Money Stuff

Puerto Rico Bonds and Cream Coins

Also performance fees, Amazon MBAs, Buffett bets, Trump SoHo and Seamless.

Puerto Rico.

One obvious fact about Donald Trump's comment to Geraldo Rivera that Puerto Rico's debt should be "wiped out" is that he didn't mean it. He doesn't mean anything, strictly speaking; he does not use words to convey meaning in the conventional sense. I am a little embarrassed for the bond market that it took him seriously, but boy did it ever:

On Wednesday, Puerto Rico’s beaten-down benchmark bonds plummeted from an already unprecedented 44 cents on the dollar to as little as 30.25 cents. 

“It may possibly be the end of the municipal bond market as we know it,” Harry Fong, an analyst at MKM Partners, wrote as the securities fell and fell.

Oh come on. Look, to be fair, if $74 billion of municipal debt were wiped out by an offhand comment to Geraldo Rivera, then that really would be the end of the municipal bond market as we know it. But that's not going to happen. Trump's budget director dutifully clarified that people should not interpret his comments about Puerto Rico's debt as predicting policy or otherwise meaning anything:

"I think what you heard the president say is that Puerto Rico is going to have to figure out a way to solve its debt problem,” Mick Mulvaney, director of the White House budget office, said in an interview Wednesday. “We are not going to bail them out. We are not going to pay off those debts. We are not going to bail out those bond holders."

But that introduces another confusion: Who said anything about bailing out the bondholders? This strange conflation of write-downs and bailouts is actually a longstanding oddity in politicians' discussions of Puerto Rico's debt. There are basically three ways to deal with Puerto Rico's debt:

  1. Puerto Rico could pay it;
  2. Someone else (the federal government, for instance) could pay it; or
  3. Nobody could pay it.

Option 1 is the ordinary course for debt, but is rough on Puerto Rico, which didn't really have the money to pay its debt even before it was hit by a devastating hurricane. Option 2 is a bailout, and it is nice for Puerto Rico and also for its creditors, and some people have called for it, but there does not seem to be a ton of political support for it.

Option 3 is "wiping out" the debt. It is also nice for Puerto Rico (at least in the short term), but not at all nice for the creditors, who do not get their money back. And this is what Trump actually said: "You can say goodbye to that, I don't know if it's Goldman Sachs, but whoever it is, you can wave goodbye to that." This is how bankruptcy (sometimes) works: If a company goes bankrupt, then the federal government declares that it doesn't have to pay back some of its debt. That is not a "bailout." It's not like the federal government pays back the debt either. Nobody pays it, and the creditors are sad. Puerto Rico is not eligible for bankruptcy under U.S. law, but last year Congress gave it a somewhat bankruptcy-like oversight board that is working to restructure the debt, and there is still a fight looming over how much of the debt will be paid back. But, from a bondholder perspective, not letting Puerto Rico wipe out its debt looks more like a bailout than letting it do so.

The genesis of this confusion is even weirder than its existence. Basically what seems to have happened is that back in 2015, as its financial troubles were mounting, Puerto Rico started lobbying Congress to give it a bankruptcy regime to restructure its debt. People opposed to this proposal -- the bondholders, basically -- naturally lobbied against it, and settled on the talking point that allowing Puerto Rico to reduce its debts would be a "bailout." (I said at the time: No, it's the opposite of a bailout.) That bondholder talking point gained traction in Congress, and Mulvaney was in Congress at the time, and so now he has somehow confused himself into thinking that writing down Puerto Rico's debts would be a bailout for those bondholders. Every intersection of finance and politics is pretty maddening. 

Elsewhere in Puerto Rico, Antonio Weiss argues that "the island’s crushing debt should be reduced to the maximum extent through the legal framework established by Congress last year." And: "Puerto Rico faces a government shutdown on Oct. 31, including halting its hurricane recovery, if Congress doesn’t provide billions in emergency funds, said Treasury Secretary Raul Maldonado."

Cream Cash.

A good indication of the froth in the cryptocurrency market is that Ghostface Killah of the Wu-Tang Clan is launching a cryptocurrency called Cream Cash, and it's not called Wu-Tang Coin because someone else already has that name. (I mean, it's probably called Cream Cash because that's a better name, but the fact is that there's already a Wu-Tang Coin.) The history of the Great Crypto Boom of '17 will include a whole chapter on Wu-Tang-themed coins, and that chapter will have multiple independent narratives. Really I would not have predicted in 1994 how much of 2017's financial news would involve the Wu-Tang Clan. They really rule everything around cash.

Anyway the Cream Cash white paper is very funny. "Cream Cash ($CREAM) is an ERC-223 token that aims to be the most easily accessible and transactable token ever made available to the general public," it begins. Structurally it seems to be a token in the category that I sometimes think of as "Excelcoin," after the idea that you could just keep the ledger in Excel. The traditional idea of a cryptocurrency is that the ledger of who owns it is kept collectively, on a decentralized trustless blockchain, but there are also some coins where the ledger is just kept by the issuer of the coins. Cream Cash seems to be one of those. (Coincidentally so is Wu-Tang Coin.) From the white paper:

Decentralized blockchains are trustless systems. However, within the Cream Ecosystem there exists a degree of centralization on our end and therefore a degree of trust that is required for us to operate efficiently. For tokens to be issued, funds must be deposited with Cream Capital whether it is through the Cream Digital Asset Exchange or the Cream ATM network. It is our responsibility to provide liquidity to all systems that might be used to distribute and withdraw Cream Cash.

That is: You give us dollars, and we keep a list of who gave us dollars, and that list is also the list of who has Cream Cash.

So one might ask, “Which is it? Is the Cream Ecosystem operating on a Proof-of-Work blockchain consensus or a Proof-of-Stake blockchain consensus?” The answer is that it’s neither. Our blockchain consensus is what we call a Proof-of-Trust ecosystem. Users trust that we will maintain liquidity within our systems. Users trust that we will protect the value of their assets and investments from market shrinkage and inflation. Our ecosystem acts as a sort of financial trust in a literal sense in that by pledging your tokens with us for certain periods of times, they will be safekept within our network for release at a later date — and with a degree of growth.

Okay. Also Cream Cash is meant to be pegged to the dollar, with the apparent result that (1) you give Cream Capital a dollar, (2) they give you back a token, and (3) they tell you that the token is worth a dollar. Umm. Why? There's also a "dividend" mechanism -- they pay you some different tokens as dividends on your Cream tokens -- which I guess is the point, as long as you don't think too hard about what would make the dividends valuable.

Elsewhere in crypto news: "A Biotech Company Changed Its Name to ‘Riot Blockchain’ and Its Stock Is Surging," and that always ends well. And here's "AERO: Enabling the Drone Superhighway Using the Blockchain." My first reaction was, wait, I thought the point of drones was that they don't need highways, but in fact the idea is to sell your airspace to drones on the blockchain. "By utilizing the blockchain, AERO Token enhances the sharing economy by demonstrating that under-utilized assets, airspace over private property, can be easily leveraged to generate income."

Performance fees.

There are two basic ways to think about fees for actively managed mutual funds. There is the supply-side perspective: People need to actively manage the funds, to do research and pay trading commissions and whatnot, and so they need to charge higher fees than index funds would in order to cover those expenses. And there is the demand-side perspective: Active funds compete with index funds, and if the active funds are more expensive, they should also outperform the index funds, or else what are you getting for your additional fees?

The first perspective -- funds charge fees to cover their costs -- has been dominant in the industry forever, but with the rising popularity of index investing it's harder and harder to get away from the second. People are now aware that they have the choice to pay low fees to get index-level performance, so charging them higher fees to get sub-index performance keeps getting harder. And so now:

Fidelity International, the overseas sister company of U.S.-based Fidelity Investments, said Tuesday that it will soon begin offering equity funds that charge a slightly higher fee when they outperform their benchmark, but less if they underperform.

AllianceBernstein also has performance-fee plans:

While Fidelity International’s plans remain short on specifics, AllianceBernstein’s fee structures have been laid out in detail. The all-in expense ratio will vary between 0.10% and 1.1%, but fees don’t climb to that higher range until there is substantial outperformance. The Large Cap Growth fund for instance will have an expense ratio of 0.6% only if it outperforms its benchmark by two full percentage points, with higher fees after that.

A 0.1 percent expense ratio is pretty comparable to an index fund. If you pay 0.1 percent to underperform the index, well, at least you can't complain that you are overpaying to underperform? And if you pay 0.6 percent to outperform the index by two points, then you should feel great about your decision. For investors it seems like a win. It is a somewhat scary business model for the fund industry, though: What happens to the roughly half of all funds that will inevitably underperform the index, and that are stuck charging passive-level fees to pay for active management?

Amazon MBAs.

Amazon.com Inc. is hiring 1,000 MBAs a year:

Tech companies, once averse to hiring PowerPoint-loving B-school grads, have embraced them in the past few years. Ms. Park said business students understand Amazon’s customer-obsessed ethos and tend to be “risk oriented,” scrappy and analytical.

One might question whether an MBA is likely to be "scrappier" than someone who didn't spend $100,000 on an MBA, or more "analytical" than a computer scientist, but certainly "risk oriented" is a standard descriptor. Going to business school is a fairly safe, conventional, keep-your-options-open career move, and so the stereotype is that MBAs tend to be fairly risk-averse. Not risk-averse like law students -- no one's as risk-averse as law students -- but, compared to a college dropout starting a company in her garage, you'd expect an MBA to be a bit more cautious, a bit less likely to "move fast and break things." And that is a big part of why tech companies were once averse to hiring them: If your goal is to disrupt the status quo, why hire someone who has spent her life trying to fit into it? 

But as "tech" has eaten the world, that mindset has changed, or at least diversified. Amazon is a disruptive force in many ways, but it is also a $464 billion market-cap company that is the dominant retailer of many products. There are plenty of startups in garages that still want to move fast and break things and disrupt the status quo, but Amazon is the status quo, and it doesn't necessarily want to break any of the things that have made it so gigantic and successful. So it brings in the MBAs.

There's going to be another Buffett bet.

Okay fine sure:

The "Oracle of Omaha" told CNBC's Becky Quick on Tuesday that he is willing to do another bet on active versus passive as long as anybody wants to put up "a significant percentage of their net worth" on the wager.

Morgan Creek Capital's founder and chief investment officer, Mark Yusko, accepted Buffet's offer on Tuesday. His firm manages a fund of hedge funds and also does direct and private investments.

"Yusko said he has not talked or reached out to Buffett yet," but the important thing is being first to grab at the publicity. So now you can continue to read annual articles about how Buffett's bet on the S&P 500 index is (or isn't!) outperforming a basket of hedge funds, at least for the next 10 years, at which point Buffett will have to roll his bet with someone else. (Unless Yusko wins, in which case, does he get next?) The betting is not actually essential to any of this. Someone could just build a hedge-fund basket, and report its daily returns, and then you could compare the S&P 500 to the hedge-fund basket over whatever period you want whenever you want, instead of making it an annual gimmick.

In other Buffett-themed gimmicks, here's "I ate like Warren Buffett for a week — and it was miserable." And in other hedge-fund news, "Gabe Plotkin's Melvin Capital is up 32.1% after fees this year through September," a strong performance for a fund that I sometimes think has the best name in the entire hedge-fund industry. There are Greek-mythology names, and there are geographical-feature names, and there's the odd Tolkien name, and then there is "Melvin."

Trump SoHo.

Here is a ProPublica story about the time in 2012 that the Manhattan District Attorney's office was building a criminal fraud case against Ivanka Trump and Donald Trump Jr. "for misleading prospective buyers of units in the Trump SoHo." The case ultimately went away after Donald Trump's personal lawyer joined the legal team, donated some money to the Manhattan DA's election campaign, and met with the DA to convince him not to prosecute. (The DA, Cyrus Vance Jr., returned the money, and says that it had nothing to do with his decision.) 

I am hesitant to assume corruption here, and what the Trumps were accused of seems like pretty light fraud. "The evidence included emails from the Trumps making clear that they were aware they were using inflated figures about how well the condos were selling to lure buyers," reports ProPublica, and, sure, you shouldn't do that. ("Prosecutors also saw potential fraud and larceny charges, applying a legal theory that, by overstating the number of units sold, the Trump were falsely inflating their value.") But misleading condo buyers about how many other buyers there were seems less bad than misleading them about, you know, whether the building will fall down or whatever: You're not lying to them about an essential characteristic of the condo itself. The disgruntled buyers sued, and the Trumps gave them most of their money back, and that seems like a basically fine outcome. 

Still, it's a decent primer on how not to commit fraud. For instance: 

In yet another [email], Donald Jr. spoke reassuringly to a broker who was concerned about the false statements, saying that nobody would ever find out, because only people on the email chain or in the Trump Organization knew about the deception, according to a person who saw the email.

If you're lying to investors, don't send around emails telling your co-conspirators not to worry because no one will find about those emails. Those are always exactly the emails that people find out about!

Elsewhere in prosecutorial decision-making, here is a really interesting analysis of how U.S. prosecutors are stretching the boundaries of the law to try to turn violations of NCAA rules into federal crimes.

Food Stuff.

This may be the sort of thing that is of interest only to me because I am dumb and provincial, but I was kind of blown away by this breakdown of the most popular food delivery services in different cities. I just assumed that everyone orders Seamless all the time, because I do, and that other services like Caviar and UberEATS were just weird novelty acts. And in fact Seamless's market share in New York is about 86 percent. But actually in many cities its market share is tiny. (Also apparently people call it "GrubHub" elsewhere?) I had thought that Seamlessing dinner was a universal experience of the young professional class, but I guess in San Jose you DoorDash your dinner?

Things happen.

There's an activist battle over Stuyvesant's alumni association. Trump’s Short List for Fed Chair Features These Hawks and Doves. Inside Traders' War Games for Trump's Fed Chair Pick. Companies That Perform Best Don’t Pay CEOs the Most. Ireland raises €4bn in negative yield bond sale. Russian Group EN+ Plans $1.5 Billion Offering in London and Moscow. Sears Canada to Choose Between Chairman’s Bid and Liquidation. Amazon Must Pay $300 Million in Back Taxes, EU Says. Americans Eating More Butter Made Dallas Wuethrich a Billionaire. SoFi's Plan to Become the Bank of the Future Isn't Going So Well. "It’s extremely timely, therefore, that two current art exhibitions in New York take nuanced, critical looks at the technological, political, and philosophical questioning AI demands." Jeremy Bentham’s actual decomposing, severed head is now on display at UCL. "One of the things we wanted to make sure was that if anybody was indicted because of this, that it wasn’t us." Hedge Fund CEO in $1.3 Billion Divorce Says He Wasn't Married.

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    To contact the author of this story:
    Matt Levine at mlevine51@bloomberg.net

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