Blockchain Mania and MiFID II
Blockchain blockchain blockchain.
Fortune magazine's new cover says "Blockchain Mania!," and the cover story's URL slug is "bitcoin-ethereum-blockchain-cryptocurrency," so you know that the era of blockchain blockchain blockchain is here. That story takes a sort of "bitcoin bad blockchain good" line, although the current line is more like "initial coin offerings bad, blockchain good":
“Right now it’s much easier to get more focused on the short-term ICO money stuff,” says Chris Dixon, a general partner at Andreessen Horowitz. “I think this unfortunately overshadows the more important technology story.”
That story goes like this: Underneath the crypto-hysteria is a grand innovation in the humble realm of accounting. The most bullish acolytes of this electronic book-balancing breakthrough, Dixon included, hold that token-based projects will anchor the web’s next revolution, spawning crowdfunded businesses and services that deliver more value to their users while being less dependent on advertisers or rent-seeking middlemen.
Blockchain good: "It’s a ledger, but on the bleeding edge." There is an anecdote about some mangoes that were tagged with numeric identifiers and then entered into a database -- a bleeding-edge database -- so that Wal-Mart Stores Inc. could know where they came from.
Elsewhere at Fortune, here is a story about how people who use Coinbase to hold their bitcoins keep getting hacked, "with surprising and unsettling frequency." ("There have been months when Coinbase users have been robbed as often as 30 times.") The essential use case of bitcoin, as Rusty Foster pointed out all the way back in 2014, is as a way for libertarians to get themselves robbed. But of course, as I keep saying, the cryptographers and computer scientists who love bitcoin have found a solution:
Smart-money investors who store their own keys often resort to the most rudimentary of tactics to protect them. They’re the Bitcoin equivalent of stuffing cash under the mattress: a private key printed out on a sheet of paper, cut into pieces, and distributed among family members who don’t know how to put it back together; an encrypted file loaded on a USB stick and buried in the backyard; a password committed only to memory.
Imagine walking into a conference of computer scientists and presenting the idea of bitcoin, knowing what we now know about how it works. "See, it's a currency. You write a number on a piece of paper, and then you bury it in your backyard. No, you can't really spend it, but you have it in your backyard." The bleeding edge!
Elsewhere ... man, there is just so much. "A group of banks led by Credit Suisse is eyeing the launch of a commercial platform for blockchain-based syndicated loans, according to reports." (I feel like you could have written that sentence, with any bank name substituted for "Credit Suisse," any time in the last two years.) Here is a company called LAToken that has "tokenized Apple shares" and is offering them to the public. And: "The lives of bitcoin miners digging for digital gold in Inner Mongolia." ("The work, though not physically taxing, can be all-consuming.") And: "'AML Bitcoin' has recently teamed up with disgraced former lobbyist Jack Abramoff, who served time in federal prison for fraud, corruption, and conspiracy, to produce a reality TV show about lobbying Congress on digital currency." And: "Yesterday’s 'plastics' are today’s crypto tokens," come on:
Imagine unlocking cash from the equity in your home without having to borrow or pay interest. Tokenize your home and sell fractions to the public.
Just make sure to bury the tokens in your backyard. And then tokenize your backyard!
Look, I know I sound like a cryptocurrency/blockchain skeptic. I guess I am one, fine. But Walmart's mangoes are being tracked throughout the supply chain in an auditable distributed database that makes them much easier to follow than previous methods did. A syndicated-loan blockchain probably will work better than the current system of transferring syndicated loans by, like, faxing signature pages. "Tokenization" of some transactions or ownership interests will probably turn out to be useful, and might change how the markets for digital advertising or cloud storage or housing or whatever work.
But the way I like to think about it is that cryptocurrency might be to the 21st century what stock was to the 17th century: an administrative change in the bookkeeping for ownership of certain assets that over time completely transformed the economy and the world, with a power that the early innovators could hardly have dreamed of. But also, the first like 300 years of the history of stocks were filled with hucksters and hype and bubbles and disaster. Cryptocurrencies and blockchain really could be revolutionary technologies that will ultimately pervade every aspect of the economy, even while almost every individual project could be nonsense.
One fun problem in financial regulation is that very soon Europe will require banks to charge asset managers explicit prices for research, while the U.S. currently prohibits them from doing that. I mean, not quite, but pretty close:
The reason why the impending European regulations are problematic in the U.S. is that under American rules, companies that charge clients money for analysis can deemed to be providing investment advice. If U.S. brokers have to register as investment advisers, they would have to comply with an additional set of costly restrictions that could shake up their business models, industry trade groups have argued.
The Securities and Exchange Commission is aware of the clash with Europe's MiFID II rules, and is working on a solution. Not in a rule-of-law sort of way, though; more in an informal "eh never mind" sort of way:
The narrow window means the SEC doesn’t have time to issue new regulations, so its staff will probably issue guidance that provide assurances that firms won’t be sanctioned for complying with the EU rules.
I feel like there are not a lot of places where the U.S. and European regulators come to opposite conclusions on what regulations will best protect investors. The difference here is of course which investors are protected, and from whom. European regulators worry that investment funds might be ripping off their clients by hiding the cost of research in their trading expenses, and so will require those funds to explicitly pay for research rather than using client trading commissions. They are protecting the investors from the funds. U.S. regulations are based on a worry that banks might be ripping off investors by charging them for biased research; they protect the funds from the banks.
In the context of large mutual-fund firms paying for bank research, the European regulators' worry seems correct, or at least more correct; the U.S. worry seems absurd. It comes from a simpler time, when research customers were presumed to be naive individual investors. But of course that simpler time informs so much of U.S. securities regulation. If you build your regulation around the ideal of the retail investor who actively trades individual stocks, relying on nothing more than his own good sense, his newspaper, and blind trust in broker research, then you will get regulations that are sometimes absurd when you have to apply them to the real world.
Elsewhere: "Equity research is the worst job in finance: I could earn more on a building site"
It probably will not surprise you to learn that Goldman Sachs Group Inc. is lobbying aggressively to get the U.S. government to roll back the Volcker Rule? Compared to other big banks, Goldman has always had more of an interest in proprietary trading, merchant banking, and other activities limited by the Volcker Rule. It has also always been much less of a bank than the other big banks. The idea that federally-insured banks shouldn't be gambling in the markets with your deposits is a bit awkward when applied to Goldman, which has always gambled in the markets and which has only recently and tentatively started taking your deposits. (Disclosure: I used to work at Goldman. Also I have a Goldman savings account, so it is looking to gamble with my deposits.)
So here is a story about that aggressive lobbying, describing Goldman as "attacking Volcker as a noose tailored for the bank's throat," and as being "relentless" in "corralling" other banks to support its approach, since "it would be the kiss of death for any proposal to be branded the 'Goldman Sachs amendment.'" There are various regulatory fronts on which the Volcker Rule could be eased, and a lot of sympathy in the executive branch for easing it. But the really interesting path is Congress "slipping Dodd-Frank changes into an end-of-year spending bill":
Mr Mnuchin and Mr Cohn have hinted at changes that would exempt investment banks from some Dodd-Frank restrictions. In January, Mr Mnuchin told senators: “I think the concept of proprietary trading does not belong in banks with [federal] insurance.” The Volcker rule applies to all banks. Narrowing it to only the parts with government-insured deposits would liberate Goldman, because unlike its rivals it keeps its trading separate from its small consumer bank.
A Volcker Rule that applied to JPMorgan Chase & Co. and Bank of America Corp., but not to Goldman, would be a thoughtful gift for Goldman alums Steven Mnuchin and Gary Cohn to get for their alma mater.
Elsewhere: "Big U.S. Banks Could See Profit Jump 20% With Trump Deregulation." And here is a proposal from Marcel Kahan and Ryan Bubb of New York University that banks should be prohibited from paying traders on the basis of trading profits.
"Four mutual-fund companies have marked down their investments in Uber Technologies Inc. by as much as 15%," which is a pretty small drop considering that during the quarter ended June 30 -- the date of these markdowns -- Uber lost its head of self-driving cars, its head of finance, its head of Asia Pacific business and its chief executive officer. But:
Vanguard Group, Principal and Hartford Funds all marked down their shares by 15% to $41.46 a share for the quarter ended June 30, according to the fund companies’ latest disclosure documents. T. Rowe Price Group Inc. cut the estimated price of its Uber shares by about 12% to $42.70 for the same period.
The last fundraising was at $48.77 per share, for a total post-money valuation of $68 billion, meaning that $41.46 should represent roughly a $58 billion valuation. TechCrunch reported secondary trading "at roughly $50 billion" on June 22, suggesting that these funds might still be a bit optimistic. Tech-company executives and venture capitalists like to complain that these mutual fund markdowns inject too much of the volatility and short-termism of public markets into private companies, but that worry is probably out of place here. If Uber had been public through the last few months, I suspect its stock would have bounced around by more than 15 percent. If your mark-to-market is performed solely by the valuation committees of long-only investors who own your stock, that is still a pretty generous way to measure.
Here is the heartwarming story of a government official who discovered misconduct at a company, reported that misconduct to the Securities and Exchange Commission, and helped the SEC conduct a successful investigation of that company. (All the details are redacted from the official account, alas.) And then, for his troubles, the government official got a commendation and a hearty handshake from his boss. No, just kidding! He got a whistleblower award from the SEC of "almost $2.5 million." (Maybe he also got a handshake, I don't know.) That seems like a lot of money to give a government official for performing the functions of government? I mean, I guess he wasn't performing the functions of his area of government. It's not like the SEC gave a whistleblower award to an SEC accountant. And the SEC says:
We note that the record is clear that this is not a situation where a claimant sought to circumvent the potential responsibilities that his or her government agency might have to investigate or otherwise take action for the misconduct. We express no view on how an award determination might differ under that alternative circumstance.
Still, it does seem a bit like the government would all be on one team. It's weird for some members of that team to just do their job for their salary, while others get a $2.5 million bonus for their help.
The email prankster.
There is a guy in the U.K. who likes to email prominent people pretending to be their bosses or colleagues or whatever and trying to goad them into saying dumb stuff. He started with the chief executive officers of banks, and had a lot of success in tricking them into believing that he was their bosses or colleagues or whatever, but no success whatsoever in goading them into saying dumb stuff. No matter what horrible nonsense their pretend-board-chairman seemed to be spouting, the bank CEOs kept it professional, and the whole prank was kind of boring.
So the prankster moved on to the Trump White House and got immediate funny results. And now he has moved on to Breitbart, emailing editor-in-chief Alex Marlow while pretending to be returning Breitbart leader (and recently ousted Trump adviser) Stephen Bannon, and almost immediately tricking Marlow into saying revealing things about Jared Kushner and Ivanka Trump. This seems to confirm my, and Samuel Johnson's, belief that "there are few ways in which a man can be more innocently employed than in getting money." The bank CEOs did great! They were fooled into thinking that they were emailing with their powerful buddies, and they kept it appropriate anyway. I am proud of them. The political and journalistic targets were much easier marks.
People are worried that people aren't worried enough.
Well, even if people have stopped worrying that the VIX is too low, they can at least keep worrying that the MOVE is too low:
The Bank of America Merrill Lynch MOVE Index, a measure of investors’ expectations for price swings in the Treasury market, fell to an all-time low of 46.9 earlier this month and has hovered near that level since then.
Of course, "history suggests this period of calm isn’t going to last–and analysts warn that investors who’ve gotten used to the quiet in the bond market may be mispricing risks on the horizon."
Elsewhere, Monday was "the third-slowest full day of the year" for U.S. stock trading, because, you know, it was a late-August Monday that happened to feature a solar eclipse. "'The distraction was welcome on a day when many struggled to keep their eyes open regardless of whether or not they were focused on the sun,' said BMO Capital Markets rate strategist Ian Lyngen, in a note to clients."
People are worried about unicorns.
Here is a Third Way report from Shai Bernstein of Stanford about initial public offerings and innovation (based on patent quality), comparing "firms going public with firms that were about to go public but held back because of market volatility":
The results of the experiment were striking: going public means a 40% decline in quality innovations for those firms in the five years immediately following listing. Meanwhile, the firms that flirted with an IPO but stayed private innovated at an accelerated rate. Why? Bernstein found that once a firm is public, early innovators within the company often cash out their stock and move to new start-ups. This may not be a bad thing for the economy because innovation is still occurring, just at a different firm. However, the authors found that inventors who stayed at the newly public company saw a 48% decline in quality innovation. They concluded that going public changed the calculation for top managers who felt it may be difficult to justify far-flung research to shareholders. The pay-off for this innovation would not be near-term; in fact, it might not occur at all, he surmised.
Stay in the Enchanted Forest, unicorns! It will nurture you, and your innovative spirit.
You could tell a story here in which public markets really are short-termist and bad for innovation, and in which innovative companies stay private longer so that they can innovate more. That would not be the end of the world: The vast pools of money sloshing into private markets would seem to mean that there's no shortage of funding for innovation. But it would in many ways be a sad story: It would mean that big public companies have trouble innovating, and it would mean that regular people -- "Mr. and Mrs. 401(k)," as Securities and Exchange Commission Chairman Jay Clayton called them -- miss out on the chance to invest in innovative companies that remain private.
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