Levine on Wall Street: Libor and Lockups

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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What was Libor for?

New York Fed president William Dudley gave a speech yesterday about Libor manipulation that included this interesting paragraph:

First, the growing popularity and liquidity of LIBOR indexed contracts led to an expanded use of LIBOR to circumstances in which the credit risk of large banks was not clearly relevant. For example, a speculative position about the future of short-term rates is predominately based on one’s view about the path of short-term interest rates, rather than how bank counterparty risk might change and affect borrowing costs. Despite this shortcoming, LIBOR remained popular because the benefit of its deeper market liquidity was viewed as more important than the added complication that LIBOR included an element of counterparty risk.

The point here -- which I've written about before -- is that if you thought of Libor as "the risk-free short-term interest rate," which was not a crazy thing to think in like 2006, then you'd want banks to minimize the impact of their own credit risk on Libor. So when banks reported false Libor numbers to make themselves look less risky, that made Libor work more like it was intended to. Market expectations were that Libor was a reference interest rate, not an index of bank terror, and the false Libor reporting made it more useful for that purpose.

That doesn't mean you have to like it, of course, and Dudley says "It is a sad state of affairs if unethical behavior is socialized among new traders with the explanation that this is business as usual." But one benefit of this theory is that it excuses the Fed a bit. The Fed, and other regulators, may or may not have known about the scammy profit-seeking Libor manipulation where traders would ask submitters to fake Libor to help out their derivatives books. But the Fed certainly knew about the risk-hiding Libor manipulation where banks submitted lower Libors to improve market confidence. The banks just straight up told the Fed about that, over and over again. If the Fed takes the view that this manipulation was in line with market expectations and made Libor function better, then that sort of justifies doing nothing about it at the time.

Banks can waive lockups you know.

I used to be a capital markets banker and there are bits of investor psychology that I'll never understand, and one of them is that people have this intense attachment to lockups. The idea of a lockup is that, when a company does an initial public offering, the company and its major insiders agree that they won't sell any more shares for some time -- usually six months -- without the permission of the underwriting banks. The idea is to protect investors from looking like suckers: If you buy at the IPO for $100, and the stock goes up to $110, and the insiders dump more stock and push it back to $95, then they've essentially taken your IPO gains away from you and you got a raw deal. So you rely on the underwriters to protect you from that.

Yesterday GoPro's bankers gave a lockup waiver to allow its founders to donate some of their stock -- I mean, a lot, around $500 million worth, something like a quarter of the size of the IPO -- to their charitable foundation. The lockup was waived for the foundation too, apparently "to make the transaction more tax-efficient," but the foundation has not sold any shares. But the stock was off 6.9 percent yesterday on, as far as I can tell, a tantrum about this news. I am with this guy:

“It’s an overreaction to this development,” said Shebly Seyrafi, an analyst at FBN Securities in New York, who has the equivalent of a buy rating on the stock. “The stock tripled in a matter of three months, and this is a buying opportunity.”

The point of the lockup is to help sell the IPO, by ensuring that you won't be made to look like a sucker by later sales. If you bought GoPro in the IPO, you do not look like a sucker. So why object to the waiver?

Why are finance workers paid so much?

There's this study saying that workers in finance are paid more than workers in other industries due to "rent sharing." When this came out, at the same time as a bunch of questionable finance ethics news, I three-quarters-jokingly said that its authors "give insufficient attention to the possibility that the high wages compensate for difficult working conditions. (You're around all those cheaters, for one thing.)" But here is my Bloomberg View colleague Noah Smith saying that mostly seriously:

In other words, Wall Streeters might get paid more for the same reason garbage collectors, plumbers and embalmers get paid more than workers of similar skill: It’s a dirty job. This is just Adam Smith’s theory of wages, which economists -- always good at giving things catchy titles -- call “compensating differentials.”

Maybe! But you hear this view a lot from financial workers themselves, and it always strikes me as a bit too pat. Investment bankers love to think that they're coal miners, working 100 hours a week on high-stress life-or-death matters and despised by the rest of society. But it's an objectively puzzling view. These jobs are fine. You wear nice clothes to your nice air-conditioned office and sit at a computer typing e-mails, and then you go out to meet with clients and flatter them for a while in conference rooms with nice views. Everyone around you is professional and well-educated and probably a member of the same fraternity as you. No one dies if a merger is delayed or a stock goes down. The 100-hour-a-week thing is basically true but, I don't know, everyone works pretty hard in New York. Like, what, you're gonna work in advertising? My own view of finance wages is that financial firms are Marxist paradises run for the benefit of their workers, and that those workers pay themselves a lot because it is nice to be paid a lot, and then justify it by saying "ohhhhh but our lives are so miserable." Elsewhere, don't major in business, come on.

Russian hackers have my address.

How should I feel about that? Apparently JPMorgan's hackers "stole customers’ contact information -- including names, email addresses, phone numbers and addresses," but not account numbers, passwords, social security numbers, or, you know, money. "If the J.P. Morgan hack was an old-fashioned bank heist, the hackers likely weren’t steps away from the vault but 'in the wrong building altogether,'" says a guy. So I guess that's good? And sort of explains why they didn't take any money, which has always puzzled me: They weren't in the metaphorical money room, but in the metaphorical room with the mail merge program or whatever. I still don't feel great about it exactly.

Is indexing too big?

If everyone indexes, then no one is allocating capital and making prices efficient, and indexing won't work. So you need active investors for indexing to make any sense. But as long as there are active investors, they will in aggregate underperform index investors, because active investors have costs that index investors don't have and they can't all be above average. So the temptation to index is strong, or it is for me at least. This is a big theoretical problem. But not a big practical problem, says Vanguard, who probably ought to know.

If you predicted inflation in 2010, how do you feel now?

There are various possible answers and they're all reflected in this hilarious survey of people who signed a 2010 letter warning the Fed that quantitative easing risked "currency debasement and inflation" and nonetheless were willing to talk to journalists in 2014. My favorite is from Douglas Holtz-Eakin: "The clever thing forecasters do is never give a number and a date." That just means "you'll never catch me!" He then goes on to give a number ("They are going to go above 2 percent"), but, craftily, not a date.

Janus bond fund managers will give the new guy a shot.

Bill Gross replaced Gibson Smith and Darrell Watters as the portfolio manager for the tiny ($13 million) Janus Global Unconstrained Bond Fund, though Smith and Watters remain in charge of the $7.1 billion Janus Flexible Bond Fund, which has recently outperformed Gross's Pimco Total Return Fund. But Smith and Watters are willing to give him a chance, though he's gotta start small:

While the toolkit at Pimco Total Return includes derivatives such as futures contracts and credit-default swaps, Mr. Smith says, “we don’t feel the need to use them.”

The Janus bond chief says the young “unconstrained” fund was the logical Janus vehicle to hand over to Mr. Gross because its mandate “fit nicely into what he was doing at Pimco.”

Things happen.

Maybe Actavis will buy Salix, taking both of them out of the Allergan/Valeant situation. The SEC is unlikely to reduce the Schedule 13D ten-day reporting window any time soon. Treasuries are increasingly trading electronically. The bond investor base is shifting. Turney Duff on children's birthday parties. Carol Loomis on Warren Buffett's car dealership deal. Ben Bernanke can't refinance his mortgage, though to be fair he refinances his mortgage a lot. Phil Ivey's baccarat lawsuit is a lot of fun. "Ad that says 'Republicans Read The New York Times in Public' shows a man with the Wall Street Journal." What's in Ken Griffin's prenup?

  1. Except on the "buying opportunity" part; I'm not endorsing (or disagreeing with) investing advice. I'm with him on the, like, morality of it.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matthew S Levine at mlevine51@bloomberg.net

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