Posts Tagged ‘risk’
“Risk comes from not knowing what you’re doing”*…
In a follow-on (in a fashion) to an (R)D earlier this month on financialization and gambling, Liz Hoffman on the striking changes underway in the financial sector…
Wall Street is starting to look a bit like a stage drama where nobody is playing the part that casting assigned.
To build a giant Louisiana data center, Meta raised $29 billion in equity from Blue Owl (a firm known for private credit) and private credit from PIMCO (a firm known for public bonds). Google has piles of cash and a red-hot stock, but is instead bringing its pristine credit rating to the deal table, backstopping crypto miners. The $7 billion that KKR and Apollo are putting into Keurig Dr Pepper is “equity” in the sense that it will help KDP reduce its debt load. But it isn’t coming from their traditional PE funds.
You think companies are built with equity and debt? That’s cute, today’s masters of the universe will chuckle while patting your head.
What used to be called simply “investing” or “lending” has been replaced by “capital solutions” — hybrid equity, kickers, and cash flows tailored to match the returns promised to investors on the other side. Growing pots of money now resemble liquid sand, moldable into whatever shape will fit the money hole in front of it. This shift has been obscured by narratives, overcooked in my view, about a battle between private credit and banks: “There’s one system,” Goldman Sachs President John Waldron told me a few weeks ago, and it’s changing quickly.
Goldman reorganized itself along these lines earlier this year… Apollo, one of the original private-equity firms, is now 80% credit… and firms from Chicago buyout shops to Middle Eastern sovereign wealth funds have launched “capital solutions” arms. Lawyers are jumping in downstream.
Prioritizing what companies actually need over whatever widgets Wall Street happens to sell is good customer service. Personal wealth management got a lot better when firms started asking “how much do you need to retire?” instead of “would you like to buy this structured note?”
And the rise of insurance money in investing has created patient capital that in many cases fits those money holes better than blunter instruments. Much of KKR and Apollo’s Keurig investment will end up in their insurance arms, backed by long-term contracts with the coffee-pod maker, people familiar with the matter said.
But flexible capital will almost certainly overflex, and not everyone with “go-anywhere” money should go anywhere. I suspect that before this cycle is over, we’ll see a few instances that leave everyone asking, “why did they own that?”… Sometimes “capital solutions” just code for investing in distressed companies, which is nothing if not a capital problem in search of a solution, trade publication Private Debt Investor wrote…
“What Wall Street’s obsession with ‘capital solutions’ tells us,” from @semafor.com.
[Image above: source]
* Warren Buffett
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As we go back to basics, we might note that it’s International Accounting Day– a celebration of the field on this date each year that commemorates the publication of Luca Pacioli’s seminal work, Summa de Arithmetica, Geometria, Proportioni et Proportionalita, in 1494, which introduced the double-entry bookkeeping system—a foundational element of modern accounting.
“We use the term risk all too casually, and the term uncertainty all too rarely”*…
How private-equity giants are overhauling the financial system, and its potential impact on pensions…
A decade or so ago private equity was a niche corner of finance; today it is a vast enterprise in its own right. Having grabbed business and prestige from banks, private-equity firms manage $12trn of assets globally, are worth more than $500bn on America’s stockmarket and have their pick of Wall Street’s top talent. Whereas America’s listed banks are worth little more than they were before the pandemic, its listed private-equity firms are worth about twice as much. The biggest, Blackstone, is more valuable than either Goldman Sachs or Morgan Stanley—and has the confidence of a winner. “It’s the alternatives era,” proclaimed the company’s ebullient Taylor Swift-themed festive video in December. “We buy assets then we make ’em better.”
This is not, though, the business that has recently boomed for them. Traditional private equity—using lots of debt to buy companies, improving them, and selling or listing them—has been lifeless. High interest rates have cast doubt on the value of privately held companies and reduced investors’ willingness to provide new funds. It does not seem to matter. Core private-equity activity is now just one part of the industry’s terrain, which includes infrastructure, property and loans made directly to companies, all under the broad label of “private assets”. Here the empire-building continues. Most recently, as we report this week, the industry is swallowing up life insurers.
All of the three kings of private equity—Apollo, Blackstone and KKR—have bought insurers or taken minority stakes in them in exchange for managing their assets. Smaller firms are following suit. The insurers are not portfolio investments, destined to be sold for a profit. Instead they are prized for their vast balance-sheets, which are a new source of funding.
Judged by the fundamentals, the strategy makes sense. Insurance firms invest over long periods to fund payouts, including annuities sold to pensioners. They have traditionally bought lots of government and corporate bonds that are traded on public markets. Firms like Apollo can instead knowledgeably move their portfolios into the higher-yielding private investments in which they specialise. A higher rate of return should mean a better deal for customers. And because insurers’ liabilities stretch years into the future, the finance they provide is patient. In banking, long-term loans are funded with lots of instantly accessible deposits; with private assets and insurance, the duration of the assets matches the duration of the liabilities.
Yet the strategy brings risks—and not just to the firms. Pension promises matter to society. Implicitly or explicitly, the taxpayer backstops insurance to some degree, and regulators enforce minimum capital requirements so that insurers can withstand losses. Yet judging the safety-buffers of a firm stuffed with illiquid private assets is hard, because its losses are not apparent from movements in financial markets. And in a crisis insurance policyholders may sometimes flee as they seek to get out some of their money even if that entails a financial penalty. Last year an Italian insurer suffered just such a bank-run-like meltdown…
Funding pension providers with private equity: “The risks to global finance from private equity’s insurance binge” (gift article) from @TheEconomist.
And lest we think that publicly-funded defined benefit pensions are less risky, see “Akin to Fraud” by Mary Willliams Walsh, an account of the sorry state of the public pension fund in New Hampshire (the state with the second-oldest population in the nation).
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As we rethink retirement, we might recall that it was on this date in 1728 that John Gay‘s The Beggar’s Opera premiered. A “ballad opera” (a satirical work with lyrics set to vernacular music), it was a huge hit– it has been called “the most popular play of the eighteenth century“– a watershed in Augustan drama.
The original idea of the opera came from Jonathan Swift, who wrote to Alexander Pope in 1716 asking “…what think you, of a Newgate pastoral among the thieves and whores there?” Their friend, Gay, decided that it would be a satire rather than a pastoral opera.
In 1928, Bertolt Brecht (working from a translation into German by Elisabeth Hauptmann) adapted the work into Die Dreigroschenoper (The Threepenny Opera) in 1928, sticking closely to the original plot and characters but with a new libretto, and mostly new music by Kurt Weill.
“Humanity is acquiring all the right technology for all the wrong reasons”*…
Further to yesterday’s post on the poverty created by manufacturing displacement, and in the wake of the sturm und drang occasioned by the coup at OpenAI, the estimable Rana Foroohar on the politics of AI…
… Consider that current politics in the developed world — from the rise of Donald Trump to the growth of far right and far left politics in Europe — stem in large part from disruptions to the industrial workforce due to technology and globalisation. The hollowing out of manufacturing work led to more populist and fractious politics, as countries tried (and often failed) to balance the needs of the global marketplace with those of voters.
Now consider that this past summer, the OECD warned that white-collar, skilled labour representing about a third of the workforce in the US and other rich countries is most at risk from disruption by AI. We are already seeing this happen in office work — with women and Asians particularly at risk since they hold a disproportionate amount of roles in question. As our colleague John Burn-Murdoch has charted [image above], online freelancers are especially vulnerable.
So, what happens when you add more than three times as many workers, in new subgroups, to the cauldron of angry white men that have seen their jobs automated or outsourced in recent decades? Nothing good. I’m always struck when CEOs like Elon Musk proclaim that we are headed towards a world without work as if this is a good thing. As academics like Angus Deaton and Anne Case have laid out for some time now, a world without work very often leads to “deaths of despair,” broken families, and all sorts of social and political ills.
Now, to be fair, Goldman Sachs has estimated that the productivity impact of AI could double the recent rate — mirroring the impact of the PC revolution. This would lead to major growth which could, if widely shared, do everything from cut child poverty to reduce our burgeoning deficit.
But that’s only if it’s shared. And the historical trend lines for technology aren’t good in that sense — technology often widens wealth disparities before labour movements and government regulation equalise things. (Think about the turn of the 20th century, up until the 1930s). But the depth and breadth of AI disruption may well cause unprecedented levels of global labour displacement and political unrest.
I am getting more and more worried that this is where we may be heading. Consider this new National Bureau of Economic Research working paper, which analyses why AI will be as transformative as the industrial revolution. It also predicts, however, that there is a very good chance that it lowers the labour share radically, even pushing it to zero, in lieu of policies that prevent this (the wonderful Daron Acemoglu and Simon Johnson make similar points, and lay out the history of such tech transformation in their book Power and Progress…
We can’t educate ourselves out of this problem fast enough (or perhaps at all). We also can’t count on universal basic income to fix everything, no matter how generous it could be, because people simply need work to function (as Freud said, it’s all about work and love). Economists and political scientists have been pondering the existential risks of AI — from nuclear war to a pandemic — for years. But I wonder if the real existential crisis isn’t a massive crisis of meaning, and the resulting politics of despair, as work is displaced faster than we can fix the problem…
Everyone’s worried about AI, but are we worried about the right thing? “The politics of AI,” from @RanaForoohar in @FT.
See also: Henry Farrell‘s “What OpenAI shares with Scientology” (“strange beliefs, fights over money, and bad science fiction”) and Dave Karpf‘s “On OpenAI: Let Them Fight.” (“It’s chaos… And that’s a good thing.”)
For a different point-of-view, see: “OpenAI and the Biggest Threat in the History of Humanity,” from Tomás Pueyo.
And for deep background, read Benjamin Labatut‘s remarkable The MANIAC.
* R. Buckminster Fuller
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As we equilibrate, we might recall that it was on this date in 1874 that electrical engineer, inventor, and physicist Ferdinand Braun published a paper in the Annalen der Physik und Chemie describing his discovery of the electrical rectifier effect, the original practical semiconductor device.
(Braun is better known for his contributions to the development of radio and television technology: he shared the 1909 Nobel Prize in Physics with Guglielmo Marconi “for their contributions to the development of wireless telegraphy” (Braun invented the crystal tuner and the phased-array antenna); was a founder of Telefunken, one of the pioneering communications and television companies; and (as the builder of the first cathode ray tube) has been called the “father of television” (shared with inventors like Paul Gottlieb Nipkow).
“Everywhere is walking distance if you have the time”*…
Sara Walker and Lee Cronin suggest that time is not a backdrop, nor an illusion, nor an emergent phenomenon; rather, they suggest in an essay from The Santa Fe Institute, it has a physical size that can be measured in laboratories……
A timeless universe is hard to imagine, but not because time is a technically complex or philosophically elusive concept. There is a more structural reason: imagining timelessness requires time to pass. Even when you try to imagine its absence, you sense it moving as your thoughts shift, your heart pumps blood to your brain, and images, sounds and smells move around you. The thing that is time never seems to stop. You may even feel woven into its ever-moving fabric as you experience the Universe coming together and apart. But is that how time really works?
According to Albert Einstein, our experience of the past, present and future is nothing more than ‘a stubbornly persistent illusion’. According to Isaac Newton, time is nothing more than backdrop, outside of life. And according to the laws of thermodynamics, time is nothing more than entropy and heat. In the history of modern physics, there has never been a widely accepted theory in which a moving, directional sense of time is fundamental. Many of our most basic descriptions of nature – from the laws of movement to the properties of molecules and matter – seem to exist in a universe where time doesn’t really pass. However, recent research across a variety of fields suggests that the movement of time might be more important than most physicists had once assumed.
A new form of physics called assembly theory suggests that a moving, directional sense of time is real and fundamental. It suggests that the complex objects in our Universe that have been made by life, including microbes, computers and cities, do not exist outside of time: they are impossible without the movement of time. From this perspective, the passing of time is not only intrinsic to the evolution of life or our experience of the Universe. It is also the ever-moving material fabric of the Universe itself. Time is an object. It has a physical size, like space. And it can be measured at a molecular level in laboratories.
The unification of time and space radically changed the trajectory of physics in the 20th century. It opened new possibilities for how we think about reality. What could the unification of time and matter do in our century? What happens when time is an object?…
Find out at: “Time is an object,” by @Sara_Imari and @leecronin, from @sfiscience in @aeonmag.
Apposite: “The New Thermodynamic Understanding of Clocks.”
* Steven Wright
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As we contemplate chronology, we might recall that it was on this date in 1947 that the Doomsday Clock appeared for the first time (as the fourth quadrant of a clock face with its hands at 7 minutes to midnight) as the background image on the cover of the June issue of the Bulletin of the Atomic Scientists. From then to the present, the Doomsday Clock image has been on the cover of the Bulletin, though the hands over the years have been shown moving forward or back to convey how close humanity is to catastrophic destruction (midnight).
The clock currently stands at 90 seconds to midnight.
[HBD, GC(S)]
“Location, location, location”*…
Adam Tooze on the biggest vulnerability in the global economy…
In this precarious moment – in the fourth quarter of 2022, two years into the recovery from COVID – of all the forces driving towards an abrupt and disruptive global slowdown, by far the largest is the threat of a global housing shock…
In the global economy there are three really large asset classes: the equities issued by corporations ($109 trillion); the debt securities issued by corporations and governments ($123 trillion); and real estate, which is dominated by residential real estate, valued worldwide at $258 trillion. Commercial real estate ($32.6 trillion) and agricultural land add another $68 trillion. If economic news were reported more sensibly, indices of global real estate would figure every day alongside the S&P500 and the Nasdaq. The surge in global house prices in 2019-2021 added tens of trillions to measured global wealth. If that unwinds it will deliver a huge recessionary shock.
In regional terms, as a first approximation, think of global real estate assets as split four ways, with the US, China and the EU each accounting for c. 20-22 percent and 35 percent or so belonging to the rest of the world.
The housing complex is at the heart of the capitalist economy. Construction is a major industry worldwide. It is one of the classic drivers of the business-cycle. But beyond the constructive industry itself, the influence of housing as an asset class is pervasive. Compared to equities or debt securities, residential real estate is owned in a relatively decentralized way. Homeownership defines the middle class. And for the majority of households in that class, those with any measurable net worth, the home is the main marketable asset.
Middle-class households are for the most part undiversified and unhedged speculators in one asset, their home. Furthermore, since homes are the only asset that most households can use as collateral, they pile on leverage. For households, as for firms, leverage promises outsized gains, but also brings with it serious risks in the event of a downturn. Mortgage and rental payments are generally the largest single item in household budgets. And household spending, which accounts for 60 percent of GDP in a typical OECD member, is also responsive to perceived household wealth and thus to home equity – the balance between home prices and the mortgages secured on it. For all of these reasons, a surge in mortgage rates and/or a slump in house prices is a very big deal for the world economy and for society more generally…
More background and an assessment of the outlook: “The global housing downturn,” from @adam_tooze.
For Tooze’s follow-up piece on the risk inherent in the $23 trillion US Treasury market, see here.
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As we mortgage our futures, we might recall that it was on this date in 1914 that the Federal Reserve Bank of the U.S. was opened. In actuality a network of 12 regional banks, joined in the Federal Reserve System, they oversee federally-chartered banks in their regions and are jointly responsible for implementing the monetary policy set forth by the Federal Open Market Committee.
In that latter role, they are central to the housing market in that they set interest rates and purchase mortgage securities from Fannie Mae and Freddie Mac (Government-Sponsored Enterprises in the mortgage market). At this point the Fed owns about a quarter of the mortgage-backed securities issued by Fannie Mae and Freddie Mac.
The Federal Reserve Banks in 1936 (source)
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