Fed Day and a Goatskin Bond

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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Happy Fed Day!

Today is called the Federal Open Market Committee policy statement and press conference day. He that outlives this day, and comes safe home, will stand a tip-toe when the day is named, and rouse him at the name of Yellen. It's a big Fed meeting is the sense I'm getting. There's a real chance that the Fed will announce the first rate hike of our lifetimes, if we are eight, and of course in some sense we are.

Of course there's also a real chance that it won't, which is what makes today so exciting. "Futures traders see only a 34 percent chance that policy makers will raise rates on Thursday at the same time 54 of 113 economists surveyed by Bloomberg predict some kind of increase." And any decision will probably be a bit mixed. "The rate decision is likely to prompt a dissent." Macro Man "agrees with the consensus take that the Fed will attempt to 'sterilize' the rate decision by leaning the other way in its commentary": a dovish hike, or a hawkish pass, or I suppose an owlish whimsy. (Not that one.)

Here are "Nine Blueprints for How to Handle the Stock Market on Thursday," which seems like too many blueprints? UBS breaks down the possible outcomes and concludes that the two unexpected extreme outcomes -- a hawkish hike or a dovish pass -- "would both have a similarly negative impact on longer-dated U.S. Treasuries and send yields higher." John Authers wouldn't hike. Lloyd Blankfein wouldn't either. A hike would probably be good for bank interest margins. Some hedge funds want a hike too. But "A quarter of a point in interest rates is not going to make a difference for most people." And here at Bloomberg View, Mohamed El-Erian says that "It shouldn't matter that much whether the Federal Reserve decides this week to raise interest rates by 25 basis points, or possibly even less."

That Yale bond.

People are really into this story about how Yale bought a 1,000-guilder (Bloomberg News helpfully notes that that's $509) Dutch water authority perpetual bond in 2003 for 24,000 euros (52,889 guilders), and then, despite Yale's $23.9 billion (46.5 billion guilder) endowment, had the nerve to contact the water authority to demand interest. "Yale University will receive 136.20 euros ($153) in interest" (300 guilders), though I assume that's for more than one year's worth of interest. ("The university hasn’t been paid interest since the acquisition, according to the agency," so I guess it's like 12 years' worth?) That interest check is 30 percent of the bond's par amount, but only like 0.6 percent of what Yale paid for it, meaning that its yield over the last dozen years is like 5 basis points per year. For a perpetual bond! You can see how years of unconventional monetary policy have distorted bond prices and depressed the long end of the curve. No doubt Yale will be watching the Fed closely. The bond is written on goatskin.

Insider trading.

Here is Peter Henning with more on the Securities and Exchange Commission administrative law judge's decision for the defendant in an administrative insider trading case, which we discussed briefly the other day. The SEC judge held that, under the Second Circuit's Newman decision, a recipient of an insider tip can't be guilty of insider trading unless the tipper received some personal benefit that the tippee knew about. But as Henning points out, "Judge Patil expressly disagreed with the Justice Department’s position that the appeals court had altered the law in a way that required the Supreme Court to step in." The Supreme Court is considering the Justice Department's request to review the Newman decision on September 28. The Court doesn't take a lot of cases. If the Newman decision has thrown the law into disarray and generated a lot of conflicts between courts, then it makes more sense for the Supreme Court to review it. If that decision just straightforwardly applied Supreme Court precedents, then it makes less sense to review. An SEC administrative judge's opinion on the matter is hardly dispositive, but it doesn't help the Justice Department. Also it seems to be right. My own (not-at-all-legal-advice!) guess was that the Supreme Court will decline to review Newman, but we'll see.

Elsewhere, you know my feelings about insider trading using short-dated out-of-the-money call options on the target just before a merger is announced. (Do not do this. This is not technically legal advice, but you should nonetheless follow it.) But I want to distinguish this from a related phenomenon, which is that when a merger is announced, there are often stories about how someone bought short-dated out-of-the-money call options on the target just before the announcement and is now rich. So for instance:

A block of AB InBev calls betting on an 11 percent advance in the next three months changed hands on Tuesday, sending volume of bullish options to its highest level since April 2014. The trade cost 1.09 million euros ($1.2 million), and is now worth more than 2.63 million euros. Shares soared as much as 12 percent today after the Budweiser maker said it wants to bid for SABMiller Plc.

Now this is an unusual case because those are call options on the acquirer, not the target, and the deal prospects are pretty vague at this point; SABMiller's shares "remained little changed." Also though just because the timing was good and the trade was in short-dated out-of-the-money call options, that doesn't mean it was insider trading.

“That was such a clever trade,” said Steve Schlemmer, who specializes in European merger arbitrage at Churchill Capital UK Ltd. in London. “Everyone was rooting for this one -- it had been rumored forever, and it makes perfect sense.”

The thing is that people buy short-dated out-of-the-money call options all the time. Sometimes it is because they are engaged in some sort of volatility strategy; other times it is because they are betting, based on public information and widespread market sentiment, that the company will be an acquisition target (or an acquirer) in the next three months. A shocking percentage of insider traders buy short-dated out-of-the-money call options, but that doesn't mean that a significant percentage of short-dated out-of-the-money call option buyers are insider traders. Sometimes people are just clever, or lucky.

Oh speaking of AB InBev/SABMiller, any actual deal would get a fair amount of antitrust scrutiny. More importantly: "Sports Seen Having Less Beer Money If AB InBev Buys SABMiller," and you'd think an antitrust regulator would want to do something about that. The sports need the beer money.

Elsewhere in crime.

Here are the last two installments (part 4, part 5) of the Wall Street Journal's saga of "The Unraveling of Tom Hayes," and honestly I find it hard to read. This poor dope:

Ms. Tighe was trying to stage-manage her husband’s approaching moment in the spotlight. She pleaded with him to lose weight to make him look better for a jury. In exchange for doing a week of his chores, including the laundry, Ms. Tighe persuaded Mr. Hayes to get a professional haircut, rather than leaving the task to his mother. Mr. Hayes talked the hairdresser’s ear off about interest rates and his old job.

It's hard to see what purpose is served by putting him in prison for 14 years, but here we are.

Elsewhere, the SEC wants the ability to read your Gmail without a warrant. And "Dewey & LeBoeuf Accounting Fraud Case Goes to Jury." And here is Guan Yang on a civil RICO case brought by the European Community against RJR Nabisco:

American prosecutors and regulators like to use the fact that any US dollar payment anywhere usually has to pass through New York to assert jurisdiction over all sorts of things ranging from Iran sanctions to FIFA corruption. It’s only sportsmanlike, then, that foreign litigants are allowed to use American courts to go after whatever they like using the same New York nexus.

People are worried about bond market liquidity.

Obviously Yale isn't, since it's buying thinly traded perpetual goatskin bonds, but that's the advantage of being a perpetual endowment rather than a bond mutual fund subject to redemption risk. But meanwhile Eaton Vance is so chill about bond market liquidity that its chief income investment officer Payson Swaffield "says concerns that the Federal Reserve’s first interest-rate increase since 2006 will herald bond-ageddon are no different than the software problem that many feared would cripple computers and create mass chaos on January 1, 2000." That rather famously did not pan out. Vanguard is also pretty chill:

Even when bond dealers had larger inventories of corporate bonds and other debt securities, the holdings only averaged 2 percent of the total market during the past 15 years, said Swaffield. If anything, the smaller dealer inventories are good for the market because --- like money managers -- they could also become forced sellers and push down prices even further, said Greg Davis, head Vanguard’s fixed-income group. “Given the amount of deleveraging on the dealer side with stricter capital controls, that makes for a safer financial system,” he said.

Elsewhere, some ETFs are risky.

Me yesterday.

I wrote about IEX's application to be a public exchange. Without wanting to wade into every emotional question of market structure, I did ask if there were any ways to game the Investors Exchange's "magic shoebox" delay on quotes. And of course I got answers, because my readers are great. Here's one suggestion involving peg orders, though the details are not fleshed out.

There's also an argument that the delay might facilitate spoofing. For instance, you send a big bid to the Investors Exchange to make it look like there's a lot of buy-side demand. Then, 300 microseconds later, you send a cancel. The bid displays for 300 microseconds, and during that time bids elsewhere go up, and you sell on other exchanges at inflated prices. By the time anyone can see your bid and try to hit it, it's been canceled. This is clever, though (1) your big spoof bid is still at risk for 300 microseconds (it can be hit by anyone who tried to sell before your bid was displayed) and (2) I don't think this is really a long enough delay for the spoofing to be all that profitable in practice (remember, other exchanges have their own delays caused by physics and programming rather than shoeboxes). More to the point, though, this suggestion violates the spirit of the contest, which was to find a legal way to game the delay. The spoofing is obviously illegal.

Things happen.

Altice to Buy Cablevision for $17.7 Billion. Jim Chanos, who's been short China for years, had a good August. Henry Kravis’ $29 billion albatross. SEC Removes References to Credit Ratings in Money Market Fund Rule and Form. Germany Defies ECB by Fortifying National Bank Control Rules. MetLife to Take $792 Million Third-Quarter Charge Tied to Tax Issues. More on next week's Bank of America chairman/CEO separation vote. Individuals' "stock portfolio weights and returns are, on average, lower when the volume of disclosure in firms’ annual reports is greater." Donald Trump seems to be the actual Republican front-runner? Lloyd Blankfein is not a Trump fan. The Dragon Dreams Museum is in bankruptcy. "We had met at a bar. I told him I was an economist. He told me he was a pot dealer." Mass incarceration and rational choice theory. "The real Brooklyn is now on the Left Bank." Artisanal sandwich.

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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 of this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:
Zara Kessler at zkessler@bloomberg.net