Airlines, Poker and Disclosure
Last week, American Airlines Group Inc. offered its flight attendants and pilots pay raises of about five percent and eight percent, respectively, and Wall Street research analysts reacted like cartoon villains:
“This is frustrating. Labor is being paid first again. Shareholders get leftovers,” Citi analyst Kevin Crissey wrote in a note to clients.
“This is a seminal event, and represents the first, credible potential blow to our long-held ‘it’s different this time’ investment thesis,” JPMorgan Chase & Co. analyst Jamie Baker wrote Thursday in a client note, calling himself “troubled” by the airline’s “wealth transfer of nearly $1 billion” to labor groups.
I feel like you are not supposed to write that? Though I guess it gives you some bragging rights at the weekly research department happy hour. "What did you write about this week?" "Oh, you know, reiterated my buy rating on Snap, you?" "I fulminated against the perfidy of Labor, which has once again connived to steal food from the barren table of Capital." "Oh cool, way to stick up for our side."
But American's raises also represent a credible potential blow to another thesis: the one that the airline industry is a conspiracy to extract value from consumers and labor on behalf of index funds. We talk a lot about that theory around here. The idea is that most of the shares of American are owned by large diversified institutional investors who also own most of the shares of United Continental Holdings Inc. and Delta Air Lines Inc. and the rest of the big airlines. If American does something to take market share from United, that doesn't do American's shareholders much good, since they are also United shareholders. Instead, they want all the airlines to have high prices, low wages, and fat profits, without worrying too much about competing with each other for passengers or employees. If all of the airlines are in on the joke, then this will work. And the theory is that they're in on the joke, but not in an explicit way. Index-fund managers don't actually sit around conspiring with airline executives to keep prices up and wages down. Instead, subtle mechanisms of executive pay, investor pressure (or non-pressure), and general background notions of shareholder value push airline executives to work for their shareholders' real interests -- reduced competition -- rather than their ostensible competitive goals.
But how does that theory explain American's move? It doesn't, is the answer. American's move is bad for its shareholders, according to those analysts, and the stock price. Not only that, it's bad for shareholders of other airlines:
Indeed, major financial players were so outraged by American’s decision to pay higher wages that they punished airline stocks across the board. American itself took it hardest on the chin, of course, but the consensus among stock analysts was that higher pay at American could signal higher pay at other airlines too, with negative consequences for the overall industry.
If all the airlines coordinated, implicitly or explicitly, none of them would go around upsetting shareholders by unilaterally raising wages. We have not reached the utopia of index-fund investing quite yet; sometimes companies still do things that upset even their own shareholders.
Elsewhere in cartoonish depictions of the capitalist class, this story about a hedge-fund poker game gone wrong would seem too lurid and implausible if you saw it on "Billions." The basic plot is that a Renaissance Technologies Corp. executive, David Magerman, who was suspended from the firm for criticizing co-chief executive officer Robert Mercer's involvement in the Donald Trump campaign, went to a charity poker tournament where he knew Mercer and other Renaissance people (including founder James Simons) would be, got a little drunk, got in a confrontation with Rebekah Mercer, and was thrown out of the St. Regis. But it is full of gloriously over-the-top details. Magerman didn't just get drunk; he got drunk on 12-year-old Scotch. He didn't just get in a confrontation with Rebekah Mercer; she said this:
“You’re pond scum,” Ms. Mercer told him, repeatedly, according to Mr. Magerman and two people at the table. “You’ve been pond scum for 25 years; I’ve always known it.”
Robert Mercer doesn't just sit down at the poker table with a made-for-TV tell; it is the most absurdly caricatural poker tell imaginable:
“When he has a great hand, he whistles patriotic songs,” Mr. English said of Mr. Mercer, referring to tunes like “The Battle Hymn of the Republic.” “When he’s not sure, he hums them.”
And of course he ended up knocking out competitor Chris English by switching it up and humming with a big hand. (Maybe. "'He might have been humming to reverse his tell,' Mr. English said, trying to explain his loss. 'It was so loud I couldn’t tell.'"). There is even a smoke-filled room, though, this being 2017, it's not the main room. ("When Mr. Simons ducked into a side room to smoke, Mr. Magerman followed.") Really exceptionally well done everyone.
Elsewhere, a hedge-fund manager was beaten up so badly by nightclub security officers at a Las Vegas casino that a jury gave him $160.5 million in damages, so it could be worse.
We talked on Friday about Elisabeth de Fontenay's theory that the cause of the decline of public companies "need not be rising costs of corporate disclosure, but declining benefits." In this theory, the historical bargain for U.S. companies has been that public companies need to disclose more than private companies, but in exchange get access to a broader pool of capital; now private companies have much the same access, but with fewer disclosure requirements, so it's no wonder that companies are staying private longer. Several readers pushed back, pointing out that private companies usually have pretty good disclosure. Private equity firms and venture capitalists often want forms of disclosure -- operational data, monthly rather than quarterly financials, board seats -- that public shareholders would never expect. Sure, Uber Technologies Inc. can raise billions of dollars from investors without telling them its net income, but most private companies tell their shareholders more than most public companies do.
And that is true, but it fits with de Fontenay's point. As she writes, the point of Securities and Exchange Commission disclosure rules is not (just) that they give investors what they want; after all, investors can just demand what they want as a condition of their investment, and (Uber aside) usually do. Instead the point of SEC rules "is that disclosure has material third-party effects or externalities," positive externalities that might be lost if companies didn't generally have to follow them. These externalities are in part benefits to investors: For instance, the fact that (say) United Continental has to disclose its financials publicly is helpful, not just to its shareholders, but also to shareholders of (say) American Airlines, who can see how their company stacks up against its competitors.
But they're also in part benefits to society, or purported benefits to society, or things that politicians want anyway. Investors don't seem to have been clamoring for companies to disclose their use of conflict minerals, or the ratio between their chief executive officer's pay and that of the median worker. But Congress was clamoring for those disclosures, and so the SEC implemented those rules. Do they have benefits to society? Maybe. But in any case they are things that society, through its elected representatives, wants, even though investors could take them or leave them. And to the extent the benefits of public-company disclosure are just about general benefits to society, then it could be rational for all companies to remain private: The public-company disclosure ecosystem could be good for politicians, but bad for public companies.
Ahahahaha the Trump administration is going to get rid of the carried interest tax break:
During last year’s campaign, President Donald Trump said he would curb that practice. And while his tax-overhaul outline didn’t follow through on that pledge, his White House chief of staff, Reince Priebus, said Sunday he would keep that promise.
I laugh because of course Trump's pseudo-plan would lower the tax rate on carried interest. Under the current system, private-equity managers pay taxes of about 39.6 percent on their ordinary income and about 23.8 percent on their capital gains; carried interest counts as capital gains even though it is "really" compensation for labor and therefore ought to be taxed as ordinary income. Under the Trump system, private-equity managers would pay taxes of 15 percent on all of their "business income" -- income they get as owners of pass-through entities like private-equity funds and firms -- including both carried interest and ordinary income like fees. So the carried-interest loophole would go away, but only by being swallowed up by a much larger loophole. Under the current system, most labor income is taxed as ordinary income, and carried interest is the exception. Under the Trump system, most rich people's labor income would be taxed at 15 percent, and carried interest would stop being a meaningful category.
Oh by the way, I have vaguely assumed that Trump's plan to tax "business income" at pass-through entities at a top rate of 15 percent would be done in a way that makes sense, something like:
- If you have a business set up as a sole proprietorship or limited liability company, and it makes money, and you keep the money in the business, you pay 15 percent taxes on it.
- If you take the money out of the business, you pay the higher individual income tax rate on it.
So, for instance, if your sole proprietorship pays you a salary, you pay the individual tax rate. If your LLC pays you a dividend, you pay the individual tax rate. (Or maybe the lower dividend tax rate.) Money that you take out of the partnership for consumption would be taxed at individual rates, while money that you leave in the partnership for reinvestment would be taxed at the 15 percent rate.
But that is just my assumption and I actually have no idea. The plan has no details yet, and this administration does not seem to place a high priority on making sense, or on preventing abusive tax structuring. And there are some double-taxation issues with my approach. (If your pass-through business makes money, and you pay 15 percent on it, and the following year the business distributes the income to you, surely you don't pay the full 39.6 percent on that distribution?) But of course if all income from pass-through entities -- even income that those entities' owners spend on personal consumption -- was taxed at 15 percent, then everyone should be earning all their income through pass-through entities, and this newsletter will soon be coming to you from Money Stuff Business Thing LLC. Anyway here is Neil Irwin discussing that point, as well as some potential anti-abuse strategies to prevent everyone from getting taxed at 15 percent.
Elsewhere, Bloomberg notes that Trump's tax plan will be "an enormous tax cut for high-income households" but might raise taxes on the middle class. And: "House Tax-Panel Chairman Still Committed to Border-Adjusted Plan." And Donald Trump apparently doesn't know what's in his health-care bill.
And elsewhere in taxes, here is a story about an Austrian plan to tax Google searches and Facebook posts:
“The business transaction that’s going on here is that users are paying with their personal data,” Schieder told journalists in Vienna. “The business model of those internet companies is based on massive revenues that are generated with the help of those data.”
That's not wrong! Taxation is hard. You want to tax the economic value of transactions, but all the interest is in figuring out what is a transaction, and how to determine its economic value.
Operational risk capital.
Bank capital requirements are a regulatory form of risk management, and there is a boringly well-known problem in risk management, which is that risk management is about preparing for the future, but all you have to go on is the past. So you set capital requirements for a thing based on how volatile you expect it to be in the future, but your main evidence of that is how volatile it has been in the past, and the future will probably be different. And you have lots of arguments over exactly how to use the past data to set the requirements: Is it more relevant that the thing has been quiet this year, or that it was very volatile 10 years ago? And there is never a fully satisfying answer, because you cannot know in general whether the future will be more like this year or 10 years ago.
But while none of those arguments are particularly satisfying, they tend to at least look like math. Like you can say things like "standard deviation" and "fat tails"; you have a daily time series of the thing's price, and can quantify its past volatility with great precision, even though you cannot forecast its future volatility with much certainty.
On the other hand, modern bank capital regulations also require banks to hold capital against operational risk: not the risk that some traded asset will lose value, but the risk that the bank itself will do some dumb thing that ends up with it being fined or sued. That just feels less math-y and more subjective, and yet it has the same basic problem as everything else:
One big gripe banks have is the backward-looking nature of the rules. Citigroup Inc., for example, still holds capital against operational risks in businesses it has been winding down since the crisis.
"When you incur an operational loss," said Citi's chief financial officer, "it has got a Plutonium-238 half-life." Sure the last decade has been a rough one for the big banks, fine-wise, but what are the odds that the next decade is as bad? Anyway, now House Republicans might want to reduce the operational risk capital requirements, and since operational risks are partly a political matter, I suppose that's a good sign that those requirements really should be lower?
Can all the evils of society be blamed on Harvard Business School?
“We have people who are social entrepreneurs, we have people who serve society in myriad ways, we have people who are soldiers, bankers, activists, CEOs. There are lots and lots of ways in which our alumni provide goods, services, employment and various other things to society. So I think that to argue that all the evils of society can be blamed on HBS seems to me a little overstated,” he said.
The dean, Nitin Nohria, is reacting to Duff McDonald's book, "The Golden Passport," which apparently blames Harvard Business School for at least many of the evils of society. "Nohria went on to cite a number of popular courses, from 'Reimagining Capitalism' to 'Leadership and Corporate Accountability,' that, contrary to McDonald’s argument, push students to equally consider ethical and legal dimensions as well as economic ones."
Elsewhere in business schools, "Stanford GSB’s full-time MBA is best for a career in finance, according to a new ranking published by the Financial Times."
People are worried about duration.
"Worried" isn't the word, really, more like "meh":
Treasury staff have long been sceptical that ultra-long debt issuance — sometimes termed “Methuselah bonds” — is a good deal for the government, given that it would have to pay a higher price than for 30-year Treasuries with questionable funding benefits.
Ultra-long bonds would probably not cost much more. George Goncalves, head of US rates strategy at Nomura, estimates that a 50-year Treasury would only yield about 20 to 25 basis points more than the existing 30-year benchmark, currently trading at 2.98 per cent. Yet even this slender premium might not be low enough to convince Treasury that it makes sense.
But of course if Treasury does issue a 100-year bond with 3-handle coupon, we will have decades of articles worrying about duration. "If interest rates go up by just one percentage point, these bonds will lose about a quarter of their value," you could write, any time over the next half-century.
People are worried about stock buybacks.
I don't know, "Apple Inc. is expected to report Tuesday that its stockpile of cash has topped a quarter of a trillion dollars," and people are salivating over what it might do with all that money:
With $250 billion, Apple could buy both Tesla and Netflix and still have plenty left over. It also might want to use some cash to pay down some of its debt or look to boost U.S. manufacturing after facing calls last year from then-President-elect Trump to build a plant in the U.S.
But of course stock buybacks are always a possibility. Apple seems like one of those rare exceptions to the general rule that companies are good at one thing and should do that thing, make money with it, and give the money back to shareholders to go find other things to do. Maybe an Apple Tesla would be better than a Tesla Tesla? Still, Tesla has probably spent more time thinking about Tesla than Apple has, and if Apple's shareholders want to buy Tesla stock, they can just do that. Especially if Apple hands them a bunch of cash.
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