Black Swans and Blockchains

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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So, how's the market?

The stock market finished up about 0.9 percent last week, down about 6.7 percent from its May high, but it's about the journey, not the destination, and the journey left various people scarred or vindicated or clean-shaven. Mark Spitznagel's Nassim-Taleb-associated, black-swan-oriented, S&P-500-put-buying Universa hedge fund made about a billion dollars last Monday, and I wonder if it gave up any of those gains as the market recovered later in the week? Spitznagel "described Monday’s fall as a 'blip' compared with what could still happen," so it's not like he's taking off his bets. And here's a guy who promised not to shave his beard until the stock market fell by 10 percent. His 11 hirsute months ended last week, though I hope he's not growing his toenails until a 20 percent drop.

Here is Robin Wigglesworth on market indicators. Here is Greg Ip on what's changed over the last two weeks. ("Not much.") Does credit widening mean that stocks will fall further? Did volatility products increase volatility, or did they increase the volatility of volatility? Did last week's trouble show the need for revisions to NYSE Rule 48 or "tighter ‘limit up, limit down’ bands"? Did exchange-traded funds work properly? Will BNY Mellon fix the glitch in its mutual-fund pricing software by the open? And the engineer syllogism.

And how's China?

Hmm well "a total of 197 people have been punished in a special campaign by Chinese police targeting online rumors about China's stock market, the recent fatal explosions in Tianjin or other key events." And "Chinese authorities took Li Yifei, chairwoman of hedge fund Man Group Plc’s China unit, into custody to assist with a police probe into market volatility":

“They’re sending out even stronger signal that people in China cannot short sell the market, or even long sell the market,” said Steven Leung, an executive director at UOB Kay Hian Ltd. in Hong Kong. “The signal is not good for the future development of China’s securities market.”

I have said before that the traditional way to stop a stock market decline is to mandate buying and ban selling, and China seems to be following that playbook. On the other hand, the mandated buying leads to problems, specifically: "what will the government do with all that stock that it already has bought?"

Unlike the U.S. bailouts of 2008 and 2009, China is in the unenviable position of having bought near the market’s top, not at the bottom. Getting a TARP-like profit from its investments seems unlikely with the market so far below where much of the buying took place.

If the gang of bailout entities known as the “national team”—banks, brokers, pension funds and government agencies—is stepping aside, it seems likely their holdings will drop even further in value.

And "Options traders have never been so pessimistic on China’s stock market, betting the government’s renewed effort to prop up share prices is doomed to fail."

Revolving doors.

Here is an article about the increasing use of bank monitors, and what is the right model for those monitors? The idea is that if a bank gets in trouble, in addition to paying a big fine to the government, it has to pay a few million dollars to a former prosecutor who will come in and make sure that the bank doesn't do it again. That seems like a good gig for a former prosecutor: You get paid well, you get to use your prosecutorial skills, and you get to feel important since the bank has to do whatever you say. (Mostly: The article includes the story of one former prosecutor fired by a bank's current prosecutors after the bank complained that he was being too prosecutorial.)

My preferred theories of the regulatory revolving door would say that prosecutors and regulators have private incentives to zealously prosecute and investigate and fine and punish banks, because those prosecutors and regulators might one day want high-paying prosecutorial jobs as bank monitors. On the other hand, if you believe that, then the incentives would also be to fine and punish banks with non-prosecution or deferred-prosecution agreements involving monitors, and not to treat the banks too harshly once they've hired the monitors. You have to make sure that the monitors are worth what they cost.

Blockchains.

Here is a story about how a lot of big financial companies, including Nasdaq, are increasingly interested in using blockchain technology to record transactions on distributed public ledgers:

The Nasdaq software will allow the trading of stocks in private companies, like tech start-ups, on a new kind of blockchain. This will replace the existing system in which private companies issue and trade shares using paper certificates — a process that means that even basic trades can take weeks to complete.

Beyond the immediate trial, Nasdaq is experimenting with several other markets in which blockchain-like ledgers could be used to make trading faster and cheaper.

There are things that I do not fully understand about the romance of the blockchain for financial institutions. One is: Nasdaq is a big company with lots of big computers on which it processes stock trades for public companies. If it wanted to create a computerized ledger of stock trades for private companies, to save them from wasting weeks using paper certificates to trade, it could have just done that years ago. The computers were there already. I think that bitcoin/blockchain technology is of so much interest to banks and financial utilities not so much because it solves previously insurmountable technical problems (like keeping a computerized ledger!), but because bitcoin's relative speed has left banks embarrassed about how slowly they process transactions. It is not obvious to me that cryptographic distributed ledgers are the only way to speed up financial transaction processing, but at least they're an exciting way to do that.

Elsewhere, Overstock.com bought SpeedRoute, a company that "currently routes approximately 2.5 percent of U.S. equity order flow." Overstock's press release calls the purchase "a pioneering development in connecting crypto capital markets to existing national markets," and quotes Marx. ("The philosophers have only interpreted the world. The point, however, is to change it," from the Theses on Feuerbach, and even though it's Marx it's a little surprising that that's not more of a tech-industry mantra.) Overstock is really into blockchain-y stuff, though I'm not sure that calling it "crypto capital markets" and quoting Marx is really the best marketing? Also I am not sure that it has too much to do with Overstock's core business of online retail but, you know, it's using computers to sell things, whatever. And Overstock has a history of market-structure fascination dating back to CEO Patrick Byrne's "jihad" against short sellers. I suppose it doesn't make any less sense than Overstock's move into online video (via Matt Zeitlin), which the Onion anticipated by two years. 

Dole and buyouts.

We talked the other day about the Dole Food buyout case, in which a Delaware judge found that Dole Food's management intentionally pushed down the stock price in order to make the controlling shareholder's planned buyout cheaper. That is sort of an amazing thing for a court to find. Here is Ronald Barusch:

The court complained that “rather than making a merger proposal when Dole's stock was trading at high levels following the announcement of” a favorable transaction, Mr. Carter ‘first primed the market by pushing down the stock.’” Avoiding this pitfall could be the hardest in future buyouts. Such deals are often proposed when a company’s stock is down, when they have the best shot of being accepted. Executives rarely intentionally try to manipulate the price of stock by making unfavorable announcements. Nevertheless, what may seem like routine and well-advised disclosure can adversely affect the price of a company’s shares. A court’s review of such announcement, with the benefit of 20-20 hindsight, could subject some future deals to the accusation that a buyout proposal was planned around such disclosure.

The bond market liquidity thing.

Remember: As of two weeks ago, the story went that bond-dealer banks, constrained by the Volcker Rule and capital requirements, had cut back their bond inventories and were no longer able to cushion bond markets against a downturn. If things got rough, mutual funds would have to dump their bonds, and without dealers to buy them their prices would crash, leading to more redemptions, more fire sales, and a vicious cycle.

That story turned out to be totally wrong, at least this time. Why? Here's a theory:

While investors yanked cash from junk-bond mutual funds for five straight weeks, broker-dealers didn’t contribute as much to the exodus because they had already been holding relatively small amounts of the debt in part due to regulations enacted since the financial crisis.

A “silver lining going into this round of outflows was below-average dealer inventories,” Wells Fargo & Co. analysts led by George Bory wrote Thursday. 

Hmm. So ... the Volcker Rule and capital requirements ... cut back dealer bond inventories ... which made bond market liquidity ... better? Hmm.

One thing to consider is that dealers as market makers ought to dampen volatility (buying when everyone is selling, at least in the short term), but dealers as proprietary traders might well increase volatility (since they're plausibly doing the same sort of herd-based bond investing as everyone else). (More properly, even the market-making function has some pain point where the dealer has to lay off bonds when the market has moved too far in one direction, meaning that a market-maker will dampen volatility in some range but may exacerbate it beyond that range.) If you think -- and this is a somewhat naive thing to think -- that post-crisis regulation has cut back on dealer proprietary trading without hurting market-making, then I suppose it could make sense that that regulation has improved liquidity. 

Things happen.

Rates are going up this year. Will Treasury yields soar if China sells? Ukraine GDP warrants. Puerto Rico Postpones Debt Plan. Aswath Damodaran on big markets. The Effect of Payday Lending Restrictions on Liquor Sales. Permanent Burning Man. What the super-rich expect on holiday. What a Pack of Cigarettes Costs, in Every State. Hot Ways To Interpret Foucault This Back-to-School Season. Trump at Wharton.

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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