Rates, Regulations and Casinos

Also IPO fees, unicorn housing and an absence of bond-market-liquidity worries.


One fun thing about the U.S. Treasury market is that you can analyze it simultaneously as both a reflection of deep macroeconomic factors, and as just a regular market where an issuer goes out and tries to borrow money and pay as little as it can get away with, and where lenders determine their prices based on supply and demand and credit risk. Usually people just talk about the macro stuff, though. U.S. Treasury bond yields have shot up since last week's election -- the 10-year was trading at about 2.26 percent this morning, up from about 1.86 percent last Tuesday, the biggest one-week gain in more than three years -- and the standard explanations include "the prospects of increased fiscal stimulus and a quicker pace of interest-rate rises," "speculation President-elect Trump’s pledge to boost infrastructure spending will trigger U.S. interest-rate hikes as economic growth and inflation pick up," "conviction that a Donald Trump presidency will deliver higher inflation," that sort of thing. 

But is it not a little tempting to be like: Look, how would you feel about lending money to Donald Trump? Things we know about his past career include that he likes to borrow money, and that he has a history of not paying it back. Things we know about his plans as president include that he has plans to spend a lot of money, that he does not have plans to raise taxes to pay for it, and that he has speculated in the past about paying for it instead by borrowing money and not paying it back. You can describe those plans in terms of "fiscal stimulus," certainly. And I am of course aware that a government's balance sheet is not the same as a business's, and that an issuer that borrows in its own currency has some important advantages.

Still, I sort of like to imagine the bond market as just an old-time country banker who is ready to lend trillions of dollars at 1.86 percent, walks into the conference room for the closing, and is astonished to see Donald Trump grinning across the table. And who quickly scratches out the 1.86 percent and writes in a higher number. It does not exactly work this way, but in some distributed sense it kind of should.

Meanwhile, here is Binyamin Appelbaum on prospects for the Federal Reserve under President Trump: "He is a borrower who now heads the political party that has long represented the interests of lenders," and he is "a low-interest-rate person" by preference. And U.S. sovereign credit-default swap prices are slightly wider, though still quite low (about 28.9 basis points annually for five-year CDS). Elsewhere in rates markets, Trump's election threatens Europe's fad of super-long-dated bonds. It also threatens my chance of getting a cheap mortgage, as rates are going up, though changes in regulation may also affect the mortgage market.

And here is a roundup of analysts projecting their hopes and dreams onto Trump. This may be my favorite:

Indeed Tokyo-based Ryoji Musha, formerly of Deutsche who now runs Musha Research, anticipated a new era of “dollar appreciation, higher stock prices and rising interest rates”.

“Surely now that the election is over he will do away with the rhetoric he used to attract voters and move to formulate a consistent and realisable system of policies,” he writes.

If you ever find yourself writing a sentence in which Donald Trump is the subject, maybe don't start it with "surely."


Generally speaking, Trump seems to be taking himself "seriously, not literally" these days, partially walking back promises to build a wall with Mexico and imprison his political opponents. Plans to repeal the Dodd-Frank Act are also perhaps not to be taken too literally:

President-elect Donald Trump vowed anew on Friday to dismantle the 2010 Dodd-Frank financial overhaul, at the same time his transition team is tempering expectations for a full repeal of the sweeping law, people familiar with the matter said.

Instead, Mr. Trump’s team is focused on rescinding or scaling back the individual provisions Republicans find most objectionable, such as the Financial Stability Oversight Council’s authority to designate large nonbanks systemically important and thus subject to tougher regulation from the Federal Reserve.

Another part of the law that is in danger is Title II, which provides for orderly liquidation of systemically important banks that fail, and which "is staunchly supported by large banks." I must say I have never understood the opposition to Title II. The essence is that opponents "would rather put big financial firms through bankruptcy," and that "Title II as it stands is simply a bailout by another name."

But this all seems like confusion about the use of words. A bailout is when the government gives a bank money. Title II is not about giving a bank money; it's about recapitalizing the bank by writing down its debts in a quick and organized fashion. Not only is that not a bailout: That's bankruptcy. Bankruptcy is just a formal legal regime for recapitalizing a failing company by writing down its debts in a quick and organized fashion. I mean, Title II is not technically bankruptcy, and it's a process that is optimized for the protection of the financial system rather than the protection of individual creditors. Still I wonder what would have happened if Dodd-Frank, instead of creating a separate resolution mechanism for failing banks, had instead just created a separate chapter of the Bankrutpcy Code with the same substantive provisions. Is the objection to the resolution process, or to the name?

Elsewhere in financial regulation, what do you make of Trump and the Basel bank capital standards? ("Now with Trump, I think the whole thing is going to become more of a symbolic exercise," says an analyst.) And here are some vague guesses from Trump transition adviser Anthony Scaramucci about what Trump might do. Dan Primack points out that, if the Volcker Rule is repealed, that will work out nicely for Goldman Sachs Group Inc., which has dragged its feet on getting rid of Volcker-non-compliant private-equity assets. It is pleasing to note that Trump's transition team includes at least three alumni of Goldman Sachs (disclosure: I too am an alum), and that their populism may end up benefiting their old firm. (Or not; it's not clear yet whether the Volcker Rule is a part of Dodd-Frank that gets to stay, or a part that is getting repealed.) And here is Catherine Rampell on the rumored appointments process: "In some cases, the criteria seem to be: What candidate stands to personally benefit most from this position, and is that person friends with Trump?"

A weird casino.

I mentioned last week that, whatever you think about Donald Trump's effect on the economy, the country and the world, he'll probably be good just for the sheer variety of financial news. Like, his administration will gesture in the direction of repealing Dodd-Frank, and do other weird financial-regulatory stuff, and financial firms will react by doing further weird financial stuff, and there'll just be a general increase in weird financial stuff to think about and write about and gawk at. So that's something.

Similarly, lots of countries have political leaders whose children run vast business empires with political connections. Usually the United States is not one of them. Now it will be! That's ... interesting no? Or: Lots of countries have political leaders with vague and indirect ties to out-of-the-way casinos that may or may not be perfectly compliant with all money-laundering regulations. Usually the United States is not one of them. Now it will be! Here's the Best Sunshine Live:

Nothing about the facility, which opened last year on the U.S. island of Saipan, hints at the money flowing through it—table for table, far more than at the biggest casinos in Macau, the world’s number-one gambling capital. Nor is there any sign of the connections of its owner, Hong Kong-listed Imperial Pacific International Holdings Ltd., which has a market value of $2.4 billion. 

It’s a power list that includes a former director of the Central Intelligence Agency, a former director of the Federal Bureau of Investigation, and three former U.S. governors, including past chairmen of both the Democratic and Republican National Committees. Behind them all: a Donald Trump protege, Mark Brown, who ran the Republican president-elect’s Atlantic City casino empire and is now Imperial Pacific’s chief executive officer. 

"We are very transparent," says Brown, who explains that most of the revenue comes from known prolific high-stakes gamblers. ("In September, Imperial Pacific reported a record $3.9 billion in bets at its casino—meaning the 100 or so high-rollers who it says come through its doors monthly each wagered an average of $39 million.") There is an alternative explanation:

The money has arrived on Saipan as Chinese President Xi Jinping intensifies an unprecedented crackdown on corruption and capital flight from the world’s second-largest economy. Macau’s casinos, traditionally a relatively simple avenue for citizens to spirit funds offshore in violation of currency controls, are a key target of his efforts, driving high-stakes gambling elsewhere. 

Honestly I had kind of thought that that was what bitcoin was for? Elsewhere in weird money movement: "Philippines Returns $15 Million Stolen From Bangladesh Account at N.Y. Fed." 

"Do Underwriters Compete in IPO Pricing?"

That's the title of this blog post and related paper, and the answer, as you'd expect, is not really:

To summarize, our results, which are more consistent with the hypothesis of implicit collusion among underwriters in IPO price setting, are in line with recent evidence suggesting that by providing analyst coverage and/or aftermarket price support, underwriters compete less fiercely on the IPO pricing dimension.

There's a huge trend in modern finance toward clarity and away from bundling. You see it in the European MiFID II research-unbundling rules, which prevent banks from paying for research through commissions. But you see it more broadly in conversations about "active share," for instance, or hedge-fund fees. The general idea is that we are getting better at measuring the value of stuff, and so customers increasingly expect to get what they value, and to pay only what it's worth. 

And then there are U.S. initial public offerings, which cost 7 percent. I mean, not always, but "IPO gross spreads, most of which cluster at 7%, seem high in absolute terms and are high relative to other countries." There is no obvious explanation for why the investment banks underwriting an IPO should get 7 percent of the proceeds. Issuers never get an itemized bill. Instead there is a sense that only a limited number of banks can do all the stuff involved -- not just the strictly necessary IPO work, like writing the prospectus and finding the buyers, but also the research and aftermarket trading and other important support functions, and even random but helpful ancillary activities like lending money or providing M&A advice -- and those banks all just happen to charge the same fees. 

I have to say that in my experience as a capital-markets banker, the "collusion" is very much implicit. No one agrees with other banks to charge 7 percent. Everyone just shows issuers the same gross spread runs, which show that the last X deals of between $Y and $Z in the Q sector were all done at fees of 7 percent. And then the issuer says "what about 5 percent," and the banker gives a pained grin and ignores it. (Except on mega-deals like Facebook, which the banks would more or less do for free.) And as long as all the bankers at all the big firms give the same pained grin, the system survives. It always struck me as sort of rickety, but on the other hand, there is not that much incentive to change. A bank that starts charging 6 percent won't win that many more deals, since most companies aren't too focused on penny-pinching during their IPOs.

People are worried about unicorns.

Silicon Valley is still engaged in a lot of soul-searching, or kernel-debugging, or doing whatever it does with whatever passes for soul out there, about Donald Trump's electoral victory. One assumes that Mark Zuckerberg, for instance, (1) did not want Trump to win, and (2) knows that he is partially responsible for Trump winning. That's at least how I read this story, and his protests-too-much Facebook post, about how Facebook's susceptibility to fake news probably didn't sway the election. ("Overall, I am proud of our role giving people a voice in this election," etc.) Or here's a story about one of Peter Thiel's partners at Founders Fund, Geoff Lewis, who is very sad that Thiel supported Trump and that Trump won, and who blogged about it. 

But there are silver linings! For instance:

Still, other Trump promises might create new markets ripe for Silicon Valley’s favorite form of disruptive innovation, such as his plan to deport millions of undocumented immigrants, some of whom form the bulk of the country’s agricultural labor force. That might create opportunity for the “agtech” sector, Wilson said.

“If they really are serious and farm labor gets threatened, then anything that automates labor is something that is going to uptrend,” he said.

Yes ... that's ... what? I have to say it does disrupt the typical Silicon Valley business model. Normally you expect the process to be:

  1. Invent a thing that puts people out of work.
  2. Put the people out of work.
  3. Look sad about it.

This approach is entirely different:

  1. Get rid of people.
  2. Look sad about it.
  3. Invent a thing that would have put them out of work, if they were still around.

Elsewhere, Slack, the meta-unicorn, is getting ready for competition from Facebook and Microsoft. And no one can afford to live in Silicon Valley. That's what makes the Enchanted Forest so enchanted; there are no people in it. "Look, a unicorn," you'd say, if you were there, and a hushed awe would come over you as you beheld the majestic creature. But you're not there, because it is too expensive. The unicorns have it all to themselves. That's why they are mythical creatures.

People are worried about bond market liquidity.

Nope, kidding, they're not. Isn't that interesting? Government bond yields have gapped out over the last week. Different companies and sectors have been affected differently by the election, with financial and health-care companies outperforming and utilities and consumer staples down. Stuff is happening. People are trading. Prices are moving. And people have stopped complaining about bond market liquidity. We've seen this before: Bond market liquidity is the thing that you worry about when you have nothing else to worry about. When things are actually happening, you're too busy trading bonds to worry about how you can't trade bonds.

Things happen.

Restructuring Venezuelan Debt. $200bn drained from equity funds since start of 2016. "It’s not that different from the Oregon Trail or the Pony Express." As Crude Collapsed, Alaska Capitalized on the U.S. Housing Bust. Banks Lure $30 Billion Deposits as Indians Struggle to Find Cash. Samsung to acquire Harman International Industries for $8bn. Obama Defends EU, NATO Amid Doubts About Trump’s Intentions. China Pumps the Brakes on U.S. Dealmaking After Trump Win. Legal-Weed Crowd’s Election-Night Euphoria Turns Wary on Trump. Why is there no Canadian Trump? Martin Shkreli Releases Parts of Wu-Tang Clan Album After Trump Victory. He Went To The Desert With $3 Million In Cash -- And Left With 150 Tons Of Cashmere. ‘No Vacancy’ Signs Are Vanishing From America’s Highways. Man hacks Alexa into singing fish robot, terror ensues.

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