Levine on Wall Street: Credit Ratings and Webcam Advisers

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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Should S&P rate CMBS?

Standard & Poor's gets paid to rate commercial mortgage-backed securities, though it took a break for a year or so in 2011-2012 because it found "a potential discrepancy in its models." The Securities and Exchange Commission is looking into another potential discrepancy -- viz., "whether the firm bent rating criteria to win business in 2011" -- and is trying to suspend S&P from rating CMBS as part of its punishment. "S&P has made efforts to avoid the sanction over concerns that the reputational consequences would harm its franchise," and that's perfectly reasonable, though of course suspending your CMBS ratings for more than a year because you yourself have lost confidence in them seems to raise its franchise issues of its own. Ratings are also strange in that they are, canonically, opinions protected by the First Amendment, and it is a little awkward for a federal regulator to order someone not to express any opinions for a while. I suppose if you do it as a negotiated settlement then it's fine. Even if not, though, the whole issue is that, in the SEC's view, S&P's CMBS ratings didn't reflect its true opinion about those CMBS, so perhaps those ratings are not constitutionally protected anyway.

Should Vanguard be your financial adviser?

Here's a pretty good article about -- well, first of all, a certain percentage of it is about how nautically themed Vanguard is (it "does not have cafeterias, it has galleys; Vanguard staff are called 'crew members'; its gym membership programme is called 'Shipshape'"), none of which may be news to you but it's news to me. But, no, the article is about how Vanguard is going after the financial-adviser business, "quietly working on a way to give simple but effective portfolio advice to US savers" for a fee of 30 basis points per year instead of "an industry average of more than 1 per cent":

Using mainly online tools, including webcam chats with advisers, it will avoid the expensive infrastructure of existing financial adviser chains.

“Can we provide really super-high quality advice at a very low cost and do that in a very large way, and change that market? I think we can,” says Mr McNabb.

Seems ... reasonable to me? I mean, everyone else is getting into the robot advising business, so that seems to leave an opening in the webcam advising business. Obviously there is another view:

But already some of the biggest independent financial advisers are chafing at the prospect of its entry into the market and raising the spectre of conflict of interest.

“Don’t be surprised if everything they recommend is a Vanguard product,” Peter Mallouk says he will be warning clients, whose own pitch is that he can tailor exactly the right mix of products for a saver’s needs.

There is some empirical evidence that the average financial adviser doesn't tailor exactly the right mix of products for a saver's needs, but instead just picks the investments that the adviser likes for herself, so why not go with the investments that Vanguard likes for itself? Disclosure, most of my non-401(k) investments are in Vanguard index funds, and while I have no immediate plans to do a webcam chat with Vanguard, if I did, and they recommended all Vanguard products, I'd be fine with that. But I am probably not the target audience for financial advice. Elsewhere in financial advising, it's Morgan Stanley for Kids, wait, no, it's the Institute of Family Wealth Management.

Should bankruptcy be different?

There's a big new report from the American Bankruptcy Institute recommending changes in the U.S. Bankruptcy Code. Here is the report, and Bloomberg News and Wall Street Journal coverage, and some things that aren't in the report. Broadly speaking, the recommendations seem to be pro-debtor, enhancing automatic stays, eliminating creditors' committees for some small-business bankruptcies, expanding the availability of cram-downs even without an accepting class of impaired claims, and weakening the protection of secured claims. Here is Stephen Lubben on safe harbors and derivatives in the new recommendations, which to his mind don't go far enough and make it too easy for derivatives counterparties to cancel trades with bankrupt debtors. The Loan Syndications & Trading Association and the Commercial Finance Association -- who are more pro-creditor -- say that the proposed changes would "limit American businesses' access to credit," which I always find sort of uncompelling as an argument against bankruptcy-law changes. It's possible that bankruptcy rules are priced into credit, but a lot of this stuff seems pretty marginal for pricing. In general it's more fun to treat bankruptcy law, like tax law, as an intellectual puzzle -- "what is fairer and more logically consistent?" -- than as a way to price credit.

Business ethics.

Here is Allison Schrager on last week's court decision in Ronald Perelman's lawsuit against Larry Gagosian, which held that Perelman couldn't sue Gagosian for misrepresenting the value of artworks. From the opinion (citations omitted):

The amended complaint alleges that defendants misrepresented the value of certain works of art and that the values were supported by market data, when they were not. As to the latter, the complaint fails to state a cause of action for fraud because plaintiffs did not allege justifiable reliance. As a matter of law, these sophisticated plaintiffs cannot demonstrate reasonable reliance because they conducted no due diligence; for example, they did not ask defendants, “Show us your market data.” 

Not legal advice or anything, but that might be something for some bond traders, and the prosecutors who love to prosecute them, to keep in mind. Misrepresenting values without actively lying about data is kind of a core bond-trading activity, and asking to see the trade data does seem like a pretty low bar for due diligence. Elsewhere in ethics, Ethisphere (motto: "Good. Smart. Business. Profit.") announced its 2014 list of the "100 Most Influential in Business Ethics"; highlights include #1 (tie) William Dudley and Preet Bharara, #4 "Anonymous Whistleblower," #8 Pope Francis (job title: "Pope, Catholic Church," category: "Thought Leadership," the Dalai Lama is #25 in the same category), #11 Carmen Segarra, and #13 (tie) Mark Zuckerberg and Priscilla Chan. Among the less ethical: Daniel Bonventre, who ran Bernie Madoff's broker-dealer business, was sentenced to 10 years in prison yesterday, and three former Detroit officials were convicted of fraud and corruption charges for taking bribes for pension deals. And Cay Clubs, pitched with "a power point presentation entitled 'Retire Rich and Young in Paradise,'" was a Ponzi

You can't just run a bitcoin stock exchange.

It's a total pain to open a stock exchange! You need to apply to the SEC and get approved and do lots of filings, and that's before you even start to think about dark liquidity and sneaky order types. And, no, you can't short-circuit the rules by letting your investors trade stocks using bitcoins. And, no, just because I said "bitcoins" in that sentence, that doesn't mean you can get around the rules by using Litecoins. Ethan Burnside, a computer programmer at a social gaming company, tried both approaches, and yesterday the SEC shut down his exchanges, fined him $68,000, and barred him from the securities industry. From the SEC's order, I get the sense that Burnside (1) was an honest guy -- he sold some bonds to investors for $5,490 and bought them back for $59,504 because prices moved against him -- and (2) had no idea that he wasn't allowed to do this. It is actually natural enough for a computer programmer -- familiar with EBay and Amazon and World of Warcraft -- to think, hey, I can just start an online market where people can buy and sell stuff without registering it with any regulators. And this is ... probably true for a lot of markets? (Not legal advice!) Just, not stock markets, the SEC has dibs on those. (Also stay away from political futures contracts.) Elsewhere in not immediately intuitive SEC news, here are eight accounting firms fined by the SEC for doing their clients' accounting. The trick is: You can prepare a client's financial statements, or you can audit those statements, but you can't do both. But you can see why a small unsophisticated client would be annoyed if his accountant refused to help him prepare his financial statements.

Who regulates the regulators?

In bank capital regulation, the answer is the Bank for International Settlements, sort of. Here is the BIS's Regulatory Capital Assessment Programme assessment of the United States, measuring how well the U.S. has implemented the Basel capital rules. The assessment was conducted by a team of experts led by the chief executive of the Swiss Financial Market Supervisory Authority, included a questionnaire, and "finds the risk-based capital requirements in the US to be largely compliant with the minimum standards agreed in the Basel framework." Even better, "in several areas, the team noted a super-equivalent implementation of the Basel framework." On the other hand, there were two problems, one a boring one about permanent versus transitional rules, the other having to do with securitizations:

Regarding the securitisation framework, a number of divergences were identified that for some US core banks lead to materially lower securitisation RWA outcomes than the Basel standard. These differences are mainly related to the prohibition on the use of ratings in the US rules. Pursuant to the Dodd-Frank Act, the US rules cannot include provisions related to the Basel framework’s Ratings-Based Approach (RBA) for securitisations, so the rules provide alternative treatments. The US agencies note that their alternative approaches are, on average, more conservative than the Basel standards, and are consistent with the G20 objectives of reducing mechanistic reliance on external credit ratings.

U.S. hostility to ratings seems to trump the (sort of minimal?) desire for Basel conformity. Here is David Zaring on the BIS review. Elsewhere in BIS and securitizations, this weekend's quarterly review also called for higher capital requirements for mezzanine tranches of asset-backed securities.

A cat.

Financial journalism was briefly convulsed yesterday by a claim that Grumpy Cat, a cat who is grumpy and on the internet, made $100 million over the last two years. Fortunately, that claim seems not to be true, though that probably just means that the real number was higher. Vox explains.

Things happen.

"Considerable time" may go away next week. Bill Gross is running a billion-dollar fund again. John Paulson is losing money again. Here is a story about Jefferies. Eliot Spitzer drove Henry Blodget to drugs. Let's see what Alan Greenspan has to say about popping asset bubbles. Momentum Trading, Return Chasing, and Predictable Crashes. The best Supreme Court lawyers. Oil and the high yield market. Wachtell Lipton discusses 2015 Corporate Governance Trends. We are all in the gutter, but some of us are looking at a stock-picker's paradise. "A word analysis indicates the most left-leaning phrase is 'post Keynesian,' followed by 'credit union.' The most right-leaning phrase is 'free banking,' and then 'bank note' and 'hedge fund.'" “My tip for home lava cooks: Be well-insulated. It gets really hot!” You can drink vodka now. Or hoard bourbon. How do you account for lost pleasures? "The daughter of Korean Air Lines Co. Chairman Cho Yang Ho ordered a plane back to the gate so she could remove a crew member who gave an incorrect answer to a question on how to serve macadamia nuts."

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:
Matt Levine at mlevine51@bloomberg.net

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