Matt Levine on Finance, Markets, and Financial Writing

Matt Levine — Bloomberg Opinion columnist and author of the Money Stuff newsletter — joins Tyler Cowen in Ep. 34 to range across derivatives, cryptoassets, IPO mechanics, efficient markets, and the Latin classics, exploring the production function behind some of the most widely read financial writing in the world.

Key ideas

1. Notional size is not the right measure of derivatives risk. The quadrillion-dollar figures cited in headlines measure notional value — the face amount of contracts — not actual exposure. What matters is the risk exposure: for an interest rate swap, that is the DV01 (how much the position loses if interest rates move one basis point); for an equity swap, the delta (sensitivity to the stock price). Confusing notional with risk is like measuring a law firm’s workload by the total value of every contract it has ever drafted.
2. Bitcoin’s best available valuation model is a store-of-value share. The currency model — estimating Bitcoin’s value from transaction volume and velocity — breaks down once people treat it primarily as a store of value rather than a medium of exchange. The better, if crude, approach: what percentage of global financial wealth might flow to Bitcoin as an alternative to gold? That figure, however uncertain, drives the price more than any intrinsic cash-flow calculus. Levine is persuaded more by repetition and first-mover inertia than by fundamental analysis.
3. Efficient markets is a conservatism, not a complacency. Levine describes himself as an efficient-markets optimist: if volatility is low, it is because sophisticated actors have reached a reasonable conclusion, not because the world is actually calm. Yet he concedes the corollary — efficient markets also means it is hard to make the world better than it is, because you cannot easily see past what everyone else already sees. Markets have probably grown better at separating financial asset prices from emotional reactions to the news, including political noise.
4. IPO underpricing is a feature, not a failure. The investment bank’s fee does not equal the first-day pop. The bank earns its cut doing pre-IPO price discovery — one-off negotiation with large investors in the absence of any observable market price, work that is structurally more like M&A than like trading. The deliberate discount relative to that discovered price rewards early investors for taking the leap of faith, and no rational seller prices the stock down. The system persists because everyone — company, bank, and early investors — prefers the stock to go up on day one.
5. The production function for daily financial writing is productive panic. Levine identifies two inputs: the metabolic rhythm of daily deadline pressure (he writes reliably in a panic every day but would do so every three weeks on a weekly schedule), and ruthless selection of topics where he has a genuine advantage or something new to say. The background is a career bridging investment banking (covering corporate clients, structuring equity derivatives, underwriting convertibles) and legal training, which taught him to explain economic intuitions — rather than legal mechanics — to smart non-specialists.

Content

Derivatives: notional versus risk

Levine opens by deflating the quadrillion-dollar derivatives headline. Professionals working in the market think in terms of actual risk exposure — the DV01 for interest rate products, the delta for equity derivatives — rather than notional. The notional figure counts the face value of every short-term interest rate swap outstanding, and the suggestion that you could lose a quadrillion dollars on such a book is, in his word, something that invites laughter. The 2008 crisis implicated a specific set of exposures — largely mortgage-credit derivatives — not the derivatives market as a whole.

On the question of centralising derivatives risk into clearinghouses (a post-crisis regulatory trend), Levine is mildly sceptical. A clearinghouse — a central counterparty that stands between every buyer and seller, guaranteeing the trade — is, he argues, more susceptible to moral hazard than a bank. A bank’s traders do not want to lose money; a clearinghouse, as a member association ultimately reliant on its members for capitalisation, has slightly more attenuated incentives to avoid blowing up.

Cryptoassets and the limits of pricing models

The currency model for valuing tokens — total transactions divided by velocity equals total market value — made intuitive sense when Bitcoin claimed to be a medium of exchange. Levine no longer finds it persuasive because Bitcoin’s advocates have shifted to a store-of-value narrative, which severs the link to transaction volumes. His substitute: estimate what share of global financial wealth might migrate from gold to Bitcoin, on the assumption that people seeking a non-sovereign store of value will reallocate some fraction of gold holdings. It is a blunt instrument, but it captures what appears to drive actual prices.

On CryptoKitties — non-fungible digital collectibles priced during the 2017–18 frenzy at steep premiums — he notes that genuine derivatives markets are marks of maturity: they allow participants to fine-tune their exposure to a well-understood underlying. CryptoKitties, built on top of Ethereum when no one fully understands what Ethereum is, run in the opposite direction — they make exposures stranger and more opaque, not more precise.

The audience question on limits to arbitrage elicits his most direct concession: asymmetric buy-sell frictions at some exchanges (easy to deposit, slow to withdraw), combined with the structural danger of shorting a highly volatile asset, plausibly cause Bitcoin to trade above fair value even by the standards of his own efficient-markets priors.

Low volatility, high prices, and efficient markets

Cowen presses Levine on a 2018 puzzle: VIX (a common measure of expected stock-market volatility) near 50-year lows, negative real yields on government bonds, elevated equity prices, and a raging Bitcoin market — all simultaneously. Levine’s preferred explanation is a partial decoupling of financial asset prices from human emotional reactions to news. As investing has grown more technological and systematic, prices may respond less to noisy signals — political headlines, for example — that turn out not to affect long-run cash flows. He is drawn to this explanation without being certain of it.

He describes himself as an efficient-markets conservative: the price is the price because a large pool of people smarter than he is reached it. Asked about his single biggest worry, he admits he does not have one — he has reconciled himself to the low-volatility puzzle by trusting the pool of sophisticated actors. His exception: ICO frauds — initial coin offerings, where issuers sell tokens to the public, often without the investor protections applied to conventional securities — which he argues should be a priority for SEC enforcement on both retail-protection and market-integrity grounds.

IPOs and price discovery

Cowen frames the IPO puzzle: investment banks take a large fee; auctions have been tried and not obviously outperformed; the first-day pop is persistently predictable in direction. This seems hard to reconcile with any version of efficient markets.

Levine’s answer has two parts. First, the bank’s work — one-off negotiation with large investors in the absence of any visible market price, researching the company, building a book of demand — is closer to M&A advisory than to market-making. It is legitimate price discovery in a context where no market exists yet. Second, the deliberate underpricing is rational: early investors need an incentive to take a leap of faith on an illiquid, unpriced company; sellers (who retain most of the stock) gain nothing from a lower price; and the bank’s fee is a separate payment for the discovery work, not a claim on the pop.

The production function

Cowen closes by asking Levine to articulate his production function — how he writes something clear, lucid, witty, and informative most mornings, covering law, finance, history, and more. Levine credits:

• Productive panic. He has the right metabolic rhythm for daily output. On a weekly deadline he would produce roughly every three weeks. The daily pressure is not pleasant but is reliable.
• Selection discipline. He writes only where he has a genuine advantage. If he wrote a take on whatever political event is dominating the news cycle, it would be the fiftieth-best of twelve thousand written that morning. Writing about an obscure FIRC regulation, he might be one of twenty people; writing about KodakCoin, perhaps one of twenty. The constraint — write only when you have something to say — is a rare flexibility that Bloomberg’s broader coverage provides.
• Cross-desk exposure. His banking career bridged coverage banking (meeting corporate clients), equity derivatives (structuring products as a principal against a trading desk), and convertible bond underwriting — three quite different perspectives on finance. The habit of explaining economic intuitions — not legal mechanics — to intelligent non-specialists (CFOs, for instance) transfers directly to his current work.

Classics, Horace, and the Iliad

Levine read classics at Harvard before law school. Cowen’s Horace quiz — distinguishing Levine’s writing from the Epistles and Odes — produces consistent correct identification. Levine admires Horace’s remove: the cynical, world-weary posture of the later Odes, in contrast to Catullus’s hotheaded romanticism, is the posture he aspires to as a columnist who professes to hold no opinions. He extends the analogy to internet writing more broadly: Buffy the Vampire Slayer represents a sensibility — colloquial surface, serious subtext — that the internet and Levine’s newsletter both inherit.

His reading of Iliad Book 9, where Achilles declines the Greek embassy despite knowing that staying means immortal fame and death while leaving means long life and obscurity, he treats as the original existentialist text: the most celebrated heroic warrior in Western literature explicitly choosing the unheroic option, at least temporarily. The forcing of that choice at the apex of Greek culture prefigures everything that follows.

Related

• Matt Levine — guest
• Tyler Cowen — host
• What Makes a Great Investor — theme; efficient-markets conservatism and the logic of indexing bear on the investor mindset
• Value Investing — concept; discussed tangentially via the M&A empirical literature and the appeal of active management