Matt Levine’s Money Stuff: Bitcoin Doubts and Buffett Criticisms

LAGOS (Capital Markets in Africa) – JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon doesn’t like bitcoin, which he says is “a fraud” and a bubble that “won’t end well”:

Do we have traders who trade it? If we had a trader who traded Bitcoin I’d fire them in a second. For two reasons: It’s against our rules, and they’re stupid. And both are dangerous.
I’m going to be really clear in this one. Forget the blockchain, that’s a technology… But… the currency isn’t going to work. You can’t have a business where people can invent a currency out of thin air and think the people buying it are really smart. It’s worse than tulip bulbs, OK?

As a critique of bitcoin, “you can’t have a business where people can invent a currency out of thin air” feels a little … outdated? Like, yes, once there were no bitcoins, and then someone just made up bitcoins, and now people are buying and selling them for $4,000, and it does sometimes feel like they were made up a bit too recently to be worth $4,000. People made up dollars centuries ago, people decided that gold should be valuable millennia ago, but bitcoin is not even a decade old. Everyone trading bitcoins today can remember a time when bitcoins did not exist. It feels weird!

But it’s a weird feeling that, if you have paid any attention to bitcoin, you got over in 2014 or so. Really by the standards of people who have paid any attention to cryptocurrency, bitcoin feels rock-solid and ancient. There are about a million newer coins that are infinitely more vaporous than bitcoin. Here is a list of initial coin offerings; it is very long. I get emails almost every day about Dentacoin, “the blockchain solution for the global dental industry,” but here is an ICO for Dentalfix, a … different dental cryptocurrency? Here is TulipToken. Here is BananaCoin. Here isJesus Coin. Don’t you feel better about bitcoin already? Isn’t it a sober, sensible currency that has been part of human culture for as long as you can remember, now?

Also Dimon went ahead and made the bull case for bitcoin!

The only good argument I’ve ever heard for it — and there is one good one — there may be a market for it, particularly if Bitcoin can keep itself to 21 million coins, if you were in Venezuela, or Ecuador, or North Korea… or if you were a drug dealer or a murderer, you are better off dealing in Bitcoin than US dollars. 

The other day Dan Davies published this 2014 estimate of bitcoin’s value based on the size of the market for illegal drugs. “The criminal uses of Bitcoin are essential to the value,” he wrote, “whether or not they’re a majority of Bitcoin transactions”: Just as the value of the U.S. dollar is in some theoretical sense underpinned by the fact that you need U.S. dollars to pay U.S. taxes, so the value of bitcoin is underpinned by the fact that you need bitcoins to buy illegal stuff on many of the most convenient platforms for buying that stuff. If there is a reliable bid for bitcoin from the drug dealers and murderers, then it’s a perfectly plausible store of value for everyone else.

Meanwhile: “Dimon Says JPMorgan Trading Revenue on Pace for 20% Decline.” If only there were some incredibly volatile and expanding financial product that they could trade to make up some of that revenue.

Should Warren Buffett be illegal?
Here is Robin Harding on “How Warren Buffett broke American capitalism,” which is nicely summed up by Buffett’s partner Charlie Munger: “Munger had always kidded Buffett that his management technique was to take out all the cash from a company and raise prices.” For instance, take Buffett’s Kraft Heinz Co. investment:

Kraft now makes a 23 per cent operating margin and an enormous return on tangible capital. In a competitive market, those high margins ought to present an opportunity for rivals to invest and steal market share. Instead, Kraft competitors such as Unilever and Nestlé are under pressure from their owners — a mixture of index funds and Buffett-like activists — to match those sky-high margins. If rivals also cut, rather than invest and compete, Kraft can cut even more. A kind of Buffett equilibrium is taking hold. 

We talk a lot around here about the thesis that index funds and quasi-indexers, large institutional investors who own shares in multiple companies in the same industry, will lead to just this sort of equilibrium: companies that are pressured by their owners to cut costs and maintain high margins rather than compete with each other by lowering prices and investing in more capacity. Buffett is of course mostly the opposite of a quasi-indexer (except in airlines!), in that he takes large concentrated positions in individual companies rather than buying whole markets or industries. But the criticism is remarkably similar: Both Buffett and the indexers, allegedly, reduce competition by lazily defending margins rather than aggressively pushing expansion. If this critique is true — and there has been a lot of discussion recently about the rise of market power and the decline of competition — then that suggests that it reflects something deeper in modern business culture, something beyond just the influence of Warren Buffett or of index funds. After all, if both concentrated active ownership and diversified passive ownership lead to the same place, then the form of ownership is not what’s driving the result.

Elsewhere in Warren Buffett news, I have to say that I really admire the chutzpah of Home Capital Group’s shareholders. Buffett’s Berkshire Hathaway Inc. agreed to rescue Home Capital back in June by lending it money and buying a big chunk of stock. The chunk of stock was so big, however, that it had to be split in two: Berkshire bought about 20 percent of the company up front, and then agreed to buy another 20 percent if shareholders approved. The stock promptly soared on the news, leaving the deal looking very good for Buffett. You might think that that’s only fair, since Buffett created all that value, but the shareholders just sort of shrugged and said no: “88 percent of non-Berkshire shareholders rejected that investment Tuesday.” This is perhaps not the best precedent for the next company that badly needs Buffett’s cash, but I guess there’s no reason for the Home Capital shareholders to care about that.

Soccer-bet structured products.
Sure why not, here’s a U.K. Individual Savings Account that pays below-market interest unless Manchester United win the Premier League and FA Cup, in which case it pays very above-market interest:

Virgin Money’s new Double Champions Isa pays 1.2pc interest over a year, which is far less than current top-payer Charter Savings Bank’s 1.31pc rate. However, if Manchester United win both the Premier League and FA Cup this season, the rate is boosted to 3.2pc. 

People sometimes talk about encouraging individual savers using lottery bonds: The idea is that rather than give everyone a low boring rate of interest, you give almost everyone an even lower (or zero) rate of interest, and you give a few people random delightful windfalls. This encourages people to save money by making it more fun and game-like than regular interest payments would. Obviously attaching sports gambling to savings accounts makes them even more fun, for people who like sports gambling, than attaching a lottery would. 

Regulation by settlement.
Here is Matthew Turk of Indiana University on “regulation by settlement”:

“Regulation by settlement” refers to a specific enforcement tactic that has been adopted by federal regulators: By pursuing settlements that are premised on novel legal theories and target certain areas of the financial system on a comprehensive basis, agencies effectively establish new legal standards of general applicability. Settlements are thereby used as vehicles for policymaking rather than the resolution of particular disputes. As a result, the framework that governs the post-crisis financial system consists of more than the regulations produced under the Dodd-Frank Act. It also includes a substantial body of implicit rules promulgated through the precedential effect of settlements between agencies and financial institutions.

The idea here is that instead of following the usual administrative procedures to make a rule saying, for instance, that banks can’t manipulate Libor, regulators will threaten massive ruinous lawsuits over the manipulation of Libor based on novel and not entirely airtight legal theories, and all the banks will settle rather than risk going to trial, and then there will be a new effective rule saying that you can’t manipulate Libor. The disadvantage is that this quasi-rule-making is done without public notice and comment, without judicial review, and without any explicit consideration of the costs and benefits of the new quasi-rules. The advantage is that it’s fast and kind of works:

The procedural looseness that accompanies regulation by settlement carries some under-appreciated advantages, however. Most important, it gives agencies greater flexibility to respond to rapidly evolving policy problems than is available under standard modes of administrative action, such as notice-and-comment rulemaking or formal adjudication. It is therefore no coincidence that regulation by settlement has centered on the banking industry, where constant technological change and the potential for regulatory arbitrage place fluid policymaking at a premium.

You see this sort of thinking a lot in financial regulation. There is a widespread view that the rule of law doesn’t quite work in financial regulation, that if financial regulators are constrained to follow the usual rule-making procedures and to give bankers advance notice of what is and isn’t illegal, then the bankers will always game the rules and be one step ahead of the regulators. So the only way to make the game fair is to let the regulators decide what’s illegal after the banks do it. As a legal theory this seems problematic, but it has a real practical appeal. Most of the stuff that regulators decide should have been illegal probably should have been illegal!

Death arbitrage.
We talked last month about Donald F. “Jay” Lathen Jr., a former banker who got into the business of survivor’s option bonds after the financial crisis. Lathen would find terminally ill patients and offer them $10,000 to set up a joint account with him at a brokerage to buy some survivor’s option bonds, which he would buy below par. The patients would die, and Lathen would exercise the survivor’s option in the bonds, which allowed him to put them back to the issuer at par on the death of the other joint account holder. If you do enough of this, and if your joint account holders die quickly enough, you can make a lot of money, and Lathen set up a hedge fund, Eden Arc Capital Management, to scale up the business.

But eventually the Securities and Exchange Commission went after Lathen for defrauding the issuers of the bonds, arguing that Lathen didn’t really have valid joint accounts with the terminally ill patients (who had no real rights to the bonds in the accounts), and therefore shouldn’t have been able to exercise all the survivor’s options. But last month an SEC in-house judge ruled in Lathen’s favor, finding that he set up the accounts in good faith and shouldn’t be liable for fraud. 

On the other hand, the Financial Industry Regulatory Authority went after Lathen’s prime broker, and yesterday found it liable for negligent misrepresentations in connection with these bonds. Finra fined the broker, C.L. King & Associates, $750,000 for its involvement (and for some penny-stock negligence). It is a bit of a strange result: The SEC found Lathen innocent of any wrongdoing for actually running the scheme, while Finra found Lathen’s broker guilty of wrongdoing just for brokering the scheme. But sure this is a bit awkward:

A striking example of C.L. King’s negligent misconduct was displayed in its handling of Participant CMK’s account with Lathen. Eden Arc submitted executed new account documents to the Firm on May 30, 2013. (Lathen signed the documents the same day on behalf of himself and as POA for CMK.) When transmitting the documents, which included the POA, Eden Arc told the Prime Services Department that “this is a ‘time is of the essence’ situation.” CMK died the next day at 6:55 a.m. Later that day, May 31, 2013, Eden Arc transferred $3.0 million in recently purchased survivor bonds from other accounts that Lathen held with other Participants into the joint account with CMK. He also journaled or transferred approximately another 70 bonds into the account from other accounts.Over the next few months, from July to December 2013, C.L. King sent redemption requests to issuers and their agents on behalf of Eden Arc and Lathen even after learning that CMK had died before the transactions in her account were effected.

It does seem like it would be hard to have a valid joint account with someone who was already dead.

Responsible investing.
Felix Salmon points out that, despite what I said yesterday, the real reason not to invest in “sin stocks” is that you’ll feel better about yourself for avoiding sin stocks — not that you will increase the cost of capital of sinful companies. Socially responsible investing is a symbolic act, not a practical one. I am sure that is correct. Still I think it is worth pointing out the downside of headlines like “Investors Can Be Ethical and Still Beat the Market.” That headline is telling you that you can invest ethically without sacrificing returns, yes, which is good for you if you like (1) returns and (2) symbolic action. But it is also telling you precisely that your ethical investing is not setting the marginal price, and so is not increasing the cost of capital for sinful firms, and so is not having any effect on how much sinful stuff happens. (For whatever definition of “sinful” you are concerned with.) If all you want is the symbolism (and the returns), then that’s fine, but if you did want to have a practical effect, that headline is telling you that you are failing. 

Elsewhere, Cullen Roche argues that “There’s No Such Thing as a ‘Sin Stock.'” 

Credit analysis.
I enjoyed this story about investors who bought bonds issued by Soft Bank Group Corp., despite not really knowing what the money will be used for and not really understanding the structure of Soft Bank’s technology-investing Vision Fund:

“Everyone is asking the same question: what am I investing in here?” said Mark Wade, head of industrials and utilities credit research at ‎AllianzGI. “Am I investing in a company’s operations or am I providing unsecured financing to fund equity contributions to the Vision Fund?”

And:

“My view is that bond investors are thoroughly unimpressed, but they’re being sucked in by the price,” said one high-yield bond fund manager.
“I find the whole structure of the Vision Fund completely perplexing, but as it’s my job to make money, we were in the [order] book.”

There is a sort of corporate-finance-theoretic view that would say that risk determines yield: Investors analyze the risks of the project that they are asked to fund, and then demand a high enough yield to compensate them for those risks. And then there are stories about actual bond offerings in which big famous companies offer above-market yields and investors fall all over themselves to get into the order book despite loudly proclaiming that they have no idea what they’re buying.

Blockchain blockchain blockchain.
Here is a consumer warning from the U.K. Financial Conduct Authority about initial coin offerings, which like many regulatory ICO warnings (outside of China) is oddly tepid. “Are ICOs regulated by the FCA,” the FCA asks itself, and answers, “Whether an ICO falls within the FCA’s regulatory boundaries or not can only be decided case by case.” My own view that almost all ICO tokens are obviously securities offerings that should be regulated by securities regulators does not particularly seem to have caught on among the securities regulators.

People are worried about unicorns.
This week’s big Silicon Valley startup with a sexual misconduct problem is apparently Social Finance, which announced on Monday that chief executive officer Mike Cagney would step down after, you know, this sort of thing:

But within SoFi, Mr. Cagney, a married father of two, continued to raise questions among employees with his behavior. He was seen holding hands and having intimate conversations with another young female employee, according to six employees who saw the two together. At late-night, wine-soaked gatherings with colleagues, he bragged about his sexual conquests and the size of his genitalia, said employees who heard the comments.

Things happen.
How Anna Nicole Smith’s Billionaire In‑Laws Secretly Lobbied the Courts. Goldman Banks on Lending to Grow. Goldman Sachs dulls sting of warning with three-year growth plan. Bain Signs Letter of Intent to Buy Toshiba’s Chip Business. China Sentences Leaders of Ezubo Ponzi Scheme to Life in Prison. Bridgewater’s Dalio, in Private Note, Reassures Clients: ‘We Are Shooting Straight With You.’ Anna Gelpern on Venezuela, amendments and sanctions. A 100-Year Bond for a 99-Year-Old Country. Return of the stock picker bolsters hedge fund performance. Investors Are Buying Stocks and Hating It. States to Trump: Leave Retirement Rule Intact or We’ll Act. Pandit Says 30% of Bank Jobs May Disappear in Next Five Years. Leon Cooperman Says Market Correction Could Start ‘Very Soon.’ Ray Dalio Says ‘It Would Be Terrible’ If Gary Cohn Left the Administration. JPMorgan has pulled ads from Zero Hedge that ended up there by accident. Amazon is hiring the most MBAs in tech, and it’s not really close. Move Over, Millennials: Generation Z Enters the Workforce. Text Messages to a Young Poet. A Day In The Life Of A New York Backpack Corgi. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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.