Libor, Phone-Smashing and Hacking
Libor and society.
We talked a bit yesterday about the demise of Libor, the London interbank offered rate, a convention for interest rates that led to manipulation and scandal. Pascal-Emmanuel Gobry responded with a thoughtful Twitter thread about Libor, society and the nature of finance, "which is that all of finance is essentially a gentleman's agreement (that's what a vanilla loan is) and that the agreement matters more than what the agreement is about."
For decades Libor's function hasn't been to be an accurate representation of bank's overnight funding costs, but to be a number that people could plug into their spreadsheets to price derivatives and other products.
Aside from the morality of actively lying, the financial system is obviously better off with a "fake" Libor than with no Libor. It's much more important to the financial system that there be some interest rate number that everyone agree to use as "the interest rate" than that number be an accurate representation of what it represents itself to be.
This is not a "bug" but a "feature" since finance is a way of managing *promises about the future*, which are inherently unpredictable. I think it was Merton who joked that it wasn't that everyone used his options pricing model because it was accurate, but that it was accurate because everyone used it. There is no "rational" way to price options, but the financial system is made much better off by everyone pretending that Black-Scholes is a rational way of pricing options.
Of course, finance is a set of social conventions because society is a set of social conventions:
In a sense, the thing about finance isn't that it's this completely made-up thing, it's that it's a completely made-up thing that has a self-correcting mechanism of turning discoverers of fictions that have become too systemically dangerous (which is not the same as "fictions that have become too inaccurate") into billionaires. In that sense, the story of Libor is the perfect finance story. The first layer is that Libor was fake because finance guys are evil, which is often true but not the most important thing. Then the second layer was that Libor was fake for a much more interesting reason. Then the third layer was that it was good that Libor was fake. In this layer lies Enlightenment.
I am not wholly convinced. Things like the Black-Scholes formula and discounted-cash-flow valuations (another example Gobry cites) really are attempts to understand facts in the world (albeit sociological human facts, and albeit stylized idealizing attempts) rather than pure arbitrary conventions. Replacing the volatility parameter in Black-Scholes with, like, last night's Mets score would not be just as good as Black-Scholes, even if you could get everyone to agree on it: The point of Black-Scholes is not just that it gives you an agreed price of options, but also that that price relates to external conditions (like the cost of producing those options) in a sensible way. The last 10 years have taught us to be cynical about some of the scientific claims of finance, but it is possible to be too cynical.
Libor, too, initially was an effort to link the costs of a bank's inputs to the price of its output, to make loan pricing more rational. And while it is good to have an agreed reference point for interest rates, it is not better if that reference point is fake. Still, there is a sense in which a "fake" Libor based on surveying banks about their unobservable cost of unsecured short-term borrowing might be better than a "real" one based on transaction data. There is a lot of discussion about what will replace Libor, with the leading contenders being fairly robust traded benchmarks. In the U.S. the focus has been on the "broad Treasuries repo financing rate," which measures the cost of secured borrowing against Treasury securities. As a reference level for trillions of dollars of interest-rate derivatives, this seems good: What you need is just a coordination point, a rate that everyone can agree is The Interest Rate so that they can write contracts betting on it, and a hard-to-manipulate rate that people trust is better than an easy-to-manipulate rate that they don't. But as a reference level for syndicated bank loans -- the original purpose of Libor -- the original Libor arguably makes more sense, since it more closely reflects the banks' costs of making those loans.
Still, yes, Gobry is right that finance is a set of social conventions. And much of the financial industry is a stylized arena for battling over those conventions. One thing that I like to think about Libor in the heyday of its manipulation is that it was supposed to reflect a real market, driven by supply and demand, for unsecured short-term interbank lending -- and it didn't -- but it did reflect a real market, driven by supply and demand, for interest-rate derivatives. Some banks would profit from high Libors and so submitted high Libors, other banks would profit from low Libors and so submitted low Libors, and ultimately you got a Libor that crudely reflected the market -- but the market for Libor, from derivatives traders, rather than the market for short-term funding, from banks. It didn't represent the thing it was supposed to reflect, but it did reflect its actual deep purpose, in a useful and market-driven way.
Diversity at banks.
Here is a story about stalled racial diversity efforts at the biggest U.S. banks, where black employees have in many cases lost ground in terms of representation in the overall workforce and in senior-management ranks. They also deal with problems that their white colleagues don't have to worry about:
Mandell Crawley, now Morgan Stanley’s head of private wealth management, said in a 2016 company conversation on race that he was often the only African American on his sales and trading desks. He mentioned Wall Street’s love for smashing phones.
“In my early years I wouldn’t dare do that, for fear of a long-held stereotype of the angry black man, and being six-foot-five doesn’t help,” Crawley said. “Now, it’s important to note I got over it, I’ve left many broken phones in my wake.”
You could imagine that story going like "I didn't want to create a bad impression by smashing phones, so I conducted myself with dignity and respect for my employer's property, and over time my example inspired my colleagues to also stop smashing phones, and now our workplace has become a friendlier and more humane place." But, no, the inspiring conclusion is "now I get to smash phones too." One reason you might root for more diversity on Wall Street -- beyond just fairness -- is that in theory a diverse workforce might change some of the less attractive aspects of Wall Street culture. But in fact the Wall Street culture seems to win out.
Is it criminal hacking to, um, look at a web page? Sure, maybe, says LinkedIn Corp., in this weird court dispute it has with data-scraping firm hiQ Labs. "hiQ monitors and analyzes LinkedIn profile pages to see who is polishing their résumés and liable to be poached, assigning so-called flight-risk scores to individual employees." LinkedIn wants it to stop doing that, arguing that it is not allowed by LinkedIn's terms of service and therefore violates the Computer Fraud and Abuse Act, "which prohibits unauthorized access to computer systems and carries both criminal and civil and penalties." But:
Lawyers for hiQ say LinkedIn has stretched the meaning of “unauthorized access” under the antihacking statute to “criminalize access to webpages that are public for the entire world to see.”
"Our members control the information that they make available to others on LinkedIn, and they trust us to honor that control," says LinkedIn, but is that true? Let me give you some advice that is not legal advice, but that is internet advice: If you put something on a public web page, it is public! If someone reads it, you can't be like "oh wow I can't believe you read the thing I posted publicly, what a jerk." I mean, you can -- lots of people do; it is a popular internet pastime -- but it will reflect an error in your own understanding of the internet.
Here, though, it doesn't really seem that LinkedIn users are complaining that their public profiles aren't private, but that LinkedIn is complaining that hiQ is making commercial use of the user data that LinkedIn wants to keep for its own exclusive commercial use. And that is fine! Lots of companies collect user data for their own exclusive use, and keep it secret, and would be upset if anyone hacked into their computers to steal their secret customer data for a competing use. It's just that usually those companies don't put that exclusive user data on a public website, and then accuse the competitors of hacking for reading that website.
How's Martin Shkreli doing?
"On paper, yeah, you know what? Doesn’t look great," says his lawyer, in the closing argument in his fraud trial. The specific pieces of paper that don't look great include the "fake performance updates" that Shkreli sent to his hedge-fund investors "after having lost all of the fund’s money," that sort of thing. Many people would call that fraud! And yet. I guess my opinions on Shkreli are:
- He is bad, with the drug-price-gouging and Wu-Tang-album-hoarding and general smirkiness;
- He is probably guilty, what with the lying about returns after losing all of his investors' money; but
- He might get away with it -- and maybe even should! -- because the people he defrauded "made more than three times their invested money once Mr. Shkreli paid them back with some combination of cash and Retrophin stock."
That is, Shkreli is bad, and he committed fraud, but his fraud wasn't bad, and a jury might sympathize with that. (Especially if, as seems likely, they don't know about the other badness.) I might sympathize too. Obviously paying everyone back is not a legal defense to fraud, and shouldn't be. (It creates poor deterrence.) But it does muddy the waters a bit, as his lawyer pointed out:
“Why didn’t he just defraud them?” he said. “Why did he sleep in his office in a sleeping bag for two years to make Retrophin a dazzling success?”
If you take everyone's money, send them fake statements, and then run off to Belize, it's pretty clear you were committing fraud. If you take everyone's money, send them fake statements, and then work really hard to make their money back, it's ... also pretty likely you were committing fraud! But you've got a slim argument that you were deluded, that your intentions were good, that you had a plan all along. Usually that ends badly and you get busted for fraud. But here it actually worked! Though he got busted for fraud anyway.
Fannie and Freddie.
In 2008, the U.S. government rescued Fannie Mae and Freddie Mac by buying vast amounts of preferred stock with a 10 percent dividend. Over the next few years, Fannie and Freddie struggled to even pay the dividends, and the government had to give them even more money just to help them pay their dividend obligations. In 2012, the government changed the deal so that instead of paying back 10 percent a year, Fannie and Freddie would just pay the government all of their profits forever. Fannie and Freddie's profits then almost immediately became much more than sufficient to cover the 10 percent dividend -- only now, instead of paying the 10 percent dividend and keeping the excess, they had to hand over all of their money to the government. Fannie's and Freddie's shareholders, who until 2012 had held out some hope that the enterprises would recover and be able to get out from government control, were very aggrieved by the hopeless new situation, and sued. They have been suing for the last five years, and they will be suing for the next five years, according to Bruce Berkowitz of Fairholme Funds Inc., a shareholder that is doing a lot of the suing.
One long-running subject of dispute is why the government changed the terms of the deal. The shareholders' answer is that the government saw that, years after the crisis, Fannie and Freddie were finally turning a corner and becoming profitable, and so wanted to seize those profits for itself (and prevent shareholders from profiting from the bailout). The government's answer is that it saw that, years after the crisis, Fannie and Freddie still couldn't even afford to pay the 10 percent dividend, and that rather than having to keep pumping more money into the enterprises just to fund the dividend, the government preferred to just switch to a pay-what-you-can model.
The government's answer makes no sense as a matter of accounting -- giving Fannie and Freddie as much money as they need to pay the dividend, and then taking it back as a dividend, is just as sustainable as taking less back as a dividend in the first place! -- but nothing about Fannie and Freddie has ever made sense as a matter of accounting, so I give up on that front. The shareholders' answer has always struck me as far more plausible, though that doesn't mean that they should get their companies back; the government's desire to take the upside of its massive rescue for itself seems perfectly reasonable.
Anyway, as happens every now and then, there's a new "trove of documents" that the shareholders say "bolsters their case that the government lied when it decided to take all of the mortgage companies’ profits," basically because some government officials said in writing that they thought Fannie and Freddie would be profitable rather than fall into a death spiral. The government disputes the characterization, as it usually does when troves like this come up, and the cases march boringly on.
"A surge in Amazon.com Inc. shares Thursday morning in advance of the online retailer’s earnings report briefly propelled founder Jeff Bezos past Bill Gates as the world’s richest person," but then Amazon's stock dropped and Bezos fell back to second place. I hope he had a blowout World's Richest Person party for the few hours when it was true. The nice thing about modern financial markets is that there are more opportunities for more people to be the richest person in the world for a little while; it's not like Croesus or Cornelius Vanderbilt had minute-by-minute marks on their wealth. And we are in a pretty low-volatility regime right now; a little more volatility and dispersion, and you could get lots of tech founders each getting their 15 minutes as the world's richest person.
Blockchain blockchain blockchain.
On Tuesday, we discussed a story about people keeping bitcoins in literal bank safe deposit boxes, and I said: "First bitcoin was a way to make electronic payments without using banks; now it is a way to keep money in a safe deposit box at a bank without being able to use it to make payments; at this rate, in a decade, it will be a face-to-face barter system." That same day, this post, titled "Bartering ... Through Blockchain!," about using the blockchain to trade electric power "with your neighbors" and "over the fence," was published. We are making good progress back toward a rural agrarian society with small local networks of person-to-person trade!
People are worried about unicorns.
Who will be the next chief executive officer of Uber Technologies Inc.? The shortlist includes "fewer than six candidates," and they seem to be pretty big names: Meg Whitman of Hewlett Packard Enterprise Co. has turned Uber down, and Jeffrey Immelt of General Electric Co. is in the running. It is hard to know how attractive an opportunity Uber is for someone who has already run a much bigger and more profitable public company, and you could imagine a lot of quick "no's" from that list. I hope it's like "Meg Whitman, Jeffrey Immelt, Jeff Bezos, Barack Obama and ... wait ... Travis Kalanick ... how'd he get on this list?"
Elsewhere, Slack Technologies Inc., the meta-unicorn, "is raising about $250 million in a funding round co-led by SoftBank Group Corp.," at a valuation above $5 billion. I have long admired Slack for its straightforward opportunism in raising cash: "It might be the best time for any kind of business, in any industry, to raise money for all of history, like since the time of the ancient Egyptians," said Slack CEO Stewart Butterfield in 2015, after raising money that he said he didn't need, just because it was there in such generous quantities. I suppose SoftBank's stated intention to throw infinite amounts of cash at tech companies at ridiculous valuations was too tempting for Slack to resist.
UBS Shares Drop Most Since January as Capital Ratio Declines. (Earnings release, slides, full report.) Credit Suisse Is Looking More Like a Wealth Manager. (Earnings release.) Vegas Gambler Billy Walters Gets Five Years for Insider Trading. Goldman Sachs Moves Deeper Into Retail Lending With Fidelity Deal. FINRA, Bats, NASDAQ, and NYSE Fine Firms for Market Access Rule Violations. Former Petrobras CEO Aldemir Bendine Arrested in Corruption Probe. Obviously the border adjustment tax was never going to happen. Spain has multiple debt collectors who pester debtors while dressed like Zorro. "In your room, you'll find the application around the chandeliers is caulked perfectly." Swamp soccer. Are Dogs Probiotic? "This movie’s 'believe in yourself' message is borne out, in a perverse way, by the very fact that it even exists."
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