Reverse bank run

Here’s a thing you could do as a bank. You could take deposits: People and companies give you money, and you promise to give it back when they ask for it. Then you take those deposits and park them as “reserves” at the Federal Reserve. Reserves are just the electronic version of money; your reserves at the Fed are just dollars. This is not the classic banking business of maturity transformation and risk diversification and borrowing short to lend long; this is just people give you money and you hold on to it for them. In a pre-electronic age, this would be just people handing you cash and you keeping it in the vault.

How risky is this model? I mean in practice you could find some ways to mess it up—you could lose the cash in the vault, or your treasurer could steal the money at the Fed—but in the abstract, as a model, it is totally safe. There is no credit risk (you are taking the credit of the Fed, which prints the money), no duration risk, no interest-rate risk, no market risk. You are just storing people’s dollars for them.

How much capital should you have to have to support this business? The idea of bank capital is that if you have a business that might lose 5% of its value in a disaster, and you fund that business with 100% borrowed money (like deposits!), then if the disaster happens you won’t be able to pay back your debts and the disaster will be worse. So you should have at least 5% equity capital—or maybe more, just to be sure—so that you’ll always be able to pay back your depositors. With this business, though, the worst you could do, in a disaster, is lose 0% of their money, so the right level of capital is zero. If you take in a trillion dollars of deposits and invest them in a trillion dollars of Fed reserves, you’ll always be able to pay back your depositors; you don’t need an extra $50 billion of equity to provide a cushion.

Up until, I don’t know, a month ago, no one especially wanted to hear things like that. Banks had gotten into a lot of trouble in 2008 doing supposedly risk-free things, and bank leverage in general was frowned upon. Banks just shouldn’t use so much borrowed money, it’s too risky, was the general consensus, even if the particular things they were doing with the borrowed money—parking it at the Fed!—were pretty safe. And so in addition to “risk-based capital” rules that require more capital for risky activities and less (or zero) capital for safe activities, the U.S., like other countries, has a “supplementary leverage ratio” that requires a minimum amount of capital for all activities. You just add up all the stuff the bank owns, safe or not, multiply by 3%, and you need to have at least that much capital.

A weird problem with that is that it limits your ability to take deposits: If people come to you with money, you can’t take their money—even to park it in super-safe Fed reserves—because doing so will gross up your balance sheet and force you to raise more equity capital. In normal times this is not a big deal; you just sort of figure out what the needs of your business are and optimize your capital around it. But if people are suddenly flocking to you to give you deposits to invest in super-safe reserves, because any assets riskier than cash make people nervous, then you will have a problem. You might not be able to take their deposits without raising more equity, which might be hard in a crisis. You will have to turn them away: “I have no more room for deposits,” you’ll have to tell them. 

Usually the way we think of financial crises is that people run to banks to take out their deposits, not to put in more, but I guess this is kind of a weird financial crisis. Anyway:

To ease strains in the Treasury market resulting from the coronavirus and increase banking organizations’ ability to provide credit to households and businesses, the Federal Reserve Board on Wednesday announced a temporary change to its supplementary leverage ratio rule. The change would exclude U.S. Treasury securities and deposits at Federal Reserve Banks from the calculation of the rule for holding companies, and will be in effect until March 31, 2021.

Liquidity conditions in Treasury markets have deteriorated rapidly, and financial institutions are receiving significant inflows of customer deposits along with increased reserve levels. The regulatory restrictions that accompany this balance sheet growth may constrain the firms’ ability to continue to serve as financial intermediaries and to provide credit to households and businesses. The change to the supplementary leverage ratio will mitigate the effects of those restrictions and better enable firms to support the economy.

Now if you are rushing to give banks your money (“significant inflows of customer deposits”), they can take it. They can take it and park it in Fed reserves, but they can also take it and use it to buy Treasury bonds, another pretty safe place to put your money, and a market that got weird over the past few weeks as investors began to prefer cash even to safe assets like Treasuries. Traditionally when people sell Treasuries, banks buy them, but if banks are constrained by leverage rules that becomes harder. Now they are not constrained:

Priya Misra, global head of rates strategy at TD Securities, said with the new rule, banks would be more likely to buy Treasuries if they cheapen sufficiently, helping to ensure the smooth functioning of the world’s largest debt market.

“This is a very big deal,” she said. “Now we don’t have to rely on just the Fed to bring normalcy back to the Treasury market . . . There’s an additional player that can restore normalcy.”

Very loosely speaking, the regulatory response to the 2008 financial crisis was to increase bank capital requirements and push banks to raise as much capital as quickly as possible; the (bank) regulatory response to the 2020 financial crisis has been to reduce bank capital requirements. The latter is much better! I don’t mean that regulators were wrong in 2008; the problem they faced was a crisis of confidence in the banking system, which required them to shore up confidence by increasing capital and implementing stress tests.

But ideally what you want is for banks to have lots of capital in bad times, and then relax those requirements—let them lever up and buy stuff and take deposits and lend and trade Treasuries and generally support the financial system and the economy—when the crisis comes. If you get too lax in the good times, then the crisis becomes a banking crisis and that approach doesn’t work. But if you spend the good times making banks better capitalized and more stress-resistant and generally more credible, then you can spend down some of that credibility in the bad times. People will run to put their money in the banks, and the banks can help restore normalcy rather than being part of the problem. 

Narrow banking

By the way that business model—take deposits, put them at the Fed, do nothing else—describes The Narrow Bank USA Inc., a bank that was set up to do exactly and only that. It has not launched yet, though, because the New York Fed has kept it in limbo by not giving it a “master account” to hold reserves. We have talked about TNB, and about the Fed’s objections to it, a couple of times, and TNB has sued the Fed to try to force it to open an account for it. The Fed’s intriguing defense to the lawsuit is not to say “no TNB is weird and bad and we should not open an account for it” (which does seem to be what the Fed thinks!), but rather to say “what, no, we haven’t done anything, we are still thinking about it, you can’t sue us yet.” 

Last week the Fed won, on that theory. The judge wrote: “Although the over 18-month wait TNB has endured is concerning, it does not approach the 30-year mark. If TNB had been waiting 30 years for a decision, I would have no trouble finding that the FRBNY had constructively denied TNB’s application, and thus that TNB had an injury in fact sufficient for standing.”

WeWon’t

Obviously if SoftBank Group Corp. had just given Adam Neumann $970 million for his WeWork Cos. shares back in October, he would have the money now, and SoftBank would have the shares now, and he would have gotten the better end of that trade. The shares were worth more in October than they are now, because the business of running short-term co-working spaces looked a lot better back before a global plague forced office workers to start working from home. But in October nobody knew that would happen, so they negotiated to have SoftBank spend $3 billion buying back WeWork shares from Neumann and other investors and employees, but for some reason they gave SoftBank a few months to actually buy the shares. And then the world changed, and SoftBank got extremely understandable cold feet, while Neumann and the other investors got increasingly antsy about getting the money, and so now:

SoftBank Group Corp. scrapped an agreement to spend $3 billion to buy WeWork stock from former Chief Executive Officer Adam Neumann and other shareholders, despite threats of legal action from some members of the company’s board.

SoftBank had agreed to buy the shares from Neumann, Benchmark Capital and others as part of a bailout package last year, but notified stockholders in mid-March that conditions for the deal hadn’t been met. On Thursday, after the deal’s deadline passed, SoftBank confirmed it would end the offer, citing five conditions that were not satisfied by the closing date. …

SoftBank cited regulatory concerns and a handful of government investigations into WeWork, including from the U.S. Securities and Exchange Commission and the Justice Department.

The two WeWork independent board directors responded, saying they would consider legal action if SoftBank pulled out. “Its excuses for not trying to close are inappropriate and dishonest,” a spokeswoman for the directors had said in a statement.

I mean they are a little dishonest, sure. For instance:

SoftBank cited the pandemic as one of its reasons for terminating the share acquisition, saying government lockdowns were “imposing restrictions against WeWork and its operations.”

That is a good little window into mergers-and-acquisitions lawyering. SoftBank’s agreement with WeWork isn’t public, but presumably it says something like “SoftBank can cancel the tender if there are any material government restrictions on WeWork’s business,” but it doesn’t say something like “SoftBank can cancel the tender if lots of customers cancel their WeWork memberships.” The very rough general rule in mergers and acquisitions is that if business conditions get worse, that’s the acquirer’s risk, but if there is some legal problem with the business then that’s the seller’s risk.

As a general rule that makes some sense; acquirers don’t want to be stuck buying a company that, unbeknownst to them, was breaking the law. Here it doesn’t really make any sense: For one thing, SoftBank is WeWork’s majority shareholder and controls its board, so it’s hard to argue that WeWork was keeping any regulatory secrets from it; for another thing, the legal restrictions here are not about anything bad that WeWork was doing but, rather, about a global pandemic that has led to lots of don’t-go-to-work orders. (There are also those government investigations, but I suspect they are not all that material to the business.) But the issue is not whether it makes any sense; the issue is whether SoftBank’s contract lets it get out of the tender offer because of “legal restrictions.” If it does, yeah, sure, SoftBank should get out of it. 

I don’t really have any rooting interest for either side here. I completely sympathize with SoftBank’s desire not to pay for the shares, and I completely sympathize with the investors’ desire to get paid, and I don’t think that there’s any strong moral or efficiency argument one way or the other. Some real bad luck happened at a bad time, and someone—SoftBank or the investors—is going to bear the brunt of that bad luck.

But I have an obvious rooting interest in litigation! It is hard to think of a better end—or, just, continuation—of the WeWork story than Adam Neumann suing SoftBank for his billion dollars. I want the internal documents, the depositions, the actors’ own accounts, under oath, of what they were thinking and how it all went wrong. I want Neumann to act as his own lawyer and tearfully cross-examine Masayoshi Son in court. One thing that SoftBank was buying with its $3 billion was quiet; Neumann and the other big investors would be happy enough with that money not to stir up more trouble or controversy for WeWork. Now that is not worth $3 billion to SoftBank—WeWork’s problems now are a lot bigger than its controversies of last October—and so SoftBank has chosen the money over the quiet. 

Work from home

Here’s a good, uh, story of late capitalism or whatever:

Citadel Securities this week opened an office in Florida to help ensure billionaire Ken Griffin’s giant trading firm can continue at full capacity during the coronavirus pandemic – and cope with the explosion in volume the illness has spurred.

The firm opened a new, temporary trading floor in Palm Beach on Monday with 24 people, according to a memo from the firm to employees seen by Bloomberg. The market maker debuted the facility two days before Florida’s governor announced a stay-at-home order for the state of 21.5 million.

The site – with capacity for 50 – is part of a hotel property that’s closed to the public, and the staff, who have been dispatched from Chicago and New York, will work and sleep there, according to the firm. 

I want to read a dystopian novel about this, or maybe a Borges story. An apocalyptic plague has made it dangerous to go outside, and so a shadowy team of elite capitalists have gathered in an out-of-the-way hotel property, closed to the public, to live together 24/7 and continue to control the world’s financial markets. Someone needs to chronicle their lives and loves and hopes and fears and, I don’t know, descent into madness or decision to abandon financial capitalism and form a new society or whatever. What if the lockdown lasts for years, and whole generations of Citadel traders are born and brought up in its closed society, a remote high priesthood of financial markets keeping the flame alive for the rest of us?