Mortgages, Layoffs and Bribes

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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Mortgages.

A lot of the time, when banks get in trouble, it's not for intentional misconduct but for missing "red flags." We talked yesterday about how Barclays was fined for failing to do proper due diligence on a transaction despite red flags like, it was a big transaction. Bank of America has paid well over $20 billion for selling mortgages to Fannie Mae and Freddie Mac without fully vetting them. So my question is, how would you feel if you read this about a bank in 2007?

Lenda even approved a loan for an Oregon software engineer who didn’t want to speak to anybody, van den Brand said. Lenda’s loans are eligible to be sold to Fannie Mae and Freddie Mac.

Ah, but you see, Lenda isn't a bank in 2007, as you can tell from the cutesy name. It's a "San Francisco-based firm" that "has funded more than $60 million in mortgage refinancings using technology to cut costs so it can offer loans at lower rates than traditional competitors," and it is one of several tech companies that are ... disrupting ... the mortgage business. One disruptive innovation is that these firms skate around saying things that you can't say at banks any more. For instance, at mortgage marketplace Sindeo:

“We come from the mind-set that anything can be done,” Wilcox said. “Then we figure out how we can make it compliant.”

Or at Social Finance Inc.:

“There isn’t a banker out there that doesn’t look at me and shake his head and say, ‘You don’t know what you’re doing,’” Cagney said. “But we’re doing it.”

That would be a good motto for "financial technology" generally. 

Job cuts.

The holiday season will not be particularly fun at Morgan Stanley:

Morgan Stanley is planning a reduction of as much as a quarter of its fixed-income staff after years of revenue declines and insufficient returns, according to people with knowledge of the plans. The shares rose.

The cuts will be across all regions and are set to take place in the next two weeks.

There is an intriguing bond market liquidity cause-and-effect story here. On the one hand:

“The available fee pool in fixed income historically was assumed to be about $150 billion to $160 billion,” Mr. Kelleher said. “The last three years it’s been $100 billion or less.”

So banks are cutting back on fixed-income trading because customers are spending less on it. On the other hand:

Some fear that a reduction in overall bank trading will make it harder to buy and sell bonds at a reasonable price and exacerbate market volatility when interest rates move.

So spending less on bond trading might end up making bond trading more expensive. 

Elsewhere, "flat is the new up," says a recruiter in this story about JPMorgan's "roughly unchanged" 2015 bonus pool, and I feel like people have been saying that for so long that it's not the new up any more. Now flat is just the regular up. I guess everyone at Morgan Stanley would take it.

Bribes.

Yesterday ICBC Standard Bank Plc was fined $25.2 million by the U.K. Serious Fraud Office, fined another $4.2 million by the U.S. Securities and Exchange Commission, and made to pay back $7 million to the government of Tanzania, for engaging in a suspicious transaction in Tanzania in 2013. Standard Bank pitched a government bond underwriting (through its "then sister company" Stanbic Bank Tanzania Limited), won a mandate, and then saw the deal stall. And then Bashir Awale, the chief executive officer of Stanbic Tanzania, suggested to Standard Bank's head of global debt capital markets, Florian von Hartig, that maybe they should bring in a local partner to help out Stanbic Tanzania's head of corporate and investment banking, Shose Sinare. Here's von Hartig's SFO interview:

And then Bashir introduced for the first time and I have a very clear recollection of this, very clear, for the first time he introduced the idea of we probably need somebody to help us because Shose alone cannot spend the time needed to get this deal over the finishing line. My initial reaction to this was, first of all I thought it was good, it was a good idea because clearly we have seen up to the point in time about, how much was it from February to September, let's say six or seven months, yeah, where we have tried to make progress. And the deal, we have weekly calls, we were pushing, there was hardly any movement. Admittedly there was a change in Government in May, as I said, yeah, but there was no progress. So I thought actually this is probably a good thing. Shose is a one-man person, was spending, as far as I was aware, a lot of time every day on the phone with the Ministry trying to get meetings, then people were travelling. Anyway the long and short of it is I thought it was a good idea, but also potentially ooze extra confidence in, you know, our ability to execute this deal before the end of the year. People on the ground that, you know, have the technical expertise, have the knowledge of our capital markets, they could support. The second thing I said, and I'm very clear please on this, the second thing I said was if we were to do a transaction with a third party all the time the bank, the bank and banks have third parties, but what you need is a proper KYC and a proper contract in place. Only on that basis can you transact. 

You can probably figure out where that went. The local partner was a firm whose chairman was the Commissioner of the Tanzania Revenue Authority, who played a role in approving the bond deal. The local partner never provided any obvious technical knowledge. The local partner got a fee of $6 million -- paid by Tanzania, not Standard Bank -- for its role in the deal. Which looks a whole lot like a bribe.

But can't you sympathize a little with von Hartig? Investment banking is such a business of relationships. There he was in London, watching his local bankers not getting much done, thinking that maybe what they needed was a local partner with better relationships, better personal knowledge, a better sense of the lay of the land. "You know, have the technical expertise," whatever, but "technical" there doesn't mean, like, bond math. He wanted someone who knew how to get the deal approved. That can lead you into a lot of gray areas, though this case isn't really one of them: Just paying a fee to the official who'd approve the deal is pretty far over the line.

Elsewhere, Sheldon Silver was convicted of taking kickbacks. And:

J.P. Morgan Chase & Co. hired friends and family members of executives at three-quarters of the major Chinese companies it took public in Hong Kong during a decadelong boom in Chinese IPOs, according to a document compiled by the bank as part of a federal bribery investigation.

Cross-selling.

One obvious appeal of the new wave of financial technology companies is specialization: If you build a firm around one specific product that you know well, rather than trying to be all things to all customers, that one product might be simpler and better and less annoying than what's offered by generalist competitors. Obviously there is a counter-argument, which is more or less Wells Fargo:

The bank’s emphasis on cross-selling dates to the tenure of former CEO Dick Kovacevich, who took the helm in 1998 and extolled the practice as a way to boost profits and deepen connections to customers.

In 1999, the bank said its customers on average used three of its products or services—the bank calls them “solutions”—and hoped to increase that number to eight. The goal has remained in place for years, according to the Los Angeles lawsuit, which said it was known internally as the “Gr-eight” initiative.

As cutesy names go, that is ... not gr-eight. Also, notice that lawsuit. Wells Fargo's cross-selling allegedly sometimes went too far, "including opening accounts for people that don’t exist and charging customers for products without permission." Disclosure: I believe that I have only one Wells Fargo solution (a credit card that I don't use much), though I suppose one lesson of that article is that you can never be completely sure.

Bailouts.

Obviously a lot went wrong before, during and after the global financial crisis of 2008, but the way U.S. politics works is that what the Fed did to fix what went wrong is now illegal:

The Federal Reserve took the final step to ensure it can’t repeat the extraordinary measures taken to rescue American International Group Inc. and Bear Stearns Cos. in 2008, adopting formal restrictions on its ability to help failing financial firms.

In the analogy that Tim Geithner likes, this is like seeing a rash of arsons and deciding to ban fire trucks. (To be fair, the Fed is still allowed to do some bailing out, but only "in a broad-based scenario including at least five entities at the same time.")

Fees.

Hahahahaha:

Eclectica is to introduce a 20% performance fee on its Absolute Macro fund and wants the flexibility to reset the high watermark to prevent management being ‘unreasonably penalised’ should the fund’s value fall heavily.

It's a fun one to model. Eclectica effectively gets both a call and a put (sort of) on the fund assets, meaning that it has even more incentive to take risks (and increase volatility) than the average 2-and-20 fund manager. On the other hand, part of the point of resetting the high water mark is to reduce Eclectica's incentive to take silly risks if it ever finds itself 30 percent out of the money: You don't want your hedge fund manager losing 30 percent and then taking it all to the casino because that's the only way to get back into the incentive fees.

Insider trading in out-of-the-money call options.

Nothing here is ever any sort of advice but I will just leave this here for you to ponder:

CBOE tick specifications and limited market depth can make trading out-of-the money equity options prohibitively expensive. Our numerical results show that in most instances an investor with a private signal about an upcoming change in the price of the underlying stock maximizes his profits by acquiring options trading near the money, or by pursuing trading strategies involving more than one security. Solutions closely resemble actual insider trading documented for a sample of SEC litigation cases, offering empirical support for our approach.

Be warned that the paper is mostly about how to catch illegal insider trading. Elsewhere: "We find that enforcing insider trading laws spurs innovation — as measured by patent intensity, scope, impact, generality, and originality." 

Mens rea.

I continue to think that you shouldn't have to go to prison unless prosecutors can prove that you meant to do something wrong, but when you throw in the words "white collar," people tend to disagree. So here is Peter Henning:

The most difficult determination in such a case is finding enough evidence of intent, which is almost always based on circumstantial evidence, like email and other electronic communication, that give a hint about what was going through the defendant’s mind at the time. Ratcheting up that element by furnishing a defense based on ignorance of the law can limit punishment to only those clearly flouting the law. But that change could effectively put prosecutions of corporate executives largely off-limits, at least when they do not have direct involvement in the decision or transaction.

But why should you go to prison for something that you're not directly involved in? Being involved in a crime seems like a pretty minimal standard of criminal liability. I understand that a lot of people just think that senior executives of corporations should be in prison, but the way it normally works is that someone has to commit a crime before we put them in prison. 

People are worried about unicorns.

Here is Will Danoff of Fidelity Contrafund, which "has about $1.4 billion invested in pre-IPO companies":

"There are so many unicorns. It means you have to be more careful than we were three or four years ago," Danoff said in a telephone interview with Reuters. "Maybe we are at a point where it's going to lose a bit of luster." 

Elsewhere, "Equities: US IPOs struggle as investors tire of negative returns," which seems like a reasonable position. 

People are worried about stock buybacks.

My favorite buyback story is Apple, which is by far the biggest buyer of its own stock these days, and which has spent more on buybacks in the last few years than it has spent on research and development in its history. And yet it's fairly well associated with innovation. It's almost as though stock buybacks and technological innovation are not in direct competition with each other.

But here is a Bloomberg Businessweek article about how "Apple Is Getting More Bang for Its R&D Buck" that makes the story even more interesting:

Under Chief Executive Officer Tim Cook, Apple leans heavily on advances made by suppliers, focusing on crucial technology such as semiconductors, according to Ram Mudambi, a business school professor at Temple University in Philadelphia. Apple’s size motivates suppliers to pitch the company their biggest breakthroughs, says Mudambi, who studies successful companies with low research budgets.

The prospect of getting a new chip, screen, or camera flash inside a future iPhone helps Apple steer other companies’ research. 

It's almost as though innovation occurs in a complex ecosystem not driven solely by the R&D budgets of the biggest publicly listed U.S. firms.

People are worried about bond market liquidity.

I mean, they certainly will be after Morgan Stanley lays off all those people. As dealers shift to more of an agency model in fixed income -- using their phones rather than their balance sheets to make trades happen -- you need actual people to work the phones.

Things happen.

Puerto Rico Debt Payment Coming Due. As Puerto Rico Crisis Worsens, Congress In No Rush to Help. Delaware Supreme Court rules against RBC in M&A case. BATS Global Markets Plans 2016 IPO. Mattress Firm Holding Agrees to Buy Sleepy's for $780 Million. US regulators propose powers to scrutinise algo traders’ source code. Trafigura Says It's Winding Down Flagship Commodity Hedge Fund. Private Equity Market Is Expected to Attract $629 Billion in 2015. Express Scripts Covers $1 Alternative to $750 Pill Daraprim. Bank of England Singles Out R.B.S. and Standard Chartered in Tests. In a Global Market for Hacking Talent, Argentines Stand Out. "Extreme Ownership is uniquely depraved—beyond repurposing battlefield tactics for the boardroom, it shamelessly mines a catastrophic war to provide pep talks for sociopaths." Former Goldman programmer accused of insider trading says 'there is a lot of misunderstanding.' To Get More Creative, Become Less Productive. Cheese smuggling. How Energy-Drink Companies Prey on Male Insecurities. The Decline of the Office Holiday Party

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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