Longreads + Open Thread

Longreads

• Khe Hy of RadReads has a look back at an expensive pivot that resulted in laying off half of his six-person team. He had multiple sources of income, and one of the biggest was courses. The difficulty with a course business is that the revenue is one-time, and that the better the initial marketing is, the fewer people there will be to reach for the next cohort of courses. If there's a subscription business where revenue follows an S-curve, the one-time-payment version of that business follows the first derivative of the same curve: a rise and then a decline. Adding ongoing expenses to cope with a business generating one-time profits isn't an impossible proposition—in plenty of industries, there's no other way to operate—but when it doesn't work out, the result is declining revenue and steady fixed costs, which is a very tough place to be.
• Patio11 wrote a great piece on some of the practical difficulties of dealing with a bank run: when the user interface improves faster than the core system, it means customers can act faster than the bank can react. For example: "Over the weekend, the regulators made some calls and asked regional banks what deposit outflows looked like on Friday and how many wires were queued up for execution Monday morning. This was complicated by some banks finding it surprisingly difficult to add numbers quickly. You see, the core puts the queued wired requests in a different part of the system than Friday’s outflows. We have a report of Friday outflows, but it gets crunched by an ETL job which only finishes halfway through Saturday, and Cindy who understands all of this is on vacation, and..."
• And Nathan Tankus looks at the same issue with a focus on a different set of technical problems: when there's a banking crisis, who is empowered to act how, and what precedents are being set? A crisis is, of course, the worst time to think about precedents except for all the others; people are busy putting out fires and should put a high value on that, but every episode tends to echo whatever got missed in the last episode. In the mid 2000s, investment banks were just wrapping up paying big fines for what they'd done in the equities market in the dot-com era when they started running into problems in credit; now that banks are more limited in how much credit risk they can take, our biggest issue is from a half-trillion dollar mark-to-market loss from lending to the world's safest creditor, the US government.
• And for a change of pace: this blog post is a quick summary of a paper looking at whether short covering behavior is informative. It's yet another entry in the catalog of research results showing that the cost and inconvenience of shorting is a driver of the gap between theoretical and realizable returns. In this case, the paper finds that much of the timing of short covering is driven by these more mechanical concerns, rather than by changes in views of the underlying company. And it's another argument for operational alpha ($): that large funds (and some specialized ones) earn excess returns partly through effective management of their borrowing, of both stocks and cash.
• Dwarkesh Patel interviews Brett Harrison, former CEO of FTX US. Harrison resigned just before the blowup, citing, among other things, a lack of transparency around management decisions. This interview is valuable both for thoughts on quant/trader culture in general and on FTX's pathologies in particular. In a sense, it's a curse to run a structurally profitable business like an exchange/casino while being unable to manage it effectively, since so many problems can be solved in the short term by throwing money at them, but the inevitable result is still a disaster in the long run.
• In Capital Gains, an explainer of what agency mortgage-backed securities are, and why they're so sensitive to interest rates. These mortgage-backed securities are completely different from the ones that brought down other banks in 2008, and while they don't carry credit risk, they aren't riskless.

Books

• Last Man Standing: The Ascent of Jamie Dimon and JPMorgan Chase: Since Wednesday of last week, the S&P Bank ETF is down 16%, but shares of JPMorgan Chase are down just 3%. The company's being pushed in two directions: down, because of a banking crisis, but up, because it's the bank best geared towards surviving a banking crisis. This book goes through some of the backstory behind this: Dimon put together a banking conglomerate after spending years as an apprentice to Sandy Weill, who had done more or less the same thing a few decades earlier. Any time there's a volatile industry, one tempting business plan is to run a conservatively-financed and cost-conscious company in that industry, and to gain market share through opportunistic acquisitions during downturns. Easier said than done. But, as Dimon demonstrates, doable.

Open Thread

• Drop in any links or comments of interest to Diff readers
• As is traditional in times of crises: what are your unorthodox bets on the next shoe to drop? Or your unorthodox—but EMH-compliant!—views on how everything will be fine?

Reader Feedback

In last week's open thread, Philo drops some book recommendations:

The Lost Bank, about the rise and collapse of Washington Mutual, still the largest bank failure ever. This one got lost a little among all of the other books about the financial crisis at the time but it was really well done. This was about bad credit rather than duration risk but in general rhymes a lot with SVB - got really big really fast (never ends well in finance) and clueless leadership.

Fatal Risk, which is about the rise and fall of AIG. Also one that got a little lost with the other financial crisis failures but it was interesting to read about how AIG came to be, and how it all fell apart.

A Piece of the Action, which is about how modern consumer finance came to be - Visa, money market funds, credit cards, mutual funds, discount brokerages. It's from 1994 but holds up very well today. Joe Nocera is a great writer and this is an exceptional business book.

Fiasco, a mid-90s classic about the MS derivatives desk. One theme here is how a lot of money in the world is controlled by people who are apt get in over their heads with financial bets they don't understand. Sometimes they get "get their face ripped off" by people selling derivatives and sometimes they just pile into risky bets without understanding them. In the mid-90s you had a lot of high profile cases of huge losses from rising rates (P&G, Orange County) which comes up in this book and that is playing out again now, in a different way.

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