EBay Arbitrage and Airline Competition
Here is a wonderful story about this simple Amazon/EBay trade: You notice that someone is selling a product for $39.99 on Amazon, you copy and paste his listing into EBay, but you set the price at $49.51. Then, if anyone buys from you, you just order it from him on Amazon, have him ship it to your buyer (use the gift shipping option), and pocket the $9.52 spread. That's it. The whole trade is just listing something online for a higher price than it's listed for elsewhere online, and hoping that someone pays you. Lots of people do, apparently. This is called "Amazon-to-eBay arbitrage," though "arbitrage" feels like too fancy a word for what it is. It is almost the opposite of arbitrage. Arbitrage is about noticing violations of the law of one price, and then trading in two markets to (make money and) bring prices into line. This is about noticing a perfectly sensible market with one price, and then creating your own, different price in a slightly different market, hoping that no one will notice. Arbitrage makes markets more efficient. This makes them more annoying.
The story is mostly about one Amazon seller who is hopping mad at the arbitrageurs who are reselling his product. (Which is: a cat toy.) Those sales have some negative economic effects on him (they lead to more returns and undermine "brand consistency"), though they also have an obvious positive effect (he still gets the $39.99 from each EBay sale). As a cold economic matter, it is hard to see why he cares so much.
But he does. People hate intermediation that doesn't look like it adds value. It's why people get so mad about high-frequency trading: It just doesn't seem like holding a stock for a few milliseconds could be a socially valuable thing, so anyone who makes money doing it must be doing something wrong. It's a moral judgment more than an economic one. Another Amazon seller even spoofed the spoofers, as it were:
Eric Wildermuth, who sells a line of children’s hats called Snuggleheads, came up with a particularly sneaky punishment: He bought his own hat from an eBay arbitrager for $27 -- and then, before the arbitrager could go to Amazon and make the purchase, Wildermuth changed his Amazon listing price to $199.
Ha! It is a game of cat-and-mouse, or cat-toy-and-Snugglehead, in the online reselling business.
Elsewhere in intermediation, here's a story about proposals "to build radio masts as tall as the Eiffel Tower" in "the tiny Kent village of Richborough" to make high-speed trading between London and Frankfurt ever so slightly faster. We've talked about one of those proposals before; it came with lovely before-and-after pictures of the English countryside with and without a giant pole. The poles are controversial, not so much because they would be eyesores but because people do not like intermediation:
Dover council’s website received more than 90 public comments on Vigilant’s plan, with one claiming the “only people to gain will certainly not live anywhere near this.” It received 178 public responses to the application by New Line Networks and one bemoaned “money-market traders” filling their “greedy boots.”
The trading firms "are considering a minimum 100,000 pound-a-year community fund as a sweetener," but again, the objection is not economic, but moral, and cannot be overcome with money:
“Absolutely not,” he said. “They’re just trading quicker than other people. One hundred thousand pounds? They probably do that in a few nanoseconds.”
Should mutual funds be illegal?
We've been talking for a while now about the idea that the growing ownership of U.S. public companies by diversified mutual funds might be bad for competition. The mutual funds own shares in every company in an industry, so they would prefer that those companies not try to undercut each other and grow the industry's overall profits, not their own share of the profits. This idea came to popularity last year because of a paper finding that mutual-fund ownership has reduced the competitiveness of the airline industry. This struck some people as a little weird, since airlines go bankrupt all the time, which you'd think would indicate a fairly competitive industry.
Also it's not like investors are calling up airlines and telling them to raise fares and avoid treading on each others' routes, right? Well, there is this:
Southwest Airlines Co. is resisting calls by some investors to pull back on planned expansion this year and raise fares, moves that could help stem declines in a key industry revenue gauge.
The carrier won’t join rivals in trimming capacity during the rest of this year, Chief Executive Officer Gary Kelly has said. Its unwillingness to take that step, which generally enables airlines to increase prices, is a disappointment to investors like Chris Terry.
“I’d like to see them boost their fares but also cut capacity,” said Terry, a portfolio manager at Hodges Capital Management Inc. “That’s what the market wants. That’s what the market is telling everyone. Supply growth is exceeding demand growth, and I don’t think that’s healthy.”
Hodges owns shares in airlines including United Continental, Delta, American, Alaska and Virgin America, as well as Southwest.
How are things at Bridgewater?
Bridgewater Associates is not happy with how it was portrayed in the New York Times the other day:
“The New York Times article doesn’t square with common sense,” the statement said. “If Bridgewater was really as bad as the New York Times describes, then why would anyone want to work here?”
I mean, I get it. It's always hard to know how seriously to take one disgruntled employee's complaint, and the Times headline -- "At World’s Largest Hedge Fund, Sex, Fear and Video Surveillance" -- was maybe a bit over the top. But "Bridgewater must be a good place to work because people work there" is an oddly literal efficient-markets argument coming from a hedge fund built on finding market inefficiencies. If these securities were really mis-priced, why would anyone want to own them? It doesn't square with common sense.
Ha, no, I kid. I am always more interested in the meta-efficient-markets argument for hedge funds, which goes like: If hedge fund performance is as bad, and fees are as high, as the press constantly says, then why would anyone -- including lots of sophisticated institutions -- want to invest in them? They must be doing something right. (Bridgewater's performance has been mostly pretty strong, and it's the biggest hedge fund in the world, so the argument has some weight there.)
Anyway, Bridgewater's response is full of interest. "Rather than being the 'cauldron of fear and intimidation' the New York Times portrayed us as," it says, "Bridgewater is exactly the opposite." (An ... umbrella over confidence and empowerment?) And despite its culture of saying negative things to people's faces ("Never say anything about a person you wouldn't say to him directly. If you do, you are a slimy weasel"), Bridgewater has "clearly defined channels for reporting private matters" that "have always been kept confidential." There is even "an anonymous 'complaint line'"; I hope the number is 1-800-S-WEASEL.
Elsewhere in investment managers with idiosyncratic interpersonal styles, Bill Gross will be the sole manager of his Janus Global Unconstrained Bond Fund again, as his co-manager Kumar Palghat moves on to co-manage an exchange-traded fund at Janus. Elsewhere in hedge fund meta-efficiency, and umbrellas, Howard Marks is not impressed:
“People have grown appropriately skeptical,” the billionaire investor, whose firm doesn’t manage hedge funds, said Thursday when asked about the $2.9 trillion industry on an earnings conference call. “The performance of the greatest hedge funds, run by geniuses, created a huge umbrella over this industry, which permitted the other 9,990 hedge fund managers to start hedge funds and command hedge fund fees.”
And elsewhere in efficient markets generally, here's a story about a Pokémon Go player finding $2,000 on the ground. "If there were really a Snorlax on this sidewalk someone would have already picked it up," etc.
Subordinated bank debt.
We've talked a bit recently about the "credible losers" problem in bank funding. The problem is that bailouts are bad (they cost money and create moral hazard), so when banks lose money you want to impose the losses on investors who agreed to put their money at risk. But some people who fund banks -- depositors, for instance -- aren't, or shouldn't be, in that category. You want the deposits to be safe. You want the losses to fall on other investors, investors who knowingly took risks and were compensated for them. Then, when those people are at risk of losing money, the government can shrug and say "you knew what you were getting into," rather than bailing them out.
But this is not a simple matter of security design; naming something "subordinated debt" does not make it a good risk-bearing instrument. Not if you sell it deceptively to middle-class pensioners:
At the zenith of the financial crisis, between July 2007 and June 2009, 80 percent of Italian banks’ bonds were sold to retail investors, according to regulator Consob. Through savers, banks funded themselves at a similar cost to the Italian government, whereas they gave professional money managers an extra percentage point in debt interest, the 2010 report found.
Ehh that is not great. And so when four small banks failed, "the government approved a decree in April to let bondholders of the four failed lenders banks be reimbursed for as much as 80 percent of their holdings if they have gross annual income of less than 35,000 euros or personal assets of less than 100,000 euros." Subordinated debt is not supposed to get a bailout, but it is also not supposed to be sold to people who don't understand it and can't afford to take the risk inherent in it.
Elsewhere, here are Gary Gorton and Tyler Muir on the liquidity coverage ratio and the pre-deposit-insurance National Banking Era:
New laws and regulations adopted since the financial crisis of 2007-’08 are reminiscent of this earlier period. They do not address the issue of the unintended consequences of forcing government money (Treasuries) to back short-term bank debt (repo) one to one. The National Banking Era shows that a system of immobile collateral contributes to a shortage of safe debt and encourages other forms of short-term debt to emerge, making the financial system riskier.
Yesterday was a good day for tech earnings: Amazon beat estimates and is "really putting the narrative that this company can't be profitable to rest," while Alphabet/Google beat estimates and "celebration ensued." This morning was a glum day for European bank earnings. "Barclays, the British bank, said on Friday that its profit had fallen 41 percent as it accelerated its plans to sell or close businesses and assets that it no longer considered crucial to its strategy." "UBS said on Friday that its profit tumbled 14 percent in the second quarter compared with a year earlier, as uncertainty about the financial markets continued to weigh on its wealth management and investment banking businesses." One gets the sense of an industry in its prime and another in its decline.
On the other hand, "predictions that banks are about to be disrupted by tech-driven upstarts are starting to look a bit like LendingClub Corp.’s stock":
It’s not that the upstarts -- often called fintech -- are failing to gain traction. Internet ventures pitching loans to cash-strapped consumers, small businesses and home buyers, for instance, have posted spectacular growth in recent years. It’s just that banks have a huge lead in lending and are watching the startups closely. As borrowers embrace new services, traditional firms are riding along.
Here is Katy Lederer on Sam Polk's new memoir about making too much money at a hedge fund: "Though it glosses at first as a trading-desk memoir, the volume is in fact an account of addiction and recovery." (The addiction being to money, though of course it's a trading-desk memoir so there are also drugs.) And:
In an astonishing scene that takes place on Fire Island, he persuades his mother and three siblings, at Linda’s behest, to dig a “shame” hole in the sand and whisper into it their life’s humiliations. In a typical addiction memoir, this New Age approach would come off as hackneyed or schmaltzy, but in a memoir set on Wall Street it is riveting.
It's true, that is not usual hedge fund behavior. Would you be surprised if Bridgewater made employees dig shame holes in the sand and whisper all their humiliations into the holes? And recorded what they whispered?
People are worried about duration.
Here's Bloomberg's Tracy Alloway on "Three Things That Show Investors Are Making a Huge Bet on Low Interest Rates"; all of the things are basically about investors accepting more and more duration risk. And here is Ben Inker of GMO:
Over the last six or seven years, most financial assets have done very well. The performance divide has not been between low-risk assets and high-risk assets or between liquid assets and illiquid assets, but between long-duration assets and short-duration assets. Long-duration assets such as stocks, bonds, real estate, and private equity have benefitted from a large fall in the discount rate associated with their cash flows, while short-duration assets have been hurt by the same fall. Investors tend to tilt their portfolios in favor of those assets that have done well, and today that pushes them to be increasing effective duration in their portfolios, just when the potential returns to those assets have dropped.
People are worried about unicorns.
I don't have much about venture-backed private tech startups valued at more than a billion dollars, but here is a little parable about the Ethereum "hard fork" that involves unicorns:
Some islanders were skeptical at first, but went all in after the gang leader told them that the Rules had been carefully verified by the best legal experts in the world, and swore that they would be followed to the letter, no matter what. They could be sure of that, he said, because the sheet with the Rules had a seal with a picture of the Invisible Blue Unicorn on it; and that meant that, if the Rules were broken, all Unicorn bills would become worthless.
Et cetera. Elsewhere in Ethereum hard-fork news, the latest fun is the "replay attack." (Explained here, here and here.) Basically when the Ethereum blockchain was forked to deal with the hack of the DAO, everyone ended up with new ether (the Ethereum currency, ETH) on the new blockchain, and also old ether (ETC) on the old blockchain. And then people sort of figured out a way to steal the old ether, or I guess more charitably, to get some old ether for free. Because the old blockchain is still functioning and ETC still has some value -- because it's impossible to get blockchain enthusiasts to do anything unanimously -- this is, I suppose, bad. Don't forget, this is the future of banking, and money, and the Postal Service.
People are worried about bond market liquidity.
Remember the Third Avenue Focused Credit Fund, the great cautionary tale about bond market liquidity? It invested in some illiquid bonds, got redemption requests, couldn't satisfy them, and so "halted redemptions in December and spurred a selloff in the high-yield market." Third Avenue is now thinking about selling the fund as a whole, and has hired Houlihan Lokey to shop it. I am ... not sure I understand:
Since it halted redemptions, the fund has been selling assets and has made two distributions to investors. It is possible that by selling a chunk or all of the fund at once, it could appeal to buyers looking to acquire large positions at once or who want to get into the mutual fund business.
I mean, I get the thing about acquiring large positions at once. Buying the whole fund might be appealing to a buyer who thinks it could get a discount on a big chunk of distressed debt, and might end up with a smaller discount than Third Avenue would get by selling one position at a time. But "get into the mutual fund business"? Like ... you'd re-open this fund? What would your marketing pitch be? "Sure we closed down once, but we're under new management with the same assets, and everything will be better." Surely getting into the mutual fund business with no track record is easier than getting in by buying a disastrous track record? This makes sense as a sale of the fund's assets, but not so much as a sale of the fund as a business.
Elsewhere in buying somewhat scuffed funds, "AllianceBernstein Holding LP said it ended its effort to buy Visium Asset Management’s Global Fund." And elsewhere in bond market liquidity, here is Alexandra Scaggs on the Financial Industry Regulatory Authority's proposal to require daily reporting of trades in Treasury securities.
Time for a drink.
I mean it's like 9 a.m. in New York, it's not actually time for a drink, come on, but at 4 p.m. today Long Island Iced Tea Corp. will be ringing the Nasdaq closing bell, and on a summer Friday that will be all the excuse you need. Sadly Long Island Iced Tea Corp. produces regular iced tea, not Long Island iced tea, though it is based on Long Island, and it has "begun exploring the development, production, marketing and distribution of alcoholic beverages."
Elsewhere, Joe Weisenthal is a gold bug now. "Gold is a physical and visual manifestation of raw power," he says, because all property is theft and all property rights are socially constructed out of power relationships.
Bank of Japan Takes Modest Easing Action. The Unraveling of Harvard’s Star Trading Desk. Apple’s Hard-Charging Tactics Hurt TV Expansion. Apple Taking Another Bite At Bond Market. Stiglitz Calls Apple’s Profit Reporting in Ireland ‘a Fraud.’ Wall Street Said to Face Renewed Pressure on Risky Lending. U.S. Stock Markets Have Become a Lot Less Exciting This Month. The Operational Consequences of Private Equity Buyouts. Deutsche Bank Said to End Latvian Lenders’ Dollar-Market Access. U.S. Prosecutors Probe ‘Panama Papers’ Law Firm’s Employees. SEC Obtains Asset Freeze in Case of Investor Funds Stolen for Shopping Sprees. Regulators Around Europe Are Saying Pokemon ‘Stop.’ Metallica Pokémon. Cabana wi-fi. CBC programming terrifies British badgers, study suggests. Police asked this 3D printing lab to recreate a dead man’s fingers to unlock his phone.
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