(Bloomberg View) -- Wells Fargo.
I don't think I've ever heard a regulator sound so downcast about a big victory:
"I am especially pleased that we were able to work closely and effectively with our colleagues at the OCC, and I appreciate the key role they played in the negotiations," said Bureau Acting Director Mick Mulvaney. "As to the terms of the settlement: we have said all along that we will enforce the law. That is what we did here."
That's Mick Mulvaney, the part-time acting director of the Consumer Financial Protection Bureau, which last week, along with the Office of the Comptroller of the Currency, fined Wells Fargo & Co. $1 billion for doing some bad consumer stuff. Not for the infamous fake accounts -- the CFPB and OCC fined Wells Fargo, $100 million and $35 million respectively, for those back in 2016 -- but for requiring auto-loan borrowers to pay for Wells Fargo's insurance on their cars even when the borrowers already had their own insurance, and for charging mortgage borrowers to extend interest-rate locks even when the need for an extension was Wells Fargo's fault. It is all a bit less sexy than the fake accounts, which had the public-relations advantages of being ridiculous and having a catchy name. "Force-placed auto insurance" doesn't have the same obvious comedy as "fake accounts." But the fine is much bigger, and probably deservedly so: The fake accounts don't seem to have made much money for Wells Fargo, or cost consumers much; the auto insurance thing actually cost money.
So the quote is weird: This is the biggest fine ever imposed by the CFPB, but Mulvaney wants to deflect credit from the CFPB altogether. This was the OCC's doing, he implies -- it's tied for the biggest fine ever imposed by the OCC too, by the way -- and the CFPB was just along for the ride. It was just doing what the law requires. It took no pleasure in fining Wells Fargo. Most heads of regulatory agencies, of course, would be happy to announce the biggest fine in the agency's history, since most regulators are in their jobs because they want to regulate. But for Mulvaney it is an embarrassment because he is very explicitly in the job because he doesn't want to regulate, thinks the CFPB is a "sad, sick joke," and has promised to stop the agency from "pushing the envelope" in its enforcement. To the untrained eye, imposing the agency's biggest-ever fine might look a bit like pushing the envelope, so Mulvaney needs to reassure his audience that that was not his intent.
The charitable reading is that this is in keeping with Mulvaney's stated commitment to the rule of law: This penalty is not the swashbuckling CFPB going out and bringing big cases to assert its clout, but just a melancholy consequence of following the law. That is hard to evaluate. For one thing, $1,000,000,000.00 is a suspiciously round number for a fine, and there is no real explanation of how the CFPB or OCC arrived at that number or how much consumers were harmed. (The CFPB notes that "the anticipated amount of the total remediation to be paid, refunded, or remitted to customers exceeds $10 million," but that seems to be regulatory boilerplate rather than a real estimate.) Also, here is an article about the possibility, which you really can't rule out, that the CFPB and OCC fined Wells Fargo so much because Donald Trump tweeted about it. ("I was aware of some of his public statements several months back but did not consult with the president on this consent order," said Mulvaney, which ... sounds like a yes?) If you were trying to demonstrate a commitment to the rule of law, you might explain the connection between the misconduct and the penalty a bit more clearly, instead of just looking really sad about the whole thing.
Elsewhere, here is James Stewart arguing that Wells Fargo has already been punished enough, which is kind of a random thing to think. Use every bank after its desert, and who should 'scape whipping, y'know?
First loss.
Everyone knows the old chestnut that hedge funds are "a compensation scheme masquerading as an asset class," but arguably that underestimates the power of compensation schemes to transform asset classes. For instance, imagine a compensation scheme in which:
- You give me money.
- I invest it in ____ on your behalf.
- If ____ goes up, I give you 50 percent of the profits (and keep 50 percent for myself).
- If ____ goes down, I eat all the losses and give you your money back.
Assuming that you trust me and I am creditworthy -- big assumptions, sure -- then this compensation scheme really transforms the risk profile of ____, whatever ____ is. If I invest your money in emerging-market stocks or cryptocurrencies or lottery tickets, and give you the returns, then that will be volatile, and you will have a significant risk of losing all your money. But if I invest your money in emerging-market stocks or cryptocurrencies or lottery tickets, and give you 50 percent of the profits while eating 100 percent of the losses myself, then the risks and returns on that strategy -- for you -- will look very different. They'll look sort of like a bond, or a bond with occasional bonus payouts I guess. If you were examining your portfolio's overall exposures, you wouldn't quite want to classify that investment -- not really -- as exposure to emerging markets or cryptocurrencies or whatever. It would not have the risk profile you'd expect from those investments. It would look like its own weird thing. Not quite an "asset class," perhaps, but not the same thing as the underlying asset class anyway.
That is not the hedge-fund compensation plan. (The hedge fund plan is, if there are gains, you get 80 percent and I keep 20 percent; if there are losses, you get 100 percent of them, though high-water marks complicate that a bit.) But it is -- almost -- this compensation plan:
Here’s how first-loss works: Managers like Paulson put their own money into an account within a first-loss fund, and any of the three firms contribute nine times as much from their investors. Managers get to keep about 55 percent of the trading profits, more than double the standard industry cut. But should the strategy go awry, all of the losses come out of their invested capital until it’s gone.
“The upside, if you do well, is good,” said Karl Cole-Frieman, whose law firm advises hedge funds on seeding deals and other structuring issues. “The downside, if you do poorly, is disastrous.”
That's from this article about "first-loss funds" provided by firms like Topwater Capital, Prelude Capital Management and Boothbay Fund Management, and specifically about how Paulson & Co., "after suffering years of losses and redemptions," is signing up to be the at-risk manager of some of those funds. The profile here is almost the one I laid out above, except that (1) the manager keeps 55 rather than 50 percent of the profits, and (2) the manager is only at risk for the first 10 percent of losses. But first-loss providers "can shut down an account once most of the hedge fund manager’s capital is gone," to try to minimize their exposure to losses past 10 percent. "Believe me, Prelude and Topwater never get a loss," says a hedge-fund lawyer.
Just for fun I modeled up a one-year first-loss strategy on the S&P 500 Index:
This is just a toy -- and not investing advice -- but it suggests that if you found a manager to invest in the S&P 500 using this compensation scheme, where the manager gets 55 percent of the gains (the at-the-money call in the first column) takes the first 10 percent of losses (the put spread in the next two columns), then that would be equivalent to paying the manager a 0.7 percent fee. Which is ... you know ... in the ballpark of money-management fees? I'm sure some bank somewhere is offering a retail structured note that looks a lot like this.
But the point is that you can do this on all sorts of things -- stocks or bonds or cryptocurrencies or, in Paulson's case, merger-arbitrage trades -- and kind of flatten out the profile. What Topwater et al. are getting isn't merger arbitrage, it's merger arbitrage run through this flattening scheme. Which is safer but less lucrative for them than merger arbitrage, or whatever the underlying strategy is.
Why would you invest in hedge funds? Well, there are lots of reasons, because there are lots of different types of hedge funds that do lots of different things. (They're a compensation scheme, remember, not an asset class.) One popular reason is "I will invest with this star hedge-fund manager because he will likely get me huge returns." That had a certain vogue, but is now harder to argue for just because you don't see so many managers like that anymore. Another popular reason is that the hedge funds will have medium-sized but steady returns that are somewhat uncorrelated to other asset classes; this reason -- which is kind of the opposite of the first one -- puts the "hedge" back in "hedge fund," and is more popular now. If what you are looking for from your hedge funds is essentially conservatism, then it may sometimes seem like an odd incentive to pay managers 20 percent of their winnings and charge them zero percent of their losses. Paying them 55 percent of their winnings but charging them 100 percent of their losses may be a compensation scheme that is closer to the asset class you want.
[Update: The toy calculation I did of the S&P 500 first-loss strategy produces a price of 1.3 percent of the call-option notional in the first column. But the call options are on only 55 percent of the underlying shares, so it's really a price of 0.7 percent of the total amount. I have corrected it above.]
People are worried about liquidity.
Investors are having a tougher time trading in a number of financial markets, a development that is weakening their ability to raise cash or to protect against big stock declines.
The capacity to get in or out of an investment, known as liquidity, was rarely tested during the long stretch when stocks and bonds rallied with little volatility. Now as inflation concerns, trade anxiety and tension in Syria roil markets, investors notice it is getting harder to trade as easily.
Stocks, options, corporate bonds; "this year’s volatility has even hampered liquidity in the popular E-mini S&P 500 futures on the Chicago Mercantile Exchange." "It’s like going into a grocery store and there’s nothing on the shelves," says a guy.
Back when we used to talk all the time about people worrying that volatility was too low -- before volatility got higher in February -- I was fond of pointing out that a well-known puzzle about the stock market is that volatility is generally too high; stocks move around more than is justified by their actual cash flows. What if, I pondered, the decline of volatility was due to markets becoming smarter: As investors indexed more and relied more on algorithms and generally became more logical and less beholden to animal whims, wouldn't you expect volatility to go down?
Another quite well-known puzzle is that the amount of trading in stock markets is generally too high; people buy and sell stocks far more often than could be justified by their having an informational edge. What if -- I might ponder now -- the decline of liquidity is due to markets becoming smarter? As investors index more and rely more on algorithms and generally become more logical and more cost-driven and less beholden to animal whims, wouldn't you expect the amount of trading to go down? I guess this wasn't really true for volatility, so whatever, but it's worth pondering.
The crypto.
Vitalik Buterin, who invented Ethereum, had Lunch with the FT and was pleasingly introspective. There is an occasional tendency among cryptocurrency enthusiasts to think that they are at the vanguard of the revolution, that they are creating a better world just by speculating on initial coin offerings. Buterin, meanwhile, who actually created an important thing, is a lot more skeptical, arguing that ICO valuations are "far ahead of what this space has actually accomplished for the world" and making fun of crypto zillionaires:
“It’s the luck of the draw, where everyone who won the draw seems to feel like they deserved it for being smarter,” rants Buterin. He impersonates a bitcoin bull: “I was loyal and I was virtuous and I held through and therefore I deserve to have my five mansions and 23 lambos!” We laugh.
Meanwhile here, from last week, is a profile of Mark Karpelès, the guy who ran the Mt. Gox exchange when it was hacked and lost all its Bitcoins. It filed for bankruptcy and then, in an odd twist, found a lot of its Bitcoins again. Not all of them -- investors still had substantial Bitcoin losses -- but enough of them to more than pay off all of the investors' fiat claims: When Mt. Gox entered liquidation, claims on it were converted into yen (and Bitcoin was worth $483 at the time); the Bitcoins it then found are now worth way more than the total amount of all of those claims. "The fact that you have a bankruptcy where the only asset that it owns goes up by 5,000%, that’s pretty unprecedented," says a lawyer. So Mt. Gox might go un-bankrupt:
Richard Folsom, an American who worked for Bain & Co. in Tokyo before founding one of the first private equity shops in Japan, hired the biggest Japanese law firm and came up with a plan: What if Mt. Gox wasn’t technically bankrupt anymore? Their petition for “civil rehabilitation” of Mt. Gox, filed in November, is now pending before the Tokyo District Court; an outside examiner recommended in its favor in February.
Elsewhere in crypto, Gary Gensler, the former head of the Commodity Futures Trading Commission, thinks that Ripple and Ether are probably securities. And Savedroid, an ICO that said it had stolen everyone's money, apparently hasn't stolen everyone's money, but was just doing a prank "meant to teach the cryptocurrency community a lesson about how easy it would have been for them to scam their investors." Look, if you invested in a company that would do that, you deserve to actually have all your money stolen, is my view on the matter.
Oh and we talked on Friday about blockchain for shipping. I pointed out the problem that "Rather than all the big shippers coming together to agree on and build a vast new platform for the industry to use, each of them seems to be building its own system and hoping that everyone else adopts it." But reader Mike Phillips noted by email that there is some precedent for that:
One point in the various shipping blockchains' defense is that this is also basically how the adoption of containers worked out, with many shipping companies having different container specs (i.e. non-compatible fasteners, different sizes, etc.) until they eventually got munged together into one winner. The full promise of containerization wasn't really able to be unlocked until that point, though there were still other gains made along the way. But in general, it makes sense for everyone in the space to want to make a play for their standard to be the default, since it will be built around their business, and make it easier for their business to operate on it (alternatively, people could guess at what the winner will look like, and try to conform to that).
It's true that, generally, you're at least as likely to create a universal standard by starting with competition as you are by starting with coordination.
Oh man.
You never want to see your boss celebrate like this when you quit:
Greenhill & Co., the boutique investment bank, said it’s losing a team of bankers -- and that it’s good for the firm’s bottom line.
The real estate-focused primary capital advisory team “has been high quality but only marginally profitable,” Chief Executive Officer Scott Bok told staff Sunday in a memo obtained by Bloomberg. Fourteen professionals are leaving, forfeiting deferred compensation, which will provide a “significant favorable impact” to pretax profit this year, he said.
Look I am going to pull back the curtain here a bit. Every day I write Money Stuff and then I tweet a link to it. The tweet is always some quote from Money Stuff repurposed to describe the newsletter itself. "TurboTax is an evil, parasitic product that exists entirely because taxes are confusing and hard to file," wrote Dylan Matthews last week, to pick an example at random, and I quoted him in Money Stuff, and then I tweeted "This newsletter is an evil, parasitic product that exists entirely because finance is confusing and hard to understand." It is all fairly straightforward, a little joke that I have enjoyed for a few years and that I hope some of my Twitter followers have enjoyed too. Occasionally it goes awry, in that I rarely write the newsletter with the tweets in mind, and every so often I finish it and then realize there is no funny quote to serve as the basis for the tweet and have to stretch a bit. Other times, though, I will be writing the newsletter and find myself quoting something and thinking "well that's the tweet sorted," and that is always a satisfying feeling.
The point of this meandering story is that today I will be tweeting "This newsletter has been high quality but only marginally profitable," and also that that would be an honorable epitaph on anyone's Wall Street career, and frankly on anyone's tombstone. "He was high quality but only marginally profitable" is a description that I rather aspire to. So congratulations to the 14 Greenhill real-estate people did good work, but who nonetheless helped their employer more by quitting.
Things happen.
UBS's Freshly Combined Global Wealth Management Unit Disappoints. Mifid II forces fund managers into sharp research cuts. It’s a Scary Time to Be Trading Wall Street’s Fear Index. Zelle, the Banks’ Answer to Venmo, Proves Vulnerable to Fraud. "Europe’s banks have raised half of their market value in new equity over the past decade." Walmart Is Close to $12 Billion-Plus Deal for Flipkart. Tencent Music Plans IPO; Valuation Could Exceed $25 Billion. Wanted: New Home for a Lot of Russian Aluminum. Don't keep all your retirement savings in your employer's stock! Moose goes to dog park.
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Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
To contact the editor responsible for this story: James Greiff at jgreiff@bloomberg.net.
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