Family Money and Financial Innovation
Family offices versus private equity.
Here is a fascinating story about how rich people are just making private equity deals themselves rather than bothering to go through private equity funds:
Wealthy families are embracing their inner Warren Buffett, albeit on a smaller scale. They used to hand most of their assets to managers to invest. Now, following the likes of Buffett, Michael Dell and Bill Gates, many are acting like private equity firms, buying large stakes in companies or acquiring them outright. Families can exert tighter control over their money, give the kids something to do and cut their deal fees.
You can read this as a confluence of two trends: First, there is an increasing suspicion of financial intermediaries and the fees that they charge, and second, there is enough inequality and concentration of wealth that now lots of families can go around buying companies just to keep their kids busy.
But you could also read the second trend as helping to cause, or reinforce, the first. In a world where everyone has a medium-sized amount of money, and a job, there are real economies of scale in pooling all those piles of money and having them professionally managed. In a world where most people have small amounts of money, and jobs, and where a few people have vast amounts of money, and idle kids, it might make more sense for the idle kids to manage the vast piles of money themselves without paying the fees of pooling, while the small investors might need to economize on fees by just indexing. Some (pretty wide) middle range of wealth is the natural target for the pooled active investment management model, and at some level the concentration of wealth might itself put pressure on that model.
(I assume "kids" in all of this means adult offspring with elite educations, by the way, not literal children, though that would be fun too. I would watch a comedy about an industrial company that is taken over by a family office and left to the family's nine-year-old scion to run. A "Tommy Boy" for these darker times.)
Elsewhere, and perhaps relatedly, David Bonderman's family office is mounting a shareholder activist campaign at Sorrento Therapeutics. Family-office activism is a little like family-office buyout investing, though it's a bit of a second-order effect here given that Bonderman made his own money by managing pooled buyout money at TPG Capital.
Cohen and Milken.
Mr Cohen is following Mr Milken’s path, and there are other parallels: both are revered in the worlds where they made their fortunes and their mistakes. And in both cases, they must work to bridge a chasm between their reputation in the industry and their public image, as the financial world’s reverence does not always extend far beyond its bounds.
It's true, Cohen and Milken are both figures of cult-like adulation in the financial industry, and treated with some suspicion outside of it. But I want to draw one distinction between the reverence for Milken and the reverence for Cohen. Milken is revered as a financial innovator. In the popular shorthand, he invented junk bonds, which allowed lots of ideas to get financed that, in an earlier and more conservative age, would never have gotten off the ground. If you use the products made by tech or biotech or energy or whatever companies that have funded themselves with high-yield bonds, you have Milken to thank for it.
Obviously junk bonds, hostile takeovers, excessive leverage, aggressive financial structuring, etc., have their negative side, too, and that, plus the criminal conviction, might explain why Milken's public image has not yet caught up with his reputation within the industry.
Steve Cohen, on the other hand, is a really good trader, and being really good at trading has its own efficient-capital-allocation benefits, but they are sort of attenuated and abstract. Mostly Cohen is respected because he has been amazingly good at making money for himself and his clients, which is impressive -- particularly within the financial industry -- but not quite as world-changing as finding new ways for ideas to be financed and brought to reality.
Last week Gawker's Hamilton Nolan wrote a strange article about his trip to the Berkshire Hathaway annual meeting. "Warren Buffett Is the Best Argument for Capitalism," says the headline. "Is It Good Enough?" But why would Warren Buffett be the best argument for capitalism? He is nice, and smart, and folksy, and drinks Cherry Coke, and has made a lot of money for his investors over the decades. And he has invested well and run businesses well in ways that have enhanced their value. But he didn't, like, invent insurance. Or the iPhone. Or even junk bonds. The best arguments for capitalism rely on the creative energies that it unleashes and the new things it brings into the world. But the heroes of capitalism tend, perhaps wrongly, to be just the people who make the most money.
Elsewhere in financial innovation, the guys at Gordian Knot Ltd., who invented the structured investment vehicle, now run "a simple, narrow wholesale bank." Greg Lippmann, a "Big Short" big shorter, is now funding wedding loans. And: "How Capitalism Took Over Sports Movies." My toy theory is that movie executives want to see people like themselves in movies, so they like movies whose heroes are unathletic guys who successfully allocate capital to risky investments in popular entertainment products.
Here's what Jimmy Dunne III, now of Sandler O'Neill & Partners, learned at Bear Stearns:
There was a small group of us divvying up the bonuses, and somebody wanted to give one guy an additional $5,000 on top of the $20,000 he was getting. Then someone said, no, he didn’t earn it, we’re not doing it, and we should give it to the guy who made a $3 million bonus, because he earned it. And either the first guy has got to do a lot better, or he has to quit, or we have to fire him.
That was not my view, but he was right, and it changed my mind. It’s about meritocracy.
I guess I don't understand the limiting principle there. Like, why give the bad guy $20,000 at all? Why not zero him, or fire him on the spot? Also, I feel like $3 million is a nice round number for a bonus? Whereas $3.005 million is ... some sort of weird signaling? If you worked at Bear Stearns back in the day, and you got a bonus of $3,005,000, was that especially satisfying? Was that, like, "I made $3 million, and I crushed the spirit of a guy who really needed an extra $5,000 but who just didn't perform?" What if you got $3,030,000? Was that, like, "sweet, six scalps"? Bear was an amazing place.
Elsewhere, here is a story about how Elon Musk likes to over-promise and under-deliver.
The Trump Trade.
On Friday I was sort of sanguine about Donald Trump's statements about U.S. government debt, interpreting them to mean that he would be opportunistic about buying back Treasuries at attractive prices, maybe take advantage of illiquidity discounts in off-the-run bonds, that sort of thing. Everyone else seems to have utterly freaked out, though. Here are Matt Yglesias ("Donald Trump just threatened to cause an unprecedented global financial crisis"), Josh Barro ("Donald Trump is floating an insane idea that would tank the American economy"), Binyamin Appelbaum ("Such remarks by a major presidential candidate have no modern precedent"), Derek Thompson ("Donald Trump's Economic Plans Would Destroy the U.S. Economy"), Liz McCormick (quoting a bond strategist saying "This is stupid and ridiculous and never going to happen"), Barney Jopson and Sam Fleming (quoting a former Treasury official saying that "Trump might be better suited to be the leader of Zimbabwe"), and Cullen Roche ("Trump’s comment about making a deal on the national debt is, to be kind, very stupid").
These people seem to be concerned because they have interpreted Trump as wanting to destroy the credit of the United States just so that he can play his favorite game of hardball bankruptcy negotiation. To be fair, that is what he said, and also probably what he meant, and also probably what he would do. On the other hand, this all happened like four days ago. Surely he thinks something else by now.
Anyway here is a 1999 story about Treasury's plans to buy back debt to put to use "the first budget surpluses in a generation"; then, as now, one concern was bond market liquidity, and the government was issuing new on-the-run bonds to buy back off-the-run issues and improve liquidity. (Gary Gensler was the Undersecretary of the Treasury for Domestic Finance in charge, and Bill Gross advised: "Individuals can actually front-run the Government.") Here is Robin Wigglesworth on Trump and the sovereign debt restructuring mechanism, and wouldn't it be funny if the U.S. had to do a sovereign debt restructuring? (No, it wouldn't, it would be catastrophic.) Someone could sue Trump in a court in Argentina. And here is Peter Schiff saying, you know, this sort of thing:
"Trump just admitted on CNBC that America has too much debt to afford a rate hike, and that he wants our creditors to accept less than 100 cents on their Treasuries," the Euro Pacific Capital CEO explained on CNBC's "Futures Now" last week. "In other words, Trump knows a U.S. government default is inevitable."
Here's a thing that Steve Wynn said on his quarterly earnings call last week:
So the stock markets got more volatile, more stupid as a gambling game than ever before. And I look at it that way, to be honest with you. I have very little respect for the integrity of the trading on the exchange in most stocks. And I have particular disdain for the fact that the SEC has failed to deal with high-frequency traders who are doing nothing more than taking advantage of inside information, a buy or a sell order, because of technology advantages. If you read Flash Boys, it's all spelled out for you. And if I execute an order, I'll use the IX (sic) [IEX], I'll use Brad Katsuyama if I was buying something, so that the - so I couldn't be fronted by the high-frequency traders. But there's an awful lot of that going on. The other day I was watching the stock open up, and it went up on share volumes of a few thousand shares. I mean, every trade was a tick up. That's not the way it should operate in an honestly or intelligently run exchange. But that's the thing, all those guys sold their dark pools and their order flow and the positioning on the floors of the servers to the HFTs. And it's made a couple of guys that I'm friendly with very rich because they are high-frequency traders. But I don't respect the activity, and I'm severely critical of it. And don't mind saying so, either.
It is very hard to figure out what Wynn is complaining about -- elsewhere, he seems to dislike short sellers in his stock, though what that has to do with dark pools or the stock trading up at the open is unclear -- but he certainly seems concerned. And it certainly seems like IEX's marketing is working. Last week I said that "People have some vague sense of the evils of high-frequency trading -- front-running, arms races, flash crashes, payment for order flow, lasers, whatever -- and some vague sense that IEX is Good and Against High-Frequency Trading, so they assume that IEX will cure all of the evils."
People are worried about non-GAAP accounting.
I have sort of a market-efficiency explanation for why journalists are so worried about non-GAAP accounting. It goes like this:
- Some journalists view part of their job as being to point out when markets are wrong.
- That is generally hard to do: If it were easy to identify error in markets, people would do it to make money, and the errors would be corrected. (This is the efficient markets hypothesis.)
- But non-GAAP accounting comes with its own confession of wrongness: Every company that reports non-GAAP numbers also has to simultaneously report its numbers according to generally accepted accounting principles, and provide a reconciliation of the two.
- So it is fairly straightforward for a journalist to say "hey, market, you are looking at these numbers, and they are wrong!"
- The market could reply "well no actually we think that those numbers are more reflective of economic reality than the GAAP numbers are," or it could reply "no we are ignoring those non-GAAP numbers and looking at the GAAP numbers further down in the press release."
- But the market doesn't reply either of those things, because while the market is very good at interpreting information, it is very bad at explaining its interpretations.
Anyway here is Jonathan Ford on "the real cost of big tech's accounting games."
People are worried about unicorns.
Here is William Alden on Palantir, the Spy Unicorn, which I guess is not just a spy unicorn. It also does data analysis stuff for corporate clients. Sometimes those corporate jobs don't work out. But when they don't, it's generally the client's fault. For instance here is Palantir's Melody Hildebrandt on the Nasdaq contract:
On July 24, Hildebrandt told colleagues about an “emotionally loaded call” with Nasdaq’s chief information officer, Brad Peterson. She complained on the call of a “constant lack of engagement” from Peterson’s team, for which he apologized, Hildebrandt said in the email.
Here's the deal with Coke:
Coke “wanted deeper industry expertise in a partner,” Jonty Kelt, a Palantir executive, told colleagues in the email. He added that Coca-Cola’s “working relationship” with the youthful Palantir employees was “difficult.” The Coke executive acknowledged that the beverage giant “needs to get better at working with millennials,” according to Kelt.
And here's Palantir's Sid Rajgarhia on Amex:
Rajgarhia laid out “five whys” about American Express, a Palantir tradition borrowed from Toyota of asking five “why” questions to get to a problem’s root cause. He concluded that the failure could be blamed on American Express’s own hardware, in addition to a lack of support from the credit card company’s executives. Rajgarhia described the Amex managers who worked with Palantir as “low-vision.”
Is this ... is this good customer relationship management? Like, if you end every failed engagement with an exhaustive soul-searching postmortem about what the client did wrong, are you ... is it possible that you're missing your own failings? Maybe not. Maybe the trick is to project so much arrogance that clients will be desperate to work with you and prove that they can live up to your standards. It's unicorn negging.
After all, unicorns are magical creatures, and people should feel honored and enchanted just to be in their presence. Take it from Uber, the Ubercorn, and Lyft, The One That's Not Uber:
Uber and Lyft are to pull out of Austin, Texas, on Monday, abandoning one of their key markets in the southern US rather than complying with a requirement to run fingerprint-based background checks on drivers.
Both companies will suspend operations in Austin starting on Monday morning, leaving more than 10,000 taxi drivers in the Texas capital out of work.
You might reasonably describe Austin as "low-vision" here.
Elsewhere, "Alphabet invested an estimated $100 million in new ventures during the first quarter of 2016." And Bloomberg View's Noah Smith says that "the tech bust, which everyone thought was coming, is probably here."
People are worried about stock buybacks.
Here is John Carney on hedge funds and buybacks:
Note that the incentives of corporate managers and hedge fund managers when it comes to capital returns are very differently aligned. Corporate managers can benefit from returning capital to shareholders if buybacks increase the value of their shares and options. Hedge fund managers, however, are loathe to return capital to their investors because they collect fees from total assets under management. A hedge fund that finds itself with mounting cash is far more likely to look for ways to invest it than consider sending it back to its limited partners.
And here is ... I hesitate to send you to this, because I don't really understand it ... but here is a Twitter thread about whether a company can take itself private by buying back all its stock. I think the answer is something like "come on, man, that is not worth worrying about," but if you want to math it out, maybe you should start from the idea that there are three categories of shares:
- Shares owned by the public.
- Shares owned by one or more insiders (chief executive officer, founder, private equity, whatever) who might want to control the company if it went private.
- Shares owned by the company itself.
Then, once you have that in mind, add the complication that category 3 does not exist: Once a company buys its own shares, those shares vanish for all purposes. (This is true in the U.S., though in some other countries "treasury shares" can matter sometimes.) A company's purchases concentrate ownership in the remaining shareholders; they do not create some weird category of self-ownership. So if a company buys back its stock until there is one share left, the owner of that one share will own the company and can do what he wants.
If you have a company that is like 20 percent owned by a founder-CEO-whatever, and the company spends its cash and/or borrows money to buy back the other 80 percent of its stock, then it can take itself private, sure, why not. As a matter of like, math, or philosophy, nothing stands in the way of that trade, and back in the glory days there were leveraged buyouts done with not much more new equity than that. But if you have a company that is 100 percent owned by dispersed public shareholders, the company itself cannot buy 100 percent of the stock and then persist as a self-owned autonomous entity. It doesn't work that way.
I'm sure that someone will e-mail me a counterexample, and I am looking forward to it.
People are worried about bond market liquidity.
I don't know, I was hoping for another post in the Treasury's bond-market-liquidity blog series, but at Money Stuff's deadline, the latest was still Friday's installment. The bond-market-liquidity pickings today are slim. To tide you over, maybe try the New York Fed's Liberty Street Economics blog on on shm-reduplication. Liquidity, shmiquidity, I always say.
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