Limit-Up Kamikazes and Private Justice

Also TLAC, file and suspend, blockchains and non-GAAP accounting.


When Chinese stock markets were crashing earlier this year, authorities were quick to blame short sellers and market manipulation. It's reasonable to be skeptical. Sometimes markets go down because they are overvalued, not because a cabal of evil hedge fund managers is manipulating them. But I mean look at this:

Chinese authorities have detained the leading light of the “Limit-up Kamikaze Squad”, a group of hedge fund managers known for their fearless speculation.

Xu Xiang, general manager of Zexi Investment Management, was apprehended on Sunday on suspicion of insider trading after a police manhunt. 

He was “captain” of the loose collection of fund managers centred around the coastal city of Ningbo in eastern Zhejiang province who are known for pushing favoured stocks up by the 10 per cent daily limit on Chinese exchanges.

I don't understand why anyone would want to be a "Kamikaze Squad." It ends in ... well, you know. A frequent criticism of these sorts of crackdowns is that authorities are quick to blame manipulative short sellers when stocks go down, but are less concerned about manipulation on the way up. Pushing stocks up is just as manipulative as pushing them down. But in fact, while it's not clear what exactly the charges against Xu are, they might well be related to upward manipulation. Or at least, the Limit-up Kamikazes seem to have stuck with their limit-up strategy even during the crash:

Mr. Xu’s Zexi Investment, based in Shanghai, was the subject of intense market speculation in September, when a post on social media accused the company of market manipulation. The online post suggested that Zexi had told China’s biggest brokerage, Citic Securities, to buy shares of an unprofitable Shanghai clothing retailer to lift its price for one of its politically connected investors. At the time, Zexi said the attacks were “fabrications from nowhere and malicious attacks.”


I've said before that a "financial crisis" means, roughly, "that someone borrows money from someone else and can't pay it back, and it is socially or politically unacceptable that the people who loaned the money not get their money back." So the way to avoid financial crises is to clearly define the classes of people whom it is socially and politically acceptable not to pay back. That is roughly how I think about the Fed's new proposed rules on "total loss-absorbing capacity," which requires banks to fund themselves partly with long-term debt that would be, as the name implies, loss-absorbing. Banks issue debt that is explicitly government guaranteed (retail deposits, etc.), and other debt that is systemically important and disastrous not to pay back (repo, etc.), but that shouldn't lull you into thinking that all bank debt is systemic and subject to implicit government guarantees. TLAC debt, with "loss" right in the name, shouldn't lull anyone. Here is Peter Eavis with more.

Blockchains and unicorns.

Here is the Financial Times on the revolutionary impact of the blockchain on finance. "We could go the way that file transfer technology changed music, allowing new businesses like iTunes to emerge," says a guy. "Suits are replacing hoodies and ripped jeans at blockchain conferences," says another guy. "You should be taking this technology as seriously as you should have been taking the development of the Internet in the early 1990s," says Blythe Masters. I have, in the past, been perhaps slightly more measured: The blockchain is the cool new way for multiple banks to cooperate on a single database, but there is some upper limit on how cool a cooperative database technology can really be. Izabella Kaminska is also skeptical about the banking blockchain:

Which is why we’re going to propose that the blockchain fad is mostly about putting finance in terms that are understandable to techies — i.e. as something absolute – and having them learn for themselves through trial and error why that’s actually a flawed assumption in finance.

Elsewhere in payment technologies, here is the ridiculous story of a fight between banks and retailers over a (withdrawn) FBI alert on chip-and PIN credit cards. It will make you a blockchain believer. And elsewhere in tech fads, "Seven of the propositions on the San Francisco ballot are either directly or indirectly related to the technology industry and housing costs."


The New York Times has a big series on company-imposed arbitration, which frequently prevents class actions, favors corporate interests, and "amounts to the whole-scale privatization of the justice system." There is a lot of compelling reporting about the abuses of arbitration, and I guess I'm prepared to say that forced arbitration seems bad. But the alternative -- ubiquitous private litigation and class actions sponsored by plaintiffs' attorneys on behalf of classes of plaintiffs they've never met -- is not, you know, perfect. Arbitration contracts seem like an excessive reaction to a system of excessive litigation. 

In the New York Review of Books, Judge Jed Rakoff reviews John Coffee's book on "Entrepreneurial Litigation," which places "today’s class actions firmly within the setting of the modern trend toward turning the practice of law ever more into a business." Coffee and Rakoff are both groping toward a better system:

Coffee, while also strongly advocating for more governmental action against individuals, proposes an interesting innovation that he thinks would make class actions more socially useful and less liable to abuse. Overall, he suggests making good on class action’s promise of a “third way” by combining its profit-seeking tendencies with oversight of the class actions themselves by public agencies. Specifically, he proposes, among other reforms, that government regulators in matters where class actions are common should employ private class action lawyers, on a contingent fee basis, to bring class actions supervised by the regulatory authority but for the benefit of the victims, to whom any recovery would be distributed.

But Rakoff, a former federal prosecutor, calls for basically more prison:

It is hard to believe that the settlements in such cases have much of a deterrent effect on the individual executives who actually committed the alleged misconduct. This is why, in my view, class actions are no real substitute for criminal and regulatory prosecution of the individuals actually responsible for corporate misconduct.

In a time when America has 25 percent of the world's prisoners, this also strikes me as not a first-best solution. (In that vein, here is Jesse Eisinger with strange advice for future prosecutors. "A good prosecutor must relish doling out displeasure," says Eisinger, as though they don't.)

It is a mess. You could imagine some better system -- in which, say, enlightened regulators vindicate the rights of individuals without the massive profit-seeking machinery of the current U.S. legal system, and without the cruel bias toward incarceration of the current U.S. criminal justice system -- but, at least in the U.S., it remains mostly imaginary.  

Social Security gamification.

"Are You About to Lose $50,000 in Future Social Security Benefits?" is the headline on this clear Bloomberg explanation of the "file and suspend" strategy for claiming extra Social Security benefits, an "aggressive" way to exploit an "unintended loophole" in the law:

Under file and suspend, married workers can file for Social Security and immediately suspend their benefits. Their benefit checks won't start arriving in the mail, and the value of their eventual benefits will keep rising as if they hadn't filed. In the meantime, their husbands or wives can apply for a portion of the spousal benefit they are entitled to once their spouse has filed.

Why is it controversial?

Arguably, couples who file and suspend are double-dipping. They're getting the extra benefits that come from waiting until age 70 to file, while also accessing benefits early. 

So what do you think? I think it is pretty clearly cheating, in the sense that it is not an economically reasonable result within the spirit of the Social Security system. But then, who is to say what the spirit of that system is? The spirit of the system is embodied in, and hard to distinguish from, its rules. I also think -- everyone thinks -- that this "aggressive" approach is clearly allowed by the letter of the rules. And lots of people do it. Are those people bad people? What, if anything, should you think about tax inversions? Yahoo's Alibaba spin-off? How should one comply with the law, other than by complying with the letter of the law? Anyway this particular loophole is closing.


I wrote about Valeant on Friday. Elsewhere, Gretchen Morgenson argued that Valeant represents the perils of relying on non-GAAP financial numbers:

Valeant is among a growing number of companies that regularly present two types of financial results: those that adhere to generally accepted accounting principles, and those that help executives put the best spin on their operations.

In accounting parlance, such adjusted figures — which exclude certain costs from calculations of a company’s earnings — are known as pro forma or non-GAAP numbers. But let’s call them what they really are: a false construct.

Journalists like to equate generally accepted accounting principles with virtue, and non-GAAP numbers with deception, as though investors think in GAAP and are easily bamboozled by disclosed and reconciled adjustments. And a lot of people have criticized Valeant's accounting. But I have to say that its recent troubles do not mainly seem like accounting problems? Like even if Valeant never backed out stock-based compensation expenses from its "cash E.P.S." calculations, the stuff about relying on a semi-secret network of pharmacies that might be engaged in questionable business practices would still be a problem.

One person who has criticized Valeant's accounting is Andrew Left, the short seller who did a lot to start Valeant's recent troubles when he put out a report accusing Valeant of using those pharmacies for accounting shenanigans. That report has been pretty well discredited, and the focus on the pharmacies has moved on to more substantive problems, but on Friday Left promised to "update full story on Monday. Dirtier than anyone has reported!!" Then he walked that back:

On Sunday, Mr. Left said didn’t have plans for further major allegations against Valeant, after having consulted with lawyers. His lawyers asked him how sure he was about what he had in mind to publish, on a scale of one to 10, and he was only at “eight,” he said. Mr. Left stressed he stood by his initial allegations.

His lawyers have advised him to “let the story evolve,” Mr. Left said.

Good lawyers! On the other hand, Russell Reitz, the pharmacist behind one of the pharmacies in Valeant's semi-secret network, is still pressing his claims that those pharmacies are "engaging in a widespread fraud." And Glenn Chan notes some of the oddities in Valeant's defense. Elsewhere, Ronald Barusch argues that Valeant needs better disclosure, Justin Fox argues that it needs better friends, Charlie Munger calls its strategy "deeply immoral," and its "woes are having an outsize impact on some of Canada’s biggest funds."

People are worried about stock buybacks.

"These Charts Suggest the Market May Have Had Enough of Share Buybacks," is the claim here:

Recent conversations that we’ve had with equity [portfolio managers] suggest that they have become far more focused on revenue growth, and are placing far less of a premium on any financially engineered EPS growth. The fact that a basket of stocks that have been reducing shares outstanding is meaningfully underperforming the S&P 500 on a beta-adjusted basis suggests that this view may not be that of just the investors we talk to, but far more broadbased.

People are worried about bond market liquidity.

I am late to this, but here is a Barclays infographic about bond market liquidity that blames the decline of bond trading on the decline in repo, blames the decline of repo on the Supplemental Leverage Ratio regulations, and illustrates the theme "More risk may be passed on to investors" thusly:

Screen Shot 2015-11-02 at 5.48.15 AM

Elsewhere: "Corporate Bond Market Booms, a Bright Sign for U.S. Economy."

Things happen.

Banks’ Cost-Cutting Plan: 'Wet-Wipe Wednesday.' Greek Banks Face Skeptical Investors in Demand for Fresh Capital. China aids eurozone QE drive with sales of German bonds. Commerzbank CEO Blessing Won't Extend His Contract Beyond 2016. Visa Agrees to Buy Visa Europe for as Much as $23.4 Billion. Globo debacle gives junk bond syndication a black-eye. BNP Sued Over $650 Million 'Wet Ink' Error in Al-Sanea Deal. Paul Singer likes Rubio. Space rat. Darth Jar Jar. Mountain Dew color. "A Vassar student told me that St. Marks Place died with the fairly recent closing of the Starbucks at Cooper Union."

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