Levine on Wall Street: Great Strengths and Deep Wounds

Scandals at Jefferies and Bank of America, though with a bright spot at RBS. Also Herbalife earnings, M&A, living wills, mutual funds, and odd lots of Puerto Rico bonds.
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Scandalous finance.

Friday's crazy Jefferies memo continues to reverberate; apparently it is Not Done to describe in detail your impromptu drug testing of senior employees. Here is Bloomberg News on how "scrappy" Jefferies is, with the interesting data point that Jefferies's investment banking revenue is now bigger than that of Salomon Brothers or Bear Stearns at their peaks. Here are Andrew Ross Sorkin and Breakingviews tsk-tsking Jefferies for its faux pas, and they have a point; I suspect there is a large class of investment banking clients who just assume that their bankers are holding frequent drug-fueled orgies, and are fine with that, but who don't want to hear them talk about it one way or the other. JPMorgan is facing a criminal inquiry into currency manipulation, which can't really be a surprise. And how can we break the "Banks' Cycle of Misbehavior"? I'm sure I don't know, and I have only limited interest in finding out, but I do really like the City of London Police's plan, which involves recruiting the Royal Bank of Scotland as sort of a special deputy to catch financial crime. Because who would know more about financial crime than etc. etc. etc. "Officers insist any investigation into the bank will be kept separate from the new venture."

Bill Gross is having fun.

Bill Gross's second Investment Outlook at Janus came out yesterday; it has been made fun of to death but here you go anyway:

I am a philosophical nomad disguised in Western clothing, a wondering drifter, masquerading in a suit near a California beach. Sand forms the foundation of my being and its porosity is at once my greatest strength and deepest wound.

Also there's some stuff about deflation. Gross says: "Going home again, to paraphrase Thomas Wolfe, is something you just can’t do," which is demonstrably false, if by "you" he means "Pimco employees who quit because they couldn't handle Bill Gross." Last week it was Michael Spence and Jeremie Banet, the latter recalled from a croque monsieur truck, and yesterday it was Marc Seidner, who "will be in charge of portfolio management and nontraditional strategies." They'll be drifting back to Newport Beach to take advantage of the porosity of Pimco employment status, a porosity that is the firm's greatest strength as it heals its deepest wound, am I doing this right?

Herbalife reported earnings.

Here is the earnings release, and the 10-Q. It was a miss, and shares were down after hours. My model for Herbalife -- Bill Ackman points out bad thing, Ackman says bad thing is fatal, Herbalife denies bad thing, Herbalife fixes bad thing, bad thing is not fatal -- seems to be mostly continuing, though I guess we still need to test the last part. Yesterday's fixes included limits on first orders, to avoid the sort of pyramid-scheme inventory loading that Ackman has alleged, as well as a big write-down of assets in Venezuela to deal with some other Ackman-inspired claims. Here is Dan McCrum on Herbalife's legal maneuvering, including settling a California class action lawsuit on Friday for $15 million. And here is John Hempton with the extremely bullish bull case, both on the fundamentals of sales growth ("Rising retention on rising numbers of sales leaders almost guarantees rising sales in the future.") and on the legal question of what the Federal Trade Commission will do ("If legal bills are any guide (and common sense says that they are a guide) then the FTC inquiry is not being very problematic.").

Some M&A news.

Dan Primack asks where all the big leveraged buyouts went, and concludes that leveraged loans are suffering both from bond-market volatility and from the Fed's pressure on banks to keep leverage below 6x EBITDA. One big recent leveraged buyout is Dell, which is chilling out of the Wall Street spotlight, and is in a bit of a weird situation: The faster and more successful its turnaround is, the better for its owners, of course, but if it's too fast and successful then the Carl-Icahn-led shareholder complaints that Michael Dell was stealing the company will start to look accurate. Not that those shareholders will be able to do much about it. Elsewhere, Allergan's head of corporate development has quit, apparently over disputes with other Allergan executives about how harshly to fight Valeant's hostile takeover offer. And what is Dollar General's end game for the Family Dollar fight?

Some living wills.

If there's a banking crisis, will the Federal Reserve lend to freely to banks against good collateral at a penalty rate? I mean. You would hope so. But the Fed is telling banks not to make that assumption in preparing their living wills, which is driving them to buy lots of Treasuries to make sure they'll have liquidity in a crisis, except that "Other banks have said only cash may be good enough and they might, in fact, have to sell Treasuries to boost their cash reserves." If your plan for the banking system involves assuming that the lender of last resort won't be a lender of last resort, you get a strange banking system.

Mutual funds are lagging again.

The average actively managed mutual fund will underperform its index, net of fees. This is just arithmetic, but it's sometimes amusing to pretend that there's some complicated story for why mutual funds are underperforming this year. Here's a version of that story, which features a stock manager saying that the "S&P 500 is masking what's going on underneath the surface," which "makes it much more difficult for active managers to keep up."

Something about Puerto Rico bonds.

Some bonds have minimum denominations -- you can buy $100,000 or $105,000 or $265,000 or whatever worth of them, but not less than $100,000 -- because they're too risky for small investors. If you are a broker, and you are dealing in those bonds, you need to enter into your computer system something like "DO NOT SELL IN UNITS LESS THAN $100,000." Actually first you need to have a computer system with a field like that. Puerto Rico sold some high-yield bonds earlier this year with a $100,000 minimum denomination, and an astounding 13 brokerage firms, including JPMorgan, Charles Schwab, and TD Ameritrade, messed this up. They were fined small but embarrassing amounts by the Securities and Exchange Commission yesterday. To be fair, all of these trades seem to have been inbound customer orders -- the brokers weren't going around trying to offload odd lots of Puerto Rico bonds on unsuspecting customers -- and several firms caught their mistakes before settling the trades. Also I guess this is better than saying to customers, "hmm, you want $30,000 of Puerto Rico bonds, no, that's too risky, you'll need to round up to $100,000."

Financialization and quantitative easing.

Here is Steve Randy Waldman with what strikes me as sensible political economy:

A few weeks back there was a big kerfuffle over whether QE increases inequality. The right answers to that question are, it depends on your counterfactual, and it depends on your measure of inequality. Relative to a sensible policy of helicopter drops or even conventional (and conventionally corrupt) fiscal policy, QE has dramatically increased inequality for no benefit at all. Relative to a counterfactual of no QE and no alternative demand stimulus, QE probably decreased inequality towards the middle and bottom of the distribution but increased top inequality. But who cares, because in that counterfactual we’d all be in an acute depression and that’s not so nice either. QE survives in American politics the same way almost all other policies that help the weak survive. It mines a coincidence of interest between the poor (as refracted through their earnest but not remotely poor champions) and much wealthier and more powerful groups. Just like Walmart is willing to stump for food stamps, financial assetholders are prone to support QE.

And here is Mike Konczal on "Frenzied Financialization" as a driver of inequality.

Things happen.

Red Lobster's Comeback Plan: More Lobster. The SEC's data lag is narrowing. MetLife has big plans to fight its too-big-to-fail designation. Malls are converting into data centers for financial and metaphorical reasons. New Citigroup branches will have touchscreen walls for some reason. The Art of Not Working at Work. A virtual mosh pit. The vomiting camel.

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

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