Money Stuff: The Tariffs Are Still Illegal

Well, sure, right:

Most of President Donald Trump’s global tariffs were ruled illegal by a federal appeals court that found he exceeded his authority by imposing them through an emergency law, but the judges let the levies stay in place while the case proceeds.

The US Court of Appeals for the Federal Circuit on Friday upheld an earlier ruling by the Court of International Trade that Trump wrongfully invoked the law to hit nations across the globe with steep tariffs. But the appellate judges said the lower court should revisit its decision to block the tariffs for everyone, rather than just the parties in the case.

“The statute bestows significant authority on the President to undertake a number of actions in response to a declared national emergency, but none of these actions explicitly include the power to impose tariffs, duties, or the like, or the power to tax,” the court said.

Here is the opinion. We have talked about this case a few times, including when it was filed and when the lower court struck down the tariffs, and it has always struck me as quite straightforward. The United States has a Constitution, and the Constitution gives Congress, not the president, the power to impose tariffs. Trump made up his own tariffs without any input from Congress, so they are unconstitutional.

The argument for the tariffs is that there is a statute, called the International Emergency Economic Powers Act of 1977, or IEEPA, in which Congress gave the president the power to “regulate … importation” in order to “deal with any unusual and extraordinary threat, which has its source in whole or substantial part outside the United States, to the national security, foreign policy, or economy of the United States, if the President declares a national emergency with respect to such threat.” Trump’s lawyers argued that IEEPA gave him the power to impose tariffs in an emergency, and the US trade deficit is an emergency, so he needs to have unlimited power to impose tariffs on every country. I have always found that argument pretty suspect; I wrote:

The idea seems to be that every trade policy of every country in the world, over the past several decades, constitutes an “unusual and extraordinary threat.” This is a strange way to use words! How can every instance of trade with every country be unusual? How, after decades of trade deficits, is a trade deficit extraordinary?

I still think that, but the appeals court had an even simpler reason for rejecting Trump’s arguments, which is that the IEEPA doesn’t actually say anything about tariffs at all:

Contrary to the Government’s assertion, the mere authorization to “regulate” does not in and of itself imply the authority to impose tariffs. The power to “regulate” has long been understood to be distinct from the power to “tax.” In fact, the Constitution vests these authorities in Congress separately. ... 

Indeed, there are important examples where Congress has granted the power to regulate to the executive branch without delegating the power to impose tariffs. … The Government’s suggestion would mean, for example, that Congress delegated to the SEC power to tax substantial swaths of the American economy by granting the SEC the authority to regulate various activities. …

Since IEEPA was promulgated almost fifty years ago, past presidents have invoked IEEPA frequently. But not once before has a President asserted his authority under IEEPA to impose tariffs on imports or adjust the rates thereof. Rather, presidents have typically invoked IEEPA to restrict financial transactions with specific countries or entities that the President has determined pose an acute threat to the country’s interests. …

For the reasons discussed above, we discern no clear congressional authorization by IEEPA for tariffs of the magnitude of the Reciprocal Tariffs and Trafficking Tariffs. Reading the phrase “regulate . . . importation” to include imposing these tariffs is “a wafer-thin reed on which to rest such sweeping power.” 

Also seems right. Anyway I am not sure what will happen here. The tariffs remain in place for now, even though they are illegal, which seems like an odd outcome. There will be an appeal to the Supreme Court, which has generally been more willing than lower courts to ignore precedent and declare that Trump can do whatever he wants, so that might still happen here. Or, as Bloomberg’s Isabel Gottlieb explains, there are various other statutes that do authorize the president to impose tariffs, and Trump could go back and use some of those. But: 

In general, these alternatives come with more limits and procedural restrictions, meaning there’s less leeway for Trump to impose tariffs virtually immediately and set the rates as high as he chooses.

“The difference between them is how much process they require,” said Ted Murphy, co-leader of the global arbitration, trade and advocacy practice at law firm Sidley Austin. “Why they chose IEEPA, I think in part, was because it comes with no required process. It’s a determination that the president can make on his or her own initiative: There’s no hearing, there’s no report, there’s no nothing.”

Yes, arguably the point of a constitutional legal system is to prevent the president from creating whatever taxes he wants with no process. 

I used to have a running section in this column called “people are worried about bond market liquidity,” because people were worried about bond market liquidity. These worries took various forms, but one went something like this:

1. Bonds used to be traded by big banks, which would buy and sell bonds for their own account based on customer demand.
2. Sometimes all the customers would get scared and would want to sell their bonds at once.
3. When this happened, the big banks would maintain orderly markets by buying the bonds from the customers at prices that were not that much lower than they were before the customers panicked. 
4. Why would the banks do that? One reason is that they had big balance sheets and could take a longer-term view than the customers: They knew that if they bought the bonds at a modest discount during panics, they could sell them at a nice profit in a week when markets stabilized. Another reason is that their long-term economics involved a customer franchise: Banks made their money, year after year, by trading with customers, so when the customers panicked the banks would quote them nice prices to keep them happy. A third, more nebulous reason is that it had always been that way: Bank traders conceived of themselves as being in the business of quoting tight prices and maintaining orderly markets, so when the customers panicked the banks would selflessly step in to help them.
5. This ended, though. Now bonds are increasingly traded by proprietary trading firms on electronic markets, or by banks arranging trades between customers without using their own capital.
6. Partly this is because the old, bank-driven model was expensive. The banks had to employ lots of expensive traders to quote prices, and lots of expensive salespeople to take customers out to steak dinners, and because they took lots of balance-sheet risk they had to make a lot of money on each trade. Faster, more computerized trading firms could quote tighter prices because their costs were lower.
7. Partly it is because the banks had a rough time in 2008 — not primarily because of their customer-facilitation bond trading, mind you — so new post-crisis regulations made it harder for banks to do this business. They were less inclined to use their balance sheets to trade bonds with customers, so other firms stepped in.
8. The new system is mostly pretty good — you can trade bonds pretty fast at tight spreads, etc. — but people were worried that it would break down in a crisis. If all the customers got scared and wanted to sell their bonds at once, who would buy them? The banks were no longer in the business of using their capital to maintain orderly markets, and the new electronic prop trading firms didn't care much about that. They had smaller balance sheets and couldn’t take a longer-term view: If markets crashed, they’d just shut down their computers and go home. They had no customer franchise: They traded with faceless counterparties on electronic exchanges; they didn’t care about keeping customers happy. They had no institutional sense that maintaining orderly markets was their job. 
9. So the worry was that, if a lot of customers wanted to sell bonds, there would be no one to buy them, and liquidity would collapse.

I don’t want to endorse this story, exactly; there were various problems with it, and honestly I mostly made fun of it. But in a broad directional sense I think it was plausible; really I think it is a standard story of financial markets. The standard story is:

• There is a thing that is done by hand by traditional specialist experts.
• This thing is expensive (the specialists are inefficient and well-paid) but pretty robust (they like their franchise and want to keep the customers happy).
• Eventually some disruptor comes in and can do the thing more quickly and cheaply using computers.
• Now the thing is cheap and fast most of the time, but the disruptor is not very well-capitalized and does not have deep customer relationships, so in a crisis the thing will be worse. In a crisis, you can’t get a person on the phone to do the thing, because everyone stopped using phones, and people for that matter.

You get better liquidity and pricing 99% of the time, at the cost of much worse liquidity 1% of the time. The system is more efficient but less stable.

It’s a useful lens for a lot of things. Here’s a Financial Times story from last week about reinsurance:

Hedge funds and private investors muscling into reinsurance threaten to destabilise the centuries-old market for catastrophe cover, a director at Munich Re, the world’s biggest reinsurer, has warned.

The growing presence of private investors such as hedge funds and family offices in the sector has intensified competition for dominant players such as Berkshire Hathaway, Munich Re and Swiss Re.

But the sector’s shifting shape has introduced new risks and greater volatility into the reinsurance market, Stefan Golling, a board member of 145-year-old Munich Re, told the Financial Times.

After a big payout event, private investors could lose their nerve, potentially raising the price of insurance, he said.

“In the traditional market, a big hurricane will not be a surprise,” Golling said. By contrast, he added, “capital is getting involved that is not informed in the same way as an underwriting company”. ...

These new entrants challenged Munich Re and other traditional suppliers of reinsurance capital in a business built on personal relationships cemented at the industry’s annual conference in Monaco.

See, in the olden days, reinsurance was done by well-capitalized specialists and “built on personal relationships” formed by hanging out together in Monaco. You can get a lot of efficiencies by securitizing reinsurance in the form of catastrophe bonds, selling them to hedge funds, and not bothering with trips to Monaco. But when there’s an actual catastrophe, the people who bought the bonds will stop buying the bonds; they don’t care. They just want to make money; they have no deep relationships and nostalgic memories of their Monaco trips. And if they compete the old-school reinsurers out of business — because they are more efficient in normal times — then who will be left to provide reinsurance when things get bad? 

We talked last week (and above) about how big hedge funds are creeping into some of the economic roles that used to be filled by investment banks. There are various sorts of trades — the Treasury futures basis trade, the dispersion trade, index rebalancing, merger arbitrage, etc. — where traditional real-money investors all want to do the same thing at the same time, creating a supply and demand imbalance. (Asset managers want to buy more Treasury futures than they want to sell, they want to buy more index options and sell more single-stock options, they want to buy new index additions all at once, they want to sell merger targets all at once, etc.) Once upon a time, investment banks used their balance sheets to offset these imbalances: They would buy what everyone wanted to sell, taking the other side of their customers’ trades and charging a spread for doing so. Now banks are not as good at taking risk, and big hedge funds compete to do some of these trades.

One important difference between the banks of 2005 and the hedge funds of 2025 is that the banks had (and have) customers, and the hedge funds mostly don’t. If an asset manager wanted to sell a bunch of stock or buy a bunch of Treasury futures or whatever in 2005, it would call up its salesperson at a bank, and the salesperson would arrange a trade using the bank’s money. But the big hedge funds mostly don’t have salespeople, so the mechanism is different. The asset manager just does the trade in the market — it pushes buttons to buy Treasury futures on an electronic platform, etc. — and hedge funds do broadly offsetting trades in the market without ever talking to the asset manager. It’s not that the hedge funds are directly facilitating customer trades; it’s just that they know that there is broad predictable asset-manager demand for certain trades, [1]  so they take the other side.

We talked last year about deal-contingent hedges. Sometimes a company announces a cross-border acquisition: A US firm might agree to buy a French company for 1 billion euros. The buyer wants to hedge its currency risk (it wants to buy euros today), but it also worries about the risk that the deal won’t close for antitrust, regulatory, tariff, whatever reasons. Ideally the firm would do a trade like “buy 1 billion euros at today’s price, to be delivered when the deal closes, but if the deal doesn’t close we tear up the contract and don’t buy the euros.” This is not a standard sort of trade that is available by pushing a button on a foreign exchange trading platform, but it is a trade that you can call up your bank and ask about. The bank, for a fee, would be happy to arrange this sort of trade for you.

Back in 2005, it would arrange this trade by taking the other side itself: It would hedge the currency risk, evaluate the merger risk, and try to make a profit by charging you more than the expected cost of the trade. Last year, though, we were talking about an International Financing Review article about how hedge funds were increasingly taking the other side of the trade: The banks had the customers and the salespeople, and would arrange the trades, but the hedge funds had the risk appetite, so the banks would offload the risk to the hedge funds. The banks were essentially arranging trades between companies and hedge funds. 

How much is that worth? Well, not nothing. The banks are communications hubs; they have relationships with hedge funds and also with companies, and they get a cut for connecting them. On the other hand you could imagine trying to cut out the middleman. Last month another IFR article reported that that’s happening:

Hedge funds have approached private equity firms about trading complex currency derivatives hedging risks on cross-border acquisitions directly with them, industry insiders say, a move that threatens to cut investment banks out of a business they have dominated for years.

Banks offer these “deal-contingent” derivatives to private equity and corporate clients looking to shield themselves against adverse moves in foreign exchange rates around the time of large mergers and acquisitions. The hedges only come into force if the underlying M&A deal completes, a feature that makes them fiendishly hard to handle for the banks that sell them. ...

“We are seeing hedge funds going directly to the largest private equity sponsors and pitching the idea of facing them directly on deal-contingent trades,” said Mark Beaumont, head of European risk management at financial consultancy PMC Treasury. “That’s a threat to the banks because it potentially cuts them out of the process.” ...

The prospect of hedge funds pitching these trades directly to their private equity clients may alarm banks, which are already facing growing competition from shadow banks like hedge funds, trading firms and private credit funds in everything from trading securities to lending money to companies. It also shows the delicate balancing act banks must perform when looking to recycle some of their riskiest and most commercially sensitive client exposures.

Historically the role of the big investment banks was both to have the customer relationships and to use their own balance sheets to facilitate trades. As the second part declines, the first part might decline as well.

I always vaguely thought that non-financial commercial paper was kind of a myth. Banks, of course, borrow from the capital markets with very short terms; that’s what a bank is. And yes some big industrial companies would finance some of their operations by selling short-term debt to investors. But most companies want to lock in their financing for years, not come back to the market every week. And most investors who want to park their cash somewhere for a week will want somewhere very safe to put their cash; they don’t want to do credit analysis on industrial companies. 

Also, the traditional big buyer base for commercial paper was prime money-market funds, and after the 2008 crisis those funds fell into regulatory disfavor. “Regulators introduced reforms aimed at strengthening those funds' ability to withstand future shocks,” notes the Investment Company Institute, but “these changes significantly reduced the demand for institutional prime MMFs — all but killing them off.” 

But Bloomberg’s Alex Harris and Ethan Steinberg report that commercial paper is back:

Once a $2 trillion cornerstone of global finance, the US commercial paper market was left in disarray following the 2008 crisis. Now, after years in the shadows, it’s staging an unexpected comeback.

Uber Technologies Inc. rolled out a $2 billion commercial paper plan in June, according to its latest quarterly filing. That followed Netflix Inc.’s $3 billion facility a month earlier. Coca-Cola Co., PepsiCo Inc., Philip Morris International Inc. and Honeywell International Inc. have all tapped the market in recent months, selling billions worth of the short-term IOUs, which typically range in maturity from 30 to 90 days. 

The renewed embrace of commercial paper is fueling the biggest expansion in the market since 2006, and underscores just how dramatically corporate America has been shifting its funding mix. Faced with elevated interest rates and tariff turmoil, companies have moved to shore up cash buffers while avoiding locking in higher long-term borrowing costs, especially with potential Federal Reserve rate cuts on the horizon. The pivot mirrors a similar move by the Treasury, which has ramped up issuance of short-term T-bills to cover the US budget gap. 

One way to think about this is that both investors and companies tend to target some level of volatility, formally or intuitively. If you are an investor, you will sleep better at night knowing that you are unlikely to lose more than X% in a week; if you are an investment-grade bond investor X will be pretty low. As interest rates are high and the future path of rates is uncertain, your portfolio becomes more volatile, but you can reduce that volatility by reducing duration: If you buy 30-year bonds and rates go up, you will lose a lot of money, but if you buy 30-day paper and rates go up, it’s fine. And roughly vice versa for corporate treasurers: If you sell 30-year bonds and rates go down, you will look stupid, but if you sell 30-day paper you can only look so stupid.

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