The Juicy Stuff Doesn’t Hit The Pit

New Substack recommendation: The Old Rope by @varianceswap

Here’s a fun excerpt from the latest issue:

Real estate in the private market exists in between the two preceding applicable stock market concepts: you want to buy quality, and you want to buy it at the price you’d buy distressed assets at. But you’re okay just buying quality- after all the private market real estate investor needs to find an asset to 1031 exchange within 45 days of a sale. Readily available dirt-cheap bankruptcy-remote leverage from commercial lending operations provides the private real estate investor with a nearly-government-guaranteed reasonable return. Buy quality and stay rich (never pay taxes).

Because private market commercial real estate is private, rarely do these quality assets sell at generous prices to counterparties outside of the “boys’ club” or in-network, off-market participants for whom favors have already been traded, country club memberships have been synched, and alumni events have been planned. This is what I would call the System 1A of real estate investing. This is where common misconceptions occur with real estate: generalist laymen see these slam-dunk transactions and the seemingly risk-free returns generated from them. They observe “dumb people” getting rich not knowing these people are actually repeat-players in a multi-generational game. They play nice with each other to stay in the club and stay rich.

Damn, this brought me back to some of the cronyism in the trading pits. On the NYMEX/COMEX floor brokers were also allowed to be traders. They could trade for their own accounts, but they were not allowed to trade against their own flow. Well, if you can imagine the incentive, you can imagine the outcome.

Here’s the scene: market makers stand in a pit while brokers run their business out of surrounding booths. The booths were the phone banks outside the pit where broker clerks would talk to the “upstairs” customer. If a juicy market order, especially one without a lot of risk or deltas such as a tight vertical spread or butterfly, there was a silent feeding frenzy. Sal couldn’t trade against his own flow, but knew that Tony would get him “next time”. You know, like a running bar tab. Better yet, maybe your sister starts her own brokerage competing (cough) for the same flow.

If a 100 lot of butterflies traded in the pit for a credit (you heard that right…the meat of a butterfly trading over the wings) you can safely deduce that several hundred lots never made it to the pit.

It’s worth reprinting the last line of that excerpt:

They observe “dumb people” getting rich not knowing these people are actually repeat-players in a multi-generational game. They play nice with each other to stay in the club and stay rich.

And if resentment to this old word order wasn’t high enough, we had the experience of watching some of these “dumb” people who owned several, sometimes tens of seats on the exchange, receive nearly $10mm a pop for them when the exchange demutualized.

[Side note: I worked for a SIG at the time who owned a bunch of seats. They made a bonanza buying NYSE seats before the stock exchange went public so they were ready for the same trade ahead of the NYMEX IPO. One of our assistant traders spent most of his time going to the admin office in the building to find the bid/ask on seats and get the color on who was looking to buy or sell. Probably didn’t take much more than regular coffee and donuts to keep in the office clerk’s good graces. On a personal note, I got some shares as part of the seat lease agreements that SIG had to (probably begrudgingly, since prop firms are ruthless maximizers) give to the people whose names were actually on the lease. The IPO priced at $59 bucks but the NMX shares opened on the first day at $120. I sold the opening print along with many other traders. It was a free $25,000 or so. The stock closed at $152 that first day so I left a lot on the table, but even worse was that my mind’s comparison monster left me feeling sour. A lot of folks down there became generationally rich.

And if they were smart, took the money and ran. It was a countdown to the end of floor trading.

[Extra salt in the wound — there was some arrangement where you had to sell your free shares through Merrill (I think) and they charged like a $500 brokerage fee. And yes, this was 2006, not 1966.]

Enough story time. Go read The Old Rope. The second post I’d read is:

Fake Life, True Wealth (2 min read)

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