Apr 21, 2019

Axios Capital

By Felix Salmon
Felix Salmon

I hope you're enjoying your holiday weekend. If you're in New York, come join me on Tuesday on the Upper West Side when I'll be talking to Joe Stiglitz about his new book. If you want a taste of what the book's about, check out Stiglitz's op-ed in the NYT this weekend.

Also, it's my birthday today! If you want to get me a present, just tell your friends about this newsletter, and get them to subscribe. And/or, send me buildings, especially if you have good horizontal photos of them I can use.

1 big thing: When laissez-faire is corrupted

Illustration: Sarah Grillo/Axios

Anyone who thinks that the stock market is a level playing field obviously has no contact with reality.
— Judge Jed Rakoff, ruling in United States v. Pinto-Thomaz this week

Laissez-faire capitalism works very well in theory. The government sets clearly-defined rules, within which corporations compete for profits. Companies win by providing the best products at the lowest price; investors win by allocating scarce capital where it can be put to best use; the country as a whole reaps the benefit. In an age of corruption anxiety, however, laissez-faire often means that companies themselves get to set the rules.

  • The Consumer Financial Protection Bureau has lost all its teeth, as Nicholas Confessore reports in today's NYT Magazine. The agency was created to work for and be answerable to consumers, but then Mick Mulvaney took over, and now it seems to answer mostly to payday lenders.
  • The CFPB's new head, hand-picked by Mulvaney, is Kathleen Kraninger. (Mulvaney himself has moved up to become the White House chief of staff.) Kraninger's first big speech this week was described as "the latest nail in the coffin of the CFPB" by LA Times consumer advocate David Lazarus.
  • Kraninger referred 11 times to "stakeholders", including "a continued commitment to engagement with all of our stakeholders". Those stakeholders emphatically include financial institutions, who don't need to worry about being sued: the CFPB's rules "are not best articulated on a case-by-case basis through enforcement actions," says the agency's new head.
  • A group of payday lenders called NDG Enterprise illegally threatened borrowers with arrest and imprisonment, per Confessore. The CFPB recently settled its three-year prosecution of NDG; the fine was exactly $0.

The big picture: When corporations capture their regulators, laissez-faire fails.

Driving the news: Corporations must not be allowed to influence bankruptcy proceedings without fully revealing their conflicts. But that's exactly what McKinsey is being accused of. Now, McKinsey itself has been given the job of drawing up new conflict-of-interest guidelines — guidelines that "could serve as a model for all bankruptcy practitioners". A spokeswoman for McKinsey told the WSJ that the firm is looking to address "ambiguities" in the existing rules.

  • Corporations literally write laws now. An investigation by USA Today, The Arizona Republic, and the Center for Public Integrity found at least 10,000 bills drafted by corporate interests being introduced in the past 8 years, of which more than 2,100 were signed into law. 

Why it matters: Regulatory stakes are high, sometimes life-and-death. Ali Bahrami, for example, the top safety regulator at the FAA, got that job after previously urging the agency to allow Boeing to self-certify the safety of it jets. (Boeing is back in the news this weekend, with a report of safety lapses at its South Carolina Dreamliner factory.) More insidiously, corporate capture of the government apparatus reduces faith in all institutions.

Go deeper: Michael Lewis's new podcast, Against The Rules, is all about the ways in which referees are no longer trusted. Episode 2 dives into the CFPB.

2. Facebook's regulatory woes

Illustration: Sarah Grillo/Axios

One company is having a hard time capturing U.S. regulators: Facebook. It's the subject of federal criminal investigation in New York, and is reportedly facing a record multi-billion-dollar fine from the Federal Trade Commission for violating its users' privacy.

  • An NBC News investigation has found that Facebook would regularly barter its users' privacy, opening up its treasured proprietary datasets to its most valuable partners, while denying them to potential rivals.
  • Regulators want to find Mark Zuckerberg personally liable, reports the Washington Post, rather than simply levying a large fine on the company. (In the context of what Wired calls "15 Months of Fresh Hell Inside Facebook," a 10-figure fine at the corporate level would hardly cause Zuckerberg to raise a sweat.)
  • Zuckerberg has accepted personal responsibility for Facebook's failings in speeches and in Congressional testimony, but Facebook is reportedly pushing back hard on attempts to get him to personally certify that his company is adhering to agreed privacy practices.

What we’re seeing: Facebook recently announced the departure of Erskine Bowles from its board of directors, noting that he has "served on the board since 2011". Bowles famously grilled Zuckerberg over how he allowed Russian interference in the 2016 U.S. presidential election.

  • Trump supporter Peter Thiel, who has sat on Facebook's board since 2005, remains there, despite attempts to remove him. Thiel, a multibillionaire, owns just $5 million of Facebook stock; Zuckerberg has said it would be "crazy" to remove him from the board.

The bottom line: Facebook faces no existential threat under the current administration. But if someone like Elizabeth Warren becomes the next president, that might change.

3. Argentina's Macrisis

Illustration: Aïda Amer/Axios

Argentina looks like it's headed, once again, for the misery of economic chaos and sovereign default, writes Axios' Dion Rabouin. It has now reached the point at which, the formerly unthinkable now looks entirely probable: That Cristina Fernández de Kirchner could, once again, become president.

It wasn't meant to be this way. Argentine President Mauricio Macri came to office at the end of 2015 as a pragmatic businessman who was going to save Argentina's economy from the ravages of 12 years of Kirchnerist Peronism. (Cristina's two terms in office, between 2007 and 2015, came after her husband Nestor's tenure from 2003 to 2007.) Instead, as this year's presidential election approaches:

  • Inflation is running at 55%, according to official statistics;
  • Poverty in the country rose to 32% at the end of 2018, up from 25% the prior year;
  • Unemployment has risen to 9.1%;
  • GDP is shrinking fast, down 6.2% from a year ago;
  • The Argentine peso is plunging, recently trading at 44 pesos to the dollar, almost triple the rate when Macri took over as president;
  • The cost of buying one-year default protection on Argentina has soared to 984bp (or 9.84 percentage points), up from 430bp in March.

The central bank has raised interest as high as 65% in an attempt to fight inflation, but that has only served to push Argentina into recession. The central bank is now fixing the exchange-rate band, or instituting currency controls, while the government freezes prices on 60 food products until October.

What's next? "I truly believe that if Cristina wins, we're looking at defaults," said an investor who was not authorized to speak publicly about the issue. "Given the state of the economy, her election would just crash the market."

The bottom line: The more likely Cristina's re-election becomes, the more money leaves the country, and the further the currency and bond markets fall, making Macri look even worse. That, in turn, only serves to make another Kirchner presidency even more likely. It's hard to see what can break the downward spiral between now and the presidential election in October.

4. Zoom's happy IPO

Photo by Kena Betancur/Getty Images

Eric Yuan helped shatter one of the weirdest corporate taboos on Thursday, becoming one of the first Chinese CEO of a major U.S. publicly-listed corporation. (Indian CEOs, by contrast, including Microsoft's Satya Nadella, Pepsi's Indra Nooyi, and Citi's Vikram Pandit, have been highly visible for years.)

  • Yuan's triumph came in the highly competitive world of videoconferencing. It's a world he knew very well when he founded Zoom in 2011: He had been the head of engineering at one of Zoom's competitors, WebEx, which was sold to Cisco for $3.2 billion in 2007.
  • Zoom was an improbable startup. As CNBC's Ari Levy writes in an excellent profile, "not even Eric Yuan’s closest friends, oldest advisers and earliest investors thought Zoom needed to exist." It was also fighting giants: Not only Cisco but also Microsoft and Google.
  • Yuan's Zoom is a great place to work. It's the top-rated company on Glassdoor, with a 96% "recommend to a friend" rating. (One corporate perk: Zoom will reimburse you for any book you buy for yourself or your family members.) In contrast to Alibaba, with its notorious "996" culture of working 12-hour days 6 days a week, Yuan encourages employees to spend a lot of time with their families — and does the same himself.

Zoom raised $751 million in its IPO on Thursday, none of which might ever be needed. The company is profitable, and, partly for that reason, now trades at a valuation of $16 billion. (“The price is too high,’’ Yuan told Bloomberg.)

  • Zoom's profits are still small — the company's p/e ratio is north of 2,000 — but profitability means long-term sustainability. Loss-making companies like Uber and Lyft, by contrast, will ultimately fail if they can't persuade investors to keep funding their losses while they attempt to find that elusive path to profitability.

The big picture: Zoom, like Slack, is part of a new breed of enterprise software companies. The financial decision to start paying for the product is still made in the executive ranks, but it's invariably driven by bottom-up adoption of the free version by rank-and-file employees. If a sales team can say that half of a company is using the product already, just because they love it, it's a lot easier to close the deal.

5. Understanding the money market

Illustration: Rebecca Zisser/Axios

The biggest market you probably never think about is the money market. Zoltan Pozsar — formerly of the U.S. Treasury, now of Credit Suisse, and the acknowledged expert on the market — reckons that it's at least $7 trillion in size: a capital-markets iceberg all but invisible to investors who concentrate mostly on equities.

  • Pozsar was the guest on Bloomberg's Odd Lots podcast last week, a conversation so dense and so interesting that I listened to it twice. You'll understand much more of it the second time around, certainly enough to understand, say, what's going on at the Turkish central bank right now.

Why it matters: Money markets are liquidity; without them, the whole system seizes up. (As it did on December 31, 2018, for reasons Pozsar explains in the podcast.) They also determine how much risk is necessary for long-term investors to achieve a positive return.

  • One of the most elegant trades in financial markets is for an investor to borrow in the money market at 3 months, and then invest the proceeds at higher rate in 10-year Treasury bonds. Treasuries pay a quarterly coupon, so when your 3-month debt comes due, you roll it over, pay the interest with your Treasury-bond coupon payment, and pocket the rest.
  • That trade is no longer attractive, with 3-month rates very close to 10-year rates. So investors first started layering credit risk on top (which explains the increasing popularity of CLOs, the instruments that package up leveraged loans), and then, more recently, started adding currency risk too.

The bottom line: Central banks rightly worry a lot about liquidity, especially now that post-crisis regulatory reforms have forced banks to minimize their balance sheets at the end of every year. It's hard to maintain sufficient levels of liquidity when the U.S. government is borrowing record amounts and the central bank is engaged in quantitative tightening, or QT. Which might explain why QT is now coming to an end.

6. How Netflix burns $10 million a day
Expand chart
Data: YCharts, FactSet; Note: Share price adjusted for stock splits; Chart: Harry Stevens/Axios

Netflix CEO Reed Hastings once called his company a “rerun TV" company. Its transformation into an original content machine is impressive — and really expensive, writes Axios' Courtenay Brown.

  • It takes about 2 years for a new show to go from production to screen. That means 2 years before Netflix sees a single cent in the form of marginal subscriber revenue from any given original show.

Driving the news: Netflix expects it will burn a bigger-than-expected $3.5 billion this year. Hastings sees the epic cash burn as a good thing for the company; still, he has reassured investors that 2019 will mark be “peak” negative free cash flow for his company.

  • The near-consensus view for Wall Street's Netflix bulls is that its cash burn ultimately doesn’t matter, especially if it's consistently growing its subscriber base.

By the numbers: Judging by the stock's performance since Netflix went public in 2002, investors like Netflix whether the company is burning huge sums of cash or not.

7. Financial theater

Edward Gero, Thomas Keegan and Jonathan David Martin in Junk at Arena Stage. Photo by C. Stanley Photography

Financial plays are having a moment. "Shareholder Value" by Tom Attea recently finished a run in New York; "Junk", by Ayad Akhtar, is currently playing in Washington DC. Both of them take a skeptical view of high finance, and worry about its effects on everyday workers.

"The Lehman Trilogy", by Italian playwright Stefano Massini, is different. More poetic than prosaic, it charts 3 generations of Lehman brothers to tell the story of 4 generations of Lehman Brothers. I can personally attest that the Ben Power translation, as directed by Sam Mendes, is a triumph; the play has also received rave reviews across Europe after being translated into 11 different languages.

  • "The Lehman Trilogy" is less didactic than most other financially-focused plays; it also takes a broader view of capitalism's centuries-long arc. While it takes just as many poetic licenses as, say, "Junk", which tells a lightly-fictionalized version of the Mike Milken story, it does so for dramatic rather than sermonic reasons. As a result, it's likely to remain a theatrical staple for decades to come.
8. The week ahead: First-quarter GDP

Illustration: Rebecca Zisser/Axios

We'll find out how much the economy decelerated in the first three months of 2019 on Friday, writes Courtenay.

  • Estimates are all over the map. FactSet says the economy likely expanded 1.8% on an annual basis, while the Atlanta Fed's GDPNow projects 2.4%.

Expect to hear a lot about Tesla this week. The company is hosting an "autonomy investor day" tomorrow. Two days later it will release quarterly results, where it's expected to swing back to a loss after two quarters of profitability.

  • The timing isn't a coincidence. As Axios' Joann Muller writes: Tesla "has a history of touting product news just ahead of poor financial results."
  • A federal judge gave Elon Musk and the SEC an extension and said the two have until Thursday to come to some sort of deal about Musk's tweets about Tesla.

More than 150 other companies are out with earnings this week — including Twitter and Snap on Tuesday, Facebook and Boeing on Wednesday, Amazon on Thursday and Deutsche Bank on Friday.

  • Stock markets are closed in Europe and China tomorrow for Easter Monday.

🎬 Avengers: Endgame opens on Friday; it has already set new ticketing records. (Presales alone guarantee it will set a new opening-night box office high in China.) If the 3-hour movie turns out to be the all-time blockbuster analysts are expecting, that will help not only Disney but also theatrical companies like AMC.

9. Building of the week: Notre-Dame Cathedral

Photo: ERIC FEFERBERG/AFP/Getty Images

It's Easter Sunday, and the 13th-century Cathedral of Notre-Dame, on the Île de la Cité in Paris, remains one of the most magnificent and recognizable houses of worship in the world. The rose windows and rib vaulting have survived, the buttresses still fly; the biggest loss is likely to be the the ineffable smell of the ancient wood.

  • All cathedrals are works in progress, being constantly restored and rebuilt. Gothic cathedrals, in particular, are tinderboxes that are naturally prone to non-fatal fires.
  • Notre-Dame's 19th-Century spire burned down, and will likely be replaced by something better. Private funds donated to the rebuilding have already exceeded $1 billion.
Felix Salmon

Elsewhere: SoFi has forced investors into its own proprietary mutual funds, even when doing so creates substantial taxable short-term capital gains. Same-sex borrowers are discriminated against in the mortgage market, despite being better risks. Money magazine is going out of print. The Brexit Party is popular. The rise of scooters.

Editor's note: The first story was corrected to show the location of Boeing's Dreamliner factor in South Carolina (not North Carolina) and the fourth story was corrected to show Eric Yuan is one of the first Chinese CEOs of a major U.S. publicly-listed corporation (not the first).