Leading off with a riotous bit from the Financial Times via the relentless Matt Levine,i here’s the whole enchilada because it’s just too good to chop up:
I want to read the risk factors here:
International investors bought bonds backed by the crime proceeds of Italy’s most powerful mafia, according to financial and legal documents seen by the Financial Times.
In one case, the bonds — backed in part by front companies charged with working for the Calabrian ’Ndrangheta mafia group — were purchased by one of Europe’s largest private banks, Banca Generali, in a transaction where consulting services were provided by accountancy group EY.
An estimated €1bn of these private bonds were sold to international investors between 2015 and 2019, according to market participants. Some of the bonds were linked to assets later revealed to be created by front companies for the ’Ndrangheta.
“Nice perfected security interest you’ve got here,” the risk factors should say. “Shame if anything were to happen to it, you know what I mean?”
Apparently the story is that the ’Ndrangheta ran some corrupt businesses providing health-care-related services (ambulances, funeral services, food in refugee camps) to government health authorities in Calabria. They would bill the government for those services. This involved a mix of extortion, “widespread fraud and double billing of invoices.” Instead of just collecting money from the government, though, the ’Ndrangheta would securitize the invoices for the money that they’d extorted or embezzled:
Under EU law, overdue invoices owed by state-connected entities incur a guaranteed penalty interest rate. This makes them attractive for special purpose vehicles, which place them into a large pool of assets and issue bonds backed by the expected cash flows from the future settlement of the invoices.
For instance:
One example of how money tainted by ’Ndrangheta activity ended up in the legitimate international financial sector is a so-called special purpose vehicle called Chiron.ii In May 2017, this was one of numerous such entities established by companies specialising in healthcare financing in Italy.
The Chiron vehicle bought up close to €50m of unpaid healthcare invoices, including bills originating from Calabria and other parts of southern Italy. … One of the companies that contributed to Chiron’s invoices was Croce Rosa Putrino SRL, an ambulance and funeral company servicing the hospital in Lamezia Terme. In late 2018, police arrested 28 people, after an investigation by the public prosecution office of Catanzaro alleged that various front companies for local ’Ndrangheta families, including Croce Rosa Putrino, had seized control of the hospital’s funeral, ambulance and other health services. The case is still being prosecuted.
I mean, why not. If you’ve got a good enough extortion racket, it will have stable and predictable cash flows; why shouldn’t you get non-recourse financing by assigning those cash flows to a special-purpose vehicle and then selling bonds out of the SPV? That’s the basic move of modern finance: You put cash flows in a box and sell bonds referencing the box, and the goal is always to find new things to put in boxes. If you put a thing in a box that has never been put in a box before, you give investors access to a new asset class, a new thing to bet on, a new set of cash flows that might be uncorrelated with the rest of their portfolio. “Diversify your portfolio with some extortion bonds,” an investment banker could say to a pension fund, and it is not a … terrible … pitch? I mean I guess you might get in trouble. Also the government might try to deny payment on the invoices—due to them being, you know, criminal—and then you’d lose your money. But those are uncorrelated risks, everyone’s favorite kind of risk, and the interest rate is presumably high.iii
The investment banks, advisers and investors all say they were trying to invest in legitimate health-care receivables and did due diligence to avoid financing crime, and it seems like Chiron wasn’t mostly mafia receivables. It is not like there is an entire sector of asset-backed securities for extortion and embezzlement. Give it time though. Here’s a quote about the people running the ’Ndrangheta now:
“A number of the younger generation, those who I grew up at the same time as, have degrees from the London School of Economics or even Harvard. Some have MBAs,” says Anna Sergi, a Calabrian-born criminologist at the University of Essex. “They live outside Calabria and appear like respectable businessmen, not directly involved in street-level illegality but there to offer technical expertise when it is needed.”
It’s like anything else; the industry starts small and scrappy, with people who really care about the work itself (extortion), but when it gets lucrative enough it starts to attract Harvard MBAs, until eventually real innovation stalls and everyone spends all their time on financial engineering and optimizing capital efficiency.
We are in the early stages of extortion-backed securities but it is a predictable path. Soon there will be mafia quants, hired to optimize the portfolios and engineer arbitrages and game the ratings agencies. “The senior tranche of this bond should be rated AAA because, while the probability of any one business refusing to pay protection money is X, the historical correlation among businesses refusing to pay is only essentially zero, so there is no real risk of eating through the credit support,” the mafia quants will argue to the ratings agencies, and the big guy behind them with a lead pipe will add some support to their mathematical arguments. I would absolutely watch—I may have to write—a movie about a mafia ABS quant.
Eventually the ’Ndrangheta will move to an entirely originate-to-distribute model, with no “skin in the game” in its extortions; it will send low-level criminals to extort promises to pay from people with no assets or income in rushed five-minute conversations, securitize those promises, and not have to worry about collecting. Its underwriting will decline, as will its collection efforts: Why bother breaking people’s legs if their payments are going to anonymous bondholders? The ’Ndrangheta securitizers will become so disillusioned with their origination practices that they will start shorting their own products, buying credit default swaps to bet on defaults in the bonds they structure. Then they’ll go to local businesspeople and threaten to break their legs if they do pay their protection money. The triumph of financial capitalism will be complete.iv
Now I happen absolutely love this 21st century ‘Ndrangheta trade storyv because it shows just how thin and ridiculous is the line between “legal” and “illegal,” between “above-board” and “below-board,” between “right” and “wrong.” I mean, just because one group of debt enforcers wears a blue uniform with a shiny plastic badge pinned to their lapel, while another group of debt enforcers wears an open-collared white dress shirt with the sleeves rolled-up to hide the specs of bolognese sauce, doesn’t mean that A ≠ B! Costumes are just costumes, after all. They’re used for social ranking more than anything, but this is very culturally specific and in no way universal.
So it is that the “Bad Guys” will do bond issuances based on sketchy shit while the “Good Guys” would, um, only ever be super truthful except for maaaaybe that one time in 2007! Right?! I mean, can’t we tell which is which because the Fed perpetually bails out one and not the other? What other arbiter of “Goodness” could there be but approval from our navel-gazing socialist overlords?
All of which dovetails neatly into the latest parental framing exercise we’re trying with our boys. After my mother’s penthouse apartment was broken into recently – a thief stealing her backpack and laptop in the middle of the night – our eldest son was duly concerned. Not that I did anything to allay his initial fears,vi but that particular pothole being now patched, we’re using this “lesson learned” to leverage a new phrase: “There are no bad people, but sometimes good people do bad things.”vii
This isn’t to absolve bad actions – if you fuck up badly enough you should still be hung from a tree – but as parents we’re hoping that this framing of actions vs. essences will be helpful for the little menschen in navigating the increasingly blurry information landscape,viii encouraging them to assume trustworthiness in others.ix The more greys we can shine a light onx and the more confidence we can inspire at this impressionable age, the better.
Goodness knows our boys have already been struck with enough fear (and scarring?) by COVID these last few months – being barred from playing with friends, seeing grandparents, going to swimming and skiing lessons, and attending preschool – that they don’t need any more flak from their roommates. And although everything is pretty well back on track now with family, friends, and programs, the edge of the knife isn’t gone just yet and we can’t forget that.
So while the Calabrians will be the first to tell you that the world isn’t so Black & White – no matter how much you capitalise your Nouns like Germans – there’s still only so much good that good people can do.
Now, as ever.
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- “Money Stuff: There Are Extortion-Backed Bonds Now. Also Robinhood, liquidity, Kanye for President and corporate parody videos.” By Matt Levine July 9, 2020 (archived). ↩
- Not to be confused with the very, very, very fast Bugatti by the same name. ↩
- Who doesn’t love uncorrelated risks? Crazy people, that’s who! ↩
- Financial capitalism isn’t in its “late stages” you say? Hmmm I guess we’ll just have to project our envy and shame another way… ↩
- In many ways this ‘Ndrangheta extortion trade is a suitable successor to the Sonny Vleisides / Butterfly Labs trade of 2013, but you’re probably too young to remember that one. ↩
- 4-year-old: Bad people stole Safta’s backpack! But bad people aren’t real, they’re just in shows and pretend [clearly trying to console himself]
Me: [Completely missing the self-consolation angle and taking the statement head-on] Oh bad people are definitely real, but they mostly live downtown by Safta’s house, not by our house
/me thinks he’s cured an annoying bit of naiveté while also comforting his child about the safety of our domicile, but then notices an unusually shocked reaction on The Girl’s face as she notices horrified look on 4-year-old’s face.
/me realised he missed the mark a bit and actually told the kid that bad people are going to break into our house next.
/me blames “the spectrum” thing while he still can ↩ - I mean, don’t ISIS fighters love their families? Don’t they love their countries? What about Dresden in 1945? Doesn’t that prove the point? ↩
- Speaking of the increasingly blurry information landscape, y’know who called the banning of Huawei and TikTok 4 long years ago? This guy! ↩
- Trustworthiness, note, is not the same as trust. ↩
- Greys, or, ahem, off-whites? ↩