Rigging and Manipulation

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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Is the stock market rigged?

Here is my Bloomberg View colleague Michael Lewis in Vanity Fair, surveying the scene one year after "Flash Boys" and concluding, yep, the stock market is rigged. Here on the other hand is Jack Bogle:

"That's such a stupid expression," Bogle said in an interview in January with Bloomberg. "That's what you do to sell books. I don't know how it's rigged. The real point is, it doesn't make one bit of difference to an investor who is in an index fund for a lifetime."

That's from Michael Regan's piece about how Lewis's "invisible scalp" doesn't show up in the returns of index funds, which often actually beat their benchmark by a little bit. Obviously not everyone invests by buying and holding index funds for a lifetime (though that's pretty close to my strategy!), but it is kind of interesting that large investors divide on the question of whether modern, high-frequency-trading-infused market structure is on net good or bad, and that Vanguard seems to come down pretty hard on the good side. The strongest voices on the bad side are people like Bill Ackman, David Einhorn and Dan Loeb, fundamental equity managers who take large, often activist positions and whose own trades tend to be newsworthy. Those are people who really don't want their trades anticipated, though it's not totally obvious how solicitous we should be of their concerns. (There is a movement afoot, led by the law firm where I used to work, to make it easier for public investors to front-run Bill Ackman.) Anyway here is a nice thing Lewis says about the founders of IEX, the dark pool that is trying to solve all the problems of market structure: "If this story has a soul, it is in the decisions made by its principal characters to resist the temptation of easy money and to pay special attention to the spirit in which they live their working lives." 

Is Herbalife manipulated?

I feel like this is market manipulation:

  1. You sell a stock short.
  2. You say mean false things about the company.
  3. The stock goes down.
  4. You cover your short.

And this, while it might be ungentlemanly, is not:

  1. You sell a stock short.
  2. You say mean things (true or false!) about the company.
  3. The stock goes down.
  4. You announce your intention to stay in your short position forever -- until the stock goes to zero -- and actually do that.

I mean, that's not legal advice, it's just a feeling: If you drive down the stock price but then don't cover your short, you're playing a longer game than market manipulation. Anyway there are apparently new investigations of people associated with Pershing Square's anti-Herbalife campaign, though of course the market-manipulation investigations have pretty much been going on as long as the campaign has. Big short-selling campaigns generate market-manipulation investigations, instantly and constantly, and it is an often-remarked fact that people who get long stock and then say nice things about the company (outside of penny stocks) tend not to attract the same level of scrutiny. This fact has sort of a public-choice element to it: If you say mean things about the company -- even mean true things -- the company's management gets mad and creates a fuss; if you say nice things about the company -- even nice false things -- the only people who are harmed are diffuse public shareholders who buy. They tend not to talk to regulators as much, or as vociferously. I guess they always have class action lawsuits though.

Are the stress tests hard?

Yesterday I was sort of blasé about the banks that needed to revise and resubmit their capital plans in the Fed's stress test, taking that as a sign that they were appropriately aggressive about capital efficiency. But there is another view:

While no big U.S. bank failed the test, some of Wall Street’s marquee names were shocked by the disparity between their expectations and the Fed’s, such as projections for how banks’ assets and net income would fare in a severe economic downturn, said people close to the banks.

“We all ended up having a wake-up call on what [the Fed] thought our losses could be,” said a person close to the process.

The rest of the article is an interesting discussion of how unpredictable the tests should be: enough to keep the banks on their toes and make them think seriously about their crisis modeling, but not so much as to be a random outcome that makes modeling pointless. Elsewhere, Peter Eavis reports on how much the three revise-and-resubmitters took out of their revised capital plans: Morgan Stanley cut out a $4.9 billion preferred-stock buyback, JPMorgan cut out about $6 billion of capital return, and Goldman probably cut out about $3 billion, all more or less in line with my guesses.

Oh Commerzbank.

This e-mail would not be good:

If for whatever reason CB New York inquires why our turnover has increased so dramatically, under no circumstances may anyone mention that there is a connection to the clearing of Iranian banks.

But that's not the e-mail that a Commerzbank employee actually sent. This is:

If for whatever reason CB New York inquires why our turnover has increased so dramatically, under no circumstances may anyone mention that there is a connection to the clearing of Iranian banks!!!!!!!!!!!!!

The 13 exclamation points do not improve matters. Clearing dollar transactions for Iranian banks is the sort of thing that U.S. and New York regulators frown upon, and covering up those transactions creates some additional frowning. And so yesterday Commerzbank settled various sanctions, bank-secrecy, and abetting-accounting-fraud charges for a total of $1.45 billion.

Everest collapses.

Huh:

Marko Dimitrijevic, a hedge fund manager who survived a quarter century of gyrations in emerging markets, is returning most of the money in his Everest Capital after a disastrous bet against the Swiss franc in January caused clients to flee.

One Everest fund "was wiped out in less than a day in January after the Swiss National Bank unexpectedly let the franc trade freely against the euro," but the others had no exposure and are being closed because of redemptions, not losses. You can sort of understand the client frustration: How much could Everest possibly have made on a bet against the Swiss franc? The Swiss franc was not exactly swinging wildly before January, and there was no real chance of a wild downward swing. I don't know the structure of the bet, but I assume it was in the broad category of a carry trade: If it went well, it would make a small steady return, and if it didn't go well, it would probably more or less break even, and there was a small deep hole where it could go terribly wrong, and Everest fell into that hole and was swallowed up. And when the hedge fund manager you go to for small steady uncorrelated returns informs you that all of your money fell into a small deep hole, you probably don't want much more to do with him.

Sovereign debt.

Here is Anna Gelpern on the International Monetary Fund's program. Ukraine has a lot of debt, much of it owed to sovereigns, $3 billion of it owed to Russia and due in December. Ukraine's relations with Russia are, you know, not great. The IMF program provides some financing to help with that debt, but the amounts are a bit curious:

I am struck by one bit of arithmetic: Ukraine has about $7.7 billion in external sovereign debt payments due in 2015, of which $5.8 billion is principal, of which $3 billion is to Russia  (see p. 138). The IMF document contemplates $5.2 billion in financing from the "debt operation" in 2015 (see p. 12). Since 7.7-5.2=2.5, and since 2.5<3, Russia does not seem to be getting its $3 billion repayment in December. The fact that the IMF board, which includes Russia, approved this scenario, seems important.

Elsewhere in sovereign debt, here is an excellent photograph of German and Greek finance ministers Wolfgang Schaeuble and Yanis Varoufakis sitting unhappily next to each other, over a story about how they are at each other's throats:

The latest spat centers on Tuesday’s press conference in Brussels, when Schaeuble referred to a Feb. 20 declaration that Varoufakis had signed, saying that “he just has to read it. I’m willing to lend him my copy if need be.”

Good times. "Schaeuble said Thursday that any suggestion he had insulted Varoufakis was 'absurd.'" And where is Putin?

Capital and growth.

"Effect of bank capital requirements on economic growth: a survey," by Natalya Martynova of the Dutch central bank:

There is little evidence of a direct effect; research focuses on the indirect effects of capital requirements on credit supply, bank asset risk, and cost of bank capital, which in turn can affect economic growth. Banks facing higher capital requirements can reduce credit supply as well as decrease credit demand by raising lending rates which may slow down economic growth. However, having bettercapitalized banks enhances financial stability by reducing bank risk-taking incentives and increasing banks’ buffers against losses.

Things happen.

The surprisingly charming relationship between Sankaty Advisors -- the WASPiest name in private equity? -- and Manischewitz Company, its matzo-making portfolio company. Chilean bucket shops. Mary Jo White on bad-actor waivers (previously). The Fed might look at Twitter for information. Why Valeant Is Expected to Prevail in the War for Salix, and Three Reasons Why Valeant Should Move Quickly on Salix. Checking in with the founder of Defense Distributed, a "27-year-old techno-anarchist known for 3D printing a pistol and posting its design files online." Marc 'Dr. Doom' Faber: Buy US stocks. Varoufakis, la nouvelle star de Match. 250-year-old pretzel unearthed in Germany.

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