The Economy’s Weekly Recap

8/25/23 - 9/1/23

Raymond Lin

This Week’s Prominent Events

UBS’s Record Breaking Profit

• The largest quarterly profit was previously JP Morgan’s $14.3 billion in 2021, but it is now UBS’ gargantuan $29 billion. Investors were seemingly quite jubilant about the news and the stock rose almost 6% in response.

• However, that massive number is only because of an accounting trick called negative goodwill. Negative goodwill is the difference between the cost paid for assets and the assets’ actual value. UBS’ acquisition of Credit Suisse and the low price of the transaction is what has caused the massive $29 billion quarterly profit. In reality, UBS has had $1.1 billion in quarterly underlying profit before tax, which doesn’t account for negative goodwill, tax, and integration expenses.

• UBS’ acquisition and integration of Credit Suisse is expected to be completed in 2026. Already, UBS has begun to cut costs by closing parts of Credit Suisse’s investment banking and trading operations and not hiring to replace leaving employees. UBS plans to consolidate Credit Suisse into its business and eventually completely stop using Credit Suisse’s brand.

The Private Fund Crackdown

• Private funds, which are investment companies that consist of capital from accredited investors and not the general public, are facing new regulation from the SEC.

• This regulation will target the $25 trillion private funds market, which includes hedge funds and private equity firms like Blackstone, Citadel, and Apollo Global management, by increasing transparency for investors. This means required quarterly performance reporting, the restriction of what expenses can be passed onto clients, and the end of secret deals.

• While the first and second regulations seem pretty sound and benign, the last one is more conspicuous. These secret deals are known as side letters. They give flexibility to certain clients in a fund by giving them more information or the ability to withdraw money more freely. Often, it is reserved for especially prominent investors who boost the fund’s credibility. The SEC is now forcing companies to disclose side letters, which were kept discreet, to all inventors if they are of material economic terms.

• Traditionally, private funds have avoided these kinds of regulations by arguing that their clients are experienced and sophisticated, so they don’t need that kind of information. They also now argue these regulations will “increase costs, undermine competition, and reduce investment opportunities”, according to the chief executive of the Managed Funds Association.

3M’s $6 billion Lawsuit

• 3M has agreed to a settlement to its lawsuit regarding the alleged selling of defective earplugs to the US military. For the 300,000 lawsuits that will be resolved, 3M will pay $5 billion in cash and $1 billion in stock over the next few years. 3M has explicitly stated that this is not an admission of liability and that the earplugs are safe and functional if used correctly.

• 3M had previously tried to avoid this by having its subsidiary Aearo file for bankruptcy and assume responsibility for the lawsuit. However, this move was denied, eventually leading to the recent $6 billion settlement announcement.

• This will likely negatively impact 3M. Seemingly in preparation for the settlement, 3M has eliminated 8,600 jobs this year, about 10% of its workforce, and is planning to spin off its health care business. These moves will help cut costs and increase cash flow. However, some, like JPMorgan, UBS, and RBC, believe that 3M’s 6.1% dividend may be at risk.

• Despite the negative impact the settlement might have, 3M’s stock jumped 5.2% on Monday because the $6 billion was less than investors expected.

• This settlement comes after another $10.3 billion settlement regarding 3M’s role in the spread of “forever chemicals” that can have severe effects on health.

ChatGPT Enterprise

• ChatGPT is an incredibly powerful and possibly transformative tool. However, it has seen limited usage of companies as concerns over privacy permeate decision making. To better capture this audience and increase its revenue, ChatGPT’s parent company OpenAi has launched ChatGPT enterprise.

• There are a number of key differences between ChatGPT enterprise and the existing ChatGPT Plus. Some are…

  • An admin console to control how employees use ChatGPT.

  • Sharable conversation templates that allow for improved workflows

  • Unlimited access to Advanced Data Analysis, which can generate insights from data, answer math questions, and create charts.

  • The training and customization of ChatGPT to fit a business’ needs.

  • Not using the data and conversations from ChatGPT enterprise, meaning companies should not have to worry about proprietary information being leaked

  • A much larger 24,000 word limit and faster responses.

  • The encryption of data when in OpenAI’s servers and when it is in transit to users, which has helped ChatGPT enterprise be certified for SOC 2. SOC 2(System and Organization Controls 2) is a framework to audit a company’s management of customer data, and it is further reassurance that ChatGPT enterprise will have better privacy

• However, the success of this new product is not guaranteed. There already exists a competitor: Bing Chat Enterprise. There is also the concern of the AI hallucinating and the impact that might have on business operations and planning.

Rite Aid’s Bankruptcy

• Rite Aid, the seventh largest pharmacy chain with over 2,200 stores, is preparing for chapter 11 bankruptcy to restructure itself in the face of $3.3 billion in debt and lawsuits relating to its role in the opioid crisis.

• The lawsuits are quite expansive and include 1,000 federal lawsuits that were consolidated into a multidistrict litigation. Rite Aid also faces several different lawsuits in state courts and a civil lawsuit by the Department of Justice.

• Bankruptcy would allow for Rite Aid to restructure its existing debt and any legal liabilities. It also allows Rite Aid to put the lawsuits on hold and resolve them in a single forum. Rite Aid will join Purdue Pharma, Mallinckrodt and Endo International as pharmaceutical companies that went bankrupt due to opioid related lawsuits.

• However, Rite Aid has been struggling for the last few years even when ignoring the opioid lawsuits. Rite Aid has been losing hundreds of millions over the last few years.

Future Events

The Plight of Insurance Companies

• Hurricane Idalia made landfall Wednesday morning and proceeded to wreak havoc through Florida, Georgia, South Carolina, and North Carolina. It has led to around 300,000 homes and businesses experiencing outages and between $12 billion and $20 billion in damage and lost economic output. While Idalia has caused significant damage, it is still less devastating than 2022’s Hurricane Ian, which caused $114 billion in damage.

• The economic disruption and devastation from natural disasters will likely only exacerbate in the future as climate change results in more extreme weather like hurricane Idalia. This foreboding future poses a difficult financial challenge for insurance companies.

• As a result, many have pulled out of natural disaster prone states. Back in July, Farmer’s, one of the largest home insurers in America, stopped renewing its insurance policies in Florida in a move to slowly end operations in the state without being abrupt. AAA also chose to not renew some Florida home insurance policies. Similarly, State Farm stopped selling homeowner’s insurance in California in May.

• These withdrawals have led to dire circumstances for some. They are left with an unstable insurance market, the exact opposite of what insurance is intended to be. Additionally, insurance premiums are often expensive and face future increases in the companies that remain. This has led to greater dependence on state run insurance plans, with ones in Florida and California experiencing explosive increases in policies.

Student Loan Payments

• Student loan payments have been paused for the last 3 years. But starting this month, they are going to start accruing interest again. The payments will be due on October 1, but there is a yearlong grace period where missed payments will not be reported to credit agencies or compounded as part of the student loans; however, they will still have to be paid.

• This will likely have a marked impact on many people as it adds a significant expense to many households. The financial freedom that the pause on student loan payment in prior years, which led to more people getting mortgages, car loans, and more discretionary income, will end. Spending may weaken as consumers begin to face a large recurring expense.

• However, student loan payments will likely make up less than 1% of consumer spending. So, although it might have a major impact on many households, the impact of the payments may not be too economically significant as a whole.

• Furthermore, the Biden administration still wishes to provide assistance and relief to those with student loans. The Saving on a Valuable Education (SAVE) plan has measures like…

  • The aforementioned grace period where there missed payments will not be compounded, considered in default, and reported to credit agencies.

  • Forgiving student loans after 10 years rather than the existing 20 if the original loan balance was less than $12,000.

  • Removing all adverse effects from loans currently in default.

  • Not allowing debt to balloon and interest payments compound as long as the monthly minimum is paid.

  • Excluding a spouse’s income on payment plans, effectively lowering the monthly payment.

  • Allowing those making less than $32,805 annually(15$ an hour) to have a $0 monthly payment.

A Soft Landing

• Two pieces of data came out this week that support an optimistic view of our economy where we are returning to normality and our economic growth is remaining strong.

• The first is the addition of 185,000 jobs in August and the increase in unemployment from 3.5% last month to 3.8% this month. This is a sign that the labor market is cooling and that the Federal Reserve’s interest rate hikes are having their intended effect. Additionally, average hourly earnings rose 4.3% year over year.

• The fact that average hourly earnings rose is good for workers as they are paid more, but they pose a possible challenge for the Federal Reserve as higher wages could lead to higher prices and further inflationary pressures.

• Fortunately, the second piece of data released shows this is likely not the case. The core personal-consumption expenditures(PCE) index, which is a measure of inflation like the consumer price index but is sourced from businesses and calculated differently, rose just 0.2% month to month and 4.2% year over year. This was in line with expectations and is in line with the Federal Reserve’s target of 2% inflation.

• Overall, the economy is doing well and inflation is settling down. S&P Global Market Intelligence estimates that US GDP will grow at an annual rate of 4% this quarter.

Weekly Question

What bank has the most total assets?

• A: JPMorgan Chase

• B: Bank of America

• C: China Construction Bank

• D: UBS

  

  UBS

Answer: C. China Construction Bank. Despite the gargantuan size of the other banks and UBS’ recent acquisition of Credit Suisse, China Construction Bank still has more total assets.