Money Stuff

Mortgage Fraud and Growing Worries

Also hedge funds, Argentina, market structure, Shkreli, and the return of people are worried about swap spreads.

Morgan Stanley.

Modern psychology has not, I think, fully come to grips with the death drive in financial e-mails. People know they are not supposed to mention illegal stuff in their e-mails and instant messages and chat rooms and recorded phone calls. You can tell because, when they mention the illegal stuff in those electronically preserved records, they regularly also mention the fact that they're not supposed to mention it. What are they thinking? If you say illegal stuff in an e-mail at a bank, there is a good chance that it will end up quoted in a multibillion-dollar settlement, but if the same e-mail also discusses how you shouldn't put the illegal stuff that you just put in writing, in writing, then your chances increase dramatically. Like this person:

In a May 31, 2006 email, the head of Morgan Stanley’s team tasked with doing due diligence on the value of properties underlying the mortgage loans asked a colleague, “please do not mention the ‘slightly higher risk tolerance’ in these communications. We are running under the radar and do not want to document these types of things.”

Where do you think the radar is? The radar is an e-mail search program that looks for phrases like "we are running under the radar." I have to believe that at some deep unconscious level this person wanted to get caught.

Anyway, the point here is that Morgan Stanley sold some residential mortgage-backed securities with a, shall we say, "slightly higher risk tolerance" than it advertised, those bonds went bad, there was a financial crisis, eight years passed, and now Morgan Stanley has settled with the Justice Department for $2.6 billion, New York for $550 million and Illinois for $22.5 million. With previous settlements, "Morgan Stanley will have paid nearly $5 billion to members of the RMBS Working Group in connection with its sale of RMBS." Here are the Justice Department settlement and statement of facts, though I assume that all of the funniest e-mails are quoted in New York Attorney General Eric Schneiderman's announcement

People are worried about everything.

I know I said I wouldn't make this a recurring section; it is too depressing. But just quickly:

  • People are worried about negative interest rates. Scott Mather at Pimco: They "may pose more risk to the financial system than commonly understood." Tyler Cowen: "They're a sign that economies are trying to solve their core problems on the cheap." And here are "Four Legal Questions the Fed Would Face If it Decided to Go Negative."
  • People are worried about banks, which are apparently in a "doom loop." On the bright side, though, Jamie Dimon "spent $26.6 million to buy shares of his bank Thursday after they tumbled to the lowest price in more than two years," some hedge funds are buying European bank stocks, and Pimco "reckons investor concerns about banks are overblown" and is buying bank bonds. 
  • People are worried about oil. International Petroleum Week was a grim affair; Bloomberg's headline is "The Oil Industry Got Together and Agreed Things May Never Get Better." And here is a Bloomberg Businessweek cover story about the connection between oil prices and the stock market; don't miss the cover illustration of a man in a suit doing something to an oil barrel that you probably shouldn't do to an oil barrel. (There's a Valentine's Day theme generally; the last paragraph quotes Barry White.) Reader Matt Lorig e-mailed to ponder whether the rising oil/stocks correlation may be due to algorithms based on historical correlations -- "Like once the correlation between equities and oil makes it into the code of a number of firms, it becomes a self-fulfilling prophecy." Maybe? I think of the Nevsky Capital letter arguing that "In such a world dominated by index and algorithmic funds historically logical correlations between different asset classes can remain in place long after they have ceased to be logical." Or the correlation could be perfectly logical; it could just be a worry about credit contagion, for instance: "Struggling oil and gas companies are maxing out revolving credit lines typically used to cover short-term funding gaps, raising fresh concerns about banks’ exposure to the decline in energy prices."
  • People are worried about credit generally, with UBS strategists arguing that "Yields would need to rise to 20 percent to 25 percent to lure investors into even the lowest rungs of junk debt outside of the commodities sector."
  • People are worried that all of the market turmoil is a leading indicator of recession, or perhaps a cause of recession.
  • John Authers is worried about twelve whole things, not all of which are on this list.
  • Gawker is worried about the imminent collapse of the capitalist system that sustains it and that it secretly loves.
  • People are not worried about gold, gold is "up nearly 18% in 2016," buy gold.

And this is all in addition to a pretty full slate of the recurring worries down below. (Even swap spreads!) Be safe out there today everyone.

Hedge funds.

In real hedge funds, it's mostly pretty grim. "Hedge funds recorded net investor capital outflows for the first time since 2011 in the fourth quarter amid market volatility." "Shares of Och-Ziff Capital Management Group LLC, the publicly traded hedge fund led by Daniel Och, lost more than a quarter of their value Thursday and hit a record low after the firm said assets declined and legal costs are likely to continue even after U.S. authorities resolve an ongoing investigation." And here is a claim that "You Are a Better Investor Than Bill Ackman," though I am probably not. In a bit of activist success, Carl Icahn and John Paulson won seats on AIG's board of directors, though Icahn is too busy to sit in his and gave it to one of his analysts. (Paulson, meanwhile, "would consider moving" to Puerto Rico "as he finds the lifestyle very attractive.")

In the ... junior-varsity hedge fund division ... here is a New York Times story about a congressman, Alan Grayson, who runs a hedge fund with $16.4 million in assets and, at its peak, four investors, two of whom are Grayson and a family trust. The other two were outside investors, but Grayson has "refunded the full original investments put in by his two outside investors in a fund that had faced steep losses," which you probably can't do if you run a real hedge fund. 

Elsewhere, here is a Finra action against two brokers "for fraud in connection with the sale of a hedge fund, the Prestige Wealth Management Fund, LP," and if you are selling hedge funds for their "prestige" you are going to end up in a Finra enforcement action. And here is a Securities and Exchange Commission action against a man who allegedly, as the headline irresistibly puts it, "Sold Investors Phony Stock to Pay Gambling Debts." The SEC complaint doesn't break down how much of the $1.9 million he allegedly took went to gambling debts; I assume in cases like this probably like a thousand bucks went to gambling debts but the SEC chose the silliest use of funds for its headline.


The pari passu injunction from New York federal judge Thomas Griesa that prevents Argentina from paying its post-2001 exchange bondholders is not a matter of eternal verities. Judge Griesa got mad at Argentina for stiffing its pre-2001 creditors, so he issued the injunction. But the injunction is an equitable remedy, and if the equities shift Argentina's way -- say, if Judge Griesa concludes that Argentina is willing to pay its pre-2001 holdout creditors the full face amount of their bonds plus a reasonable amount of interest, while those creditors are holding out for an unreasonable amount of interest -- then he can always drop the injunction. Similarly, if Argentina reaches a settlement with the holdout creditors who currently have an injunction, and some new holdout creditors come in to demand a copycat injunction to prevent Argentina from paying the first set of holdouts until the copycats get paid even more, no mandatory feature of the law requires Judge Griesa to give the copycats their own injunction. It is all pretty loose. In any case, "representatives of newly seated President Mauricio Macri used a settlement with some holdout creditors to urge U.S. District Judge Thomas Griesa on Thursday to drop orders barring it from paying holders of its new debt before it pays on bonds Argentina repudiated in 2001," and "Griesa ordered the holdouts to file papers responding to Argentina’s request by Feb. 16."

Market structure.

In Money Stuff yesterday I said that "I seem to be losing the fight against semantic drift in the term 'front-running,'" which (I thought) used to mean a broker's breach of fiduciary duty by trading ahead of his customers, but which now seems to mean anyone's trading ahead of anyone else. Reader Bill Bremse pointed out by e-mail that some form of the second sense has been in respectable use for quite a long time, including by Larry Harris in the 1990s. I am not sure there is any higher authority on market-structure usage than Larry Harris, so I will cheerfully confess error on this one. "Front-running" can indeed mean something other than an illegal fiduciary violation, though at least Harris seems to have used it to mean trading ahead of exposed limit orders, not racing to trade on one exchange after seeing executions on the other. Though I don't know how much that was a thing in the 1990s.

Elsewhere in market structure, Bats Global Markets now opposes IEX's application to become a stock exchange:

"IEX has repeatedly demonstrated, through its public misstatements, its public relations campaign and its reckless misrepresentations to the SEC and the public, an inability to satisfy the basic tenets of being a national securities exchange," Bats, which had expressed support for IEX’s application as recently as December, wrote in the letter.


Yesterday former pharmaceutical executive, current securities-fraud defendant and perennial online performance artist Martin Shkreli offered to buy Kanye West's new album for $10 million to prevent it from being released publicly. Shkreli infamously bought a Wu-Tang Clan album for $2 million, so he is repeating himself a little, but he has refined the performance by releasing a silly little letter to West in which he says that the "offer is not subject to a financing condition and I have discussed this offer with several investment banks and counsel which would assist me in this acquisition." I assume this is a joke, but imagine if it was true? Imagine being the banker who gets that call. Imagine the due diligence and know-your-customer work you'd have to do. Imagine negotiating the collateral for the financing. (You'd want your negative-pledge clause to explicitly prohibit Shkreli from pledging the new album to secure his bail, right?) Imagine writing up the committee memo and then going to your lending committee to explain why your bank should finance this particular deal. Imagine the looks on the committee members' faces. (In my version of this fantasy, the committee members are a humorless bunch, and not fans of rap or Twitter.) Imagine drafting a commitment letter, or maybe a "highly confident letter," that Shkreli could tweet to show his financial capacity to buy the album. None of this is happening, of course, but investment banking would be more fun if it was.

Shkreli continued the joke by tweeting that "Kanye and his label are legally required to take my offer letter to their Board of Directors"; again, I assume he is kidding, and I don't presume to give Kanye West or anyone else legal advice, but I am pretty sure that's not how Revlon duties would work even if the album was a public company. (Which it isn't; it's an album.) Like if Martin Shkreli tweeted a one-page letter at Mark Zuckerberg offering to buy Facebook for $400 billion, Zuckerberg could probably just block him on Twitter without bothering Facebook's board.

People are worried about swap spreads.

Here is David Keohane on a Citi research note from Matt King, who worries that negative swap spreads, along with "a sharp move negative in the cash-CDS basis (i.e. underperformance of cash bonds vs derivatives), and another move negative in the index skew to intrinsics (i.e. underperformance of single-name CDS relative to traded indices)," indicate something wrong with the plumbing of the financial system, as an increased cost of leverage makes it harder for markets to arbitrage away distortions:

If investors cannot rely upon relationships which previously mean-reverted in a regular fashion, not only will they be more cautious about intervening when dislocations occur; they must try pre-emptively to guard their portfolios against such dislocations in the first place.

And the real economy may be affected by weirdness in swap spreads, not just by higher debt costs:

Instead, it is something more pernicious: an erosion of the confidence issuers and investors alike can have in the durability of the market levels they see on screen. When traditional relative value frameworks fail to hold, and when dislocations can appear out of nowhere and then, just as abruptly, disappear to nowhere, it is likely to make everyone more risk-averse – not only in their investments in markets, but also in their activity in the real economy. There is evidence that it is the fear of drops in asset prices, not the fear of deflation per se, which is damaging to growth.

People are worried about unicorns.

Is occupational licensing mostly about rent-seeking by incumbents who try to restrict competition from new entrants in their industry, or is it mostly about the regulatory need to protect consumers from underqualified providers? One way to check is that if the licensing requirements are clearly tailored to actually ensuring that providers are qualified and consumers are safe, then they might be about consumer protection. If the licensing requirements are mostly about accumulating hours and paying for training, rather than about acquiring relevant knowledge, then that looks like protectionism.

Of course a lot of startups are in the business of disrupting protected incumbent industries, and in a move-fast-and-break-the-law sort of way. So it is not entirely surprising that employee-benefits unicorn Zenefits developed a program that was basically Uber, but for cheating on California insurance-broker licensing requirements:

Many of our California sales representatives received access to a software tool called a “Macro” that may have allowed them to complete mandatory online pre-licensing education courses offered by a third-party test preparation provider in less than the legally required 52 total hours. The Macro functioned to keep a person logged into the course and prevented the person from being logged out for inactivity. The Macro did not advance through the required material or quizzes in the education course — the Macro only kept the person logged in. The Macro only pertained to the prelicensing education course and did not affect the broker exam taken later. Use of the Macro enabled — but did not cause — a person to spend less than the 52 hours of required time in the prelicensing course.

I mean, obviously you are not supposed to do that; bad work, Zenefits! On the other hand, what is the point of a licensing requirement that, in addition to requiring a body of knowledge for insurance brokers (measured by quizzes and a broker exam), also requires 52 hours of sitting at a computer and clicking? What harm was done to California businesses by Zenefits insurance salespeople who hadn't done the requisite amount of clicking? The appeal of technology is that it automates processes that once were done unhappily by humans; surely a computer can click through a pointless prelicensing course more efficiently than a human can.

Elsewhere: "Inside How Mutual Funds Value Private Tech." And you might be getting a dollar back from an Uber class-action lawsuit

People are worried about stock buybacks.

Miriam Gottfried at the Wall Street Journal worries that Amazon's potential $5 billion buyback "may have a whiff of desperation," because it might signal a shift away from investment in top-line growth.

People are worried about bond market liquidity.

That Matt King note is about bond market liquidity as well as swap spreads: "With dealers’ (and hedge funds’) previous ability to act as at least a temporary buffer having been all but completely curtailed by a combination of the Volcker Rule, leverage ratio, and repo constraints, markets feel much more one-sided than previously." Elsewhere: "Volcker rule didn't dry corporate bond liquidity, research says." And here are two more installments in the New York Fed's Liberty Street Economics liquidity series, "Is Treasury Market Liquidity Becoming More Concentrated?" (apparently not) and "Primary Dealer Participation in the Secondary U.S. Treasury Market" (still a lot of it).

Things happen.

With Shares Plunging, Deutsche Bank Sets Out to Prove It Can Be Fixed. Britain Eyes Switzerland’s Arms-Length Relationship With Europe. Goldman Sachs Bankers Said to Depart on Guidelines Breach. Bill Gross rivalry with Pimco hinges on US economic performance. Tangled: Minority Shareholders Wage Legal Battle Over Euro Disney. Boeing to Face SEC Probe of Dreamliner and 747 Accounting. Pandora Is Said to Have Held Talks About Selling Itself. Banks vs. patent trolls. Zuckerberg's Land Deal Feud Digs Up Developer's EBay Alias. Gravitational Waves Detected, Confirming Einstein’s Theory. Turkey media critic. Millennials quit. Congressman vapes. Caity Weaver interviews Justin Bieber.

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