| Programming note: Money Stuff will be off tomorrow, back on Monday. Fallen angels One popular conclusion after the 2008 financial crisis was that official reliance on credit ratings agencies was bad and should be replaced with … something. Instead of laws and regulations referencing credit ratings and giving them effectively the force of law, the laws and regulations should not reference credit ratings, and they should not have the force of law. One problem with this theory is that the purposes for which credit ratings have the force of law are kind of important. Another problem is that no one had any great ideas about how to replace them. Basically credit ratings are used to impose some constraints on people who would otherwise be tempted to take too many risks. "Buy whatever bonds you want" is probably not a good mandate for, say, a money market mutual fund whose job is never to lose any money. "Buy only good safe bonds, as determined by you," is not really any better! "Buy only good safe bonds, as determined by some external judge" is better, even if the external judge is kind of bad. It is all just sort of embarrassing though. "The ratings agencies are imperfect and conflicted in judging credit quality, but better than nothing, so their ratings will be used to legally constrain investment managers" is actually sort of a fine theory, but it sounds a little like giving up. It was hard to think of how to replace credit ratings, so it never really happened, and the post-2008 consensus just sort of faded away until, when the U.S. Federal Reserve decided to start buying corporate bonds in response to the present coronavirus crisis, it announced that it would only buy corporate bonds with investment-grade ratings from the major ratings agencies. This decision was controversial because some people think that the Fed should also buy junk bonds and other people don't think that, but no one really went around being like "the Fed should only buy investment-grade bonds but it should use its own internal risk models to decide what bonds are investment grade rather than relying on conflicted ratings agencies." That's not a thing people say in 2020; that's more of a 2010 thing. The latest version of the Fed's bond-buying program is a little weird, though, in that it gives the force of law not to the actually existing ratings agencies, but to the ratings agencies of three weeks ago[1]: To qualify as an eligible issuer, the issuer must satisfy the following conditions: … 2. The issuer was rated at least BBB-/Baa3 as of March 22, 2020, by a major nationally recognized statistical rating organization ("NRSRO"). If rated by multiple major NRSROs, the issuer must be rated at least BBB-/Baa3 by two or more NRSROs as of March 22, 2020. a. Issuers that were rated at least BBB-/Baa3 as of March 22, 2020, but are subsequently downgraded, must be rated at least BB-/Ba3 at the time the Facility makes a purchase. If rated by multiple major NRSROs, such issuers must be rated at least BB-/Ba3 by two or more NRSROs at the time the Facility makes a purchase. b. In every case, issuer ratings are subject to review by the Federal Reserve. ... I mean, clause 2(a) gives some legal force to the current opinions of the ratings agencies, and clause 2(b) is a halfhearted gesture in the direction of "actually the ratings don't have the force of law and the Fed can use its own risk models," but the real point here is that the Fed can invest in bonds that had investment-grade ratings in March, even if they have since been downgraded. If you want to limit the Fed's money to investment-grade companies, but you also want to address the coronavirus crisis, this makes some rough sense sense: It allows the Fed to send money to companies that were investment-grade in ordinary circumstances, without taking into account the fact that credit quality has deteriorated across the board due to the shutdown of the economy. For the Fed's purposes, March 22 ratings are more relevant than current ratings, so it will just use those and (partially) ignore what happened after March 22. I have suggested a few times that it might not be an entirely bad idea if the ratings agencies were to take a few months off. "Sorry, we're closed due to virus," they could say, and stop updating ratings. Companies that were rated investment grade would stay investment grade even as their credit quality deteriorates. On the one hand the ratings would become increasingly inaccurate. On the other hand … who cares? You do not need specialized expertise and advanced models to figure out that credit has gotten worse because of the economic shutdown; anyone can see that, so the information added by ratings revisions is not especially valuable. And if downgrades force investors to dump bonds (because their mandates limit their holdings to certain ratings), then they harm investors and companies to achieve a very theoretical improvement in accuracy. One specific worry that I gave was that the Fed's program is dependent on ratings. "The ratings agencies have a lot more power today than they had last week," I wrote on March 23; "now a downgrade can take a company out of eligibility for Fed support." Not any more! Now the historic ratings agencies—the agencies of March 22—have a lot of power, but the actually existing agencies do not, because their downgrades can't affect the Fed's decisions.[2] The ratings agencies aren't taking a few months off, but as far as the Fed is concerned they are, because the Fed has decided to ignore their post-March-22 decisions. You could imagine others following the Fed's example here. Why not change the mandate of an investment-grade bond fund, or the rules for money-market funds or banks, to say "you can buy anything rated investment-grade as of March 22, but if its ratings have changed since then you can ignore the change." Why not announce "we normally use credit ratings to limit our investment discretion, but we're gonna ignore anything we get from the ratings agencies from now until the coronavirus crisis ends"? Credit ratings don't really have the force of law, or at least they're not supposed to; it is just a convention that everyone pays attention to them. If they wanted to, everyone could just stop. Small business loans One key part of the U.S. government's coronavirus response is the Paycheck Protection Program, loans to small businesses harmed by the virus that turn into government grants if they are used to keep employees on the payroll. If you run a restaurant that employs fewer than 500 people, and your business has dried up, you can use the PPP grants to keep paying your employees despite your lack of revenue. Even if revenue hasn't entirely collapsed—even if you're still doing some takeout business—you can get PPP grants as long as you can certify that "current economic uncertainty makes this loan request necessary to support the ongoing operations" of your business. Not just restaurants, though, lots of small businesses are affected. For instance what if you run a hedge fund whose performance fees have suffered because markets are down? Lots of hedge funds have fewer than 500 employees. Can they get PPP loans? An alternative-investment consultant warned hedge fund and private equity firms not to take government help meant for small businesses during the Covid-19 crisis, saying it would be less inclined to steer institutional clients to any manager that does. Aksia LLC, which advises on more than $160 billion of alternative allocations, said it would be looking for "opportunistic" use of the U.S. government's Paycheck Protection Program in its due diligence process and "viewing that negatively," according to a memo sent to money managers on Tuesday. "A manager with a healthy business, taking advantage of the program, just because it is available and PPP's necessity conditions are not precisely defined, is not only showing poor moral judgment and potentially hurting the reputation of the alternatives industry, but it's also probably crowding out struggling workers and businesses severely impacted by Covid-19," Aksia said in the memo. "If, for example," the letter says, "a manager with locked up capital and management fee amounts exceeding the costs of paying salaries and running costs is opportunistically taking advantage of the PPP and its loan forgiveness, Aksia will be looking for that in our due diligence process and viewing that negatively." I don't know, there is clearly a belief that hedge-fund and private-equity firms will be applying for PPP grants for themselves. (Not for portfolio companies, I mean, which can be ordinary small businesses, but for their management companies.) "The tax IDs for those receiving #PPP loans are public," tweeted NBC's Stephanie Ruhle to hedge funds and private equity firms; "I will search them until my last breath on Earth." I'm with Aksia in thinking that hedge funds are not quite the intended target for these grants? But if you're a hedge fund applying for government grants, let me know why I'm wrong! One oddity of the PPP is that it is government money but administered through banks, who have at least some obligation to vet applications. I am not sure which way that cuts. On the one hand, hedge funds are more likely to have deep and profitable banking relationships than, say, restaurants are, which might get them ahead of restaurants in line for this money. On the other hand if I were a bank I would probably try to have procedures to reject PPP applications from hedge funds? I am not sure that being the bank that funnels government grants to hedge funds would be the best public-relations move. Everything is securities fraud (1) The S&P 500 Index peaked on Feb. 19, 2020, closing at 3386.15. Since then it is down about 19%. That is a pretty broad retreat; not a lot of stocks do better when the economy shuts down. Some do! Zoom Video Communications Inc. is up about 13% over that time period, because it turns out that when office workers and schoolchildren all stay home, they do a lot of videoconferencing.[3] The rapidly increased use of Zoom has exposed some problems: Zoom Chief Executive Officer Eric Yuan has apologized for the lapses, acknowledging in a blog post last week the company had fallen short of expectations over privacy and security. Cybersecurity researchers warn that hackers can exploit vulnerabilities in the software to eavesdrop on meetings or commandeer machines to access secure files. Weak encryption technology has given rise to the phenomenon of "Zoombombing", where uninvited trolls gain access to a video conference to harass the other participants. Recordings of meetings have also shown up on public internet servers. And when there are problems with a public company's software, problems that undermine the privacy of its users and expose them to harassment and hacking, guess who the real victims are? That's right, of course, it's the shareholders: In a complaint filed Tuesday in San Francisco federal court, the company and its top officers were accused of concealing the truth about shortcomings in the app's software encryption, including its alleged vulnerability to hackers, as well as the unauthorized disclosure of personal information to third parties including Facebook Inc. Investor Michael Drieu, who filed the suit as a class action, claims a series of public revelations about the app's deficiencies starting last year have dented Zoom's stock price -- though the shares are still up 67% this year as investors bet that the teleconferencing company would be one of the rare winners from the coronavirus pandemic. We talked a few weeks ago about the first wave of coronavirus-related securities fraud lawsuits. Everything is securities fraud, I often say, so of course the coronavirus is securities fraud. The weird trick is that the companies that get sued over the coronavirus will disproportionately be: - Companies that were especially hurt by the coronavirus: "You didn't tell us that you were unusually vulnerable to a global pandemic or that you weren't doing enough to prepare, and your stock went down a lot," is the basic theory for shareholders suing, say, a cruise line.
- Companies that were helped by the coronavirus: "Your stock went up because we thought you had a great product for the coronavirus times, but it turns out you only had a pretty good product for the coronavirus times," is the theory for shareholders suing, say, a drug company touting a promising therapy, or Zoom.
Still it's pretty weird that, of all the disgruntled shareholders in America, the ones at Zoom are among the first to sue. They're doing a lot better than a lot of shareholders! Everything is securities fraud (2) The "everything is securities fraud" theory is that everything bad that happens to a public company is also securities fraud. If something bad happens and the company doesn't disclose it immediately, it is misleading investors (by omission) about its financial and operational situation. (Even if something bad happens and the company does disclose it immediately, someone might argue that it didn't previously disclose enough about its vulnerability to the bad thing, etc.) This theory, I admit, overstates the facts a little; it is a theory about who might sue a company for what (anyone, for anything) more than it is a theory about who will win. One rather morbid form of this is that if a company's chief executive officer has health problems, the company and CEO may not want to disclose those problems fully and immediately for pretty good personal reasons, but the shareholders might want to know about the problems. It's a thing, in the everything-is-securities-fraud literature. Here are some law firm memos about how public companies should handle executive-health disclosure. And here is Stephen Bainbridge, a month ago, blogging about "What do companies need to disclose (if anything) if their CEOs catch coronavirus?" "Simply remaining silent about the CEO's health should not result in liability, because there is no SEC rule requiring disclosure or any caselaw imposing a duty to disclose such information," he concludes. Morgan Stanley apparently agrees: Morgan Stanley's Chief Executive Officer James Gorman said he has fully recovered from the illness caused by the novel coronavirus, according to a video that was sent to the bank's employees on Thursday. A Morgan Stanley spokesman confirmed the contents of the video, adding that the development was not considered to be material because Gorman was not incapacitated at any time. Morgan Stanley had not disclosed earlier that Gorman had tested positive for the respiratory disease. Seems reasonable. Critical functions People sometimes ask me why I left investment banking, and I usually say something like "I didn't like travel." Which is true, as far as it goes—I really didn't like flying out to meet clients every week—but it's only part of the story. I didn't love the actual meetings either, the market updates and pitches. I wasn't great at it; I never believed in equity derivatives quite as much as I should have to go around pitching them. Anyway I often find myself reading stories about senior investment bankers' intense commitment to the cause and thinking—and writing—"ah, that is why I never really made it as an investment banker." But I have never had that feeling more strongly than in the past week or so, as I have read stories about senior traders at investment banks telling each other to risk their lives to do more trading. (I should say I have not seen similar stories about investment bankers, who seem to be quite happy at home.) There were a couple of stories about JPMorgan Chase & Co. ("The trading desk will be in the office unless they have a medical condition with a dr's note"), and now here is quite a thing about Bank of America Corp.: Two weeks ago, on a March 25 conference call with the firm's most important equity and equity derivatives traders, Bank of America's Global Head of Equities, Fabrizio Gallo, laid out the stakes for those considering staying at home, especially if the crisis lasted for an extended amount of time. "At some point in time, one has to make a decision," said Gallo to the group assembled on the phone. "And the reason why it's called critical function is because we have a critical requirement by senior-ups to provide proper and orderly markets. And we cannot provide proper and orderly markets if 99% of the population decides they don't feel comfortable." … "So, people have to understand that too," he said. "You cannot on one hand say you cannot trust the firm and on the other hand get the money from the firm, for a long period of time if you are in a critical function. Now if people decide they don't want to be in a critical function we can have that conversation too. Every single person in this office right now has a family. Every single person in this office right now has children. Every single person in this office right now has elderly parents. Some are very far away, some are here. Every single person in this office is worrying about it." Though Gallo told those on the call there would be "special circumstances" for those with underlying illnesses – singling out one staffer with a compromised immune system from a battle with cancer – he made it clear that everyone wouldn't get the same treatment. "Of course, we are going to entertain special cases but not the 'I don't feel comfortable, sorry.' It doesn't work that way over the long term." I often write that big investment banks are socialist paradises run for the collective benefit of the workers, but these stories are forcing me to rethink that theory. This does not sound like a socialist paradise! These people are not thinking about the best interests of their workers, not exactly. I'm not sure they're thinking about shareholder value either? This is more like a strong commitment to the abstract notion of orderly markets, a commitment to equity derivatives for their own sake: Equity derivatives need trading, and so we are going to trade the equity derivatives, even at the risk of our health and lives. It is what the markets want. Things happen Fed to Buy Junk Bonds, CLOs and Lend to States in New Stimulus. Bank of England to directly finance extra government spending. Saudis Take Big Stakes in European Oil Companies. Argentina puts off payments on $10bn in local-law debt. WeWork Skips Some Rent Payments as Coronavirus Undermines Revenue. Fed Eases Wells Fargo's Asset Cap to Lend to Small Businesses Harmed by Coronavirus. U.S. SEC's Clayton Says Companies Seeking Bailouts Must Disclose Plans, Communicate With Investors. Bosses Stretch the Definition of Who Is 'Essential' — and Workers Take the Risk. Bodegas, Now More Than Ever. The mystery of Travis Kalanick's 'Internet Food Court.' 'Smart toilet' recognizes users' backsides, analyzes poop. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! [1] I am linking to and quoting from the Fed's April 9 termsheet for its Primary Market Corporate Credit Facility. The Secondary Market Corporate Credit Facility has similar provisions (though interestingly it omits clause 2(b), about issuer ratings being subject to Fed review). [2] I mean except if they downgrade all the way down to single-B, which seems like a lot. [3] Disclosure, since February I have become a paying Zoom customer and the coordinator of a daily preschool Zoom call. | 
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