Bank Earnings and Bond Lies

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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Bank earnings.

Citigroup released earnings that slightly beat expectations "as legal costs fell and revenue rose," and as "revenue at Citi Holdings, the portfolio marked for disposal, jumped 61 percent to $2.91 billion." Here are the press release, presentation and financial supplement.

In JPMorgan's earnings yesterday, one piece of good news was the G-SIB surcharge:

JPMorgan said its surcharge for global systemically important banks -- a closely watched measure that will determine its required capital ratio -- fell to 3.5 percent after the company cut client deposits and reduced derivatives. A year ago the bank said it could be as high as 5 percent. An insignificant amount of revenue was sacrificed to whittle down the surcharge, Chief Financial Officer Marianne Lake told reporters Thursday.

Unlike MetLife, which is responding to pressures on systemically important financial institutions by planning to separate out its retail business, JPMorgan seems unlikely to break up. Instead it is responding to those pressures the old-fashioned way: By optimizing its balance sheet to minimize the costs of regulation. The particular optimizations here include shedding about $200 billion of non-operating deposits: That is, JPMorgan is a bit less willing to act like a bank for its corporate and institutional clients, because taking those deposits increases its systemic risk scores. 

Elsewhere in big banks, "Morgan Stanley Heeds Investors With Cuts in Fixed-Income Division." And elsewhere in earnings, here are BlackRock's.

Demand exaggeration.

I think the most interesting current question in securities regulation is: What are you allowed to lie about? When you put it that starkly, it does sort of seem like the answer should be "nothing," but historically that wasn't the universal consensus. Bond salespeople sometimes, I don't know, let's say shaded the truth about things like how many bonds they could get and at what price, in order to try to convince their customers to pay more for them. Some people think this is utterly and obviously illegal, while others think it is just a normal part of the poker game that is the bond market. The Justice Department is very much in the first camp, though, and its efforts to prosecute traders for lying about the prices they paid have met with some success.

Here is the next frontier:

Deutsche Bank AG officials are reviewing whether some employees exaggerated demand as they marketed new securities backed by risky auto loans, potentially suppressing yields for investors, according to a person with knowledge of the matter.

The bank has looked at communications between the employees and investors to determine whether such marketing practices were normal salesmanship or if they crossed a line, said the person, who asked not to be named because the matter is private.

Obviously if you are a customer being asked to buy a new issue of bonds (or asset-backed securities or whatever), you want to know how the deal is going. If there is a lot of demand, you will feel better about buying, and you'll be willing to pay more. If there is no demand, you'll stay away or demand a cheaper price. But equally obviously, the job of the bond salesman is to drum up demand, to make investors enthusiastic about the deal. It is a bummer to tell customers "no one else is buying this, but you really should." You can sort of see how, in that context, a salesman might ever so slightly exaggerate the state of the book. If a customer asks "How is the deal going?" the answer can never be "terrible." It's "great," or "we're seeing some good early signs," or "we're starting to build momentum," or "you're going to want to get into this deal before everyone else does," or something. But it probably shouldn't be "we're already three times oversubscribed" if you're not. Regulators are looking for that sort of thing now. 

Pay to play.

Here is a Bloomberg Businessweek story about Scott Garrett, a Republican congressman from New Jersey who is chairman of the House Subcommittee on Capital Markets and Government Sponsored Enterprises. The main points of the story are that Garrett stridently opposes gay rights, and that this has created a rift with his Wall Street supporters who, however Republican their views on financial regulation may be, tend to be strong supporters of gay rights. Garrett's biggest donors, Paul Singer and his Elliott Management, have stopped giving him money, and "when contacted by Bloomberg Businessweek to ask about their rationale for sticking with Garrett, U.S. Bancorp and Nomura both said they would cease donations." The story is a nuanced and fascinating examination of the tensions between financial and social issues both in the Republican party and in the financial sector, and there are a couple of good Barney Frank quotes.

But then there's stuff like this, about Garrett's committee chairmanship:

In Washington, the committee is known as the ATM, because banks and hedge funds shower the chairman with contributions. After the Dodd-Frank financial law forced hedge funds to register with the Securities and Exchange Commission, Garrett, already the recipient of more Wall Street money than almost any other member of the House, got millions more. The banks pay to have a voice, ensure they’re at the table when new rules are discussed, and insinuate themselves into the chairman’s good graces.

Or this:

But banks and investors inclined to drop Garrett over his antigay views would be taking a risk: They rely on him to fight their battles and could open themselves up to retaliation. Garrett, for example, has led the effort to block the Treasury Department from designating nonbank institutions as “systemically important financial institutions” and imposing an added regulatory burden.

I guess I am pretty cynical about U.S. politics, and none of this is exactly a secret, but I still found it depressing to see it put so explicitly. I'm not even particularly a break-up-the-banks proponent of tough financial regulation; for me, this is just a process point. Is it really that nakedly transactional? Is it really as simple as: Banks give piles of money to the head of the committee that regulates them, and in exchange he gives them the regulations they want? 

Compare Garrett's story with the story of State Street, which yesterday "agreed to pay $12 million to settle charges that it conducted a pay-to-play scheme through its then-senior vice president and a hired lobbyist to win contracts to service Ohio pension funds." According to the Securities and Exchange Commission's order, State Street paid a pseudo-lobbyist thousands of dollars, knowing that he would share that money with Amer Ahmad, the Ohio deputy treasurer; people related to State Street (a lobbyist, the lobbyist's nephew, etc.) also made some donations to Ahmad's campaign. In return, State Street won subcustodian contracts with Ohio pension funds that seem to have been worth as much as $43.5 million in gross revenues, depending how you count. State Street "received the highest qualitative score from the committee evaluating competing bids, and also submitted the lowest bids," so it's not exactly like the Ohio pension funds were ripped off. Again, it's mostly a process point: Even if you're the best bidder, you shouldn't also bribe the guy awarding the contracts.

Ahmad was sentenced to 15 years in prison in 2014 for these deals, the pseudo-lobbyist who funneled him money got four years, and now State Street is paying the SEC $12 million. The exercise for the reader is, of course: Why is this stuff so much worse than the campaign-contributions-for-regulation stuff? Part of it is that there are specific pay-to-play rules against giving politicians money in exchange for public-pension business, while giving politicians money in exchange for favorable regulations is just the American way. Part of it is that the quid pro quo was made amateurishly explicit in the State Street case, while in Washington the deals are usually better lawyered and more ambiguous than that. But those seem like differences of style rather than substance. In substance, the future of financial regulation is worth a lot more than some Ohio pension contracts.

Crypto.

Here is a story about Overstock.com's quest "to radically change how stocks and bonds are bought and sold" by doing some blockchain stuff:

“We’re ready to start a crypto Wall Street,” Byrne said. “Like Jonas Salk injecting himself with polio, our first client is going to be ourselves.”

One assumes that the vaccine will inoculate Overstock against naked short sellers, a particular obsession of CEO Patrick Byrne. Anyway here is a claim:

Because it’s bypassing traditional exchanges like the Nasdaq Stock Market and New York Stock Exchange, the trades will clear nearly instantaneously instead of taking several days.

I want to push back on this a bit. Nasdaq and NYSE complete trades "nearly instantaneously"; much of the controversy about high-frequency trading has to do with the exact down-to-the-microsecond mechanics of trading on Nasdaq and NYSE. Then once you've completed a trade, you wait three days for the trade to settle, which is less of a stock-exchange issue and more of an issue of back-office brokerage functions. The bitcoin blockchain, on the other hand, is very very slow at doing trades, compared with a modern stock exchange; it supports about three transactions per second and "takes over 10 minutes to 'commit' a transaction." On the other hand, after those 10 minutes, you're done; settlement occurs on the blockchain, with no need for three days of back-office machinations. So it's a fast way to clear, but a slow way to trade.

Elsewhere, here is the story of a man whose faith in humanity was shaken by bitcoin.

Bankers behaving badly.

One thing that sometimes happens in the financial services industry is that bankers who are fired for inappropriate behavior respond by suing their banks for encouraging even more inappropriate behavior. As an "everybody's doing it" defense it is perhaps not wholly persuasive, but the lawsuits are often funny. Here's one out of Australia, involving two bankers fired from ANZ, the country's third-largest bank, for "highly inappropriate and offensive electronic communication" and other misbehavior. Their lawsuit describes "a culture where profanities and bullying were the norm"; one of them claims that when he started at ANZ, he met with his new boss and "two female human resources employees" at a lap-dancing club. That would set a certain tone for the rest of his tenure there.

Heir location.

Did you know that there's a "heir location services industry"? Did you know that it has multiple competitors? Did you know that the Justice Department and the FBI are conducting an "ongoing federal antitrust investigation into customer allocation, price fixing, bid rigging and other anticompetitive conduct" among those competitors? Now you know. I don't really know what you'll do with that information. In this era of increasingly gigantic corporate mergers, it seems like an odd antitrust focus, but, you know, bid rigging is bid rigging. 

People are worried about unicorns.

One sign of a certain unicorn insouciance is that Morgan Stanley and Merrill Lynch are apparently soliciting high-net-worth customers to invest in Uber without giving them financial information; I wrote about that deal this morning. 

In less frothy unicorn news -- wait, Foursquare was never actually a unicorn, was it? It seems to have topped out at $650 million, an, I don't know, .65icorn. It just raised $45 million at a valuation of "roughly half" of that peak, "as it tries to bolster its location data-based advertising and developer businesses." I find Foursquare considerably more baffling than even Snapchat, and I generally assume that apps that baffle me should be worth billions, but Foursquare may be the exception.

People are worried about bond market liquidity.

It's a little light today, but possibly of interest is that "Most of the seven tranches in AB InBev's new US$46bn bond swung back inside re-offer levels by midday on Thursday, rebounding after first gapping wider when the deal was priced." I thought big deals sold to big funds were supposed to be profitable immediately? If you can't make instant money buying gigantic new issues, where can you make money? I guess in distressed debt of energy companies? "Oil slide leaves distressed debt managers ready to roll," says this headline, though that sounds riskier than just playing new-issue pops. 

People are worried about bag market liquidity.

All sorts of assets -- or, better, "things" -- sometimes go up in price, and sometimes they go up in price more than other, more conventional assets, and so the Internet generates articles about the comparison. "Wine or stocks: Which is a better investment?" "Is Lego a better investment than gold?" Or the latest: "Study Says Birkin Bag Is a Better Investment Than Stocks and Gold." That one is popular; here are seven more articles about it. At BuzzFeed, Sapna Maheshwari is skeptical, pointing out that "the market for Birkins is absurdly small compared to stocks and gold," "investing in Birkins means you have to buy and sell in units of at least $10,000," and "it’s more expensive to sell a Birkin than a stock or commodity." The higher returns are compensating for the illiquidity of the asset, or thing, and if you set up a mutual fund to buy Birkin bags and offer investors daily liquidity, then you will create a liquidity illusion, and if investors want out all at once then etc. etc. etc. you know how this story ends, for the Birkin bags.

Things happen.

Saudi Life With $30 Oil. Switzerland: A Test Case for Currency Shock. China’s Haier to Buy GE Appliance Business for $5.4 Billion. Apple May Be on Hook for $8 Billion in Taxes After Europe Probe. Lawmakers Want Feds To Probe Warren Buffett’s Mobile-Home Firm. The Bank for International Settlements's revised market risk framework. "Given the greater ease of converting labor income into capital income, I no longer am so convinced that a zero rate of taxation on capital income is best." Steve Cohen seems not to have won the Powerball. Manhattan Packing More Workers Into Less Office Space. "People are watching TV the way that God intended." You Can Be an Idiot on Social Media and Still Get Into College. Hiring through Tinder got my business going with a bang. Fantasy Bachelor. Full-stack bananas. Adaptive manspreading. Emotional support turkey.

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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