(Bloomberg View) -- Banks as utilities.
Banks are boring now. This is of course by regulatory design: The post-crisis mantra for many regulators and politicians and commentators has been to make banking boring. Often the way people express this is by saying things like "banks should be like utilities." Usually this is kind of a vague metaphor; the notion is that utilities are important, boring, heavily regulated, and no one gets all that rich running them, so the regulation must be doing something right.
But here is a new paper, "Money as Infrastructure," by law professor Morgan Ricks, that takes the utility metaphor much more seriously. Ricks's idea is that the central function of banking is money creation (not lending, but issuing deposit accounts), and he argues that money is the kind of quasi-public infrastructure that utilities should provide:
Rather than seeing bank money creation as a legitimate private activity that is then regulated, [this monetary view] sees money creation as an intrinsically public activity that is then outsourced. The institutional baseline, then, is direct public provisioning. Insofar as banks are engaged in money creation, they do so pursuant to what amounts to a franchise arrangement. Notably, if the government chose not to outsource money creation—if, say, everyone held his or her transaction account directly with the central bank—then the notion that the interest paid on such accounts should be determined by “market forces” would be nonsensical. Surely the monetary authority would determine this interest rate as a matter of monetary policy, based on macroeconomic conditions. By similar logic, under direct government provisioning the government might conclude that broad or even universal access to transaction accounts would serve the public interest, even if this meant serving some users below cost. Many government services work this way. Crucially, the decision to outsource has no necessary bearing on these decisions. This is government procurement and the government must supply the specifications.
In his view, banking -- money creation -- is essentially a public service, and the government should consider regulating its price, who gets access to it, and who gets to do it. "Bank regulation instead becomes a subfield of public utility and common carrier regulation," he argues, and the government should be involved in rate-setting and in mandating universal access.
Research.
Here is a story about how sell-side research analysts are sad that Europe's MiFID II regulations may cost a lot of them their jobs. I mean, fair enough; I'd be sad too if I were being regulated out of existence. And MiFID's method of driving analysts to extinction is particularly gruesome: By requiring banks to charge clients directly for research, regulators will force banks and clients and analysts to figure out exactly what the analysts are worth, and then (presumably) get rid of the ones who aren't pulling their weight. I mean when you put it like that I guess it is just capitalism, but I always think of investment banks as being warm and friendly refuges that protect their employees from the ravages of capitalism. I know it sounds like I am joking but of course I am not.
In any case, bringing efficient measurement and evaluation to sell-side analysts is making the analysts sad, but at least they get to be self-aware and meta about their predicament:
On earnings calls in October, analysts asked bank chief executives how the research model would change, effectively checking in on their own jobs.
Evercore ISI analyst Glenn Schorr recently titled a research note “Writing My Obituary,” with a follow-up called “Stay of (my) Execution.”
Really he should title them "Please Pay a Lot for This Research Note."
FX fines.
Apparently the banks that have paid over $10 billion in fines for rigging and manipulating the foreign exchange market will be paying a few more billion dollars for manipulating the foreign exchange market. "UBS, Royal Bank of Scotland, JPMorgan Chase, Citigroup, Barclays, HSBC and two other banks are gearing up to negotiate settlements likely to cost billions of euros combined," to the European Commission, for antitrust violations. It's all the same violations -- teaming up in a cartel, called with depressing literalness "the Cartel," to manipulate fixing prices for FX trades -- but they just have to be fined over and over again by different regulators.
A good cyclical indicator that it would be useful to track is the ratio of penalty to reward for financial misconduct. Banks were fined untold billions of dollars for mis-selling mortgages in the lead-up to the financial crisis, but a lot of people believed, with some justification, that those fines were "just a cost of doing business," and were small relative to the size of the dishonest-mortgage-selling business. (Certainly they were small compared to the harm done by the financial crisis.)
But after the crisis, that calculation changed. The fines for the Libor scandal seem to have been much bigger than the gains that banks made by manipulating Libor. And these FX fines don't just dwarf the amount of money the banks could have made by manipulating fixing prices; they are closing in on the total amount of FX trading revenue the banks made during the years where that conduct went on. When we talked about the last big round of FX fines, in 2015, I pointed out that JPMorgan Chase & Co. "would have been better off not having an FX business for those years." Or then there is Wells Fargo & Co.'s fake-account scandal, where as far as I can tell Wells made $2.4 million in revenue and paid $185 million in fines.
I suspect that the going rate for a really juicy banking scandal is that your fine is on the order of 100 times your revenue from the scandal. I also suspect that we are near the high-water mark for that ratio: The regulatory cycle has turned, and the ratio of fines to revenue will decline along with the enthusiasm of enforcement.
Cross-border arbitrage.
Here is the story of a hedge fund manager who did a lot of fraud and then developed a clever trade to get himself out of prison: He agreed with U.S. prosecutors to take a plea deal with a 20-year sentence, but with a provision allowing him to be transferred to Canada to serve out the sentence. The prosecutors got a savage sentence to make themselves look tough; he got out of prison in about seven years. (Canada didn't make him serve out the whole sentence.) I suppose it will be difficult for financial engineers to commercialize this trade, but I'd like to see someone try. Like why wouldn't Vanuatu sell citizenship to indicted financial criminals so that it can spring them from prison after they plead guilty?
Elsewhere, here is the story of a Russian banker named Alexei Kulikov, who seems to have been at or near the center of the Deutsche Bank AG "mirror trade" scandal, and who was sentenced to nine years in prison in Russia. After Deutsche Bank got suspicious about some of these trades, in which Russian money was laundered out of the country by buying stocks in Moscow and simultaneously selling them in London, Kulikov demanded a meeting with a Deutsche Bank compliance officer in a café, where this allegedly happened:
According to Deutsche Bank’s internal report, Kulikov told the compliance official it was vital that the German bank resume trading with Rye Man, insisting the transactions were legitimate. Then, according to the account the compliance official later gave the police, Kulikov said he had an “unofficial proposal” for the compliance officer and discreetly slid his cellphone across the table. The screen showed “0.1-0.2% of monthly volume,” the official told police. He said he refused what he understood to be a bribe, which he later reported to Deutsche Bank. Asked about this during a break in his trial, Kulikov confirmed the meetings but denied offering a bribe.
Does sliding a piece of paper (or, fine, cellphone) across the table with a bribe written on it usually work on compliance officers?
Taxes.
How should I feel about the proposal, in the new Senate tax bill, to tax sales of stock on a first-in first-out basis? The idea is that if you buy some XYZ shares for $20, and then you buy some more XYZ shares for $30, and then you sell one share for $35, for tax purposes you'd have to conclude that you sold a $20 share for $35 and had $15 in gain. (Under current law you get to choose which shares you sell, so you could sell a $30 share and have only $5 in gain.) This would increase the effective capital-gains tax rate by reducing the ability to defer, which strikes me as a better way to raise taxes than many alternatives, but I am sure someone will explain that it is unfair or has unintended consequences or that capital gains should never be taxed or whatever.
But one problem with this idea is that it affects mutual funds in weird ways. Mutual funds -- even index funds -- have to buy and sell stock to account for flows, and if they sell stocks they can have capital gains. Those capital gains will be greatly -- and arguably "inaccurately" or "unfairly" -- increased if they have to sell their oldest stocks first. (If an ancient mutual fund gets inflows and buys a $30 share of XYZ, and then the next day gets outflows and sells that share for $30.01, it might have $29.01 in gains because it first bought XYZ decades ago when it was at $1.) And then those gains are charged to the mutual fund's investors, who have no realized capital gains (they haven't sold any shares), and who might not even have any unrealized gains, so it seems a little unfair to ask them to come up with cash to pay the taxes.
So "senators exempted fund firms after some of the largest ones, including Vanguard Group and Eaton Vance Corp., protested by saying the proposed change would tie their portfolio managers’ hands, make markets less efficient, and raise taxes on investors." (The change "would still apply to individual investors.") Again: Seems fine to me! It raises capital gains taxes on investors who sell stock and have capital gains, which was the goal, but it doesn't impose new taxes on mutual fund investors who don't sell shares and don't have capital gains, which seems like a perfectly sensible exception.
But I also sort of like the symbolic implications of treating mutual funds better than individual investors. It sounds mean! “This would be another blow to individual investors, who are already suffering from the delay in the fiduciary-standard rules,” says a Betterment executive. There is endless political and regulatory lip service paid to the ideal of the individual investor, to making sure that she can compete on a level playing field with professional investors. I always find it pretty silly: Of course a dentist who invests in her spare time should not expect to have the same success as a giant mutual-fund firm, any more than a mutual-fund manager who fills cavities in her spare time should expect to do it as well as a licensed dentist. (And of course normal people actually invest -- I invest, anyway -- through funds, not individual stocks; favoring individual investors actually means favoring rich hobbyists over the middle class.) So I enjoy the rare exceptions where Congress gives an advantage to institutional investors that it doesn't give to individuals.
Blockchain blockchain blockchain.
"Skedaddle, an 'Uber-for-buses' startup, is launching a blockchain project that aims to completely eliminate tipping," is the first sentence here, and then somehow "Users can rate any interaction with a service worker, which also functions as a tip, and follows a worker from job to job," is the second, and by that point your soul has probably already left your body. But it keeps going!
The "Kudos Project" will run on the Ethereum blockchain, allowing customers to rate any transaction they make, Skedaddle co-founder and CEO Adam Nestler told Business Insider.
Oh!
Those ratings, for anyone from your Uber driver to restaurant server to grocery supermarket cashier, are then instantly published to a decentralized database that allows anyone using the system to see the ratings that then follow an employee from one job to another throughout the full gig economy.
I see!
"We think this will be the first cryptocurrency for real world use," Nestler said in an interview. "This is a massive opportunity to completely take down Yelp and Facebook reviews, while completely eliminating tipping."
Ah!
Look: no. Skedaddle is not going to eliminate Yelp or Facebook or tipping. It's not going to be "the first cryptocurrency for real world use." But at some level they're not wrong! One day 20 years from now we'll wake up and all of our interactions and performance will be tracked on the blockchain and will directly determine our income and socioeconomic status, and on the one hand we'll get pretty good customer service, but on the other hand we'll be terrified all the time. It is the logical endpoint of the "gig economy."
The thing is that this omniscient blockchain of terror will be run by Facebook, not Skedaddle. If you just come out and say that your mission is to build a dystopia of economic precarity and constant surveillance, then you do not have the soft skills to actually carry out that mission. (Never mind if you say that your mission is "to completely take down Yelp and Facebook reviews, while completely eliminating tipping.") If you say that your mission is "to make the world more open and connected," then you have the ruthlessness, and the facility with euphemism, to actually do it.
Elsewhere in dystopian blockchain fiction, here is a story about doomsday preppers who are hoarding bitcoins against the apocalypse. Doomsday prepping and bitcoin enthusiasm go well together psychologically: Both involve distrust of modern social systems, and both tap into deep libertarian and self-sufficiency themes. But they don't go at all well together logically: If modern society is wiped out in some massive catastrophe, it seems unlikely that the electric grid and global internet infrastructure will survive to run an energy-hungry blockchain for a currency with no physical form that even now basically can't be used to buy anything. But the bitcoin/apocalypse enthusiasts are undeterred:
“It may be difficult, if not impossible to access for a while, but once things start returning to some level of normality, then the blockchain will return as it was before the disaster,” said Rob Harvey, a bitcoin investor who prepares for natural and nuclear catastrophes by learning and teaching survival skills, like making a fire. “The blockchain does not need a specific place or a specific person to survive—that’s a strong survival tactic.”
I feel like you will need somewhat more advanced technology than fire to run the post-apocalyptic blockchain, but sure.
People are worried about unicorns.
Private markets are the new public markets, I keep saying, and I keep being right:
Wealthy investment firms are snapping up stock in some of the most highly valued startups by buying positions from early shareholders. The deals, known as secondary sales, are allowing employees and investors to cash out of some stock while the companies avoid the public markets, bringing an injection of funds to many in Silicon Valley despite a dearth of tech IPOs.
"To get meaningful stakes at lofty valuations, investors often want to inject more capital than the startup needs," so they buy from existing investors.
Why go public? It's a pain, you have to pay lawyers and bankers, you have to get your financial statements audited and disclose them to gossips and competitors, you have to deal with activist investors and high-frequency traders, there is nothing appealing about it. But in the old days companies went public because they needed money, and public markets were where the money was. Now that reasoning seems quaint: Buzzy private companies can get plenty of money from venture capitalists (or, for that matter, from mutual funds or individual investors), and if they do an initial public offering it will often be with no particular use for the money they raise.
Now, instead, the normal explanation is that companies go public to cash out their earlier investors: Those investors have limited time horizons and want to see a return on their investment. But that story is also on the way to becoming quaint: Buzzy private companies can get plenty of money -- "more capital than the startup needs!" -- not only for themselves, but also for their earlier investors, still without ever going public. "Ah, but won't those later-stage private investors need to cash out eventually in an IPO," you ask, and I suppose you have a point, but at some point this ecosystem can be self-sustaining. It's not like public-company investors need some further event to cash out; they are perfectly content trading among themselves for eternity. Private markets seem to be well on the way to that place.
Me Friday.
On Friday I wrote about Hovnanian Enterprises Inc., a homebuilder that may refinance its debt with the help of (1) Blackstone Group LP's GSO Capital Partners credit fund and (2) some credit-default-swap magic. The potential magic has blown out Hovnanian's CDS: 6-month CDS was trading at about 4,750 basis points on Friday, according to Bloomberg, up from about 1,500 a month ago. Of course part of this may be because GSO was buying the CDS, but most of it seems to be because of market rumors that they have proposed to trigger the CDS and engineer a large payout on it.
Now, if they can't convince Hovnanian to trigger the CDS in a way that generates a large payout, and if Hovnanian muddles through for a few months, that short-dated CDS will expire worthless and GSO will have a loss on its position. Unless ... one reader emailed me to ask, "how much brinksmanship would GSO need to perform to liquidate their CDS book above where they bought it?" If you buy CDS at 1,500, and then push it up to 4,750 based on rumors that you are going to perform evil magic with it, why not sell some at a profit even before performing the magic? "That would be the most artful, postmodern outcome," writes my correspondent, "that GSO could generate PnL on pure self-parody."
Things happen.
How China’s Acquisitive HNA Group Fell From Favor. GE Housecleaning Will Alter Board’s Makeup. Should the Upper Middle Class Take the Biggest Tax Hit? Mitu Gulati and Mark Weidemaier on Venezuela's default. "Pawel Morski" grades Venezuela. Why Didn't Puerto Rico Use its "Local Law" Advantage to Reduce its Debt? Can Barclays Afford to Compete Against U.S. Investment Banks? Some Fund Ads Misrepresent Morningstar Ratings. Subways May Be the Latest Casualty of China's Crackdown on Debt. Ex-Treasury Secretary Jacob Lew Joins Private-Equity Firm. Man gets his dying wish: To be buried with 2 cheesesteaks. Sausage Roll Jesus Creates Heartburn for U.K. Bakery Firm. Haggis Hurling.
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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 author of this story: Matt Levine at mlevine51@bloomberg.net.
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