Human Trading Glitches and Coin Flips

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.
Read More.
a | A

Oh well.

I'm a little embarrassed that I got up on a horse and recited the Saint Crispin's Day speech yesterday and then the Fed didn't raise rates. I guess that was pretty widely expected, but now I don't really know where to go, pep-talk-wise, for the next meeting.  

There are some indications that it was a dovish hold -- here is a funny revival of a somewhat stale cartoon, and the Fed's dot plots include some projections for negative Fed Funds rates, which would be weird -- but I guess a hike in December seems likely. "Janet L. Yellen, the Fed’s chairwoman, described the decision as a close call and said the central bank still expected to raise interest rates later this year," and there was a hawkish dissent from Jeffrey Lacker. Housing remains depressed. Here's "How An Interest Rate Hike Could Deflate The Tech Boom." Here's an exit strategy reading list

Market structure.

The story of what happened to KKR's stock on August 24 is just bizarre:

The exchange delayed trading in KKR on its platform by three minutes and 15 seconds before Mr. Himpele opted to open shares of KKR at $10. That was about half the $19.55 at which they closed at the previous Friday, despite there being no significant news affecting the company. It was also below the $17-to-$18 range at which the stock was trading at on electronic exchanges in the preceding three minutes. It wasn’t clear what information Mr. Himpele used to determine his opening price.

Mr. Himpele is Donald Himpele of IMC Financial Markets, the New York Stock Exchange designated market maker for KKR's stock. We talked the other day about how corporate executives find modern equity market structure confusing and scary, and want to be protected from computers making crazy decisions that whipsaw their stocks. But this was a person ("a human with a financial interest") making ... inexplicable ... decisions that whipsawed KKR's stock. "KKR says IMC failed to adequately explain its floor trader’s decisions that on Aug. 24 briefly cut the private-equity firm’s market value in half and momentarily wiped away about $1 billion from each of its founders’ net worth," and you can see why that would be of interest to them. Just because a market is run by people doesn't mean that it will make more sense than one run by algorithms.

Elsewhere, here is a Healthy Markets report on dark pools. And "Exchanges Face Pressure to Disclose High-Speed Trader Perks."

Jefferies.

Jefferies announced earnings yesterday and they were not so hot, with trading revenue down 50 percent quarter over quarter. "During earnings season, Wall Street regularly looks to Jefferies for insight on how the larger banks might perform in areas like investment banking and trading," since it announces early and has a relatively less complicated business, but that seems less relevant this quarter. For one thing, Jefferies was idiosyncratically focused on distressed energy debt trading and underwriting, and that went poorly for it last quarter, with $90 million of distressed energy losses. Also, though, Jefferies is now not so much a microcosm of the bigger banks but rather a picture of those banks as they might have been, were it not for the Volcker Rule. The answer turns out to be: They might have lost a lot of money on distressed energy debt! But because of Volcker, and a general risk-off shift in the big banks, that seems less likely this quarter. Though you never know. Goldman Sachs apparently "has lost $50 million to $60 million on its distressed-trading desk in 2015," so maybe Jefferies remains a bellwether.

Elsewhere in distressed energy debt, "KKR’s Samson Resources Files Bankruptcy as Shale Bet Sours."

You can't invest with Coinflip any more.

I have a theory of investment-opportunity names where the worst names are the ones that say how safe it is ("Super Great Conservative Never Lose Money Fund"), the second-worst names are the ones that say how risky it is ("Probably Don't Do This LLC"), and the best bets are the ones in the middle. I don't quite know what that theory predicts for Coinflip, Inc. On the one hand, I mean, probably don't bet your retirement savings on a coin flip? On the other hand, if you need to gamble on something, a fair coin flip is better than a lot of the alternatives. Coinflip did not actually offer online bets on coin flips, though come to think of it that's a pretty good business idea; instead it offered bets on bitcoins. Specifically its Derivabit platform was intended to let people trade put and call options on bitcoins. Yesterday the Commodity Futures Trading Commission announced a strange settlement with Coinflip, declaring that Coinflip was illegally operating an unregistered commodity derivatives trading operation. I was going to say that the CFTC shut down Coinflip, but that is not obvious from the CFTC order, in which Coinflip just agreed to stop violating the law without exactly specifying what that means. Perhaps it will apply for the relevant licenses and launch a registered bitcoin derivatives exchange.

In any case the interesting point is that the CFTC has declared that bitcoin is a commodity subject to CFTC regulation. This point is so interesting that it's the sub-headline of the CFTC press release, but it's not exactly novel. As the order says:

Section 1a(9) of the Act defines "commodity" to include, among other things, "all services, rights, and interests in which contracts for future delivery are presently or in the future dealt in." 7 U.S.C. § 1a(9). The definition of a "commodity" is broad.

Basically the way commodity derivatives regulation works is that if (1) it's not a "security" (stock, bond, etc.), and (2) there are derivatives on it, then it's a commodity. (Even currency derivatives are covered by the CFTC as "excluded commodities" under Section 1a(19).) The CFTC regulates derivatives on lots of commodities that are not intuitively commodities. U.S. elections, for instance, though I suppose there's an argument that elections are in fact intuitively commodities.

People are worried about bond market liquidity.

The prospect of saying goodbye to zero interest rates yesterday really focused people's minds on all the good times we've had together, us and zero interest rates, over the last six years or so. Here's a terrific post from Tracy Alloway on "Eight Things That ZIRP Did for the Corporate Bond Market," and while you should read it in its entirety for its detailed picture of where we are now with corporate bonds (boom in issuance, low defaults, reduced rewards for taking credit risk, lots of stock buybacks), for my glib purposes I suppose I'll focus on the usual:

Years of low interest rates have also led to a vastly different corporate bond market structure featuring diminished ease of trading, or what's known as liquidity, in financial parlance. While the decline of liquidity in fixed-income markets has often been attributed to new banking rules that have impeded banks' ability to deal debt, a huge portion of the trend could arguably be traced back to the search for yield behavior on the part of big investors.

Alloway cites the fact that a growing percentage of corporate bonds are held by a smaller number of big investors, reducing trading activity. A related theory is that, with low interest rates and compressed spreads, the rewards of trading don't outweigh the costs, so investors just want to trade less than they would in a more normal interest-rate environment. If you believe that, then rising interest rates might help bond market liquidity.

Feh, millennials.

It seems unnecessary to criticize this Elite Daily article about how you shouldn't save money in your twenties because you are a special snowflake and magical elves will recognize your poetic soul and reward you with a fairy castle where enchanted birds will cater to your every whim. That is not how 21st-century capitalism works, as Slate and the Huffington Post and also every person who read the article pointed out. But I do want to mention it as further evidence for my view that millennials "seem really determined to un-learn all of the financial lessons that previous generations have absorbed through hard experience." The lesson being un-learned here is the one about compounding of returns, and at least they have an excuse for unlearning it: If you're in your mid-20s, interest rates have been zero for practically your whole adult life. If you put aside $1,000 in your twenties and it compounds at zero percent interest for 50 years, by the time you retire you will have $1,000 and probably a diminished utility of money. Might as well blow it on parties now.

Me earlier.

I wrote about Treasury bond auctions.

Things happen.

U.S. Appellate Court Puts Hold on Action Against Lynn Tilton. Women Led Investment Funds Continue to Outperform the Industry, But Struggle to Raise Capital: KPMG Report. The DOJ settled with General Motors over an ignition switch defect that killed 124 people; no individuals were charged. The Data-Driven Rebirth of a Salesman. Goldman Sachs Will Advertise on Snapchat. Ryan Adams's "1989" comes out on Monday; here is "Bad Blood." Exercise mashupsMuppet sex. Dad fashion

If you'd like to get Money Stuff in handy e-mail form, right in your inbox, please subscribe at this link. Thanks! 

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