Money Stuff

Shale Shareholders and Direct Listing

Also AlphaZero, activism, deferred tax assets and whatever price bitcoin is at now.

Should index funds be illegal?

We talk a lot around here about a theory that diversified institutional investors – index funds, other mutual funds, whatever – who own shares in multiple companies in the same industry might discourage those companies from competing aggressively with each other on price. The idea is that if you own a single, say, airline, you might want it to lower prices and take business from competing airlines: Your airline could benefit from expanding its business even as it cuts margins. But if you own shares in every airline, then that sort of competition is negative-sum: One airline takes customers from another, but no one gains customers overall, and margins decline.

If this theory is correct it might be a problem for antitrust law. More competition is good for consumers. If one small group of investors has big stakes in all the competing companies in an industry, and discourages them from competing, then that looks a bit like the old “trusts” that antitrust law was supposed to prohibit.

A lot of people dismiss this theory. It seems a little far-fetched. There is some economic theory behind it, sure, but it seems to be lacking a practical mechanism. It is not like airline shareholders are really getting together to discuss how they can get airlines to cut back on capacity and raise prices.

Here is a story about a cabal of investors who “met this September in a Midtown Manhattan high-rise” to plot a strategy to try to convince U.S. shale oil and gas producers to cut back on capacity and raise prices. It’s not airlines, and they’re not index funds – they “included giants such as Invesco Ltd. and smaller shareholders including Sailing Stone Capital Partners LLC” – but it is still suggestive. Are shareholders really supposed to get together to talk about how to get industries to cut production?

The confab began with ground rules: No one would speak of specific companies or action plans, to avoid running afoul of antitrust regulations and rules governing passive and activist investors. Instead, they discussed how to make frackers pump less and profit more. “We’re not backing down,” one investing participant told the assembled, some of the attendees say. “This is an existential issue for us.”

To be fair, the issue here is that there is a ton of overproduction among U.S. frackers: “In the past decade, the shale-fracking revolution has made the U.S. the world’s largest oil-and-gas producer and reshaped markets,” but U.S. energy-producer stocks have fallen over that period and “energy companies in that time have spent $280 billion more than they generated from operations on shale investments.” The investors’ advice might be perfectly sensible. But it makes sense that, if common ownership does discourage companies from competing vigorously with each other, it would start in industries – like airlines and shale drilling – where competition has been too vigorous. You go for the easy wins first.

Elsewhere, here is Aron Szapiro at Morningstar asking: “Would Policymakers Target Index Funds?

Given the academic literature on common ownership among asset managers of competing companies, this could pave the way to new, novel forms of antitrust action, effectively ending broad index funds, thus raising the costs (and lowering the returns) of ordinary investors. Furthermore, high-profile Democratic senators (Cory Booker, Amy Klobuchar, Kirsten Gillibrand, and Al Franken, among others) are taking the idea seriously and recently introduced a bill (S. 1811) that would require the Federal Trade Commission to study whether common ownership of companies by asset managers affects competition.

And here is my Bloomberg View colleague Noah Smith on Matt Bruenig’s idea of a “social welfare fund,” which we have discussed before, and which is sort of the flip side of this debate: If common ownership isn’t an antitrust problem, if it doesn’t reduce competition, then there should be no efficiency problem with extending it more broadly to a social welfare fund that owns shares in all companies on behalf of all citizens. On this theory, index funds are an unintended half-step toward socialism.

Direct listing.

It looks like Spotify AB really is going to go public by doing a direct listing on a U.S. stock exchange, and I am starting to get excited. The idea of a direct listing is that, instead of doing an underwritten initial public offering in which sellers (Spotify and its founders and early investors) decide how much they want to sell, sign up some banks, build a book of demand, and then all at the same time sell their stock to investors chosen by the underwriters, Spotify will just one day declare that it is public and that anyone who wants to buy or sell can, on the stock exchange, like any other stock.

In practice I assume this means that Spotify will go public by means of an opening auction on the New York Stock Exchange or Nasdaq: Early one morning, some Spotify shareholders will make indicative offers to sell their shares, and some bold investors will make indicative bids to buy them, and the exchange will publish some tentative price that seems like it will clear the supply and demand, and then other shareholders and buyers can come in and adjust the prices and quantities that they want, and eventually a clearing price will be reached, and the stock will open and trade normally. It's what happens in every other stock every morning, except that every other stock had a closing price the day before, and Spotify won't. So that opening auction will be a bit wild. 

If it is totally wild, that's a little bad: If the opening cross in Spotify is at $10 and then the stock quickly trades up to $30, future companies will be skeptical about direct listing because it "leaves money on the table" (for their shareholders), while if it opens at $10 and then trades down to $3, future buyers will be skeptical about direct listing because it "creates a winner's curse." On the other hand, it's not that bad, just because not that much stock needs to change hands at the opening price. If you're an early investor who owns a million Spotify shares, you can chuck a thousand of them into the opening auction to see what happens, and then sell the rest over the course of the day or week or month. It's not as much of an all-or-nothing proposition as a traditional IPO is, where you sell a big chunk the first day and then are (typically) locked up from selling any more for six months.

My bigger worry with the direct listing is just that: If not much stock changes hands on the first day, then you have a weird situation where the public market for Spotify is a tiny fraction of its market capitalization. Usually when a company IPOs, it sells a lot of stock, and then frenzied speculators and high-frequency arbitrageurs and excited retail investors have a lot of stock to trade back and forth amongst themselves. If Spotify direct-lists and most of its investors decide to wait a while to see how it shakes out, then you'll have a lot of people doing a lot of trades with not very much stock. That could lead to a lot of volatility for a long time.

But if it works! Part of the point of a traditional IPO is that you need the human touch to make trading orderly: Bankers need to allocate shares thoughtfully to a mix of long-term investors, and set a price that gives those investors reasonable upside. A stock exchange’s mechanical auction process – where anyone can buy or sell, and where prices are set by brute supply and demand rather than the experienced judgment of professionals – is fine for the daily opening of a public stock, but obviously inappropriate for something as important as an IPO. Unless it works. In which case, what do you need the humans for?

Artificial intelligence.

The computers won: DeepMind built a program called AlphaZero that learned chess on its own by playing against itself with no human input and was the best player in the world within 24 hours. For good measure it also learned shogi and Go the same way. "The Age of the Centaur is *Over* Skynet Goes Live," is Tyler Cowen's headline: A computer is now better off learning these games on its own rather than working with humans.

You will continue to read articles about how Steven A. Cohen or Ray Dalio or other big famous investors are trying to program computers to think like them, but: Why? You wouldn’t program a chess computer to think like Magnus Carlsen; even if you succeeded perfectly, your Magnusbot would get demolished by AlphaZero. In domains like chess and Go, the computers can figure things out on their own, and the humans just get in the way.

Investing is of course different: It is not deterministic, market regimes evolve over time, humans need to provide the data, etc. AlphaZero is not going to go off and master the investing game in the next 24 hours, despite having “alpha” right in its name. Still it feels like special pleading to say that just because markets change over time, only human intelligence can really master them. It’s not like humans have any obvious innate talent for spotting market inflection points or whatever. They have just played the game a lot and learned from their experience some rough ways of spotting patterns. That’s what the computers would do too, except maybe better.


On the other hand, will the computers do this?

As Elliott ramped up its pressure on Arconic, friends and colleagues of Kleinfeld, along with board members of Arconic, reported more suspicious run-ins: Others who live near the CEO were followed to a local restaurant by strangers who then approached the couple; they claimed to be considering investing with Kleinfeld, but first had a few questions. The German-born executive declined to speak with Fortune, but five people familiar with the events confirmed this account. They all believed Elliott to be behind it: “We thought they crossed the line,” one of the people says.

The most unnerving incident was when one of Kleinfeld’s daughters, a student at Harvard Business School, was approached on campus by someone who asked to “friend” her on Facebook; the person also spoke to her friends, fishing for information about her family. While lawyers and advisers say it’s common to hire investigators to do opposition research in the context of a proxy campaign, executives’ kids—of any age—are typically considered off-limits.

That’s from this story about how Paul Singer’s hedge fund, Elliott Management, is “virtually impossible for adversaries—from industry titans to nation states—to beat in a fight.” Elliott’s fight with Arconic Inc. is famous for its weird ending: Arconic Chief Executive Officer Klaus Kleinfeld sent Singer a soccer ball with a veiled threatening letter that seemed to refer to an embarrassing incident from Singer’s past, Singer raised a stink about it, and Kleinfeld was forced to leave, which is what Singer was asking for in the first place. And you might say: Yes, fair enough, those sorts of scurrilous attacks have no place in a polite proxy fight! But meanwhile Elliott was (maybe!) fishing for dirt on Kleinfeld’s daughter. They were a bit more subtle about it, though.

Tax assets.

This is really going to be the stupidest possible development for the saga of Fannie Mae and Freddie Mac: If corporate taxes are lowered, then the government-sponsored enterprises' deferred tax assets will be less valuable, which will require a writedown, which will flow through their income statements, which will cause the enterprises to have a net loss, which will reduce their capital below zero, which will require them to draw on their financing lines from Treasury in order to have positive capital. None of those things are things. Nothing will happen. Fannie Mae and Freddie Mac will continue insuring mortgages, and will continue charging fees, and those fees will continue to be above their costs, and they will continue to make large operating profits. But because of a series of accounting fictions -- mark-to-market accounting for deferred tax assets through the income statement, but also the dumb accounting in which Fannie Mae give their profits to Treasury and then have to draw on Treasury when they have losses, instead of just consolidating with Treasury like the wholly-owned arms of the state that they are -- we are now faced with the likelihood that the tax bill will require "another bailout of Fannie and Freddie." And now politicians and GSE types and their allies will go around saying "this is another bailout" and "bailouts are bad" and "Fannie and Freddie should be allowed to retain earnings in order to avoid just this sort of bailout," and I will quiver with impotent fury because that's so stupidthat's not a thing, if Fannie and Freddie give money to Treasury now and take it back later that is just as good as (better than!) them keeping the money themselves, every discussion of Fannie and Freddie is based on a nonsensical confusion of accounting entries with economic reality, and it just makes me sad and tired.

Elsewhere, "Citigroup Faces $20 Billion Hit From Tax Overhaul." And: “Fannie-Freddie Overhaul Plan Comes Into Focus on Capitol Hill.”

Happy Bitcoin 13,000 Day.

I mean, that was yesterday. A few hours after I sent out Money Stuff saying Happy Bitcoin 12,000 Day, which was also yesterday. At this rate we'll have Bitcoin 25,000 before my "Bitcoin 25,000 Before Dow 25,000" hats get here.

Happy Bitcoin 14,000 Day.

That was also yesterday.

Happy Bitcoin 15,000 Day.

That was this morning. See what I mean?

Happy Bitcoin 16,000 Day.

That will be this afternoon, probably.

Happy Bitcoin 17,000 Day.

Just in case, why not.

Still more bitcoin.

Bitcoin futures are set to start trading next week at CBOE Global Markets Inc.'s futures exchange, with CME Group Inc. following the week after that, but some people object:

The Futures Industry Association, whose members include Goldman Sachs Group Inc., JPMorgan Chase & Co. and Citigroup Inc., detailed its concerns in a letter to the Commodity Futures Trading Commission on Wednesday. The association said there should have been more discussion about margin levels, trading limits, stress tests and clearing before the contracts were given a green light.

For clearing members of futures exchanges, the worry is that some bitcoin futures trader will blow up, and that bitcoin is so volatile that the trader's margin won't be sufficient to cover its losses. That will leave the members of the exchanges on the hook for losses. This seems like a ... totally reasonable worry? If you collected 25 percent margin from someone who was short bitcoin on Monday, they would have blown through it by this morning. Also the standard fate of bitcoin exchanges seems to be to get hacked and lose their customers' money, so if you are a customer of a futures exchange I can see why you'd be skeptical of your futures exchange turning into a bitcoin exchange.

Meanwhile, here is a nice profile of Coinbase, a bitcoin exchange that hasn't been hacked, much. (Though: "In May, the company was criticized by a customer who could not reach anyone at the company after his account was hacked.") It "runs an exchange, called GDAX, tailored to larger investors," overseen by Adam White. "A year ago, his Wall Street outreach was difficult, but 'it’s all inbound now,' Mr. White said." Indeed.

Oh and another bitcoin thing was hacked:

NiceHash, the marketplace for cloud-based mining of cryptocurrencies, said hackers breached its systems and stole an unknown amount of bitcoin from its virtual wallet.

Some $60 million worth of bitcoins may have been affected. Elsewhere here's a guy who lost the password to his 40 bitcoins.


Wal-Mart Stores Inc. is changing its name to Walmart Inc. Deleting the “Stores” is pitched as a 21st-century nod to online shopping – “We felt it was best to have a name that was consistent with the idea that you can shop us however you like as a customer,” says Walmart’s (doesn’t that feel good?) chief executive officer – but normal people will be more excited about the deletion of the hyphen. That hyphen felt very 1970s, and deleting it is such a pleasing official concession to actual modern usage. You can’t begin to know how happy I am to tell you about it in this email newsletter, instead of in an e-mail newsletter. It gives me hope that one day we will live in a world where “Google parent Alphabet Inc.” will re-rename itself “Google Inc.”

Things happen.

Bear Stearns' Last CEO Tries to Keep Guggenheim Together. Sinopec sues as China loses patience with Venezuela. Traders Want to Know What Exchanges Earn From Market Data. Companies shunned all-stock mergers in 2017. Move Over, Cushing: Houston Emerges as Key Oil Trading Hub. Goldman and Barclays are each writing $20 billion bridge loans in the CVS/Aetna deal. The Great Credit Party Is Almost Over, Societe Generale Says. The High-Powered Lawyers Fighting Over AT&T's Future. Iger Likely to Stay On as Disney CEO Past 2019 if Fox Deal Is Reached. Trump’s Middle-Class Tax Pledges Go Unfulfilled in Senate Bill. 'Holy crap': Experts find tax plan riddled with glitches. GILTI. Trump Team to Slash Budget, Staff at Financial-Data Office. House Republicans Weigh Linking Debt Ceiling Increase to Spending Bill. Volkswagen Manager Sentenced to Prison Term in Emissions-Fraud Case. U.S. Chip Engineers Charged in Theft Scheme for Chinese Firm. A Saudi prince bought “Salvator Mundi.” Booms without boomtowns. These Harvard Business Grads Are Putting Politics Above Profits. Paul Tudor Jones Told Weinstein That Sex Allegations Would Blow Over. Dog commutes alone. I Made My Shed the Top Rated Restaurant On TripAdvisor.

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