Liquidity, Activism and Crime

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 market liquidity.

I missed it yesterday, but here is a Wall Street Journal op-ed by Stephen Schwarzman titled "How the Next Financial Crisis Will Happen," and, spoiler, it's bond market liquidity. And here is Josh Brown arguing that "if enough people believe there could be a liquidity crisis, then there will be a liquidity crisis," which I think is interestingly wrong. Brown means that if people think that other people will dump bonds, they will dump bonds, and then bond prices will go down. That's not a "liquidity crisis"; that's just, like, bond prices going down. The "liquidity crisis" that I keep reading about is the one where investors are seduced by "liquidity illusion" into taking excessive liquidity risks, leading to instability as funds offering daily liquidity invest in bonds offering no liquidity. And if enough people are worried about that, then it won't happen. If everyone's disillusioned then the illusion can't be a problem. But in a deeper sense Brown is probably right: The "liquidity crisis" worries are really worries that there are crowded trades in the bond markets, and that eventually those crowded trades will reverse and the people who are in them will lose money. 

Elsewhere! "A global rout in government bonds is accelerating," but some funds have "stepped in to buy on the expectation that yields don’t have much more room to run." This sort of fits with my view that the crowded-trade, liquidity-mismatch, etc. worries in corporate bond markets are not as relevant in government bond markets, where it seems like value buyers of last resort are easier to find. On the other hand, the Treasury market is "definitely not functioning as normal," and Deutsche Bank argues that "High-yield investors are very aware of the illiquidity in their market, but people are less aware of the problem in Treasuries." You know my views on that last claim.

Speaking of buyers of last resort, here's a story about how, as investors redeemed more than $100 billion from the Pimco Total Return Fund after Bill Gross left, Pimco's own funds and accounts bought about $18 billion of Total Return's bonds in cross trades. The implication seems to be that Pimco bought some of Total Return's less liquid positions -- e.g. the Pimco Income Fund, which previously didn't own many TIPS, bought hundreds of millions of dollars worth from Total Return -- to avert fire sales. One could worry about fairness between funds, but of course if you believe in the liquidity-crisis narrative then averting a Total Return fire sale is very good for Income Fund investors. 

It keeps going. Here is a story about bond investors hedging bond risk with VIX futures because it's so hard to hedge with CDS. And here are the New York Fed's Treasury Market Practices Group's "Best Practices for Treasury, Agency Debt, and Agency Mortgage-Backed Securities Markets":

Market participants employing trading strategies that involve high trading volume or quoting activity should be mindful of whether a sudden change in these strategies could adversely affect liquidity in the Treasury, agency, or agency MBS markets, and should seek to avoid changes likely to cause such disruptions. Because market participants may need to change their trading or quoting activity, they are not expected to continue trading or quoting at the same level under all circumstances, but they should evaluate the impact of abruptly changing their traded volume or quoting activity on market liquidity. Market participants who employ strategies that involve high trading volume or quoting activity should have plans in place that would allow them to change participation in a manner that incorporates the impact of the changes on market functioning. These plans should be vetted with senior management and control functions and be reviewed on a regular basis.

Meanwhile, "Leveraged Loans Tumble as Buyers Feel Impact of Shrinking Yields." And in equities, is Dow Theory true

Activism.

Some people believe that American shareholder democracy has gone too far and that activists are a pernicious force in capital markets, but from my very outside perspective it does look like South Korean shareholder democracy maybe doesn't go far enough and could use some activists? I am not alone in this; here is one investor's reaction to Elliott Associates' fight at Samsung C&T Corp.:

“Elliott is standing up for what other investors are feeling and thinking,” said Sachin Shah, a special situations and merger-arbitrage strategist at New York-based Albert Fried & Co. “It’s a rallying cry for shareholders who were waiting for this.”

Elliott is fighting Samsung C&T's proposed merger with Cheil Industries, the "de-facto holding company of the Samsung Group conglomerate." Elliott argues that the merger is underpriced, and the market seems to agree; the shares are now 17 percent above Cheil's offer because of Elliott's involvement. Meanwhile Samsung C&T is fighting back by "selling a 5.8% stake in itself to KCC Corp., a Korean construction company with a vested interest in making the deal go through," thus "effectively adding new votes in favor of the deal," and it "is straightforward in saying the purpose of the deal is 'promotion of merger resolution.'" Elliott plans to sue to stop this, and I have to say that if it was suing in Delaware I'd like its chances.

Elsewhere in asset management.

Crispin Odey had a rough April:

"I make money very quickly in surprising moments," he says. "I am also quite good at losing money."

I feel like if I were investing in hedge funds that's the sort of attitude I'd want. Seriously, it's much better than like "I am correlated to broad indexes in surprising ways. I am also quite good at charging fees." At the other end of the spectrum, Waddell & Reed is seeing a lot of outflows:

Waddell & Reed has grown primarily by marketing to mom-and-pop investors, which make up 86% of its clientele. That makes it more susceptible to shifts in popular sentiment than larger competitors that also invest for pension plans, insurers and sovereign-wealth funds.

You won't be surprised to learn that a healthy dose of bond market liquidity worries crept into this article too. Elsewhere, the hedge fund chapter of Meredith Whitney's life is over, so I guess that Kenbelle and BlueCrest did not settle their lawsuit by agreeing to double BlueCrest's investment, as I hopefully speculated the other day.

White collar crime.

I write a fair amount about white collar crime here so it's worth mentioning this case, in which prosecutors in the Southern District of New York, "one of the city’s most powerful clubs," led by Preet Bharara, "a fiercely effective and limelight-loving figure in an office already legendary as the strongest arm of the Justice Department," went after a guy working at dollar store for letting poor people exchange food stamps for cash. He was caught in a sting operation: Here's the indictment, alleging that "On or about May 30, 2013, KHALIL MOUGHAWECH, the defendant, in his capacity as an employee of Peso Value Plus, exchanged food stamp benefits for cash at the request of a cooperating witness posing as a store customer." Moughawech was sentenced to two years in prison and fined $2 million for this; the government says that "the fraud resulted in a loss of $1 million" to the food stamp program, though that seems to just mean that he gave customers $1 million worth of cash rather than $1 million worth of food. It's a good reminder that America's federal criminal laws -- even its financial fraud laws -- are mostly used against the poor, and that high-profile prosecutions of hedge fund managers and politicians are mostly just a distraction from the real work that is being done. 

Elsewhere in misbehavior.

Here is the Fair and Effective Markets Review published by the Bank of England, the U.K. Treasury and the Financial Conduct Authority, intended to improve behavior and transparency in fixed income, currency and commodity markets. And here is BOE Governor Mark Carney being, like, no we mean it this time

“This is a major opportunity for the industry to establish common standards of market practice,” Carney said. “If firms and their staff fail to take this opportunity, more restrictive regulation is inevitable.”

The report "said sanctions for market abuse should be toughened, with maximum jail terms increased to 10 years from seven."

And here is a Securities and Exchange Commission case "against a New Jersey man accused of posing as a hedge fund manager and defrauding small companies out of more than $4 million," and the alleged fraud is just like a Nigerian prince scam but even dumber:

Upon information and belief, Company A is an entity that acquires distressed oil and gas assets and manages those assets. In October 2013, while seeking external sources of funding, Company A was introduced to Associate A, who was acting as a representative of Lattanzio and Black Diamond Fund. Associate A told officers of Company A that he was capable of arranging project financing for Company A in the form of a $20 million credit facility from a third party. Associate A also told Company A that, as a condition for securing the credit facility, Company A would first be required to invest $2 million with Black Diamond Fund.

So it did! Why on earth would that work? 

Herbalife.

Here is John Hempton's magnum opus on Herbalife. If you're interested in Herbalife, Hempton seems to be its most thoughtful, open-minded and empirical defender, and this is his most complete case for Herbalife, so I recommend it to you. I mean, if you're still interested in Herbalife. 

Things happen.

Open-Source Loan-Level Analysis of Fannie and Freddie. The U.K. will begin selling its Royal Bank of Scotland stake. Banco Santander Chief Ana Botín Rethinks Father’s Legacy. Jamie Dimon Says He's Unsure If Elizabeth Warren Understands Global Banking System. What Is Code? United States of America 'AA+/A-1+' Ratings Affirmed; Outlook Remains Stable -- Standard & Poor's. SEC questioned revenue at Twitter and Etsy pre-IPO. Bitcoin options come a step closer. Prosper will charge securitization fees. Vikram Pandit backs loan-trading platform MMKT Exchange. Fintech and regulationTendr Is Tinder For Finding Your Next Equity Crowdfunding Investment. "So I was like, whatever, let me know when you get to 60,000 words in a row, and we’ll get coffee" -- Nell Zink. The Columbia House business model. The Unkillable Demon King. Steve Cohen Evicts Beloved Pet Pig That Had Been Living In His House Like A Member Of The Family (But Don’t Worry, There Was A Going Away Party).

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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