Home Equity and Bad Apples

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.
Read More.
a | A

Point!

If you want to own a thing, there are basically three ways to pay for it:

  1. With your own money.
  2. Borrowing money from someone else.
  3. Selling equity in the thing to someone else.

No. 1 is pretty much always an option, if you have enough money, but often people don't. No. 2 is also pretty universally available; you can borrow money to start a business, or buy a house, or finance a college degree, or get a cup of coffee on your credit card.

No. 3, selling equity, is actually of very limited use. Lots of businesses are owned jointly by partners, or financed by selling equity to friends or family members, but I think it's fair to say that the market for equity in hardware stores is less robust than the market for bank loans to hardware stores. The costs and risks of underwriting and appraisal and monitoring lead outside financing sources to prefer debt -- where their return is fixed, senior, and paid back at known times -- over just owning a chunk of the business. Public companies, and private ones that are big or hope to become big, sell equity to outside investors, but they are in a broad sense exceptional.

And that's kind of it. Businesses are financed with outside equity, but not much else is. You can't fund your cup of coffee by selling equity in it, or in yourself. 

But there is a widespread, and not unfounded, sense these days that Debt Is Bad, and so people are constantly trying to think up ways for people to fund their lives with equity rather than debt. It's huge in the education-finance space; I have lost track of all the proposals to let students sell stock in themselves -- that is, a portion of their future income -- to pay for college. Here are the Verge, the Economist, Slate, the Wall Street Journal and Fusion on some of these efforts. The federal government has gotten into the buying-equity-in-students business, sort of. I wrote a paper on the topic in law school, over a decade ago, when the big student-equity idea was the implausibly named MyRichUncle. (It filed for bankruptcy in 2009.) Each time I see a new one, I sort of look away in embarrassment at my youthful enthusiasm for the idea.

Also houses. People have been talking forever about letting homeowners sell a share of the equity in their house. Here's Bloomberg in 2013, and MarketWatch earlier this year. Here's Bloomberg Businessweek in 2014, on Atif Mian and Amir Sufi's proposal for "shared responsibility mortgages." Here's Robert Shiller, in 2008, on the related topic of "Derivatives Markets for Home Prices"; here are Shiller and Allan Weiss in 1999 on "Home Equity Insurance." The basic concept is appealing enough. Homeowners get to diversify, putting less of their net worth into their house and more into the stock market or whatever. Investors also get to diversify: They can invest in 10 percent of a bunch of different houses, instead of just buying one investment property. 

Yesterday Andreessen Horowitz, the venture capital firm, announced that it had led a Series A funding round for Point, another company looking to let people sell equity in their homes. "I thought, why can’t you sell a fraction of your home," says Point's co-founder, in what I guess is the company's origin story, and the origin story of all of these efforts.

The technical details of the Point product are perhaps not completely clear from its website, and the uncertainty has sent financial Twitter into a tizzy, but the gist of it seems to be that Point gives a homeowner (say) 10 percent of the value of her house in exchange for (say) 20 percent of the appreciation. When the house is sold or refinanced at a gain, Point gets back its principal plus appreciation; if it is sold or refinanced at a loss, Point ... shares somehow in the loss. (Point's downside appears to attach at some "risk adjusted property value" that is below the initial value of the house, so it may not share 1-for-1 in the losses.) If the house isn't sold or refinanced, the homeowner has to pay Point back in 10 years, with appreciation based on an appraisal at the time. Loosely speaking, the homeowner is selling equity in her house, plus additional warrants for more upside exposure, plus perhaps giving Point some downside protection. And she is guaranteeing Point liquidity in 10 years. Also there's a 3 percent up-front fee. Point sells its exposure to investors.

For the homeowner, that may still be attractive financing versus mortgage debt; unlike a mortgage, Point doesn't require monthly payments. For the Point investor, you know, it's an investment. "There are few asset classes that have outperformed super-prime real estate in the last 60 years," says Andreessen Horowitz, and Point investors seem to be getting more than their pro rata share of the appreciation in the houses that they invest in. (The focus seems to be on super-prime for fairly obvious reasons. You're more likely to get paid back!) The basic deal is: If you get money from Point and your house price goes up a lot, you wish you had just gotten a bigger mortgage instead. If your house price stays flat, Point is a better deal for you. For the homeowner, it's a bet against housing prices; given that home ownership is a huge bet on housing prices, that could be a sensible hedge. Whether it is sensible depends on the details of the pricing; selling 10 percent equity in your house at the market price seems like a no-brainer, while selling 20 percent equity at the price for 10 percent might require some more thought.

Anyway, Point is now valued at $32.4 million, and "has so far written more than 50 cheques averaging $80,000 each to homeowners," meaning that it is something like 0.00004 percent of the residential mortgage market so far. I am of course in favor of all of this sort of structuring in the abstract, but long experience has taught me to temper my enthusiasm for the early stages of plans to turn debt into equity. It's so popular an idea that it seems like it has to eventually work, but it hasn't really yet.

Wells Fargo.

I really cannot recommend highly enough this article about an interview with John Stumpf, the chief executive officer of Wells Fargo & Co., which last week announced $185 million in settlements because employees had opened at least 2 million accounts for customers without the customers' permission. Wells Fargo has fired 5,300 employees for doing that stuff over the years, and Stumpf wishes that the number were lower:

“I wish it would be zero, but if they’re not going to do the thing that we ask them to do—put customers first, honor our vision and values—I don’t want them here,” he said. “I really don’t.”

Yes right that's why you fired them, but the question people have is: Why were there so many of them? 

“The 1% that did it wrong, who we fired, terminated, in no way reflects our culture nor reflects the great work the other vast majority of the people do,” he said. “That’s a false narrative.”

You hear bank CEOs say that sort of thing all the time when a few rogue employees do bad stuff that incurs a big fine for the bank, but there are never 5,300 of them. It is the sorites paradox of "a few bad apples": If one or two or eight rogue employees don't reflect the broader culture, why should 5,300? Really there is no principled place to draw the line, and I look forward to a bank CEO one day saying "the bad actions of 95 percent of our employees in no way reflect the values and culture of the other 5 percent."

"There was no incentive to do bad things," says Stumpf, implausibly. Why did 5,300 people do bad things if they had no incentive to do so? These 5,300 employees were fired because they responded to Wells Fargo's aggressive cross-selling goals, not by convincing customers to open more accounts, but by opening fake accounts for those customers. The more interesting question to me is how many people Wells Fargo fired during the same time period for failing to meet the sales goals -- for responding to Wells's impossible requirements with honest failure rather than dishonest success. (I asked Wells Fargo, but a spokesperson told me that they don't have that data.)

In any case, despite Stumpf's defense of the incentives, Wells Fargo has "eliminated product sales goals for its consumer bankers." "We think we can adapt our business model, take sales goals out and still have a growth culture with people trying to deepen relationships with customers," says the chief financial officer. I suppose this should not be surprising, and yet I am a little surprised. It seems obvious to me that you can have an aggressive sales culture without fraud, or at least without the particular kind of fraud that Wells Fargo found. As I said yesterday: "If Wells Fargo had kept its brutal and aggressive culture of cross-selling, but just had a filter to reject new accounts with fake e-mail addresses, it still could have made the tens of billions of dollars on cross-selling, without defrauding any customers or incurring any fines or scandals." You'd think that Wells Fargo could have responded to the scandal by tightening up its fake-account checks, not by totally jettisoning the sales culture that made it so successful. But it went with jettisoning the sales culture, which suggests that the problem was even bigger than I thought.

In other Wells news, it is no longer the world's most valuable bank by market capitalization, a ranking that pretty much corresponds to "mega-bank whose big scandal was least recent." And the Wells debacle has come at a very good time for the Consumer Financial Protection Bureau, which congressional Republicans are trying to kill, an effort that seems less promising after Wells Fargo's 2 million fake accounts. Turns out consumers need financial protection!

Space blockchain!

Shh, shh, here are words: "An organization offering cryptocurrency to promote solar power generation has signed a deal to purchase data center capacity in space in order to secure its blockchain wallets from hacking."

"SolarCoin will be able to provide its customers with an inviolable record of their transactions, and parties can be recorded and viewed via the internet," a Cloud Constellation spokesperson said in the company's statement on the deal. "[SolarCoin Foundation] will purchase space on the SpaceBelt network to securely host its Cold Storage Vault and protect its $5 billion treasury of SolarCoin currency. When operational, SolarCoin will be the first currency transaction sent to and from space."

Obviously people will sign up for this, because: space blockchain! The trick to marketing anything bitcoiny is to make it as science-fictiony as possible; that's why one of the biggest bitcoin exchanges was named for Magic: The Gathering. And obviously it will be hacked, because all cryptocurrency projects are eventually hacked. And obviously Money Stuff will one day have a section headlined "Space blockchain hack!" And we'll all chuckle, because: space blockchain hack! It all seems so drearily inevitable. Maybe the hackers will be aliens? That would be fun.

Elsewhere, here's an art show about blockchain at a Chelsea gallery:

For this exhibition Denny will present three different platforms highlighting the differences in each company’s utilization of blockchain and the political and ideological differences these are based on. Their aesthetic context and geo-political ecosystems are imagined through a global diagram, a community of computer Case-Mods and other sculptural infographics. The exhibition maps the myths, dreams, winners and losers of the global game of governance design. Artworks borrow their forms from the hardware of competitive gaming – with oversized special editions of the board game “Risk”, personal computer cases turned corporate “deal toys” and cartoonish entrepreneurial “players” in a land-grab for the decentralized, encrypted infrastructure of possible self-governing future worlds.

I am increasingly convinced that the boundaries between art and finance have collapsed, and that the regular activities of finance -- trading stocks, making stock charts, explaining the blockchain using infographics -- now qualify automatically as Art. I wonder if there's a gallery out there that will put on a show that is just me typing Money Stuff every morning for a week.

Hedge funds.

The Delivering Alpha conference was yesterday. Carl Icahn endorsed Herbalife in these words:

“They make some good products, I believe. I personally don’t like the drink. I drank it, gave me a lot of gas. I didn’t like it,” Icahn said. “But a lot of people love the damn drink.”

He also endorsed Donald Trump. He seems to have been in the minority: "When Avenue Capital's Marc Lasry then asked the room how many would do business with Trump, no one raised a hand." 

Meanwhile the hedge-fund world is not just male-dominated; it is bizarrely, anomalously male-dominated, in a way that is perhaps not immediately apparent:

Women are very much present in compliance, marketing, and operations roles, but largely absent from investing jobs, the crux of the industry.

Industrywide, only 3% of senior investment roles in hedge funds were held by women in 2012, according to a 2014 article in the trade publication CIO.

Three percent! The hedge fund industry has managed to go from a scruffy niche product into a massive institutionalized asset class without ever fully institutionalizing itself. If you are just two guys running some money and you need a third guy, you probably hire a guy you know. But that model scales awkwardly to an entire giant industry. At some point you might want a more careful and comprehensive recruiting process. But, nope: "Positions are not usually publicly posted, so jobs are found through networking, which tends to be stronger among men," and:

Another recruiter, David McCormack, CEO of DMC Partners, says he rarely gets requests by hedge funds to provide a diverse slate of candidates.

"Hedge funds just want the best performers in the industry," he said. "It isn't driven by diversity hiring."

Given all the recent stories about hedge-fund mediocrity, it is not clear that hiring a guy who knows your guys is the way to get the best performers either.

Whiz kid.

Here is a $1.5 million Securities and Exchange Commission settlement with "self-proclaimed 'stock trading whiz kid' and his stock newsletter company in Los Angeles" for, you know, exactly what you'd expect. "I’ve created a tool that can predict the exact movements of select stocks at an exact point in time, all with unprecedented precision!” Etc. etc. etc. I do really like that his newsletter company is called "Wealthpire" though. Is that, like, build an empire of wealth? Or is it, like, this newsletter is a vampire for your wealth? Who knows. Wealthpire's website is still online, with the lovely headline "Screw Up ALL Of Your Trades And Still Bank Gains Every Month," which I guess the SEC is cool with?

It's not boring.

"Traders who complained all summer about markets stuck in a zombie state are getting what they wanted," and isn't that so nice? Not just that there's been a ton of volatility this week, after months of investors complaining about dull markets, but also that the timing is so perfect. You get the summer off, you come back after Labor Day, and, boom, wild markets. The market is a brilliant coordination mechanism for aggregating human desires, and it seems like all the humans in the market really wanted a quiet summer. The system worked.

On the other hand, volatility has people worrying about risk parity funds again. It seems weird that there's never been a "people are worried about risk parity funds" section of Money Stuff. They are a popular menace. 

People are worried about non-GAAP accounting.

Congratulations to Perrigo, which leads the GAAP gap league table:

In its full-year 2015 report, Perrigo listed $1.09 billion in adjusted profit. The word “loss” was used sparely, despite a net loss of $33 million using non-adjusted accounting that adheres to Generally Accepted Accounting Principles, known as GAAP.

It was the biggest percentage disparity last year between adjusted and GAAP figures among companies in the Standard & Poor’s 500 index, according to data compiled by Bloomberg.

People are worried about unicorns.

Shh, shh, here are some more words:

“Can I scan you really quick?” asked Audia Tulloch, the booth host at iTutorGroup, an online tutoring platform. Earlier that morning, a handful of iTutorGroup representatives had done yoga inside the booth area. “We’re entering you to win an Oculus, HTC Vive, or Beats headset,” Tulloch said, scanning the barcode on this reporter’s name badge. The online tutoring sessions on iTutorGroup “promote live H2H,” which means human-to-human interaction, said Emily Schne ider, a spokesperson. “It’s different than a YouTube channel.”

That's Will Alden reporting from "TechCrunch Disrupt, the San Francisco trade show for startups," an Enchanted Forest all its own.

Elsewhere, here is Izabella Kaminska being very skeptical about Uber's $62.5 billion valuation:

In this way, investors preoccupied with FOMO seem to have missed that for a bespoke chauffeur driven service to be readily available to anyone 24/7 at a price that is competitive with public transport, the ratio of spare drivers to potential riders at peak times must be 1:1. Extend that logic to off-peak times and you realise that for every potential user there must be a score of drivers or more sitting idly in standby mode to accommodate that luxury. Unless every single one of those drivers has a secondary job that doesn’t require any real commitment, that’s tantamount to the re-establishment of an upstairs downstairs server-master model, afforded by subsistence wages on labour’s part.

That makes it pretty clear why Uber is so interested in driverless cars, though Kaminska also argues that it has no particularly obvious advantages in building and owning a driverless car fleet either.

People are worried about bond market liquidity.

I mean, here is "Bond-Market Selloff Deepens as Money Managers Pile Into Cash," but no one actually seems to be complaining about liquidity? We have discussed this phenomenon before: "Bond market liquidity" is a fair-weather complaint; when things actually get bad, people talk about prices dropping, not about liquidity.

Things happen.

Bayer Clinches Monsanto Deal For $66 Billion With Fourth Bid. U.S. Household Incomes Surged 5.2% in 2015, First Gain Since 2007. Fed Proposes Ban on Merchant Banking, a Practice With Little Risk. Goldman Sachs Fund to Buy Secondhand Stakes in Private Equity. There’s a $300 Billion Exodus From Money Markets Ahead. Libor’s Reaching Point of Pain for Companies With High Debt. M&A synergies are overrated. Berkshire Hathaway and underwriting unit sued for running ‘reverse Ponzi scheme.’ Tucker Max in the Harvard Business Review, why not. How to Talk to Your Kids About Money When You Have a Lot of It. "In Berlin, techno can now officially be considered high culture." Adrian Grenier Lives Every Day Like He’s at Burning Man. Gorilla naming hoax.

If you'd like to get Money Stuff in handy e-mail form, right in your inbox, please subscribe at this link. Thanks! 

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