Bailout Fights and Blockchain Ideas

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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Fannie and Freddie.

Here's how I think about the bailout/nationalization/whatever of Fannie Mae and Freddie Mac. Once upon a time they were quasi-public utilities where the government took the ultimate risk of guaranteeing mortgages but gave the profits to private shareholders. Then, in 2008, they collapsed, and the government had to bail them out. This seemed very unfair to people at the time, and so they naturally assumed that shareholders would lose their entire investment. If the government was going to take all the downside in Fannie and Freddie, it would take all the upside too.

But for reasons having to do with, basically, accounting, when the government took over Fannie and Freddie it took about 80 percent of the ownership, not 100 percent. At the time -- September 2008 -- this seemed like a trivial difference. Things were crazy in September 2008! It was hard to imagine getting through the next week, never mind getting back to a place where Fannie Mae and Freddie Mac were profitable and anyone wanted to argue over that 20 percent of the stock. (Plus some preferred stock.) But eventually things did get better, and the government realized that it had left 20 percent of Fannie and Freddie's stock in private hands, and so, in mid-2012, it more or less grabbed it. (This is called the "Third Amendment.") Then the shareholders sued.

This is not the official story, and probably no one on either side would entirely agree with it, but I think it's more or less right. The government will tell you that things never really got better, and that even today Fannie and Freddie aren't really profitable, but this is an extremely boring argument about, again, accounting. (How do you compute how much preferred stock is outstanding and paying coupons? What is the proper fee for the government to charge for support? What about deferred tax assets?) No one quite believes that the government took over all of Fannie and Freddie in the 2012 Third Amendment out of pure disinterested concern for the companies' well-being. Everyone assumes that zeroing the shareholders was also an important motivation.

Anyway here is Gretchen Morgenson on some newly uncovered e-mails and stuff making it really clear that zeroing the shareholders was also an important motivation:

An email from Jim Parrott, then a top White House official on housing finance, was sent the day the so-called profit sweep was announced. It said the change was structured to ensure that the companies couldn’t “repay their debt and escape as it were.”

This cannot really be a surprise to anyone, but the government has spent the last few years, bizarrely, denying that punishing the shareholders was a motivation for the Third Amendment. It does not strike me as legally all that important, but honestly the legalities of the Fannie/Freddie lawsuits are a bit beyond me. I am a bit torn about the justice of the situation, though. On the one hand, in 2008, it really was probably fair for Fannie and Freddie shareholders to lose their entire investment. But they didn't. And once the government had left 20 percent of the companies in shareholders' hands in 2008, it was a bit rough to take it back in 2012.

Blockstuff.

The DAO, the general partnership/venture fund/experiment in corporate form/blockchain showpiece/whatever that we talked about last week, made the front page of the New York Times this weekend. "My opinion is that the D.A.O. will be D.O.A. (Dead on Arrival)," says a guy. I should note that when we talked about it last week, I interpreted the DAO mainly as an aesthetic object, a clever new arrangement of the forms of corporate structuring. But it's important to note that it is also a thing that is actually raising money -- "about $152 million, at last count" -- on a blockchain, and things that raise money on blockchains have a bit of a history. (Of libertarians robbing each other.) The Times article begins with Olivier Stern, "a 31-year-old French socialist," who "recently invested a third of his life savings — 10,000 euros, about $11,000" in the DAO, and "who previously lost a small sum of money he invested in Bitcoin when a major Bitcoin exchange — Mt. Gox — went bust." Perhaps this will end better for him. Here is more on the DAO from Todd McDonald of R3. And here is "Bitcoin Catches On With Gold Bugs."

Elsewhere in blockchains:

Trade financing, a centuries-old banking mainstay, may become ground zero for blockchain adoption because it promises to do away with paper invoices and the fraud that accompanies them -- if banks can come together around a joint platform.

For blockchain applications, “invoices should be considered a leading candidate here, given the high potential for fraud,” said Henry Balani, global head of strategic affairs at Accuity, which provides technology to monitor trade-based money laundering.

Sure. As I understand it the potential for fraud comes from the possibility that the invoice will not accurately describe the container full of stuff that is being financed; the invoice says "here is a container full of diamonds," but really it is a container full of coal. This seems like a problem that cannot be solved purely through cryptography, though I guess the cryptography can't hurt. But in general I am a bit skeptical about claims that the blockchain will solve, not just problems of electronic database architecture, but problems of correspondence between electronic databases and the physical world. Building a better database of blood or cargo or whatever is useful! But you still have to move the blood or the cargo.

Merger Monday.

Do you love lawyers? I love lawyers. (I am married to one. Also I was one.) This is how lawyers fight:

During a heated exchange over the litigation, Anthem General Counsel Tom Zielinski wrote on May 5 to his Cigna counterpart,Nicole Jones, that he did “not intend to correspond further” about it.

Ms. Jones, who traded several letters with Mr. Zielinski, responded: “Suffice it to say that we disagree with just about every characterization and assertion that you make with respect to the matters raised in your letters—other than your suggestion not to continue a correspondence.”

Oh that is so beautiful. I assume that ancien régime European aristocrats all went around writing letters that buried vicious insults in long, polite, flowery sentences, but these days our lawyers are the last upholders of that noble and ancient tradition. Anyway that kiss-off is from this story about how Cigna and Anthem are fighting over executive responsibilities and antitrust approvals in their pending merger. Back when I was, briefly, a mergers-and-acquisitions lawyer, you negotiated a deal, and you tried to make sure the merger agreement required both sides to complete the deal, and then you went and tried to close the deal. I feel like circa-2016 M&A practice is a little different; there seem to be cracks in executives' desire to complete the deals they sign on to. It's hard to quite know what to make of Anthem/Cigna, but there is at least some possibility of intentional foot-dragging that would prevent antitrust approval. And then there is the wild Energy Transfer/Williams tax-opinion holdup, where a tax problem is either blocking the deal's completion, or is being used as an excuse to block the deal's completion. Never mind the deals -- like Pfizer/Allergan or Halliburton/Baker Hughes -- where the parties wanted to close but the government disagreed: These days it seems like, if you want to get out of a deal, it's easier to find regulatory excuses.

Elsewhere it is of course Monsanto Merger Monday:

In response to further market speculation and stakeholder inquiries, Bayer is publicly disclosing the contents of its private proposal to acquire Monsanto. Bayer has made an all-cash offer to acquire all of the issued and outstanding shares of common stock of Monsanto Company for USD 122 per share or an aggregate value of USD 62 billion.

"Bayer would likely abandon the Monsanto name after the purchase." And the relative dearth of M&A so far in 2016 has been bad for stocks:

Take the knee-jerk jump in acquired companies on the first trading session after a takeover is announced. Those gains alone added $192 billion to equity values in 2015, according to data compiled by Bloomberg. This year, single-day moves following M&A are on pace to add $70 billion -- the least since 2009.

I sometimes talk about a toy model in which all capital allocation is done by (1) index funds and (2) corporate treasurers; in that model the corporate treasurers are mostly allocating capital by buying back their own stock but, sure, sometimes they buy other companies instead.

“M&A, buybacks, flows into equities -- they’ve been like safety nets for the market, and if something goes wrong, it’s likely to be more exaggerated in their absence,” Thomas Melcher, the Philadelphia-based chief investment officer at PNC Asset Management Group, said by phone.

Banks.

It is hard for me to imagine having a useful and informative popular debate about bank capital, but people keep trying. It seems to me that bank capital regulation has three drawbacks as a subject for public discussion in U.S. politics:

  1. It is complicated.
  2. Beyond the complexity, it is just sort of conceptually mysterious. Banking is a weird business. Did you know that bank deposits are actually debt, for the bank? Of course you did, come on. But when politicians and pundits try to have popular discussions about bank capital, they can't assume that knowledge. And so they have to start from a weird place of not-quite-right metaphor. Capital is money set aside for a rainy day, or the delicious frosting on a layer cake of debt, or something.
  3. It is very boring.

Anyway here is Pedro da Costa with a confused call for more clarity on bank capital:

Second, there’s “risk-weighted capital.” This is basically equity plus stuff that bankers would love to treat as capital even though it really isn’t. That includes debt instruments deemed very safe, like government bonds. But before the financial crisis, it also included AAA-rated housing bonds that turned out to have little or no value.

Almost! But I do not think it is especially clarifying to say that risk-weighted capital rules let you count AAA mortgage assets, or any assets, as capital. That is not how balance sheets work. (Da Costa also criticizes John Stumpf for implying that Wells Fargo's customer deposits don't count as debt -- "Because we have this substantial self-funding with consumer deposits we don’t have a lot of debt" -- which strikes me as a pretty venial sin as these things go.) As with most attempts to popularize bank capital regulation, this one calls for abandonment of capital complexity -- risk-weighting, different tiers of capital instruments -- and a focus on the simple common-equity leverage ratio. I always assume that this is driven less by an informed substantive conclusion that the leverage ratio is a better capital regulatory tool than risk-based capital, and more by the fact that the leverage ratio is the only capital regulatory tool that you have any hope of explaining to normal people. It does solve the complexity problem, if you completely ignore all the complexity in the leverage ratio. But the conceptual trickiness, and the boredom, remain obstacles to public understanding. 

Elsewhere, a victim of Jamie Dimon's bank-on-bank violence responds: "The chief executive of the nation's largest bank called me a 'jerk' on national television following my comments on the differences between large financial firms and local community banks." 

People are worried about unicorns.

Here is Katie Benner on how bad things are in the Enchanted Forest. So bad that now, when startups try to raise money, investors ask questions, and negotiate terms, and do due diligence, and take their time making decisions. It is unfamiliar territory.

“Venture capitalists are putting founders through everything short of a proctology exam before they invest,” said Venky Ganesan, a partner at Menlo Ventures, a Silicon Valley venture capital firm.

The changing balance of power is evident in the numbers. Venture capitalists have put less money into start-ups in the United States in the last two quarters, according to the National Venture Capital Association; funding dropped 11 percent to $12.1 billion in the first quarter from a year earlier. With a smaller capital pie, entrepreneurs have to work harder for a piece.

Elsewhere, Adam Ozimek argues that "sometimes tech companies should be regulated less than their low-tech competitors if the regulations are designed to solve problems that the technology mitigates." Chris Sacca do-you-know-who-I-am'ed "Hamilton." And "Drive 2: The Uber Years."

People are worried about stock buybacks.

I feel like a lot of the people who worry about stock buybacks also worry about corporate cash hoarding? They are, in a sense, opposites, but they are two sides of the same coin, the coin in this metaphor being a coin not spent on research and development or paying workers or whatever good use of corporate cash you prefer. The bad uses of corporate cash, stereotypically, are (1) buybacks and (2) not using it at all. Never mind that use (1) can solve problem (2). Also the cash hoarding looks like tax avoidance. Anyway there is a lot of it:

Five US tech giants are hoarding more than half a trillion dollars, a record sum that underscores how cash has become increasingly concentrated at a handful of groups seeking to avoid a tax hit.

Apple, Microsoft, Alphabet, Cisco and Oracle had amassed $504bn of cash by the end of 2015, nearly a third of the total $1.7tn held on the balance sheets of US non-financial companies, according to a new report from rating agency Moody’s. The top 50 holders accounted for $1.1tn of that amount.

People are worried about bond market liquidity.

And when people are worried, other people see a commercial opportunity. In this case for a bond market liquidity tool:

The tool shows four main data sets to fund managers: what was traded, what would be eligible for purchase by European central banks under the quantitative easing programme, what level of the security is being held by Euroclear for its members and the concentration of the holders of a certain bond.

Jean Sayegh, co-head of sovereign bonds investments at Lyxor, told Financial News: “Our clients are demanding transparency and this data will ensure we can show them that we are paying the right price for liquidity. We believe liquidity is going to become a new factor of performance.”

Me Friday.

I wrote about golf, the sport of insider traders. And here is John C. Coffee Jr.:

If a presidential candidate of either party wants to show that he or she has not been “captured” by Wall Street, the best signal would be support for insider trading legislation and a promise to prod Congress to enact it.

That can't be right, can it? Insider trading is not really a priority for Wall Street. It's more of a golf-course activity.

Things happen.

How Hungary’s Central Banker Funneled Funds to Friends, Family. U.K. Treasury Says EU Exit Could Cause Recession. Fed-Convened Committee Narrows the Search for a Libor AlternativeDecades After ‘Boom-Boom Room’ Suit, Bias Persists for Women. Russia to issue first international bond in three years. Creditors of Puerto Rico government bank revive lawsuit over debt moratorium. Investors Check Out of Europe. Oil Traders Are Borrowing From Banks to Store Crude at a Loss. Online Lender SoFi’s Bond Deal Receives Highest Moody’s Rating. CLO Debt Market Peps Up. Hedge funds still like momentum stocks. Smart beta is still a thing. Liquid alts are disappointing. Only About One-Quarter of Corporate Stock is owned by Taxable Shareholders. It's a buyer's market for private jets. "She’s the vegan Bernie Madoff." McKinsey Academy. Unethical amnesia. Adult stroller. Binghamton Baseball Players.

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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