Mortgages, Gasoline and Bankruptcy

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Fannie and Freddie.

In most of the world, the way you get a mortgage is you go to a bank, and you borrow money from the bank, and if you don't pay the money back that is the bank's problem. Or perhaps the bank divides the risk up and sells it on to other banks or hedge funds or whatever. This is also more or less how business loans and car loans and credit cards and other forms of credit work: You go to a bank, the bank makes the decision, the bank takes the credit risk, and maybe the bank sells on that risk to some other willing private buyer.

Imagine if the U.S. had that system in 2015, but someone suggested that we should change to a system where you go to a bank, the bank makes the lending decision, the bank makes a profit on the loan, but then, instead of the bank being at risk if the loan goes bad, the government comes in and (for a fee) guarantees the bank against any losses on the loan. That might be a good idea, or a bad one; the government might overcharge for the guarantee, or undercharge for it. But I think that the political reaction would be pretty obvious: Everyone would ask why we would create a new government program just to subsidize big banks. Politically, that system looks too much like a massive giveaway to the banks for anyone to take it seriously in 2015.

Of course, in the actual U.S., we have had the second system for decades, with Fannie Mae and Freddie Mac providing an implicitly or (since 2008) explicitly government-backed guarantee to mortgages made by banks. It might be a good system (cheap mortgages!), or it might be a bad system (2008!?), but in any case it is so ingrained and American a system that Gretchen Morgenson has written a long investigative story about how government officials and bankers want to go back to something like the first system (mortgages made by banks and supported by private capital), and about how that would be a giveaway to the banks:

The policy to eliminate Fannie and Freddie was a page out of the mortgage bankers’ playbook. And like the authors of that plan, the administration emphasized that taxpayers would be protected and that a new, level playing field would benefit all participants in the housing market.

In private, however, officials cited another group of beneficiaries under the plan: big banks.

An internal Treasury memo written on Jan. 4, 2011, to Mr. Geithner by one of his top deputies characterized the administration’s first option to wind down Fannie and Freddie as “a bank-centric model” that “benefits larger institutions” with the capacity to hold mortgages on their books.

It does seem likely that a system of private mortgages would benefit banks with enough money to make private mortgages. But that is how banking usually works! It's just that the U.S. mortgage system is a very strange exception. Elsewhere, here is Antonio Weiss arguing that "recap and release" of Fannie and Freddie "is simply a bad deal for taxpayers and homeowners alike."

Insider trading in commodities.

A fun quasi-fact is that it is generally legal to insider trade in commodities. This shocks some people, but it makes sense. The main traders of commodities (commodities futures, but also just physical commodities) are producers and users of those commodities, so they have inside information. Oil companies know how much oil they produce, which affects the price, but you can't ban them from selling oil based on that information. Farmers know how their crops look, but you can't ban them from hedging their crops in the futures market. So it's just sort of agreed that it's fine to trade commodities based on material nonpublic information.

On the other hand you obviously can't do this:

According to the Order, between September 3 and November 26, 2013, Motazedi noncompetitively prearranged at least 34 trades between his former employer’s account and the personal accounts at prices which disadvantaged his former employer’s account, in that Motazedi caused the employer’s account to buy at higher prices and sell at lower prices in trades opposite the two personal accounts. The Order also states that Motazedi defrauded his employer by placing orders for the personal accounts ahead of orders he placed for his former employer’s account (a practice known as “front running”) on at least 12 occasions, and thereby generated additional profits for himself to the detriment of his former employer. According to the Order, Motazedi’s trading activity caused his former employer $216,955.80 in trading losses.

That's from a Commodity Futures Trading Commission case last week against a former proprietary gasoline trader who allegedly traded ahead of his employer to make some extra money for himself. (He settled the case for $316,955.80 and a CFTC ban.) You can't do that; that is front-running, and it's illegal in all sorts of markets. But the CFTC thinks it's something else, too: illegal insider trading in commodities. Its order says:

As a gasoline trader, Motazedi was privy to the material, non-public information regarding the intended trading of his employer, including the timing, contracts, prices and volume of its orders. Motazedi held a relationship of trust and confidence with his employer and owed a duty to his employer not to misuse proprietary or confidential information.

This is something like the "misappropriation theory" of insider trading in stock markets. As we frequently discuss, insider trading is not about fairness, but about theft; it is legal to trade on nonpublic knowledge of your own intentions, but not on misappropriated knowledge of someone else's intentions. It is legal enough for an oil company to trade oil based on its knowledge of its own oil production, but oil company executives might start to worry about trading oil in their personal accounts based on their knowledge of their companies' production. Andrew Verstein has a blog post about the case, and a law review article about insider trading in commodities markets, arguing that it's not as legal as everyone thought.

Meanwhile in old-fashioned insider trading, "Samsung Officials Probed for Insider Trading Before C&T Deal."

Bankruptcy in Puerto Rico.

On Friday the Supreme Court agreed to hear Puerto Rico's appeal of a federal court ruling that it couldn't restructure the debt of its municipal corporations. It's the sort of case that only a lawyer could love: The Bankruptcy Code creates a debt restructuring regime for municipalities (Chapter 9), and prohibits states from creating their own competing restructuring regimes. But Chapter 9 is not available to Puerto Rico, and the question is whether the prohibition applies to Puerto Rico (as it seems to) even though the restructuring regime doesn't. The argument for Puerto Rico is that it is weird, and probably an oversight, to leave Puerto Rican municipal agencies with no debt restructuring regime at all; the argument against is that our federal structure really does disfavor state- and territory-created restructuring regimes, and that Chapter 9 restructuring is an exception granted by the grace of Congress rather than the norm. Here are Puerto Rico's petition for Supreme Court review, responses from BlueMountain Capital Management and Franklin California Tax-Free Trust, a reply from Puerto Rico, and other materials from SCOTUSblog.

"The court may hear arguments as soon as late March and rule by June," which is not that soon; meanwhile Puerto Rico is negotiating on a lot of other fronts:

Restoring the law would give the commonwealth additional leverage as it negotiates with mutual funds, hedge funds, bond-insurance companies and lenders, said Matt Fabian, a partner at Concord, Massachusetts-based Municipal Market Analytics. Puerto Rico may also decide to put on hold an agreement between the Puerto Rico Electric Power Authority and some bondholders to reduce the utility’s $8.2 billion in obligations through a debt exchange, he said.

Yahoo!?

Yahoo's board was supposed to have a final decision on its possible Alibaba/Aabaco spinoff by the end of the weekend, though I don't know what it is yet. And "Marissa Mayer's Next Headache May Be a Nasty Proxy Fight." And I enjoyed this Victor Fleischer article about how "Yahoo’s Spinoff Plan Could Be Risky Business," particularly for this description of the faux precision of tax lawyers:

There is more lore than law when it comes to tax opinions. There are different levels of confidence. When the lawyers are just a little nervous, the letter might say that “while the matter is not entirely free from doubt,” in its opinion the deal will be tax-free. When the risk is more significant, the firm might write that, in its opinion, the deal “should” be tax-free – reflecting something like a 75 percent level of confidence. An opinion that a deal is “more likely than not” shows a 51 percent level of confidence. There are often more subtle qualifications in the opinion letter as well, which the tax lawyers behind the scenes might describe as a little loose or as having some hair on it. 

Banking culture.

Here's a story about Daiwa Securities Group, which "in October appointed a chief health officer -- a former investment banker who had collapsed and nearly died of overwork until he started on a fitness path eight years ago -- to oversee programs that give incentives for employees to exercise and leave work on time." Investment banking is probably the only industry where the route to being put in charge of wellness and work-life-balance programs involves working yourself almost to death.

People are worried about unicorns.

You know who's probably worried about unicorns? Silicon Valley Bank, the bank of Silicon Valley, which has several branches in the Enchanted Unicorn Forest and which pioneered the securitization of alicorn-backed loans. (This is not true.) Unicorns are its thing:

But strains in the tech market are starting to hit the bank, too. In October, SVB said it expects slower loan growth next year. The volume of loans for which the bank doesn’t expect to be fully repaid has nearly tripled since March but still is a tiny percentage of all loans.

Even the bank’s fans say its devotion to being in the middle of the money flow in Silicon Valley makes SVB vulnerable to growing uncertainty about the valuations of closely held startups and the chilly environment for recent initial public offerings. More than half of all U.S. venture-capital funds and venture-capital-backed companies are clients.

"If the music stops, it can stop really fast," says a guy, and I thought we had agreed to ban that metaphor in banking. Elsewhere, "Google Ventures, which will be renamed GV this week, invested 20 per cent less this year than last, even as the amount of capital it has earmarked for start-up investing has risen."  

People are worried about bond market liquidity.

Actually no, bond market liquidity worries seem to have taken the weekend off. I mean, here's an article about bond ETFs, but it's just about interest-rate exposure, not liquidity. Similarly, here's one about the risks to bond traders betting against the Fed, but liquidity doesn't even get a mention. And here's an article about junk bonds, but it's about credit ("Junk bonds are headed for their first annual loss since the credit crisis, reflecting concerns among investors that a six-year U.S. economic expansion and accompanying stock-market boom are on borrowed time"), not liquidity. You get the sense that bond market liquidity might be a boom-time worry, easily displaced when actual things go wrong. On the other hand, "Goldman: All Those Strange Things Happening in Markets Could Help Keep Interest Rates Low." And here is the New York Fed's blog on "Dealer Positioning and Expected Returns":

The chart shows a very tight correlation (55 percent) between expected fixed-income returns and dealer fixed-income positioning, with periods of sharp changes in asset valuations typically accompanied by sharp adjustments in positions. The low level of debt securities as a share of total assets prior to the financial crisis was thus associated with a compression of expected returns at that time. Similarly, the sharp rise in debt securities during the financial crisis corresponded with a period when expected returns were unusually elevated.  

People are worried about the CME/LCH swap basis.

Sure.

Things happen.

Hillary Clinton: How I’d Rein In Wall Street. Fed Finds Fault With Its Own Stress Tests. The new BIS Quarterly Review is out, with a special feature on "Calibrating the leverage ratio." GE pulls $3.3bn deal with Electrolux after DoJ opposition. Caesars Entertainment is lobbying to amend the Trust Indenture Act. Madoff Fund Manager Begins Court Defense Backed by History. Brazilian prisons sound unpleasant. Manhattan U.S. Attorney Announces Arrest And Unsealing Of Charges Against Senior Adviser To The Operator Of The “Silk Road” Website. Izabella Kaminska on Goldman's blockchain patent, which "arguably makes the process of exchanging securities more arduous, more complex and less liquid for the executioners, who must now either be fully pre-funded to act or able to initiate perfectly matched trades through a non-fungible multi-tiered cash system." Meet This Year’s $1 Trillion M&A Club. Fixing bankers’ pay: punish bad risk management, not bad risk outcomes. Smart drugs. Exploding hoverboards. Subtweet™. "In conference calls, no one knows you’re in the downward-dog position." Crowds Of Stock Traders Gather At Weeping Statue Of Wall Street Bull.

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:
Zara Kessler at zkessler@bloomberg.net