An old-fashioned bank run happened if enough people tried to withdraw their funds from a bank; even if the bank was solvent, it might not be able to meet all the withdrawals and thus the fear of bank failure could become a self-fulfilling prophecy. In the current crisis, participants in the interbank market take the place of long queues of withdrawers. They have stopped extending credit to other banks that they suspect to have been contaminated by the subprime loans and which therefore may face solvency problems. The commercial bond market and structured investment vehicles are facing similar trouble.
Both the old and new forms of crisis have at their heart a coordination problem. In the current one, participants in the interbank market and in the commercial bond market do not renew their credit because of fear others will not either.
Bagehot advocated in 1873 that a Lender of Last Resort in a crisis should lend at a penalty rate to solvent but illiquid banks that have adequate collateral.
Central banks, because of information limitations, are bound to make mistakes, losing face and money in the process. This doesn’t mean they should not try.
The collateral should be valued under “normal circumstances”, that is, in a situation where the coordination failure of investors does not occur. This involves a judgment call in which the central bank values the illiquid assets. A central bank that only takes high quality collateral will be safe, but will have to inject much more liquidity and/or set lower interest rates to stabilise the market. This may fuel future speculative behavior.
The problem is that central banks are extending the lender of last resort facility outside the realm of traditional banks to entities, like Bear Stearns, that they do not supervise and, therefore, over which they do not have first hand information. How does the Fed know whether Bear Stearns or other similar institutions are solvent? It seems that the Fed is not following Bagehot’s doctrine here.
Finally, if banks and investors are bailed out now, why should they be careful next time? This is the moral hazard problem: help to the market that is optimal once the crisis starts has perverse effects in the incentives of market players at the investment stage. The issue is that only when the moral hazard problem is moderate does it pay to eliminate completely the coordination failure of investors with central bank help. When the moral hazard problem is severe, a certain degree of coordination failure of investors – that is, allowing some crises – is optimal to maintain discipline when investing and, amending Bagehot, some barely solvent institutions should not be helped.
I will take a certain amount of issue with the idea that there is a major problem with central banks lending to institutions they don’t supervise … most central banks, including the Canadian and UK institutions, have no supervisory powers. While I feel it is preferrable for them to supervise the banks, I am not prepared to agree that this is a necessary condition for lending.
The Fed / JPM / BSC situation is clearly a special case, with Bernanke using his discretion to address a problem that he felt had the potential for contagion – with the agreement of the other Fed governors. That’s fine with me. Why hire a smart guy and pay him well if you’re not going to allow him to exercise discretion? As far as solvency goes … JPM is prepared to take on risk and he’s got (surely!) reports from the SEC on BSC’s capital adequacy, as well as some collateral. The internuts are screaming that the collateral is all worthless, but I continue to believe that regulation – via the SEC – is good enough that prices have been marked down to some plausible estimate based on ultimate recovery and influenced by market value.
There is a danger in throwing out the baby with the bathwater here. I believe that Investment Banks should be regulated, but not in the same way and not by the same people as regular banks.
Of most interest, however, is Dr. Vive’s assertion that targetting the “bad collateral” that is the source of the problem, the Fed is acting to minimize the amount of more general liquidity injection that will be necessary to surmount the crunch. That seems eminently sensible to me.
Lehman Brothers Holdings Inc., which has dropped 42 percent this year in New York trading, is selling at least $3 billion of new shares to U.S. institutions to reassure investors it has ample access to capital.
“We still maintain that we don’t need capital, but we’ve realized that perception is the dominant issue in today’s markets,” Chief Financial Officer Erin Callan said in an interview. “This is an endorsement of our balance sheet by investors.”
Merrill Lynch raised $6.6 billion in January by selling preferred shares to a group including the Kuwaiti Investment Authority and Japan’s Mizuho Financial Group Inc.
Today’s motto is “Strong Balance Sheets Are Good”. I’ve just read a history of the Overend & Gurney collapse which drives this home – I’ll be reviewing the book here shortly, to add to the PrefBlog Museum of Catastrophe.
It looks like CPD managed to arrest its fall and remain very slightly above its historical low point (in terms of total return) to close the month. This won’t be much consolation for holders, though, as their total return will have been minimal over the past four months since November 30. It’s close enough to the trough that I will not speculate on whether the BMOCM-50 was also able to eke out a gain. MAPF did not do well on the month, ending its streak of three superb months with a rather poor one – but will have outperformed CPD handsomely on the quarter.
Perpetuals got smacked today by the new National Bank issue; volume was good.
|Major Price Changes|
|SLF.PR.C||PerpetualDiscount||-3.3168%||Now with a pre-tax bid-YTW of 5.74% based on a bid of 19.53 and a limitMaturity.|
|HSB.PR.D||PerpetualDiscount||-2.8251%||Now with a pre-tax bid-YTW of 5.79% based on a bid of 21.67 and a limitMaturity.|
|NA.PR.L||PerpetualDiscount||-1.9524%||Now with a pre-tax bid-YTW of 5.99% based on a bid of 20.59 and a limitMaturity.|
|BNA.PR.B||SplitShare||-1.8972%||Asset coverage of 2.8+:1 as of February 29, according to the company. Now with a pre-tax bid-YTW of 8.86% based on a bid of 19.65 and a hardMaturity 2016-3-25 at 25.00. Compare with BNA.PR.A (6.47% to 2010-9-30) and BNA.PR.C (7.57% to 2019-1-10).|
|BNS.PR.K||PerpetualDiscount||-1.8577%||Now with a pre-tax bid-YTW of 5.53% based on a bid of 21.66 and a limitMaturity.|
|RY.PR.A||PerpetualDiscount||-1.8447%||Now with a pre-tax bid-YTW of 5.58% based on a bid of 20.22 and a limitMaturity.|
|PWF.PR.L||PerpetualDiscount||-1.8365%||Now with a pre-tax bid-YTW of 5.78% based on a bid of 22.45 and a limitMaturity.|
|MFC.PR.C||PerpetualDiscount||-1.8233%||Now with a pre-tax bid-YTW of 5.40% based on a bid of 21.00 and a limitMaturity.|
|RY.PR.W||PerpetualDiscount||-1.7652%||Now with a pre-tax bid-YTW of 5.57% based on a bid of 22.26 and a limitMaturity.|
|SLF.PR.A||PerpetualDiscount||-1.5603%||Now with a pre-tax bid-YTW of 5.57% based on a bid of 21.45 and a limitMaturity.|
|BAM.PR.N||PerpetualDiscount||-1.3815%||Now with a pre-tax bid-YTW of 6.45% based on a bid of 18.56 and a limitMaturity.|
|PWF.PR.K||PerpetualDiscount||-1.3778%||Now with a pre-tax bid-YTW of 5.67% based on a bid of 22.19 and a limitMaturity.|
(until after rebalancing!)
|-1.2914%||Now with a pre-tax bid-YTW of 5.65% based on a bid of 24.46 and a limitMaturity.|
(until after rebalancing!)
|-1.2846%||Now with a pre-tax bid-YTW of 5.94% based on a bid of 24.59 and a limitMaturity.|
|PWF.PR.F||PerpetualDiscount||-1.2733%||Now with a pre-tax bid-YTW of 5.73% based on a bid of 23.26 and a limitMaturity.|
|GWO.PR.I||PerpetualDiscount||-1.2285%||Now with a pre-tax bid-YTW of 5.64% based on a bid of 20.10 and a limitMaturity.|
|PWF.PR.I||PerpetualPremium||-1.2152%||Now with a pre-tax bid-YTW of 6.06% based on a bid of 25.20 and a limitMaturity.|
|RY.PR.E||PerpetualDiscount||-1.1594%||Now with a pre-tax bid-YTW of 5.58% based on a bid of 20.46 and a limitMaturity.|
|RY.PR.D||PerpetualDiscount||-1.1143%||Now with a pre-tax bid-YTW of 5.59% based on a bid of 20.41 and a limitMaturity.|
|SLF.PR.D||PerpetualDiscount||-1.0654%||Now with a pre-tax bid-YTW of 5.74% based on a bid of 19.50 and a limitMaturity.|
|FTU.PR.A||SplitShare||-1.0453%||Asset coverage of just under 1.4:1 as of March 14, according to the company. Now with a pre-tax bid-YTW of 9.29% based on a bid of 8.52 and a limitMaturity.|
(Until After Rebalancing!)
|-1.0204%||Now with a pre-tax bid-YTW of 5.73% based on a bid of 24.25 and a limitMaturity.|
|BNS.PR.L||PerpetualDiscount||-1.0135%||Now with a pre-tax bid-YTW of 5.49% based on a bid of 20.51 and a limitMaturity.|
|POW.PR.D||PerpetualDiscount||+1.0638%||Now with a pre-tax bid-YTW of 5.50% based on a bid of 22.80 and a limitMaturity.|
|LBS.PR.A||SplitShare||+1.1940%||Asset coverage of just under 2.1:1 as of March 27, according to Brompton Group. Now with a pre-tax bid-YTW of 4.89% based on a bid of 10.17 and a hardMaturity 2013-11-29 at 10.00.|
|DFN.PR.A||SplitShare||+1.2795%||Now with a pre-tax bid-YTW of 4.76% based on a bid of 10.29 and a hardMaturity 2014-12-1 at 10.00.|
|ELF.PR.G||PerpetualDiscount||-1.8980%||Now with a pre-tax bid-YTW of 6.15% based on a bid of 19.40 and a limitMaturity.|
|CL.PR.B||PerpetualPremium||+2.0776%||Now with a pre-tax bid-YTW of -7.63% (negative!) based on a bid of 26.04 and a call 2008-4-30 at 25.75.|
|RY.PR.K||PerpetualPremium||1,372,231||Nesbitt crossed 200,000 at 25.15, then CIBC crossed the same amount at the same price. Nesbitt then crossed 170,000 at the same price. Somebody’s looking for short stuff! Now with a pre-tax bid-YTW of 4.98% based on a bid of 25.10 and a softMaturity 2008-8-23 at 25.00.|
|GWO.PR.I||PerpetualDiscount||154,235||Nesbitt crossed 149,500 at 20.15. Now with a pre-tax bid-YTW of 5.64% based on a bid of 20.10 and a limitMaturity.|
|RY.PR.G||PerpetualDiscount||56,250||Now with a pre-tax bid-YTW of 5.57% based on a bid of 20.50 and a limitMaturity.|
|TD.PR.R||PerpetualDiscount||24,790||Now with a pre-tax bid-YTW of 5.68% based on a bid of 24.87 and a limitMaturity.|
|NA.PR.L||PerpetualDiscount||24,250||Now with a pre-tax bid-YTW of 5.99% based on a bid of 20.59 and a limitMaturity.|
There were nineteen other index-included $25-pv-equivalent issues trading over 10,000 shares today.
|Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30|
|Index||Mean Current Yield (at bid)||Mean YTW||Mean Average Trading Value||Mean Mod Dur (YTW)||Issues||Day’s Perf.||Index Value|