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Slate Money
The Peer Pressure Edition
00:48:41
Slate Money on Lending Club, Google payday loan ads, and public pensions.
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- [00:00]
Host (Slate Money Announcer)
Slate Money is brought to you by Texture, the mobile app that gives you full access to more than 150 of the world's most popular magazines. Anytime using your phone or tablet, read Vogue, People, Esquire, Time, and hundreds more from back issues to the one currently on the newsstand. Right now, try Texture for free at texture.com slatemoney and by ZipRecruiter. With ZipRecruiter, you can post your job to more than 100 job sites with a single click and an interface that's easy to use. And right now you can try it for free. Go to ziprecruiter.com slatemoney and by Casper, an online retailer of premium mattresses for a fraction of the price. All Casper mattresses come with free delivery and returns within a 100 day period. Get $50 towards any mattress purchase by visiting Casper.com slatemoney and using the prom Slate Money.
- [01:06]
Felix Salmon
Hello and welcome to the Peer Pressure edition of Slate Money, your guide to the business and finance news of the week. My name is Felix Salmon of Fusion and I am joined as ever by Kathy O', Neill, the data scientist and blogger@mathbabe.org hello. As well as Slate's Moneybox columnist, Jordan Weissman.
- [01:32]
Jordan Weissman
You're looking ravishing this morning, Felix.
- [01:34]
Felix Salmon
I'm looking awesome this morning.
- [01:36]
Kathy O'Neill
I'm pretty in pink.
- [01:38]
Felix Salmon
I'm just. You guys are really missing out when you're listening to this.
- [01:42]
Jordan Weissman
He's wearing a very sexy short sleeve button down, let me tell you.
- [01:45]
Felix Salmon
We are going to be talking this week about all manner of sexy things. We're gonna talk about whether companies can really sort of take public policy into their own hands. We heard this week that GOOG is going to ban all ads for payday loans. We are also going to talk about hedge funds and whether people are, whether investors are getting a little bit fed up with the lack of outperformance that they're paying for. But first, Jordan, there was some big news coming out of San Francisco this week.
- [02:22]
Jordan Weissman
Yeah, things are kind of a mess for Lending Club.
- [02:26]
Felix Salmon
What is Lending Club?
- [02:27]
Jordan Weissman
I'll tell you what Lending Club is. Lending Club is the largest. Well, I guess now they call them marketplace lenders really. But they're companies that theoretically are supposed to connect people who want to borrow money with. At first it was individuals who wanted to lend money, just kind of retail investors. If someone felt like giving Felix a loan because he wanted to buy a new car, I wanted to lend Felix money to buy a new car. I could do it by a lending club. Their Business models have kind of changed over time where it's less individual joes lending to one another and it's become institutional investors doing it. Banks and hedge funds. So what happened with Lending Club this week? Well, well, first off, they are the 800 pound gorilla of this growing market, or at least they're the biggest in this market. They're a public company and their CEO, I'm sorry, I always pronounce this wrong. Renault Laplanche, right?
- [03:18]
Felix Salmon
Renaud Laplanche, lovely guy. Actually I've hung out with him a bit.
- [03:21]
Jordan Weissman
Well, he stepped down and the details of why are sort of still dribbling out.
- [03:27]
Felix Salmon
But he was fired by his board.
- [03:29]
Jordan Weissman
Yeah, well, there are two separate reasons it seems like. One is a batch of loans that Lending Club, I guess sold to an investment bank. Jefferies, one of these institutional investors are so important to their business model, now had some irregularities. There were just things wrong with them. And I think it's still not 100% clear what exactly was wrong with them. But they somehow didn't conform to what Jefferies asked for. The other, and to me at least seems like bigger issue is that it looks like Laplanche had a, had a interest in another, in another fund and a thing called Circus Capital that was buying a lot of Lending Club's loans. However, at the same time Lending Club or he had urged Lending Club to make an investment in CX without ever revealing that he had this financial interest in it. And that's a problem. You can't have your company invest in your fund without telling them that it's also your fund. So he was, when that came out, he was basically forced to step down.
- [04:26]
Felix Salmon
So we do actually have a little bit of information about what was wrong with the loans. It seems that as Lending Time said, it wasn't anything to do with the payment terms, the credit terms. They sold these loans to Jefferies at par. They bought them back at par, they sold them to someone else at par. But loans themselves were pretty standard Lending Club loans. The problem was basically the dotting of the I's and the crossing of the T's and the legalese in the loans up until a certain point in, I think February or late earlier this year. What happened was, was that in order to be able to securitize the loans and do all of the things that Lending Club needs to do, they need a limited power of attorney to be able to sort of transfer these things and that kind of stuff. And Jefferies looked at the Lending Club power of attorney, which was in the boilerplate legalese that you click through when you get the loan and decided it wasn't quite the way they wanted it worded. And so they wanted the wording to be changed. And so Lending Club changed the wording and sold Jefferies $22 million of loans with the new wording. Except in that $22 million of loans was $3 million of loans which had the old wording because they were older loans. And in order to make them conform to what Jefferies wanted, they basically changed the date on those $3 million of loans in order to make them look like they were later. So they had the new wording rather than the old wording.
- [05:59]
Jordan Weissman
That's not so.
- [06:00]
Kathy O'Neill
Wait, wait. This is like in the case of a bad thing happening, the actual terms of how it unfolds would be up for debate. What does it mean for those $3 million loans?
- [06:15]
Felix Salmon
It doesn't. Well, okay, in terms of what?
- [06:17]
Jordan Weissman
They're just going back date stuff?
- [06:18]
Kathy O'Neill
Well, obviously.
- [06:19]
Felix Salmon
No, no, no, no. Forward date.
- [06:21]
Jordan Weissman
Forward date. Oh, sorry, they forwarded.
- [06:22]
Kathy O'Neill
Sorry.
- [06:22]
Jordan Weissman
They forward dated.
- [06:23]
Felix Salmon
So in the event of a bad thing happening, it wouldn't make any difference. The important thing here, the really important thing is that the whole point of marketplace lending is that you have complete transparency down to loan level information. You know exactly what the individual credit ratings and underwriting is for every single borrower. And it's all based on this kind of super transparent API big data model, as opposed to the old school securitization model which was we'll bundle up a bunch of stuff and you'll have no idea what it is, and you'll just have to trust us that it's cool. And so the fact that Lending Club was in some way capable of making a bunch of loans look different than what they really were, even in something relatively minor like dating. I mean, it's not minor, it's important. But you know, the fact that they could change anything at all was. Was deeply worrying. And so that's. And so they wound up firing a couple of people who are in charge of that deal and also the CEO.
- [07:29]
Kathy O'Neill
I've gone to Lending Club's website because. Because it does actually. Basically you're right. It markets itself as like, we're so transparent. And they even have like data that you can download for the loans that are like up for grabs and historical data. So they make a big, big deal out of sort of like saying you could be your own personal quant shop and which loans you want or don't want on Lending Club's website and in.
- [07:54]
Felix Salmon
The as Jordan says in the early days they would really encourage individual lenders to go through loans, loan applications one by one. And people would ask loans and they would type in, I need this to refinance my credit card. I need this to build a new pool deck. You know, I'm a trustworthy person, please can you lend me some money? And you would go through each one you go, that seems good, I'll lend this one money on that one. That, as Jordan says, has kind of gone by the wayside now. And you don't have those kind of personal notes from borrowers anymore. But yes, there is way, way, way more information about individual loan level data at Lending Club than you could ever dream of getting in a standard loan product or even bond product really.
- [08:40]
Kathy O'Neill
I looked at the IPO price of lending club, which was $25, it's now around $4. I feel like this is not the only thing that's going wrong.
- [08:50]
Felix Salmon
All of the marketplace, lenders prosper has been moving in the same direction. That, I mean, frankly is the other big thing that's going on here is that if you're the CEO of a company and you go public with great fanfare and then your share price basically never ever hits that IPO price ever again and it just goes steadily down into the right for the past couple of years, which is what it has been doing, your board is going to get upset and is going to be much more willing and likely to kick you out. Like if the share price of Lending Club was going through the roof right now, I kind of suspect that maybe he wouldn't have got ejected like this.
- [09:30]
Jordan Weissman
Yeah, I mean part of it is just they have this issue of scale they have to deal with. I mean they make their money off of fees from each transaction. Right. And so in order to, you know, get profits or revenue where they want it, they just have to keep doing more and more and more transactions. That's that's their only option. And so that's actually part of that that ties into this circ story as well. There's this sense that one of the reasons, you know, they were essentially turning to this outside fund to buy that they had a secret relationship essentially with through the CEO to buy up more and more of their own loans and in order to basically fund their operations.
- [10:06]
Felix Salmon
In a way it's a two sided market. And what has rapidly become obvious in this, in this market is that in all two sided markets you need to balance supply and demand. Right. So you need to have a certain supply of borrowers Asking for new money. And you need to have a certain supply of lenders like wanting to lend money. And the amount that's borrowed needs to be the same as the amount that's lent. And there's always one which constrains.
- [10:31]
Kathy O'Neill
So what is the constraint?
- [10:34]
Felix Salmon
For the past few years, since even before the ipo, the constraint has been much more on the lending side than on the borrowing side. They can always find the borrowers they need. They have a bunch of like knobs they can whittle to get new borrowers. They have a bunch of relationships with websites and stuff who send them new borrowers when they need new borrowers. What they have been finding more difficult is finding investors who can invest the amount of money they need. These like billions of dollars. They need to start to keep on funding more and more and more loans. And as Jordan says, they're built on a growth model so they need to just always keep on growing.
- [11:11]
Jordan Weissman
Which I mean it makes sense when you, when you think about it, right? If your model at first, the early model was let's get mom and pop investors essentially to make loans directly and disintermediate banks, that, that is hard to scale because you're doing almost retail consumer outreach to do investors to get them into, to supply money. And so that's, I mean it makes sense that eventually they would start turning to major, to banks themselves and also to hedge funds and whatnot because it's so much easier to get the capital you need.
- [11:46]
Kathy O'Neill
Let me dwell a little bit more on the borrower's side though. I don't borrow from Lending Club. If they want to double their business every year, which is probably what they want to do, they have to enlarge their borrowers from people who go online to borrow. We're going to talk about payday lenders in a second. I feel like it's not just the number of borrowers they have willing to borrow. Right. It's the quality of borrowers.
- [12:09]
Felix Salmon
So Lending Club has always, and this is how it got big. Lending Club has always been very, very tough in terms of its underwriting. They accept roughly 10, maybe sometimes 15% of the people who want to borrow money. They are only lending to the most credit worthy borrowers. And so basically you don't borrow from Lending Club right now, but in few months you're going to suddenly realize that, oh wait, I've spent three months where in a row where I haven't been able to pay off my credit card bill in full and I've been running this balance on My credit card. And I know it's insane to run the balance on my credit card. So what I should do is pay off the balance in full with a lending club loan, you know, which would be at, I don't know, 12% instead of paying 29% on my credit card. And that would be good for you. And it would be. And if I'm the lender, you know, I'm lending money out at 12% which is a hell of a lot higher than 0%, which is what I can get everywhere else. So as long as they can keep on finding people like you. Now this is the one other thing which needs to be emphasized is that in the early days it was very easy for Lending Club to find these credit card refinancers and like the overwhelming majority of their borrowers were refinancing credit cards. But increasingly now people are refinancing basically old lending club loans and the supply of credit card refinancers because people have become a little bit more sensible when it comes to credit cards and they don't have that sort of post financial crisis overhang hangover that they had in the early days of Lending Club. Those credit card refinancings are becoming less common, relatively speaking. And so again you're right, it's becoming a little bit harder to find those really good credit worthy borrowers.
- [14:05]
Jordan Weissman
I have sort of a big picture question that I want to ask you, Felix. I have some thoughts on it, but it's this. Given that Lending club has now essentially become a conduit not between individuals but large financial players and borrowers, what do you think? It's, what purpose does it really serve now? I mean again I have a sense.
- [14:29]
Felix Salmon
Of it, but because there is no other way for large institutions. If I'm an insurance company or a hedge fund or something like that and I want exposure to individual borrowers, there's no other easy way for me to get that. Lending club is a really good way for me to get exposure to those individual level loans.
- [14:50]
Jordan Weissman
Okay. And so I'm also thinking from the consumer side. I mean it's still there, still in the end probably going to be because it's taking the whole banking infrastructure out of, out of the picture. It's taking the branches and out. They're probably going to save money in the end. Still.
- [15:03]
Kathy O'Neill
Well, can't they buy like securitized credit card loans?
- [15:09]
Felix Salmon
You can, but the, from the point of view of the borrower, it is still the case that it is ridiculously difficult, stupidly difficult for individual Americans to Just go out and borrow money unsecured. The banks have every incentive not to give out loans because the banks all have credit cards. And the banks make so much more money on credit cards and on revolving credit card balances than they do on loans that they really don't want people to take out loans. They really want people to just keep those balances on their credit cards. Lending Club in this sense is a really good thing for personal finance generally in America because it gives people the option to do what used to be quite easy, which is just, I used to go into your bank and ask for a loan. No one goes into their bank and asks for a loan anymore because banks don't do it because banks make it as difficult as they possibly can. So Lending Club is stepping into that gap and saying, we'll give you a loan and that's a good thing.
- [16:11]
Jordan Weissman
And so with, I mean, sort of the doubts this raises about Lending clubs. I mean, I guess the financial interests of the CEO are very kind of, I mean that's a one time thing. That's a guy did not disclose his interest in a side fund. But with the, I guess forward dating and the weirdness with their loans. Do you think this does any kind of long term damage to the company, to the idea, or do you think it's just sort of a passing, just kind of a passing event?
- [16:43]
Kathy O'Neill
I mean, I think there's other things going on here. You know, in every single article I've read about Lending Club it says there's also regulatory pressures going on. And you know, we maybe talk about that another time. But I think there's all sorts of growing pains this industry is going to do. It's largely unregulated. It's, you're right, it's tapping into a, into a need, but it hasn't really sorted itself out yet.
- [17:05]
Felix Salmon
Well, I mean let's, let's be clear about this again. Lending Club, the reason it's the 800 pound gorilla in the space is precisely because it was very, very early in terms of getting regulated by the sec. And they did this thing which everyone thought was insane, which was that they took every single individual loan, even if it was just for 1000 bucks, and turned it into its own SEC registered security.
- [17:29]
Kathy O'Neill
That's right.
- [17:31]
Felix Salmon
They have a huge amount of regulatory compliance and stuff which they have been doing for many years. The big question is what happens through the credit cycle. Lending Club has never gone through a bad credit cycle. And we're coming to the end of this credit cycle right now and we don't know how it's going to go through the downside of the credit cycle. It did fine during the upside. People are worried about that and the share price reflects that worry. Will it come out the other side smelling like roses? It might, you know. Alternatively, will the credit cycle claim Lending Club and people like it as a, as a high profile scalp? That's possible too. We just, we just don't know. Anyway, that is all we have time for on Lending Club. I will move on to Google and more payday lenders and stuff like that in a sec. But first I need to talk to you guys about Texture, which is an app for your phone or your iPad or whatever you like to read things on. And it gives you access to every single magazine. So we all like reading magazines, but the problem with reading magazines, frankly, there is no problem with reading magazines. It's fun. You should, we should all do more of it. The only problem with reading magazines is that you need to carry them around with you and spend money on them. And texture kind of solves that problem because you have your device with you anyway. And once you subscribe to Texture, which is less than the cost of like three magazines, you have access to every single magazine in the world.
- [19:06]
Kathy O'Neill
I just realized something about what's great about texture.
- [19:08]
Felix Salmon
What is good about texture is that.
- [19:10]
Kathy O'Neill
When you, when you're using texture, those little like things don't fall out of your magazine while you're reading the blowout cards. Yeah, I hate those.
- [19:16]
Felix Salmon
It's magazines. It's all of the upside of magazines, which is the article with none of the downsides, which is the blowout cards. And then you're on the subway and you open up the magazine and the blockhead falls onto the floor of the subway. And then you like, you feel like because you're a good civic citizen, you should pick that thing up, but you don't want to pick it up on the floor of the subway. And it's. Yeah, all of that goes away.
- [19:37]
Kathy O'Neill
Yeah.
- [19:38]
Felix Salmon
And what's more, you know that huge pile of New Yorkers you have like sitting by your couch by your bed? They multiply. They infest your entire living space. Because there's always so much you want to read in the New Yorker. You can only really realistically carry around what, like three or four New Yorkers maximum at any one time. With Texture, you can have access to thousands of them. It's amazing. There's all of the back issues, so you get, and you can take, you can read across subjects. It's awesome.
- [20:08]
Jordan Weissman
You'll never be able to make a decision again.
- [20:11]
Felix Salmon
So, yeah, so you can read everything. Vogue, New Yorker, Consumer Reports, even these expensive ones. So go to texture.com slatemoney right now and you can try it out for free. And free is good, right?
- [20:28]
Kathy O'Neill
Free is good.
- [20:29]
Felix Salmon
Free is good. So get all of the magazines you could possibly ever want to read for free@ texture.com slatemoney you get everything except for the blowout cards.
- [20:40]
Kathy O'Neill
I didn't know that was the name of those. That's good.
- [20:42]
Felix Salmon
Kathy.
- [20:43]
Kathy O'Neill
Yeah, Google. Google has decided to stop letting payday lenders make advertisements on their site. This is a big deal. I mean, it's a big deal. I'm really excited. I know people, some people think, what now? Google's in charge of deciding who's good and who's bad in the world of lending. And the answer is yes.
- [21:05]
Jordan Weissman
Yes, that's exactly right.
- [21:07]
Felix Salmon
Okay, so there are two angles to this which I want to talk about. I think we can probably just get past the simple like, are payday lenders bad? Yes, they are. Okay, next question.
- [21:21]
Jordan Weissman
Right?
- [21:22]
Felix Salmon
There are two next questions that I have. The first question is, this comes in the wake of a bunch of Silicon valley companies like PayPal saying that they're going to reverse their plans. They had to move into North Carolina because North Carolina passed HB2, the sort of homophobic crappy law, their bathroom bill. And all of these companies were like, if you're going to pass these homophobic crappy laws, we're just totally not even going to move into your state. And they were bullying the state that way. And this kind of feels similar in a way that you have these companies, these Silicon Valley companies mainly, who are making sort of social decisions. They're saying payday lending is bad. And so we are going to act. We're going to use our big, massive corporate might to fight against it, or transphobic laws are bad, and we're going to use our big, massive corporate might to fight against it. And is that. I mean, so long as those fights are on the side of the angels, people don't really complain. But there's no sort of a priori reason why the big, massive corporate might should always be on the side of the angels. Should we be worried that corporations have this kind of power?
- [22:42]
Kathy O'Neill
I'm going to answer that. I have a very strong opinion about that. Corporations are already making these decisions. The question is, what decisions? Where do they draw the line? And it's not like we can go back to the world where they're completely benign and objective. And neutral, because they've never been like that. So let's just kick neutrality out of the entire conversation. There is no such thing. And just to be clear, Google already makes a stand against counterfeit goods, illegal drugs, anything about guns. So they already have that line. But I agree with you. It's interesting that they've moved the line up to payday lending.
- [23:20]
Jordan Weissman
I think there are two different issues here. It's one thing when a company says, we're not going to move our corporate headquarters because we disagree with this law that you passed and it violates our values. You know, we think it's transphobic. It's another when you're talking about exercising its power essentially as a utility. Right, right. That's what Google is for all intents and purposes. It is search. It is for most of. For most of America, for a lot of people.
- [23:39]
Felix Salmon
This raises my second big question, which is what is happening with search? Because the ads next to search are an ad product. And if Google doesn't want to sell that ad product to payday lenders, I'm like, that's fine. They don't need to. But the core of what Google does is search. And it never really reveals how it sets up its algorithm in terms of search results. That's a very secret source. So the huge big question here for me is, along with banning the ads for payday lenders, is Google also quietly tweaking its algorithm to put the payday lenders lower down in search results and not on the first page? Because otherwise all that happens is that the money which used to go into buying ads just goes into SEO instead, and these people still get all of that Google traffic.
- [24:35]
Kathy O'Neill
That's a good point. I mean, look, to be clear, when they get rid of those ads, they'll probably be replaced by, I mean, theoretically they'd be replaced by ads that are not payday lending ads. Right. They're just other kinds of loan ads.
- [24:48]
Felix Salmon
Or not even loans at all. It could just be ads for holidays.
- [24:51]
Kathy O'Neill
Well, it's. Usually. It could be, but it's unlikely because usually it's a keyword search advertisement. And the keywords are something like, how do I borrow money? So typically, somebody else will sort of step in and it might be a better. A better lender. So my question is, I know we're all asking different questions slightly, but how do they know who's a payday lender or not? I looked at the policy, and it says 36% APR or more, and the loans have to be longer than 60 days. And I can imagine all sorts of ways that people that want to do essentially payday loans can get around this and that historically, we know that payday lenders have gotten around laws in various states about payday lending.
- [25:32]
Felix Salmon
Right. But this isn't this. The good thing about this is that it's not some government regulation with loopholes. Right. That Google is just going to look at certain companies and say, you're a payday lender, you're a payday lender. It's not like there's some appeals court where someone can say, no, I'm not in a payday lender. You know, Google just can unilaterally make that decision.
- [25:53]
Kathy O'Neill
They unilaterally make the decision, but companies will game it.
- [25:56]
Felix Salmon
There's like companies will try to game it and then at the margin it will be games. But the big picture is that we all know who these big payday lenders are. And Google's just going to say, you, you, you and you, you're not allowed to advertise.
- [26:08]
Jordan Weissman
It's a lot harder to game when you're trying to buy advertising services versus, you know, I think it would be, there'd be more opening to do that if it was Google trying to put them lower in search results. That's a different issue.
- [26:19]
Kathy O'Neill
I have to disagree that I think it will be largely gamed. The other issue is that they've also said that they're going to get rid of what are called lead aggregators for payday lenders. Those are people that sort of find would be borrowers and sell the information to payday lenders. It's also going to be hard for them to know exactly who's doing that.
- [26:36]
Felix Salmon
And again, they're going to be people who slip through the cracks. Yes, but if this policy is 90% effective instead of 100% effective, it's great. I don't think worrying about the 10% is.
- [26:48]
Kathy O'Neill
I'm not worried to the exclusion of wanting it. I don't want it to go away. And going back to the question of utility, the payday lending lobby, you might imagine, is very upset about this decision by Google. And they are claiming basically that this is discrimination and censorship and they're kind of acting like they have a free speech issue here, which they don't.
- [27:10]
Jordan Weissman
Well, they don't because Google is a private company. It happens to control this huge, huge part of our community.
- [27:18]
Felix Salmon
But let me come back to my question. Insofar as it is a utility and it is, I mean, it dominates the search market. It has basically 100% of the mobile search market, insofar as it is a utility, should there not be some kind of public interest in making sure that it doesn't discriminate against certain people? Probably more in terms of search than in terms of advertising. But if it becomes obvious that payday lenders are not coming up in search results for people who want payday loans, you know, I feel like maybe, I mean in that case that's a good public policy outcome. But there's no particular reason, again Kathy, that like Google can't do the same kind of thing. They've dropped. Don't be evil, you know.
- [28:05]
Kathy O'Neill
Yeah, they have. Look, I think you brought up the very most interesting thing about this whole. It's a turning point. Like Google has gone, they've moved their line, they've moved into a gray area. They say we care about predatory loans and we don't think it's good for the most vulnerable of our users. And, and yes, the question of how far are they going to go with that? Like to what extent are they going to protect their most vulnerable users for search results from payday lenders? It's really an important question. But I feel like they've put themselves in that arena where they are taking some responsibility, which is interesting. And I didn't unexpected to be honest.
- [28:40]
Jordan Weissman
I do feel like just inherently there's something weird about Google paternalism. Right? Like they are, they are. I mean this is, it is paternalism in this case. It's good paternalism. But where does that paternalism cease? Does it, does it, do they look for other products they don't think the poor should be buying essentially, or that they think are predatory where there might be more of a question about it. I don't know where that line. If this is a one time thing or if this is something we see them pursue further.
- [29:07]
Kathy O'Neill
If you feel uncomfortable about this then you should. I mean the algorithms we're seeing taking control of our lives are really powerful.
- [29:16]
Felix Salmon
Kathy is totally plugging her new bird in. I am, thank you. But we're gonna come back to Kathy's book at some point and we're also. I really want at some point to spend a segment talking about what happened to Facebook in India with its free basics program, Internet.org but that is for another episode. We're going to move on to hedge funds now, just after I tell you guys about ZipRecruiter which is the best way to hire people. Instead of putting your job ad on a million different job sites, you just go to one site. Ziprecruiter.com and, and they will manage to get your job ad out in front of millions, literally millions of candidates. ZipRecruiter has been used by over 800,000 businesses, which is telling. It's something which has been around for a while and is really good. So stop trying to work this out on your own. Give this to the professionals. Ziprecruiter.com they can find you pretty much anyone you want. So if you go to ZipRecruiter.com slate money, you get to try it for free. Like literally, you get to put a job ad up out to millions of potential people for free. It's a free job ad and it will work really well and you will love it and then you'll use it again and again. So free trial of ZipRecruiter@ziprecruiter.com slate money. Okay, hedge funds.
- [30:50]
Kathy O'Neill
Yeah, what's going on?
- [30:53]
Felix Salmon
We've just come out of the SALT Conference, which is this big annual hedge fund bash at the Bellagio Hotel with lots of hedge fund managers complaining this year a little bit about how they don't have as much money as they used to. Wow. $15 billion actually is the amount of money that got withdrawn from hedge funds just in the first quarter. And we haven't seen a quarterly outflow that big in six years. It looks like the investors who are investing in hedge funds are having second thoughts. They're looking at the way that hedge funds have completely failed to outperform the stock market or add any what they call alpha. They looking at the very high fees that are being charged and they're asking themselves whether these fees are worth it. And there's this long list of people like AIG and MetLife and China sovereign Wealth Fund and the New York City pension fund and the Illinois pension fund and CalPERS, the huge California pension fund. They were very early to the game in like 2014. They were like, we're not getting value here, we're just pulling out. And these very big names are pulling out of hedge funds and saying, you know what? We're not getting value. We're not going to invest in hedge funds anymore. It kind of makes sense because there's not a lot of evidence that in aggregate these hedge funds are really helping investors.
- [32:20]
Jordan Weissman
And yet though, and yet it seems that a few high profile pension funds like CalPERS have pulled out. But on the whole, public pension funds are actually sticking with it.
- [32:32]
Felix Salmon
Okay, this is the really fascinating article that came out in Reuters this week, which was the bat background to the SALT conference. This is the statistic in 2010, there were 234 public pensions invested in hedge funds. By 2016, that had increased to 282. And those 282 public pensions are investing more and more, not less. They're rapidly coming up to 10% of their assets that they have invested in hedge funds. So. So it seems like the really big, loud, high profile departures from the hedge fund space are weirdly detracting attention from a bunch of smaller, less obvious public pensions who are going into it.
- [33:22]
Kathy O'Neill
I have a theory in both directions. So maybe first of all, I remember being at D.E. shaw and our gates were up after the crisis hit, which meant we weren't allowing people to take away their money even if they wanted to. For the most part, you don't really cry for the investors of a hedge fund because they're typically very, very wealthy individuals. But for the state pension funds, you're like, wow, that's not good. North Carolina or whatever. I don't remember which state. They can't get their money. And that money is supposed to go for retired folks. It's kind of weird for them to be even in the hedge fund space, which famously risky. But at the same time, like the alpha that hedge funds are supposed to provide, it's not supposed to be just like beyond the market. We get this much return. Right. It's supposed to be sort of statistically independent of the market. And that is sort of a critical point.
- [34:19]
Felix Salmon
So this is, this is the point that every single hedge fund manager has been making for the last few years. His stocks have been going up. They've been saying, in bull markets we underperform, and in bear markets we outperform. And what you're doing is you're getting diversification ra an outperformance. And certainly the large sophisticated investors that are increasingly investing in hedge funds, they're not the people who used to invest in hedge funds, which were individuals wanting to get 25% returns. They're big corporations who are really worried about diversification and they worry that they have too much exposure to public equities and they want some other kind of asset and some other kind of strategy.
- [35:01]
Kathy O'Neill
Exactly. So that's my theory about the problem.
- [35:04]
Felix Salmon
Is that no one knows whether hedge funds are really providing that.
- [35:07]
Kathy O'Neill
Right. My theory is that sort of like middle size or smaller sort of public pension funds are being managed by people who are convinced by this argument, which is why they have around 9% of this in a sort of diversification push, and that maybe the really large pension funds like CalPERS and Stuff have their independent minded, like big deal money managers who are like, I know better than this marketing ploy. That's my theory about what's actually happening.
- [35:35]
Jordan Weissman
So it's the dumb money.
- [35:37]
Kathy O'Neill
The other theory of course, is that what are the alternatives? It's a very low interest environment and the way the accounting is done for pension funds assumes a very good rate of return on investments. And that's a real problem for money managers.
- [35:52]
Felix Salmon
I have another theory of what's going on here, which is the difference between top down and bottom up. Investing in hedge funds. If you're CalPERS or New York City or one of these huge investors, what you're doing is you're trying to pick the very best hedge fund managers because you can get into any hedge fund you like and you're trying to pick the ones which are going to really give you the performance and the alpha that you want. Because you know that overall the hedge fund industry is kind of crappy. There's $3 trillion in hedge funds or whatever it is, and over, if you aggregate over the entire 3 trillion, you're not going to see alpha there, you're not going to see diversification there, you're just going to see a whole bunch of fees, a lot of fees. Whereas people, there is a general feeling in the industry that if you manage to invest in the very best hedge funds, then you can actually get some value out of them. The problem is, of course, no one knows what the very best hedge funds are. So they're maybe changing their mind or they're saying, well, you used to be a really great hedge fund, Mr. Ray Dalio or Mr. Leon Cooperman or whoever. But maybe we don't think think you are anymore because you've got too big and now that you're this big, you can't generate the same kind of idiosyncratic returns. So that's on the big side, the big institutional investors who can invest in anyone. Meanwhile, on the medium side and the smaller side of the pension funds, they are not trying to pick hedge fund managers so much as they're trying to allocate to an asset class. And they have this bucket of money and it's 5% or 8% or 10% or whatever it is. And they're saying we want diversification. Hedge funds are a diversification play. We're going to throw a bunch of money into this bucket called hedge funds and then once it's there, we're going to just allocate it more or less willy nilly across. However Many hedge funds make sense and this is what AIG was doing. This is a crazy statistic. AIG was invested in 100 different hedge funds.
- [37:48]
Kathy O'Neill
Were they invested in like 10 funds of funds? Is that what that means?
- [37:51]
Felix Salmon
They had individual investments in 100 different hedge funds. How it does that help you?
- [37:57]
Jordan Weissman
I was going to say, isn't the idea of treating hedge funds as an asset class kind of inherently crazy? They are. I mean a hedge fund is not an asset, it is a, it is a fund that finds assets to invest.
- [38:07]
Felix Salmon
The slogan is that it's a compensation scheme masquerading as an asset class.
- [38:12]
Jordan Weissman
Yeah, exactly. But yes, I mean it's, I mean this brings up another thing actually. Like the idea that there are these gradations of hedge funds, but they all charge, supposedly charge the same damn rate.
- [38:22]
Kathy O'Neill
And have the same price fixing, doesn't it?
- [38:24]
Jordan Weissman
It seems like yeah, places are kind.
- [38:26]
Felix Salmon
Of coming down a tiny bit. The days when everyone would just pay 2 and 20, gone. Now you see a lot more 1 and a half, you see a lot more 15s, you see some 18s or 19s. The 2 and 20 is definitely negotiable now in the way that it wasn't a few years ago. The fees are coming down, but they're coming down very slowly. And even the hedge fund managers themselves are saying they should probably come down more quickly.
- [38:51]
Jordan Weissman
Yeah, I mean that's good then that's one upside of counters and such leaving right. When the big guys leave and basically send this message that has to be part of it, right.
- [39:02]
Kathy O'Neill
I think the hedge fund industry did. Nobody any impressed, nobody. When the markets crashed in 2008 and a lot of hedge funds crashed, that just flew in the face of this theory that we're up when markets are bad. I feel like the only thing that's really keeping the hedge fund alive, the hedge fund industry alive right now, is just extremely. I feel like it's going to change everything.
- [39:25]
Felix Salmon
And then the other thing that's happening is that you get these periodic hedge fund blow ups where you get stocks like Valeant which are overwhelmingly owned by hedge funds and then which just implode and a bunch of hedge funds lose money and everyone's like, you guys really aren't smarter.
- [39:42]
Kathy O'Neill
Hedge funds are always going to be around. But my hope is that they're literally going to be playthings for rich people at some point. And that like, like pension funds, which.
- [39:51]
Felix Salmon
Is what they were back in the 70s, early 80s, but then they became this institutional asset class thanks to people like David Swenson. At Yale. And that worked until it didn't. Okay, that's it for hedge funds. We're going to move on to the numbers round after I tell you guys about Casper, which is the best mattress company. You get to sleep beautifully. You get your maximum sleep. You cannot oversleep. You know this. Unless you are like clinically dep. Basically impossible to sleep too much if you have to wake up.
- [40:24]
Kathy O'Neill
Oh my God, you're making me so tired.
- [40:27]
Felix Salmon
You haven't got enough sleep, have you?
- [40:29]
Jordan Weissman
You're talking to.
- [40:30]
Kathy O'Neill
I really have, but I have pollen allergies and it's just the worst.
- [40:34]
Jordan Weissman
I don't sleep.
- [40:34]
Felix Salmon
I didn't get enough sleep last night. I had to set my alarm this morning. And that's bad. But there are two ways of getting enough sleep. Number one is you just need to be in that room for eight and a half hours. And there's no two ways around that. But the other one is like that when you're sleeping, you need to sleep well. And you can't be on some crappy, lumpy, horrible, uncomfortable mattress. What you should do is get into your latex foam and your memory foam and just get a great mattress and don't overpay for it because you don't need these things to be expensive. You just go to Casper and you can get these things for as little as 500 bucks. And it just transforms your health, your life, your happiness. And. And it's not even 500 bucks if you get $50 off. And I can give you $50 off if you go to Casper.com slatemoney and use the promo code slatemoney. You get your $50 off twin size mattress. It comes down from 500 to 450. You can get $50 off anything at Queen. That $900 king. It's a really good deal. And if you don't like it, you can send it back. There is it arrives for free, completely free shipping. You can send it back after 100 days. It's a free trial. It's a no brainer. Casper.com slatemoney Coupon code slatemoney 50 bucks. Free money numbers round.
- [41:57]
Kathy O'Neill
I got something.
- [41:58]
Felix Salmon
What's your something?
- [41:59]
Kathy O'Neill
175 billion.
- [42:01]
Felix Salmon
Wow, that's a big number.
- [42:02]
Kathy O'Neill
It's a big number. It's a number of dollars that we expect to be spent on smart city projects in the next decade.
- [42:09]
Felix Salmon
What the hell is a smart city project and who is going to be spending money?
- [42:12]
Kathy O'Neill
So it's going to be some kind of Chinese accounting. Chinese company along with an American Company called Sensiti Systems and what they mean by Smart city is like video surveillance and things that monitor traffic and air quality sensors. So all sorts of sensors and video.
- [42:32]
Jordan Weissman
I can see that that would be very important to Beijing where they want to do nothing but monitor the sensitivity citizens and make sure no one's choking.
- [42:39]
Felix Salmon
I have a very, very deep mistrust of all these numbers that you get. Like some industry shill putting out something which looks a little bit like a report has a massive, great big number in it. And everyone goes, ooh, this industry expert but, you know, says big number. But this number just was basically just pulled out of their ass.
- [42:58]
Kathy O'Neill
Possibly. But it is kind of interesting that an American company has teamed up with a Chinese company to like, like surveil everything in sight.
- [43:05]
Felix Salmon
Wait, are they doing the surveillance and also releasing the report?
- [43:11]
Kathy O'Neill
This is a Bloomberg article. I don't know who released the report.
- [43:15]
Felix Salmon
Okay. My number is also China related. It's $1 billion, which is the amount of money that Apple has invested in Didi Shushing, which is the big Uber competitor.
- [43:28]
Kathy O'Neill
I was going to use that number. I was like, Felix is going to take that number.
- [43:31]
Felix Salmon
I'm totally taking that.
- [43:31]
Jordan Weissman
You deserve applause for getting, getting the pronunciation even close to it sounded right.
- [43:35]
Kathy O'Neill
Did you just make that up or did you check with someone or do you just know Mandarin?
- [43:39]
Felix Salmon
My Mandarin is rusty. But Didi Chooshing is one of the more interesting companies out there, mainly because it's more or less the only company which has successfully competed with Uber. Uber has poured an insane amount of money into China and is in a distant second place to Didi.
- [44:05]
Jordan Weissman
Is that like local preferences at play? Is that some sort of subtle government favoritism at play? Is it like people, Uber drivers getting their kneecaps broken, or is it just.
- [44:16]
Felix Salmon
These things are by their nature, winner takes all, network effect kind of market. And once you have a population locked into one of these things, it's almost impossible to get them to change to another one. What's fascinating about to me is that Apple very, very rarely makes minority stakes in other companies or minority investments in other companies. So this is very rare. It looks to me like it's a combination of two things. One is that it is a long term strategic investment in two things which are absolutely core to Apple. One of them, of course, is China. And the other one is cars. We know that Apple has like a thousand people working on it, an autonomous car project. And the way that autonomous cars work is you need to be able to call them and then ride them somewhere. And so you need some kind of ride sharing partnership to do that. You know, it could well be that the heart of Apple's autonomous car project is going to be in China rather.
- [45:14]
Jordan Weissman
Than, or at least gets its kind of virgin launch. And yeah, I mean, because that's the thing everyone envisions for Uber one day is it's a fleet of autonomous cars, but maybe that'll get off the ground in China, where people. Where the government might be more willing to just try that out.
- [45:28]
Felix Salmon
And the other thing which is quite clearly going on here, I think, is this huge question of Apple's offshore cash pile, which it's not allowed to bring back, because if it does, it needs to pay massive taxes on it. And so they have tens of billions of dollars just sitting offshore, and they have no conceivable idea of what to do with it. And so they're like, hey, we can use this to make a strategic. Indeed, let's do that. Because it's better than having it sitting in the bank earning negative interest rates.
- [45:59]
Kathy O'Neill
That's so true.
- [46:01]
Jordan Weissman
My turn.
- [46:01]
Felix Salmon
Your turn.
- [46:02]
Jordan Weissman
My. My number's dumb. It's like, really dumb. But I'm sharing it anyway because it's so dumb. I have to share it.
- [46:08]
Kathy O'Neill
Please.
- [46:08]
Jordan Weissman
Seven trillion. That's.
- [46:11]
Felix Salmon
Is this a Trump number?
- [46:12]
Jordan Weissman
It's a Trump number.
- [46:12]
Felix Salmon
We can't have a Trump. We're not allowed to Trump on Slate money. An entire rule about this. We have a rule about this.
- [46:19]
Jordan Weissman
I just, I. I have to. I have to just do it fast. That's how much of a budget surplus Donald Trump's advisor said their policies would lead to in the United States. Keep in mind 7 trillion. Keep in mind they're proposing a $10 trillion tax cut, but somehow, one way or another, they're gonna create a $7 trillion budget surplus.
- [46:39]
Felix Salmon
We're not even gonna talk about this. It's a dumb number. Dumbbell.
- [46:45]
Jordan Weissman
Dumb, dumb, dumb. You know, there's a line in Teenage Mutant Ninja Turtles, one of the original, where literally, I think Michelangelo just looks at someone and goes, dumb, dumb, dumb. Those guys are so dumb. And that's what the episode ends on. And I feel like that's where we are right now.
- [46:58]
Kathy O'Neill
Yeah, thank you.
- [47:00]
Felix Salmon
Yeah, I'm not gonna thank you for a Trump number. And frankly, I think it's against.
- [47:06]
Kathy O'Neill
Let's hear from listeners. What do they think? Is it Trump free zone? That's my proposal.
- [47:10]
Jordan Weissman
If we wanna make it a fully Trump free zone, I'm okay with that.
- [47:13]
Felix Salmon
There is a panoply podcast called Trump Cast hosted by Jacob Weisberg. If you want your Trump, you can get all the Trump you need there. I'm not sure you need that much Trump.
- [47:22]
Jordan Weissman
We don't have to ask listeners. We could actually. Do we want to make a vow right now that I would. That this will be a Trump free zone?
- [47:27]
Kathy O'Neill
Yes.
- [47:28]
Jordan Weissman
What happens if he wins? Do we continue making it a Trump free zone?
- [47:32]
Felix Salmon
Yeah. No. If he wins, we will move to Canada. So it's like that.
- [47:35]
Kathy O'Neill
Moot point. Moot point.
- [47:36]
Jordan Weissman
All right. We can record a podcast in Canada, guys.
- [47:41]
Felix Salmon
So. Okay, that is it. I hope maybe this was the last week we hear the word Trump. Probably not. I think he's gonna wind come wind up coming back one way or another. Thank you for listening to us talk on Slate Money. Do subscribe to the show. We're in itunes. Leave us a review there. Write to us. Our email address is slatemoneylate.com Many thanks to Audrey Quinn, the producer, Andy Bowers and Steve Lichti, the executive producer. And go check out all of their podcasts@itunes.com panoply and we will talk to you next week with an awesome special guest on Slate Money.