Loans, Sales and IPO Advisers
Let's say you have a thing worth $100. I offer to buy it from you for $99. You say yes, perhaps because you need the money quickly and it will take a while to find a full-price buyer. You now have $99. I sell the thing, and have a $1 profit.
Let's say instead that I offer to lend you $99, if you will sell the thing and pay me back $100 with the proceeds of the sale. You say yes, again to get the money quickly. You now have $99. You sell the thing, give me the money, and I have a $1 profit. Maybe I even help you sell the thing.
Those are very similar transactions (if the thing is really and knowably worth $100). The former is called a "sale," and the latter is a "loan," but it has long been well understood in the financial industry that those concepts have a lot of overlap. (See, e.g., repo lending.)
Now let's make one small change to the numbers. You have a thing worth $100, but instead of offering you $99 for it, I offer you $50. If we do this as a sale, well, you have been ripped off. But that's life. If I haven't lied to you and don't have a fiduciary duty to you, then there's generally no rule against me underpaying you for the thing.
But if we do it as a loan, things are different. If I lend you $50, and you pay me back $100 a few months later, then I have charged you really a whole lot of interest. Many states have rules against charging hundreds of percentage points in annual interest. It is called usury. It can be a crime.
This sounds bad:
Today the Consumer Financial Protection Bureau (CFPB) and the New York Attorney General filed a lawsuit against RD Legal Funding, LLC, two related entities, and Roni Dersovitz, the companies’ founder and owner, for allegedly scamming 9/11 heroes out of money intended to cover medical costs, lost income, and other critical needs. RD Legal also allegedly conned National Football League (NFL) concussion victims. The CFPB and New York Attorney General allege that the illegal scheme deceived 9/11 first responders with cancer and other illnesses and football players with brain injuries out of millions of dollars by luring them into costly advances on settlement payouts with lies about the terms of the deals.
The specific allegations also sound bad:
For example, one consumer was awarded $65,000 from the Zadroga Fund. While she waited for her full payment from the Fund, RD advanced her $18,590. When her award payment from the Fund arrived six months later, she repaid $33,800 to RD.
That interest rate seems to "exceed New York’s 16% civil usury cap and its 25% criminal usury cap," as the attorney general notes. But "interest" is in the eye of the beholder. RD Legal wasn't, according to it, lending any money to anyone. It was buying the concussion victims' and 9/11 heroes' compensation claims. They had a thing worth $33,800, and they sold it to RD for $18,590:
For example, on its website, RD asserts that its “plaintiff funding is not a loan.”
RD labels its contracts as “assignment and sale agreements.” Most of RD’s contracts with consumers do not disclose an interest rate for the transaction.
Some of these contracts indicate explicitly that there is no “annual percentage fee” to disclose because “the transaction is a purchase and not a loan.”
The CFPB and New York attorney general disagree, because the relevant funds -- the NFL settlement and the statutory Zadroga Fund for 9/11 first responders -- did not allow assignments. "RD knows or recklessly disregards that the purported assignments are prohibited and that it is impossible to structure the transactions as assignments," says the CFPB.
Obviously nothing substantive turns on this distinction. The harm to the consumers was that they had a thing worth $33,800 and gave it up for $18,590, or whatever. It's not like they were harmed because it was a loan, but wouldn't have been if it was a sale. The defense is: Well, they took the discount voluntarily, for speed or convenience or whatever. That's true -- or not -- whether it was a sale or a loan. What the CFPB and attorney general want to do is punish RD Legal for underpaying victims for their settlements. But they have to do it in code, dressed up in the language of these formal distinctions, by arguing that a thing called an "assignment" is really a "loan."
Bloomberg's global equity offerings league table for 2016 ranks Moelis & Co., the boutique investment bank, 152nd, with 9 deals for a total of $229.4 million of league-table credit. The number 1 bank was JPMorgan Chase & Co., with 260 deals for $41.4 billion. Honestly it's a bit of a surprise to see Moelis ranked so high. The good thing about being a boutique advisory investment bank is that, with no sales and trading division, you can focus on providing unconflicted advice to your corporate clients. The bad thing is that, with no sales and trading division, it is hard to underwrite equity and debt offerings. You have no one to sell the stock!
But the very biggest deals simply transcend that concern. The Saudi Arabian Oil Co. initial public offering "is predicted to raise about $100 billion," and selling $100 billion worth of stock seems ... hard, but that problem is not at the top of Aramco's list. Someone will do it. It is not impossible that every equity salesperson employed at every investment bank in the world will, at some point during the Aramco IPO, call a client to try to sell some Aramco shares. Finding salespeople, for a $100 billion IPO, is trivial. The problems, now, are meta-problems: structuring the company, structuring the IPO, structuring the syndicate of salespeople who will do the selling, and keeping down their fees. And for that, you want a bank that won't be doing the selling. Aramco picked Moelis, giving it "the biggest equity advisory mandate in history." Eventually, you know, every bank will be added to the syndicate, and Moelis seems unlikely to hog all the league table credit for itself. (It may not get any!) But, you know, good for Moelis.
One popular high-minded thing to say about bank regulation is: Well, I like the fact that banks are better capitalized than they were in 2007, but some of the other stuff goes too far. You can pick what other stuff you dislike -- the Volcker Rule, the movement of derivatives to clearinghouses, "orderly liquidation authority" -- but higher capital requirements are pretty widely beloved. The Republican Financial CHOICE Act provides an "off-ramp" from Dodd-Frank, but only "for banking organizations that choose to maintain high levels of capital." My Bloomberg View colleagues Noah Smith and Tyler Cowen published this debate about Dodd-Frank yesterday; they quickly agreed that more capital is good and moved on to the controversial issues.
So you might expect that, whatever happens next with U.S. financial regulation, higher capital requirements will be here to stay, and all the fights will be over the other stuff. But maybe not!
Lloyd Blankfein said he’d like to operate Goldman Sachs Group Inc. with less capital as growth picks up and the rebound in fixed-income trading appears set to continue.
“Left to our own devices, we wouldn’t hold as much capital as we’re holding,” the chief executive officer said Tuesday at an investor conference in Miami Beach, responding to a question about what regulatory changes he’d like to see.
Blankfein, of course, is not in charge of U.S. financial regulation, though a bunch of his former employees are. But even bank executives used to criticize Dodd-Frank mostly in the usual high-minded terms, complaining about complexity rather than capital. ("We started with rules that were one page that turned into 1,000 pages that requires us to put in 20 or 30 thousand pages to show people that we’re complying," said Morgan Stanley's Jonathan Pruzan at the same conference. That sort of thing.) After the financial crisis, it was hard for bank executives to argue that they should have more leverage. Now it seems easier to argue that. Perhaps soon it will be easier to do it.
Trolling as a short strategy.
This is kind of genius:
- Pick a company.
- Sell its stock short.
- Craft an argument that the company is somehow being mean to Donald Trump.
- Try to get Trump's attention so he'll tweet mean things about it.
That seems to be the strategy of Andrew Left's Citron Research:
“What would President Trump think about U.S. Law Enforcement Agencies Paying 5 TIMES the Prices Motorola Charges EU Countries?” Citron wrote at the top of its 13-page report on Motorola. The report goes on to compare Motorola’s pricing to the F-35 jets made by Lockheed Martin Corp. that Mr. Trump has in the past claimed to be overpriced.
It seems unlikely that Trump is going to read a 13-page equity research report, though. Citron sensibly tweeted it, but neglected to include Trump's Twitter handle in the tweet, or to phrase it in Trumpian terms. There is room for improvement. The really smart move would be to buy ads on Trump's favorite television shows to bash companies that you're short.
We talked yesterday about how deregulation, like regulation, is an administrative action, and requires reasoned decision-making by regulatory agencies. It takes a long time and a lot of effort to issue new regulations, but it also takes a long time and a lot of effort to repeal regulations. You can't just quietly mutter "never mind" and tear them up. And just as regulators need statutory authority to make new rules, they need statutory authority to change, or soften, or repeal those rules. If their deregulatory decisions are wrong, courts can second-guess them, just like they can second-guess new regulations.
But courts tend to be deferential to agencies' interpretations of the statutes they are charged with enforcing. This is called "Chevron deference," and is viewed with suspicion by conservatives, who think that it leads to increased regulation. Which in the long run it probably does. But if the Trump administration intends to be massively and rapidly deregulatory, a little judicial deference will probably help.
Anyway here is a funny story about how the Trump administration intends to soften the requirements of the Affordable Care Act by letting insurers charge old people up to 3.49 times as much as they charge young people. The Affordable Care Act is a statute, passed by Congress, that among many other things caps premiums for old people at 3 times the premiums for young people. That cap is section 2701(a)(1)(A)(iii) of the Public Health Service Act (page 83 here): Premium rates may vary by "age, except that such rate shall not vary by more than 3 to 1 for adults." To amend or repeal that act, Congress would need to pass a new statute, which is a complicated undertaking.
The Trump administration can't repeal or amend it on its own: Congress, not the President, makes laws. But the executive branch makes rules implementing the laws. The Obama administration's rules implementing that age-based cap are explained at pages 13411 to 13413 here; they're more complicated than just "you can't charge old people more than 3 times as much as you charge young people." There are age bands and curves and whatnot. Various interpretive questions came up, and the Obama Department of Health and Human Services did its best to answer them. Some people may disagree with its answers, but a court is unlikely to second-guess them, because it's the expert agency.
On the other hand, the Trump Department of Health and Human Services might decide that "shall not vary by more than 3 to 1" means "shall not vary by more than 3.49 to 1":
According to sources privy to HHS discussions with insurers, officials would argue that since 3.49 “rounds down” to three, the change would still comply with the statute.
That is not how math works, of course, but the question is: Is it how administrative law works?
Fannie and Freddie.
Here is Steven Davidoff Solomon on what to do about Fannie Mae and Freddie Mac. I sometimes think the Fannie/Freddie problem is both simpler and harder than everyone else thinks it is. Like, there are a bunch of policy questions about how Fannie Mae and Freddie Mac should operate, what assets they should hold, what mortgages they should back, how much government support they should get, and how much they should pay for it. But there is also the simple brute fact that the U.S. government now owns -- or controls, or possesses in conservatorship, or whatever -- two giant companies that also have private shareholders whose ownership rights have been snuffed out. Everyone seems to assume that that can't go on indefinitely, though I have never seen much evidence for that assumption. (It's gone on for a long time!) But if you do assume that, then eventually the government will have to re-privatize Fannie and Freddie, or some successor entities. And then two straightforward questions are:
- How much will the new private entities be worth, and
- How much of that value will the government give to the existing private shareholders?
Your answers could be "zero and zero": Just shut down Fannie and Freddie entirely and let banks make mortgages on their own. (Don't count on it!) Your answers could be "many billions of dollars, and zero": Set up strong well-capitalized government-subsidized new entities, zero the existing shareholders, and sell shares in the new entities to new investors. (Who might be a bit hesitant, given the zeroing of the old investors.) Or your answers could be "many billions of dollars, and many billions of dollars": Set up strong well-capitalized government-subsidized new entities and then just hand them over to the hedge funds who currently own a lot of Fannie Mae and Freddie Mac shares. (Politically awkward!) Or various intermediate configurations.
This is all pretty much up to the government to decide, though the various lawsuits by existing shareholders mean that any answer ending in "... and zero" might run into trouble in court. And it is sort of the prime political problem of Fannie and Freddie. There are massively valuable mortgage companies that are run by the U.S. government, and that still have vestigial shareholders kicking around. Privatizing any massive government entity is complicated; look at Aramco. The claims of the existing shareholders, and the fact that any privatized Fannie/Freddie will almost certainly have some sort of continuing guarantee relationship with the government, makes this one particularly complicated.
Here's a story about how Apple spent a really long time designing its new headquarters:
When Apple tapped general contractors Holder Construction and Rudolph & Sletten to finish the main building in 2015, one of the first orders of business was finalizing a door handle for conference rooms and offices.
After months of back and forth, construction workers presented their work to a manager from Apple’s in-house team, who turned the sample over and over in his hands. Finally, he said he felt a faint bump.
The construction team double-checked the measurements, unable to find any imperfections – down to the nanometer. Still, Apple insisted on another version.
The construction manager who was so intimately involved in the door handle did not see its completion. Down to his last day, Apple was still fiddling with the design - after a year and a half of debate.
Walking around downtown SF, past giant Internet companies with thousands of employees, at some level you have to acknowledge that the things that really work just don’t have to try as hard as things that don’t. Or to put it even more simply: The best-designed stuff doesn’t tell you some high-minded story; it just gets out of the way, and lets you tell your own damn story.
People are worried about unicorns.
Nah, everything's great in the Enchanted Forest today. Here are "Five Reasons VCs Are Bullish About This Year's Outlook for Startups," including that they expect more initial public offerings this year, that venture capital firms have tons of dry powder, that non-tech incumbents have been buying startups, that the stock market is up, and that tax policy may favor domestic acquisitions.
Portraying Silicon Valley’s powerful as “uber-nerds” who struck it rich is as reductive and unhelpful as referring to technology that integrates personal payment information and location tracking as “little buttons.” The effect is not only to protect them behind the shield of presumed harmlessness, but also to exempt them from the scrutiny that their economic and political power should invite.
People are worried about stock buybacks.
Here is a McKinsey Global Institute study finding "Finally, Proof That Managing for the Long Term Pays Off." "Managing for the long term" here is measured through a bunch of indicators, including the difference between earnings and earnings-per-share growth: "We hypothesize that long-term companies are less likely to overindex on analyst metrics like EPS and less likely to consistently take actions (such as share repurchases) that boost EPS." The study "found that companies that operate with a true long-term mindset" -- as they measure it -- "have consistently outperformed their industry peers since 2001 across almost every financial measure that matters." (Though they underperformed during the financial crisis.) So there you go, I guess: Avoiding buybacks, when used as part of a balanced diet of long-termism, may be good for your company.
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