Votes, Mortgages and Mackerel

(Bloomberg View) -- Italy.

The recurring story of Western democracies in 2016 has been one of elites asking the people to weigh in on subtle and complex structural issues in the form of a wildly oversimplified binary question, and the people giving the "wrong" answer, and then everyone trying to figure out what that means. Brexit means Brexit, but is it a hard Brexit or a soft Brexit or what? Donald Trump will be the president, but will he be populist Trump or Secret Trump or Wall Street Trump or what?

And this weekend Italy held a constitutional referendum to reduce bicameralism in its legislature and centralize some government functions in Rome, and the people voted no, and so is that going to be a ... hard bicameralism? Or what? I don't know; as in most of these things, the symbolism of the vote seems almost unrelated to its practical consequences. Or, well, one practical consequence seems to have mattered: Prime Minister Matteo Renzi said he would resign if the referendum failed, and it did, so he did

“The Italy vote was mainly a vote about Renzi; it wasn’t a populist vote against the mainstream, it wasn’t a vote against the euro,” Wolfango Piccoli, the co-president of Teneo Intelligence in London, said on Bloomberg Television.

"In Italian politics, no one ever wins," said Renzi, and he could have left out the "Italian." But while the voters rejected Renzi, it's not clear what they chose instead; Alberto Mingardi writes that "a big problem now is that a 'no' side just doesn't exist." As for economic consequences, it is still early days. European stocks were up, as "investors had widely anticipated the result of Sunday’s referendum and subsequent resignation of Prime Minister Matteo Renzi, and consequently sold Italian equities, bonds and the euro in the weeks leading up to the vote." The euro also rebounded quickly. Monte dei Paschi di Siena's recapitalization plan is in trouble, though, and it's not great news for any Italian banks really.

Fannie and Freddie.

Here is a syllogism:

  1. Fannie Mae and Freddie Mac give all their profits to the government, instead of retaining them to build capital.
  2. If they run into trouble, because they have no capital, the government may have to give some of those profits back to them.
  3. Therefore the government should give all of the profits back to them now.

I read this argument about once a week, and it makes me run around screaming and punching walls. How could anyone believe it? Taking all the money now and maybe having to give back some of it later seems strictly better, as a matter of arithmetic, than giving all of it away now. I say this all the time, but I cannot get anyone to believe me. It is one of my greatest professional frustrations. Anyway here is Gretchen Morgenson:

A first step in ensuring that Fannie and Freddie are safe would be to let them rebuild their capital. Since the government began taking all their profits in 2012, it has directed the companies to operate on a small and shrinking sliver of capital. Under the current arrangement, the companies will have zero capital at the end of 2018.

This is clearly untenable and unsafe for taxpayers, who would again be on the hook if Fannie and Freddie began losing money.

An easy way to let them rebuild capital would be to end the quarterly transfer of all their profits to the Treasury.

Right but see ... oh, never mind.

Elsewhere, Bill Ackman is down only about 10 percent this year, instead of 20 percent, because of the Fannie and Freddie rally.


Poor Charlie Shrem, the bitcoin-exchange operator who was sent to prison for selling bitcoins for drug trafficking on Silk Road, learned exactly the lesson you'd expect from his experience:

He started to think about the value of digitizing the prison economy and putting it on the blockchain.

If there was a shared, distributed ledger among say a dozen inmates, everyone would have a real-time record of all transactions that occurred in the prison. All members would have to verify and validate a transaction to make sure it was legitimate before taking place.

"Everyone has a financial incentive to make sure the system maintains its integrity," said Shrem.

Yes, it's easy! If you want to buy something from me, instead of just handing me a can of mackerel (the main currency in federal prison), you can just instruct a dozen other people to transfer one mackcoin from your account to mine, and they can update their decentralized ledgers. Which they keep on paper. In their cells. Obviously the transaction will be delayed if the cells are, you know, locked. But assuming you can move freely around the federal prison -- why not? -- to discuss the transaction with a dozen other inmates, the only issue that remains is for them to cryptographically verify the transaction. Instead of lifting weights out in the yard, the new generation of inmates will spend their time factoring large numbers on scraps of toilet paper.

I kid, but eventually the prison system really will build up a critical mass of bitcoin drug dealers and money launderers (and Ethereum pyramid schemers and hackers), and they can build their own prison economy based around the blockchain and use it to steal from one another.

Loss enhancement.

We talked a couple of weeks ago about my pet theory that there really isn't any white-collar law:

Basically the illegal thing is "fraud," and all sorts of very different actions -- insider trading, pyramid schemes, bribery, lying to investors to raise money, etc. -- are all analyzed under that very generic term.

You could imagine some sort of legislative scaling of culpability, where intentionally lying to steal money for your personal use is punished more harshly than, say, unknowingly trading on a third-hand insider stock tip, or following generally accepted accounting principles and the advice of your auditors in a way that nonetheless paints a misleading picture of your company's financial position, or whatever. You'd make a list of which actions and intentions and harms are morally bad, and which are less bad, and punish the worse ones more.

Instead it is only a small exaggeration to say that there is just one big lumpy crime -- fraud -- and that punishments are scaled by dollar amounts under the U.S. Sentencing Guidelines. So there's basic fraud, which will generally get you probation; there's million-dollar fraud, which might get you three years in prison; and there's billion-dollar fraud, which might get you 20 years. And yet billion-dollar fraud is less likely to be venal and intentional than million-dollar fraud. You can just go steal a million dollars. It's hard to steal a billion dollars, though Bernie Madoff did it. Most of the billion-dollar stuff is squishy, executives bending the rules to keep their companies afloat rather than thieves directly lying to pocket money for themselves. 

Anyway here are Douglas Berman, and Stephanie Teplin and Harry Sandick, on a recent federal appellate court decision (in a food-stamp fraud case) finding "that the outsize effect of the loss amount enhancement on the defendant’s base offense level—a sentencing scheme for fraud that is 'unknown to other sentencing systems'—required the district court to reconsider whether a non-Guidelines sentence was warranted." That is: The court realized that sentencing white-collar crimes based mainly on dollar amounts is weird, and "unknown to other sentencing systems," and it suggested that trial courts shouldn't feel themselves too bound by those dollar-amount guidelines. 

Elsewhere in white-collar crime, United Continental Holdings, Inc., agreed to pay $2.4 million to settle a Securities and Exchange Commission case over the time that it bribed the chairman of the Port Authority of New York and New Jersey by reinstating a money-losing flight to South Carolina that he liked to take. What's the moral culpability of that, I wonder. The SEC got United for failing "to make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer." I feel like that does not accurately and fairly reflect what went on here.

Information and shadow banking.

Here are a blog post and related paper by Kathryn Judge of Columbia Law School about runs in the shadow banking system. Judge contrasts the regulation of capital markets, which rely on disclosure and expect investors to understand what they're buying, and the regulation of banks, which issue information-insensitive money claims (deposits, etc.) but which are prudentially regulated to make sure those claims are good. In capital markets, investors know what they're buying; in banks, they don't, but the banks and regulators do. The issue with shadow banking is that no one knows what the investors are buying:

In contrast, the short-term debt issued in the shadow banking system takes forms like asset-backed commercial paper (ABCP).  The value of ABCP depends not only on the value of the underlying loans, but also on the terms of the ABCP, the terms of the securitization structures that transformed the underlying loans into the the asset-backed securities packaged into that ABCP conduit, and other factors.  Moreover, in contrast to the banking system, there is no prudential oversight of the institutions issuing the short-term debt.  As a result, there is often no party, private or public, with the information required to assess the implications of bad news on the creditworthiness of outstanding ABCP.  In the face of bad news, money claimants still have the capacity and incentive to run. But, in contrast to banks, no one has the information that might stop them.  Information gaps thus operate alongside information asymmetries and coordination challenges to exacerbate the fragility of the shadow banking system.

There is a story of the 2008 financial crisis that is all about information asymmetry: Banks made loans that they knew were bad, and packaged and sold them to investors, and the investors were deceived by the evil banks. But that story can't be entirely right; after all, the banks ended up holding a lot of exposure to those bad loans. (If they'd sold them all, it wouldn't have been a crisis for them!) A story of information gaps, in which the structure of the system results in no one having all the necessary information, seems to fit the facts better.

Elsewhere in shadow banking, "Investors Tiptoed Back Into Prime Money-Market Funds, Then Left." And elsewhere in financial crisis retrospection, here are remarks on regulation since the crisis from William Dudley and Daniel Tarullo of the Federal Reserve. 

Oh no.

You know what E.B. White said about the frog, but there is something particularly embarrassing about reading how Wall Street research analysts inject personality into their notes:

David Woo at Bank of America, for instance, likened the dollar-yuan exchange rate to a bad marriage in one report. Societe Generale SA’s Kit Juckes has been known to weave Bob Dylan lyrics and Latin proverbs into his notes. And at Credit Suisse Group AG, Shahab Jalinoos dropped rhymes by rapper Notorious B.I.G. into analysis of the Bank of Japan’s monetary policy.

I am sure that in each case you had to be there. Well not the Biggie lyrics, you can probably guess those. "It’s like the more money we come across/The more problems we see," Jalinoos quoted, about quantitative easing. That's a pretty convenient one. The "money" is right there in the lyric, and it is ... quantitative. Next analysts will be quoting Eagles lyrics about how "you can check out any time you like, but you can never leave." (That one's great if you're worried about bond market liquidity!) Analysts who prefer novels might notice that if they are writing about two things, Charles Dickens has already written a book about two things, and so they can freshen up their work and knowingly wink at his title by calling their note "A Tale of Two Cross-Currency Bases" or whatever. There are many other similar literary options, which I have collected here, and which are freely available to any analyst -- or journalist -- who'd like to use them. 

People are worried about unicorns.

This is from a while ago, but why not: "Unicorns are Overrated. Triple Crowns are Better." And those in Silicon Valley who are worried about Peter Thiel may not be reassured by his appearance at Robert Mercer's "Villains and Heroes" costume party:

Peter Thiel, the billionaire libertarian tech entrepreneur and founder of Clarium Capital, sported one of the evening’s most talked-about costumes. He dressed as the professional wrestler Hulk Hogan, whose real name is Terry Gene Bollea, according to two guests who saw him there. Earlier this year, Thiel, who nursed a grudge against Gawker Media, secretly financed Bollea’s successful invasion-of-privacy lawsuit against the company, and forced it into bankruptcy. 

Donald Trump was also there: "Asked what his costume was, he pointed at himself and mouthed 'me.'"

People are worried about stock buybacks.

Donald Trump is going to get all the multinational companies to bring their money back to the U.S., where they'll use it for stock buybacks:

Corporate share buybacks on Wall Street, a major source of demand for US equities since the financial crisis, are expected to set a new record thanks to a boost from the incoming Trump administration’s planned tax overhaul.

If you worry about stock buybacks, you probably have some hierarchy of what companies are supposed to use money for. Paying wages, capital expenditures, research and development, etc., are all probably pretty high on the list, and stock buybacks are quite low. But "leaving money in cash offshore to avoid paying taxes" is also, I would bet, pretty low on the list. So even if you're a buyback worrier, you might be happy about this particular coming increase in buybacks.

People are worried about bond market liquidity.

Panellists at the 2016 Global Capital Markets Conference in London discussed whether the fixed income market is in a better place now than at the time of the financial crisis in 2008.

James Wallin, senior vice president of fixed income at Alliance Bernstein, explained: “The depth of the bond market is not there anymore and we’ve seen mini-stress since the crisis and we should not feel good about what we’ve seen.”

“We need to replace that pool of liquidity that we lost and we have not solved this problem. With the absence of a safety valve or some kind of relief, a huge stress event could have dire consequences.”

Global bonds lost $1.7 trillion of value last month, with the Bloomberg Barclays Global Aggregate Total Return Index showing its worst results since its inception in 1990. And that's "mini-stress"! The real stress -- the one that will cause the bond-market liquidity worries to come true -- is forever in the future.

Things happen.

Dakota Access Oil Pipeline in New Setback as U.S. Permit Denied. Morgan Stanley Toughens Some Pay Hurdles for Brokers. R.B.S. Reaches Agreement to Settle Rights Issue Litigation. Small Insurers’ Big Collapse Reflects Deep Industry Woes. Russian Central Bank: Hackers Stole $31 Million From Correspondent Accounts. Credit Restrictions Cost Home Buyers ‘Deal of a Lifetime.’ SoftBank’s Masayoshi Son Chases First Place With Tech Deals. A slideshow of Wall Street innovation labs. Finance Twitter reading list. Fake U.S. embassy. Bull leaping. Kangaroo punching. Horse pilates

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To contact the author of this story: Matt Levine at