A Greek Proposal and a Shower With a View
Shortly after I published this newsletter yesterday morning, "German Chancellor Angela Merkel told lawmakers she did not expect any new developments on Greece on Tuesday." So you had to know how that would go. It's like Canute trying to hold back the waves. For one thing, Greece sent a letter asking for a new two-year loan from the European Stability Mechanism, though that didn't go anywhere. And so yesterday evening "Greece became the first advanced economy to miss a payment on IMF debt," though I'm not sure that exactly qualified as a new development. That was the base case. Nor does it even qualify as default: "By declaring Greece in arrears, the I.M.F. avoided using the term 'default,'" because the most important thing in this crisis is the proper use of terminology.
But then late last night Greek prime minister Alexis Tsipras sent a letter to the troika of official creditors saying that Greece "is prepared to accept" their previous proposal, of course with some modifications. Here's the letter. The creditors are skeptical:
Greece has provided “no basis for talking about any serious measures” to break the deadlock, German Finance Minister Wolfgang Schaeuble said on Wednesday. “From a legal and a real-world point of view, we can’t just move forward based on the status quo. We’re in a completely new situation” now that Greece’s second aid program has expired
And "Angela Merkel reacted coldly to the proposal, emphasizing that Berlin would maintain its tough stance and was prepared for a fight." Meanwhile Greece's planned referendum on Sunday, in addition to being a vote on a bailout proposal that is no longer on offer, is also mistranslated. Here's Martin Wolf on how he would vote. (It's, like, none of the above.) Joseph Stiglitz would vote no. Hedge funds think the vote will be yes, as does Paddy Power. Domingo Cavallo, Argentina's economy minister when it defaulted in 2001, thinks Greece should stay in the euro. Here at Bloomberg View, Clive Crook points out that "There's no reason, in law or logic, why a Greek default necessitates an exit from the euro." But of course today is a critical day for the European Central Bank to decide what to do about Greek banks. Elsewhere: German Businessman Trademarks 'Grexit' for Vodka Drink. Save Us Taylor Swift Cry Greeks As Capital Controls Shut Apple iCloud Space. And "It's been well over 150 years since South Carolina last formally considered an exit from the union."
Meanwhile in America's Greece, Puerto Rico's proposal to restructure its debts is awkward for municipal bond mutual funds, many of which "have placed sizable wagers" on Puerto Rico's bonds because of their high interest rates and triple tax exemption. If you are worried about bond market liquidity, one thing you might worry about is retail investors redeeming from those muni bond funds and the funds selling other debt to meet the redemptions (because there's not much demand for Puerto Rico bonds), driving down prices for non-Puerto Rico municipal bonds and further concentrating those funds' Puerto Rico holdings.
The answer lies in a confluence of factors, including American investors’ desire to avoid taxes; the mutual fund industry’s practice of competing on the basis of yield; complacency about the practice of long-term borrowing to plug holes in budgets; and laws that supposedly give bond buyers ironclad guarantees.
Yesterday I wrote about Puerto Rico and bankruptcy, though Cate Long correctly points out that I neglected to discuss debtor-in-possession financing, a key element of most bankruptcies that is not available to Puerto Rico. Also, given the amount of Puerto Rican bonds covered by bond insurers, a voluntary exchange offer to those insurers might not be as big a mess as I feared. And in fact the Puerto Rico Electric Power Authority, the Puerto Rican public corporation with the most immediately pressing debt problems, is "close to a deal" with its bondholders and insurers.
China's stock market is ... well there is this:
Colorful moving ads at the top of the Ppmoney website proclaim “four times leverage, speedy transfer” and “we provide funds, you invest, profits are all yours.” Investors can borrow as much as 5 million yuan for potential daily returns as high as 60 percent, the website says.
“Leverage is a very good tool in a bull market as it helps investors to accumulate profits more quickly,” said Liu Yang, chief executive of Miniu98.com, another site that arranges stock loans. “Reaping higher returns by taking on higher risk is a right that every investor should enjoy. I am hoping to afford small investors with the right.”
Take lots of leveraged retail investors, have them invest in companies with limited free float, and you get wild volatility. And so the government has to balance the need to prevent a crash against the risk of further inflating a bubble. Meanwhile, "China must take urgent steps to reform a 'distorted' financial system in its transition to a more balanced economic model, the World Bank has warned in its latest review of the country’s economy."
People are worried about bond market liquidity again.
Yesterday, at more or less the same time that I was boldly saying that people weren't worried about bond market liquidity, Bill Gross was publishing this Investment Outlook about his bond market liquidity worries. Also about his shower, which is apparently awesome:
We have the world’s greatest shower. To be quite candid, it’s not the water, the temperature, the simple knobs, or even the shower head that makes it the best; nor is it the combination of all four. The key to our shower in fact, is not the actual experience of hot water on a 98.6° body at all. It’s the view; our shower has the world’s greatest view. The scenery from it is so gorgeous that when we sell our home, we may list the shower separately and see if it attracts an offer higher that the rest of the house. If not, we’ll just sell the house with a shower “easement” and continue to come in and out from the street every morning at 6:00 a.m.
This goes on for quite some time but eventually transitions to fairly conventional bond market liquidity worries:
Mutual funds, hedge funds, and ETFs, are part of the “shadow banking system” where these modern “banks” are not required to maintain reserves or even emergency levels of cash. Since they in effect now are the market, a rush for liquidity on the part of the investing public, whether they be individuals in 401Ks or institutional pension funds and insurance companies, would find the “market” selling to itself with the Federal Reserve severely limited in its ability to provide assistance.
The fun part is how hard Gross comes down on his former colleagues at Pimco, criticizing their use of derivatives (Bill Gross! Criticizing Pimco's use of derivatives!) and hinting that Pimco ought to be regulated as a SIFI, though he doesn't get the acronym quite right. (It's "Systemically Important Financial Institution," not "Strategically.") He also announces plans to make Janus into a SIFI, which is a good plan. We should all dream big, specifically too big to fail.
Elsewhere in liquidity, I missed this article on how a lack of corporate bond liquidity may increase Treasury volatility, as mutual funds sell liquid Treasuries to meet redemptions because corporates are too illiquid. That actually sounds sort of ... pleasingly volatility-dampening? Like, if there's a corporate credit crunch and people want to dump corporate bonds and flee to safe haven assets (Treasuries), but mutual funds choose instead to keep their corporate bonds and dump Treasuries, then won't that reduce volatility in both markets?
Oh and "John Cryan, on his first day as Deutsche Bank AG’s co-chief executive officer, pledged to tackle costs and cut back the trading operation built up by his predecessor Anshu Jain," mainly by reducing the capital intensity of the fixed-income, currency and commodities business:
“We cannot afford that luxury,” Cryan said. “Reducing this reliance should not place us at a competitive disadvantage as the market has anyway already moved in that direction.”
So if you're worried about shrinking dealer balance sheets, there you go.
People are worried about stock buybacks.
Here's a Brookings Institution paper calling for "more builders and fewer traders," arguing that in the U.S. stock market, "a set of incentives has evolved that favors short-term gains over long-term growth." The authors have various proposals on executive compensation and corporate disclosure, but the first thing on their list is to repeal Rule 10b-18. We've talked about this before, and I continue to find it weird that Rule 10b-18, a stock manipulation safe harbor that limits the speed at which companies can buy back stock, has so captured the American political imagination.
Goldman Sachs messed up some options trades.
Here's a fun Securities and Exchange Commission enforcement action (and $7 million penalty) against Goldman Sachs for "violating the market access rule in connection with a trading incident that resulted in erroneous executions of options contracts." This seems bad:
On August 20, 2013, as a result of a configuration error in one of GSCO’s options order routers, the firm erroneously sent thousands of $1.00 limit orders to the options exchanges prior to the start of regular market trading. Before the market open at 9:30 a.m., GSCO shut off the creation of additional options orders and initiated efforts to cancel the erroneous orders that it had sent to the exchanges. However, within minutes after the opening of regular market trading, GSCO already had received executions for a portion of its unintended sell orders, representing approximately 1.5 million options contracts (representing 150 million underlying shares). Though GSCO faced up to a potential $500 million loss from the executions, the firm’s loss ultimately amounted to approximately $38 million, after taking into account executed orders that were cancelled or received price adjustments pursuant to the options exchanges’ rules concerning clearly erroneous trades.
Shouldn't somebody have been ... you know ... checking that?
During market hours, Sigma Options applied price checks based on the then-current bid and ask prices for each listed option series. However, during pre-market hours, Sigma Options employed a “default” price check that allowed the transmittal of options orders with any price greater than $0.01 and less than 1.5 times the highest closing price for any listed option from the prior day. On August 19, 2013, the highest closing price of any listed option was $2,060 (the price of the call option to purchase 100 shares of the Nasdaq 100 Index at a strike price of $1,000 with an expiration date of December 2013). Thus, on August 20, option orders that were entered prior to market open “passed” the price check as long as they were priced above $0.01 and below $3,090.
Yeah that is not a very good price check. Elsewhere in SEC enforcement, the case against Lynn Tilton will go forward in front of an administrative law judge.
Willis Towers Watson taxes. "Wall Street is not that different from ballet." Banks and fintech. "That makes Bitcoin about 5,033 times more energy intensive, per transaction, than VISA, at current usage levels." The Supreme Court will hear a naked short selling case. Duncan Niederauer Joins Fantex Holdings’ Board of Directors. Steve Cohen Relists NYC Penthouse at $3 Million Discount. Alex Balk's critique of a critique of "This Is Water" is correct. Summer Associate Allegedly Dismissed Over Wild Incident With Cocaine, Hookers. Planetary Defense Is a Public Good. Giuliani-Blasted Madonna With Dung Art Sells for $4.6 Million.
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