STCMA – 27th April 2021

I read this strongly worded article in FT on the ‘bogus’ claims (as per the FT authors) of Bitcoin being environmentally not-unfriendly. Clearly, as the FT authors pointed out, the folks who wrote such a report had a natural conflict of interest. They were heavily invested in Bitcoin. Bruno Maçães countered it here. He has a point that, over time, the energy consumption of Bitcoin would or could come down. Two, Bitcoin farms can be located near sources of renewable energy that have surplus energy to sell. All that is fair.

He also highlights the case of petrodollars. He is right. Petrodollars were earned by extracting and burning fossil fuels and they were re-invested in US assets, including Treasuries. Of course, that was that. Now, the world has changed. When the West changes its ways, it wants others to change their ways too. But, it does not acknowledge that it has been guilty of similar conduct and has profited from it, while it wants to shut others’ access to such profits now. Some see it as hypocritical, arbitrary and self-serving. There is something to be said for it.

Stephen Roach’ mea culpa does not come across as inauthentic or as disguised self-praise. He is writing about how he got his forecast of a double-dip recession in 2021 for America wrong. Of course, he proudly recalls some of the big calls he made. Nothing wrong with that.

On the topic of the booming consumer, here is the latest global consumer confidence dipstick by Ipsos Mori. Consumer confidence is booming. For macroeconomists, that is a boost to aggregate demand. 

You have to believe these stories. Bubbles are not inferred from valuations alone. But, from such stories as well. It is a bubble psychology that matters. Or, for that matter, the blog post by Matt Levine – I had covered it as a separate post a short while ago – on the business model of helping businesses to be set up to to defraud individual investors – these are tell-tale signs of an euphoric market.

On market psychology, check out Robin Wigglesworth’s long article on the bubble in US stocks vs. not-so-much in UK stocks. The Shiller P/E for US stocks at 37 times is not just shy of the peak reached during the dotcom era of 1996-2000. Tobias Levkovich of the Citigroup also has a cautionary tale to tell about investing at current levels. 

It is always interesting to read that investors cannot see obvious triggers for a correction, let alone a crash. Tobias mentions that their clients tell him that. But, what they don’t seem to get is that the trigger is never obvious, except in hindsight.

The header for the article leaves no one in doubt as to what NYT Editors think of the subject: ‘A global tipping point for reining in tech. has arrived.’ The article discusses the emerging thinking, regulatory actions and their successes in different parts of the world, against the technology giants. On this one, I hope NYT has got it right. 

Business model to facilitate fraud

Bloomberg Opinion: Money Stuff by Matt Levine: ‘Actually it is a 2 billion dollar Deli’ (21st April 2021)

On Friday, though, the SEC brought a case against another Israeli binary-options company, called Spot Option Ltd., that is a little different. Spot Option, according to the SEC’s complaint, is not in the business of selling binary options to retail customers. It’s allegedly in the business of selling binary-options businesses to binary-options scammers (including Banc de Binary, Bloombex, LBinary, etc.).

From the press release:

The SEC alleges that the defendants developed nearly all of the products and services necessary to offer and sell binary options through the internet, including a proprietary trading platform, and that they licensed these products and services to entities they called “white label partners,” who directly marketed the binary options. According to the complaint, Spot Option instructed its white label partners to aggressively market the binary options as a highly profitable investments for retail investors. As alleged, investors were not told that the defendants’ white label partners were the counter-parties on all investor trades, and thus profited when the investors lost money. To ensure sufficient investor losses and make the scheme profitable, Spot Option allegedly, among other tactics, instructed its partners to permit investors to withdraw only a portion of the monies the investors deposited, devised a manipulative payout structure for binary options trades, and designed its trading platform to increase the probability that investors’ trades would expire worthless. According to the complaint, the defendants’ deceptive business practices caused U.S. and foreign investors to lose a substantial portion of the money they deposited to their trading accounts. The defendants allegedly made millions of dollars as a result.

In the SEC’s telling, the binary-options business is so good and easy and lucrative that it comes in kit form: If you want to sell binary options to suckers, Spot Option will tell you how to do it, write scripts to pitch it, and give you the software to run it.

From the complaint:

Spot Option developed and provided its Partners with a turnkey package of products, software, and services that included nearly all of the tools necessary to offer and sell Spot Option’s security-based and other binary options online to anyone.

Spot Option advertised to potential Partners that its package “generates great revenues with minimal efforts” and that it would enable Partners, under their own brand names, to operate an online business selling binary options in as little as four to six weeks. Spot Option described what if offered as a “business in a package” that allowed Partners to succeed “without doing the work.” Spot Option similarly said that its package “generates great revenues with minimal efforts as most of the work is done by the Spot Option team.” Spot Option also touted to prospective Partners the profitability of the business by noting that the average investor lost 80% of their investment within five months.

Again, “the average investor lost 80% of their investment within five months” means “you get to keep at least 80% of the money you raise after five months.” The binary-options operator is not running a market-making business, matching customer buys and sells; nor is it hedging the binary options in the market for the underlying stock. It is just taking customer bets, paying out the ones that win, and keeping the ones that lose. They mostly lose.

They mostly lose because Spot Options’s software sets the terms of the bets, and it makes sure the terms include a large house edge:

Spot Option determined and structured the key terms of the binary options offered and sold through its platform. Specifically, Spot Option’s platform provided investors with a choice of: (a) several forms of binary option; (b) numerous reference assets from multiple asset classes, including securities; (c) various expirations; (d) the investment amount; and (e) whether to predict the price of the reference asset would go up (e.g., buy a “call” option) or go down (e.g., buy a “put” option). Spot Option also set the amounts investors would receive for winning trades or would forfeit for losing trades (i.e., the profit/loss ratio), sometimes with the input of the Partners.

Spot Option structured the profit/loss ratio so that on any one trade investors always risked losing more money on an incorrect prediction than they stood to gain on a correct prediction. Spot Option typically set the ratio at a 70% to 85% profit for correct predictions and a 90% to 100% loss for incorrect predictions. Defendants knew that this payout structure made it extremely difficult if not impossible for investors to trade Spot Option’s binary options profitably over time because, on average, investors only won half of their trades.

And because the model of binary options dealers is not really “options dealer” (buy and sell options, hedge in the underlying, try to minimize risk and collect a spread) but rather “Las Vegas casino” (take the other side of every bet, make sure you have a lot of edge, exploit compulsive gambling behavior), the edge could be adjusted to prevent good gamblers from winning too much:

Spot Option’s Risk Management Services allowed Spot Option, on its own initiative or as requested by the Partners, to designate investors as “low,” “medium,” or “high” risk. The risk setting was displayed to the Partners through the CRM software. When investors made too much money, Partners requested Spot to change the investor’s profile to “high risk” to make it more probable the investor’s future trades would lose money. As a Spot Option employee who worked in Risk Management explained to a Partner, changing an investor’s risk level to “high,” “should be more aggressive and reducing his profits in the soon future.”

On November 17, 2014, for example, a Spot Option Risk Management employee informed a Partner that Spot Option’s system had placed a successful trader on the highest risk setting. “We are familiar with the client, he won some consecutive EUR/USD positions on Friday morning and won them all. Our system already put him with highest risk level. Let’s hope he will keep trading.”

Or to prevent bad gamblers from losing too quickly and walking away:

Similarly, the Partners could request that an investor be placed on a low risk setting in the hopes that making profitable trades would induce reluctant investors to trade or trade more, or add additional funds to their account. For example, on July 10, 2014, an employee at a Partner asked his manager to “Please make sure he [investor] is on low risk. I feel he is loaded.” On October 13, 2014, another employee wrote, “please put [investor] on low risk until i resive [sic] more money from him.” On the same day, another employee wrote “put [investor] on low risk need to put more money tnx.” On June 26, 2015, to induce a particular investor to deposit more funds, a Partner emailed Spot Option, “I need this client off high risk because we are getting too many losses and looks bad.”

It really was a turnkey system; in addition to pricing and risk management, Spot Option allegedly wrote its partners’ marketing materials:

Spot Option supported its Partners’ solicitation efforts by providing them with scripts that endorsed high pressure sales tactics and included false statements. Among other things, Spot Option’s scripts instructed the Partners’ call center employees to tell investors that most traders earned thousands of dollars a month trading binary options. For example, a Spot Option training script provided:

“Most <Brand Name> clients produce an income of 1000s of $ / month, just from trading in their spare time on our simple, efficient, and comprehensive platform.” …

“Most of our clients activate their trading account with a small deposit of 4- 5,000$ to start learning how to trade and supplement, and in some cases replace, their income stream.”

And it worked: People put in money, did not take it out, and lost most of it.

Spot Option reports show that, for the period December 2014 through June 2016, on a monthly basis, investors across all Spot Option Partners withdrew only 18% to 25% of the total dollars that they deposited. These documents also show that the Partners’ monthly net deposits (which represented investor losses and Partner revenue), correspondingly totaled approximately 75% to 82% of investors’ total deposits. Other Spot Option reports show that for the period January 2014 through September 2017, on average, investors across all Spot Option Partners lost approximately 72% of their principal investments.

Seems like a good business to be in! Makes sense that someone would franchise it.

Why some stories do not have happy endings?

I read this well-written story in WSJ on how three school friends came to meet each other, traded stocks on the Robinhood platform, made money, joked about buying Lamborghini cars and, as you would have guessed, they lost most of it and are back to their modest and more humbler ways.  As I said before, it is a good story to read. It is sad, sobering and needed.

To be sure, seldom do these stories end with the greed working and they continue to make money all the way. It can be never that way. What would happen is what happened with the three gentlemen in this story. They will double down and lose most of it.

But, what about another ending? Where these folks know when to stop and stopped. In that happy ending, they pay off their student loans, buy a car or another apartment or do up their house, invest in a mix of safe and risky investments with the latter a small portion and go back to paying off their bills with regular earnings.

In other words, human beings not quite conquering their weaknesses or temptations but living in moderation. Or, knowing when to quit. That applies to many situations. Politicians, corporate leaders, athletes and so on. Knowing when to quit too is a rare knowledge. Knowing when to quit in investing. Rare too.

One can think of people with enormous self-belief and self-confidence. They create enterprises, institutions and achieve feats that the rest of us cannot or would shy away from, calculating the odds. But, people with enormous self-belief and self-confidence are not ‘reasonable’ people. They are so full of themselves that it is beyond reason. It works for them until it does not. The same traits become millstones. That contributes to their downfall too, eventually. Or, they meet with their comeuppance at some point. Some learn. But, many actually double down!

I remember reading Swami Ranganathananda of the Sri Ramakrishna Mutt in the 1980s, talking about the concept of ‘Raja Rishis’. People who have power, people who wield power but people who do so with a spirit of detachment to the trappings of power, including the ego that goes with it. It is not just about shying away from the material benefits of wielding power. That is relatively easier. But, tempering the self-belief with accommodation, with an ear for other perspectives, with a willingness to be questioned and challenged and so on…

Strange are the ways of God/Universe. The ever-elusive and eluding balance, completeness and equilibrium that stays….

Conflict in; cooperation out

Two interesting insights:

(1)

Several people familiar with the talks said the US team rebuffed Chinese efforts to “reset” the relationship via the creation of strategic dialogues, which was one of the Chinese goals for the first high-level meeting under the Biden administration. Towards the end of the Alaska meeting, Yang told Blinken and Sullivan that he hoped to welcome them in Beijing for more discussions.

According to people familiar with the situation, Blinken leaned across the table and said, “thank you”, which prompted a discussion on the Chinese side about whether the US was accepting the invitation. After the Chinese had conferred for some time, Yang asked Blinken what he meant by “thank you” and whether his reply meant the US negotiators were prepared to hold follow-on discussions in Beijing. “Thank you means thank you,” Blinken replied, signalling to Yang and Wang that the answer for now was “No”. [Link]

(2)

Alarms were blaring inside Wall Street’s corridors of power in the middle of last week, as executives realized they might be facing the biggest hedge fund blow-up since Long-Term Capital Management in the 1990s.

 Global investment banks, gathering in a hastily arranged call, needed a swift truce to deal with Bill Hwang’s Archegos Capital Management if they were to head off billions of dollars in losses for banks and a potential chain reaction across markets. Yet by Friday, it was everyone for themselves…. 

… Soon came the finger-pointing over who was breaking ranks, the people said. Some emerged from the talks suspicious that Credit Suisse wasn’t fully committing to freezing sales. By early Friday, rival banks were taking umbrage after hearing that Goldman planned to sell some positions, ostensibly to assist Archegos. Morgan Stanley began drawing public attention with block trades. [Link

So much for the prisoner’s dilemma!

We have seen this with vaccine distributions. Bulk of the supplies has been cornered by some ten nations. EU is restricting vaccine exports to other nations. We are moving towards ‘me first’ regardless of the high-sounding rhetoric. Watch what I do and not what I say. This is de-globalisation. It will mean the end of ‘just in time’ inventory and global supply chains, etc.

On Archegos, the important thing is the number of similar skeletons in cupboards that we have not seen yet. The dust has not fully settled on Greensill. Revelations on the role of the former British PM are just surfacing. David Cameron is an advisor to the group.

While these personal angles are more interesting to read, the systemic aspects are more important. Much of this should be laid at the doors of central banks. Their easy-money has encouraged market participants to assume risks that they know nothing about, in the end.

This gentleman gets it right:

“Since the Covid outbreak, central banks in different countries have been providing liquidity, so banks and brokers are more likely to lend more money to their wealthy clients to keep the business,” said Kenny Ng, a securities strategist at Everbright Sun Hung Kai Co. in Hong Kong. [Link]

That is why these things must be considered tips of bigger icebergs.

This is a tantrum for more drug and not less

My column in Mint on Tuesday:

Let’s end this nonsense of taper tantrums by easy-money addicts

5 min read . Updated: 22 Mar 2021, 10:36 PM IST

 
V. Anantha Nageswaran

Monetary policy must never be held captive by markets but the US has waded too far into liquidity

Between 11 March and 17 March, four major central banks held their monetary policy meetings: the European Central Bank (ECB), US Federal Reserve, Bank of Japan (BoJ) and the Bank of England (BoE). On the face of it, the most accommodative or dovish policy stance and communication emanated from the ECB. Silver goes to the US Fed, bronze to the BoE and a simple certificate goes to the BoJ. Japan’s central bank appeared (horror of horrors!) to give the impression that it was incrementally nudging policy in the direction of very slight restraint.

Words matter, but so do numbers, if not more. Ed Yardeni, an independent analyst, tracks the evolution of central bank balance sheets. In his latest analysis, dated 17 March, he does not consider the BoE as one of the major central banks, whereas he lists the People’s Bank of China (PBoC) as one. Excluding the PBoC, the annual growth rate of their balance sheets was 57.5% in February. Including the PBoC, it was 46.3%. So, China’s monetary policy stance is far more prudent than the rest’s.

There was something charmingly innocent in the press release of the US Fed after the conclusion of the two-day meeting of its Open Market Committee (FOMC). The panel would like to allow US inflation to run at an unspecified rate above 2% for an unspecified period, and yet would like to anchor public inflation expectations at 2%. One should not be surprised that American economist Larry Summers sees the US macroeconomic policy setting at its least responsible in 40 years.

Going forward, bond market maven Mohamed A. El-Erian outlines three choices for the Federal Reserve: “Trying to calm the yield concerns by signaling more purchases of securities, thereby risking yet another leg up in inflationary expectations”; “Doing nothing on forward policy guidance because yields are rising for the right economic reasons and the pickup in inflation will just be transitory, thereby risking a tantrum from a market conditioned to expect repeated policy reassurances in response to higher in volatility”; or “Signaling the potential start of a monetary policy taper given that significant fiscal expansion is in the pipeline to turbocharge a continuing recovery and substantial pent-up private demand exists, thereby risking disorder from markets always keen on ample and predictable Fed liquidity injections.”

The first is what the FOMC did in its meeting last week and what it will continue to do, because a rise in inflationary expectations is something it wants. Up to a point, that is, but much more than what the consensus opinion of economists would expect or is able to imagine. If the Fed uses bond purchases to keep nominal rates from rising in line with inflation expectations, then real yields will go even more negative. That would be a welcome development for the Fed.

In any case, the Fed may be doomed if it signals a taper of its extraordinary easing of monetary conditions. Even though that is the right thing to do from a long-run perspective, the Fed is too far down the path of leverage and liquidity to risk it. Its chairman Jerome Powell tried and abandoned it in 2018. He now simply has only one prayer: “Let the s**t not hit the fan when I am there. It will, one day. Let it be when I am gone.”

Both policymakers and markets are now in thrall to debt and liquidity. They have been captured or trapped by the debt that has been created since 2007. If they go for a ‘normal’ policy setting and normal real rates, they would be in trouble. The pain would be too acute for anyone to contemplate doing the right thing for the economy. Therefore, in general, major central banks will hope to ride out their policy choices from one meeting to the next between El Erian’s first two options.

Are bond and stock markets uneasy right now because they want a return of normal monetary policy? No, they want a reassurance that the Fed’s ‘put’ option of Alan Greenspan’s vintage is firmly in place. They don’t want just a verbal assurance, they want to see the Fed walk its talk by cranking up asset purchases quantitatively and qualitatively. Once an addict is used to a particular dosage, it ceases to provide the desired delirium after a while. The dosage has to go up. That is what we are witnessing now. Both the drug dealer and addict are locked in their respective modes of behaviour. They will not change it on their own volition. Only accidents will, and they do happen. Like Greensill.

So, let us be clear. We are currently seeing a tantrum, but it’s not for policy tapering; nor will monetary policy taper and dare provoke a bigger tantrum. This is a different kind. It is silly to think that financial markets are clamouring for sobriety and prudence among policymakers.

What it means is that capital flows into reasonably stable emerging economies from foreign jurisdictions will be ample in the coming years. Gross foreign direct investment equity inflows into India totalled $51.47 billion from April to December 2020, the highest in two decades. That it happened despite an economic contraction is noteworthy.

India is batting on a good wicket. Rash strokes must be avoided. Keep a calm head, and the runs will come. More on that in subsequent columns.

V. Anantha Nageswaran is a member of the Economic Advisory Council to the Prime Minister. These are the author’s personal views. [Link]

The highlight is mine.

… and then, there was wind

Perhaps the perfect embodiment –with emphasis on ‘body’– of this central-bank hot air is that a New Yorker just recorded a compilation of himself and his friends breaking wind, and successfully sold it as an NFT (or digital Bitcoin-style “art”) for USD85. Will we soon get a celebrity series, as we do in everything else? I can think of more than a few who would be more than willing to use flatulence to earn even more millions. Think of all the fun we could then have trying to identify whose was whose! I can also think of tens, if not hundreds, of millions of working people who would happily think of doing the same for a lot less than USD85 a pop. Indeed, would we not then need a whole new spectrum of credit analysts to sniff out the underlying value in such ‘artistry’ as potential inflation-hedge investments? And why stop there, of course? What about burps? So many new exciting disruptive market opportunities are being opened up. In short, just look at all the wealth and good jobs that are already being created as central banks try to fight geopolitical wind with wind: it sure smells like success to me!

Source: Global Daily, Rabobank Research (22nd March 2021)

An interesting NY Post article on the story here.

To bond or not to bond

From David Rosenberg:

Then again, there are many indications that inflation is picking up. In the USA, inflation expectations have risen to the highest level in more than five years.

Let me put it this way: The level of outstanding debt in the United States today at all levels of society, government, households, businesses, is just about $80 trillion. If the general level of interest rates goes up by 100 basis points and stays there, you’ve just pushed $800 billion or 4% of GDP into debt servicing. The US economy can’t really afford to have bond yields back up more than they already have.

Still, the US economy is expected to pick up steam this year. The Atlanta Fed’s GDPNow indicator signals 9.5% growth for the first quarter.

If bond yields rise because economic growth is accelerating, that’s one thing. But it’s not clear to me that the economy is going to be on a self-sustaining upward trajectory. Right now, it’s just an assumption, and we already know that less than 30% of these stimulus checks are actually going into the real economy. All that is happening is that we are borrowing from future growth; that is the overriding story: Money spent on borrowed money from the government. So we are building up for a «fiscal cliff» of epic proportions in 2022, and very likely a renewed economic downturn. And this means that the backup in Treasury yields will ultimately be reversed and I would not be surprised if the lows get revisited. [Link]

From Edward Chancellor:

During the war, short-term interest rates were held below 0.5% by order of the U.S. Treasury and 30-year yields were capped at 2.5%. To help finance the war effort, the Fed acquired bonds directly from the government. Wartime restrictions suppressed household consumption and boosted savings. Believing that interest rates might never return to their prewar levels, bond buyers bid down the yields on long-dated Treasuries below 2% for the first time in history. Their timing could not have been worse.

The ending of hostilities released the Fed’s excess liquidity and consumers’ pent-up demand, pushing inflation into double-digits. Nevertheless, Washington continued holding interest rates at their wartime level. The great bond bear market commenced in April 1946. Over the following three and a half decades, an investment in 30-year U.S. Treasuries, held at constant maturity, lost more than four-fifths of its value. Across the pond, British Consols lost 97% of their purchasing power. By the late 1970s, government bonds were widely reviled as “certificates of confiscation.”

The “war” on coronavirus has much in common with this earlier period. Once again, U.S. government debt is back at wartime levels. Once again, the Fed is lending a hand by buying Treasuries. Policies to counter the pandemic have suppressed consumption and boosted savings. Once again, the monetary authorities are committed to maintaining ultra-low rates even as inflation picks up. Once again, investors can’t believe that today’s low bond yields won’t last forever. [Link]

I am on the side of David Rosenberg. I find the historical analogy of Edward Chancellor interesting and very compelling but, for me, ultimately unpersuasive. The context is different. America is not in a position to prime the pump again and get growth going while the post-war reconstruction with America being the lone man standing helped push yield along. The Western world is tired in more than one aspect.

David Rosenberg’s point about the secular rise in the personal savings rate in America is on the money. See the chart here:

The average savings rates between 2000 and 2010 and between 2010 and 2020 are quite different. It was at least two percentage points in the last decade compared to the previous decade. He thinks it would continue to trend higher, given extreme uncertainties in the economic, health and climate areas. Fair enough.

Thoughts on SPAC

Let me start by saying that being anti-SPAC is not an unconventional or off-consensus view. It is perhaps becoming quite mainstream. Some of us – I include myself – would not have even minded being offered a shot at one of the SPACs for a small bet. Well, I cannot afford anything more than that. So, it could be a case of sour grapes. You decide.

First, I am not even sure how SEC in America could even allow something like SPAC or Blank-Cheque companies. The level of scrutiny that IPOs go through goes missing with SPAC. This long article in WSJ which is more of a profile article on Chamath Palihapitiya points out at least a couple of specific things that one cannot do with a IPO but are easily permitted in the case of SPAC:

A SPAC avoids many of the rules governing a traditional IPO by executing a reverse merger between a corporate shell that raised the money and a private company that takes both the cash and the shell’s stock listing. …

…. Unlike in a traditional IPO, executives and sponsors of SPAC transactions can make projections about the company’s future revenue and profits. Because such deals are structured as mergers, SPAC sponsors don’t have to worry about restrictions on talking openly about a business before its shares start trading.

Mr. Palihapitiya takes advantage of these loopholes. He talks his deals up on Twitter, which his lawyers then submit to the Securities and Exchange Commission to comply with stock-solicitation rules. Mr. Palihapitiya arranged with CNBC extended airtime on the days his deals were announced and went through slides from his investor presentation, according to people familiar with the matter. CNBC declined to comment. YouTube and Amazon.com Inc.’s Twitch have also approached him about moving his deal announcements to their live-video streaming services, some of the people said….

…. The Securities and Exchange Commission proposed new guidance in December for SPAC sponsors to provide more disclosure around their compensation arrangements. [Link]

Second, the incentives of the sponsors are out of alignment with that of the other shareholders. Of course, other shareholders, these days, do not seem to mind this asymmetry. Greed drives all.

The sponsors get to earn some extra 20% and also enjoy additional warrants. So, their incentive is aligned with finding a target acquisition to be taken public through this route. Second, they have no long-term incentive to ensure that the company so bought is going to deliver long-term returns/value to the investors. Of course, the reasonable justification for that is that no one cares about the long-term these days. Not even so-called non-political technocratic policymaker-elites in central banks…

But, in theory the incentive of SPAC promoters is similar to the incentives of executive in investment banks who packaged sub-prime mortgages into securities. They took their payoff as soon as the securitisation was completed. Not even when the securitised structure was wound up. So, what went into the securitised asset was of least concern to them. It did not matter if its loss-tolerance was very low or that it was leveraged multiple times over. That is why the biggest innovation that the Reserve Bank of India, under Dr. Y.V. Reddy, did was to change the incentive structure for securitised products.

The compensation was to be reckoned when those structures were safely wound up and not when they were structured. See here:

The RBI has issued guidelines on securitisation of standard assets in February 2006. The guidelines are applicable to banks and financial institutions, including nonbanking financial companies (NBFCs). These guidelines provide for a conservative treatment of securitisation exposures for capital adequacy purposes, especially in regard to the credit enhancement and liquidity facilities. The regulatory framework encourages greater participation by third parties with a view to ensure better governance in the structuring of special purpose vehicles (SPVs), the products, and the provision of support facilities. A unique feature of these guidelines, which may be at a variance with the accounting standards, is that any profits on sale of assets to the SPV are not allowed to be recognised immediately on sale but over the life of the pass through certificates issued by the SPV. We believe that these guidelines, as a package, have ensured an appropriate incentive mechanism for securitisation transactions. [Link]

Emphasis mine. This is an extract from a speech (‘Global Financial Turbulence and Financial Sector in India: A Practitioner’s Perspective’) that Dr. Y.V. Reddy delivered in March 2008. America did not do this before 2008. Now, again, SEC and the Federal Reserve are missing this trick with respect to the incentives that accrue to SPAC sponsors. So, some of us will be bitter about it – because we are missing out on easy-money and also because it is systemically risky. That is human nature for you!

Having written this, let me point out the exit of a sponsor – Chamath Palihapitiya – from Virgin Galactic. You can read the article in Bloomberg on why the SPAC party may be over (I don’t think so) and this article in ‘Business Insider’. Both could be behind paywalls. A shorter version of the article in ‘Business Insider’ is available here. One week is too long these days. Therefore, the article in Bloomberg was a product of its times, a week ago! Now, all is clear and it is back to ‘risk on’ in financial markets. SPACs are not going away anytime soon.

From ‘The Economist’ last month:

Their sudden popularity and the sheer variety of their size, scope and structure raise the question of which spacs are sensible and which show signs of mania. A financier in charge of a big investment bank’s spac business sees a clear bifurcation. There are plenty of good spacs with excellent management teams that can help turn mediocre companies into good ones. But the rest, perhaps a third to two-thirds, “don’t know the first thing about the businesses they are dealing with”.

That seems to be confirmed by a recent study by Michael Klausner and Emily Ruan of Stanford University and Michael Ohlrogge of New York University. The authors look at blank-cheque firms that made acquisitions between January 2019 and June 2020. They find that, in 25% of cases, the sponsor’s payout exceeded 12% of post-merger equity, compared with a median stake of 7.7%. [Link]

The above article does point out that the incentive of Bill Ackman, a SPAC-sponsor was aligned with that of his investors:

…. like Mr Ackman’s, which will issue him 6.7% of the shares in the merged firm only once investors earn a 20% return, are more sensibly structured, valuing it more handsomely than the rest. (Its share prices are trading at 50% above their ipo level.) 

Incidentally, the article talks about the valuation of electric cars. On that topic, readers should read this excellent report at http://www.researchaffiliates.com on how not all electric vehicle makers will succeed and, hence, all of them commanding extremely high valuations is a case of market delusion.

The concluding line of the article in ‘The Economist’ is what it is:

Seen this way, the mania around SPACs is simply an expression of wider exuberance.

Of course, that will take us next to other expressions of the wider exuberance or delusion: Non-Fungible Tokens or Green Energy, Green Finance or ESG, etc.

All these ‘expressions of wider exuberance’ must be traced to central bank exuberance, of course.

The ‘Greensill’ canary in the coalmine

I understand the following:

(1) Greensill offers supply chain finance: pays off suppliers of a company at a discount. The original buyer is now a receivable with Greensill.

(2) Greensill packages these receivables (securitises) and these are invested into by funds like CS Supply Chain Finance Fund

(3) Greensill gets its receivables insured (credit insurance).

Insurance is now not being offered; or was being offered at more onerous terms. That has triggered the collapse of Greensill.

An Edit in Financial Times provides some useful conceptual backdrop:

The practice of a supplier selling on invoices to a middleman who takes over collecting payments from buyers, known as factoring, is long-entrenched. “Reverse” factoring, or supply chain financing, flips things round: a buyer — often a large business — agrees with its suppliers that they will be paid by an intermediary, so they receive payments more quickly but at a small discount. The business later pays the full sum to the finance provider.

Greensill is among those that have added a new spin to the practice, by arranging funding for companies not just through a bank it owns in Germany but by packaging supplier bills into bond-like investments that are sold to investors. In Greensill’s case, one of the biggest buyers has been Credit Suisse — which on Monday suspended $10bn of funds linked to assets that Greensill originated. Its founder, Lex Greensill, cultivated political contacts in the UK and his native Australia, and successfully pitched to bring his supply chain financing methods into public-sector contracts and procurement. [Link]

Greensill, on the face of it, offers supply chain finance to many different industries. But, what one does not know is the relationships between Greensill and all its debtor-companies. For example, were they all funded by Softbank? Was there a Softbank connection? Is Sanjay Gupta a big concentration risk for Greensill? Was there a Softbank connection there? Well Sanjay Gupta is a former Greensill shareholder himself!

But, loans to Sanjay Gupta are not the only warning signs of potential or possible wrongdoing. This story in WSJ on Softbank bailing out Katerra and Greensill cancelling/forgiving the loans extended to Katerra through the bank in Germany it owned does not smell good. The headline of this story tells the story already! It actually stinks quite badly from a distance. Too many inter-connected deals and conflicts of interest. As central banks create money out of thin air and in spades, it just finds it way into all the cesspools (only). It is incretdible that Softbank appears to be in the thick and thin of all of them.

This does sound quite like the sub-prime mortgage situation.

This could be the canary in the coalmine as the BNP Paribas Funds were, for the 2008 crisis. Let us see.

Select musings of Michael Every

So, yes, there is a path to real reflation ahead, if we have the energy. But it isn’t what we are seeing now in Texan energy markets, which is partly weather, partly supply and demand, and a lot of asset-price juicing by central banks (e.g., the RBA’s minutes today made clear that rates are on hold for years and years, and QE is not going to end soon) alongside traditional sugar-high fiscal spending.

The ultimate path to real reflation likely runs through something far more like the heavily-regulated world of Bretton Woods than the heavily deregulated world of Bloomberg Woods. Few in said markets seem to have the mental energy to understand that uncomfortable fact, however. 

Source: ‘I just don’t have the energy’, Global Daily, 16th February 2021 (Michael Every of Rabobank)

In the same daily, he had mentioned a brilliant and savage tweet on California:

“Texas is proof that if you assemble enough Californians in any one place, a rolling blackout occurs”.

It used to be said in the 1990s, if Colorado (the river) went, the California went and if California went, then America went. If it still is true, then the reputation of California now does not augur well for America.

It’s no surprise that as oil prices surge, 10-year Treasury yields in the US jump higher in tandem. 10s were up 10bp yesterday to 1.31% and technically Piotr Matys argues that we are not far from a test back to 1.41%, which if we break through then opens a channel all the way back to 2%. On one level we can look at this and scream “Great Reflation!” Or we can look at a chart going back a year and realise that before Covid struck we were trading at nearly 2% – and that was a time when the market prevailing concerns were still about “secular stagnation” and the “new normal” and the lack of power of labour vs. capital. So even with an oil price squeeze and a sugar-high US fiscal stimulus of close to 10% of GDP, we are just getting back to where we were in the already-gloomy pre-virus norm.

Yes, general inflation almost certainly lies ahead of us now that commodities are the new dot com: but call me when general wage inflation is too. (I will be in my usual Gloomy Place.)

Source: ‘More Champagne?’, Global Daily, 17th February 2021

That is very well said. The comment about the current UST 10Y yield is only near where we were pre-Covid and that was not exactly a world of reflation was the point I made to Latha Venkatesh in my interview yesterday. Well, I don’t know if this clip contains my comments on UST 10Y yield. The full interview may be available here.