The Saudis Need To Pick A Fall Guy: CIA Veteran Devine

Podcast on Apple Podcasts, SoundCloud, and Bloomberg dot com. Let's turn our focus now to Jamal Kashogi, the Saudi Arabian writer journalist who was killed sensibly at the Saudi consulate high level Turkish officials so that they have evidence about this. This has thrown a lot of diplomatic relations into questions,

particularly between the US and Saudi Arabia. Saudi Arabia had to care is is having to see corporate leaders move away from the nation joining us now to try to give us some insight into the potential impact of this move is Jack Divine, former acting director of the CIA and founding partner and president of security firm The Arkan Group. Jack, what do you make of this? What's going on here? Well,

the news is unfolding by the minute. I mean, it is one of the more bizarre cases that I can remember in terms of diplomacy or in the intelligence world. So what's going on is our one of our most important allies now has a political crisis on his hands, which by extension, draws us into it and everybody and and uh, I was just going to say in the Middle East, but also in Europe. So it's it's a big story that has to be resolved. How could it

be resolved? Well, the blue book would tell you that when you get a crisis like this, um, the the focus of it steps aside and a new person is appointed. Okay, Unfortunately blue blue books are collecting dust on OCE shelves nowaday, But I think the I don't think. Yeah, the way the way the game is played, so to speak, whether it's diplomacy, military, there are all there are a set of principles on pond which each of the people in those fields of endeavor operate. Right, So you would say,

when you get this crisis. For example, when Jack Kennedy ran into debate at Pigs and it turned into fiasco, he told Alan Donalds, the director of CIA, fiasco, one of us has to go, I'm president, You're you're resigning, You're fired. So uh, no matter where who's called here, somebody has to take a fall on a new person comes into it. That's the only way you can move forward. Dying every day A slice salami slice at the time is a really difficult policy. This. The sooner this thing

can be said right, the better it is for everybody. Wait, hold on a second, said right, because this has been sort of the focus of a lot of articles that have been written, which is, how can Saudi Arabia and the US joined forces this of spin this in the right way to be able to continue things as things were before, and my characterizing that correctly because that seems to be the way that I think I would agree with, at least other than the words spin. I don't think

Spain is viable. In other words, I think the war you try and spend it, this is one where you have to get as close to the truth as possible. And I would hope that you know, we just saw that our secretary state was out there in the desert, and you know, I think the point is to make clear what we think is is known, and that the story needs not to wander too far from that. So how should the US react if indeed the Saudi Arabian leadership led by Mohammed bin Salman, who has been close

with our leadership here in the US. How should the US respond if they did just outright kill a critic of their of their administration. I think the burden really begins with the Saudis. The Saudis need to decide how they are going to respond because we are their most important now I and so are all. There are other important allies. Um UH need to be in the zone

where it's comfortable dealing with them. So at this point, if the record shows that MBS the Crown Prince is involved, than the only way this goes forward if somehow he steps aside, which is a really high ask. But I think the Saudis have to decide where they're going, and I think we have to stay as close to the reality as possible. I don't think there's this is not a spin opportunity. Floating floating floating ideas is probably one

thing to see what's viable. But I think it's a huge mistake for anybody to try and work between the lines. You do not know what everyone else knows, so you put out a story. The next day of the story is overtaken because there's more information credible information put into it. The charts are sitting a lot of information. I suspect that we are others people within the Saudi government. You this is one that's not going to go away easily, Jack.

Do you believe that U. S Intelligence assets know what happened? I think you know what happened. It covers a lot of territory. I would say that because of our relationship with a lot of foreign governments, our own collection capabilities, I think we'd have a pretty good sense of what happened. What literally happened inside the consulate may not be uh noable for some time. Do you believe the Turkish government knows? They say, Well, they say in the press says that

they do. Um. My own instinct as opposed to fact, is that they probably know a heck of a lot more than anybody wish they know. So I'm wondering about the arms deal. I believe it's a hundred and ten billion dollar arms deal at the US has with Saudi Arabia. There have been numerous reports that one reason why President Trump was initially reluctant to sort of castigate Mohammed bin Salman and the Saudi Arabian government was because he didn't want to jeopardize this deal. Do you buy that now?

I think it's too small of the piece. I mean, I think there's the bigger relationship. I mean, we're in a you know, and when you look at the Middle East, you know, in terms of countering around which is a large part of the last several administrations, you have to look at Saudi Arabia as a key the key player, and this when you look at oil and the oil industry. I mean, I think the deal is is an important deal.

You don't want to see it go up and smoke, But there's an awful lot riding on the overall relationship. It's in everyone interested to get this thing reset. And as I said, I and you know that this place out the way it appears to play out, it's going to be very hard to reset it without a change in in in leadership, which means Mohammed bin Salman stepping down or being pushed out of office, out of the leadership.

That that I mean again, I would come back to you know, if I were looking at old formulas on how problems are resolved quickly, it's to change personnel and the basic relationship stays in fact intact This one is a seems to me a great deal more difficult than others I've seen in the past, because it's not clear to me, uh, how much wait the king has or is willing to exert, and how much the person it has to step aside is going to be prepared to

do that. And you know, people's first instinct, as we saw in this case, is to try and weather this storm. It is not weatherable and particularly if the pace of attention stays where it is now. Is there any chance that this reflects a power struggle inside of Saudi Arabia, Well, clearly this has been a in my I shouldn't say clearly. In my view, it's been a path coo. The the MBS coming into power is really I think took people by surprise. But it's not a singleton. It's uh, it's

a the predominant faction. But there are a lot of losers and um, you know, there are the prospects of external forces, in other words, those that have been thrown back orchestrating something that would remove MBS is unlikely. Any change would have to come from the internal forces. Thank you very much for being with us. Jack Divine, former acting director of the Central Intelligence Agency, founding partner and president of the security firm the Arkin Group. Return on

equity is up for the revenue trend is good. So why is the stock down thirteen and a half percent so far this year? I'm talking about Morgan Stanley. And here to help us understand the situation is Chris Whalen. He is the chairman of Whalen Global Advisors. Chris, why is the stock of Morgan Stanley down when the results seem so good? Well, the results are not bad. Um, there's done a lot of animal spirits in these stocks

like Morgan Stanley. Now their asset managers, Uh, predominantly they have a banking business, of course, um, but they are really feed driven. They don't make money on interest rates. So Goldman, Morgan Stanley, all the near banks, if you will, um, are a function in the market. So if they have some big deals that make you know, good money on the trading investment banking side, and then the rest is

pretty much fixed. Um. You have treasury and then you have the asset managers who work for a set feet right, That's why they like it. It's stable, but it's not exciting. So no biggish about City was the best of a bunch so far, but really why Yeah, just in terms of you know, year over year comparisons of falling credit costs in all of the two key factors for the last eight nine years have been cost cutting and cheap funding.

So the question is how do we transition from that when the banks, you know, a year from now, their funding costs are almost going to be normalized back to where they were in two thousand eight, more balanced by the way between investors and equity because during the crisis. After the crisis, the bank equity holders got the interest dollar well through banks and their depositor has got nothing. Well well, I mean, that's actually exactly where I wanted

to go with this, right. I mean, we talk about the KNT interest margins, which have been increasing, but the gap between what big banks are paying people to put their money in their deposit accounts and what the banks are earning from the Fed funds overnight rate has widened dramatically. I mean, I think it's more than a percentage point now on average for the four biggest banks that they're basically capturing an extra and extra revenue without doing any thing.

And at what point will they be forced to pay up. Will big banks be forced to offer depositors some additional yield to entice deposits? And how much could that hurt their earnings? Well, it's already happening. Um, as the FED balance she runs off, you eliminated dollar of deposits for every dollar in access to reserves. So that's just mechanistic. Um. The other thing, remember is that the FED crush funding costs in two thousand eleven, I think it was or fourteen.

It was literally done like ten billion dollars for the whole industry for a quarter. So normal is closer to a hundred. Right now it's about thirty, and it's increasing year over year, so buying you know, a second quarter next year, the increase in funding costs will be higher than the increase in interest earnings. And that's when you'll see him flatten out and go down. Now, Chris, you talked about the City Group and they're they're sort of

a report and saying that that they're better. But I'm just trying to understand wouldn't this wouldn't this whole group benefit from what you described maybe a low valuation base, also cost pressures. You said they're abating they're expanding the net interest margin, you've got shared buy back programs and better than anticipated EPs growth. Why wouldn't. Yeah, the business is okay, but for banks that really run off of

interest rates, of the advantages eving um. You know, as I said before, the last five years, cost cutting, reserve reverses, things of that nature really drove Burnning to Then we

had the tax bill. The text bill structurally increased those equity returns you were talking about earlier, So at one time adjustment both asset and equity returns after tax obviously, right, But if you really want to understand the business, you look at the pre tax line, you look at credit costs and other factors, and they've all been very low. I mean right now, real estate has gone up so much PIM that banks are making money on defaults. In other words, they get all their money back, they sell

the defaulted property, and they make money on that. So it's like negative um. So there's no credit issue on the street today. But to your question, you know, it's a function of deal flow. For Marian Stanley and for Goldman and the transactional houses. JP has a big component of this. But JP also makes money on interest, not as much as their peers, by the way, because they're big, you know, Marianne with Lake would love to be uh you know, no, no, maybe smaller should get much better

equity returns, you know, more manageable business. So you know, to me, the Street is losing their advantage on interest that the Fed gave them very quickly. And I think people have to pay attention to this because name is not going to be expanding next year, it's gonna be contracting because the cost of phones has gone up so quickly. Chris Whalen, thank you so much for being with us

and for that perspective. Chris Whalen as chairman of Whalen at Global Advisors and some an interesting trend to watch him, and one that we've been talking about for a long time, which is banks are going to have to start paying their depositors more and when they do, will that lead

to much more disappointing earnings? Although he did his strength with deals to Yeah, but also if you're going to see higher interest rates, that means that if they are really asset gatherers, they're gonna be making more on the assets that they gather. It depends which interest rates go up. Faster and how I mean if we get the flattening

yield curve, if they have to pay depositors more. I mean Ally Bank actually came out with this front page advertisement in the New York Times talking about how the biggest bank heist in the world is going on right now. But we can talk about that later. Well, I know that Paul Sweeney, the US director of Research and senior media and Internet analyst for Bloomberg Intelligence, he's got a

list of things he's going to watch on Netflix. He's probably already going to tape Fight World that has already debut. Then he's got The Haunting of Hill House as well as Marvel's Dare Devil. These are all Netflix only on Netflix. I have a whole new feeling towards Paul Sweeney. Now, yeah, he's got it all. The reason I bring up these only on Netflix productions, Paul is this is where the money's going, isn't it. It really is. And uh, you know, for the record, I am a big fan of Ozark.

I'm kind of hooked on that, so I'm binging the second season of that. But yeah, they're going to spend

you know, over eight billion dollars this year in programming. Um, you know, most of that, A lot of that is original programming, So they're not just licensing movies and TV shows from the networks in the studios, they're they're producing more and more of their own content and there, and they they recognize that from their perspective, that is what drives their subscriber growth, that is what their users want,

and so they're stepping up to spending there. And maybe even tonight we'll get an an outlook from the company on what they expect to spend next year, and most investors, um, you know, expect that number will be even higher than what it is this year. So they're by far the biggest UH creator of content in Hollywood, the biggest spender on content in Hollywood, and that looks to to get even bigger going forward. Will this be the year that

investors start to care about profitability here? You know, I don't think so. Um you know, the the it's interesting as you segment the company, the more mature US business for them already is profitable and and they and they showed a pretty good path to profitability there, so we know the business or investors know the business can be profitable at these expense levels. Uh, internationally, they have not turned a profit corner. That's a less mature business. But

we've seen some markets internationally that have turned profitable. So but the big question I think for investors is free cash flow. This is a company that has no free cash flow and they'll probably lose a couple of three billion dollars in free cash flow this year. Um. And so the question is how do you fund eight billion dollars or even more of programming? And the answer as you go to the debt markets and your borrow money and um, and that's kind of how they're funding it.

And so the question is how long can they continue to do that? And at increasingly investors are charting starting to get uh, you know, a little sensitive to the kind of the free cash flow generation of the business. They have more than eight billion dollars in debt right right, and uh, you know that the debt markets have been very open and very receptive to this credit, even though there's no profits or cash flow to pay back the debt.

But you know, I think they look and they see that big equity valuation cushion underneath their debt supporting their their debt. And you know when you take a look at street consensus numbers, UM, this company will not be free cash flow till one maybe. Uh so there's still ways off from free cash flow, UM, but there is a path. So one question that I have is that Disney is going to take a lot of its content off of Netflix starting at the beginning of next year,

and they're starting their own streaming service. And I have to wonder how big of a competitive concern this is for Netflix and how can we really even determine that. Yeah, competition is ramping up, no question about it. That you mentioned Disney, the big reason that they epped up and spend eighty billion dollars to buy Century Fox was to get more content UM for their streaming service which they're going to launch next year, a T and T, which

just spent eighty billion dollars buying Time Warner. They announced this week that they in fact are getting into the director consumer streaming business with some of the Warner Brothers content. So competition is absolutely ramping up, UM. And I think

Netflix clearly recognized this several years ago. UM, and that's when they really started to ramp up their original program because they knew at some point Hollywood would wisen up and they would, you know, start taking back some of their content and that Netflix would need to rely on

more on original programming. And the good news is, um, you know, as long as you have a big check book, and Netflix has a big checkbook, you can get any writer, any talent, any director, uh, any producer to come and make content for you, just like they would make it for one of the big studios. Paul Sweeney just quickly. I understand that Netflix with its understanding of the consumer, meaning they know what you watch, they know what are interested in. They have able they have been able to

broaden they're offering. And that's just talking about series. They've got the stand up comedy specials, They've got films. They know what you want to watch, don't they They do. They have a lot of information because they have a direct relationship with the consumer. They know what the consumer wants. As opposed to a cable network which has a you know, intermediary, which is the cable system, the comcast or the satellite provider. Uh, they don't own the content, they don't know what their

consumers really run. Netflix does so originally on the original programming the Netflix created in house. They knew that their users liked Kevin Spacey. They knew that their users liked political dramas, so let's create a political drama with Kevin Spacey, as simple as that. And they're they're using that in international markets because they're starting to bring up a lot of original programming in international markets. Paul Sweeney, thank you

so much for being with us. Paul Sweeney, us director of Research and senior Senior Media and Internet Analyst for Bloomberg Intelligence. Fidelity Investment is jumping into the world of crypto currency. It is offering to manage digital assets for a hedge funds, family offices and trading firms. And here to tell us more about this particular aspect of the

financial industry and fidelities Responses Aaron Brown. He is a former managing director and head of Financial market Research at a q R Capital Management, and he is the author of the book The Poker Face of Wall Street. Aaron Brown, It's always a pleasure to hear your views. Tell us what do you make of Fidelity offering this digital asset

management business? Well, thanks for having me, Um. I think this is mostly important symbolically, UH, Fidelity has always been among similar financial institutions they've been a relative cheerleader for crypto. And the fact that they're promising in two thousand nineteen that they'll offer custody and trading for some of the larger cryptos for some larger investors is uh, sort of a you know, it's an affirmation of the legitimacy and the faith they have in crypto. It doesn't really add

a lot. If institutional investors have been dying to pour billions and billions of dollars into crypto, They've had many opportunities since two thousands seventeen. We had led your ac c m E, cbo E offering futures claim based, Gemini have offered services. We know Northern Trust is looking at probably all the other big custodians are looking at this.

So I don't think there's a lot of pure news here fundamentally, but it's certainly going to uh, you know, charge the market and and give a lot of name recognition to people who perhaps don't really know what a

custodian is. But but no the fidelity name well, Aaron, I'm struck by sort of the risk that is implied by holding something uh that could potentially evaporate and value and what is the potential risk that Fidelity would be taking on if it really does become a major player and if this market continues to expand, well, of course they're they're brokeer, so they're holding these for other people,

and crypto could go to zero. Um UM. I hope everyone who knows that before they invest, and then Fidelity would be uh, you know, I probably have a lot of customer relation issues. Um. But they're offering this to institutional investors who presumably know the rules. UM. I would say the bigger risks to Fidelity as a company are

that they get hacked. Now they're planning to put all of these assets in cold storage, which is supposed to be hacked proof, but you know, you're never quite sure, and cold storage can be very vulnerable to an internal

rogue employee and the internal embezzlement or fraud. UM. If there are problems with the pricing, if they sell institutions a lot of assets that you know, six thousand dollars of bitcoin and it turns out that wasn't really the price, that it was being manipulated, and some of the shadowy exchanges, the crypto trades on UM. I think this kind of thing could be a big black eye, or if there's a regulatory problem, if if people give the regulators come in and say the stuff is all illegal. Um, I

don't take that. I don't think those are huge risks today. I think, you know, two years ago, people would have worried a lot more about those things. But I think crypto's mainstream enough that Fidelities maybe pushing the envelope a little bit. But I would expect to see all the big financial institutions follow suit. Here. The arm of Fidelity that's going to handle this is going to be called Fidelity Digital Assets. And according to Tom Jessup, who runs

that business, they've been mining bitcoin since twenty fifteen. Can you give us your views on mining bitcoin and bitcoin as a proxy for this world of cryptocurrencies? Yeah, I mean, I mean mining was I started mining in two thousand thirteen, and and you know, I quickly got, you know, pushed out of that business. You need to be really big now. Fidelities obviously big enough to do it if they want.

It's not a hugely profitable business anymore, but but you know, it pays the bill, but it's a very good way. I always tell people who want to invest in crypto. Listen, mine a little bit. You know you're not going to get rich doing it. If you're doing on your PC. You know you may make making ten cents for for a month of letting your PC churn away at this, But you'll excuse me, eron, Can I just interrupt and ask you what kind of set up of technical setup

were you able to put together in order to mine bitcoin? Well, okay, back in two thousand and thirteen, you just did it on your PC. You know, with spare you let it run at night while you weren't using it today to be competitive in mind and you need highly specialized equipment and need to be next door to a hydroelectric plant. Um. So I'm not urging people to go and do this to make money. I'm just saying you do it. You really learn what cryptocurrency is when you mind it and

you spend it. And before you invest in something, it's always nice to you know, make it and sell it. And then you say, okay, now, I maybe it was only ten cents worth and maybe he used it to you know, by something you didn't really want. But but but but you know what you're doing in a way that somebody who's just read about bitcoin doesn't and you learned an awful lot about exactly what it is, what a key is, how these work, and how convenient it is.

Um so so for Fidelity, I think, I think, you know, it makes perfect sense. I don't think they're going to go in the business of mining to compete with some of these Chinese giant consortiums, but it does give them a lot of legitimacy in the space, and it's given them a lot of legitimacy among crypto enthusiasts the fact they're actually willing to get their hands dirty with this stuff. A lot of financial people who talk about crypto have never, you know, spent a bitcoin and wouldn't know what it

is if you know, somebody gave a hundred Well. One thing that I'm struck by is it seems, on its face as if this is a risk that Fidelity is taking getting into sort of a more niscent market, one that is that is spurned by a lot of people. On the other hand, I'm wondering how much is a move like this is a risk like this required for big asset managers that focus on index funds that increasingly pay zero fees or next to nothing in terms of fees.

I mean, in other words, how much do these types of services have to be the drivers of profitability to place like Fidelity going forward? Okay, I'm not an expert in fidelities business. I know more on the hedge fund side, but I do know, yes, everybody and asset management is desperate for new kinds of revenue because the fee impression.

We've gotten so efficient with ets with indext funds free now many places, Uh you just can't make money, you know, just for existing the way you used to, and so yeah, you need some sort of value added. Uh. Crypto is one, you know way where they're still margins. You can still differentiate yourself. You know, there are other things you could do.

But yes, I think we're going to be seeing more experimentation, more risk taking among asset managers and the ones that refuse, the ones that try to keep just the traditional business alive, I can't see them. I got to see the profits

slowly eroding until nobody wants to work there anymore. Aaron, just real quick here, how profitable do you think a cryptocurrency department the way that Fidelity is sort of outlineyone could be well if they're the only one, or if they're you know, they're the giant one, then I think

it could be tremendously profitable. I think there's a lot of money that wants to go into crypto and UH, and it's kind of for you know, you buy the crypto and currency exchange yourself to your customers, you keep it in cold storage, costs you nothing, and you can probably charge pretty good fees on it. If everybody in the world gets into this business, and you know, the fees are going to go down to zero, just like everything else. Aaron Brown, thank you so much for being

with us. We love having your views highlighted here. Aaron Brown is a columnist for Bloomberg Opinion, also former managing director and head of financial market risk Research at a q R Capital Management. Thanks for listening to the Bloomberg P and L podcast. You can subscribe and listen to interviews at Apple Podcasts, SoundCloud, or whatever podcast platform you prefer. I'm pim Fox, I'm on Twitter at a Fox, I'm on Twitter at Lisa Abramo. It's one before the podcast.

You can always catch us worldwide on Bloomberg Radio.