Levine on Wall Street: Flattering Ratings and Nice Activists

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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Don't change your ratings criteria to win business.

Are you excited for Standard & Poor's settlement with the Securities and Exchange Commission, expected to come as soon as today? S&P will pay some money -- $60ish million, just a warm-up for its apparent $1.37 billion settlement with the Justice Department and state attorneys general that is also in the works -- and be barred from rating commercial mortgage-backed securities for a year:

The deal, which the person said may be announced as soon as tomorrow, is the agency’s toughest action yet in an industry blamed for fueling the 2008 financial crisis by assigning inflated grades to risky mortgage debt. Instead of securities created during that period, though, the SEC’s investigation has looked at whether S&P bent its criteria to win business on commercial-mortgage bonds issued in 2011.

These cases are always sort of weird because they exist in a competitive dynamic. No one does CMBS deals with no ratings. Everyone wants to do their CMBS deal with the highest rating they can get from a reputable rating agency. So if Brand X has 90 percent market share, and S&P has 10 percent, that means that Brand X has generally easier rating criteria than S&P. And if S&P then changes (loosens) its criteria to gain market share, then that looks bad. There will be e-mails and whistleblowers and stuff saying "hey let's bend our criteria to win business." But of course Brand X was already out there with looser ratings criteria, so they never had to send those e-mails. There's a first-mover advantage, or at least a quiet mover advantage. This seems to be true in the main, crisis-era, Justice Department case, but it will be fun to see if it's true in the CMBS case too.

Activism, but friendly activism.

How do you feel about "Hudson Executive Capital," as a name for a hedge fund? I'm not sold. "Hudson" is a little generic -- I get it, you're in New York -- and "Executive" gives it a bit of a feeling of a car service? I guess the point is that Hudson Executive -- a $250 million activist fund started by Doug Braunstein of JPMorgan and James Woolery of Cravath/JPMorgan/Cadwalader -- is advised by a flock of "14 current and former chief executives" that will help it figure out how to nudge other public companies into better performance. Using executives. Hence the name. As an idea this ... seems promising? A lot of low-hanging fruit in activism is financial engineering, and so the activist skill set tends to run toward demanding stock buybacks or breaking up senseless conglomerates or forcing the sale of inept companies. But a lot of higher-hanging fruit is, like, "hi, I'm a hedge fund manager, and I have some operational ideas for how you can run your company better." Starboard vs. Olive Garden was mostly about sale-leasebacks, but most of the discussion was about breadsticks and pasta-salting policy. It is not obvious that a hedge fund manager would know more about running a company than the people running the company. But I guess a flock of CEOs might. Also the flock of CEOs will supposedly be nicer to incumbent management, which arguably somewhat misses the point of activism, though it might turn out to be a better negotiating strategy. 

Volatile currencies.

The Swiss franc fallout continues. Here is more on the fall of FXCM Inc., and doesn't this sound great?

Who gets into this market? Niv described FXCM’s typical client as a male, white-collar professional between 35 and 60. “They want to trade as a hobby, and often aren’t allowed to trade at work,” he said in May. Unlike in the stock market, the currency market allows for online trading 24 hours a day, five days a week. “FX, you can do it in the middle of the night, you can do it after dinner,” he said.

Meanwhile, "The National Futures Association, a self-regulator responsible for policing the futures industry, said it is considering whether to alter a cap on borrowed money, or leverage, for currency bets in response to last week’s market tumult," and obviously the time to alter the cap on leverage is before the once-in-a-generation tumult but, sure, whatever.

Elsewhere in foreign exchange trading, it's become more automated, as "Banks are directly connecting to price feeds from Global Trading Systems LLC and Virtu Financial Inc. to help complete their clients’ currency orders." And is the dollar next? To be unpegged? No? But its rise is hurting U.S. exporters, and the Manhattan luxury apartment market. And here is Matt Klein on the Danish krone: "While the implied 1-week volatility in EURDKK is a lot higher than it used to be, it is about the same as 1-week implied volatility was in EURCHF back when everyone thought the currency floor was unbreakable." 

Also there is a rather important European Central Bank meeting tomorrow. Here is Lorcan Roche Kelly on what the ECB should do. And here is Mohamed El-Erian on why the Swiss National Bank did what it did.

Oil. 

Things are bad, if you're in the oil business. BHP Billiton, which "has spent billions building out its business to become one of the biggest petroleum producers outside of the major integrated oil companies in places such as the U.S. and Australia," now kind of regrets that decision, announcing "up to $250 million in write-downs on its petroleum business and a sharp reduction in U.S. drilling activity." Here is a claim that BP -- not BHP, mind you, but the artist formerly known as British Petroleum, with its $113 billion equity market cap -- might be a takeover target. And here is a sad story about the effect of the oil collapse on strippers, and no come on it's not that:

Strippers are scavengers who make a living by resuscitating once-prolific oil fields to coax as little as a bathtub full of crude a day from each well. Collectively, the strippers operate almost half-a-million oil wells that produced more than 730,000 barrels a day in 2012, the most recent year for which figures were available.

Strippers tend to be pretty small operators and I hope some of them are actually using their bathtubs to store the oil? Anyway it is not a great time for them. And "Investors have lost millions backing this humble legume"; it's guar, which is used to make guar gum, which is used in hydraulic fracturing, which is a less lucrative use than it was six months ago.

Some market structure.

Here is more on the Fidelity/BlackRock/etc. plan to start Luminex, a dark pool for Fidelity and BlackRock and a few other big asset managers to trade stocks with each other. (With a name that is ... spaghetti Latin for "light exchange"?) The idea seems to be for a block-crossing dark pool, like Liquidnet, in which you're committed to trade at least a certain minimum size if you match with another trader, to avoid the problem of investors fading on their block indications. An earlier version of the article described Luminex's traditional long-only participants as "asset managers who bet on prices to increase," and I joked that it's a dark pool that allows buying but not selling, and that ... there's something to that, right? In this era of quasi-indexing, you might wonder how frequently two big long-only funds will naturally find themselves on opposite sides of a large block at the same time. But we'll see.

Elsewhere, the New York Stock Exchange has a new room (umm ... new furniture in an old room? I don't know) called the "Buttonwood Room," and man do they milk that buttonwood thing. Among my favorite facts about market structure is that the New York Stock Exchange, which was founded in the 18th century by some guys trading stocks under a buttonwood tree, still trades stocks under a buttonwood tree in the 21st century. It's just that now those buttonwood trees are in Mahwah, New Jersey, providing shade to the data center where NYSE stocks actually trade

And over in bond market structure, it's sort of interesting that JPMorgan has started "a new 12-person unit focused solely on trading credit index products such as credit default swap benchmarks and exchange-traded funds." I wonder how much of that is the love of indexing that you see in equities creeping into fixed-income, and how much of it is that liquidity in single-name credit trading is drying up and indexes are the best thing to trade.

Sauce.

Sarah Nassauer:

“All these kids grew up dipping their chicken fingers and their baby vegetables in ranch dressing. They have a very long standing relationship with dipping,” says Ms. Nielsen.

Sterling-Rice has identified “advanced Asian” as a mega food trend this year, Ms. Nielsen says. “Whatever place you are with Asian food, you will have the urge to take it one level deeper.”

Stuff happens.

Starboard Value is still pushing Staples to take over Office Depot. Steven Davidoff Solomon on Family Dollar shareholders' quandary. Detroit's bankruptcy professionals don't think they're overpaid. Alexis Goldstein on the Volcker Rule ("I’m curious to know what LSTA’s hedge fund members make of fact that they’re being demonized in order to justify pro-bank legislation."). Honda Warns Against ‘Stupid’ Loans Driving U.S. Sales Gains. Marc Faber has a trade idea (it's "buy gold," obviously). How many of The Top 20 New York Socialites To Know This Year do you know? If your password is "123456," you should change it, but if it's "dragon" probably just carry on. New Hampshire lotto releases bacon-scented scratch-off. German Rabbit Breeders Criticize Pope's Sex Comments

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