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Money Stuff: The Vaccine Is Not a Competition

February 24, 2021
Bloomberg

Index funds will save us

One way to model the world of public companies is that there is only really one public company, call it The Stock Market Inc., whose shareholders are a bunch of diversified investors.[1] The Stock Market Inc. has a board of directors, made up of the dozen people who run the biggest diversified asset managers, BlackRock Inc. and Vanguard Group and so forth; these people manage money for the people who own most of the shares of The Stock Market Inc. (i.e., most of the shares of each of the underlying actual companies), so they control the votes, so they function like a board of directors.

The Stock Market Inc. does not have a chief executive officer, though; instead it operates through a bunch of autonomous divisions. The divisions are the actual public companies: Apple Inc. is the cool-phone-making division of The Stock Market Inc., GameStop Corp. is the mall-video-game-retailing division of The Stock Market Inc., Timken Co. is the ball-bearings-manufacturing division of The Stock Market Inc., etc. Lots of divisions overlap with other divisions: Delta Air Lines Inc. is the airline division of The Stock Market Inc., and so is United Airlines Holdings Inc., and so is American Airlines Group Inc., etc.

Each division has its own CEO, and its own employees and processes and offices and ad budget and billing software and Friday happy hours; each has its own tradition of fierce independence, and most of the time they operate at arm's length from each other. The divisions buy stuff from each other at market prices, without any discount for the fact that they're all owned by the same company, to align incentives and properly calibrate price signals and so forth. The overlapping divisions compete with each other; each airline division wants to sell more tickets and make more money than the other airline divisions, motivated by team spirit and competitive pride and the desire to impress the board of directors and, of course, financial incentives that reward the division's employees mainly for increasing their own division's profits. And the board of directors looks upon this intra-division competition and sees that it is good; usually, it is in the best interests of the shareholders of The Stock Market Inc. for the divisions to compete with each other, to submit to market discipline, to try to build innovative new products and please customers and keep costs low.

But it doesn't always work like that. For one thing, the employees do have some financial incentives to increase the whole company's—The Stock Market Inc.'s—profits. (Many employees of many companies have much of their savings in diversified mutual funds, not just their own company's stock.) For another thing, the employees might have a general sense of fiduciary responsibility to the owners and board of directors: The airline-division employees know that if they compete the rival airline divisions into bankruptcy, the shareholders—their shareholders, the shareholders of The Stock Market Inc.—will lose money and the board of directors will be mad. The competition is somewhat more constrained and polite than it would be if they were not all divisions of the same company. "We are all in this together," the employees of the various airline divisions might think, somewhere in the back of their minds; "it's okay if we lose a little market share if the result is higher income for all of us."

Also, occasionally the board of directors will turn its attention to the operations of particular divisions; the directors will call up the CEO of a division and tell her what to do. This is pretty rare: The Stock Market Inc. is very big, it has lots of divisions, and the board doesn't have a lot of time to devote to detailed operational questions about each one. Generally the board concerns itself with gigantic policy questions of broad applicability to all of the divisions: What are the best practices for governing and managing every division, how can the divisions make sure they are improving society, what will they do about climate change, etc. It is worth it for the board to spend time on those questions, and they can (sometimes) be answered at a level of generality that is useful for all of The Stock Market Inc. The directors are not going to spend their time looking at ball-bearing designs to advise the ball-bearing division on how to improve its manufacturing process.

But occasionally one division will be doing work that is so crucial to The Stock Market Inc. as a whole that the board of directors will pay attention to it. Or occasionally two divisions, or a dozen divisions, will have different parts of a product or service or idea or business that, if they were combined together, would be crucial to The Stock Market Inc. as a whole, so the directors will call up those divisions and say "hey you've got to work together to get this project done, for all of our common good." And then of course they will, because they all work for the same company and answer to the board of directors and do what they're told. 

None of this is real, this is not at all how the stock market works, this model is a complete fairy tale. Nonetheless it is worth keeping in the back of your mind sometimes. For instance:

Some of the world's biggest drugmakers are joining forces with rivals to help produce Covid-19 vaccines, forging unusual alliances that promise to substantially increase supplies by this summer.

Normally big pharmaceutical companies compete to sell cancer, arthritis and other drugs. The desperate need for Covid-19 vaccines, however, is turning fierce industry competitors into fast pandemic friends.

Sanofi SA recently agreed to help make a vaccine from Pfizer Inc. and its partner BioNTech SE after Sanofi's experimental Covid-19 shot suffered a five-month setback, freeing up a production line in Frankfurt.

"We were looking to contribute," said Thomas Triomphe, executive vice president for vaccines for Sanofi, which will start in June performing a crucial final step to make 125 million doses.

Novartis AG also agreed to help Pfizer and BioNTech produce more doses, while Baxter International Inc. and Endo International PLC have agreed to help Novavax Inc. produce its shot.

"This is a time when the pharma companies are saying, 'We'll go back to fighting when this is over. We'll take you to the cleaners and maybe drive you to bankruptcy, but right now we need to be working together,'" said James Bruno, who consults for drug companies.

BlackRock is Sanofi's biggest shareholder, Pfizer's second-biggest, Novartis's seventh-biggest, Baxter's second-biggest, Endo's biggest and Novavax's second-biggest, according to Bloomberg HDS data. Vanguard is Sanofi's fourth-biggest, Pfizer's biggest, Novartis's fourth-biggest, Baxter's third-biggest, Endo's second-biggest and Novavax's biggest. Other big diversified institutions also own lots of shares of most or all of these companies. But BlackRock and Vanguard and all the other big institutional investors who own shares in these pharmaceutical companies also own shares in all the other companies, the airlines and hotels and retailers and everyone else who will benefit if vaccines are deployed rapidly and economic activity returns to normal.

And so we have talked a few times about how it is in their interests—the interests of the shareholders of The Stock Market Inc.—for pharmaceutical companies to produce and distribute vaccines quickly and effectively and cooperatively and cheaply, even if it is not necessarily in the narrow financial interests of any of those particular pharmaceutical companies. We have talked about how these big shareholders, the board of directors of The Stock Market Inc., have tools and incentives to get the pharmaceutical companies to act in the general interest of The Stock Market Inc. rather than their own particular interest. And we have talked about news reports that BlackRock and other big asset managers said "that they want drug companies to put aside any qualms about collaborating with rivals." And now, that's what they've done. When the board of directors speaks, the divisions listen.

Tether

How did fractional-reserve banking start? I don't know, but I am going to tell you a stylized story that I made up because it's funny. In medieval times, people would leave their gold with goldsmiths, and the goldsmiths would hang on to it for them, as a favor or a marketing device or whatever, and give it back when they asked for it. (This part is true-ish.)

And then one day a local farmer came to a goldsmith and said, look, you've got all this gold lying around, can I borrow some of it to buy a horse and plow? Then I'll plow my field and make lots of money at next spring's harvest, and I'll pay you back the gold I borrowed with interest. You can keep the interest, and you'll be richer. And the people who left their gold with you will be none the wiser, because what are the odds that they'll all want their gold back at the same time between now and spring?

And the goldsmith said, no, absolutely not, that's so dumb, how can I trust that you'll pay me back? And if everyone did want their money back at the same time I'd be ruined and, like, beheaded, because remember we are in medieval times. And so fractional-reserve banking did not start.

And then the goldsmith's brother-in-law came to him and said, look, you've got all this gold lying around, can I borrow some of it to buy a horse and plow? And the goldsmith said, ehhhhhh. But then he said, well, I basically trust you, and I have to see you at family gatherings, and it'll be annoying if I say no, so, sure, have some gold, what's the worst that can happen, the small risk of beheading is better than the awkwardness of disappointing my brother-in-law. And so he loaned some gold to his brother-in-law, and the brother-in-law had a successful harvest and paid him back with interest, and after enough goldsmiths made enough successful loans to enough brothers-in-law, they realized that this could be a more general business open to the public, and so they started making loans to other people, and fractional-reserve banking did start.

And eventually there was banking regulation, and regulators told banks that they should only make prudent loans based on good security and careful underwriting. And regulators realized that it's probably not a good idea for a bank president to lend money to his brother-in-law; there are obvious conflicts of interest, obvious incentives for a bank president to make imprudent loans to his brother-in-law (to avoid awkwardness at family gatherings). And so there is a common norm in modern banking that related-party banking transactions are disfavored and heavily scrutinized, that the point of a bank is to take in deposits and lend money to strangers, not to relatives and affiliates of the bank. It is the opposite of how, in my completely pretend story, things started: Bank lending began because of the conflicts of interest engendered by related-party transactions, but in its fully developed form it is careful to try to avoid those conflicts.

I cannot emphasize enough that I have no reason to think that this is the actual history of fractional-reserve banking. But I write sometimes that the story of cryptocurrency is in large part a story about rediscovering traditional finance. And the story—one story, anyway—of how cryptocurrency discovered fractional-reserve banking looks a lot like what I made up above about goldsmiths.

It goes like this:

  1. There is a company called Tether that runs a stablecoin, called "Tether" or "USDT," which is a cryptocurrency whose value is pegged such that one USDT equals one U.S. dollar.
  2. The way Tether ran the peg was supposedly that it kept one dollar in a bank account for each USDT that it issued.
  3. For a while, this was approximately true. (It wasn't quite true, but for our purposes it was true enough.[2])
  4. Tether was affiliated with Bitfinex, a cryptocurrency exchange. Bitfinex also had to keep lots of U.S. dollars in its own accounts, dollars that customers deposited with it to buy crypto. 
  5. Bitfinex lost hundreds of millions of dollars of customer deposits due to some combination of (1) zealous regulators freezing crypto exchanges' bank accounts and/or (2) hilarious theft by an unscrupulous payment processor whom Bitfinex foolishly trusted with its money. (Unclear which, though the payment processor has been indicted.[3])
  6. Customers asked Bitfinex for their money back.
  7. Bitfinex thought, hmm, who will lend us hundreds of millions of dollars without asking too many uncomfortable questions about how we lost all this customer money?
  8. Oh, right, Tether, its affiliated stablecoin, which was run by the same people and which also had hundreds of millions of dollars in the bank.
  9. So Bitfinex asked Tether to borrow the money, and Tether agreed, because "Bitfinex" and "Tether" were largely overlapping groups of people.
  10. So Tether went from being backed one-for-one by U.S. dollars in a bank account to being backed one-for-one by a combination of (a) U.S. dollars in a bank account and (b) U.S.-dollar-denominated loans to its affiliate Bitfinex.
  11. Tether (eventually) changed its disclosure from "USDT in the market are fully backed by US dollars that are safely deposited in our bank accounts" to "[e]very tether is always 100% backed by our reserves, which include traditional currency and cash equivalents and, from time to time, may include other assets and receivables from loans made by Tether to third parties, which may include affiliated entities (collectively, 'reserves')."[4]
  12. I don't know if Tether has actually made any loans to third parties other than its affiliates (Bitfinex), but I guess now it's allowed to? Like, under that disclosure, it could make dollar-denominated loans to non-related parties? Maybe those loans will be safer than lending money to your affiliated crypto exchange that just lost a bunch of customer money?

Also, Tether is not subject to prudential banking regulation or anything, but it is sort of creeping a little bit in that direction. The reason I'm writing about Tether today is that in 2019 New York Attorney General Letitia James sued Tether and Bitfinex, alleging that all of this was fraud, and yesterday James announced a settlement of that case. Under the settlement, Tether and Bitfinex agreed to pay $18.5 million in penalties, stop trading with New Yorkers and, most interestingly, do a better job of disclosing their reserves:

Specifically, both Bitfinex and Tether will need to report, on a quarterly basis, that they are properly segregating corporate and client accounts, including segregation of government-issued and virtual currency trading accounts by company executives, as well as submit to mandatory reporting regarding transfers of assets between and among Bitfinex and Tether entities. Additionally, Tether must offer public disclosures, by category, of the assets backing tethers, including disclosure of any loans or receivables to or from affiliated entities.

Here is the settlement agreement. It is a fun read. We discussed the case in 2019, and covered many of the funny details of how Bitfinex lost a bunch of customer money and had to borrow from Tether, but yesterday's settlement fills in more details about how Bitfinex's money went missing:

In 2017 and 2018, Bitfinex began to increasingly rely on third-party "payment processors" to handle customer deposits and withdrawals from the Bitfinex trading platform. The primary entity Bitfinex used was a purportedly Panama-based entity known as Crypto Capital Corp. ("Crypto Capital").

An individual known as "Oz Yosef," or "Oz Joseph," or simply "Oz" was Bitfinex's point of contact at Crypto Capital.

By mid-2018, Crypto Capital held over $1 billion of funds that emanated from customer deposits at Bitfinex.

In May 2018, Bitfinex asked "Oz" how Bitfinex could "move money efficiently out of Cryptocapital." That request came on the heels of a report in April 2018 that the government of Poland had frozen a Crypto Capital bank account holding at least $340 million. In response, "Oz" repeatedly stated that the account freeze was temporary. In the ensuing months, "Oz" would go on to provide a number of different excuses for why he could not return the funds to Bitfinex (or its clients), including tax complications, hurdles placed by various compliance personnel at various banks, bankers being on vacation, typos in wire instructions, and corruption in the Polish government. 

Ah, yes, vacations, typos and corruption, the three great problems of finance. 

It is all quite tawdry and stupid, but in my stylized story that's just how banking begins, with tawdry and stupid related-party transactions; it doesn't have to end there. Now Tether is at least notionally in the business of, like, financing projects and underwriting loans and being a sort-of-bank, not because it wanted to get into that business but because its affiliate came to it for a loan and it couldn't say no. You've got to start somewhere.

How's GameStop doing?

It's a real company! Isn't that so weird? Imagine going to work at GameStop Corp.'s corporate headquarters and, like, discussing your plan to pivot from mall-based retailing of video games to an online-first model. You are the most famous company in the world, Congress is holding hearings about you to which you are not invited, the market's estimate of the discounted present value of your future cash flows has soared by 2,000% and then fallen by 900% over the course of a few weeks, and there you are, plugging away on the quarterly financial statements, debating the fine points of the online business plan, fixing typos in the board memo, not selling your hugely overpriced stock because you're in an earnings blackout.

Nothing that happened inside of GameStop (selling video games, thinking about better ways to sell video games, accounting, etc.) could possibly be half as weird as dozens of things that happened outside of, but somehow about, GameStop. There was a short squeeze and a gamma squeeze; a person named Roaring Kitty made millions, dipped chicken tenders in champagne, became a folk hero and testified before Congress; discount brokerage Robinhood had to raise billions of dollars to address a collateral crunch and faced renewed scrutiny over payment for order flow; Melvin Capital lost a fortune and had to take new money from other big hedge funds; U.S. stock settlement may move from T+2 to T+1 or even same-day; the foundations of financial capitalism were shaken; etc. etc. etc. etc. etc.; and there was GameStop, keeping its head down, doing its best to ignore all of this and sell video games.

Anyway the CFO is leaving:

GameStop Corp., the beleaguered video-game retailer whose shares soared and then collapsed in a trading frenzy this year, said Chief Financial Officer Jim Bell is resigning, effective next month.

The board and management pushed Bell out to make way for a new finance chief who shares their vision of transforming GameStop from a brick-and-mortar retailer into an e-commerce company, according to a person with knowledge of the situation who asked not to be identified. Bell didn't respond to a request for comment.

Yeah, look, a month of GameStop news has made me want to quit my job and go live in a cave; I cannot imagine what it would be like to be GameStop's CFO.

Nor can I imagine sharing the vision of transforming GameStop into an e-commerce company, not because I think it's impossible but because it seems so small and inadequate after the last month of GameStop news. "If we cut expenses by reducing rent and strike some smart partnerships with console makers to sell their games online, we could add as much as $5 per share to our stock value by 2023," you might write in the board presentation, after GameStop at one point added $120 to its stock price in 30 minutes and lost $370 in the next 90 minutes.[5]

I realize that some—not all, perhaps not most, but some—of the people who bought GameStop stock at outlandish valuations in the last few weeks expect that GameStop's future business performance will eventually justify those prices, that by hard, smart, careful work GameStop will transform itself into a successful online retailer worth $40 or $80 or $400 or $1,000 per share. But after already getting paid for that work—after the stock market rewarded GameStop in advance for pulling off that transformation with complete and brilliant success—it seems tedious to come into work every day and try to actually pull it off.

Bell will get severance that might be worth $30 million. I'm going to say he deserves it? "As CFO, took GameStop stock from $2.80 per share to $483," he can say on his resume, and it will sort of be true?

Euphemisms for "bribes"

Well, right, sure:

A former Glencore director said he used to fly the world carrying a bag full of cash to secure deals for the commodity trader, evidence of the industry's longstanding history of corruption, a problem it's still grappling with today.

"I used to go with 500,000 pounds to London," Paul Wyler who was one of Glencore's most senior executives and a board director until 2002, said in an interview for The World for Sale, a book on the history of the commodity trading industry.

In those days paying so-called "commissions" was both legal and even tax-deductible for a Swiss company, Wyler said, adding that Glencore's past as a private company -- it went public in 2011 -- had been helpful. "We had advantages if we wanted to pay commissions. So if we wanted to pay certain things, we didn't have to declare it in our annual report."

See, this is the difference between professional and amateur payers of bribes. Amateurs hide their bribes and refer to them by cute euphemisms; when they are caught, the fact that they called their bribes "chickens" or whatever makes it obvious that they knew what they were doing was wrong. Professionals are matter-of-fact about their bribes and refer to them by business-y euphemisms like "success fees" or "consultancy charges" or "goodwill payments" or "commissions." And then they deduct them on their tax returns. This serves two purposes:

  1. If later you are criticized for the bribes, you can say "no, see, these were just normal commissions, it's totally fine, you can tell because we reported them on our tax returns. We wouldn't have done that if they were illegal bribes, would we?"
  2. Lower taxes!

Things happen

Morgan Stanley Courts Startup Employees With Stock-Plan Deal. Puerto Rico Rides Muni-Bond Rally to Bankruptcy Deal. Trump's former treasury secretary expected to launch investment fund, seeking backing of Persian Gulf state funds. Italian mafia tightens grip on small businesses during lockdown. The Fight to Save the LME Ring Begins as Traders Warn on Pricing. Robinhood CEO Tells Portnoy Limits Prevented Liquidity Crunch. Robinhood CEO Criticizes 'Runaway Chain Reaction' of Short Sales. Panasonic's Nicobo is a pricey robot cat that farts whenever it feels like it. MSCHF's latest drop lets you control a Boston Dynamics robot with a paintball gun on its back. Long String Instrument. Arizona Man Is Accused of Faking Own Kidnapping to Evade Work.

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[1] A more accurate model would be that there's one giant public company, The Stock Market Inc., and then a bunch of smaller public companies that are controlled by their founders or a founding family or one big activist or whatever. So Facebook Inc., which answers only to Mark Zuckerberg, is not really a division of The Stock Market Inc. in the way that most public companies are. But I am not exactly striving for perfect accuracy here, with this model.

[2] In fact Tether had trouble getting bank accounts and for a long time kept its money in *Bitfinex's* bank accounts, which is a whole separate mess. See paragraphs 20, 21 and 29 of the New York settlement agreement.

[3] Paragraphs 30-47 of the New York settlement agreement cover the outlines of this story.

[4] I am quoting from paragraphs 42 and 45 of the New York settlement agreement. 

[5] That's the morning of Jan. 28, when GameStop went from $265 per share at 9:30 a.m. to $483 at 10 a.m., before falling to $112.25 at 11:24.
 

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