Are you as puzzled as I am by the mild brouhaha over the CFTC’s new swap execution facility rules? Basically the rules require that most swaps be traded on pseudo-exchange-y-type things called “swap execution facilities,” which are run either by an order-book system or a “request for quote” system. The RFQ system would require anyone wanting to trade to send an RFQ to at least 3 (2 for “an initial phase-in period”) potential counterparties. The original proposal was for that to be five counterparties. The revised proposal has caused a striking amount of rage, as various people have confused themselves into thinking that of course it’s obvious that every transaction should be an auction among five potential counterparties. Presumably few of those people orient their daily life that way. I don’t, anyway; I get lunch at Chipotle every day because it’s next door to Dealbreaker HQ.1
On the other hand people who think that customers should choose how many quotes to get don’t like the 3-quote compromise either. Here’s a SIFMA guy whining about it, and he doesn’t seem all that wrong:
SIFMA’s Asset Management Group continues to believe that any minimum-bid requirement will tie the hands of portfolio managers who already have a fiduciary obligation to serve the best interests of their clients. Requiring portfolio managers to broadcast their trading position more widely than they would otherwise choose could negatively impact the prevailing price of their trades, making it more expensive and difficult to hedge their clients’ risk. SIFMA strongly believes that professional investment managers, and not the government, should determine appropriate trading strategy.
The thing that trading is is, deciding how broadly to expose your order. Wider exposure gets you more and potentially better bids, but at the risk of getting front-run or picked off or otherwise abused.2 I realize that I won’t persuade everyone by quoting a trading textbook but here: Read more »
Bloomberg has a fantastic article today about how Lehman’s decaying corpse is suing a bunch of former clients, many of them wee and sympathetic nonprofits, who hosed Lehman when they terminated swaps in September 2008. Some of these lawsuits turn on disputes over when those clients, or their consultants, should have valued the swaps for termination purposes, and I was looking forward to reading Bloomberg’s account of which of those customers used the SWPM <go> function on their terminals and on what dates, but for some reason that wasn’t mentioned.
The basic story is that clients had trades with Lehman that were in-the-money to Lehman, and when Lehman went bankrupt the clients terminated the trades and wired Lehman termination payments that Lehman now rather belatedly finds inadequate. You could understand why the clients would want to get out of these trades: for one thing, the trades had moved against the clients (thus being in-the-money to Lehman) and seemed likely to move further against them1; for another, if the trades did move back in the clients’ favor, what were the odds that a freshly bankrupted Lehman would pay the clients what they were owed?
Is Lehman right that the clients underpaid? Oh, I mean, of course. I don’t have the details of the trades but you can reason this out from first principles. Here:
- It’s September 15, 2008, and Lehman has just filed for bankruptcy.
- You owe Lehman some money.
- How much you owe them is a somewhat subjective matter that depends on what termination date you pick, what model you use, whom you ask for a quote, etc.
- You know, with some certainty, that everyone at Lehman who knows anything about your trade, and also everyone who doesn’t, has bigger things to worry about, like stealing office supplies on their way out the door.
- You can basically write them a check and enclose a note saying “here’s what we think we owe you,” and see if they write back.
- How big is the check?
Read more »
Another day, another rotten Easter egg uncovered in an exchange’s sensitive systems. Read more »
“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 »
Here’s a Bloomberg article about how banks made money by doing interest rate swaps with Detroit, and now Detroit is sad, because like a lot of municipalities Detroit swapped its floating rate bonds to fixed to hedge the risk of rates going up, and rates went down, and now the PV of Detroit’s swap liabilities is like $350mm, which is big, and that’s sort of that. I’m generally unmoved by the notion that municipalities should be able to get out of swaps that move against them for free, and while I’m sure there’s some nefarious record of mis-selling and fee-inflating in here somewhere, which would justify you getting all mad at Detroit’s banks, Bloomberg has not dug it up. The evidence so far is “rates went down,” so whatever.
Still this a pretty interesting story. The normal posture of these swaps cases is:
- City has floating-rate bonds and swaps to fixed.
- Rates go down but city is still effectively paying high fixed rate.
- City says “WTF, why don’t we stop doing this?”
- City goes to bank and says “remember that swap? never mind”
- Bank says “we’d be happy to tear up the swap, just pay us a $400 million termination fee.”
- City freaks out, calls press, etc., shouts about windfalls, etc.1
But Detroit is different! Detroit, to its great credit, doesn’t want to tear up its swaps. The banks do. But they’re not exactly pushing it: Read more »
There are two questions worth asking about today’s Wall Street Journal story about how Deutsche Bank “made at least €500 million ($654 million) in profit in 2008 from trades pegged to the interest rates under investigation by regulators world-wide”:
- is that a lot?, and
- did they do it by manipulating Libor?
The second one is hard, huh? Here’s the Journal:
[A] former employee has told regulators that some employees expressed concerns about the risks of the interest-rate bets, according to documents. He also said that Deutsche Bank officials dismissed those concerns because the bank could influence the rates they were betting on.
A Deutsche Bank spokesman said those allegations were “categorically false.”
So, who knows; Yves Smith says “unless the source can provide some sort of supporting evidence, this is ‘he said, she said,’ and the matter will shake out in the German bank’s favor.” I sort of come at this from the other direction, which is:
- Every other bank has mountains of emails and IMs to the effect of “hey we’re gonna go mess with Libor don’t tell anyone.”
- Deutsche isn’t, like, the #1 most-careful-with-emails-and-IMs bank in the history of banks.
- So, totally possible that supporting evidence will float up, no?
Also totally possible that these were legitimate trades unrelated to a few bad apples at DB who were admittedly manipulating Libor, of course. But where is the fun in that?
So let’s talk about the first question. Read more »
What should we do with the new real-time swaps data depository? As of the new year, the CFTC is requiring all swaps dealers to report their swaps trades in real time, starting with rates and credit index trades, and here is the data depository with those (anonymized) reports. It’s … not particularly real-time! It’s not particularly user-friendly either, I gotta say; somebody is presumably planning to make a lot of money translating these zip files of haphazardly coded data into Useful-ese.
But I guess we can pick at it now, no? What is interesting here? That sort of depends on what you want. If, like me, you’re into general bloviating, this seems like as good a source as any for a rough depiction of what trading activity in the credit index and rates derivatives markets looks like. So, for example, here is a delightful table of notional amounts traded yesterday across rates products and currencies; the notionals appear to be in local currency so one important takeaway is “boy a South Korean won is not worth a lot of money.” Or here is a toy chart I made by downloading the “cumulative slice report” for rates trades and focusing on US-dollar-only trades, then slicing them by what sort of rates they used1:
One conclusion to draw here is, remember when people were talking about phasing out Libor because it’s so corrupt and made-up and stuff? Read more »
It’s time to play survey results versus revealed preferences. First:
A key interest rate for more than $500 trillion of securities worldwide will be replaced by a benchmark subject to greater government control, according to a plurality of global investors.
Forty-four percent of those responding to a quarterly Bloomberg Global Poll said the London interbank offered rate, known as Libor, will be supplanted by a more regulated model within five years. Thirty-four percent predicted the rate will continue to be set by banks in the current fashion, while 22 percent said they didn’t know.
That’s from a poll of 847 randomly selected Bloomberg users, which is sort of a fascinating data set; like, Dealbreaker is a Bloomberg user (but, sadly, not surveyed). The substance is interesting too, beyond the Libor question.*
But, anyway, the Libor question: the plurality answer is “Five years from now, do you think LIBOR will … Be replaced by something more like a government-run rate.” What is a government-run rate? Meh, whatever, but have a look at revealed preferences:
That is from LCH.Clearnet’s data depository of cleared interest-rate swaps and actually tells you nothing about what we’re talking about but it looks pretty. Read more »
I very much enjoyed this Morgan Stanley electric shenanigans case that settled yesterday. According to the complaint, this happened:
- KeySpan, an electric generator, realized that prices for electric generation would be going down as more capacity came online.
- It decided to keep up prices by cutting back its own generation.
- But that’s dumb, because then it wouldn’t be able to sell much electricity at the high prices, which would mainly benefit its competitors.
- So it decided to buy its main competitor, cut back generation, but still sell plenty of electricity at high prices.
- But it “concluded that its acquisition of its largest competitor would raise serious market power issues” and so would raise problems with antitrust and electric grid regulators.
- So it said “aha, a swap!”
- And it synthetically acquired the capacity of its largest competitor (Astoria Generating) by entering into a swap with Morgan Stanley where it effectively bought that capacity at $7.57 a kilowatt-month.
- And Morgan Stanley hedged that trade by entering into a swap where it effectively bought the capacity from Astoria at $7.07 a kilowatt-month.
- Attentive readers will note that that’s a $0.50 difference, so Morgan Stanley made $0.50 per kW-month for about three years, for total revenue of around $21.6mm.*
So what do you make of it? The complaint sounds terrible, but then it would, and Morgan Stanley isn’t talking (and not admitting or denying etc. etc.), so we’ve only got one side of the story and maybe it’s exaggerated. But if you believe the complaint then everyone at KeySpan and Morgan Stanley knew that they were structuring this deal to get around antitrust requirements that they knew would make it impossible for KeySpan to buy Astoria directly. That’s certainly one possibility – everyone was as criminal as criminal can be – and, yeah, sure, probably, though the relatively low-dollar-value settlement might suggest otherwise.
But I like imagining the other possibilities in which someone was taking advantage of someone else’s naïveté. Read more »
The news these days is full of stories about swaps gone awry, where “awry” means “down in value for people who bet on rates going up, because rates went down.” Oakland and Libor, yes, but there’s a fun one in Floyd Norris’s column last week about this horror:
The security had a mouthful of a name: Floating Rate Structured Repackaged Asset-Backed Trust Securities Certificates, Series 2005-2. It was created and sold in 2005 by Wachovia Securities, then part of Wachovia Bank, which was renamed Wells Fargo Advisors after Wells Fargo acquired Wachovia. The bank called the securities Strats, a quasi-acronym.*
Basically the Strats were made by the following formula:
- take $25 worth of JPMorgan 5.85% trust preferred securities maturing in 2035,
- replace the 5.85% coupon with a floating coupon of 3-month Treasuries + 100bps,
- cap that floating coupon at 8% and floor it at 3%,
- sell the resulting thing for $25,
- hope for the best.
If you bought this thing – and, serious question, why would you buy this thing?** – the best didn’t happen. The worst happened, or nearly: the worst you could do, outside of default, would be to get a 3% coupon for 30 years, instead of the 5.85% coupon that you’d get by just buying the JPMorgan TRUPS directly like a human.*** And with the 30-year treasury in the 2.6%-2.7% area, that’s more or less what a Strat holder had to look forward to as of a month or two ago. Read more »
Oakland has been fighting with Goldman Sachs over an interest rate swap for a while and I’ve always thought it’s a little embarrassing to talk about. Obviously Oakland’s theory – “we entered into a bet, and we lost, so we want to pretend it never happened” – is pretty silly, but it’s like, yeah, Oakland has it rough, and Goldman has it less rough, so just give them some money, no?
Oakland is trying to get out of a Goldman-brokered interest rate swap that is costing the cash-starved city some $4 million a year. The swap, entered into 15 years ago as part of a bond sale to hedge against rising interest rates, has turned sour for Oakland now that interest rates are near zero. … Oakland is paying 5.68 percent on debt associated with the swap, even with interest rates at record lows. Getting out of the contract would cost the city $16 million in termination fees, it says; it wants Goldman to waive the termination fees. …
But at Tuesday’s protest, civic leaders said the bank had benefited from a government rescue package during the 2008 financial crisis, and now it should give a break to cities like Oakland.
This is not a way to run a railroad, of course: Why Oakland? Why Goldman? Maybe AIG could give Oakland some of its bailout money? It got more than Goldman did, after all.
To really buy into Oakland’s case you have to think that this swap deal was somehow unfair when it was entered into.* But it doesn’t sound like Oakland is saying that: they entered into a synthetic fixed-rate deal with Goldman in 1998, and now they’re sad that they didn’t enter into a floating-rate deal. Since rates are down since 1998, that is a sensible thing to be sad about, but it’s hardly Goldman’s fault. Oakland’s synthetic fixed-rate deal with Goldman has a rate of 5.6775% for a 23-year bond thingy; from Bloomberg it looks like the same Oakland agency issued a 15-year fixed-rate bond in December 1997 at 5.65%, and you don’t see Oakland complaining to those bondholders just because rates subsequently went down.
Still, Oakland’s city council seem to be the last people who could figure out if this swap is unfair, so maybe someone should do it for them. (HINT: lawyers?) One place to start would be Oakland’s disclosure of the swap: Read more »