Fleeing Bonds and Going Back to 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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People are worried about bond liquidity.

We talked a little yesterday about BlackRock's efforts to revive the credit-default swap market, and BlueMountain's Jes Staley is sounding similar themes:

Mr. Staley says that when he looks around for potential systemic threats to the financial system, this contraction in trading in credit-default swaps — derivatives that function like insurance for bonds and loans — coupled with an expanding supply of corporate bonds is something that he thinks is worth monitoring.

I never quite understand this argument. "Derivatives, Mr. Staley said, often serve as a hedge and provide liquidity to the corporate bond market." The liquidity stuff I sort of get -- CDS is a way to trade a company's credit in a generic way without sourcing specific bonds, so in the right regulatory environment it ought to be more liquid than bonds. The hedge stuff I kind of don't get; it seems like shifting credit risk to someone other than bondholders would be more of a systemic threat than leaving it in the hands of bondholders. But, sure, liquidity is probably worse without a functioning CDS market. The question is always: Is that a systemic threat, or just a way to make bond investors internalize the risk of bond investing?

Elsewhere! Bund yields spiked yesterday -- "It was complete carnage," says a guy -- and some people blame liquidity problems, with bid-ask spreads reaching "0.27 basis point for German 10-year bunds on Thursday, up from as low as 0.1 in March and an average of 0.2 this year," which, again, does not seem to me like a systemic crisis? And overall volatility was down in April.

Back to banking.

UBS is hiring investment bankers in the U.S. and you can just see the cycle happening here:

When UBS announced in 2012 that it would further scale back and get out of several businesses in a restructuring, some analysts questioned whether it would ultimately part ways with the troubled investment bank and focus instead on its large and valuable wealth-management operation.

But the recent acceleration in hiring shows UBS still has ambitions for the cyclical, yet at times highly profitable, investment-banking business—even if they are more measured than before.

My general model of the post-financial-crisis period for the big global banks is that the banks have been hard at work figuring out who they are, in their hearts' hearts, and then focusing on that rather than on being big universal banks. But! You know how it is. You decide you're a European private wealth management firm. But to get the richest private-wealth clients you need to be able to build products and trade for them, so you need a sales and trading business. And you need to help advise your clients on their businesses, not just their personal funds, so you hire a few mergers and acquisitions bankers. (UBS's Andrea Orcel "likens UBS to a 'super boutique,' an allusion to a crop of smaller merger-advisory firms that have enjoyed success of late.") And if you're doing M&A and have trading desks anyway, you might as well help companies raise capital, since it is lucrative and offers M&A cross-selling opportunities. (UBS's advisory revenue in the first quarter was 172 million Swiss francs, versus 306 million francs for equity capital markets.) And if you're doing deals in Europe, you're eventually going to need to expand to the U.S. so you can handle cross-border deals. ("You can’t have a global investment-banking franchise without a credible business in the U.S.," says Orcel.) And then to get into the top rank of merger advisers you need to lend. ("UBS no longer has the lending muscle that helps larger rivals win business," though.) And then you're a global bank with lending, sales and trading, advisory and capital markets businesses, but you don't trade Particular Product X, and some rival does, and you persuade yourself that the only way to compete with other global universal banks is by trading Particular Product X too. And you do, and it blows up, and you are humbled, and shrink back to your roots as a European private wealth management firm. For a while.

Spoofing and sleuthing.

One interesting question about spoofing is: How easy is it to spot? Spoofing is a sin of intent: It's not placing orders that don't execute, but rather placing orders that you never intend to execute in order to move the price. So effective spoofing cases tend to rely on e-mails or discussions with outsiders or other indicators of the trader's intent to spoof, and not just on his order history. On the other hand, order history sure can be suggestive: If you always end up trading on the opposite side from the big orders that you place and quickly cancel, that starts to look suspicious. And one of the scandals of the Nav Sarao flash crash case is that the Commodity Futures Trading Commission seems to have looked mostly at trade data rather than order data in trying to explain the crash, thus missing an opportunity to catch Sarao's alleged spoofing.

Anyway high-frequency trading firm Hudson River Trading thinks it can spot spoofing:

Hudson River’s spoofing-detection system refers to potential manipulators as Cylons, a reference to a race of robots that rise up against humans in the TV show “Battlestar Galactica.”

On an average day, the “Cylon detection” system finds 10 to 20 incidents that the firm considers highly suspicious and several hundred that are moderately suspicious, said Adam Nunes, Hudson River Trading’s head of business development.

Cylons, cool. Trillium is skeptical that Hudson River can spot spoofing using anonymous public market data feeds, but argues that spoofing "is not hard to detect at firms with access to customer ID tagged order messages." Which regulators have, or at least ought to.

Elsewhere in spoofing, poor Nav Sarao: "Legal experts say he does not stand much chance of staying on British soil and the recent cases of Britons challenging US extradition requests have met with little success." 

itBit.

Bitcoin is a system that allows people to send money (well, bitcoins) without having to trust each other or a central counterparty. But because bitcoin was built by cryptography nerds, it is weirdly onerous for regular people to actually get and store and spend bitcoins, so lots of people end up relying on central counterparties like bitcoin exchanges for that basic functionality. And because bitcoin is a libertarian utopia for people who don't trust central counterparties, the central counterparties that do exist often turn out to be untrustworthy. "The libertarian rubes who think Bitcoin is anything but a way to get themselves robbed have gotten themselves robbed yet again," is how Rusty Foster put it after one of many, many bitcoin thefts last year.

But here is the story of itBit, a bitcoin exchange that "said Thursday morning that it was beginning to take on customers in the United States immediately after receiving a banking trust charter from New York State’s Department of Financial Services." The idea seems to be that by meeting the basic standards of banking regulation, itBit will be so far superior to other bitcoin exchanges that (1) it will get a lot of market share but (2) more importantly, regular people will be able to use bitcoin as something other than a way to get robbed by libertarians. “This is a big deal, not just for us, but for the entire Bitcoin industry,” says itBit’s chief executive officer. If you think that the value of bitcoin is its clever technology for making payments more efficient and for allowing smart contracts, then a bitcoin ecosystem that fits within the world of regulated financial services is a very good thing. If you think that the value of bitcoin is its secrecy and anarchic rejection of government regulation, then, I mean, there are probably still lots of unregulated exchanges that would be happy to take your bitcoins off your hands.

Arbitrages.

The way I understand mortgage real estate investment trusts is that they use a lot of short-term debt to buy a lot of mortgage bonds and then make money on the spread, like a pure arbitrage version of a bank. This is a somewhat alarming business to be in "as investors fret about challenges including the Federal Reserve nearing a decision to raise interest rates, which would boost the companies’ borrowing costs," and so Annaly Capital, the biggest mortgage REIT, "trades at about 77 percent of its book value." What should Annaly do with that information? "Selling all of its assets and buying back all of its equity at that valuation would in theory produce an immediate gain of more than 20 percent for holders," and some analysts want to see more buybacks. The company disagrees. One analyst suggests that Annaly's management company wants to avoid buybacks because its own compensation is based on the size of assets under management, and buying back stock would reduce that compensation. The company, again, disagrees. Discussion questions include: Would "selling all of its assets and buying back all of its equity" actually produce a gain for Annally, or would dumping its assets drive their prices down to be in line with where the stock market values them? And: If you're Annally and you're not buying mortgage assets at 77 cents on the dollar by buying your own stock, why buy mortgage assets at 100 cents on the dollar by buying mortgage assets? 

Things happen.

The Betrayal of Brazil. Greek bailout talks near ‘drop dead’ moment. A profile of Jonathan "Jono" Steinberg, the chief executive officer of WisdomTree Investments and son of corporate raider Saul Steinberg. T. Boone Pickens backs Jeb Bush. Blackstone Said to Raise $17 Billion for Buyout Fund. Venture capital club deals. Syngenta Rejects $45 Billion Takeover Offer From Monsanto. Yelp Seeks Buyer Amid Slow Growth, Rising Costs. The Robinhood free-stock-trading app raised $50 million. The Clintons keep all their money in cashPeter Schiff met Ben Bernanke. Zombie consumer debt. Leverage dynamics and the real burden of debt. B-corps and benefit corps. iLap, lorpm, Vultr, Quip, Dash, Tiggly, Zettaly, Innbx, Chimany, Aivvy, Biobots, Nexmo, Chai Energy, Paribus, PAVLOK, ParkENT Cycles, Nexpaq, Maker Bloks, Klarismo, Skotch, Revolue, Urbanstems, Dreame, Eyewire, Xact Sense, CarLingo, Shutta, Wuf. 

Me yesterday.

I wrote about strangles.

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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:
James Greiff at jgreiff@bloomberg.net