In the News
Stories I am following now
For the last several weeks I have been very focused on understanding the Biden-Harris Student Debt Relief Plan. As my wife will attest, I have spent countless hours researching, writing and generally blabbering about student loan debt, even going so far as to update my previously published blog posts. (For the latest version of my most recent Biden-Harris post, including never before seen comments and links hot off the press, read here.). And the more I have learned about this topic, the less impressed I am with the quality of the reporting and commentary in the mainstream press and of course on social media, which often contains little more than fact-light ideology and bumper sticker slogans repeated ad nauseam in our various national echo chambers.
But while I have had my head buried in the books learning about the economics of higher education and student loan debt, there has apparently been a lot else going on in the world of finance. (Not to mention in that other world—the world of politics, war and other natural and unnatural disasters.) I will be writing more about some of this in the future, but for now let me just mention a few of the stories I am currently following.
The World Series. OK, this isn’t finance per se but there is a lot of money and data analytics involved in baseball, which sounds a lot like finance. My interest in professional baseball goes up significantly every year about this time, as we approach the World Series, even when my Cubbies are not in the hunt (which of course is most years). As I wait for the playoffs to begin, I am genuinely pleased to see that Aaron Judge finally hit the big one, if only so that ESPN will stop interrupting my weekend college football games with a split-screen video of BAJ striking out (yet again). And while Judge’s HR performance is truly remarkable, one could argue that perhaps it doesn’t quite match the previous records set by Babe Ruth (1927) or Roger Maris (1961), at least not in ‘present value’ terms. (See how I weaved in a bit of finance?) Not to mention the 73 homers hit in 2001 by He Who Will Not Be Named.
The Fed and the Economy. If you work in finance, staying current on the Fed is always a good idea. As we all know, the Fed is rapidly raising rates in an attempt to fight persistently high inflation in the US economy. The Fed’s policy rate target is currently set at 3-3.25% and is expected to peak at over 4%, which for much of my professional career (1981-2009) would have been considered a normal (not tight) rate. The yield on longer-term UST bonds has increased, although perhaps not as much as one would expect. (The ten-year UST is now at 3.8%, with yields a bit higher at shorter maturities). And the US stock market has given back all of its mid-summer gains and then some, and is now down over 20% year-to-date. But this story isn’t fully written yet, and there is a lot we still don’t know about Fed policy and its impact. How high will the Fed take rates and how quickly? With what impact on the real economy? How will the capital markets react? With what impact on banks and other financial institutions? In the US and globally?
Stocks and bonds have been very volatile this year, but are generally down significantly in price, while the USD has been up big. A stronger US dollar may excite our patriotic fervor, but it is not entirely a good thing for either the US or the global economy. A strong dollar has been known to wreak financial and economic havoc across the globe, for example back in the 1980s, and may be doing so again today. In his fight against inflation, Jay Powell seems to be channeling his inner Paul Volcker, which the US press and most commentators seem to think is a good thing. But has the Fed forgotten already some of the lessons learned in the 1980s, when high interest rates and a strong USD (admittedly much higher and stronger than now) effectively tanked the US economy causing a very nasty recession and long-lasting damage to important sectors of industry? As well as creating mayhem abroad? For now the inflation hawks are calling the shots at the Fed. As perhaps they should be. But for how long and with what consequences here and abroad?
The UK’s ‘KamiKwasi’ Budget. You have to hand it to UK Chancellor of the Exchequer Kwasi Kwarteng. For a seeming introvert, he certainly knows how to make a big splash. It is not often that a single budget announcement (oops, ‘fiscal statement’) immediately knocks more than 5% off the value of a developed country’s currency, adds 70bp (20%) to its long-term borrowing costs and temporarily shuts down the government’s access to the capital markets. But Chancellor Kwasi and his boss, UK Prime Minister Liz Truss, just about pulled it off. And they did so without even mentioning their planned announcement to other members of the Cabinet or to the Office of Budget Responsibility, let alone signaling their policy shift to the capital markets. Very unconventional indeed. But how exciting!
In the end Kwasi and Liz were more or less bailed out by the Bank of England, which came immediately to the rescue, promising to buy gilts in whatever quantity was needed to restore a semblance of stability to the market. (So much for monetary tightening!) Not to be out-staged by the folks at Threadneedle Street, however, the government announced just a few days later a rather ungraceful about-face on tax policy, the centerpiece of the Tories’ budget plan, which it had hoped would reverse the party’s declining electoral prospects. Oops, not so much it seems.
Of course none of this is normal behavior of the sort we expect to see from those in charge of a large developed (I hesitate to say ‘mature’) economy like the UK. But at least the Queen was not around to witness this grand display of fiscal incompetence by Her Majesty’s newly appointed government, which she had asked Ms Truss to form just two days before she died. To be clear, that’s the Queen who died, not Ms. Truss, although I’m pretty sure that most Brits (not to mention the Bank of England) would have preferred that their positions had been reversed.
The Musk-Twitter Merger. I have published on this story more than once, but this deal really has been like the gift that keeps on giving. As you will know if you have read my posts, I think Elon Musk is a flake. He may well be a business genius—the Thomas Edison of our time, as some call him—but he is still a flake. Which he reminds us of regularly, often via Twitter, and this past week has been no exception.
In case you haven’t been following this story, Musk agreed to buy Twitter back in April for something over $44 billion, a price of $54.20 per share, in an all-cash deal not conditional on financing. Within weeks of signing the merger agreement, however, Musk began publicly trashing the Company and very clearly looking for a way out. He claimed this had something to do with Twitter’s estimated bot count, which was almost certainly a pretext and not the real reason for his cooled ardor. Right around the time Musk agreed to buy Twitter the stock market resumed its fall, the online advertising market weakened and social media share prices tanked, at which point Musk appeared to be sitting on mark-to-market loss of potentially $20 billion, from a deal that hadn’t closed and that he no longer wanted to do.
In July, Musk and his attorneys notified Twitter that they were unilaterally terminating the deal, citing various alleged breaches of the merger agreement by Twitter. Twitter responded promptly by filing suit in Delaware Chancery Court seeking a court order granting ‘specific performance’ and forcing Musk to complete the deal on the agreed terms, as provided for in the merger agreement. The trial date was set for October 17th, with Musk as the star witness, an event we were all looking forward to. I for one had blocked that entire week off my calendar, not that I have much else going on at the moment (other than watching baseball of course).
But with the scheduled start of trial just 10 days away, Musk once again unexpectedly reversed course and communicated to the Court that he was now prepared to close the merger at the originally agreed price. (The parties had apparently been confidentially negotiating to complete the deal at a somewhat lower price.) The conditions for Musk’s new ‘commitment’ are somewhat unclear (to me at least), but seem to include not only an end (or stay) of the litigation but also a new contractual debt financing ‘out’ for Musk.
As you will recall, Musk had previously arranged for $13 billion or so of acquisition debt financing committed by a consortium of banks led by Morgan Stanley, and the banks’ funding commitment had essentially no outs other than those which also applied to Musk (eg a contractual breach by Twitter). The remaining $31+ billion of equity funding was committed and underwritten entirely by Musk personally, although at one point he appeared to have laid off $7 billion or so of this risk onto a handful of high-profile (but soon to be poorer) co-investors, who may or may not still be on the hook.
I think it is entirely reasonable to view Musk’s latest overture with a healthy degree of skepticism. Twitter’s attorneys argued vehemently in court that Musk’s proposal should not be taken at face value, and with good reason. Nevertheless the Court this week announced a stay of the litigation through October 28th with a new trial date to be scheduled in November if the deal hasn’t closed by the court-imposed deadline. This delay will give the parties a bit of extra time to close the deal and specifically for Musk to get his financing into place. Or I suppose for Elon and his attorneys to come up with some new more credible reason(s) he isn’t legally obligated to close.
It isn’t entirely clear to me exactly what more needs to happen with Musk’s debt financing, which was committed back in April. But Musk’s financing banks appear not to have previously syndicated any of their risk—which begs the question why—and they are now collectively sitting on mark-to-market losses estimated at $500 million or more. And so we can assume that the financing banks are not at all keen to see this deal close, and neither I suspect is Musk despite what he has told the Court. But I suppose the Court can be excused for giving Musk the benefit of the doubt. After all what’s the big deal with a few weeks delay in the trial date if it will allow the parties to close this deal voluntarily?
Well I am not sure, but something smells a bit fishy here, and I don’t think it’s the nearby Menemsha Harbor. It is possible that I am completely misreading the Twitter situation—which wouldn’t be the first or likely the last time I will have done so—and that Musk really does intend to close and is making a good faith effort to do so as quickly as possible. This seems to be the view of the financial press as well as the stock market, with TWTR shares closing Friday at just a touch under $50, not far off the original deal price. Which tells me that Charlie Brown may not be the only one gullible enough to try and kick that football with Lucy (Elon) as the holder.
Read here, here, here, here, here and here.
Credit Suisse. This has not been a good year or so for Credit Suisse, which I have written about on a few occasions. CS has suffered huge losses in its prime broking (hedge fund), structured finance (securitization) and leveraged finance (private equity) businesses and made wholesale changes to its senior management and its board. Most recently, CS has experienced a renewed fall in the share price and a big jump in CDS spreads, apparently exacerbated by CS bankers calling clients to reassure them. “Don’t worry”, they said, “our firm is really in robust financial health despite what the capital markets seem to be signaling.” Which of course is rarely a good strategy for building market confidence. To paraphrase our good friend Walter Bagehot (Lombard Street, 1873), if a bank has to attest to its sound financial position, the battle for customer and market confidence is likely already lost. And it makes matters worse, not better, when you call your clients (soon to be former clients) at home over the weekend to deliver the message.
I doubt that things are really this dire at Credit Suisse, but you have to wonder given how they chose to handle the latest communications. The CS stock is now trading at a hefty discount to book value with a big strategy announcement, more internal restructuring and a possible capital increase yet to come. Now might be a great time to buy CS shares, but then again it might not. Perhaps you should call your contacts at CS for some advice, if they will still pick up the phone.
Read here, here, here and here.
Moral hazard and our next financial crisis. OK, this isn’t a ‘news’ story per se. But the subject of moral hazard has been on my mind a lot recently, as I have been thinking about President Biden’s plan to cancel large amounts of outstanding student loan debt and to reduce substantially the future payment obligations of millions of current and future borrowers. And the topic of moral hazard came again to mind as I was reading about the Bank of England’s market interventions following the surprise announcement of the UK’s “KamiKwasi Budget” (see above).
As described by Marc Rubinstein in this week’s Washington Post, the Bank of England and other central banks seem to have become increasingly comfortable extending widespread support not only to regulated banks but also to a wide range of non-bank financial institutions as well as non-financial corporations, governments and the capital markets more generally. The central banks mostly seem to be following Bagehot’s dictum for providing liquidity support in times of financial crisis: lend freely, to sound institutions, against good collateral, at a penalty rate of interest. But increasingly the central banks are providing wholesale liquidity support not just to individual firms but to entire industries or markets. (Some of which is now mandated by law, as in the US with Dodd Frank.) This may not be entirely a bad thing, but every time the central banks do this they run the risk of spreading the contagion of moral hazard deeper and deeper into our financial markets, creating systemic risks that may be hard even for large central banks to manage.
We saw what happened to risk management in the US financial system after twenty years of investor reliance on the ‘Greenspan put’. But the actions of central banks since then have made the actions of Mr. Greenspan look judicious and even parsimonious by comparison. And the risks to the global financial system may again be rising along with inflation and interest rates, as discussed recently by economic historian Adam Tooze.
Of course we all want central bank support to be there when we really need it—after all this is a large part of why we have central banks. But what if repeated central bank ‘bailouts’ cause future interventions to become increasingly ineffective. Who will we call then?