Money Stuff

Bank Bailouts and Property Taxes

Banco Popular.

"It is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change," says the epigraph from Charles Darwin on page 7 of Banco Popular Espanol SA's 2016 annual report. Well, there is change coming at Banco Popular

Banco Santander SA agreed to take over Banco Popular Espanol SA after European regulators determined that the troubled lender was likely to fail and ordered it to be sold.

Santander will raise about 7 billion euros through a rights offer to bolster Popular’s balance sheet, it said in a regulatory filing on Wednesday. The lender will acquire Popular for 1 euro after its stock and shares resulting from the conversion of its riskiest debt and Tier 2 instruments were wiped out, imposing losses of about 3.3 billion euros on the bank’s securities holders.

Technically, Europe's Single Resolution Board slashed all of Popular's common stock to zero, and its Additional Tier 1 capital instruments to zero, and then converted its Tier 2 capital instruments into common stock, and then sold that common stock to Santander for one euro. So Popular's failure ate through three layers of Popular's capital structure, but in the neatest possible way. The common stock, and the two layers of capital instruments above it -- all equity-like instruments that were explicitly intended to bear the risks of Popular's business -- were all totally wiped out. (I assume the Tier 2 holders won't, like, actually split that one euro amongst themselves.) The senior debt, and everything senior to it (that is: deposits), was unaffected. Risky bank instruments turned out to be risky; safe bank instruments turned out to be safe; taxpayer help turned out not to be necessary. It is as textbook a bank resolution as you could hope for.

I mean, it is early days. But the Single Resolution Board sort of needs a win. The big question in post-2008 bank regulation is: Have regulators figured out how to wind up big failing banks without causing a panic or requiring taxpayer bailouts? And there has been a ton of skepticism about the answer. U.S. regulators have built stress tests, living wills, and additional capital and leverage and liquidity requirements, but there are constant complaints that we still haven't solved "too-big-to-fail." In Europe, there are bail-in rules for the private resolution of failed banks, but they sometimes seem to be swamped by the exceptions. (The Popular resolution "comes less than a week after the European Commission gave preliminary approval to plans for a government rescue of Monte dei Paschi di Siena, a troubled Italian bank.") But if the textbook Popular resolution works out, then that's a big confidence-booster that regulators will follow the rules, and that those rules will work.

It is only a start. The basic mechanism that regulators have chosen to wind up failing banks is to require those banks to have different capital instruments with different priorities, and for the regulators to be able to choose which instruments to vaporize based on how bad the problem is. If you have a failing bank with a minor solvency problem, you vaporize the common stock. If the problem is bigger, you vaporize the Additional Tier 1 instruments, but keep paying the Tier 2s. If the problem is even bigger, the Tier 2s go. If it's really big, you'd bail in senior debt before going to taxpayers for aid. In principle these don't have to be binary decisions; a bail-in could zero the common, leave the Tier 2 intact, and pay the Tier 1 at 40 cents on the dollar, say. The decisions would be adapted to the facts; a more solvent bank would have a gentler resolution than a less solvent one.

In a sense, the Popular outcome is almost too neat: Zeroing the common, Additional Tier 1 and Tier 2 instruments, while leaving the senior debt intact, is the most obvious dividing line. It sends a signal that European regulators are serious that bank capital instruments are meant to bear losses, while maintaining confidence in senior instruments. If you had 100 more bank resolutions, you wouldn't want them all to go like this. You'd want some discrimination. You'd want a bank to fail while keeping its Tier 2 securities intact: Otherwise, why would investors pay more for Tier 2 securities than for Additional Tier 1s? You'd want a bank to fail with a haircut on its senior debt: Otherwise, investors will treat bank senior debt as risk-free. But these are all advanced moves; first the Single Resolution Board needs to get the basics right. 

Is property theft?

Yesterday a small section of financial Twitter greatly enjoyed this 2016 paper, "Property Is Another Name for Monopoly," by Eric Posner and E. Glen Weyl, whom you may remember for also arguing that index funds are a form of monopoly. I suppose that was a specific case of the general theory: If anyone's ownership of anything is a monopoly problem, then index funds' cross-ownership of multiple stocks in the same industry is, trivially, a monopoly problem. But in that case, the problem cannot be solved by banning index funds; the only solution is banning property. So!

The existing system of private property interferes with allocative efficiency by giving owners the power to hold out for excessive prices. We propose a remedy in the form of a tax on property, based on the value self-assessed by its owner at intervals, along with a requirement that the owner sell the property to any third party willing to pay a price equal to the self-assessed value. The tax rate would reflect a tradeoff between gains from allocative efficiency and losses to investment efficiency, and would increase in line with expected developments in information technology.

Here is Matt Klein at Alphaville, making fun of this proposal. The basic problem is ... you know, the basic problem is the "requirement that the owner sell the property to any third party willing to pay a price equal to the self-assessed value." There is self-evident ickiness there. Like your house? Great, you have to sell it if a higher bidder comes along. Or you can just put a really high price on it, to keep it in the family, but then you have to pay much higher taxes.

But the problem I can't get past is, like, like your pen? Well then, you need to value it on your tax return at $2, or whatever, and pay 20 cents of taxes on it, or whatever. Or you can just forget to value it on your tax return, but then anyone who wants it can just take it, since your self-assessed price is zero. This seems like an overwhelming problem with the system: Humans would spend essentially all of their time filling out frequent valuation self-assessments for all of their possessions. It seems like I am kidding but no that is literally the proposal. But Posner and Weyl have a solution, and it is one of the most amazing paragraphs I have ever read, something that Borges would be proud to have written:

Current owners would have to report values with some frequency for all of their possessions, presenting a tradeoff between convenience and accuracy. If they must report self-assessed valuations frequently, they must undergo the trouble of thinking about how much they value something and of recording the valuation, but if they report infrequently, then valuations will become inaccurate as tastes and budgets change. One approach would be for taxes to accrue in continuous time based on an annualized tax rate, with individuals having the right to change their valuations at any point in time. This system could be managed through a web interface accessible, for example, by a smartphone application or a web browser. A well-designed interface would likely automatically retrieve information from tracking devices of the sort associated with the “Internet of Things,” to help the owner keep track of her possessions. It would be linked to her methods of electronic payment, so that her purchases would automatically be added to the cadaster, at which point she would be asked to assign a value to them. While some individuals would want to carefully weigh each valuation, a sensible system would allow for plug-ins from third parties, that would offer advice to participants about valuing goods, or default valuations, in an automated way using collaborative filtering and other techniques that form the basis of the ubiquitous recommendation engines. When an owner began to tire of a piece of property, rather than undertaking large expenses to market and sell the property, she could just begin to lower its price on the cadaster, and eventually someone would take the property from her. Indeed, she could use a program that gradually reduced the price until a sale took place, in effect, conducting a Dutch auction, with the rate of reduction reflecting the owner’s reservation price, liquidity needs, and the prices of other comparable goods in the market.

Is that not gorgeous? We often think of abolition of private property rights as a form of socialism, but this is the abolition of private property rights as a form of hypercapitalism: Property is abolished in favor of pure markets; you don't own anything permanently because you are constantly buying and selling everything. Your pen is on the Internet of Things, and if you tire of your pen you just implement a third-party algorithm to slowly lower its valuation until someone comes along and buys it from you. (Couldn't be simpler!) Property rights would be limited with the result of turning all of life into constant commercial calculation, infusing all of our actions with prices. On the blockchain. Through a web browser.

Ha, isn't that our future? With or without Posner and Weyl's "Harberger tax" approach, the "sharing economy" -- where everything is rented rather than owned -- and the blockchain -- where everything's price is available to everyone in a shared public record -- could land us in much the same place. You don't have to be a socialist to embrace this future; it's the cutting edge of capitalism.

I should add that I have some sympathy for the actual Harberger tax idea. Property is a social construct, and you can come up with principled reasons why a society would want to limit property rights -- and impose market mechanisms -- in particular cases. Here is Steve Randy Waldman arguing for a similar approach to patents and urban real estate, noting that "the social cost of excluding alternative uses varies dramatically between resources." One tech company's ability to prevent another from using rounded corners may be socially harmful, and we might want to rethink how we administer that right. My ability to prevent you from taking my pen, though, seems really socially useful! It's kind of how we have a society.

Rosneft.

"The structure of the deal is unusual," says a guy, about Glencore PLC and Qatar Investment Authority's purchase of 19.5 percent of Russian state-owned oil company PAO Rosneft last year, and he is not kidding:

Russian President Vladimir Putin hailed the €10.2 billion ($11.5 billion) sale of the PAO Rosneft stake in December as a sign of investor confidence in his country. But the people with knowledge of the deal say it functioned as an emergency loan to help Moscow through a budget squeeze.

Moscow agreed with Qatar that Russia would buy back at least a portion of the stake from the rich Persian Gulf emirate, the people said.

That's from the Wall Street Journal, but "Kremlin spokesman Dmitry Peskov said he didn’t agree with the characterization of the deal as an emergency loan," and "Glencore and the Qatar Investment Authority said the deal’s contract contained no right for Russia to buy back Rosneft shares." So if this deal is effectively a repo arrangement, it's a very secret one. Also unusual: the bulk of Glencore's and Qatar's payment was financed, by Russian banks and by Intesa Sanpaolo SpA, on a non-recourse basis, meaning that you could almost characterize the whole trade as a very complicated way for Intesa to lend money to Russia.

Also it doesn't seem to be the traditional sort of loan-like repo arrangement, where the seller agrees to buy the thing back at a fixed price:

Qatar wanted its Rosneft stake to be temporary, the people said. The emirate believes it will profit from selling the shares back to Russia at a later date, the people said, betting that oil prices will rise and push up Rosneft’s share price.

I used to structure and market equity derivatives, and people would occasionally ask for a derivative in which A sells stock to B at the market price today, and then agrees to buy the stock back from B in a year at the market price then. "That's not a thing," I would tell them, because it usually isn't: Normally derivatives create rights or obligations to buy or sell stock in the future at some price other than the market price. You don't need a contract letting you buy stock in the future at the market price in the future! You can just wait until the future, and then buy the stock at the market price. But in the case of Rosneft, "it isn’t easy to buy and sell large pieces of the company because it remains majority-owned by the Russian state," so if you are planning to sell it back at the market price in the future, I guess it makes sense to have that in writing.

People are worried about unicorns.

How can you not love the unicorns:

Pinterest Inc. raised $150 million in venture funding from a group of existing investors at the same share price as two years ago as growth at the closely held company fails to keep pace with internet rivals.

The last fundraising round was in April 2015, valuing the business at about $11 billion. Because the number of shares in the company has grown over time, its new valuation is $12.3 billion, Pinterest said.

Is this a flat fundraising round, because Pinterest is selling stock at the same price as it did in 2015? Or is it an up round, because it has issued about a billion dollars' worth of stock since that round, making its total valuation larger? Hahahaha who cares, it is what it is, "up round" and "flat round" are meaningless scorekeeping words, not actual economic concepts. But of course the Enchanted Forest is full of meaningless scorekeeping games; strong alpha unicorns are only supposed to raise money at ever-increasing valuations, so they care a lot about the technicalities of what counts as an increasing valuation.

Meanwhile the alpha-est of the unicorns, Uber Technologies Inc., is engaging in some self-reflection:

Uber fired more than 20 people after a company-wide investigation into harassment claims and hired at least two high-profile senior executives whose job will be to set strategy and rethink branding.

Law firm Perkins Coie LLP led the investigation, reviewing 215 human-resources claims; while it took no action in 100 instances, it’s still probing 57 others.

Is that a lot? It seems like a lot. Maybe other 12,000-person companies fire 20 people over time for sexual harassment, but not, you know, all at once. "Some of the people fired were senior executives," and "aside from those fired, 31 employees are in counseling or training, while seven received written warnings from the company." And "Uber hired two women as senior executives -- former Apple Inc. executive Bozoma Saint John as chief brand officer and Harvard Business School Professor Frances Frei as senior vice present for leadership and strategy."

A popular model of Uber is that its culture was so uniquely bad and sexist -- and sparked such a strong backlash -- that now it will become uniquely good and progressive: While the Uber of a year ago was unusually tolerant of sexual harassment and hostile to women, the Uber of tomorrow will be unusually intolerant of harassment and welcoming to women. I don't know! But there is something very Silicon Valley about this pivot, that Uber might be somehow almost indifferent between being the most sexist unicorn and the least. What matters is not the direction of the choice, but the magnitude: There are many ways to run a giant unicorn, some of them diametrically opposed to each other, but the important thing is that whatever you do, you have to do it as much as possible.

People are worried about bond market liquidity.

It seems like the Financial Stability Oversight Council is worried about bond market liquidity:

Now, under President Donald Trump and his Treasury secretary, Steven Mnuchin, FSOC is looking at what the administration has said is a very different kind of threat. The council is studying whether regulations themselves are causing financial instability, rather than preventing it, said three people with knowledge of the matter.

Wall Street has long argued that post-crisis rules have made markets more susceptible to shocks by drying up liquidity. A key contention is that it has become much harder to trade during periods of stress, because banks -- the biggest buyers and sellers -- have retrenched.

Meanwhile Jim Greco is worried about U.S. Treasury clearing:

If Matt Levine’s shtick is that people are worried about bond market liquidity, mine is that people should be worried about US Treasury clearing. The US Treasury clearing landscape is broken. The bifurcated system reduces liquidity, allocates clearing costs inefficiently, and increases systematic risk. Together, these factors stifle innovation and entrench incumbents.

Things happen.

Einhorn's GM Stock Split Fails as Holders Side With Barra. (Earlier.) The New Gold Rush Is All About Vaults. Long Promised, the Global Market for Natural Gas Has Finally Arrived. Wells Fargo is least-respected company in America — even less than Big Tobacco. Marvin Goodfriend: the dovish counterweight to Yellen and Fischer? Harvard Endowment Ditches Hedge Fund Run by Alumnus. The Harvard Yard Sale: Private Equity, Real Estate and New Zealand Dairy Farms. Accountants Jump Into the Immigration Debate. The Corporate Demand for External Connectivity: Pricing Boardroom Social Capital. David Brooks wants to use $1 billion to start Skull & Bones for everyone. “The concerns were, ‘The guy won’t pay and he won’t listen.’” How Donald Trump Shifted Kids-Cancer Charity Money Into His Business. Legislature bites back: Governor signs bill banning dog leasing. (Earlier.) Lloyd Blankfein’s Only Twitter Follow Pairs Well With Vodka. 

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    Matt Levine at mlevine51@bloomberg.net

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