Inversions, Elections and Hedge Funds

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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Pfizergan. 

Pfizer and Allergan announced a $160 billion merger "that would create the world’s biggest drug maker" and would also "be the biggest transaction aimed at helping an American company shed its United States corporate citizenship in an effort to lower its tax bill." I think there are two possible views of the problem of tax inversions:

  1. It is bad that the U.S. tax code taxes companies at U.S. rates on income earned abroad, while most other tax codes don't do that; or
  2. It is bad that U.S. companies want to move abroad to take advantage of other countries' more favorable tax codes.

That is, you can blame the tax code, or you can blame the companies. Either view is perfectly self-consistent, and neither strikes me as particularly right or wrong; there is no intuitive morality to extraterritorial taxation one way or the other. But what seems to me to argue for view 1 is that you can do something about it. (I mean, not you, but Congress.) If the tax code is bad, Congress can change the tax code, and if the U.S. taxed corporate income the way most other countries tax corporate income, companies wouldn't keep moving abroad.

But if you keep taxing income earned abroad, there is no obvious way to stop companies from inverting. I mean, you can make rules against inversions, and there are rules against inversions, and they don't stop inversions. You can make more rules against inversions, and Treasury just made more rules against inversions, and they won't stop the Pfizer/Allergan deal. But you can't -- practically -- make rules against foreign companies acquiring U.S. companies, and at the end of the day if a U.S. company just sells itself to a foreign company to get out of U.S. worldwide taxation, that is inversion enough.

And that's what Pfizer is doing: "The deal will be technically structured as a reverse merger, with Dublin-based Allergan, which is smaller, buying New York-based Pfizer," despite the facts that Allergan is getting a premium and that the new company will be named "Pfizer plc."

Argentina elections.

You don't often see defaulted bonds trading at 115 cents on the dollar but here you go:

Argentine assets extended their rally early on Monday. The benchmark securities due in 2033 gained to a price -- which includes interest owed since last year’s default -- of 115 cents on the dollar. That’s up from 113.8 cents on Friday and 102 at the end of September. 

"Argentina voted for deep change on Sunday, electing the center-right opposition leader Mauricio Macri to be president in a decisive end to 12 years of leftist populism, setting the stage for economic liberalization, a warming of relations with the U.S. and political reverberations across Latin America," and also, in more purely financial news, a likely resolution to years of wrangling with Elliott Management over Argentina's last bond restructuring. Or at least I take it that that 115 price implies a likely resolution. It'd be weird to pay over par for bonds that keep not paying interest.

Computer scientists. 

Here is a story about how "hedge funds and asset managers are scrambling to poach talent from Silicon Valley" so they can program computers to do more good trading stuff. One reaction that you often see to this sort of news is that it is a waste for smart computer scientists to work in the financial industry, because they should be changing the world by programming self-driving cars or computers that cure cancer or whatever. This is of course a bit irrelevant to the actually existing tech industry, which mostly optimizes advertising. Also, though, the point of hiring computer scientists in finance is to automate functions of the financial industry. If you accept that allocating capital is a worthwhile social function, then automating it so that fewer people can do it more efficiently is also worthwhile. And, then you need fewer people to allocate capital. So all those human traders who used to allocate capital based on gut instinct and favor-trading are freed up to do whatever more socially valuable thing it is that they should be doing.

What are hedge funds good for?

I enjoyed this new paper, by Harvard Ph.D. candidate Jonathan Rhinesmith, called "Conviction and volume: Measuring the information content of hedge fund trading." The idea is that hedge fund stock purchases are predictive of future stock prices: If hedge funds buy a lot of a stock, relative to its volume, over one quarter, that stock is likely to go up in future quarters. (This is not particularly true of mutual funds.) So (equity) hedge funds, even in the aggregate, aren't just throwing darts; they are actually picking good stocks and making good capital allocation decisions. But if they buy a lot of a stock, relative to its volume, over one quarter, that stock is also likely to go up a lot in that quarter, because of their buying, which reduces the returns to the hedge funds themselves, since they have to buy at prices that reflect their own price impact. In other words, hedge funds make the market more efficient, but the market is too efficient for the hedge funds to fully capture the benefit they provide. Or: Hedge funds are actually good at picking stocks, but the market is so efficient that that skill doesn't show up in the hedge funds' returns.

Muni fraud.

Here is a Securities and Exchange Commission fraud action against Christopher F. Brogdon, who allegedly "amassed nearly $190 million through dozens of municipal bond and private placement offerings in which investors supposedly earn interest from revenues generated by the nursing home, assisted living facility, or other retirement community project supported by their investment" and then commingled the funds and used some of them to pay for his personal expenses. I have to say, you don't see a lot of municipal bond fraud cases like this, where someone raises money from municipal investors and then (allegedly) takes it for his own personal use. If you can get municipal governments to raise money for you, and give it to you, and then you can keep it, that sounds like a pretty good racket, no?

People are worried about swap spreads.

One way to think about swap spreads is that swaps are termed-out Libor, while Treasuries are termed-out repo. That's not precise or anything, but, you know, if you receive fixed on a swap, that means you're getting a long-term fixed payment of the swap rate and financing it at Libor, while if you own a Treasury note, that means you're getting a long-term fixed payment of the Treasury rate and (probably, marginally) financing it in the repo market. Since the repo market is secured, and Libor is unsecured, you'd expect repo to be cheaper than Libor, so you'd expect Treasury rates to be lower than swap rates, so when they're not it's weird, and so people are worried about (negative) swap spreads. But here is Izabella Kaminska on the general case of that weirdness: 

A strange thing is happening in money markets: the cost of borrowing unsecured wholesale funds is now below the cost of borrowing secured funds.

The problem, according to repo dealers, is that new leverage ratio rules are set to make it far too costly for repo market participants to transact.

People are worried about unicorns.

Here is the sad story of LivingSocial, a unicorn avant la lettre, which never went public and is now "more unicorpse than unicorn." Look upon its rows of empty desks, ye mighty, and etc. Actually I guess look upon its empty desks and think pretty seriously about doing your own initial public offering even if market conditions are unfavorable? Not that an IPO is a guarantee of immortality -- Pets.com, etc. -- but at least it lets some people cash out.

Elsewhere, Airbnb "raised more than $100 million" at a $25.5 billion valuation, flat from its $1.5 billion round in June; the S&P 500 is also roughly flat since then. "Short Sellers Take on Billion-Dollar IPOs." And here are the names of the a capella groups at the big tech companies, and Facebook's "The Vocal Network" is clearly way better than Airbnb's boring "Airbnbeats," which is currently leading Re/code's vote for best name. Also Microsoft's "Baudboys" is hilariously, perfectly bad. 

People are worried about stock buybacks.

"Is the Surge in Stock Buybacks Good or Evil?" is the headline here, and remember, capital allocation decisions within a firm almost always have less moral significance than you think. Otherwise this is mostly the usual -- short-termism, earnings manipulation, disguised management compensation -- though this is sort of an interesting statistic from an S&P Dow Jones Indices analyst:

He calculates that about 12% of S&P 500 companies already have bought so many shares that, even if their total fourth-quarter earnings don’t rise and they buy no more shares, their fourth-quarter earnings per share will be up at least 4%, due simply to reduced share count.

People are worried about bond market liquidity.

"Anything after the first or second call, you are really dicing with death," says a buy-side trader about how dangerous it is to call around looking for liquidity. And so traders turn to electronic platforms and data services to try to find liquidity without calling every dealer. And so a lot of platforms grow up. But:

Although there have been more than a dozen new such trading venues, including dark pools such as Liquidnet for fixed income, their very number will impede their growth. Fragmentation makes it harder for asset managers to find buyers or sellers.

“You risk fragmenting the liquidity across a large number of platforms,” says Mr Robinson. “And the other issue is that people could be tempted to list their trade on every available platform,” which he says creates a false impression of liquidity.

Ah, man, fragmentation and disappearing liquidity, it's just like equities. Elsewhere: "Liquidity Crisis? What Liquidity Crisis?"

Things happen.

Creditors Signal Potential Support for Overhauling Puerto Rico Debt. Lynn Tilton Patriarch Partners Seeks Bankruptcy Protection for Zohar-I Fund. Guotai Junan Unit Says Chairman Yim Fung Can't Be ContactedPetco Nears $4.7 Billion Sale to CVC and Canadian Pension Plan. Fairness of SEC Judges Is in Spotlight. Pensions’ Private-Equity Mystery: The Full Cost. Masters of the Finance Universe Are Worried About China. Fidelity Joins Growing Field of Automated Financial Advice. Accused Mastermind of J.P. Morgan Hack a Product of Israel’s Internet Underbelly. The Cotton Famine of 1862-63 and the U.S. One-Dollar Note. FanDuel Told Employees Not To Win Too Much Money On DraftKings Or People Would Get Suspicious. PhunkeeDuck. Selfie rat.

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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