(Bloomberg Opinion) -- Hovnanian.
The Wall Street giants had taken opposite sides of a bet on bonds issued by home builder Hovnanian Enterprises Inc. The trades, engineered by Blackstone’s GSO Capital Partners LP, involved the home builder intentionally skipping a small interest payment earlier this month in exchange for an attractive financing package from the private-equity house.
Blackstone had bought insurance against a default, which would allow it to make money from the skipped interest payment. It bought this insurance, through what are known as credit-default swaps, from Goldman and others. This put Goldman at risk of losing money.
Goldman and Blackstone last week effectively zeroed out the trade between them, with Blackstone agreeing to assume Goldman’s position, people familiar with the matter said. Goldman is now off the hook for a payout that could have run tens of millions of dollars, and Blackstone reduces its exposure to a wager that has become increasingly fraught.
We have discussed this trade a bunch of times, and nothing in that discussion is really changed by this news. GSO still owns a bunch of CDS and still wants to get paid, other CDS holders stand to get a windfall from GSO’s cleverness, and a bunch of CDS sellers are still on the hook, some of whom are suing. The trade is still running; it’s just that Goldman is now out of it (at, one assumes, a loss) and GSO has taken some risk off the table (at, one assumes, a profit).
Still it is fun to imagine that GSO was the only CDS buyer and Goldman was the only seller. Goldman bet on Hovnanian’s credit, GSO bet against it, its credit was more or less fine—but GSO found a way to engineer a trivial default, and then further to engineer a ridiculously high payout after that trivial default. The proper reaction for Goldman in that situation, I have asserted, would be “envy and admiration and possibly tweaking future CDS documentation.” You tip your hat, you say “well played sir,” you hand over the money, and you learn from the experience. And if the loser does take that gentlemanly view of the matter, there is no need to, you know, do all the tedious stuff. Don’t make Hovnanian actually default on some debt to itself, don’t go ask the International Swaps and Derivatives Association for a ruling that CDS has been triggered, don’t have an auction to set the clearing price of Hovnanian bonds to find a settlement price of the CDS. Just acknowledge that that is the endgame, and pay up. The CDS trades at prices reflecting the expectation that this thing will happen. Back before GSO dreamed it up, that expectation was zero, and the CDS was cheap, and GSO bought it from Goldman for cheap. Now that GSO has come tantalizingly close to pulling it off, that expectation is high (though not as high as it was a few months ago, as counterparties and regulators and pontiffs make worrying noises about stopping this trade), and the CDS is expensive, and Goldman should have to buy it back from Blackstone for a lot of money. You can settle everything based on expectation, without waiting for it to boringly play out.
By the way there’s something else that GSO gets out of closing out its trade with Goldman. The basic trick of GSO’s trade is that Hovnanian has created a weird bond that will be cheapest to deliver in the auction to set the payout for CDS; that bond is trading at about 40 cents on the dollar, which should lead to a payout of 60 cents (100 minus 40) for every dollar of CDS notional amount. But ever since it was announced, there have been rumors that CDS sellers might somehow game the settlement auction to reduce the CDS payout. The head of Solus Alternative Asset Management, another CDS seller, actually said on Bloomberg Television that he might do that. It seems implausible to me that the CDS sellers could manipulate the auction here in a way that would actually help them (or hurt GSO) much; sure, they could bid up the prices of Hovnanian’s weird new bonds, but that would basically mean buying them from GSO at hugely inflated prices, and I suspect that most of what they’d gain on the CDS they’d lose on the bonds. Still CDS auction mechanics are complicated and it is not outside the realm of possibility that some CDS seller could find a way to squeeze GSO’s profit. And if anyone could, it’s probably Goldman. (Disclosure: I used to work there.) So if you have Goldman on the other side, and a tricky auction coming up, why not try to get them out of the picture?
Oh Deutsche Bank.
Look: A thing that Deutsche Bank AG does, from time to time, is accidentally send counterparties wires for tens of billions of euros that it didn’t mean to send them. It usually gets the money back. It is not that big a deal, just something that happens occasionally between banks:
A 28 billion-euro ($35 billion) payments error at Deutsche Bank AG in March wasn’t the first such blunder to befall the lender.
In March 2014, the German bank mistakenly sent 21 billion euros to Macquarie Group Ltd. as collateral for an over-the-counter derivatives trade, according to a person familiar with the matter who declined to be identified. That incident led directly to the introduction of fail-safes, though these didn’t catch the latest gaffe, the person said. … In both cases, the errant transfers were quickly spotted and the money returned, with no financial harm done.
I dunno. On the one hand, it is emphatically the province and duty of banks to know where the money is. If you keep accidentally misplacing tens of billions of euros then there is a real sense in which maybe you are not cut out to be a bank.
On the other hand, the system to know where the money is comes with lots of backup mechanisms and redundant defenses, and one of the last lines of defense is people not being jerks about stuff like this. If Deutsche Bank accidentally wired me 21 billion euros, I’d probably be like “what 19 billion euros?” but in practice they are wiring these random billions of euros to other institutional counterparties who extend them the professional courtesy of just giving the money back. Obviously they should build some better fail-safes. It is less obvious that we need to be systemically worried about this. But obviously we should make fun of it a lot.
A point for RMTI-A.
We talked yesterday about the mysterious doings at Rockwell Medical Inc., where the universe has split into two alternate realities, in one of which (which I called RMTI-A) the board of directors has fired the chief executive officer, and in the other one (which I called RMTI-B) it absolutely has not, and in fact the directors are themselves in trouble for doing some unspecified bad things. Both sides raced to file dueling 8-Ks explaining their side of the story, leaving investors to try to figure out who is really in charge, the CEO or the board. But why limit yourself to that list? Lots of people have some claim to control a public company. The shareholders, for instance, are often referred to as the “owners” of the company; surely they get some say? Especially big shareholders who have waged successful proxy fights to get more control?
Based on the public information available to us, we fully support the decision made by Rockwell’s Board of Directors (the “Board”) to terminate Mr. Chioini from his positions as the Company's President and Chief Executive Officer. In light of Chief Financial Officer Thomas Klema’s role in assisting Mr. Chioini in making the unauthorized filing in which Mr. Chioini seemingly attempted to “un-fire” himself, we also support the termination of Mr. Klema’s positions with the Company.
Sure that seems reasonable. But it goes on:
Richmond Brothers launched a proxy contest at the 2017 annual meeting of shareholders (the “2017 Annual Meeting”) because we believed that there was a desperate need for accountability at Rockwell after year’s of underperformance under Mr. Chioini’s leadership. Despite the successful election of our nominee, Mark Ravich, at the 2017 Annual Meeting, we were resigned to the fact that additional change was warranted after learning that Mr. Ravich had largely been shut-out of the boardroom and his requests for materials and access to the Company’s personnel were repeatedly denied.
Hey that’s great stuff. Before Rockwell’s board fired the CEO and he said no, Rockwell’s shareholders elected a new director and the board “largely” said no. Are there … are there three Rockwells? The shareholders earnestly elect a director whom the other directors blithely ignore, the directors earnestly fire the CEO which he blithely ignores, and the CEO just goes and does his thing. Whatever your theory of corporate governance might be, you can find it reflected—and refuted—at Rockwell. Maybe no rules apply there at all. I tell you what, if you work at Rockwell and are fired for stealing office supplies, you should probably announce that you have concluded that the governance requirements for firing you were not met and that you’re going to keep showing up at work.
What do words mean.
If you work as an interest-rates trader, and you get a call from one of your colleagues on a recorded line, and you say “I may as well manipulate this rate,” and then you buy a lot of bills and the rate goes down, and you get charged with manipulating the rate, and they play that tape at your trial, then people are going to conclude that you manipulated that rate. Because, you know. You said it. And then you did it.
If on the other hand you get that call and you say “I may as well just accept this rate, whatever it is, there’s nothing I can do about it,” and then you buy a lot of bills and the rate goes down, and you get charged with manipulating the rate, and they play that tape at your trial, then … well, people might be a bit confused. You said you weren’t going to manipulate it. Then you … I don’t know, you did some stuff, there could be lots of explanations for why you did all that buying. But you said it wasn’t manipulation, anyway. The tape helps you.
But you could say other words! Here’s what Westpac debt trader Colin “The Rat” Roden said on a recorded call about the Australian bank bill swap rate, which he was accused of manipulating:
"I knew it was completely wrong, like I knew it was completely wrong but I thought f--- it, I may as well f--- it," he said. "We've got so much money on it, we just had to do it right. Just had to be done."
The conversation was one of the most sensational in the trial because it seemed to be an acknowledgement that the traders knew they were moving prices. Westpac's lawyers tried to convince the judge that the meaning had been misconstrued by ASIC.
They argued that, when Mr Roden said "f--- it, I may as well f--- it", he meant it was prudent to limit the bank's exposure to a change in official interest rates that day.
It is a flexible word. What did it mean? The judge in the case, Justice Jonathan Beach, addressed the question with gusto:
"It is contended that his use in this sentence, twice, of 'f--- it' was not as an active verb but rather as a statement that he had 'no option' but to hedge his exposure to the RBA decision by reducing his risk position," Justice Beach wrote in Thursday's judgment.
"I disagree with Westpac's analysis. True it is that Mr Roden's use of the 'f---' word and its derivatives was rich and diverse. He had a sense for every occasion. But it seems to me that on balance the f--- word was being used here with its classic active transitivity.
"In my view the natural and ordinary meaning of the contemporaneous communications support ASIC's case that Mr Roden traded with the sole or dominant purpose of influencing the BBSW to set lower," he wrote elsewhere in the judgment.
Ah the classic active transitivity. There is quite a lot more of this:
"Clearly, the 'f---' word and its derivatives are not terms of art in the finance industry. Nevertheless, their use in otherwise polite conversation appears to have been well understood by the colourful interlocutors.
"More generally, the language games used by the participants, albeit not quite as attractive as the philosophical description given by Ludwig Wittgenstein, should be seen for what they are.
"They are frank discussions. They are designed to communicate information quickly and without the usual social niceties. They proceed on an unstated foundation of concepts and strategies well understood.
"To state the obvious is to be avoided. Robustness and directness are prized. That is the context in which the participants' communications must be analysed."
I don’t know, if you were prizing directness, you might directly say “I may as well manipulate it,” or “gun” or “smash” or “rip” or some other monosyllabic quasi-synonym. The actual word used here is … indirect? “Colorful,” as one says—meaning sweary—but indirect. Which makes sense: Roden wasn’t giving his colleague instructions to manipulate (or whatever) the rate; he was just telling a tiny war story about what he had already done. His goal was not to communicate actionable information as efficiently as possible; his goal was to convey his feelings, to give her a sense of his state of mind. You can dissect his language clinically in a court of law after the fact, but the language, and the state of mind, was not clinical. He was having a big day; a lot of money was on the line; he was excited. He wasn’t saying he wanted to manipulate the rate. He was saying he wanted to do something else to it.
Congrats Ray Dalio.
“A Spanish galleon laden with gold that sank to the bottom of the Caribbean off the coast of Colombia more than 300 years ago was found three years ago with the help of an underwater autonomous vehicle operated by the Woods Hole Oceanographic Institution, the agency disclosed for the first time” this week; the ship, the San Jose, “went down on June 8, 1708, with 600 people on board as well as a treasure of gold, silver and emeralds during a battle with British ships in the War of Spanish Succession. The treasure is worth as much as $17 billion by modern standards.” Also: The underwater autonomous vehicle that found the treasure “is owned by the Dalio Foundation.” I guess if you are a billionaire hedge-fund manager, finding billions of dollars’ worth of sunken treasure is a good hobby. I assume Ray Dalio doesn’t get to keep the treasure.
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