Cool Derivatives and Bank Consultants

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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Vest.

I used to sell equity derivatives, and the way you sell equity derivatives is by telling scary stories about the future. Are you worried that the crisis in Ruritania will wreak havoc on your tungsten-miner stocks? We can build a product for you that will give you peace of mind. There are only so many products in the world, honestly, so the one we've built for you more or less reduces to a put option (deeply, it reduces to selling some deltas of your tungsten-miner stocks). But we don't use terms like that, which are alienating to non-experts and which send experts scurrying to their Black-Scholes calculators to see how much we're overcharging them. We just talk in terms of the story. What if a bad thing happened? What if we could save you from the bad thing? There, there.

This is of course a well-established business. Banks do it for retail clients in the form of structured notes, which combine a variety of retail-friendly derivatives stories with cheap funding for the bank. There is a tendency to be suspicious of structured notes, but whatever, everyone's got to make a living.

Here's a story about a guy who's making a living by selling listed single-stock options to millennials, and his patter is ... well, I don't know, you decide:

"People can use the language they talk," he says. "I want this much downside so please protect me. And I'm willing to give up some of my upside to buy that protection. This is a language that anyone understands."

His company, Vest, is funded by Y Combinator and is designed to appeal to millennials who don't trust the stock market and want to put their trust instead in authentic handcrafted derivatives. "Vest presents this type of option contract as a counterpoint to investment strategies like diversification," I suppose because diversification is not at all bae. 

Look I mean this is silly on many levels but let me focus on one: There are economies of scale in options manufacture. Making artisanal stock options in your Brooklyn loft co-working space is expensive. If you buy structured notes from a big investment bank -- and, if you're a millennial, you probably don't! Which is fine! I don't either! -- then they are building those options for you in a clean modern options factory. They have trading desks that deal in large sizes and that can manufacture options inexpensively. Bloomberg wrote about Vest last month, saying that it is "taking aim at perceived weaknesses of structured notes, from the credit risk of the issuer, to high fees and illiquidity," and those weaknesses are real, but I mean, really, listed options on single stocks?

Promontory.

After a brief showdown, bank consultant Promontory Financial Group settled its dispute with bank antagonist the New York Department of Financial Services, agreeing to a $15 million payment and "a 6-month voluntary abstention from new consulting engagements that require the Department to authorize the disclosure of confidential information." It also agreed to this:

Promontory acknowledges that any report it submits to the Department must be objective and reflect its best independent judgment.  In all pending and future matters in which it or its client submits a report to the Department, Promontory will document any changes to such a report that it makes at the suggestion of a client or the client’s counsel.

Perhaps it's just because I used to be a lawyer but I find that so weird. (Surely no lawyer could agree to it?) Promontory got in trouble for making what seem like fairly small changes to a report on Standard Chartered's sanctions violations that it prepared for Standard Chartered and submitted to the DFS. Promontory was working for Standard Chartered (technically for its counsel), and so took suggestions from its clients in producing a report to submit as part of settlement negotiations. Those suggestions were mostly about tone -- changing the title of a table, making language more neutral, etc. -- and DFS never suggested that the report was inaccurate or that Promontory violated any laws or rules. (Though yesterday "Promontory agreed to acknowledge that it fell short of the agency’s current standards for consultants.") But now I suppose Promontory will have to submit like redlines of the drafts showing all changes that the client made? (Even if the client submits the report!) That puts a lot of pressure on the first draft.

The DFS theory that consultants are not allowed to consult with their clients just seems so strange to me. In any case, if you were a bank in trouble with DFS would you hire Promontory now? (Or after the six months are up?) I feel like they have not exactly built up a ton of goodwill here, though the fault for that looks like it's mostly on DFS's side. 

Work is hard.

It seems appropriate that the New York Times's apparent series on how difficult and miserable upper-middle-class white-collar work is comes in late August when everyone is on vacation. "Remember how bad work was?," the upper-middle-class white-collar workers ask each other, as they sit on the beach flipping through this article about how "brutal competition remains an inescapable component of workers’ daily lives." Here (via Shane Ferro) is Dan Markovits's very good speech from Yale Law School's graduation this year arguing that our modern economy "promotes human flourishing for no one: certainly not for the excluded rest; nor even for the ensnared rich," who are forced to go work at Amazon or Cravath. Tyler Cowen says: "There is no right to an upper middle class lifestyle.  And for a large number of people, getting one is not easy." 

Elsewhere in tech jobs, "It’s an employee’s market right now," as big startups are using their piles of venture money to staff up by hiring from bigger public companies, according to this article that used to be headlined "Unicorns Hunt for Talent Among Silicon Valley Giants."

"Could Twitter help predict a bank run?"

That is the question that the Bank of England staff asked itself before the Scottish independence referendum. (Via the Wall Street Journal.) So the staffers dutifully sat down and searched Twitter for tweets combining the words "run" and "RBS," and honestly I feel like if there were a run on the Royal Bank of Scotland it would not be indicated by tweets like "time for a run on RBS!" In any case what they got was a Minnesota Vikings game where the running backs were running, and again honestly if I were watching a Vikings game I feel like I would not be tweeting "wow look at all these runs by RBs!" The lesson is, be careful with unstructured-data tourism. 

Man uses bitcoin.

Every sentence of this article about a guy traveling around the world using only bitcoin is highly quotable but I will restrain myself to just this:

Often three or four people gather to listen as he — usually — convinces someone to accept it as payment. Then he pulls out a selfie stick.

Oh fine and this: 

After a free historical tour of the Israeli port city Jaffa, Weis had offered to tip his tour guide in bitcoin. To do so, he had her download a bitcoin wallet app to her smartphone, then used his own phone to scan the wallet’s QR code. Within seconds the guide possessed the bitcoin equivalent of 30 shekels. Finally, Weis pulled up a map of Tel Aviv on Coinmap.org to show her all the nearby stores, restaurants and services where she could spend it.

There's also a picture of him paragliding while holding one of those fake bitcoin coins, though there is no discussion of what side he's taking in the Great Bitcoin Forking Debate of '15

People are worried about stock buybacks.

But Allison Schrager isn't, because "even if it’s true that publicly-traded companies have become more short-termist, it’s far from clear that this is causing them to innovate less, or that it’s bad for the economy as a whole." She argues that "The new model is that small, private firms do the innovation and, if successful, are bought by big public firms." This is more or less my view too.

People are worried about bond market liquidity.

The cup overfloweth today. There's the New York Fed series; today's installment is on "High-Frequency Cross-Market Trading in U.S. Treasury Markets." It happens:

Market participants often presume that price discovery happens in Treasury futures. However, our findings show that this is not always the case: Although futures usually lead cash, the reverse is also often true. 

Then there's this in the Wall Street Journal, "Bonds, Bonds Everywhere and Not a Drop to Drink?" which perhaps stretches the liquidity metaphor a bit. It cites this presentation by Matt King at Citi, which Tracy Alloway discussed the other day and which I recommend highly if you like bond liquidity. It's balanced and sensible and data-driven and focuses on investor herding as well as dealer balance sheet. My favorite part might be slide 15, "Less leverage means lower repo," which in turn means "Reduced relative value trading, especially in low-risk markets." Intuitively it makes sense to me that the liquidity worry worth worrying about is not dealer risk capacity but rather a monoculture of long-only funds with daily liquidity.  An absence of relative value trading supports that story -- but King's point here is that reduced dealer balance sheet contributes to that problem.

And here is David Keohane with a note from Jim Croft at Standard Bank:

First, we have the issue of indexation of the asset class. With so many funds now index tracking it means huge portions of the market no longer care about the marginal movements in asset prices. Someone “on index” in a particular credit can happily sit back whether a bond is at 95 or 105 and not necessarily have to express a view in the market. This means less trading and hence less supply of liquidity into the market.

Elsewhere in liquidity, it is getting harder to get wine allocations.

Me yesterday.

I wrote about BNY Mellon's special interns.

Things happen.

The Ashley Madison hack is a big dealGreek Bailout Moves Ahead After German Parliament Backs Program. Michael Pettis: "Do markets determine the value of the RMB?" Currency speculators lose money when currency is devalued. Start Soul Searching, CalPERS CIO Tells Private Equity. Mario Gabelli is well-paid, old-fashioned. Information-Based Trading and Autocorrelation in Individual Stock Returns. D.C. Circuit voids SEC “conflict minerals” policy on First Amendment grounds (again). There are a lot of grad-school loans. "The idea that a $1tn crash was caused by $200m of cancelled trades raises more questions than it answers." The Use and Abuse of Implementation Shortfall. Why Soylent is a dangerous cult. Incoming college freshmen have never licked a stamp. The Dictionary of Guttural Screams. Dot sucks. Buy a flamethrower

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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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