When it comes to fighting for a piece of the commission from a client’s big trade, Wall Street analysts are often unarmed.
That’s the view from
Brad Hintz, a former Lehman Brothers Holdings Inc. finance chief and
14-year financial analyst, who says a new chapter of the saga is
starting. As big banks overhaul how they produce and distribute
research-- using the Internet to limit access and track what gets read
-- they may finally see how much clients are willing to pay for
analysts’ work.
Hintz, now an adjunct professor of finance at New
York University’s Stern School of Business, shared his take on the
plight of analysts:
“This is
simply another chapter in the unending quest for revenue clarity in
institutional equity trading. When an institutional client executes a
trade in equities and generates commission revenue, everyone on the
floor claims his or her share. The equity block desk demands its
portion, since it has provided liquidity to the client. The derivatives
desk says ‘It’s mine’-- and points out the structured trade it recently
made for the client. The sales force points out the numerous sporting
events and lavish dinners that they provided the client. ‘We took ’em to
the U.S. Open.’ And even the quants ask for a cut, arguing that ‘their’
algos or ‘their’ dark pool are the true reasons the client is even
trading with the firm.
"Only the poor equity research staff has
nothing to prove that the commission dollar belongs to them. Research
management knows that the analysts meet with the institutional client
regularly, they know that the client’s portfolio managers are on their
research distribution list, but they cannot prove that their specific
research is being read -- or if read, acted on. Indeed, research
management relies on internal votes of client portfolio managers and the
voluntary self reporting by clients to judge the success of their
efforts.
"And this client reporting is not reliable. Research
management knows that during IPO booms, client research votes shift to
the largest underwriters and away from the rest of the Street. This
boosts a client firms’ ranking among the bulge-bracket firms and thus
allows an asset manager to capture a greater share of highly sought
after underwritings.
"And to make matters worse, only a minority
of hedge funds (which represent more than 30 percent of the total U.S.
commission pool) report research analyst usage at all. So research
management is always flying blind; measuring analyst effectiveness with
e-mail counts, telephone time logs, numbers of research calls written,
number of ‘actionable’ research calls written, number of travel days,
number of clients on conference calls and of course the annual
Institutional Investor rankings.
"It’s
not surprising that research shrinks and grows with the predictability
of a pendulum. ‘Clients don’t care; research costs us money’ goes the
mantra of investment banking. ‘Research is a leech on the compensation
pool’ is the familiar cry from traders at bonus time. But after each
decimation of research, contrite management teams decide that
fundamental research is part of the service that clients expect and the
department is rebuilt -- only to be put to the sword once again.
"Maybe this time, technology will finally provide the answer to that age-old question: ‘Whose commission dollar is this?’"
Wall Street Cracks Down on Free Sharing of Analysts' Notes
Wall
Street banks may have finally hit on a way to pinpoint the value of
analysts and squeeze more money from their research: Stop making it so
easy to share.
Bank of America Corp. has started embedding
analysts’ reports into web pages, so it can more easily restrict access
than with PDF files that are widely shared with people who aren’t paying
clients, said Candace Browning, the firm’s head of research. It’s joining rivals Morgan Stanley and
Citigroup Inc. in limiting access, and more plan to follow. The
approach also makes it easier to track analysts’ readership and
customize products for specific types of clients, according to bank
executives and consultants.
“The sell side for years has had a model where it blasts out everything it produces,” said
Michael Mayhew, founder of Integrity Research Associates LLC, which
helps investors find the research they need. “This is an absolutely
necessary next step because they have to understand what their customers
are consuming.”
The main
goal is to restore profitability to Wall Street research following a
slew of new regulations in the past 15 years, including rules spurred by
allegations that analysts touted stocks under pressure from investment
bankers. But it also may provide key data in a debate that erupts every
bonus season and job cull: How important, really, is analyst research to
winning trades and other deals?
‘Another Chapter’
“This is simply another chapter in the unending quest for revenue clarity in institutional equity trading,” said
Brad Hintz, a former chief financial officer of Lehman Brothers Holdings
Inc. who last year ended a 14-year career as an analyst. Traders often
win the credit for generating commissions on transactions that analysts
feel they deserve, he said. “Maybe this time, technology will finally
provide the answer to that age-old question: ‘Whose commission dollar is
this?’”
(For Hintz’s full portrayal of the fight over commissions, click here.)
The
first big hit to modern stock research came in a 2000 rule requiring
companies to disclose material information to all investors at once,
making it harder for analysts to break market-moving news. Then a
scandal led to the 2003 walling off of analysts from investment bankers,
who sometimes pressed them to tout clients’ stocks. A third obstacle is
unfolding, as regulators in Europe are considering ending the
commission-based model, the industry standard which compensates banks
for research with a share of an investment firm’s trading revenue.
Eliminating Analysts
The
developments have prompted many firms to eliminate analysts. Also
frustrating for executives is that a lot of research ends up in some
form on Internet platforms such as Twitter minutes after release.
Banks
and brokerages will spend $3.4 billion on their research analysts
around the world in 2017, down by more than half from $8.2 billion in
2008, according to Neil Scarth, a principal at Frost Consulting in
London. That doesn’t include costs for technology, sales and other
methods of distribution.
Money
managers cut the amount they spend on commissions by about 26 percent
after the 2008 financial crisis to $22.7 billion last year, according to
Greenwich Associates, a Stamford, Connecticut-based consulting firm.
Between 55 percent and 60 percent of those fees typically go to research
each year.
Bloomberg News parent Bloomberg LP also offers research products through its Bloomberg Intelligence division.
Old Habits
Investors
consume almost two-thirds of research via e-mail, according to a bank
executive who studies readership patterns and asked not to be identified
talking about proprietary data. Most others get it from platforms such
as those run by Bloomberg or Thomson Reuters Corp. that provide access
to reports from multiple brokers. Bank websites account for less than 10
percent of consumption.
While the web technology is hardly new,
banks have been slow to take full advantage of it for analysts’ notes.
Investors will still access research the same way -- through an e-mailed
link or a company website -- but what they see will change. Instead of a
PDF that could be viewed, downloaded or shared with others, they’ll be
directed to a secure Web page.
Bank of America has been tracking
clients’ habits for years through e-mails and a website where customers
can see and download reports. But it doesn’t know what happens after
they save them. Under the new system, clients must access a site to view
material that stays there, much as they would peruse a favorite
newspaper behind a paywall, according to Daire Browne, Bank of America’s
chief operating officer for global research. The pages are more dynamic
than a PDF and will have more security, making them harder to
recirculate, he said.
“You’re not accessing a static PDF, you’re
going into a website and you are authenticating,” Browne said. “That’s
the whole premise here, that you have a greater ability to control the
access coming in when it’s a living, breathing environment that we
control.”
At Citigroup, clients receive an e-mail with just a few
sentences about a report. Clicking a link takes them to a website where
they can sign in to read the rest. This lets the firm track how many
times a report has been viewed, how often clients access the system and
which analysts are most popular. The system was put in place within the
past year.
Guessing Trades
At least one money manager who
asked not to be identified said he isn’t thrilled about being monitored.
He said he’s concerned that banks might figure out his trades based on
what he’s reading. Bank of America doesn’t zero in on what individuals
view and looks only at aggregate data, according to Browne. Spokeswomen
for Citigroup and Morgan Stanley declined to comment.
Banks
also are fighting internal resistance. Analysts and sales staff have for
years made it as easy as possible for clients to get reports, according
to Mayhew. Until firms can persuade employees to change behavior, or
prohibit PDF attachments, it will be difficult to prevent sharing, he
said.
The next step, still to come for most banks, is to customize
offerings to specific clients. Citigroup, Morgan Stanley and others are
part of a group that has come up with a coding language intended to
make it easier to search reports. Banks also may tailor the reports to,
say, macro traders or stock buyers by adding or subtracting components
they find most valuable such as charts or models, according to a bank
executive.
“Over time, there is a prospect of premium prices,” Frost’s Scarth said.
‘Competitive Advantage’
Firms
also are rethinking long-accepted practices of tracking client
conversations with analysts, as well as attendance at bank-sponsored
conferences and meetings with management. UBS Group AG, for example, is
considering the amount of time spent with analysts in a model that
assigns a higher value to a 30-minute phone call than one lasting 10
minutes, according to a person familiar with the Zurich-based bank’s
policies.
“The fact is there is a lot of stuff produced by Wall
Street that probably nobody would pay for,” Scarth said. “This should,
in theory, force all research producers to specialize in areas where
they really do have a competitive advantage.”
I think history will show that the result is a massive misallocation of capital.
With central banks driving down interest rates, savers and investors saw their incomes reduced. The losses they incurred limited their ability to invest in business startups. While we all celebrate Silicon Valley and the venture capital business, the reality is that most small businesses are not started with venture capital but with personal savings and investments or loans from friends and family. When you reduce the amount of money available on Main Street, it should be no surprise that you get fewer new business startups. In fact, for the first time in the history of this country, we are seeing more businesses close than are started. The Federal Reserve would contend that low rates make the cost of money lower, but very few new businesses get started with just bank loans from a small community bank.
I am shocked at the amount of money that banks will lend me today. I truly am. But back in 1977 at the tender age of 28, all I could get was $10,000 for inventory. And I paid 18% interest. Well, there is an example of a bank lending to small business. Except I later found out they really didn’t. My mother went to them and guaranteed the loan without telling me. Otherwise, I was just some kid with a business idea. It was literally friends and family at the beginning, after all.
How many great ideas died in the last decade for lack of funding? I think the answer would startle us. I’ll bet some of them would have boosted productivity enough to get GDP to that 4% Jeb Bush thinks would be wonderful.
Instead of going to the people and businesses who could have made best use of it, all that money simply drove asset prices higher – mainly stocks and real estate.
Financial engineering became the mantra of the day. It is now cheaper to buy your competition than it is to actually invest in equipment or people and compete with rivals. Or you can borrow money cheaply to buy back your own stock, thus engineering increased profits per share and bonuses for management all around.
Meanwhile, the Obama administration and Congress gave us financial regulations (Dodd-Frank) that drove a lot of innovation out of public markets and into Silicon Valley’s private ventures. This is certainly spurring innovation – but innovative people elsewhere still struggle to raise capital.
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Moreover, there is a growing consensus among commodity bears that the
boom-bust commodity cycle was a natural consequence of the past several
decades of rapid liquidity growth and excessive debt accumulation.
It is important to note that accentuated commodity boom supercycles that
deviate greatly from their physical fundamentals are not possible
without a permissive monetary environment. Indeed, supercycles have
their origins in reflationary monetary conditions and are fueled by
negative real interest rates or excess liquidity growth.
The fact that reflationary monetary measures were left in place for such
a long time aggravated the problem, since they fueled a powerful
debt-financed consumption and investment boom that eventually became
unsustainable. The reflationary measures did succeed in igniting global
recoveries in 2003 and 2009, but they also created new asset bubbles. In
particular, they set the stage for the increasing “financialization” of
commodity markets. Indeed, the growing participation of financial
market investors in commodity trade likely contributed to the excessive
rise in prices during the boom, worsening the subsequent bust.
For some commodities, such as iron ore and aluminum, abundant capacity
will likely ensure downward pressure on prices for some years.
So the odds are that commodity prices will remain relatively flat,
rather than recover strongly, for at least several years. Indeed, IHS
believes commodity prices will not regain their early 2014 levels for
the rest of this decade.
The economies that have benefited most from the lower prices are those that are primarily manufacturing or service oriented
only three major net commodity exporters that are advanced
economies—Australia, Canada, and Norway. These three countries had
benefited immensely from the booming commodity prices during the last
decade and a half, but they are now facing a very challenging period of
austerity that will likely last several years
The biggest losers at the end of the supercycle are the developing
countries that earn most of their foreign exchange inflows from exports
of energy and/or minerals—in other words, most countries in the Middle
East, Africa, and South America, as well as some in Asia. The economic
situation of these countries has already deteriorated rapidly since
2014, and their prospects are expected to remain negative as long as
commodity prices remain depressed.
China’s ascension to the World Trade Organization (WTO) in December
2001 was a watershed event, without which the supercycle might not have
been possible. At a minimum, the cycle’s amplitude and duration would
probably have been far smaller. WTO membership not only boosted
tremendously China’s exports to the rest of the world, but also
attracted huge volumes of foreign direct investment (FDI) into the
country’s manufacturing sectors. These, in turn, led to vast amounts of
domestic capital being invested in precisely those industries that are
intense users of energy and raw materials.
The domestic investment binge, which was easily financed by the
Chinese people’s excessive savings, generated an insatiable appetite for
energy and raw materials during the last decade. Indeed, not only did
levels of physical consumption of commodities rise, but the rate of
their growth accelerated as well. It was this acceleration that started
to strain commodity markets and pushed prices progressively higher—far
above previous nominal cyclical peaks. Commodity prices roughly doubled
between 2002 and 2004. They doubled again between 2004 and early 2008,
before crashing during the Great Recession’s global credit crunch.
If so, then the potential for negative feedback loops is high for, as growth
falls, the ex-post returns on the ‘financial borrowings’ will not be as high
as expected. And if, for whatever reason, interest rates then start to rise
(as they have lately been doing) then in a world in which the amount of
debt remains fixed, falling returns combined with rising servicing costs,
will mean that ‘somebody’ will have to eat an adjustment. That somebody
can be ‘capital’ (through a debt restructuring) though, more often than
not, the first port of call will be ‘labor’. Financial pressures will lead to
people being fired while remaining employees will be on the receiving
end of what was nothing but an attempt to get rich without working, by
capturing an undue rent created by the wrong cost of capital.
In other words, excessively low real rates seem to lead to rent seekers
(those close to the issue of new money) gorging themselves by bidding
on other people’s businesses and, then turning around when these assets
do not perform as expected and firing the employees. If this is the case,
then because zero interest rates trigger capital and labor misallocation,
we could perhaps conclude that they also end up being responsible for
a lower structural growth rate and a higher level of uncertainty for the
workforce (hence a fall in consumption, consumer confidence, birth
rates, etc.). This is how well-meaning central bankers and their zero
interest rate policies end up generating higher structural unemployment
rates, falling median incomes, and a huge increase in part time jobs.
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In the early 1990s I know that I went through a number of books and articles on the mathematics of feedback processes, Cedric, but my memory has never been very good and I cannot remember titles. You might want to do searches on words like “reflexivity”, “feedback”, and “pro-cyclical” and see what you get. One suggestion however: if you are interested in this topic mainly because you want to improve your understanding of finance and economics, you probably should focus on trying to understand as intuitively as possible the basic mathematics of how these things work, and not worry too much about taking the mathematics too far. Usually, as these feedback processes occur in the real world, we simply don’t have data with high enough levels of precision for us to do very sophisticated modelling and, more importantly, the ways these processes occur can be so complex and with so many moving parts that it is hard enough just to see all the relevant mechanisms, let alone model them accurately. But once you get the basic intuition of how feedback mechanisms work, both positive feedback in which volatility is exacerbated and negative feedback in which it is muted, you will start to see them everywhere.
My second suggestion is on how you incorporate them into your thinking. We know that increasing or reducing volatility affects value, partly because we value stability, of course, but also because there are “breaking points” at which the changes in value are discontinuous. To put it in a less abstract example, if I have assets and debt, and the value of one or both sides of my balance sheet is volatile, the range of outcomes when my assets are worth more than my liabilities might be very different from the range of outcomes when my assets are worth less than my liabilities. As you know almost any time there is a sharp discontinuity, which I call “a kink in the payout curve” in my classes, you can probably find one or more implied options buried in there. This means that you can model the impact of volatility on changes in value by using basic option theory, although once again these are complex “options” with many moving parts (and usually with no specified expiry date) and so there is little additional value in applying option theory much beyond the basics.
If you train yourself to identify feedback mechanisms and implied options, I promise you will find them everywhere, and they will, I think, profoundly improve your ability to understand the economy as a system. Because so few economists seem to think this way, it will be to your great advantage if you do and you can find yourself making predictions that seem crazy to most people but almost inevitable to you. But the key, and this is probably true much more widely, is to get a deep and intuitive understanding of the basics (feedback loops, options, and probability theory) and not worry too much about knowing the advanced stuff. This may seem like a strange thing to say, but it is much, much easier to find people who understand the advanced stuff than it is to find people who understand the basic stuff intuitively.
I am not sure you can design “just right” growth. Perhaps you can in principle design a system of incentives such that businesses and individuals are more likely to take advantage of existing resources in the most productive way, and this must include financing mechanisms and property rights that maximize the social value of intellectual and physical property while at the same time maximizing incentives to create more productive intellectual and physical property. Some people argue that this means effectively creating the ideal Adam-Smith economy of an infinite number of competitive agents who are free to innovate, none of whom, including the government, are important enough to create institutional distortions. But you quickly realize that these are mutually contradictory goals: Eliminate all institutional distortions and you eliminate the ability to enforce property rights, and while this might increase the value of the some or most of the existing stock of assets, it would also probably reduce the future value of assets by, among other things, reducing innovation and investment aimed at improving capital stock. Eliminate all institutional distortions and you also eliminate rules that prevent businesses from lying or otherwise taking advantage of credibility generated by someone else, and if you reply that requiring total transparency might solve this problem, then you need an agent powerful enough to enforce transparency. Eliminate all institutional distortions and you make it impossible, or at least much harder, to protect commonwealth assets or to invest in projects that create externalities that are greater than the ability to capture those externalities — for example it is hard to capture the full social value of creating a first-rate primary education system, or enforcing an optimal pricing structure in any industry with returns to scale.
But once you agree that certain institutional distortions are good for long term value creation then you face the problem that the economy is a dynamic system with strong learning capacity, so that even if you could design the optimal set of institutional distortions, it would almost immediately become sub-optimal as the economy adapted and developed. This brings us back to Minsky when we think of the financial sector. The optimal financial sector must allow for enough value destruction to impose discipline, but not too much, and as the economy evolves from the agricultural economy of mid-19th-century California or the industrial economy of mid-19th Century New York to the information economy of early 21st century California or the creative/design economy of early 21st Century New York, is it even conceivable that the financial system that created the optimal amount of value destruction for the former will also create the optimal amount for the latter?
I will not even pretend that I know the answer, but remember that while there are clearly advantages to economic stability, and we know the many ways in which economic and financial instability can be extremely damaging to wealth creation, on the other hand in the past two centuries the periods of greatest technological innovation were almost always also periods of financial excess, asset bubbles, and foolish capital misallocation, and there is some evidence that from the Renaissance onwards, the fastest growing countries and regions in Europe and North America were never those that enjoyed the most stable financial sectors or even the most stable currency systems, but were in fact countries or regions that were relatively poorly served by their financial and monetary systems (for example few have been able to explain why the US was the most astonishingly productive country in a period of great economic advances for Europe and North America even though the US probably had the most unstable financial sector of any major rich country and a currency system that barely functioned to maintain the value of savings, and this outperforming economy and under-performing financial and monetary system held even against British colonies that were similarly endowed socially, legally, culturally, and physically, like Canada and Australia).
Many fear that the current deflation outbreak will turn into a “vicious circle of deflation,” in which consumption is postponed and investment plans are curtailed in anticipation of lower prices. These behaviors contribute to a further drop in demand and additional reductions in prices. Deflation is misunderstood The first part is correct "Consumption is postponed and investment plans curtailed" but is it 1) in anticipation of lower prices 2) in anticipation of job losses, not getting social security payment, not saving enough for retirement there are very different explanations for consumer behavior here. One claims that future liabilities (expenses) will be lower if I wait, the other is based off expectations of future cash flow from my assets (in essence I've written down my social security assets and goodwill and must increase savings, lower expenses to meet future spending). And is it really only fear itself and something far fetched or is it something that happens all the time all over the world? Take what's being asked of the Greeks and their 'secure' retirement funds:
“Pensions should not be higher of 53% of the salary due to the financial situation of the social security funds.”
Pension for a civil servant (director, 37 years of work) should come down to €900 from €1,386 today after the pension cuts during the austerity years.
Pension for private sector – IKA insurer (37 years of work, 11,000 IKA stamps) and salary €2,300 should come down to €1,250 from €1,452 today after the austerity cuts. (examples* via here)
Of course, with the PSI in March 2012, Greece’s social security funds suffered a huge slap in their deposits in Greek bonds.
There's no confidence that the future will provide sufficient opportunities, there's no hope of a brighter tomorrow. The most powerful country the world has ever seen, slouched over on its mound of treasures, angry, divided and hopeless. I agree with someone at the FED? “If consumer behaviour is still being impacted by the experience of the financial crisis, the Great Recession, and the painfully slow recovery, then it is possible that the economy will not be as robust as many economic models would suggest, because the models do not take into account this behavioural change,” Eric Rosengren said. How do you inspire confidence in the future? How does one unite a divided country and steer it towards a common productive goal? What has been the most effective way to redistribute wealth and lower inequality? What can bring back millions of manufacturing jobs in less than a year? War...preferably between nations with great wealth that will purchase from the US, a repeat of WW2. perhaps SE Asia, Japan vs China? Maybe Saudi Arabia vs Iran? Maybe Europe vs Russia? the possibilities are endless. The change in mindset (across the populace and as reflected in our congress, senate and white house) and wealth redistribution are the hardest tasks to accomplish and have a longer impact than the war itself.
Buybacks in US “Buybacks have been a tremendous support for US equities,” says Orrin Sharp-Pierson, a strategist at BNP Paribas. Referencing the efforts of aggressive central bank policy, he adds: “It’s been like quantitative easing directly on equities, $40bn-$50bn per month. Companies have been a key source of support in recent years as investors have stepped back from buying equities. Since the start of 2010, companies have spent $3.3tn on share buybacks and dividends, as the US economy has recovered and investors sought blue-chip names with stable and growing returns.
Over the past five years, US investors have poured $301.5bn into domestic equity exchange traded funds, data from XTF.com shows. However, with redemptions of $411.1bn from US stock mutual funds over the same period, there has been a shortfall of more than $100bn between the two, according to the Investment Company Institute.
Negative Bond Yields in Europe via QE Negative bond yields cause the value of liabilities to balloon and the adverse impact on thepension fund’s solvency will tend to outweigh any benefit from QE on the value of the asset.
The risk is that cheap borrowing will finance suboptimal investments, whether in fixed assets or expensive share buybacks in a frothy equity market. At the same time the debtors’ paradise keeps zombie banks afloat and allows them to roll over the debts of zombie companies. That in turn holds back productivity growth.
"Higher yet than the love of human beings I esteem the love of things and ghosts. This ghost that runs after you, my brother, is more beautiful than you; why do you not give him your flesh and your bones? " - Nietzsche This ghost that runs after me, My brother, has caught me My flesh and bones, my daughter You are beyond me, more beautiful An evolution and a leap ahead Still warm from the blaze of the eternal Zlatica defying the Fates Ascending from the realm of the impossible From ghost to flesh
Hours from the greatest country on earth
The streets of my youth will forever be memories
I am banished and excommunicated in modern times
I have no political enemy, the city itself warns me
Plagued with faceless, warped and savage brothers
Never to hold my grandmother again
Or to introduce her to her grand-daughter
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