Bank Disruption and SEC Visits
Broadly speaking, there are three ways for financial technology startups to disrupt the banking industry:
- With a different business model: For instance, instead of taking money from depositors to fund loans made in bank branches, fintech companies can make loans over the internet and package and sell them to investors. This can be clever, but in many cases the fintech firms are either reinventing something that banks already do (packaging loans to sell to investors) or doing something that the banks can easily co-opt (making the loans over the internet).
- With the same business model, but with more computers: For instance, instead of underwriting a loan by looking the borrower in the eye and talking about sports, you get some big data, you get a big computer, you put the big data into the big computer, and the computer tells you whom to lend to. This sounds great but might not be. Dan Davies describes it as "reinventing the past mistakes of the banking industry because you don't know about adverse selection," and notes that "if you look into the digital archives of any large incumbent player, you will tend to find an extremely sophisticated, cutting-edge algorithmic risk pricing system which was thrown away a couple of years ago because it worked great in testing and then fell apart really badly in the real world."
- With the same business model and computers, but while wearing a hoodie: You don't do your thing all that differently from how a bank would do the same thing, but you don't do all the other things that the banks do, and you have less intense regulation, and less accumulated ill will from the mortgage crisis, and more air hockey tables, and a better app, and a more appealing brand name, and you generally try to reinvent one corner of the banking industry not by making it substantively different but by making it cooler. Coolness is of course a powerful technology.
Anyway here is a story about how, "for the first time in over a decade, a group of Silicon Valley’s top venture firms are making a sizable bet on a deposit-taking U.S. bank." The bank is called Cross River Bank, it has one branch in Teaneck, New Jersey, and "it has partnered with some of the highest-profile financial technology, or fintech, startups offering online loans and payments, such as Affirm Inc., Stripe Inc., and TransferWise Inc." to "do things that are tougher for nonbank firms under U.S. rules," like originating loans and moving money. The idea seems to be that Cross River Bank provides the bank-y back end to the cool fintech firms:
Cross River’s new backers said they viewed it as the “pick-and-shovel” equivalent for fintech, an analogy for quietly providing services to people hoping to strike gold.
The service here is banking, though, and the people hoping to strike gold think that the gold is in replacing banking. But if many fintech firms aim to replace banking mostly by throwing a cool app or a clever algorithm in front of a traditional banking service, then a fintech-friendly bank back end will have lots of opportunities.
UK-based insurer Admiral has come up with a way to crunch through social media posts to work out who deserves a lower premium. People who seem cautious and deliberate in their choice of words are likely to pay a lot less than those with overconfident remarks.
Here's an adviser who helped develop it:
“An overconfident person will use phrases such as ‘always’, ‘never’ and exclamation marks rather than ‘maybe’, ‘perhaps’ and ‘let me think about it’. An overconfident person might be a risky driver.”
An overconfident person might even use Facebook word choice to judge driving skill! Ha ha ha no I kid, this is just being rolled out for 17 to 21-year-olds in "a new product called firstcarquote"; presumably by their secondcarquote Admiral will just judge their driving by their driving record, not their Twitter.
Oh, also, the other day we talked briefly about HackerRank, "a web platform that trains and grades people on writing computer code," whose rankings are apparently used by big financial firms to hire developers. Here is someone -- to be fair, a Java developer -- claiming that he achieved the top ranking for Java programming on HackerRank in two hours by going to the site's discussion area for each question, finding the answers to the questions, and then copying and pasting those answers into his answer submissions. That seems ... way too easy? Like if you are giving someone a high-stakes test, don't also simultaneously give them extensive annotated answers to the test? I don't know what to tell you, except that if he got the top ranking by cheating, then some bank should definitely hire him.
The Securities and Exchange Commission just doesn't come around that often:
More than one-third of the approximately 12,200 mutual-fund companies, wealth managers and other investment advisers that come under the agency’s sole purview have never had an on-site check for signs of fraud or misconduct, according to data provided to The Wall Street Journal in response to public-records requests. SEC Chairman Mary Jo White has called those inspections the greatest protection her agency can offer to retail investors.
And the SEC visits only about 12 to 13 percent of covered money managers each year. There are basically two models of law enforcement: Constant surveillance, and after-the-fact deterrence. Constant surveillance is pretty popular in many areas of the financial system; the biggest banks, for instance, are pretty much full of Fed employees at all times, and initial public offerings can only go forward after the SEC has reviewed the prospectus and had its comments incorporated.
But the basic default mode of law enforcement is deterrence-based; the police don't visit my house annually to make sure I haven't murdered anyone. They wait for a murder, then go talk to the murderers. This is unfortunate for the murder victims! But there is not much of a practical alternative. With thousands of money managers, the SEC is in a similar situation: Despite White's claim, I suspect it is more likely to catch fraud based on whistle-blowing, or customer complaints, than it is by just wandering into every manager's office and asking "hey, you doing any fraud?"
Still, you could pretty easily improve these stats a bit? "At the most productive SEC office, the average investment-adviser examiner looked at 4.6 firms in fiscal 2015, almost double the 2.4 average for the slowest office." So even the fast examiners are averaging two or three months per inspection. The SEC could keep doing those sorts of thorough inspections, but just pull a few examiners off them and assign them to like a casual check-in role. Like, they'd get one day per money manager: Just show up by surprise, make sure the office exists, glance through the marketing materials, check out the books, chat with the boss, and generally look for signs of obvious dumb fraud. Ask "hey, you doing any fraud," and if the manager panics and runs out of the room, maybe chase him. You're not going to catch subtle sophisticated fraud that way, but then, the SEC didn't catch Bernie Madoff even with full inspections.
Elsewhere in surprise visits, here's "The Murphy & McGonigle Surprise Law Enforcement Response App." If I worked in law enforcement, I'd be pretty interested in a list of who downloaded that app.
Elsewhere in constant surveillance: "In a letter to KPMG last week, Sen. Elizabeth Warren (D., Mass.) and three colleagues said the firm’s failure to uncover practices that included Wells Fargo employees opening as many as two million accounts without customers’ knowledge 'raises questions about the quality of your audits,'" which strikes me as a bit harsh. Wells Fargo's fake accounts brought in something like $2.4 million in revenue over five years; Wells Fargo's net revenue in 2015 was $86 billion, making the fake-account revenue something like 0.0006 percent of the total. You can see why the auditors might not have focused on it.
And elsewhere in SEC news, it has proposed new rules limiting mutual funds' ability to use derivatives, and some of the comments about the proposed rules argue that they should somehow risk-weight those derivatives (so that mutual funds would have more leeway to use safe derivatives than risky ones), and so the SEC's Department of Economic and Risk Analysis produced this clear and straightforward overview of how risky various types of derivatives are, for regulatory purposes. I mean, it will not solve all of your derivative risk problems, but it has good basic tables of how much, say, interest-rate swaps typically move compared to equity swaps.
It is generally silly to psychoanalyze the market, but mergers are a bit of an exception. They provide a nice venue for the great man theory of history in the stock market: Some individual chief executive officer made a conscious decision to push any particular merger, so you can go find out what she was thinking. Or you could have a theory, anyway; here's one:
“There’s an extremely strong desire among executives and boards to position their companies for the long term, that is outweighing the short-term instability linked with the current political cycle,” says Jeff Raich, co-president at Moelis & Co, the advisory boutique.
That is the opposite of two very popular views that you sometimes hear about business generally -- that public companies are excessively focused on the short term, and that political uncertainty has a crushing effect on investment -- and it's true that an increase in big transformative mergers sort of undercuts those views. Though you could take the political uncertainty view the other way; Steven Davidoff Solomon argues that "in Washington, you can expect not just greater enforcement but possibly a change in the laws to focus on corporate giants that dominate a market through their immense size," so "there is a rush to get deals through before the laws change." More generally, you can psychoanalyze the recent merger boom as a sign of confidence -- world-bestriding chief executives who finally feel free to take big risks on transformative deals -- or as a sign of nervousness and defensiveness, as "companies, particularly in technology, media and telecommunications, are racing to keep up and avoid being outmaneuvered," just by getting bigger. Again, from Davidoff Solomon:
Forget about shareholder value; the top priority of any chief executive is to remain employed. And in a sluggish economy with few obvious opportunities, a big merger has become the only way to acquire growth or a new product or new technology and ensure that the chief executive holds on to power.
I don't know, what about the chief executive officer of the target? She's out of a job, after the merger. It seems to me that frenzied merging as a CEO job-security device would make sense, in the aggregate, only if a CEO's chance of keeping her job with slow growth and no mergers was less than 50/50.
In any case, it's good news for investment bankers:
On Dealogic figures, M&A accounts for 32 per cent of total fees from investment banking so far this year — the highest share since 2008, and well clear of the average 28 per cent over the past two decades.
And yet in this environment of slow growth, easy financing and nervous technology/media/telecom companies pushing to combine, Gannett Co. still managed to terminate "its $683 million bid for rival Tronc Inc. after financing fell through, ending a months-long pursuit that would have put some of the biggest U.S. newspapers under one roof." Here is Bloomberg Gadfly's Brooke Sutherland on how Tronc got Tronced. ("New Tronc takeover premium: zilch.") Tronc. Tronc. I have nothing here really but it's a fun name to say.
Elsewhere, here is the official case for the Tesla Motors, Inc./SolarCity Corporation merger. And "AT&T Inc.’s practice of exempting its streaming video services from data-usage caps is rankling competitors and shaping up as a major issue for regulators set to weigh the telecom giant’s proposed $85.4 billion acquisition of Time Warner Inc.," and while I know this is a very naive way of looking at it, doesn't it seem a little strange to block a company from giving consumers free stuff because that would be bad for consumers?
Don't use e-mail.
Here's an article about how many of the most important people in finance -- Jamie Dimon, Carl Icahn, Warren Buffett -- don't use e-mail very much. The conceit here is one of information security -- "Recent email woes among Washington power players have provided yet another reason for bankers to try to protect private correspondence from prying eyes," etc. -- but the real reason not to use e-mail is just as a display of power. E-mail is annoying and distracting! But that's what work is, mostly; you go to a big building and sit in front of a computer and it annoys and distracts you. But at some plateau of wealth and power, you get to stop, or at least curate your annoyances. One CEO's "staff filters important messages, prints them out and puts them on his chair for review," which is exactly the level of involvement in e-mail that I would choose, if I had the choice, and the staff. (Though Dimon's approach -- he "uses email but is known to keep his replies short and factual, favoring 'yes,' 'no' and 'thank you' -- is also pretty solid. Nothing makes me feel as powerful as responding to a long email with just a "thanks.")
These powerful men do ruin things a bit by using the phone, though. The phone is even worse than e-mail! The truest exercise of corporate power would be to sit quietly in a plush chair, surrounded by a vast silent expanse full of absolutely no blinking or beeping things, with communication limited to one subordinate who occasionally whispers "all is well." Maybe a little Twitter.
People are worried about unicorns.
"Imagine learning how to attract and retain the best talent while sitting on a deserted warm beach half naked at 2 a.m. with a shot of Jägermeister in your hand," says a man, unimaginably. I mean! I start trying to imagine it and get nauseated and dizzy and have to lie down. I feel like if I worked diligently for a month, I could just about imagine learning how to attract and retain the best talent, like in a conference room. But I would not want to add the warm 2 a.m. half-nudity to my talent-retention imaginings without the help of a trained meditation coach and years of deep breathing exercises. The Jägermeister is strictly impossible.
Anyway that's from an article about how British tech entrepreneurs go to a lot of parties that sound world-historically horrific, but now they "are turning to self-reflection and thinking harder than ever about their real priorities and new realities," by going to another party -- this one in Mykonos -- that sounds even more horrific. "Sessions with life coaches were booked through an app, Qudini, being developed by one of the attendees." There was "modern-day jousting on unicorns." It is all very hard on the imagination.
Elsewhere, here is Felix Salmon arguing that "it’s a lot easier to work at a hot Silicon Valley company like Palantir if you’re already firmly entrenched in the bubble of tech privilege," because Palantir pays a lot of its compensation in stock options, which are most attractive to the well-off and risk-tolerant. Of course tech startups prefer risk-hungry employees, which is why they pay them in options; the fact that that preference overlaps with economic privilege and youth is just a subject that they try to avoid. And here is Noah Smith at Bloomberg View arguing that "Instead of making American capitalism less cuddly, government should focus on finding ways to limit personal risk" if we want more entrepreneurship, because mitigating the downside consequences makes people more likely to take risks like starting a company. And here is a paper polygonal unicorn mask that I am sorry to say I did not wear for Halloween.
People are worried about bond market liquidity.
Here is Bloomberg Gadfly's Lisa Abramowicz arguing that you should be very worried about outflows from credit exchange-traded funds, and all worries relating to bond ETFs count as bond market liquidity worries.
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