Libor Chats and Bitcoin Scams

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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Libor.

There's not much new in Citigroup's $175 million Libor-manipulation settlement with the Commodity Futures Trading Commission yesterday. It's the same sort of dumb e-mails and chats that you've seen before; once again, the CFTC helpfully compiled the dumbest examples in a separate document for those who don't care about the law or the fines and just want to read the trader chats:

Senior Yen Trader: i think after june I will push for higher libors and lower tibors after june imm we are joining fixing panel in tibor and will keep it high [. . .]
Deutsche Yen Trader: after june coolio
Senior Yen Trader: after june higher lib is ok for you? [. . .] I selling june ey will keep tibor high at least till june for year end I will need low tibor and high l;ibor

Coolio is new, but otherwise it's even a familiar cast of characters: The main villain in the CFTC order is "Senior Yen Trader," whom Citi hired in the fall of 2009 because, in a Citi manager's words, "this guy has forty percent of the market, and he knows where all the fixes are, he knows everybody on the street, he's a real fuzzy animal, this guy owns it," only he didn't say "fuzzy." Senior Yen Trader seems to be Tom Hayes, whom you may remember from the UBS Libor settlements, and the interdealer broker Libor settlements, and from being sentenced to 11 years in prison for manipulating yen Libor at UBS before manipulating it at Citi. 

The one real novelty may be the chats and e-mails between Libor submitters and "salespeople in other funding units of the bank" about how Citi shouldn't borrow at rates above Libor. Libor is famously "the rate at which banks don't lend to one another," and so Libor submitters could more or less make up their Libor numbers freely. But when bank funding was difficult in 2008 and 2009, Libor submissions were closely watched as a sign of possible distress, and it would be awkward if the banks were actually borrowing in the short-term unsecured funding markets at rates above Libor. So a submitter complained:

I just wanted to try to understand the level [ ...] the level at which they were paying was quite higher than LIBOR and we as an institution have to be a little be careful about what rates we show in the market since we're LIBOR setters[...] we monitor quite heavily what different Citi branches pay in the interbank bank market, and the reason is here in London we set the LIBORs, and the CFTC in the 'States have been very sharp on institutions that set LIBORs [...] you were paying in the market quite higher in the market than compared to where I would set LIBOR which kind of ties my hands a little bit so I'm trying to work out what you're trying to do, [ ...].

If Citi had submitted a high Libor, that would have undermined confidence and made it hard for it to get short-term unsecured funding. So its Libor submitters begged its funding salespeople not to get short-term unsecured funding. It's a real privileging of form over substance.

Citi also settled an entirely separate benchmark-manipulation case with the CFTC yesterday, for $250 million, over manipulating Isdafix, a benchmark for swap rates. Here's the order, and the dumb-chats roundup. Isdafix was a little harder to manipulate than Libor: Like Libor, it was fundamentally a poll of made-up numbers from banks, but the poll was based on actual trades and bid/asks on an ICAP brokerage screen at 11 a.m. each day, so you could manipulate it either by skewing your made-up poll numbers or, more effectively, by doing trades with ICAP right around 11 a.m. Citi did both. Isdafix is a weird second-order derivative manipulation: Swaps are derivatives on short-term Libor, so swaps traders wanted to manipulate Libor, while people who traded derivatives on swaps (swaptions, curve options, other rates exotics) wanted to manipulate Isdafix, the benchmark swap rate. Manipulating Libor had massive consequences for the real world, as lots of real companies borrow at Libor, or hedge their interest rate risk with Libor swaps, etc. I feel like fewer real-world companies were much affected by distortions in the cash-settled swaptions market, but you never know.

Bitstuff.

Mt. Gox, once the biggest bitcoin exchange, turned out to be mostly a way for people to get their bitcoins stolen. Oops! But now it's in bankruptcy, and some money ($91 million) was recovered, and the people whose bitcoins were stolen are demanding their share of that money. Sadly, in death as in life, Mt. Gox seems to be mostly a venue for scams. The claimants want $2.4 trillion back, reports Nathaniel Popper, about 26,500 times as much as the Mt. Gox estate has, and about 340 times as much as the value of all the bitcoins in the world. "The giant gaps between those numbers are an indication, if nothing else, of the sheer number of dishonest people who have been drawn to the fiasco around Mt. Gox and Bitcoin," writes Popper. Also: "Bitcoin investors have complained about how long it has taken to work through the claims, not to mention the legal and accounting costs." Remember how bitcoin was meant to make public distributed ledgers efficient and transparent and trustless, so you didn't need to trust your counterparty or spend endless time and money on lawyers to figure out who owned what?

I am being glib, of course. The problems at Mt. Gox are not blockchain problems; they are problems at the interface between the blockchain and the rest of the world. (Popper's book is particularly good on the ironies of Mt. Gox.) But that interface isn't going away. As long as dollars are more useful than bitcoins, you'll need some way to exchange bitcoins for dollars, and even after that you'll need some way to exchange bitcoins for food or whatever. Out here in the real world, we have learned, over hundreds of years of experience, that it is important for financial institutions to be very very careful with our money, and we have evolved (imperfect) rules and norms to make sure that they are. Over in blockchainland, though, those norms are weaker -- in part because everything is new, in part because of "the sheer number of dishonest people," but also in part because the blockchain seems to promise the end of the need for external rules and norms. It doesn't.

Elsewhere, Goldman Sachs put out a big research note on the blockchain and how it will revolutionize various bits of Wall Street by speeding up settlement and eliminating post-trade disputes.

Market structure.

Evgeny Buryakov, the poor dope of a Russian spy who worked as a banker in New York, was sentenced to 30 months in prison yesterday. The amazing MarketWatch headline is "Russian sentenced over spy plan that included high-frequency trading plot," because of the time that Buryakov helped his handler, Igor Sporyshev, come up with questions for a Russian news agency to ask the New York Stock Exchange:

EB: Well, I thought about it. I don't know whether it will work for you but you can ask about ETF. ... E-T-F. E, exchange.

IS: Yes, got it.

EB: How they are used, the mechanisms of use for destabilization of the markets.

IS: Mechanism - of - use - for - market - stabilization in modern conditions.

EB: For destabilization.

IS: Aha.

EB: Then you can ask them what they think about limiting the use of trading robots. ...

That's the high-frequency trading plot. The spy told another spy to tell a news organization to ask NYSE questions about ETFs and "trading robots." The well of high-frequency trading paranoia is so deep that cartoonish Russian spies are cobbling together uninformed questions about it, and that a U.S. financial publication is treating those questions as proof of a Russian high-frequency trading plot. Surely someone is plotting to destabilize the markets with ETFs! It's a race between Russia and the U.S. to find them. 

Elsewhere, Thomas Peterffy, who owns a big electronic brokerage, thinks that brokerages will get bigger and more electronic. And "a bipartisan bill under development in Washington would weaken stock exchanges’ grip on a key part of trading: the data feeds that provide the backbone of the market," and I have to say I am a little surprised that exchange data fees are a congressional priority?

Maybe partying will help.

If you were an enterprising Securities and Exchange Commission investigator, I suppose you could make the case to your superiors that you should spend your evenings hanging out in the strip clubs of midtown Manhattan waiting for financial-industry employees to reach the point in the dark night of their souls when they reveal the horrible things they're getting up to all day. Maybe that stereotype is a little dated. Anyway though:

Like a skunk at a garden party, the SEC has been moving in on the fun-loving Wall Street conference circuit in hopes of getting a better handle on who’s up to no good in the world of finance. Officials scour attendee lists to spot the biggest players in advance and, properly wearing name tags, schmooze over drinks. Of course, they don’t accept any -- that’s a no-no under SEC policy.

I love it. We're all just buddies here, sharing a drink, having a good time, reminiscing about all our best Libor manipulations, jotting down some notes, pulling out a voice recorder, just a totally casual chat. Unlike the CFTC, which has no chill:

The Commodity Futures Trading Commission was especially transparent about its intentions when it set up a booth in the middle of an industry gathering in March. Attendees at the opulent Boca Raton Resort & Club in Florida were greeted by smiling agency officials handing out metal whistles emblazoned with “CFTC” and mouse pads advertising their toll-free number.

"Hey, great party, check out this mouse pad." Come on. But the lures of partying go both ways:

One possible downside of the SEC’s social sleuthing is that officials will get so close to industry employees that some may be lured to leave for higher paying jobs on Wall Street, said James Cox, a professor at Duke University School of Law.

"I had such a great time doing shots with that SEC guy, we should bring him onto the desk." Elsewhere, the Wall Street Journal counted how many people were charged civilly or criminally for doing bad financial stuff at big banks. And big banks have big social media teams for some reason.

Hedge funds.

I don't know, what do you think of Tony James's claim that "the $2.9 trillion hedge-fund industry may lose about a quarter of its assets in the next year as performance slumps"? I feel like the complaints about hedge fund fees and underperformance are now at least several years old at this point. Here is a deeper dive into the question -- "Hedge funds: Overpriced, underperforming" -- that focuses on increasing pension-fund disillusionment with hedge funds:

According to Chicago-based Hedge Fund Research, pension funds and other big institutions now account for only 43.1 per cent of hedge funds’ assets, from 47 per cent three years ago. The reasons for moving their money mix populist politics — many are enraged by the fortunes that hedge fund managers can amass on the back of high fees — with disappointment in their performance.

But total hedge fund assets under management are much higher than they were three years ago, which means that pension assets in hedge funds have increased over those three years (by about 15 percent, by my rough math). It's just that other investors' assets have increased faster.

I find this all very mysterious. There is endless talk about hedge funds' excessive fees, disappointing performance, and troubling correlation to other asset classes. And there is much hand-wringing about what seem like pretty small outflows ($15 billion, or around 50 basis points of assets under management, this year). But overall hedge fund assets seem pretty stable. As a believer in market efficiency, I am skeptical that a lot of hedge funds can add enough value to earn their fees. But as a believer in market meta-efficiency, I am skeptical that all the institutions who pay those fees are doing so for no reason. It's a puzzle. I assume that the industry will lose a lot of assets just before the market turns and hedge funds start outperforming stocks. Elsewhere, Gawker is mad. And Yale endowment manager David Swensen is probably underpaid.

People are worried about unicorns.

There was a time when my big question about the Theranos story was, is it a revolutionary company with a great technology that is being unfairly nitpicked, or is it a company whose technology has big serious problems? I am satisfied that that question has been answered. Now my big question is, is this a story of smart well-meaning people who are working on a great idea to change the world and who got a bit over their skis, or is it something darker? It is silly, so late in the game, to fixate on one Theranos detail and say "that's weird," but here is a story about Theranos's relationship with Walgreens, and this is really weird:

While Theranos didn’t provide a device to Hopkins, Walgreens got a prototype, and members of Dr. Rosan’s team set it up in a cubicle.

The prototype came with kits to perform esoteric tests that other labs and test makers apparently didn’t offer, producing results such as “low” and “high” rather than numeric values.

As a result, Walgreens couldn’t compare results from the Theranos machine to any commercially available tests.

I will leave it as an exercise for the reader to think of an innocent explanation for that.

Elsewhere, here is a breakdown of who gets venture capital funding (mostly men, a lot of Stanford grads, also a lot of college dropouts). And here is a unicorn being barbecued in what looks like a medieval manuscript that I will just assume prophesies the coming of Theranos. "And lo, a Unicorne shall come among ye, and ye shall call it by the name Theranos, or in the Old Tongues, Elasmotherium Haimatos. And it shall take your Bloode, but only a lyttle bit of your Bloode, and it shall do strange Magick upon said Bloode, and tell ye many Things. But then it shall come to pass that its Magick was [makes 'so-so' hand gesture], and that those Things were mostly not true. And ye shall barbecue that Unicorne."

People are worried about bond market liquidity.

Here is Bloomberg Gadfly's Lisa Abramowicz on how exchange-traded funds are being used as a source of bonds for dealers who need to provide liquidity:

An increasing number of bond dealers are using BlackRock’s $14.9 billion junk-debt ETF the way they used to used their own stockpiles of riskier bonds. Rather than hold assets that could lose value and would require them to hold extra capital, these banks are instead relying on this fund to be an easy source of bonds when clients want them.

Here's how it works: A client gives money to a dealer to buy a certain amount of high-yield bonds. The broker then uses the money to buy ETF shares that they can then redeem in kind for the underlying bonds. The broker then sells some or all of the bonds to the client.

That seems good? You can divide the dealer function into two jobs: Keeping a big inventory of bonds, and taking on asymmetric risks to match up willing buyers and willing sellers. Regulation has made inventory more expensive for dealers, so they're outsourcing the inventory function to ETFs. The other function -- of having an order to buy bonds on one side, having an order to sell slightly different bonds (the ETF basket) on the other, and standing in the middle to take the residual risk and facilitate the trade -- is still left to the dealers. 

Elsewhere here is "Treasury Market Liquidity: The Forgotten 98%," and I cannot resist the image of a scraggly group of off-the-run Treasury bonds occupying Zuccotti Park and chanting "we are the 98 percent."

Things happen.

People are worried about Alibaba's accounting. There's a "hiring frost" in parts of Deutsche Bank. Bayer’s Room to Raise Monsanto Bid Looks Limited. AT&T Wants Yahoo's Internet BusinessShares in Spain’s Banco Popular Plunge on $2.8 Billion Rights Issue. Qatar Stuns Mideast Debt Market With Record $9 Billion Bond. The Key Questions Asked About Saudi Arabia’s $2 Trillion Fund. Dong Energy IPO Could Value Danish Utility at $16 Billion. Bob Diamond’s Atlas Mara Posts $6.7 Million Loss. Hackers turn stock advisers as Anonymous targets China Inc. The Don’t Ask, Don’t Tell Guide to Trading on Inside Information. The too-big-to-fail premium in Australia is as much as $3.75 billion a year. Top UK model agencies accused of price fixing by watchdog. We live in a weird new world where angry billionaires get to decide which publications should be shut down, and call it philanthropy. But would you want to do business with those billionaires? "Millennials aren't real." Terms of service. Goldfish drone. Rubik's Cube murals. "A total of 605 licensed dogs answered to Daisy, the most popular flower name."

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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:
James Greiff at jgreiff@bloomberg.net