Junk Bonds, Yahoo and Lies

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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Junk.

Some things, like banks, but also apparently like open-ended high-yield bond funds, are subject to runs, in which investors rush to get their money out before all the money is gone. If you manage a runnable thing that gets into trouble, there are two key goals:

  1. If a run can be avoided, you have to avoid it. This means putting on a brave face, assuring people that things are good, and giving people their money back in full if they ask for it.
  2. If a run can't be avoided, you have to face up to it. This means shutting the doors, liquidating in an orderly fashion, and giving everyone (as much as possible of) their money back at the same time, rather than paying out investors first-come first-serve.

This is basic stuff -- at least as old as Bagehot -- but the tensions between those two goals is obvious. It's basically impossible to identify the point at which a run tips over from avoidable to inevitable. Anyone who shuts down a fund can be criticized for shutting it down too early, and preventing investors from redeeming even though they really should have been allowed to redeem, or for shutting it down too late, and letting investors take their money out even at the expense of investors who remained behind.

Poor Third Avenue decided to liquidate its Focused Credit Fund last week, and Massachusetts Secretary of the Commonwealth William Galvin is getting it both ways:

Galvin, who took on big Wall Street banks in the wake of the subprime mortgage crisis, said he sent a subpoena to New York-based Third Avenue and wants to know more about the timing of the decision to liquidate the fund.

On the one hand, he wonders, "Were some investors aware of the decision before others?" If so, the favored investors might have been able to take money out of a doomed fund at the expense of others who remained behind. (Do mutual fund managers really have favored investors?) On the other hand, he seems aggrieved that Third Avenue shut the fund at all:

“Investors have been seeking yield in the current low interest rate environment and junk bond funds have offered an alternative,” Mr. Galvin said, “but average investors do not expect to be cut off from trading.” He added that his office is opening the investigation to determine the impact on Massachusetts investors.

Man, if you run a mutual fund, try not to suspend redemptions; no one likes that. The Securities and Exchange Commission is also looking into Third Avenue's approach, which seems not to have been wholly conventional:

The Wall Street Journal reported Monday that Third Avenue paid out all redemption requests through Dec. 8, the night before it closed the fund; it then transferred all of its investments to a liquidating trust, which issued interests to be distributed to shareholders in the now-defunct fund.

Third Avenue made the argument to SEC officials that the distribution of the shares in the trust would count as a full redemption, meaning the fund wouldn’t legally have halted distributions.

That seems like the right approach to me, and if it's not allowed by the rules then it should be, but again no one seems happy with Third Avenue right now.

Elsewhere: "Third Avenue Portends Regulators' Fears and Could Spur New Rules." "Third Avenue Sought Internal Loan Approval Before Fund Shut." "Why High-Yield Debt Selloff Isn't 2007 All Over Again. Or Is It?" "Five Mind-Blowing Stats from the Selloff in the Biggest Junk Bond ETF." And "there are signs across Wall Street that investors are losing confidence in lower-quality bonds and the firms that most actively deal in them."

Yahoo?!?

There are two ways to look at Yahoo. Either it is a massive Internet business that has fallen on hard times but that can be, with tenderness and care and vision, revived into a behemoth that competes with Google and Facebook -- or it is a pile of Alibaba shares that are locked up in a corporate structure with lots of unrealized gains but that can be, with tenderness and care and financial engineering, extracted in a tax-efficient manner. Either way, you need tenderness and care, so it seems to me that you have to choose: If you focus on reviving the Internet business, you will probably be a bit blundery with the tax optimization, and vice versa. I'm team tax optimization, but then, I would be. 

Part of the charm of this Yahoo presentation by SpringOwl, a small activist hedge fund, is that it fully embraces both options. It endorses both a "real turnaround of the Core with new management and a new board to create $20 - $30/share in value for current shareholders," and bringing in "someone like a Liberty Media" to figure out how to do the tax stuff right. But the presentation is more generally full of charm, criticizing Yahoo for destroying value via acquisitions and underwater stock buybacks (slides 36-37), and then recommending spending $10 billion on additional buybacks (slide 83). If you keep doing buybacks, they eventually have to work.

Here is my Bloomberg View colleague Justin Fox on SpringOwl's recommendations, and here is Andrew Ross Sorkin on Marissa Mayer's responsibility for Yahoo's current state. Canyon Capital Advisors, another Yahoo investor, is impatient. And "Tech Startups Long for the Days of Yahoo’s Binge Acquisitions."

Lying in politics.

Here's an amazing little anecdote about the 2012 election, in which Karl Rove's super-PAC raised a "surge" of cash from big Republican donors:

A few days after the election, New York hedge-fund manager Daniel Loeb, who’d helped finance Rove’s surge, tried to sue Crossroads and Fox News for misrepresenting the facts. “Loeb felt this was like an investment bank committing fraud on a road show,” a friend of his told me. After conferring with a securities lawyer, Loeb discovered that there are no investor protections in politics. He never filed a suit. (And Loeb declined to comment.)

You can see why he'd be confused. "The business model of Wall Street is fraud," says Bernie Sanders, but in fact, on Wall Street fraud is at least nominally illegal. In Loeb's world, lying to people to raise money is frowned upon, and if you do it you get in trouble. In politics, lying is legal, common and encouraged, and consequences for lying are unheard-of. "All Politicians Lie. Some Lie More Than Others," goes a recent New York Times op-ed headline, and Sanders himself comes off looking like a paragon of relative honesty because only 28 percent of his fact-checked statements are "mostly false" or worse. (Ben Carson is at 84 percent.) Imagine if 28 percent of a mortgage-backed securities prospectus was "mostly false." 

Elsewhere, Senator "Bob Corker failed to properly disclose millions of dollars in income from real estate, hedge funds and other investments since entering the Senate in 2007." And Donald Trump's doctor says that Trump's "physical strength and stamina are extraordinary," his lab tests are "astonishingly excellent," and he "will be the healthiest individual ever elected to the presidency," all of which might even be true but is in any case amazing.

Best execution.

One much-discussed scam, or potential scam, in high-frequency trading has to do with the "SIP," the "securities information processor," which provides a relatively slow consolidated feed of stock prices on all the U.S. stock exchanges. The notional scam is that bad actors -- brokers, internalizers, dark pools -- subscribe to faster direct feeds from the individual stock exchanges, find out when the direct-feed price is different from the SIP price, and then trade against their customers at the stale SIP price whenever it is more favorable to the brokers. So if the SIP still says that a stock is trading at $40.00, but you know that it's now trading at $40.01, you buy from your customers at $40.00, knowing that you've got an automatic profit. This is a form of "latency arbitrage," and is perhaps legal because the SIP provides, as it were, the official view of the national best bid and offer, and brokers are expected to trade at the national best bid or offer. On the other hand, if you are knowingly doing a lot of this, it fits awkwardly with your obligation to provide customers "best execution," since you are knowingly giving them a not-quite-the-best execution. 

How often this happens, and how worked up you should get about it, are open questions, but the weirdly open question has for a while been whether it complies with brokers' "best execution" obligations. You'd think regulators would just have an answer for that, but they haven't really. Now they do

The Financial Industry Regulatory Authority, Wall Street’s self-regulator, recently said firms using the fastest, most expansive price databases for their own stock trading must also use those so-called direct feeds when handling client orders. That means they can’t just rely on the decades-old repository known as the SIP -- which gives a slower view of trading that critics say exposes investors to predators.

“If you’re a firm that has the proprietary feeds, you can no longer execute and say, ‘Hey, I got you guys the SIP price, everything is good,’ which is how a lot of things have historically worked,” says a guy. 

Happy Fed meeting!

The Fed meeting begins today, and tomorrow it announces its decision on whether to raise interest rates. In the lead-up to the last Fed announcement I galloped around reciting the St. Crispin's Day speech to rally everyone, and the Fed didn't raise, so now I've got nothing, even though it's "widely expected" to raise this time. Once more unto the breach I guess. Here is Bloomberg's preview of "What the Fed Will Be Watching to See If Liftoff Worked." Here is Robin Wigglesworth's explanation of "How the US Federal Reserve intends to raise rates." Here is Matt Klein on parallels between now and 1997-1998. Here is Alexandra Scaggs on "The Bizarre Theory That Says Fed Increases Will Spur Inflation." "Some large U.S. banks are revamping short-term trading desks that have languished in recent years, anticipating that a Federal Reserve rate increase this week will unleash a flood of activity." And here is a story about dollar bills that trade above their face value, which seems sort of deflationary. Or maybe it is a story about how even a $1 bill costs $114.99 these days, which would be inflationary?

People are worried about unicorns.

Gilt Groupe, which achieved unicorn status in 2011, "is close to selling itself for a fraction of the value placed on it by investors four years ago, the latest sign private companies are struggling to live up to once-soaring valuations." Specifically, Hudson's Bay Co. is looking to buy it for about $250 million, making it only a quadranticorn, or perhaps a demisemicorn, or in any case a unicorpse. I'm not sure anyone ever understood the deals-site business model, so perhaps Gilt's fall from unicornity is not a harbinger for the current crop of unicorns, but now you can buy canned unicorn meat online. 

Elsewhere, "Seeking Alpha Now Covers Unicorns!" And The Information has a new database of deal terms (valuations, anti-dilution protections, etc.) for a bunch of big private tech firms. 

People are worried about stock buybacks.

SpringOwl is, at least, though its solution is more stock buybacks.

People are worried about bond market liquidity.

Certainly all the regulators sniffing around Third Avenue are. Meanwhile in Germany, "Zittern vor dem Bond-Tsunami."

People are worried about non-GAAP financial measures.

This sort of worry seems to me to bespeak a troubling lack of faith in the efficiency of markets, but anyway, here it is again.

Things happen.

Former Wall St titans shake-up banking with fintech investments. Newell Turns Franklin's Worthless Award Into $133 Million. South Africa gets third finance minister in 5 days. Craft Brewers Have to Compete for Beer Cans. "The financial advice industry is among the least diverse in the country." New York Attorney Found Guilty In Manhattan Federal Court Of Fraud In Connection With A Scheme To Purchase Maxim Magazine. Mark Roe on bondholder voting. "Fundamentally, immigration doesn't determine how many jobs are available for native-born workers. The Federal Reserve does." Sweet potato fire. Mule trader. American Pharoah responds to his Sports Illustrated 'Sportsperson of the Year' snub.

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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