Bond Liquidity, Mortgage Lending and Merger Associates

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 is bond market liquidity anyway?

Has any financial story been more relentlessly covered in the last few years than the market's worries about bond market liquidity drying up? (A small sample of Bloomberg's coverage can be found herehere, here, here, etc.) In its latest quarterly review, the Bank for International Settlements included a thoughtful little article about the question, and it's I guess what you'd expect if you'd been following things? Like:

  • Sovereign liquidity is mostly back to pre-crisis levels but some people still worry.
  • Corporate liquidity is below pre-crisis levels, though some of that is because "trading volumes have not kept pace with the surge in debt issuance."
  • The main factor seems to be that "market-makers are focusing on activities that require less capital and less willingness to take risk," and "are trimming their inventories, particularly by cutting holdings of less liquid assets."
  • This is driven in part by a cyclical "reappraisal of risk tolerance among market-makers in the wake of the financial crisis" and in part by regulation (capital, Volcker, etc.).
  • It is not clear that bank market makers can be replaced by new entrants. ("On the one hand, new liquidity providers are likely to have fewer incentives to support market liquidity under more stressed conditions, because they lack access to any ancillary revenues from their clients. On the other hand, a wider range of liquidity providers could make supply more reliable, especially in the context of electronic trading.")
  • Everything is basically fine for now, but in a crisis, who even knows?
  • "Market participants and relevant authorities should work to dispel liquidity illusion -- that is, the overestimation of market liquidity, particularly how easy it would be for market participants to exit from their positions in more stressed environments."

Here is John Carney: "Liquidity risks aren’t just rising -- they are being shifted to fixed-income investors, particularly large asset managers," which is of course arguably a better place for them than banks. And here are some investor complaints echoing the BIS. 

I guess my question is: How much should I care? Like, widows and orphans don't seem to be starving because BlackRock has to pay slightly higher bid/ask spreads to trade bonds. The big concern is the liquidity illusion: that big investors buy a lot of bonds thinking that they'll be easy to unload in a crash, but in fact they won't be easy to unload, and there'll be panicked fire sales that worsen the crash and lead to a real crisis. But how is that illusion tenable when everyone talks about it all the time? What big investor is suffering from the liquidity illusion? Presumably not all the investors who are quoted constantly in stories about the liquidity illusion, right? I don't know. I would love to have a better framework for thinking about this; if you've got one, do let me know.

Elsewhere! Energy bonds have had a rotten 10 days, and banks seem to have a lot of hung energy loans, so maybe there's your liquidity crisis. BlackRock has a new exchange-traded fund that, like all new ETFs, is very slightly different from all the other ETFs in ways that make its managers unreasonably excited. And in stock markets, here is a paper from the Treasury's Office of Financial Research arguing "that U.S. stock prices today appear high by historical standards" and discussing relevant financial-stability issues.

Some M&A.

Yesterday I was puzzled by Macerich's ominous rumbling that there were "serious questions" about the legality of Simon Property Group's hostile bid, including some related to the toehold that Simon accumulated before launching its bid. Here is the answer, and it is as dumb and shareholder-unfriendly as you could want: "Maryland law prohibits companies from doing mergers with so-called 'interested stockholders' for a period of five years," and an "interested stockholder" is anyone who, along with its "affiliates or associates," owns more than 10 percent of the company's stock. Simon owns 3.6 percent of Macerich. But Vanguard Group owns more than 10 percent of both Macerich and Simon, which under the law makes Simon an "associate" of Vanguard, which might mean that Simon can't do this takeover. Or it might not; ludicrously, this is what the answer turns on: "Although it’s clear Simon is an associate of Vanguard, that doesn’t necessarily mean Vanguard is an associate of Simon." One thing to notice is that Vanguard is a passive, index-focused investor, and hardly the sort of corporate-raiding accomplice that the drafters of Maryland's anti-takeover law were (presumably (you'd hope)) worried about. Another thing to notice is that, if Vanguard owns over 10 percent of most of the big mall REITs -- and it does -- then an over-literal reading of the law would say, well, they are all interested stockholders in one another (since all of them have an associate who is a 10 percent holder of the other REITs), and therefore none of them can buy any of the others. Anti-takeover laws are pretty dumb, is the main point here.

Elsewhere, Salix's bankers at Centerview and JPMorgan are getting about an extra $3.8 million each (for total fees of $48.2 million each) because Valeant bumped its acquisition price from $158 to $173 to compete with Endo's topping bid. So, you know, good incentives. Presumably Valeant's bankers were not also paid as a percentage of transaction price. And Delaware is changing its corporate law to reduce appraisal arbitrage by reducing the accrual of statutory interest to just the amount in controversy.

How do you stop housing bubbles?

Here's a discussion of a paper, "Regulating Against Bubbles: How Mortgage Regulation Can Keep Main Street and Wall Street Safe - From Themselves," by Ryan Bubb and Prasad Krishnamurthy (disclosure: my law school classmates), that sort of takes the idea of a housing bubble seriously as a bubble. So for instance Bubb and Krishnamurthy are not impressed by risk-retention "skin in the game" rules:

The costs of Dodd-Frank’s risk retention requirement, according to the authors, will only be “increased by the bubble.” They point out an important feature of mortgage securitization: its “tail risk” -- the risk that a loan will greatly underperform on its expectations. A tail risk can produce devastating financial crisis if it is concentrated in important financial institutions, such as banks and securities companies, who then must bear the brunt of the losses. Housing bubbles create tail risks, leading Bubb and Krishnamurthy to conclude that imposing greater housing risks on securitizers will be an ineffective and even counterproductive approach to reducing overall “systemic risk” during bubbles.

The idea of "skin in the game" rules is that banks won't securitize bad loans if they remain on the hook for a portion of those loans. But that assumes a rationality at the banks -- and a passing on of the banks' incentives to the actual bankers making the decisions -- that was not at all in evidence in the last crisis. (The banks bought a lot of the mortgage-backed securities that they securitized so badly, etc.) So it doesn't fix the problem, but leaves more of the risk at the banks, which are not necessarily good places to stick risks. Bubb and Krishnamurthy's solution to leverage-driven bubbles is less cutesy -- limiting mortgage leverage and debt-to-income ratios, and reducing teaser payment loans -- but has the disadvantage of making it harder for people to buy houses without money, which sort of runs counter to the apparent purpose of American mortgage finance.

Elsewhere, "a more than 50-year low in the U.S. murder rate opens new possibilities for singles and families who want to become homeowners." And banks are keeping more mortgage loans in their portfolios, in part because they think that the Fannie Mae/Freddie Mac guarantee fee is no longer a bargain:

Because g-fees have increased substantially from roughly 0.2 percent pre-crisis to well over 0.5 percent currently, lenders are finding it much more profitable to retain higher quality mortgages and keep the g-fee income, as opposed to selling and ceding g-fees to the GSEs.

The lower quality mortgages for which the g-fee underprices risk, on the other hand, still go to the GSEs.

Herbalife won a lawsuit.

When the unstoppable absurdity of shareholder lawsuits runs into the immovable absurdity of Herbalife, they create quite an explosion. Look at this nonsense:

Herbalife Ltd. won dismissal of a lawsuit by a shareholder who said he lost money after hedge-fund manager William Ackman accused the nutrition company of being a pyramid scheme.

Ackman’s allegations aren’t evidence that Herbalife committed fraud, so investor Abdul Awad and two pension funds that joined his suit can’t show that losses they suffered were caused by the company’s alleged misrepresentations, U.S. District Judge Dale S. Fischer in Los Angeles wrote in a March 16 ruling.

Like, the lawsuit is almost "you induced me to invest in a pyramid scheme, and I lost money, so I want my money back," which is sensible enough. (I mean, enough.) But it is not quite that. It is more like: "Look, I don't know if you're a pyramid scheme or what, but some people think you are, so I want my money back," which is less an assertion of fraud on Herbalife's part than it is an assertion of red-blooded American litigiousness on the plaintiffs' part. And here's how Herbalife won:

The company has consistently disclosed that it may be “susceptible to legal challenge because its business model contains multiple components that resemble those found in illegitimate pyramid schemes,” according to Fischer. That’s the main hurdle to the shareholders proving their case, the judge wrote.

Shareholders can't sue Herbalife for maybe being a pyramid scheme, because it already told them it might be a pyramid scheme.

Tim Sykes is still a thing.

Tim Sykes is a guy who trades penny stocks, and who will teach you how to trade penny stocks, and who will drive around in a Lamborghini, and who will, if you want any stereotype of a penny-stock trading system promoter, happily oblige you with that stereotype. Here is an article where ... I mean, the headline is "How to Make Millions by Marketing Yourself as a ‘Douche Bag,’" and his mother says, "All his marketing makes him look like a jerk." He has been doing this forever and it has made him rich, or at least rich enough to buy the Lamborghini. What is wrong with you, society? I mean obviously as a financial matter you shouldn't buy his newsletter and trade penny stocks, but that is the least of it; the much bigger problem is the aesthetic one. Surely he makes his money as an entertainer, not as a financial adviser. Why is this entertaining?

Things happen.

The New York Times's 3D yield curve toy is really cool. Goldman Sachs is now the most heavily weighted stock in the Dow, because the Dow is silly, or because Goldman is the most important and representative American company, you decide (disclosure: I used to work there). Jana Partners sold a 20 percent stake in itself to Neuberger Berman's private equity unit. Oil may be a bad business, but oil storage is doing great. "Recently, this supposition of regulatory capture has become as pervasive as it is false," says Rodge Cohen. Does the Fed Have the Legal Authority to Buy Equities? Was Sweet Briar College done in by swaps? Someone who did alumni admissions interviews for Harvard has a ton of feelings. Steve Cohen Confident This Is His Year To Win Office NCAA Tournament Pool. Bar brawls give dentists a post-St. Patrick’s day surge. Study Finds Majority Of Deaths Caused By Failure To Heed Omens. "Kant is a moron."

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Matt Levine at

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