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On June 11th, Samsonite (officially, Samsonite International SA), a perennially troubled company with international complexities-based in Massachusetts, incorporated in Luxembourg, and controlled by the London-based private equity shop CVC Capital Partners, went public. It chose an appropriately global setting-the Hong Kong Stock Exchange to list its shares. And it wasn’t alone-the first half of the year saw many large, foreign companies, including Prada SpA, list their IPOs in Hong Kong.
Although a robust IPO season in New York had DealBook wondering if Hong Kong was slipping, according to statistics from the World Federation of Exchanges, the Hong Kong Exchange, though small compared to global behemoths like the NYSE, continues to boom. Between 1990 and 2010 it attracted more than 1000 new listings – more than twice as many as the NYSE. Although it suffered in the financial crisis it peaked earlier and it’s crash wasn’t as steep, or as severe. I fed the WFE statistics into Excel, charts follow.
Mas y Minos
Title X of Dodd-Frank creates the Bureau of Consumer Financial Protection (BCFP)—a new regulatory agency described as “an independent bureau within the Federal Reserve.” If you’re confused about how the BCFP can be “independent” and also “within” the Federal Reserve, hold on to your helm—the maze is about to get more complicated: on July 21st the House passed HR 1315, the *ahem* “Consumer Financial Protection Safety and Soundness Improvement Act of 2011” (CFPSSIA). CFPSSIA would not, despite its title, improve soundness – it would bring the “independent” BCFP under the control of the Fed, well … kinda.
The BCFP created by Dodd-Frank is entirely independent of the Fed. Section 1012(c) (“Autonomy of the Bureau”) forbids the Board of Governors from “intervening in any matter” before the BCFP, appointing, directing or removing any officer, or merging or consolidating the BCFP “with any office or division” of the Fed. The director of the BCFP is appointed by, and responsible to, the President.
CFPSSIA wouldn’t amend s. 1012, instead it would create a new top-level of bureaucracy—a commission, like the one that runs the SEC, composed of four members appointed by the President and chaired by the Vice Chairman for Supervision of the Federal Reserve. The Vice Chairman for Supervision, a new post created by section 1108 of Dodd-Frank (and currently vacant), is a member of the Federal Reserve Board of Governors. So, although under CFPSSIA the BCFP would remain independent of the Board of Governors, the Bureau’s new head honcho would actually be a member of the Board of Governors.
Makes you wish you had a ball of thread, doesn’t it?
More Sausage
I don’t know about you, but I was glad to be off the legislative beat. Watching the Dodd-Frank sausage get made left a bad taste in my mouth (eyes?). Notice I said I “was?” Cue the flood of bills to slow, derail, or de-fang Dodd-Frank.
Two weeks ago, for example, the House Committee on Financial Services reported out a bill called the *ahem* “Small Business Capital Access and Job Preservation Act” (HR 1082). The SBCAJPA carves out an exemption for “private equity managers” from the Dodd-Frank requirement that private fund advisors register with the SEC. The bill is short – it doesn’t even get around to defining private equity – but the Committee’s accompanying justifications are copious. The Committee report cites the testimony of “Mr. Andrew Bursky” (in case you think Andrew is a girl’s name) about PE’s role “in preserving existing jobs and creating new ones” and abhors the high cost of registering which “some have estimated to be as high as $500 million industry-wide.” Thus, an exemption is necessary to prevent registration that “needlessly diverts capital, time, and effort from investment activities that could be creating jobs.”
Having Faith
Back in May, 300 million shares of AIG – about $9 billion worth – were offered for sale to the public. As enormous as that offering sounds (it was half the size of GM’s IPO), it is but a weensy piece of AIG’s equity. The US Department of the Treasury, seller of 200 of those 300 million shares, still owns nearly 80% of the company. And thus, AIG was required to inform sellers about the singular problems associated with investing in a company controlled by a state apparatus. To begin with, Treasury has “a control vote on substantially all matters [requiring shareholder approval], including approval of mergers, sale of all or substantially all assets, and amendments to our certificate of incorporation.” This isn’t so different from investing in a company with a dual-class share structure like Tyson Foods, where “members of the Tyson family … have the ability to exert substantial influence or actual control over our management and affairs and over substantially all matters requiring shareholder action.”
What makes AIG different from Tyson is the nature of AIG’s controlling shareholder. AIG’s prospectus warns that Treasury’s priorities “may not be the same as those of other holders of our common stock.” Why? Because Treasury is the “executive agency of the US government responsible for promoting economic prosperity and ensuring the financial security of the United States” In other words, investor, the controlling shareholder does NOT have your back – they have more important things to worry about than protecting your investment. They’re thinking about the economic prosperity of the whole country. Similar warnings may be found in the offering documents of state-controlled Chinese companies. China Southern Airlines Co. Ltd. warned that “public policy considerations of the Chinese government in regulating the Chinese commercial aviation industry may conflict with its indirect ownership interest in the company.” PetroChina Co. Ltd. also warned that the interests of its government-owned controlling shareholder “may sometimes conflict with those of some or all of our minority shareholders.”
Thus, those investing in state-controlled companies risk their investment losing priority to grander, broader schemes they may not entirely understand.
You Look Like a Monkey, and You Smell Like One, Too!
Ah, birthdays. A barbarous relic of a time when another 365 days alive was a big deal, as well as an opportunity to glory in ones existence and accomplishments.
Dodd-Frank turned one last week, but the Senate Banking Committee’s modest fete was marred by the presence of an eloquent heckler (Richard Shelby) and the absence of a proud parent (Chris Dodd). A Congressional hearing is a grim way to celebrate one’s birthday, but Dodd-Frank’s party got downright moribund when Tim Johnson, after praising the statute’s goals, lamented that the guest of honor was “constantly under attack.”
Richard Shelby had the bad grace to criticize the celebrant for not creating jobs, and added: “the American people aren’t in the mood to celebrate.” He also ascribed our un-hearty partying to something about TARP being too risky for the returns we got, although that alternate scenario (where Treasury bargains harder with the banks) hasn’t dampened my spirit in the least. Wait, I take that back.
Barney Frank, appearing by special invitation (there was no party in the House), responded with sarcasm. He thought Shelby’s criticism of TARP was “unfair to the Bush administration,” and he suggested that legislators who found Dodd-Frank too long might want to “wait for the movie.” He also went wonk and raised the discussion to a level of complexity that (in my opinion) was inconsistent with the gusty, hyperbolic tone set by the other opening statements. Frank singled out two small parts of Dodd-Frank as the law’s most significant accomplishments. First, he spoke about the importance of the ABS securitizer risk retention rules, and mocked anyone who suggested that the ABS market couldn’t survive without risk-offloading. “What did we do before 1986?” Second, he spoke about new research confirming that commodity speculation increases prices. The CFTC, he said, has the power to control speculation in commodity derivatives, if Congress will appropriate the money.
I was surprised to hear Richard Shelby complain that Dodd-Frank hadn’t created jobs, I thought job-creation was, at most, an unintended effect of the law, but Tim Geithner, opining defensively in the Wall Street Journal (A Dodd-Frank Retreat Deserves a Veto), explained that Dodd-Frank was meant to “lay a foundation for economic growth and job creation.” He also explained why the administration chose to draft a law instead of simply issuing regulatory principles – they “did not want the new rules written by those who had brought us to the edge of financial catastrophe.” Congress?
Zork for Quants
Great Moments in UI: a user interface designer on why Bloomberg looks as it does, and why it will never change.
Ridiculousness
I just watched someone use the OVDV function on Bloomberg to graph the “volatility surface” for an S&P 500 index option. This kind of operation is considerably above my pay grade and I don’t pretend to understand the wrinkly, multi-colored 3D image that resulted (to me, it looked like something from Battle Zone). What it appeared to be was an ordinary option yield curve, where one axis is how long you hold the option, and the other axis is how much money you make, with an additional axis titled “moneyness.” I looked it up, and moneyness, as far as I understand it, is how likely it is that an option will make money. So, it is a measure of riskiness particular to options because it measures whether, and how much, an option is in or out of the money. An option that’s out of the money has negative moneyness.
Moneyness is an adorable name, but there’s nothing cute about it – when I tried to learn more, I was soon overwhelmed by frightening technical talk, scary math, and mention of something that sounds like the name of an 80′s art rock band, or a bond girl: “volatility smile.”
I was reminded of another cutely-named-but-nigh-impenetrable idea: aboutness, a library science term for quantifying what things are about. Aboutness was coined to replace “subject” which was found not to be the mot juste, though some have argued that the words mean the same thing. Are you tired of this yet? Figuring out how to figure out what something is about is key to making that something findable, and library scientists have been lobbing unreadable journal articles on the topic at each other for years (including the hilariously named, and completely non-understandable, “Aboutness from a Commonsense Perspective“).
So, while moneyness is all hard edges and scary math, aboutness is all mush and scary math. I can’t help but think that there’s a connection.
The Shadow Knows
Money market funds are open-end mutual funds (meaning they can be redeemed at any time unlike closed-end funds which are much harder to liquidate) that invest in short-term corporate debt. Because they are in the business of loaning money at interest they are considered part of the “shadow” banking system. Lack of regulation is what makes the shadow banking system shadowy. According to the Investment Company Institute, money market funds make available a tremendous amount of credit ($3 trillion in 2008) to businesses of all sizes.
When money market funds first appeared in the late 1960′s, there weren’t obviously, any special rules for them. They were treated like other mutual funds, but in a couple of ways they were different. For one, mutual funds valued their assets by marking them to the market – in other words, using the asset’s current market price to determine its value. Because money market fund assets are debt instruments held to maturity, money market funds did not mark their assets to the market. Instead, money market funds used “amortized cost” valuation – meaning the thing was worth what they paid for it. The current market price of their assets (they argued) was irrelevant: unless the issuer defaulted, they were going to get their money back, plus interest. The SEC objected in a 1975 concept release, and in 1977 it outlawed amortized cost (Accounting Series Release No. 219, IC-9786, “ASR 219″).
As one, money market funds applied for exemptions from ASR 219. The SEC, beset by 90-plus applications, held a consolidated hearing, and granted all the exemptions (IC-10451, 43 FR 51485). Shortly thereafter, the SEC amended Investment Company Act Rule 2a-7 to allow money market funds to use cost amortization valuation (Valuation of Debt Instruments and Computation of Current Price per Share, IC-12206, 47 FR 5428, 1982), with a number of conditions. One of the conditions was frequent “shadow pricing” of the fund’s portfolio, via mark-to-market, and a mandated comparison of the cost amortization price with the shadow price. If the prices were out of whack, the fund had to do something about it.
The compromise held until the financial crisis when a very (very) large money market fund called Primary Reserve went bust. The SEC responded by amending Rule 2a-7 to raise money market fund capital reserves and improve disclosure, including disclosure of the shadow value of money market fund portfolios. Disclosures started last week. There’s some panic, but BofA embraces the change, and Goldman offers “education.”
Sinking Feeling
Since we’re on the subject of Glass-Steagall, I would be remiss if I did not mention that on the 22nd, Sir John Vickers, head of the UK’s Independent Commission on Banking, mentioned (in a speech at the London Business School) that his commission was considering a proposal to “ring-fence the retail banking activities of systemically-important institutions and require them to be capitalized on a stand-alone basis.” Sir John goes on to say that the jury is still out on whether creating a Glass-Steagall-like economic division between retail and investment banking would be better, or worse. “In shorthand,” he said, “retail banking is safer with universal (meaning, not-separated) banking if the probability that I (investment banking) saves R (retail banking) exceeds the probability that I sinks R.”
Turn it Up!
“Noise trading,” said Fisher Black, is the “essential missing ingredient” that makes trading worthwhile. In his fantastically influential 1986 article “Noise” (J. Fin. vol. XLI, No. 3, 529, July 1986) Black distinguished between “noise” trades and “information” trades. Noise trades, based on anything that “makes observations imperfect” – stuff that isn’t true, or isn’t known – are important because without them markets would be perfectly efficient. No one would trade because we’d *know* what things are worth. Noise trades push prices out of whack, and create opportunities for people with information to bet against the noise traders.
It is, of course, obvious that giving everyone access to exactly the same information would not make markets perfect, but “Noise” doesn’t consider psychology. It operates in the BF Skinner world where people are organic robots and “differences in beliefs must divine ultimately from differences in information.”
Black admits that his theory can’t be tested and that “the information traders can never be sure that they are trading on information rather than noise,” but he is supremely confident: “if my conclusions are not accepted, I will blame it on noise.”
