Pari Passu, Blobs and Fortune Cookies

(Bloomberg View) -- Pari passu.

When Argentina defaulted on its debts in 2001, some people sued to get their money, and won court judgments, which didn't help them that much. It's not like they could foreclose on Argentina. But some hedge funds -- led by NML Capital, a unit of Elliott Management Corp. -- sued under a different and cleverer theory. Argentina's defaulted bonds had a pari passu clause that said that the bonds would "at all times rank at least equally with all its other present and future unsecured and unsubordinated External Indebtedness." After the default, Argentina had done a restructuring in which it exchanged many of those bonds for new bonds, which it then serviced normally, while continuing to stiff holdout creditors who refused the restructuring and kept the old bonds. NML sued in U.S. courts, claiming that the pari passu clause banned Argentina from paying interest on the new exchange bonds without also paying off the old holdout bonds in full: By paying the exchange bonds and not paying the holdout bonds, Argentina was violating its promise that the old bonds would "rank at least equally" with the new ones.

No one in the sovereign debt world really thought that the pari passu clause meant that, but they had to deal with the awkward fact that the pari passu clause said that. The more standard interpretation was that Argentina couldn't issue bonds that explicitly said they were senior to the old bonds, but that the clause didn't restrict how Argentina actually paid the bonds. (Even though actually paying some bonds and not others is a very practical form of seniority.) But the U.S. courts, to everyone's surprise, sided with NML Capital, and Argentina couldn't make payments on its new bonds, and it was forced to default again, and everyone was very sad, and ultimately Argentina solved the problem by settling with NML and its fellow holdouts for quite a ton of money.

The whole drama left people very uneasy, because if you take the pari passu clause as literally as the courts seemed to, it meant that sovereign debtors could never restructure their debts: Holdouts like NML Capital could always block payments on the restructured debts unless they got paid off in full. The courts were careful to say that they weren't reading the pari passu clause quite so broadly, and that their decisions were based on Argentina's unusually contentious conduct, which included doing things like passing laws explicitly saying that the old bonds could never be paid off -- which does seem a bit like facially subordinating them. But there was still a lot of uncertainty, and sovereign-debt lawyers advised issuers to write narrower pari passu clauses (and add collective-action clauses) to avoid the problem. But the problem remains in old bonds with the old clauses. 

This week, though, another U.S. district judge in New York solved it a bit, holding that Argentina/NML really was an unusual dispute and most pari passu cases won't go that way. Coincidentally this case involved some bonds issued by the Province of Mendoza in Argentina, but Mendoza, unlike Argentina, was not the sort of "truly extraordinary case" covered by NML:

In NML Capital, the court found that Argentina violated the pari passu clause of the FAA Bonds because the President's declaration of "a 'temporary moratorium' on principal and interest payments on more than $80 billion of its public external debt including the FAA Bonds" and the Argentine legislature's enactment of the Lock Law and Lock Law Suspension were extraordinary acts undertaken to "subordinat[e] the[] FAA Bonds to the Exchange Bonds and lower[] the ranking of the[] FAA Bonds below the Exchange Bonds." 

However, the Court went to great lengths to note that this was a truly extraordinary case that would not likely apply to many cases involving pari passu clauses in the future. 

(Citations omitted.) In the Mendoza case, on the other hand, the only claimed violation of pari passu was "that the Province has paid principal and interest on other bonds," which "is insufficient to state a claim of breach of pari passu." That is not exactly a new interpretation of pari passu -- it's what the courts said in NML Capital, too -- but this court clearly meant it, and declined to block payments on Mendoza's new bonds.

Elsewhere in sovereign debt troubles, here is Anna Gelpern on analogies for Venezuela. And: "The Scandalous Persecution of a Greek Whistle-Blower."

Should index funds be illegal?

Here's Paul Singer of Elliott Management Corp.:

“Passive investing is in danger of devouring capitalism,” Singer wrote in his firm’s second-quarter letter dated July 27. “What may have been a clever idea in its infancy has grown into a blob which is destructive to the growth-creating and consensus-building prospects of free market capitalism.”

I suppose that some people might question how growth-creating and consensus-building it was when Argentina was kept out of international markets for years until it ponied up billions of much-needed dollars to pay Singer's NML Capital 369 cents on the dollar on long-defaulted bonds that NML had bought for pennies on the dollar. That is the thing about financial markets: Nobody is exactly curing cancer or building cars on the assembly line. Everyone is kind of shuffling papers around to enhance economic efficiency, and it is sometimes hard for outsiders to see where the efficiency comes from. From the wrong perspective, everyone's efficiency-enhancing activities -- whether "vulture" investing or index investing -- can look uncomfortably like freeloading, or rent-seeking, or whatever. 

Elsewhere in investor letters, here is Jeremy Grantham in GMO LLC's letter:

I have in general been over-intellectualizing the working of the market for a few decades. I have had too strong a belief that investors would at least be influenced by past data in a sensible way. The market, however, appears not to care at all about the past or to learn much from it. This model for sure seems to say that for 92 years, at least, the market has with remarkable consistency been a coincident indicator of superficially appealing variables that in a strict economic sense have been inappropriate, and that have caused spectacular and unnecessary market volatility. The model is apparently a reflection of human nature and, of all factors influencing the market, human nature, as economically inefficient and unsophisticated it may be, seems the least likely to change.

That is not exactly a ringing endorsement of the market, or of human nature. It's enough to make you want to index.

Fortune cookie investing strategy.

Umm, Walt Hickey analyzed the "lucky numbers" on the back of fortune-cookie fortunes, and:

I took all the lucky numbers from the fortunes and compared them to the Powerball numbers stretching from Nov. 1, 1997, to May 27, 2017, and calculated what the winnings would be if a degenerate gambler bought one Powerball ticket for every single one of the allegedly lucky number combinations over all 2,043 drawings. Such an individual — buying one ticket for each batch of numbers, including repeats — would make $4.4 million on $4.2 million in ticket purchases. The expected value of that investment using “unlucky” randomized digits and assuming an average jackpot at each drawing? $1.7 million in winnings on $4.2 million in ticket purchases, based on multiplying the current probabilities of each event by the current prizes for each event across 2,043 drawings.

It would appear that the lucky numbers are legit lucky.

"Obviously, this is weird as hell," writes Hickey, and I am not sure that the results would hold up to rigorous analysis, but what does it mean for your investments? Should you just go long Powerball tickets based on fortune cookies? Maybe? (Not investing advice!)

We have talked a few times before about data mining and legibility in quantitative investing: If your algorithm spots a profitable pattern in the data, how do you know if the pattern reflects a real underlying fact about how the world works, or whether it is just random noise? Classically, one answer is that if there is some intuitive economic or behavioral explanation for the pattern, then it is more likely to be real than if it is just an unexplained statistical correlation. But as neural networks become more complex, it becomes more likely that they will spot real patterns whose explanation eludes human understanding: If you build an algorithm that is smarter than you are, who are you to second-guess its results just because you don't understand them? 

More importantly: Isn't "superstition" itself an explanation that is understandable, at some level, to humans? We talked a little while ago about an investor who said "I do want to invest in lucky people -- that’s better than investing with unlucky people." My suspicion is that a preference for luck is more widespread than you'd expect in investing, that even if you could conclusively demonstrate that a fund's stellar returns were due to luck rather than skill, some people would still want to invest in that fund because, hey, better to invest in a lucky fund than an unlucky one. Well, what about investing in lucky numbers? 

Anyway this is all by way of saying that if your machine-learning investing algorithm comes to you and says "hey I ordered Chinese food last night and today I am going to trade based on what the fortune cookie told me," would you let it? What if it showed you a convincing backtest?

Elsewhere, Andrew Hall, "who gained wide notice for fighting over a $100 million payout from his former employer Citigroup Inc. during the depths of the financial crisis, confirmed Thursday that he is closing the main fund at the firm he founded, Astenbeck Capital Management LLC":

Mr. Hall, 66 years old, is known for making big, long-term bets on rising oil prices, a strategy that worked well when commodities were soaring but has fared poorly as prices deteriorated in the past three years. His bullish stance on oil ran headlong into the shale revolution, which in the past decade defied predictions that the world would soon run out of easily accessible crude.

Poor Carl Icahn.

It was always a little awkward that Carl Icahn was simultaneously:

  1. The majority owner of CVR Energy Inc., a refining company that spends millions of dollars a year on renewable-fuel credits (called RINs, "renewable identification numbers") to meet U.S. regulatory requirements;
  2. A quasi-official "special adviser" to Donald Trump on regulatory matters, with a particular focus on RINs policy, and an even more particular focus on shifting the RINs obligation from refiners (like CVR) to fuel blenders; and
  3. Actively trading in the RINs market while discussing RINs policy with the administration.

It just looked like a sordid mix of special-interests lobbying and quasi-insider trading. The defense was pretty much, what, Icahn was just a private citizen expressing his opinion to the government: There's nothing unseemly about his advocating for policies that he thought were good, or about his trading on his own opinions, and while he expressed those opinions to the government, he had no formal power to influence policy and no inside information about what the government would do.

That defense did not perhaps sound wholly convincing, but it turned out to be completely right!

The Trump administration plans to reject a proposal that would let oil refiners off the hook for complying with the federal ethanol mandate, a senior administration official told POLITICO, dashing the hopes of billionaire Carl Icahn and a slew of independent companies.

Oops! "Icahn's CVR lost $19 million in the second quarter of this year after guessing incorrectly that the administration would make the policy change." 


Usually when a debtor doesn't have enough money to pay off its debts, it "restructures" them, a euphemism that means agreeing with its creditors to give them less money than it promised by changing structural features of the debt: reducing the principal, often, but also perhaps reducing the interest or lengthening the maturity, and perhaps increasing seniority or security to compensate. Dana Gas PJSC, on the other hand, seems to be contemplating a far more radical restructuring that would change a really important feature of its debt: who owes money to whom.

The Sharjah-based gas producer says that in one scenario the court battle with holders of the Islamic securities, or sukuk, may see it having to return less than 10 percent of the amount it borrowed, according to a person familiar with Dana Gas’s own analysis. In a second scenario, it believes creditors may have to pay it as much as $150 million, the person said, adding that the case may last more than 10 years.

Islamic finance forbids interest-bearing debt, and so sukuk are structured with equity-like features, even though they are meant and marketed to be debt-like. Dana Gas borrowed $700 million, has paid $635 million in interest (profit payments) so far, and has not generated that much in profits, which means that the holders may have been overpaid and may have to give some money back. That is, to say the least, a disputed interpretation of the situation, but it would be a worrying precedent. Traditionally, if you buy most securities, the worst you can do is lose the entire amount of your investment. Owing even more is rough.

Blockchain blockchain blockchain.

Sure fine sure:

Dentacoin is the first Blockchain concept designed for the Global Dental Industry. The Dentacoin ERC20 token is configured to be used globally by all individuals. 

Dentacoin aims at improving dental care worldwide and making it affordable through utilizing the Blockchain advantages. We believe that empowering patients to become an active part in the industry development process is the key to shaping the future of dental care.

I am becoming increasingly convinced of my thesis that the story of cryptocurrency is not one of re-learning all of the lessons of modern capitalism, but of un-learning them. Here in the 21st century, I assumed that the purpose of currency was to intermediate between different goods and services, to make them fungible and commensurable, so that people didn't constantly have to negotiate the exchange rate between yams and goats, or between goats and dentistry. Who decided that the problem with dentistry is that it needs its own currency? In 50 years, I will reminisce to my grandkids about the olden times, when there was a single currency that you used to pay for food and rent and cloud storage and heroin and dentistry. "Wow, grandpa," they will say, "that sounds ... actually really convenient?" 

People are worried about unicorns.

People are worried that Uber Technologies Inc. bought more than 1,000 recalled Hondas in Singapore and leased them to drivers without fixing the safety problems that led to the recall, which, yes, seems worrying, particularly if you were the Uber driver whose car caught fire. The internal debate at Uber on this question -- roughly, "should we pull these recalled cars off the road or not sweat it?" -- seems particularly Uber-y. "There is clearly a large safety/responsible actor/brand integrity/PR issue," said an internal report, on the one hand. On the other hand, taking the cars out of service would be expensive and embarrassing, argued Uber's Singapore general manager. Another manager argued that leaving the cars on the road "feels like low risk": "The recall happened nine months ago," with no exploding cars yet, so how urgent could it be? Nine months! If you've had no problems for nine months, then you're in the clear! The whole future of the world can be predicted by historical experience over the last nine months! It's possible that having a startup's fruit-fly-like historical memory is not conducive to good risk management.

Elsewhere: "Inflated valuations hurt startup employees the most."

Things happen.

London Whale’ Has a New Target: J.P. Morgan’s Top Brass. Avon Chief Executive to Resign in Latest Win for Activist Investors. Blackstone, CVC Clinch Paysafe for $3.9 Billion in Latest Online-Payments Deal. LSE Chief Backs Listing Rule Changes. "A self-taught computer-security researcher credited with stopping a devastating cyberattack that crippled British hospitals in May was arrested on charges that he created malware used to hack banking systems in Canada and Europe." China blacklists nine HSBC mutual funds for IPO violations. J. Christopher Giancarlo was confirmed as Chairman of the CFTC. Trump Praises the Stock Market at 22,000 That He Said Was a Bubble at 18,000. ETFs Are Taking Flight From NYSE Platform. Paul Murphy calls DryShips a "specialist printer of share certificates, with a Greek shipping business attached." Micronational rulers. The Indonesian island that was traded for Manhattan. Boeing Dreamliner draws a giant outline of itself over the U.S. 

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Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.

To contact the author of this story: Matt Levine at

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