Money Stuff: You Don’t Need Profits Anymore

Money Stuff

Vaccine profits

Oh man I feel like I need to go down to Congress and explain some stuff:

Executives from four companies in the race to produce a coronavirus vaccine — AstraZeneca, Johnson & Johnson, Moderna Therapeutics and Pfizer — told lawmakers on Tuesday that they are optimistic their products could be ready by the end of 2020 or the beginning of 2021. All four companies are testing vaccines in human clinical trials.

Three of the firms — AstraZeneca, Johnson & Johnson and Moderna — are getting federal funds for their vaccine development efforts. AstraZeneca and Johnson & Johnson pledged to the lawmakers that they would produce hundreds of millions of doses of their vaccines at no profit to themselves. Moderna, however, which has been granted $483 million from the government to develop its product, made no such promise.

"We will not sell it at cost," said Dr. Stephen Hoge, the president of Moderna. …

At the Congressional hearing on Tuesday, some House members raised concerns about Pfizer's decision to reject federal funds, suggesting it could lead to price-gouging and a lack of transparency.

Don't worry, the thing I am going to explain is not Econ 101. I'm not going to go to Congress and be like "if you don't let pharmaceutical companies make a profit on a vaccine that billions of people need, they will have no incentive to make it, so you will not get a vaccine and people will die." I don't know if that's true—the federal funding is itself an incentive, as is the desire to save lives, etc.—but more to the point, you can get tons of people to explain it to Congress, there are people whose whole careers are just explaining Econ 101 to Congress, that one is boring and easy.

No, the thing I am going to explain to Congress is that almost 30% of Pfizer Inc.'s stock is held by Vanguard Group, BlackRock Inc., State Street Corp., Capital Group Cos. and Wellington Management Group. All of those are giant institutional investment firms that own shares of hundreds or thousands of companies, and those are just Pfizer's biggest holders; lots of investors lower down the list are also huge diversified institutions. If Pfizer finds a coronavirus vaccine and distributes it as widely as possible—even at cost, even below cost, even for free, even at an enormous loss—it will make its owners richer by many many billions of dollars. BlackRock, for instance, owns about $16 billion of Pfizer stock. If Pfizer went to zero—if it bankrupted itself, selflessly producing and distributing vaccines—BlackRock (really its clients) would lose $16 billion. BlackRock owns about $2.9 trillion of other stocks; if a coronavirus vaccine allowed businesses to reopen and normal economic life to resume, and as a result those other stocks went up by 1 percent, that would more than make up for bankrupting Pfizer.

For BlackRock, I mean. BlackRock would be happy with that tradeoff, as would its clients, as would Vanguard and State Street and, in all likelihood, a majority of Pfizer's shareholders, many of whom are diversified investors who own a lot of companies that aren't Pfizer and are struggling. Presumably Pfizer's executives would be sad about it. Right now they have prestigious jobs where they get paid a lot; if Pfizer went bankrupt then they would be embarrassed and probably stop getting paid. And they're the ones who set the prices. 

But there is a trade there, you know? That is the thing that I want to explain to Congress. The shareholders, in some loose sense, own the company; in some loose sense, Pfizer's executives are getting paid with the shareholders' money; in some loose sense, the shareholders are the executives' bosses. If the shareholders were to call up the executives and say "look, if you find a working vaccine and give it away for free, we will give you a bonus pool of one billion dollars to share with each other and your scientists," then … presumably that would be an incentive?[1] Like, the executives would think "if we find this vaccine and make a big profit I'll probably get like a $17 million bonus, but if we find it and make no profit I'll definitely get like a $100 million bonus," and they will have strong incentives to (1) find it and (2) give it away. Econ, like, 101.5, really.

One way to think about this, if you're Congress, is that we've got a whole great big economy, and a vaccine will be very very good for the economy as a whole, and what you want is to find some mechanism to transfer some of that value—enough to incentivize vaccine research and development and production—from the rest of the economy (the households and restaurants and retailers and everyone else who will benefit, economically, from a vaccine) to the people researching and developing and producing the vaccine. You want the people who benefit from the vaccine and are happy about it to send some money to the people who make the vaccine, so that those people will be happy to make the vaccine.

There's a super traditional Econ 101 way to do that, which is pricing; the people who make the vaccine can charge a lot of money to the people who want the vaccine. There are problems with this method, which I will not dwell on here because Congress is obviously well aware of them. (Some people don't have the money to pay for the vaccine, etc.)

All I am saying is that now there is a new way! Now the whole great big economy is knitted together not only by pricing in product markets but also by common ownership of all the stocks by the same investors, and so you can think of all of the companies—Pfizer, American Airlines, Carnival Cruises, The Gap, whoever—as divisions of one giant company, and the one giant company has an executive committee (Larry Fink and the other heads of big investment firms), and the executive committee can tell the divisions (Pfizer, etc.) what to do and how much to charge, and if the giant company's executive committee says "we are going to have our Pfizer division try to find a vaccine and give it away as a loss leader to improve the performance in our other divisions" then, you know, fine, that's how divisions operate, that's how corporate hierarchies go, it's fine. It's not quite like that—there is no giant company, there is no hierarchy—but it is kind of like that, it is enough like that that you ought to start thinking about it, that you ought to think of giant public corporations not as acting on their own pure selfish self-contained profit motives but as part of a vector of interests of their diversified investors, and that you could maybe use that. "Sure, pharmaceutical executive, you say you want to make a big profit on this drug, but what if we asked your owners what they want?"

To be clear, Pfizer doesn't say it wants to make a big profit. It says … what you'd expect it to say, in its owners' interest:

"We didn't accept the federal government funding solely for the reason that we wanted to be able to move as quickly as possible with our vaccine candidate into the clinic," said John Young, Pfizer's chief business officer.

"We'll price our potential vaccine consistent with the urgent global health emergency that we're facing," Mr. Young said, adding that "a vaccine is meaningless if people are unable to afford it."

Plenty of drug companies sell plenty of drugs that plenty of people aren't able to afford, not because they are meaningful but because they are profitable; this is a different situation.

I have written versions of this argument before,[2] but I still feel like Congress might enjoy hearing it.

Moderna has more concentrated owners than the bigger companies, though. If you don't like drug profits maybe you have to regulate them or nationalize them or whatever, that's not my problem, that's Congress's problem.

Elsewhere in indexing

Uh oh, this is happening:

Tesla Inc., for the first time in its 17-year history, reported a fourth-consecutive profitable quarter, a milestone that is sure to bolster Chief Executive Elon Musk's pitch that he can usher in the age of fully electric cars. …

The achievement of four cumulative quarters of profitability means Tesla can now be considered for inclusion in the S&P 500 index. If included, large index funds would likely race to include the shares among their holdings.

Bloomberg tells me that the total market capitalization of companies in the S&P 500 is about $27 trillion; S&P tells me that there is about $4.6 trillion indexed to the S&P 500. Dividing those numbers suggests that when Tesla is added to the S&P, index funds will need to buy about 17% of its stock. Tesla's stock price bounces around a lot, but as of yesterday's close its market capitalization was about $295 billion; 17% of that is about $50 billion. So index funds would have to buy $50 billion of Tesla stock when it is added to the index. That number is too high—S&P weightings are based on float-adjusted market cap, and Musk owns a lot of Tesla stock—but on the other hand it doesn't count all the active managers who are benchmarked to the S&P 500 and might give Tesla a whirl once it's in the index.

It's a lot:

With a market capitalization of $304 billion, according to FactSet, Tesla is the 12th largest U.S. company, ahead of names like JPMorgan, UnitedHealth and Home Depot. Research firm Baird noted that it would be the largest company ever added to the index.

According to analysis from Credit Suisse, Facebook was the last mega cap company added to the index back in 2013, when it was worth roughly $120 billion.

"Accordingly, it's possible an S&P add may not occur until 2021," the firm said, noting the company's size. "That said, once Tesla becomes eligible, we would expect S&P to see pressure to add Tesla to the index."

One popular partial explanation for the recent rise in Tesla's stock price is that it is much beloved among retail traders on Robinhood. Robintrack, a website that tracks Robinhood traders' holdings, lists Tesla as the 8th-most-popular stock at the brokerage, held in about 500,000 Robinhood accounts, up from about 200,000 in March. The average Robinhood account size is apparently $4,800. If all 500,000 of those Robinhood traders who own Tesla (1) have twice as much money in their accounts as the average Robinhood investor and (2) put all of it into Tesla, they would represent about $5 billion of demand for Tesla, or about one-tenth the demand that might be coming from index funds. If Robinhood demand has been responsible for Tesla's 280% rise so far this year, then watch out when the index demand comes in.

One popular criticism of large-cap indexes like the S&P 500 is that companies tend to get added to the index after they have gone up a lot, which means that index funds structurally tend to buy high and sell low. If a company has a bubble and gets big, the index funds will buy it at the top of its bubble; if the bubble pops they'll sell it at the bottom. The good news is that if a company bubbles its way into the S&P 500, it will usually be one of the smallest companies in the index—it will bubble up from like number 600 to like number 495, at which point it will be added to the index—and index funds won't have to buy that much of it. Tesla is unusual in that it grew enormous while being ineligible for the S&P 500 (due to a lack of full-year profits), so it will join the S&P as the largest newcomer ever after a wild rally. Maybe that's fine!

On the other hand maybe indexing will make Tesla boring? Basically the reason you buy Tesla stock now is that you love Elon Musk, or Musk announced some big piece of good news, or you've decided to start gambling on stocks because you're bored; the reason you sell Tesla stock now is that you hate Elon Musk, or Musk announced "Tesla stock price is too high imo." Once Tesla is in the S&P 500, a lot of people will be buying and selling it for soporific reasons: You make your monthly 401(k) contribution and half a percent of that goes to Tesla, or you're a market maker in S&P 500 futures hedging your exposure by selling a basket of constituents including Tesla, that sort of thing. Things that are blessedly unrelated to Elon Musk's Twitter feed. Right now Tesla is driven by news and emotion and Twitter, but putting it in the index will create huge sources of supply and demand that have nothing to do with any of that; it will turn Tesla's stock from a pure bet on Tesla's business and image into, partly, a tool for generic stock-market investing, used by lots of people who don't actually care about Tesla. Maybe that will calm things down a bit.[3]

Central bank accounting

The U.S. Federal Reserve has a balance sheet, which is audited by KPMG LLP, and which lists the Fed's assets and liabilities. This balance sheet is of considerable interest to a lot of people but not, I think, for quite the same reasons that a company's balance sheet is of interest to its investors. The Fed's balance sheet provides a window into monetary policy and financial conditions and the banking system, but investors do not generally look at the Fed's balance sheet to answer questions like "how creditworthy is the Fed?" or "what are the odds of the Fed running out of money?" The Fed creates the money! As a matter of monetary policy it is interesting to know how many Treasury bonds the Fed owns, but as a matter of understanding the Fed's solvency, the main asset is "we can print as many dollars as we want," and the value of that asset is infinity.

I am going to get so many angry emails about that paragraph, oh boy. Certainly it is all very loose and not at all how accounting works. Plus even if you believe it, in its loose way, it is only really plausible for the central bank of a big country that prints its own stable currency that is much in demand globally. Meanwhile in Lebanon!

Lebanon's central bank chief arbitrarily boosted the institution's assets by at least $6bn using unorthodox accounting measures as the country's financial system careered towards collapse, leaked financial statements indicate.

The 2018 audited statements, a copy of which was seen by the Financial Times, reinforce concerns that Riad Salame, the veteran Central Bank of Lebanon (BdL) governor, relied on shifting accounting practices to swell the bank's assets and balance its books as risky liabilities grew.

The accounts, which were signed off by auditors EY and Deloitte with qualifications on June 30 this year and have not been made public, record an asset worth L£10tn ($6bn) for "seigniorage on financial stability", whose value "the governor determines . . . as deemed appropriate by him", according to the financial statements. …

"This is too bizarre for words," said Willem Buiter, former Citigroup global chief economist, academic and central banking specialist. "It is just a way of accounting to artificially blow up the assets of the central bank and hide [its] massively negative net worth or capital." He added: "Many of the assets are inventions."

Joerg Bibow, an economics professor at Skidmore College, New York, said it was highly unusual that the governor's judgment should be used to determine an asset's value, as they are normally defined by standardised accounting rules. "I've never heard that the governor can make up a number," he said. ...

Since 2009, even the BdL's unorthodox definition of seigniorage has gone beyond the conventional connotation of currency production, to add L£18tn in expected future profits from its holdings of Lebanese government debt, and finally in 2018 including an expected profit generated by "financial stability" as valued by the governor.

Yeah, look, a central bank is a weird creature, and I am sure that running one would be a heady experience. "I can just print money," you might think, "the world is my oyster, my balance sheet can be as big as I want, this is magical!" But you gotta keep those thoughts to yourself! Particularly if your currency is not a global hegemon, if investors do worry about your solvency and foreign-reserves position, you can't really have your balance sheet say "Assets: Whatever we want!" It is tempting, I know, but it doesn't work that way.

Everything is securities fraud

Is climate change securities fraud? Oh sure, everything is securities fraud, and we have talked about efforts by state attorneys general to sue coal and oil companies for securities fraud because they contribute to climate change. (Or, technically, because they fail to give investors enough dire warnings about the potential effects of climate change, but you know what the lawsuits are really about.) These lawsuits don't always succeed, but the theory is out there.

I have written a lot about this phenomenon, of suing companies for securities fraud to address more fundamental, non-securities-fraud-related issues. I find it a little troubling. I tend to think that the way societies are supposed to solve big collective problems is with democratically enacted substantive regulation. If climate change is bad, and if coal companies contribute to climate change, the way to deal with that is for elected governments to pass laws banning or limiting or regulating coal. Having state attorneys general, or activists who buy 100 shares of a coal company, sue for securities fraud seems sort of indirect and second-best.

But here's an even more indirect one: Why not sue governments over climate change to try to get them to regulate it substantively? Governments issue bonds, bonds are securities, good enough. I suppose the idea is that if you win the lawsuit—or if the government settles, due to bad publicity or the risk of losing—then the government will have to pass laws regulating coal or whatever, and you'll get the substantive regulation that you really want through the mechanism of securities law. In some ways that's better; you end up with actual laws about climate change, instead of just weird securities settlements with coal companies. In a lot of ways it's worse; instead of doing the usual things to make the democratic process work (voting, campaigning, etc.), you try to use securities law to force it. 


A Melbourne university student has launched what has been described as a world-first legal case against the Australian government, accusing it of misleading investors in sovereign bonds by failing to disclose the financial risk caused by the climate crisis.

In a claim filed in the federal court on Tuesday, Katta O'Donnell, a fifth-year law student at La Trobe University, said the government was breaching a legal duty and deceiving investors by not informing them upfront of the climate risk they face. … She said it would put the government "on trial for misconduct" for failing to deal responsibly with the climate crisis. …

She said young Australians owned bonds through their superannuation funds but were in the dark about government assessments of the climate risk their investment faced. Sovereign bonds are issued by governments to fund spending. Australia's are worth more than $700bn, mostly held by central banks and pension funds.

"While the current government will be long out of power by the time we can access this money, our financial security … will bear the brunt of its climate legacy," O'Donnell said.

Yes, bondholders will bear the brunt of climate change, why not.

I write about these cases, by the way, not because I expect the most outlandish ones to win. I don't expect this one to win, though I am not an expert in Australian courts. I don't expect the tech-industry lack-of-diversity-is-securities-fraud ones to win. I expect some of them to result in settlements, not so much because they are legally plausible but because it will be embarrassing for some defendants to fight them; a tech company sued for not having enough Black executives might decide that vigorously fighting that lawsuit is a bad look and it should just hire some Black executives. But mostly I write about the outlandish ones because they are signs of how broadly the theory has penetrated, how normal it has become for people to identify problems in the world and to say "huh I bet this is securities fraud." 

Things happen

Arkansas Pension Sues Allianz Over More Than $700 Million Loss. How Ben & Jerry's Perfected the Delicate Recipe for Corporate Activism. Inside the rise of Ram Sundaram, the leader of a secretive Goldman Sachs desk that's minting billions by designing some of the bank's most imaginative — and controversial — trades. Quirky IPO Rule Means Wall Street Won't Lead Ant Group's Shanghai Sale. Wirecard's Markus Braun Is Arrested Again as Scandal Embroils Angela Merkel. Fake Businesses Are Fooling Real Banks Into Processing Online Drug Purchases. SEC disclosure change would allow activists to 'go dark', lawyers warn. People are worried about marriage market liquidity. UBS Scores Naming Rights to N.Y. Islanders Arena in Queens. Scientists Have Finally Calculated How Many Hot Dogs a Person Can Eat at Once. 'It's like bombs loading on': Venice restricts numbers allowed on gondolas, complaining that tourists have gotten fatter. DA: Typo gives away man who faked death to avoid prison. 

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[1] How would this work? I suppose the big shareholders could team up to write them a check, for consulting fees or whatever, I don't know. It's a bit complicated. More practically, if you assume that it wouldn't *actually* bankrupt Pfizer to give away a vaccine for free—or that the shareholders' priority is more "broad rapid distribution" than "totally free vaccine"—you could just have the shareholders agree to approve whopping great incentive packages to be paid out of corporate cash. In general companies tend to link executive pay to performance, measured by traditional economic measures like income or stock-price appreciation, and this linkage tends to be enforced by shareholder pressure. Ordinarily, if a company had a big unexpected loss and paid its executives enormous special bonuses, the shareholders would grumble a lot and refuse to approve the pay package and maybe vote the directors out. My point here is that the shareholders could just cut a different deal, and in this particular case they should. (Formally the shareholders don't set the pay, the directors do, but the shareholders could call the directors and demand this sort of pay package and threaten to vote them out if they don't do it.) If Pfizer really were going to bankrupt itself giving away the vaccine this wouldn't work—then it's not the shareholders' money anymore—and you'd need some way for the shareholders to directly write a check to the managers. Also of course there are negative incentives. "If you develop a vaccine and make too much profit on it, we will put up a proxy fight, elect a new slate of directors and fire all the executives": That threat, from a majority of shareholders, could also make the executives give it away for free!

[2] In particular, in April I wrote "that solving any big societal problem is generally a high-stakes competitive endeavor for the for-profit companies looking to do it, and that this might not always be good for the world. But it is the normal way we structure capitalist society, and usually we think that it's pretty good. There's a thing that people want, and if you build it you will add a lot of value to the world; you will be able to sell the thing at a price that reflects that value, and capture some of that value for yourself in the form of profits. This is good for you because you get rich, but it's good for society because it provides incentives: You will work hard to invent things that people want, because the more they want them the more money you can make. This is basic capitalism stuff. The argument that I am making here, though, is that common ownership by institutional investors provides another way for companies to capture the value of what they do, besides selling it for a profit. If you build a thing that people want, if you make customers better off, if you add value to the world, you can internalize that value not by charging people for it but by owning all your customers, or rather by having the same owners as your customers. Someone else benefits from the thing you make; they capture all of the surplus, and you capture none of it, but it's fine, because you and they are in some sense the same person. You all work for the same super-company—the company of the index funds—and so you are motivated to pursue the common good rather than your own individual profit. Maybe the index funds really are the vanguard of socialism."

[3] There is also governance. Right now if you own Tesla there's a pretty good chance that you love Musk and think he's a visionary who can do no wrong, which is reflected in a board of directors that lets Musk do whatever silly thing he wants. Presumably if you're an index fund and you buy Tesla because you have to, you will be less amused by all of this, and you might vote for stronger oversight. I don't know that that is likely to matter, really, but at the margin it could.


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