Bail-Ins, Social Norms and Cows
Banco Popular.
We talked yesterday about the resolution of Banco Popular Espanol SA, which was wound up by Europe's Single Resolution Board by wiping out its shareholders, wiping out its Additional Tier 1 capital, writing down its Tier 2 capital to 1 euro, and then selling it to Banco Santander SA, leaving its senior debts and deposits untouched. "It is as textbook a bank resolution as you could hope for," I said. Bloomberg View's editorial board agrees:
Credit where credit's due: The sale for 1 euro of Banco Popular Espanol SA, a failing Spanish bank, to rival lender Banco Santander SA shows how the euro zone should handle such cases. The regulators acted swiftly and fairly. Global markets barely noticed.
But you could quibble. One complaint that I think has force is that the purchase price is sort of a suspiciously round number. In theory, when a bank runs into trouble, the regulators should seize it and sell it to the highest bidder; the bidder should pay a price equal to its assets minus its liabilities. In the case of a failing bank, that number will normally be negative, but arithmetic with negative numbers is not particularly a problem. You just line the liabilities up from most junior to most senior, and start haircutting them until you get to the value of the assets. First goes the common stock, then the Additional Tier 1 capital instruments, then the Tier 2 capital, then the senior debt, and you hope you never get to the deposits. Notionally, that sort of happened with Popular: Santander and the regulators valued the assets, lined up the liabilities, and determined that the assets were worth precisely 1 euro more than the senior debt and deposits. So they zeroed the common stock, zeroed the Additional Tier 1 capital, and paid 1 euro to buy the bank from the Tier 2 holders.
But that is a weird coincidence! It is strange that the hole in Popular's balance sheet can be precisely filled -- well, precise to within 1 euro -- by the amount of capital securities (Additional Tier 1 and Tier 2) that it had outstanding. Naively you might expect the valuation to find that there's a little extra money after assuming the senior debt, so the Tier 2 holders should get 10 cents on the euro or something. Or else there's not quite enough money to assume the senior debt, so the senior debt holders should also get a haircut and get 95 cents on the euro or something. But, no: The senior debt holders get exactly 100 cents on the dollar, the Tier 2 holders get exactly zero. (Well, 1 euro between them, but we'll come back to that.)
That coincidence seems unlikely to be explainable by accounting; you will not figure out what is going on by carefully valuing each asset on Popular's books. Instead it is a matter of regulatory and negotiating dynamics. Additional Tier 1 and Tier 2 capital instruments are meant to assume the risk of a bank's losses, so by gosh they are going to assume some losses. As Aaron Brown points out by email: "When Santander, which wants the lowest possible price, negotiates with the government, which wants the least chance of future problems and perhaps wants to punish Popular investors, it's hard to think anyone is pushing hard for Tier 2 rights." If you are imposing some losses on capital securities, the temptation on both sides -- the buyer and the regulator, that is, not the buyer and the seller, who doesn't get much say -- is to impose maximal losses on those securities. George Whittle at FIIG Securities writes: "It is challenging to comprehend any circumstances where a regulator believes a liquidity crisis is sufficiently dire that it justifies the extraordinary step of bailing in capital instruments to facilitate a coercive equity raising or sale, but isn’t sufficiently concerning to bail in everything they can."
On the other hand, there's also a temptation to stop there: Zeroing capital securities feels virtuous, but haircutting senior debt feels risky. A regulator will not want to trigger systemic worries about bank debt by haircutting one bank's bonds. (On the other hand some regulators might feel like haircutting bank bonds is also a virtuous thing to do: The notion of "total loss absorbing capital" bail-in-able senior bonds does rather encourage that.) Even the buyer might not want to pay less than the value of the senior debt: Santander is going to need to go back to the debt markets, and treating Popular's bondholders well might help its credibility in the future.
So Popular's textbook result -- zeroing all the capital instruments, paying off all the debt -- is an equilibrium point that you would expect to occur a lot more often than is justified by the economics. That is ... fine, I guess? But it does rather wipe out the distinction between Tier 1 and Tier 2 capital, and between senior bank debt and risk-free debt. The choices are categorical as much as they are financial; they encourage holders of risky securities to worry about risk, and holders of senior securities not to, but it's not clear that they force anyone to quantify it carefully.
Oh, about that 1 euro. "I assume the Tier 2 holders won't, like, actually split that one euro amongst themselves," I said yesterday. I was right! Reader Jokin Beltran De Lubiano pointed me to pages 15-16 of the decree resolving Popular (from FROB, Spain's Fund for Orderly Bank Restructuring), which sets set forth the waterfall for the distribution of the 1-euro purchase price. In my rough translation:
The sale price of the entity shall be distributed in the following order and form:
- To pay all reasonable expenses that have been incurred by the SRB and the FROB in relation to the preparation of the disposition of this resolution and the transfer of shares, in conformance with article 20.6 of EU Regulation No. 806/2014 and Article 25.4 of Law 11/2015.
- To the holders of Tier 2 capital instruments ...
I assume that the regulators will submit an itemized list of expenses incurred in winding up Popular, and that list will come to more than 1 euro, and the 1 euro will be paid to the regulators, and the Tier 2 holders won't get any of it. It would be funny if the expenses list came to, like, 95 cents (some photocopying?), and the Tier 2 holders got to split the remaining 5 cents. But I would not hold my breath.
One more dumb thing about Popular. I started yesterday's Money Stuff by quoting the epigraph from Charles Darwin at the beginning of Popular's 2016 annual report. "It is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change," I said that Popular said that Darwin said. Of course Darwin didn't say it: It's a 1963 summary of Darwin by Leon Megginson, a management and marketing professor at Louisiana State University. A fake Darwin quote from a management professor is somehow even more perfect as an epigraph for Banco Popular.
Paul Singer.
I tend to take a fairly efficient-markets-ish view of finance, and one tenet of that view is that if you want higher returns, you have to take higher risks. But I am not dogmatic about putting that in quantitative terms; the point is not necessarily that higher expected returns come with a higher standard deviation of those returns. "Risk" comes in lots of forms, with volatility of financial returns being a relatively minor case. To take an obvious example: If you insider trade ahead of merger announcements, you can obtain high and stable returns, which look in classical terms like "risk-free profits." But then you might go to prison. "But I had such a good Sharpe ratio," you will tell your cellmate, but he will not be impressed.
Much more generally, behavioral economics suggests that there are some ways to obtain higher returns with lower volatility, but that people do not choose those ways because they find them psychologically unpleasant. If you are willing to take the psychological risks, then you should be able to obtain higher returns with lower volatility. These higher returns will not be arbitraged away, because the psychological risks are sufficiently daunting to deter most arbitrageurs. A basic trick in financial markets -- in life -- is to find something that everyone else finds unpleasant and that you don't mind, and then press your advantage.
Anyway here's a profile of Paul Singer and Elliott Management Corp., which is famous mostly for sharp-elbowed negotiation in sovereign debt fights, activist investing, whatever else you've got. "They are a pain in the ass to negotiate with," says a former hedge funder. "They retrade at the last minute all the time." And:
"Because they've been so massively successful, their rapaciousness is now viewed in hindsight as success," a former hedge fund executive says of Elliott's appeal. "They are the ultimate rational economic actor. Breaking the social norm of being pleasant in business is not a high cost for them. That lets them be more effective because they are rougher."
The worry is that there might be too many people in the financial industry for whom "breaking the social norm of being pleasant in business is not a high cost," in which case (1) the profits from doing that might be arbitraged away and also (2) that would not be very pleasant.
Structured Operations.
I used to work at a bank on a desk called the "Structured Equity Group," and I have always been fond of financial uses of the word "structured." It always feels somehow euphemistic. Everything is structured, really; the things that are called "structured" are just a bit more structured than everything else. Why are they so structured? Oh, you know, for reasons. Anyway here is the story of Odebrecht SA's bribery division:
In the past decade or so, their group, the Structured Operations Division, had helped the company secure contracts to build dams, power plants, airports, and refineries across Latin America. They did it by creating fake engineering, construction, and consulting companies that used secret bank accounts to pay fake invoices submitted by fake customers. At the end of the chain, always, were the people in a position to say yes to another Odebrecht bid.
Often these people were politicians—the company had been bankrolling campaigns in Brazil, including presidential campaigns, going back to when bribery was strictly a cash business. Since the establishment of Structured Operations, Odebrecht had funded plots to elect a half-dozen presidents in Latin America; buy the friendship of heads of state in Angola, Peru, and Venezuela; and pay off hundreds of legislators from Panama to Argentina.
I mean, we just did convertible bonds and stock buybacks in the Structured Equity Group. We never elected a president. I appreciate these guys' devotion to the cause of Structuring.
Moonshot man, moonshot man.
Here is a profile of David Hudson, who "left Johannesburg in 1999 after learning Cobol, a computer language for business, in the hopes of making his fortune fixing the Y2K bug," and who is now "in charge of spearheading disruption within JPMorgan Chase & Co.’s trading businesses":
A phrase scrawled on a whiteboard in Hudson’s Canary Wharf office encapsulates his mission: “It’s the incumbent’s job to find the innovation before the innovators find distribution.”
Pleasingly, the first innovation they found is "a trading platform for asset managers and regional banks":
“An asset manager or regional bank can call us up and say, ‘Buy us €100 million of government bonds,’ ” Hudson says. “We’ll find the best price on the market, which may or may not be from JPMorgan, and buy it on their behalf, so now they don’t need traders. We’ll charge them a commission, do their best execution reporting, provide that as a service.” In other words, the pitch is: Fire your traders, stay in business.
I do think it's a little funny that JPMorgan's big innovation is buying bonds on behalf of customers on a commission basis. You might naively think that that would have been a core legacy function of a big bond-trading bank, but nope! (The legacy function was selling bonds to the client as principal, and requiring the client to hire savvy traders to play banks off against each other.) If you're trying to disrupt the big banks, you might take this as an encouraging story: There's a lot of stuff to disrupt!
Choice Act.
The House of Representatives is going to pass the Financial Choice Act today, which would "roll back major portions of the Dodd-Frank Act of 2010 and change significant aspects of the bank oversight process." But "the bill has no chance whatsoever of becoming law," says David Dayen, so let's not talk about it, because while financial regulation is interesting, the politics of financial regulation is endlessly tedious and terrible.
Meanwhile, the debt ceiling is going to be a thing again, because Congress is always more comfortable creating problems than solving them. And the Treasury Department remains understaffed, with lots of "closed doors and blank nameplates."
Blockchain blockchain blockchain.
"Curious About Trump’s Tax Returns? Blockchain Might Provide the Answer," says a guy. Not really, of course; Trump's tax returns aren't on the blockchain. But in an alternate universe in which they were on the blockchain, and in public unencrypted form, then you could just go read his tax returns. And anyone else's, I guess. I am not sure that that is much of an advertisement for anything.
Here is Izabella Kaminska on some people raising money for a blockchain bank with an initial coin offering. "It seems like you could sneeze twice on a piece of paper and launch an ICO and get a couple of million for it the way tokens are going now," says a person associated with the offering.
But my favorite blockchain news today is that there will be not one but two congressional hearings about consumer fintech and virtual currencies at 10 a.m. today. Do you know what else is happening in Congress at 10 a.m. today? You do, you really do.
People are worried about unicorns.
Hey what's going on with Uber Technologies Inc. these days?
Uber has fired a senior executive who obtained the medical records of a woman who was raped by an Uber driver in India, the latest example of misconduct unearthed at the ride-hailing giant.
Eric Alexander, Uber’s president of business in Asia, was terminated on Tuesday after reporters began asking questions about his actions ...
And: "Both Travis Kalanick, Uber’s chief executive, and Emil Michael, the company’s senior vice president of business, had read and discussed the woman’s medical records with Mr. Alexander at length." And: "The three men once attended a South Korean escort bar together, according to two of the people familiar with the medical-records matter." Remember yesterday when we talked about how Uber had fired at least 20 people after its sexual-harassment investigation? This guy was not one of them. Did those 20 people behave worse?
Also: Given that Alexander was fired for snooping into a rape victim's medical records, doesn't that make things a little uncomfortable for Kalanick, who also read those records? Kadhim Shubber is angry: "Uber does not have an image problem, it has a chief executive problem," he writes. "One day we will look back at what will hopefully be the smouldering wreckage of Kalanick’s career and ask how a person so lacking in basic human and corporate ethics was allowed to run a company for so long." One boring answer: "Uber Founders Have Super-voting Shares." As with so many startups, Uber's board is made up of Kalanick's advisers, not his bosses.
Fearless Cow.
Bad news, Money Stuff is done for the year; it is only June 8 but already we have the unsurpassable dumbest financial story of 2017:
The financial company that installed the “Fearless Girl” statue on Wall Street to help market a female mutual fund originally wanted to commission the bronze in the shape of a cow, according to an email exchange between the company’s rep and City Hall obtained by The Post.
Oh. I see. From the initial email proposing the cow to New York City:
A financial services company (as yet to be named to me) that has Mutual Funds is developing and looking to launch a fund that will be exclusively comprised of women-owned or women run companies. As a precursor to the announcement, they are looking to set up a statue of a cow to be set opposite the iconic Wall St bull at Bowling Green.
It goes on, beautifully; "'put brand ambassadors around the cow' and 'the event itself will have no production besides the cow' are the best prose ever written," says Felix Salmon, correctly. But what throws me about this story is just thinking about how easily 2017 could have been even dumber than it actually is. Like, the actual controversy over Fearless Girl is a little dumb, but this is just confounding. In a universe not all that different from our own, State Street Corp. could have put a cow in Bowling Green, next to the Charging Bull. They could have been like, "see, the cow represents ...," wait, honestly, how would you finish that sentence, I am at a loss. Would Elizabeth Warren have posed next to the cow? Would the Charging Bull sculptor have gotten furious about the cow? Or would he have been glad to see his bull get a companion?
Anyway: “The client realized, after we had gone down the road a bit, that a cow sculpture could be conceived as demeaning to women," State Street's representative says. But what I want to know is: How far down the road did they get? Did they actually cast the cow? Because, if so, bring her on in! Bowling Green already has Charging Bull, Fearless Girl and Pissing Pug, and I am hard at work on IPOing Unicorn and Worrying Squirrel, but there is still plenty of room for Bizarrely Sexist Cow.
Things happen.
Italy Said to Press Banks to Help Rescue Veneto Lenders. ECB’s long-term, cheap funding proves lifeline for banks. Wells Fargo Focuses on Pivot From Scandal to Growth. Bill Gross Says Market Risk Is Highest Since Pre-2008 Crisis. Four things to watch at the ECB’s Tallinn meeting. "The. Government. Budget. Is. Not. A. P&L. Statement." The Real Story Behind Elon Musk’s $2.6 Billion Acquisition Of SolarCity And What It Means For Tesla’s Future–Not To Mention The Planet’s. Snap Is Most-Shorted Tech IPO of 2017 as Lockup Expiration Nears. Felix Salmon suggests that charitable endowments should give money away. Russian mobsters arrested for peddling stolen chocolate.
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Matt Levine at mlevine51@bloomberg.net
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