Tamed Banks and Unequal Markets

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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Has Wall Street Been Tamed?

Betteridge's law states that "Any headline that ends in a question mark can be answered by the word no," but this New York Times Magazine article by Nathaniel Popper is the second use of the headline "Has Wall Street Been Tamed?" in the past two weeks (the first was this Bloomberg article), which makes me think that the answer is ... maybe? Popper's answer is closer to yes, and he attributes the taming primarily to increased capital requirements:

In 2010, central banks agreed that the large commercial banks needed to double or even triple their capital buffers. Riskier ventures require even more capital.

The most immediate impact of these rules has been to serve as a sort of brake on business activity, given the hassle and cost of raising more capital. And indeed, when banks today explain why they are moving into or abandoning certain businesses, they almost always cite capital requirements as their main motivation.

He is more skeptical of claims that banks' pay structures still incentivize short-term risk-taking:

To focus on pay packages misses how capital requirements have changed incentives for the entire system. I hear constantly from traders who say that the daily work of buying and selling bonds or stocks, and thus the amount of money they can take home, is constrained by the capital limits.

This all strikes me as basically right, but of course the big question is: cyclical or secular? The cyclical case is that banks are boring because interest rates and volatility are low and it's hard to make enough money in trading businesses to justify your cost of capital, particularly when investors are still anchored on pre-crisis expectations for return on equity. Also, risk-based capital requirements -- and even the sort of risk-based-lite capital requirements in the leverage ratio -- have a way of channeling banks not so much into low-risk activities as into low-risk-weight activities. Since the crisis, regulators no longer think that, like, buying senior tranches of synthetic collateralized debt obligations of subprime mortgage-backed securities is a low-risk activity, but in the long run I'm not sure I'd bet against the banks' ability to find new activities that are both lucrative and blessed as safe by capital requirements.

But I might. The best case that this change might be permanent is just that, by making banking boring, the new rules will bore all the creative geniuses out of banking. If pay is down and "Wall Street is in decline as the career path of choice at elite colleges and business schools," the people who would otherwise be building the next generation of capital-arbitraging synthetic CDOs will go elsewhere and build, like, quant hedge funds or augmented-reality gaming apps or whatever. In the long run, the measure of whether Wall Street has been tamed is not so much about structure as it is about people. If banking attracts people who want to work at conservative utilities, then that's what banks will be.

Elsewhere: "HSBC Profit Down 40% in ‘Difficult’ Environment." And: "HSBC Climbs Most Since April on $2.5 Billion Stock Buyback Plan." And "banks are ramping up their efforts — and trying new ways — to convince the public that they are not as bad as politicians make them out to be." And:

Regulators are asking big banks to provide investors with more-detailed disclosures about their trading businesses, a push that could peel back the curtain on a huge and volatile source of Wall Street revenue, according to people familiar with the matter.

Market structure.

The way most markets have worked over most of human history is that some people provide the service of intermediation, of buying and selling for customers at the customers' convenience. The people who set themselves up as professional intermediaries have, as a matter of course, much better information about the market than their customers do. Bond traders at big banks hold themselves out as being able to buy or sell bonds for customers, so customers call them and ask to trade bonds with them, so the bond traders tend to know who owns bonds and who wants bonds, which is information they can use to match buyers and sellers and make a profit. My supermarket will sell me eggs whenever I want, and my supermarket knows a lot more about the volume of egg purchasing in my neighborhood than I do.

But there is another model in which everyone just gets together in a room and has an auction, and whoever is willing to pay the highest price gets to buy the thing, and everyone gets the same information at the same time so that the auction can be fair. In, like, human economic life generally, this is a far less popular model than the professional-intermediation one. I'm not standing outside my supermarket with a pallet of eggs, trying to undercut them on price. But when you have electronic trading of financial assets, everyone instinctively seems to like the equal-access model. People get really, really, really upset when electronic market-making firms get stock market trading data a few microseconds before everyone else. 

Anyway this is fun:

ICAP Plc, which has seen its share of currency trading dwindle in recent years, is rolling out an unprecedented plan to revive liquidity in its electronic market.

The venue will feature a price feed called EBS Live Ultra that updates five times as often -- every 20 milliseconds -- as the old one. But it comes with a catch, according to documents obtained by Bloomberg: at least 40 percent of the time, customers of the $50,000-per-month service must passively provide bids and offers, generally viewed as a less aggressive form of buying and selling. That trading must amount to $200 million or more a day.

The approach is unusual, because exchanges typically go out of their way to avoid the appearance that one set of customers has more information than another.

Now one way to characterize this is that ICAP isn't giving one set of customers more information than another: Rather, it is dividing its subscriber base into customers (who trade less often, or who mostly take liquidity) and dealers (who trade a lot and provide a lot of liquidity), and implementing the traditional economic norm that the dealers should have better information about the market than the customers do. Of course, both the customer/dealer division and the information disparity are pretty crude -- and probably anyone using this service is more or less in the business of trading currencies professionally -- but that's what happens when you run an electronic market. Everything has to be a pretty bright line. 

Meanwhile in equities:

Bats got regulators’ approval to move quickly against market participants whose clients engage in illegal practices like spoofing, barring them from trading in weeks rather than the months or years it used to take. The company also introduced a neighborhood-watch style program to encourage more brokers to speak up when their peers abet manipulation.

Direct lending.

Speaking of market structure, and of banks as boring utilities, alternative asset managers are getting more and more into the business of direct lending, that is, arranging and syndicating leveraged loans themselves without involving banks. "While banks still control most corporate lending, the ascendance of direct lenders reflects the power shift transforming Wall Street as investment firms increasingly take on roles previously occupied by banks." 

You can sort of imagine three stages of bank lending:

  1. Banks have money, and lend it to companies.
  2. Banks arrange loans for companies, but most of the money for the loans comes from investment firms rather than the banks themselves. ("Banks usually prefer to sell loans they arrange to outside investors, who can get fickle if markets turn.")
  3. The investing firms cut out the middlemen and just arrange the loans themselves.

Loosely speaking, the move from phase 1 to phase 2 was led by the banks, and was in the banks' immediate interest: It is more pleasant and profitable to charge fees for arranging loans -- "Fees for arranging leveraged-buyout loans average about 2%" -- without the risk and hassle of actually coming up with all the money. The move from phase 2 to phase 3, cutting the banks out of the picture and redirecting those fees to direct-lending firms like Ares Management, is less great for the banks. But in hindsight it looks sort of inevitable.

Hedge funds.

I don't know, do you think in 20 years there will still be people who sit around reading research reports and examining economic data and then deciding which stocks or bonds or currencies to buy? Right now, computers are better than humans at chess and go and basically all other intellectual games. Ah, but global macro investing isn't a well-defined rules-based game; its playing field is coterminous with the world, and its rules are the rules of human life. But computers are probably better than humans at driving, too, and they surely will be in a few years. Computers aren't just good at carefully prescribed games; they're good at human activities that require quick reactions and high precision and learning from experience. Surely they can figure out what stocks to buy. And they're less likely than human traders to hide their losses or exceed their risk limits or panic when they lose money or hold back on a recommendation because they're afraid the portfolio manager won't like it. 

Or maybe not, maybe there is something irreducibly human about macroeconomic analysis and investing. It would be a little weird if that were the case, though. Anyway Paul Tudor Jones is hiring more computers:

Jones, suffering losses and about $700 million in investor withdrawals in the second quarter, has accelerated a high-tech revamp at Tudor Investment Corp. in the past year, according to three people familiar with the matter. Scientists and mathematicians, some with doctorates, have joined Tudor to bring new analytical rigor to its trading strategies, the people said.

Elsewhere, AIG keeps reducing its investments in hedge funds. College endowments are doing poorly: "Funds with more than $500 million lost a median 0.73 percent in the fiscal year through June 30, while endowments of all sizes lost 0.74 percent," the worst performance since 2009. And "Gramercy, a US hedge fund, has handed investors in its two-year Argentina-focused vehicle about $750m, a gain of 20 per cent net of fees two months ahead of schedule."

New Bill Gross Investment Outlook!

Sex is a three-letter word that has rarely appeared in an Investment Outlook until now.

You know what, never mind.

Krimes paid.

Wait are $2 ATM fees illegal now?

JPMorgan Chase & Co.’s contract to provide debit cards to inmates released from federal prison may have backfired after a former convict raised a ruckus.

The bank agreed to pay a total of $446,822 to thousands of ex-prisoners to settle a class-action suit claiming JPMorgan ripped them off with $10 fees to withdraw money from a teller window and $2 charges for using non-network ATMs, according to a filing on Monday in federal court in Philadelphia.

The case was brought by an artist and former prisoner named Jesse Krimes, "who made artwork from prison-issued sheets and soap while serving six years after pleading guilty to distributing cocaine." There were other fees, "including 45 cents for balance inquiries and a $1.50 inactivity charge," all of which seem shady and exploitative but also not all that far off market. The average non-network ATM fee is $4.52. My sense is that, if you're a bank, you can mostly charge whatever the market will bear, but if you focus your fees on one vulnerable group -- especially a group that doesn't even get to choose whether to use your services -- that may not go so well.

Elsewhere in crime and finance, one defendant has pleaded guilty in the big hacking-corporate-press-releases insider trading case. That's such a great case. Like, the Supreme Court this term will consider the case of a guy who got tips on a couple of upcoming mergers from his brother-in-law. That's the big marquee insider trading case this year, coming after the big appeals-court ruling on some guys who got earnings information from an investor-relations employee. Those cases are utterly trivial! Those are insignificant amateurs, compared to the guys who just hacked into all the press releases and took all the inside information about all the companies. "It was bad judgment and I am very sorry," says the guy who pleaded guilty.

Elsewhere: "Israeli Man Charged With Operating FOREX Ponzi Scheme." And Reza Zarrab, the Turkish gold trader charged with violating Iran sanctions, has pretty much hired all the lawyers

Blockchain blockchain blockchain.

Do you even need me to tell you that Bitfinex, a bitcoin exchange, has been hacked, and that "some of our users have had their bitcoins stolen"? Apparently "the hackers took 119,756 bitcoin, or about $65 million at current prices." This follows previous thefts at Mt. Gox, Cryptsy, Gatecoin, Bitstamp, and so many other bitcoin exchanges and wallets. Also there was the DAO hack, though that was ether, not bitcoin. And big banks look at the bitcoin ecosystem and think: We need to be more like that! It really is amazing.

Great news!

I don't have to learn how to use Snapchat, because now Instagram will also be Snapchat! Because Instagram, which I more or less know how to use, is copying Snapchat's "stories" feature, which is ... a feature ... that Snapchat ... has. And that now Instagram will have. Hurrah, stories. Here is Instagram's explanation. "With Instagram Stories, you don’t have to worry about overposting," it says, and I won't.

One possible lesson here is that the social networking business has matured enough that ideas aren't all that valuable anymore. Twitter gets live video streaming, and it is good, so Facebook quickly copies it. Snapchat has stories, and they are good -- one assumes -- and so Instagram copies it. It used to be that if you had a great idea for a new social-network interface, you could roll it out and compete with the big established networks. But Snapchat might be the last network to succeed that way: Now, the value of the existing network -- just the number of people using Facebook or Instagram or Snapchat or whatever -- outweighs the value of any clever new interface you can come up with. I am not holding my breath for Peach. Here is a claim that "Mark Zuckerberg is officially the new Bill Gates — that should make startups nervous." 

People are worried about unicorns.

Here is Sheelah Kolhatkar on Theranos's abrupt pivot from its controversial blood testing laboratories to its brand-new machine: 

By all accounts, her delivery was smooth and forceful, and, taken on its own, it would likely have been seen as a success. “I have to say, Holmes, who is wearing a suit, not a turtleneck, is doing an amazing job presenting this,” Matthew Herper, of Forbes, live-blogged as the event was under way. “I understand why people invested in her.”

It is possible that our society and economy somewhat overvalue smooth, forceful delivery. Like, I can sit here and tell you not to invest with someone just because she has a smooth, forceful delivery. But, in the moment, I'm not sure I'd be able to resist either. Elsewhere, "Margot Robbie Just Made A Strong Case For Unicorns In A World Of Mermaids." I don't really understand that headline either, but there's a picture of Robbie in a dress with a giant glittery unicorn on it, which maybe you can wear to your startup's next happy hour.

People are worried about bond market liquidity.

I missed this yesterday, but "Now We Have Two Answers to the ECB Corporate Liquidity Question," which coincidentally is the number of answers we have to most bond market liquidity questions. ("The data don't prove the ECB has actually undermined corporate-bond liquidity," but Bank of America credit analysts "fear the sheer size of CSPP buying has heightened investors' nervousness over credit market liquidity.") Elsewhere, here's an update from U.S. regulators on their review of Treasury market structure. And: "Bank of England May Resume Bond Buying, but Some Wonder Why." And: "Google parent Alphabet Inc. sold $2 billion of bonds Tuesday, joining a rush of issuance from technology companies that have already raised more than $100 billion this year."

Things happen.

Greece to press ahead with criminal trial for ex-statistics chief. Illegal in Massachusetts: Asking Your Salary in a Job Interview. Top Executives at Riverstone Holdings Face Prospect of Returning More Than $300 Million. Obscure Rule to Fix $2.7 Trillion Market Draws Tireless Opponent. Buffett's Bet on a 'Relentless' CEO. Anxiety Weighs on U.S. Corporate Earnings. China Inc. Has $1 Trillion in Cash That It’s Too Scared to Spend. Underwater in the Las Vegas Desert, Years After the Housing Crash. Treasury Issues Proposed Regulations to Close Estate and Gift Tax Loophole. An MBA explains what life is like a year after business school. "Donald Trump on Tuesday said interest rates set by the Federal Reserve are inflating the stock market and recommended 401(k)-holders to get out of equities, just like he did." Donald Trump Proposes $550 Billion in New Government Debt. Federal Judge Allows Suit Against Trump University to Proceed. "We find no statistical evidence that strip clubs have ‘secondary effects’ on nearby residential property prices." Is flossing a fraud? What are Martha Stewart's cats up to? Watch a Teen Play Basketball and Eat Donuts With a Deer Named Money.   

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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:
Brooke Sample at bsample1@bloomberg.net