Lehman Day and Identity Theft
(Bloomberg View) -- Happy Lehman Day!
When do you think we'll stop commemorating the anniversary of the Lehman Brothers bankruptcy? It is really amazing the extent to which the financial industry is still stuck in the shadow of 2008. Or maybe it isn't; maybe we have moved on too quickly and failed to learn the lessons of 2008, and the only cure is to wallow in Lehman's failure on each anniversary for the rest of time. My own memories of Lehman Day are embarrassingly fond: I was working as an investment banker and had just left for a week's vacation when Lehman filed, and when I got back I had more or less another six months off because markets were utterly dead. Still it was surreal to walk around that day, far from New York, and see people acting like everything was normal.
Anyway Elizabeth Warren is celebrating Lehman Day the way she spends many days, by calling for more bankers to be put in prison:
Massachusetts Sen. Elizabeth Warren is marking the eighth anniversary of Lehman Brothers’ bankruptcy with a new push to investigate — and potentially jail — more than two dozen individuals and corporations who were referred to the Justice Department for possible criminal prosecution in 2011 by the Financial Crisis Inquiry Commission, a government-appointed group that investigated the roots of the 2008 financial crisis. None was ever prosecuted.
Meanwhile in the U.K., "the total amount paid in bonuses in the 2015-16 financial year hit a fresh record – in cash terms – of £44.3bn," breaking the previous record set in, of course, 2008.
Speaking of putting bankers in prison: "Federal prosecutors are in the early stages of an investigation into sales practices at Wells Fargo & Co. that led to the bank being hit last week with a $185 million fine, according to people familiar with the matter." (And: "Wells Fargo has received subpoenas from three different United States attorneys’ offices in the last week." It's a competitive sport!) I am not exactly an expert in federal identity-theft law, but it does seem like opening a credit card in someone's name without their permission might be, you know, somehow not allowed. Presumably prosecutors would have a case against some of the 5,300 Wells Fargo employees who were fired for doing that. Though I bet they want to hold the bank, or some of its senior executives, responsible for those employees' identity theft, which I suspect will be harder.
What seems pretty easy is that, if it wanted to invoke clawback provisions, "Wells Fargo & Co. could recoup about $17 million in unvested shares from retiring executive Carrie Tolstedt, a fraction of the compensation the former head of community banking has received over her 27-year career." I have to say, the temperature of public opinion about Wells Fargo seems to be running pretty hot, and if I were on the board I'd be looking for a few prominent heads to chop off. Clawing back some of Tolstedt's compensation might look pretty appealing.
Meanwhile shareholders are upset, and are planning to do things like "resubmit a proposal for an independent chairman to the bank’s annual meeting next spring," or "submitting resolutions for the bank's springtime shareholder meeting that may call for things like clawing back executive pay or requiring the company to report on its governance procedures," which is pretty mild stuff, under the circumstances.
Who among us.
I enjoyed this article and U.K. Financial Conduct Authority Decision Notice about Andrew Tinney, formerly the Chief Operating Officer of Barclays Wealth and Investment Management, who got a nasty report about his business and made the extremely understandable decision to lock it in his desk drawer and never speak of it again:
The FCA said Mr. Tinney hired a consultancy to look at how “tone at the top” influenced Barclays Wealth America. Upon receiving the highly critical report Mr. Tinney ensured that no-one else could read it, didn’t put it on a computer and told the consultancy that it didn’t need to circulate a copy.
I kid, a little; "he discussed the report’s findings with his boss and made plans to address some of the failings outlined in a workshop," but then got in trouble when an anonymous tipster told senior management about the report and Tinney was perhaps not fully forthcoming about its existence or contents. Anyway the FCA is trying to ban him from senior management roles in the financial industry; Tinney is fighting back.
If the FCA's allegations are true, Tinney is not exactly a model of moral courage. On the other hand, if you got a scathing negative review of your performance, would you rush to post it on Facebook? You can kind of see where he's coming from, no? So much of the throw-bankers-in-prison thing assumes that there is an attribute called "Wall Street greed" that is totally alien to most people, that comes from a place of incomprehensible psychopathy. But it seems to me that most of the time when bankers mess up it's for much more normal and understandable and banal reasons. Sometimes they're just embarrassed.
I mean, yes, sure, why not:
BBY chairman and major shareholder Glenn Rosewall used a psychic to provide budget forecasts for the stockbroker and its advisers that he would check against figures from his own finance department, a court has heard.
The former finance and strategy manager of the firm told the court that "psychic and professed vibrational healer Nevine Rottinger" got a last look at the Australian brokerage firm's budget estimates before they were approved:
She described a process in which each broker would be interviewed and forecast for their revenue provided and those figures would then be taken to Ms Rottinger and “Nevine would put the number in there’’ before the firm decided what was reasonable.
This court hearing is a liquidation proceeding, so I guess BBY's psychic forecasts didn't work out particularly well, but still it is not obvious to me that a broker's unfiltered forecast of his own future revenue would be more accurate than a vibrational healer's revision of that forecast. Maybe she got a vibe from some of the brokers that they were being overconfident, or sandbagging, and adjusted their estimates accordingly. Forecasting the future is a necessarily inexact science, or craft, or branch of the dark arts, and there is no reason to think that the average broker is a specialist in it. But a psychic is, exactly, a specialist in forecasting the future. For whatever that's worth.
Speaking of which, valuation expert Aswath Damodaran followed up on his post about why fairness opinions are bad, which we talked about last week, when I said that the bankers who give fairness opinions are experts in negotiating deals, not in forecasting the future. Damodaran is still offended that fairness opinions are not true or independent valuations, and has suggestions for how courts could hold them to a higher standard:
Many judges have allowed bankers to browbeat them into accepting the unacceptable in valuation, using the argument that what they are doing is standard practice and somehow professional valuation. As someone who wanders across multiple valuation terrain, I am convinced that the valuation practices in fairness opinions are not just beyond the pale, they are unprofessional. To those judges, who would argue that they don't have the training or the tools to detect bad practices, I will make my pro bono contribution in the form of a questionnaire with flags (ranging from red for danger to green for acceptable) that may help them separate the good valuations from the bad ones.
The list is excellent, great advice for any banker thinking about how to do fairness opinions, or financial modeling generally, the right way. But those bankers won't like this:
It should go without saying that a deal making banker cannot be trusted to opine on the fairness of the deal, but the reason that I am saying it is that it does happen. I would go further and argue that deal makers should get entirely out of the fairness opinion business, since the banker who is asked to opine on the fairness of someone else's deal today will have to worry about his or her future deals being opined on by others.
"It does happen" is an understatement there: The normal approach in mergers and acquisitions is for the bankers who do the deal to also give the fairness opinion. (In awkward, conflicted, contested, etc., deals, there's often another bank to give an independent fairness opinion.) But Damodaran thinks "it should go without saying" that that's not okay.
I think M&A bankers and lawyers would square this by saying: Look, the bankers aren't "doing the deal." The bankers are advisers. The company is doing the deal. The managers of the company are the ones responsible for knowing how much it is worth, and deciding whether to sell. The bankers are advising the managers, helping them apply standard valuation methods to the information that they have, giving them their own opinions about price and strategy and fairness. But ultimately the company is the principal. It's the company's money.
This fits awkwardly with, you know, how the bankers get paid (for doing deals, mostly), but I suspect it is why deal-making bankers generally give fairness opinions: because the opinion is a key part of the bank's advice on the deal. It's also, I think, why bankers tend not to take the lead on estimating the future cash flows for the valuation, but instead mostly rely on the company's forecasts: because the managers are the ones who really know the company; the bankers are just providing technical advice. Though of course Damodaran is right that there should be some sanity-checking of those company forecasts. Companies sometimes have weird ways of coming up with their forecasts.
Here is a Planet Money episode about "EBay arbitrage," or "drop shipping," in which people buy an item on Amazon and resell it simultaneously on EBay at a higher price, without taking any risk. We talked about this phenomenon before, and it makes people angry in a way that is not entirely explained by its economic impact. But I was struck by this, from the episode summary:
The Internet was supposed to get rid of the middleman. Consumers can buy directly from manufacturers at wholesale prices. They can book flights themselves on sites like Kayak—no more travel agents, no more unnecessary fees. Or, that was one of the hopes anyway.
Of course, it didn't work out that way. Instead, middlemen are stronger than ever.
Of course I think about the rise of electronic all-to-all trading venues in the financial-services world. There was a time when, if you wanted to buy stock, you had to go to a dealer or specialist and buy it from them, because they were the only centralized source of supply and demand for stocks. But then electronic exchanges proliferated, and now if you want to buy stock, you can just go to the exchange, put in an order, and wait for someone who wants to sell stock to meet up with you and make the trade. Natural buyers and sellers can meet each other in a transparent central location and trade with each other, without ever involving dealers or middleman.
But it turns out that essentially all the trades are with middlemen, high-frequency electronic market makers. Why wouldn't they be? Waiting around for a natural seller just takes too long, and the high-frequency traders are just there all the time. An economist tells Planet Money that "the economic logic of selling reductions in transactions costs" -- that is, intermediating trade -- "is irresistible and inevitable," which is I guess the nice way of putting it.
This is worth keeping in mind when people talk about all-to-all electronic platforms for bond trading. The idea there is something like: Bond dealers have cut back on their dealing, so fundamental investors can't trade as easily with them as they used to. So those investors should all get together on a big central platform and cut out the middlemen, trading with each other directly. But big central platforms seem to attract their own breed of intermediaries, and even to need those intermediaries to function. Someone probably has to be dealing bonds, even in a world with electronic platforms.
Here are a fun paper and blog post about informed trading before government natural-gas inventory announcements. The authors find that "natural gas futures prices begin to drift in the 'correct' direction about 90 minutes prior to the announcement," and try to figure out why. Here's a possible answer:
Bloomberg assigns ranks to the three best analysts based on their past forecasting accuracy. We use the median of the ranked analyst forecasts as a proxy for the “informed” forecast. We then compute a simple predictor of the inventory surprise as the difference between the “informed” forecast and the regular Bloomberg consensus forecast.
And this predictor works: It "has explanatory power for the natural gas inventory surprises and for the pre-announcement futures returns." The forecasts, and the forecaster rankings, are public, allowing the authors to conclude "that informed trading due to superior processing of public information is a plausible explanation for the pre-announcement price drift," which "may alleviate concerns of traders and regulators that pre-announcement informed trading is necessarily driven by information leakage."
Sure, but that just pushes the question back a step. How are the good forecasters so good at forecasting?
At some point the business of investing is about finding out information that nobody else knows, and then using that information, either to make investments or to make predictions that inform other people's investments. Some of the places that people get information are Bad, and some are Good, but either way, it shouldn't be that surprising if prices drift in the right direction before everyone knows the information that causes them to drift. You'll never have much of a market if everyone knows all the same information at the same time.
Selling equity in stuff.
We talked a bit yesterday about Point, the startup that allows people to more or less sell equity in their homes to investors. By way of introduction, I said that if you want a thing, there are three ways to pay for it: with your own money, by borrowing, or by selling equity. A reader pointed out that I neglected a fourth possibility: You can steal it. True! (Not legal advice.) That feels somehow like a material omission. I don't know if there are any startups working on that approach.
Anyway, I also mentioned that there is a long and not especially distinguished history of proposals to allow students to sell equity in themselves to finance their education, instead of taking out loans. And I said that I wrote a paper about it in law school, quite a long time ago. And then yesterday I got this e-mail from a student at Harvard Law School:
Since coming to law school last fall, I have co-founded a company, Alfie, with a co-founder who graduated MIT Sloan this past May. Alfie is, at a high-level, quite similar to the companies discussed in your paragraph .... We are working with universities with the aim of delivering an Income Share Agreement platform that they can use to offer their students and alternative to debt, with the aim of locking in affordability for students, while also providing them some downside risk protection.
Here's the website. Hope springs eternal, among law students.
Blockchain blockchain blockchain.
Here's a video about "OpenDime: Real Life Cyberpunk Cred Sticks," which look like an incredibly inconvenient way to exchange bitcoins physically without leaving any record on the blockchain. (You put the bitcoins onto little memory sticks, and then you try to give them to someone to pay for stuff, and then you all put the little memory sticks into USB ports to check how many bitcoins are on them, and then how do you make change?) One way to think about bitcoin/blockchain is that it is perpetually engaged in reinventing all of the aspects of regular modern finance, but slightly worse. This is the bitcoiny reinvention of cash, but much worse.
People are worried about unicorns.
"No unicorn IPO boom, but market will pick up next year, expert says," why not.
People are worried about bond market liquidity.
Oh hey, exchange-traded funds as a cure for bond market illiquidity:
Goldman's new fund, its first fixed-income ETF, trades under the ticker GBIL, with the goal of tracking the Citi U.S. Treasury 0-1 Year Composite Select index. The pitch to investors is that it's a vehicle to bypass the complications of trading short-term Treasuries by trading a stock-like ETF instead.
Elsewhere, the yield curve is steepening.
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