Money Stuff

Pizza-Joint Investors and High-Speed Traders

Also passive governance, AT&T/Time Warner Whichever, Fannie and Freddie, unicorns, lions, and a BuzzFeed quiz.


Do you think this is true?

Graham stressed that Instavest would live or die on the network effect: Better ideas rise from a larger base. More users would increase the likelihood of uncovering that diamond-in-the-rough investor, who would in turn attract more users. “I’m willing to bet there’s a guy working a New York City pizza joint who’s a better investor than the guy sitting on Park Avenue,” Graham told them. He turned to Khatri. “Find me that person.”

It sounds clever and, you know, disruptive. But I find that it is often helpful to replace the word "investor" with the word "dentist." Would you turn to a pizza guy to do your root canal? Maybe if he'd gone to dental school he'd be a better dentist than your dentist. But he didn't. Your dentist has knowledge and skills that the pizza guy lacks, and like, a chair and a drill and stuff. It stands to reason that he'd be better at dentistry.

Ah, you say, not so fast: Dentistry is a skilled profession, whereas investing is ... not. It is more or less a coin-flipping contest, so the pizza guy's chances are just as good as the Park Avenue guy's. Maybe! I mean, that is a perfectly respectable theory. That's why a lot of people use index funds, because they think that professional investing skill is overrated, and that it's basically impossible to identify in advance which mutual fund managers will consistently beat the market. But why would it be easier to identify in advance which pizza guys will consistently beat the market? It's fine to be skeptical of the investing skills of professional investors, but that is a reason to index. It is not in itself a reason to be enthusiastic about the investing skills of amateurs. 

I suppose a middle ground is possible, and you could have a wisdom-of-the-crowds, untrained-superforecasters-of-cash-flows theory in which

  1. investing skill exists, but
  2. it is not concentrated among trained professional investors.

But doesn't that seem like a slightly odd combination of things to think? Anyway Instavest is a company, funded by Y Combinator, that lets people write up their investing ideas and invest in them jointly, and it's already landed one guy a hedge fund job, though that was sort of not the point. 

How does high frequency trading work?

A lot of studies seem to come to this pretty intuitive conclusion:

“In a calm market environment, HFT market participants contribute a significant amount of liquidity,” according to the Bundesbank study. “However, during highly volatile market phases, the research shows that HFT market makers in both Bund and DAX futures markets temporarily reduce liquidity. HFT actors are especially active in times of strong market fluctuations and can therefore contribute to trend-enhancing price developments.”

In small moves, high-frequency traders act as liquidity providers, increasing liquidity and smoothing price moves. In larger moves, they tend to flip, reducing liquidity and increasing price moves. You don't even have to be a computer to have this intuition: If a stock (or bond or future) is mostly trading in a range, being a market maker and being paid the spread is a good business, so you should buy when people sell and sell when they buy. If the stock is plummeting, you'd be a fool to buy when everyone else is selling. And if you're pretty sure it's going to keep plummeting, you might as well sell too. This is the basic structure behind most flash crashes.

What do you do about it? One thing you can do is yell about evil HFTs and unstable algorithms. But the central problem here is not one of software design. It's that these decisions by the algorithms -- to provide liquidity when it's safe, to get out of town when it's not, and to join the trend when it's really pronounced -- are basically rational. If you tell HFT market makers not to join big moves, you're telling them to reduce their profits. If you're telling them to stand in the way of the big moves, you're telling them to take big risks to stabilize the market. These are not necessarily unreasonable things to demand -- there is some history of requiring market makers to put their capital at risk to create an orderly market -- but it's important to recognize that these are economic choices, not software bugs. 

Passive funds and governance.

Hmm where have we heard this sort of thing before:

Daniel O’Keefe of investment firm Artisan Partners Ltd., an active manager, contends that “the tyranny of passivity is you have large pools of money that are unengaged in their investments,” which he argues is “a far greater risk than the tyranny of activism.”

The last time such a concentrated group of owners had as much control over U.S. companies as index funds do now was during the era of J.P. Morgan and John D. Rockefeller, when those two businessmen had board positions at a number of companies in which they were large owners, researchers at the University of Amsterdam wrote in a recent paper.

I guess the "tyranny" comment is reminiscent of the idea that passive investing is "worse than Marxism," but mostly this makes me think of the pleasing theory that index funds, and diversified mutual funds generally, might be illegal under antitrust law because they concentrate too much power over too many companies into too few hands. Vanguard and BlackRock, on this theory, are the new Morgan and Rockefeller, and they have built an anticompetitive trust to enrich themselves at the expense of workers and consumers. The trust is, like, the S&P 500. Like, every big public company is in the trust.

How do these new monopolists manage their new monopolies? Mostly by not:

Vanguard has 15 people overseeing work on about 13,000 companies based around the world. BlackRock has about two dozen people who work on governance issues at some 14,000 companies held in its index funds and exchange-traded funds, and it plans to add seven more in the coming months, according to a spokesman.

Their shareholder engagement style seems pretty chill. "Rakhi Kumar, head of corporate governance at State Street’s asset-management unit, said she tells her team not to agree to every meeting companies ask for because of time constraints." "It’s not shareholders’ role to second guess what management is doing in every single issue," says the woman in charge of BlackRock's voting. There is some active decision-making, on executive pay and mergers and proxy fights. "We moved from a position of reluctance to make our weight felt to absolute interest in making our weight felt," says retired Vanguard founder John Bogle. “We’re riding in a car we can’t get out of,” says a Vanguard governance principal. “Governance is the seat belt and air bag.”

But there doesn't seem to be a ... theme? Like no one quite says "active managers want their companies to be governed like this, and passive managers want their companies to be governed like this." There are some statistical trends -- companies with high passive ownership tend to have more independent board members and fewer takeover protections -- but there is no radical rethinking of what corporate governance means in an age of passive management. It just means regular established good governance practices, with a lot fewer meetings. In particular, no one seems to be giving much conscious thought to how to run a company when you also own all of its competitors. (Or at least they're not talking about it on the record.) If the passive firms are running monopolies, they seem to be doing it by accident.

What company is AT&T buying?

Here is an unusual merger filing in which AT&T reminds the market that it is trying to buy Time Warner Inc., the media and entertainment company, not Time Warner Cable, "a distinct, independent company owned by Charter Communications." A common confusion, they get that all the time. It is a bit of a shame that Time Warner Cable is now part of Charter, with the unrelated ticker CHTR, instead of still being an independent company with a ticker (TWC) that is easy to confuse with Time Warner Inc.'s (TWX). Because there is nothing quite like a stock ripping higher on news of an unrelated but similar-sounding company's merger to remind you that the stock market is only loosely, approximately efficient.

Elsewhere in continuing AT&T/Time Warner Whichever news:

  • the antitrust breakup fee is really low;
  • it faces a tough regulatory environment, with "resurgent antitrust enforcement in Washington and politicians fired by a new bipartisan populist rage";
  • it has moved JPMorgan up to the top spot in the mergers and acquisitions league tables;
  • it will also be pretty lucrative for Perella Weinberg Partners, which "has been investing to rebuild its team" after an acrimonious breakup with Ducera Partners;
  • it means that AT&T, which "has no journalistic lineage," will own CNN;
  • the deal might inspire more dealmaking in the media/telecom world, though "there was little agreement on Monday about what the aftershocks" might be; and
  • "nobody knows anything," but the deal "diversifies AT&T’s offerings": "If it turns out that in the future, content becomes more valuable than distribution, the new AT&T will have that; if the opposite happens, it’s covered there, too."

Fannie and Freddie.

Everyone seems so committed to making Fannie Mae and Freddie Mac seem more complicated than they are:

Allowing Fannie Mae and Freddie Mac to build $50 billion of capital buffers each would cost the U.S. government at least $10 billion and increase the amount of taxpayer funds backing the mortgage finance companies, according to the Congressional Budget Office.

The budgetary cost of recapitalizing the companies would be even higher—as much as $85 billion—under the accounting approach preferred by the Obama administration, according to a CBO report released Friday.

Here, look. Fannie and Freddie are wholly owned subsidiaries of the U.S. Treasury. As long as they stay that way, every dollar earned by Fannie and Freddie is a dollar for the government, and every dollar lost by Fannie and Freddie is a dollar that the government has to pay. If the government sets them free, and lets them keep the money they make, then the government will forego all those dollars that Fannie and Freddie make. If they build $50 billion of capital by retaining earnings, instead of paying it to the government, then the government will have 50 billion fewer dollars. (And if they then lose $60 billion, well, that will eat up the capital and presumably still leave the government on the hook for the rest, because who else is going to pay it?) There is no particular mystery to this, though people keep wanting to turn Fannie and Freddie's accounts into some weird magic trick.

A quiz.


You attend a friend's amateur DJ set on a rainy Tuesday night. What has this good deed earned you?

  1. Equity
  2. Entity
  3. Commodity
  4. Merger

Did you pick "equity"? Really? You know that "equity" means ownership, right? You don't own any of your friend, or of his budding DJ business, just because you went to his show. But, sure, I guess it's better than the other answers. In any case it is the credited answer on this BuzzFeed quiz sponsored by Morgan Stanley. ("Much like friendship equity, financial 'equity' is the value of the ownership of an investment," says Morgan Stanley, charmingly.) I guess if you get all 10 questions right maybe you should apply for a job there? It is sort of a grim sign for the financial industry if Morgan Stanley can't organically attract people who humorously mis-apply financial jargon to their everyday lives, and has to resort to a BuzzFeed quiz to find them. If you're the sort of person who refers to "spending more time deciding which movie to stream than actually watching the movie" as "due diligence," then yes, absolutely, you should be an investment banking analyst. But you should have known that already.

But what if you didn't? I want to read a novel that begins with a young person with no background or interest in finance, floating around the internet clicking on BuzzFeed quizzes, as I am assured young people do. He stumbles across this Morgan Stanley quiz, aces it, and thinks "huh, I have an undiscovered talent for, and interest in, making awkward analogies between everyday social situations and basic financial terms." So he applies, and goes in for an interview, and is hired purely on the strength of his puns. And he goes to work on his first day and says things like "protect me on that lunch print," and his colleagues cheer, and his bosses recognize his talent, and he rises rapidly through the ranks, all on the basis of skills he displayed in that first BuzzFeed quiz. After a series of boardroom intrigues and hostile mergers, he finds himself running the world's biggest bank, a figure of absolute power and enormous fame in the financial world. And he sits in his top-floor office and thinks back on that day when he discovered Morgan Stanley on BuzzFeed. It would be like a "J R" for the 21st century.

Also if you are a Morgan Stanley analyst I hope you will tell your vice president that you're leaving early tonight for your friend's amateur DJ set. 

Trump Tower.

Here are Max Abelson, Jesse Drucker and Zachary Mider on the residents of Trump Tower:

Weichselbaum, the helicopter executive, rented an apartment in another Trump building after he was indicted for cocaine trafficking in 1985. He pleaded guilty, and Trump called him “a credit to the community” in a letter on his behalf before sentencing. While Weichselbaum was behind bars, his girlfriend bought two units in Trump Tower, where he lived for about five years after prison. “It was fine, other than parking issues,” Weichselbaum said about the building. “And try getting a bagel or a container of milk.”

Try getting a bagel in prison! "Renting space has nothing to do with color or race – or indictment," says one former tenant, who spent 18 years in prison.

Elsewhere in Trump, I guess: "Trump, Name Now Awash in Controversy, Readies Scion as New Brand." "Fearing Trump, Bar Association Stifles Report Calling Him a ‘Libel Bully.’" "Dilbert Creator Scott Adams Says He'll Help Kill Trump If He Turns Out to Be Hitler." And here is a story about a political scientist whose model predicts that Trump will win the election, which I share with you mainly for this glorious quote: "Whatever happens in the real word doesn’t affect the model." 

People are worried about unicorns.

People in Europe are worried about ... look, there is apparently a whole ecosystem in the Enchanted Forest? Here is Jonathan Margolis quoting Ben Robinson about Europe's lack of big public internet companies:

“We really need to fix this,” he said. “People get excited about unicorns. The problem with unicorns, however, is that the internet giants’ technology creates the unicorns. And then the giants buy them up. They eat them.”

He and a collaborator, David Galbraith, a partner in the New York investment group Anthemis, call these unicorn-munching giants “lions”, the internet businesses at the top of the food chain — the likes of Google, Facebook and Microsoft.

“We need more unicorns,” says Robinson, “but most of all, we need more European lions.” To ... eat the unicorns. The beautiful unicorn prances nobly through the Enchanted Forest, bathing in rainbows and sprinkled with starlight, and then, BAM, it's mauled and eaten by a lion. The lion is Facebook. The other unicorns are ... happy about this? You can't lean too hard on these cryptozoological metaphors. The point is that big internet companies buy medium-sized internet companies for a lot of money, which encourages more people to start small internet companies, and all of these things have to have animal names.

Elsewhere: "How the fleece vest became the unofficial uniform of Silicon Valley investors."

People are worried about bond market liquidity.

The people who worry about bond market liquidity love having conferences where they can talk about their worries, and Treasury market liquidity worries got a workout in a New York Fed conference yesterday. Here are New York Fed President William Dudley's opening remarks, which include a focus on post-trade transparency:

Given the role of the Treasury market as the deepest and most liquid fixed income market in the world, it is clear that both the official sector and the public need improved access to transaction-level data, and I am pleased that we are making real progress on this front. Greater transparency into Treasury market activity is necessary in maintaining the market’s many important roles:  as a risk-free benchmark for financial instruments; as a liquid investment and source of safe collateral; as a channel for the implementation of monetary policy; and, of course, as a tool to help finance U.S. government activities.

And Treasury counselor Antonio Weiss said that "trading in our nation’s debt should be transparent to the public."

Things happen.

Venezuela Winning Bondholder Relief as 39% Accept PDVSA Swap. Austria’s 70-Year Debt Sale Expands Europe’s Ultra-Long Universe. Iceland poll brings hope of end to capital controls. Tata Group in Turmoil After Chairman’s ‘Bizarre’ Ousting. Patriarch Partners’ Tilton Battles SEC as Fraud Trial Begins. The MetLife too-big-to-fail appeal was argued yesterday. Blockchain Hype Takes Hit as Chain Releases Code for All to Use. Madrid woos UK business with promise of sun, football and low costs. Renewables overtake coal as world’s largest source of power capacity. China’s Aggressive New Deal Makers: $199 Billion This Year and Counting. Online Small-Business Lenders Display Loan Prices. Monte Paschi Jumps as CEO Pledges to Boost Profit, Cut Branches. Euro Gripes Threaten Economic Recovery as Populism Advances. Twitter Planning Hundreds More Job Cuts as Soon as This Week. Watford face fine and points deduction over forged HSBC bank letter. Hong Kong Court Sees Chilling Video of Banker Describing TortureEx-Deutsche banker jailed for killing security guard in Ferrari crash. Silicon Valley Decides It’s Just Too Hard to Build a Car. Super-Cheap Driverless Taxis May Kick Mass Transit to the Curb. Self-driving beer truckDrunk androids. Man dressed as tree arrested for blocking traffic in Maine.

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