Bro's Clubs and Bond Risks

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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A "subordinate 'bro's club' of all-male sycophants."

How bad is this?

Trepanier sold a large portfolio of TruPS CDOs to Kerry Findlay at Third Point, a hedge fund.

Kerry Findlay has expertise in the mortgage asset class, not the TruPS asset class.

Trepanier spoke with her about the positions over a period of time and got her to buy the portfolio. He was very open on the desk that he “stuffed her” with the portfolio. In other words, Trepanier was boastful that he over-charged Findlay.

That's from Megan Messina's gender-discrimination-and-whistleblower-retaliation lawsuit against Bank of America, which "was the talk of Wall Street" yesterday. David Trepanier was Messina's co-Head of Global Structured Credit Products at BofA, on whom Messina was, in her telling, frequently blowing the whistle. For ... well, what is this? It's definitely rude to take advantage of a customer's ignorance to overcharge her. It's even ruder to boast about it. It's the sort of thing that, if she found out, she might put BofA "in the box" and not trade with them for a while. But if it's illegal to overcharge customers sometimes, all the trading floors of all the banks in the world would be ghost towns. Certainly the structured credit desks would be!

Messina's other whistleblower allegations are more substantial -- the words "front-running" are thrown around, as are allegations of mis-marking of trading books and violations of the Volcker Rule. I confess I do not understand all of them, and some seen incorrect even if you assume that everything she says is true. (The Volcker Rule complaint seems to misunderstand the rule, for instance.) But, while I stress that these are just allegations in a lawsuit, at least a few have a certain ring of plausibility:

When going through their business after being promoted, Messina asked Trepanier about the marks he had on the Bank’s trading positions. Trepanier boldly responded, “It is an annuity so that the trading book produces revenue every year.”

Of the $4 Billion, two-thirds was below investment grade, and one-half of that two-thirds was equity purchased for cents on the dollar and marked up very slowly over the years since they were first purchased.

If it's illegal to slowly mark up a position over time to create a steady stream of revenue, then, well, I don't want to say "ghost towns," but some number of trading desks would perhaps see some departures. But it is illegal! (And there are departures.) You're supposed to mark your positions accurately.

Anyway I don't know about the whistleblower stuff. It is perhaps not quite as illegal, over all, as Messina's complaint makes it out to be, but if it is true it is at least awkward for client relationships. Which were apparently already awkward: Messina alleges that at some point the rates desk misbehaved toward Pimco, after which the head of fixed income had to fly out to apologize in person, and "PIMCO’s managers made DeMare rot in a conference room in California; they did not take his meeting."

The gender-discrimination stuff is more vivid, and depressing. Messina was the only woman who directly reported to Frank Kotsen, Head of Global Credit and Special Situations, who allegedly told her "I don't understand what you do" and focused instead on questions like "Have your eyes always been that blue?" He, in the words of Messina's lawyers, "made it clear that she was NOT welcome within his subordinate 'bro's club' of all-male sycophants." One way he made it clear was by almost never talking to her, which seems like an extreme length to go to on a trading floor.

But they were traders, so the main way he made it clear was by paying Messina much less than her male colleagues: $2 million to $2.75 million per year over the three years from 2013 to 2015, versus more than twice as much for Trepanier. Most of her male peers allegedly got more than her, as did some traders who reported to Trepanier. She claims that "according to client surveys (the Greenwich Surveys, Orion Survey) and informal customer feedback, Messina has consistently outperformed her Co-Head, Dave Trepanier," but if there is a claim that she produced as much revenue as him, I seem to have missed it. My sense is that trading managers are usually paid mostly for making money, not for getting good informal customer feedback.

The sycophant bro club allegations have their own ring of plausibility, though. "We take all allegations of inappropriate behavior seriously and investigate them thoroughly," says a BofA spokesman.

Elsewhere, here is a two-part Twitter story (part 1, part 2) from Chris Arnade about selling, and overcharging for, structured credit products back in the day. And: "Women in Elite Jobs Face Stubborn Pay Gap." "Of the 10 major occupation groups where women’s earnings lagged most, five were in finance," including "securities, commodities and financial services sales agents."

People are worried about bonds, non-liquidity category.

People worry about lots of things in lots of ways, but Money Stuff "people are worried about XYZ" sections tend to fit a particular pattern. XYZ seems good, and people are worried that that is deceptive. People are worried that other people aren't worried enough about XYZ. The worry is a meta-worry. This is a big chunk of bond market liquidity worry: that bond mutual funds make it deceptively easy to get bond exposure, creating a "liquidity illusion" for bond-fund investors that may one day vanish in a crash. People are worried about unicorns because they are worried about a unicorn bubble. People are worried about stock buybacks and non-GAAP accounting because they think that other investors -- most investors, the ones making prices go up -- are lulled into an overly rosy view of earnings per share because those earnings don't conform to U.S. generally accepted accounting principles and are spread over share counts reduced by buybacks.

Anyway the Wall Street Journal is worried about duration risk, worried enough to produce a duration calculator with the headline "The World’s Safest Bonds Are Actually Wild Risks." (The calculator is somewhat superfluous: In a zero-interest-rate-forever world, a bond's duration gets creepily close to its maturity. Eyeballing the calculator I get a duration for Germany's 0.5 percent 10-year of something like 9.8 years.) Another headline: "Bond Buyers Can’t Stop Themselves as Risks Hit a 15-Year High." And: "Investors’ Flight From Negative Rates Flattens Yield Curve."

“The flattening yield-curve trade is crowded,” said Stanley Sun, interest-rates strategist at Nomura Securities International in New York.

It's a straightforward mechanism. Short-term rates are low, have been low for a long time, and are negative in many parts of the world. No one wants low yields, and even fewer people want negative yields. So they all have to buy very long-duration bonds, which pushes down the yields on those, leading to a flat yield curve and a lot of investors grumpily owning a lot of duration risk:

Mr. Lindbloom said he is aware of the risk in holding Treasury bonds at such slim yields, but he said he “is holding [his] nose” in investing in Treasury debt because there are few alternatives out there.

I suppose the meta-worry might be that investors are piling into these long-duration positions without a full understanding of the risks, and when rates eventually, inevitably go up, a lot of people will be shocked to lose a lot of money on their Treasury portfolios. But all the investors who are quoted seem to have a pretty good understanding of the risks. (This is even more true in bond market liquidity, where so many people talk about the liquidity illusion that it's hard to figure out who might still suffer from it.) They are putting on their duration risk with open eyes and heavy hearts. They just can't stop themselves.

Artificial intelligence.

Here's a really smart and wistful article, titled "Soon We Won't Program Computers. We'll Train Them Like Dogs," about the rise of artificial intelligence and the end of comprehensible engineered reality:

“People don’t linearly write the programs,” Rubin says. “After a neural network learns how to do speech recognition, a programmer can’t go in and look at it and see how that happened. It’s just like your brain. You can’t cut your head off and see what you’re thinking.”

There is some version of this in finance. You can build a quantitative investing system that trades lots of stocks, and in some sense you can describe it deterministically: It looks at market data, matches that to historical correlations, and buys things that are likely to go up based on those correlations. But in another sense you can't describe its story, its logic: It might buy XYZ because ABC went up and they tend to be correlated on Tuesday afternoons in the spring, but you can't necessarily explain what the correlation means. The program has its own sort of intelligence, but it is not quite comprehensible to human intelligence. It's all a bit sad. Then, of course, your computers rise up and kill you.  

Pay will be bad.

Sorry everyone!

Bonus pools could decline by as much as 20 percent for some Wall Street workers this year, with incentive pay falling at almost every type of financial-services firm, according to compensation consultant Johnson Associates Inc.

I have to say, it is mid-May, a lot can change between now and bonus time. Keep your chin up. Right Alan Johnson?

“Our clients believe that there really is no light at the end of the tunnel,” Alan Johnson, founder and managing director of the New York-based consultant, said in a phone interview. “People no longer believe this is cyclical; it’s a systemic change in the business. For the results to get better, we’re going to have to do a lot more cost-cutting.”

Oh man, that's a bummer.

Conflicts of interest.

Here's a weird story about how McKinsey & Co.'s "Recovery & Transformation" business sometimes competes to work on Chapter 11 bankruptcies, but the U.S. Trustees in some of those cases object that McKinsey doesn't disclose all of its potential conflicts of interest:

McKinsey said in court filings it isn’t aware of any conflicts of interest, but that it may have worked, or currently works, with the bankrupt companies’ creditors, lenders, shareholders or others involved in the cases, all of whom could potentially have interests that are adverse to the companies now seeking the firm’s guidance.

And it won't disclose those relationships for client confidentiality reasons. Our conflict-of-interest norms come from a simpler time, when investment banks and law firms and consultancies were small partnerships with long-standing trusted relationships with their clients. Of course if Joe McKinsey was a longtime consultant to your biggest creditor, you wouldn't hire him to advise you on your bankruptcy. But in the modern world I am perfectly willing to believe McKinsey when it says "it isn't aware of any conflicts of interest," and to assume that a McKinsey restructuring partner's advice to a bankrupt client won't be influenced by the fact that some other McKinsey partner, in a different business and a different part of the world, is also giving some unrelated advice to a creditor of that client. The big banks and consultancies are global institutions, and you go to them for their breadth and contacts and experience, not for their undivided loyalty and focus. You can't really expect, any more, that just because you hire a bank or consultant to help you with something, someone else at that bank or consulting firm isn't helping your competitor on the same thing. The solution is information siloing, good behavior from individual employees, and a certain amount of cynicism on the part of the clients.

Circuit breakers.

There's a generally accepted logic that stocks should trade pretty freely, but that trading should sometimes be halted when the trading is likely to be uninformed. Sometimes this is dictated by prices: If the price gaps down a lot all at once, that may be because the market is struggling to absorb news, or it may be because someone accidentally added a zero to an order, and either way maybe trading should be shut down for a second or a minute or 15 so that traders can regroup, get an idea of value, and then start trading again with clearer heads. Other times it is dictated by news: If a company is going to announce a merger at 10 a.m., it probably shouldn't open for trading at 9:30. 

But you can't get carried away with this: Ideally every trade in every stock should be fully informed, and perhaps it makes sense to stop trading for 15 minutes or an hour or a day to prevent uninformed trading and unfair information disparities, but at some point uninformed trading is better than no trading. Anyway the Hong Kong stock market perhaps goes a bit overboard:

Hong Kong’s system means investors can find their money frozen for months or even years, while companies and regulators work out problems, conduct investigations or go through the delisting process.

Including just for accounting irregularities! Yes, companies should put out accurate financial statements that they stand behind. But if they stop doing that, that's when you really want to sell -- not wait a year while they get their accounting in order.

People are worried about non-GAAP accounting

Speaking of accounting, here is an updated Q&A (strictly, a set of "Compliance & Disclosure Interpretations ('C&DIs')") from the Securities and Exchange Commission about non-GAAP financial measures. For instance:

Question: Can a non-GAAP measure be misleading if the measure excludes charges, but does not exclude any gains?

Answer: Yes. For example, a non-GAAP measure that is adjusted only for non-recurring charges when there were non-recurring gains that occurred during the same period could violate Rule 100(b) of Regulation G.

People are worried about unicorns.

Donald Trump is worried about unicorns:

"I'm talking about companies that have never made any money, that have a bad concept and that are valued at billions of dollars, so here we go again," Trump said.

Hey that's super. Elsewhere in Trump's economic analysis: "If we make our big banks too much not big, they won't be able to compete with the banks from China and the banks from Germany and other big banks." 

I'm always going around saying that private markets are the new public markets, so I suppose I should point you to this paper about how public markets are the new (old) private markets:

A wide body of literature emphasizes that venture capitalists focus on young private companies, generally in high-tech industries. However, contrary to this notion, we find that 29% of the firms that were backed by VCs prior to the IPO received additional VC funding within the first five years after the IPO, in a sample of IPOs between 1988 and 2010.

We find that this post-IPO VC financing is focused on companies with high information asymmetry and substantial growth opportunities.  These companies might otherwise find it difficult to raise capital at a viable price.

Of course the sample runs through 2010. Back then the hip thing might have been for VC firms to invest in public companies; now, it's for public mutual funds to invest in private companies.

Elsewhere, in non-unicorn non-profit startup news, here's a story about Trek Medics, which is sort of an Uber but for developing-world 911:

Trek Medics seeks to bring a 911 alternative to countries where such services are rare. While the transportation research group at the University of Alabama at Birmingham found conventional ambulances cost an average of $1.46 a mile, one 2008 study found the motorbikes can operate for about 18.6¢ a mile. So Trek has been able to build a volunteer network of about 200 people in the Dominican Republic and Tanzania with a shoestring budget supported by Google, Cardinal Health, the U.S. Agency for International Development, and private donations.

Meanwhile Amazon is launching another delivery service for Manhattan restaurant meals. 

People are worried about bond market liquidity.

Here's a speech by Nathaniel Wuerffel of the New York Fed on "Market Structure and Liquidity in the U.S. Treasury and Agency Mortgage-Backed Security (MBS) Markets."

So if liquidity conditions seem to have changed, why is it not obvious in traditional measures?

Changing market structure provides at least some insight to this question. Structural changes mean that our interpretation of some liquidity measures must adapt, and that we may also need to search for new ways to measure liquidity. In other words, both the interpretation and measurement of liquidity must evolve as market structure evolves.


A common theme among these anomalies is the influence of the rise in the cost of funding cash as compared to derivatives instruments. Market participants have pointed to constraints on dealers' repo financing of Treasuries as contributing to these trends, as such constraints increase the cost of establishing and funding positions in cash securities relative to swaps and futures. In the agency MBS market, dollar roll implied financing rates for securities currently being produced ("production coupons") have increased to multi-year highs, and in some cases exceed agency MBS term repo. Similar to the dynamics affecting the Treasury market, MBS participants cite constraints related to dealer balance sheets as driving implied financing rates above MBS repo rates.

Things happen.

Another Year of Anger for Deutsche Bank's Investors. J.P. Morgan Reduced Some Employees’ Access to Swift System in Recent Weeks. Niobium mining executive: "I had to actually open up the periodic table just to double-check that it was an element." When the oil boom went bust, Oklahoma protected drillers and squeezed schools. The Latest Fannie and Freddie Reform Bill Offers A Bonanza For Hedge Funds. Mutual funds with the word "absolute" in their names have underperformed, though to be fair that is based largely on bull-market results. "A former Barclays Plc trader helped fix Libor rates in an attempt to boost his career by currying favor with the swaps desk, where the 'glamour boys' and 'big dogs' worked, a prosecutor said Tuesday at a London trial." Donald Trump’s Plan for America Includes Shutting Down the Media. "Our current design is very clean, very practical, very familiar, and people are familiar because it’s Taco Bell and they know us, but now this is focused on creating that dining environment that people would appreciate." Millennial experts. Jelly Belly Family Sued Over WWII Tank Death. Staley Gala-Hangs With Therapy Dog as J.K. Rowling Defends Trump (the dog is a Goldendoodle named Reggie; there is a picture). Troublemaking Pandas Make It Impossible To Get Anything Done. 

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