Spoofing, Brexit and Fake Biofuel

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.
Read More.
a | A


"Michael Coscia, the first person convicted of spoofing after it was made a crime under the Dodd-Frank Act," was sentenced to three years in prison, less than the seven-plus years sought by prosecutors, though more than the probation sought by Coscia. What is the right sentence for spoofing? How would you go about answering that? My starting point is that, in an age of mass incarceration in which the U.S. has 22 percent of the world's prisoners, we probably shouldn't put anyone in prison for a first-time nonviolent crime, but obviously I am in a tiny minority on that one. The judge chose to base his answer on the g-word:

The only explanation for Coscia engaging in fraud while he was making $150,000 a month trading futures and had a net worth of $15 million was greed, the judge said.

Yes, the reason people commit financial crimes is usually that they want more money, though I never know what the word "greed" adds to the analysis. "This is a serious crime with serious consequences," added the judge, but is it? We talked about Coscia back when he was arrested in 2014; basically the story is that he made futures prices slightly wrong for increments of a fraction of a second in order to make a few hundred dollars at a time off of the high-frequency trading firms who were deceived by his orders. I am perhaps more sympathetic to high-frequency trading firms than the average American, but even so I am a little uncomfortable with sending people to prison for outwitting them. 

Here's a view:

Three years is a substantial sentence for doing something that isn’t easily distinguished from every day cancellation of orders and will put high-frequency trading firms on alert, said Peter Henning, a law professor at Wayne State University’s Law School in Detroit.

“This should throw a scare into them,” Henning said. “They need to figure out where the line is between permissible trading strategies and spoofing.”

I don't know; I suspect that the high-frequency trading firms who were ripped off by Coscia are fine with this prosecution. And I am not sure it's as hard as all that to distinguish between, on the one hand, a spoofing algorithm designed to submit fake orders, trade on the other side of the market, and then cancel the fake orders and, on the other hand, a market-making algorithm designed to submit real orders and then move them as information changes. Though if I wrote the latter sort of algorithm, I'm not sure I'd want a jury making that distinction, with the threat of years in prison if they get it wrong.

Elsewhere in cancellations, Hillary Clinton's "financial transaction tax on Wall Street" seems to be aimed at high-frequency trading firms who cancel a lot of orders, though it "remains little more than a talking point for now."

No complaining about Brexit!

Here's a passage from David Graeber that I love:

If you managed to convince everyone on earth that you can breathe under water, it won’t make any difference: if you try it, you will still drown. On the other hand, if you could convince everyone in the entire world that you were King of France, then you would actually be the King of France. (In fact, it would probably work just to convince a substantial portion of the French civil service and military.)

This is the essence of politics. Politics is that dimension of social life in which things really do become true if enough people believe them. The problem is that in order to play the game effectively, one can never acknowledge its essence. No king would openly admit he is king just because people think he is. Political power has to be constantly recreated by persuading others to recognize one’s power; to do so, one pretty much invariably has to convince them that one’s power has some basis other than their recognition.

I don't quite know what is going on in this Financial Times story about people complaining about JPMorgan complaining about Brexit, but man is it fun:

The concerns come amid efforts by the Treasury to encourage international banks to paint a rosier picture of the City’s future in the aftermath of the UK’s referendum vote to leave the EU. The Treasury has separately urged British banks to refrain from public proclamations about any dire consequences from Brexit, people briefed on the discussions said.

Officials asked international banks to sign a “more optimistic” joint statement than the one eventually published last Thursday and said banks and the Treasury would “work together … to help London retain its position as the leading international financial centre”.

Banks resisted, arguing that they were “not cheerleaders”, one of the people present said.

Obviously there are some questions about external facts in the world here, and some scope for reasonable disagreement about the U.K.'s negotiations with Europe, financial and immigration regulations, etc. But the story seems perfectly Graeberian. U.K. Treasury officials and many bankers seem to think that London will remain a leading financial center as long as everyone says that it will. Which is probably true! Being a "leading financial center" is a coordination problem; if everyone agrees you're a leading financial center, you are. And yet the Treasury's approach -- just going around asking everyone to sign happy statements -- seems wrong. While London will remain a leading financial center as long as all the banks say it's a leading financial center, asking all the banks to say that it's a leading financial center is not the right way to keep it a leading financial center. 

In other approaches, "The Bank of England left its key interest rate at a record low and signaled it’s readying stimulus for August as the economy reels from Britain’s decision to quit the European Union."

Fake biofuel!

This Bloomberg Businessweek story about Green Diesel features lovely elements like a ninja robbery, a luxury-jet repossession, and a lawyer who knew just how to deal with regulators like Environmental Protection Agency engineer Jeffrey Kimes:

An attorney for Green Diesel showed up. Kimes asked how he could reconcile the lack of production with what Green Diesel had been telling the EPA. The attorney said he didn’t know, he’d been hired only the day before.

This is the furthest possible thing from legal advice, but if you work at a fake factory, and the regulators show up and ask you to explain yourself, I mean, you might -- I wouldn't -- but you might just consider telling them "what are you talking about, I just got here." It can't hurt. (It can hurt.) 

Anyway, while the details are lovely, the heart of the story is about market structure. Basically the government requires fuel makers to blend a certain amount of renewable products (ethanol or biodiesel) into their fuel. Or they can just buy "renewable identification numbers" associated with biodiesel:

The EPA allows biodiesel makers to strip RINs off their product and sell them separately as tradable credits. Refiners who fall short of blending the statutory minimum of biodiesel into their refined products must buy RINs to make up the difference or pay penalties.

I assume there is a reason for this -- like buying carbon offsets -- though it is not entirely intuitive why paying for biodiesel without using it would be good for the environment. In any case, a market has sprung up for RINs, and the scammy course of action is clear: If you can make money for just writing down a 38-digit number and e-mailing it to someone, why not get to work writing down numbers? Apparently Green Diesel actually did produce biofuel for a while, but then stopped and moved into the more efficient -- and frankly less polluting -- business of producing 38-digit numbers. Eventually the EPA caught on. Philip Rivkin, Green Diesel's founder, is now serving 10 years in prison; I assume the lawyer avoided trouble. 

Market efficiency.

One popular puzzle in financial markets is whether the rise of passive index funds makes active management easier or harder. On the one hand, if everyone else is just trusting to the efficiency of markets and not trying to pick stocks with good underlying fundamentals, it's easier for you to find the mispriced stocks. On the other hand, if that's the case, then the mispricing might take a long time to correct itself. 

Anyway here is a delightful article about how political prediction markets have gotten less predictive as people think they're more predictive:

But more recently, prediction markets have developed an odd sort of problem. There seems to be a feedback mechanism now whereby the betting-market odds reify themselves.

If you think that prediction markets are a fun gambling tool, and the market shows one candidate winning while the polls show her losing, you go to the market and bet against her. But if you think that prediction markets are "the wisdom of the crowds" and the best predictor of outcomes, and the market shows her winning while the polls show her losing, you just shrug and assume that the polls are wrong. So no one corrects the prediction markets' odds with new information. 

Of course that should just mean that the prediction markets offer better opportunities for well-informed gamblers to make more money. The Grossman-Stiglitz paradox is a slippery beast. If you think that everyone thinks that markets are efficient, but you don't think markets are efficient, then you have incentives to find mispricings. But if you are right that everyone thinks that markets are efficient, you probably also think that markets are efficient, so why would you look for mispricings?

Elsewhere in betting markets, "video game maker Valve is walking away from the rapidly expanding gambling ecosystem that has evolved around its games, potentially destroying an industry that was expected to take $7.4 billion in bets this year."

And elsewhere in Grossman-Stiglitz or whatever, here is an article about MSCI's power as a stock picker:

Thanks to the surging popularity of passive investing, MSCI and a handful of its rivals -- including FTSE Russell and S&P Dow Jones Indices -- are quietly replacing the giants of money management as the most important arbiters of where the world’s stock investments flow. The average proportion of equity funds in the U.S., Europe and Asia that mimic index providers’ security and country allocation decisions has doubled over the past eight years to about 33 percent, according to Morningstar Inc.

Blockchain blockchain blockchain.

Here is a very funny and ill-tempered rant by Daniel Krawisz about why blockchain without bitcoins doesn't make any sense, which I cannot resist quoting at length:

I don’t see that there is a lot of use for some kind of general “blockchain technology” outside of its application in Bitcoin. In Bitcoin, the blockchain is a way of solving the double-spending problem without privileging any party as to the creation of new units or of establishing a consistent history. This is an extremely costly and complicated way of maintaining an accounting ledger. How often do I really need to do my accountancy in this way? I would say that it is only a good idea when the game being played is so important that no one can safely be put in the position of referee. There are not a lot of things that I would really need that for, but I think there is a good argument to be made that a blockchain is a reasonable alternative to the monetary system under which the rest of the world is currently oppressed. Otherwise I'd really rather be able to keep my accounting records to myself rather than leaving them out in public.


A blockchain that was used for an application with no double-spending problem is nothing more than a database, so you could just replace it with a distributed hash table.


If money is a shared hallucination, then you can’t replicate Bitcoin’s value by replicating the technology. You would have to also replicate the hallucination, which you can’t.


Yet people are running around everywhere in the Bitcoin world screaming “blockchain blockchain blockchain” for all kinds of non-intuitive purposes until they're buried under piles of money.

My views aren't quite as ill-tempered. The standard financial-industry plan to set up a blockchain for, like, settling syndicated loan transactions seems fine. You have a smallish group of players (banks, etc.), all of whom are trusted enough to participate but not enough to be the referee. You want to prevent double-spending. You compensate the players for participating (checking transactions and maintaining the blockchain), not by paying them in new bitcoins (the way bitcoin mining works), but just by letting them participate in an efficient system for trading a product that they all find lucrative anyway. It basically hangs together. There might be simpler ways to do it -- a distributed hash table -- but you can't discount the social fact that running around screaming "blockchain blockchain blockchain," in the banking world as well as the bitcoin world, makes people pay attention

People are worried about unicorns.

"Unicorn Valuations Are Nearing a Reckoning" is the perfect people-are-worried-about-unicorns headline here, about predictions of down-round initial public offerings: 

Eighty-five percent of the investment-bank capital markets executives surveyed by BDO think more unicorns will have initial public offerings at valuations below their most recent level of private financing, as some did last year. Fifty-two percent expect unicorns’ valuations broadly to undergo a significant correction, BDO said.

Elsewhere in reckonings, "Silicon Valley Looks for Lessons in Theranos," including by "moving to bolster oversight" and by telling reporters that "the Silicon Valley community also has to avoid buying into its own hype machine." Probably don't take that last one too literally. If you run around believing that you are changing the world, that can sometimes end in embarrassment, but if you run around telling everyone that you're changing the world while secretly believing that it's all a bunch of nonsense, that can end in an even worse place.

People are worried about stock buybacks.

But not John Carney, who points to studies showing that stock prices actually under-react to buybacks: 

In other words, investor fears that buybacks are “financial engineering” keep prices lower for longer, stretching out the higher returns over years. That’s actually good news for long-term investors because it means the opportunity to capture some of the upside that follows buybacks lasts for years rather than moments.

So when you read that stock buybacks are just a short-term fix, remember that they actually create long-term value.

I guess that sounded sarcastic? How can just buying back stock create long-term value? I feel like the answer is obvious and deep and wonderful, and it is that the long-term value created by a capitalist system is mostly about properly allocating capital. What creates long-term value is not just "doing research and development," or "investing in capital equipment," or whatever; it's doing the right R&D, or buying the right equipment. It's making sure that great ideas are well-capitalized and dumb ideas are not capitalized and that medium-sized ideas are capitalized a medium amount. If the result of a stock buyback is that a company is more appropriately capitalized -- and that, therefore, the cash that it paid out to shareholders is instead redirected to better uses -- then that creates long-term value.

I mean obviously sometimes it's financial engineering to achieve short-term earnings targets for executive-compensation purposes, but it can't always be that. Eventually the shareholders would catch on. There are certainly enough news articles about it.

People are worried about bond market liquidity.

Oh hey a new bond trading platform:

Investors complain that “liquidity” in the US Treasury market is declining. OpenDoor, set up by industry veterans Susan Estes and Brian Meehan, is a platform that preserves the anonymity of its participants in an attempt to allow users to trade on a larger size.

It will focus on inflation-linked securities and so-called off-the-run Treasuries.

Also a new meta-platform for keeping track of all the bond trading platforms:

AllianceBernstein, the asset manager that oversees $487 billion, has a solution to all this chaos. The system is called ALFA, which stands for Automated Liquidity Filtering and Analytics, and it pulls all the various platforms together into one place — giving the firm a real-time view of the entire bond market.

Apparently AllianceBernstein is "looking at commercializing" ALFA, which has this exhausting routine for finding out where bonds trade: 

ALFA takes in data from the slew of trading venues that have popped up, such as TruMid, Electronifie, and Liquidnet, as well as legacy players like MarketAxess. It is also plugged in to Project Neptune and is about to connect with Tradeweb to receive data on dealer inventory.

Me yesterday.

I wrote about the ValueAct HSR settlement.

Also, in Money Stuff yesterday we talked a little about IEX's discretionary peg order type, and I suggested that IEX's opponents often object to features of IEX that look more like what a broker does than what a stock exchange classically does. That perhaps overstated things; IEX objected by e-mail:

From a practical perspective, brokers cannot replicate the protections of DPEG on their own. To do so, a broker would need to be faster than every other trading participant in the market. DPEG works on IEX because we have a speed bump that ensures that we effectively are faster at processing market data (i.e. picking up signals) than trading participants on IEX. Many agency brokers are active users of DPEG and we have not heard of any client-facing brokers criticizing the order type.

Also, yesterday I rounded up some of the most important news about Pokémon Go, which prompted reader Steve Lindemann to e-mail:

One thing I haven't seen anywhere (yet?) is how augmented reality games could actually be used to fight inequality in a way that's a bit different than standard gold farming. Since PG is location aware, the game can easily skew the appearance of rare Pokémon to economically disadvantaged areas, allowing locals to capture and trade them as a source of income -- or perhaps even increasing tourism to the area. The geographical distance barrier means that it's unnecessary to make time the barrier, the way most games do to reduce the impact of gold farming (i.e., people in targeted areas can acquire in-game goods without being forced to adopt the "work a 20 hour shift killing monsters as they spawn" approach).

If Pokémon Go ends up being the cure for global income inequality, well, you read it here first. Probably. Maybe not, I don't know; there are a lot of Pokémon takes out there. Elsewhere: Pokémon at funerals.

Things happen.

J.P. Morgan Posts Stronger-Than-Expected Results on Trading Surge (earnings release, supplement, presentation). How Private Equity Found Power and Profit in State Capitols. Viacom in Talks to Sell Paramount Pictures Stake to Chinese Group. Robo-Adviser Betterment Hits the $5 Billion Mark. Law Center Calls Seller-Financed Home Sales ‘Toxic Transactions.’ Valeant’s Ex-CEO Michael Pearson Sells Nearly $100 Million in Company Stock. "Seven percent of Point72's investment staffers are women, which is a laughably low figure until you realize that Point72 is actually a rare leader." Singapore Exchange Malfunction Spoils CEO’s One-Year Anniversary. UBS to Offer NextShares on Its Financial Adviser Network. Faiza Saeed to Become First Woman to Lead Cravath, Swaine & Moore. U.S. Senators Ask FTC to Probe Airbnb’s Impact on Housing. Chinese Businessman Gets Nearly Four Years in US Hacking Case. Omar Amanat Arrested and Charged as Kit Digital Case Widens. Investors Now Pay Germany to Borrow for 10 Years. "Bond investors don’t expect economic catastrophe; they simply assume central banks will act as if catastrophe is around the corner." Sorry, You’re Just Going To Have to Save More Money​. The Data-Driven Case for Vacation. Null Island. Bear in Subaru. People in the Four Seasons pool.

If you'd like to get Money Stuff in handy e-mail form, right in your inbox, please subscribe at this link. Thanks! 

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