Bond Trading and Bank Memoirs

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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Banks.

Here's a Bloomberg article about Goldman Sachs's declining fixed-income market share that is also about the struggle for the soul of the financial industry or whatever:

Goldman Sachs’s underlying problem goes to the heart of its business. Almost three-quarters of its trading clients are hedge funds, asset managers, banks and brokerages -- a group bruised by market swings and stiffer regulation. Their travails have hurt revenue at Goldman, a specialist in structuring complex bets. In contrast, commercial banks like JPMorgan and Citigroup serve larger numbers of corporations that want relatively simple products like interest-rate swaps and currency hedges to guard against turmoil.

“You have seen a shift over the last couple of years in terms of what products have been more active,” said Devin Ryan, an analyst at JMP Securities. “It has not been in Goldman’s favor.”

Goldman is working on it, with "an effort to add corporate clients" and improvement "particularly in flow products," though a UBS Group analyst thinks this is all a front that "masks a larger restructuring as the company directs investment dollars to businesses such as equities trading."

Maybe? I am biased, since I used to work at Goldman building derivatives, but it seems to me that Goldman is just sort of structurally always going to be a bet on financial complexity. Simple boring utility-like banking requires lots of balance sheet and relationships, and not so much cleverness and innovation and structuring. It is not totally clear to me what Goldman's advantage would be in a world of low-risk utility-like flow trading and banking.

On the other hand, if Goldman's bet is that the move away from complexity is cyclical, that might work out fine. The long-term movement of finance over the last hundred years has been toward more complexity; the post-crisis reversal might be a blip. And, I mean, even the utility industry eventually created Enron. 

Meanwhile, "Bank of America Corp. reported quarterly earnings that were dragged down by continued low interest rates, but a pickup in bond trading helped results beat expectations." Here are the earnings release, presentation and supplement.

New banking memoir.

Here's a claim:

Until now, insiders who have written about Wall Street have tended to temper their criticism. A Colossal Failure of Common Sense by Lawrence McDonald and William D Cohan’s tomes are excellent and richly detailed, but they are not first-person chronicles of what it is like to live as a banker and to realize the system is flawed.

Thus far, the only book to attempt that is Greg Smith’s Why I Left Goldman Sachs, published in 2012.

Nah, though. Nah. My Bloomberg View colleague Michael Lewis, whom you may know as the author of a first-person chronicle of what it is like to live as a banker and to realize the system is flawed, once wrote:

Twenty five years ago I quit a job on Wall Street to write a book about Wall Street. Since then, every year or so, UPS has delivered to me a book more or less like my own, written by some Wall Street insider and promising to blow the lid off the place, and reveal its inner workings, and so on. By now, you might think, this game should be over.

He wrote that in 2013, about Smith's book; since then there's been at least one more addition, John LeFevre's "Straight to Hell." And now there's a new one, "For the Love of Money," by Sam Polk, a former investment-bank and hedge-fund trader who wrote the "bro talk" op-ed in the New York Times earlier this month. This seems right:

One of Wall Street’s dirty little secrets, he says now, is that while it’s full of people talking about how risky their jobs are, they’re dissembling.

“It’s one of the most stable career paths available,” he argues. “Once you get to the level of making $1m a year, you rarely dip below it. Hedge fund managers who leave Goldman talk about how risky it is, but it’s all upside.”

I tend to think of the Wall Street memoir as a sub-category of the addiction memoir. Polk seems to agree:

“Wall Street wasn’t a talent-based meritocracy; it was more like an addiction,” he writes. “Doing whatever you had to do – rationalizing, lying – to get the money to fill that empty hole inside.”

The money multiplied – less than four years after starting to work on Wall Street, Polk was offered a guaranteed $1.75m for two years. But that didn’t make him happy.

But addiction memoirs too frequently consist mostly of fun boastful stories about the author's crazy drug-fueled antics, followed by some rote expressions of regret that fall flat after all the boasting. "I hit rock bottom when I went to a party in Soho and snorted so much cocaine that I blacked out and came to in a hotel suite in Monaco with three naked models and a jaguar, it was great, I mean terrible, it was terrible, sobriety is so much better." If you are truly over your money addiction, why do you have to write a memoir itemizing all your bonuses?

Bailouts.

My rough definition of a financial crisis is that it's when someone borrows money from someone else, and can't pay it back, and it is politically and socially unacceptable not to pay it back. This I think is a more general and more useful concept than "too big to fail," which I have never quite understood. Here's a story about Banca Monte dei Paschi di Siena SpA, Italy's third-largest bank, which is not looking forward to the results of European bank stress tests:

The bank has €50 billion ($55.5 billion) in bad loans on its books and is widely expected to emerge as the worst performer. That could trigger calls to raise capital, put more pressure on the bank to reduce its bad debts and increase the risk of a failure that could shake Italy’s banking system.

Analysts say there is virtually no chance private investors will finance a recapitalization of Monte dei Paschi, the world’s oldest bank, founded in 1472.

Instead, Italian officials have been pushing hard to use some sort of government support. The rub is that new EU banking rules ban the use of public funds for bailouts unless private investors are wiped out first, setting up a contest to see which side will blink first.

Europe has quite sensibly demanded that banks have bail-in-able junior debt that will be wiped out before socializing any bank losses, and investors in that debt should know that they are at risk. But "Monte dei Paschi has €5 billion in outstanding junior bonds, with about half believed to be in the hands of Italian households," and it is hard to be certain that those households knew what they were getting into and can afford to lose their money. The hard part is not getting the banks' capital structure right; it's getting the right pieces of the capital structure into the right hands. Obviously putting bail-in-able junior debt of one bank in the hands of other banks is bad, creating the risk of contagion. But putting it in retail hands -- creating the risk that politicians will be sympathetic to wiped-out individual bondholders who didn't know what they were signing up for -- isn't great either.

Elsewhere, here is Bloomberg's Tracy Alloway on differences in capital stringency across countries.

Politics.

Well here's Minneapolis Fed President Neel Kashkari:

“For 30 years, or maybe longer, the Fed had adopted this Wizard of Oz posture, that we’re so mysterious, we’re so powerful, don’t ask any questions,” Kashkari, who at 42 is the youngest regional Fed bank president, said in a July 7 interview. “At the end of the day, we’re here to work on behalf of Main Street.”

Here's how he communicates with Main Street, or at least Financial Twitter Terrace:

“.@Six1FourCapital 4 me it’s a q of r we hitting dual mandate? Is there still labor slack? R we hitting infl [target emoji]. Where r expectations going?” the Minneapolis Fed president said in a Twitter post May 25, in response to an online question from a commodities trader.

See, it's important to communicate with Main Street about the Fed's 2 percent inflation target, but it's hard when you use impenetrable jargon like the word "target." The solution is to use softer, friendlier, more mainstream language, like the target emoji.

Selective disclosure.

We talk sometimes around here about how awkward it is that companies are always going around having one-on-one meetings with their shareholders. On the one hand, the rules are clear -- in the U.S., the rule is called Regulation FD -- that the companies aren't supposed to tell the shareholders anything material in those meetings that they haven't already announced to the broad market. On the other hand, why do the investors bother with the meetings if not to learn useful things that they didn't know before? It is a puzzle. Adding to the puzzle is the fact that Regulation FD enforcement actions are extremely rare. There are rules that seem designed to create a level playing field among all investors in U.S. public stocks, but no one seems to seriously believe that that is possible, or to want to do anything about it.

Anyway here is a new blog post, and related paper, about the effectiveness of Regulation FD:

We find significant increases in abnormal trading volume during the trading hour immediately prior to the first public release of Reg FD disclosures. In fact, we find that 20 percent of the abnormal volume reaction over the two hour window surrounding Reg FD disclosures occurs during the hour before the disclosure. Second, this pre-disclosure increase in trading volume is larger when the information is of greater consequence to the market. Finally, stock returns during the trading hour immediately prior to Reg FD filings predict returns during the trading hour immediately after the filings, but only for the disclosure of consequential, negative information.

This study looks only at cases where the company did put out a press release disclosing something material, though. The story here seems to be something like: The company decides a fact is material, gets together a press release about it, and meanwhile tells a few favored investors before issuing the press release. (Or: The company meets with favored investors, tells them something, the lawyer says "oh I guess that was material," and they rush out a press release.) I casually assume that the bigger issue is all the times when the company meets with investors, the investors go out and trade on whatever they learned in the meeting, and the company concludes that nothing material was said and never puts out a press release at all.

People are worried about unicorns.

One worry about unicorns is that they are too quick to take money from people whose politics are unpopular within the Enchanted Forest's community of enlightened libertarian unicorns. Like for instance Uber taking money from Saudi Arabia's sovereign wealth fund:

“It would not have been a choice I would have made if I were them,” Wesley Chan, a partner at venture-capital firm Felicis Ventures, said of Uber.

Mr. Chan, who is gay, said he wouldn’t accept money from Saudi Arabia or any other investors whose values he didn’t agree with. “We want to make money for folks who are tolerant and agree with our principles of diversity,” he said.

I wonder if anyone is turning down Peter Thiel's money these days? I mean, I guess I wonder if anyone is turning down Saudi Arabia's money these days, rather than just talking about it hypothetically. Still it is a perfect piece of Silicon Valley exceptionalism -- the conflation of business and public service, the drive to change the world, the entrepreneur-centric corporate governance model, the distrust of public markets and transferable stock, the libertarian faith in private ordering, the certainty that unlimited funding will always be available -- that tech firms would want to choose their investors on political as well as economic grounds.

Elsewhere, here is a fascinating description of Rocket Internet SE, a German company that offers, basically, unicorn cloning services:

On the top floor of its seven-story headquarters, employees monitor tech startups world-wide for businesses to copy. When an idea is approved, Rocket assigns marketers, engineers and managers.

As the business develops, it moves down floor-by-floor, eventually making it to the ground level, where managers start to look for offices outside the building.

Once your desk is right next to the front door, it is time for you to go. It's like a physical manifestation of the unicorn's quest to leave the Enchanted Forest. Anyway Rocket is facing difficulties, including businesses "struggling to prove that they can be profitable," trouble understanding the public markets, and of course the obvious difficulty that a business of copying startups is easy to copy.

People are worried about bond market liquidity.

I have nothing for you, really, but I guess the stuff at the top about Goldman's and Bank of America's bond trading businesses counts. And fixed-income trading results at JPMorgan and Citigroup, announced last week, were pretty good. Sometimes "people are worried about bond market liquidity" means that people are worried about bond market liquidity, and more often it means that people are worried about bond prices going down, but perhaps most often it means that people are worried about the declining profitability of investment banks' bond trading desks. 

Meanwhile, 10 percent of fixed-income managers think that "yields are never going to rise."

Me Friday.

I wrote about Herbalife's settlement with the Federal Trade Commission. So did Bloomberg Gadfly's Brooke Sutherland and Gillian Tan. And Herbalife investor John Hempton sent me a copy of an e-mail that he sent to the FTC, which is worth excerpting here:

a. I have visited 17 different Herbalife distributors in America and more globally.

b. They bear no resemblance to the short case as outlined by Bill Ackman or the assertions in the FTC filings of today.

c. Instead the basic argument has been that these poor ill-educated Hispanics are systematically deceived (even when they have been distributors for years) and this tall, handsome New York hedge fund manager will save them. This has been Rudyard Kipling sustained display of white man's burden racism.

d. I object to the court and the FTC becoming a tool by which racist themes are carried out.

Hempton added: "I think  there will be almost no effect on the business because the business is fundamentally ethical." He also wrote a blog post about the settlement:

The FTC settlement is a Rorschach Test. You will see in it what you want to see in it.

If you see a pyramid scheme in advance then the conditions that the FTC has imposed will cause that scheme to collapse.

If you see something that is not a pyramid scheme then lo - the FTC conditions will do almost nothing.

You can check this out yourself. Shoe leather. It's really an opportunity for you to make money on primary research.

Also: "I think that the FTC might actually have trouble finding enough 'victims' to distribute the $200 million in restitution. I intend on FOIA requests over time to monitor that." 

Also, in Money Stuff on Friday, I said: "If there is not an academic finance paper examining how the returns of a country's stock market are affected by the handsomeness of its leader, there really should be." More than one reader sent me this paper, on the value of CEO attractiveness. It's not the same thing, but I guess it's close.

Things happen.

SoftBank to Buy Britain’s ARM for $32 Billion in Record Deal. Bridgewater, World’s Biggest Hedge Fund, Is Said to Be Slowing Hiring. Corporate Profits Set to Shrink for Fourth Consecutive Quarter. Brexit worse than 2008 for finance chiefs, study finds. Ireland Hits Brexit Alarm in Biggest Foreign Crisis in 50 Years. Brexit vote triggers falls in London house prices. When Yahoo Ruled the Valley: Stories of the Original ‘Surfers.’ Yahoo’s Failed Alibaba Spinoff May Benefit Other Deals. "Complex orders usually exist to replace broker or trader functionality, otherwise we'd all just be using simple limit orders." Martin Shkreli Back in the Spotlight as Musical Theater Villain. "I genuinely believe that if Trump wins and gets the nuclear codes there is an excellent possibility it will lead to the end of civilization," says the guy who wrote "The Art of the Deal." Donald Trump's childhood home is for sale. Wuthering Heights Day. Clown makeup copyright eggs. Marmot fight. This 25-year-old makes $500,000 a year tweeting random facts. A designer will grow Alexander McQueen’s skin in a lab to use for leather bags and jackets. Fjords.

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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