PrefBlog

You know who the smartest people in the world are? Harvard grads are the smartest people in the world:

When Larry Estrada graduates from Harvard Business School next week, he’ll begin work at Goldman Sachs Group Inc. He’ll do so only after taking an oath.

Estrada, 30, joined about 150 fellow business school students and faculty worldwide to campaign for the acceptance of an MBA ethics pledge modeled on the Hippocratic Oath taken by doctors. The aim is to get as many as 6,000 graduates at 50 MBA programs to swear they won’t put personal ambitions before the interests of their employers or society.

See how smart they are? They know what’s in the best interests of society. I consider myself lucky if I know what’s in my own best interests – but then, I’m not smart enough to go to Harvard.

It is possible that the carried interest loophole in US tax law may be plugged – finally!:

Managers of investment partnerships typically are paid 2 percent of fund assets as an annual management fee and 20 percent of the profit earned for investors above certain levels. While the management fee is taxed as income, the share of profit, known as carried interest, is taxed at the lower capital-gains rate, currently 15 percent and slated to rise to 20 percent in 2011.

A summary of the still-unreleased legislation said it would allow carried interest that reflects return on invested capital to continue to be taxed at capital gains rates.

For other funds, “the bill would require investment fund managers to treat 75 percent of the remaining carried interest as ordinary income,” the summary said.

Common equities had a bad day:

The Standard & Poor’s 500 Index plunged 3.9 percent to 1,071.59 at 4 p.m. in New York, its biggest drop since April 2009. The Stoxx Europe 600 Index lost 2.2 percent and the S&P GSCI Index of commodities tumbled to the lowest since October. The losses accelerated even as the euro rallied as much as 1.5 percent to $1.2598 after earlier flirting with a four-year low. Ten-year Treasury yields sank to the lowest level of the year, down 15 basis points at 3.22 percent.

The Canadian preferred share market continued its slow slide on relatively (by recent standards) modest volume, with PerpetualDiscounts down 11bp and FixedResets losing 8bp.

More on Basis Alpha:

The Basis fund’s main contention is that the fund’s managers were misled by Goldman when it purchased two $50 million tranches of Timberwolf, a $1 billion CDO that Goldman took to market in March 2007, according to Mapley and other people familiar with the situation.

The Basis fund sank money into Timberwolf in June 2007, after the one-time $500 million fund claims it got assurances from Goldman’s mortgage trading desk that the market for CDOs had stabilized after falling sharply.
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Mapley said he has been told Goldman sold the Timberwolf securities to the hedge fund at a significantly higher price than what similar mortgage-linked securities were selling for at the time. Basis’ managers were not aware that Goldman’s mortgage trading desk was actively shorting CDOs and other subprime mortgage-linked securities at the time of the Timberwolf deal, he said.

That’s it? That’s the basis of the complaint? These guys are clowns.

The German attempt to distort markets hasn’t got much political support:

The euro is at risk and Europe may be facing its greatest challenge since the founding of the European Union, [German Chancellor Angela Merkel] said. The consequences are “incalculable” if leaders fail to act.

For all that, a Europe-wide ban on naked short-selling is “doubtful,” Eddy Wymeersch, Europe’s top market regulator, said in a telephone interview. The Netherlands and Finland said they have no plans to implement similar measures to Germany.

France, which lined up with Germany on market regulation before the last two G-20 summits, doesn’t plan to follow Germany in banning the use of contracts to speculate on European sovereign debt, Finance Minister Christine Lagarde said.

“We haven’t envisioned doing it,” Lagarde told reporters in Paris. France has banned “naked short sales” on equity markets since September 2008. Portugal’s financial regulator said it was keeping its restrictions on naked short selling that date back to 2008.

It is important that member states act together and that we design a European regime to avoid regulatory arbitrage and fragmentation,” EU Financial Services Commissioner Michel Barnier said in an e-mailed statement.

A ban in Germany alone will likely be ineffective, former U.K. Finance Minister Nigel Lawson said in an interview with Bloomberg Television.

“People will find ways of getting round it, move to other jurisdictions,” Lawson said. “It can only be workable for a very, very short time.”

What’s worse, there are fears that Lucas van Praag, Worlds’ Greatest Corporate Spokesman, is losing his touch.

Volume on the Canadian preferred share market was merely elevated today and volatility was muted as PerpetualDiscounts were up 2bp and FixedResets were down by the same figure.

The yield on PerpetualDiscounts is now 6.39%, equivalent to 8.95% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.65%, so the pre-tax interest-equivalent spread is now about 330bp, a mild (and perhaps spurious) increase from the 325bp recorded May 12.

One of the guys who ran Basis Yield Alpha Fund (mocked on PrefBlog on April 30 is haranguing the regulators for a crusade:

THE man who blew the whistle on Wall Street banking giant Goldman Sachs has urged Australia’s corporate watchdog to follow the lead of the US Securities and Exchange Commission in suing the investment bank for fraud.

David Mapley, a former non-executive director of the local Basis Yield Alpha Fund, said the Australian Securities & Investments Commission should closely examine the role of the investment bank’s local arm, Goldman Sachs JBWere, in marketing a mortgage-related investment product that ultimately led to the fund’s demise in August 2007.
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He confirmed that he had approached the SEC with his concerns shortly after the decision was made to place the fund in liquidation.
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“Myself and a colleague examined the trade and we had a strong belief that that the security was fraudulently concocted and then sold to us,” Mr Mapley said.

Maybe Mr. Mapley and his colleague should have examined the trade before plunking their clients’ money down!

BIS has released a working paper by Nikola Tarashev, Claudio Borio and Kostas Tsatsaronis titled Attributing systemic risk to individual institutions. Their conclusion supports PrefBlog’s notion of progressive capital surcharges on risk-weighted assets:

The analysis also suggests that, once risk characteristics have been controlled for, charges imposed on financial institutions would need to increase faster than their size.

but, I confess, I have not reviewed the paper in sufficient detail to determine whether the premises that lead to this conclusion are supportable.

OSFI’s Ted Price gave a speech at the Centre for Monetary and Financial Economics Conference at Carleton University titled Developments in Bank Supervision – a Canadian Perspective. Nothing new, just a reiteration of the party line. That’s one superiority of the US system of bank regulation, which is run by the Fed, which is run by a Board of Governors who are independently selected for the board by the regional banks. This means that there is not only a diversity of opinion at the table, it means that these guys’ speeches can be much more informative as they engage in public diplomacy, at least to some extent.

Quick! What’s more important – knowledge or political correctness?

“Some of Professor Katz’s controversial writings have become a distraction from the critical work of addressing the oil spill,” Stephanie Mueller, a spokeswoman for the Energy Department, said in an e-mail today. “Professor Katz will no longer be involved in the department’s efforts.”
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While Katz’s early work focused on astrophysics, he now consults on a variety of physics puzzles, he said. Katz wrote articles on his personal website, including, “What Is Political Correctness,” “In Defense of Homophobia” and “Why Terrorism Is Important.”
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He was fired from the panel this morning, he said. He declined to specify which articles triggered the dismissal.

Fed up with the spectacle of mere investors taking a view on economics, BaFin will introduce short-selling bans:

Germany’s BaFin financial-services regulator said that it will introduce a temporary ban on naked short-selling and naked credit-default swaps of euro-area government bonds starting at midnight.

The ban will also apply to naked short-selling in shares of 10 banks and insurers including Allianz SE and Deutsche Bank AG, BaFin said today in an e-mailed statement.

The markets instantly panicked:

Credit-default swaps soared as a move by German Chancellor Angela Merkel to ban speculation on European government bonds with the contracts sparked anxiety among investors about increasing government regulation
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“The market sees an inadequate policy such as this as an act of desperation and a refusal to address the fundamental problems at hand,” said Brian Yelvington, head of fixed-income strategy at broker-dealer Knight Libertas LLC in Greenwich, Connecticut.

Prohibiting speculation in the contracts may cause trading in the market for swaps tied to Europe government bonds to freeze up, possibly increasing borrowing costs or limiting the flow of capital, said Tim Backshall, the chief strategist at Credit Derivatives Research LLC in Walnut Creek, California.

Same thing as I always think when reading about bloggers being jailed for “disrespecting the state” or “insulting the president” (or even just cutting funding to a parade because the word “Apartheid” makes the boo-hoo-hoo brigade feel uncomfortable; geez, I wish those morons would spend less time sucking up to foreign governments and more time trying to figure out how to license a souvlaki cart in less than three years), as often happens in the Mid-east: if you have to make criticism illegal, then maybe you simply have no better answer.

There’s more!

The proposal backed by finance ministers at the European Council calls for fund managers to be authorized by national governments. National authorities will also review the trading activities of funds and approve their internal risk-management practices.

The SEC & CFTC have rushed out a preliminary report on the bungee jump:

At this point, we are focusing on the following working hypotheses and findings–
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(5)
the use of market orders, stop loss market orders and stop loss limit orders that, when coupled with sharp declines in prices, for both equity and futures markets, might have contributed to market instability and a temporary breakdown in orderly trading;
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Stop Loss Market Orders. An additional hypothesis as to why some securities suffered more severe declines than the broader market on May 6 is that they were particularly affected by stop loss market orders. These orders have stop prices that, for sell orders, are lower than current prices. When the stop price is reached, such orders turn into market orders to sell. In fast-falling market conditions, stop loss market orders could potentially trigger a chain reaction of automated selling if they are in place in significant quantity for a particular stock. We are investigating whether such a chain reaction led to abnormally large declines for some stocks on May 6.

There was continued heavy volume today, as PerpetualDiscounts edged downwards another 2bp, while FixedResets continued to impress, gaining 21bp. The Floating Rate sector continued its recent slide, so there are conflicting signals being emitted!

Government financial problems are all the dealers’ fault!

The state’s securities division sent letters today to 10 underwriters of municipal bonds, asking them to detail their trading of credit-default swaps linked to state and local government bonds they’ve underwritten in Massachusetts since 2003. Recipients have until May 28 to respond. The letter asked each bank to “identify the entity that purchased CDS from your firm for each Massachusetts state or municipal bond offering.”
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The probe follows a similar inquiry in California, where Treasurer Bill Lockyer asked banks to say whether they bet against the state with credit-default swaps. The U.S. Securities and Exchange Commission is also exploring conflicts of interest for banks that sold municipal bonds and bet the securities would fail, the Wall Street Journal reported, citing people familiar with the matter who it didn’t name.

IIROC has released a a new version of the consolidated UMIR, with updated annotations.

Somehow, you just knew that Greek deficits are the banks’ fault, didn’t you?

Greece is considering taking legal action against U.S. investment banks that might have contributed to the country’s debt crisis, Prime Minister George Papandreou said.

“I wouldn’t rule out that this may be a recourse,” Papandreou said, in response to questions about the role of U.S. banks in the crisis, in an interview on CNN’s “Fareed Zakaria GPS.” The program, scheduled to air tomorrow, was taped on May 13. Neither Papandreou nor Zakaria mentioned any banks by name.
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Papandreou said the decision on whether to go after U.S. banks will be made after a Greek parliamentary investigation into the cause of the crisis.

“Greece will look into the past and see how things went,” Papandreou said. “There are similar investigations going on in other countries and in the United States. This is where I think, yes, the financial sector, I hear the words fraud and lack of transparency. So yes, yes, there is great responsibility here.”

Pity he couldn’t think of anything suspicious! I suggest that his parliamentary investigation focus on Mr. Micawber’s Principle:

Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

Meanwhile, European banks are having trouble raising funds:

Banks were locked out of the credit markets as the eurozone debt crisis escalated this month. A week after the European Union and International Monetary Fund’s €750bn ($935bn) bailout was announced, concerns remain.
The shockwaves from the debt woes in Europe mean that all but a few highly rated banks will find bond issuance tougher over the rest of the year, according to bankers.

Following a strong first quarter when European banks sold $243.5bn in bonds, so far this month they have sold bonds worth only $879m, according to data provider Dealogic.

Domestic banks in Greece, Portugal and Spain have been hit over the past six weeks by movements in spreads on their governments’ bonds. For example, credit default swap spreads on National Bank of Greece more than doubled between April 5 and May 6, climbing to a high of 890bp.

James Hamilton of Econbrowser passes on some fascinating observations on the European shadow economy:

Aruoba’s paper notes some interesting regularities in a data set of 118 different countries. One measure he looks at is the size of the underground economy in different countries. If you carry out your business in the underground economy, you will benefit by avoiding taxation, but you lose the legal and contract protection that you would have had if you’d instead been working in the formal sector. If only the first effect mattered, you’d expect to see countries with higher tax rates have a greater role for the informal sector. But Aruoba finds just the opposite– the bigger the informal sector, the lower tax receipts as a percent of formal-sector GDP. Aruoba attributes this to the fact that in countries with better legal institutions, the benefits of conducting business above board outweigh the taxation costs, and the governments can afford to raise more of their revenue through traditional taxation.

Mind you, banks are already being punished for Greece:

Royal Bank of Scotland Plc and Barclays Plc led financial firms punished by rising borrowing costs, British Bankers’ Association data show. The cost to hedge against losses on European bank bonds is 63 percent higher than a month earlier. Investment-grade corporate debt sales in the region plummeted 88 percent last week to $1.2 billion from the prior period, according to data compiled by Bloomberg.

The rate banks say they charge each other for three-month loans in dollars is the highest in nine months, even after a government-led rescue designed to prevent Greece from defaulting on its debt and a new financial crisis. The euro is trading at its weakest level versus the dollar since the aftermath of Lehman Brothers Holdings Inc.’s collapse, and stocks tumbled.
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The three-month London interbank offered rate in dollars, or Libor, rose to 0.445 percent last week, the highest level since August, from 0.428 percent on May 7 and 0.252 at the end of February, according to the British Bankers’ Association.

This is why the Fed has restarted the dollar swap lines, as noted May 10.

A Bloomberg story illustrates one of the hazards of contingent capital: if it converts, there might be tears:

A JPMorgan Chase & Co. reverse- convertible note paying 64 percent annualized interest plunged in value on May 14, three days after being sold, showing the risks of these products usually bought by individual investors.

The structured notes offered 10.7 percent in interest payments over their two-month term and a return of principal, as long as shares of TiVo Inc. didn’t fall more than 25 percent, according to a prospectus. TiVo dropped 42 percent on May 14 after an adverse court ruling, triggering a provision that will leave investors holding the possibly depressed stock at maturity.

Banks including JPMorgan, Morgan Stanley and Barclays Plc sold $656 million of reverse convertibles in the U.S. last month, according to data compiled by Bloomberg. The securities, which combine features of bonds and stock options, are often sold to individuals who don’t understand the risks, said Jake Zamansky, a New York-based attorney who represents investors.

“It’s being sold as a bond, an income-generating product, and I don’t think it’s being explained to people that you can get stuck with the stock,” the securities lawyer at Zamansky & Associates said in a telephone interview on May 14. He has represented investors in lawsuits related to the products.

The Canadian preferred share market resumed its slide today, with PerpetualDiscounts down 17bp and FixedResets down 10bp, with a return to highly elevated volume. Equity markets were enlivened by the scheduling and subsequent cancellation of the end of the world.