Mortgage bankers and hedge-fund revivals

Why do we fine banks lots of money for doing bad things? The fines are more or less paid by the shareholders, and it’s not like the shareholders did the bad things. But in theory, the shareholders don’t want to be fined, so they will hire directors who don’t want to be fined, who will hire executives who don’t want to be fined, who will hire employees who don’t do bad things. The banks are supposed to be integrated rational economic actors that want to avoid fines, and so the fines should deter them from hiring people who will do the things that incur fines.

It sounds a little silly and tenuous when you say it like that, but it is quite orthodox. (And why else would you fine the banks?) But John Griffin and Samuel Kruger of the University of Texas, and Gonzalo Maturana of Emory, went and looked at what actually happened to the employees who did all the crisis-era residential mortgage-backed securities deals that got banks fined so much money, to see if those fines caused any career problems for the employees who incurred them. And, nope:

We find no evidence that senior RMBS bankers at top banks suffered from lower job retention, fewer promotions, or worse job opportunities at other firms compared to their counterparts in other areas of structured finance that experienced no fraud. This result holds for every major RMBS underwriter. Outside of the top underwriters there is some evidence that RMBS employees did relatively worse, potentially due to poor firm performance.

More specifically:

As of 2011, 26% of RMBS bankers remained employed at the same firm, 42% were employed at a top underwriter more generally, and 47% had more senior job title than they had from 2004 to 2006.

To determine whether these career trajectories are consistent with discipline, we compare RMBS bankers to a control sample of non-RMBS bankers involved in asset-backed security (ABS) deals related to commercial mortgages, auto loans, student loans, and credit card debt. Across a wide range of regression specifications, RMBS bankers and non-RMBS bankers had similar employment and promotion outcomes, and standard errors of the estimates are small enough to rule out any meaningful discipline.

If you were a bank that has paid tens of billions of dollars in mortgage-fraud-related penalties since the financial crisis, wouldn’t you at least fire the people who did all that mortgage fraud? No, no you would not, is the answer.

Why not? I feel like the answer is obvious, though not likely to make anyone happy. It’s that no one — no one making hiring and firing decisions at banks, I mean — really believes that people who worked in residential mortgage-backed securitizations in 2006 were “committing fraud,” while people who worked in credit-card securitizations in 2006 were “not.” Sure, yes, it turns out there was a lot of fraud in the RMBS securitizations, and not in other sorts of asset-backed securitizations, and that the banks agreed to pay billions of dollars in fines for the RMBS fraud. But that is not because the people working in RMBS groups — at every bank! — were radically different from the people working in other ABS groups, that RMBS groups somehow attracted particularly unethical people.

The fraud was not, in this line of thinking, a feature of the people. It was a feature of the asset class. The fraud was an emergent property of a system involving real-estate agents, borrowers, mortgage brokers, loan-origination firms, ratings agencies, collateralized debt obligation managers, buyers hungry for high-yielding AAA assets — and, yes, the RMBS bankers at big banks who signed the prospectuses that were full of misrepresentations. You might almost say that it was their bad luck to find themselves in the middle of a system that generated all that fraud. Had they only worked in credit-card securitizations, their outcomes would be very different. And so the people in charge of hiring and firing took sympathy on them, and in fact “many RMBS bankers who stayed at top underwriters moved from issuing RMBS to managing mortgage portfolios and overseeing other structured finance activities.”

Of course this is unsatisfying. Fraud should not be an emergent property of a system; it does not arise spontaneously. It should be a bad act committed by an identifiable person. And yet there are obvious senses in which it is true. There is a well-known paperby Ing-Haw Cheng, Sahil Raina and Wei Xiong, finding that a sample of “midlevel managers in securitized finance … neither timed the market nor were cautious in their home transactions, and did not exhibit awareness of problems in overall housing markets.” That is suggestive evidence that the people doing the deceiving — the people signing the underwriting documents that were full of misstatements — were deceived themselves. As Gillian Tett says, the evidence is “that most of the financiers who inflated that bubble were not crazy or evil (as popularly perceived) – but plagued by tunnel vision and groupthink.”

Also, it’s not just banks who shrugged and decided not to punish individuals; regulators seem to have come to much the same conclusion. I count only two high-profile cases against individuals at underwriter banks for misleading mortgage investors: Fabrice Tourre, who was fined over Goldman Sachs Group Inc.’s Abacus deal, and Rebecca Mairone, who was fined for her work on the Countrywide Financial Corp. Hustle program, though that was later reversed on appeal. Regulators fined the banks, not because that was a convenient aggregation mechanism for punishing the individuals who actually did the bad things, but because in some sense those bad things really were done by the banks, not the individuals.

Steve Cohen.

Speaking of the absence of labor-market discipline for regulatory settlements, Steve Cohen is planning to launch a $20 billion hedge fund after he is un-banned from the securities industry in 2018.

The new target would blow past the $16 billion managed at peak by Mr. Cohen’s SAC Capital Advisors LP, one of the most profitable hedge-fund firms in the U.S. before it pleaded guilty to criminal insider trading charges in 2013.

Something like $11 billion of that would be Cohen’s own money, but it still counts. Cohen’s current large institutional not-a-hedge-fund, Point72 Asset Management, “has made no money this year and barely posted a gain in 2016,” so it is perhaps not the most auspicious fundraising environment for him, but overall he’s got a pretty good track record — even after regulators made him get rid of all his insider traders and replace them with armies of compliance officers. Also there’s a throwback appeal to launching a giant human-driven long-short equity fund in this environment: If anyone can return the hedge-fund industry to its glory days, it’s Cohen, its once and future king, who picked a good few years to sit out the industry. (I can think of some other hedge-fund managers who might wish they had been out of the game since 2014.)

Not everything about New SAC will be a return to the olden days, though. I mean, obviously one expects less insider trading. Also the fees will be lower, with a variable performance fee and with a pass-through arrangement in which investors pay some expenses themselves. And Point72 has “been at the forefront of the push by fundamental firms to incorporate quantitative models and big data”: Cohen hasn’t been immune to modern hedge-fund trends, even while not technically running a hedge fund.

Elsewhere in hedge-fund managers who’ve had trouble with regulators, Leon Cooperman announced “I’m not a complainer” in an interview in which he also complained about the Securities and Exchange Commission’s “abusive” insider trading case against him. And: “The U.S. Supreme Court rejected an appeal by Lynn Tilton, the Patriarch Partners founder once known as the ‘Diva of Distressed,’ refusing to intervene in a Securities and Exchange Commission case that could bar her from the securities industry.”

Bribery.

As I’ve said before, my fascination with bribery is that it is so hard to distinguish from salesmanship. Obviously if you just hand a client a bag of cash to induce him to do a deal with you, that’s bribery. But if you go out to dinner with a client, and you pay for the meal, is that bribery? What if it’s a really nice meal? What if he brings his girlfriend? What if you only discuss the deal for like five minutes? What if you take him on a fancy ski trip, but also discuss the deal a little? There are no clear perfect answers here. There are some contexts, some industries, some cultures where taking the client skiing is just normal relationship-building; there are others where it’s a crime.

If he works for the New York state pension fund, and you are a broker at Sterne Agee & Leach looking to do business with that fund, it’s a crime:

Deborah Kelley, 59, a resident of Piedmont, California, was accused of spending tens of thousands of dollars to pay for trips for Navnoor Kang and his girlfriend to New Orleans and Park City, Utah, and VIP tickets to a Paul McCartney concert. She expensed the costs to Sterne Agee, while omitting that the money was spent entertaining Kang, prosecutors said.

Kelley pleaded guilty to conspiracy to commit securities fraud and honest services fraud, and she could face five years in prison when she is sentenced September 15.

She was confused too: “The guilty plea proceeding was temporarily thrown into disarray when Kelley, in response to a question from U.S. District Judge J. Paul Oetken in Manhattan, said she didn’t know at the time that what she was doing is illegal.” Sure! The slope from “buy client coffee” to “buy client VIP Paul McCartney tickets” is slippery, and what is and isn’t allowed is not always clear. Kang worked for a public pension fund, and the municipal securities business tends to take a stricter view of this sort of thing than other businesses: Giving a public employee gifts to influence their use of public money seems worse than giving corporate employees gifts to influence their use of corporate money, though it involves the same basic conflicts. On the other hand this is pretty much always a bad idea:

Another broker, Gregg Schonhorn, pleaded guilty and agreed to cooperate with authorities. He was accused of plying Kang with cocaine, prostitutes, luxury travel and a $17,000 watch.

I am sure there are some industries where giving clients cocaine is also just common courtesy, but you never want to have to explain that to federal prosecutors.

Market structure.

Yesterday I said that there’s no rational reason to care about dollar stock prices or stock splits. And of course all of my market-structure-expert readers wrote in to complain. Yes, okay, fine, there are market-structure reasons to care about stock prices, and stock splits. For one thing, investors pay commissions on a per-share basis, so higher share prices mean lower percentage commissions. On the other hand, higher share prices can lead to thin order books and odd trading dynamics. “To have a robust well-functioning order book, with tight spreads, deep liquidity, and inhospitable conditions for spoofing, large cap companies like AMZN are better off with share prices under $100,” writes Michael Friedman of Trillium. So, yes, there are rational market-structure reasons for and against stock splits. (I wrote about a weird one back when Apple Inc. split its stock.) I just doubt that many of them are top-of-mind for corporate issuers deciding whether or not to split their stock.

Elsewhere in market structure, here’s a story about how you used to be able to make money buying stocks after Standard & Poor’s announced that they were going to be added to the S&P 500 index, but before they were actually added; now you can’t. Part of that is that the post-announcement returns have gotten lower, but part of it is that they have gotten faster:

“There are no significant abnormal returns to be exploited by buying at the close of trading on the announcement date and selling at the close of trading on the effective date,” the group wrote. “Our findings indicate that the return is almost entirely confined to … after-hours trading sessions, which are facilitated by automated electronic transactions platforms where high-speed trading is prevalent.”

This is such a good Rorschach test for what you think about high-frequency trading. On the one hand: It’s so mean that the high-speed traders took all those gains for themselves, instead of leaving them for hedge funds and hobbyists! On the other hand: They’ve made the market so much more efficient. There was a simple data point — that a stock was going to be added to the index — and it took hours or days to incorporate it into market prices. Now it happens more or less instantly. Prices are more informative, because the high-speed traders react quickly.

People are worried that people aren’t worried enough.

Remember when people stopped worrying that people weren’t worrying enough, because people were worrying? (That is, because the VIX briefly jumped, closing at 15.59 on May 17.) Well, people have stopped worrying again, which means that it is once again time to start worrying about how they are not worrying:

The CBOE Volatility Index, an options-based measure of expected swings in the S&P 500, finished below 10 on Friday, less than half of its long-term average. The VIX has only closed below 10 on 13 occasions since 1990; four of them have occurred this month, according to CBOE.

Placid markets can serve as an all-clear signal for investors. It can also indicate that investors have grown complacent as stocks chug higher.

People are worried about unicorns.

In Uber Technologies Inc. news, let’s see, it has fired the engineer who was leading its self-driving car initiative because he was accused of stealing trade secrets from Alphabet Inc.; its drivers sometimes film passengers and circulate the footage “in closed online forums, public groups, and on YouTube”; and it is incentivizing property developers to get rid of parking and rely on Uber instead. Also: “Uber could be the next MySpace, some say, a company that created a market but was foiled by its own missteps and overtaken by savvier competition.”

In Theranos Inc. news, apparently its investors and the press weren’t the only people who thought that it was reliably running blood tests on finger-prick samples using its own machines: Its own directors also seem to have been confused. Former directors Gary Roughead and George Schultz said in depositions “that they thought Theranos could do all its patient tests on its proprietary device,” which turned out not to be true. And:

Mr. Shultz separately testified that he “didn’t probe into” whether the firm’s technology was working, adding: “It didn’t occur to me.” He added: “Since I didn’t know, I didn’t have anything to look into.”

I can sympathize. Some questions probably are too fundamental for the board to ask. You can’t really go to a board meeting, after years of service as a director, and be like “oh hey quick question, does our thing work?” At some point you pretty much own it.

In non-Uber/Theranos unicorn news, here is Sujeet Indap on Good Technology and the tension between preferred and common shareholders in struggling unicorns. And here is a “2017 Venture Capital Report” from Wilmer Cutler Pickering Hale and Dorr LLP:

The number of reported venture capital financings declined by 12%, from 4,244 in 2015 to 3,718 in 2016. Even adjusting for the normal lag in deal reporting, deal flow appears to have slowed toward the end of the year, with the 862 deals in the fourth quarter representing the lowest quarterly tally since the first quarter of 2011.

Total reported venture capital financing proceeds contracted by almost one-third, from $77.3 billion in 2015 to $52.4 billion in 2016.

Work stuff/food stuff/booze stuff.

Oh hey great no one goes out to lunch any more. That’s fine, we knew that, that’s life in our modern age. (True story: I read that article yesterday while eating lunch at my desk.) But this is too much:

When he isn’t on the road for a Detroit-based building products company, Mr. Parks works from his home in Carlisle, Ohio and eats there. When he meets clients at their offices, they have food delivered and work during what they call a “lunch and learn.”

Look, if you are going to have a working lunch with clients, just get on with it; no one needs your cutesy alliterative nickname. Or at least give it an over-the-top acronym, like in that “30 Rock” episode. Elsewhere, Jason Gay demands a return of the bar cart in offices. “We call it ‘drink and deal’!”

Art.

Oh sure, sure:

City sculptor Alex Gardega — seething over the “Fearless Girl” statue being placed across from Wall Street’s “Charging Bull” — has decided to retaliate with a work of his own.

Gardega created a statue of a small dog, titled “Pissing Pug,” and his sloppily crafted pooch takes direct aim at “Fearless Girl” — or, at least, at her left leg.

I have sort of lost track of the political postures of all the sculptures at Bowling Green, but I do love the sheer accretion of bronze objects there. There is something appealing about Wall Street being a venue for eccentric personal artistic expression. It’s a graffiti wall, but in bronze, and somehow about capitalism. I’m going to commission a Worrying Squirrel to put in front of Pissing Pug, with a little thought bubble over his head showing a chart of the VIX. Someone should commission an IPOing Unicorn, nuzzling up against Charging Bull. And of course you’ll want an Irate Artist, shaking his fist at the menagerie.

Things happen.

Morgan Stanley’s 16,000 Human Brokers Get Algorithmic Makeover. Big Pension Funds Oppose Election of Six Mylan Directors. This Is What the Demise of Oil Looks Like. EU presses plan to bundle eurozone debt. The $50 Billion Question: What Makes a Bank Big? Ex-UBS Banker’s ParentsBought Into China IPOs He Helped Arrange. “We find no evidence to support concerns that settlements enable activists to extract significant rents at the expense of other investors by introducing directors not supported by other investors or by facilitating ‘greenmail.'” Jeb Bush Said to Abandon Marlins Bid in Clash With Derek Jeter. The Rise and Fall of Toronto’s Classiest Con Man. A first-person essay from someone suing Donald Trump over his fake university. Dating via Twitter? Robot priest. Police snap selfie with drunk man’s phone to show how he got home. I Want to Apologize for How This Tragedy Has Hurt Our Stock Price. Raccoon Family Tired Of Taking Care Of Rabid Father.