Stress Tests and Meal Deliveries

(Bloomberg View) -- Happy stress tests!

Yesterday the Federal Reserve released the results of its Comprehensive Capital Analysis and Review stress tests, and every bank passed, for the first time since the tests were introduced after the financial crisis. So that is a nice milestone. But the real milestone is this:

Generally, banks are expected to distribute close to 100 percent of their earnings over the next four quarters, substantially more than a year earlier, according to a senior Fed official. On average, analysts had estimated that the 34 firms in this year’s tests would pay out about 86 percent, according to figures gathered by Bloomberg.

The basic function of most mature modern public companies is to generate income and give it to shareholders in the form of dividends and stock buybacks. If you are generating income that you are not giving to shareholders, you need a pretty good excuse. Some companies have excuses like "we are investing it in our business in order to grow our profits in the future," but that has not been particularly a theme among big banks in the post-crisis era. Instead, they have consistently retained earnings to build capital: In 2008, it turned out that they had too little money to get through a financial crisis, so every year since then they have set aside a portion of the money they've earned to build up their buffers against a future crisis. (Mostly because regulators told them to, in the form of the stress tests.) 

And, yesterday, they finished the job: They now have enough money, by their reckoning and the Fed's, to survive a future financial crisis, so now they can give all the money they earn in the future back to shareholders. They are normal companies again. It's a big deal:

“This is the big payoff after seven years of pushing the industry to get to a place where capital planning is well ingrained,” said David Wright, a managing director at Deloitte’s advisory business who once worked at the Fed. “They reached the summit.”

They have spent arduous years climbing Mount Capital, and now they can stand at the summit, high-five each other, and look down at the green vistas of the Valley of Stock Buybacks. 

The metaphor works more broadly. Banks a decade ago were too little capitalized, regulated, careful; they had too much risk, they paid traders too much. Then the bad thing happened, the dials were turned the other way, and banks got more capitalized, regulated, careful; less risky, lower-paid. And at some point, on all of those measures, we will reach or have reached an inflection point: We will reach the summit and start to roll downhill, back towards less regulation and more risk. "This year’s results come during a broad effort in Washington to roll back financial regulation."

But they are not exactly part of that effort. The story here is not that regulators relaxed the stress tests so that more banks could pass. (The stress tests were in some ways harder this year than in previous years, in that banks were tested on their stressed supplementary leverage ratio for the first time, though on the other hand some of the qualitative tests were relaxed.) The story is that, in the post-crisis period, while regulation was still sloping upwards, regulators imposed a series of capital requirements -- risk-weighted capital, leverage, stress-test capital, etc. -- to force banks to build up their capital buffers. And now the banks have, as a group, finished that job. Obviously some people think that banks are still undercapitalized, and want even stricter capital requirements that will force banks to build more buffers. But I suspect that the political influence of those people is also on the downward slope. 

Blue Apron.

I obviously don't know how much you should pay for a share of Blue Apron Holdings Inc., and I guess neither does anyone else? It launched its initial public offering with a price range of $15-$17 per share, valuing the company at about $3 billion, but then cut the range to $10-$11 and ended up pricing yesterday at $10, the low end of the revised range. That's a $1.9 billion valuation, below the $2 billion valuation it got in its last private round in 2015. Given that volatility, it is not hard to imagine further big moves when Blue Apron opens for trading today, though it is hard to imagine those moves being good for anyone: If Blue Apron trades below its IPO price despite cutting that price drastically, then that will be a bad sign about the market's current receptivity to startups; if it closes today at, like, $17, then Blue Apron will for once be a startup with good cause to complain about "leaving money on the table" in its IPO.

Here is something that Blue Apron didn't cut: its three-class share structure. Blue Apron's executives and venture investors own Class B stock, which gets 10 votes per share and gives them control of the company. It sold Class A stock, with one vote per share, to the public in the IPO. It is keeping around Class C stock, with zero votes, to use as acquisition currency and avoid diluting its insiders in the future. Dual-class stock, triple-class stock, nonvoting stock, entrenched insider voting power: All of these are things that investors profess to hate. But in hot IPOs like the one for Snap Inc., which sold nonvoting stock to the public, priced above its offering range, and then jumped on the first day of trading, investors seemed perfectly willing to ignore the governance issues and pay up for startups.

And then in ice-cold IPOs like Blue Apron's ... what? Blue Apron cut its valuation by a billion dollars -- and cut the amount of money it was raising by $100 million -- when it repriced this IPO from $15-$17 down to $10. What do you think the discussions were around the voting rights? Did any investor say "I'll pay $10, or $12 if you scrap the triple-class structure"? Did any banker say to the company "this deal is not going well, and we'll need to reprice, but you might get a better price without the triple-class structure"? Or is there just no tradeoff at all between governance and economics: Hot deals get done with bad governance, and cold deals get done with bad governance, but no one can just move a slider to increase valuations by improving governance?

Also I am continually fascinated by the fact that Blue Apron is a bellwether for other tech startups. My Bloomberg Gadfly colleague Shira Ovide writes:

Maybe this isn't just about Blue Apron but a signal that broader doubts have crept in about the wisdom of fairly full valuations for untested companies. I assume Spotify is watching. It's another fast-growing company with many red flags that is hoping to go public at a rich valuation.

Spotify AB is a tech startup in the sense that it uses computers to stream digital music files over the internet. Blue Apron is a tech startup in the sense that it uses humans to chop up vegetables, put them in a box, and mail them to your house. Oh, but it advertises on podcasts! What a strange economy we have, where social networks and streaming music platforms and grocery companies are all comps for each other, not because they share a common industry or business model but just because they target a similar demographic.

Elsewhere (in Germany): "Delivery Hero Prices $1.1 Billion IPO at Top End of Range."

How's Martin Shkreli doing?

There are a lot of reasons to dislike Martin Shkreli. The drug-price gouging, for one thing. He is awful on Twitter. "He disrespected the Wu-Tang Clan, so," said one prospective juror in his fraud trial. Weirdly, the directors of Retrophin Inc., the pharmaceutical company that Shkreli formed in 2011, may have disliked him because they had questions about his sexuality -- or at least that's what Shkreli's lawyer Benjamin Brafman suggested in his opening statement yesterday:

“Whether Martin is gay or straight or bisexual is irrelevant; it’s 2017,” Mr. Brafman said. “Get a life, board of Retrophin. The Retrophin board? A bunch of thugs.”

"Get a life, board of ____," is an amazing insult, and if you are an activist investor I hope that your next hostile letter to a board includes that phrase. But there is also, Brafman noted, another problem that you might have with Shkreli:

“Martin is Martin,” he said. “He sometimes said some things to an investor on a certain date, but not everything he said was 100 percent accurate, but he was truthful to the mission” of making Retrophin a success.

I do not give legal advice around here, and of course Benjamin Brafman is a highly skilled trial lawyer and I am not. But I will say, just as a concerned bystander, that if you ever find yourself in a federal criminal court, and your lawyer in his opening statement says "he sometimes said things to an investor on a certain date, but not everything he said was 100 percent accurate," then something has gone wrong in your life. Who among us, really, is 100 percent accurate? And yet that fallibility is not what you want to lead with, to the jurors in your fraud trial. Prisons are full of people who were truthful to the mission, and who spent, say, 97 or 98 percent of their time not forging documents, and yet.

Anyway! I said the other day that Shkreli's pattern of making everyone hate him might have been part of a brilliant strategy: If everyone hates him, then no one can serve on his jury, so he can't actually be tried for securities fraud. And you know what? It almost worked!

Shkreli’s lawyer had moved for a mistrial Tuesday morning, claiming coverage by The Post and other outlets that documented potential jurors on Monday deriding his client as a “snake” and “evil” meant his client couldn’t possibly enjoy a fair trial.

I mean, it didn't -- the judge denied the mistrial, and eventually they found enough jurors -- but still I am not sure it is significantly less promising than the "he was truthful to the mission" defense.

Wrap your hedge fund in insurance.

Sure, why not, it's insurance dedicated funds:

How it works: The client buys a private-placement life-insurance policy. The insurance company invests in alternative assets such as hedge funds. Profits, if any, would ordinarily be taxed as capital gains, but because it involves an insurance company, which must abide by certain restrictions, the money can grow tax-free. Beneficiaries get their money when the insured person dies. For products structured correctly, there aren’t any levies on death benefits.

Also, if you don't want to wait until you die to enjoy your profits, you can borrow from the policy without paying taxes. A useful way to think about the U.S. tax system is that it is designed for the entertainment of tax lawyers, and that to keep them entertained you need to offer them both challenging intellectual puzzles and also tangible rewards -- tax-free investment growth! -- for solving the puzzles correctly. I say that this is a useful way to think about the tax system because (1) it seems to produce accurate predictions about how the system works and (2) it is a nice way to think about the tax system. When you think about a fun game that makes tax nerds happy, you will be happy: Who could begrudge tax nerds their harmless fun? Who could deny that cleverness, creativity, and devotion to solving intellectual puzzles should be rewarded? When you think about the fact that rich people don't have to pay taxes on their investment income, you might be more annoyed.

Blockchain blockchain blockchain.

Here is a very ... busy ... Goldman Sachs Group Inc. presentation about "Blockchain -- The New Technology of Trust":

Blockchain has the potential to change the way we buy and sell, interact with government and verify the authenticity of everything from property titles to organic vegetables.

I like the idea that Goldman Sachs is working on verifying your organic vegetables. "No, see, it's a trustless system," the nice man from Goldman will explain to shoppers at the food co-op. (Disclosure, I used to work there. Goldman, I mean, not the food co-op.)

Elsewhere, here is a blockchain Schuldschein. ("Daimler AG and Landesbank Baden-Württemberg (LBBW) for the first time have jointly used blockchain technology to execute a financial transaction," a one-year, 100 million euro bank loan.)

And here is a story about how "Crypto Platforms Scramble to Manage Surging Interest" by hiring more customer-support people to process refunds for people whose accounts were hacked, etc. Because if your business is built around trustless decentralized blockchains running immutable code, you are going to have to manually process a lot of refund requests!

People are worried about unicorns.

Here is a story about a fight between the New York Police Department and Palantir Technologies, the Spy Unicorn, which apparently helped the NYPD arrest rapper Bobby Shmurda but which is now allegedly not playing nice with the NYPD's efforts to transition to a different analytics system. And here is Aswath Damodaran with a subscriber-economics-based valuation of Uber Technologies Inc., which he thinks is worth about $37 billion, very close to his previous $36 billion discounted-cash-flow-based valuation, and probably not that far from where the market is pricing Uber these days?

People are worried about bond market liquidity.

Last month the New York Fed's Liberty Street Economics blog published a post finding "that post-crisis regulation has had an adverse impact on bond-level liquidity," which was a little unusual for them; most regulatory studies -- including others from the New York Fed -- have downplayed any declines in bond liquidity and the role of regulation in causing them. But Liberty Street is back to normal now:

We find that dealer balance sheets have continued to stagnate and that various measures point to less abundant funding liquidity. Nonetheless, we do not find clear evidence of a widespread deterioration in market liquidity.

Still, their mood on liquidity is a bit more cautious than it used to be; they cite evidence that "less abundant funding liquidity" from reduced dealer balance sheets has harmed some measures of bond market liquidity. Also they can't be sure that they're seeing the market correctly:

For example, our Treasury market metrics are from the interdealer market, and hence do not gauge liquidity in the dealer-to-customer market. Moreover, our corporate metrics are based on transactions data, and cannot account for the time required to trade or the liquidity of bonds that do not trade. 

Elsewhere, here is Bloomberg Gadfly's Lisa Abramowicz with "Debt-Trading Death by a Thousand Boring Days," which is both people worried about bond market liquidity and people worried that people aren't worried enough.

Work Stuff.

"Say goodbye to your last shred of dignity in the modern, open office," it says here, and can you even guess what it is? There are so many options, which I guess means that we actually have several shreds of dignity left. But this is a pretty comprehensive shredding: a desk "outfitted with sensors that learn your habits and preferences through constant vigilance," and that then tells your boss how productive you are and determines "whether you need a desk at all—a real question at $10,000 per desk per year—or if you can be consigned to the hot-desking pool, where employees are allotted workspace depending on their demands that week, that day, or that hour." There is a story here about the dangers of specialization: If you are just a person doing a job, it would never occur to you to buy a $10,000 desk that nags you to stand up, or on the other hand to get rid of your desk entirely. But once a company is big enough to have a desk procurement department, then gosh darn it the desk procurers are going to procure the most complicated desks they can find.

Things happen.

Walgreens, Rite Aid End $9.4 Billion Merger; Walgreens to Buy Half of Rite Aid Stores. Staples to Sell for $6.9 Billion, and Its New Owner Has an Uphill Battle. Investors Say Beijing Enabled Unfair Trading by Chinese Banks. Traders seek source of Hong Kong’s ‘Enigma’ market crash. JPMorgan will save money by turning lights out. The Tiny Satellites Ushering in the New Space Revolution. Elon Musk tracker. How Silicon Valley Pushed Coding Into American Classrooms. BOFI Federal Savings Bank tried to hire short seller Marc Cohodes as a consultant to ward off short sellers. SEC Charges Oil and Gas Company and Top Finance Executives with Accounting Fraud. Clinton Portis thought about murdering the investment managers who lost his money. "After the talk, heading home, I’ll check Twitter, where some Dutch guy will have written, 'He was not the worst.'" Czech power plant apologizes for using bikini photos to choose interns. French air force chief accused of using fighter jet for weekend jaunts.

If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Thanks! 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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 author of this story: Matt Levine at mlevine51@bloomberg.net.

To contact the editor responsible for this story: James Greiff at jgreiff@bloomberg.net.

For more columns from Bloomberg View, visit http://www.bloomberg.com/view.