurance has lost the bidding war for Starwood Hotels & Resorts, after it failed to demonstrate that it had the financing in place to back up its latest $14bn offer, a person directly involved in the deal said.

That's ... pretty weird? The other day I mentioned this Cleary Gottlieb blog post about how, essentially, U.S. mergers and acquisitions lawyers are nervous about Chinese acquirers, and build in escrows and other protections to make sure that those buyers actually show up with a check at closing. Anbang's disappearing offer, which only a few days ago Starwood had determined was "reasonably likely to lead to a 'Superior Proposal'" over its deal with Marriott International, won't do much to increase confidence. I do not quite understand the financing story, though: When Anbang's consortium, which included private equity firms J.C. Flowers & Co. and Primavera Capital Group, originally bid $78, Starwood "had been comfortable that it had the funding for the original offer." But after the consortium raised its bid to $82.75 per share, Starwood's confidence melted away? It's certainly possible that Anbang could finance a $78 deal but not an $82.75 one, but it is a strange way for a deal to fall apart. Bloomberg Gadfly's David Fickling and Nisha Gopalan argue that getting financing might be tough for Anbang just because of its unusual ownership structure: "Anbang hasn't helped its case by having such an opaque structure and business model."

There are of course other versions of the story:

“The reason of withdrawal is simple - Anbang isn’t interested in a protracted bidding war,” Fred Hu, founder of Primavera who formerly ran China dealmaking for Goldman Sachs Group Inc., said in an e-mailed comment. “While attracted to Starwood’s high-end global hotel portfolio, at the end of the day Anbang is a disciplined buyer.”

My favorite version may be the official one, in which Anbang and its partners "said in a statement late Thursday that they decided to abandon their Starwood bid 'due to various market considerations.'" Keep it simple, and vague. Starwood is rather sheepishly returning to the spurned Marriott. Jeffrey Goldfarb points out that at least Anbang served as a stalking horse to get Starwood a higher bid from Marriott. And Leslie Picker reports that the volatile first quarter of 2016 was surprisingly decent for M&A:

Globally, companies conducted $682.3 billion worth of transactions during the three months through March, according to data compiled as of Wednesday by Thomson Reuters. While that figure is below last year’s comparable period, it is about 14 percent above the average volume during each of the first quarters over the last two decades, the data showed.

Top-ticking.

Here's a fascinating story about Deputy Crown Prince Mohammed bin Salman's vision for the future of Saudi Arabia in a post-oil world:

Over a five-hour conversation, Deputy Crown Prince Mohammed bin Salman laid out his vision for the Public Investment Fund, which will eventually control more than $2 trillion and help wean the kingdom off oil. As part of that strategy, the prince said Saudi will sell shares in Aramco’s parent company and transform the oil giant into an industrial conglomerate. The initial public offering could happen as soon as next year, with the country currently planning to sell less than 5 percent.

This might be my favorite part, and not just for the time stamp:

“IPOing Aramco and transferring its shares to PIF will technically make investments the source of Saudi government revenue, not oil,” the prince said in an interview at the royal compound in Riyadh that ended at 4 a.m. on Thursday. “What is left now is to diversify investments. So within 20 years, we will be an economy or state that doesn’t depend mainly on oil.”

What I love there is the vision of the transformative power of finance. Owning an oil company is dirty and lame and old-fashioned. Owning shares in an oil company is the future. The very minimum of financial structuring can move you up the value chain. Anyway, would you buy shares in a $2 trillion oil-company IPO if Saudi Arabia is selling?

Mr. Grumpy.

Here's a fascinating story about Co-Chief Executive Officer John Cryan's vision for Deutsche Bank in a post-, you know, banking-being-fun world:

At an investors conference in early March, Mr. Cryan didn’t dispel the gloom. “Our problem as a bank was and remains, and will be for a little while, a lack of profitability,” he said. “There’s a lot of stuff we have to get done this year, so this year is not going to be profitable.”

Cool vision. "Cryan’s doing all he can, but what he needs is a market in which he can execute," says an analyst. Meanwhile it's a lot of this:

He shrank the fleet of black Mercedes-Benz S-class sedans that shuttle senior executives around Frankfurt, according to people familiar with the moves. He canceled the bank’s NetJets private-jet contract. And he discontinued airport VIP services that for years had whisked executives through security checks and onto the tarmac in chauffeur-driven cars.

Mr. Cryan’s dour demeanor earned him, among some colleagues, the nickname “Mr. Grumpy.” In the New York office, some traders took to calling him the “Bernie Sanders of investment banking.”

Oilpro.

Saudi Arabia may be preparing for a post-oil world now, but back in 2014 the oil industry was so hot that the founder of an oil-industry networking site allegedly hacked into another oil-industry networking site (that he had also founded!) to steal customer information, solicit new customers, and ultimately sell his new company to his old company. That honestly sounds like a difficult way to make a living, but I guess oil-industry networking is so lucrative that it drives people to crime. Alleged crime. Was so lucrative. Anyway here is the criminal case against the founder, David Kent, who founded Rigzone in 2000, sold it to DHI Group in 2010 "for what ended up being about $51 million," founded Oilpro after his non-compete expired, and allegedly hacked into Rigzone to get customers. Outside of the oil industry -- by which I mean, "on Finance Twitter" -- Oilpro is perhaps best known for its delightful Instagram account, which I hope will be maintained regardless of the outcome of this case.

People are worried about unicorns.

Oh man, Securities and Exchange Commission Chair Mary Jo White went to Stanford, the very heart of the Enchanted Forest, and just slayed some unicorns yesterday:

In the unicorn context, there is a worry that the tail may wag the horn, so to speak, on valuation disclosures.  The concern is whether the prestige associated with reaching a sky high valuation fast drives companies to try to appear more valuable than they actually are.

Nearly all venture valuations are highly subjective.  But, one must wonder whether the publicity and pressure to achieve the unicorn benchmark is analogous to that felt by public companies to meet projections they make to the market with the attendant risk of financial reporting problems.

"The tail may wag the horn" is of course impeccable, but I am not so sure about the substance of White's concern. Sure, lots of startups want to raise money at high valuations, and so they stretch to get investors to pay up. But -- and here I rely on anecdotal public evidence; perhaps White knows better -- it seems to me that they stretch by negotiating, by painting a vivid picture of a possible future, and by giving in on terms, not by just, you know, misrepresenting their financials. Sometimes they don't even give investors financials! And even when they do, it's not like you're investing in startups because of their attractive current price/earnings ratios. "Unicorn valuations are too high" is a perfectly sensible investing worry; but as a regulatory worry -- as a sign of fraud -- it seems less compelling. 

But then again there is Theranos, the Blood Unicorn, Elasmotherium haimatos, which, just, come on, man:

The blood-testing devices that Theranos Inc. touted as revolutionary often failed to meet the company’s own accuracy requirements for a range of tests, including one to help detect cancer, according to a federal inspection report.

"The technology was the main basis for the $9 billion valuation attained by Theranos in a funding round in 2014," adds the Wall Street Journal, which does sound a bit like the tail wagging the horn.

And finally there is Juicero, the Juice Unicorn (Juicicorn?), which, just, come on, man, forever:

To make a glass of juice, you insert a pack ($4 to $10 each) into the machine, close the door and press a button. There are five flavors, including Sweet Roots (carrot, beet, orange, lemon and apple) and Spicy Greens (pineapple, romaine, celery, cucumber, spinach, parsley and jalapeño).

Each pack has a QR code on it. A camera in the machine scans the code on each pack and, using Wi-Fi, checks in with an online database. If the pack is no longer fresh, or has been deemed contaminated, the machine won’t press it. If the pack is O.K., the gears start turning and out squirts the juice.

So far, so complicated. But the real logistical feat is behind the scenes. To create those packs in the Los Angeles plant, workers receive truckloads of produce from nearby organic farms, triple-wash it, then chop it into specific shapes (carrots are finely diced, while beets are chunkier).

Someone should really open a Museum of Dumb Things Done With QR Codes. Also just, like, if you are chopping that many vegetables, why not juice them yourself, and sell people the juice instead of the packets and the $700 juicer? I don't know. Here is a Vogue article that is somehow even crazier than the New York Times one:

When you’re done, you simply remove the packet and throw it away. (Or, once the company switches to plant-based pouches in a couple of months, compost it. Or use the pulp to make quiche, or an omelet, or some especially healthy bread.) Meanwhile, the Wi-Fi-enabled machine sends data to your profile in the smartphone app, which records your drinking habits and allows you to order the packets (which cost between $4 and $10 each, depending on flavor and quantity ordered) and track and adjust incoming deliveries.

Technically I don't know if Juicero is a Juice Unicorn, by the way, but it has "extracted a remarkable $120 million in investments from Silicon Valley titans." And I suspect that, in the best unicorn tradition, if you get sick after drinking a Juicero, you vomit rainbows

People are worried about bond market liquidity.

The bad news is that people are worried about bond market liquidity:

Three-fourths of the respondents said they’ve seen a pullback from the biggest dealers in providing liquidity in the past year and more than half expect further declines.

The respondents here are 58 investors surveyed by Greenwich Associates, and the good news is that they're fixing the problem themselves:

More than half of institutional investors now consider themselves market makers in corporate bonds as banks pull back.

I ... really? More than half? Consider themselves market makers? Like, are regularly making two-sided markets in a wide range of bonds? Is market maker the new cool thing to be? I don't know, but if half of big investors have become market makers, what did they even need dealers for? Though: "About half the survey respondents expressed interest in plans that would allow dealers to access investor holdings for a fee in order to boost trading." 

Me yesterday.

I wrote about how it's kind of weird that politicians use the securities laws creatively to go after all sorts of stuff they disagree with, like pollution and corporate lobbying against regulations. Coincidentally yesterday the SEC settled a pollution-related disclosure case against Navistar International Corp., charging that it "failed to fully disclose the company’s difficulties obtaining Environmental Protection Agency (EPA) certification of a truck engine able to meet stricter EPA Clean Air Act standards that took effect in 2010." As far as I can tell the SEC's concern here really was with the disclosure, not the pollution. Elsewhere: "Regulators Examine Financial Risks of Climate Change."

Look at your calendar!

Today is April 1, the day that the Internet, and perhaps your real life, if your friends and colleagues are terrible, will be full of hoaxes and nonsense. I mean, more hoaxes and nonsense than usual. There's a lot of nonsense all the time. Be careful out there today, but also every day. The Financial Industry Regulatory Authority knows what I'm talking about:

"April 1st is a day to indulge in silly hoaxes and pranks. But there's nothing funny about a fraudster carrying out a scam – and no one will yell 'April Fools' to make the harm melt away," said Gerri Walsh, Senior VP of Investor Education at FINRA. "So instead of offering practical jokes, we're marking the start of Financial Literacy Month with practical tips for becoming a smarter investor."

Elsewhere: Trump Treasuries ("Surprisingly, the bonds will be fully sharia compliant"). And here is an April Fools' Voxsplainer.

Things happen, or maybe don't, remember what day it is.

Bill Gross reveals his math SAT score. Argentina’s Senate Allows Payment to Bondholders. The Credit Collapse Opened the Door for Trump and Sanders. Lackluster IPO Market Flashes Warning. Casino-Junket Operator Turns Over $4.63 Million in Central-Bank Theft Case. Valeant Sinks Deeper Into Junk as Moody's Lowers Rating. SunEdison Is Hurting Hedge Funds as Badly as Valeant Did. "Finance isn't a monopoly. In fact, it's one of the most globalized, fluid, and competitive industries on the planet. Why haven't its profits long since been reduced to zero, or close to it?" William Dudley: The Role of the Federal Reserve—Lessons from Financial Crises. The Richmond Fed on Puerto Rico. Despite Dire Predictions, Salespeople Aren’t Going Away. In Landmark Ruling, Judge Says Mortgage Bankers Have Right To Engage In “Profanity-Laced” Rants About Clients In The Bathroom. Is Craig Wright Satoshi? Rupert Murdoch’s Ex-Wife Wendi Deng Is Dating Vladimir Putin. Hero lawmaker urges colleagues to stop saying ‘physical’ when they mean ‘fiscal.’ Harvard Square’s Au Bon Pain is closing. Tracing Drug Use Patterns Through Nightclub Toilets.

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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:
James Greiff at jgreiff@bloomberg.net