Bank Worries and Foreign Bribes
People are worried about Deutsche Bank.
The optimistic interpretation of 2016 is that it is the year when all of history is repeating itself as farce all at once, so I hope that Deutsche Bank's current worries will turn out to be just the farcical echo of Lehman Brothers' tragic troubles in 2008. The big news yesterday was that some hedge funds are reducing their exposure to Deutsche, a Lehmanesque moment that brought the stock to a record low. Except that this is not a story of counterparties tearing up trades or standing in lines to withdraw deposits. It's more like this:
The funds, a small subset of the more than 800 clients in the bank’s hedge fund business, have moved part of their listed derivatives holdings to other firms this week, according to an internal bank document seen by Bloomberg News.
Look, when you run a bank, every dollar helps. But the dollars in listed derivatives customer accounts don't help that much. As Dan Davies writes, "because these balances are so volatile, they’re basically unusable by the bank as a funding source." This stuff is not how Deutsche Bank makes ends meet. There seem to be some other hedge fund withdrawals too, but Deutsche "has a far more diversified client base, sourced from German retail banking and multiple institutional business lines," not just flighty overnight hedge-fund counterparties. Also making ends meet is not really Deutsche Bank's problem:
“Deutsche has many problems, but liquidity is not one of them,” Stuart Graham, founder of Autonomous Research, said in a note, adding the bank had a liquidity reserve of 223 billion euros as of the second quarter. “There can be no doubt that Deutsche could access significant additional liquidity from the ECB, should it ever need it.”
The problem so far -- and with big money-center banks with access to central banks generally -- is not liquidity but capital, not Deutsche Bank running out of ready cash but its debts destroying shareholder value. Davies again:
The uncertainty, substantial as it is, all relates to the right-hand side of the balance sheet. The capital might not be sufficient, and the equity might be impaired by a big charge for DoJ fines. Both of these threats come from somewhere other than the left hand side of Deutsche Bank’s balance sheet (one of them is, literally, a number chosen by a regulator, which rather starkly points out how not “out of control” the situation is compared to 2008).
This is all potentially unpleasant for Deutsche Bank. It has perhaps too little capital, and might need to raise more. Even before the current round of trouble, no one was all that excited about its actual business, and if it does need to raise money, it "will struggle to convince investors that it can make a return that beats its cost of capital in the years ahead." But these seem less like the sharp catastrophe of Lehman, and more like an intensified version of the slow sad slog of post-crisis banking generally. The efforts to make banking boring may succeed in making even its crises boring.
The other echo of 2008 is of course that the catalyst for Deutsche Bank's current problems is the U.S. Justice Department's effort to fine it $14 billion for, you know, 2008. (That is, for selling bad mortgage-backed securities in the run-up to the crisis.) "This is about Deutsche Bank paying up for the financial crisis," says Vox. And the Justice Department "hopes to agree an omnibus settlement with Barclays, Credit Suisse and Deutsche Bank" over their mortgage cases, grouping them "to achieve maximum public impact by collecting an eye-catching sum in penalties from the trio just weeks before the US presidential election."
There is a popular view -- among politicians, prosecutors and the public -- that the banks who caused the 2008 financial crisis have not been appropriately brought to justice. A lot of people think that the response to the 2008 crisis was too lenient to banks, and wish they could have a do-over, one in which banks fail without bailouts, or recapitalize themselves by cutting bonuses, or at best limp on unprofitable, humbled and worried. It would be poetic if a fine for the last crisis gives them a chance at that do-over.
Also I must say it is an awkward time for the European Union to complain about higher bank capital requirements.
Sometimes when you want to do business in a new country, you hire a local consultant who knows a lot about that country's culture, who knows the people with money and power there, and who can get you introductions and contacts so you can do your job better. That is perfectly legitimate: Knowledge and introductions are important commodities -- they're what investment bankers sell, for instance -- and there's nothing wrong with paying for them. On the other hand, if your consultant just passes on your payments as bribes to get the locals with money and power to do business with you, that is bad. You're not supposed to let that happen. You're supposed to check to make sure that it doesn't.
When Och-Ziff Capital Management "entered into a partnership an infamous Israeli businessman with close ties to government officials at the highest level within the" Democratic Republic of Congo, it didn't do enough to check:
From Och-Ziff’s first contact with DRC Partner in 2006, Och-Ziff Employee A was aware of allegations that DRC Partner used corruption and bribery in his dealings in the DRC. Och-Ziff Employee A emailed a third-party in 2006 that DRC Partner “has some skeletons,” and that he “has some suits outstanding regarding him bribing the drc gov.” Undeterred, Och-Ziff Employee A went forward with DRC Partner as Och-Ziff’s business partner in the DRC.
That is of course from the Securities and Exchange Commission order against Och-Ziff, which yesterday agreed to pay $412 million to settle criminal and civil charges that it knew or should have known that its various middlemen were bribing various local officials in various African countries for quite a while. The allegedly infamous "DRC Partner" -- Israeli billionaire Dan Gertler -- was only one of several allegedly bribe-happy consultants, but he was a particular charmer:
In or about April 2008, for its first transaction with DRC Partner, Och-Ziff invested in a London stock exchange-listed mining company with operations in the DRC. DRC Partner was a significant shareholder in this entity, and he stated in an email to Och-Ziff Employee A that he wanted to have Och-Ziff as his “long-term partner,” and that he had “facilitated Och-Ziff’s investment at an attractive time/price knowing that you see the bigger picture in all of this. What the bigger picture looks like, is yet to be determined, but it is your partner who is holding the pen – I just need flexibility on the drawing board [t]o create full value for our partnership.”
"You see the bigger picture in all of this. What the bigger picture looks like, is yet to be determined," is just a lovely piece of incoherent flattery. How can they see the bigger picture if the bigger picture doesn't look like anything yet? That is not how pictures work. Anyway this is how accounting works:
In its books and records, Och-Ziff recorded the fee paid to Libyan Agent as “Professional Services – Other.” This designation was inaccurate; the payment was for an introduction and to pay bribes, and not for professional services.
Now who's being naïve, SEC? "Professional Services -- Other" is just industry parlance for "bribes." Och-Ziff's record-keeping was fine. Anyway, in addition to the $412 million, Och-Ziff agreed to a deferred prosecution agreement, its African subsidiary pleaded guilty to a federal criminal charge, and Och-Ziff Chief Executive Officer Daniel Och also agreed to pay $2.2 million to settle SEC record-keeping charges.
IBM is buying Promontory Financial Group, the financial-regulatory consultancy, which ... I would not have expected? IBM? Really?
IBM hopes to combine Promontory’s financial regulatory expertise with Watson, the technology company’s artificial-intelligence computer system, to help banks meet ever-rising regulatory expectations in areas such as anti-money-laundering detection systems, consumer-complaint databases and so-called stress tests.
“There is no way that professionals can keep up with critical information growing at these rates,” IBM Senior Vice President Bridget van Kralingen said in an interview. “Watson is going to learn … by continuously ingesting this regulatory information as it is created.”
It's so beautiful. I love the idea that financial regulation is too complex for any human, or any team of humans, to master. Imagine the rule-of-law implications of that conclusion: No one can know what the law requires, but here, this robot knows, so everything's fine. Or you know how people are always complaining that banks are "too big to manage"? Well, sure, too big to manage by a human. But this robot is great at it. Why not make the robot CEO?
Also I talk sometimes about how the "revolving door" between banks and regulators may encourage regulatory complexity: If you are a regulator, the harder you make it to understand the regulations, the more likely it is that you can get a high-paying job later at a place like Promontory helping banks figure out the regulations that you wrote. But now that business model is being undercut by robots. Will that lead to simpler regulation? Regulation whose subtlety eludes robots? Actually, come to think of it, why not have robots write the regulations, as well as interpret them? The future is so weird.
I said yesterday that "if banks wanted to be good neighbors to each other, they'd constantly have scandals in rotation, so that each new scandal would distract from another bank's previous scandal," and how much attention are you paying to Wells Fargo today? Thanks, Deutsche Bank! Still, Wells has been having quite a time. CEO John Stumpf appeared before the House of Representatives yesterday, and while unlike in his Senate testimony he did not have any visible physical injuries, he clearly received some emotional scars. "You ought to be downright ashamed of yourself," said one congressman. "I, sir, think you ought to submit a resignation and your board cannot hold off action on that," said another. Wells is "too big to manage and I’m moving forward to break up the bank," said a third. "When the prosecutors get a hold of you, you’re going to have a lot of fun," said a fourth. There was even criticism of Wells Fargo's use of the term "stores" for its branches. ("You don’t sell grapefruit. Why are you calling these things stores? You’re a bank.") It was not a fun field trip for Stumpf.
Meanwhile back at the office:
“Wells Fargo Bank unlawfully repossessed hundreds of servicemembers’ cars without the proper process, and the bank will now rightfully pay for its violations,” Bill Baer, the Justice Department’s No. 3 official, said in a statement. The department “is committed to protecting our country’s servicemembers as they continue to fight for our freedom.”
I don't entirely understand this alleged scam but I like it:
As alleged, even though the options Lindstrom acquired were so far out of the money as to be essentially worthless, they settled each day up until expiration at the minimum tick value of $15.625. The Complaint states that from one contract expiration to the next, as the options expired worthless and his account’s phony profits were wiped out, Lindstrom allegedly acquired more and more out-of-the-money options to cover the realized losses his account had incurred and create more phony profits. By January 27, 2015, when his trading activity was discovered, Lindstrom accumulated a position of more than 950,000 deep out-of-the-money T-Note Options, and held 99.9% or 100% of the open interest in at least ten T-Note option contracts, the Complaint alleges.
The idea is that you can find someone to sell you a worthless far-out-of-the-money option on Treasury notes for, say, $5 per $100,000 notional. It will almost certainly expire worthless and you'll eventually lose the $5. But meanwhile, the Chicago Board of Trade, at the end of each trading day, will tell you that that option is worth $15.625, or one sixty-fourth of one percent of the notional, which is its minimum increment for reporting values. (Then when the option expires, it will tell you that it's worth $0.) This doesn't do you any real good -- you can't actually sell it for $15.625 -- but you do get to tell your bosses that you made a quick profit by buying something for $5 that immediately went up to $15.625, and point to the CBOT pricing as evidence that you're telling the truth. That is allegedly what Thomas C. Lindstrom did "to defraud his employer, proprietary trading firm Rock Capital Markets, LLC (Rock Capital), into paying him $285,000 in draws to which he was not entitled," ultimately leading to the collapse of Rock Capital.
It's such a dumb simple trade, and yet. A core activity of finance is finding arbitrages, things that have one price in one market and another price in another market, and trading between those markets to capture the price difference. What Lindstrom allegedly did isn't too different from classic arbitrage: Those options had one price in the real world, and another price in the CBOT statements that determined his paycheck, so he arbitraged between them. The boundary between cross-market arbitrage (which improves price efficiency) and, let's say, cross-reality arbitrage (which just enriches you by exploiting mistakes in rules), is porous. You can see why a lot of people distrust finance.
Here's a weird insider trading case. I mean it's a pretty standard case -- the "senior director of regulatory affairs" at Puma Biotechnology allegedly "pocketed more than $1.1 million in illicit profits by secretly purchasing Puma stock and short-term call options based on nonpublic information he learned about positive developments in two clinical trials for Puma’s drug, neratinib" -- but the weird part is that, according to the SEC, "Puma confronted Gadimian after learning about his trades and he admitted to trading because of 'greed.'" I have never heard of that before! Who does that? My general presumption is that "greed" is never a useful explanation; it's a pejorative that people are happy to attach to other people's actions, but no one explains their own crimes by reference to "greed." You don't say you insider traded because of "greed," you say you insider traded because you really needed money to pay for medicine for your wife's cancer, or college tuition for your kids, or a bigger house in a nicer school district, or a new Ferrari, or a fancier yacht, or whatever. No one, in the heat of an insider trading investigation, looks at their own lifestyle and says "yeah I guess I am just greedy, sorry." It's so strange.
Here's another weird one in London:
Mark Lyttleton, a former BlackRock Inc. fund manager, was charged with three counts of insider trading Thursday.
The Financial Conduct Authority said the charges relate to trades in shares and a call option between Oct. 2, 2011 and Dec. 16, 2011 and that a court hearing was held in London earlier Thursday.
Here is the FCA press release, which is not especially informative. Lyttleton was arrested in 2013, and BlackRock said that whatever he did, it was "for his personal gain while off our premises." It is all a little mysterious.
People are worried about unicorns.
Here's a SharesPost research report titled "Private Tech Growth Emerges as an Asset Class," finding that "massive growth in $100MM+ equity financings is replacing the traditional tech IPO," and that "late-stage mega deals captured more than 70% of incremental VC dollars invested since 2013":
From 2009-12, VC dollars invested in US-based private tech companies roughly doubled from $10-12B per year to $20-25B per year. Companies across all stages experienced a post-recession tailwind leading to a “reversion to mean” funding levels. Since 2013, VC dollars invested in US-based private tech companies have doubled again. That was driven by 8x increase in the dollars raised via late-stage mega deals (more than $100MM per financing), effectively growing from 12% of dollars in 2013 to 44% of VC dollars invested in trailing twelve months.
And there have been 18 "mega $500MM+ financing rounds worth $21.5B since late 2014, accounting for 25% of capital invested in US-based private tech companies." People worry sometimes about mission creep as public equity mutual funds start investing in big private companies, but on the other hand mutual funds are used to investing in $500 million deals raised by multi-billion-dollar companies. The real mission creep is in venture capital, which isn't exactly limiting itself to startups in garages these days.
People are worried about bond market liquidity.
MarketAxess isn't worried:
Shares in MarketAxess, the largest electronic bond trading platform, have surged more than 50 per cent so far this year as Wall Street banks retreat from their dominant role as middlemen in buying and selling corporate debt under the cosh of a tougher regulatory environment.
“There is a revolution going on,” says Rick McVey, chief executive of MarketAxess, whose market capitalisation stands at $6.4bn. “The regulatory changes have been very positive for us.”
I wrote about Goldman Sachs's derivatives deals in Libya.
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