Money Stuff

Bank Blockchains and an Alibaba Box

Also a fun trading strategy, Twitter recruiting, Uber and arbitrage.

Blockchain blockchain blockchain.

The basic idea of blockchain technology is that it is supposed to let people transfer digital objects -- money, securities, whatever -- like they're physical objects. Transfers of dollars rely on banks, and central banks, to keep records of who has all the money; we have to trust them; we don't get to hold our dollars -- except a few paper bills -- ourselves. Transfers of securities rely on intermediaries -- brokers and the Depository Trust & Clearing Corp. -- to keep records of who has all the stock; we have to trust them; we don't get to hold our stocks ourselves. Transfers of bitcoins don't rely on any trusted intermediary, the distributed ledger -- the blockchain -- of bitcoin transactions allows people to transfer bitcoins between themselves without trusting a third party. Anyone can use the ledger; you don't have to be a member of a selective club. The blockchain idea is about decentralized, permissionless transfers of value.

So it's weird that basically every well-publicized experiment with blockchains in finance is done by a centralized intermediary. There is the endless chatter about central banks, which already keep the ledgers of who has dollars or whatever, using blockchains to keep those ledgers. And there are endless consortia of big banks who want to build permissioned blockchains for their own use. And DTCC, which is the main centralized intermediary for U.S. securities transactions, is endlessly announcing its own blockchain experiments. There was one last year about repurchase agreements, and now there is this:

Wall Street’s largest back-office processing service is partnering with IBM to upgrade how payments and record-keeping for credit-default swaps are handled by putting the system on a blockchain by early next year.

Depository Trust & Clearing Corp., the New York-based utility that settles and clears all stock and bond trades in the U.S., is seeking to reduce redundancies and cut costs in the system that manages $11.7 trillion in outstanding credit swaps, the company said in a statement Monday.

One aspect of blockchain is technological: It is arguably a better way to build a database, for some purposes. Maybe one of those purposes is keeping track of stocks or derivatives or whatever. But as I often say when I read these stories: You could just have a list. DTCC could just write down a list of who owns the stocks. When people trade, they could just tell DTCC, and it could update the list. That's what DTCC does now, for stocks, and, you know, it's fine. Maybe the blockchain is better. "Because the database will be edited in group fashion, the hope is that it will provide a more streamlined and reliable source of information," reports the New York Times. Bloomberg notes:

Trade processing is now done electronically, but banks and money managers maintain their own record of trade details in private databases. That means details must be reconciled among the different users, which takes time and can be error-prone. A distributed ledger, on the other hand, allows all those users to share the same exact data so that confirmations, payments and other processing can be done in seconds rather than days.

Another aspect of blockchain, as I often emphasize, is sociological: Blockchains are cool. If you announce that you are updating the database software used by a consortium of banks to track derivatives trades, the New York Times will not write an article about it. If you say that you are blockchaining the blockchain software used by a blockchain of blockchains to blockchain blockchain blockchains, the New York Times will blockchain a blockchain about it.

But there is a third aspect of blockchain, at least as originally conceived by the bitcoiners of the world, that is sort of philosophical, or economic. It is the idea that trade should be decentralized and permissionless, that people should be able to do electronic transactions without relying on a powerful incumbent intermediary. If I want to sell you a share of stock, I should just be able to do it, without bringing some consortium of big banks into it. The consortia of big banks, and the utilities that they have created, obviously do not share this philosophical viewpoint. And so it has vanished from most of the announced blockchain applications. You and I can't just walk in and trade derivatives over the new DTCC blockchain: It's for the big incumbent players who are part of the DTCC consortium anyway. There is no disruption, no disintermediation. The blockchain here is about perpetuating the existing intermediaries, not about replacing them. DTCC knows it:

“A lot of people are talking about how they’re going to make us disappear,” Michael Bodson, chief executive of DTCC, said in an interview. “But here we are, one of the first users of the technology.”

Users of the technology, sure. But not of the idea.

Altaba!

Yahoo! Inc. consists of basically three things:

  1. A big pile of shares in Alibaba Group Holding Inc., which are worth a ton of money.
  2. A big tax liability if it sells those shares.
  3. Other stuff (like Yahoo itself).

Things 1 and 2 are way more important than thing 3, and so we have been talking for the last two years or so about how Yahoo could gently extract value from thing 1 without incurring thing 2. My answer has consistently been: You have to very carefully put the Alibaba shares into a box, and then sell the box to Alibaba itself. Taking the shares out of the box is what incurs the tax, and anyone other than Alibaba would want the shares, not the box. But Alibaba could effectively retire the shares just by buying the box, which makes it the only natural buyer of the box who wouldn't care about taxes.

There are various ways to do this, and Yahoo tried some of them. You could put the Alibaba shares into a box and spin the box off to Yahoo shareholders (and then sell it to Alibaba later). Yahoo tried this -- it called the box Aabaco Holdings -- but the Internal Revenue Service killed it. So Yahoo moved on to an even simpler plan, which is basically selling the non-Alibaba stuff to Verizon Communications Inc., and leaving the Alibaba shares behind in a relatively pristine box. (The box will also contain shares of Yahoo! Japan, but let's not worry about that.)

A series of hackers in the past may have killed that plan, but maybe not, and Yahoo is pressing ahead as though it's happening. If the Verizon sale does close, the next step is presumably to get Alibaba to buy the leftover box. This is not necessarily easy: There's no pressing need for Alibaba to buy the box, any transaction will likely be hairy, and Yahoo's leverage is limited. But there are some things it can do. For instance, once it sells the actual Yahoo business to Verizon, the left-behind box will need a name, and a name that reminds Alibaba that it's supposed to buy the box might be helpful. Like, "Alibaba Annoying Residue Inc." would be a good name for the box, but you might have trademark issues. So Yahoo is going with "Altaba":

The new company, a shareholder in Alibaba Group Holding Inc. and Yahoo! Japan, will change its name to Altaba Inc. and reduce its board to five members as it looks ahead to its next chapter with fewer ties to the iconic brand, according to a filing Monday.

Here is the filing. Marissa Mayer, Yahoo's chief executive officer, will leave the board of Altaba, perhaps to go with Yahoo's businesses to Verizon.

Cool strategy.

I don't know if this is really a strategy?

Dean and Fowler used the same basic strategy in the 27 customer accounts: the purchase of a stock followed by the sale of that stock within a week or two. The quick sales occurred regardless of price movements. 

That's like saying "my strategy in this basketball game is to run and move my arms." Running and moving your arms are definitely things you do in basketball! Buying stocks and then selling them is definitely a thing you do in investing! But the strategy is about how you do those things: where you run and what you do with your arms; or which stocks you buy, and when, and why.

That is from this charming Securities and Exchange Commission enforcement action against two brokers at a firm in Syosset, New York (disclosure: my home town), who allegedly used that strategy. In the SEC's telling, it was not much of an investing strategy, but it was an excellent broker-compensation strategy, insofar as every time they bought and sold the stocks, they charged the customers big commissions. "The average annualized cost-to-equity ratio for these accounts was 110.90%," says the SEC, "meaning that the customers, on average, had to realize 110.90% in profits just to break even." They did not.

The SEC thinks this is bad, and you can see why: It looks like "churning," trading solely to generate commissions and not to help the client. But that's hard to prove: If you look at any particular trade that a broker recommended, even if the stock went down, the broker can argue that he thought it would go up and that it was a good trade for the client. So the SEC focuses on the "strategy," and argues that the brokers pursued it "without having a reasonable basis for believing that this strategy was suitable for anyone":

Prior to recommending their strategy, Dean and Fowler did no analysis to determine whether this high-cost strategy had any reasonable basis. Instead, they purportedly relied on general interest news publications, investment periodicals, and the internet. These resources, however, provided information on issuers and market conditions and not on the impact of their high-cost structure on an in-and-out trading strategy.

Isn't that sort of an odd argument? The most stereotypical, traditional role of the stockbroker, since time immemorial, has always been to read investment periodicals, call you up, and say "hey you should buy this stock." The suitability determination was that the stock was suitable (because the periodical said that it was good). Brokers were not expected to do any extensive suitability analysis of how often they should call you up. Any time they had a good idea, or thought they did, why not call? 

Obviously we now live in a much more scientific age of investing. Investors, and regulators, are more skeptical of stock-picking, more aware of the benefits of diversification, more conscious of costs and their effect on overall returns. Buying and selling stocks every couple of weeks based on recommendations that a cold-calling Long Island stockbroker cooked up by reading the newspaper now seems a little insane, even though it's exactly how most people invested in stocks for most of the history of stocks, or at least of Long Island. 

But is it fraud? There is an obvious subtext to this SEC complaint: The SEC thinks that the brokers were churning, that they didn't really believe that their recommendations were good for clients, that they were just trying to capture commissions. But what if they weren't? What if they did extensive research into every stock pick, and had a good track record of picking stocks, and really thought that each of their picks was great? Would the SEC still sue them for fraud, just for calling too often?

Recruiting.

Hey kids, if you tweet good about stocks, maybe Deutsche Bank AG will just show up at your door one day with a job offer?

Germany’s biggest bank launched a programme late last year to monitor the online activity of university students to identify those who might be a good fit for the bank but would not apply through traditional channels such as on-campus recruitment drives.

Great? ("Invading social media with cold, mature advertising feels like turning up at a university house party with a careers brochure," says a recruiter at another bank.) I say "if you tweet good about stocks," but actually I have no idea what Deutsche's criteria are. Maybe they are filtering for good Golden Globes tweets? Grammar and spelling? Cute dog pictures? I don't know, but I would love to be able to reverse-engineer the algorithm. If you have received an unsolicited job offer from Deutsche Bank because of something you tweeted, please do let me know.

Elsewhere, Facebook's diversity hiring efforts are not going great:

Facebook started incentivizing recruiters in 2015 to find engineering candidates who weren't already well represented at the company – women, black and Latino workers. But during the final stage for engineering hires, the decision-makers were risk-averse, often declining the minority candidates. The engineering leaders making the ultimate choices, almost all white or Asian men, often assessed candidates on traditional metrics like where they attended college, whether they had worked at a top tech firm, or whether current Facebook employees could vouch for them, according to former recruiters, who asked not to be identified because they were not authorized to speak publicly about their work.

People are worried about unicorns.

Here's Timothy B. Lee on "Why Uber lost $2.2 billion in 9 months." There seem to be about four main theories of Uber Technologies Inc.:

  1. Uber is charging below its cost now, but network effects will allow it to provide taxi services so efficiently that it will eventually be profitable.
  2. Uber is charging below its cost now, but self-driving cars will allow it to provide taxi services so efficiently that it will eventually be profitable.
  3. Uber is charging below its cost now, in order to build a monopoly, at which point it will be able to provide taxi services so inefficiently that it will eventually be profitable.
  4. Uber is charging below its cost now, and always will, and will eventually eat through its investors' money and disappear.

Lee seems to mostly buy theory 1, but he adds that it "might not actually matter that much in the long run": Eventually there will be self-driving cars, and there's no special reason to think that Uber will be the best at building them, or that its dominant position in the ride-hailing-app space will protect it from better self-driving-car businesses.

Elsewhere in questionable on-demand business models, Washio, which was once "Uber for Laundry," and which was the subject of a famous Jessica Pressler articleis now kaput.

People are worried about bond market liquidity.

Here is the New York Fed's Liberty Street Economics blog on "Trends in Arbitrage-Based Measures of Bond Liquidity," looking at bond trading relative to credit default swaps and finding that "the CDS-bond basis has been increasing since January 2015 for investment-grade bonds and since the middle of 2015 for high-yield bonds, suggesting that liquidity of the cash bond market has been deteriorating relative to the CDS market." (And also that CDS liquidity isn't so hot itself: The basis between single-name CDS and the CDX index has increased, "suggesting that while liquidity of the CDS market has improved relative to the cash bond market, it has deteriorated relative to the CDX market.") There is a general regulatory-structural-decline-of-arbitrage flavor to the post, suggesting that similar assets trade differently now because "post-crisis regulatory changes have limited the willingness of regulated institutions to engage in arbitrage trades across a variety of markets." Perhaps a deregulatory Trump administration will allow a return to the glory days of arbitrage?

Things happen.

John Carney is going to Breitbart. Under New Chairman, S.E.C. Enforcer Role Might Shrink. Bank of America Sued for $542 Million Over FDIC Risk Rule. ‘Cartel’ Currency Traders Said to Face U.S. Rigging Charges. Algorithmic price fixing. China Considers Relaxing Curbs on Stock-Index Futures. Valeant to Sell $2.1 Billion in Assets to Pay Down Debt. Goldman Sachs Names Elisha Wiesel Chief Information Officer. (He is a noted puzzle hunter.) The iPhone is 10. Fifa to expand football World Cup to 48 teams. "All the dress shops" are not sold out. Dunning-Kruger. Kids are expensive. Bee rustlers. "How to activate insights around latent mobility or multimodal needs?"

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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

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