Levine on Wall Street: Rubles and Swaps

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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Huh, Russia.

A lot of central banks have been trying to weaken their currencies recently, leading to intense and potentially lucrative speculation on who will be next and whether they will succeed. After the Swiss National Bank abandoned its franc cap, anything seems possible. Will the UAE abandon the dollar/dirham peg? Will Denmark be able to defend its euro peg by cutting rates? What about the Turkish lira? So many good options, you never know where the next cut will come from, but it's safe to say that not too many people were expecting this:

Russia’s central bank unexpectedly slashed its key interest rate from 17 per cent to 15 per cent on Friday, sending the rouble plummeting, as it struggles to balance the threat of a recession with surging inflation.

Part of the surprise is that Russia didn't seem to need that much help weakening its currency, which was down 43 percent against the dollar last year, with inflation now running at 13.1 percent. But the recession risk apparently outweighed inflation and currency weakness, plus I guess if there's a currency war Russia wants in on it.

Elsewhere, here is a story about FX arbitrage at the Mexico City airport, which, unlike most stories of arbitrage (that Swiss town!), is actually a sad story: "Regulations aimed at curbing money laundering have made it so onerous to deposit large amounts of physical dollars in banks that the currency brokers would rather get rid of them at fire-sale prices." So if you have a U.S. bank account you can buy dollars cheap, deposit them, and make a quick profit. If you don't, you're stuck selling dollars cheap.

Bankers vs. politicians.

Yesterday Elizabeth Warren and Elijah Cummings trolled Wall Street by sending "letters to four top Wall Street banks Thursday asking for details about how the firms will alter their derivatives trading operations in the wake of the change" to the swaps push-out rules. Here's the JPMorgan letter, which reminds Jamie Dimon that "On the night of the House vote, you reportedly 'telephoned individual lawmakers to urge them to vote for it,'" though it doesn't ask him to confirm or deny that under oath.

But Wall Street is trolling Warren right back with this piece of work: a collateralized loan obligation intended to get around the risk-retention rules by basically pre-issuing CLOs. Starting in December 2016, CLO managers will need to retain at least 5 percent of the risk of their deals. But if you do a CLO now, you might (might!) be grandfathered in for that deal, but any repricing or refinancing after 2016 would subject you to the rule. But what if you just "issue" some extra notes now without selling them to investors? Then can you sell them later without triggering the rule?

Apollo raised a $786 million CLO on Jan. 23 that created two sets of bonds. The first set was sold to investors, while the second hasn’t yet been funded and would be used to refinance or reprice the deal in the future, said one of the people, who asked not to be identified because the information isn’t public. By assigning the shell notes an identification number and dating them now, the New York-based money manager is seeking the option to redo the deal without making it subject to the regulations.

This doesn't sound that plausible to me -- or, really, to anyone interviewed in that article -- but the important thing is that they're trying. In unrelated news, here is a Goldman Sachs banker saying "They go right up to the chalk on the line. That’s what innovators do," though he's talking about the New England Patriots. Here is William Cohan on how hurt bankers are that Elizabeth Warren dislikes them. And here is a claim that "the president's new proposed tax on highly-leveraged financial institutions" would increase the middle-class tax burden.

Finally, here is a white paper from Commodity Futures Trading Commission Commissioner J. Christopher Giancarlo on "Pro-Reform Reconsideration of the CFTC Swaps Trading Rules" under Dodd-Frank. One push of the new rules is for swaps to trade transparently via a central limit order book (CLOB), rather than through phone calls to chummy dealers. Giancarlo:

It is unclear how those who support the CFTC’s impetus for electronic CLOB execution of swaps, yet decry HFT in today’s equities and futures markets, will reconcile these views when the enormous but humanly-managed swaps markets are launched into unmanned hyperspace by HFT algorithmic trading technologies

It's true, all markets are bad, and the people who dislike high-frequency public trading in equity markets do tend to be the same people who dislike low-frequency private trading in derivatives markets.

Bet on celebrities.

Here's a press release from AIG:

American International Group, Inc.’s (AIG) Commercial Insurance division today announced the introduction of Celebrity Product RecallResponse®, a new insurance product designed to help customers respond to risks from a celebrity endorser's public fall from grace, scandal, or unexpected death.

It goes on, with hilarious sincerity. "Customers also have access to AIG's RiskTool Advantage® to help them assess exposure and prepare and execute a recall plan." What? AIG has a model to "assess exposure" to celebrity embarrassment? What are the inputs to that model?

In America, there are about three ways to characterize a bet. You can just call it gambling, which imposes few restrictions on form or subject matter, but which is sort of illegal in most places. (You can't advertise it like this, anyway, though there are probably 10,000 "Weirdest Super Bowl Prop Bet" articles today.) You can call it a derivative -- a swap or future or whatever -- but that throws you into a weird morass of CFTC rules that forbid certain types of bets (political bets, for instance) and require others to trade on exchanges. Celebrity Default Swaps would be tempting, but unlikely to pass muster. Or you can call it insurance, which lets you take bets on all sorts of nonsense, but which requires an insurable interest: You can't bet on a celebrity to embarrass himself unless that embarrassment would actually hurt you economically. Here, the contract pays off if you'd have to recall a product that the celebrity endorsed, which seems like a pretty tiny niche. 

Some more Yahoo SpinCo.

How bullish should you be about SpinCo's prospects? (Previously, also.) It owns $34 billion worth of Alibaba stock subject to about a $12 billion tax liability. (When last we talked about it those numbers were $40 billion and $16 billion, but since then Alibaba has had a rough couple of days.) SpinCo's Alibaba stock is worth $34 billion in Alibaba's hands but $22 billion in anyone else's. So I think, anyway, that Alibaba should buy SpinCo, for stock. But for how much stock? A reader points out:

So … you have exactly one possible person who can buy Spinco without 35% tax liability. How might that negotiation play out?

To me, bargaining theory 101 would suggest Alibaba pays $24B+$1 for Spinco (in other words, they pay a 34% discount for Spinco’s BABA stake). Because that is demonstrably better than any other outcome Yahoo Spinco could get.

That is a worry for SpinCo shareholders. Basically -- ignoring the small legacy business that Yahoo is popping into SpinCo -- SpinCo ought to trade at a discount to its underlying Alibaba stock of somewhere between 0 percent (they're totally interchangeable) and 40 percent (the full tax effect). Alibaba should want to acquire SpinCo for stock, and any discount of more than 0 percent would be a good trade for Alibaba. (Just issuing 383 million shares to retire 384 million shares is a free earnings-per-share boost.) Any discount of less than 40 percent would be a good trade for SpinCo's shareholders, in the abstract. But SpinCo's stock will be publicly traded, and if it trades at a 15 percent discount, say, then it will be hard for Alibaba to offer to buy it at a 35 percent discount. You gotta offer a premium to get a merger done. So SpinCo's shareholders, by bidding up the stock, have some opportunity to make their own luck with Alibaba.

Some dumb things. 

Price weighted stock indices are dumb. 529 college savings accounts are dumb -- "a piece of utter trash policy," says Ryan Cooper, and he is not wrong. Less dumb: Credit Suisse's net asset value analysis prepared for Freeport-McMoRan's acquisition of McMoRan Exploration "projected that MMR would have after-tax cash flow that exceeded its pre-tax cash flow," which sounds like a case of someone just typing a formula in a box and not checking whether it yielded a nonsensical result. The IRS doesn't actually give companies extra money if they report negative net income. But in the acquisition context it seems a little shorthand but basically fine: "Freeport can take those MMR losses and use them to offset its own positive pre-tax income," so the losses to create tax value. Suisse is being sued over this but really they ought to win.

Things happen.

Saying farewell to ECB LTROs. The Shake Shack priced its IPO at $21, above the range, and here is a look back at Shake Shack's history. Here is a look back at the Securities and Exchange Commission's year in enforcement. Here is a look at the GFI takeover battle. Deutsche Bank is under "enhanced supervision" by the UK Financial Conduct Authority. Activist investing in Japan. Bank of America equities bonuses will be down about 10 percent. There's a new Blackstone fund for individuals. The New York Stock Exchange is getting a new software platform. The head of Nasdaq is disappointed not to be on the SEC's market structure advisory committee. The Qatari royal family couldn't get a permit to build a palace in London. What time is the Puppy Bowl? What time is the Super Bowl?

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