Trading Teens and Bank Blockchains

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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Kids these days.

If you are a teenager who has maybe been running a commodities hedge fund out of your house, and if your marketing materials have maybe not fully complied with the requirements of the National Futures Association, and if an investor who claims that you won't give him his money back has complained to the NFA, and if the NFA shows up at your house to ask you a few questions, one thing you could do -- and I want to be particularly emphatic here that this is not legal advice -- is hide:

NFA commenced an exam of Nex Capital on June 20, 2016. On that date, the NFA exam team went to the Los Angeles, California address that Nex Capital had listed as its main office address in NFA's Online Registration System (ORS). When the exam team arrived at this address, they found that it was a residential home. The exam team knocked on the front door of this home but no one answered the door.

They'll come back, though. Keep hiding! Make sure they don't see you!

On June 21, 2016, the exam team again went to the residential home in Los Angeles where it had gone the day before and again there was no answer. However, the exam team noticed someone at the second floor window who appeared to be taking photos or a video of the exam team. 

But then they're going to go look for you at your parents' house:

The exam team then went to the address that Nex Capital listed in ORS as the location of its business contacts. This address turned out to be a residential home in Corona, California. A boy answered the door at this address and told the exam team that Wohl did not reside there and that he was not sure where Wohl was.

But even that won't deter them, so you might want to give up and bring in your dad. Surely he'll be able to make the problem go away:

Approximately 20 minutes later, one of the exam team members received a telephone call from an individual who identified himself as David Wohl, Jacob Wohl's father. David Wohl threatened legal action against NFA and said that he was going to contact the Los Angeles Police Department to report NFA's trespassing and harassment. He told the exam team member, to "stay away or else."

Wait this is going off the rails a bit.

Approximately an hour later, NFA received an e-mail reply from David Wohl, who represented that Nex capital had withdrawn its NFA membership and, therefore, claimed that NFA no longer had any jurisdiction over the firm or Jacob Wohl.

David Wohl's e-mail accused NFA of "stalking and harassing Jacob and our family repeatedly, at our homes" and "demanding a meeting that is not going to take place under any circumstances." David Wohl's e-mail also claimed that he had "initiated a formal complaint with LAPD, and they are now investigating this matter" and that he would "also seek a permanent restraining order in court, the violation of which will result in criminal penalties."

This is actually a great idea; more people should take out restraining orders against regulators who are investigating them. (Super not legal advice!) Really the ideal version would be to commit a crime, and then call the police to get a restraining order against the police who are coming to arrest you. What gives them the right to stalk and harass you?

Obviously -- obviously! -- those quotes are from the NFA's enforcement complaint against Nex Capital Management LLC and Jacob Wohl, its 18-year-old founder. (And obviously they are just allegations, and just NFA's side of the story.) We have talked about Wohl around here before, and each time I have felt a little bad about it, because everyone should get to do embarrassing things as a teenager without having them preserved and amplified by the internet. On the other hand, if your teenage hijinks include using the internet to make big claims about your commodity-trading prowess, you are kind of asking for attention. And that attention begets regulatory visits:

As part of its internet surveillance program, NFA found a web-based article about Wohl capital, dated March 2015, and entitled "High School Jock Turned Hedge Fund Trader - ls Regulatory Trouble Ahead," which reported that Wohl Capital had accepted funds from approximately twenty investors for the purpose of trading futures and securities.

By the way, the most interesting part of the complaint may be this:

NFA sent a request for information to all futures commission merchants to determine what business, if any, Nex Capital and/or Wohl were conducting. Through this request, NFA learned of two trading accounts controlled by Wohl - one in the name of Wohl Capital and one in the name of Michelle Wohl, Wohl's mother. These accounts had a total of approximately $260,000 in deposits, trading gains of approximately $36,000, and about $296,000 in withdrawals. These accounts were open from April through October 2015, before Nex Capital and Wohl were NFA Members

He really did trade commodity futures successfully!

Blockchain blockchain blockchain.

I mean sure why not:

Four of the world’s biggest banks have teamed up to develop a new form of digital cash that they believe will become an industry standard to clear and settle financial trades over blockchain, the technology underpinning bitcoin.

UBS, the Swiss bank, pioneered the “utility settlement coin” and has now joined forces with Deutsche Bank, Santander and BNY Mellon — as well as the broker ICAP — to pitch the idea to central banks, aiming for its first commercial launch by early 2018.

Sounds good:

The utility settlement coin, based on a solution developed by Clearmatics Technologies, aims to let financial institutions pay for securities, such as bonds and equities, without waiting for traditional money transfers to be completed. Instead they would use digital coins that are directly convertible into cash at central banks, cutting the time and cost of post-trade settlement and clearing.

The idea here is that a central bank more or less runs a centralized ledger of, say, dollars: Each bank has an account at the Federal Reserve, and that account lists how many dollars the bank has. And if Bank A buys some bonds from Bank B, it has to send Bank B some dollars to pay for the bonds. So the banks go to the Fed and tell it to deduct some dollars from Bank A's account and add them to Bank B's account. And the Fed is like "hang on, we're a little busy here," and stonily eats its lunch while the banks tap their feet and look at their watches. So the transfers take a while. But what if the banks just ran their own shared ledger, and could deduct some pseudo-dollars from Bank A's account and add them to Bank B's account? And what if the Fed had agreed to convert pseudo-dollars into dollars -- at its leisure, naturally -- so that the pseudo-dollars are just as good as real dollars for Bank B?

It seems ... fine? Like the problem in settlement is that you agree on a trade, and then:

  1. It takes a while to move the securities around.
  2. Also it takes a while to move the dollars around.

Having a pseudo-currency does not solve problem 1, though of course there is much discussion of blockchains to record entitlements to securities. Having a pseudo-currency also does not solve problem 2: You don't get your dollars any faster; you just get your pseudo-dollars faster. (To get the dollars faster, you'd need to speed up the Fed's central-ledger technology.) But for many purposes -- for example, just doing more transactions with other banks -- the pseudo-dollars are just as good as dollars. If every bank signs on for this, then they can go out and buy more securities with their pseudo-dollars, and rarely need to bother with the Fed.

This is what blockchain is: It's banks developing better and faster systems to agree with each other on what they all own. (I mean, the bitcoin blockchain is a wilder and woollier thing, but too scary for many banks.) That seems good! I have no real complaints! It is all just, like, 20 percent less magical than it is usually made out to be.

Investor reads documents.

Well this is delightful:

A pair of former Goldman Sachs Group Inc. traders who bought and sold mortgage debt before the U.S. housing crisis are now hoping to make a fortune off its rubble.

The two, Reza Ali and Joshua Birnbaum, run separate hedge funds that years ago began snapping up a carefully chosen set of beaten-down mortgage bonds. It was a wager that unusual wording in their contracts would net them millions of dollars when a large bank settlement was paid out.

Basically Countrywide sold some mortgage-backed securities with legal documents that, weirdly, appear to cap certain payments to holders of senior tranches. (This June Debtwire article has more details.)  Those bonds blew up, investors sued, and Bank of America (which now owns Countrywide) settled for $8.5 billion. Ali and Birnbaum bought junior tranches of those deals, and are now arguing in court that there really is a cap on payments to the senior tranches, and that more of the money should go to them. The holders of senior tranches, like BlackRock and AIG, disagree:

If defaulted junior bonds receive settlement payouts instead of senior bonds, “that would be an unanticipated and unfair outcome,” AIG’s lawyers said in a court filing this month.

I have not read the documents and don't know who's right, but it's notable that one side is using the language of fairness, while the other side is using the language of "hahahaha look what we found in these documents!" ("They saw an opportunity in the market and capitalized on it," says their lawyer.) That certainly suggests that they're right about what the documents say. On the other hand, the senior holders are obviously right that it's unfair. Now it's up to a judge to decide if the documents could really have meant the unfair thing that they say.

By the way, you occasionally see stories that follow this general pattern, which is:

  1. Person works at a bank in a fairly specialized structuring group.
  2. Person realizes there is a flaw in the securities that his colleagues (or his competitors) are creating.
  3. Person leaves to start a hedge fund to exploit that flaw.

This is not quite that -- a former research analyst seems to have brought the idea to these funds -- but it's not unrelated. This pattern does not, perhaps, create the best incentives for structurers to get things right and keep them simple. But I am a former derivatives structurer at Goldman (disclosure!), and it makes me smile.

TeslaCity.

My general view of the proposed merger between Tesla and SolarCity is that it's about as good as you can expect, from a corporate governance perspective, given that Elon Musk is the biggest shareholder of both companies, and the chief executive officer of Tesla, and the chairman of SolarCity, and his cousin is the CEO of SolarCity. It is a tangled monstrosity, but that is just a sunk cost at this point. Musk has decided to try to untangle the monstrosity a bit, and he let independent directors negotiate the price, recused himself from voting and gave SolarCity time to seek other buyers. It's all a fairly reasonable approach to an uncomfortable situation.

But this ... does not ... help?

Tesla Motors (TSLA.O) Chief Executive Elon Musk is buying $65 million of bonds from SolarCity Corp (SCTY.O) in the latest debt offering by the solar panel company that Tesla plans to acquire for $2.6 billion, according to a filing on Tuesday.

That's a bit more than half of the $124 million offering, and Musk's cousins at SolarCity are in for another $35 million. "It appeared to be the first time Musk has directly purchased SolarCity bonds, although his rocket-making and space transport services company SpaceX has bought them in the past." So now he has $65 million more of his own money hoping that Tesla shareholders will vote to rescue SolarCity. It is not, like, a great time to further tangle the Musk/Tesla/SolarCity relationship, but I guess SolarCity needed the money? 

In happier Musk Empire news:

On Tuesday, Tesla Chief Executive Officer Elon Musk released a new, 100-kilowatt-hour battery pack for the dual-motor versions of the Model S and Model X. The upgrade makes the Model S the first all-electric sedan with a range of more than 300 miles, and it cuts the zero-to-60 miles per hour interval to just 2.5 seconds. Only a few cars can compete with that, including the LaFerrari and Porsche’s 918 Spyder. Those cars, however, are limited-run supercars that cost $1.4 million and $845,000 respectively.

For the first time, Musk said, “the fastest car in the world, of any kind, is electric.”

Needless to say, Musk teased this news with a tweet, and the stock jumped. It must be a constant delight being his lawyer.

What is a levered commodity exchange-traded note?

I mean, it is an entertainment product, right? This "26-year-old Toronto man trades Credit Suisse Group AG’s VelocityShares 3x Long Crude ETN," and he gets it:

“There’s a theme among the younger generation to try to get rich quick," according to Santos. The oil market’s been "like a roller coaster,” he said. “Ultimately, that’s why I’m trading this position. It’s been pretty volatile lately, with these huge swings. It’s kind of fun.”

Lots of people get it:

“There’s a lot of juice if you have a short-term tactical outlook and you want to take a risk with some big reward,” said Jason Bloom, director of commodities and alternatives research and strategy at Invesco Advisers Inc, who emphasized that leveraged ETNs are appropriate only for short-term bets and those with a higher risk tolerance. "It certainly provides entertainment."

Look I can't say that the idea of day-trading a triple-levered oil ETN sounds all that fun to me, but I don't like "The Big Bang Theory" either, so who am I to comment on people's entertainment choices? "I can afford to lose the money," says Chris Santos. Go for it!

There is a weird view that banks should only offer products that are suited for risk-averse elderly retirees, and that goofball levered products have no place in anyone's portfolio. But they clearly have a place in Santos's portfolio. They bring him joy, and joy is rarer and more precious than alpha. The problem is that if you build a triple-levered ETN for young gamblers to play with, it will inevitably end up being sold to retirees. Part of that is that you can't rely on every financial adviser to do a good job advising their clients, but there is also a problem with the bloodless disclosures on these things. "Credit Suisse writes in its prospectus that the ETNs 'may not be suitable for investors who plan to hold them for a period other than one day.'" That doesn't quite fire the imagination. The prospectus should have a big skull and crossbones on the cover, and say in 40-point font "this product is dumb, come on, bro." That might -- might -- scare off the retirees, and I guarantee you it would increase sales to thrill-seeking 20-somethings. Why aren't banks doing it already?

People are worried about unicorns.

Profitability is the new unicornity!

Not so long ago, joining the "unicorn club" of companies valued at $1 billion or more was the most sought-after bragging right in Silicon Valley; now startups are just as eager to proclaim profitability.

I don't know, making more money than you spend seems like a very old-economy goal, but I guess the Enchanted Forest goes through fads for nostalgia like everywhere else.

People are worried about bond market liquidity.

Where once there were, like, 800 new electronic bond-trading platforms, now there will be 799, because Direct Match, an all-to-all Treasury-trading startup, "will not be able to execute on our vision anytime soon," and "has started to explore other strategic options," according to founder Jim Greco. The problem was with clearing relationships: "Uniquely in Treasuries, the dealers are serviced by a utility (the FICC) that they own, and everyone else is at the mercy of an ever shrinking oligopoly of clearing firms who are themselves dealers, or are dependent on them." (Joe Rennison at FT Alphaville has more.) But Greco still believes that his day will come:

Despite the setbacks we have suffered and the uncertain future of the firm, I am more convinced than ever that the secondary market will look more like Direct Match in the future. Dodd-Frank, the Volcker Rule, and Basel III are here to stay.

Dealer liquidity will continue to deteriorate while buy-side demand increases unabated. Matt Levine will continue to write a daily section on why “People are worried about bond market liquidity.” However, until market participants pay more attention to the plumbing of the Treasury market, little may actually change.

Man is that a grim future. Not the shift from dealer to all-to-all liquidity, I mean, but the idea that I'll be writing this section forever. It's true, isn't it? Elsewhere: "Treasury 10-year notes are stuck in their tightest monthly trading range in a decade." And: "A Pilot Survey of Agent Securities Lending Activity."

Me yesterday.

I wrote about accelerated monitoring fees. Elsewhere: "Incredulous Judge Tosses Lawsuit Accusing Starbucks of Putting Too Much Ice in Cold Drinks."

Things happen.

Canada quietly treads radical path on pensions. Trying to Turn Back the Clock on Deals Gone Sour. Money Market Squeeze on Short-Term Bank Debt Gets Tighter. Derivatives Users Hit as Negative Rates Raise Collateral Costs. Dealers grapple with netting valuation adjustments. The Alpha Paradox. The Woman Who Revived Russia’s Markets. Hostile Raid on China's Biggest Developer Marks New Takeover Era. Hong Kong’s Markets Regulator Fines Morgan Stanley $2.4 Million. Penny-Stock Scammer Pleads Guilty to Fraud Hatched in Prison. Turing Pharmaceuticals Accused of Retaliating for Sex Assault Complaint. In A Blow to Fannie and Freddie Shareholders, Court Tosses Out Another Lawsuit. Largest Oil Companies’ Debts Hit Record High. Solar Industry Braces as Looming Glut Threatens to Erode Prices. How to Stay Rich in Europe: Inherit Money for 700 Years. The U.S. Government Is Buying 11 Million Pounds of Cheese. "DRINK: Yeah you will." Steve Bannon, Donald Trump’s Campaign CEO, Once Wrote a Rap Musical. Dog elected for third term as mayor of Minnesota town.

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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