Muni Bonds and Boomeranging Investigations

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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Banking regulation.

The point of a bank is to take safe insured deposits and invest them in risky projects, which creates some tension in bank regulation. Even the most boring Bedford-Falls-y version of banking involves investing deposits in risky loans to businesses and individuals; you don't want your bank taking wild unjustified risks, but you don't want it taking no risks either. Everyone more or less knows this -- banking regulation tends to focus on prudent risk-taking, and on having capital resources to survive mistakes -- but sometimes the discussion gets muddled, as people don't want banks to do anything risky, but also want those same banks to support the economy by investing in risky projects.

So here is the story of a fight over whether banks should be allowed to count municipal bonds as "high quality liquid assets," which would encourage banks to hold more of them. The argument against is that municipal bonds aren't uniformly all that high-quality or liquid, so if you want your banks to be safe you should demand that they hold fewer munis and more assets that are more liquid. The argument in favor is that municipal bonds fund good projects and we want banks to buy them. Senator Mark Warner:

“We shouldn’t make it more expensive for local governments to finance essential investments such as school and road construction by making it harder to access capital markets,“ Mr. Warner said in a statement.

("More expensive" than what? Than it would be if bank purchases of munis were subsidized by regulation?) These are more or less incommensurable arguments. It is generally a political winner to demand that banks take fewer risks, until the specific risk that they stop taking is one that you liked.

Elsewhere, Greg Ip argues that "the preoccupation with 'too big to fail' is misplaced," because "systemic financial crises occur when numerous banks, investors and regulators collectively misprice risk," not when one big bank fails. But Peter Eavis reports that "some mergers-and-acquisitions bankers on Wall Street are privately beginning to conclude that some of the largest banks may break up in the coming years." 


It is embarrassing but somehow inevitable that the Securities and Exchange Commission probe of Valeant Pharmaceuticals "was triggered by Valeant’s own request that regulators investigate a short seller's allegations": Short seller Andrew Left published an inflammatory note questioning Valeant's accounting ("Could this be the Pharmaceutical Enron?"), Valeant disputed the note, harsh words were exchanged, and Valeant asked the SEC "to investigate what it called 'completely untrue' allegations from" Left. Left's note really is overwrought, but his core accusation was that Valeant was using misleading accounting for sales to its controlled specialty pharmacy Philidor, and Valeant has now more or less admitted that, so "completely untrue" was perhaps an exaggeration. In any case, the SEC investigation seems to have boomeranged back to Valeant's own accounting. So Valeant seems to have made a tactical error, though on the other hand I'd like to hope that after the last few months of news the SEC might have looked into Valeant on its own initiative, even without Valeant's request.

There is a general signaling problem here, which is that when a short seller harshly criticizes a company, the company is now sort of expected to shout about how the short seller is committing securities fraud, and to demand that the SEC investigate. So if someone noisily shorts you and you don't huffily demand an SEC investigation, that kind of makes you look like you have something to hide. So what should you do if you do have something to hide? Maybe you can make a lot of public noise about how you want the SEC to investigate, but then kind of soft-pedal it to the SEC. ("I know you are busy, no need to make this a priority.") But I guess that might make the SEC suspicious too. A broader de-escalation might be the right approach here; not every short seller requires an SEC investigation. Sometimes people can just disagree. Or maybe I am wrong and every dispute over accounting should end with one side in jail.

Also, I just do not understand Valeant's investor-relations strategy. I mean, no one does -- the stock is down 74 percent since August -- but it's not just the secret pharmacies and bad accounting that I mind, it's this stuff:

Companies are barred from selectively disclosing material information to analysts or big investors without disclosing it to everyone, under the Securities and Exchange Commission’s Regulation FD. But one-on-one analyst calls are generally permitted as long as executives don’t reveal anything significant that hasn’t been made public.

The analysts who spoke with Mr. Pearson said afterward in notes or calls with investors that they ultimately expect Valeant to lower its guidance. But they said talking with Mr. Pearson left them with the impression that there were no more major surprises in store for investors.

Look, I get it: The fact that Valeant withdrew its guidance probably does mean that it's going to lower that guidance, and if the company thought it had more major surprises to disclose it would probably have disclosed them. So there is nothing necessarily material in those analysts' conversations with Chief Executive Officer Michael Pearson. But given all of the surprises so far, isn't it a little unseemly that Valeant is doing so much of its communications through one-on-one calls?

Elsewhere: When should companies disclose SEC investigations?


Accounting errors seem to be hitting both sides of Bill Ackman's portfolio. Valeant has its problems, but at least his Herbalife short might be getting some help from this:

Herbalife Ltd., the nutrition company under federal investigation for allegations of fostering a pyramid scheme, said it overstated growth of new customers last year because of database errors.

A metric called active new members increased 3.2 percent worldwide in the fourth quarter from a year earlier, not the 16.7 percent cited on a Feb. 25 conference call, the Los Angeles-based company said in a regulatory filing Thursday. U.S. active new members increased 30.7 percent, not the 71 percent mention on the call, Herbalife said. 

Those are some big mistakes! Though it's not clear how important that metric is; Herbalife says that "no information regarding this non-financial metric has been included in any of the Company’s periodic reports filed with the Securities and Exchange Commission and the errors do not impact the Company’s historical consolidated financial statements." Does this mean anything for the pyramid-scheme allegations, which Herbalife is close to resolving? On the one hand, Herbalife's inability to keep track of its members is a little disturbing. On the other hand, I'd think that lower member growth would make it less likely that it's a pyramid scheme, keeping financial results constant: Pyramid schemes need new victims, while actual diet-shake-sales companies can make money by selling diet shakes to the same people over and over again. 

Congratulations Eric Dobkin!

Yesterday Eric Dobkin, "among the longest-serving partners at Goldman Sachs," announced that he is retiring. Dobkin "is known by many as the father of the modern-day initial public offering of stock," since he apparently invented the idea of selling IPOs to institutions rather than retail. He long ago "stepped down as partner but continued to serve on a number of committees, including the commitments committee and the suitability committee," both of which examined deals to make sure they were worth doing. That is how I knew him when I worked at Goldman, as a benignly terrifying presence on the commitments committee who would shout at you a bit when you brought him a questionable deal. That seems like an important role for any organization to fill, and I hope Goldman will find someone to take over Dobkin's tough-drill-sergeant-with-a-heart-of-gold job on the commitments committee. I am tempted to volunteer -- he always seemed to be having fun -- but alas it is not quite my skill set.

Elsewhere in Goldman Sachs something-somethings-with-a-heart-of-something, here is an enormously long and lavishly illustrated e-mail that a Goldman partner (with the overloaded title "head of fixed income, currencies, and commodities European hedge fund sales and cohead of European macro rates sales") sent out to associates telling them basically to stop worrying and get back to work. The metaphor is one of running a marathon, but having your boss constantly e-mail you to ask "What mile are you on?" How would that question be helpful? "Every young person on Wall Street should read it," pants Business Insider, but I may be too old to appreciate it. 

Congratulations Jay Newman!

Here is a Wall Street Journal article about Jay Newman, the Elliott Management portfolio manager who decided, in the early years of the new millennium, that it might be fun to buy some Argentine debt. "Elliott reckoned it might take a few years for the investment to pan out." Or 15, whatever. 

The investment, which outlasted five Argentine presidents, was all that occupied Mr. Newman, friends said.

“He wasn’t going to give up,” said one friend. “There was a Moby-Dick and Ahab quality to it.”

In 2009, "Mr. Newman flew to Argentina to negotiate a deal," which was honestly pretty bold of him? "At one point, he worried that 'they would send him into a dark cell,'" and this is a man who later seized an Argentine navy ship, so you can see why he'd worry. He was waging war there, and traveling behind enemy lines. But the treaty has finally been signed, and Newman's investment is about to pay off

Aubrey McClendon.

Aubrey McClendon, the shale-oil pioneer and former CEO of Chesapeake Energy, "died in a fiery single-car crash Wednesday, a day after he was charged with conspiring to rig bids for oil and natural gas leases." McClendon was both an energy visionary and a consistently colorful character, and he will be missed. Here are some reminiscences from Ben Casselman and Daniel Gross on McClendon's life and impact on the energy industry.

In other news: "The natural gas explorer who allegedly conspired with the late Aubrey McClendon to rig drilling auctions was Tom Ward, then chairman and chief executive officer of SandRidge Energy Inc.," and a co-founder of Chesapeake with McClendon. And U.S. drilling activity may soon be at its lowest level since the 1860s.

Facebook trolling.

Here is "someone who’s spent the past eight years working as a social media consultant" (!?) worrying about how Facebook's new Reactions feature -- you know, the thing where instead of liking a Facebook post you can love, haha, wow, sad or angry it -- will help Facebook's algorithms to manipulate our emotions:

Will we be served only positive content because Facebook has determined that we prefer to be happy? Will I be more likely to see “Angry” content because I personally stay on Facebook longer when I’m reading stories that make me mad? Or if I indicate that a post makes me angry, will I stop seeing posts about that topic altogether–and thus make my way through life in blissful ignorance? Will I get an honest picture of what’s happening in my social network–or will the new data be tweaked to tap into my personal emotional preferences and get me to stay logged on as long as possible?

These are fair questions and my advice is to invest as little as possible of your emotional life in Facebook, though that is easier said than done. But here is a more important story about Facebook and emotional manipulation. It is the story of a man who made an annoying video claiming to be able to read minds, asking people to think of a number and guessing that they picked 7. Obviously this is not how mind reading works; he recorded the video and made his guess before you watched it, come on. But the video went viral because it annoyed people, and whatever the algorithm says, people come to Facebook to be annoyed.

The point here is that you can worry about the algorithm, or try to hack the algorithm, but ultimately the algorithm is just there to give people what they want, and people are terrible and easy to hack. 

Elsewhere, "Kelly Winters, a 2008 Kellogg M.B.A., is a product manager for Facebook Inc.’s Compassion feature, which allows couples to see less of each other on the site after a breakup." 

People are worried about unicorns.

Here is William Alden on Zenefits, the Unlicensed Insurance Agent Unicorn, which seems to have had quite an aggressive sales culture and an addiction to handing out oversized novelty checks to successful sales representatives:

Recipients tended not to take the checks home — what are you going to do, frame it? — so they just piled up, leaning against a wall or stacked on the floor, former employees said.

At least one employee in operations submitted a complaint to their manager about the checks, asking that they be removed, according to one person who saw the email and another person familiar with the matter.

This is how Ben Bernanke will eventually feel about his sitcom appearance fees.

People are worried about bond market liquidity.

Here is the "Securities Markets Risk Outlook 2016" from the International Organization of Securities Commissions, and guess what risk gets seven pages of attention? That's right, it's "Corporate Bond Market Liquidity." As these reports usually are, the IOSCO discussion is inconclusive: "While dealer banks may be stepping back from their market-making role in corporate bond secondary markets, constituting a fundamental shift in market structure, it is not clear that liquidity is in fact being critically affected." We seem to have reached a stalemate in the great bond market liquidity wars. There's a separate "Discussion on Asset Management" that might also be of interest to bond market liquidity connoisseurs:

Data show that mutual funds generally experience greater net inflows than outflows, and in aggregate benefit from a stable investor base. Additionally, funds’ investments in portfolio assets do not currently represent a large portion of the market for these assets as a whole. The historical case study examination did not produce evidence of contagion or systemic events following fund liquidity stress events outside the money market fund space.

Elsewhere, "Traders Plow Record Cash Into Junk Bond ETF as Tone Improves." And "Pimco Says It's Time to Buy Junk Bonds." And "Marc Lasry says oil price drop fuels distressed debt deals." And here is a Bank for International Settlements animation of the "Bund tantrum" set to an energetic Vivaldi concerto.

Things happen.

New Bill Gross Investment Outlook! In Deal Boom, More Firms Ask: Is My Banker Conflicted? Goldman Likely to Drop Bid on Russian Bond Deal Following U.S. Pressure, Sources Say. Would Monetary Tightening Increase Bank Wholesale Funding? 'Awkward' Hedge Managers Hold Investor Edge. SunEdison’s Troubles Darken Prospects of Vivint Deal. Lynn Tilton’s Patriarch Is Sued by Ex-Employees of Unit. Porsche Trial Takes Long and Winding Road. A blockchain experiment. CFPB Fines Fintech Firm Dwolla Over Data-Security Practices. UBS’s French Business Faces Inquiry Into Possible Witness TamperingLarry Fink and His BlackRock Team Poised to Take Over Hillary Clinton’s Treasury Department. Wall Street readies big Trump assault. Is Trump overstating his income? Was Trump an economics blogger in 2005? Let's all move to Canada. "Burger King’s hot dogs are a disgusting disgrace." McDonald's testing Happy Meal box that folds into VR viewer. Dog vs. robot. "These dogs literally go from living on the street to taking a private jet home to the Hamptons." Puppy record!

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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

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