Long-Termism, Weather and Risk
It's a little weird that corporate governance standards should be set by stock exchanges. A stock exchange is a place -- or a computer -- for people to get together and trade stocks. A good stock exchange has fast computers and good rules for trading stocks. Separately, a good stock exchange might trade only good stocks, but in modern markets there is no real conceptual connection between those things. I could just write down a List of Good Stocks, and decide only to buy those stocks, and not care which exchange I buy them on.
But in practice a lot of governance standards -- about independent directors and shareholder vote requirements and so forth -- are set by exchanges as a condition for listing. And here is the story of a new proposed exchange that will have different governance standards:
If all goes according to plan, the LTSE could be the stock exchange that fixes what Ries sees as the plague of today's public markets: short-term thinking that squashes rational economic decisions. It's the same stigma that's driving more of Silicon Valley's multi-billion-dollar unicorn startups to say they're not even thinking of an IPO. "Everyone's being told, 'Don't go public,'" Ries said. "The most common conventional wisdom now is that going public will mean the end of your ability to innovate."
LTSE stands for "Long-Term Stock Exchange," and Eric Ries is the author of a book called "The Lean Startup." The things that will make his exchange long-term-oriented and innovative are, like, different executive compensation, and more voting rights for investors who've held shares for a longer time. This contrasts with the efforts by, for instance, Facebook to combat short-termism by giving public shareholders (essentially) no voting rights. "The LTSE also wants to nudge companies and investors to share more information, such as detail on R&D spending," which contrasts with some of the calls to fight short-termism by reducing public disclosure.
It is a little weird that short-termism is a problem with so many opposite solutions, but then, I am a bit skeptical that it is actually a problem. In any case, I am a big fan of companies experimenting with the formulas of governance and share ownership, so I am happy that Ries is doing his thing. I don't really know why it needs to be an exchange -- companies could, for the most part, just do these things on their own -- but I guess every governance innovation needs some sort of marketing angle.
Here is a story about Cumulus, a London hedge fund that launched in 2006 and "employed traders and expert meteorologists to look for discrepancies in weather predictions and find arbitrage opportunities." It's up 970 percent since inception, though recent months haven't been as good. We talked the other day about a U.K. politician who complained that hedge funds were commissioning exit polls to try to predict the Brexit vote:
“Information about a historic vote that will shape the future of our continent should be made available to everyone at the same time, not shared among a privileged few whose only motive is to gain financially by attempting to predict the outcome. ”
Is that true about weather, too? Should hedge funds be allowed to hire private meteorologists and know whether it will rain before you or I do? "Of course," is the answer, but people get so tangled up trying to think about "unfair" informational advantages in financial markets. Is it unfair if Cumulus knows next week's weather and I don't? Should I be able to compete against Cumulus on a level playing field, knowing-the-weather-wise? I think that the answer is obviously not, but this form of question comes up all the time, and sometimes the answer is less obvious.
Elsewhere in hedge funds, the combination of high fees, mediocre performance and relentlessly negative press has put some pressure on the industry's long track record of more or less consistent increases in assets under management:
Now, in a bid to persuade investors to stay, some managers are sweetening the deal by lowering fees in return for locking up investor money for a longer period of time and setting certain performance targets that if exceeded, investors would pay a fee. For newcomers, managers are even offering the favorable terms once exclusively offered to longtime loyal clients.
“Managers are having to negotiate, and investors are demanding much more than they used to in the absence of value,” said Adam I. Taback, head of global alternative investments at Wells Fargo Investment Institute.
I find that combination -- hedge-fund performance is meh, fees are high, everyone complains all the time, and yet the industry keeps growing -- one of the strangest mysteries in financial markets. It's possible that it will dissipate before I ever figure it out, though.
Banks borrow a lot of money (deposits, etc.) to finance a lot of assets (loans, etc.). This is risky. The main way that regulation deals with this risk is that banks are required to have a reasonable amount of capital, that is, money that they haven't borrowed and never need to pay back. A reasonable amount of capital is measured against their assets: A bank with $1 trillion of loans needs to have more capital than a bank with $10 million of loans. You might go a bit further and say: A bank with $1 trillion of risky illiquid junk-rated loans needs to have more capital than a bank with $1 trillion of Treasury bonds.
How do you decide how much capital a given asset requires? There are three main approaches:
- Banks decide: They build models, based on historical volatility and other inputs, to decide how risky each asset is, and then have enough capital to protect them against those expected risks.
- Regulators decide: A mortgage loan requires X percent capital, a Treasury bond Y percent, a credit derivative Z percent.
- No one decides: Everything just has the same capital requirement, regardless of how risky you think it is.
Those three approaches are listed in sort of declining order of sophistication. Approach 3 -- called the "leverage ratio" -- is just kind of dumb; you really should have more capital if you own junk bonds than if you own only short-term Treasuries. Regulators like the leverage ratio as a backup to more sophisticated capital regulation, but politicians are constantly proposing it as the only capital regulation, just because it sounds so simple. (It isn't.)
But the fun fight is between Approaches 1 and 2. Approach 1, in which banks build sensitive models of asset risk, tends to be more sophisticated than Approach 2, in which regulators just say "mortgages get a 50 percent risk weight" or whatever. It also encourages more diversity, which is probably good: If regulators decide that, say, government bonds or AAA mortgage securitizations have zero risk, then every bank will load up on them, creating a bubble. But if each bank builds its own model, some banks will prefer some assets and others will prefer others, and there will be a healthier ecology of bank investment.
On the other hand Approach 1 does kind of look like the banks are regulating themselves, and no one loves that look. Not even Jamie Dimon:
James Dimon, chief executive of J.P. Morgan Chase & Co., also has questioned the way different banks calculate their risks. During an investor-day presentation in 2011, he said a comparison of his bank’s risk-weighted assets with those of peers suggested the peers’ approach “can’t be accurate … I mean, obviously, someone’s using far more aggressive models.”
Anyway that controversy is back in the news now, as "the Basel Committee on Banking Supervision is considering a series of rule revisions as part of their effort to finalize postcrisis capital rules," and one possibility is to "stop banks from calculating their own exposure to other banks, large corporations and stockholdings."
Citigroup has some fun lawsuits.
Citigroup's credit-card loyalty program uses the word, or almost-word, "ThankYou." AT&T's customer loyalty program uses the word "thanks." One would hope that all customer loyalty programs would use a similar word, or at least the sentiment. It is only polite. But trademark law is not polite, so Citi is suing AT&T for trademark infringement. "AT&T’s use of the 'thanks' and 'AT&T thanks' marks in connection with a customer loyalty program is likely to cause confusion or mistake or deceive consumers into thinking that AT&T and its products and/or services marketed using the 'thanks' and 'AT&T thanks' marks are authorized by, or affiliated, connected or otherwise associated with Citigroup and/or its services," says Citigroup, because trademark law is also utterly unconnected with reality. "Thank you for the birthday present, grandma," you say, and your grandma replies "what are you, Citigroup?" You hold the door for someone, he says "thanks," and you mistake him for a Citi ATM. The entire concept of gratitude was invented by Citigroup in 2004 and is irrevocably associated with the bank. Before that we were just rude; it was a dark time. Anyway here's AT&T:
“This may come as a surprise to Citigroup, but the law does not allow one company to own the word ‘thanks,’’’ AT&T spokesman Fletcher Cook said in an e-mail. “We’re going to continue to say thanks to our customers.”
That sounds very reasonable until you remember that this suit came about because AT&T itself filed with the Patent and Trademark Office for a trademark on the phrase "AT&T thanks," and uses a little "SM" symbol attached to the word "thanks," suggesting that the battle is not over whether a company can own the word "thanks" but just over which company does.
Elsewhere, we talked a bit last week about Guy Hands's lawsuit against Citigroup over his unfortunate acquisition of EMI in 2007, which he blamed on Citi lying to him about the auction dynamics. On Friday he just dropped the case. Oh well. "I'm sure this is the right result," said the judge.
Speaking of guy hands, here is a Securities and Exchange Commission action against a man, Thomas Connerton, accused of scamming women he met through online dating sites into investing in his allegedly fake surgical-glove startup. The story of the glove startup involves a mysterious chemical engineer whom Connerton met in 2005:
The chemical engineer died in November 2008. Connerton, who has no formal education or training in chemical engineering, stated in testimony before the staff of the Commission that the chemical engineer’s death left him “with notes which were un-legible and [which he] literally had to go back to [his] chemistry books to understand what it was that [the chemical engineer] was involved with.”
In addition to learning chemistry, Connerton allegedly ran quite an investor-relations operation:
Of Safety Tech’s approximately 55 investors, six (6) are women Connerton met through a well-known Internet dating service and another 14 are family members or friends of those six women. Approximately 36% of Safety Tech’s investors and about 51% of the money Connerton has raised tie back to Connerton’s online dating activities.
Of the $2.3 million he raised, Connerton allegedly took about $1 million for his personal use, of which $20,000 went to "an engagement ring for his current fiancée," although the SEC unconscionably omits to mention how he met her. There are many investing lessons here, including:
- Don't invest with a guy you just met on Tinder.
- Don't invest with a guy your friend just met on Tinder, come on.
- Don't invest with a guy who (allegedly) says "No Bernie Madof's [sic] here!" Real companies just ... I mean, that is implied; Apple's prospectus doesn't say "oh by the way we're not Bernie Madoff."
Elsewhere in SEC actions, here is the amazing story of an expense reimbursement request:
The regulator’s obligation to pick up the tab for taking depositions of the two men, principals of a defunct Panamanian broker-dealer firm, Verdmont Capital SA, doesn’t extend to “exquisite" expenses like first-class flights from Panama City to London, a five-star hotel, a $1,000 bar tab and a two-day side trip to Madrid, U.S. District Judge William Pauley in Manhattan said in a ruling Thursday.
Here is the judge's order, which is three pages long and well worth reading. Why did they think that would work?
Gawker Media filed for bankruptcy on Friday, after being sued into the ground for publishing a Hulk Hogan sex tape. It is putting itself up for auction, with Ziff Davis an early bidder. Buyers will probably be interested in its e-commerce business and its relatively uncontroversial lifestyle sites; it is less obvious that Gawker.com will find a home elsewhere. Felix Salmon is gloomy:
This is a raw capitalist sale to the highest bidder, whomever that bidder might be; the court will pay no regard to whether or not the bidders are aligned with Gawker’s existing editorial policy.
In the specific case of Gawker itself, that matters a lot. Gawker has had various incarnations over the years, but it has always had the same proprietor, and that proprietor – Denton – has always seen Gawker’s independence as being key to its ability to speak truth to power.
Most of my opinions about the Gawker situation -- that publishing a sex tape is bad, that secretly funding an effort to sue a publication out of existence is also bad, that $140 million in damages is way too much -- are sort of weakly held and not of much interest to anyone. And of course I dislike some of what is published on Gawker, as I dislike a lot of what is published everywhere on the internet. But I am 100 percent on Team Gawker Is Good, and as someone who reads and writes things on the internet I am constantly aware of how much I owe to Gawker and Nick Denton and the internet that they created. And I will be very sad if this is the end for Gawker.
The Warren Buffett charity lunch auction thing happened again. This year the winning bidder was "an anonymous fan of the billionaire investor," and the winning bid was $3,456,789, topping last year's $2,345,678, each of which is the kind of combination an idiot would have on his luggage. I feel like the cutesy number-magic bids in these auctions are a little at odds with Buffett's old-school value-investor schtick, but I guess you don't get to choose who your fans are.
Elsewhere, JPMorgan's list of what rich people should be reading this summer is out once again, and once again it doesn't overlap much with my personal summer reading plans. ("The Last Samurai"! The last Neapolitan Novel! Gilbert Murray's "Five Stages of Greek Religion"!) The "Hamilton" coffee-table book is on the list, even though, if you are a JPMorgan ultra-high-net-worth customer, you can probably afford to just go see "Hamilton"? Of the ten titles on the list, nine are of the "Title: Subtitle" format, and three subtitles use the word "World." A decent summer-reading heuristic would be: Don't read books with colons in their titles. I'm sure "Paper Clip: The True Story of an Invention That Changed the World" will keep until September. (I made that one up, but if it actually exists please don't tell me; I don't want to know.)
People are worried about unicorns.
They're so worried that now it is a little embarrassing to be a unicorn, and unicorns are filing down their horns to pass as horses:
Most investors have awoken to the greed, folly, and fear that were evident, in hindsight, in the investment rounds that inflated some of the unicorns’ worth. Fred Giuffrida, a managing director at the venture fund of funds Horsley Bridge, told me that, in some circles, “unicorn has boomeranged to become a pejorative term.” Certain companies, he said, prefer to be valued below a billion dollars, to avoid the taint.
Elsewhere, Walgreens has decided to terminate its relationship with Theranos, the Blood Unicorn, after being repeatedly and bloodily gored.
People are worried about stock buybacks.
This is perhaps not exactly a buyback worry, but here is Jason Zweig on companies that go "dark," de-registering with the Securities and Exchange Commission because they have fewer than 300 shareholders. This saves them the cost of SEC filings, but leaves their shareholders without, you know, SEC filings.
People are worried about bond market liquidity.
Did you know that Gogo, which pulled a bond deal after the bonds were already trading, which is one of the craziest things that a company can do in the capital markets, then re-launched the deal two weeks later because it turns out that it needed the money after all? The pulled deal had a 12 percent coupon; the new one priced at 12.5 percent, because the market will punish you a little for doing something that ridiculous. I don't know what to tell you. New issues are the easiest way to make money in the bond market, so if you issue a bond and it goes up, investors will be sad when you take it away. But on the other hand they'll be happy if you give it back, especially at an even higher yield. Here is Bloomberg Gadfly's Lisa Abramowicz.
That's not even a liquidity story, really, it's just nuts.
Elsewhere in bond stories that aren't really that much about liquidity, Morgan Stanley is bullish on Treasuries, while Goldman Sachs is not. The "Most Expensive Bond Market in History Has Come Unhinged. Or Not." And "Investor demand strong for risky energy groups’ debt."
I wrote about drugs.
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