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Programming note: We’ll be off this Monday for the Fourth of July but will be back in your inboxes on Tuesday.
HOLIDAY WEEKENDS ARE A GREAT TIME TO UNWIND — If you’re on a trading desk at a crypto lending platform, “unwind” will mean something very different to you this Fourth of July.
The swift collapse of digital asset prices over the last two months sparked a cascade of liquidations at multibillion-dollar crypto businesses after they were caught flat-footed on highly levered bets on Bitcoin and digital startups.
The downturn has already forced at least one major crypto hedge fund, Three Arrows Capital, into liquidation. Celsius Network, a popular lending platform that promised retail customers double-digit yields for deposits, has frozen trading and withdrawals. Other online trading and depository businesses like BlockFi and Voyager have had to take on rescue financing from entities linked to FTX founder Sam Bankman-Fried.
“Most of [the troubled businesses] were leveraged — or they had loaned to someone who was leveraged and now can’t repay that loan,” Bankman-Fried, a billionaire and political megadonor, said in an interview on Thursday. He added that FTX is looking for opportunities — no doubt on favorable terms – to “bail out, you know, places where customers would otherwise be underwater.”
Against that backdrop, the SEC on Wednesday announced that it was blocking Grayscale Investments’ application to convert its $12.9 billion Bitcoin trust – the largest Bitcoin-holding investment fund globally – into an exchange-traded fund whose shares would be available on NYSE Arca.
That decision has a bearing on the liquidity crises facing certain troubled firms like Three Arrows and BlockFi, both of which held shares in the trust (GBTC) prior to their recent troubles. (Both firms did not respond to requests for comment).
Shares of Grayscale’s Bitcoin trust are currently traded over-the-counter and subject to restrictions that limit their ability to be bought and sold. Since early 2021, those shares have traded at a steep discount to the value of the Bitcoin tokens held in the trust.
That wasn’t always the case. When the share price was above the trust’s net asset value, investors could buy up shares with Bitcoin – which make up the trust’s underlying assets – and flip them to other investors at a premium.
Once that premium went away, “leveraged traders shit their gym shorts,” Ryan Selkis, a crypto investor and founder and CEO of industry data provider Messari, wrote in a research note on Wednesday. “No one knows how to unwind their leveraged positions and are left with Schroedinger’s bitcoin collateral: if you look at the GBTC shares, the position and its borrower are dead.”
Grayscale — as well its investors — have argued that those problems could be solved if the trust were allowed to convert into an ETF. That would lift certain trading restrictions and make it easier for GBTC shares to realign with the value of the vehicle’s Bitcoin holdings. The firm had deployed an aggressive lobbying and public relations strategy to make that case with both the SEC and Congress.
“The 28 to 30 percent discount that GBTC is trading at; that represents billions of dollars of unrealized shareholder value,” Grayscale CEO Michael Sonnenshein said in an interview on Thursday. “In that context, this is a very, very much missed opportunity on [the SEC’s] part.”
The agency, however, has repeatedly rejected other Bitcoin ETF proposals on the grounds that the vehicles couldn’t adequately protect investors from fraud or manipulation. Its 86-page decision letter on Grayscale’s fund makes the same case.
“SEC staff likes products to fit into well-defined slots like kids toys; crypto doesn’t easily fit,” Justin Slaughter, a former SEC and CFTC staffer who’s now policy director at the crypto investment firm Paradigm, wrote in a series of tweets on Thursday. “We’re at an impasse.”
To that end, the SEC’s decision on Grayscale wasn’t unexpected. Earlier this month, the firm tapped the former U.S. Solicitor General Don Verrilli to lead its legal strategy in the event of a denial. Grayscale has already filed a petition challenging the SEC’s decision in federal court.
It will take months, possibly more than a year, for Grayscale’s case to reach any sort of resolution. In the meantime, troubled crypto lending businesses and investment funds who had locked up their balance sheets with GBTC shares will have little recourse for generating much liquidity to pay off any of their outstanding loans.
Given the amount of leverage and risk-taking that fueled some of the industry’s excesses over the last two years – often in the absence of meaningful investor and customer protections – crypto skeptics aren’t clamoring for those groups to get thrown a life raft.
“The SEC’s overriding mission is to protect investors and that could not be more important than now after more than $2 trillion have been lost in crypto investments during just the last several months,” Better Markets President and CEO Dennis Kelleher said in a statement. “While the current crypto-crash, carnage, and seeming death spiral may not kill the product, investors are nonetheless suffering enormous losses and the SEC must act very, very cautiously before unleashing yet another vehicle for investors to lose money.”
KEY INFLATION GAUGE REMAINS HIGH — AP’s Paul Wiseman: “A measure of inflation that is closely tracked by the Federal Reserve jumped 6.3 percent in May from a year earlier, unchanged from its level in April. Thursday’s report from the Commerce Department provided the latest evidence that painfully high inflation is pressuring American households and inflicting particular harm on low-income families and people of color.
“The report also said that consumer spending rose at a sluggish 0.2 percent rate from April to May. Consumer spending is beginning to weaken in the face of high inflation. But it’s still helping fuel inflation itself, especially as demand grows for services ranging from airline tickets and hotel rooms to restaurant meals and new and used autos.”
POLITICO’s Garrett Downs has more on how food is one of the biggest driversof spiking prices: “The cost of meat, eggs and other edible items at the grocery store has been a big driver of the historic inflation and rose by 11 percent in the last year, surpassed only by increases in energy expenditures…A July Fourth cookout is expected to be 17 percent more expensive than last year, according to a recent survey.”
FORMER TREASURY SECRETARY GEITHNER: FED’S RATE PIVOT HIGHLIGHTS NEED FOR TREASURY MARKET FIXES — WSJ’s Nick Timiraos: “The Federal Reserve’s sprint to withdraw stimulus in the midst of concern that high inflation could be more persistent is underscoring the need to improve the resilience of the U.S. Treasury market, according to a report prepared by former senior policy makers. The Group of 30, an independent group of central bankers, financiers and current and past regulators, released the report to highlight the status of recommended overhauls to the $23 trillion market for U.S. government debt. The report followed an initial set of recommendations released last year to reduce the risk of a crackup in the Treasury market.”
A WORD WITH MFA’S BRIAN CORBETT — From Kate: MM sat down with Bryan Corbett, president and CEO of the Managed Funds Association, which has strongly objected to SEC Chair Gary Gensler’s aggressive regulatory agenda, including rules that would impose new reporting requirements for fund managers. A few takeaways from the conversation:
Why now? One of the group’s main arguments is that the current wave of proposals hasn’t been driven by a crisis or major legislation, like the 2010 Dodd-Frank Act. “In our mind, it’s hard to figure out what the problem is that he’s trying to solve with this voluminous rulemaking that’s coming at such a frenetic pace that it’s almost impossible for market participants – and the industry who have to deal with these rules – to thoughtfully respond to him and help provide thoughtful feedback.”
Market volatility: Corbett said some of the proposals are especially unwise at a time of heightened market volatility, warning they could reduce choices for investors. “The SEC proposal on dealers will actually push people out of the Treasury market and result in more concentration, less liquidity, and potentially more dislocations like we saw back in March 2020.”
Full steam ahead: The sense is that Gensler is racing to get as much done as he can before January, when Republicans could regain control of the House or Senate, Corbett said. “But he still has the votes, he still has the three-to-two majority, he still has an administration that will stand behind him. … Will there be more (congressional) oversight? Without a doubt. But does that stop him from moving forward on some of these? I don’t think so.”
Potential for lawsuits? “Right now we are working to effect the best possible outcome on these,” he said. “Should these rules pass in a form that our membership believes is fundamentally damaging to their ability to operate … we’re going to consider all options, and certainly legal challenge is an option to consider. But it’s premature until we see the final rule.”
ROE V. WORKPLACE:POLITICO’s Victoria Guida on what impact the Supreme Court’s decision to strike down constitutionally protect abortion could have on the American workforce: “While the likely impact of the ruling on the labor force isn’t clear-cut — some conservative economists say it could be minor — a wave of academic studies in recent decades suggest that the option to terminate a pregnancy increases economic freedom, especially for women of color.”
Tanner Daniel, former vice president of congressional relations at the American Bankers Association, will join the federal government affairs team at Citi starting July 5.
STOCKS SLUMP (AGAIN) — AP’s Damian J. Troise and Alex Veiga: “Wall Street racked up more losses for stocks Thursday, as the market closed out its worst quarter since the onset of the pandemic in early 2020. The S&P 500 fell 0.9 percent, its fourth consecutive drop. The benchmark index is now down 21 percent since it hit an all-time high at the beginning of the year. It entered a bear market earlier in June. … The market’s steep decline this year has all but wiped out its gains from 2021, what was a banner year for the market as it emerged from its previous bear market in early 2020.”
Markets post worst first half in decades, but that doesn’t say much for the second half — WSJ’s Akane Otani: “The good news for investors is that markets haven’t always done poorly after suffering big losses in the first half of the year. In fact, history shows they have often done the opposite. When the S&P 500 has fallen at least 15 percent the first six months of the year, as it did in 1932, 1939, 1940, 1962 and 1970, it has risen an average of 24 percent in the second half, according to Dow Jones Market Data.”
LIBOR TRANSITION ENTERS CRITICAL PHASE — Reuters’ John McCrank: “The one-year countdown began on Thursday to the end of the publication of the tarnished London Interbank Offered Rate, or Libor, for existing U.S. dollar-denominated contracts, and volatile market conditions have delayed the switch to new rates for some market participants.
“‘We have 12 months until D-Day from a legacy paper perspective,’ said Tal Reback, who leads KKR’s global Libor transition effort across private equity, credit, capital markets and real estate. ‘The next six to nine months are really the critical range because you alreadylost a few months due to market volatility this year,’ she said.”
POLL: PESSIMISM ABOUT THE ECONOMY IS GROWING — NYT’s Ben Casselman: “Americans are becoming more pessimistic about the economy, more worried about inflation — and now, more anxious about the job market, as well. Fifty-two percent of American adults say they are worse off financially than they were a year ago, according to a survey conducted for The New York Times this month by the online research platform Momentive. That was up from 41 percent in April, and was by far the highest share in the survey’s five years. Only 14 percent of Americans said they were better off than a year ago, the worst in the survey’s history.”
JPMORGAN EXEC WARNS OF RECESSION — Bloomberg’s Thygaraji Adinarayan and Achalee Worrachate: “Bob Michele kicked off his Wall Street career during the stagflation crisis of the early 1980s. More than four decades later, JPMorgan Asset Management’s chief investment officer says the economic outlook today looks even worse — with a US recession now looking more likely than a soft landing.