Bond Prices and Banker Mistakes

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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Bond mis-marking.

The Public Sector Pension Investment Board of Canada sued Boaz Weinstein's hedge fund, Saba Capital Management, for mis-marking bonds in order to stiff the board on a redemption request. Here is the complaint, which does not strike me as particularly convincing. Saba had some poor performance -- its net asset value fell by more than half between 2012 and 2014; the board says, rather cruelly, that the "losses appeared to be unrelated to any market development that could or should have adversely affected the Fund's performance had the Fund been properly managed" -- and the board asked to redeem its money. According to the complaint, Saba had been valuing some McClatchy Company bonds based on a third-party pricing source, but when it was cashing out the board Saba and Weinstein "deviated from their past practice by using for the first time a different method for valuing the MNI bonds in the Master Fund's portfolio, namely, they used a bids-wanted-in-competition ('BWIC') process that purportedly produced materially depressed bids reflecting a significant liquidity/blockage discount from the values previously assigned by defendants to the Master Fund's holdings of MNI Bonds."

Which sounds ... pretty reasonable? Like, if you are actually going to have to sell the bonds to redeem out a big investor -- the board's complaint says that it was "the Fund's largest investor" -- you want to do it at the actual price at which you can sell them? People, as you may have heard, are worried about bond market liquidity, and the specific worry is that if funds see big redemption requests they will have to meet them by selling bonds at prices below where they had previously marked them. This is that thing. The complaint goes on to say that as soon as it redeemed out the board (without, apparently, actually selling the bonds), Saba went back to its old way of valuing the bonds, causing them to be marked up, but Saba says: "In fact, we continued to use the auction to price those (and other) bonds in the second and third quarters of 2015." But really even if everything in the complaint is true, I'd be inclined to say that it sounds a bit sharp but not actually fraudulent. 

Mistakes were made.

"Switzerland’s Competition Commission said on Monday that it had begun investigating seven financial institutions, including the Swiss banks UBS and Julius Baer, over potential collusion to manipulate the precious-metals market," to go along with similar U.S. and European investigations, and to follow up on similar fruitful investigations of collusion to manipulate the markets for Libor and foreign currencies. (Also maybe Treasuries, who knows.) You can no longer really be surprised to hear that banks might have colluded to manipulate a market in something.

Elsewhere, here is Lucy Kellaway on banks and mistakes:

Last week the chief executive of UBS told all the bankers who work for him that henceforth it was OK for them to make mistakes. A culture in which everyone was petrified of taking risks, Sergio Ermotti said, was not in the interests of the bank or its clients.

How mature, came the response. How refreshing to hear a bank chief acknowledge that risks need to be taken and honest mistakes will sometimes be made.

But it wasn’t mature. It was mad.

I feel like the regulators agree with Kellaway. Her point is that "This mistake-loving nonsense is an export from Silicon Valley, where 'fail fast and fail often' is what passes for wisdom," but that it is inappropriate in the banking context. As I once put it, "Tech is an industry of moving fast and breaking things. Finance is an industry of moving fast, breaking things, being mired in years of litigation, paying 10-digit fines, and ruefully promising to move slower and break fewer things in the future." 

Of course there's a reason that Ermotti said what he said. A workplace culture of experimenting, taking risks, being unafraid to try new things, not being harshly penalized for messing up is nicer than one of zero-tolerance striving for boring perfection. That's why people want to work at tech startups and are less keen on working at banks these days. Regulators want to turn banks into utilities -- boring and mistake-free -- but the bankers look back on their mistakes with nostalgia.

Speaking of which, here's a Hollywood thriller about the housing crisis. And Bloomberg News reports on the script that Deutsche Bank prepared to fire traders for Libor manipulation. "Thank you for making yourself available for this call today," it begins, and then "We have decided that your employment agreement should be terminated with immediate effect by reason of your gross misconduct," which is the way to do it. Rip the band-aid right off; don't mince any words about exactly how gross the misconduct was. Elsewhere in Deutsche Bank firings, "A former Deutsche Bank AG executive fired when female colleagues accused him of sexual harassment won a discrimination lawsuit after London judges ruled the women had lied, exaggerated and used lewd language themselves." See? Sometimes "everyone was doing it" is a defense.

Capital regulation and non-banks.

Here is a very good speech by Federal Reserve Governor Daniel Tarullo about "Capital Regulation Across Financial Intermediaries":

The scope and nature of a firm's liabilities provide the justifications for capital requirements regulation. Differences in liabilities can, accordingly, sometimes warrant different capital requirements for portfolios of similar assets across firms. At the risk of packing too much into these introductory points, let me also note that an emphasis on a firm's liabilities is related to, but not synonymous with, an emphasis on its activities. Thus, for example, simply deciding that an intermediary provides mostly commercial banking services or insurance products does not fully answer the question of what its capital requirements should be.

There is a lot here, including on prudential regulation of asset managers, but I particularly liked this:

When concerns are raised about regulatory arbitrage or a level playing field, they are usually in the context of a similar asset being held, or a business activity conducted, by financial firms with different regulatory structures. My discussion today would suggest that attention must be paid to the liability structure of the different firms before deciding whether the asymmetric regulatory treatment is prudent or an invitation to the propagation of new financial risks.

This is it seems to me the core question of financial regulation. There are assets. They are risky; they might go down in value. Someone bears the risk of those assets. If regulation tends to push that risk into entities that are funded with short-term debt from investors who expect it to be money-good, that leads to potential crises. If regulation tends to push that risk into entities with long-term equity-like funding from investors who knowingly bear the risk, that is the best it can do. You can't get rid of risk, but you should try as much as possible to keep it from being funded by short-term debt with no capital buffers.

Elsewhere, here is Craig Pirrong writing against capital regulation of commodity traders. 

Issue the high-premium bonds!

Here is John Carney on why John Boehner's resignation might be good for markets (lower chance that House Republicans intentionally wreck the U.S. economy with a government shutdown this fall). But here are Josh Zumbrun and Ben White and Pimco's Libby Cantrill on why it might be bad (higher chance that House Republicans intentionally wreck the U.S. economy with a debt ceiling fight in November or December). I suppose just not wrecking the U.S. economy at all is not an option? There are solutions to this problem, but they are creepy.

Unicorns.

Here is a BuzzFeed story about "The Dark, Scammy History of JustFab and Fabletics" that is illustrated with a picture of an unshaven unicorn smoking a cigarette and looking generally sketchy. More stories about billion-dollar tech startups should be illustrated with pictures of their representative spirit unicorns. Uber's unicorn would have fifty horns and be driving a town car with a copy of "Atlas Shrugged" open on the passenger seat. Pinterest's would be crafty. Airbnb's is in your bed right now. Twitter's would be dazed and glassy-eyed and yoked with Square's to a little chariot carrying Jack Dorsey. Speaking of which, Fortune reports that "Payments startup Square plans to file an S-1 document for its initial public offering within the next two weeks," which would plausibly make Dorsey the chief executive officer of two public companies at the same time, putting him in the company of Elon Musk, Carlos Ghosn, Steve-Jobs-once-upon-a-time, and not too many other people. Fortunately Twitter's governance and strategy are robust enough to ha ha ha ha I can't even finish that sentence, have you seen the new "Noteworthy mention" thing?

People are worried about stock buybacks.

No, I'm kidding, people seem pretty pleased about the big Chinese companies buying back their shares after the recent rout. 
"It’s a positive sign that they believe in their growth opportunities and their strategies," says one analyst, whereas I feel like with U.S. companies buybacks are often criticized as a sign that a company has run out of growth opportunities and is drifting without a strategy. In any case, Alibaba "plans to repurchase as much as $4 billion of stock over two years," and you know where it could find a lot of cheap stock?

People are worried about bond market liquidity.

It's actually quiet on the liquidity front today, though the Financial Stability Board met in London on Friday to talk about liquidity (among other things). And George Soros is investing in TruMid, another startup designed to improve bond market liquidity by letting investors trade with each other. "Trading is focused on 10-minute periods called swarms, with the idea being that having small windows of trading focuses liquidity in specific periods of time." Elsewhere, the CDX index is an increasingly problematic hedge for cash bonds. And investment-grade spreads are widening.

In other bond news, Soho House "had to pull a planned £200m high-yield bond after investors baulked at the company's high leverage and limited free cashflow." Also the roadshow was super awkward:

"There is no strict anti-banker policy but our clubs are very much rooted in the creative industries," a Soho House spokesperson told Reuters in 2011.

The irony was not lost on some in the market.

"It's pretty funny," said one bond investor. "They say that we're not cool enough to join their club but they're perfectly willing to take our money when they need it."

The roadshow had a "casual dress code, which explicitly forbade wearing ties," which I do not really understand? If you are asking people for money, you can't also tell them what to wear.

Things happen.

Alcoa to Split Into Two Companies.  Profiling the Average Whistleblower. Wall Street banks are tracking everything employees do. Billionaire Carl Icahn Endorses Donald Trump. Icahn warns of potential looming catastrophe. "Zambia’s Finance Ministry rejected a credit downgrade by Moody’s Investors Service, saying the move was unsolicited and should be ignored." U.K. Trader Navinder Sarao’s Extradition Hearing Is Delayed Until February. Pay-what-you-like financial services. Banker Loyalty in Mergers and Acquisitions. "Early option exercise can be optimal when it reduces short-sale costs, transaction costs, or funding costs." Ashton Kutcher nailed his 'Shark Tank' debut. Man at Job Interview Gets Into Dispute, Allegedly Threatens to Kill Everyone. If a tree falls in the forest put a megaphone next to it. Kung fu. London Zoo meerkat handler glassed her monkey expert love rival colleague in the face in a row over her hunky llama keeper. 

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(Corrects start date of Saba's losses in first paragraph.)

  1. I know: Horses have hair all over their faces, so how could a unicorn develop a five o'clock shadow? Unicorns are magic, is the answer.

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