Money Stuff

Blogging, Bonds and Bathrooms

Also Steve Schwarzman, Ray Dalio, blockchains, GAAP  and liquidity.

Spoofing, etc.

If I were an ambitious securities regulator or prosecutor, I would spend a few minutes each morning reading blog posts with titles like "Why I Quit my Investment Banking Job to Start a Tech Company." There seem to be new ones every day, and you never know what you might find in them. For instance, if the author discusses his time as a trader at an investment bank and says that he was "uncomfortable with some of the things I witnessed/experienced," an alert regulator might call him up and ask: Well, what, specifically? Was it mortgage fraud? Insider trading? Spoofing? 

I don't know how the Feds got David Liew but I sure hope it was from his blog post:

Liew resigned from Deutsche Bank in 2012 and in July of that year wrote a blog post called, "Why I Quit my Investment Banking Job to Start a Tech Company," according to the FBI affidavit. In the post, he discussed his three years of trading, saying he was "uncomfortable with some of the things I witnessed/experienced.”

Liew, who traded precious metals for Deutsche Bank AG in Singapore, pleaded guilty last week to spoofing charges. (He also settled with the Commodity Futures Trading Commission for spoofing and triggering stop orders.) He has agreed to cooperate with prosecutors to go after some of the other things he witnessed/experienced:

In his court plea, Liew described working with others at his own bank and at two other operations. He refers to “The Legend,” without naming him, at another unidentified global bank.

A tip for traders: It might be fun to call yourself "The Legend" for your spoofing prowess, but resist that temptation. "The Legend," "The London Whale," "Lord Libor": All of these are bad nicknames. If you are ever prosecuted for your misdeeds, you want your nickname to be, like, "the Staten Island Minnow," or "Go-With-the-Flow Pete," or "Ol' Whatsisname."

Anyway, as you might expect, an ex-trader who was disgruntled and indiscreet enough to blog about his discomfort also wrote some dumb stuff in electronic chats. Spoofing is hard to prove without evidence of intent, but it is very easy to prove if you have lots of electronically preserved chats with other traders explaining how you are spoofing:

After trading silver futures on March 29, 2011, Liew wrote to the trader he called The Legend. "Look at silver … all algo play … basically I sold out … by just having fake bids," according to chats transcribed in the FBI affidavit.

By June 2011, Liew had begun teaching others the mechanics of spoofing, according to the FBI affidavit. In a chat with a trader from an unidentified trading firm, Liew explained how he used high-speed traders to move the market to his advantage. "I just spam … then cancel a lot … its actually stupid … cause im risking … but it gets the job done."

Sadly his blog post has been deleted, so you and I may never know why Liew quit his trading job to start a tech company, but the important thing is that the FBI does. 


Last week, Goldman Sachs Group Inc. got in some public-relations trouble when it came out that Goldman Sachs Asset Management had bought some Venezuelan bonds from the government, arguably helping to prop up President Nicolás Maduro's ... the standard word is "embattled" ... government. (One economist worries that the government "might use the money on tear gas against protesters.") One weird thing about the transaction is that Goldman bought the bonds for 31 cents on the dollar. That's not that weird; Venezuela is in bad shape, and its bonds are trading well below par.

But it is a little weird to buy government bonds directly from the government at a big discount to par. That's not precisely what happened -- the bonds were issued in 2014 by Petroleos de Venezuela SA, the state oil company, in a private placement to Venezuela's central bank, which then sold them to Goldman through an intermediary this year -- but, economically, it kind of looks like that. The bonds were never sold to an unaffiliated third party for cash until they went to Goldman. When we first talked about the trade, I asked:

What if Goldman had bought brand-new Venezuelan government bonds directly from the government at 31 cents on the dollar? Would those bonds have par claims in any future restructurings?

The traditional answer would be no: If a government sells a new bond for 31 cents on the dollar, then it is an original-issue-discount bond and its claim in a restructuring would be 31 cents (accreting up to par over time). If the government did a restructuring, then someone with a 31-cent original-issue-discount claim could expect to get back only about one-third as much as someone with a par claim, even if that par claim was also trading for 31 cents on the dollar in the secondary market. I am not sure that that traditional answer applies here, since Goldman's bonds are not new (issued in 2014) and not government bonds (issued by PdVSA), but I am not sure it doesn't, either. 

It's not just a question for Goldman, though, since Venezuela's main financing source these days seems to be finding old bonds that it issued to itself and reselling them at a discount:

Venezuela is attempting to resell at a deep discount $5 billion of bonds it originally issued in December through a Chinese brokerage as it struggles to squeeze through a tightening cash crunch, according to investors who were offered the bonds.

The bonds were originally issued "by Venezuela’s government in a private placement to state-run Banco de Venezuela," so they too have remained within the government; now they're being shopped at a discount. Which worries investors:

Potential buyers fear that if Venezuela defaults, owners of the 2036 bonds wouldn’t have the same claim as other bondholders because their bonds were issued at discount prices via an intermediary,  

Deal fees. 

The best reason for a company to pay investment bankers tens of millions of dollars to help negotiate a mergers or acquisition is that, if the bankers are good at their job, they can add (or subtract) hundreds of millions of dollars to the sale price. But this is hard to signal in advance. You can't just walk in to a pitch and say "oh I am really good at negotiating higher prices." I mean, you can, but anyone can say that; how do you prove it? You can point to data -- maybe your deal premiums are higher than other banks' premiums, for instance -- but this data is famously manipulable, and every deal is different, and getting a small premium on a hard deal may be more impressive than getting a big premium on an easy one. You can lay out some of your strategy in the pitch -- have a page saying "we plan to contact large sovereign wealth funds and ask them to pay a lot of money" -- but that doesn't really give the client a sense of your ability to think on your feet in negotiations.

More satisfyingly, you can try to build a relationship with the company. This is partly general salesmanship -- the more you hang out with the chief executive officer, the more she will feel like she owes you the M&A mandate -- but if you actually have negotiating skill, then the CEO might notice it during your relationship. You'll give the CEO some free advice on negotiating to hire a new employee, or on dealing with an internal business issue, and maybe she'll think "oh hey this guy is pretty good at giving negotiating advice" and be more inclined to hire you for the big M&A assignment. Or, of course, there is word of mouth: CEOs who are happy with their investment bankers will tell their CEO friends, who will also go hire those bankers.

Best of all, the CEOs who are happy with their investment bankers can tell a newspaper, preferably in colorful language:

Still, one executive whose company used both Goldman and a large universal bank to handle its sale experienced the Goldman modus operandi at close quarters.

“The banker at the large firm had done a ton of free work for us for years so we threw him a few million dollars as bone. But he could not have gotten us the 40 per cent above our all-time high that we got,” he said. “Goldman had the poker tactics, down to telling our management not to even talk to the buyers in the bathroom during due diligence. We went to them when we needed the A team. Other bankers didn’t have their nuts of steel.”

I hope they gave him a discount in exchange for that five-star review! (Disclosure: I used to work at Goldman, and I am therefore biased to favor this sort of shameless glorification of the firm.) Imagine going into an M&A pitch with a pitchbook page saying "we will tell you not to talk to the buyers in the bathroom during due diligence." That is not a good slide! (Imagine the clip art!) And yet it's the thing that stuck out to this former client, and that convinced him that Goldman's skill is what got him a 40 percent premium. 

Steve Schwarzman.

The best thing in this Bloomberg Markets interview with Steve Schwarzman -- besides his fondness for "Law & Order" reruns -- is the sort of fairy-tale quality to how opportunities seem to come in to the Blackstone Group LP. For instance, Schwarzman had been pursuing GSO Capital Partners for a while without success, but then after Blackstone went public this apparently happened:

Bennett [Goodman, the CEO] came in, and I said, “Why do you want us to buy you? You’re like a pretty girl we’ve been asking out all these years. What’s happened to you?” And he said, “We’ve read your prospectus, and what you all have done is so impressive that if we can combine with you, our ability to grow will be accelerated so much just by virtue of all the relationships you’ve cultivated around the world and how you handle your business. We would rather be with you than on our own, and we’d love to be acquired.” Who knew?

Do you think that is a common occurrence, in the world of public companies? Like people just show up at your door and say "I read your prospectus and it brought a tear to my eye. I think your company is just so wonderful that I want you to have my company too." That is an effective prospectus! The lawyers who drafted it should be very proud. Also here is how Blackstone got a large equity infusion from the Chinese government:

In the spring of 2007, I got a call from Antony Leung. I was at home watching Law & Order and doing some office work. Antony was very well-known in China, having helped them restructure their banking system when it got into trouble. He’d been the head of Greater China for Citibank and JPMorgan and then financial secretary of Hong Kong before we hired him to be our chairman in Greater China. So the phone rang, and Antony said, “Steve, I was in Beijing for a meeting with ICBC”—which is China’s biggest bank—“and the chairman said there were two Chinese people who wanted to see me. So I saw them, and they offered to invest $3 billion in our $4 billion IPO.” At this point I asked, “What did you say?” and turned down the volume on Law & Order. “Who are these people, and where do they work?” He said, “Well, they don’t have jobs.” I said, “That’s interesting. I assume they’re very rich if they can write a check this big.” He said, “No, they’re not rich at all.” “So,” I said, “they’re unemployed nonrich people who want to give us $3 billion?” He said, “Yes, that’s right.” I asked, “Is there some reason you called me with this?” And he said, “Because they want to invest $3 billion.” I said, “Not to be forward, but where are they going to get $3 billion, and what did these people used to do?”

“One of them,” he said, “was the deputy finance minister of China, and the other was the deputy head of the Central Bank.” “Aha,” I said. 

The whole trick, in finance, is to work very hard to put  yourself in a position so that one day, when you are sitting at home watching "Law & Order," a stranger will call you up and offer you $3 billion.

Dalio vs. Trump.

Ray Dalio has been a very successful hedge fund manager but don't you sort of wish that he'd take a sabbatical to serve as Donald Trump's ... chief of staff? Life coach? Therapist? Spiritual adviser? That is a reality television show that I would watch, just Dalio and Trump meeting every day, Trump listing his accomplishments and grievances, Dalio saying things like this:

For example, if Donald Trump were optimizing for his own well-being through conflict, it's entirely possible that he would undermine his own well-being because the retaliation could be more damaging to him than the cooperation.

That's from Dalio's LinkedIn post yesterday. "Trying to figure out Donald Trump's perspective, what choices he will make, and their feedback loops has been an interesting and challenging puzzle to try to solve," says Dalio. One thing that I tend to think about Bridgewater Associates is that its"Principles"-based management approach is not so much a blueprint for managing a hedge fund as it is a philosophy for living a good life, a set of techniques for solving the puzzle of life, not of financial markets. I think Bridgewater is at its core a quasi-religious organization whose purpose is to help its members find meaning and fulfillment and self-mastery. (The money is a byproduct, and frankly the link between the employees' self-knowledge and the firm's profits has always seemed a bit tenuous to me.) If that's right, then there is no particular reason for Dalio to confine himself to coaching his own employees. There might be other people who have more urgent need for his help. Of course, Dalio has said that Bridgewater's approach of radical self-reflection is "not for everyone," and if there's anyone for whom it's not, it's probably Donald Trump. 

Elsewhere, it's Larry Summers vs. Jamie Dimon on Donald Trump.

Blockchain blockchain blockchain.

Jim Greco is skeptical about current blockchains-in-finance efforts: "Blockchain startups are going to need to spend a lot more time in the weeds solving real-world problems in finance before distributed ledgers take over the back office." The big problems are anonymity ("By definition, there are no anonymous transactions in a distributed ledger!") and speed ("In a distributed ledger, you are continuously reconciling the entire system’s transactions"), and it is not clear that a distributed ledger is an improvement over a centralized ledger kept by a trusted counterparty. On the other hand it's clearly an improvement over some things:

This is one of the reasons why Chain and NASDAQ’s implementation of a market for private securities was smart. Private securities transactions are basically just paper now, and there is almost no technology in place to service customers. Literally, any system is an improvement!

That is my basic thinking about blockchain in finance: If shouting the word "blockchain!" makes people more enthusiastic about modernizing creaky old systems, then more power to them, even if the blockchain is not the optimal way to modernize those systems.

Elsewhere: There's a bitcoin comedian who asks audiences, "Do we have any libertarians in the house?" Yes, yes you do.

People are worried about non-GAAP accounting.

Well here is a short animated movie about the glories of U.S. generally accepted accounting principles. ("The Summer Movie About Accounting You Won't Want to Miss," says the Wall Street Journal, for some value of "you.") One thing that you sometimes hear is that GAAP numbers are "real" numbers, and that companies reporting non-GAAP numbers are using "fantasy math" or whatever. What I liked about this little film is that it seems to have been made by accountants, who know that nothing works that way. It doesn't advertise GAAP as representing objective reality; it advertises GAAP as a useful human-made coordination system. It analogizes GAAP to traffic rules. There is no moral importance or objective truth involved in driving on the right or stopping on red and going on green; the value is that everyone agrees to follow the same rules. Similarly the value of GAAP is not so much that it reflects reality -- though it does the best it can -- but that it is generally accepted.

Elsewhere: "Tech Teams Rush to Catch Up as New Accounting Rule Looms."

People are worried about bond market liquidity.

It's been a while since we talked about the worry that exchange-traded funds might create a liquidity illusion in which ETF buyers think that they own liquid securities but are then surprised by the illiquidity of the underlying bonds, but my Bloomberg View colleague Noah Smith is worried about it:

If banks or other big broker-dealers suddenly become unwilling to facilitate the trading of certain kinds of bonds, ETFs that include large amounts of those particular bonds might suddenly plunge in price. Investors now buying up ETF shares might not realize that danger, thus leading to general overpricing.

Things happen.

SEC Power to Recoup Illegal Profits Curbed by Top U.S. Court. Buyout Firms Eye Gusher of Cash From Aramco IPO. The World’s $100 Trillion Question: Why Is Inflation So Low? Central clearing makes further inroads. How China’s Biggest Bank Became Wall Street’s Go-To Shadow Lender. How to listen for the hidden data in earnings calls. Carson Block's Mystery Short Target Roils Hong Kong Stocks. Passive funds are on pace to eat the entire US stock market by 2030. White House: Intends To Nominate Banker Joseph Otting To Top Bank Oversight Post. Donald Trump's company plans to open new downscale hotels to profit from his presidential campaign. The Silicon Valley Billionaires Remaking America’s Schools. The Warren Buffett of Memes. Katie Holmes at Harvard Business School. "A group of angry zoo investors have fed a live donkey to tigers at a Chinese zoo after a dispute with management." Dog serves on medical-journal boards.

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