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June 6, 2023 | Watching the latest example of human nature in the hype surrounding stocks that refer to “artificial intelligence,” we remind readers of The Institutional Risk Analyst that if it’s artificial, then it’s not intelligent. Muscular pattern matching is not deliberate intellect, one reason why we agree with Mark Cuban and others that “A.I.” is probably more a risk rather than a help. And yeah, we’ve got the stop loss order right underneath our position in Nvidia (NVDA). H/T Jim Cramer.
Source: Google
Even as the cult of AI reaches a fever pitch, the members of the regulatory and law enforcement communities are tightening the lasso on the world of crypto fraud. Federal regulators sued Binance, the world’s largest crypto trading scheme, accusing the company of running an illegal securities exchange and commingling billions of dollars’ worth of customer funds.
The Securities and Exchange Commission alleges the company acted in “blatant disregard” of US securities laws. It also named Binance’s CEO Changpeng Zhao, known as “CZ,” as a defendant. “Through 13 charges, we allege that Zhao and Binance entities engaged in an extensive web of deception, conflicts of interest, lack of disclosure, and calculated evasion of the law,” SEC Chair Gary Gensler said Monday.
Meanwhile in the world of fintech, the wheels are coming off the wagon for several familiar vehicles. Last summer, we wrote about Upstart Network (UPST), a financial startup that promised to avoid credit risk by using AI to underwrite unsecured consumer loans (“Update: Upstart Holdings & Cross River Bank”). UPST is up over 100% in the past month, but is still down 40% over the past year, reflecting the powerful updraft from the AI hype fest led by NVDA.
Source: UPST
We notice that Giuliano Bologna at Compass Point in Washington has a “sell” rating on UPST and an $8 price target, this vs a ~ $27 price for UPST today. Why the concerns from Compass Point? First, the primary source of loan purchases historically, Cross River Bank, is now the target of an enforcement action by bank regulators led by the FDIC and is likely to be reducing funding for UPST.
Second, the other bank lenders that have been supporting UPST are apparently heading for the door, a bad sign for an originate-to-sell model. Compass Point notes that Customers Bancorp (CUBI) may have been purchasing up to a third of the production from UPST. Bologna writes:
“Cross River Bank (CRB, private) and one other bank have likely been a significant majority of UPST's bank funding channel and that those two partners have materially reduced loan purchase volumes and could potentially stop buying loans from UPST during 2Q23.”
The concern about UPST is warranted, in our view, because of both funding and credit. As banks pull back from third-party originators such as marketplace lenders, originate-to-sell models like UPST become problematic. Nonbank lenders that are forced to retain production on heavily leveraged balance sheets are not long for this world. Note that PacWest Bancorp (PACW) stabilized near $8 after selling its loan business. Take the hint.
Compass notes that concessions made by UPST today to retain funding may mutate into credit risk down the road. Moreover, the visible default rates disclosed by lending facilitators like UPST are still understated due to QE. By this time next year, we expect that the default rates on production from UPST will look pretty much like other unsecured marketplace products. AI does not make superior credit decisions, it simply makes your loan underwriting mistakes look like the mistakes made by everyone else.
Consumer defaults are still running at very low rates, as we noted in The IRA Bank Book for Q2 2023. By the time that credit card default rates normalize, we expect that subprime consumer lenders like UPST will also see rising losses appropriate for their select clientele. But it could be worse. You could be a developer of commercial real estate with legacy assets in Lower Manhattan.
Jeff Blau, The Related Companies CEO, just put a bullet in the head of the return to work tendency in New York City. Blau’s advice to the owners of B & C grade commercial properties in Manhattan: “Take what you can and run,” The Real Deal reports.
“Every landlord thinks they have Class A,” said Blau. “There is a big difference between a 50-year-old, well taken care of building and a new building.”
We notice that new buildings in markets like San Francisco are also trading at distressed prices. Blau's less than kind remarks about other commercial properties, it seems to us, amount to wishful thinking in terms of the long-term prospects for urban office space of whatever description or vintage.
While Blau is happily disparaging the owners of older commercial properties, he claims that Hudson Yards is 80% leased and that he will be able to harvest $200 per square foot rents indefinitely, even as the rest of Gotham slides into the East River under the weight of progressive destruction. The fact that anchor tenant Neiman Marcus fled the barren wasteland of 10th Avenue & 34th Street does not deter Blau, who is reportedly turning the vacated retail space into, wait for it, more offices.
Perhaps if the lucky tenants of The Related Companies buy some of the new Apple (AAPL) Vision Pro Mixed-Reality Headsets, they can pretend that there are people and actual economic activity on the streets around Hudson Yards. Mr. Blau can also wear the headsets and pretend that Hudson Yards is the Westfield World Trade Center, with real people and shopping. He can even pretend that Hudson Yards is Time Warner Center, also with real people and shopping. No word yet on when Related is starting Phase 2 of the construction of Hudson Yards.
But one thing that Blau and other real estate developers cannot change, with or without AAPL goggles, is the deteriorating economics of core cities like New York. Blau can pretend that he can demand $200 per square foot for newer commercial properties while the rest of the city is deteriorating. We suspect that the dismal outlook for most commercial real estate in NYC will soon be reflected in the fiscal situation. Without commercial tenants, New York City does not work. Just ask your favorite co-op owner or realtor.
Down-sizing of investments in urban commercial real estate is a long-term reaction to the invention of the automobile and related car-centric development patterns of the past century. Enabled by technology, the COVID lockdown allowed Americans to break free of the commuter model that was an allegory to the world of automobiles created by Henry Ford. Fifty years later, Robert Moses turned New York into a car-centric metropolis, a model that is now dying a most natural and timely death.
Knight Frank reports that a survey of 350 large employers, those with more than 50,000 employees, found that half of employers planned to downsize office space by 10-20%. Smaller employers, not surprisingly, plan to expand their office space needs. While observers of the world of corporate real estate like to refer to working at home as “hybrid working,” in fact it reflects a more traditional pattern of local working and living that actually predates the age of the automobile.
As we noted in Ford Men: From Inspiration to Enterprise, the cities built two centuries ago along the St Lawrence seaway and Great Lakes no longer have a clear economic purpose. The compact, grid layout of New York City reflects an economic reality that died fifty years ago, but humans are creatures of habit. It took the shock of COVID to change behavior patterns and create new possibilities, even if the “new” model of working at home looks a lot like the pre-automobile model of America before WWI.
Joe Costello wrote back in December:
"In an era where America must transcend the automobile as the primary means of transportation, how can information technologies help us restructure our transportation and distribution infrastructure? Here’s a clue, it would mean a company like Amazon wouldn’t exist. We have no politics to even ask these questions."
And we don't even begin to have the politics to discuss the restructuring of great cities like New York, Chicago, San Francisco and Los Angeles.
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