Sovereign Debt and Stock Bonuses

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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Sovereign debt.

Yesterday the main holdout bondholders in Argentina's debt drama, led by NML Capital and Aurelius Capital, "roundly rejected Argentina’s attempt to remove a financial blockade that is preventing its access to international capital markets" in this filing with U.S. District Judge Thomas Griesa. On the one hand NML and Aurelius are probably right that it's a bit premature to lift the injunction against Argentina, which after all is the only leverage they have in negotiations:

Representatives of President Macri's administration first discussed the terms of a potential settlement with the Lead Plaintiffs on February 1 for about two hours, and last met with that group, plus the Varela Plaintiffs, on February 4, for 20 minutes. On February 5, rather than continue negotiations, Argentina went public with an ambiguous tender offer for the defaulted bonds. 

The injunction has now been in place for as long as four years, depending how you count, and the dispute has been going on for over a decade; the holdouts should probably get more than a couple of hours of negotiations with the new government before losing all their leverage. On the other hand, the holdouts' position here is pretty much that no matter how generous the court thinks Argentina's offer is, the holdouts are entitled to 100 percent of their principal and interest, and if they aren't satisfied with the offer they can say no and keep their injunction:

The purpose of the Injunctions is not, as Argentina would have it, to compel Argentina to negotiate. Rather, as the Second Circuit held, the Injunctions are "intended to remedy Argentina's breach of the equal treatment obligation in the FAA." It should go without saying that Argentina's requested order to permit it to resume violations of the equal treatment obligation is contrary to the purposes of the Injunctions as found by the Second Circuit.

(Citation omitted.) This does not strike me as super sympathetic, and I feel like at some point if Judge Griesa is satisfied with Argentina's offer he can tell the holdouts to take it or leave it. We probably aren't there yet, but we're getting closer.

Elsewhere in sovereign-debt news, "Russia said it filed a lawsuit against Ukraine in the High Court in London after the government in Kiev defaulted on $3 billion in bonds." Russia had had the option of seeking private arbitration rather than a public lawsuit, but "the fact that they are taking this to the High Court shows that the Russians think they are going to win," says an expert.

That's a little counterintuitive: In the high court of my heart, "well umm you invaded us" would be a decisive defense to a lawsuit over nonpayment of debt. But I guess it is a real achievement of modern civilization -- of compartmentalization and predictability and abstraction -- that that isn't a defense, that a court considering how much money Ukraine owes Russia won't necessarily worry about the fact that Russia invaded Ukraine. Sometimes fairness matters in sovereign-debt fights, but often it doesn't; often courts prioritize the mechanical application of contracts and rules, because in the long run that will get results that are more predictable and efficient than making ad-hoc decisions about fairness. Even when the ad-hoc fairness decisions seem pretty obvious. "Anyway, it’s worth being reminded every so often that in the higher consciousness of the bourgeoisie, nations and all other social arrangements exist only in order to generate payments to owners of financial assets," writes J.W. Mason.

Bank compensation.

Obviously the purpose of paying bankers in stock that they have to hold for several years is that if they make bad decisions, the stock will go down and they will be punished for those decisions. Even if the decisions take a while to come to light, they'll still be holding the stock, and the decisions will still come back to bite them. Still the recent plunge is maybe a little arbitrary:

Employees at Goldman Sachs Group Inc. have been hit with nearly half a billion dollars in paper losses thanks to a plunge in the value of stock bonuses paid out early last year, according to a Wall Street Journal analysis.

For most of those employees, it would probably be tough to point to any particular bad decision that they made that caused the drop in their stock bonuses. It's more like, just, the markets are re-rating expectations about the future value of the business, so those bonuses are worth less than everyone thought. But there's an efficiency benefit to that too:

If the recent bank-share slump persists, technology firms and other industries may find it easier to recruit bankers away from what some see as a politically battered industry.

Fewer bankers today are saying, “ ‘Oh, I could never leave here, look how much money I’d be leaving on the table,’ ” said Stacy Stevens, president of recruiting firm Park Avenue Group.

A capitalist society uses the price mechanism to allocate resources. Right now it's telling some of those resources to flee to Silicon Valley.

In cheerier news, Mike Corbat got a raise. And in the junior ranks, "Credit Suisse will establish a fast-track programme for top-performing investment banking juniors," with a five-and-a-half-year minimum time from new analyst to new vice president. I topped out as a vice president in investment banking, and while the title wasn't particularly impressive even then, I will be a little sad when investment banks start awarding it to summer interns as a courtesy. Anyway I assume that titles are a cheaper form of compensation than cash, or even stock, and also that sticking around for six and a half years to become an investment-bank VP doesn't have the same appeal that it used to.

Smart beta etc.

Money Stuff yesterday contained a little discussion of the vanishing distinction between alpha and beta as more risk factors are discovered and systematized and made investable. On Twitter, Sid Prabhu pointed me to this wonderful passage by John Cochrane: 

I tried telling a hedge fund manager, “You don’t have alpha. Your returns can be replicated with a value-growth, momentum, currency and term carry, and short-vol strategy.” He said, “‘Exotic beta’ is my alpha. I understand those systematic factors and know how to trade them. My clients don’t.” He has a point. How many investors have even thought through their exposures to carry-trade or short-volatility “systematic risks,” let alone have the ability to program computers to execute such strategies as “passive,” mechanical investments? To an investor who has not heard of it and holds the market index, a new factor is alpha. And that alpha has nothing to do with informational inefficiency.

Most active management and performance evaluation today just is not well described by the alpha–beta, information-systematic, selection-style split anymore. There is no “alpha.” There is just beta you understand and beta you do not understand, and beta you are positioned to buy versus beta you are already exposed to and should sell.

Cliff Asness has also often written in a related vein. In general it is not much help to say that a manager adds, or doesn't add, alpha against some list of risk factors if those risk factors are not something that you can understand and replicate. If a manager invests your money and it goes up a lot and doesn't go down very often, that is good, regardless of how you decompose it into alphas and betas. On the other hand, once you can replicate a particular manager with a computer, the prices he charges probably have to go down.

Elsewhere in hedge-fund replication, "Goldman Sachs has just filed for a new ETF called the Goldman Sachs Hedge Fund VIP ETF, which is based on its popular 'Hedge Fund Trend Monitor' research report." And elsewhere in hedge funds, here are two items out of Citadel in unavoidably ironic juxtaposition: It is getting "rid of more than a dozen analysts and portfolio managers" in its Surveyor Capital long-short equities business after underperformance this year, and its founder Ken Griffin "recently paid $500 million for 'Number 17A,' a Jackson Pollock painting, and 'Interchanged' by Willem de Kooning." Whenever hedge-fund managers describe themselves as value-oriented and contrarian, I wonder about the prices of Abstract Expressionism. You could buy like 100 Velazquezes with that money! I guess a Pollock looks good hanging over a couch, but it is weird.

Tracking error.

Here's a lovely story about securities lending. The headline is "Hedge Funds Will Pay for You to Own Small-Cap ETFs." This is true. Small-cap exchange-traded funds track small-cap indexes. They own the stocks in the indexes, and charge (small) fees and have (low) costs, so the ETFs should in theory slightly underperform the indexes. But they also lend out the shares that they own to short sellers and get paid for it:

In some cases, an ETF has securities in its portfolio that are in such high demand from short sellers that the lending fees add up to more than the fund's expense ratio—so the ETF not only makes up its fees but also pushes returns above those of the index.

Should you feel good about this, if you invest in those ETFs? The answer is "compared to what?" You are beating the relevant index, so that is good. On the other hand, there is a reason all those hedge funds are paying so much to short the stocks those ETFs own: They think the stocks will go down. Recently they have been right: "Small-cap ETFs are down more than 17 percent in the past year, so why care about being paid a few extra basis points to own such lousy performers?" You got paid, like, 0.03 to 0.21 percent to own a thing that went down 17 percent. Good job!

It strikes me that this is the deep story behind a lot of financial-services marketing. The trick is to find a benchmark against which your thing looks good, and then get customers to anchor on that benchmark. Imagine going to investors with this proposition: I will buy a collection of horrible stocks, and then I will lend them out to short sellers, so you will get the performance of the horrible stocks, plus a few basis points in stock-lending fees. I could call it the Horrible But Enhanced Yield Fund. No one would buy it. But once it's an index ...

Central banking.

One classic reason to own gold is as a hedge against inflation. If you don't trust central banks and think that low interest rates and unconventional monetary policy will lead to hyperinflation, sure, load up on gold. But in the modern world in which many developed-economy central banks are fighting deflationary pressures with negative interest rates, you should ... obviously load up on gold:

“Leave a million dollars with a bank, and in a year, you get only something like $990,000 back,” Marc Faber, the publisher of the Gloom, Boom & Doom Report, said by phone. “I would rather want to own some solid currency, in other words gold.”

Incidentally that argument only works for rates below zero: Most of the time (even now!), if you leave a million dollars with a bank, in a year you'll get back something like $1,010,000, but if you leave a pound of gold in a vault, in a year you'll only ever get back your pound of gold. "You can fondle the cube, but it will not respond."

Gold is a popular hedge against the collapse of the modern financial system, but for the truly gloomy, boomy and doomy, it is not pessimistic enough. After all, if there is such a collapse, gold might be a more "solid currency" than dollars, but what if the whole concept of currency is destroyed along with the rest of the financial system? The only real hedges against total collapse are isolated farmland, guns and ammunition. I do not know what to tell you about the fact that "the National Bank of Hungary bought 200,000 rounds of live ammunition and 112 handguns for its security company." Perhaps it is a hedge.

Elsewhere in central-bank hedging, the Swiss National Bank owns a lot of gold-miner stocks. Further afield, here is Ray Dalio on "Monetary Policy 3." And here is a cartoon about negative interest rates.

Shareholder value.

Here is a fun paper by Paul Weitzel and Zachariah Rodgers on "Broad Shareholder Value and the Inevitable Role of Conscience," arguing "that shareholder wealth maximization is based upon a faulty premise: that shareholders value only profits." Every time I write about, like, tax inversions or whatever, someone will e-mail and point out that corporate managers have a fiduciary duty to their shareholders to maximize profits and minimize taxes. A fun fact is that that's not true. Corporate managers have no duty to maximize profits. That duty is a pure myth, but a foundational myth for our modern age of financial capitalism. Anyway, sure, you can be a loyal servant of your shareholders while valuing things other than profits.

Elsewhere, here is the "Rise of the Reluctant Activist," because there's a limit, and eventually shareholders do want profits. And the Delaware Court of Chancery "held that directors of companies without a classified board (i.e., boards that are elected annually) can be removed without cause, irrespective of provisions in the charter or bylaws purporting to permit removal of directors only for cause," which kind of has to be right if you think about it.


Here is Mike Konczal on why cost-benefit analysis of financial regulations is a bad idea. I had vaguely assumed that people who were calling for cost-benefit analysis of financial regulations were mostly just stalling and trying to weaken regulation, but I also figured that the cost-benefit analysis would nonetheless be in some abstract marginal way a good idea. I think Konczal has more or less changed my mind:

The financial system is "constructed" through economic rules in a way more "natural" systems of health and environment are not. Since the effects of financial regulations are determined by economic institutions and other financial regulations, it is virtually impossible to get reliable numbers by considering regulations by themselves.

And any attempts to measure costs and benefits are wildly fuzzy; for instance, measures of the costs of raising bank capital requirements run from zero (Modigliani-Miller!) through "a two percentage point increase in credit pricing." So cost-benefit analysis of financial regulations may in practice be hopeless. But where does that leave you? Probably with no criterion for deciding which financial regulations are good, which I guess is where we are anyway. I counsel despair.

Food Stuff.

As I often mention, the best business journalism is about trends in food marketing, and I've been following the Rise of the Bowl closely. So I am embarrassed that somehow I missed a Wednesday New York Post story titled "Hot, skinny people are ditching salads for 'power bowls,'" which contains sentences like "We'll always be seeing new bowls and tagging each other in photos" and "Even if I had the option to eat off a plate, I would eat out of a bowl." Meanwhile, Tesco is switching to straight croissants "because people in Britain find it too difficult to spread jam and other fillings on the crescent-shaped pastry."

People are worried about unicorns.

Good lord, so much unicorn worry, there is rainbow vomit everywhere. Unicorn shareholders are increasingly trying to dump shares, and "the phones of secondary buyers are beginning to ring with a little more urgency, along with discounted offers of up to 30 percent off companies’ most recent valuations." Davis Polk published a client memorandum on "Down-Round Financings of Private Companies: Considerations for Outstanding Equity Compensation Awards." (It turns out a down round is not great for the outstanding equity compensation awards.) "The IPO market is foundering." Startups are increasingly financing using convertible debt instead of equity, because it is quicker, has lower fees, and is "a way to put off the valuation discussion." And then there is Zenefits:

Health insurance brokers in California, for example, have to score at least a 60% on a state exam to get their license. But a running joke among the Zenefits sales staff was that anyone who scored significantly above 60% was a nerd who had studied too hard, former employees said. Even managers, including Hazard, the new head of sales, promoted the idea that a barely passing score was more than good enough, according to former employees.

“D for done,” managers would say, giving a high five to those who scored close to 60%, according to two former employees.

Hmm. When I worked in finance I got my Series 7 and 63 licenses, and "the idea that a barely passing score was more than good enough" is not entirely alien to me. But Zenefit's D-for-done culture seems to have affected clients: "Breakdowns, often the result of a Zenefits employee’s clumsiness, were common — sometimes causing employees of client companies to go for stretches of time without health insurance."

Elsewhere, a San Francisco city supervisor is trying to raise the city's mansion transfer tax. And "a genre of novels has emerged describing the working lives of tech employees."

People are worried about bond market liquidity.

"Having spoken at numerous investment conferences over the last year, I can tell you that this is THE hot button issue amongst professional investors," writes Josh Brown, and guess what he's talking about! (Strictly, it's the worry that "fire sales of mutual funds could represent a systemic risk to our financial system," but I count that as part of the Greater Bond Market Liquidity Worry Complex.)

Meanwhile, the New York Fed's Liberty Street Economics blog series on bond market liquidity marches on. Today's installment is another hot topic: "Did Third Avenue’s Liquidation Reduce Corporate Bond Market Liquidity?" The answer, as it often is in these Liberty Street posts, is meh:

Empirically, we find that liquidity was most affected in bonds that were most sensitive to news about Third Avenue, but that those bonds were less liquid to begin with. However, in terms of magnitudes, the liquidity reactions were not particularly large compared with recent variation.

And there is a companion piece, "Quantifying Potential Spillovers from Runs on High-Yield Funds." ("These numbers seem relatively small and nonsystemic.") In happier bond news, "Corporate titans continued their return to the the U.S. debt markets on Thursday as investors globally showed a renewed willingness to take on risk."

Things happen.

Citigroup Plans Argentina, Brazil Retail-Banking Exit. New Bond Rules Target Large Broker Fees. Investors Clamor for Energy-Share Offerings Despite Oil Slump. Why Venmo, And Every App Like It, Is So Annoying To Use. PBOC to Raise Reserve Ratios for Banks That Don't Meet Criteria. Above the Law's 2016 Top Transactional Law Firms by Pedigree. Oligarch Says Credit Suisse Mismanaged His Money. VimpelCom fined $795m in corruption case. Kyle Bass' latest short target got raided by the FBI and the stock is tanking. Oil-rig parking. The Robber Baron Who Botched the World's First Oil Storage Trade. Eliot Spitzer's Extremely Lucrative Exile. Lounging lizards. Tumbleweed Buries Australian Town. Otter killed by pants. Dolphin killed by selfies. Drunk monkey armed with kitchen knife chases bar patrons.

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Matt Levine at

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