Bonds, Plastic and Boiler Rooms

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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People are worried about the bond market. 

What if we actually have a financial crisis driven by the liquidity mismatch between corporate bond mutual funds and their underlying holdings, exacerbated by the inability of banks to buy and sell bonds due to new regulations? I mean, it would be bad, obviously -- crises are bad -- but it would also be kind of amazing. The bond-market-liquidity crisis is the most anticipated crisis since, you know, tech bubbles. Everyone called it! Everyone can go on television and congratulate each other for anticipating the crisis. And yet it is ... still ... happening? The very first time I wrote about bond market liquidity, I wondered how anyone could hold on to the "liquidity illusion" in corporate bonds, given the relentless public worrying about that illusion. But I guess the investors in Third Avenue's Focused Credit Fund were surprised when it went into liquidation? I don't know, though back in 2012 Third Avenue called liquidity worries a "myth."

Anyway, "after junk-bond prices posted their largest drop since 2011 on Friday, investors say they are bracing for another difficult week, likely featuring hectic trading and large splits between buy and sell orders," as credit worries combine with fund closures and the Fed meeting this week to make liquidity challenging. "If it's got any hair on it, it's got no buyer," says a guy. "If the weakness persists until the end of the year, 2015 could become the worst non-recession year for" high yield, says Goldman Sachs. CDX, awkwardly, has been rallying.

In bond funds, Stone Lion Capital Partners suspended redemptions last week, and Lucidus Capital Partners announced today that it "has liquidated its entire portfolio" and will shut down. And David Barse, until recently the chief executive officer of Third Avenue, has "been let go and isn't allowed back in the building," which sends a certain message about the consequences of suspending redemptions. Scott Minerd at Guggenheim Partners predicts contagion, as do Jeffrey Gundlach, Carl Icahn, Bill Gross and Wilbur Ross. "The meltdown in High Yield is just beginning," tweeted Icahn. "A lot of this looks like late 2007 or early 2008," says a guy. Peter Tchir and Stephen Foley are somewhat less worried about contagion spreading from Third Avenue's Focused Credit Fund, which as Foley points out is "very different from mainstream junk bond funds." Here are nine lessons from Mohamed El-Erian at Bloomberg View.

Meanwhile, "the lack of Wall Street dealers on standby to purchase, sell and even research corporate bonds after they’ve been issued means fund managers are increasingly left to their own devices when it comes to handling and trading their vast portfolios of the debt." And of course:

The volatility in junk bond markets spreading across the financial system intensifies a debate already raging between Wall Street and Washington: have post-financial crisis restrictions actually made markets less safe, by curbing the ability of banks to help absorb shocks?

One question is, how happy would you be if you found out that big banks had decided to step in to warehouse risk as junk bond prices plummet? Like, if you're a bond manager, you'd probably be happy, but otherwise? Michael Santoli tweeted that "by curtailing banks' role as risk warehouses, we've made it harder (not impossible) for this wholesale-credit panic to go systemic." 

DowPont.

My favorite slide from the Dow/DuPont merger presentation is slide 12, which has a little map of how Dow and DuPont compete in food packaging:

Dow and DuPont products currently have an uneasy truce in that, like, 60 to 140 microns of packaging thickness. (The "maximum width of a strand of human hair" is 181 microns.) But now they can combine forces and totally dominate the whole 140 microns. Now you can make food packaging with a full-stack DowDuPont solution. Is it an antitrust problem? Maybe? But it somehow feels like a counterargument to the view that mergers are about financial engineering without real-world logic. Doesn't it just seem like the entire thickness of your plastic sandwich wrap should be made by one company? Doesn't it seem like a glitch in the world to have to shop around for it?

Elsewhere, Dan Loeb is apparently happy with the Dow/DuPont deal, but mad that it was signed just before Loeb's standstill with Dow -- which prevented him from criticizing the company publicly -- was set to expire. I don't know how mad it's worth being about that, honestly, but on the other hand this is weird:

“Personally I think it’s almost laughable to say that anyone tried to engineer this date to the expiration of the standstill,” said Raymond Milchovich, one of the two directors Mr. Loeb had nominated a year ago. “There was never any rushing on the part of management or the boards of either company to skip steps along the way.”

The standstill expired this weekend, and the deal was announced on Friday, and even before the deal was announced there were news articles about how Dow and DuPont were trying to get out ahead of activists. It's not laughable to find that coincidence odd. 

Elsewhere, Dow/DuPont is a big deal for boutique banks, might affect the other Dow, is the latest in a big year for all-stock M&A, and might let Dow finally force Warren Buffett to convert his preferred stock -- which pays $255 million in annual dividends -- into common. 

A(n alleged) boiler room.

Oxford City is an actual football (soccer) club, founded in 1882, that plays in the sixth tier of English football. It is also partly owned by a U.S. public company called Oxford City Football Club, Inc., which also purports to own some other sports teams and "a diversified portfolio of academic institutions," presumably because with "Oxford" in your name you might as well capitalize on the possibility that investors might confuse you with the university. Anyway, "Sports Team Offering Is A Penny Stock Fraud," says the Securities and Exchange Commission in this enforcement action, which alleges that the academic stuff was mostly fake, the profitability of the soccer teams was exaggerated, and the whole thing was sold through a really impressive range of boiler-room tactics:

Defendants also coerced numerous individuals to purchase OXFC stock by tricking them into thinking that they had already agreed to purchase the shares when they had not. Throughout the relevant period, Defendants engaged in a scheme to defraud by obtaining investors' personal information over the telephone, such as a date of birth and Social Security number, while pressing buttons on their telephone to give the appearance of the use of a recording device.

One "79-year-old widow" was tricked into believing that she had already agreed to buy shares, tried to not buy the shares, got a threatening e-mail, and:

Five days later, the widow had a heart attack that she attributes to the stress Defendants placed on her, and soon thereafter, liquidated a substantial portion of her stable annuity and gave Defendants $250,000.

High fives all around, good boiler-rooming. Also excellent is the chief executive officer of Oxford City, who "is an author of two self-published books: 'How to Master and Understand Securities Laws and Regulations: A Manual for Series 66 Success' and 'How to Understand and Master the Stock Market: A Manual for Series 7 Success,'" and who "routinely portrayed himself as 'world renowned for being one of the most powerful and influential CEO's in the history of Wall Street.'" The stuff about berating widows into giving you their annuity is not on the Series 66.

Fannie and Freddie.

Gretchen Morgenson continued on the free-Fannie-and-Freddie beat this weekend, arguing that the bailouts of the government-sponsored mortgage entities were much harsher than the bailouts of banks. I'm actually not unsympathetic to the argument that Fannie Mae and Freddie Mac were treated unfairly by the government, and that the Third Amendment of their bailout was excessively harsh. But there is a vein of Fannie/Freddie argumentation that I have never understood. For instance this, from Morgenson: 

But the government’s actions have even hurt its own investment in Fannie and Freddie. Under the terms of the bailout, the Treasury received a large stake in both companies. This stake would rise in value if the companies were allowed to keep their profits and rebuild their capital.

There is a related argument that by refusing to let Fannie and Freddie keep their profits, the government leaves them undercapitalized and so more likely to need a taxpayer bailout. These seem to me like errors of accounting. Fannie and Freddie have businesses. Those businesses produce profits. Treasury can either keep all of those profits, or leave them in the business and give (or sell) them to someone else. It's certainly possible that some outside buyer of Fannie and Freddie would overpay for the companies' future profits, or that an outside buyer would manage the businesses better and produce more profits. But the argument is usually expressed as a simple arithmetic one, that every dollar that Treasury takes from Fannie/Freddie reduces the value of Treasury's investment in Fannie/Freddie (by a dollar). But then Treasury has the dollar! It doesn't just vanish! The value of Treasury's stake in Fannie/Freddie would rise if it left more money in Fannie/Freddie, yes, but on the other hand Treasury would have less money.

FIFA and banks.

Oh man, this is happening:

US prosecutors are threatening to punish banks for failing to report suspicious activity on Fifa-related accounts as part of the sprawling corruption probe into world football’s governing body, people familiar with the case told the Financial Times.

Back in May, I cracked some jokes about this, and we talked a little about the rationale for demanding that banks police the probity of foreign organizations' finances. But still doesn't it seem strange? Like, why not hold FIFA's sponsors responsible for its bribery, instead of its banks? Surely the sponsors were more important in enabling FIFA, and surely the red flags about FIFA have been visible for years not just to banks, but also to sponsors, prosecutors and astronauts in space?

People are worried about swap spreads.

Here's Pimco on "The Repo Market, Swap Spreads and Shrinking Balance Sheets."

People are worried about bond market liquidity.

Obviously!

Things happen.

The Securities and Exchange Commission proposed "a new rule designed to enhance the regulation of the use of derivatives by registered investment companies, including mutual funds, exchange-traded funds (ETFs) and closed-end funds." Argentina's Prat-Gay Unveils Team, Promises Tough Holdout Talks. Some Yahoo investors are still not happy with Marissa Mayer. BTG Avoids Fire Sale as $1.5 Billion Credit Line Buys Time. Jon Hilsenrath: Fed Officials Worry Interest Rates Will Go Up, Only to Come Back Down. Matt Klein on demographics and valuations. "Jesse Livermore" on backtesting. CFTC quizzes clearing banks over leverage-cutting tactic. Bank of England Says Lenders Must Issue Additional Debt Under New Rules. England Closes Its Last Deep-Pit Coal Mine. "Those who do both would tell you that trading and [sports] officiating have a lot in common." "If Mark truly wanted to save the world, he would have given away all his money, and then borrowed more money from someone else and given away all their money." Crystal Pepsi is back. "It's a dog show, so you gotta show."

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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