Money Stuff

Searching for Meaning and Prosecuting Fraud

Also banning index funds, food marketing, Theranos, bond-market liquidity, it's like I never left.

Hi, I'm back! I was away on paternity leave for a few weeks, during which I deleted the Twitter app from my phone, which is the single best use case I have yet found for Twitter. Few internet products have ever given me as much joy as Twitter did, when I deleted it. I don't know how Twitter can monetize that? Anyway now I'm back, at Money Stuff, and on Twitter.

The other appealing use case for Twitter seems to be to become president and then use the presidency, and Twitter, to pursue various revenge whims. That is monetizable, though apparently not by Twitter, and so of course: "This app will send you alerts when Donald Trump tweets about stocks you own." The app is called Trigger. (Counterpoint: "Stop worrying about Trump’s tweets.")


My model of Bridgewater Associates is that it is a computer that makes pretty good investing decisions, and 1,700 people whose job is to distract each other so that they don't interfere with the computer's investing decisions. I always think that I am joking about this model, in part because, you know, why have all those people? The computer is running a very successful investing business, and the people are running sort of an odd group-therapy session, and there don't seem to be too many synergies between those two activities? But it seems to work for them. Here is a crazy interview between Henry Blodget and Ray Dalio in which Dalio says: "I have a saying that the whole purpose of what we do is meaningful work and meaningful relationships, and they support each other." What if ... what if the purpose of what they did was to make money for clients? It doesn't even come up. It's not that they don't make money for clients. They do! It's just not a ... goal. They seek meaning, and the money takes care of itself.

Or there is this crazy Wall Street Journal article about how Bridgewater hired an artificial intelligence expert to automate, not the investing, but the group therapy:

Though outsiders expected Mr. Ferrucci would use his talents to help find hidden signals in the financial markets, his job has focused more narrowly on analyzing the torrent of data the firm gathers about its employees. The data include ratings employees give each other throughout the work day, called “dots.”

Think of how little sense this makes. Most of Bridgewater's employees aren't involved in its investing activities. And now it is building a sophisticated computer system, not to analyze the markets, and not even to analyze people who analyze the markets, but to analyze people who don't analyze the markets. Somehow this makes it a massively successful hedge fund.

The Dalio/Blodget interview, by the way, is mostly about how much Dalio disliked that Journal article. His dissatisfaction with his press coverage leads him to weird places, calling for regulation (or self-regulation, whatever) of the press to prevent, I guess, news from being wrong? When a newspaper reports something about someone, and the subject claims that it's not true, then, Dalio points out, "We don't have ways of resolving the arguments in idea meritocratic way." That is ... true? But it is also the difference between a hedge fund and, you know, the world. A hedge fund is a hierarchical institution that is in the business of making decisions about what is true or not. (Bridgewater's hierarchy is unusual, and I suppose you could call it non-hierarchical, but Dalio spends a lot of the interview explaining exactly how its credibility-based decision-making process works.) The world is just a world. It doesn't have a universally acknowledged efficient process for arriving at the truth on all contested matters of fact. It's a little strange to think that one could be imposed. But I guess if you run a hedge fund for long enough, you begin to think that you could be the arbiter of truth in other domains.

Steve Cohen.

Here is Sheelah Kolhatkar's behind-the-scenes look at why federal prosecutors didn't charge Steven A. Cohen with criminal insider trading, which seems to be that:

  1. They had no proof that he committed criminal insider trading, and
  2. He had persuasive arguments that he didn't.

Those seem like good reasons not to charge him? But the prosecutors were pretty broken up about it:

They knew that they had to assess the evidence coldly. They looked again at what they had, and what they had, they saw, wasn’t enough to insure a victory. Klotz’s defense was patchy, tenuous, and rooted largely in speculation, but it could be enough to withstand the government’s meagre evidence.

Klotz is Martin Klotz, Cohen's main lawyer, who presented his defense to the prosecutors to convince them not to charge Cohen. (He brought along other lawyers, including Theodore Wells, a trial lawyer "whose closing statements were so powerful that he sometimes brought himself to tears." Is that good?) He also argued that the government's desire to charge Cohen for getting a tip about Dell from a guy who got it from a guy who got it from a guy who got it from a guy who got it from a guy who got it from an investor-relations employee went a little far:

“A number of people I’ve spoken to say that isn’t a legitimate extension of insider trading,” Klotz said.

“Are any of these people federal judges?” Zabel asked. He, like his colleagues, felt confident about his interpretation of the events. “Give me a break.”

Ha, good one! This was in early 2013, and by the end of 2014, the relevant federal judges had agreed with Klotz.

People mostly think about white-collar enforcement in institutional and symbolic terms. Imprisoning Cohen "would prove that the new billionaires who dominated America’s economic and political life were not above the law," writes Kolhatkar. Sure! But there is also, you know, the law, which says that you can't send someone to prison without proving beyond a reasonable doubt that he committed a crime. You can see why that sometimes makes prosecutors sad! And it's not always great for symbolism. And yet.

Jesse Litvak.

We have talked before about Jesse Litvak, the former Jefferies LLC bond trader who lied to customers about the prices he had paid for bonds and was convicted of criminal fraud for doing it. Then his conviction was reversed by an appeals court, and sent back for a new trial where he would be allowed to argue that those lies were really no big deal because everyone lies about bond prices and no one takes them seriously. I thought that that was the right result, but I also said that "I don't particularly fancy his chances of convincing a jury" of this argument. Now he's back on trial and ... I still don't love his chances? But his lawyer is giving it a go:

In Mr. Butswinkas’s telling, the messages reflected tactics that verged on pathetic—attempts to hoodwink savvy institutional investors whose “special, secret, computer-driven” ways to calculate their desired prices always overrode whatever Mr. Litvak told them.

Mr. Litvak’s techniques, Mr. Butswinkas said, were akin to those of “your local used-car salesman. The kind of statements we have learned—and these sophisticated investment companies have learned—to take with a grain of salt.”

The problem here is that "local used-car salesman" does not, to the lay juror, sound like a good thing. No one is like "oh, right, he acted like a used-car salesman, I love used-car salesmen, no problem." The broader problem here is that a lot of activity in business and finance is, in some very broad sense, shady: People misrepresent their positions, in a variety of ways, to try to get an advantage over their counterparties. Many of those ways, in the cold light of a criminal courtroom, would look bad. The trick is not to get charged with fraud. Once you are telling a jury that you're just like a used-car salesman, it is probably already too late.

Should index funds be illegal?

No, says BlackRock Inc. Vice Chairman Barbara Novick, and I guess that settles the matter. Novick objects to the academic theory -- which was all the rage, at least in Money Stuff, late last year -- that index funds reduce competition and drive up prices for consumers:

These papers lack economic logic and factual support from the real world. For instance, why would passive managers want airline prices to be higher given that air travel is a cost for nearly every other business that is owned by the index funds? And if index funds diminish competition, why would the average tenure of companies’ inclusion in the S&P 500 be shorter in the index era than in 1958, or even 1980?

Then she goes on to point out that index funds are good for investors. This is a common reaction from people -- and not just people who run big asset-management companies -- when they hear about the index-fund-antitrust critique, but it is not really a response to that critique. My favorite thing about the ban-index-funds crowd is that they concede that index funds are great for investors. (They tend not to concede that they want to ban index funds, but I like to think that I know their desires better than they do.) They just think that the economic gain that we get from making low-cost diversified equity investing available to everyone is less important than the economic harm that we get from concentrating stock ownership in companies like BlackRock. I am not exactly convinced that they're right -- yet!? -- but I appreciate the boldness. They're not tinkering at the margins; they're rejecting the main premises of modern finance.

Elsewhere: "Vanguard has topped a table of the bestselling fund managers globally for 2016 after drawing nearly $200bn from investors, eclipsing the total amount of new money raised by its 10 nearest competitors." And: "We find that companies with higher percentages of transient institutional investors experience more overvaluation, defined as excess firm value relative to firm fundamentals, in the following quarter." And: "It’s Time for Investor Fees to Go Even Lower." 

Fake news. 

Barclays Equity Research began its U.S. Large-Cap Banks 2017 Outlook like this:

This marks the 13th straight year we are publishing our Charles Dickens's "A Christmas Carol" inspired report at the start of the trading year.

We would describe the year 2016 as "A Tale of Two Cities".

Yes well of course they would. In financial news and research, everyone describes everything as "A Tale of Two Whatevers," though the whatevers are only occasionally cities. (They're not really cities in Barclays's telling, either; they're stock indexes.) Barclays goes on predict "Great Expectations" (for 2017) worry about potential "(Oliver) Twists." It is a bleak house. But at least it is literature, or the titles of literature anyway. I worry that even our clichés are coarsening:

Fake news. It’s the hot new thing all the kids are talking about. There’s an entire epidemic of it going around, according to Ray Dalio, founder of the world’s largest and most cult-like hedge fund, Bridgewater. And now Goldman Sachs is on the case, “Debunking the ‘fake news’ of the imminent great rotation from bonds to stocks.”

Whatever "fake news" is, "the imminent great rotation from bonds to stocks" isn't it. (Try making that go viral on Facebook!) Things can be wrong without being "fake news." I feel like I don't even know what we talk about when we talk about fake news.

Food Stuff.

Look I am not Bloomberg View's resident kitchen-gadget expert, but when I read that "Brewer Anheuser Busch InBev and coffee maker Keurig Green Mountain have teamed up to develop a countertop appliance that could dispense alcoholic drinks in the home," my first thought was: I already have an appliance like that! It's a bottle of bourbon. I keep mine in a cabinet but you can put it on your countertop, I don't judge. It dispenses alcoholic drinks great. Technology is amazing. Elsewhere: Black-cod-with-miso purchasing power parity.

People are worried about unicorns.

Somehow it's still possible to worry about Theranos, Inc., the Blood Unicorn (Elasmotherium haimatos). You'd think they'd have sort of wrapped that up by now, but here we are:

The Silicon Valley company, which once promised to reshape the medical-testing industry, said it laid off 155 employees Friday. The cuts come after 340 employees were laid off in October, and leave the firm with about one-quarter the staff it had in August.

One lesson here is that if you start with N employees, you can fire half of your employees roughly (log N)/(log 2) times. Theranos now "has identified a core team of 220 professionals to execute on its business plans," so you'll be able to read similar announcements up to seven more times. Also it told some more patients that their blood test results were wrong. It can do that lots more times.

People are worried about stock buybacks.

I don't know if you'd exactly call this a stock-buyback worry, but it's stock-buyback-adjacent anyway:

The U.S. is becoming “de-equitized,” putting some of the best investing prospects out of the reach of ordinary Americans. The stock market once offered a way for average investors to buy into the fastest-growing companies, helping spread the nation’s wealth. Since the financial crisis, the equity market has become bifurcated, with a private option available to select investors and a public one that is more of a last resort for companies.

I think that "last resort" is still the wrong way to characterize the public stock market. In the aggregate, the public markets are not a last-choice option for public companies to raise money from investors; they're a first-choice option for public companies to return money to investors. (They raised the money in private markets, while they were still growing, before they went public.) That's why net issuance of stock -- sales of stock by public companies, minus buybacks -- has been negative for years. If you want to invest in a promising new business before it is big and established, the private markets seem to be the place for you. Fortunately the private markets are the new public markets, and lots of mutual funds are buying Uber shares anyway.

People are worried about bond market liquidity.

They are! Still! Isn't that so comforting? Here you go:

The Volcker rule bars banks with government backstops from taking market bets with their own money. Critics say that curtailing bank trading activity has reduced market liquidity when it is most needed, during times of stress.

The latest institution to advance this view isn’t some self-interested bank or libertarian think tank but the Federal Reserve. In a paper issued just before Christmas, using corporate-bond downgrades as a proxy for stress, it finds deterioration of liquidity around these events has worsened substantially since the rule was put in place. This suggests the Volcker rule “may have serious consequences for corporate bond market functioning in stress times.”

Here is the Fed staff discussion paper, which should not be confused with the New York Fed's frequent blog posts finding that corporate bond market liquidity is just fine. Elsewhere, here is some worrying about bond market makers who provide too much liquidity:

"Asking a market-maker to consistently provide liquidity in a market with no visible pricing is like asking a taxi driver to set the fare before knowing the destination," Chris White, chief executive of ViableMkts, a consultancy in New York, tells "The market-maker is very susceptible to charging $20 for driving someone from Manhattan to the Hamptons."

And: "Biggest banks each set to be hit with $200m trading rule costs."

Things happen.

"Does anybody have these? Will it protect my hands since I punch very hard?" Pound Falls to 10-Week Low as May Hints at Single-Market Exit. The Dow almost hit 20,000. Libor is over 1 percentLow Interest Rates and the Financial System. "Destination-based cash flow tax with border adjustment." And Larry Summers on corporate tax reform. BofA Said to Boost Bonuses for Bond Traders, Cut Equities. Saudi Aramco gets ready for ‘no ordinary IPO.’ Saudi Arabia Said to Hire PwC to Advise on $20 Billion Cost Cuts. China Foreign-Exchange Reserves Keep Dropping. Meet the Mercers: A Quiet Tycoon and His Daughter Become Power Brokers in Trump’s Washington. Derivatives regulation under Trump. "We find that firms reduce dividend payments when stock liquidity increases." Jon Corzine to Pay $5 Million for Role in Collapse of MF Global. What's Martin Shkreli up to? Fake plane crashes as team bonding exercises. The Pros and Cons of Pros-and-Cons Lists. Mexican klezmer. Who's a smart dog? "After a month at a Zen silent-meditation retreat, Heller went back to his job at Goldman Sachs as a commodities trader in oil and gas."

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