Money Stuff

It’s Easy to Borrow Money If You Have

Money
Also FICO, Chinese education tech, Bitcoin prices, Greensill/Bluestone, interns and nice gestures.

By Matt Levine
26 de julio de 2021 12:11 GMT-5

Buy borrow die

You could have a dumb oversimplified model that goes like this:

1. In the olden days, rich people invested their money in stocks and bonds. They wanted cash flow from
those stocks and bonds, money that they could live on without spending principal. So the stocks and
bonds produced cash flows. Investment-grade bonds paid interest, blue-chip stocks paid dividends, and
their rich owners used the interest and dividend payments to finance their lifestyles.

2. In modern days, rich people still invest their money in stocks and bonds, but they have discovered the
concept of tax efficiency. Dividends and interest payments are taxable; if you have $100 million of
wealth, it earns 5% a year in interest and dividends, and you pay a 40% tax rate, then in a year you will
pay $2 million of taxes and be $3 million richer. You’d prefer not to pay the taxes.

3. So it is no longer particularly expected that good stocks will pay large, or any, dividends: Companies
retain earnings to reinvest in growth (rewarding their shareholders with capital appreciation rather than
dividends), or if they want to return cash they do it via tax-efficient buybacks rather than dividends.

4. Meanwhile the interest rates on bonds are really low. This is more of a macroeconomic thing than a tax-
efficiency thing, honestly, but it’s worth noting.

5. If you have $100 million of wealth and it appreciates by 5% per year without paying out any cash, then
in a year you will pay no taxes and be $5 million richer. Better!

6. How do you pay for your lifestyle? Well, if you have $100 million, you can pretty easily borrow money
secured by your portfolio. If you borrow $3 million a year (what we assumed you were taking home
under the old system) and your wealth keeps compounding at 5% per year, you will never borrow more
than about 23% of the value of your holdings.
1
 A bank should be fairly comfortable lending you 23%
of the value of your portfolio of stocks and bonds, since you’re rich.

7. Borrowing money is not income, so you don’t pay taxes on it.

8. And you’ll pay very low interest on this borrowing (see point 4).

It is just a more efficient way to extract spending money from wealth. (This model is sometimes called “buy
borrow die,” because if you die in step 9, that can further improve the tax efficiency of the strategy.) It does
require a change in the business model of banks, though: Instead of principally being in the business of
lending money to people who don’t have money and need some, they are increasingly in the business of
lending money to people who have lots of money but don’t want to liquidate financial assets.

So here you go:

The lending businesses of large US banks are doubling down on wealthier customers, as well-to-do
Americans borrow to buy second homes, invest in the stock market and potentially lighten their tax
bills.

The combined value of loans made by the wealth management arms of JPMorgan Chase, Bank of
America, Citigroup and Morgan Stanley surpassed $600bn in the second quarter, up 17.5 per cent from
a year earlier. This represented 22.5 per cent of the banks’ total loan books, up from 16.3 per cent in
mid-2017. ...

This type of borrowing has been on the rise for more than a decade but the pace has picked up since the
Federal Reserve cut interest rates in response to the pandemic. For a two-year loan against liquid
investments such as stocks, wealth management clients can expect to pay a rate of about 1.4 per cent,
according to bankers and advisers. 

“Rates are so remarkably low that they look at it as cheap money,” said Christopher Boyett, co-chair of
the private wealth practice at law firm Holland & Knight.

The contrast with the banks’ consumer and corporate loan books is startling. Wealth management loans
at JPMorgan, Bank of America, Citi and Morgan Stanley have grown 50 per cent in the past four years,
compared with only 9 per cent for their overall loan book.

JPMorgan and Citi are now lending more to a small number of ultra-high net worth clients than to their
millions of credit card customers. A decade ago, JPMorgan was lending five times as much to credit card
customers as it did to private clients. ...

Controversially, the borrowings can also serve to lower taxes. Instead of selling assets to raise cash —
and facing a capital gains tax bill — high net-worth clients obtain funding by borrowing against the value
of their investments.

“The other way that these families could get liquidity from these assets would be to sell them and that of
course would have tax consequences and those would not be favourable,” said Sabrena Silver, a partner
at law firm White & Case.

If you are a bank, it is better to lend people money equal to a fraction of the value of their portfolio of
liquid financial assets than it is to lend them money that they don’t have. If they already have plenty of
money, they are more likely to pay you back. Meanwhile if you are a rich person, it is better to get liquidity
without paying taxes than to get liquidity and pay taxes. Seems like a good trade for everyone?

Credit scoring

I mean this is the sort of cute pat anecdote that banks love to publicize:

FICO is becoming a smaller factor in underwriting decisions at Citizens Financial Group Inc. When
shoppers apply for its buy-now-pay-later loans, the bank considers factors including the products they
are buying, according to a person familiar with the matter. Fitness equipment, for example, is viewed as
a sign of creditworthiness because it suggests a positive change in the applicant’s behavior. By next year,
the bank plans to use cellphone, cable and utility-payment information to help vet loan applicants, the
person said.

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Yes, right, buying a Peloton on credit increases your debt-to-income ratio but improves your credit because
people who do group fitness classes don’t default on debt, fine, but if you’re going to brag about this to
journalists you’ve got to publicize the whole list. Fitness equipment is credit-positive; what else is positive?
What’s negative? If you are financing a flat-screen TV, that’s bad, right? A nice suit is good? What about a
boat? Are there … are there purchase types that correlate both with creditworthiness and also with race or
gender? I feel like this discussion is cute and positive when it is limited to fitness equipment but you don't
actually want to open up the box here.

That’s from an article about how the “FICO Score’s Hold on the Credit Market Is Slipping”:

Big lenders are moving away from FICO, according to people familiar with the matter. Capital One
Financial Corp. and Synchrony Financial don’t use its scores for most consumer-lending decisions. They
are becoming a smaller factor in some underwriting decisions at JPMorgan Chase & Co. and Bank of
America Corp.
 A key financial regulator, meanwhile, is encouraging banks to de-emphasize credit scores in an effort to
expand access to affordable credit. And housing-finance giants Fannie Mae and Freddie Mac are
considering allowing lenders to use other scores when evaluating mortgage applicants.

There are a few reasons for the shift. Many lenders now review a wealth of new data and use it to refine
their own proprietary scores that they say are better able to predict who will repay and who won’t. …

For banks, one benefit of their own scoring systems is their ability to tweak them when problems arise.
Several years ago, JPMorgan noticed that when borrowers transferred their credit-card debt to a
personal loan, their FICO scores often increased because the share of debt they carried compared with
their cards’ spending limits had fallen, a person familiar with the matter said. But the debt was still
present in the form of a personal loan. The bank found a similar issue with its own credit score but was
able to quickly fix it, the person said. FICO said recent versions of its scores address this issue. 

On first principles you might think that a bank is in the business of deciding whom to lend money to. It is
weird to outsource that core decision to someone else, and sensible to try to bring it back in-house and also
differentiate yourself. Like, banks should try to compete with each other by making better credit decisions,
lending to creditworthy borrowers that the rest of the market misses and avoiding lending to risky
borrowers that the rest of the market loves. If you are a bank you should try to get better at the core skills of
banking.

The counterpoint is that banks are not always exactly in the business of lending money from their balance
sheets and hoping to get paid back. Sometimes they’re in the business of packaging loans and selling them,
and there, being right is less important than being standard:

FICO has a big advantage: Investors rely heavily on the scores to decide whether to buy packaged-up
consumer loans. The scores are a common language of sorts, one that requires no time-consuming
translation. Even lenders that don’t use FICO to make lending decisions tend to use them in loan
securitizations.

Chinese tutoring

Two notable facts about the People’s Republic of China are that (1) it has been communist for the last 70
years and (2) it bans foreign investors from owning shares of certain sorts of technology companies. Until
like a month ago, everyone thought China was … kidding? Yes sure China is ruled by the Communist Party,
but look at all the profits that were being made by Chinese capitalists. And yes sure foreign investors aren’t
allowed to own Chinese tech companies, but a robust “variable interest entity” structure allowed foreign
investors to effectively own shares in profitable Chinese tech companies. It’s fine! In very broad strokes,
investing in China was like investing everywhere else.

Things are different now:

 China unveiled a sweeping overhaul of its $100 billion education tech sector, banning companies that
teach the school curriculum from making profits, raising capital or going public.

Beijing on Saturday published a plethora of regulations that together threaten to up-end the sector and
jeopardize billions of dollars in foreign investment. Companies that teach school subjects can no longer
accept overseas investment, which could include capital from the offshore registered entities of Chinese
firms, according to a notice released by the State Council. Those now in violation of that rule must take
steps to rectify the situation, the country’s most powerful administrative authority said, without
elaborating.

In addition, listed firms will no longer be allowed to raise capital via stock markets to invest in
businesses that teach classroom subjects. Outright acquisitions are forbidden. And all vacation and
weekend tutoring related to the school syllabus is now off-limits.

The regulations threaten to obliterate the outsized growth that made stock market darlings of TAL
Education Group, New Oriental Education & Technology Group and Gaotu Techedu Inc. They could also
put the market largely out of reach of global investors. Education technology had emerged as one of the
hottest investment plays in China in recent years, attracting billions from the likes of Tiger Global
Management, Temasek Holdings Pte and SoftBank Group Corp.

TAL, New Oriental Education and Gaotu are all Cayman Islands companies; they — or rather their Chinese
variable interest entities — are in education-tech businesses that foreigners are prohibited from owning.
Through a series of contracts, foreign investors can own these Caymans companies, which in turn can
share in the profits of the onshore Chinese education-tech companies. Except, oops, no profits!

I have to say that I am impressed by the regulatory move of banning profits. In the U.S., I don’t think it
would really occur to a regulator to tell an established industry that it is not allowed to make profits
anymore. “That’s just the same as shutting down the industry, right?,” I think U.S. regulators would say. But
in a nominally communist system I suppose you don’t have to believe as much in the profit motive; you can
distinguish businesses that are illegal from ones that are not allowed to turn a profit.

All of these companies, in their disclosures to foreign investors, include risk factors about how the legal
status of their VIE structures is uncertain and how the Chinese government might decide that they are in
violation of the law and impose all sorts of remedies, like “confiscating any of our income that they deem to
be obtained through illegal operations” or “revoking the business and operating licenses of our PRC
subsidiaries or consolidated affiliated entities.” In a sense there is nothing surprising here; the boom in
foreign investment in Chinese tech companies has been entirely a creature of regulatory grace that might
end at any time. People got used to the grace, though. Now it might be ending.

Elsewhere, my Bloomberg Opinion colleague Noah Smith asks: “Why is China smashing its tech industry?”
Bitcoin

I understand that Jeff Bezos and Andy Jassy have better things to do with their time, but if I ran
Amazon.com Inc., I’d be pretty tempted to:

1. Quietly buy a ton of Bitcoins,

2. Put up a job posting looking for a “Digital Currency and Blockchain Product Lead” on my website, and

3. Sell all those Bitcoins when the price of Bitcoin rallies 20% on the news that Amazon might be getting
into crypto.

To be clear, I don’t think that happened. I just think it should have: 

Bitcoin surged near $40,000 as a crypto-related job ad from Amazon.com Inc. stoked speculation about
the company’s involvement in the industry.

The job posting, which was reported by CoinDesk last week, said the Amazon is looking for an executive
to develop the company’s “digital currency and blockchain strategy.” Analysts have also wondered
whether the move could eventually lead to Amazon accepting Bitcoin as a method of payment.

Yeah. The thing about Bitcoin is that it has no, as it were, interior fundamentals. The fundamental drivers of
Bitcoin's value are not internal facts about Bitcoin, its technology or the actions of its developers or
whatever; there is no company with cash flows and expenses and executives and factories. The
fundamental drivers of Bitcoin’s value are social facts about who is using it for what. If you are someone
whose use or non-use of Bitcoin is material to its value — if you are, for example, a gigantic dominant player
in online commerce, or Elon Musk — then your decision to use Bitcoin is obviously going to drive the price,
it’s obviously going to be the main factor that day, even rumors about it will move the price, and why
shouldn’t you make a profit on your own information?

We talked last month about how Amazon actually does a form of this strategy: When it strikes commercial
deals with smaller companies, it pushes to get warrants to buy those companies’ stock, because it knows
that news of the commercial deals will make those companies’ stocks go up. I wrote:

I am a simple man and to me this seems good. Buy a thing, create good news for the thing, announce
that news, watch the price of the thing go up. In general I think it is under-utilized, as a strategy. 

I assume that Amazon didn’t utilize it here. But it should have.

Here’s another explanation for Bitcoin’s move:

 Some analysts said short covering also fueled the gain. More than $940 million of crypto shorts were
liquidated on Monday, the most since May 19, according to data from Bybt.com.

“The extent of the jump was probably driven by over-leveraged shorts,” said Vijay Ayyar, head of Asia
Pacific at crypto exchange Luno in Singapore.

Why? Partly on a short squeeze I suppose: Amazon news pushes up the price of Bitcoin, which causes
leveraged shorts to lose all their equity and get closed out. But this is also intriguing:

Two of the world’s most popular cryptocurrency exchanges announced on Sunday that they would curb
a type of high-risk trading that has been blamed in part for sharp fluctuations in the value of Bitcoin and
the casino-like atmosphere on such platforms globally.

The first move came from the exchange, FTX, which said it would reduce the size of the bets investors
can make by lowering the amount of leverage it offers to 20 times from 101 times. Leverage multiplies
the traders’ chance for not only profit, but also loss. …

About 14 hours later, Changpeng Zhao the founder of Binance, the world’s largest cryptocurrency
exchange, echoed the move by FTX, announcing that his company had already started to limit leverage
to 20 times for new users and it would soon expand this limit to other existing clients.

Reducing leverage for Bitcoin trades could push the price of Bitcoin down (if it forces leveraged Bitcoin
holders to sell) or up (if it forces leveraged Bitcoin shorts to buy). Elsewhere: “Crypto has ‘no inherent
worth’ but is good to trade, says Man Group chief.”

Bluestone and Greensill

We have talked a few times around here about Greensill Capital, a “supply chain finance” company that
was notionally in the business of making short-term loans secured by its clients’ accounts receivable (or
payable) but was actually in the business of making long-term unsecured loans against its clients’
“prospective receivables.” In basic receivables finance, a client would sell its products to its customers on
credit, Greensill would front the cash to the client, and Greensill would get paid back with interest a few
weeks later when the customers paid. In prospective receivables finance, a client would think of a potential
customer and write down how much it wanted to sell to the customer, Greensill would lend it some money,
and it would roll the money over every few months until the client one day actually managed to sell some
products to the potential customer and get money to pay back Greensill. 

Greensill imploded a few months ago, and the discovery that it was largely in the prospective-receivables
business led to a lot of awkwardness. For instance, Greensill’s insolvency administrator was alarmed to
discover that Greensill was financing fake receivables: It “approached companies that were listed as
debtors” to a Greensill client, and “several of these companies have disputed the veracity of the invoices.”
This sounds a lot like fraud, but there is an innocent explanation: These invoices represented prospective
receivables, so of course they were fake and the supposed “debtors” had never heard of them. This is just
how prospective receivables financing works! It all made sense at the time to the people who did it!
Probably.

One customer who got a lot of prospective receivables financing from Greensill was Bluestone Resources
Inc., a coal company owned by West Virginia Governor Jim Justice. When Greensill imploded, it (or rather,
its administrator and lenders, particularly Credit Suisse Group AG, which bought a lot of Greensill loans)
asked for the money back, which it was entitled to do because after all it was notionally making short-term
receivables-backed loans to Bluestone. But Bluestone didn’t have the money, because in its mind it was
doing long-term unsecured borrowing against potential future sales. So Bluestone sued, asking, basically,
for more time to pay off the loans. 

In Greensill’s defense, I guess, it kind of makes sense to lend to a commodity company against its
“prospective receivables”? Like a coal company is not really in the business of building deep customer
relationships so it can upsell higher-margin products to those customers. A coal company is in the business
of owning a bunch of coal in the ground, taking it out of the ground, and selling it at market prices. So if it
needs to pay back the money sooner than expected, all it has to do is take more coal out of the ground.
Anyway:

West Virginia Gov. Jim Justice and Credit Suisse Group AG are looking to take advantage of surging coal
prices to help him pay off nearly $850 million in loans his companies borrowed from now-collapsed
Greensill Capital.

Representatives of the Swiss bank and Mr. Justice’s family of companies met face-to-face this month in
West Virginia to sort out the mountain of debt, which Mr. Justice personally guaranteed.

Plans under discussion include ramping up output at coal mines operated by the Justice family’s
Bluestone Resources Inc., according to a person familiar with the conversations. 

Yeah it's fine. You dig the coal, you sell it, boom, the prospective receivables become real ones, no
problem.

The interns are back

God love 'em, they are working hard:

Working in the office means experiencing the energy of a trading floor. On her third day at JPMorgan’s
office, 21-year-old environmental science major Anna Albright learned how worked up traders can get.
 It was June 16, and the Federal Reserve had just shocked markets by signaling two potential interest-rate
increases in 2023. The seventh floor of the largest U.S. bank was a flurry of chat pings, ringing phones
and cross-floor shouting as analysts pored over Chair Jerome Powell’s press conference diction for an
explanation behind the abrupt change in the Fed’s dot plot.

“It was like the Super Bowl, but way more intense,” said Albright, a trading and sales summer analyst.
“We were like ‘Oh my God, what world have we entered?’”

And playing hard:

For others, New York’s reopening is an opportunity to bond with fellow interns after work. One popular
spot is Phebe’s, the downtown bar known as a “haven for NYU kids and Wall Street interns,” according
to bartender Lauren Ramirez, 28. It’s clear the summer analysts have arrived when you see “anything
Vineyard Vines, pastel button-ups and boat shoes,” Ramirez explained.

By 10 p.m. on a Friday in June, interns crowded a packed dance floor, screaming along to an electronic
remix of Taylor Swift’s “Love Story,” and the line to get in was the only thing visible outside the
entrance. By 10:15 p.m., the queue stretched down the street, crowding the sidewalk and blocking the
entrance to neighboring apartments and businesses. Black cars double-parked to let out packs of young
men and women as they headed inside and assumed a place at the bar.

There is nothing more intense than the energy of a trading floor during a Fed press conference, unless it is
the energy of Phebe’s on a summer Friday. I mean, I’m lying, there are totally things that are more intense
than that, but the point is that the Wall Street interns are having a nice time and learning a lot about the
industry and themselves.

A nice gesture

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Here is an article about campaign finance for local elections in New Jersey. Municipal contracting is
hard because there are often “pay to play” rules forbidding firms from contributing to local officials’
election campaigns and also winning municipal contracts given out by those officials. But those rules are
complicated and there are exceptions, and so some firms will do business with a city while also
contributing to the mayor’s campaign funds. And sometimes they will give reporters great quotes about it:

In March 2020, Parsippany-based firm Statewide Striping donated $2,600 to Fulop’s campaign; four
months later, the city (legally) awarded Statewide a $1.16 million contract for road painting.

Kenneth Kida, the president of Statewide, said such donations were meant as “a nice gesture.”

“It’s just a thank you for the pleasure of doing business with the city,” he said.

We talk enough about these sorts of euphemisms that I wanted to make sure to record that one. 

Things happen

Tether Executives Said to Face Criminal Probe Into Bank Fraud. Robinhood Ditches IPO Traditions Again in
a Roadshow Open to All. Fed’s MBS Buying High on Agenda as Officials Begin Taper Talk. Private-Equity
Firms Spark Bidding Wars in U.K. SoftBank Vision Fund’s bet on Didi falls $4bn into the red. Hedge funds
back away from Binance after regulatory assault. Sri Lanka to Repay $1 Billion Bond, Ending Default Threat.
Credit Suisse Settles Spying Case With Ex-Wealth Chief Khan. Jeremy Grantham’s Firm Says Stocks Are
Overpriced and Social Media Is Wrong. Elon Musk says Tesla caused two-thirds of his personal and
professional pain. Jeff Bezos' 18-year-old space-flight companion reportedly told him he had never bought
anything from Amazon before. “For Romania, the broadcaster used an image of Count Dracula.”

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1 That is, (wealth in year n+1) = (wealth in year n) x (1.05), while (debt in year n+1) = (debt
in year n) + ($3 million). Or (wealth in year n) = ($100 million) x (1.05^n), while (debt in
year n) = ($3 million) x n. If you divide the latter by the former you get a maximum of about
22.61% in around year 20; then it starts declining. Obviously this math is dumb and
unrealistic: You will owe interest on the debt, and your expenses will growwith inflation; it
is too cute to assume that your debt grows linearly while your assets grow exponentially. (Also
the assets can go down.) Still.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:

Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:

Brooke Sample at bsample1@bloomberg.net

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