Relationships and Glass-Steagall

Also the return of volatility, Leon Cooperman, corporate governance, and some more Juicero.


One thing that I like to say around here is that a lot of the financial industry is run as essentially a gift economy. Investment bankers don't just do stuff for clients and send them the bill: They do stuff for clients for free, running financial analyses and giving them informal advice and merger ideas, with the expectation that all the free stuff will make the client grateful enough to one day overpay the bank for a merger mandate or securities offering. Bank research analysts don't come up with trade ideas and sell them to clients: They come up with trade ideas and give them away, with the expectation that all the free trade ideas will make the clients grateful enough to overpay the banks for executing trades. Banks are not in the business of providing quantifiable value and then charging for it; they're in the business of giving clients lavish presents and then hoping for even more lavish presents in return.

That is a little counterintuitive, isn't it? Finance seems like an industry where value would be quantifiable. There are a lot of numbers. Your trade ideas either go up or they don't. Why not get paid based on how much they go up? There are some good reasons for the gift-exchange approach (it lets clients test the quality of the advice before paying for it), and some bad reasons (it might mask the costs of banking services, and allows bankers to butter up agents and get paid back by their principals), but mostly I suspect there is a sociological reason, which is that it feels more high-status to live in a world of favor-trading and gift exchange than a world of naked commercial transactions. "Oh, I'm close with the CEO of XYZ Corp., we play golf together and he listens to my advice" is a more satisfying description of your work life than "I have sold four units of M&A to XYZ Corp. this quarter." Business as a network of gift exchanges allows you to cast your business life as a life, your work relationships as friendships, your work as influential rather than merely lucrative.

Anyway European regulators are kind of trying to ruin all that with the MiFID II regulations. Here is a story about "alpha capture," in which investors pay directly for trade ideas that they use and that perform well, instead of paying for them indirectly with trading commissions (which will soon be outlawed by the MiFID II rules).

One winner from this system: Smaller brokerages that lack the established relationships of investment firm Goliaths can now win clients by showing that their advice is superior. That worked for Conway, a quantitative analyst who says he has received payments for his trading ideas posted on TIM Group.

"Nobody had considered the performance angle before, it used to be only about price” of trading execution, said Conway. “Now, there’s an audited record of ideas. It’s a very clinical system, but it’s proven to work."

"It's a very clinical system, but it's proven to work" is of course good, for a business thing (you don't even need the "but"!), but it comes off like faint praise. If you learned that your new boss was "very clinical, but proven to work," you'd be scared to come to the office the next day. 

Or here is a story about bond syndication, another area touched by MiFID II. The old system was that investors put in orders for bonds, and banks gave the bonds to the investors that they liked. They liked them for reasons, of course -- because they supported the company, or they had supported the last deal the bank underwrote, or they did a lot of trading with the bank, or the bank's traders had fun when they went out drinking with the investors -- but those reasons were not straightforwardly quantifiable on a single axis. But "the European Securities and Markets Authority, the EU regulator, has said that, under the new rules, bond syndicates 'must provide a justification for the final allocation made to each investment client' and banks are developing drop-down menu systems to speed up this process." Drop-down menus! Imagine reducing a relationship to a choice on a drop-down menu.

Obviously one thing that is going on here is that the regulators believe the bad reasons for the gift exchanges: They see them as conflicts of interest, as principal/agent problems. Banks give out research to investment managers in exchange for fees paid by the managers' clients; they give bond allocations to help their own bottom lines rather than to help the issuers selling the bonds. But there is a side effect to these changes, which is to make the business of banks less enjoyable, less relationship-based, more transactional, more ... business-like. The mantra in post-crisis financial regulation is to make banking more boring; this might be one way to do it.


We talked on Tuesday about how Donald Trump's administration's plans for a "21st century" version of the Glass-Steagall Act have no resemblance to either (1) Elizabeth Warren's previously proposed "21st Century Glass-Steagall" or (2) the Glass-Steagall Act itself, which separated commercial and investment banking. Yesterday, in Senate testimony, Treasury Secretary Steven Mnuchin made that explicit, and also absurd:

“We never said before that we supported a full separation,” Mnuchin said, rejecting the claim that this marked a policy reversal. He also apologized for the confusion that the 21st Century phrase, often bandied about by Trump and his aides, happens to match the title of the bill pushed for years by Warren and Republican Senator John McCain. Their legislation is called the “21st Century Glass-Steagall Act.”

“We never said we were in favor of Glass-Steagall; we said we were in favor of a 21st Century Glass-Steagall,” Mnuchin said.

"It couldn't be clearer," added Mnuchin, who seems to have a good sense of humor but a stunted sense of the possibilities of language. It could be clearer! For instance, instead of literally precisely saying that they were in favor of Glass-Steagall, and that they were "looking at" breaking up the banks, the administration could have said "we are opposed to Glass-Steagall and do not want to break up the banks." But of course if you say that then some people would disagree. If you say that you are in favor of Glass-Steagall and also not in favor of it, then you will please everyone, until they notice.

Mnuchin also promised that Trump's plan to allow pass-through business entities to get a 15 percent tax rate would only give that rate to the pass-throughs that you think should get it (small businesses), and not the pass-throughs (hedge funds, Trump's real-estate business, Money Stuff Business Thing LLC) that you think would be gaming the system by being taxed that way. The Trump tax plan, which currently exists in one-page outline form, will do everything that you think is good, and nothing that you think is bad. Donald Trump seems to be learning that being president is harder than he thought, but to be fair he is also teaching the rest of us that politics is much easier than we thought. The trick is to just promise everyone exactly what they want, and then not do it.

I guess people are no longer worried that people aren't worried enough?

We talked on Wednesday morning about how the markets seem to under-react to all the bizarre news out of the Trump administration, and so right on cue volatility spiked on Wednesday, with the S&P 500 Index closing down 1.82 percent and the CBOE Volatility Index -- the VIX -- closing at 15.59, a 46-percent move from Tuesday's close. (Things got better yesterday, with the S&P up 0.37 percent and the VIX down to 14.66.) Volatility is still pretty low, by historical standards, and yet the popular narrative that markets are complacent and ignoring political crises seems to have been shattered. Or, put differently:

“Crazy times, huh?” said Matt Maley, an equity strategist at Miller Tabak & Co. “I’ve talked to a few personal friends and a few customers who I know are supportive of Trump that are saying, boy, this isn’t good.”

Really if you looked at just the last two days of trading, you might even conclude that the market saw a bunch of political shocks, overreacted to them, and then pulled back the next day as cooler heads prevailed. That's a very normal story -- stock markets usually overreact to news -- but it's a surprise these days. 

"Now that there is volatility, will people stop talking about the VIX," asks Justin Lahart at the Wall Street Journal, and it is an interesting question. If interest in the VIX -- the "Fear Index," as it is inevitably called -- moves inversely to the level of the VIX, then what is it measuring? The lower the Fear Index gets, the more fear there seems to be. Anyone who's ever watched a horror movie knows that the scariest parts are when gory stuff isn't happening. And here is Ben Bernanke:

“It always puzzled me a little bit,” Bernanke said In an onstage interview at the three-day, hedge-fund focused SkyBridge Alternatives Conference, or SALT, in Las Vegas. Financial markets have long shown a tendency to be “blasé” about political risks until the “last moment.”

Meanwhile in Brazil everything is crazy.

Elsewhere here is Emanuel Derman on Twitter, on volatility products:

This isn't deep, but I think part of the reason vol is low is because vol has become an asset class. Once upon a time you had to buy or sell options and hedge them to trade vol, because an option gave you exposure to both stock price AND volatility.

Think about CDS. Once upon a time you had to buy corporates & short T-bonds to trade credit, because a corporate had risk of credit and rates. Then with the invention of CDS that gave pure exposure to credit, it became easy to speculate on credit. And eventually a credit bubble. 

Similarly the invention of variance swaps and the VIX led to a way to trade volatility as an asset class, and to think of it that way. And hence easy to speculate on volatility, to sell it without having to hedge equity exposure, and hence (perhaps) a volatility bubble.

If you believe in efficient markets, then moving from one form to another -- from bonds plus Treasury hedging to credit-default swaps, or from options plus stock hedging to VIX products -- should be just an administrative convenience; it shouldn't change anything in the real world. But of course the point of a bubble is that it is a breakdown in market efficiency, an irrational event. And "irrationality occurs when a previously difficult thing becomes easy" is a pretty satisfying explanation: If it's hard, you have to be smart to do it; if anyone can do it, then irrational people will. 

And Jon Corzine is so sure that Trump will create volatility that he's starting a Trump-volatility hedge fund, or something?

In his first interview since the MF Global meltdown began, Mr. Corzine detailed his plans for a new hedge fund, saying that he will seek to anticipate what often seems unpredictable: how the Trump administration and other world leaders will enact policy and, in turn, move markets.

"In Tumult of Trump, Jon Corzine Seeks a Wall Street Comeback," is the headline of that article, which is odd to read after weeks of articles about near-record-low volatility. 

Leon Cooperman settles.

I have always been kind of sympathetic to Leon Cooperman in the Securities and Exchange Commission insider-trading case against him; he talked to a corporate executive and then traded, sure, but the evidence that he had promised not to trade seemed weak and implausible. And Cooperman vowed to fight this case to the ends of the earth, so you know what that means:

Now, nearly eight months later, he and his firm, Omega Advisors, have agreed to settle, paying just under $5 million in civil penalties and forfeited profits.

But unlike other hedge fund managers who have reached settlements with the Securities and Exchange Commission in insider trading cases, Mr. Cooperman is not admitting any wrongdoing. Significantly, he will not be barred from the securities industry.

"I look forward to putting this matter behind me, with no restriction on my ability to invest and manage client assets, for much less than it would have cost to continue defending the case," said Cooperman, which is probably a correct calculation. It is a little disappointing as a matter of incentives. What if he's totally right? What if he did nothing wrong, and could prove it in court, but would rather pay $5 million in settlement costs than $8 million to lawyers? What incentives does this settlement create for the SEC to go after the next dubious insider trading case? 

Corporate governance.

Well this, from Alan Palmiter of Wake Forest University School of Law, is lovely:

Recent research in the nascent field of moral psychology suggests that we humans are not rational beings, particularly when we act in social and political settings. Our decisions (moral judgments) arise instantly and instinctively in our subconscious, out of conscious view. We rationalize our moral decisions — whether to feel compassion toward another who is harmed, to desire freedom in the face of coercion, or to honor those matters we consider sacred — after we have made the decision. We layer on a veneer of rationality, to reassure ourselves of our own moral integrity and to signal our moral values to like-minded others in our group. This is particularly so when we operate in the “super-organism” that is the corporation, where specialized roles have led to almost unparalleled human cooperation.

Thus, the decision-making and actions that arise from the shareholder-management relationship are best understood as the product not of rational economic incentives or prescriptive legal norms, but instead moral values. On questions of right and wrong in the corporation, the decisions by shareholders and managers, like those of other human actors, are essentially emotive and instinctive. The justifications offered for their choices — whether resting on shareholder primacy, team production, board primacy, or even corporate social responsibility — are after-the-fact rationalizations, not reasoned thinking.

Elsewhere in corporate governance, Ronald Barusch criticizes the fact that companies don't have to disclose apparently material news about their chief executives' health: "Securities and Exchange Commission rules don’t require it, even as they mandate disclosure of other, much less important matters." And "Deutsche Bank expects former board members to contribute substantial sums toward the costs of its past misconduct as Germany's biggest lender seeks to rebuild its reputation." You don't see compensation clawbacks from former board members every day. Board members tend to have negative emotive and instinctive reactions to that sort of thing.

People are worried about unicorns.

It's been a few weeks since we talked about Juicero Inc., the Juicicorn, which raised $120 million to build a $400 machine that will squeeze juice out of bags of wet vegetables, an innovation that was somewhat undercut when Bloomberg's Ellen Huet and Olivia Zaleski discovered the somewhat-obvious-sounding-in-hindsight fact that you can just squeeze juice out of a bag of wet vegetables with your own two hands. But here is a Gizmodo article about the troubles at Juicero, arguing that "these darkly comic gaffes" -- the hand-squeezing, the over-engineering of Juicero's own squeezer -- "are only a keyhole view into the kingdom of dysfunction Juicero’s employees have been living in." I guess? There is a bunch of gossip about how Juicero employees are mad or whatever, but the highlight for me remains the hand-squeezing. Here:

Convenience and “a great experience” not achievable by hand-squeezing, as current CEO Jeff Dunn put it on Medium after a flurry of negative headlines, is ultimately what the company is selling. Ramtin Naimi, the 26-year-old phenom heading Abstract Ventures—which has investments in over two dozen companies including a series B investment in Juicero—went a step further, calling the Bloomberg story “lazy journalism.” In one sense it wasn’t much of a scoop: people within the company across multiple teams knew manual extraction was possible since approximately mid-2016. Naimi’s informal assessment—which he emailed to to Gizmodo broken down by flavor and millimeter yields, and which Gizmodo is as yet unable to confirm due to current shipping restrictions—suggests hand-squeezing nets significantly less juice, especially with tougher produce like carrots and kale.

I am not sure what a "millimeter yield" is but I don't care. The important points here are: 

  1. A "26-year-old phenom" venture capitalist spent time hand-squeezing bags of vegetable in order to assess their yields and emailing the results to a technology reporter doing an investigative story.
  2. The reporter could not replicate those experiments "due to current shipping restrictions." (Wouldn't want to let just anyone hack the juice bags!)
  3. "People within the company across multiple teams knew manual extraction was possible since approximately mid-2016" is honestly such a wonderful sentence. Imagine being the person who discovered that you can squeeze juice out of vegetables with your hands! Imagine characterizing that as "manual extraction was possible"! Imagine the spread of that illicit knowledge "across multiple teams"! Was it multiple independent discoveries, or did the Christopher Columbus of manual juice extraction on one team whisper it to a member of another team in the break room, over a refreshing cup of properly-machine-extracted juice?
  4. Everything, I am melting, I love it. 

I think Scott Alexander is largely right that the technology industry is mostly about actual technology, doing things -- space exploration, 3D printing, lab-grown meat, instant money transfer, or just "enterprise data solution software application package analytics targeting management something something something 'the cloud'" things that make business more efficient -- that are only possible as the culmination of decades of research in science and technology. Only very rarely is it about applying pressure to vegetables until juice comes out.

But sometimes it is! The important lesson of Juicero is not that it is representative of Silicon Valley, that all "tech innovation" is essentially flimflam applied to simple pre-existing ideas. The lesson is that it is a logical end point of Silicon Valley, that a culture founded on a belief -- even an accurate belief! -- that it is changing the world through technology will extend that belief outward until it becomes absurd. A lot of things really do work better when you connect them to the cloud. Possibly not vegetables though.

Things happen.

Would You Let Trump Run Your Company? Never Mind the Ferrari Showroom, Bank Regulators Call This a Poor Neighborhood. U.S. Examines Russia’s Grip on Citgo Assets. Humbled by Valeant, Ackman goes back to basics. U.K.'s Brexit Bill Could Be as Low as $6.5 Billion, Study Says. Paris turns to English law to lure City business. EU hopes Ireland will recover money from Apple 'very soon.' IBM, a Pioneer of Remote Work, Calls Workers Back to the Office. An ETF named "SHAG." Passive’s aggressive march poses thorny questions. Jim Chanos Says Markets Hope Pence Replaces Trump as President. "Jim Chanos says he blew out his knee at a Snoop Dogg concert." Alexandra Scaggs on the Martin Shkreli musical. Robert De Niro as Bernie Madoff. 2017’s ‘Bachelorette’ Contestants, Ranked By Shirt Terribleness. Every Color Of Cardigan Mister Rogers Wore From 1979–2001. "At a recent dinner, a friend unfamiliar with Mr. Met asked me what his race is." Dutch king reveals double life as an airline pilot for KLM. Yale dean is placed on leave over offensive Yelp reviews.

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