Too Convenient to Fail
(Bloomberg View) -- Are banks tech companies?
How many banks does the United States need? In the very olden days you might come to an answer by saying, well, each town needs a bank, preferably two so there's competition, maybe more in big towns. Multiply that by the number of towns and you get your answer. Perhaps one bank could have branches in multiple towns, but that would frankly be weird: Putting your money in a bank is a profound act of trust, and you want to be able to look the bank owner in the eye and make sure you trust him before giving him your money.
Times changed. Licensing and deposit-insurance rules made it easier to trust banks without knowing them personally. National banking allowed banks to have branches in multiple states, and national banks became acquisitive. The trust calculus flipped: If you are going to trust an impersonal bank whose managers you have never met, it might as well be a big impersonal bank whose managers you can see on TV, rather than a little impersonal bank whose managers are invisible.
Still there remain some reasons to use local banks. You might have an aesthetic preference for buying local. Your local bank might have local expertise and be more competitive at giving you a small-business loan or whatever. And your local bank might just have branches in your town, while JPMorgan Chase & Co. and Bank of America and Wells Fargo & Co., still, might not.
Last year, about 45% of new checking accounts were opened at the three national banks, even though those lenders had only 24% of U.S. branches, according to research by consulting firm Novantas. Regional and community banks, by contrast, had 76% of branches but got only 48% of new accounts, the firm said. ...
Before online and mobile banking became popular following the financial crisis, these consumers generally opened a new account at the bank with the nearest branch, no matter the size of the institution, said Andrew Frisbie, executive vice president at Novantas.
But now that many banking transactions are done online or through smartphones, these customers are picking national banks because of their well-known brands and the perception that their technology is better, Mr. Frisbie said.
Why wouldn't their technology be better? If you serve a lot of accounts all over the country, you can amortize the cost of developing good apps over a lot of accounts, and driving people to the app instead of to branches saves you a lot of money. If you serve fewer accounts out of one branch in one small town, where do you even find a local app developer?
There is nothing especially novel about this. Bookstores used to be local businesses. Bookstore chains killed a lot of local bookstores, because there were economies of scale in running a big chain, but there were still niches and preferences that allowed local stores to survive. Amazon.com Inc. was the real problem. When the market becomes national, or international, it is a lot harder for local-scale businesses to compete.
Obviously lots of people have lots of complaints about Amazon, and about other big companies in big industries that used to be local and are now national. These complaints are often antitrust complaints, or consumer-welfare complaints more broadly; often they are producer-welfare complaints (what about the book publishers?), or competitor-welfare complaints (aren't local booksellers entitled to earn a living?), or general nostalgia (aren't local bookstores just nice?).
But of course banking raises another level of issues, because we had a financial crisis 10 years ago, and people remain worried about banks that are systemically risky or "too big to fail." Concentrating all the deposits into a few national banks, banks that also happen to provide the plumbing of the financial system and do a lot of trading and investment-banking business, seems to a lot of people to be an unnecessary risk. Often you hear explanations of this concentration that suggest that it is unnatural, that the big banks have artificially low costs because of too-big-to-fail subsidies, or that the regulatory burden on big banks actually forces them to become bigger.
But the explanation could be as simple as, you know, how many competing banking apps do people need? How many online-bookseller apps or car-hailing apps compete at national or international scale? The answer is rarely "one," but it is rarely hundreds, either. If banking is an app, then of course the banks will be few and enormous. And regulation will need to reckon with that directly: Optimizing capital requirements or whatever won't prevent banks from becoming giant and systemically risky, if the basic market demands of their business push them in that direction.
Are banks moral arbiters?
Citigroup is setting restrictions on the sale of firearms by its business customers, making it the first Wall Street bank to take a stance in the divisive nationwide gun control debate.
The new policy, announced Thursday, prohibits the sale of firearms to customers who have not passed a background check or who are younger than 21. It also bars the sale of bump stocks and high-capacity magazines. It would apply to clients who offer credit cards backed by Citigroup or borrow money, use banking services or raise capital through the company.
"The company declined to name clients or describe the extent of affected partnerships but said that 'real revenue is at risk' if relationships fall through and customers protest." There is a fairly standard story about banking in which banks are Bad -- reckless, selfish, amoral -- and therefore need to be overseen by government regulators who are Good -- prudent, public-spirited, moral. But humans and institutions are complicated and face different constraints and incentives, and it is at least possible that sometimes the banks will be more unselfish or more prudent than the government, that market forces will create better rules than democratic ones.
Read the 10-K!
Public companies in the U.S. have to make public filings -- annual and quarterly reports on Form 10-K and 10-Q, announcements of material events on Form 8-K, descriptions of trading by insiders and big shareholders, etc. -- on the Securities and Exchange Commission's Edgar website. Should you read them? For amateur investors that is perhaps a difficult question: There is an obvious conventional wisdom that you should read them so you can be informed about the companies you invest in, but there is also an argument that reading SEC filings gives casual retail investors merely the illusion of competence. After all these filings are publicly available and you are competing with professionals whose only job it is to analyze stocks; surely those professionals are also reading the filings and then also doing a lot of other research that you just can't do.
On the other hand, if you yourself are a professional stock investor, sure, go ahead and read the filings. The company is telling you what it thinks you need to know about its operations and finances, so you should probably take a look. It's not going to give you a huge advantage over anyone else -- everyone else can read the filings too -- but it seems like the sort of bare minimum work you'd do to understand a company before investing in it. Right?
Here is kind of a wild paper from Alan Crane, Kevin Crotty and Tarik Umar of Rice University called "Do Hedge Funds Profit From Public Information?" that looks into whether hedge funds download filings from Edgar, and whether it helps. On the first question, some do, some don't, and "while the median fund-month download amount is only 4 filings, the mean is 672." On the second question, it helps:
Hedge funds that access any filing have higher abnormal returns in the next month compared to funds that do not access filings. The result is statistically significant and economically large, representing a difference in abnormal returns of about 1.5% per year. More intensive information acquisition is also associated with higher subsequent abnormal returns, with the above-median users generating 2%-per-year higher returns than non-users.
It is hard to know what to make of that. One obvious interpretation is that markets do not efficiently incorporate the most basic public information into stock prices, and if you go and read companies' public filings you can outperform the market. A flip side of that interpretation is that some hedge funds do not do that most basic part of their job, and that if you don't bother to read companies' public filings then of course you are going to underperform your peers.
But other interpretations are available. For instance the paper does not seem to be limited to fundamental long-short equity hedge funds, where actual reading of filings would be most relevant, and you could imagine that "number of Edgar downloads" might mostly index what style of fund you are rather than how seriously you take your job. A quantitative macro fund -- or an international stock fund for that matter -- would not use Edgar much; a fundamental U.S. equity fund would use Edgar a medium amount; a quantitative equity fund might scrape hundreds of Edgar documents a day. ("Even within funds, performance is better in periods when those funds access more," write the researchers, which "suggests that the relation we observe is more than just an indicator of fund type.")
There are confounding factors. The sample of "hedge funds" seems both over- and under-inclusive. There are lots of ways to get Edgar filings without accessing Edgar -- from the Bloomberg terminal, for instance, or from the companies' own websites -- so it's not clear that actual Edgar download activity is a good indicator of use of public filings. And it's not clear that there's a causal relationship between the outperformance and the downloading. Still it is an odd result. You would expect this sort of basic public information to be disseminated so widely and efficiently that you couldn't beat the market just by reading it. But perhaps you can.
But here's another wild thing about this paper: You can go find out which hedge funds accessed which documents on Edgar! I mean, that seems wild to me, but the authors' literature summary mentions several other papers that use the same technique. In each case researchers use public records to figure out which hedge funds own which IP addresses, and then match the IP addresses to Edgar traffic logs that the SEC makes available. (Here they are.) The Edgar logs are posted quarterly with a six-month lag, and you can't necessarily match up every hedge fund with an IP address, so you can't find out, say, what companies Dan Loeb or Bill Ackman are looking at today. But you can at least find out what companies some hedge funds were looking at a year ago, and what sort of research they did. It might tell you interesting things about their investing processes. I would definitely read a second-order paper examining usage of the Edgar logs: Can hedge funds profit from looking at data about what other hedge funds are looking at?
Elsewhere in investment advantages based on public disclosure:
Consistent with theory, results show that when the disclosure medium is a conference call, investors are less willing to invest when the CEO is modest about positive firm performance compared to when the CEO brags. In contrast, when the disclosure medium is Twitter, investors are less willing to invest when the CEO brags about positive firm performance compared to when the CEO is modest. Further analysis reveals that perceived CEO credibility mediates the influence of a CEO’s communication style and disclosure medium on investor judgments. Additionally, we find that regardless of the disclosure medium, investors are less willing to invest in a firm when the CEO humblebrags about positive firm performance relative to when he brags or is modest.
That's from "How Disclosure Medium Affects Investor Reactions to CEO Bragging, Modesty, and Humblebragging," by Stephanie Grant, Frank Hodge and Roshan Sinha of the University of Washington. The findings are based on a lab study -- they wrote fake disclosures for a fake company, showed them to a bunch of accounting students, and asked the participants to rate their willingness to invest -- and there are appendixes with the texts used in the study. You are unlikely to read any prose today that is more enjoyable than these hypothetical earnings-call humblebrags:
An overall increase in consumer demand for wireless products caused an increase in revenue this quarter. Looks like we didn't even need our innovative and groundbreaking marketing campaign.
External consultants helped develop new manufacturing processes to reduce production costs, causing us to beat earnings expectations. We didn't even have to unleash our creative and talented internal teams.
Finally, strong macroeconomic conditions caused an increase in cash flows from operations. Apparently we will have to wait for a down market to see the true effect of our innovative new collection practices.
Yeah I wouldn't invest in a company whose CEO talked like that either.
So a bit of a mea culpa. Yesterday I wrote about Union Square Ventures' investment in CryptoKitties, and expressed a certain amused skepticism. And Union Square partner (and excellent tech/venture-capital blogger) Fred Wilson tweeted at me to acknowledge my skepticism but suggest that I read this post by his colleague Nick Grossman. That post confronts the skepticism that many people have about CryptoKitties, but explains that it is actually a profound technological development:
Because each kitty is a token on Ethereum, that means that anyone else (aside from the original developers of Cryptokitties) can view that asset and integrate it into other systems, without anyone’s permission.
For example, on Kittyhats — developed independently from CryptoKitties — you can buy a hat for your kitty.
Look: They are right, and I was wrong, and I am sorry. I thought that CryptoKitties was just a game that allows you to buy cartoon cats on the blockchain, and I thought it was silly. But I completely missed the point. CryptoKitties is actually a game that allows you to buy cartoon cats on the blockchain, and put little hats on them.
I'm sorry, I'm sorry, I have tried, but I am only human and there is absolutely no way to write about this that is not sarcastic. But Grossman's post is smart and worth reading! The interesting, ambitious vision of token/blockchain technology involves thinking of new ways to build decentralized tools on the internet, and CryptoKitties and their hats might actually give some useful pointers in that direction. Grossman:
The (original) internet brought us a world where any site could link to any other site, and they could all be accessed from anywhere in the world. This was the first interoperability revolution. The next one will be with data and digital assets. For a long time, data has been the property of platforms — with cryptonetworks and cryptoassets, data can live outside of any one platform, under the control of users. This has the potential to open up a lot of innovation.
It does. You could put little socks on the kitties. The future is amazing.
Combination record store and hedge fund.
Here is an extremely pleasing story from the Village Green of Maplewood & South Orange with the extremely pleasing headline "Outsider Records & Hedge Fund Opens in Maplewood’s Elmwood Arts District." It is what the headline says:
Buying vintage records is pretty trendy right now. Many of these shops share space with barber or coffee shops. What you probably haven’t seen is a place to buy your vinyl and watch a hedge fund in action. But that’s what you’ll find at Outsider Records & Hedge Fund, which opened at the beginning of March.
It may sound like an odd pairing, but to owner Michael Wynne, it makes a lot of sense: “Hot sauce and cauliflower, chocolate and peanut butter, lots of unusual tastes go together.”
"The records and the hedge fund are completely separate businesses," "the hedge fund may take some time to come to fruition," and "the record store income allows him funds for operational expenses while his recently established hedge fund develops." It is not unusual for someone to make a lot of money running a hedge fund and then pour that money into an expensive passion like record collecting; it is somewhat less common for someone to make money by collecting records and pour that money into an expensive passion for hedge-fund management.
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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.
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