Money Stuff

Meat, Marijuana and Call Options

Also too-big-to-fail, Uber governance, ICO enforcement, basketball and negative convexity.


When I tell people that I am a financial columnist they sometimes ask me, like, will the stock market go up or whatever, and I have to shamefacedly tell them that I'm not that kind of financial columnist. I don't make predictions about stuff. "If I knew that, I wouldn't be doing this, har har har," I sometimes say, a trick I learned as an investment banker.

That said, I do occasionally, by accident, make predictions. For instance, I once wrote:

The conventional wisdom is that cryptocurrency is about re-learning all of the lessons of modern finance in a sped-up way. ... But what if it's the opposite? What if the story arc of cryptocurrency is about traveling back in time? First bitcoin was a way to make electronic payments without using banks; now it is a way to keep money in a safe deposit box at a bank without being able to use it to make payments; at this rate, in a decade, it will be a face-to-face barter system. By 2050, bitcoin users will undiscover fire. 

That last sentence happens to be a testable prediction, and I stand by it 100 percent. Here you go:

No trend epitomizes this better than "Bitcoin carnivory," a diet-slash-lifestyle being promoted by a small but prolific group of cryptocurrency enthusiasts online. The idea is simple: Use only Bitcoin, eat only meat. The espoused benefits are as much spiritual as they are financial and physical, and its advocates are self-serious. For the Bitcoin carnivore, there is a kind of metaphysical parallel between decentralized digital ledgers and an imagined idea of what our ancestors ate, and by extension, how they lived. Politics, food, and money—it's all connected.

"Bitcoin is a revolt against fiat money, and an all-meat diet is a revolt against fiat food," says a person whose food comes "only from the animal kingdom, and mostly fat." ("Is there a picture of him?," asked my wife.) I have 33 whole years for my joke about fire to come true, but I won't need them. "Bitcoin is a revolt against fiat money, and eating raw food and huddling together in dark caves for warmth is a revolt against fiat civilization," someone will tell Vice, by like 2022, and I will nod in quiet satisfaction that at least one of my predictions came true. 

Elsewhere in cryptocurrency: "Cryptocurrency Flash Crash Draws Scrutiny From Watchdog." And: "Cryptos fear credit."

Insider trading.

We have talked a lot, over the years, about the murky areas of insider trading law. In particular, multi-level insider trading cases -- in which an insider tips someone else, who tips someone else, who tips someone else, who trades on the information -- are complicated. The "downstream tippee" -- the person who actually trades -- may genuinely not know that the information came from an insider and was obtained illegally, so he may not be guilty of insider trading. And the insider may not have known that the eventual tippees were going to trade, so he may not be guilty of insider trading. You could have a whole network of people trading on inside information, none of whom is quite guilty of insider trading.

But here is a four-level insider trading case that is -- at least according to the government -- about as bright and neat as you could imagine. Here's the Securities and Exchange Commission's chart of who told what to whom:

Fleming was an insider at Life Time Fitness Inc., who allegedly learned about an upcoming merger and tipped his buddy Beshey. Neither Fleming nor Beshey traded on the information. Instead, Beshey tipped some other people, one of whom (Kourtis) tipped still other people, and those people all traded. And then they all kicked back some money to the people above them in the network, who kicked back money to the people above them, with some of it eventually going back to Fleming.

Basically every link on that chart represents a sentence in the SEC complaint saying "A and B agreed that B would trade Life Time stock options and share the profits with A" -- an explicit agreement on a quid pro quo necessary to proving insider trading. (I hoped that the kickback percentage might be fixed, but it wasn't: Mansur allegedly paid just over 1.1 percent of his $133,326 of profits up to Kourtis, while Bonvissuto allegedly paid more than a third of his $33,677 of profits up to Beshey. Fleming, the guy at the top of the chain, who was allegedly responsible for almost a million dollars of insider-trading profits, got just $10,000 of kickbacks.)

Beshey and Kourtis allegedly "agreed that Kourtis could share the inside information about Life Time with some of Kourtis’s friends," but when Kourtis did tip those friends, he "told all four men to keep this information to themselves." Why? Why was Kourtis allowed to pass it on, but his buddies weren't? I don't know, but it makes the pyramid neat; there are no loose ends, no possible additional lines meandering off the page. And it sounds almost as though the insider traders were constructing the chart themselves: At one point third-level tippee Kourtis allegedly told fourth-level tippee Kandalepas "that he had a friend who was long-time friends with someone who worked in a high-level position at Life Time." Gotta keep the number of links straight for everyone!

This is ... I don't give legal advice, and this is all based on the SEC's biased characterization of these conversations ... but this is not the way to do it. Leave some ambiguity! Nod and wink a little, you know? Say "I got a hot tip," not "I have a friend who is friends with someone who is an insider, want to join our chain of tips and kickbacks?"

Two other not-the-way-to-do-it points. One is, if you are going to violate the First Law of Insider Trading (don't do it) and the Second Law of Insider Trading (don't do it by buying short-dated out-of-the-money call options in a merger target), at least act like you've been there before. These guys were allegedly so hot to trade options that they had to call their brokers repeatedly to figure out how options work:

At 12:45 pm CT, Bonvissuto called Brokerage Firm 1 to place an order. When he placed his order, he stated “We only want to buy ….” (emphasis added). Brokerage Firm 1 asked if he wanted to place a market or limit order. Bonvissuto said he would call back.

The other is, maybe don't take your kickbacks in weed?

After realizing these profits, Weller gave Kourtis at least ten pounds of marijuana as a kickback for sharing the inside information about Life Time. Kourtis sold the marijuana for over $20,000.

I mean, I have no problem with a barter economy of insider trading; if you want weed and your dealer wants stock tips, then a mutually beneficial transaction can be worked out. But if you are taking the marijuana for its cash value, and then selling it, then you have a problem, which is that you need to commit a second crime to monetize the proceeds of your first crime. It's just a little inelegant.

Too big to fail.

"AIG Is No Longer Too Big to Fail, So Now It Wants to Get Bigger," is the terrific headline here, and it points to a real discontinuity in financial regulation. There's no single axis on which too-big-to-fail-ness gets measured; it's not like having $50,000,000,001 of assets makes you TBTF while $49,999,999,999 keeps you small enough to fail. Instead there is a subjective multifactor test involving size and complexity and interconnectedness and, implicitly, likelihood of failure, and the Financial Stability Oversight Council has plenty of leeway to decide which non-bank financial companies are or aren't "systemically important financial institutions."

But some companies are really gigantic, and other companies are really small. The really small ones aren't TBTF. The really gigantic ones are more likely to be. If you assume -- as most SIFIs seem to -- that being big is good, but that too-big-to-fail regulation is onerous and should be avoided, then you get weird incentives. Being the biggest SIFI you can be is good: You're intensely regulated, but at least you're huge. Being the biggest non-SIFI you can be is good: You're smaller, but you're as big as you can be without the extra regulation.

But there is no value in being a small SIFI, in being very close to the line but on the wrong side of it. And because there is no line, just a vague blur, calibrating it is difficult. There's no a priori reason to expect the biggest non-SIFI to be smaller than the smallest SIFI. If you're a SIFI and you want to stop being a SIFI, you need to dramatically overshoot and get much smaller. Then, once you're much smaller and the FSOC has let you out of SIFI regulation, you can start getting bigger again, as long as you don't overshoot in that direction.

Anyway also yes: American International Group Inc. is no longer too big to fail. As I said last month, that makes sense: "Giving firms a realistic off-ramp from SIFI status encourages them to shrink and become less systemic," and AIG really did shrink, and now it gets its reward. But given AIG's centrality to the last crisis -- and its plans to start growing again -- it does seem a little ominous. What if the entire cycle plays out entirely within AIG? Regulations were loosened, AIG grew big and reckless, it crashed the economy, regulations were tightened, AIG got small and cautious, everyone forgave it, regulations were loosened, and now AIG can grow again. What comes next?

How's Uber doing?

Umm. I give up. I often say that the way to analyze Uber Technologies Inc. is that it is not a "startup," but rather a giant public company that happens to be privately held. But public companies don't really do this:

The phone calls began late Friday among Uber’s new chief executive, Dara Khosrowshahi, and the ride-hailing company’s executives, as well as board members and a raft of lawyers. They were facing an emergency.

The problem was that Travis Kalanick, Uber’s former chief executive and a board member, had appointed two new directors — Ursula Burns, the former chief executive of Xerox, and John Thain, the former chief of Merrill Lynch — to the privately held company without informing them.

Normal companies tend to know who is on their board of directors. That's not usually too difficult to keep track of. But at Uber it is a fun surprise. "That is precisely why we are working to put in place world-class governance to ensure that we are building a company every employee and shareholder can be proud of," said Uber in a statement.

That said, some of what's going on at Uber seems almost normal, or rather, like preparations for normalcy. Kalanick exercised his power to appoint two directors to try to head off the board's consideration of some proposals to reduce his influence and to prepare for an initial public offering. These proposals included eliminating the supervoting rights of Uber's preferred stock and Class B common shares (which would reduce Kalanick's voting power, as well as that of some early venture investors) and staggering the board elections, which "would make it hard for an activist shareholder to take over the board." There is also a specific anti-Travis provision, which "states that any person who has previously been an officer of Uber can return as chief executive only if he or she can get the approval of two-thirds of the board and 66.7 percent of all shareholders." And there's a 2019 deadline for Uber to go public. If Uber goes public with single-class voting stock, a staggered board, and some safeguards against the return of Kalanick drama, it will look ... sort of like a real company?

ICO crackdown.

Here is the first Securities and Exchange Commission enforcement action against an initial coin offering, aimed at RECoin, "The First Ever Cryptocurrency Backed by Real Estate." "The investments offered during the REcoin ICO were 'securities' within the meaning of Section 2(a)(1) of the Securities Act [15 U.S.C. § 77b(a)(1)] and Section 3(a)(10) of the Exchange Act [15 U.S.C. § 78c(a)(10)]" says the SEC, a forceful conclusion that would matter more for the future of cryptocurrency regulation if it weren't so obvious in this particular case. RECoin was not a "utility token," where you'd buy the token to use it in transactions on some blockchain-based distributed platform. It was just a pure investment, a form of ownership of real estate that happened to be tokenized on the blockchain.

Oh except also (1) there was no real estate and (2) there was no blockchain. "It was simply not true that REcoin investments were backed or secured by real estate investments," says the SEC, and "investors who transferred funds to Zaslavskiy via the REcoin website never received any form of digital asset, token, or coin, and no token or coin for REcoin has ever been developed."

Those are the sorts of quibbles that tend to make an enforcement action successful, but they also make it less interesting. If RECoin had built a blockchain and distributed tokens, and if those tokens had represented interests in actual real estate, would those token still have been securities? (Yes, obviously, I think -- even if other ICO utility tokens aren't securities.) Would the SEC have gone after RECoin for violating the securities laws by conducting an unregistered securities offering if it wasn't also an (allegedly) fake securities offering? If you are running a real blockchain that is selling interests in real investments, without bothering to comply with securities laws, how worried should you be after this case?


One weird thing in white-collar crime is figuring out which crimes are worse than other crimes. The dollar amounts involved are frequently important, but they are not the only thing. So for instance: Is it worse for the assistant coach of a college basketball team to take a few thousand dollars of bribes from a financial adviser in exchange for steering his players to that adviser, or is it worse for that financial adviser to forge documents to misappropriate hundreds of thousands of dollars from his clients? The latter seems much more directly harmful, and the dollar amounts are bigger. On the other hand, "corruption in college basketball" is a more exciting and high-profile story than "financial adviser is a crook."

So here is the story of Marty Blazer, the financial adviser, who got in trouble with the Securities and Exchange Commission and federal prosecutors for the document-forging and client-money-misappropriating, and who worked out a deal with them "to reduce any penalties he might face by somehow leading prosecutors to bigger, more prominent crimes." Which might mean "smaller, more prominent crimes"? The FBI set up a big operation with undercover agents, and Blazer went around and (allegedly) bribed some assistant coaches while working as an informant, and last week federal prosecutors charged a bunch of people in a college-basketball-corruption case. (Blazer still had to plead guilty to his crimes, though he has a cooperation agreement that may get him a reduced sentence.) I guess I am not that moved by the corruption stuff? It feels a little bit like arresting someone for murder and then letting him out to help you catch jaywalkers, but the jaywalkers are basketball coaches so it's very important that you catch them?

People are worried that people aren't worried enough.

But that will be over soon. Here's Matt Klein on the Federal Reserve's plan to reduce its balance sheet over time, and its likely effect on interest-rate volatility:

It seems reasonable to think that the Fed’s withdrawal from the agency MBS market will increase volatility and risk premiums. Traders bored by the markets should get excited.

The basic story is that when investors buy mortgage-backed securities, they are short convexity (their duration lengthens when rates rise, due to mortgages' prepayment options), and they often hedge this risk by buying duration when rates go down and selling it when rates go up. This tends to increase the volatility of interest rates: When rates fall, MBS hedgers buy more bonds, pushing rates further down, and vice versa. When the Fed buys MBS, it doesn't hedge them; it just throws them in a vault. Soon it will be opening the vault, though, and MBS will start to be owned more by regular owners who are more likely to hedge, and more likely to increase volatility.

Things happen.

"I’m convinced Argentina will be the star of emerging markets for the next 20 years," says Argentina's finance minister. At the Center of the Equifax Mess: Its Top Lawyer. Trump Team Pushes Back Against ‘Tax Cuts for Wealthy’ Critics. Cohn Says Repatriation Tax Rate Will Be in ‘10-Percent Range.’ Cher Sues Billionaire Entrepreneur Over Stock Sale. An accounting recruiter was "like a drug dealer, deliberately seeking out vulnerable people and getting them hooked on the high-status identity." Hedge Funds Ain’t Dead Yet. Twitter mood does not actually predict the stock market. NYC Restaurateur Danny Meyer Raises Private-Equity Funds. Monty Hall, Host of ‘Let’s Make A Deal,’ Dies at 96. Canada MPs to loosen penalties for drunks in kayaks. Raccoon family takes over Toronto bank. "When I first encounter René Redzepi, he is cutting a live elk in half with a chainsaw."

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