CLO Market Structures Credit Problems for Itself

“Reuters – US leveraged loan borrowers are increasingly switching to a cheaper short-term Libor rate to reduce interest payments, which is squeezing the returns of some Collateralized Loan Obligation (CLO) investors…”

Here’s an interesting battle brewing in the structured credit world, which was borne out of recent developments in the debt markets that originated on rates desks across the pond. Got it? Good.

So, there is this thing called LIBOR, which stands for London Inter-bank Offered Rate. It’s the rate at which banks around the world are willing to lend money to each other for different short-term maturities: overnight, one week, and 1, 2, 3, 6 and 12 months. The longer the maturity, the higher the rate (for the rest of this blog, any reference to LIBOR means 3-Month LIBOR unless stated otherwise). Pretty simple. This rate is incredibly important because, logically, banks borrow money from each other at any LIBOR, add a few percent onto it (the spread), and then lend that money to retail and commercial clients (think car loans, credit cards, mortgages, corporate loans, revolving credit, etc.).

Some of those commercial clients are companies with poor balance sheets that need to borrow capital to operate, so they’ll tap what’s known as the leveraged loan market to do so. In a leveraged loan transaction, a bank will arrange and structure the loan, then sell pieces of it to other banks or investors to transfer some of the risk in a process known as syndication. Because the company borrowing already has a poor balance sheet, the participating banks view them to be at a higher rate of default and that is factored into the interest rate they charge, which is typically LIBOR + the spread (normally between 200 – 500 basis). Now, the thing with loans tied to LIBOR is that it changes every single day. Because of this feature, banks will usually reset the coupon every month or two in order to reflect whatever the current LIBOR is. It’s for this reason that you’ll see the terms leveraged loan and floating-rate loan used interchangeably. It just means that the interest rate on the loan changes periodically based on where LIBOR is moving (and you should check your credit card – I bet your interest payments are ticking up, as they’re floating-rate as well).

We said before that when a loan is syndicated, other banks and investors buy a piece of it and receive their portion of the interest. We know what a bank is but who are the other investors? CLOs. These are shell companies that go out and buy a bunch of different loans, structure their cash flows into debt tranches and sell them to asset managers, pension funds and insurance companies as investments. The debt tranches are just like bonds, each having a credit rating and an accompanying coupon payment based on the credit risk an investor is taking. There is also something called the equity tranche. Investors here are taking the most risk and only receive interest payments after all of the debt tranches have been paid off. Now, let’s get to the good stuff.

The post-crisis era has been a boon for the leveraged loan and CLO markets. Rates were low, so risky companies were able to borrow and investors were searching anywhere for yield, so demand for CLOs skyrocketed. Alas, the party wasn’t going to last forever, and now we have quite the credit quandary on our hands. 3-Month LIBOR has gone parabolic since about Thanksgiving 2017, which means that loan interest payments are ticking up in lockstep. No worries, though, we have a fix for that. Like we mentioned before, these loans are floating-rate, so their interest rates reset every month or two. Wouldn’t you know it, creditors are resetting these loans at the much cheaper 1-Month LIBOR in order to ease the interest burden on companies and prevent defaults. That seems great, and it is, for the banks and the companies that borrowed. CLOs aren’t enjoying it as much. See, the CLOs issued the debt tranches at fixed coupons which were tied directly to the interest they expected to generate from loans referencing 3-Month LIBOR. However, the underlying loans are now paying less interest as they reference the cheaper 1-Month LIBOR, which has created a mismatch between the CLO’s assets and liabilities. As a result, you have CLO managers trying to renegotiate coupons on tranches they promised to investors to reflect the cheaper rate, but investors are saying, “no thanks”. Can’t really blame them for not willingly accepting a lower return, can you? At the end of the day, these CLOs are taking in less money than they’re paying out, so someone needs to lose.

Raise your hand if you’re thinking “equity tranche”. That’s correct, these guys are gonna get smoked. They only receive what’s left over after the debt tranches are compensated, so any shortfall in funds will erode returns for these guys and impact what investors are willing to pay for an equity tranche in the secondary market – and that will also impact new CLO issuance as investors require more yield for their risk. At the end of the day I don’t think you’ll see any material impacts here, but you’ll most likely see funds write down some positions and perhaps a downtick in new issuance. The structured credit markets have always been fans of ingenuity, though, so I have no doubt they’ll come up with a mechanism to rectify this hiccup as well.

 

Larry Fink Only Needs to Build Another Eleven BlackRock’s to Catch Up to Schwarzman

“CNBC – Larry Fink, the chairman and CEO of investment management company BlackRock, is one of the latest Wall Street investors to surpass $1 billion in personal wealth, according to the Bloomberg Billionaires Index.”

On behalf of everyone at Leveraged Burnout (myself), I’d like to congratulate Larry Fink on finally crossing the billion dollar mark. After years of building BlackRock into the asset management behemoth it is today, Larry is finally reaping the rewards of his 0.7% stake in the company.

There is an interesting history between Larry Fink and Steve Schwarzman, CEO and founder of Blackstone. In 1988, Fink and his team was given a $5M credit line from Blackstone, in exchange for 50% of the equity, in order to build out an institutional fixed income platform. They named it BlackRock in order to establish that it was an entity within the Blackstone family. BlackRock began to take off and, with its success, came disagreements on management style. Fink and Schwarzman butted heads over equity compensation. Larry favored distributing equity to new hires to lure top talent, while Steve wanted to keep ownership with management in-house. Schwarzman and Fink amicably agreed to go their separate ways, allowing BlackRock to pursue any management style it saw fit.

The split was important not only for the two companies involved, but the broader financial services industry and its comp structure. Steve Schwarzman is worth about $12B today, while Larry just only crossed $1B. If you were to compare the two solely on the size of their wallets, Schwarzman obviously came out on top. Larry, however, used his equity as cash to build the largest asset manager on earth. At over $6T under management, BlackRock’s asset base crushes Schwarzman’s $430B, making it a much larger and more valuable company – which came directly at the expense of Fink’s own net worth.

So, I guess beauty really is in the eye of the beholder. Would you want the money, or the prestige that comes with upending an entire industry and becoming legend? It’s easy to be cynical and say take the money, but anyone that fancies themselves a Sandlot fan knows the answer isn’t so simple.

Extending Credit to Instagram Chefs Likely Not a Prudent Investment

“Bloomberg – Salt Bae Restaurant’s Owner to Start Talks on $2.5 Billion Debt“

So as a disclaimer, I’m pretty indifferent on Salt Bae. He rose to prominence last year, after the internet decided having a guy run salt through his arm hair before landing on your steak was appetizing. If that’s what the people want, then who am I to judge? I just saw this Bloomberg headline and knew immediately that I wanted to make a meme of him sprinkling coupon payment stubs on a steak, so now we have a blog post.

Anyway – it looks like Salt Bae’s restaurant, Nusr-Et, is owned by a Turkish Conglomerate, Doğuş Group, under their food and beverage subsidiary, d.ream International BV. From what I can tell, the Company has borrowed pretty heavily to bolster its international presence in the hospitality space, including restaurants. Oddly enough, the Bloomberg piece doesn’t mention why they’re looking to restructure 40% of their outstanding debt, so I’m going to infer that they’re currently dealing with an unfavorable coverage ratio. However, without the debt-fueled spending binge, NYC wouldn’t have been blessed with a Nusr-Et of our own – and what would NYC be without another overpriced, underwhelming steakhouse?

The company is looking outside the realm of restructuring to repair its balance sheet as well, including selling off assets. It recently sold a 17%, or $200M, stake in d.ream International BV to Temasek and British PE firm, Metric Capital Partners. Doğuş has also floated the idea of offloading its entire stake in d.ream International BV through an IPO, which should frighten Salt Bae. Once the public market gets its hands on a restaurant chain, the dynamic immediately switches to cost cutting and maximizing shareholder value. For a guy who built his entire brand on showmanship, quality ingredients and cachet, nothing should terrify him more than becoming the Turkish equivalent of Outback Steakhouse. So best of luck to our friend, Salt Bae, because if he doesn’t actually start raining coupon payments soon, he may be serving gimmick meals like unlimited Meze on Turkish Tuesdays, instead.

Barney Frank is Gonna Be Pissed…

“CNBC – Sub-prime mortgages make a comeback—with a new name and soaring demand“

The wheel. The printing press. Sub-prime mortgage securitization.

The three greatest innovations in human history. Prior to the wheel, ancient man was destined to live a relatively stationary life. There was no ability to explore, hunt and migrate beyond the area that you could walk and carry your belongings. It resulted in tribes and solitude. Before Gutenberg, Western Civilization was mired in a medieval rut. People relied on scribes to replicate texts, making it almost impossible to spread new ideas en masse. Once the printing press entered the scene, the great enlightenment took off, leading to what we know as The Renaissance. Preceding the boom in sub-prime mortgage securitization, banks were relegated to making markets in the infinitely boring world of agency paper and prime, private label mortgages. It was almost impossible to make a decent buck, the typical structured finance banker usually only had two or three different pairs of Gucci 53’s – these were trying times, indeed. Once Angelo Mozilo started slingin’ subprime credit around the West Coast, though, things would never be the same. Bankers were closing deals and collecting fees hand over fist. Working at a ratings agency wasn’t nearly as bad (this pertains to working in the structured finance group, can’t say the same for corporates or munis). There were even new industries growing as bankers left their analysts behind to set up their own shop as CDO managers. This was the height of human ingenuity and it changed the world (while making a handful of people a bunch of money).

Look – I’m not here to praise what happened with the sub-prime mortgage boom, but I’m not here to relentlessly bash it either, no matter how snide and sarcastic the previous paragraph was. There is no doubt that the boom in sub-prime credit and the securitization machine that fueled it played a large role in the financial crisis (side note: I wonder when we’ll stop calling it THE financial crisis, like there haven’t been many before and will be many after). But there were also other causes as well, like the rewrite of the Community Reinvestment Act in 1995, which incentivized banks to extend mortgage credit to communities with outsized populations of “credit deprived” citizens in order to stimulate local economies that needed it (good!). That also meant that banks needed to throw their standard underwriting practices out the window and lend money to people who were previously deemed unworthy of credit in the first place (bad!). One could also look to Alan Greenspan’s tenure at The Fed, where he opened the monetary spigots and took, what some believe to be, too much of a laissez faire attitude toward regulating the exploding sub-prime mortgage markets.

Securitization (sub-prime included) is a much-maligned, but widely misunderstood capital markets mechanism that does have great benefits. It plays a very important role in a modern, credit-based economy that takes place largely behind the scenes. The purpose of securitization is to assist banks in financing the borrowing activities of a large pool of individuals or corporations through the use of third party (investor) capital. The beauty is, you can securitize almost anything: mortgages, credit card balnces, aircraft leases, capital assets, you name it. Hell, even David Bowie securitized the future profits from his catalog. In a nutshell, banks are able to extend credit to borrowers, structure the future interest/principal cash flows from the borrowers into securities and sell those to investors. This allows the bank to move the debt off its own balance sheet, freeing up the capital to continue lending into the economy. This is a great thing if done in a proper way and I doubt everyone really understands how much of an impact it has on their daily life (including allowing us to live and spend the way we do).

Sure, things got out of hand last time and it really did blow up in our faces. But when I see alarmist headlines like this out of CNBC it makes me shake my head, because lending to people who need it is a good thing and all that does is perpetuate the belief that these funding mechanisms are inherently detrimental to society. Sub-prime mortgages and securitization didn’t cause the financial crisis, people did (and odds are, they’ll do it again with something else).

Blackstone Doing Its Damnedest to Ruin Blythe Masters’ Legacy

** UPDATE **

The CEO of Solus was on Bloomberg this morning explaining the situation. Great video if the blog below is a bit too arcane to read through.

“Bloomberg – The Great Blackstone Swaps Saga Just Became a Whole Lot Crazier“

Buckle up. This is a doozy, but it’s also one of the more ridiculous stories from the street in the last few years. It’s also a great example of what I alluded to in my very first post, where I opined that financial services has almost completed its transformation into a parody of itself. This may be the story that pushes it over the proverbial goal line.

Credit-default swaps (“CDS”) were invented in the early 90’s by Blythe Masters and her team at J.P. Morgan in response to the Exxon Valdez incident. JPM extended $5B in credit to Exxon for remediation costs after the spill and wanted to hedge the credit risk associated with it. For the uninitiated, investors buy CDS to hedge their long exposure to a company’s bonds, or, in the case below, short the company’s bonds outright and make money if they default. It’s simply an insurance policy against a company defaulting on their obligations.

The CDS market is governed by the International Swaps and Derivatives Association (“ISDA”), which is a self-regulatory committee that has developed the framework for what constitutes a technical default in the CDS market. There are many nuances and mechanisms  in the framework  that make determining whether or not a credit event has occurred more difficult than it should be (we saw this in the Greek sovereign debt debacle of 2012, which was eventually ruled a default after much debate). I don’t want to get into the weeds too much, but there is one mechanism we do have to touch on – that is “cheapest-to-deliver”.

The idea behind CDS is that they protect investors from default generally, not specifically. Meaning, it doesn’t matter which of a company’s bonds actually trigger the default. Once the ISDA committee determines a credit event has occurred, the company is now “in default” and CDS will pay out across the capital structure (equity not included, of course) in what they call a credit auction. The auction consists mainly of banks and investors determining at what prices they would be willing to buy and sell the defaulted bonds, which then sets the recovery and payout amounts. Once the trades clear and a recovery price is determined, the CDS will payout via a cash settlement. The payout will be equal to (1 – recovery %) * CDS notional amount. This is where cheapest-to-deliver comes in. If you are short bonds through CDS, you need to deliver bonds to the bank to settle the trade. Remember, we said CDS protects investors generally and not specifically, meaning if you need to deliver bonds for settlement, all you need to do is go out and source the cheapest one possible for delivery to the bank. For example: If I’m short a company’s bonds, I don’t actually own a particular bond to hedge. I’m purely gambling that they’ll default one day – so when they do, I just need to go out and find the cheapest company bond possible for delivery to maximize the payout. If you have the option to deliver a $20 or $30 bond on a $100 CDS, you deliver the $20 bond every time and take the $80 payout (this is oversimplified for purposes of the blog).

K, now that we have that out of the way we can get into the actual story. A couple of years ago, Blackstone (through their credit entity, GSO) put on a large CDS position against a New Jersey-based homebuilder, Hovnanian. They were betting that the company would default on its debt, triggering the CDS to payout and padding some MD’s pockets. Well, the thing is, that never actually happened and Blackstone decided they were going to do what it took to force a default. They offered to structure a refinance package which would have Hovnanian exchange their current bonds for newly issued ones at longer maturities, lower rates and, hilariously, a higher notional amount of debt on their books (while technically the incremental debt wouldn’t hurt them since the rates are so low and maturity so long, its funny to hear of a company solving their debt problems by adding more debt to its balance sheet). This means that the company says “Hey, we know you had $100 bond from us, but we’re gonna replace that with a new bond that says we owe you $125 now. Oh, and it’ll also be at a much lower rate and take us much longer to pay you back.” That crushes the value of the new bonds in the market, which would work precisely in Blackstone’s favor if the company defaulted and Blackstone was forced to deliver the bonds for settlement in the auction under the “cheapest-to-deliver” mechanism. The only thing left was figuring out how to structure the default. Well, the parties decided that a Hovnanian affiliate would buy back some of the old bonds before the exchange, and there would be a clause in the new bonds that prohibits the Hovnanian (and its affiliates) from making any interest payments on the old bonds prior to maturity, triggering a default – through a subset of bonds that only Hovnanian itself owns! For the avoidance of doubt, Hovnanian was going to halt interest payments it owed to itself in order to trigger the default. That’s just shameless.

Naturally, the banks and hedge funds that were on the hook for CDS payouts were less than excited about this newest feat of financial engineering. One fund, Solus Alternative Asset Management, is taking their grievances to the courts, which is fine (but arduous). However, there’s always been one firm that’s never been afraid to go to the mattresses, who wasn’t going to take this disrespect lightly. One firm who wields so much power in the markets that anyone would be crazy to cross them: Goldman Sachs. Goldman was one of the largest sellers of Hovnanian CDS, and they stand to lose a hefty amount if Blackstone pulls this off. They had been relatively quiet on the matter, until some chatter started popping up last week that Goldman, alongside Solus and Anchorage Capital, had been lining up enough demand for the defaulted bonds in the upcoming credit auction that they would be able to push the price up high enough to materially impact the recovery amount and wipe out most of Blackstone’s potential CDS payout – which makes sense! There should be demand for this company’s debt, they’re in an even better financial position in default than they were beforehand thanks to the refinance package. The value of Hovnanian CDS dropped sharply on the rumors and it appeared that Blackstone had met their match. That’s a veteran move by a market-maker that knows exactly what they’re doing – kudos to GS.

BUT… if you thought that was the end of it, you don’t know how petty money can make people. Hovnanian has now announced it’ll be exchanging an additional $840M worth of bonds at, once again, a higher notional amount, with a 3% coupon and a maturity date of 2047. That, my friends, is the most preposterous thing I have ever seen in my life. That’s almost exactly on par with what it costs the U.S. government to borrow money for thirty years, and these guys just build houses for a living. As you can expect, this will depress Hovnanian bond prices further should they decide to move forward with this newest exchange, once again putting Blackstone in a perfect place to cash in on their CDS position in the upcoming auction. As a result, their position has materially increased in value over the last couple of days.

Truth be told, this is a sad day. Blackstone is making a mockery of, if used properly, a great market mechanism to manage the risk associated with financing growing companies around the world. The CDS market suffered greatly in the post-crisis era of tighter regulations, but this will likely be the straw that breaks the camel’s back. The ability for a company itself to determine if and when it will trigger an unnecessary technical default makes the instruments utterly useless and, if that’s the case, then maybe the CDS should die because Pandora’s Box is now open. Markets do need a way to hedge credit risk, though. There just isn’t a clear alternative in the works yet. In my opinion, the easiest mechanism would be for re/insurers to be paid a nice fee to wrap each individual bond issuance with market standard triggers (just like their regular insurance policies), but that is probably unlikely after what AIG, MBIA and AMBAC did to themselves in the financial crisis. If anyone has any ideas, I’d love to hear them.

Connecticut Striving to Become the Municipal Equivalent of Sears

“Bloomberg – Connecticut and Hartford Get $2 Billion Offer for Properties“

Connecticut is a fiscal disaster. Their decades long episode of legislative ineptitude has put the Nutmeg State in a perilous financial position that most government officials only dream about. As it stands, CT has one of the worst public pension systems in America with an embarrassingly low 44% funding ratio, one of the largest per capita tax burdens in the nation and a shrinking tax base as corporations and citizens flee the state.

You can only operate in that way for so long before markets smell the blood in the water, and it seems like one fund just got its first whiff. Chicago-based Oak Street Real Estate Capital sent a LOI to the state capital last week, offering up to $2B in cash in exchange for certain state-owned properties structured as a leaseback, yielding 7.25%. For anyone unfamiliar with a leaseback, this is when a company sells properties and/or heavy machinery to a buyer and then leases it back for continued use. This is a common way to generate liquidity for cash-strapped companies whose fixed assets are generally worth more than the business itself, like Oak Street’s neighbor, Sears Holdings.

Sears, like Connecticut, is a balance sheet disaster. Eddie Lampert bought Sears years ago through his fund ESL Investments. In a bid to free up cash and provide some short term flexibility, he sold Sears’ best performing properties into a publicly-traded REIT called Seritage Growth Properties. The asset sale was structured as a leaseback, allowing Sears to continue using the properties as retail outlets, generating a healthy rental yield for Seritage shareholders and protecting ESL LPs from the eventual Sears bankruptcy, as they own a healthy chunk of Seritage partnership units as well. The move was savvy financial engineering which, in the face of what will be a well-publicized credit event, Lampert doesn’t get enough praise for. While the move will ultimately benefit ESL’s investors and the ridiculous corporate structure they set up with Sears, it is going to destroy the company, as the now struggling retailer has the added expense of paying rent to its own investors – and that is most likely the same fate that awaits Connecticut if they try to financially engineer their way out of this mess. They couldn’t agree on a simple budget for years, I’d love to see how they navigate the asset-backed lending markets.

 

Cryan Out; Sewing In; Retail Banking En Vogue.

“CNBC – Deutsche Bank tapped Christian Sewing to be its new chief executive, the bank announced on Sunday, confirming widespread speculation that John Cryan would be replaced.”

So, a quick update on our friend, John Cryan. As I wrote a little over a week ago, there was no doubt that he would be asked to take a long walk off a short pier once shareholders started putting calls in directly to the Board. So while that was a foregone conclusion, what wasn’t as clear was who would succeed him. Last night we got our answer in the 47 year old Deutsche Bank lifer, Christian Sewing. If you thought banking in Frankfurt couldn’t become even more boring, you’d be wrong, as Sewing is currently DB’s retail banking CEO and has a background in risk management and audit. It seems like the Board is set on simplifying DB’s complex operations and returning it to a more traditional banking model, which doesn’t bode well for any of our friends at 60 Wall Street.

While Cryan stunk at his job, Christian Sewing isn’t going to swoop in and save DB from its mistakes overnight. He’ll likely look to begin a longer term process of shedding some of the bank’s “flashier” assets / businesses, taking a deep dive into the bank’s book of business and assessing how to prepare for a future focused on retail and commercial banking – which will inevitably result in further dings to DB’s reputation and prestige in the marketplace. It hasn’t been a fun few years to be a DB employee and it doesn’t seem like it’ll be better any time soon.

Pershing Square Destroying Its Business Just In Time to Open Swanky, New West Side Headquarters

“Bloomberg – About two-thirds of the capital that investors could withdraw from Pershing Square Capital Management’s private funds was redeemed at the end of last year, according to a person with knowledge of the matter. Blackstone Group LP has been pulling its money, while JPMorgan Chase & Co. has removed Bill Ackman’s Pershing Square from its list of recommended funds for clients, the person said.”

They say there are three days in a man’s life that define him: the day he’s born, the day he dies and the day his institutional LPs start pulling their capital (nobody actually says this, I made it up for the purpose of writing this blog). Today, Bill Ackman is here to add a second notch to his legacy-defining belt.

Listen, it’s not unheard of to have some smaller, high net worth LPs redeem some cash when things get a little shaky. They most likely don’t have a deep enough capital base to ride out a cold streak from their managers, so it’s understandable. When the likes of Blackstone and J.P. Morgan start raining redemption requests on your lowly investor relations analysts, though, times are dire. Ackman has had a tough few years, marked by chronic underperformance, a gut-wrenchingly expensive divorce and what amounts to the hedge fund equivalent of a public caning from Carl Icahn. But this is America, and as far as I’m concerned, we love a great comeback story – which led me to wonder if 2018 would be the year Ackman would begin his. I can now say emphatically that 2018 will not be his comeback year, as a Pershing Square liquidation / return of capital seems to be a much more likely scenario. As the fund moves to satisfy redemption requests and liquidate hundreds of millions of dollars worth of positions into an already down year, Ackman (and his LPs) will likely be selling into deeper losses as they look for bids wherever they can get them (not ideal!), further tarnishing his record and reputation. The only thing he has going for himself at this point is that the funds are gated, limiting LP redemptions to 12.5% of their capital each quarter, allowing Pershing Square to clip some last minute management fees (isn’t the hedge fund comp model grand?).

Billy has had some high-profile misses in the last few years, getting torched most notably by Valeant and Herbalife (he also blew up his first fund, Gotham Partners, which is rarely mentioned in the media these days). While it’s fun to point out all of his mistakes, we’d be remiss not to revisit some of his biggest wins – because despite all of the negative news recently, he actually has made his investors money over the long haul, even beating out the broader market. He’s had great success in his Canadian Pacific, General Growth Properties and Wendy’s plays. His greatest, and savviest, play IMO, has to be his short of MBIA all the way back in 2002. Billy had a hunch that the mortgage credit markets were about to turn ugly and he wanted some action. He turned his sights on MBIA, who was buying mortgage credit risk by selling credit default swaps on securitized mortgage debt. Ackman went out to markets and started building a credit default swap position against MBIA’s own debt and shorting their stock, betting that the company was destined to payout on all the protection they sold, eventually bankrupting themselves. It took a few years, but the bet paid out handsomely during the 2008 financial crisis, proving Ackman was ahead of the hedge fund curve and launching him back into the limelight.

That was a long time ago, though, and investment management is a “what have you done for me lately” business. We should be thanking Ackman, though. Never has anyone provided so much content, both good and bad, for the financial media and its consumers. He has a complex tale that has been wrapped in a “truth is stranger than fiction” aura since he burst onto the scene. Whatever you think of the guy (and many hate him), we’ll be discussing his legacy for a long time – and we all know, he wouldn’t have it any other way (except the terrible returns, he’d probably take those back).

 

Inflation Is Here, but You’ve Probably Been Looking for It in the Wrong Places

“Bloomberg – The cost of maintaining a drugs, booze and cigarettes habit got a lot more expensive in the U.S. last year, rising the most of almost anywhere in the world, the annual Bloomberg Global Vice Index shows.”

Economists, portfolio managers, politicians, laypeople. We’ve all been wondering for years, how it could be possible that, in the era of cheap money, there haven’t been any inflationary consequences. Sure, one can argue that inflationary pressures have made their presence known in equity markets, as the financial system has benefited the most from a decade of low rates. But I’m talking about real inflation, the kind of insidious inflation that eviscerates the consumer’s purchasing power and drives raw material prices through the roof. Well, ladies and gents, it’s finally arrived – we’ve just been looking for it in the wrong places, at the wrong raw materials, if you will:

“The gauge compares the share of income needed to maintain a broad weekly habit of cigarettes, alcohol, marijuana, amphetamines, cocaine and opioids…”

There you have it, the purchasing power of your typical 18-30 year old, white-collar professional is deteriorating right before our eyes. According to this Bloomberg index, the weekly cost of living your best life as George Jung is about $617/week (an YoY increase of over 50%). While that sounds expensive, it’s even worse considering this amounts to 54% of average weekly income. If you’re, quite literally, blowing 54% of your take-home pay while living in NYC, you’re most likely surviving on 2 Bros. Pizza and 16oz. PBR’s at Brother Jimmy’s as well – and that’s no way to go through life (just your early 20’s).

I can’t say I’m surprised, though. If you think about how well the economy performed in 2017, a massive YoY increase like that makes perfect sense. Americans are, generally, more well off than they were at this point last year, and in true American fashion, we’re burning through our newfound wealth, celebrating like the consumers we were born to be. The jury’s out on whether being this specific type of consumer en masse is bullish or bearish for America’s future prospects, but we’ll deal with that issue when we get there – and if living to excess and dealing with the repercussions later isn’t the definition of Americanism, then I don’t know what is.

 

I’m Shocked That an ICO Promoted by Floyd Mayweather and DJ Khaled Was Fraudulent

“Gizmodo – SEC Charges Founders of Cryptocurrency ICO Promoted by Floyd Mayweather Jr. and DJ Khaled with Fraud“

I’m not even going to comment on Floyd Mayweather or DJ Khaled here, because if you invested a single dollar based on what a guy who can’t read posted on his Instagram, you should get burned. However, whatever you think about cryptocurrencies and their *sigh*, relevance, there is one indisputable fact: they have contributed to the meteoric rise of the ICO.

For anyone unfamiliar, an ICO (Initial Coin Offering) is a new way to raise start-up capital in the crypto space. At a high level, a start-up has an idea for a new payment system and agrees to issue their new currency supporting it to investors in exchange for bitcoin and/or ethereum. They then turn around and use the funds raised to develop the payment system and currency infrastructure. Say for instance, Domino’s wants to develop a system to revolutionize the way we all pay for pizza. You fund their venture with bitcoin and they give you PizzaCoin. If the payment system takes off and the value of PizzaCoin increases, good on you and your investment prowess.

The problem with the process is that it totally skirts the SEC regulatory framework for issuing securities and raising capital – ipso facto: it’s the wild west out here in ICO land. Any start-up in the world can issue its fake currency to any sucker that’s willing to fork over their fake bitcoin purchased with actual dollars. They can market the currency however, and to whomever, they please. This has resulted in numerous fraudulent companies raising millions of dollars from retail investors for their useless currencies. When I say useless, I mean totally useless – kinda like this ICO, the aptly named Useless Ethereum Token which has raised over $125K. What a world.

The worst part is that many unsophisticated investors don’t understand they’re not purchasing an equity interest in the company itself, but merely gambling on the value of the stupid currency they bought. Were one of these currencies to be widely adopted, the company itself would be clipping transaction fees left and right, but the ICO participant experiences none of the upside provided by the increased cash flows. You have investors providing equity capital to build the company and its product, but receiving a 0% equity stake in said company or product. It’s a perversion of the venture capital model, used solely to benefit the founders (equity holders) at the expense of investors bearing literally all of the execution risk.

These companies are extracting real dollars from the economy in order to build equity value for themselves, and leaving investors holding useless assets they created out of thin air. The sad part is that it doesn’t seem investors are catching on to the scheme, because every time one ICO blows up, I wake up the next day and it’s just like: