Levine on Wall Street: Swaps Pushed Back In, Harvard Gets in Trouble

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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Swaps push-out.

There is some intellectual content to financial regulation but not, obviously, to grandstanding political showdowns over financial regulation. Those are mostly about emotional identification and symbolism. And so, swaps push-out. "A fierce fight is raging in Washington over an arcane banking regulation that has yet to take effect and whose impact was always going to be slight," says Peter Eavis, and he is right, just skip down to the next boldface heading, this is silly, come on. If you're still here, try this Q&A from the Wall Street Journal, which explains that the swaps push-out rule -- section 716 of Dodd-Frank, which would require banks to book their derivatives in subsidiaries that are not their insured depository institutions -- may be killed as part of the new deal to fund the government. Or here is Mike Konczal arguing to preserve the rule. You don't need me to tell you how terrible the politics (all politics) are -- Why do financial regulation in an unrelated spending bill? Why rewrite financial regulation based on a draft by Citigroup lobbyists? -- but let's spend a minute on why it's not worth caring about. 

First: The rule doesn't apply to most derivatives. Federal Deposit Insurance Corporation Vice Chairman Tom Hoenig:

In fact, under 716, most derivatives -- almost 95% -- would not be pushed out of the bank. That is because interest rate swaps, foreign exchange and cleared credit derivatives can remain within the bank. In addition, derivatives that are used for hedging can remain in the bank. The main items that must be pushed out under 716 are uncleared credit default swaps (CDS), equity derivatives and commodities derivatives. These are, in relative terms, much smaller and where the greater risks and capital subsidy is most useful to these banking firms.

I have my biases, but I have a hard time believing equity derivatives will bring down a bank. Uncleared CDS, I'll grant you, has a rough track record, though the market is slowly moving away from it in general. But the big derivatives risks, by notional, were going to be allowed to remain in the depository banks anyway. "Oh but no one could be blown up on interest rate swaps," you say, as the Fed discusses the timing of rate increases.

Second: Pushing out derivatives into non-insured subsidiaries doesn't make them go away. Defenders of the rule cite the example of AIG, which foundered on uncleared CDS and brought down the financial system. AIG: not an insured bank! Neither was Lehman! The people arguing for the swaps push-out rules are not people who, in other contexts, would say that only insured depository banks get any government support. They'd say that "too big to fail" banks (you know: derivatives dealers) pose risks to the financial system even in their non-bank subsidiaries, risks that lead to an implicit expectation of government support beyond the explicit FDIC insurance. Here, they are right. If JPMorgan blows itself up trading CDS, that will be a problem for everyone, whether it happens in the insured bank or some uninsured subsidiary. The rule won't stop that. The rule is (was?) fine, but it's not worth getting upset about. This is all theater.

More on insider trading.

Here's an unusually chastened statement by U.S. Attorney Preet Bharara on yesterday's big insider trading decision, saying that, in the prosecutions that were so thoroughly overturned, his office "investigated and prosecuted misconduct based on our good faith assessment and understanding of the facts and the law that existed at the time." I should hope so? The prosecutors' good faith may be of some comfort to the former employees of Level Global Investors and Diamondback Capital Management, Chiasson's and Newman's hedge funds, which were shut down after FBI raids in 2010 because everyone assumed they had insider traded. (Along with Loch Capital, which was also raided but never even charged.) Apparently not, oops. "For the dozens of my high-integrity colleagues at Level Global who lost their jobs and their reputations because the F.B.I. improperly raided our firm in this now-discredited fishing expedition, today’s legal vindication is a reminder of how prosecutorial recklessness has real impact on real people," said a Level Global co-founder. 

Elsewhere here is Peter Henning on the decision:

The latest decision does not give a free pass to hedge funds to trade on any confidential information they might gather as long as they can just deny knowing about the source. One way the government can prove a case is through a person’s “willful blindness,” which means ignoring red flags about the questionable nature of the information to avoid learning too much. Sometimes called the “ostrich instruction,” it allows a jury to find defendants can violate the law by putting their heads in the sand when it came to knowing whether how the information was obtained.

Maybe. After considering "willful blindness" arguments, the court yesterday said that even if the information that Chiasson and Newman had "could support an inference as to the nature of the source, it cannot, without more, permit an inference as to that source’s improper motive for disclosure." It strikes me as easier to point to red flags that information came from an insider than it is to find red flags that the insider was bribed.

Naughty Harvard.

Here is an utterly loony paper by Securities Exchange Commissioner Daniel Gallagher and former SEC commissioner Joseph Grundfest arguing that Harvard is violating the securities laws in its Shareholder Rights Project. That project, run by Harvard professor Lucian Bebchuk, submits shareholder proposals to public companies asking them to de-stagger their boards, so that all directors are elected every year instead of electing one-third of directors a year to three-year terms. Staggered boards make activism hard and hostile takeovers nearly impossible, and so are often viewed as shareholder-unfriendly. There is some empirical evidence that they are in fact bad for shareholders. There is other empirical evidence that they are good for shareholders. There is yet other empirical evidence that they are sometimes good and sometimes bad. (This is how empirical corporate governance research always works out, by the way.) Harvard, in advocating against staggered boards, cites the research that supports its side, and doesn't cite the research that supports the other side. Gallagher and Grundfest argue that this could be "a material omission that violates" the proxy rules. Umm? It is not exactly news that some people think staggered boards are good and others think they are bad, and that the ones who think they are bad will, you know, say that they're bad. It would be hard to argue that Bebchuk et al. don't believe that their arguments are true.

"If the SEC took the more draconian step of suing Harvard, the agency would be 'in my opinion, very likely to prevail,' Mr. Grundfest said in an interview," though, I mean, it won't? The purpose of this paper is to make life a bit easier for companies that are targeted by the Harvard Shareholder Rights Project. First, it will probably drive Harvard to soften the language of its proposal a bit. Second, and more importantly, it will give companies that oppose de-classification a very authoritative-sounding source of empirical data for their position ("Look, the SEC says staggered boards are good!"). And third, it may allow companies to exclude the Harvard proposal from their proxies entirely, by arguing to the SEC that it is false and misleading. 

Bonds. 

It's a bond-picker's market in corporate debt, apparently. And junk bonds are still falling, still driven by energy. Here's Matt Klein disaggregating high-yield returns by sector; after you strip out energy, which is around one-sixth of the market, it doesn't look so bad. European high-yield, which is less energy-centric, has outperformed the U.S. recently. Elsewhere in bond news, more or less, is the headline "Bond Deals Can't Skirt Leveraged Lending Guidance." You know how I keep making fun of the rules supposedly prohibiting banks from lending to companies at more than 6x leverage? Some banks figured that they could finance companies at more than 6x leverage by selling bonds to investors, without a bank-loan component. That's fine, as far as it goes, but the problem is that even bond-funded leveraged acquisitions come with a bridge loan from the banks to guarantee that the acquisition will be funded; the loan is taken out with bonds but the banks at least commit to, and sometimes briefly fund, the loan. And that loan, if the total leverage is over 6x, is apparently still forbidden. So another rule for banks to ignore I guess.

Private equity.

Good private equity firms are beating investors away with a stick, but less good ones are forced to offer concessions, and even that has its problems:

“It’s like the Marx Brothers routine: Any club that would take me as a member, I don’t know that I want to join,” said William R. Atwood, executive director of the Illinois State Board of Investment, which invests in private equity among other strategies. “If I can go into a partnership and demand specific terms, that sounds good, except why is that the case? Why aren’t they oversubscribed?”

Ha, it's true, do you want performance, or do you want good customer service? I guess oversubscription is no guarantee of performance either. Elsewhere, private equity is considerably more wary of public-company leveraged buyouts than it was in the last merger boom. And here is Andrew Ross Sorkin on the M&A cycle.

Crowd-whatever.

Lending Club priced its initial public offering at $15 a share, above the range of $12 to $14, which was $10 to $12 last week. So that's a $5.4 billion market cap, with around $1 or $2 billion of that added this week, and some of the demand comes directly from lenders on Lending Club's platform, meaning that it's sort of crowd-IPO'ing its crowd-lending business. It's probably not particularly accurate to call Lending Club a crowd, or even a club. Elsewhere here is a story on start-ups using crowdfunding.

Scandals, etc.

The SEC fined Morgan Stanley $4 million for not stopping the hilarious Rochdale rogue trader. Goldman Sachs "has to pay two former financial advisers more than $7.5 million for wrongly firing them and withholding their bonuses"; the team was fired because one of them "spent time away from Goldman to serve in the military," man. Investec put a really really bad headline on a research note. And Prestige Wealth Management was not as prestigious as it sounded:

The SEC’s Enforcement Division alleges that Timothy S. Dembski and Walter F. Grenda Jr. steered their clients at Reliance Financial Advisors to invest in a hedge fund managed by Scott M. Stephan, whose experience in the securities industry was greatly exaggerated in offering materials they disseminated.  Dembski and Grenda allegedly knew that Stephan had virtually no hedge fund investing experience at all, and spent the majority of his career collecting on past-due car loans.

Things happen.

Securities-based lending, "rich man's subprime." Cliff Asness: Efficient Frontier "Theory" for the Long Run. The Long Reach of Delaware's Corporate Influence. Criteria for identifying simple, transparent and comparable securitisations. Analyst salaries. Who are New York's Highest Paid Hedge Funders? (#1 lives and works in New Jersey, #2 lives and works in Connecticut and doesn't manage a hedge fund, so ... ?) Hedge-Fund Manager Makes Millions Moonlighting as Wildlife Photographer. Starboard Value really likes office supplies. Is Piketty's literary history wrong? (A rebuttal.) Some Uber contractors got termination notices written in Comic Sans. The Year in Sandwiches. "Staten Island cost $7,868." Hedge Fund Manager Whose Goats Speak French Would Rate Their Intelligence Around That Of Your Average Investment Manager. Don't work too muchMolotov.

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