Money Stuff

Mortgage Fines and Bond Restructuring

Also bedbugs, blockchains, Mooch and terrible office floor plans.

Deutsche Bank.

There was a time, not that long ago, where every week seemed to bring a new multibillion-dollar settlement with a big bank over fraudulently originating and selling mortgages in the run-up to the financial crisis. But they've thinned out a bit, and so when there is a big one now it feels more like an event. Yesterday Deutsche Bank AG did its $7.2 billion of penance, and from the press release it seems like everyone in the Justice Department lined up patiently to give a fierce quote about how bad Deutsche Bank was. "Deutsche Bank did not merely mislead investors: it contributed directly to an international financial crisis," said Attorney General Loretta Lynch. "This $7.2 billion resolution – the largest of its kind – recognizes the immense breadth of Deutsche Bank’s unlawful scheme by demanding a painful penalty from the bank, along with billions of dollars of relief to the communities and homeowners that continue to struggle because of Wall Street’s greed," said a principal deputy associate attorney general. There's also a principal deputy assistant attorney general, and some other quotes.

So, sure, yes, but the Statement of Facts does not create the impression that Deutsche was uniquely evil. The Deutsche story -- the story with every mortgage-settlement bank, really -- seems more like a story of going along with everyone else, because it's what the cool kids were doing:

However, as early as 2005, Deutsche Bank knew that mortgage loan originators were expanding their underwriting guidelines to such an extent that they no longer sufficiently assessed the borrowers’ ability to repay their loans.

In March 2005, the Diligence Supervisor reported to a senior member of Deutsche Bank’s Mortgage Finance team, (hereinafter, the “Mortgage Finance MD”), that it was "concerning that we’re being sent proposed guidelines changes from Sellers every week. The larger firms (AMQ, NCEN, OOMC, and FMT) [Ameriquest, New Century, Option One, and Fremont] are putting significant pressure on the marketplace by expanding their guidelines. Very few Investors will push back on these large Sellers and it had made originating very difficult for lower tier competitors….It’s definitely a Seller’s market! (Sic.)"

Indeed, in May 2006, the Diligence Supervisor warned a senior Trader on the Subprime Desk, a Managing Director (hereinafter, “Trader 1”), that Option One, a large mortgage loan originator, was making such “aggressive” revisions to its underwriting guidelines that it would underwrite a loan to anyone with “half a pulse”

That "half a pulse" line sounds bad, but this is not Deutsche Bank cackling with glee at the garbage it is foisting on investors. This is Deutsche Bank fretting about the garbage being foisted on it. The big mortgage originators were lowering their standards. That was forcing other originators to lower their standards, to compete. If Deutsche Bank pushed back and refused to securitize loans from those originators, then it would have no loans to securitize. If it had no loans to securitize, all these people fretting about the low origination standards would have nothing to do. Their jobs depended on finding a way to accommodate these new, lower standards. All they could do was complain about it.

Plus -- look, they thought the standards were too low, but if everyone else was okay with them, maybe they were actually fine? I mean obviously, in hindsight, they weren't fine. In Deutsche Bank's foresight, they weren't fine. In every bank's foresight, really, they weren't fine. (We have a lot of Statements of Facts by now!) But no one said anything, and so everyone assumed that everyone else was fine with it, and it all went horribly wrong. But it's pretty clear that Deutsche Bank took no joy in it as it was happening.


The thing about how no one reads bond documents is that they sort of sit around unread, accumulating dust, and then every so often someone will read one of them and be like "oh hey wait we've been doing this wrong the whole time." (The make-whole situation we discussed last week is arguably one of those stories.) So for ages and ages, troubled companies have done out-of-court restructurings of their bonds that work something like this:

  1. Bondholders vote on the restructuring.
  2. The bondholders who vote yes get the restructured bonds.
  3. The bondholders who vote no get punched in the face.

I mean, I have simplified. But if you can get a supermajority of holders to swap into new bonds, they can (by "exit consents," etc.) also vote to modify the terms of the old bonds (the ones retained by the objecting bondholders) so that they become more or less worthless. They can strip out guarantees or covenants, or sell assets, or otherwise make it very unpleasant to hold on to the old bonds. And so, if the company can win over most of the bondholders to its restructuring, it can avoid holdout problems: You don't want to be the only one left holding the old bonds, once they've been stripped of their rights, so you go along with everyone else.

But then one day someone read  the Trust Indenture Act of 1939, the U.S. federal law governing bonds, which as its name suggests was written in 1939 and not read by anyone ever since. Section 316(b) of the TIA says that "the right of any holder of any indenture security to receive payment" on a bond "shall not be impaired or affected without the consent of such holder," which sort of sounds like these out-of-court restructurings are illegal. After all, if you strip away the guarantees or covenants or assets on the old bonds, it sure looks like the rights of the bondholders to get payment have been impaired without their consent.

So a clever hedge fund called Marblegate Asset Management, LLC, refused to go along with the 98 percent of bondholders who approved a restructuring of Education Management Corp. (The restructuring featured an intercompany asset sale and parent guarantee release, leaving objecting bondholders with bonds in an empty shell.) It sued, and won, convincing a federal district court in New York that the TIA means that you can't do that. The bond restructuring world was shocked: It had apparently been doing things wrong this whole time, because no one thought the TIA meant that. 

But yesterday the U.S. Court of Appeals for the Second Circuit overturned that decision and said, no, you're fine, you can go ahead and do that. The TIA forbids only modifying the right of payment on the bonds, not other credit terms. So as long as the bonds still formally have to pay back the same amount, you can go ahead and strip all the assets from the issuer, etc., even if that means that the likelihood of the bonds being paid back goes way down. Here's the opinion, and a Davis Polk & Wardwell client memo. One lesson here is that it doesn't always pay to read the documents. Every so often you discover something no one else knew and make a profit. But a lot of the time, you discover something no one else knew and spend a lot of money suing, only to find out that the court sides with everyone else. 


Way back in 2014, Valeant Pharmaceuticals International Inc. and Pershing Square Capital Management, L.P., teamed up to make a hostile bid for Allergan, Inc. Allergan fought this takeover effort every way it knew how, but there are only so many ways. It said mean things in public about Valeant's business model. (Some of those turned out to be true!) It talked with other companies that might take it over in a more friendly way. (Ultimately, one of those, Actavis plc, did.)

There's one other thing you can do in fighting a takeover fight, though. This is America, and our securities laws are complicated, so you can go around trying to convince someone that your opponent in a takeover fight broke some securities law. There are various ways to do that. You can sue them for breaking the law, and Allergan did, suing Valeant and Pershing Square for insider trading. But you can also hope that the Securities and Exchange Commission will find some violation and go after them for you. Or, to speed that along, you can casually point out some violations to the SEC and hope that they take it from there. This is popularly called "bedbugging," and you can usually assume that both sides in any hostile fight are doing it.

Anyway here is an SEC settlement in which Allergan agreed to pay $15 million for not making timely disclosure of some of its discussions with other potential buyers (including Actavis) during its fight with Valeant. Oops! One lesson here is, you know, if you are in a hostile tender offer situation, you have to make timely accurate disclosure about your material negotiations with potential white knights. But the other lesson here is that if you are bedbugging them, they are bedbugging you, and the securities laws are complicated enough that you can never be sure if the SEC is more likely to go after your opponent, or you.

Blockchain blockchain blockchain.

"Blockchain technology could help the world’s largest investment banks cut their infrastructure costs by between $8 to $12 billion a year by 2025, according to a report by Accenture," so there you go.

David Treat, a managing director for Accenture’s financial services industry blockchain practice, said the significant investments in the technology were no surprise "given the tremendous cost of data reconciliation, which is part of every aspect of the capital markets industry".

This seems to be the growing consensus about banking blockchain: You have a computer program to do your trades, and another program to do your securities financing, and a third program to do your financial reporting, and a fourth program to do your taxes, and all your time and money is spent making sure that they are speaking to each other correctly, not to mention to the similar programs at other banks. Replacing them all with the blockchain makes it more likely that they will speak to each other correctly. None of this seems particularly inherent to the blockchain -- just build a good API, you know? -- but, sure, in practical terms "getting databases to talk to each other" seems like a good goal, and blockchain seems like a plausible way to achieve it.

Some Trump.

Anthony Scaramucci is a fund-of-funds marketer who has achieved some public notoriety for complaining that Barack Obama was "whacking at the Wall Street piñata" and and for comparing the Department of Labor's fiduciary rule to slavery. So of course he has a new job doing public relations for Donald Trump at Davos, which I think might be the absolute worst job/employer/location combination I can imagine? He seems happy though:

“This is my 10th year here, but my first year here with a food taster,” Mr. Scaramucci quipped at the beginning of a conference session Tuesday afternoon nominally on the “Outlook for the United States” but really about President-elect Trump—and a little bit about Anthony Scaramucci.

"If Davos is FOMO in its most rarefied form," writes Felix Salmon, "then Scaramucci is now up there with the likes of Bono and Bill Clinton in the select group of people who can rest assured that there’s no party they’re not invited to." It is always nice to see opportunism rewarded.

Scaramucci also founded and owns a fund-of-funds business called SkyBridge Capital, which of course he is selling "to a group led by a fast-growing Chinese conglomerate." I hope Trump will tweet a demand that he sell it to Americans instead.

Elsewhere in Trump appointees, Wilbur Ross is quitting 38 jobs to be Commerce Secretary. Treasury Secretary nominee Steven Mnuchin "was the kind of deal maker who would 'know the cost of every pencil.'" Tom Price, the Health and Human Services nominee, will be questioned at his confirmation hearing "on possible ethical issues surrounding Mr. Price's stock purchases," with the basic issue being that he repeatedly traded stocks of health-care companies while also advocating legislation that would affect those companies. And here is some speculation about algorithms programmed to trade on Donald Trump's tweets.

Seating charts.

Here's another article about some company's terrible open-plan office. In this case the company is the Boston Consulting Group, and its new open-plan office in New York is the latest in modern office design, insofar as it gets rid of desks, phones, windows and all evidence of human inhabitation:

BCG staffers will not have desks so much as tables, and about 75% can convert to standing desks. The tables also lack what was once an office essential, a telephone. Instead, staffers are assigned to a neighborhood log-in on each table’s iPad and instantly join the flow.

The windowless, closed offices for the 105 partners and senior staffers are referred to as “convertibles,” and made available for use by others when vacant, requiring personal effects to be kept to a bare minimum.

Honestly what are they doing in architecture schools? Imagine if doctors worked like this. "We've gotten rid of your stomach, intestines and liver and replaced them with new 'neighborhoods' where anyone can pop in and digest some food. It's very hip and modern and encourages cross-fertilization, though of course you'll have to keep your personal food to a bare minimum." Also there's no gym. Of course BCG is doing a case study of what will happen. And, data:

To quantify the impact of the physical space, BCG has hired data firm Humanyze to outfit staffers with biometric sensors. “We take behavior and we turn it into a data stream,” said Jeremy Doyle, a Humanyze senior vice president. Among other things, he measures “latency,” how long an individual goes without uttering a word to anyone—and when that word does come, where does it happen and to whom is it addressed.

I think if I worked there I would win the prize for most latency. (More is good, right?) And then, when my word did come, it would be addressed to the architect, and I'm pretty sure I know what it would be.

[Update: BCG spokesman David Fondiller e-mailed to object to the article quoted above, writing:

We haven’t gotten rid of desks. 75% of the desks in the open areas are sit-to-stand desks to promote wellness and comfort.

The desks do not lack phones. Traditional hardware-based phones have been replaced by computer-based softphones (i.e., Cisco’s Jabber) to allow communication anytime and anywhere in the office.

The “convertible” offices for partners and senior staff are not windowless. Their entire front wall is glass and transparent and faces floor-to-ceiling windows around the office perimeter, allowing for ample light and openness.

He also informs me that only about 100 employees will wear sensors to track their interactions.]

People are worried about unicorns.

Theranos, the Blood Unicorn (Elasmotherium haimatos), is just doing its thing:

Theranos Inc. failed a second major U.S. regulatory inspection of its laboratory facilities, people familiar with the situation said, a setback the Silicon Valley blood-testing firm hasn’t disclosed to investors or patients.

It's business as usual at Theranos, insofar as its usual business seems to be getting in trouble with regulators. And Dan Primack interviewed venture capitalist Tim Draper about Theranos:

Q. Can Theranos survive, and would you invest again if given the opportunity?

A. "Sorry, I only had 30 minutes for this and really need to go."

Elsewhere, Juicero, the Juice Unicorn (Elasmotherium chylizon), is cutting prices. And what will be the next Craigslist? And: "Can Snapchat’s Culture of Secrecy Survive an IPO?"

People are worried about bond market liquidity.

Well, they are worried about "dai chi," a Chinese practice of informal repo lending that ... sounds ... worrying:

Banks sometimes use the “dai chi” agreements to move risky assets temporarily off their books during earnings periods or audits, the people said. Brokers like Sealand typically use them to borrow quickly and flexibly—leveraging their investments many times over, they said.

Ooh, secret leverage and disguising assets for audits. And:

“Because it’s not really an official business, agreements aren’t legally binding,” said the executive who had bought bonds from Sealand.

People are worried about real estate market liquidity.

Why not:

Investors are piling money into real-estate funds—but fund managers are finding it a challenge to spend it.

Global fund managers had a record $237 billion available to invest in commercial property at the end of last year, according to data firm Preqin, up from $229 billion at the end of 2015 and $136 billion at the end of 2012.

Obviously in, like, medieval times it was easier to buy a building (or anything else), than it was to buy shares in a fund that invests in buildings (or anything else). Much of modern finance is about flipping that relationship. So now, as we are endlessly reminded, it is easier to buy and sell shares in a bond mutual fund or exchange-traded fund than it is to buy or sell bonds themselves, and that relationship puzzles and worries people. What if everyone wants to sell their bond-fund shares, but the bond funds can't sell the bonds? In the 1960s, people had similar worries about equity mutual funds, but they got over them. In the future, they'll have similar worries over real-estate funds, or whatever. Now though the real-estate worries are on the other side: What if everyone wants to buy real-estate-fund shares, but the funds can't buy real estate fast enough? That is called "dry powder."

Me yesterday.

I wrote about Citadel and the SIP

Things happen.

Goldman Sachs Earnings Climb as Trading Outpaces Expectations. (Earnings release.) Citigroup Trading Revenue Climbs 31% as Profit Beats Estimates. (Earnings release, supplementpresentation.) James Gorman plays it cool at Morgan Stanley. May’s Brexit Hardball Raises Chances of All-or-Nothing EU Deal. HSBC CEO Says Bankers Generating 20% of London Revenue May Move. Lael Brainard: Monetary Policy in a Time of Uncertainty. Why Dodd-Frank Has Little to Fear From Constitutional Challenges. Wachtell Lipton Discusses Acquisition Financing: the Year Behind and the Year Ahead. Diamond Said to Mull Atlas Mara Options Including Taking Private. Land Rush in Permian Basin, Where Oil Is Stacked Like a Layer Cake. Dealbreaker MBA rankings. Bribery Fails to Sway Buffett on ‘Celebrity Apprentice.’ Swiss Police Are Ready to Blast Drones Out of the Sky at Davos. Portland man shovels snow while riding unicycle, playing bagpipes. Brooklyn is too expensive. "It seems poisonous to make a monster (Dracula) to appear as a competent teacher (even a teacher of numbers) because such an appearance would seem to mislead children into trusting Dracula, and possibly monsters in general."

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