If you are a retail stockbroker, sometimes your customers will come to you looking to do a trade. “I want to buy this Nvidia,” they say, or “this Bitcoin,” or “I want to buy the S&P 500 index and also write monthly out-of-the-money calls on it for income.” And if their idea is basically sensible you will try to help them do the trade they want to do. Sometimes this means just buying a stock for them; other times it might mean lending them money to buy it on margin, or lending them stock to short, or writing them derivatives or structured notes to get exactly the payoff profile they want.

And then other times you will go to the customers with ideas, saying “hey you should really buy this Nvidia” or “diversify into some Bitcoin” or “consider writing covered calls on your S&P portfolio.” You will do this for the obvious combination of reasons:

1. You will make money by executing these trades for them, particularly if they involve weird derivatives.
2. You think (reasonably or not) that these trades will be good for them, and you want what is best for them.
3. You want to provide customer service; you want to do stuff; you want them to feel like you are paying attention and coming to them with ideas. This is not quite the same thing as Point 2. You will be somewhat tempted to come to your customers to propose popular ideas, or cool-sounding ideas, ideas that impress them and make them think you are clever. That will make them respect you more and invest more money with you, even if the ideas turn out to be bad. “Just put it in index funds” might be good advice, but they can get that anywhere; they want some pizzazz from you.

These things interact: The more customers come to you saying “I want to write covered calls for income,” the more you will be tempted to go to the other customers and say “hey writing covered calls for income is very popular right now, you should do that.” 

I am describing all this stuff that a retail stockbroker might do, but somewhat hypothetically. A lot of people do still talk to their brokers on the phone, calling for ideas and stock tips. A lot of people use apps, though. A lot of people are self-directed investors, just buying and selling stocks by pushing buttons on their phones without ever talking to a human broker who could execute their more complicated ideas or suggest new ones.

Fortunately there are exchange-traded funds. The way I think about the ETF industry is that it is the modern source of pizzazz in retail investing. There are lots of trades that retail investors want to do, and/or that someone wants to market to them, and ETFs exist to package those trades into convenient formats. This can be helpful for brokers and advisers: Instead of coming to customers and saying “here’s a trade you can do,” explaining the trade in detail, and then working hard to execute the various legs of it, the brokers can go to customers and say “here’s a trade you can do in ETF format,” point the customers to the ETF’s disclosures to explain it, and then just buy the ETF to execute the trade. Everything is efficient and neatly packaged, so the brokers don’t have to do their own work in explaining and pricing and executing the trade.

And it’s even more convenient for self-directed investors: Instead of having to go to a stockbroker to put on some weird derivatives trade, you can buy it yourself, in ETF form, by pushing a button on your phone. The fun pizzazz trades that people want from their brokers, and that brokers pitch to their customers, get turned into ETFs so that anyone can buy them directly.

So here’s this:

Tidal Investments plans to offer a family of actively managed exchange traded funds that take leveraged long positions in pioneering and innovative companies and pair those with short positions in their legacy counterparts, a regulatory filing shows.

The new Battleshares family of strategies comprises eight ETFs across the entertainment, finance, news and technology sectors, according to the filing. The Battleshares NVDA vs INTC ETF, for example, will take a leveraged long position in Nvidia and a short position in Intel. ...

Each ETF will target a leveraged long position of 180 to 220 per cent in the pioneer company and a negative 80 to negative 120 per cent in the counterpart legacy leader, according to the filing.

Vildana Hajric wrote about these ETFs last week in the Bloomberg ETF Brief newsletter, noting that they are a new category: Classically ETFs represent diversified portfolios (index-y, thematic, actively managed, whatever) of stocks, and more recently there have been lots of single-stock ETFs, but these would appear to be the first two-stock ETFs. Hajric:

They’re not exactly single-stock ETFs, given that they’d each focus on two different companies. So what do we call them? …

Ben Johnson, head of client solutions at Morningstar, had a more NSFW suggestion: We could call them WT(ET)F ETFs. 

“Less provocatively, you might call them DIFM (‘Do it For Me’) single-ticker trade ETFs,” he said. “A lot of them replicate common trades and/or options overlays without all the complexity of a DIY (‘Do it Yourself’) approach.” …

While all of these were decent suggestions, my quest for a new category name was a ploy because all along, I had already planned to pick a moniker Katie Greifeld and I came up with as the winner: double-single-stock ETFs. 

Far be it from me to question Hajric or (my podcast cohost) Katie Greifeld, but I like the “Do It For Me” description. This is a way to take a moderately complicated trade — invest $100, take out a margin loan to buy $200 of Nvidia, also short $100 of Intel and rebalance periodically as prices change — and turn it into a single button to push on your phone. If you were going around looking to do that trade, this is a pretty convenient way to do it. And while you are paying for that convenience, it’s not clear that you’re paying much: Tidal might have cheaper leverage and lower trading costs than you do in your retail brokerage account, so it might be cheaper for you to do the trade through the ETF.

But Tidal is not only making it easier for you to execute this idea; it’s also suggesting this idea to you. It’s marketing it. You can read about it and think “ah yes, Nvidia is in the news in good ways recently, and Intel is in the news in bad ways, and I should get do something about that.” And Tidal has something for you to do about it.

I love this? It is just such a life-finds-a-way sort of story. Any sort of trade can be packaged into an ETF, as long as you can write a cool elevator pitch for it, and eventually every trade will be.

Jack Bogle famously hated ETFs, for reasons that used to strike me as bad, but you can see why he’d hate this. You could tell a story of investing that is like:

1. People used to think about what stocks to buy, get advice from brokers, and then buy some stocks rather than others hoping to make money. This could be hard and intimidating, but it was pretty fun if you were into it, and sometimes the results were exciting.
2. Financial theory discovered that actually most ordinary investors’ best bet is to just buy all the stocks in a diversified market portfolio and not think about it at all.
3. The financial industry built the index fund, to give retail investors low-cost access to that theoretically approved portfolio.
4. Then the financial industry built the index ETF, as a cleverer and more tax-efficient way to do index funds.
5. The investing problem for retail investors was in some rough sense solved. You can just buy a handful of big index funds — or maybe one life-cycle fund that buys index funds — and hold them until you retire. Simple tools (self-directed brokerage accounts, robo-advisers) exist to make that easy. The whole problem of thinking about your investments, learning how they worked, trying to choose good ones, getting excited if they went up, etc., seemed like it could be automated away.
6. Apparently people got bored?
7. It turned out that you could put all sorts of exciting fun trades into ETFs.
8. And now “I think Nvidia is going to eat Intel’s lunch” is a thesis that exists in an ETF package.

We talked yesterday about a way to harvest tax losses. You have a diversified portfolio of securities. Some of them have gone down. You would like to deduct your losses on your tax return, to offset taxable gains elsewhere. In order to deduct them, you have to “realize” the losses, by selling the stocks that have gone down. That is risky, though: You have this diversified portfolio, and it will be out of balance if you just sell all the losers.

What you want to do is sell all the losers, realize the losses, and then buy them back, so that you remain fully invested. But you can’t do that: The tax rules say that you can’t deduct your losses on a stock if you do a “wash sale,” meaning selling it and then buying it right back. 

What I said yesterday is that this problem is easily solvable because, to a rough approximation, “stocks are all kind of the same.” A diversified portfolio of stocks can be described reasonably well by its exposure to some list of factors (the market, industries, size, value, etc.), and you can find some other portfolio of different stocks with similar exposures to those factors. So if you have 30 stocks that went down, you sell those and buy 30 different stocks that are reasonably similar. It’s not a wash sale, because you bought back different stocks, but it’s good enough, because the stocks you bought are decent substitutes for the ones you sold. This is not tax, legal or investing advice. 

Meanwhile if instead you own exchange-traded funds, and one of them goes down, you can pretty easily sell that, deduct the losses and buy a different ETF with … the same stocks? Similar stocks? A broadly overlapping set of stocks that serves exactly the same purpose in your portfolio? I don’t know, here we are even farther from tax advice, and I would not necessarily want you to try this at home, but a reader did point me to this paper from July:

Tax wash sale rules prohibit investors from recognizing capital losses when they sell and immediately repurchase substantially identical securities within short windows. This study examines whether institutional investors use ETFs to circumvent the wash sale rule. We find incumbent ETFs experience more trading volume upon the introduction of nearly identical ETFs, particularly when recent returns are negative. Tax-sensitive institutions' investment in highly correlated ETFs has proliferated in recent years, exceeding a quarter of AUM. Further, we find that tax-sensitive institutions holding more ETFs are significantly more likely to engage in swapping near-identical ETFs. This swapping behavior has become widespread, with tax-sensitive institutional investors swapping $417 billion of near-identical ETFs since 2001. Overall, we estimate that a one standard deviation increase in ETF swapping results in an incremental $138 billion of aggregate losses harvested for tax-sensitive institutional investors.

That’s “ETFs and the Wash Sale Loophole,” by Michael Dambra, Andrew Glover, Charles M.C. Lee and Phillip J. Quinn. We talked last year about a ProPublica investigation into tax-loss harvesting that wealth managers do for wealthy investors. ProPublica reported on some cases of investors selling ETFs for losses and then buying different ETFs with similar exposures, and noted:

In theory, the stocks inside two different funds could overlap so much that the IRS might deem them “substantially identical” and thus disallow any tax loss on such a trade.

In practice, however, there is only one scenario in which the wash sale rule is consistently enforced. IRS regulations require brokerages to mark a trade as a wash sale if, in the 60-day period around the sale, the investor buys, in the exact same account, the exact same security (with the same ID, called a CUSIP number). The amount of the forbidden loss is then noted on a form, called a 1099-B, that brokerages send to the IRS each year to detail stock trades.

Beyond that, the IRS has provided no clear guidelines. Instead, the agency has commented on only a few little-used scenarios, while directing taxpayers to “consider all the facts and circumstances” of a trade. Is it OK to swap Vanguard’s ETF tracking the S&P 500 for Blackrock’s version of the same index? Some tax experts say yes, some say no. Besides the IRS’ vague guidance, there are few relevant court cases, and all are decades old. (The IRS declined to comment.)

ProPublica’s analysis of its IRS data found dozens of examples of taxpayers switching between funds with the exact same holdings.

If the wash-sale rule is actually “the only thing that is a wash sale is buying and selling the exact same CUSIP,” then it does seem pretty easy to avoid.

A basic idea is that mortgages are pretty safe. If someone buys a house for $500,000, and you lend them $400,000 secured by a lien on the house, you’ll probably get your money back. If they stop paying, you take the house, and you can probably sell it for more than $400,000. Houses retain their value pretty well, and in fact that value usually goes up over time. Not always! Lots of ways to go wrong with mortgages. But broadly speaking a good idea, and a very popular one.

And then another idea is that you can package a bunch of mortgages and make them even safer. Lend $400 million against 1,000 houses worth $500 million, and there’s an even better chance that you’ll get back more than $400 million. A few borrowers might default and their houses might turn out to be worth less than they borrowed, but if you diversify over a lot of different houses what are the chances that a lot of them will go wrong? The answer is “not zero,” it turns out, but again the idea isn’t terrible.

And then a third idea is that you can slice the cash flows to make some of them even safer. Lend $400 million against 1,000 houses worth $500 million, and package the $400 million loan into bonds. The first $200 million you get back goes to the holders of Tranche A bonds, the next $100 million to the Tranche B bonds, the next $90 million to Tranche C and the last $10 million to Tranche D. Maybe lots of borrowers will default and their houses will turn out to be worthless and there will be a huge crisis and even diversified portfolios will lose money, but not the Tranche As, right? That would require wiping out the $200 million of B and C and D tranches; it would require the houses to lose more than half of their value. So those Tranche A bonds can get AAA ratings from ratings agencies and investors will buy them as perfectly safe investments.

And then a fourth idea — or maybe it’s more like subtracting a previous idea? — is to do that slicing with a single mortgage on one big building. You have an office building that’s worth $500 million, you borrow $400 million against it, you slice that debt into tranches, and the, say, $200 million that gets repaid first is much safer than the rest of it, so it gets a AAA rating. What are the chances that this big office building downtown will lose more than half of its value and impair the AAA-rated debt? 

I mean, not that low? “It is virtually impossible for a diversified portfolio of prime office buildings to lose two-thirds of its value” is the sort of thing that (1) sounds a bit sketchy when I say it like that but (2) is reasonably acceptable as a claim in modern structured finance. But “it is virtually impossible for a single office building to lose two-thirds of its value” seems much sketchier. Bloomberg’s Carmen Arroyo, Natalie Wong, Aaron Gordon and Christopher Cannon report:

Of all the hot spots across global finance that were upended by the pandemic, few remain as fragile as the commercial mortgage-backed securities market. And within this market, the pain is most acute in a new breed of bonds, known as SASBs, that buildings like 1407 Broadway represent.

SASB stands for “single asset, single borrower”: Just a mortgage on a building, sliced into tranches, some of which are rated AAA: 

A Bloomberg analysis of almost every SASB tied to a US office property, more than 150 in all, revealed that creditors across numerous deals are on track to get only a portion of their original investment back. In multiple cases, the losses will likely reach all the way up to buyers of the AAA portions of the debt.

This is in large part because unlike conventional CMBS, which bundle together hundreds of property loans, SASBs are typically backed by just one mortgage tied to one building. ...

“There will be deals that are horrific, where the AAAs may not be paid off in full and there’s basically no bid for the asset,” said TJ Durkin, head of structured credit and specialty finance at TPG Angelo Gordon. “The investment community thought the real estate would never become obsolete. It ended up being wrong.” …

“The AAA rating is designed to be a debt security that would typically default less than once every 5,000 years,” said John Griffin, a chaired professor of finance at the University of Texas in Austin. “Yet, here we are not far from the financial crisis observing defaults,” he said, adding that “it does not appear that the major issues in structured finance have been fixed.” …

Over a quarter of outstanding SASB bonds originally rated AAA by S&P have had their credit rating cut, compared to just 0.4% for so-called conduit CMBS that pool large numbers of mortgages, according to data from Barclays Plc. For KBRA, 17% of outstanding AAA SASBs have been downgraded, versus just 0.3% of conduits.

“Rating agencies need to revisit how they rate the AAA in these deals if they are single asset, as they don’t have the benefit of pooling,” said Leo Huang, head of commercial real estate debt at Ellington.

I sometimes think that the ultimate purpose of finance is to find progressively more intricate ways to package cash flows to get AAA ratings. SASBs are weird in that they are, relative to the previous state of the art (diversified commercial mortgage-backed securities), a simpler way to package cash flows to get AAA ratings. 

I really do wonder how people thought this would work:

JPMorgan Chase has begun suing customers who allegedly stole thousands of dollars from ATMs by taking advantage of a technical glitch that allowed them to withdraw funds before a check bounced.

The bank on Monday filed lawsuits in at least three federal courts, taking aim at some of the people who withdrew the highest amounts in the so-called infinite money glitch that went viral on TikTok and other social media platforms in late August.

A Houston case involves a man who owes JPMorgan $290,939.47 after an unidentified accomplice deposited a counterfeit $335,000 check at an ATM, according to the bank.

Here is that Texas complaint:

On August 29, 2024, at a walk-up ATM at 9:42 p.m. at night, a masked man deposited a check (the “Check”) into Defendant’s Account in the amount of $335,000.00 (the “Funds”). 

After the deposit, on August 30, 2024 at 11:10 a.m., Defendant withdrew $10,000.00 in-person at a Houston-area Chase branch. Approximately one hour later, Defendant wired $100,000.00 from a different Chase branch. Then, two hours after that, Defendant purchased a cashier’s check for $150,000.00. Defendant continued his scheme the next day and withdrew $40,000.00 and $20,000.00 just two minutes apart. In sum, Defendant has withdrawn or transferred at least $320,000.00 of the original $335,000.00 counterfeit deposit.

I suppose the answer is that they thought they’d just disappear: The Texas “Defendant has not responded to any of Chase’s correspondence, has not communicated with Chase in any other manner, and has not returned the Funds.” If the trade here is “open a Chase account, write yourself a fake check for $335,000, deposit it one night while wearing a mask, walk in the next day and withdraw the money, then disappear forever,” I suppose that might possibly have positive expected value. Still seems like a lot of work.

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