For those of you who don't receive his daily recap. We've put a few sections of it in Steemit form! All content courtesy of Matt Levine from Bloomberg. Hopefully you enjoy it as much as we do.
Market based finance.
The Trump Treasury Department has apparently decided that the term "shadow banking" is a slur and should be avoided:
Treasury prefers to transition to a different term, “market based finance.” Applying the term “shadow banking” to registered investment companies is particularly inappropriate as the word "shadow" could be interpreted as implying insufficient regulatory oversight, or disclosure. Registered investment companies, as described in this report, are regulated by the SEC and provide extensive public and regulatory transparency of fund portfolio holdings on a quarterly, monthly and, in some cases, daily basis
Look. I half get it. "Shadow banking" is a useful term. It means issuing short-dated information-insensitive money-like debt claims and using the proceeds to buy longer-dated risky assets -- doing the core maturity-transformation and risk-transformation functions of banking -- outside of a bank. So money market funds are pretty shadow-bank-y. "Structured investment vehicles" and "asset-backed commercial paper conduits" that issued short-dated money-like claims on pools of mortgage bonds before the financial crisis were quite shadow-bank-y.
On the other hand, there is no formal definition of "shadow banking," and it is sometimes used quite broadly and unhelpfully to apply to any non-bank doing anything that a bank might do. Lending to companies by private-equity firms for instance, is often called "shadow banking." Big asset managers are sometimes called "shadow banks" just for being big and finance-y. And it does sound pejorative. If I were BlackRock Inc., I'd be annoyed about being called a "shadow bank," and if I were Treasury I'd sympathize with that annoyance.
But "market based finance" is a far, far dumber term. "Market based finance" just sounds like it means, you know, market based finance -- any form of financing that is not bank loans. Bonds are market based finance. Stocks are market based finance. Asset-backed commercial paper conduits are market based finance. All financial things not done by banks -- and most financial things done by banks -- are market based finance.
But there's a reason that people talk about (core) shadow banking as a category: The particular thing that core shadow banks do, issuing money-like short-term instruments to fund the purchase of long-term assets, is risky, and it is risky in the specific way that banking is risky. All finance is "risky" in the sense that prices can do down, but banking and shadow banking are risky in the specific sense that they are subject to run risk: If depositors or quasi-depositors lose faith in the risky assets held by the bank or shadow bank, they will rush to cash out their (short-term, fixed-priced) holdings and create a self-fulfilling crisis.
This stuff is quite well understood, and the regulatory apparatus governing banks is specifically set up to address it. That apparatus is not about "extensive public and regulatory transparency" of holdings. (Bank holdings are not especially transparent, at least to the public.) It is about capital requirements and liquidity reserves and prudential regulation, and about deposit insurance and a lender of last resort. After the global financial crisis, commentators understood that shadow banks were subject to the same risks as banks, and that runs on shadow banks could cause financial crises. And regulators set to work thinking about how to apply bits of banking regulation -- capital requirements and prudential regulation and liquidity requirements and deposit insurance and access to the Fed -- to shadow banks. And this was a broadly sensible response to the actual risks of shadow banking, that had actually come true in a shadow-banking crisis.
But dropping the term and replacing it with "market based finance" hints at abandoning those efforts. "Market based finance" drops not just the "shadow" part of "shadow banking," but also the "banking" part: It ignores the maturity transformation effects of shadow banking, treating them as just incidental features of regular market transactions. And it suggests that the risks can be mitigated the way other market risks are mitigated, with disclosure and transparency. This did not work particularly well in the financial crisis, and it seems weird to ignore the lessons of the crisis just because the phrase "shadow bank" sounds rude.
Analysts and companies.
Here are a blog post and related paper by Ole-Kristian Hope, Zhongwei Huang and Rucsandra Moldovan, titled "Economic Consequences of Hiring Wall Street Analysts as Investor Relations Officers." That is of course a career path: If you are a Wall Street sell-side analyst writing research reports to help investors understand a company, you might end up getting hired by that company (or some other company) to help it explain itself to analysts and investors.
The authors describe the benefits to companies of hiring analysts to run investor relations. For one thing, they tend to improve the writing style of a company's disclosure -- making it less complex and more readable -- presumably because, if they weren't writing the disclosure, the lawyers would be.
But here are the real benefits:
Building and maintaining close relationships with financial analysts and institutional investors is a major focus of the IR function. Prior research shows that analyst coverage and institutional ownership are increasing in corporate disclosure, consistent with the notion that the effort analysts expend to analyze the firm is an important determinant of analyst coverage. An analyst has expertise in processing corporate disclosure and understands good-versus-bad disclosure practices from the perspective of investors. If a firm capitalizes on such expertise and deep understanding by hiring a former analyst as head of IR and reshapes corporate disclosure and the way the firm’s story is communicated, the investment community would likely incur lower costs to process corporate disclosure. Consistent with this line of thought, our findings show that firms attract more interest from analysts and institutional investors after hiring a former financial analyst as IRO. In particular, we find a significant increase in analyst following and an increase in the number of institutional owners.
The ex-analyst IR person knows the analysts who cover the company; they used to be her colleagues and competitors. She knows the investors who invest in the company; they used to be her clients. She knows what analysts want, and what investors want. When they call her to ask "hey can you help me with this bit of my model" or "hey can you give me more color on your margins" or "hey your competitor posted good revenue growth, should we assume your numbers are similar" or whatever, she will have the ability and inclination to be helpful.
We talk about those interactions a lot. Here are a few things we can say about them:
- They are useful to the investors who have them. That's why investors like to talk to companies: It gives them information that is useful to them in their trading. It gives them an advantage over investors who don't have those "close relationships" with corporate management.
- They are not supposed to be useful to investors. Or rather they are not supposed to be "material." Regulation FD prohibits companies from disclosing material nonpublic information to favored shareholders, without disclosing it to everyone. And yet these private meetings happen, and they seem to be useful, and almost never lead to Regulation FD enforcement.
- They are useful to the companies who have them. That is a result of Hope, Huang and Moldovan's paper: The IR officers' close relationships with analysts lead to more analyst and investor interest in the company and more liquidity in its stock. Those are things that the company could reasonably want, since they could lead to higher stock prices and easier financing terms.
- Every so often they lead to insider-trading charges: The IR officers cultivate such close relationships with analysts or investors, and give those analysts or investors such useful information, that prosecutors decide to characterize the information as a "tip" and the relationship as a "friendship" that creates a "personal benefit" for the IR officer.
- But those characterizations are, I think wrong. Instead, what I think happens is pretty much what Hope, Huang and Moldovan suggest. The job of the IR people is to cultivate relationships with investors, which they do in all the ways people normally cultivate business relationships: They give the investors useful business-y information, and they also ask about their personal lives and try to socialize together. This helps the investors' companies -- they get to buy stock with useful information -- and it helps the IR people's companies -- they get to cultivate loyal investors and have better access to financing. It is all very normal and business-y except that it is legally quite shadowy.