Mortgage Finance and Taxing Wealth
GSE reform and whatnot.
There is a lot of unclear thinking about Fannie Mae and Freddie Mac, so let's make some lists. There are three main choices for how they can work:
- You can have a government agency (or two, or 10) that packages, standardizes and guarantees mortgages.
- You can have an independent company (or two, or 10) that packages, standardizes and guarantees mortgages.
- You can have nobody packaging, standardizing and guaranteeing mortgages.
The status quo in the U.S. is number 1; Fannie Mae and Freddie Mac are wards of the state, guaranteeing mortgages with the backing of the government and giving all their profits to the Treasury. Before 2008, the U.S. system was sort of number 2, and a lot of people want to return to some version of that now. Number 3 -- just getting rid of the government-sponsored enterprises entirely, and leaving mortgages to banks -- is the preferred approach of some Republican politicians in the U.S. (It is also how mortgages work in most of the rest of the world.)
Let's say you prefer option 2. Here there are three further decisions. First, option 2 blew up in 2008; what are you going to do to prevent that from happening again? There are two choices:
- (a) You can give the independent company an explicit government backstop, and charge it a fee for that backstop; or
- (b) You can not do that and hope the company is just really well capitalized.
Next, you have to decide who will own the private company or companies. Given that Fannie and Freddie already exist, and have lots of employees and computers and whatnot, there are two realistic choices:
- (i) Give them back to their existing shareholders, who have no real economic or ownership rights now, but who have been clamoring for their return for years; or
- (ii) Just ignore those owners and sell them off to whoever wants them.
Finally, there is one more issue, which is that the newly private companies need to have a lot of capital to be credible mortgage guarantors. Again, there are two places to get that capital:
- (A) From the owners; or
- (B) From the government.
That's your choice set. I think there are 10 options. You can pick option 1 (public mortgages) or option 3 (no public mortgages), and in either case you stop there. (Obviously there are lots of choices still to be made about how to run, say, a government mortgage agency, but let's ignore them.) Or there are eight flavors of option 2, 2(a)(i)(A) through 2(b)(ii)(B). For instance there is 2(b)(i)(A): Re-privatize Fannie and Freddie, without a public backstop, return them to their existing shareholders, and demand that they raise billions of dollars of new capital from those shareholders. Or there is 2(a)(ii)(A): Re-privatize them with a public backstop, but capitalize them by finding new owners and raising billions of dollars from them.
Those have some intellectual interest, but the dominant approach seems to be 2(b)(i)(B): Re-privatize the GSEs, return them to their existing shareholders, and give them billions of dollars from the government. (This is sometimes called "allowing them to build capital," but that is a distraction.) There are very good arguments for this approach! When the GSEs were semi-nationalized in 2008, their common and preferred shareholders were left with some ownership interest, which would be valuable if they were re-privatized today. But the deal was re-cut in 2012, without consulting those shareholders, to essentially cut off that ownership interest and give all of the GSEs' profits to the government. The shareholders have been suing ever since. They have a real case that all of this was unfair. (They have a further case that any approach that doesn't give them back the value they lost will make it hard for Fannie and Freddie to raise new private capital.)
On the other hand there is an optical difficulty with this approach, which is that it looks a little like the government is taking some government agencies, handing them over to hedge funds, and then saying "oh, sorry hedge funds, those agencies we gave you look a little thin, here, have billions and billions of dollars to re-capitalize them." If you are, say, a new U.S. presidential administration whose election promises involved fighting on behalf of the working class against special interests, that looks a little weird.
Anyway there has been a lot of tea-leaf-reading about what the Trump administration will get up to with the GSEs, but yesterday Trump Treasury Secretary nominee Steven Mnuchin (a former mortgage banker) explicitly endorsed option 2:
“We will make sure that when they are restructured, they are absolutely safe and don’t get taken over again. But we’ve got to get them out of government control,” Mnuchin said.
"Perhaps most important for shareholders, Mnuchin did not appear to mimic Republicans who have said that Fannie Mae and Freddie Mac should be wound down or eliminated," that is, option 3. "It's right up there in the top 10 list of things we're going to get done," said Mnuchin, which is maybe a little weird when you consider it was never really mentioned during the campaign? But the main question remains how you re-privatize Fannie and Freddie. If you go with, say, 2(a)(i)(B) -- re-privatizing Fannie and Freddie as systemic private enterprises that don't pay for government backing, and giving billions of dollars of value back to their hedge-fund owners -- then that looks a bit like a windfall for hedge funds. The hedge funds took it that way -- Fannie and Freddie shares have rallied -- but you can see why that priority might not have been made explicit during the campaign.
Elsewhere in Mnuchin.
Here are some fun quotes from our presumptive next Treasury Secretary:
- "The number one problem with Dodd-Frank is that it’s way too complicated and cuts back lending."
- "The number one problem with the Volcker rule is it’s way too complicated and people don’t know how to interpret it."
- "So we want to strip back parts of Dodd-Frank and that will be the number one priority on the regulatory side."
I do not think that that tells you anything about how the Trump Treasury will look to change financial regulation, except that it will not be a fan of complexity, which you probably could have guessed anyway.
But Mnuchin has dropped some more specific hints on other issues. For instance, on taxes, he told CNBC that "any reductions we have in upper-income taxes will be offset by less deductions so that there will be no absolute tax cut for the upper class." This is not a correct description of Donald Trump's actual tax proposals, and Jordan Weissmann and Neil Irwin don't believe it. But never mind that; isn't there a bigger problem? There is an intellectual basis for tax cuts on the wealthy: Tax cuts stimulate growth, the wealthy create jobs, whatever. You can disagree, but there's a theory there. What is the theory for cutting taxes on the wealthy in a way that doesn't actually cut their taxes? Is that also stimulative, because they think their taxes are lower even though they really aren't?
Also Mnuchin might want to issue 100-year Treasury bonds, which strikes me as perfectly reasonable, though more reasonable three months ago than it is now. I feel like I would charge a premium to lend Donald Trump money for 100 years. (Presumably so would Mnuchin, whose hedge fund Trump once sued after borrowing money from it.)
Elsewhere, here is hedge-fund manager Whitney Tilson gloating about Donald Trump's economic team:
“I can take glee in that -- I think Donald Trump conned them,” said Tilson, who runs Kase Capital Management. “I worried that he was going to do crazy things that would blow the system up. So the fact that he’s appointing people from within the system is a good thing.”
Elsewhere in the Trump team, Goldman Sachs Group Inc. President Gary Cohn is being talked about as a potential head of the Office of Management and Budget, which has led to a new round of Goldman executive kremlinology. ("Should Mr. Cohn opt to seek opportunities outside the firm, his role as chief operating officer and president would likely be split between two executives," with Harvey Schwartz, David Solomon, Marty Chavez and Stephen Scherr mentioned as possibilities.) And Preet Bharara will stay on as the U.S. Attorney for the Southern District of New York.
Divorce, death and taxes.
Here is a delightfully complicated story about divorce and tax avoidance that I could not fully enjoy because I was rooting against everyone. The centimillionaire multi-yacht couple involved built a series of internet businesses that ... well, let's let the wife's lawyer describe them:
Oesterlund was “a highly successful internet swindler,” engaged in “internet scams, forgeries, tax fraud, bank fraud, HUD fraud, immigration fraud, fraudulent overseas transfers and other misconduct,” Fisher told a Florida judge.
Or here's the wife's defense of the business:
“Every time you click on an ad, someone gets money,” she told me, shrugging. “We were the people who got the money.”
My hope was that the couple would hide all their money from each other so effectively that they'd be unable to find it themselves, and an orphanage would end up stumbling on it and using it for some good. That didn't quite happen. A lot of it went to lawyers, actually. "The companies had their own lawyers. There were lawyers for the banks. There were lawyers for the accountants. Even some of the lawyers had lawyers."
Elsewhere in tax avoidance, "Credit Suisse Group AG has frozen dozens of accounts as it tries to determine if U.S. clients are hiding money from the Internal Revenue Service after the firm pledged to come clean about secret assets." And the new all-Republican government may repeal the estate tax, which has people rethinking their plans to die:
Some of the wealthiest families in the U.S. are hoping for a $21 billion benefit from President-elect Donald Trump next year.
They and their businesses are re-evaluating, or putting on hold, strategies for transferring money to heirs as the new administration could work with a cooperative Congress to reform or repeal federal estate and gift taxes among its early moves.
Look I realize that "strategies for transferring money to heirs" is not, strictly speaking, a euphemism for "dying." But that is normally how you transfer money to heirs. And if you think that the estate tax will be repealed soon, you really should put off dying until that happens. It is a particularly clear application of the Second Law of Tax, which is that it is always better to die later than sooner.
Remember SAC Capital? Steven A. Cohen's investing business is now run out of a family office called Point72 Asset Management, but he has kept SAC around to manage his other main activity, settling insider-trading lawsuits. But now that's done:
SAC Capital will pay a group of investors $135m to resolve the last major outstanding charge related to insider trading, putting founder Steven Cohen one step closer to resuming business as usual.
“We are pleased to have resolved this matter and close the books on this chapter of SAC-era litigation,” said Mark Herr, a spokesman for Mr Cohen’s family office, Point72 Asset Management.
This settlement is a private class action on behalf of shareholders of Elan Corp., whose stock SAC traded based on the work of convicted insider-trading analyst Mathew Martoma. (SAC previously settled a similar case with Wyeth shareholders.) Given Martoma's conviction, and SAC's guilty plea, the outcome of these lawsuits can't have been in too much doubt. And yet they are interesting. Insider trading is often called a "victimless crime"; anyone who bought Elan stock when SAC was selling would probably have bought the stock anyway -- at a higher price! -- if SAC hadn't sold.
Prosecutors and regulators pay a lot of lip service to the idea that there are victims of insider trading, but usually in a fairly abstract way. The victims are "confidence in the markets," not identifiable individuals. After all that's why insider trading cases are usually brought by the SEC or the Justice Department, instead of by the victims; the victims never notice. These victims noticed! Because the Justice Department did first, but never mind that. The point is, SAC's downfall involved several instances of the victims of insider trading receiving compensation, which you don't see every day.
We talked the other day about the NASDAQ Stock Market LLC's proposed "Extended Life Priority Order Attribute," which somehow abbreviates "ELO," and which would give orders that remain in force for one second priority in the order queue. As I usually do with new market-structure proposals, I asked readers for suggestions on how this order could be gamed for nefarious purposes.
In return for giving retail and institutional orders queue position, Nasdaq will require that these orders be marked as extended life orders. This identifier will be disseminated to anyone who purchases a proprietary data feed from Nasdaq. In other words, ELO orders will be easily identified by high frequency traders since they are the ones who most commonly purchase the exchange proprietary data feeds.
I pass it along, but I am not particularly moved by this. I think one way to put it is that if high-frequency traders know that you are stuck in the book for a full second, they will be more likely to "pick you off," that is, to trade with you when the price is moving away from you. But that is kind of the point of the extended-life order. The point is that you give up the ability to react rapidly to price changes, in exchange for a better chance of actually executing your order. Being "picked off" when the price is moving against you is just a symptom of that more general tradeoff.
Also: If you don't like the extended-life order, you don't have to use it. What I really want is not a way that the ELO could work out badly for its users, but a way that it could be gamed by high-frequency traders to get an advantage over everyone, not just ELO users. The fact that the ELO is for now limited to retail investors seems to limit that possibility.
Oh no Jacob Wohl.
We've talked a few times before about teen stock trader and performance artist Jacob Wohl, who has starred in such comedic masterpieces as a ValueWalk article about his pivot from value investing to options trading, another article about his purported "7.87%" Sharpe ratio, a (now-private) YouTube video discussing how he would trade in the event of a terrorist attack, and of course the hilarious National Futures Association action against him for allegedly (1) violating regulatory requirements in his marketing materials and (2) hiding when the NFA came to his office to talk about it.
But like many young performers, Wohl seems to want to move past comedy and into more serious roles, and he has recorded a very strange video for Vice (YouTube version here) under the very strange headline "Meet the Teen Finance Guru Who Makes More Money Than You." Vice gives no evidence of how much money he makes, or that he is a "finance guru"; Wohl's most guru-like utterance in the video is probably: "The market is just an easy way to exploit people's psychological failures and make money." (So is the internet!) There is some humor in the video. "This is our trading room here," Wohl says of a suburban living room. "I try to make it sort of like the inside of a B-52 cockpit." All in all, though, everyone involved stays disappointingly straight-faced, and some of the wild joy of Wohl's earlier work is missing here.
Elsewhere in misspent youth, here's an "X under Y" list you don't have to feel too bad about not being on: "Five CEOs 40 or Younger Having a Rough Year." Only one of them, Martin Shkreli, is currently facing criminal securities-fraud charges.
People are worried about unicorns.
Here is Bloomberg Gadfly's Shira Ovide on the "valuation divide" between public and private companies:
Some startup investors say they're worried about the multiple disconnect between startups and their public peers. If most public software companies trade at 5 to 10 times forward revenue, then it doesn't make sense to finance them at valuations of 20 times forward revenue and expect their companies will be the ones that defy the average..
Elsewhere, here is Erin Griffith on how "startups are helping The Disrupted get stronger." And: "Start-ups are trying to revolutionise the food industry and have received hundreds of millions of dollars in funding from venture capitalists to do so." And: "Thiel’s 1517 Fund Is Stalking the Next Zuckerberg." And: "An Incubator for (Former) Drug Dealers."
People are worried about bond market liquidity.
Nope! It's over! Unless there's actual news! When I omit this section entirely tomorrow, and you e-mail me to ask what happened, I will know that you haven't been paying attention.
Of course tomorrow probably Donald Trump will give a two-hour speech about bond market liquidity but those are the risks I take.
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