Russian Deals and Petri-Dish Funds
Yesterday the U.S. Department of the Treasury fined Exxon Mobil Corp. $2 million for violating U.S. sanctions against Russia back when Exxon was run by current U.S. Secretary of State Rex Tillerson. So, you know, politically, that's weird. It's also quite weird legally! Exxon entered into some deals with Rosneft OAO, an oil company majority-owned by the Russian government whose chief executive officer is Igor Sechin. Rosneft is not subject to sanctions, and U.S. companies are allowed to do deals with it. But Sechin is subject to U.S. sanctions, and U.S. companies are not allowed to do deals with him. Exxon did its deals with Rosneft, so it thought it was fine. But the contracts were signed by Sechin, which the Treasury thinks is not fine.
So Treasury fined Exxon $2 million -- the "statutory maximum civil monetary penalty" for the violation, which is a little embarrassing -- and issued a sharply worded judgment calling the violations "an egregious case." Meanwhile "a spokesman for Exxon called the fine 'outrageous' and said it would fight the Treasury’s findings, saying they are a 180-degree turn from previous guidance handed down by the Obama administration when the sanctions were enacted." It has sued to stop the fine.
I guess my instinctual sympathies are with Exxon here: If you're allowed to do deals with Rosneft, then you should be allowed to do deals with Rosneft, even if -- as you'd imagine he often does -- Rosneft's CEO signs those deals. Otherwise what is the point of leaving Rosneft off the list? Exxon's distinction -- that doing deals with Sechin personally is banned, but that doing deals with his company in which he is involved purely in his role as a corporate officer is fine -- makes sense; Treasury's view -- that doing deals with Rosneft where the CEO signs a piece of paper is banned, while doing deals with Rosneft where the CEO just nods and someone else signs the paper is fine -- is sort of trivial and formalistic.
But more importantly you'd just think there would be a clear answer to this question; if you're sanctioning CEOs of giant companies while not sanctioning their companies, then this issue is going to come up a lot. And in fact it does. Treasury pointed to the Frequently Asked Questions on its website to argue that Exxon should have known better:
There was a Frequently Asked Question (FAQ) publicly available on the OF AC website at the time of the violations that specifically spoke to the conduct at issue in this case, though framed in the context of the Burma sanctions program. FAQ #285, which OFAC issued in 2013 and was publicly available on OFAC's website at the time ofExxonMobil's violations, stated that U.S. parties should "be cautious in dealings with [a non-designated] entity to ensure that they are not providing funds, goods, or services to the SDN, for example, by entering into any contracts that are signed by the SDN."
I guess that clears it up then? I am not sure that the FAQ is as binding as Treasury wants it to be though.
Hedge fund biology.
Here is a story about how a computational biologist named Desmond Lun is running a successful quant hedge fund, and more generally about how computational biologists are the new hotness in quantitative finance:
Wall Street firms are now chasing these biologists who are on the cutting edge of the data science revolution. They not only work with huge data sets. Cloning gives biologists another advantage: They can repeat experiments again and again, providing a better view of causal interactions inside cells, said Richard Bonneau, a New York University professor who studies computational biology.
“We are kicking butt more than any other data science,” said Bonneau, the incoming director of NYU’s Center for Data Science. Financial firms have noticed. “They steal my Ph.D. students, which is annoying, but good for them. They get nice jobs,” he said.
Emanuel Derman has his doubts:
“I’ve developed a lot of skepticism about anyone bringing their expertise from one field to another,” said Derman, author of the book “Models.Behaving.Badly” and a Columbia University professor of financial engineering. “They say stocks are like atoms, or like genes. But stocks are not atoms or genes. There is a resemblance, but ultimately they are very different.”
I don't know. Lun's background is in studying algae to predict how they will behave. I suppose you could argue that the interactions of investors in the stock market are more sophisticated and unpredictable than the interactions of algae in a petri dish. It is tempting to take the other side. They are all just organisms, bashing into each other, fighting for survival.
Anyway a lot of the interesting philosophical questions in quantitative investing are about whether quants' models need to be comprehensible to their human masters: Are you building essentially a big calculator to help you make investing decisions, or are you building essentially a big brain to make investing decisions that you don't even understand? Lun seems to be somewhere in the middle, leaning toward the incomprehensible camp. ("On any given day, I can't explain all the factors that led to the system reaching that decision.") But if your vision of quant investing is that it involves building a big external brain to go off and do its own thinking, I guess a biologist is well equipped to do that? A pretty good hedge fund pitch would be "we have hired some really good biologists to clone Warren Buffett, and then we're going to lock Warren-2 in a room, feed him burgers and Coke, and make him pick stocks."
Last year hilarious Twitter prankster Elon Musk founded a hilarious prank company with the hilarious prank name "The Boring Company" and the hilarious prank purpose of drilling tunnels in the ground to get around traffic. Yesterday he tweeted a hilarious prank tweet saying that he "Just received verbal govt approval for The Boring Company to build an underground NY-Phil-Balt-DC Hyperloop." Next, one assumes, he will assemble a quirky cast of Wes-Anderson-movie characters, put them in jumpsuits, get them a big drill, and send them out to start drilling holes in the middle of traffic in what I think everyone will agree is a hilarious prank.
Or, I don't know, maybe all of this is real? Of course "a White House spokesman confirmed that the administration has had 'promising conversations to date' with Musk and Boring Company executives," because the current White House also believes in governance by hilarious prank. Also Musk really does have a drill, which has its own hilarious prank name:
Musk began digging in May on a small test tunnel using a second-hand boring machine, called Godot, which he acquired for his speculative new enterprise. Here’s how Musk described the Boring Co. at a Ted Talk in April: “This is basically interns and people doing it part time. We bought some second-hand machinery. It’s kind of puttering along, but it’s making good progress.”
Of course setting up a white-hot Silicon Valley startup, hiring interns, and then putting them to work drilling holes in the ground is itself a hilarious prank.
I think a lot about that New Yorker article from last year that discussed the Silicon Valley obsession with the "simulation hypothesis, the argument that what we experience as reality is in fact fabricated in a computer," and noted that "two tech billionaires have gone so far as to secretly engage scientists to work on breaking us out of the simulation." (Everyone assumes that one or both of them are Musk and/or his fellow PayPal founder Peter Thiel.) My familiarity with the simulation hypothesis comes mostly from watching "The Matrix," and I don't really know how one would break us out of the simulation, but judging by "The Matrix" one promising approach seems to be to create absurd conditions within our world in order to convince everyone that it is not real. So Thiel worked to get Donald Trump elected as president of the United States, and Musk is ... boring. Perhaps he is really drilling holes in the fabric of reality, to break us out of the simulation.
How do you get more IPOs?
We have talked a couple of times about the Security and Exchange Commission's new focus on getting more companies to go public, so that "Mr. and Mrs. 401(k)" -- as SEC Chairman Jay Clayton calls them -- can invest in innovative growing businesses in the public markets. Clayton, like a lot of people, talks about this in terms of onerous SEC disclosure requirements for public companies: Companies aren't going public because there are so many forms to fill out, and by just reducing the disclosure requirements we can encourage more initial public offerings.
I tend to think that the reason is a bit deeper, and that part of why companies are staying private longer is just that private capital is more abundant, and private markets are more sophisticated, than they used to be. Being public has always been more annoying than being private, for entrepreneurs: As a private company you essentially get to pick your shareholders, and you can build a cozy relationship with them that gives you durable control of your business with stable funding from trusted investors. Public companies just have to take whatever shareholders they get, if they're activists or high-frequency traders or litigious pension funds or whatever. But of course public markets have always been where the money is, so if you want to raise a lot of money -- and get liquidity for your nice early investors -- you have to go public. Or you had to; now, you can raise billions of dollars in private markets and even have something of a secondary market, so the economic imperative to go public is reduced.
If that's right, then it's a change that can't be reversed just by reducing disclosure rules. "If you want to flush all the unicorns out of the Enchanted Forest and into 401(k) accounts," I said last week, "you might need to do more than reduce the length of Form 10-K filings: You might need to make more fundamental changes to how public companies interact with their shareholders."
And this week here is SEC Commissioner Michael Piwowar:
A key U.S. securities regulator on Monday voiced support for possibly allowing companies to tuck language into their initial public offering paperwork that would force shareholders to resolve claims through arbitration rather than in court.
"For shareholder lawsuits, companies can come to us to ask for relief to put in mandatory arbitration into their charters," said Michael Piwowar, a Republican member of the U.S. Securities and Exchange Commission. "I would encourage companies to come and talk to us about that."
There you go: You can go public, and have public shareholders, but if you don't like litigious public shareholders then you can just make them give up their right to sue. Of course there have been other recent experiments in fundamentally changing how public companies interact with their shareholders: Several big private equity firms have gone public while eliminating directors' fiduciary duties to their shareholders, and Snap Inc. went public while eliminating shareholder voting rights.
If you're a founder who doesn't want to give up control of your company, but who wants to raise money publicly, now you can have a public company whose shareholders can't vote, can't sue the company, and can't expect directors to act in their best interests. Investors will let you get away with it -- until something goes horribly wrong with one of those companies, anyway -- and now so will the SEC. That's a pretty good offer! It might even make being public more attractive than being private. It has very little to do with how much audits cost, or how many pages are in the annual report.
Blockchain blockchain blockchain.
Law enforcement authorities shut down AlphaBay, a big "dark net" market for "deadly illegal drugs, stolen and fraudulent identification documents and access devices, counterfeit goods, malware and other computer hacking tools, firearms, and toxic chemicals," arresting its 25-year-old creator Alexandre Cazes, who committed suicide in a Thai jail. The authorities also took "millions of dollars' worth of cryptocurrencies" from Cazes and AlphaBay. "We're literally funding our own investigations," one Reddit user realized. Eventually U.S. law enforcement authorities are going to be among the biggest holders of cryptocurrency in the world. What will they do with it? You can't exactly use bitcoins for military procurement, though I guess AlphaBay did sell firearms. Will they start paying FBI agents in bitcoin? Will they sell their currencies for cash on lightly-regulated exchanges to unknown purchasers who might have nefarious uses for their bitcoins? Will they invest in initial coin offerings like everyone else?
Elsewhere: "Bitcoin Community Cheers as Miners Back New Scaling Framework."
People are worried that people aren't worried enough.
My own cheerful spin on all the worries about eerily low volatility has been: What if markets just got smarter? We've long known that stock markets overreact to news. Now we have all these calm index funds that don't trade in and out of the hottest stocks, and we have all these algorithmic investment funds that try to profit by spotting stock-market anomalies, like (perhaps) the one about overreacting to news. Whatever insights scientific finance has managed to gain are being put to work in investment management: Shouldn't that make the market more efficient? Shouldn't prices move quickly to the correct level and stay there until something fundamental changes, rather than bouncing around like crazy due to whim and panic and uncertainty?
Everyone I talk to about this theory thinks it is stupid, and they have a fair point: We've had hundreds of years of experience with financial markets, and while humanity has gained a lot of knowledge over that time, the basic financial cycle of booms and busts has not changed much. Still I am an optimist; it would be a little odd if those hundreds of years of experience didn't make markets any better at incorporating information. Anyway here's a Wall Street Journal article about "How Quants Calm the Stock Market":
“If there are fewer things that lead to surprises because information is going from completely unknown to completely known…then you should have less volatility,” says Leigh Drogen, a former quant trader and chief executive officer of crowd-sourced earnings-estimate provider Estimize.
Investors sell when they hear bad news about a company, but if they get that news from multiple sources over time, the selling should be spread out. In the past, everyone learned of the downturn when the company announced earnings, making the selloff rapid and the stock more volatile. While hard to quantify, the VIX, now below 10, may well be two or more points lower thanks to better information.
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