The New, Boring Banking

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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How bad is banking?

What should you make of today's big New York Times story about how Wall Street "appears to be in the middle of a humbling transformation"? Maybe you could start with an arithmetic point. Tim Geithner says (brags? laments?), "We’ve cut the profitability of banking roughly in half," and the article attributes the bulk of the humbling to higher capital requirements. If you make -- as I have in the past -- the oversimplifying but not crazy assumptions that (1) debt financing is free and (2) capital requirements have roughly doubled since the crisis, then you have explained 100 percent of the profitability drop. Banks could basically keep doing exactly what they were doing before, exactly as profitably, but they have to share the profits among twice as many shareholders. Whose shares, arguably, are twice as safe, and who should therefore be pleased with the lower returns.

That is not quite what is going on, of course. [Update: More thoughts on this here.] For one thing, the banks aren't doing exactly what they were doing before, because market-structure changes and non-capital regulation are pushing them out of some lines of business. For another thing, they aren't doing exactly what they were doing before because they are optimizing around capital, bulking up fee-driven low-capital-intensity businesses and slimming down capital-intense principal trading businesses. (From the Times: "In 2006, before the financial crisis, banks dedicated 41 percent of their assets to trading -- a number that fell to 21 percent in 2013.") Also the shareholders aren't all that pleased with the lower returns, and so are demanding that some of the higher capital costs be borne by employees. Pay is down, and headcount has fallen for four consecutive years

But as a dumb simple model you could do worse than the capital-arithmetic one. In particular, it lets you explain the sense of malaise without resorting to deep fundamental changes in the banks' business models. Everything is almost the same, but emphases have shifted, risks are lower, and it's all just a bit more boring.

Freddie Mac.

Freddie Mac reported earnings yesterday, and they were down 95 percent relative to the fourth quarter of last year. This is because Freddie Mac, as a thing that buys mortgages, is naturally long lots and lots of interest-rate duration, so when interest rates decline, as they did in the fourth quarter, the value of its portfolio goes up. Which sounds good, right? But it also has a bunch of derivatives to hedge that interest-rate risk, and when interest rates decline, the value of its derivatives goes down. The derivatives are marked to market in income; the portfolio is not. So when Freddie's portfolio increases in value, its accounting income goes down; when it decreases in value, its income goes up. Last quarter its portfolio got more valuable, so its income was way down.

The low income means that Freddie Mac will pay only $851 million in dividends to the Treasury, and John Carney points out that that's much less than the $1.8 billion that it would be paying if the government hadn't controversially amended the terms of its bailout in 2012. Before that amendment, Treasury took a 10 percent dividend on its preferred stock, and loaned Freddie more money if it didn't have enough money; after the amendment, it just takes whatever Freddie makes and leaves nothing for shareholders. That meant huge dividends in 2013, when Freddie had accounting gains for reversing a write-off of its deferred tax assets, and lower dividends now, when it has accounting losses for those derivatives losses. Both of those things, though, were basically uneconomic; neither had much to do with the actual economic results of Freddie's business. Freddie is a pure creature of arbitrary accounting, as most financial institutions are, but unlike most institutions it is forced to pay out tons of actual cash based on that arbitrary accounting.

What's Standard General up to with RadioShack?

Here's a fascinating story about Standard General, the hedge fund that owns a lot of RadioShack's stock and secured debt and that has proposed to buy a lot of its stores out of bankruptcy. Standard General's thesis is that RadioShack's business of selling cell-phone contracts "was by far the biggest reason the company wasn’t profitable," and that outsourcing that business to a Sprint kiosk in the corner of every RadioShack store would let the company concentrate "on the cables and gadgets that were once a staple." I am sure these are smart people but doesn't that just sound crazy? Like, RadioShack's problem is that it wasn't focused enough on selling random cables? I would love to be wrong about this, though; the world would be more interesting if they're right.

Elsewhere in retail, credit-default swap prices don't say anything good about Sears Holdings.

Some M&A.

BGC Partners announced that it is close to a friendly deal with GFI Group, after GFI previously rebuffed it, tried to do a lower-priced deal with CME Group, and saw shareholders reject that deal. You don't actually see a lot of announcements that a bidder is expecting to reach an agreement? The context for this announcement is that BGC's hostile tender offer was scheduled to expire yesterday, and it wanted to get GFI shareholders to tender before the expiration while it was still finalizing an agreement that would satisfy the tender-offer conditions. I suppose if there ends up being no deal, someone who tendered might be aggrieved, though it's hard to see what their damages would be.

Elsewhere in mergers and acquisitions, Delaware judges are becoming more skeptical of appraisal lawsuits, and one plaintiff is responsible for a ton of merger objection suits. The Federal Trade Commission is challenging the merger between Sysco and US Foods. And elsewhere in antitrust, what do you think of this American Express ruling? Amex charges merchants more than Visa and Mastercard, and its rules say that if you accept Amex you can't encourage people to use a different card. A judge found that this gave Amex "the power to repeatedly and profitably raise" its merchant fees "without worrying about significant merchant attrition," which I am not sure I entirely understand, because lots of places discourage the use of Amex by not taking Amex. But I am sympathetic with the idea that businesses should be able to encourage their customers to use lower-cost forms of payment rather than higher-cost ones, and that if you make a store pay higher processing fees so that you can get some cash back, they should be allowed to give you a nasty look.

Some CDO auctions.

Here's a Securities and Exchange Commission case against a brokerage called VCAP Securities, which was hired to run some auctions to liquidate collateralized debt obligations. VCAP also ran some investment funds and wanted to buy some bonds in the CDOs it was liquidating. But its auction agreements prohibited it from doing that: It was just the auctioneer, it couldn't also be a participant. So its president, Brett Thomas Graham, got another broker-dealer to bid on his behalf:

Before the first liquidation in which Third-Party B-D bid on behalf of Vertical, Broker asked Graham whether the trustee was aware of the arrangement. Broker asked, “[W]ill the seller know or care that a B/D maybe be [sic] biddin for some of your funds?” To which, Graham responded, “[N]o…Auction, so high bid wins. Auction was published in WSJ.” Broker understood Graham’s response to mean that the arrangement was permissible.

That's, like, awkward, but not necessarily harmful -- he's got a point that the seller should only care about getting the highest price. But then there was other shady stuff; Graham seems to have told his broker what the other bids were, so he could bid only a tiny bit more to make sure that he won. And "In one particular instance, Graham instructed Third-Party B-D to resubmit its bid for a lower amount because Graham subsequently received bidding information indicating that the next high bid for that particular bond had decreased," which is really not great. Anyway they're paying $1.5 million to settle this, and Graham is banned from the industry for three years.

Elsewhere in SEC enforcement, a dentist is accused of insider trading on information that he got from his brother-in-law, which seems about right.

A little Greece.

Things seem tense. Are Schäuble and Merkel on the same page, and what is going on with the capital controls leaks? Abasement gambits. Liquidity accidents. Erratic Marxism. "Since when does currency show people fleeing buildings in terror?"

Things happen.

"Hey, there is English law going on over here!" Jeff Gundlach hates automakers. Levered Betas and Wholesale Funding in the Context of Secular Stagnation. High-frequency trading firms don't all go home flat. CoCo greenshoe! Congrats to Ronald Perelman, the new chairman of Carnegie Hall. The gold fix will be set by an electronic platform starting in March. Guy Races The Subway From Bowling Green To Wall Street. Murder suspect dubbed 'Michelangelo of buttocks injections.'

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To contact the author on this story:
Matt Levine at

To contact the editor on this story:
Zara Kessler at