Earnings, Bailouts and Lawsuits
Hey bond trading is back:
Goldman Sachs Group Inc., the Wall Street bank most reliant on trading, posted a 74 percent increase in second-quarter profit as legal costs fell and fixed-income revenue surpassed analysts’ estimates.
Much of the cost-cutting burden is falling on the bank’s staff. Bank of America has shed about 25% of its jobs since Mr. Moynihan became CEO in 2010, with employment falling to about 210,000 from nearly 284,000. The bank slashed about 6,000 jobs over the past 12 months, or 3% of its work force, and in January it let retention packages for some of its longtime Merrill Lynch brokers expire.
“We’re down 2,600 people quarter over quarter,” Mr. Moynihan said. “It’s a constant reduction in personnel through hard work and automation.”
"I’ve always maintained that Moynihan was a great fix-it guy but not a good growth guy," says an analyst, more or less approvingly. In general I feel like there was an old 2006-ish model for banking, in which everyone worked hard and was crazy busy but got paid really well because the business was growing. And there was like a 2013-ish model for banking, in which the business was slower and more boring and less lucrative than it used to be, but at least you didn't have to work too hard. (JPMorgan even hired more bankers so that they could all work less.) Either of those models can be fine for morale, though each model will appeal to a different group of workers. But the 2016 model of "the business is weak, so work really hard so we can fire your colleagues" does not seem particularly appealing to anyone.
We talked a little yesterday about what I think of as the core problem in banking bailouts,. You want investors in a failing bank to lose money before the government steps in to rescue the bank; that saves the government money, and creates the right incentives. But you want the right investors to take losses, not the systemically important or politically sympathetic ones. Obviously you don't want, like, small-time insured depositors to take losses. Probably you want shareholders, and holders of specifically designated bail-in junior debt, to take losses. But only probably. Maybe those holders are themselves sympathetic small-time retail investors, and you want to rescue them too. It is a hard problem.
Here is a new paper, by John Crawford of the University of California Hastings College of Law, about "credible losers" in bank bail-in design. "It is not enough for regulators to say that they will impose losses on some class of creditors to reset the creditors’ expectations: such promises must be credible," writes Crawford. And here is a distinction that I think about a lot:
Among debt claims, a distinction should be drawn between what Oliver Hart and Luigi Zingales call systemically relevant claims and non-systemically relevant claims. Other commentators draw similar distinctions using slightly different terms: Robert Merton and Richard Thakor distinguish the claims of “customers” and “investors.” Assistant vice president of the Federal Reserve Bank of New York, Joseph Sommer, speaks of “financial liabilities” as opposed to “bonded debt.” Morgan Ricks draws a distinction between “money claims” and securities traded on capital markets. What falls on the systemically relevant side of the divide? First and foremost, bank deposits. Second, other types of short-term debt that create similar run-like risks. Several commentators include derivatives and insurance claims as well.
Crawford likes long-term debt as a credible loser instrument. It is not "systemically relevant," so it can be bailed in: If the bank fails, the long-term debt holders can be made to take losses before the government steps in to rescue the depositors.
This is a sensible, functional approach: The financial risk of banks comes from their runnable short-term debts, so making long-term debt holders take losses is not a systemic problem. (Of course you have to make sure that the long-term debt holders are not themselves other banks.) But as we see a lot in Europe, there are political as well as functional reasons why you might not want to bail in debt. If all that long-term bank debt is in the hands of sympathetic retirees, the government may not be excited about writing it down. This is part of the worry at Monte dei Paschi di Siena. It's not enough to have debt with the right structure, it has to be held by the right people.
In related news:
The European Union’s highest court issued a ruling that endorsed Slovenia’s 2013 bank bailout that wiped out about 600 million euros ($664 million) of debt held by junior bondholders in so-called “burden sharing” linked to state aid.
The ruling is a potential boon for the country’s central bank, led by Governor Bostjan Jazbec, after it was raided by Slovenian police earlier this month on suspicion of wrongdoing during the government’s bank rescue three years ago.
Here is the ruling of the EU Court of Justice, and an earlier advocate general's opinion. The court approved "a condition of burden-sharing by shareholders and holders of subordinated rights as a prerequisite to the authorisation of State aid," says the court, but found that writing down junior debt "must not exceed what is necessary to overcome the capital short-fall of the bank concerned." Here are Yakov Amihud and Carlo Favero on recapitalizing Italian banks using a deep discount rights offering. And: "These Sicilian Mortgages Show How Difficult It Is to Rescue Italian Banks."
Here's a weird financial-crisis case: Carlyle Capital Corp., a fund raised by Carlyle Group to make hugely levered bets on Fannie Mae and Freddie Mac securities, collapsed in 2008, and its Guernsey liquidators are suing, claiming that Carlyle co-founder Bill Conway "and six other Carlyle and CCC officials acted recklessly and should have started selling the fund’s assets months before it failed." Actually it's not that weird. The claim is basically that Carlyle officials set up the fund and ran it, and did a bad job, and should have done a better job. Given that investors gave Carlyle $945 million and got back, basically, zero, it's not that hard to sympathize.
But it is sort of anomalous among financial-crisis cases. There is a basic narrative of the financial crisis that goes like: A lot of people committed a lot of fraud, and because of the complexity of their crimes or evidentiary difficulties or bad laws or cowardly prosecutors or whatever, they haven't been caught and punished and forced to return all the money they made. There is a popular and in some ways compelling counternarrative that goes like: There was some fraud, but there was also a lot of innocent stupidity and groupthink and over-optimism, and you can't put people in prison for making bad decisions.
But why can't you sue them? Like, if they managed your money, and lost it all by making bad decisions? In some ways it is weird that the crisis didn't give rise to more cases like this, alleging not that people committed fraud but that they lost money out of recklessness. To be fair, these cases are hard; proving a breach of fiduciary duty is not as easy as proving that Carlyle made the wrong decisions. In particular, the allegations against Conway include "that he refused to have CCC sell assets or restructure as loans dried up in the summer of 2007 because he didn’t want bad publicity from CCC to jeopardize an investment by an Abu Dhabi government fund in Carlyle Group." (He denies it.) It's not quite enough that Carlyle's decisions turned out wrong; the investors also need to prove a conflict of interest or some other fiduciary failing beyond just being wrong in good faith.
Blockchain blockchain blockchain.
Here's Elaine Ou on the DAO, smart contracts, law and metaphysics:
The DAO controlled $150M worth of ether, and an attacker exploited a bug to extract $60M of that. This current reality is unacceptable to many people.
The only way to get the ether back is to create an alternate reality where the attacker does not have anything.
“Invent a new version of the universe” is normally not permitted by the software protocol, which is why this involves a client update and a hard fork.
We've talked a few times about the difficulties that early smart contracts have with the fact that regular contracts are embedded in a world with legal rights and customs that come from outside of those contracts. Smart contracts that attempt to fully define the parties' rights in all circumstances, just like regular contracts that attempt to do that, will inevitably run into problems. And then what? Well, those contracts are embedded in a world too -- a world of code, the blockchain -- and so the solution is to recreate the world. I like the radicalism of Ou's description. You can't, like, amend the contract, or go to court to have it reformed for mutual mistake. That would be too old-school and squishy and normal. No, you just rebuild the universe from scratch, but in your new universe the contract never happened.
MASSIVE PILES OF MONEY is the best validator in the world. The amount of wealth contained in the DAO was a proxy measure for its security. With $152 million, the DAO was an invincible economic machine, “operating solely with the steadfast iron will of unstoppable code.”
Elsewhere in smart-contract dispute resolution: "P2P Markets Need P2P Justice."
Elsewhere in, I'm going to say, the intersection of millenarian faith and finance, discount rates are discontinuous around the end of the world:
We implemented this approach with members of a group that expected the “End of the World” to occur on May 21, 2011 by varying monetary prizes payable before and after May 21st. To our knowledge, this is the first incentivized elicitation of religious beliefs ever conducted. The results suggest that the members held extreme, sincere beliefs that were unresponsive to experimental manipulations in price.
The Republican platform will call for the return of Glass-Steagall, for some reason. (Jordan Weissmann: "Officially, the Republican party now favors rebuilding the wall between commercial and investment banking, which would lead to the dismantling of the United States' largest financial conglomerates, even though it's still decrying just about every other regulatory decision by the Obama administration as gross overreach.") "Any prohibition barring investment bankers from operating under the same roof as federally insured deposits would pose an existential challenge to Citigroup, JPMorgan, Bank of America, Wells Fargo and, to a lesser extent, Goldman Sachs," says the Financial Times.
Meanwhile, the Democratic party platform will call for more antitrust enforcement, though I am not holding my breath that it will call for a ban on index funds. And the S&P 500 is good at predicting presidential elections: "When stocks are higher in the months before a vote, the sitting party has won 86 percent of elections."
People are worried about unicorns.
Here is some straightforward unicorn worrying:
According to a new report from KPMG International and CB Insights, global deal activity for venture capital-backed startups continued a decline in the second quarter after hitting record levels one year ago. In fact, at the current rate, deal activity will just barely top 2013’s numbers.
I, meanwhile, am worried about this proposal that a tech entrepreneur should build a "politically correct keyboard" that "would work almost like spell check, but catching mistaken innuendo and inappropriateness instead of misspellings":
I would start by selling to HR departments. They would likely want some extra features for their employees like custom dictionaries, and the ability to blacklist certain words rather than simply suggest improvements.
At first a basic per-installation monthly charge for the PCK seems like the way to go, but over time you could imagine charging companies for the number of political correctness “saves” that the keyboard makes.
My expectation would be that over time there is a real networked data play with the politically correct keyboard where knowing who you are addressing will serve as a feedback loop to improve the correctness algorithm. With enough context and data, it will be possible for the PCK to have an index of pronouns, a personalized understanding of “trigger phrases” and all sorts of other context to help users get their phrasings right.
"Is it satire" is of course the wrong question; the right question, now and for the rest of 2016, is "is satire even possible?" Also here is Pooper, which is Uber but for dog poop.
People are worried about stock buybacks.
Here's Bloomberg Gadfly's Michael Regan on stock buybacks at banks:
For buyback skeptics, it could be easy to look at all of this as some sign of capitulation on the part of banks that have concluded they have no better ideas for deploying capital in the real economy. As Ernst & Young described it recently, investors "want to better understand why capital used for stock repurchases is not better off invested in human capital, innovation and other long-term strategies."
That may be a solid knock on some companies in some situations. But when it comes to banks, there's also an obvious motivation that is often ignored: They issued tons of shares to raise capital or buy competitors during the financial crisis, and buying them back now simply reflects continuing efforts to recover and normalize.
Though also, like, a bank is a bank. It's an intermediary; it's not (directly) building factories or researching cancer cures. The big complaint about buybacks, that they take money away from the research and capital expenditures that could lead to innovation and long-term value, just doesn't apply as strongly to banks. People who dislike stock buybacks mostly aren't clamoring for more financial innovation.
People are worried about bond market liquidity.
Bloomberg Gadfly's Lisa Abramowicz notes that fixed-income activity was up last quarter, but argues that it won't last: "one quarter does not signal a sustained turn in the business. Instead, it highlights the perfect storm for big debt brokers that will fade eventually." And then, back to worrying about liquidity.
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