“Bucket shop” has become a general-purpose Wall Street insult – “don’t work at Blackstone, it’s a total bucket shop” – but it’s actually a particular thing, “[a]n establishment, nominally for the transaction of a stock exchange business, or business of similar character, but really for the registration of bets, or wagers, usually for small amounts, on the rise or fall of the prices of stocks, grain, oil, etc., there being no transfer or delivery of the stock or commodities nominally dealt in.”1 The “bucket” bit comes, I think, from the notion that your long order and someone else’s short order would be thrown into a bucket together, netting them out with the shop as a bookie, rather than being forwarded to the stock exchange.
These are illegal now in all sorts of ways, and when they existed in the olden days they seem to have been pretty shady, but I’ve always thought that as a concept they get sort of a bum rap. What’s wrong with giving people synthetic exposure to equities, particularly exposure with low initial margin requirements and limited recourse?
Anyway Risk has this truly delightful article today about synthetic prime brokerage: Read more »
I’ve occasionally pointed out that one problem with the antitrust Libor lawsuits is that the allegations are mostly “the banks lied about Libor in order to trick each other about their creditworthiness and/or screw each other on some swaps trade,” so it’s hard to claim that they were all working together in a big antitrust conspiracy. But Judge Naomi Reice Buchwald, who mostly dismissed a batch of Libor lawsuits on Friday, has an even better objection, which is that even if it was a conspiracy, it was supposed to be a conspiracy:
[T]he process of setting LIBOR was never intended to be competitive. Rather, it was a cooperative endeavor wherein otherwise-competing banks agreed to submit estimates of their borrowing costs to the BBA each day to facilitate the BBA’s calculation of an interest rate index. Thus, even if we were to credit plaintiffs’ allegations that defendants subverted this cooperative process by conspiring to submit artificial estimates instead of estimates made in good faith, it would not follow that plaintiffs have suffered antitrust injury. Plaintiffs’ injury would have resulted from defendants’ misrepresentation, not from harm to competition.
As Judge Buchwald points out, in a delightfully sensible 161-page opinion, antitrust violations require a competitive market that can be subverted by a conspiracy. Here, there was no competitive market to subvert, and the injury that the plaintiffs suffered – manipulated Libors – could have come as easily from individual bank manipulation as from a grand conspiracy. Normal markets don’t work that way: if I just decide to charge you twice the going rate for my product, and no one else does, that tends not to work. If I submit twice the real rate for my Libor, and no one else does, that kind of still works, though I guess it works better if everyone joins in.
So, so much for antitrust. Read more »
I learned a new word, or word-like sequence of letters, reading the Dell merger proxy this weekend. The word is “must-believe,” and it’s a noun meaning a thing you must believe in order to embark on a certain course of action. You don’t have to believe a must-believe, but if you don’t believe it you shouldn’t do the thing that it’s a must-believe for. There are no prizes for guessing that I learned it from a management consulting deck.1
What are the must-believes for selling Dell to its CEO, Michael Dell, and his private equity sponsors at Silver Lake? Well, here is a must-not-believe, from JPMorgan’s fairness presentation to Dell’s board:2
The dotted box on your right floats rather far above the red line of Silver Lake’s offer: if you’re the board, and you are deciding to sell Dell to Silver Lake for $13.65 a share, you must not believe that Dell’s management is telling you the truth about its projections or that it is competent to achieve them. Because even at the low end of those projections (from September 21, 2012), Dell is worth at least $15.50 a share. Read more »
Once upon a time there was a settlement between the SEC and Citigroup over some bad stuff that Citi did, or maybe did, since the settlement did not require Citi to admit any guilt. But then the judge overseeing the case, Jed Rakoff of the Southern District of New York, bravely stood up and said: No, this settlement is Not Right, in small part because of that not-admitting-guilt thing.1 And lo he was a hero throughout the land, except in the Court of Appeals for the Second Circuit, which will likely reverse him.
I’m sure Judge Rakoff’s colleague Victor Marrero didn’t hold up SAC Capital’s proposed settlement with the SEC last week with the express goal of getting financial bloggers to say on Twitter that “Victor Marrero is the new Jed Rakoff,” but … kind of, right?
Here you can read the New Yorker‘s John Cassidy getting all exercised about the settlement, saying that “To his credit, Judge Marrero has, at least for now, refused to go along with this travesty.” I guess a lot of people don’t like this not admitting or denying thing that’s all the rage in SEC settlements these days (and, to be fair, always). But there’s an important difference between the two cases; Judge Rakoff had a reason for rejecting the Citi settlement, and Judge Marrero doesn’t particularly seem to have a reason for rejecting the SAC one.2 Read more »
Here’s a good Sonic Charmer post about how JPMorgan could have prevented the London Whale loss by imposing a liquidity provision on the Whale’s desk:
Liquidity provision means: ‘the more illiquid the stuff you’re trading, the more rainy-day buffer we’re going to withhold from your P&L’. And since one way a thing becomes illiquid is ‘you’re dominating the market already’, you inevitably make it nonlinear, like a progressive income tax: No (extra) liquidity provision on the first (say) 100mm you own, half a point on the next (say) 400mm, a point on the next 500mm, 2 points on the next 1000mm, etc etc. (specific #s depend on the product). Problem solved. In fact, it’s genuinely weird and dumb if they didn’t have such a thing.
The London Whale’s problem (one of them) was that he traded so much of a particular thing that he basically became the market in it. That means among other things that even if on paper “The Price” of what he owned was X there would have been no way for him to sell the position for X. A liquidity provision is a rough and dirty way of acknowledging this fact.
This suggestion isn’t a matter of GAAP accounting: JPMorgan wouldn’t report its asset values, or its revenues, net of this liquidity provision. It’s just an internal bookkeeping mechanism: his bosses informing the Whale that, for purposes of calculating his P&L and, thus, his comp, they would take the GAAP value of the things he had and subtract a semi-arbitrary number for their own protection.
It is weird and dumb that they didn’t do this although you can sort of guess why: the Whale portfolio started very small, and by the time it got big the Whale was both profitable and a (mostly imaginary) tail risk hedge, so it would have been hard for a risk manager to take a semi-punitive step to rein in his risk-taking. “Just tell the Whale to take less risk” does in hindsight seem like a sensible suggestion, but I suppose if he’d made $6 billion it wouldn’t.
Something else though. Here you can read about an exchange between the SEC and JPMorgan about the Whale newly released yesterday. Read more »
Yesterday we talked a little about Dell and its vague desire to escape the short-term obsessions of the public equity market yesterday. Today I came upon this new paper by Harvard Law professor Jesse Fried, about how long-term shareholders are really just as bad as the short-term ones. The argument is:
- companies like to talk about favoring long-term shareholders over short-term ones, because
- they think (er, say) that short-term shareholders want things (slashing R&D, earnings manipulation) that reduce the overall economic value of the firm, while long-termers only want to grow its value, but
- in fact long-term shareholders also want things that reduce the overall economic value of the firm, so
- maybe favoring the long-term isn’t as good an idea as people think.
The particular things that long-term shareholders prefer that are value-destructive involve transacting in the company’s stock. On the buyback side, favoring long-term shareholders can mean using money to buy back stock when it’s underpriced, even if spending that money on productive investments would be better for shareholders as a whole. It can also mean manipulating earnings lower to get more profitable buyback opportunities. There is some evidence that these things happen.1
On the issuance side, favoring long-term shareholders means issuing more stock when it’s overpriced, for instance to engage in otherwise value-destructive M&A. Amusingly, Fried’s example of this is AOL Time Warner, famously the worst M&A transaction from the invention of the corporate form until Countrywide; he argues that, despite this value destruction, AOL’s long-term shareholders were enriched by AOL’s purchase of Time Warner.2 Read more »
Ninety percent of what happens in the typical lawsuit is (1) a lawyer for one side sends a letter to the other side asking for some information to prepare for a trial that will never happen, (2) the lawyer for the other side sends back a passive-aggressive letter refusing to provide that information, and (3) the lawyer for the first side sends a passive-aggressive letter to the judge saying “NO FAIR.” Seriously, that’s what happens. It’s called “discovery,” and it goes on until the lawyers’ bills have gotten big enough that everyone decides to settle the case.
In that milieu, someone sending an aggressive-by-passive-aggressive letter qualifies as huge news, and so there is a lot of excitement over this rather tart mandamus motion that fifteen big banks filed to overturn some discovery rulings that Judge Denise Cote made in a mortgage-backed-securities lawsuit. I will not attempt to convince you that its tartness is all that interesting; I just want you to have context for why some people think it is.
The case is interesting though. The FHFA, the regulator that oversees Fannie and Freddie, is suing the fifteen banks1 for selling crappy subprime residential mortgage-backed securities to Fannie and Freddie. Being a securities-fraud lawsuit, the basic claim is “you lied to us in the offering documents for these RMBS, and we relied on those lies, so we bought your RMBS, and then we lost money because of your lies.” And the lies in the offering documents are not “these mortgages will never default!,” but rather lies to the effect of “we bought these loans from originators, and reviewed those originators’ underwriting practices, and we believe that the originators underwrote them carefully and didn’t just stuff them full of fraud.”
The banks make a pretty good point, though, in this motion: Fannie and Freddie, who were being deceived by the big underwriter banks into buying all these RMBSes stuffed with crappy mortgages from crappy originators, were also separately buying similar mortgages directly from the same originators. And, presumably, doing whatever due diligence they expected the underwriter banks to be doing: Read more »
Two ideas at the heart of modern financial economics are the efficient markets hypothesis, which says that investing doesn’t work, and the Modigliani-Miller theorem, which says that corporate finance doesn’t work.1 Also there is a financial industry which is pretty much organized around ignoring those ideas. Hahaha how stupid of David Einhorn to think that he could make Apple more valuable just by issuing some preferred stock! But also how stupid of David Einhorn to think he should invest in Apple rather than a market-cap weighted index of all the companies! I mean, stock picking, so last century, just index.
Management buyouts are one place where those two efficiency hypotheses break down in obvious ways. Of course management knows more about a company’s prospects than public shareholders do, and so will be able to buy when the company is undervalued.2 And of course adding giant gobs of debt to the balance sheet, with the attendant tax benefits, will make the stock more valuable. This doesn’t always work out – managements have their own problems estimating their company’s prospects, and leverage is risky – but it’s a perfectly plausible theory.
Or so I think but I come from a corporate finance background. Neil Irwin is an economics guy so he is puzzled: Read more »
What is CalPERS’s job? There’s actually an answer: it’s to “Provide responsible and efficient stewardship of the System to deliver promised retirement and health benefits, while promoting wellness and retirement security for members and beneficiaries.” I suppose “the System” is defined somewhere, and blah blah blah health benefits and wellness and beneficiaries, but I prefer to stop at the capitalized abstraction: CalPERS provides responsible and efficient stewardship of the System.
“Responsible” and “efficient” can conflict, though:
The second-largest pension fund in the United States is considering a move to an all-passive portfolio while at the same time, the largest brokerage firms are falling over themselves to push passively managed exchange-traded funds. The California Public Employees’ Retirement System’s investment committee started a review of its investment beliefs last week, with the main focus on its active managers ….
CalPERS oversees about $255 billion in assets, more than half of which already is invested in passive strategies. … “CalPERS investment consultant Allan Emkin told the investment committee that at any given time, around a quarter of external managers will be outperforming their benchmarks, but he said the question is whether those managers that are doing well are canceled out by other managers that are underperforming.”
So: financial markets exist to allocate capital to its most productive uses.1 One use of capital that may not be all that productive is allocating capital, so it’s understandable that rich sophisticated capital-allocators like CalPERS would allocate less capital to the business of allocating capital. Why spend so much money on external active manager fees when they turn out not to be that good at active management? Just index, right? Read more »
Derivatives are confusing, even pretty simple ones, which is why Goldman Sachs can describe Warren Buffett’s sale of $5 billion of GS stock like this:
The Goldman Sachs Group, Inc. today announced that it has amended its warrant agreement with Berkshire Hathaway Inc., and certain of its subsidiaries (collectively, Berkshire Hathaway) from cash settlement1 to net share settlement.
“We intend to hold a significant investment in Goldman Sachs, a firm that I did my first transaction with more than 50 years ago,” said Warren Buffett, Chairman and Chief Executive Officer of Berkshire Hathaway. “I have been privileged to have known and admired Goldman’s executive leadership team since my first meeting with Sidney Weinberg in 1940.”
“We are pleased that Berkshire Hathaway intends to remain a long-term investor in Goldman Sachs,” said Lloyd C. Blankfein, Chairman and Chief Executive Officer of Goldman Sachs.
In September 2008, Buffett bought – among other things – warrants to buy 43.5mm shares of Goldman Sachs stock in October 2013 for $115 a share, for a total purchase price of $5 billion. Today he amended that to instead allow him to buy in October 2013, for a total purchase price of zero, a number of Goldman Sachs shares equal to (A) 43.5 million times (B) [the average trading price of those shares at the end of September 2013 minus $115] divided by (C) that average trading price. As of when I type this, at a price of $145.80, that works out to around 9.2 million shares. So one way to read today’s agreement is that in effect Buffett is selling back 34 million (give or take) shares to Goldman for $5 billion. Read more »
There is a widespread perception that some banks are so systemically important that they are “too big to fail,” and that this status gives them a funding advantage because if they do run into trouble the government will bail them out and protect the investments of those who fund them,1 and that this is an implicit subsidy, and is Bad.
Because the subsidy lives entirely in expectation, there is essentially one way to get rid of it, which is to say: no, these banks aren’t too big to fail. This is a very politically appealing approach, because saying things without regard to their truth is pretty much the job of a politician, so the idea that you could fix a problem solely by doing that seems like magic. Is magic.2
But seeing through bullshit is pretty much the job of financial markets, so that approach only goes so far. Saying “we’ll let banks fail” and obviously not meaning it – say, by passing a unanimous symbolic Senate measure “direct[ing] the government to eliminate the advantages in federal subsidies and funding that banks larger than $500 billion in assets derive from the perception that the government won’t let them fail” – works a certain magic, I suppose, but not the magic of eliminating the subsidy provided to too-big-to-fail banks.
Letting nationally important banks fail, whacking creditors, and then giving press statements to the effect of “that’s right, screw your banks and their creditors,” might work though: Read more »
If you’re an activist investor your job is to (1) think of an idea for how to make a company’s stock go up, (2) buy stock in the company, (3) convince them to do your idea, and (4) sell high. Step 3 tends to involve lots of attention-seeking – it’s easier to wear a company down into doing your idea if they’re constantly hearing about it from other shareholders and reporters and stuff – but steps 1 and 2, importantly, don’t.1 If you tell everyone about your great idea for Apple to issue GO-UPS,2 then they’ll all realize that Apple will certainly do it and unlock tens of billions of dollars of value, so they’ll bid up the stock before you can buy it and you’ll lose the opportunity to benefit from all those gains. That may be a bad example but just work with me here.
There’s another way of putting that, which is: if you secretly conceive of an idea to make Apple a better company, and then secretly buy up a bunch of Apple stock, and then announce to the world “surprise! I have 12% of Apple’s stock, and a brilliant idea that starts with a thematically appropriate lowercase i!,” and the stock goes up, and you make a lot of money – isn’t that unfair? You got to buy stock at the low, pre-publication-of-your-idea price; the people who sold to you were bamboozled into selling out too low because they didn’t know about your great idea. It almost “smacks of insider trading.”
Or something. I may not be doing this theory justice because I think it’s silly: that great idea is your idea; why shouldn’t you be able to make money off of it? (And why should anyone else?) The money is your incentive to come up with the idea in the first place, and do the hard ego-stroking work of pitching it to CNBC and the target company; if you had to share it with free-riders why would you take on the responsibility? We talked about this a little last year when there were vague rumors that the SEC was buying into it, and that they might require investors to disclose 5% stakes within 1 day of acquiring them (instead of the current 10 days), and include synthetic share ownership in computing the 5%, in order to make it harder for activists to secretly accumulate shares. I have not heard much about that proposal since, though I hesitate to assign any causality.
But last week in another, colder part of town, someone proposed the same thing. Canada, I mean. Canadian securities regulators proposed: Read more »