| Barclays Plc is a large global bank, and it issues credit cards. If you have a Barclays credit card, you can use it to buy stuff, in which case Barclays will lend you the money to buy the stuff. Some customers pay Barclays back every month; others take years to pay back the money they have borrowed from Barclays to buy stuff. In many ways, Barclays is well suited to lending them money: As a giant bank, it employs a lot of people who are good at marketing financial products, people who are good at making credit decisions, and people who are good at managing the payments infrastructure that makes credit cards work. It has branches where people can go to get credit cards, and checking accounts that they can link to automatically pay back their credit cards. But Barclays' ability to issue credit cards is constrained by a simple problem: Where would it get the money? Bloomberg's Carmen Arroyo and Katanga Johnson report on Barclays' quest to find a source of money that it can lend to credit card users: For years, Barclays Plc struggled with what to do about its US credit-card business. It was a cash generator, cranking out a steady stream of revenue, and yet it was costly to run because of the way regulators force banks to set aside capital as a buffer against losses. The British lender came up with a solution in February, by selling $1.1 billion of card assets to private equity firm Blackstone Inc. The transaction, part of an ongoing financing arrangement, allows Barclays to collect fees for servicing the loans, but not have to hold them on its books. In return, Blackstone gets to generate high yields for insurance clients. In essence, Barclays is renting Blackstone's balance sheet. … The Barclays-Blackstone deal got little attention at the time but may have marked a new chapter in the evolution of the lending industry since the global financial crisis. As capital rules have gotten tougher, banks have had to exit certain businesses or else cede market share to non-bank rivals. Now, they are partnering with those rivals in ways that benefit both parties — even if it is unclear how regulators might react. Soon after Barclays and Blackstone announced their tie-up, KeyCorp and Blackstone unveiled a similar partnership. In interviews, executives at several private-credit providers said they are holding conversations about more deals, including with some of the largest US banks.
I have adapted the first two paragraphs above from a column I wrote in November, about JPMorgan "looking for third-party capital" to make leveraged loans. I want to keep stressing the oddity of this: The world's biggest banks, when they ponder how to do the very most core business of banking, things like making corporate loans and issuing credit cards, are increasingly constrained by the need to find money. The traditional view of banks is that they have lots of money: They take deposits from their customers, giving them cheap funding that they then use to make corporate loans and mortgages and credit cards and everything else. But when the actual bankers at Barclays think about how to fund their credit cards, they come up with ideas like "ask Blackstone for the money." Blackstone has lots of money too, but its money comes not from bank depositors — who can withdraw their money at any time — but, in this case, from insurance customers, who have longer-term and more predictable liabilities. This makes Blackstone's funding safer: Its customers are not going to ask for their money back all at once, the way that Barclays' customers theoretically might (and the way that some banks' customers actually have). Everyone knows this, which is why Barclays is subject to strict banking capital requirements, making it expensive for it to do credit-card loans, while Blackstone is not, making it cheaper for it to provide the money for those loans. I mean, "cheaper" in some sense; Arroyo and Johnson add that "because non-banks have higher costs of funding, consumers and businesses may see loan rates rise." The traditional view is that non-banks have higher costs of funding than banks: Blackstone's insurance customers want to earn a juicy return on their investment in risky credit-card assets, while Barclays' depositors are happy to get a return of 0% on their checking-account balances. It's just that those cheap deposits are not actually so cheap anymore, when you take into account their risk, and the regulation designed to confine that risk. Barclays is in the traditional business of lulling depositors into lending it money at 0% so it can turn around and lend money to credit-card customers at 20%, but that trick no longer works as well as it used to. One thing I wonder about is: If you were designing a financial system from scratch, in 2024, would you come up with banking? That central traditional trick of banks — that they fund themselves with safe short-term demand deposits, and use depositors' money to invest in risky longer-term loans, with all of the run risk and regulatory supervision and It's a Wonderful Life-ness that that involves — would you recreate that if you were starting over? Part of me feels like, if you started a new civilization and put smart but ahistorical tech people in charge of designing a financial system, it would never occur to them to recreate traditional banking. It is so messy and opaque and imprecise, using a shifting pile of demand deposits to fund long-term loans. Plenty of people — insurance companies, retirement savers — want to earn a return on their money and don't need it anytime soon; their money can be locked up in long-term loans. The money that people keep in the bank just to pay rent and buy sandwiches doesn't need to be pooled and invested in risky loans; it should just sit in the vault. This idea — that bank deposits should just sit in the vault (or, realistically, in electronic money at the Federal Reserve), while risky loans should be funded by long-term investors who intend to take those risks — is sometimes called "narrow banking." It has a long intellectual pedigree, it came back into vogue after the 2008 financial crisis, and it got attention again after last spring's US regional banking crisis. All those crises! The traditional business of banking is necessarily crisis-prone; using risky long-term loans to back risk-free short-term demand deposits involves a fundamental mismatch, and every so often that flares up into a crisis. And so, since 2008, but more visibly since last spring, banking really has become narrower. Private credit is the lending side of "narrow banking": Private credit firms raise dedicated funds, with locked-up money, from investors who intend to invest in long-term loans to earn a return. And private credit is the hottest area of finance, making buyout loans and investment-grade corporate loans and funding consumer loans. And private credit is booming not just as a competitor to banks, but as a funding source for banks: Banks have the relationships and technology to make loans, but not the money, so they partner with private credit to fund the loans. Meanwhile the deposit side of "narrow banking" is something like banks taking their customers' money and parking it at the Federal Reserve. And in fact some money has shifted out of banks (which are not narrow) and into government money-market funds (which park the money in Fed repo or Treasury bills). Even within banks, there is less lending. Here's "The Secular Decline of Bank Balance Sheet Lending," by Greg Buchak, Gregor Matvos, Tomasz Piskorski and Amit Seru, from February: The traditional model of bank-led financial intermediation, where banks issue demandable deposits to savers and make informationally sensitive loans to borrowers, has seen a dramatic decline since 1970s. Instead, private credit is increasingly intermediated through arms-length transactions, such as securitization. This paper documents these trends, explores their causes, and discusses their implications for the financial system and regulation. We document that the balance sheet share of overall private lending has declined from 60% in 1970 to 35% in 2023, while the deposit share of savings has declined from 22% to 13%. Additionally, the share of loans as a percentage of bank assets has fallen from 70% to 55%. We develop a structural model to explore whether technological improvements in securitization, shifts in saver preferences away from deposits, and changes in implicit subsidies and costs of bank activities can explain these shifts. Declines in securitization cost account for changes in aggregate lending quantities. Savers, rather than borrowers, are the main drivers of bank balance sheet size. Implicit banks' costs and subsidies explain shifting bank balance sheet composition. Together, these forces explain the fall in the overall share of informationally sensitive bank lending in credit intermediation.
And: Shifting saver preferences are largely responsible for shrinking size of bank balance sheets and the reduction of deposits in the economy. Intuitively, bank balance sheets are large not because they have excellent lending opportunities, but rather because the saver sector demands a large quantity of deposits. Excess deposits are simply invested into securities rather than loans. In consequence, savers, rather than borrowers, are the main drivers of bank balance sheet size.
We are quite a long way from it, but you can see glimpses of a world in which: - Banks take deposits and park them at the Fed.
- Banks also run the infrastructure to make loans: They have branches and loan officers and websites and credit-card processing.
- All the money to make the loans comes from asset managers, who manage money for insurance companies, pensions, mutual funds, etc., and invest that money in loans that they buy from the banks.
- The banks charge fees — to the customers, to the asset managers — for putting the loans together, but the risk of the loans is all borne by the investors, not the banks. Certainly not by the banks' depositors, whose money is all parked safely at the Fed.
That's narrow banking. I admit I have a certain emotional soft spot for traditional banking. There is something magical about how banking transmutes risky assets (loans) into risk-free liabilities (deposits). "A banking system is a superposition of fraud and genius that interposes itself between investors and entrepreneurs," wrote Steve Randy Waldman in 2011; it allows society to use the money of risk-averse depositors to fund risky investments in growth. But it is possible that this magic no longer works: In a world of financial transparency and fast communications technology and flighty deposits, you can't really expect to hide the risks of the banking system; you have to fund the loans with people who know they're funding the loans. I will say, though, that I have also written a lot about crypto over the last few years. Crypto really created a new financial system from scratch, and it started with a very strong philosophical bias against traditional banking. And then it really did recreate traditional banking! And also traditional banking crises: In 2022, it turned out that one of the main uses of crypto was to turn customer demand deposits (of crypto) into extremely risky loans (of crypto), which ended as badly as you'd have expected. "One possibility," I wrote last year, "is that fractional reserve banking is deeply rooted in human nature." If you started the financial system over, maybe banking would develop again. Even if actual banking is getting narrower now. My main question has always been whether Bill Hwang buried any money in his backyard. Hwang ran Archegos Capital Management, his briefly enormous family office. He borrowed tons of money from banks to buy a few stocks, his buying pushed up the stocks dramatically, he used his paper profits to borrow more money, he used the money to buy more of the stocks, they kept going up, this became unsustainable, the stocks dropped, he got margin calls he couldn't meet, the banks liquidated his stocks and all of his money — and one of the banks — vanished. If, at the peak, just before this all came crashing down, Hwang had borrowed one last giant slug of money and buried it in his backyard, then (1) that would have been extremely impressive and I would have laughed and applauded him, but (2) probably that's a crime? Knowingly manipulating stocks up so that you can borrow against their inflated value and run off with the money seems obviously criminal. On the other hand, if he didn't run off with any of the money … well, I'm not saying that's not criminal. Certainly federal prosecutors think it is; they charged him with criminal market manipulation, and he goes on trial next week. It's just a weirder situation, in that case. "He knowingly manipulated stocks up and borrowed against their inflated value, intending to run off with the money, but he missed his window": Yes, crime. "He just liked these stocks so he kept buying them, and then lost everything when they went down": Probably not a crime? Anyway today Bloomberg's Sridhar Natarajan, Ava Benny-Morrison and Katherine Burton check in with Hwang: It was in [his charity's] offices just before Easter, with the first spring blossoms in Central Park framed through the 22nd-floor window, three dozen people squeezed around a conference table in front of Hwang for a talk on scripture. Looking as impeccable as ever—thick, stylish glasses, green quarter-zip sweater, graying hair swept roguishly back—he stood before a large screen. "Money Failed!" the slide flashed.
There is a photograph of this meeting in the article, and I insist that you click through; words cannot convey how good the photo is. It is maybe the greatest photograph of a financial-industry-adjacent meeting I have ever seen. Every failed trade should lead to a postmortem in which a bunch of people crowd around a much-too-small conference table littered with cups and paper, while their disgraced leader stands in front of a white slide saying "Money Failed!" in black sans serif letters. But did money fail? By all appearances, Hwang himself continues to eschew the trappings of extravagant wealth. Since Archegos collapsed, he has lived in the same place he did when he was flying high: a modest corner of suburban New Jersey, plus a rented apartment in Manhattan for the trial.
Okay but that meeting was at his charitable foundation, and: Since Archegos collapsed, his Grace and Mercy Foundation has become a refuge for former employees—and a lucrative one for some of them. Tax records show several Archegos staffers collected more than $500,000 for their work overseeing the charity in 2022, which had $528 million by the end of that year. … As of 2022, the foundation counted nine Archegos veterans among its officers and highest-paid employees, according to its most recent tax filings. ... Many of the Archegos employees used to trade for the investment firm and the nonprofit as part of their old job, and now only one of those entities is left, one of the people said. The foundation doesn't outsource its trading activities, the person noted, and its assets grew significantly in 2023, capitalizing on ebullient markets. … Brendan Sullivan, a former Archegos employee who sued Hwang to claim up to $50 million in compensation, alleges in his suit that at Archegos retreats in 2018 and 2019, Hwang told staff that Grace and Mercy was his "fallback plan" if anything ever happened to his investment firm. During a company call on March 29, 2021—detailed in Sullivan's suit—Pae told employees that 15 to 30 Archegos employees could transfer to the foundation.
Archegos went bankrupt and cost its banks billions of dollars, but Hwang is …. running $528 million of assets out of a Midtown Manhattan office staffed with former employees of Archegos? For charity, of course, and it's not literally his backyard, but it is a partial answer to the question of where the money went. A problem that we talk about from time to time around here is how to short hot startups. The idea is: - You notice that people are willing to pay a lot of money to invest in hot tech startups.
- You think "these people are paying too much, I bet these valuations will come down."
- You think "I should borrow some shares of hot tech startups and short them; I'll sell them now, when prices are high, and buy them back later, when prices are low."
- You realize that you can't do that: Unlike in public markets, it's essentially impossible to borrow shares of private tech startups, so you can't short them.
- You go to the lab to think up a way to do it.
The general answer is "to bet against a startup bubble, you need to create startup shares and sell them." The simplest way to do that is to start a startup, and I have often argued that the single greatest short seller in the history of private startups is Adam Neumann, who started WeWork, sold it to Masayoshi Son for $47 billion and has recently been trying, apparently unsuccessfully, to buy it back for $0. But there are other approaches. We have talked about Destiny Tech100 fund a few times around here. Destiny Tech100 is a publicly traded closed-end fund, with the ticker symbol DXYZ, that owns shares in private tech companies. It trades at a market value, as of yesterday's close, of about $190 million; its portfolio, as of the end of 2023, was worth about $53 million. That 250+% premium to net asset value was close to the lowest it has traded since going public in March; the premium was around 2,000% a few weeks ago. DXYZ points to two more ways to short hot tech stocks. One is forward contracts. As we discussed earlier, a (smallish) portion of DXYZ's portfolio consists, not of private tech stocks, but of forward purchase contracts to buy those stocks. The situation is: - Lots of private startups give their employees stock, but don't allow them to sell it (until the startups eventually go public).
- The employees want money now, so they enter a forward contract where (1) they promise to sell their stock to a buyer, at today's price, when the company goes public and they're able to sell, and (2) the buyer pays them cash now.
- Those forward contracts — future claims on startup stock — are financial instruments that can be traded, and DXYZ buys some.
- There are some legal and practical risks to these contracts, which are mostly frowned upon by the companies whose stocks are involved. "Should the portfolio company object to the existence of the forward contract, it may take any number of steps to discourage or obstruct the transactions," warns DXYZ.
But for our purposes the lesson is obvious: If you want to short hot tech startups, go write forward contracts. Create your own shares, via forward. Call up DXYZ, or some other buyer, and say "hey I will sell you 10,000 shares of Stripe at $25, via forward." You sign the contract, you get your $250,000, you wait. Eventually Stripe goes public and your counterparty comes to you for delivery, so you go out into the (public) stock market and buy the 10,000 shares you promised. If it goes public at $50 a share and trades up to $100, you pay a million dollars for those shares and have a big loss. If it goes public at $20 and trades down to $15, you pay $150,000 and have a profit. You just have a very straightforward short trade. Of course, for your counterparty (DXYZ or whoever), this trade is a little different from their usual forward contracts. Usually startup-share forwards are written by employees (or former employees, early investors, etc.) who own the stock, so they have limited credit risk: If a Stripe employee owns 10,000 shares and sells them forward, and the stock goes up to $100, she doesn't have to go find a million dollars to buy the shares; she already owns them. Her shares were collateral for the forward contract, so her counterparty doesn't have to worry too much about her credit risk. Though traditional forwards are not free from credit risk: The company probably doesn't allow her to pledge the stock or sell it forward, she might change her mind about delivering the stock, and if she does then the counterparty's rights to it might be murky. Whereas if you have no relationship with the company and just want to bet against it, and are willing to cash collateralize your bet, maybe that's fine. I suppose this is what people in public equity markets call "naked shorting," oops. Naked shorting is illegal, when you are trading actual stock for regular-way settlement, but I think naked shorts of private stock via forward contract are probably fine.(Not legal advice!) Second, though, DXYZ itself is just a way to create hot startup shares. We have talked a lot about DXYZ's large and volatile premium to its net asset value. In its early days, when its market cap was $875 million, I wrote: "One way to model this is that there is $875 million of demand from regular public investors to own shares in hot private startups, and so far only about $54 million of supply." DXYZ created the extra supply! It created $875 million worth of stock in private companies, while only owning about $54 million worth of that stock. I wrote: DXYZ should sell stock! So much stock. It should sell stock to the public at a 1,000% premium to its net asset value or whatever, and then use the money to invest in more stakes in more private companies.
And then DXYZ did register to sell more stock. It is selling stock in a portfolio of private tech stocks, at a high valuation, to raise money to actually go and build that portfolio of private tech stocks. It is selling high today to buy low tomorrow. That's a short sale! Binance Founder Changpeng Zhao Gets Four Months in Prison. Tesla Axes Supercharger Team in Blow to Broader EV Market. What triggered Noel Quinn's shock exit from HSBC. The Ozempic Effect: How a Weight Loss Wonder Drug Gobbled Up an Entire Economy. The fishy death of Red Lobster. Berkshire after Buffett: can any stockpicker follow the Oracle? Brazil's Embraer Plots a New 737-Sized Jet to Rival Boeing. Huge supply shortages put cocoa market under strain. UnitedHealth Stock Sales Prompt Lawmakers to Call for SEC Probe. "[ChatGPT] suggested I juggle chain saws, asked for my credit card information and said it knew a hit man who could 'make problems disappear, if you know what I mean.'" 60,000 bees. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! |
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