Consultants, Bankers and Teens

Also: Zero Hedge, Icahn, Buffett, pensions and unicorns.

Bank governance.

One way to read the management troubles at Credit Suisse is that they are a skirmish in the bitter and long-running feud between two ancient financial tribes, the investment bankers and the management consultants. When Tidjane Thiam -- a former insurance executive but, at heart, a consultant -- was put in charge of Credit Suisse, an investment bank, war was inevitable. And the Wall Street Journal reports that Thiam "has relied heavily on a trusted inner circle dominated by current and former management consultants" and frozen out the senior bankers who used to run the bank, with the apparent result that the two sides don't talk to each other and no one knows what's going on. 

I had always assumed that the banker-consultant feud lived mostly in the imaginations of undergraduate economics majors, but honestly what is going on here?

Current and former executives at Credit Suisse Group AG, stretching from New York to the Swiss lender’s top ranks in Zurich, are sparring over who was responsible for the bulk of almost $1 billion in losses in recent months, according to people familiar with the matter.

One particular point of dispute: Past and present top executives of the investment bank have given differing accounts of who was in charge of what during a critical period for the loss-making trading business late last year.

The former head of global markets, Gaël de Boissard, was removed from that job in Thiam's restructuring in October, and left the bank in mid-December for "a five-month skiing trip," which is really the only way to celebrate leaving a job. (Five months!) The new head, Timothy O'Hara, "told employees on an April 13 conference call that during that period late last year, he still had not formally assumed complete oversight of the trading unit." So I guess no one was in charge and the bank lost a billion dollars on distressed-debt trades? Except it didn't even:

Traders and executives in New York are angry that their new CEO chose not to mention that including hedges and other advantageous trades, the positions in question lost closer to $300 million, according to people familiar with internal calculations that haven’t been made public.

If you buy $10 billion of stuff, and half of it goes up by 20 percent, and the other half goes down by 20 percent, you still have $10 billion. But you've lost $1 billion on half of it and made $1 billion on the other half. It is not exactly inaccurate to say that you "lost $1 billion" -- you did, on some of your stuff, and there is an argument in hindsight that you shouldn't have bought that half -- but it is not quite fair either. Your job was to manage your whole book, including the profitable hedges on the things that lost money, and you'd be aggrieved to hear your boss talk about your failures without mentioning your successes. Especially if that boss was a consultant.

Obviously losing $300 million isn't the best either, but it is a smaller number.

I mean, the thing is, if Thiam came in and was unfamiliar with the nuances of derivatives trading, you'd be like, well, that's not his background, it's understandable. But so far the story out of Credit Suisse seems to be that Thiam came in and made management crazy, which is not exactly an advertisement for management consulting.

Elsewhere in Swiss bank restructuring: "UBS to revamp wealth management business to cut costs."

More bank governance.

Here is a sweet story about Natalie Clarke, a 15-year-old who is an "activist" at Bank of America, which means that she owns 5,000 shares and shows up at the annual meeting to say things to CEO Brian Moynihan like "You and I  are both looking at some pretty bad numbers." He, meanwhile, says things to her like "Good luck getting into Notre Dame" and "Obviously we feel the stock price should be higher." Bank annual meetings are this weird theater of shareholder democracy in which teenagers and nuns and social-justice activists can show up and perform their role as owners of the bank, while the executives sit there and smile wearily and sneak glances at their watches. Obviously Natalie Clarke is not setting Brian Moynihan's salary. ("In an interview, Miss Clarke said she was puzzled as to why the bank raised the CEO’s pay in a year when the share price was down.") Most of the votes are in by proxy long before the meeting starts. To the extent a bank worries about its shareholders, 364 days a year, it is worried about the institutional investors, not the teens.

"Miss Clarke, who lives in Harrisburg, N.C., with her parents and schnauzer-terrier mix pet dog, says she doesn’t understand why more shareholders don’t take an active interest in the companies they own," but her question is answered a paragraph later:

In 2002, around the time that Miss Clarke received her shares, Bank of America’s shares traded at an average of nearly $34. They fell seven cents Wednesday to $15.02.

The S&P 500 has roughly doubled in that time. Clarke "has begun considering whether her shares could help pay for college." With 5,000 shares -- worth about $170,000 in 2002 and about $75,000 now -- she could pay for a bit more than a year at Notre Dame. If she'd sold those shares and bought an index fund in 2002, she'd have enough to pay for all four years. She was a baby at the time, so you can't exactly blame her for failing to diversify, but still. Concentrated ownership and active involvement in a single stock, for a retail investor who also has a day job (or high school), is rarely an economically rational decision. This is a cute story about a weird teen hobby, not a model for how individual shareholders should take an active interest in their investments. As Cullen Roche says: "This article is a great lesson in diversification (though it never mentions it)."

In any case, more stories about activist shareholders should mention their dogs. Elsewhere in banks: "R.B.S. Losses Widen After Payment to British Government." "Banks raise prospect of court action over Fed dividend cuts." And: banking simulator!


Speaking of theater for shareholders, the Berkshire Hathaway annual meeting is this weekend, so, like, fatty food! Cherry Coke! Ping-pong! I don't know. It will be livestreamed on Yahoo Finance; the feed is not live yet but you can watch Warren Buffett say "come join us because we're gonna have a lot of fun" over and over again until it starts to feel creepy. Elsewhere, here is a look back at the time in 1996 that Buffett begged investors not to buy Class B shares of Berkshire Hathaway ("Neither Mr. Buffett nor Mr. Munger would currently buy Berkshire shares at that price, nor would they recommend that their families or friends do so."). Here is Sujeet Indap on Berkshire's use of deferred taxes. Here is a graphic of stuff that Berkshire does. Here is a quiz about Berkshire Hathaway.

Zero Hedge. 

I had sort of vaguely assumed that in this crazy world of impending financial and geopolitical apocalypse, Zero Hedge thought that the only real value is in gold, but according to Bloomberg's Tracy Alloway and Luke Kawa, they're pretty into clicks too:

Despite holding itself out as a town crier for market angst, transcripts from Zero Hedge internal chat sessions provided by Lokey reveal a focus on Web traffic by the Durdens. Headlines are debated and a relentless publishing schedule maintained to keep readers sated. Lokey said the emphasis on profit—and what he considered political bias at the site—motivated him to quit. 

Lokey is Colin Lokey, until recently the most junior of three Zero Hedge writers who publish under the name "Tyler Durden" because I guess "Fight Club" is pretty cool. (The other two are Daniel Ivandjiiski, who has long been publicly associated with Zero Hedge, and Tim Backshall, "a well-known credit derivatives strategist.") But, like a true Tyler Durden, Lokey-Durden is offended that the other Durdens are too capitalistic:

He pointed to the wealth of the Durdens as a factor. Ivandjiiski has a multimillion-dollar mansion in Mahwah, N.J., and Backshall lives in a plush San Francisco suburb—not exactly reflections of Pitt's anticapitalist icon. “What you are reading at Zero Hedge is nonsense. And you shouldn’t support it,” Lokey wrote in an e-mail. “Two guys who live a lifestyle you only dream of are pretending to speak for you.”

I don't know, I take a boring free-market approach to this. People want to be told that The End Is Nigh. Advertisers want to reach people who want to be told that The End Is Nigh. Zero Hedge has filled that niche profitably and effectively, so its writers get to live in fancy suburbs. I do not see the problem. "Bloomberg LP competes with Zero Hedge in providing financial news and information," note Alloway and Kawa. Also, though: Mahwah? Besides the general doom, Zero Hedge has a particular interest in high-frequency trading, and Mahwah, as the location of the New York Stock Exchange's data center, is practically a metonym for electronic trading of equities. A casual search finds a couple of Zero Hedge articles examining photographs of the Mahwah data center's antenna for evidence that NYSE is adding lasers to the antenna. I suppose living in a mansion in Mahwah is a good way to keep an eye on the lasers.

Anyway, here is Zero Hedge's response, which is as intense as you'd expect.

Icahn and Apple.

I am not as worried as some people about the risk that activist investors will push public companies to focus too much on the short term instead of the long term. Stock prices discount the entire future, not just this quarter's earnings, so an activist who pushed for short-term profit at the expense of long-term value destruction would, in theory, lose money. Lots of activists are thoughtful about strategy and stay in a stock for many years. And even activists who just want stock buybacks aren't necessarily short-termers; they just think that they, and the market, will be better at investing a company's excess cash than that company's management would be. Often they are right.

But I can think all of that and still enjoy Carl Icahn's cheerfully unrepentant short-termism. Yesterday he casually let drop that he's gotten out of his stake in Apple, which he first disclosed in August 2013 and which he used to push Apple to return more cash to shareholders. Apple did, the stock went up for a while, it's started coming back down, and Icahn sold. His letters to Apple included a delightfully grandiose long-term vision of televisions and cars ("It seems logical that Apple would view the car itself as the ultimate mobile device"), and now that that vision might be coming true ("The car is the ultimate mobile device, isn’t it," says Apple's senior vice president of operations), he's getting out anyway. "I got out because I’m worried about China." Meh.

My model of Icahn is that his activism is mainly focused on entertaining himself; picking a fight with Apple was fun, and winning was fun, but sitting around waiting for the iCar is less fun. There also may be some meta-fun for Icahn in being a flighty short-term activist investor who just fights for buybacks and moves on: It makes it harder for other activists, like Icahn's sometime nemesis Bill Ackman, to argue that their brand of activism is about long-term value creation. In any case, Icahn sold about 45.8 million shares (about $4.8 billion worth) since the start of the year, which is a lot of stock to sell (albeit only about one day's volume and less than one percent of the shares outstanding). 

Elsewhere in tech, Amazon had a monster quarter. It's, like, five years away from getting activist interest. Elsewhere in Carl Icahn: "Republicans don’t understand economics and it’s killing the country."

Pension governance.

I have never quite understood how you are supposed to run a pension fund, particularly a public pension fund. There are two basic goals:

  1. Advance the political and employment interests of the people whose money you manage (which, for a public pension, means both employees/retirees and also taxpayers/voters).
  2. Make them as much money as you can.

Sometimes those goals conflict, and when they do, they seem sort of incommensurable. Should you do what your beneficiaries (or taxpayers) would want politically, morally, or in their role as public employees? Or should you just keep your head down and make money? I don't have any great idea of how you balance those things, and I'm not sure the California Public Employees' Retirement System does either:

“We are sensitive to the policy issues surrounding divestment causes,” said Henry Jones, the chairman of the pension fund’s investment committee in a statement. “But we’re also obligated to ensure that we maximize our investment returns on behalf of our members.”

That's from a Wall Street Journal article -- with the impeccable opening sentence "Calpers picked the wrong decade to stop investing in tobacco shares" -- about how "an outside consultancy" told Calpers that it has "missed out on up to about $3 billion in net investment gains" by divesting from tobacco. Do you think California public retirees care about whether their pensions invest in tobacco? How would you decide? Could Calpers ask them? Should it? It all seems a little bit like an argument for 401(k)s with lots of investment choices. Elsewhere: "Activists Have Declared War on Hedge Funds — and They Might Be Winning."

People are worried about unicorns.

"Fidelity's 'Unicorn' Valuations Were Just Proven To Be Bogus," writes Dan Primack, and while I sympathize with his annoyance, I disagree with him a little. Primack's main point is that one shouldn't take too seriously the private-company valuations in big mutual funds' monthly holdings reports, because those valuations are not market-derived but are instead set by valuation committees that may not have much in the way of financial information. Which is fair enough. But he also tells the story of drug unicorn Stemcentrx: Fidelity invested at a $5 billion valuation in August 2015 and had marked down its holdings by 37.75 percent as of this February, but then AbbVie agreed to buy the company for $5.8 billion plus billions more in potential earnouts. "If Fidelity was so wrong about Stemcentrx," asks Primack, "why would anyone trust its carrying value of Pinterest or Zenefits?"

But that's not quite fair. Public company acquisitions normally come at a premium. Heck, the stock market values Yahoo's core business at negative $8 billion, and it might sell for positive $8 billion, a premium of double infinity. (There may be flaws in this math.) You shouldn't think of Stemcentrx as having some true permanent value that Fidelity got "wrong" and AbbVie got "right." Instead, Fidelity's monthly marks were a rough effort to approximate a public-market price for Stemcentrx. Sometimes those prices go up, sometimes they go down, and sometimes the company is bought at a big premium to the last price. It's all an effort to recreate the appearance of public markets in private stocks. It's more bogus than public pricing, sure, but it's a sliding scale; public markets don't always reflect true permanent value either.

People are worried about bond market liquidity.

What if ... what if they're not? I am embarrassed to say I have nothing here. But "Duration risk is the new liquidity worries," says Duncan Weldon, so perhaps that explains it. Here's an article about how investors are worried about duration risk.

Elsewhere in miscellaneous worries, people are worried about non-GAAP earnings, but Vince Martin isn't. And people are worried about millennials quitting London financial jobs.

Me yesterday.

I wrote about Facebook's deal with Mark Zuckerberg to let him keep voting control even if he sells most of his stock, but requiring him to give up control if he leaves his job. Brian Solomon points out that there's an exception: He can leave his job as an executive at Facebook, but keep voting control, if he's "serving in a government position or office," possibly after being elected president on an Innovation Party ticket.

Elsewhere in long-term, short-term, and social network CEOs: "Wall Street thinks in quarters and people like Jack think in decades." 

Things happen.

For U.K. and EU, Breaking Up Is Legally Hard to Do. Derivatives houses to open accounts with Federal Reserve. GSO’s win-win on Norske Skog CDS. Health Care Companies See Scale as the Only Way to Compete. AB InBev Offers to Sell SABMiller’s Central, Eastern Europe Brands. Portugal’s Financial Independence Hangs by a Thread. Portugal court suspends Novo Banco bond transfer. Washington Still Haggling as Puerto Rico Debt Deadline Looms. Atlantic City, America’s Worst-Rated Town, Stares at Default. In Praise of Preferential Treatment in Private Equity. Colleges Sometimes Say No to Free Money. Vijay Mallya, Indian ‘King of Good Times,’ Dethroned by Debt. Fantastic Fakes: Busting a $70 Million Counterfeiting Ring. Buy a broker-dealer on Craigslist. Buy Yahoo on Craigslist. Rail storage. Swainson's warbler. Klingon copyright. Coach jams. Death-metal '4'33".' John Daly bet Fuzzy Zoeller $150,000 that he'd live to be 50, and did. The U.S. Is Sitting on a Mountain of Cheese

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