Mortgage Math and Sympathetic Sales
We talked on Friday about Goldman Sachs Group Inc.'s consumer mortgage relief program, which is complicated by the fact that Goldman doesn't have a consumer mortgage business. But it owes the government $1.8 billion of consumer mortgage relief, and so it is buying up delinquent Fannie Mae loans at a discount and restructuring them with the dual aims of (1) providing consumer relief and (2) making the loans worth more than it paid for them. It is an odd way to penalize Goldman for its role in the mortgage crisis: If Goldman buys a loan at 60 cents on the dollar, it can forgive 30 cents of principal and still make a 10-cent profit.
But Deutsche Bank AG has an even odder way to get consumer relief:
Rather than follow Goldman’s tack of buying mortgages to modify, Deutsche is aiming to take advantage of a unique provision in its settlement. A footnote to the document allows Deutsche to get credit for lending to others who purchase delinquent loans, as long as those loans are later modified.
Deutsche Bank just needs to be somewhere in the general vicinity of a mortgage that gets modified: If an investor buys a loan at 60 cents on the dollar, forgives 30 cents of principal and makes a 10-cent profit, Deutsche Bank can get 30 cents of loan modification credit for lending the investor 45 cents. (Terms "include lending up to 75% of the total purchase price of loan portfolios with rates of around 2% above a benchmark rate known as Libor.") Goldman's consumer relief seems likely to turn a profit, but at least it's actually modifying the loans, and directly taking the risk that some of them won't work out. Practically and economically, Deutsche Bank is even more insulated.
Now, I know what you're thinking: What if Deutsche Bank loaned Goldman $60 to buy mortgages with a face amount of $100, and Goldman wrote down those mortgages to $70, sold them for $70, paid $5 in interest to Deutsche and kept $5 profit for itself? Would Deutsche and Goldman both get credit for $30 of consumer relief? (Is that not what you were thinking?) Hahaha no the footnote in Deutsche's settlement actually covers that case:
Credit is given for Menu “Item 1” for loans that serve as collateral for financing arrangements provided by Deutsche Bank, or for participation arrangements (in which Deutsche Bank owns an equity interest by which it can influence the provision of consumer relief) invested in by Deutsche Bank with third party originators and servicers and for which no other party is eligible to claim credit under a mortgage-related FIRREA settlement that involves its own respective consumer relief schedule with the Department of Justice.
Presumably the hardest part of Deutsche Bank's consumer relief program is finding people to buy and modify mortgages who don't have their own Justice Department settlements.
Sales and advice.
One thing that we sometimes talk about around here is how the financial industry likes to collapse the distinction between sales and advice. The way to sell someone a derivative, or an extra bank account, is to create the impression in his mind that you are his friend and trusted adviser, concerned with his problems and interested only in solving them, not in grubbing money for yourself. Then, when he sues you for ripping his face off on the derivative pricing, you go to court and say: "What? I was an arm's-length counterparty, not a fiduciary; I don't see what the problem is here."
But finance isn't the only industry that does this. Sales is a pretty well-studied business, and basically everyone in any kind of sales business has figured out that trusted advisers are better salesmen than salesmen are. So the way to sell a pencil is not to sell the pencil -- "this pencil writes great!" -- but rather to ask the customer about her hopes and dreams and problems and accomplishments, elicit from her the heartbroken confession that sometimes she needs to mark up memos but isn't at a computer, and then slide the pencil across the table to her with a meaningful nod. Later you send her the bill.
This sort of "consultative selling" can shade into self-parody, and here is Scott Edinger on its silliness. "The kind of questions sales professionals are taught to ask typically focus on drawing attention to client problems, pain points, and sources of dissatisfaction," he writes, "so the client will then view the seller’s offerings as a solution." It's not so much an open-minded conversation about the customer's hopes and dreams as it is a series of questions leading subtly but inevitably to the PencilMatic 3500X solution. Or not so subtly:
I joke about this in speeches using the example: “If I could show you something interesting, would you be interested?”
As a former investment banker, I cringed with recognition. It turns out that if you just have a free-form conversation with a corporate chief financial officer about his daily frustrations and big-picture goals, he almost never volunteers that what he really wants out of life is more equity derivatives. You kind of have to guide him there.
Private markets are the new public markets.
Ehh, not quite. Part of the appeal of staying private, even if you are a multibillion-dollar company, is that you can keep a lot more control over how your stock trades. You can require your shareholders to ask your permission to sell stock, and deny permission for any trades you don't like. This way, you can keep out pesky activists, freaky high-frequency traders and snooping competitors. Also I guess you can front-run trades if you want?
Palantir, following a common practice in Silicon Valley, requires that any sellers of its stock seek the company’s approval for the transaction; companies do this to limit and manage ownership of their shares.
But remarkably, KT4 claims that when Palantir receives information from an investor about a planned sale, it uses that information to contact the buyer and persuade them instead to buy shares directly from the company or from certain Palantir insiders. One particular broker, Disruptive Technology Advisers, or DTA, repeatedly gets commissions from these sales, even when it “performed no legitimate work,” KT4 claims.
That's from this story about a dispute between Palantir Technologies, the Spy Unicorn, and KT4 Partners, an investor in Palantir. There's a flurry of other claims not relevant to us here, but even if you assume that KT4's allegations are true, they seem sort of shady but ... allowed? The point of giving the company the right to approve stock transactions is that it can refuse, and it can refuse for its own interests. If it needs money, that's an interest! (Blocking one shareholder's sale to favor another, or to favor a broker, seems less justifiable.) If you don't want the company to jump in front of your trades, maybe you should try investing in public companies.
The problem with amassing vast dynastic wealth by successfully running a multibillion-dollar hedge fund for many years is that it imbues you with an undeserved sense of omnicompetence. "If I can outperform the market year after year," you think, "then I can do nuclear physics, or solve global warming, or fly." This isn't much of a problem for you! You still have your money, and your friends still love you, because of the money. But for the people in your orbit it can be annoying, and if you're rich and ambitious enough your orbit can get quite large.
Here's a Jane Mayer profile of Robert Mercer, the co-chief executive officer of Renaissance Technologies, who is a major backer of Donald Trump and Breitbart News, and who seems to have taken the confidence he gets from investing in markets and extended it into other domains:
Another onetime senior employee at Renaissance recalls hearing Mercer downplay the dangers posed by nuclear war. Mercer, speaking of the atomic bombs that the U.S. dropped on Hiroshima and Nagasaki, argued that, outside of the immediate blast zones, the radiation actually made Japanese citizens healthier. The National Academy of Sciences has found no evidence to support this notion. Nevertheless, according to the onetime employee, Mercer, who is a proponent of nuclear power, “was very excited about the idea, and felt that it meant nuclear accidents weren’t such a big deal.”
Ah. On the other hand, great success leads to high standards, and Mercer has troubles of his own:
Mercer retains a domestic staff that includes a butler and a physician; both accompany him whenever he travels. But this, too, has sparked bad publicity. In 2013, three members of the household staff sued to recover back wages, claiming that Mercer had failed to pay overtime, as promised, and that he had deducted pay as punishment for poor work. One infraction that Mercer cited as a “demerit” was a failure to replace shampoo bottles that were two-thirds empty. This suit, too, was settled.
My favorite bit of the story might be that Mercer's investment in Breitbart News "was made through Gravitas Maximus, L.L.C.," a name that definitely conveys maximum gravitas.
The problem with amassing vast dynastic wealth by successfully running a multibillion-dollar hedge fund for many years is that it imbues you with an undeserved sense of omnicompetence. Even just in the markets, sometimes. I mean really outperforming the market for a long time is good evidence that you'll keep outperforming the market, but sometimes it goes wrong, and when it does overconfidence is not a virtue. This isn't much of a problem for you! You still have your money. But it can be rough on your investors. Here's a Gretchen Morgenson and Geraldine Fabrikant story about Bill Ackman and Valeant Pharmaceuticals International Inc.:
As confident a money manager as ever walked Wall Street, Mr. Ackman has acknowledged that his investment in Valeant represented a breakdown in his firm’s due diligence — the research it does about the companies it backs. That concession came last spring when he was called to testify before a Senate committee on Valeant’s drug pricing practices.
In an email to The New York Times, Pershing Square said, “Valeant is an anomaly in an outstanding record over nearly 14 years.”
Here's an excerpt from David Enrich's book "The Spider Network," about Tom Hayes, the mildly autistic British trader convicted of masterminding Libor manipulation. Hayes's relationships with his co-workers, including his mentee Mirhat Alykulov, make for tough reading:
Once, at a dinner party, Mr. Hayes told Mr. Alykulov’s girlfriend all about his dandruff problem; she later sent Mr. Alykulov to work with a bottle of special shampoo to present to Mr. Hayes.
Despite Mr. Hayes’s propensity to explode at colleagues, Mr. Alykulov recognized that he was a brilliant trader. Mr. Hayes, not the best at reading interpersonal cues, concluded that he and Mr. Alykulov were pals.
The poor dope. Alykulov later recorded calls with Hayes for the Justice Department.
Meanwhile, here's the start of a review of "The Spider Network":
This book should be a flop. It is nearly 500 pages about the most boring subject on Earth: interest rates. The main character is a convicted criminal with anger-management issues. Furious that his girlfriend is late to come to the dinner table one evening, he carries the shepherd’s pie he has cooked upstairs and tips it into the bath, where she is relaxing, leaving her picking bits of meat and peas out of her hair.
Mention Libor — an acronym for the London interbank offered rate — and even bankers’ eyes are likely to glaze over.
These people all seem to assume that interest rates are boring. Is that a thing? What could be more interesting than interest rates? It's right in the name! There seems to be an expectation that books about finance, if they're going to be interesting, should take it easy on the finance. People who buy a book about the Libor scandal, this thinking goes, are really interested in who threw a shepherd's pie at whom, and would prefer to skip all the stuff about Libor. I hope that is not true.
People are worried about unicorns.
Here's a story about Bill Gurley, the venture capitalist, Uber backer and Silicon Valley contrarian:
Going against the Silicon Valley orthodoxy, the venture capitalist has urged technology start-ups to go public as soon as they are able, instead of continuing to take venture capital funding: Taking on too much venture funding, he has said, can fuel a lack of discipline.
“Bill was the one who pushed hard for my company, Net Gravity, to be profitable at the height of the dot-com boom” in the late 1990s, said Thuan Pham, a tech entrepreneur who joined Uber in 2013 and is now chief technology officer. “It was a very unpopular stance. At Uber, he is willing to speak up too.”
I love the idea of a businessman who will risk everything by saying to businesses: Hey, what if you made some money? It's such an unorthodox business philosophy! Venture capitalists were burnt at the stake in the Middle Ages for even whispering similar heresies. But in the modern Enchanted Forest you can find a few brave rebels -- like Gurley, who "went against conventional wisdom even before he became an investor" -- who are willing to speak out boldly, whatever the consequences, and say: "I think businesses should be profitable."
Meanwhile, you never want to say "We want to thank Jeff for his six months at the company and wish him all the best." Jeff is Jeff Jones, the president of Uber Technologies Inc., who is leaving because -- in his words -- "the beliefs and approach to leadership that have guided my career are inconsistent with what I saw and experienced at Uber, and I can no longer continue as president of the ride sharing business." Ouch! We have talked before about the difficulty of bringing in an outsider to fix Uber's culture. (Jones was hired from Target Corp. to fix Uber's marketing, not its culture, but at Uber "was viewed by many as the so-called adult in the room.") The problem is that the culture-fixer is not going to be a cultural fit, and then is going to quit in a huff in six months.
And elsewhere in the post-ownership car economy: "GM Tries a Subscription Plan for Cadillacs—a Netflix for Cars at $1,500 a Month."
People are worried about stock buybacks.
I think that "people are worried about debt-financed special dividends at private-equity-backed companies" is an important special case of "people are worried about stock buybacks," though I realize that the dividends aren't technically buybacks. Anyway people are worried about debt-financed special dividends at private-equity-backed companies:
Private equity firms have always borrowed to buy companies. But now, with debt so cheap, they’re layering on subsequent borrowing at an unprecedented clip to pay themselves, putting an additional, and at times fatal, financial strain on their newly acquired companies. From the start of 2013, private equity owners have taken out more than $90 billion in debt-funded payouts, according to data compiled by LCD, part of S&P Global Market Intelligence.
“Private equity firms are hastening the demise of companies that are already troubled by siphoning off money for themselves,” said veteran litigator Ronald Sussman, who has represented creditors in retail bankruptcy cases.
The usual complaint with buybacks is that that money could instead be used to fund research, innovation, expansion. That complaint is perhaps less compelling in the case of debt-financed dividends at companies like Payless Inc. Payless's private-equity owners probably did have more compelling places to put their money than in a shoe retailer. "Hastening the demise of companies that are already troubled" is called capitalism. I guess the problem here is that it wasn't so much the private-equity owners' money, as it was the creditors' money, but whose fault is that?
Deutsche Bank Seeks $8.6 Billion Selling Shares at Discount. Fired U.S. Attorney Preet Bharara Said to Have Been Investigating HHS Secretary Tom Price. U.K. to Trigger Brexit on March 29, May’s Spokesman Says. Activist Investor Takes a Page From Greenpeace, Pushing Companies for Change. Mexico calls on its builders to boycott Trump’s wall. Bitcoin Price Plunges on Fears of a Currency Split. The Bitcoin Backlog. It’s Good to Be a CEO, Again: Stocks Rise, and So Does Pay. The Magic Behind Glencore’s Recovery: Mastering the Zinc Market. "Depositing money into my investment accounts every day felt, and still feels, like a game." The Giancarlo Agenda: The CFTC Gets Back to the Basics. Of Goosebumps and CCP default funds. "Given the structure of our social safety net, automation tends to increase poverty and inequality rather than unemployment." Money Doesn’t Buy Happiness (in America). How pre-ordering coffee has turned into a nightmare. Odd Lots: How a Hedge Fund Manager Teaches His Kids About Money and Banking. "Osborne has now been a Tory chancellor, an investment banker and a newspaper journalist – a sequence whose next two terms are estate agent and serial sex killer." Monopoly’s 3 new tokens further obscure the game’s anti-capitalist roots — or do they? Narcissist bird.
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