Dec 16, 2018

Axios Capital

By Felix Salmon
Felix Salmon

Situational awareness: Did you receive the beta version of the new Axios Markets newsletter, which will be coming out daily in the new year? Sign up here, and you'll receive the next two weekly issues for, um, free. I'll be contributing.

Thanks for subscribing, please encourage all your friends and colleagues to do likewise. And keep the requests coming, to Item 6 today is the answer to a reader query.

1 big thing: Corporate impunity

Illustration: Lazaro Gamio/Axios

“Corporations are people,” said Mitt Romney in 2011, famously, but if they are, they seem to have an impressive degree of impunity.

The big picture: Just like people, corporations display impressive instincts for self-enrichment and self-preservation, even when they're not-for-profits. They're not holding themselves to account, but — unlike real people — no one else seems to be holding them accountable either.

  • CBS had a "total failure" not only in its C-suite but also at the board level, according to documents obtained by the New York Times. While the sexual harassment by former CEO Les Moonves is on him, the broader culture of denial and multimillion-dollar payoffs and coverups was much more endemic. Yet the result of the board investigation into Moonves is likely to result in CBS keeping — for itself — the $120 million it would otherwise have had to pay him.
  • At Tesla, the CEO and controlling shareholder openly scoffs at his regulator, the SEC, and the settlement he signed with them. There's no sense that he or Tesla feel any sense of real accountability for his actions.
  • Multiple non-profits, including the Boy Scouts and USA Gymnastics as well as more than 20 Catholic dioceses and religious orders, have either filed for bankruptcy or are considering doing so in order to head off lawsuits alleging sexual abuse within their organizations. It's a move that wipes out non-existent equity (non-profits don't have equity) while also making it much harder for victims to receive justice.

Why it matters: The proximate cause for the rise of Trumpism was the financial crisis, where no senior bankers were prosecuted even as millions of Americans saw their livelihoods destroyed. That pattern continues to this day, with corporate entities receiving privileges that the 99% could never dream of.

Our thought bubble: Populism will remain a powerful and righteous force in American politics so long as that continues.

2. The too-good-to-be-true checking account
Illustration: via Robinhood

On Thursday, online brokerage firm Robinhood announced a new checking account paying 3% interest. It seemed too good to be true. It was.

The big picture: Checking accounts are extraordinarily powerful things. They're one of the key mechanisms by which banks create money and help to keep the economy growing. They're also they key mechanism behind bank runs that can cause an economy to crash. That's why depositary institutions are the most regulated companies in the world.

  • Deposits are a very low-cost unsecured loan from depositors to a bank. They're a stable and cheap source of funding, and non-banks tend to be very jealous of banks' deposit bases. As a result, the non-banks (including Robinhood) constantly try to invent products that look like bank deposits but aren't. When those products blow up (see the Reserve Fund breaking the buck in 2008), the consequences can be catastrophic.

How it works: If you want to offer a real checking account, you need to submit to regulation not only by a bank regulator, but also by the FDIC, which provides the all-important deposit insurance. Those regulators insist that you have a minimum level of capital, and they ensure that your business model is sustainable. Getting a bank charter for a mobile-native app is extremely difficult: Only Varo Money is even close, and it has spent years getting to this point.

  • Banks are the riskiest part of the financial system. Lenders can go bust no problem; their borrowers won't mind. Brokerages are basically safety deposit boxes for your securities. But if a bank fails, it takes your money with it.

Robinhood was trying to game the system. It was a brokerage trying to be a bank. It wanted to get the advantages of being a bank, like deposit insurance and maturity transformation, without the concomitant regulatory oversight. It even contracted with a genuine bank, Sutton Bank of Ohio, to provide things like routing numbers and Mastercard-branded debit cards. But Sutton Bank wouldn't get the money. That would stay at Robinhood.

  • Robinhood was less than clear about what it wanted to do with its depositors' money, but it seemingly felt happy investing it in bonds for its own account, just like MF Global. Lack of transparency seems to be an endemic problem at the company, which was last valued at $5.6 billion.

The bottom line: Robinhood took down the site on Friday evening and put up a blog post talking instead about a "cash management program" to be announced at an unspecified point in the future. The "do first, ask forgiveness later" approach, it turns out, doesn't work very well in financial services.

3. The data the CFPB didn't want you to see
Expand chart
Data: Consumer Financial Protection Bureau; Chart: Andrew Witherspoon/Axios

Robinhood was certainly addressing a gap in the market: Very few people actually like their bank, which is quite likely to be the same bank they've had since college. This chart shows why that isn't going to change anytime soon.

  • The chart comes from a CFPB report that was written — but not published — earlier this year. It was finally made public last week after Allied Progress obtained it through a Freedom of Information Act request.

The big picture: The report studies the fees levied by bank accounts held by college students, roughly a third of whom now attend schools where a single bank or credit union pays the college a fee to promote its products.

  • If you attend a college that accepts such a deal, your average annual fee is $36.52, more than three times the average fee for students at colleges that don't accept paid account promotion.
  • At one college with a paid-promotional deal, the average fee exceeded $90 per year.
  • Wells Fargo had the highest average fee, of $46.99 per year.
  • Not all banks that paid colleges to promote their products had high fees. Fifth Third Bank had an average annual fee of $0.

Why it matters: Seth Frotman, the CFPB's former student loan ombudsman, resigned after this report was suppressed. In his resignation letter, he accused Mick Mulvaney, the CFPB's acting head (and Donald Trump's new acting chief of staff), of serving the wishes of America's most powerful institutions. Those banks, he said, were "ripping off students on campuses across the country by saddling them with legally dubious account fees." Now, we can see for ourselves what he was talking about.

Bonus: Mastercard helps saves lives

Illustration: Lazaro Gamio/Axios

Mastercard’s main business is providing payments card technology, but it turns out that the same tech can be used for much higher purposes: Saving lives in some of the poorest countries in the world.

The big picture: Thanks to a partnership between Mastercard and Gavi, the global vaccination alliance, children will be given a "digital birth certificate" that looks a lot like a standard credit card. That card can then be taken into any clinic, which will be able to see exactly which vaccinations the child has received and which shots are still needed.

  • The card is also linked to the parent's phone number, so they receive reminder texts for follow-up appointments.
  • With a central record for which children have received which immunizations, local governments will be able to assess coverage and adjust programs accordingly.

The bottom line: Vaccinating the world's most remote children is a significant undertaking, but it's the most effective way we know to transform communities for the better. Other technologies being tried out by Gavi include deliveries by drone, as well as solar-powered fridges that can be used to preserve shots on trips into isolated areas.

4. Risk off
Expand chart
Data: Hedge Fund Research; Chart: Andrew Witherspoon/Axios

The amount of money fleeing into money-market mutual funds hit $81 billion last week, the largest such flow on record. Meanwhile, the flows out of equity mutual funds, at $46 billion, were almost double any other week on record.

The big picture: What you're seeing is a risk-off flight to boring safe assets — which means that now is the worst time in years to try to open up a new hedge fund. Just 450 new hedge funds were opened in the first three quarters of this year, the lowest number in a decade.

  • The total number of hedge funds and fund of funds is now 9,760, per HFR — down from 10,142 in 2014. The sector isn't imploding, but it has long since stopped growing.

It's also a bad time to be running an existing hedge fund. Jabre Capital Partners this week joined a long list of other high-profile fund managers — John Paulson, Richard Perry, Highfields, Eton Park, Leon Cooperman and many others — who have decided to return money to their investors rather than keep on struggling in a tough market.

Why it matters: Public equities have rarely seemed less attractive as an asset class, even as big private companies like Uber, Lyft and Slack are set to IPO. If you have a good idea for how to make money in this market, good luck trying to find anybody to bet on you.

5. The twilight of the conglomerates

Illustration: Rebecca Zisser/Axios

United Technologies is breaking up. General Electric is a shadow of its former self. The great conglomerates of the past, names like ITT and Gulf + Western and Hanson Trust, are dim memories at best.

  • One of the few conglomerates still alive is Berkshire Hathaway. And it won't long survive the death of its founder, Warren Buffett, who's 88 years old.

The big picture: The other claimants for conglomerate status are the private-equity shops, but they, much like Berkshire Hathaway, are ultimately built on financial engineering rather than genuine economies of scale.

What they're saying: Edward Hadas reckons that conglomerates are far from dead. "Without the ability to bring disparate businesses and skills together, costs in most firms would be higher, revenues lower and many new and improved products would never have been created," he writes for Reuters. "Diversified enterprises, by one name or another, will play a big role in the business world for a long time."

  • Hadas doesn't mention the cloud; he should. The reason to build a conglomerate is to centralize certain skills and apply those skills across multiple business lines. You can do that the laborious way, via acquisition and regular senior-management retreats, or you can just move a large part of your business into a cloud that provides state-of-the-art services on demand.

The bottom line: Maybe the big cloud providers — Amazon, Microsoft, IBM, Oracle — are in some way the new conglomerates. They don't own the companies they power, but they deliver impressive and valuable synergies all the same.

6. The U.S. is not riskier than China

Illustration: Lazaro Gamio/Axios

It's certainly a striking headline: "Markets Conclude the U.S. Is Riskier Than China." And the author should know whereof he speaks: Matthew Winkler, the editor-in-chief emeritus of Bloomberg News, literally wrote the book on how to report on markets.

But Winkler is wrong. (And/or he has created "an unintentional Sokal Hoax for finance.") Contra Winkler's assertion, the U.S. Treasury does not have to "pay a premium over Chinese bonds to attract investors." To see that, just compare the two countries' bond yields. China sometimes borrows in dollars, so we can compare apples to apples. And the evidence is clear: At every maturity, China pays more than the U.S. does.

  • A bond maturing in 2022 yields 3.1%, or 33bp over Treasuries.
  • A bond maturing in 2023 yields 3.3%, or 50bp over Treasuries.
  • A bond maturing in 2027 yields 3.5%, or 62bp over Treasuries.
  • A bond maturing in 2028 yields 3.6%, or 72bp over Treasuries.
  • A bond maturing in 2048 yields 4.1%, or 96bp over Treasuries.

Winkler is comparing domestic-currency interest rates; he concludes that there's a "dichotomy between the U.S and China in the credit markets." But in doing so he ignores the fact that he's comparing two entirely different currencies. He also makes two category errors.

  • These numbers aren't about credit. Countries that issue debt in their own currency, like China and the U.S., can always print money to repay that debt. Local-currency bond yields, by definition, are rates, not credit.
  • There is no correlation between interest rates and riskiness. Italy is a risky country, but the yield on its 1-year notes is only 0.3%. U.K. 1-year bonds, at the height of Brexit chaos, yield 0.8%. Meanwhile, the U.S., which remains the global hegemon and the safest haven in the world, has a 1-year risk-free rate of 2.7%.

Be smart: Local government-bond interest rates are mostly a function of domestic monetary policy and inflation expectations; they tell you next to nothing about a country's creditworthiness. Neither do they indicate anything about endogenous economic risk.

7. 1 heartless thing

New York State made public its 157-page pitch to Amazon as a home for the tech giant's second headquarters, just before a contentious city hearing about the final decision. The front cover was the classic Milton Glaser I❤️NY logo, with the heart surgically removed.

8. To err is human; to forgive, divine
The church’s small, K-8 school notified police that Sister Mary Margaret Kreuper and Sister Lana Chang, who both had retired earlier this year, were “involved in the personal use of a substantial amount of school funds.” But the nuns had expressed remorse, and the archdiocese and the church were not pursuing criminal charges.
— Nuns improperly took as much as $500,000 from Torrance Catholic school, Long Beach Press-Telegram
9. This week: Another Fed hike (probably)
Illustration: Rebecca Zisser/Axios

The conversation around the Fed’s policy decision on Wednesday will be less about the rate hike — which is almost certainly coming — and more about how Jay Powell’s view of the economy has (or hasn’t) changed, writes Axios' Courtenay Brown.

  • Powell is not the only central banker walking a fine line this week. The Bank of Japan is holding a policy meeting on Wednesday and Thursday, as serious questions loom about Japan’s slowing economy.

The U.S. government will partially shut down on Friday at midnight, barring a deal in Congress.

  • 75% of the federal budget is funded through 2019. There's still "mass confusion" over what will happen to the other 25% of the government, in the event of a shutdown.
  • Expect the markets to ignore the shambles, absent any indication it will turn into a full-blown debt crisis.
10. Building of the week: Habitat 67
Photo: Universal Images Group/Getty

Moshe Safdie lived in his 1967 Montreal masterpiece. His personal duplex has now been restored and is open to the public.

Felix Salmon

Elsewhere: The 100 largest U.S. charities. The 100 most just U.S. companies. Dr. Elon & Mr. Musk: Life Inside Tesla's Production Hell. Santa Macron blows hole in budget. Delaying Brexit beyond March is easier than you might think. India's farmers on the march. NYSE regulatory staffers mill around on the trading floor to impress Snapchat's Evan Spiegel. €5,936 to polish door handles.