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Regulator Pissed Off That Banks Are Providing Client Service

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A thing that most people kind of know about the business of investment banks is that it’s not that hard. You have to be able to do basic math and communicate with humans, but most of what front-line bankers and salespeople do is not rocket science. It’s also not that differentiated. Everyone looks at comps and DCFs to write fairness opinions. Everyone markets IPOs by calling big investors and saying “this is a good company,” and then tries to get the highest price. Any new product that a bank invents is reverse-engineered and offered everywhere within a week. There's no investment banking iPhone.

So how do you convince clients to pay you for services? Well, you can offer services more cheaply than your competition. That is unpleasant. Or you can try to convince clients that your business is awesomely complicated and you provide awesomely differentiated service. That is why IPO pitch books are 80 pages long.

But most of what you do is just make people like you and find you useful. That’s why you play golf. A more meaningful way to be likable and useful is to provide useful information to clients. Banks sit in the middle of lots of markets. Bankers talk to lots of clients in the industry they cover; traders and salespeople talk to lots of investors. They can get a sense of trends in industries and markets, and they can provide that information in appropriately aggregated-and-public form to clients.

The advantage for banks is not just access to information: even more important is that they have cheap labor to aggregate it. “Cheap” is relative, but banks are overstuffed with 22-year-olds who don’t know much except how to use Excel, and who are convinced that staying up until 3 a.m. doing so is somehow glamorous. Corporates and hedge funds lack that.

Thus a non-trivial amount of the work of a junior investment banker is of the form of: a company asks “how many companies reduced widget production this year?” You look at 100 10-Ks that anyone could find but that no one in their right mind would actually read. You compile a list. You format it carefully, check the colors and font size, and lovingly emboss it with your bank's logo. And you send it to the company, who if they're feeling generous will write back "tx."

Of course they don't pay you for doing this: why would anyone pay for a prettily formatted list of public information? And they don’t tell your MD “if you get an analyst to send me this list, I’ll pay you $20 million to sell my company.”

But neither is that understanding entirely absent: if you're a CFO and you constantly use a Wall Street bank for free labor and never give them a fee-paying assignment, you might feel like a dick. (You might not.) They might think you were a dick. They might even stop providing free labor – although in my experience the bar for that was pretty high (“sure they’ve never done a deal with us, but that just means we’re due!”). Nobody wants to feel like a dick, so they try to have a rough quid pro quo. Plus if the bank is good at providing free information, maybe they’ll be good at negotiating your merger. (Though, why?)

This is how I understand this article from DealBook, which basically says “banks are helping hedge funds find accountants and receptionists, just like they sometimes help them get office space.”

This seems like a good way to provide client service and reduce friction costs. Banks talk to lots of hedge funds. They know who is looking for accountants and who just got laid off. They hear which receptionists have the sexiest phone voices. They also have a slew of recent Penn grads who can’t really be entrusted with a trading book but who probably won’t fuck up building a database of hedge fund receptionists. Hedge funds don’t necessarily have those things.

Also, with 9.1% unemployment, this is finding people jobs. So, yay. Right?

Now if you are entirely perverse, you could decide that this is a bad thing:

It is unclear if hedge funds report their use of Wall Street staffing services. [Massachusetts securities regulator William] Galvin said that the money managers should disclose the value of the services they receive from big banks and the employees placed by banks.

“It’s the type of relationship investors should know about, or simply shouldn’t exist,” Mr. Galvin said.

“Simply shouldn’t exist” seems like a bad result: let’s have more unemployment, and higher search costs, just because we don’t like the idea of people doing each other favors.

“Investors should know about” is more palatable, I guess: maybe investors really wouldn’t want hedge funds to – I guess the worry is “steer trading and prime brokerage business to the banks that found them an accountant, thus eating into client returns.”

But empirically that can’t be true. First of all, the investor cares about returns: if a fund would have returned 20% if it had used the prime broker with the best pricing, but instead returned 19% because it used the prime broker with the hottest pool of receptionist candidates, then the investors don’t care about that 1% cost: they care about the 19% return. The hedge fund could just be burning 1% of its money; if its returns are better than other alternatives, you should still invest there. In any case, if you believe that most banking business is relatively undifferentiated, it doesn’t matter that much which bank the hedge fund uses - so they might as well use the hot-receptionist one. And in a world where time and attention are finite, adding a page to a hedge fund offering memo explaining "here's how we valued the introductions that our prime brokers provided to accountants" probably reduces the information content of the offering memo.

Of course if you are really, really perverse you could imagine more serious concerns:

The practice could also have unwanted consequences for hedge funds. If the Wall Street bank knows a top executive wants to leave a firm, the departure could raise red flags about the health of the hedge fund, [guy who provides administrative support to hedge funds Dick] Del Bello said. The bank, in response, might decide to withdraw the fund’s credit, potentially forcing it to sell assets.

Yes! If Ray Dalio is calling his prime broker and saying “you know what, Bob, I’m sick of running money, could you see if SAC is looking for a receptionist?,” that would be a problem.

Wall St. Banks Help Hedge Funds Recruit [DealBook]


Banks Prove That They Are Not Too Big To Fail By Saying "We Can Fail" On A Piece Of Paper, Moving On

One way you could spend this slow week is reading the "living wills" submitted by a bunch of banks telling regulators how to wind them up if they go under. Don't, though: they're about the most boring and least informative things imaginable and I am angry that I read them.* Here for instance is how JPMorgan would wind itself up if left to its own devices**: (1) It would just file for bankruptcy and stiff its non-deposit creditors (at the holding company and then, if necessary, at the bank). (2) If after stiffing its non-deposit creditors it didn't have enough money to pay its depositors it would sell its highly attractive businesses in a competitive sale to willing buyers who would pay top dollar. This seems wrong, no? And not just in the sense of "in my opinion that would be sort of difficult, what with people freaking out about JPMorgan going bankrupt and its highly attractive businesses having landing it in, um, bankruptcy." It's wrong in the sense that it's the opposite of having a plan for dealing with banks being "too big to fail": it's premised on an assumption that the bank is not too big to fail. If JPMorgan runs into trouble that it can't get out of without taxpayer support, it'll just file for bankruptcy like anybody else. Depositors will be repaid (if they're under FDIC limits); non-depositor creditors will be screwed just like they would be on a failure of Second Community Bank of Kenosha.