Month: May 2021

Yesterday’s events regarding the large oil companies shows that money talks and b.s. (Bad Science) walks as noted in three headlines:

• A Bad Day for Big Oil – Washington Post
• Climate Activists Defeat Exxon in Push for Clean Energy – New York Times
• Climate activists hail breakthrough victories over Exxon and Shell – Financial Times

For some time there have been numerous groups working to organise shareholders to take action on climate change. This work led to stunning successes at the annual meeting of Exxon Mobil where at least two directors were elected to encourage Exxon Mobil to address climate change. These directors were not supported by management but rather by shareholders who are concerned about the impact of climate change. Of interest was the support these insurgent directors received from large investment managers including those responsible for passive investing (Vanguard, BlackRock, etc.).

But the success at Exxon Mobil was just one of three yesterday where large oil companies will be required face their responsibility for climate change. The shareholders of Chevron, supported a resolution that the company must substantially reduce its climate impact. And a Dutch court ruled that Shell was required to substantially reduce its emission impact. 26 May 2021 will be remembered as a day when money via investors impressed on oil companies that their strategy of ignoring climate change is no longer sustainable.

On occasion a simple sentence in a longer analysis captures not only the core issue being discussed but provides a solid framework for thinking about finance in general. Such was the case in an essay from Paul Krugman in the 20 May 2021 New York Times. In a very clear and insightful discussion on bitcoin, Krugman asked a very simple question: “What problem does this technology solve?” He expanded on that simple question as follows: “What does it do that other, much cheaper and easier-to-use technologies can’t do just as well or better?” Refining his initial question to: What problem does this financial product solve? pivots his analysis to be a very valuable framework for looking at finance and banking. Focusin on meeting real needs rather than invented needs use to generate profits to pay bonuses would certainly push finance and banking in a healthy direction.

The importance of Krugman’s analysis was reinforced in today’s Financial Times in an article on bitcoin. That article was focused on the value of bitcoin but not once raised the issue of why is bitcoin relevant or what problem does it solve. Perhaps it is time for the financial press to use the common sense of Krugman as they write about financial innovation.

Occasionally there is an article that captures very well so many of the themes impacting banking and finance today. A recent New Yorker article covering Robinhood, an online trading platform is such an article. And the story is told using the lives of real people who faced real consequences from their involvement with finance – including a suicide.

Robinhood is a “zero-commission” trading firm that according to its own publicity has a mission to “democratize finance for all.” As noted in the article: “A Robinhood spokesperson said that attracting users who had previously been excluded from the financial system is a ‘profoundly positive change,’ and that ‘suggesting otherwise represents an élitist, old way of thinking.’ As noted in the article by the CEO of a competitor, Robinhood is “. . . the first company that introduced premier user experience and design in a mobile application to finance, and they also dramatically lowered the cost of investing,”

The mission of a democratic financial system is one held by many banks that practice values-based banking. Therefore it would seem that Robinhood’s actions would be supportive of values-based banking. But as one digs deeper into the practices of Robinhood a different story emerges. A story that aligns more with the traditional “greed is good” associated with Wall Street.

Although appearing to be commission free, as everyone knows there is no free lunch. So how does Robinhood generate revenues if not by charging commissions for trading? They do so by a practice called Payment for Order Flow (“pfof”). The trades made with Robinhood are directed to brokers who pay Robinhood a fee for that activity. As noted in the article: “Payment for order flow is common among brokers, but it is controversial, because it appears to create an incentive for them to send their customer orders to whichever market maker is willing to pay them the most.” The article further notes: “In exchange for access to the orders, the firms pay rebates to the brokerage company that routed the orders to them. The rebates and the skimming are invisible to the customer placing the trade order.” So it would appear that the commission free trading is funded through execution at prices that are not the best in the market for the buyer or seller of shares. As noted in the article even after controversy, “in the first quarter of 2021 Robinhood’s pfof revenue was three hundred and thirty-one million dollars.”

But the motivation of the users of Robinhood is also of interest. Their motivation seems to be often related to the issues that arose from the financial crisis of 2008 so many years ago but sill impacting banking, finance and politics. Some of the users of Robinhood see it as a means to get revenge for a financial crisis that impacted their families very personally. Those stories as reported in the article surfaced on chat sites focused on trading. As one individual wrote: “I remember when the housing collapse sent a torpedo through my family. My father’s concrete company collapsed almost overnight. My father lost his home.” Around the same time, the author claimed to have seen “hedge funders literally drinking champagne as they looked down on the Occupy Wall Street protesters.” The poster said that, as a result of the loss, his father had descended into alcoholism, and existed as only “a shell of his former self, waiting for death.”

This theme was taken up by one of the key characters in The New Yorker article had a similar family experience. He wrote in response to that post his reasoning for holding a position in Game Stop: “This is about more than just money, it’s about fucking these hedge fund managers until they understand what we’ve all gone through because of them. I am holding to ensure my parents can live comfortable lives at the expense of the assholes that almost cost them their lives. This is for you, Dad.”

But underlying all of this story is a fundamental misuse of the financial system. No where in the story is there a discussion of how Robinhood, various other institutional investors or the individual investors were thinking about how money should be used to finance productive assets. Rather the focus is on finance as a casino. And as we all know, betting in casinos is a losing proposition for everyone except the casino owners. Or in this case the financial companies that are running a casino and not investing in addressing the needs of society.

In the current economic climate and in times of rapid technological change, banks are facing unique challenges to their business models. This challenge is especially large in Europe where profitability of banks has been under attack for many years. For many years some European banks have tried to compete with the US investment banks – in some cases by purchasing them. But the recent events surrounding Archegos suggests that they have not been successful in using these new banking opportunities to create profitable sources of not only revenues but also net income for their stakeholders.

A recent series of articles in the Financial Times highlights this conclusion. The first article on 6 April noted that the collapse of Archegos cost Credit Suisse a $4.7 billion impairment charge in their prime broking activities. The article goes on to note: “In theory, prime brokers hedge all exposures, making only a modest margin on their activities. In practice, hedges are rarely perfect. Bonus-hungry bankers can find ways to exploit that.” The article also highlights that Credit Suisse is not the only bank active in this area.

The second article on 20 April goes further to note that Credit Suisse had substantially reduced its risk management capability in the run up to the Archegos debacle as well as the losses it incurred on Greensill. Whilst these losses have led to the departure of several senior managers (and one board member) responsible for risk management, that is a a bit like locking the barn after the horses have been stolen. The article noted that “six current and former Credit Suisse managers said the bank hollowed out risk expertise and trading acumen in favour of promoting salesmen and technocrats. Dissenting voices were suppressed, they said.” As anyone familiar with banking knows, suppression of dissenting voices is almost always the start of a downhill trend.

In an article on 27 April the Financial Times provided an update on the Archegos situation noting that total bank losses on Archegos were likely to exceed $10 billion. Interestingly all these losses were at non-US banks. It would seem that the US banks had in place much better risk management systems that allowed them to exit their exposures with minimal losses.

Finally on 3 May the Financial Times reported that the revenues (not net income but only revenues) on the Archegos relationship were just Swiss francs 16 million in 2020. Clearly a business model that faces potential losses of $4.7 billion for revenues of around $17 million is not sustainable. The only good news from this article comes in the following statement from the new Chair of Credit Suisse, António Horta-Osório:  “I firmly believe that any banker should be at heart a risk manager.” Clearly a signal of new times at Credit Suisse.

The large amount of liquidity in the current market has led to some unusual stories – stories that too well illustrate why the financial world easily loses touch with reality. The story of Hometown International, Inc. is told with humor and insight in a recent short article in The New Yorker. The article details how a small deli in New Jersey chose to go public including refusing to state that they were a shell company since after all they were an operating business. A deli with average sales of about $80 per day. The New Yorker goes on to test the deli’s pastrami sandwich to see if there was a “special sauce” that made it worth $2 billion at one point but later returned to a less stratospheric level of $100 million.

More information on the financial activities was available from an article in the Financial Times. This article noted that included in the investors of Hometown International, Inc. were the endowment funds of two major US universities, Duke and Vanderbilt. These investments appear to be made by an Asian asset manager on behalf of the universities. It would also appear that the ultimate goal is to use the entity to be a cheaper version of a SPAC (special purpose acquisition corporation).

Many bankers claim that all this innovation is good for the overall economy but is that so or merely a chance for bankers to make fees that can be used to pay their bonuses? And is it responsible for university endowment funds to support this type of speculative activity?