Margin calls The point of repo lending is that it's very safe. In a repo, one party (call it the "lender") buys a security from another party (the "borrower") for less than it's worth (the "haircut"), with a promise to sell it back for an ever-so-slightly higher price (the "interest") at some point in the near future. If the borrower pays back the money, the lender gives back the security and collects its interest. If the borrower doesn't have the money, the lender gets to sell the security—which should be worth more than it paid, since it "bought" it at a discount—and so is made whole. This all happens over a short term; much repo is done on an overnight basis, and even term repo tends to be for a matter of months, so the lender can always get its money back in fairly short order. During the term of the repo, the lender can generally issue margin calls: If the security loses value, the lender can demand more money (or securities) to protect its investment. If it demands more money and the borrower doesn't come up with it, the lender can sell the security to get its money back. As loan terms go, these are all pretty draconian. There are other kinds of loans, in the world. Many loans do not allow margin calls: If you have a mortgage on your house and house prices go down, the bank can't just call you up and ask for more money. Many loans are unsecured: If you don't pay your credit card bill, the bank can't just grab your stuff and sell it the same day; there's a long and complicated default process. Even many secured loans are harder to enforce than repo: In many secured loans the lender will have some sort of lien on collateral that will be complicated and costly to enforce, but in repo the lender just owns the collateral—it bought it!—and can sell it without much process. There are good reasons that repo terms are draconian. From the lender's perspective, the reason the terms are so tough is that they make repo very safe. Because you lend for a short term, take possession of the collateral and are protected by a haircut and the ability to sell quickly at the first sign of trouble, you are not taking a lot of risk. So you can do a lot of repo without worrying too much about it, without doing a lot of due diligence and underwriting, without reserving a lot against the risk of loss. Repo is "information insensitive," "money-like." And so a lot of safety-seeking investors—not just banks but money market funds and other big institutions looking to park cash that they can't afford to lose—will park their cash in the repo market. From the borrower's perspective, the advantage of the tough repo terms is that they make repo very available. Because repo is so safe and information-insensitive, there are lots of people willing to lend money in repo markets. You don't need a deep relationship of trust with your lender; lots of banks and funds will just put up cash in the market, knowing that it's all pretty safe. And because it is a competitive market, in which deep relationships don't matter that much, repo tends to be pretty cheap financing and haircuts tend to be low. If you want to borrow a lot of money to finance securities efficiently, repo is the way to do it, because the terms are so draconian. The downside, for the borrower, is obvious. If things go wrong you are not dealing with an understanding lender who has a long and deep relationship with you and who is motivated to see you succeed; nor are you dealing with a lender who faces a long and complex and uncertain legal process if it forecloses on you. You are dealing with an arm's-length counterparty who can seize and sell your collateral in a day, and who has been lending you money in a briskly efficient market with pretty thin margins because it expects that loan to be very safe. You can call up your lender and say "work with us here, it is in all of our interests for us to succeed, you don't need to foreclose now," but your lender is just not that sort of lender. Your lender was expecting boring safety out of its repo arrangements; it did not sign up for a wild ride. We have entered the "lawsuits over margin calls" phase of the current financial crisis: Royal Bank of Canada is using the coronavirus pandemic to seize a large portfolio of assets at rock-bottom prices, a New York real estate investment trust claims. In a suit filed Wednesday in federal court in Manhattan, a subsidiary of AG Mortgage Investment Trust Inc. said it received March 23 margin calls from Canada's largest lender. According to the complaint, RBC said the REIT's commercial mortgage-backed securities have "drastically declined" in value due to the crisis, allowing the bank to demand additional cash or securities to meet requirements. But the trust says the calls are entirely subjective and don't actually reflect the true value of the CMBS. While many other banks have agreed not to pursue remedies against mortgage real estate investment trusts, RBC has refused - and planned to hold an auction Wednesday that included $11 million of the trust's assets, the lawsuit says. Here is the complaint. There is an obvious paradox. AG objects to the margin calls by arguing that RBC's prices are wrong: Defendants' margin calls, however, are based on their entirely subjective and self-serving calculation of "Market Value," and do not come close to reflecting the fundamental value of the securities or following the contractually-mandated means of assessing those values. Indeed, because the "Market" is temporarily frozen, there currently is no objective
means of calculating "Market Value." Now, first of all, I suspect that the "fundamental value" of commercial mortgage-backed securities has been pretty seriously impaired in recent weeks. If all the stores are closed they might stop paying their rent; if they all stop paying their rent then their landlords might stop paying their mortgages; we are early in the current mortgage crisis but things are not especially encouraging. But the bigger problem with AG's argument is that repo haircuts and margin calls are not based on "fundamental value"; they are based on "Market Value." AG argues that the market value of its securities is unknowable, which is actually plausible enough, but RBC's basic point is that the market value is low—lower than it was two weeks ago, low enough to trigger margin calls—and that is surely true. It's surely true not only because, you know, stuff is bad, but also because AG concedes that if RBC were to sell the bonds it would get very low prices for them: Were such a fire-sale auction to proceed, it would not only dramatically and prejudicially underprice these securities to Plaintiffs' detriment, but would also likely precipitate a chain reaction of other banks being pressured to foreclose on other mREITs' pledged securities, all at prices informed by the fire sale that Defendants seek to hold. The argument is essentially "these bonds' prices have not gone down so you have no right to sell them, and if you sell them it would be a disaster because of their current very low prices." There is always an "objective means of calculating 'Market Value'" of assets, which is to sell them at auction; the problem is just that the market value will be low. Which is bad for AG for two reasons. One is that it will lose money on these particular securities. The other, bigger problem is that AG's other banks have held off on making margin calls and seizing collateral. But if these securities trade at very low prices, it will be hard for other banks to hold off on marking them down and acknowledging that they have insufficient margin, which will lead to more margin calls, which will lead to more repo lenders seizing and selling collateral, etc. I have to say that my instinct here, as a former banker, is to sympathize with the bank. RBC was just not signing up to take a lot of risk when it entered these repo agreements; now that they're super risky, it wants out, and is taking the perfectly normal steps that it's allowed to take to protect itself. AG's paradoxical argument—prices haven't gone down and don't sell because the prices are down—leaves me cold. But I suspect that I should resist that instinct. This is not a story about a deadbeat overlevered borrower who repo'd some bad securities and now doesn't want to pay its debts; this is a story about basically every single commercial mortgage-backed security, and every other security for that matter. (Treasury bonds!) AG points out that most other banks have not moved as fast to issue margin calls and seize collateral, though they are in the same basic position as RBC: "Recognizing the aberrant state of the markets, most banks have stopped short of taking precipitous steps that could push the mREIT industry into the abyss." It also points out that many of the Federal Reserve's measures in the past few weeks have been designed to prevent these sorts of bank-run-like collateral liquidations from happening: With respect to the market for mortgage related securities, like CMBS, the Federal Reserve has taken urgent action to support market value and return market liquidity, while state and federal regulators have urged banks to desist from foreclosing on their clients' assets. … The Federal Reserve's interventions all recognize that the challenge facing the markets is to bridge across the disruptions caused by the COVID-19 pandemic and maintain the flow of capital to—not away from—borrowers. In particular, these actions recognize that temporary market dislocations are not representative of the true value of the securities that Plaintiffs and other borrowers have financed under repurchase transactions. Instead of permitting these securities and the underlying loans to be liquidated in a system-wide fire sale, these debt obligations should continue to be eligible for purchase at levels reflective of their intrinsic credit quality. That seems basically correct. The Fed has moved fast and decisively to shore up market confidence, and "shore up market confidence" really does mean pretty much "head off margin calls and fire sales." One very general way to characterize the situation is that, when times are good, everyone loves short-term, low-risk, low-information secured financing arrangements. (I mean, everyone in the financial industry loves them.) They provide liquidity, they work quickly, they let risk-seeking traders get a lot of leverage, they let risk-averse investors park their cash safely, they perform a certain mysterious alchemy—transmuting risky investments into risk-free money claims—efficiently and at scale. The downside is that they are tightly coupled; everything has a pretty slim margin of error, and the spell is easily broken. If you look down, if you notice that the risk-free repo arrangements are actually risky, everything comes crashing down. Information-insensitive debt arrangements are the systemic risk; they're the things that create bank runs. One solution is to ban those arrangements, but those arrangements are very popular. Another solution is for the market collectively to refuse to look down: When the crisis comes, when people begin to panic and demand their money back, everyone can just agree not to do that. "Everyone" there means mostly the Fed: If the Fed steps in to buy and finance everything, then that can reduce the need for a run. But it also, secondarily, can mean banks and other large financial companies: If they refuse to mark to market, if they don't make margin calls, if they pretend everything is fine, then maybe it can be fine. More margin calls Meanwhile: Citigroup Inc. and Truist Financial Corp. are among banks that have been selling off hundreds of millions of leveraged loans to help unwind swap trades tied to the debt, according to people familiar with the matter. The banks solicited buyers for around $1.3 billion in two separate leveraged loan auctions on Tuesday, said the people, who asked not to be named discussing private transactions. About half of the loans seeking bids ultimately traded, the people added. ... Amid the coronavirus panic, the S&P/LSTA Leveraged Loan Price Index has tumbled nearly 20 points to as low as 76.2 cents on the dollar, which left many investors vulnerable to margin calls. One theme here is that there are a lot of ways to subtlyadjust and recharacterize margin loans, lots of ways to get the basic idea of a margin loan (someone lends you money to buy securities) but with slightly different documentation and economics and risks. They are called "total return swaps" and "repo" and "basket options" and lots of other things. But in a financial crisis they are all basically margin loans, and they all basically lead to margin calls and forced sales. Elsewhere: Dutch bank ABN Amro has announced a $200m hit to its profits after recent market volatility led to the failure of a client in its business catering to proprietary trading firms. ABN Amro Clearing was forced to close out the positions of its unnamed client at a significant loss after the firm was unable to meet margin calls on its trades in US options and futures. Again, I have some sympathy with the banks that are making margin calls! They're not just being mean; it is their money that's at risk. Zoom/Zoom People keep buying the shares of Zoom Technologies Inc., a company that doesn't seem to do much, but which has the Nasdaq ticker "ZOOM," when they mean to buy shares of Zoom Video Communications Inc., a company (ticker "ZM") that does a brisk business in the newly booming corporate-and-preschool-videoconferencing sector. I have written about this phenomenon at least twice, but people keep emailing me about it every time ZOOM goes up. I assume they kept emailing the SEC too, because here's an order suspending trading in ZOOM: It appears to the Securities and Exchange Commission that the public interest and the protection of investors require a suspension of trading in the securities of Zoom Technologies, Inc. ("ZOOM") (CIK# 0000822708) because of concerns about the adequacy and accuracy of publicly available information concerning ZOOM, including its financial condition and its operations, if any, in light of the absence of any public disclosure by the company since 2015; and concerns about investors confusing this issuer with a similarly-named NASDAQ-listed issuer, providing communications services, which has seen a rise in share price during the ongoing COVID-19 pandemic. By the way I hope you didn't get too clever about this. For instance, if you noticed that everyone was buying the wrong Zoom and decided to profit from their stupidity by selling ZOOM short, then (1) you have done poorly (ZOOM is up almost 900% year to date) and (2) now you might not be able to close out your short. Stress tests It would be pretty relaxing to be working on the stress tests at a big bank this year. Everyone else at your bank is dealing with horrifying reality, but you are off in a hypothetical universe that is merely bad: Specialized teams inside the nation's biggest banks are hunkered down, working out how they would handle a nightmare economic scenario the Federal Reserve dreamed up. Turns out, reality is worse. The annual stress tests for the biggest banks, due April 6, are meant to gauge if banks would survive a hypothetical recession that sends the stock market plunging, oil into a tailspin, loan defaults rising and unemployment to society-shattering highs. … For instance, the Fed's severe recession imagines U.S. gross domestic product dropping 9.9%, unemployment hitting 6.1% and the Dow Jones Industrial Average falling to 18623 by the end of June. Last week, Goldman Sachs economists projected a 24% drop in second-quarter GDP, and Treasury Secretary Steven Mnuchin said unemployment could hit 20% without government intervention. The Dow closed at 18592 Monday, then rallied to 20705 Tuesday. ... The banks at this point have mostly run their models, and it is too late to insert the world's far more alarming crisis, people familiar with the process said. There have been a lot of criticisms of the stress tests over the years, with a big one being that they are too gentle and do not anticipate bad enough scenarios for the banks. Which turned out to be true! But the bigger picture seems to be that the banks are holding up pretty well, so far, all things considered; the stress tests were wrong in their details, but they seem to have done their basic job of forcing banks to be well capitalized and risk-focused in the good times, so that they can be robust in the bad times. Good trade! I mean: On March 3, 2020, we disclosed that we had acquired large notional hedges which have asymmetric payoff characteristics; that is, the risk of loss from these hedges was limited, while their potential upside was many multiples of our capital at risk. We did so because of our concern about the negative effect of the coronavirus on the U.S. and global economies, and on equity and credit markets. … On March 23rd, we completed the exit of our hedges generating proceeds of $2.6 billion for the Pershing Square funds ($2.1 billion for PSH), compared with premiums paid and commissions totaling $27 million, which offset the mark-to-market losses in our equity portfolio. Our hedges were in the form of purchases of credit protection on various global investment grade and high yield credit indices. Because we were able to purchase these instruments at near-all-time tight levels of credit spreads, the risk of loss from this investment was minimal at the time of purchase. That's from an investor letter from Bill Ackman's Pershing Square Capital Management LP. Ackman has had a few rough years recently, and since his basic business is owning stocks he's probably not having a great year now. His permanent-capital fund, Pershing Square Holdings Ltd., was down 7.1% year-to-date through the end of February, and was 106% long stocks at the time; the market has been … worse … in March. The hedges were hedges—they "offset the mark-to-market losses in our equity portfolio"—rather than pure bets on catastrophe. Still, evaluated as pure bets on catastrophe, they're great! You don't make a 10,000% return in 20 days very often. By the way, It is a little puzzling to me what the trade was. U.S. high-yield credit spreads roughly doubled over those 20 days; making a 100x return out of that seems challenging. In an interview with the Wall Street Journal Ackman said that, if the trade hadn't worked, "we'd lose about $25 million in a month," suggesting that his hedges were in the form of short-dated options on credit indexes, rather than outright purchases, and that he timed and priced them really perfectly. Good timing? If this had happened a month ago everyone would have said "lol this is the top," and they'd have been right, but now it just feels like a relic of a vanished civilization: NEW YORK--(BUSINESS WIRE)--WallStreetBets today announced it will host the world's first live esports-style stock market trading competition, The WSB Championship. The competition, which will be held October 28-30 at America's largest esports arena, will pit the country's top traders against each other, using real money, to see who is most skilled. The event will be held at Esports Stadium Arlington and live-streamed globally via pay-per-view. Over the next several months, a pool of 12 contestants will be selected from the public through a competitive application process. The organizers are looking for contestants as diverse as the one million members of the Reddit r/WallStreetBets community; professional traders, day-traders, and amateur investors across any age, gender or background are encouraged to participate in the application process. "We are bringing the world's first live trading event to the country's biggest esports stadium to showcase the high-risk, high-reward mentality that in recent years has exploded in popularity with traders from all walks of life," said Jaime Rogozinski, founder of WallStreetBets. "I launched the WallStreetBets subreddit in 2012 as an alternative to the conservative, index-investing mindset that prevailed at the time. There's a place in the market for diversified, low-risk investments. This isn't it." Contestants will start with an equal, predetermined amount of their own money, in live markets, and use only stock options to trade. The competition will take place during open market hours, and trading will be conducted through a broker to be named later. The winner will be the trader who makes the most money, or is the last player with money remaining. A cash prize will be awarded. Great! I will definitely watch this. I wish they were doing it now; that would be a challenge. I hope it is like one of those heavyweight championships that gets hyped up for months and then ends in a knockout in 90 seconds. They'll "use only stock options to trade"! I hope they all lose all their money in the first five minutes and the person who goes like 4:58 is declared the winner. Things happen Jobless claims are real bad. Wall Street Bonuses Could Fall 40% This Year in 'Perfect Storm'. Fed Enlists BlackRock In Its Massive Debt-Buying Programs. JPMorgan's Equity Derivatives Haul Soars to $1.5 Billion. Small Businesses Fear Hold-Ups in $350 Billion Rescue Program. Boeing CEO Says He'd Resist Aid If U.S. Demands an Equity Stake. Credit Suisse Cuts Former Chief Executive's Bonus Due to Spying-Scandal Fallout. Occidental Petroleum Reaches Truce With Activist Investor Carl Icahn. WeWork employees fear financial losses in SoftBank battle. "WeWork is not SoftBank's only drama child." As Airbnb Ponders Timing of Listing, Stock Grants Impose Deadline. Shortage of Virus Tests in U.K. Lures Profiteers and Con Artists. MLMs are using the coronavirus to recruit new sellers. A Silicon Valley firm said it could help investors get expedited coronavirus tests — but then said it misspoke. Newest Shortage in New York: The City Is Running Out of Dogs to Foster. Park Slope Food Coop "temporarily suspended its member work requirement for the first time in 47 years." "In the US, White men from higher ranked colleges are better-looking." "Orange juice futures are the best performing asset so far this year." "We'll gradually bring those people back and see what happens. Some of them will get sick, some may even die, I don't know." Britney Spears calls for wealth redistribution, general strike on Instagram. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! | 
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