End Game

by Matthew Glass

  ‘What about Uganda?’ said Adil Menon, one of the portfolio managers. ‘Maybe Kenya. Let’s think about opportunity. We have no exposure at all to those markets. It’s no-lose. If this intervention gets rid of the LRA, there’ll be some kind of economic payoff. If it fails, they’re no worse off than they are today.’

  Grey knew nothing about the Central African region and had never invested there. Adil, who mostly traded currency, was keen to develop a specialism in fourth-wave countries, as the least developed of the emerging markets were known.

  ‘You want to get out there?’ he said.

  Adil nodded.

  ‘Maybe we put a couple of hundred million into Uganda if we can find some opportunities,’ said Ed. He liked the idea. He had made a heap of money in Ghana at one stage after having read a couple of articles about the country in The Economist and getting out there to investigate.

  ‘Liquid opportunities,’ said Evangelou. ‘Don’t get us stuck in some shitty trades we can’t get out of, Adil.’

  Menon smiled. That was Evangelou’s mantra, liquidity, having a market that was deep enough with a sufficient number of counter-parties so you could get out of a large position when you wanted to. You never wanted to be the last guy holding the parcel with no one to pass it to. Evangelou hated developing markets, especially fourth wave, because liquidity was always an issue.

  ‘So apart from local effects in the region, this Uganda thing is a storm in a teacup, huh?’ said Grey.

  There were nods around the table.

  Grey thought so himself, but he was going to continue to challenge that view as the situation developed. Markets across the world had been on a slow but steady bull run for almost three years and event-driven opportunities for outsize returns were few. He didn’t think this was one of them, but he was going to keep watching. The conflict looked so trivial that if it blew up into something big and began to have a material impact, the opportunity for those who spotted the effect early was going to be substantial.

  ‘Anything else?’ he said.

  There was silence for a moment.

  ‘I have an idea.’

  Ed looked along the table and two rows back to see who had spoken. Boris Malevsky was a new joiner Ed and Tony had hired out of Morgan Stanley to work as an analyst on Evangelou’s team. He was the child of Russian immigrants and had a slight accent courtesy of the first eleven years of his life in Moscow. Boris was curly-headed, overweight, sweaty and, in the fortnight since he had joined Red River, rarely clean-shaven. Grey liked him. There was something about Malevsky that made Grey think he might have what it takes to be a trader, a mix of intellect, rebelliousness and contrarianism that you always find in truly great portfolio managers who are capable of backing themselves against the market to win the kind of iconic bets that he himself had won over the years. On the other hand, you often found those same qualities in truly terrible fund managers who were capable of losing more money than most people knew existed. The difference between the two was another set of qualities: the stomach to hold a position, the discipline to execute your strategy, and most importantly, the humility to accept that you were wrong when the market had turned against you and the flexibility to act on that realization quick enough to save yourself from a trap door that was opening under your feet. Ed Grey had no idea if Malevsky had those qualities, but he wanted to find out.

  ‘What is it?’ he said.

  ‘We short US banks.’

  There were smirks around the table. Ed Grey wondered if Malevsky was saying that just to show how contrarian he could be. The line between a contrarian and an idiot was a thin one.

  ‘What’s that got to do with Uganda?’ said Evangelou.

  ‘Nothing. I didn’t say it did.’

  ‘Then what the fuck are you talking about?’

  ‘I’m saying we should short some banks,’ said Boris, with a slight Slavic slur just detectable in his accent.

  ‘Boris, right now banks are on a one-way ride.’

  ‘And we’re long all the way.’

  ‘Because they’re on a one-way ride.’

  ‘And if there’s a correction?’

  ‘They’re still on a one-way ride. If there’s a correction, it’s limited. At Red River we look at a six month to one year horizon and our investors know that. If banks correct, over that time horizon they’ll come back and they’ll still keep going up.’

  ‘I agree,’ said Malevsky. ‘But shouldn’t we make some money in the correction?’

  Grey watched him with interest. ‘How do you know there’s going to be a correction?’

  ‘You think this Uganda thing’s going to do it?’ said Maria Lomax. ‘You know some banks with exposure to Uganda?’

  ‘It’s going to be good for them,’ said Evangelou. ‘Adil’s right.’

  ‘It’s got nothing to do with Uganda,’ said Malevsky.

  ‘Boris, why the correction?’ asked Grey.

  ‘This administration is scared of a bubble. It’s scared of anything that looks like a bubble.’

  ‘We haven’t got a bubble,’ said Evangelou impatiently.

  ‘No, but we’re in a bull market that’s run eleven consecutive quarters. You look at any public statement that’s ever come from Knowles, from the Fed, from the Treasury. This administration will not allow the banks to drive a bubble.’

  Evangelou rolled his eyes. ‘We haven’t got a bubble.’

  ‘We’re coming up to the midterms. If anything happens, even the slightest thing, they’re going to overreact. They’re going to do something, or say something, that’ll haul the sector back. The Fed especially. You look at the way Strickland talks.’

  Ron Strickland was chairman of the Federal Reserve, appointed by the previous administration explicitly to do what Alan Greenspan and Ben Bernanke hadn’t done, burst the bubbles that inevitably develop in the financial system before they get too big to bust. When Knowles took office he affirmed that was exactly what he wanted Strickland to keep doing.

  ‘That’s his job. That’s what this administration is focused on. They’ll sacrifice twenty-five, fifty basis points of growth if they think they have to. They won’t say that, but that’s what they’ll do.’

  ‘Why now?’ said Grey.

  ‘I’m not sure it’s going to be right now. I’m only saying, this is the kind of time when it might happen. Midterms coming up. Maybe there’s a feeling things have been going good a little too long and we’re getting to that point where you need to be watchful. The Democrats are saying this administration isn’t committed to regulation. There’s just a bunch of things that might make them damp down somewhat. Not do anything dramatic – just show they’re in control.’

  Grey considered it. The rationale was way too vague, too wishful, to back with any of the fund’s capital.

  ‘I’m not saying we short the whole sector,’ said Malevsky. ‘It’s going to be a wobble, not a crash. But when it wobbles, there’ll be some that really drop.’

  ‘Really?’ said Evangelou skeptically. ‘Do you have any in mind?’

  Malevsky glanced around the table, then looked back at Grey.

  Grey understood. ‘Okay,’ he said.

  BEING A TRADER for two decades had taught Ed Grey a bunch of lessons. One of them was that it’s easy to be right at the wrong time. You could have the greatest trade in the world, and if you did it at the wrong time you’d lose a shitload of money. The fact that six months or a year later the market moved in the direction you predicted was zero consolation. Everyone had done it, himself included. The trick was not to do it too often.

  Was a correction coming? Probably. Markets always get a little twitchy after prolonged periods of rising value and some participants decide to sell and take their profits, if for no other reason than everyone knows the party has to end some time. More and more people were talking about it, and at some point that kind of talk becomes self-fulfilling. But that wasn’t stopping anyone yet. It was the typical schizophrenic behavior of the marke
t, where investors rationally know that the good times can’t last forever and yet keep acting as if they can.

  The question was: when, how long and how deep was the inevitable dip going to be?

  If market fears and desire for a little profit-taking were the only reasons for the correction, it would be shallow and short-lived, as Tony Evangelou expected, with a rapid return to growth. In that case, the risk-reward for trying to pick the timing of a minor correction didn’t add up.

  Was there any reason for it to be deeper? There was a general sense in the financial community that regulation was falling behind again. The new rules that had been introduced under Obama in the years after the crisis had been around long enough now for smart people to start finding ways around them. Everyone knew there were novel financial products and practices that could potentially – in certain circumstances – create the same kind of risks that had brought down Lehman Brothers at the height of the last financial crisis. But those circumstances didn’t exist and no one believed anything like that level of risk had actually developed. No one believed the world was back to anything like the corrupted, hollow shell of a financial system that had been in place in 2008.

  Globally there were the usual tensions. An implicit deal had been struck in the worst days of the financial crisis: China would increase consumption and reduce savings as a way of rebalancing the world’s trade flows, and in return it would receive a greater say in global financial governance and institutions such as the IMF and G20. The deal had been breached by both sides. The old G7 powers still retained enough votes to get pretty much whatever they liked in the IMF, and the G22, as it was now, was an empty talkfest that left the western powers to do their deals in informal meetings in Washington, London and Tokyo. China continued to maintain an artificially undervalued currency, paying lip service to its obligations with occasional tiny revaluations, and sequestered its citizens’ savings in state banks instead of encouraging domestic consumption. The disturbances in China in 2014 had only entrenched the problems – making it easier for the Chinese regime to argue that it couldn’t make any of the necessary changes and for the west to argue that China wasn’t ready for a larger international role. Essentially, then, nothing had changed but for the added resentment on each side towards the other for having, as each side saw it, reneged on their side of the deal. Red River had some big, long-term bets placed on the way the dollar, euro and yuan would move in relation to one another, and Ed Grey was confident that eventually those bets would pay out. In the meantime, growth continued, stretching the global imbalances even more, and it was in no one’s immediate interest to do anything about it.

  Everything suggested that there could be a market correction but it was going to be shallow and short. It was possible, as Malevsky said, that the administration would want to show how tough it was in the next couple of months, and talk out of the Fed might make the correction a little deeper, if it happened at all. Even so, the risk-reward profile just wasn’t there for Red River to take a position.

  And yet there was something more than this that Malevsky was thinking of, Grey understood. Something he knew.

  HE PULLED HIM into his office and asked Evangelou to come in as well.

  ‘So who are they, Boris?’ he said. ‘Who are these banks?’

  ‘I’ve got four in mind.’

  ‘How have you identified them?’ demanded Evangelou.

  ‘Basic analysis. Leverage, capital ratios, loan books … I’m not saying these banks are going to fail. I’m just saying they’re the most vulnerable. When Strickland feels he needs to start talking the market down, they’re the ones that are going to drop.’

  ‘How much?’ said Grey.

  ‘I’m guessing ten, fifteen per cent. Maybe twenty.’

  ‘Why isn’t everyone else shorting them?’ said Evangelou.

  ‘Because no one thinks they’re the ones that are going to hurt. And no one’s prepared yet to bet on a correction. But there will be one. Strickland will overreact and haul things back.’

  Grey thought about it. It was the perennial paradox in the markets. If no one else was doing something, why should you? On the other hand, if you only did what everyone else did, you never made any money.

  ‘Ed, this is all hunch,’ said Evangelou.

  Grey agreed. There was nothing behind this, it seemed, but some simple analysis and Malevsky’s insistence that the Fed chairman would be too heavy-handed in his statements, which was pure speculation. But he was interested in seeing what Malevsky was made of as a trader. It might be worth putting twenty or thirty million into short positions to find out.

  To sell short, a DIV ‘borrowed’ stocks for an agreed period from banks that were holding them on behalf of passive shareholders like pension funds or university endowments. That cost a fee, usually measured in thousandths of a per cent of the stock’s value, for each day you borrowed them. When you got hold of the stock, you sold it for its current price and hoped you could buy it back cheaper before you had to return it to the bank that had lent it. In other words, you were betting on the stock falling. The difference in the price when you sold and the price when you bought the stock back, less the fee for borrowing the stock, was the profit. Or the loss, if the stock price rose. In the meantime, the longer you held the stock, the greater the fee you paid.

  And Malevsky, of course, had no idea when this correction of his was going to happen.

  ‘Strickland’s testifying to Congress next Tuesday,’ said Malevsky. ‘That’s his last testimony before the midterms. We could borrow for a week. Worse case, we lose the fee. What will it be for a week? Nothing. Best case, Strickland says something and we get the dip.’

  ‘Wrong,’ said Evangelou. ‘Worst case, Strickland says the opposite because he thinks the president wants him to boost the markets and we get a spike. No way he’s talking the market down a month before the midterms.’

  ‘No way he’s talking it up. That’s not something he does and that’s not what the president wants. If anything, he wants Strickland to push things down a little. Wall Street will yell and Knowles’ll make political hay with his rectitude-and-trust spiel.’

  ‘Before an election? I don’t think so.’

  ‘Why not? Doing that before the election is exactly what Knowles wants. He wants to show he’s tough. The markets can’t push him around. There’ll be no bubble on his watch. If he has to take action to stop one developing, he will.’

  Evangelou looked at Grey. ‘Ed, this is all a hunch about the psychology of what Strickland’s going to say. This is bullshit.’

  Grey was inclined to agree. He had hoped there was something more that Malevsky knew but it looked as if he was all hot air. ‘Boris,’ he said, ‘I don’t think–’

  ‘There’s one more thing,’ said Malevsky.

  Grey stopped.

  ‘I heard something when I was at Morgan. Not something in the public domain.’

  Grey raised an eyebrow. This was it.

  ‘I heard something about one of these banks needing to raise some capital. Something about losses they need to declare.’

  Now Grey understood. Malevsky had been hoping to present his idea as the result of some great psychological insight and analytical research. In fact, there was a nugget of very valuable – and very confidential – information underlying it.

  Malevsky shrugged.

  ‘How much capital will they need?’

  ‘I don’t know. Enough to make people interested.’

  ‘A couple of billion?’ Grey paused. ‘Five billion?’

  ‘I don’t know. I really don’t. But I do know they’ve got losses they need to declare and they’re big enough to make them come to the market for funds.’

  ‘So that was all bullshit?’ said Evangelou. ‘All that stuff about Strickland and the correction and everything?’

  ‘No, I believe it’s going to happen. That’s the context. Strickland’s going to keep talking hard. Maybe before the election, maybe after. I’m not s
ure when. But when you get this bank coming to the market for more capital in that context, suddenly there’ll be pressure on banks. The other ones, the other three I’ve identified, are the ones I think most likely to take a hit. I’ve done the analysis on them.’

  ‘Would you have identified the first bank from your analysis?’

  Malevsky shook his head. ‘That’s what’s so beautiful about it. No one’s going to expect it.’

  Grey looked at Evangelou. ‘What do you think?’

  Evangelou shrugged. ‘It’s a little more interesting, that’s for sure. It’s not exactly kosher.’

  Grey didn’t say anything to that. Rumor was rife in every market. In most cases, unless you went about it extremely stupidly, the difference between insider information and informed speculation was almost impossible for an investigator to make out.

  Malevksy watched him hopefully.

  ‘It’s chickenshit,’ said Evangelou. ‘Ed, what is it? What are we going to make? One bank. Who knows what the others will do? Say we put a hundred million on this one bank and it comes off ten per cent. Say twenty per cent. Twenty million? Is it worth it?’

  ‘Maybe we take a bigger position.’

  ‘And maybe it goes nowhere. And if we have to short a bunch of others, and they go nowhere …’

  Grey nodded. Still, it was interesting. ‘I like the thinking. We have something that’s pretty much a sure-fire thing, which derisks the trade, and if Strickland does his bit like Boris says, we get a bonus on the other three. I like the structure.’

  Malevsky smiled.

  ‘Which one is it, Boris, this bank of yours? Is it a serious player?’

  Malevsky nodded.

  ‘Which bank?’

  ‘Fidelian.’

  7

  MARION ELLMAN PUT her points succinctly. Efforts to deal with climate change since Copenhagen had so far largely been a failure not only because the targets set at successive meetings were insufficient, but because enforcement had been nonexistent. But recognition of this problem was increasing. With recognition would come action to address the problem. The place for that was the next major round of negotiations, scheduled for Santiago in two years’ time. The Santiago round had to create a global enforcement mechanism that would ensure compliance. She was confident it would do that and cited a number of reasons for believing so. One of the key foreign policy objectives of the United States in the coming two years leading up to Santiago was to provide the leadership to ensure that goal was reached.