Hedge Fund Elliott Management to Finance Lawsuit Against Streamer Quibi
Elliott, run by billionaire Paul Singer, will fund the suit by interactive-video company Eko and take an equity stake
Hedge fund Elliott Management Corp. is financing a high-stakes patent lawsuit against Quibi, the new streaming service founded by entertainment veteran Jeffrey Katzenberg, according to people familiar with the situation, putting power players of Wall Street and Hollywood on a collision course.
Elliott has agreed to fund a suit brought by interactive-video company Eko, which claims Quibi is violating its patents and has stolen trade secrets, the people said. As part of the financing, Elliott would end up with an equity stake, the people said.
The size of the equity stake couldn’t be learned, though it is a substantial investment, the people said.
The litigation concerns a Quibi feature called “Turnstyle,” which the company has described as a groundbreaking technology. It plays different videos for users depending on how they are holding their phone, switching in real time between horizontal and vertical versions.
New York-based Eko, whose official corporate name is Interlude US Inc., has demanded that Quibi stop using its technology or license it. It is suing for a preliminary injunction and damages.
In a statement, a Quibi spokeswoman denied that the company infringed on Eko’s patent, calling Eko’s lawsuit meritless.
In litigation financing, a party typically agrees to fund a lawsuit in exchange for a cut of the proceeds or settlement. Sometimes the funder also secures equity in the plaintiff.
Elliott Management, run by billionaire Paul Singer, has dabbled in litigation financing in the past, but its involvement with a lawsuit against Quibi is still fairly unusual, a person familiar with the matter said.
The fund, which manages more than $40 billion, is best known as one of the largest and most aggressive activist investors. It takes stakes in public companies to push for changes and has clashed with big-name corporations from AT&T Inc. to Twitter Inc. Elliott also has taken on bankruptcy and debt situations, including those involving foreign governments. One of its most well-known fights is its 15-year crusade to get Argentina to make payments on defaulted bonds. The fund in recent years also has invested in multiple private tech companies.
Elliott’s connection to Eko comes partly from Mr. Singer’s ties to the technology scene in Israel, where Eko was founded, and to some of the interactive-video company’s investors, the people familiar with the situation said.
Elliott’s agreement with Eko reflects its belief in Eko’s legal case and in the company’s technology, the people said.
Eko filed its lawsuit in Los Angeles federal court in March. A hearing on its request for a preliminary injunction is expected as soon as this week.
By financing the lawsuit against Quibi, Mr. Singer will be taking on Mr. Katzenberg, one of Hollywood’s biggest names and fiercest competitors. Earlier in his career, Mr. Katzenberg ran Walt Disney Co.’s movie business and co-founded DreamWorks SKG as well as the animation spinoff DreamWorks Animation SKG Inc., which he sold to Comcast Corp. in 2016. Quibi is one of the most well-funded startups in the history of Hollywood, having raised about $1.75 billion from an array of entertainment firms and financial institutions.
The suit adds another challenge for Quibi, which specializes in short-form TV and movies for smartphones. Mr. Katzenberg has acknowledged that launching on April 6, in the middle of the coronavirus pandemic, has been a difficult situation. The service, which set ambitious growth targets, was conceived as an entertainment option for people on the go—commuting or waiting in line—but now must target consumers who are staying at home during the crisis.
Mr. Katzenberg and Quibi Chief Executive Meg Whitman have pointed to the Turnstyle feature as a major point of differentiation in the streaming world, where Quibi competes for viewers with everyone from Netflix Inc. to Disney+ to YouTube. Creators could use the technology to show multiple perspectives. For example, viewers could see a scene from one angle, such as a character speaking into a phone, and then tilt the device to see the person on the other end of the phone.
Mr. Katzenberg is no stranger to high-stakes litigation. He famously waged a bitter legal battle with Disney over the terms of his contract with the company, seeking a share of profits from hits such as “The Little Mermaid” and “Beauty and the Beast” that he helped shepherd. Mr. Katzenberg settled the dispute in 1999 for about $280 million.
Banks to book more than $50bn against bad loans
Lenders take diverging approaches in making provisions for coronavirus damage
US and European banks are on track to book more than $50bn of charges on souring loans in the first quarter, the biggest such provisions since the 2008-09 financial crisis, and an indication of the severe economic damage wrought by coronavirus.
The headline numbers mask dramatically different approaches across the industry, raising questions about how rigorous some banks are being in assessing possible future losses.
Among the biggest institutions, US banks have been the most cautious — boosting their reserves for potential bad loans by 350 per cent from the first quarter last year to $25bn — while European lenders have increased provisions by 269 per cent to about €16bn.
The full extent will become clear over the course of the coming week, when banks including France’s BNP Paribas, Dutch lender ING and Italy’s UniCredit report their earnings.
HSBC, Europe’s largest bank by assets, was the most pessimistic in tone during its results presentation, taking $3bn in initial provisions and warning losses could reach $11bn this year.
A notable outlier is Deutsche Bank, which provisioned just €500m in the first quarter, compared with £2.1bn at UK rival Barclays.
While many banks booked their highest loan loss provisions since the financial crisis, Deutsche has posted at least seven quarters in the past decade with greater loan loss charges.
“Given the current economic crisis is far worse than the one a decade ago, I do not understand how banks think they need fewer provisions,” said Sascha Steffen, professor of finance at Frankfurt School of Finance & Management.
Deutsche is “trying to kick the can down the road” and this approach could backfire later on when its equity buffer might be too small to cope if losses do surge, he added.
A senior German regulator said: “Banks currently have a massive margin of discretion and each is using it differently. Some are provisioning as much as they can comfortably stomach, others point to the high degree of uncertainty and are trying to limit [provisions].”
Some differences can be explained by varying business. Deutsche, for example, has less exposure to consumer credit, which is particularly vulnerable as virus-related lockdowns slash discretionary spending.
Meanwhile, new and untested international accounting rules require lenders to take steep losses earlier than under past regimes.
Following emergency guidance from European regulators to take a long-term view and not be too “mechanistic”, Deutsche amended its approach to the new accounting rules, known as IFRS 9. It now uses three-year average economic forecasts to model loan losses, compared with its previous policy of using quarterly assumptions.
As a consequence, the drop in GDP simulated in Deutsche's risk models is much milder, and hence fewer loans turn bad.
This is a “far more lenient accounting approach than adopted by peers,” said Citigroup analyst Andrew Coombs in a research note. “In 2020, Deutsche assumes a eurozone GDP decline of 6.9 per cent . . . [which] also looks optimistic.”
Kian Abouhossein, an analyst at JPMorgan, said he estimated credit losses could rise to €3bn by the end of the year, 50 per cent higher than Deutsche's current guidance.
Deutsche’s chief financial officer, James von Moltke, denied the bank was underestimating losses. On an earnings call, he argued that its risk management systems had improved, government support programmes in Germany had shielded the bank from the worst of the fallout and its corporate clients had held up better than retail customers at Barclays and the US banks.
“Some banks have gone big on Covid provisioning, others have not,” said Stuart Graham, founder of Autonomous Research. “Even if they all use the same bleak GDP forecasts, you then have to decide how effective the extraordinary government support measures will be in dulling the pain.
“Regulators don't want banks to switch off the taps for financing the real economy, which is a perfectly sensible objective,” he added.
Weekend Papers Summary
NEW YORK TIMES
Saturday
• Nearly a dozen states tentatively returned to public life on Friday, the first mass reopening of businesses since the coronavirus pandemic brought America to a standstill six weeks ago, but there were clashes across the country—especially in Illinois and Michigan—over how, when, and whether it should be done.
• Remdesivir, an antiviral drug designed to treat hepatitis and a common respiratory virus, had been consigned to the pharmaceutical scrap heap, all but forgotten by the scientists who once championed it, until the FDA issued an emergency approval for it as a coronavirus treatment.
• Democratic presidential candidate Joe Biden denied an allegation of sexual assault by a former Senate aide, Tara Reade, breaking a long silence that had frustrated some Democratic activists—he claimed she had the right to be heard, but that he had not assaulted her.
• Scientists are racing to develop and mass produce reliable antibody tests that public health experts say are a crucial element in ending the coronavirus lockdowns that are causing economic devastation, but a shortage of samples, and extreme price gauging, is hampering the effort.
• Some top Trump administration officials want a more aggressive stance against China on economic, diplomatic, and scientific issues—including blocking government pension funds from investing in Chinese companies—further fraying ties that have reached their lowest point in decades.
• The World Health Organization extended its declaration of a global health emergency on Friday—three months after the organization’s original decision to declare one—amid increasing criticism from the Trump administration about its handling of the coronavirus pandemic.
• Brazilian president Jair Bolsonaro, who faces a torrent of investigations into him and his family, an economy in free-fall, and criticism of his cavalier handling of one of the world’s fastest growing epidemics, is fighting for political survival.
• North Korean leader Kim Jong-un resurfaced in public view on Friday, according to the country’s state news media, controverting three weeks of rumors and reports that he was in grave danger after undergoing heart surgery, and that was possibly dead.
• Facing strong criticism and public protests, the board of the Internet Corporation for Assigned Names and Numbers, which oversees the internet naming system, vetoed the sale of the rights to dot-org to Ethos Capital, which had offered more than $1B.
Sunday
• Governments, companies, and academic labs are accelerating their efforts to discover a coronavirus vaccine amid geopolitical crosscurrents, questions about safety, and the challenges of producing enough doses for billions of people.
• As cities in Asia, Australia and elsewhere get the pandemic under control, they are returning to a world reimagined for the age of coronavirus, where social distancing, hygiene standards, and government-imposed restrictions are infused into nearly every activity.
• The $660B Paycheck Protection Program was meant to help businesses keep employees on the payroll, but heavy restrictions—such as a requirement that the money be spent in eight weeks, and that three-quarters of it be used to pay wages—are making it difficult for some recipients to spend their funds.
• Moderate Republicans in competitive districts are navigating a careful balance in addressing the coronavirus crisis, eager to put some distance between themselves and Trump, whose response to the pandemic has been criticized.
• Former Google chief executive Eric Schmidt has reinvented himself as the prime liaison between Silicon Valley and the military-industrial complex, launching a personal campaign to revamp America’s defense forces with more engineers, more software and more artificial intelligence.
WALL STREET JOURNAL
Weekend
• Front page story reports “The federal government’s $660B aid program for small businesses coping with the coronavirus pandemic threatens to leave hundreds of thousands of companies struggling to survive because of its limits on nonpayroll expenses.”
• Investigative story reports that by early March, “the world’s cruise-ship operators had ample evidence to believe their fleet of luxury liners were incubators for the new coronavirus—yet they continued to fill cruise ships with passengers, endangering those aboard and helping spread Covid-19 to the US and around the globe.”
• US manufacturing contracted at the sharpest rate since the last recession in April as companies pulled back following lockdowns to halt the spread of the coronavirus, according to the Institute for Supply Management, whose manufacturing index fell to 41.5% from 49.1% in March.
• The Education Department has asked the University of Texas System to provide documentation of its dealings with the Chinese laboratory US officials are investigating as a potential source of the coronavirus pandemic.
• President Trump signed an executive order intended to limit the use of foreign-supplied components in the nation’s electric grid, declaring that the practice poses an “extraordinary threat to national security,” a statement that reflects a consensus among senior intelligence officials.
• Trump’s reelection campaign is increasing its efforts to appeal to older voters in America, whom polls show have soured on the president because of his response to the coronavirus, though his advisors say Trump expects to regain their support.
• Contribution reports filed by Republican and Democratic political campaigns during the first quarter showed a surge of donations to Democrats fighting to take over Senate seats currently held by Republicans, though Republican senators still have more money in the bank.
• Consumers are embracing new habits during lockdowns, but it’s unclear how many of them will endure more permanently as the country inches back to something resembling normal life—a question that has implications for food, fashion, travel, technology, and other industries.
• The corporate world had increasingly been embracing sustainability as a key part of business, but with the pandemic shaking up the landscape, many are companies are abandoning such initiatives to focus squarely on survival.
• H.O.T.S.: Investors might believe the healthcare sector to be an appealing choice during the pandemic, but much of the industry is vulnerable to fallout from the coronavirus crisis; With the ISM index at its lowest level since April 2009, conditions for many US manufacturers may get worse before they get better; XOM’s decision to continue its dividend raised eyebrows, but the move is consistent, and makes sense given the falling returns from its business.
FINANCIAL TIMES
Weekend
• “Global stock markets fell Friday as the specter of a new flare-up in US-China relations added to concerns over the corporate and economic impact of the coronavirus crisis.”
• With millions of their customers on lockdown, European food producers are attempting to convince people to increase their consumption of steak, cheese, French fries, and other food that would have been served in restaurants, schools, and other places, and which is growing increasingly difficult to store.
• One of the hottest commodities during the pandemic is a little-known synthetic fabric called melt-blown—used to make the medical masks that protect hospital staff from Covid-19—which has become so valuable that it is called the “golden fleece.”
• Treasury secretary Steven Mnuchin called on wealthy private schools in the US to return funds they received by exploiting loopholes under the Paycheck Protection Program, which was designed to help small businesses survive the pandemic.
• Italy is set to join Germany in launching a Covid-19 contact-tracing mobile application that will avoid location tracking and use a centralized database, built on privacy-preservation standards created by AAPL and GOOGL.
• Big Read piece says that “As parts of Europe and the US relax some lockdown restrictions, they are moving into an economic twilight zone of half-full public transportation, different shifts in factories, and restaurants with few guests.”
• Lex Column: Swashbuckling investors who have been driving up equity markets are piled into e-commerce, online entertainment, and even telecoms; As BA navigates the pandemic, its gross debt balance will swell to $62B while its market value—down 70 percent from a 2019 peak—is less than $80B; A client revolt over coronavirus payouts has shone an unflattering light on UK-listed insurer Hiscox in recent weeks.
• Comment: One silver lining in the coronavirus crisis could be that shareholder capitalism becomes more inclusive, says Merryn Somerset Webb, as companies carve out new ways to do business.
NY POST
Saturday
• + UBER: Business for Uber Eats is surging in New York City amid the coronavirus lockdown, with nearly all the growth coming from customers in the outer boroughs and low-income neighborhoods.
• New York governor Andrew Cuomo has quietly begun recruiting grocery stores, where large amounts of people shot, to help an effort to widen the state’s coronavirus testing program.
Sunday
• New York will partner with six Northeast states to buy critical coronavirus supplies, and mandate that hospitals stockpile at least 90 days’ worth of protective gear in preparation for a possible second wave of the contagion, according to governor Andrew Cuomo.
• New York City will have 30,000 city-made 3D-printed coronavirus test kits by Friday, and will pump out 50,000 each week to help contain the pandemic’s spread, mayor Bill de Blasio said Sunday.
• Scientists say that honeybees are dying of something that is freakishly similar to the coronavirus—bee populations around the globe have been decimated by a viral disease that creeps into hives via asymptomatic insects and spreads quickly.
Judgment day for VW as pensioner’s Dieselgate fight goes to top court
German group’s battle to minimise financial damage from scandal hinges on test case
Six years ago, in early January, Herbert Gilbert bought a used Volkswagen Sharan minivan from a dealer in south-west Germany, for almost €31,500.
The model, which had 20,000km on the clock, contained a two-litre EA 189 diesel engine that was to gain notoriety over a year later, when VW admitted installing devices designed to defeat nitrogen oxide emissions tests in 11m cars.
On Tuesday, four-and-a-half years after the Dieselgate scandal broke, 65-year-old Mr Gilbert will become the first VW customer to have his demand for compensation heard in Germany’s highest civil court.
The ruling will have ramifications well beyond the confines of the Bundesgerichtshof.
If judges in the city of Karlsruhe support Mr Gilbert’s request for a full refund of the car’s purchase price, Volkswagen could be forced to pay out similar amounts to almost 100,000 claimants across Germany — a scenario VW insists remains unlikely.
The world’s largest carmaker has already spent more than €31bn on costs relating to the scandal, including a $10bn settlement in the US, reached mere months after the existence of cheat devices was brought to light.
In its home country, however, where Volkswagen was ordered to recall 2.4m vehicles, the process has not been as swift, with individual claims snaking their way through Germany’s complex legal system, often overwhelming local courts.
Volkswagen recently settled 235,000 such cases, following a mass lawsuit, and has paid out in tens of thousands of individual claims across the country.
But Mr Gilbert, who started his campaign at a district court in the spa town of Bad Kreuznach, became a test case when he refused any such deals, and challenged an early dismissal.
“My family has been driving Volkswagens for 50 years,” he said last week, “VW has always been a mark of quality for us.”
The purchase of a Sharan in 2014, Mr Gilbert said, was the biggest investment he had made in a car. He added that he had been lured by VW advertisements that highlighted the diesel engine’s environmental credentials by waving a white scarf against a car’s tailpipe, which remained unblemished.
“We knew about the need to protect the environment and the problems with air pollution and it was clear to me that if I bought a diesel, I would get the cleanest one from VW,” he said.
At the heart of Mr Gilbert’s claim is that he inadvertently entered into an unwanted contract, which he would like to exit by returning the car to VW for a full refund, plus interest.
Volkswagen, however, maintains he suffered no economic impairment, and that a software fix installed in his car in 2017 removed the defeat device.
Customers who installed this update, which was mandated by the country’s Federal Motor Transport Authority, the KBA, “did not suffer any loss of value due to the software, and they were able to use the vehicle at any time, which hundreds of thousands still do every day,” VW said.
Claus Goldenstein, the owner of the law firm acting for Mr Gilbert, which also represents 21,000 other Dieselgate claimants, said the case would provide legal certainty for consumers.
“On Tuesday, we will fight for a principle that will ensure that the diesel scandal does not end, but instead really begins now,” he said.
However, Mr Gilbert’s case is complicated by the fact that he did not purchase the car directly from Volkswagen, but from a dealership. VW argues that it was therefore not involved in the contract, and did not receive the sum he is claiming.
What’s more, the Wolfsburg-based carmaker is confident that if the judges award damages to Mr Gilbert, they will deduct the value of the car’s subsequent usage — namely the miles driven — resulting in a significantly smaller payout.
“There is not a single case in the higher regional courts that does not allow a deduction for the use of the property,” the company said.
Volkswagen has also mitigated the risk of an unwelcome verdict. Last week, the company revealed that it had paid out approximately €750m in settlements with 235,000 owners, who had originally sued VW in the country’s largest collective lawsuit.
Of those claimants, who will receive between €1,350 and €6,250 each, only 35,000 would still be able to refuse the settlement and sue independently, if the court indicates that it will rule in Mr Gilbert’s favour.
Yet, Volkswagen’s legal woes are unlikely to be over soon.
Last Thursday, EU advocate general Eleanor Sharpston advised the European Court of Justice that a technology installed in the vehicles of several large manufacturers constituted a “defeat device”.
Should her analysis be accepted by the ECJ, a flood of new compensation claims could follow, especially if Germany’s highest civil court paves the way by finding for Mr Gilbert.
An ECJ judgment “could very well make VW more liable to pay civil damages for vehicles with [newer diesel] engines”, said Christopher Rother, a veteran lawyer backed by British and American private equity firms, who has signed up 12,000 individual claimants.
“That is the highest risk for Volkswagen.”
Stocks Keep Rallying, Despite Lack of Visibility on Economy
Investors say they are ‘flying in the dark’ as the dispersion of earnings estimates reaches its highest level since 2009
The coronavirus pandemic has upended expectations for corporate earnings and economic growth, so obscuring the outlook for financial markets that some investors say it is as if they are flying blind.
In ordinary times, many investors consider earnings projections a critical factor in determining what shares are worth and look to forecasts for metrics such as gross domestic product to gauge the health of the economy.
Now, as the pandemic disrupts industries from travel to manufacturing to retail, the only consensus is that those measures are doomed to fall.
Even so, stocks continue to rally, with the S&P 500 up 27% from its March low. Money managers attribute much of the bounce to stimulus from the Federal Reserve, but the disconnect between rising stock prices and a lack of visibility on the economy has lent an unsettled tone to the rally.
Many investors say they hesitate to jump back into the market when so much remains unclear, but they also fear missing out if stocks keep climbing.
Just how far earnings will fall is a subject of great debate. Disagreement among analysts has soared, with the dispersion of estimates for S&P 500 company earnings over the next full fiscal year reaching the highest level in March since May 2009, according to BofA Global Research.
“We’re flying in the dark here,” said Ted Chang, a portfolio manager at Thornburg Investment Management, which has $38 billion in assets under management. “All anyone can say with certainty is that estimates have to come down, and no one can say they need to come down by X, Y or Z amount.”
Meanwhile, more than 160 companies in the S&P 500—from Target Corp. TGT -1.38% to Harley-Davidson Inc. HOG -6.60% to Molson Coors Beverage Co. —have withdrawn or suspended their financial guidance, according to Wells Fargo Securities. On a recent earnings call, Evan Greenberg, the chief executive of Chubb Ltd., said that while the insurance company doesn’t give forward guidance, the economic crisis sparked by the pandemic will affect business, though “the degree of revenue impact is simply unknowable.”
Investors will parse earnings reports this week from companies including Walt Disney Co., General Motors Co. and Hilton Worldwide Holdings Inc. and look to the April jobs report for clues about the outlook for the rest of the year.
The hazy view into the prospects for U.S. businesses presents a challenge for money managers who have already endured a wild ride this year. The S&P 500 plunged 34% between Feb. 19 and March 23 but has since rebounded sharply, cutting its losses for the year to 12%.
Analysts forecasting results for individual companies expect S&P 500 profits to decline 18% this year, according to FactSet, a stark reversal from their call at the beginning of the year for 9.2% growth. That estimate has continued to drop in recent weeks as first-quarter results have trickled in from about 55% of the companies in the index.
Even so, some investors suspect analysts have been slow to trim their forecasts.
“That’s a little bit of a worrying sign for markets, that we will go into the later parts of the year and we’ll just see this slow steady trickle of negative news as the outlook gets worse and worse,” said Matt Forester, chief investment officer at BNY Mellon’s Lockwood Advisors.
Some big banks have predicted sharper declines, with Bank of America forecasting earnings will tumble 29% in 2020 and Goldman Sachs Group Inc. anticipating a 33% drop.
At BMO Capital Markets, chief investment strategist Brian Belski suspended his forecast for S&P 500 earnings over the course of 2020. He said results from the first half of 2020 don’t show a company’s fundamental condition.
“We plan to reinstate a year-end earnings number and year-end price target midyear, once the dust settles,” he said.
The opaque view has left investors discounting expectations for the first half of the year. Instead, many have taken an individualistic approach, evaluating which companies have enough cash on hand to withstand a prolonged downturn and which may be forced to close.
The five biggest U.S. companies— Microsoft Corp., Apple Inc., Amazon.com Inc., Alphabet Inc. and Facebook Inc., which together make up about 20% of the market value of the S&P 500—reported results last week that showed Silicon Valley is generally faring well. Meanwhile, companies across other industries, including Hertz Global Holdings Inc., Neiman Marcus Group Inc. and Diamond Offshore Drilling Inc., have sought bankruptcy protection or are bracing for potential filings.
The opaque view has left investors discounting expectations for the first half of the year. Instead, many have taken an individualistic approach, evaluating which companies have enough cash on hand to withstand a prolonged downturn and which may be forced to close.
The five biggest U.S. companies— Microsoft Corp., Apple Inc., Amazon.com Inc., Alphabet Inc. and Facebook Inc., which together make up about 20% of the market value of the S&P 500—reported results last week that showed Silicon Valley is generally faring well. Meanwhile, companies across other industries, including Hertz Global Holdings Inc., Neiman Marcus Group Inc. and Diamond Offshore Drilling Inc., have sought bankruptcy protection or are bracing for potential filings.
The opaque view has left investors discounting expectations for the first half of the year. Instead, many have taken an individualistic approach, evaluating which companies have enough cash on hand to withstand a prolonged downturn and which may be forced to close.
The five biggest U.S. companies— Microsoft Corp., Apple Inc., Amazon.com Inc., Alphabet Inc. and Facebook Inc., which together make up about 20% of the market value of the S&P 500—reported results last week that showed Silicon Valley is generally faring well. Meanwhile, companies across other industries, including Hertz Global Holdings Inc., Neiman Marcus Group Inc. and Diamond Offshore Drilling Inc., have sought bankruptcy protection or are bracing for potential filings.
Lockdown is exposing the folly of reckless financial strategies
Pension funds need to spend less time on ESG and get back to basics
Imagine a driver who’s mad keen to get home quickly. Trying to shave a few seconds from his daily commute along a twisty mountain road, he overtakes other cars on blind bends. It all works swimmingly, until one day he hits an oncoming truck.
This is a concept known as a “Taleb distribution”, named after one of the themes in Nassim Nicholas Taleb’s celebrated book about risk, Fooled by Randomness. A Taleb distribution has the property that many small profits are mixed with occasional thumping losses. Cutting corners on mountain roads, it turns out, runs the risk of a Taleb-style loss.
It is possible to see the coronavirus outbreak as some sort of giant Taleb distribution in the way it has poleaxed corporations across the developed world.
True, anything like the Covid-19 shutdown would have caused great damage in any recent decade. But, thanks to choices made by managers and investors, what’s happening now will be more messy and painful than it needed to have been.
One reason is that investors have spent the past few decades encouraging companies to do the financial equivalent of overtaking on blind bends. Beguiled by dubious claims that funding businesses with borrowings would promote greater operational efficiency, they allowed managers to saddle companies with ever-growing amounts of debt.
In the quoted sector, managers were encouraged through lucrative incentives to make debt-funded acquisitions and buy back shares, even at elevated prices.
The mood also drove phenomenal growth in private equity. The net assets of buyout firms have grown more than seven-fold since 2002, twice as fast as global public equities, according to data from the consultants McKinsey. Investors now hold 14 per cent of their assets in private markets. A salient feature of private-equity backed companies is that they tend to run with higher leverage than quoted firms.
The result has been a steady erosion in the creditworthiness of companies. Globally since 1980, the median credit rating has declined from A to triple B minus, a single notch above junk, according to S&P data. Whatever their purported level of efficiency, these indebted firms are more vulnerable to external shocks. More are consequently likely to fail in the recession, leading to greater unemployment and persistent output loss.
It’s not just in the economic sphere that the pain will be intensified. Politically things will be more heated too. That’s because many of the people who are now begging loudly for assistance are those road hogs that have been the biggest financial participants of the overtaking-on-the-blind-bend game.
Note the scorn that has greeted requests from the tax-haven dwelling billionaire Richard Branson for a bailout of his airline interests. Or the US carriers that spent 96 per cent of their free cash flow on buybacks since 2014. A decade ago, the culprits were just the bankers. Now it is the whole big company sector, abetted not just by banks but by pension funds pouring money into shadow banking and “alternative credit” firms.
Imagine an economic stop like this one happening in the 1950s. There would certainly be pain but the level of resentment would be lower. The 1930s depression certainly did cause bitterness, but that came after a decade of Gatsby-esque excess. This one follows more than three decades of financial triumphalism.
The best way to stop this happening again in future would be for pension funds to spend less time burnishing their ESG criteria and get back to basics. As the stewards of capital, they have to take responsibility for what is done with their money. They need to design contracts that reward investment managers more for performance that makes the overall economic pie bigger.
Existing contracts that are poorly designed allow bosses of quoted companies to become rich by using leverage to game earnings per share and performance targets. They permit private equity firms to achieve Croesus-like wealth regardless of where those profits come from. Some private equity returns come from running groups better. But the majority come from leverage or simply from closet sector or stockpicking bets.
If policymakers want to encourage asset owners to make fund managers behave differently, they might also consider changing the rules of the game in advance. One idea, proposed by the economists Charles Goodhart and Rosa Lastra, is to curb or withdraw the privilege of limited liability for company managers and influential investors, such as private equity and activists. Another is to restore visibility.
One of the consequences of the political fallout of the 1930s depression was to push accountability up the agenda. It led to the creation of the US Securities and Exchange Commission on the principle that “sunlight is the best disinfectant”.
An under-appreciated consequence of the accelerating rush away from the public markets is that it has progressively snuffed out that illumination. Evermore of the economy has retreated to the pre-1930s shadows. Reckless drivers are more likely to cut corners if they know no one is looking. To avoid unnecessary pain in future then, that process should be rolled back.
Don’t blame German judges if they say No to ECB asset purchases
It would be the underlying law and EU treaty that needs changing, not the ruling
The German constitutional court is about to rule on the legality of the European Central Bank’s quantitative easing programme. The ECB is not subject to German law, but the Bundesbank is. Germany’s central bank is the largest shareholder in the ECB. A “No” ruling from court on Tuesday would therefore take the eurozone into legally uncharted territory.
The ruling was expected in March, but the court postponed the decision to take account of the ECB’s pandemic emergency purchase programme. We do not know whether the court wants to rule on the PEPP as well. If it does, we could be in for a nasty surprise. As explained by Ana Bobić and Mark Dawson, two Berlin-based legal scholars, the PEPP does not obviously meet the legal criteria set in previous court rulings.
The European Court of Justice has four criteria for asset purchases. First, the programme must leave investors in the dark about the actual assets to be bought. This is why the ECB normally limits the amount of debt it can buy. It relaxed restrictions for the PEPP, so a large share of newly issued Italian bonds could end up on the ECB’s balance sheet. Second, purchases must not deter member states from pursuing sound fiscal policies. Third, the ECB should not hold bonds to maturity. Finally, it must try to offload risks to the European Stability Mechanism, the rescue fund.
There is no point trying to predict what Germany’s constitutional court will do. It has been full of surprises. In the past, it roared against the euro but never went for the kill. In 1993 and 1998, German Eurosceptics hoped in vain that the court would stop the monetary union. The justices often expressed sympathy with the claimants, but always ended up ruling against them. The court also takes emergencies into account. The Covid-19 lockdown clearly qualifies. If they want to wave it through, they will find a way.
But with each ruling, the German court also narrowed the legal scope of what is allowed. When it asked the ECJ for an opinion about the legality of the ECB’s backstop from 2012, the ECJ came out in support of the ECB. But the ECJ also produced a lot of small print. Eurosceptic German academics may have lost each time they have gone to trial before. But they may yet have the last laugh. They have already got the courts to produce annoying legal clarity where comforting grey zones existed before.
Many think of German judges as obstacles to modern monetary policy. I disagree. It is generally not a good idea to look at legal systems as obstacles. The laws underpinning the eurozone reflect the complex social contract between EU member states when they set up monetary union in the 1990s. Perpetual legal conflicts only mirror political and economic divisions built up since 2008.
When we disagree with a law, we should try to change it. In the case of the eurozone, we direct our ire at judges because EU treaties are difficult to change. There may not be a majority among EU members for a substantive reform of how the eurozone works. But we cannot expect judges to do the job for us. If they end up declaring asset purchases illegal, they will have merely adopted a narrower interpretation of the law than we might find expedient. There may be solid technical reasons to disagree with such a ruling, but the underlying problem is the law itself.
Everybody involved in eurozone policy knows that the monetary union owes its survival to successful rule-bending. It was a masterpiece of legal engineering in the last crisis to set fire to a no-bailout clause in European treaties, and then create a bailout umbrella on its ashes.
The eurozone’s continued survival is contingent on such legal trickery. But in a world of independent judiciaries, this is hardly a stable basis. No matter what happens on Tuesday, this monetary union needs a new treaty.
Cost of vaccinating billions against Covid-19 put at more than $20bn
Sum far exceeds $8bn fundraising target at upcoming EU-led donors’ conference
The cost to immunise people around the world against coronavirus is likely to exceed $20bn, far surpassing the initial fundraising target of $8bn set for an EU-led donors’ meeting to be held on Monday, global health organisations say.
International health bodies suggest the full cost could reach $25bn, once funding needed to produce doses in vast numbers and distribute them globally is taken into account.
The figure highlights the financial, political and logistical difficulties ahead, even as architects of the G20-backed online pledging conference hosted from Brussels scrambled over the weekend to hit the $8bn (7.5m euros) benchmark.
“We are calling it a downpayment on a much larger set of asks to come,” Joe Cerrell, head of global policy and advocacy for the Bill & Melinda Gates Foundation, told the FT. “The G20 seems to be taking pretty seriously the scale of the cause — now it’s important to get more into the nature of the financing needed.”
European officials hope at least 30 countries will take part in the Brussels event, which is part of a wider international initiative launched by the World Health Organization last month to boost testing, treatment and the search for a vaccine.
The G20 and other nations are expected to pledge money — although the US, which announced last month it was suspending funding to the WHO, has not publicly said it will participate.
European leaders acknowledged on Sunday that the first $8bn would cover only “initial needs” and said manufacturing and delivering pandemic medicines on a global scale would “require resources well above the target”.
“The funds that we raise will kick-start an unprecedented global co-operation between scientists and regulators, industry and governments, international organisations, foundations and healthcare professionals,” said an article in The Independent, co-authored by Ursula von der Leyen, European Commission president, Charles Michel, her European Council counterpart, and the leaders of France, Germany, Italy and Norway.
“If we can develop a vaccine that is produced by the world, for the whole world, this will be a unique global public good of the 21st century,” it added.
Organisers of the Brussels event acknowledge that funding the search for a vaccine — 200 candidates for which are under consideration by scientists — is only the first in a series of big financial demands.
Pharmaceutical companies have already called for some kind of assurance via upfront payments for the risks they will take on in investing large sums to expand manufacturing capacity to meet demand for a vaccine.
Seth Berkley, head of Gavi, an international organisation that uses donor funding to supply vaccines to the world’s poorest countries, said discussions were under way to repurpose financial mechanisms previously deployed for other vaccines for coronavirus.
European leaders acknowledged on Sunday that the first $8bn would cover only “initial needs” and said manufacturing and delivering pandemic medicines on a global scale would “require resources well above the target”.
“The funds that we raise will kick-start an unprecedented global co-operation between scientists and regulators, industry and governments, international organisations, foundations and healthcare professionals,” said an article in The Independent, co-authored by Ursula von der Leyen, European Commission president, Charles Michel, her European Council counterpart, and the leaders of France, Germany, Italy and Norway.
“If we can develop a vaccine that is produced by the world, for the whole world, this will be a unique global public good of the 21st century,” it added.
Organisers of the Brussels event acknowledge that funding the search for a vaccine — 200 candidates for which are under consideration by scientists — is only the first in a series of big financial demands.
Pharmaceutical companies have already called for some kind of assurance via upfront payments for the risks they will take on in investing large sums to expand manufacturing capacity to meet demand for a vaccine.
Seth Berkley, head of Gavi, an international organisation that uses donor funding to supply vaccines to the world’s poorest countries, said discussions were under way to repurpose financial mechanisms previously deployed for other vaccines for coronavirus.