(Bloomberg View) -- Oh Wells Fargo.
Janet Yellen kicked Wells Fargo & Co. on her way out the door at the Federal Reserve on Friday, announcing that the Fed will "restrict the growth of the firm until it sufficiently improves its governance and controls." The bank's total assets, averaged over any two-quarter period, will not be allowed to exceed its total assets at the end of 2017, until it gets its act together to the Fed's satisfaction. The Fed's action came in a response to Wells Fargo's recent string of regulatory failings, of which the most embarrassing was the 2016 revelation that Wells Fargo bankers, pressured to meet sales quotas, had opened millions of fake customer accounts.
The Fed also announced that four of the bank's directors will step down, and "sent letters to each current Wells Fargo board member confirming that the firm's board of directors, during the period of compliance breakdowns, did not meet supervisory expectations." Here's the letter, which I hope Wells Fargo will have framed and hang in its boardroom. Actually the letter is on the Fed's website; anyone can go print it out and frame it. If I ran Goldman Sachs or JPMorgan, I'd frame it and hang it in my boardroom. It focuses the mind!
We have talked a bit recently about bad financial-regulatory penalties; on Friday I criticized the Securities and Exchange Commission's rules that (supposedly) automatically penalize some misbehavior with a bar on participation in private placements. So it is worth saying: This is a good penalty!
For one thing, it's a really good deterrent. To the extent a big bank can be said to want anything, it wants to grow; its Darwinian urge is to keep doing more banking and gathering more assets. And in particular, a big bank's chief executive officer really wants it to grow. The CEO may not pay attention to legalistic trivia like private-placement bad-actor bars. He may not even pay attention to nine-digit fines; he runs a big budget with a lot of line items. But a cap on growth he will notice. His importance as a bank CEO is closely bound up with the bigness of his bank; big bank CEOs are statesmen and celebrities, while small bank CEOs are just rich businesspeople. Limiting growth is about the most painful thing the Fed could do short of, you know, forcing Wells Fargo to shrink. But whereas shrinking a bank is painful and disruptive not only to its executives but also to its customers (whose loans do you get rid of?), capping its growth hurts "the bank" as an entity -- and its CEO's ego -- without too many follow-on effects on anyone else. (Though Wells Fargo is "planning on trimming its deposits from financial institutions and some commercial clients in response to the central bank's action.")
Even better, though, this penalty is also a relevant remedy to Wells Fargo's actual problems. Wells Fargo's errors were, fundamentally, statistical ones. No senior executive pushed bankers to open millions of fake accounts; you can tell because the fake accounts didn't make money for Wells Fargo. Instead, senior executives pushed their bankers to open millions of real accounts. But no senior executive could supervise and understand that sales effort in any direct way. There were too many bankers, too many accounts. Instead, the executives had to rely on culture and delegation and incentives to motivate the bankers to open accounts ethically, and they had to rely on statistical aggregates to check on them.
They did not do a great job with that. "The 1% that did it wrong, who we fired, terminated, in no way reflects our culture nor reflects the great work the other vast majority of the people do," former Wells Fargo CEO John Stumpf once said, in a particularly tone-deaf use of that commonplace. (Stumpf got his own suitable-for-framing letter from the Fed on Friday.) And, look, if only 1 percent of your employees are a problem, and you are a scrappy startup with 20 employees, that's great: In expectation you have zero problems. But 1 percent at Wells Fargo -- and Stumpf's percentages might have been a bit off but whatever -- meant firing 5,300 employees for setting up millions of fake accounts. The lesson is that if you are a gigantic bank you need to have a much lower than 1 percent tolerance for grievous error.
I am skeptical of some of the buzzwords that are used to criticize big banks. "Too big to fail," for instance, often leads to confusion: We have bank resolution mechanisms and a lender of last resort not because some individual banks have too many assets, but because the banking system is both valuable to society and fundamentally run-prone, and so it might require a societal backstop. But "too big to manage" is, it seems to me, a thing. A bank's CEO, and its board, cannot possibly know everything that is going on at their bank. They must manage probabilistically, they must set up processes that provide reasonable assurance that things are fine even when they cannot directly observe the things. This is a difficult and error-prone task to do at scale. But if a board can't do it at its bank's scale, that doesn't mean that the Fed should just shrug and say "well, it's hard, never mind." It can prevent them from getting any bigger until they fix the problem! It's a good solution.
The crypto.
There is a well-known phenomenon whereby hedge-fund managers who have a bit of success begin to fancy themselves experts in everything. The typical case begins with style creep in investing: A merger-arbitrage expert will have a few good years and will then start making macro bets on currencies. How hard can it be? Politics and policy will be next, and he will begin lecturing politicians on optimal education policy. Eventually no domain is off limits; he'll buy a sports team and start giving advice to its coach, or show up at NASA and explain how they've gotten astrophysics all wrong.
This often ends up looking kind of silly but, to be fair, many successful hedge-fund managers really do have a lot of general intelligence and knowledge. They tend to have been successful in academics and business all their lives; some of them actually have astrophysics Ph.D.s. And while the experience of being a successful hedge-fund manager can involve a certain amount of flattery and insulation from criticism, the experience of becoming one is decent training: It is hard to succeed at investing by being dogmatic and ignorant; success requires deep research, humbling failures, and a willingness to admit error and learn from mistakes. If we are going to have a class of overlords who control all human activities, success at hedge-fund management is not, like, the optimal way to choose them, but it is not the worst way either.
The worst way is success at cryptocurrency investing! Good lord. Here is another dispatch from Nellie Bowles's travels among cryptocurrency subcultures, and it is gruesome stuff:
Dozens of entrepreneurs, made newly wealthy by blockchain and cryptocurrencies, are heading en masse to Puerto Rico this winter. They are selling their homes and cars in California and establishing residency on the Caribbean island in hopes of avoiding what they see as onerous state and federal taxes on their growing fortunes, some of which now reach into the billions of dollars.
And these men — because they are almost exclusively men — have a plan for what to do with the wealth: They want to build a crypto utopia, a new city where the money is virtual and the contracts are all public, to show the rest of the world what a crypto future could look like. Blockchain, a digital ledger that forms the basis of virtual currencies, has the potential to reinvent society — and the Puertopians want to prove it.
"What's happened here is a perfect storm," says one of them, about Hurricane Maria. "If you take the MY out of money, you're left with ONE," says another, who also plays a video of Charlie Chaplin on his phone for the benefit of a tree.
But they are also "debating whether to buy Puerto Rico's Roosevelt Roads Naval Station, which measures 9,000 acres and has two deepwater ports and an adjacent airport," because at least some of them seem to have rapidly become wealthy beyond the dreams of hedge-fund managers or Bond villains. And the screening mechanisms that tend to mitigate the ridiculousness of hedge-fund-managers-turned-universal-experts-on-society don't apply here. You don't have to know anything to have bought bitcoin three years ago. You don't have to have learned humbling lessons about being wrong if you just bought bitcoin and it kept going up until you were a zillionaire. A single trade is all the evidence you need that you're a genius -- and the proceeds of that trade can fund whatever dumb thing you want to do with your brilliance.
Elsewhere in Cryptopia:
- "JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc. said they're halting purchases of Bitcoin and other cryptocurrencies on their credit cards."
- "Cryptocurrencies Drop With Risk Assets as Stock Rout Endures." Just for giggles, Bloomberg tells me that Bitcoin's daily correlation with the S&P 500 Index was 0.047 in 2017, -0.049 in 2016, 0.07 in 2015 and -0.081 in 2014. That is about as uncorrelated an asset as you could ask for -- and a lot of Bitcoin buyers were asking for uncorrelated assets. So far in 2018 the correlation is 0.286. Still pretty uncorrelated! But ... less so. When Bitcoin was a weird alternate-currency dream of anarchists, there was no reason for it to be correlated with stocks. When it is just an asset class that regular people trade, buying when they feel confident and selling when they feel nervous, that correlation ticks up.
- And Bryce Elder has a pretty good Bitcoin explainer.
Full circle.
Everyone knows the story of Uber Technologies Inc. right? Once upon a time, in the bad old days, the way to get around the city was in a taxi. Each city regulated its taxi industry in order to make sure it was safe and fair, but hahaha come on, really the taxi regulators were always captured by the local taxi industry and regulated the industry mainly to protect it from competition.
Then along came Uber with its clever business strategy of brazenly ignoring the law. It would come into town and offer people a cheaper and more convenient way to get around than taxis. Eventually the taxi industry and its captive regulators would notice, and they would say "hey you cannot drive an unregistered taxi here, that is not safe or fair," but by that point Uber was already driving people around in the city, and those people would not have noticed anything particularly unsafe or unfair about their Uber rides, and so they would not be particularly impressed by the taxi regulators' claims.
And then Uber would be all "well if you are going to regulate us we are going to leave your city and deny you the sweet sweet freedom to call a car with a phone app, never mind, we'll just be over here reading 'Atlas Shrugged,' see you later," and the city's citizens and politicians would miss Uber, and they would change the rules to break the taxi monopoly and allow Uber to come back. And Uber would come back in triumph and be given the keys to the city and give a little speech summarizing the good bits of "Atlas Shrugged" and pointing out that regulation in the service of incumbent monopolies is bad while freedom is good.
I mean that is a stylized summary, but essentially correct in spirit. Anyway (via Atrios) last week Uber and many of its car-sharing-app competitors (Lyft, Didi, Ola, Via, etc.) signed on to a set of "Shared Mobility Principles for Livable Cities," and here is number 10:
10. WE SUPPORT THAT AUTONOMOUS VEHICLES (AVS) IN DENSE URBAN AREAS SHOULD BE OPERATED ONLY IN SHARED FLEETS.
Due to the transformational potential of autonomous vehicle technology, it is critical that all AVs are part of shared fleets, well-regulated, and zero emission. Shared fleets can provide more affordable access to all, maximize public safety and emissions benefits, ensure that maintenance and software upgrades are managed by professionals, and actualize the promise of reductions in vehicles, parking, and congestion, in line with broader policy trends to reduce the use of personal cars in dense urban areas.
Yes that's right, in the driverless-car future, Uber will be lobbying cities to forbid you from owning a private car that might compete with Uber. Cars need to be in "well-regulated" fleets to "ensure that maintenance and software upgrades are managed by professionals." You wouldn't want an unregulated amateur to be in charge of a car's maintenance! That would be anarchy.
Elsewhere in Uber, driverless cars, and (allegedly) brazenly ignoring the law, the Uber/Waymo driverless-car theft-of-trade-secrets trial kicks off today.
The banking life.
Last week JPMorgan Chase & Co., Amazon.com Inc. and Berkshire Hathaway announced that they were teaming up to disrupt the U.S. health-care industry and set up a new company "that is free from profit-making incentives and constraints." Health-insurer stocks promptly dropped, since their shareholders tend to like profit-making and assumed that the JPBerkazon effort would cut into it.
Which was awkward for the JPMorgan bankers who cover health insurers!
JPMorgan's health-care bankers only learned of the plan around 9 p.m. the evening before it was announced, according to people familiar with the matter. After the plan became public, some of these bankers fielded calls from clients concerned and confused about the impact.
Oops. They -- and JPMorgan CEO Jamie Dimon -- ''assured clients that the initiative is designed only to serve the employees of the three firms in the partnership." It is fun to go back and reread the JPMorgan/Amazon/Berkshire joint announcement in light of JPMorgan's client sensitivities. "The ballooning costs of healthcare act as a hungry tapeworm on the American economy," says Warren Buffett. "Hard as it might be, reducing healthcare's burden on the economy while improving outcomes for employees and their families would be worth the effort," says Jeff Bezos. But Jamie Dimon is not about to say that the existing health-care system is bad or inefficient or needs changing. "Our people want transparency, knowledge and control when it comes to managing their healthcare," is as far as he is willing to go. Just some internal human-resources adjustments; nothing for clients to worry about.
People are worried that people aren't worried enough.
Ha, no, a couple more days like Friday -- when the S&P 500 Index was down 2.1 percent -- and we're gonna have to flip this to People Are Worried That People Are Too Worried. It's starting already; here is "As Stock-Market Rout Spreads, Investors Fear Markets Falling in Lockstep":
U.S. stocks last week suffered their largest weekly drop in two years. But some investors worry that falling prices for things like oil futures, gold and bitcoin are offering a more ominous signal that could presage deeper declines.
It is the circle of life. People stop worrying. They start buying all the stuff and leveraging it up. Everything goes up, and everything is correlated with everything else. Eventually a switch is flipped, and the leveraged holders of all of the stuff have to sell all of the stuff, and it all goes down at the same time. Too little worrying leads to too much worrying.
Alternative funding mechanisms.
Last Thursday I suggested that Elon Musk's flamethrower stunt -- in which he sold $10 million worth of flamethrowers to raise money for The Boring Company to pay for tunnel-drilling equipment and tunnel-drilling lawyers and also probably flamethrower-liability lawyers -- is an interesting experiment in alternative corporate finance that is analogous in some ways to the initial coin offering craze. Musk's fundraising, like an ICO, is non-dilutive, doesn't need to be paid back, doesn't rely on actual results of his actual business, and works mainly through internet hype. Then on Friday I noted that the flamethrowers were earning ICO-like returns on eBay, so I guess I am committed to the bit now. Fortunately Musk keeps providing material:
That is the most ICO-like thing yet! Apparently some regulators are saying that they won't allow unregistered sales of things that are obviously "securities," so to solve that, a lot of ICO promoters are renaming their tokens "not securities." Fine they are calling them "utility tokens" but same basic idea. Musk also proposed "Temperature Enhancement Device" for his non-flamethrower.
Things happen.
U.S. consumer protection official puts Equifax probe on ice. Are you a pass-through entity yet? CFTC Orders Deutsche Bank Securities Inc. to Pay $70 Million Penalty for Attempted Manipulation of U.S. Dollar ISDAFIX Benchmark Swap Rates. "Greg Coffey, a star hedge fund trader who retired five years ago, is raising $2bn for a new fund." Broadcom Raises Qualcomm Hostile Bid to About $121 Billion. "A lot of pundits have a sense that automation is accelerating in replacing jobs. In fact, I predict it will slow down, because we have been picking the low hanging fruit first." OCC Releases Dodd-Frank Act Stress Test Scenarios for 2018. Samsung's Lee Jae-yong freed from jail by appeals court. Can a $1.2 Billion Casino Lure Asian Tourists to the Catskills? Microsoft Says It's True: Cat Videos Distract Workers. Nigel, the world's loneliest bird, dies next to the concrete decoy he loved.
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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 editor responsible for this story: James Greiff at jgreiff@bloomberg.net.
For more columns from Bloomberg View, visit http://www.bloomberg.com/view.
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