Senate Hearings and Friendly Mergers

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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Happy Wells Fargo hearing day.

Today at 10 a.m. the Senate Banking Committee will roast Wells Fargo & Co. Chief Executive Officer John Stumpf about the millions of fake accounts that his bank set up for unsuspecting customers, so tune in if you like that particular sort of comedy. It should be a good time. I don't exactly expect much insight from the hearing? There seems to be an unshakable notion that Wells Fargo's fake accounts were a diabolical plan hatched at the highest levels, that Wells Fargo's senior management wanted to set up all the fake accounts because they were somehow good for them, that maybe Stumpf will break down in the hearing and confess that he masterminded the whole thing.

But the reality seems to be messier and more boring: Wells Fargo wanted its employees to push lots of real accounts, it asked too much of them, and the employees rebelled by opening fake accounts to get the bosses off their backs. The fake accounts weren't profitable for Wells Fargo, and no rational executive would have wanted them, which is why Wells Fargo kept telling the employees not to open them. But the employees did anyway because they felt like they had no other choice. It was not an evil high-level plot. It was just dumb. It was a form of employee resistance that was channeled into fraud by bad incentives and bad management. There is a limit on how many times you can ask a guy in a hearing "this thing you did was pretty dumb, wasn't it?" Though look for the Senate Banking Committee to test that limit.

Anyway here is Stumpf's prepared testimony. Here is an article about his "apple-pie image," at least compared to the other big bank CEOs, which is now a bit spoiled. Here is an article about Carrie Tolstedt, who was in charge of Wells Fargo's branch network before deciding this summer that it was "time to go back to Nebraska, time to go home." Here is a list of proposed questions for Stumpf from the Wall Street Journal.

Meanwhile, "the Justice Department was kept in the dark until the last minute about the San Francisco-based bank’s alleged fake accounts and its $185 million fine," in an odd failure of regulatory coordination. "Hillary Clinton is jumping on the Wells Fargo & Co.-bashing bandwagon, issuing an 'open letter' to the bank’s customers touting her campaign’s proposals to rein in rogue financiers." And the Wells Fargo scandal has led to calls for stronger clawback requirements.


Assume for a minute that the proposed acquisition of SolarCity by Tesla is (1) clearly good for SolarCity and (2) clearly bad for Tesla. The deal requires separate votes of the independent shareholders (meaning, more or less, the ones who aren't Elon Musk) of both companies. On those assumptions, will it go through? The natural thing to think is that SolarCity shareholders will vote yes (because the deal is good for them), and the Tesla shareholders will vote no (because the deal is bad for them), and the deal will fail. But this analysis is confounded by the fact that SolarCity shareholders and Tesla shareholders are the same shareholders:

Musk watchers on Wall Street are still predicting he can pull it off, and go on to raise fresh money from investors. A main reason: The two companies have many of the same big stakeholders, after the biggest of all, Elon Musk, who’s chairman of both and chief executive officer of Tesla.

If you own shares in both companies -- like, say, Fidelity, which owns 11.62 percent of SolarCity and 13.95 percent of Tesla -- then it is pointless to make one decision in your capacity as a SolarCity shareholder and another in your capacity as a Tesla shareholder. You should just make a decision on the deal, based on your overall economic interest, and then vote all your shares that way. If there are enough overlapping shareholders, then that will decide the deal. And, "Musk aside, seven of the top 10 Tesla owners have chunks of SolarCity."

We talk a fair amount around here about the effects of cross-holdings on competition. There is a hip theory that mutual funds who own large stakes in multiple companies in the same industry may depress competition in that industry, and that antitrust regulators have not been appropriately attuned to the dangers posed by cross-holdings. But I feel like that is just a subset of a broader issue, which is that our notions of corporate law and governance really come from a time when shareholders were relatively small and un-diversified, and we don't quite have the terms and categories to deal with the modern world of giant diversified asset managers.

So Tesla needs a special committee and independent advisers and rigorous procedures to protect its shareholders from the risk that Elon Musk will force them into bailing out SolarCity. But what if those shareholders -- or many of them, anyway -- want to bail out SolarCity? Because it is in their aggregate interest? At some point it will start to seem odd that corporate governance focuses only on shareholders' interests as owners of a particular company, rather than their interests as diversified investors in the broader market.


Well here is just a delightful yarn from Michelle Celarier about Carl Icahn's maybe-efforts to sell his Herbalife stock, some of it maybe to Bill Ackman, which fell apart when Icahn couldn't get a high enough price. Icahn didn't think he should have to sell at much less than the market price:

For his part, Icahn had long maintained that he could sell when he wanted to, and not have to take much of a, or any, discount. Icahn “has never had trouble selling large blocks,” says one source close to him. Icahn, this source adds, even maintained that Herbalife’s shares could actually rise when he sold. Without him as an investor, Icahn argued in a sort of circular logic, Herbalife could simply trade on its fundamentals. No more worrying about what would happen if he sold.

But Jefferies, which was marketing the shares, couldn't persuade buyers of that logic:

Finally, on Aug. 25, Jefferies was able to put together a bid. A group of institutional investors were willing to pay $51.50 a share for more than 11 million of Icahn’s Herbalife shares, according to individuals familiar with the situation. Ackman was not part of the group.

That bid would be about 17% less than the near $62 per share Herbalife was trading at—a discount traders say is almost unheard of in such block sales.

So Icahn said no. And then the story broke, helped along by Ackman, that he'd been looking to sell. And then Icahn sort-of-denied the story ("I have never given Jefferies an order to sell any of our Herbalife shares," he said, which is not quite the same as denying that he'd asked them to look for buyers), and ended up buying even more shares.

How do you interpret that decision? There is of course the simple reading: Icahn and Ackman really like to mess with each other, Ackman annoyed Icahn (and drove down the stock price) by talking about his selling efforts, and so Icahn annoyed Ackman back (and drove up the stock price) by buying more. There is no economic logic to it; it is just a game of bullying and counter-bullying.

The alternative reading is that all of Icahn's decisions were economically motivated. He wanted to sell, at a nice profit, in the $60s. He thought that was the right price. He looked discreetly for buyers at that price. He couldn't get any, and Ackman blew up his discretion and the stock tanked. So he doubled down on his enthusiasm for Herbalife, knowing that his own involvement is a major factor in determining the stock's price, and figuring that a show of confidence would drive up the price so that he can one day sell it in at least the $60s. Icahn proved his confidence by putting up money, but expects to have that confidence rewarded in profit later.

If you do any of this too fast -- if you put it about that you're selling and then buy when the stock drops, or if you buy to push up the price so you can sell -- it can look a bit unsavory. (Is it "spoofing"? "Manipulation"?) But at the level that Icahn is playing at -- with enormous scale and publicity, and with plenty of time -- those critiques seem beside the point. It's a big poker game with Herbalife's shares, and Icahn is very good at that game, or at least very entertaining to watch. 

Elsewhere, Icahn sold more than half of his Chesapeake Energy shares, "for tax reasons."

Blockchain blockchain blockchain.

The advantage of a blockchain is that it is an immutable record of transactions that is maintained and validated by everyone who uses it, without the need to trust a single central administrator, which is why this is such a delight:

Accenture is courting controversy in the blockchain community by patenting a technique for editing information stored using the nascent technology in a move designed to make it more commercially viable.

By allowing a central administrator to amend or delete information stored on a blockchain, the consultancy says that its prototype — to be unveiled on Tuesday — will make the technology more attractive to the financial services industry.

Hey look guys. If you want Accenture to run a ledger keeping track of all your transactions, and you trust Accenture to modify it, you don't need a blockchain. Accenture could just write down a list of transactions, like in a relational database, or Excel, or on a legal pad. The technological question of how to create a ledger maintained and modified by a central administrator is completely solved. It was solved by the invention of the ledger. 

I have said before that the blockchain seems to solve a sociological problem in finance: Blockchain's weird popular appeal has gotten banks and other market participants to focus their energy on making back-office settlement procedures more efficient, even if improving those procedures doesn't strictly require blockchain technology. But you can get a lot of that sociological effect by just saying the word "blockchain." If you hold a meeting about using the blockchain to reform settlement procedures in the syndicated loan market, every bank will show up. And if, when they get to that meeting, you tell them that your blockchain will be centrally administered in pen in a spiral-bound notebook and that every transaction will require a faxed signature page on letterhead, they won't bat an eye. Just mumble something about a "hash function" and you'll be fine.

Three crude assumptions that seem to explain a lot of the blockchain craze are:

  1. Banks want some blockchain.
  2. They don't really know why.
  3. They definitely don't want to tie their fortunes to the messy bitcoin blockchain.

This leaves a lot of room for ... let's say innovation, in the blockchain space? The bitcoin blockchain's purpose was to serve bitcoin's needs and values, to find a way to create a decentralized immutable ledger of transactions that is open to everyone without permission and doesn't require trust in any single authority. Once you abandon those requirements, you can make up pretty much anything you like and call it a blockchain.

Elsewhere, here's a new draft of the "Ethereum 2.0 Mauve Paper."

Merchant banking.

Here is an argument from Saule T. Omarova that big U.S. banks shouldn't be allowed to engage in merchant banking, despite its long history:

The original European merchant banks were small private partnerships that took a lot of risk with a lot of their own capital. They did not take federally insured demand deposits from the general public who had no means of policing their affairs. They did not run a nation’s payments system. And their failure could hardly have pushed the global economy into a severe crisis followed by protracted recession.

I think a lot about path dependency in financial regulation. Take the Volcker Rule. It is hard to distinguish "proprietary trading" from "market making," and so the Volcker Rule is probably over-broad and has reduced market making by big banks. That is bad. (For bond market liquidity, etc.) But one obvious answer is: Well, why should banks be in the business of bond market making? They didn't used to be, under Glass-Steagall. But with time and deregulation, they got into that business, and now it's very hard to get them out of it. There aren't that many other people to do it! The banks have big funding advantages, so they are good at market-making, and it's hard for underfunded entrants to compete with them. So the big banks remain the dominant market makers, and any regulation that banned them from market making -- or even one that, like Volcker, restricted their market-making activities a little -- would initially be bad for markets.

Anyway merchant banking is a little like that, though less important. In some abstract sense, Goldman Sachs really should be allowed to keep its merchant bank. It just seems like a Goldman-y thing to do. (Disclosure: I used to work there.) But in another sense, merchant banking and insured deposit-taking probably should be different activities. The anomaly is that now Goldman Sachs is a deposit-taking bank, and everything that people thought they knew about banking for centuries is not quite true anymore.

Elsewhere, a lot of partners are leaving Goldman Sachs's securities division.

People are worried about unicorns.

"Jack Ma’s Finance Business May Be Worth More Than Goldman Sachs," it says here, about Alipay and its parent, Ant Financial, which we have previously discussed -- with visual aids! -- as the world's first ant unicorn (Formica elasmotheriosa). It's a public-company affiliate, so I am not sure it quite qualifies as a unicorn, but if it does, then it might be an even bigger unicorn than Uber: A research analyst values it at $70 billion.

People are worried about bond market liquidity.

In bond-liquidity-adjacent news, here is a working paper from the European Systemic Risk Board on "Liquidity transformation in asset management: Evidence from the cash holdings of mutual funds," which finds "evidence suggesting that mutual funds’ cash holdings are not large enough to fully mitigate price impact externalities created by the liquidity transformation they engage in." I assume we have been over this enough that you know what that has to do with bond market liquidity.

And in not-really-liquidity-at-all news, here is Alexandra Scaggs worrying about what will happen if coupons on floating-rate bonds (mostly residential and commercial mortgage-backed securities and collateralized loan obligations) get below zero. I worry less about this, not only because most of these bonds have pretty large spreads to Libor that would require rates to get really negative before the coupons went negative, but also because most of them are linked to Libor. "Interest rates" may be generically low or negative, but Libor has stayed stubbornly high and even risen as banks' demand for short-term unsecured funding has gone up even as the supply from money market funds has gone down. If you bought securities indexed to Libor because it seemed like a generic risk-free interest rate, then I guess the banks' and mutual funds' problems have come as a pleasant surprise for you.

Me yesterday.

I wrote about love-struck accountants.

Things happen.

Deutsche Bank is working on a synthetic collateralized loan obligation for capital relief. Theresa May canvasses Wall Street over Brexit. Sector Switch Trips Up An ETF. Steve Eisman said some funny things about online lenders and the financial industry. Star Names Struggle as Smaller Hedge Funds Make Hay. Two of Fed’s Own Primary Dealers Warn Shock Hike Awaits Markets. Markets Tighten Ahead of Fed. Guess which market someone said this about: "This whole year has been a big readjustment, a much-needed one, like a chiropractic session." US business schools hit by weaker demand for two-year MBA. It's Time to Kill the 9-to-5"Who in this world finds a pressure cooker with a phone and just takes the bag?" Norwegian black metal musician ‘not pleased’ after being voted into office. "As a father, I would rather all my sons work at Goldman Sachs." Homemade McRib. Get Soft Serve In Fish-Shaped Pancake Cones Because Sure, Why Not? Celebrities All Have Little Real Teeth Under Their Big Fake Teeth. Apple Unveils Bag.

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Matt Levine at

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