Financialisation link fest

Rajeev Mantri's excellent collection of article references on financialisation.

1. Fractionalising home equity - Patch Homes defines itself,

Patch Homes is a modern finance company. We provide home equity financing with no monthly payments or interest, in exchange for a share in the future appreciation or depreciation of your home’s value.

Sample this admiring article,

The bigger idea behind Patch and some other startups out there is the ability to break up your home equity into pieces and sell some of it while holding onto most of it. I call this fractionalizing home equity. In the existing home finance world, the only thing you can do with your home equity is borrow against it. And many homeowners do this. It is a big market and helps a lot of homeowners out. But once you borrow against your home equity you have larger monthly mortgage payments to make and many can’t afford to do that. And you need a certain credit score to be able to access the home equity loan market.

What Patch offers instead is to take a piece of your home equity (currently limited to $250k maximum) and sell the upside on it to a investment fund. Note that I said upside. This is effectively a call option on the equity not a full transfer of that equity... There are some great use cases for a partial sale of home equity. One example I like a lot is a family whose children are heading to college and soon will be out of the home. They plan to sell the home when all the kids are gone but don’t want to do that until then. They could sell some of their home equity, help pay for college, and then sell the house after all of the kids have graduated.  

2. If you thought that the falling and negative rates had its limits and would spook investors, then you did not account for the fact that it is not just humans who trade today,

Some money managers trading these bonds have nevertheless chalked up big gains for the year. One of the most obvious strategies has involved simply riding the big rally. Yields fall as prices rise; managers who clung on to their holdings as yields tumbled below zero have reaped juicy profits. Among the biggest winners are computer-driven hedge funds that try to latch on to market trends. While many human traders may question the wisdom of buying or keeping a bond that apparently offers a guaranteed loss, robot traders that monitor price moves have no such qualms... Some human investors “focused on fundamentals have struggled to hold on to bonds” as yields have turned negative.

It is not just holding securities and waiting for yields to decline, there are other opportunities,

For starters, fund managers based outside the eurozone can profit from buying Europe’s negative-yielding government debt thanks to an uplift from hedging the currency. That is because such hedges are based on the relative levels of short-term interest rates. These are much higher in the US than in the euro zone, meaning dollar-based investors are effectively paid to hedge their euro exposure back into dollars. For instance, a two-year German Bund currently yields around minus 0.88 per cent. However, after hedging the currency, this becomes a positive yield of around 1.9 per cent for dollar-based investors. For a US-based investor, this is better than buying a two-year Treasury.

Managers can also earn money from the steepness of yield curves. While German government bonds up to 30 years in maturity are now offering negative yields, the curve is fairly steep. That means a likely rise in price for an investor who buys a 10-year future, then waits until it becomes a nine-year, and then sells it and buys a 10-year again, pocketing a small gain... For euro-based fund managers sizing up how to bet on negative-yielding debt, the cold reality is that they are penalised for doing nothing. That is because of the negative rate of interest paid on cash held by custodians — the companies like State Street and BNY Mellon that look after a fund’s assets. That could amount to a drag of about minus 1 per cent a year, meaning that buying a bond with a smaller negative yield is more attractive than leaving cash in its account.

3. The financialisation story marches on with Apple, sitting on over $200 bn worth surplus cash reserves, raising $7 bn in debt. It plans to use the money for general corporate purposes, a euphemism for share buybacks and dividends.

4. Many parts of financialisation involve practices that border on fraud, like this by making money from the weaker oversight on municipal bond issuances by financial intermediaries systematically underpricing them. Sample one story,

When the West Contra Costa Unified School District in California needed money to repair and upgrade deteriorating classrooms, it hired Piper Jaffray Cos. to sell $191 million of municipal bonds... However, within a day of the initial sale, the original buyers sold, or “flipped,” $35 million of the district’s bonds for a profit of $306,000... Within 10 trading days, the post-offering trading had generated $1.24 million of market-adjusted profits. Piper Jaffray participated in some of that trading, buying back bonds and reselling them... The post-offering buying and selling suggests West Contra Costa’s bonds—sold in what is called a negotiated offering—were initially underpriced. That means the district will pay more in interest over the life of the bonds than it would if the bonds had been priced closer to what subsequent investors paid.

And it is systematic,

A Journal analysis of municipal-bond data found such post-offering trading to be routine. About $60 billion, or roughly 5%, of newly issued bonds in negotiated offerings between 2013 and 2017 were sold to customers who turned around and sold them to dealers within a single day of the initial offering, usually for a profit, the Journal found. Prices on those flipped bonds were then marked up further as they were sold to longer-term investors, bringing the total market-adjusted profits to more than $900 million. The Journal’s investigation found that those profiting from the flipping often include the banks hired to price and sell the bonds... Underwriters are obligated to purchase any bonds they can’t place with customers, which ties up cash and exposes them to risk. So they have an incentive to price the bonds to move—and, if necessary, to sell them to customers who have no intention of holding them for long. When those customers want to sell, the underwriter often will step in to buy. Under federal rules, underwriters have a duty to set prices that are “fair and reasonable” taking into consideration all relevant factors, including their “best judgment” of the fair market value... During the period of the Journal’s analysis, insurers bought and quickly sold $3.7 billion of newly issued municipal bonds, the filings show. Of that total, $2.6 billion, or 70%, was sold back to the underwriter that had just priced and sold the bonds. The underwriter paid the insurer more than the initial price 88% of the time... The trading profits suggest the bonds were underpriced, meaning taxpayers will wind up spending additional money for interest payments...

When cities and school districts decide to sell municipal bonds, they engage securities firms to underwrite them. Generally, the public entities have two options. They can put the bonds up for competitive bids and award them to the securities firms that price them with the lowest interest cost. Or they can choose an underwriter in what is known as a negotiated offering. Negotiated offerings account for about 75% of the money raised in bond offerings... The underwriter, after consulting with the issuer, slices the total amount to be raised into a series of bonds with different interest rates and maturity dates, then buys the bonds at a discount to their offering prices—typically less than half a percentage point. The difference between the discounted price and what the underwriter sells them for is the underwriter’s pay. The underwriting process sets up an obvious conflict. The municipal issuer wants to pay the lowest possible interest rate. The underwriter wants to ensure the bonds will be attractive enough to easily resell to investors and bond dealers. The Municipal Securities Rulemaking Board, or MSRB, which writes rules for underwriters, requires them to disclose that they have “financial and other interests that differ from those of the issuer.”

And when talking of such trades, can Goldman Sachs be far away,

In 2017, the Washington Economic Development Finance Authority sold $134 million of tax-exempt bonds on behalf of a private company building a facility that would convert farm waste to paper pulp. The company, Columbia Pulp I LLC, paid Goldman Sachs & Co. $3.8 million, or about 2.9% of the money raised, to underwrite the bonds. The unit of Goldman Sachs Group Inc. set prices so the bonds would generate annual interest of 7.75% for buyers—a high yield indicative of the speculative nature of the company’s new technology. Goldman sold the bonds in 25 trades, all at 11 a.m. on July 25, 2017. A little more than an hour later, some of the original buyers sold $10.75 million of the bonds to dealers at 5.3% more than they had just paid, generating profits of $571,000. Later that day, according to NAIC filings, Goldman bought back $6.6 million of bonds it had sold to insurers for $376,000 more than the buyers had paid. Trading records show Goldman then resold those bonds for a $42,000 profit. Within 10 trading days of the initial sale, $32 million of the bonds were flipped by initial buyers, the Journal analysis showed. Goldman and the dealers and customers who bought and resold them made market-adjusted profits totaling $2.2 million. 

5. Stock ownership has been rising unabated,

More Americans than ever are invested in the stock market. Just 30 years ago only about 30% of Americans owned any form of stock—now more than 50% do... The rising popularity of index and mutual funds makes stock market investing easier and safer, since risk is spread across many securities. But the bigger reason is the increased popularity of 401(k)-type retirement plans in the 1990s gave many Americans easy access to the stock market. Often they are automatically invested in stock... In 1989, only 22% of Americans under 35 owned stock, while in 2016 41% did.

6. Softbank has plans to take retail investing further down the road,

SoftBank Corp.’s brokerage unit plans to do something that may be a first in capital markets. It will allow individuals in Japan to participate in initial public offerings with as little as a 1,000-yen note (worth a bit less than a 10-dollar bill). One Tap BUY Co., controlled by the wireless unit of investment giant SoftBank Group Corp., is preparing to start offering such sales as early as March 2020 after obtaining the necessary regulatory approvals. This will mark the first time that investors will be able to subscribe to an IPO by investment amount rather than specified number of shares.

7. But this coverage expansion comes with its risks. A study finds,

An increase in local stock wealth driven by aggregate stock prices increases local employment and payroll in nontradable industries and in total, while having no effect on employment in tradable industries. In a model with consumption wealth effects and geographic heterogeneity, these responses imply a marginal propensity to consume out of a dollar of stock wealth of 2.8 cents per year. We also use the model to quantify the aggregate effects of a stock market wealth shock when monetary policy is passive. A 20% increase in stock valuations, unless countered by monetary policy, increases the aggregate labor bill by at least 0.85% and aggregate hours by at least 0.28% two years after the shock.

And this,

It also suggests that in the same way a recession can be self-fulfilling, sustained growth can be, too. If people feel richer because of the stock market and spend more, the companies will be more profitable and stocks will climb further. At least for a while. Without a meaningful rise in productivity, even a self-fulfilling boom can crash if there’s some external shock or anything that undermines confidence.

8. Fuelling financialisation have been the failure of the gatekeepers, both market-based ones like rating agencies and auditors as well as the public regulators. Much has been written about them. WSJ has more on rating agencies,

Inflated bond ratings were one cause of the financial crisis. A decade later, there is evidence they persist. In the hottest parts of the booming bond market, S&P and its competitors are giving increasingly optimistic ratings as they fight for market share... The problem is particularly acute in the fast-growing market for “structured” debt—securities using pools of loans such as commercial and residential mortgages, student loans and other borrowings. The deals are carved into different slices, or “tranches,” each with varying risks and returns, which means rating firms are crucial to their creation. The Journal analyzed about 30,000 ratings within a $3 trillion database of structured securities issued between 2008 and 2019. The data, compiled by deal-tracker Finsight.com, allowed a direct comparison of grades issued by six firms: majors S&P, Moody’s Corp and Fitch Ratings, and three smaller firms that have challenged them since the financial crisis, DBRS Inc., Kroll Bond Rating Agency Inc. and Morningstar Inc. The Journal’s analysis suggests a key regulatory remedy to improve rating quality—promoting competition—has backfired. The challengers tended to rate bonds higher than the major firms. Across most structured-finance segments, DBRS, Kroll and Morningstar were more likely to give higher grades than Moody’s, S&P and Fitch on the same bonds. Sometimes one firm called a security junk and another gave a triple-A rating deeming it supersafe.

The fundamental problem is well acknowledged,

Behind the ratings inflation is a long-acknowledged flaw Washington didn’t fix: Entities that issue bonds—state and local governments, hotel and mall financiers, companies—also pay for their ratings. Issuers have incentive to hire the most lenient rating firm, because interest payments are lower on higher-rated bonds. Increased competition lets issuers more easily shop around for the best outcome.

In the aftermath of the financial crisis, though there was pressure on SEC to impose restrictions one ratings shopping by issuers, vested interests prevailed and little changed. But the importance of rating agencies has only increased,

Investor reliance on credit ratings has gone from “high to higher,” says Swedish economist Bo Becker, who co-wrote a study finding that in the $4.4 trillion U.S. bond-mutual-fund industry, 94% of rules governing investments made direct or indirect references to ratings in 2017, versus 90% in 2010.

And the rating agencies business is booming,

Strong bond issuance and a rebound in the lucrative structured-securities market have brought good times back to the rating industry. SEC disclosures show fees for rating structured deals can top $1 million. Industry revenue rose 20% to $7.1 billion in 2017 from 2016, the most recent SEC data show. S&P’s and Moody’s shares are up more than eightfold in the past decade, and their stocks hit all-time highs last week.

And the risks too are becoming more apparent,

Two fast-growing structured-bond sectors are commercial mortgage-backed securities, or CMBS, and collateralized loan obligations, or CLOs. CMBS fund deals for hotels, shopping malls and the like. CLOs are backed by corporate loans to risky borrowers, typically to fund buyouts. In a May speech, Federal Reserve Chairman Jerome Powell compared CLOs to precrisis mortgage-backed debt: “Once again, we see a category of debt that is growing faster than the income of the borrowers even as lenders loosen underwriting standards.”

9. Finally financialisation in pharmaceuticals industry,

From 2006 to 2015, 18 major pharma companies spent $261bn on buying back shares, 57 per cent of what they spent on R&D, according to William Lazonick, a professor of economics at the University of Massachusetts Lowell.

Update 19.10.2019

Ultra-low interest rates are distorting the mortgage markets, encouraging homeowners to take out longer term mortgages and pay them out longer tenures. 

That since March 2014, the proportion of mortgage products available at a maximum term of 40 years rose from 36 per cent to 57 per cent, according to finance website Moneyfacts. The chart also shows a sizeable drop in the proportion of shorter 25-year and 30-year maximum loans offered. Deals offering a maximum 25-year loan have shrunk from 7.5 per cent to 3.4 per cent over the same period... In 2005 just 2.5 per cent of new mortgages were for 35 years or more, according to the Bank of England. By 2017 it said that had risen to 15.75 per cent. Numbers published this year by the Financial Conduct Authority show the overall number of mortgage sales above 25 years is now at 41 per cent and rises to 66 per cent for first-time buyers.