Libor Lies and Toned-Down Consultants

Also bond market liquidity, and the difficulty of valuing illiquid bonds.

Poor Tom Hayes.

It is not exactly a surprise that Tom Hayes was convicted of manipulating Libor, what with his 82 hours of confessing to the Serious Fraud Office:

“I probably deserve to be sitting here because, you know, I made concerted efforts to influence Libor,” Hayes told the SFO in an interview. “Although I was operating within a system or participating within a system in which it was commonplace, you know, ultimately I was someone who was a serial offender.”

You know I'd never give you legal advice, especially about British law, but I will say that if you ever find yourself in a position where you're spending 82 hours confessing to crimes, probably something has gone wrong in your life. Possibly it was committing all the crimes? But endlessly confessing to them seems like its own lapse in judgment.

Still 14 years in prison for asking people to make up some numbers seems unnecessarily brutal. The Libor settlements depicted a widespread culture of Libor dishonesty, and came with dozens of chats in which dozens of traders acted much like Hayes. But the approach is not to punish all of them sensibly, but rather, as so often, to single out one for insane exemplary punishment. (Though more Libor trials are coming.) Because, you know, no cruelty in defense of the truth is too much. Lead prosecutor Mukul Chawla:

“What’s so hard about telling the truth?” Mr. Chawla asked at one point.

“You’ll have to give that question some context,” Mr. Hayes replied.

I suppose this sort of lightning-strike justice has some deterrent effect. But Hayes is of course right: Everyone bends the truth sometimes; very few of them go to prison for 14 years for it. 


For instance, Pimco might be in trouble for how it valued some small illiquid bonds in 2012. The idea -- we talked about it a bit last year -- seems to be that Pimco's small Total Return Active ETF bought those small bonds and then marked up their prices in the absence of much of an objective market price. The ETF's early performance was good, and that performance attracted assets. But at least some of that performance might have come from now-disputed valuation choices rather than from, you know, performance in the traditional sense. Pimco is excited for the "opportunity to demonstrate to the SEC staff why we believe our conduct was appropriate," and of course its marks on those bonds could have been appropriate and in line with industry practice without necessarily being right. In fact, for many small illiquid bonds, there's probably no "right" valuation.


Or there is the bizarre story of Promontory Financial, the regulatory consulting firm that the New York Department of Financial Services wants to suspend from assignments because it advocates too strongly on behalf of its clients. Standard Chartered hired Promontory to look into its U.S. sanctions violations. Promontory looked into the violations and prepared reports, and Standard Chartered admitted a bunch of violations and paid a big fine. (And then, later, another big fine for more violations.) The problem, according to the new DFS report on Promontory, is that Promontory would sometimes "tone down" language in its reports at the behest of its client. I mean, I can see why regulators don't like that? But also, this was a consulting firm hired by the bank to help the bank deal with regulators. Why shouldn't it help its clients deal with regulators? Wasn't that the job? Promontory was not acting as a court-appointed monitor of Standard Chartered. It wasn't working for DFS. It was working for the bank. I understand that for, like, marketing reasons, it's important to act like Promontory was a neutral umpire doing an independent review. The DFS report quotes Promontory's website for blather about how "credibility is critical" and "depends upon independence and subject matter expertise." But that is ... literally marketing? The whole thing just seems like a nothing:

The New York regulator did not accuse Promontory of a legal violation, or its employees of perjury, saying only that the firm “exhibited a lack of independent judgment” expected of consultants. The agency found only two transactions worth about $300,000 — out of roughly 133,000 worth some $590 billion — that Promontory failed to flag for the authorities.

But DFS is so offended that the people who pleaded with DFS on behalf of the bank were working for the bank that it wants to prevent them from pleading with it on behalf of other banks. 

People are worried about bond market liquidity.

Jerome Powell of the Fed is the latest, saying that regulatory changes "may be one factor driving recent changes in market-making," though also saying that high-frequency trading of Treasuries "is way more complicated than the ’Flash Boys’ story." And Goldman Sachs has a "Top of Mind" report (no link) called "A Look at Liquidity"; a sample:

Allison Nathan: Won’t other participants—i.e., hedge funds and independent broker-dealers—step in if banks can’t?

Steve Strongin: Not necessarily. If a bank is subject to a rule, its clients can become indirectly subject to the same rule. This is because client access to banks’ balance sheets is now more limited and expensive as banks charge clients more for use of this scarce resource. So hedge funds and independent broker-dealers don’t rent more balance sheet—i.e., obtain bank financing or establish lines of credit—than they need to conduct their daily business. And they can no longer rent balance sheet from a bank on demand in order to be the bid in a dislocated market. So their ability to step in during a stress event is  significantly reduced relative to history. Regulators probably intended this to ensure that banks were not enabling a transfer of outsize risk to shadow banking areas. But very few market participants are able to hold cash outright to wait for a dislocation. So if banks can't expand their balance sheet to provide leverage, the shadow banking system can't make the bid in a period of stress.

Allison Nathan: What about asset managers? Given their growth, are they in a better position to step in?

Steve Strongin: No. Asset managers manage a constant pool of assets against a constant leverage. They have no ability to expand their balance sheets in order to provide a bid in a stressed market. In order for them to be the bid, they have to be holding much higher cash balances, which is expensive and weighs on their performance relative to their benchmarks. Expecting an asset manager to use its cash balances to buy other people’s stressed assets—especially when it is likely to be facing redemptions—is not realistic. And, if anything, the increased size of asset managers in recent years has put them in a position to demand more liquidity, not to provide it.

Meanwhile CCC bonds aren't doing well.

Things happen.

Puerto Rico defaulted on an agency bond. China's response to its stock market crash was problematic. Yanis Varoufakis as a media star. Deutsche Bank is being investigated for doing Russian mirror trades, which "involve stocks bought by Russian clients in rubles through Deutsche Bank, and simultaneous trades through London in which the bank bought the same securities for similar amounts in U.S. dollars." Citadel has recovered strongly from the financial crisis. "Gender-discriminating bias in thermal comfort." Donald Trump and the mob. A Harvard Lampoon Donald Trump prank. Mark Hamill is more than happy to ruin your Star Wars stuff with his autograph. The Data Drive.

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