Commodities, Fines and Steak

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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Physical commodities.

As far as I know there are no capital requirements for trading oil. Planet Money bought and sold some oil this year, and they are a public radio show. Bloomberg's Tracy Alloway bought some last year and sold it to  Izabella Kaminska, who then defaulted on the trade. If you wanted to get into the oil business and borrowed $45 from your mom to buy your first barrel, that would be fine. There are of course lots of environmental regulations, and you'd probably need insurance to drill it up or move it around, but the basic capital structure of the oil industry -- how much of the money comes from shareholders and how much is borrowed -- is a private decision, a matter for negotiation between companies and investors and banks. 

Meanwhile the Federal Reserve wants to put a 1,250 percent risk weight on some physical commodity trading at Goldman Sachs and Morgan Stanley. "The 1,250 percent risk weighting basically means about $1 in capital would be needed for every $1 in investment." So while you are free to borrow money to get into the oil business, Goldman wouldn't be: Banks would need to back their physical-commodity trades with their own money. Other physical commodity trading activities at big banks would get a 300 percent risk weight, and the proposed rules have other restrictions. The Fed says that the purpose of the proposed rules is "to help address the legal liability and reputational risks of physical commodity activities as well as the inherent uncertainty in valuing the potential damages associated with a catastrophe." Viewed as environmental regulation -- as a way to make sure that physical commodity traders have enough money to pay for any damage they cause -- it is odd, insofar as it applies only to banks. But of course it's not environmental regulation; it's banking regulation, and we're much more worried that a bank could fail than we are that an oil company could cause catastrophic environmental damage and be unable to pay to clean it up.

The core business of banking is taking deposits and making loans. It's a fine business as businesses go, but there you are, a bank, with all that money. You want to do things with it, things other than making 30-year fixed-rate mortgages. You have a key advantage in any business that you get into: You can get money a lot cheaper than anyone else can. (People are lining up to give you their money!) So you can fund your bond trading or power-plant-building or whatever a lot cheaper than your non-bank competitors can. But you also have a key disadvantage: You are a prudentially regulated bank. Some regulator in Washington, who is not interested in maximizing your profits, is sitting around thinking about what businesses you should be in and how you should finance them. 

It seems like a hard job, being that regulator. How do you decide what businesses a bank should be in? The fact that a business is risky is not a great reason to discourage it: The basic business of taking deposits to make loans is itself pretty risky, and other risky businesses add diversification. The fact that a business is socially useful is not a great reason to encourage it: If banks get out of the physical commodities business, commodities trading houses -- or public radio shows and Bloomberg reporters -- can presumably trade commodities instead, though their cost of capital may be higher. Sometimes we want banks to do a business, perhaps because we want their cheap funding to subsidize the business (this is "people are worried about bond market liquidity"), or perhaps because we want the business to be subject to continuing prudential oversight by banking regulators (this is "people are worried about shadow banking"). Other times we want banks to stay away, because we worry about banks monopolizing the business with their cheap funding, or because the business is too risky or reputationally icky and we'd prefer to leave it to firms with less famous names. The judgments often make sense but there seems to be something unsystematic about them, a constant series of ad hoc negotiations and special pleading rather than an overall structure of what banks should and shouldn't do.

Deutsche Bank.

Every time a bank pays a massive fine, someone will say "yeah but that represents only four minutes of profits for them" or whatever. So it is intriguing that Deutsche Bank's market capitalization -- something like 14.8 billion euros ($16.7 billion) when last I checked -- is approaching the fine ($14 billion) that the Justice Department has demanded to settle its mortgage-backed securities case:

“Clearly headlines around the DoJ settlement and those $14 billion continue to weigh on the stock,” Daniel Regli, an analyst at Main First, said by phone. “Nobody believes that they will end up paying that amount, but for some investors it might be a concern that even the German government is discussing Deutsche Bank’s situation."

Presumably the DoJ won't really get its full $14 billion, and really the fine has already been taken out of Deutsche Bank's market cap, in the sense that the current stock price reflects expectations of a hefty fine. When the actual settlement is announced, the stock might well rally. Still it would be an amazing piece of symbolism if the Justice Department fined Deutsche Bank its entire equity value for alleged mortgage-backed security fraud.

Times are something in Greenwich.

Not tough, exactly. An approximation of tough. A gesture at tough. Lavish, but slightly less lavish than they used to be:

The new Greenwich is like that. “We aren’t getting caviar and champagne,” says Edward Tricomi, co-owner of Warren Tricomi Salon on Greenwich Avenue, “but we’re still eating steak.”

The obvious issue here is that aggregate performance in the hedge fund industry has not been so great, leading to investor redemptions, pressure on fees, and a general sense that vast Connecticut estates and ten-carat diamonds are maybe not in the best of taste. But there is also something subtler, a sense that the hedge fund industry has become more institutionalized, more conservative, less flamboyant in its investing just as it is less flamboyant in its spending habits:

Members of the younger Wall Street crowd are quite conservative, says Robin Kencel, a broker with Douglas Elliman. “They used to say ‘Oh, I’ll stretch.’ Now they’re more practical. They’ll ask ‘What are the utility bills? Oh, wait -- I don’t want it.’”

There's an obvious mechanism by which poor performance will cause hedge funders to worry about their utility bills. The interesting question is: Are hedge funders who worry about their utility bills the sort of people who cause poor performance?

Elsewhere: "Few places in the country illustrate the divide between the haves and the have-nots more than the county of Fairfield, Connecticut." Meanwhile in Europe:

“This vintage of new funds is probably going to be the best performing vintage since 2009 because you are getting higher quality managers coming out, hungry to prove a point," said Erik Serrano Berntsen, chief executive officer of Stable Asset Management, which invests in hedge-fund startups. “All the best investments, to some extent, are a bit contrarian."

Mutual fund voting.

Here is Gretchen Morgenson criticizing mutual funds for voting shares they own without asking for their investors' opinions:

If you invest, as most people do, with a large fund manager, like BlackRock or the Vanguard Group, the chances are very good that your objections to common corporate practices are not getting through. That is because fund overseers vote your shares and often do so without regard to your views.

The result is a breakdown in one of the few accountability mechanisms available to individual investors in our so-called ownership society. This failure has everything to do with the fact that executive pay rises higher each year.

Of course, the funds also buy and sell shares without regard to your views; the reason I use mutual funds is because I want to outsource decisions about my investments to professionals, and I'd be pretty annoyed if my funds were constantly asking me how to vote on corporate events and pay packages. Still, I mean, de gustibus; you'd think there'd be a market opportunity for a fund for people who want to be able to vote on corporate decisions. Or, more simply, a fund for people who just want their fund to vote against management on everything. The S&P 500 Index Anti-Management Voting Fund. Or, the You Invest in the S&P 500 But Are Still Pretty Suspicious of Modern Capitalism Fund. Actually that is kind of a great idea; that does seem like an under-served niche. 

Naked shorts.

Here are the first four parts (1, 2, 3, 4) of David Dayen's eight-part series about Chris DiIorio, a guy who put a lot of his money into a penny stock, lost it, and jumped headfirst into stock-market conspiracy theorizing. DiIorio had the essential characteristic of any penny-stock mark: He "prided himself on being a savvy trader." That's why he hung out on the sorts of message boards where he was persuaded to sink $100,000 into a penny-stock company based on press releases and message-board chatter. And it's why, when the stock crashed, instead of inquiring into what the company did (purportedly computer chips, then vacation booking, then commercial real estate, then seafood import/export), he "started learning what firms traded Best Rate Travel," so he could piece together a grand overarching conspiracy in which he was the hero, instead of admitting that, you know, he'd put all his money into a fake company without doing any due diligence. ("DiIorio initially saw it as a classic 'pump-and-dump' scheme," but quickly moved on from that hypothesis. "Phone numbers and email addresses listed for CEO Adrian Stone no longer function, so he could not be reached for comment.")

Part 2 gets into the conspiracy theory, which involves naked short selling:

But in naked short selling, you don’t even borrow the stock. You sell additional, phantom shares. This is even more likely to drive down the price than regular shorting, because suddenly the supply is larger but the demand is the same. “I can think of a number of stocks where the shares on the short exceeded the shares ever issued by the company,” said Alabama Securities Commission Director Joseph Borg. “You can’t do that unless it’s naked.”

None of that is quite right as a matter of market structure, but that's not the biggest problem with it. The problem is that we are talking here about naked shorting of a company that, as far as anyone in the article suggests, never had any real business at all. Its correct price, at all relevant times, was zero. (The stock's current 52-week high, as far as I can trace its series of mergers and rebrandings, is $0.0001 per share.) Sometimes the price was higher than that, presumably because its promoters found people like DiIorio who could be convinced to buy their shares. But this does not seem like a story of evil short sellers conspiring to drive down the price of a good company for their own nefarious purposes. If it were, presumably the CEO would be around to talk about it.

Part 3 is about Knight Capital's (now KCG's) involvement in naked short selling of penny stocks, which is kind of weird actually:

“I didn’t know they did that,” said Jim Angel, a Georgetown University business school professor. “I’m kind of shocked to think that Knight would be working with paper stock certificates.”

And part 4 is about DiIorio's efforts to get the Securities and Exchange Commission to buy into his theory that "the core business at Knight has always been naked shorting penny stocks." (So far, no luck.) There are still four more parts to come, so perhaps DiIorio eventually finds out who's been rigging the penny-stock market all along. Stay tuned.

Elsewhere, on Friday the SEC "charged three company executives with defrauding investors in a purported project to construct the largest movie studio in North America at a suburban location outside Savannah, Georgia."

Blockchain blockchain blockchain.

The advantage of a blockchain is, again, that it is an immutable record of transactions that is maintained and validated by everyone who uses it, without the need to trust a single central administrator, which is why this is such a delight:

Bank of Tokyo-Mitsubishi UFJ, together with U.S. technology services company IBM, will use blockchain technology to manage the bank's internal documents in the Asia-Pacific region, starting next year.

See I would not have thought that you'd need a trustless permissionless decentralized system to manage your internal documents -- I would have thought that, you know, a filing cabinet would have worked fine -- but I guess all these blockchaining banks know what they're doing. To be fair, BTMU's approach seems to be a practice blockchain: You work on booking internal trades between desks on an internal blockchain, and once you figure it out, you move on to using a blockchain to trade with external counterparties. "The bank has not decided whether to use the system for contracts with third parties," but a BTMU executive points out that "Only by actually using it, can we learn a lot about the technology and find challenges in it."

Elsewhere, "Rep. Mick Mulvaney (R-SC) and Rep. Jared Polis (D-CO) announced the formation of the new bipartisan Congressional Blockchain Caucus dedicated to the advancement of sound public policy toward cryptocurrencies and other blockchain-based technologies." And banks' back-office systems are a mess:

Christian Nentwich, chief executive of Duco, a technology firm that works with banks to integrate disparate data feeds, said one bank he worked with “had setups where 20 to 30 systems were all touched in the life cycle of a single trade." And many of those systems produced data in different formats, sometimes resulting in different names for the same trading partner.

If only there were some magical solution that could not only solve those technological problems but also get banks excited about spending time and money to implement it. 

People are worried about unicorns.

We were promised flying cars, and by some mythological transference people love the idea of flying unicorns, so this should go over well:

Uber products head Jeff Holden said the fast-growing ride sharing company was seriously looking at a new form of transportation to offer its customers: Short-haul flying in cities.

Called VTOL—which stands for vertical takeoff and landing—Holden said that he has been researching the area, "so we can someday offer our customers as many options as possible to move around." He added that "doing it in a three-dimensional way is an obvious thing to look at.

It's so good: 

Simply put, VTOL is an aircraft that can hover, take off and land vertically, which would also describe a helicopter. But, unlike the typical helicopter, these planes would have multiple rotors, could have fixed wings and perhaps eventually would use batteries and be more silent. In time, like cars, such aircraft could be autonomous.

And: "Holden talked about landing on top of buildings in cities, reducing commuting time and congestion dramatically."

I confess that I am kind of rooting for Uber to win the self-driving-car, and self-driving-helicopter, and self-driving-VTOL-aircraft-landing-on-roofs race. I mean, sure, Uber is evil, fine. (Surge pricing!) But in 30 years, when we're all being flown around by robots, do you want the origin story of the robots to be like "oh yeah Tesla built cars, then it made the cars self-driving, then it put wings on them"? Or "oh yeah Google built artificial intelligence robots, then it put them in cars, then it put wings on them"? Or "oh yeah Apple built gloriously shiny devices, and then they spontaneously levitated"? It is all so predictable, so reasonable, such a normal march of progress driven by incremental research at companies with obviously relevant expertise. Uber's story -- "oh yeah some guys wrote literally an iPhone app to match up drivers and passengers, and then somehow venture capitalists gave them tens of billions of dollars to build autonomous flying robots, and then somehow it worked" -- is so much richer and stranger and more 21st-century and less plausible

Elsewhere in private-company cryptozoology, "Cortec Group, with just 20 employees in Midtown Manhattan, could make a profit on paper of about $3.3 billion in the coming initial public offering of Yeti Holdings Inc." Yeti is not exactly a Silicon Valley tech company -- it makes coolers -- so I am not sure if it qualifies as a unicorn. But it is a yeti.

People are worried about bond market liquidity.

I guess this is less a liquidity worry and more a price worry, but it can be hard to tell them apart:

But these days, foreign central banks have become yet another worry for investors in the world’s most important bond market.

Holders like China and Japan have culled their stakes in Treasuries for three consecutive quarters, the most sustained pullback on record, based on the Federal Reserve’s official custodial holdings.

Elsewhere, "ETFs are increasingly becoming the market when it comes to $1.4 trillion of U.S. high-yield bonds."

Things happen.

Goldman Sachs to axe 30% of Asia investment bankers. ‘Brexit’ Prompts Many British C.E.O.s to Consider Relocating, Survey Finds. City of London fears May government is shifting towards ‘hard’ Brexit. How Yahoo’s Data Breach Could Affect Its Deal With Verizon. BlackRock, Vanguard Hail Regulatory Shift on Too-Big-to-Fail. LendingClub Fund Has First Negative Month on Valuation Overhaul. Profit Slump for S&P 500 Heads for a Sixth Straight Quarter. Barroso says Goldman is 'no drug cartel,' blasts EU judgement. Allison Schrager on the Moonlite Bunny Ranch. Ex-Société Générale Trader’s Huge Fine Is Cut to 1 Million Euros. "Contrary to what risk-shifting theory would predict, I find that firms reduce risk-taking as they approach distress." Quant trading economies of scale. 2008 Crisis Deepened the Ties Between Clintons and Goldman Sachs. Eric Trump: My dad appeals to millennials because he's like Mark Zuckerberg. Fifa disbands its anti-racism taskforce declaring that the job is done. "Using superfluous words is superfluous." Web-safe colors. Dogs are good.

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