PrefBlog

Senator Phil Grassley, well known for his eagerness to support legislated subsidies for Alternative Fool lobbyists, does some more grandstanding with his questions regarding the Goldman-AIG pseudo-scandal:

The fifth largest amount listed is about $175 million that Lehman Brothers would have owed Goldman Sachs on CDS protection. However, given Lehman’s financial position at the time (September 15, 2008), isn’t it true that the real value of this hedge to Goldman would have been much less than $175 million? Wouldn’t it have only been worth the approximate value of any collateral that Lehman had already posted to Goldman up to that date?

2. Similarly, is it possible that financial health of the other institutions on the list may have prevented them from being able to pay Goldman in the event of an AIG default? Does this undermine Goldman’s claim that it was “fully collateralized and hedged” with regard to the risk of an AIG default, and thus demonstrate that Goldman did, in fact, receive a direct benefit from the government’s assistance to AIG?

3. Will the Panel be seeking additional details about these transactions in order evaluate Goldman’s claim to have been indifferent to whether AIG went bankrupt? If so, please describe the scope of your additional requests and inform the Committee if you do not receive complete cooperation.

In other words … ‘I don’t care whether you’ve got battery back-up, a fuel generator and three month’s worth of diesel stockpiled! Is it not true that in the event of the complete collapse of civilization, your electricity supply will fail to function?’

Attachment 1 (“Confidential Treatment requested by Goldman Sachs”) shows that Goldman bought a net value of USD 1.7-billion in CDSs on AIG. Canadian entries are Royal Bank (London Branch) $76-million; BNS, $36-million; BMO (London), $25-million; BMO (Chicago), $18-million; and Royal Bank [$43-million] [sold to] – that’s a net of about $100-million from Canadian banks. Naturally, there is no way of telling whether these positions were laid off against other investors.

Attachment 2 (“Confidential Treatment requested by Goldman Sachs”) shows the collateral shortfall on Goldman’s AIG deals – total of about $1.3-billion. So they were, it appears, over-hedged.

Despite all this, various analysts are still pointing out that Goldman would have lost money had an AIG bankruptcy coincided with a giant asteroid hitting New York City:

Joshua Rosner, an analyst at research firm Graham Fisher & Co. in New York, said the list of counterparties indicates that Goldman Sachs may have had difficulty collecting on those swaps.

“Clearly Goldman’s calculation was more tied to their expectation of the political dynamics of forcing moral hazard than the fundamental realities of the financial strength of counterparties,” Rosner said.
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“The financial institutions from whom we purchased protection were required to post collateral to settle their net exposure to us on a daily basis,” Lucas van Praag, a spokesman for New York-based Goldman Sachs, said yesterday. “A default by any particular counterparty would not reduce the effectiveness of a hedge provided by that entity if adequate collateral had already been posted. This was the case with the protection we bought, even during the most stressed periods of the fall of 2008.”
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“There’s a question about Citigroup’s ability to pay Goldman if AIG failed, given it had major problems,” said Ed Grebeck, CEO of Stamford, Connecticut-based debt-consulting firm Tempus Advisors and an instructor on derivatives at New York University.
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The document shows only the “notional” amount of money Goldman Sachs was owed by its counterparties, Cambridge Winter’s Date said. The firm is likely to have written down the value of at least some of the protection, he said.

Goldman Sachs “should have been haircutting the valuation of that protection pretty significantly as the viability of those firms looked more and more suspect,” Date said.

At least Goldman’s won something – the anti-Goldmanites have shifted their position from ‘an AIG bankruptcy would have killed Goldman’ to ‘an AIG bankruptcy and the simultaneous collapse of more than one other major global financial institution would have killed Goldman, provided they’re lying about the collateral, and even if they’re not lying about the collateral it was probably junk anyway.’

I once did some career mentoring for a young and idealistic high school student who wanted to get into the business – it was probably one of the most cynical mentoring sessions ever presented. But, for free, gratis and for nothing I will present to other idealists the lesson behind the Goldman debate: DON’T GIVE A SHIT AND DON’T EVER BOTHER DOING ANYTHING RIGHT. Goldman’s taking more grief for competently managing their AIG exposure than any of the clown-firms is taking for reckless idiocy.

But then … politicians across North America have shown a breathtaking disregard for creditors rights throughout this crisis – as best exemplified by the General Motors leapfrogging discussed on June 9, 2009. And if you have no rights, why would you want to protect them? The lunatic fringe even turns Goldman’s insistence on collateral into evidence of a dark plot:

Goldman wanted their counterparties to post collateral so they would have protection against corporate downgrades. The monolines refused to have collateral posting requirements in their CDS contracts. The rating agencies supported them in this position on the argument that maintaining their AAA rating was “fundamental to their business”.

AIG, on the other hand, agreed to collateral posting requirements. in fact, they used this as a competitive advantage – they got more business because of it and marketed their flexibility on this issue to the banks.
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All of the other banks got comfortable with the monolines not having to post collateral for CDS trades because of their AAA ratings. Goldman never did.

Of course, Goldman was one of the few banks that clearly set out to profit from shorting CDOs. They obviously realized that if their CDS counterparty was on the hook for a lot of ABS CDOs that were going to blow up, the insurance provider would likely get downgraded. If the downgrade of the insurer was very likely, the only way the short-CDO strategy worked was if the insurer would post collateral.
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So Goldman only used AIG, who would provide protection against their downgrade, which Goldman knew would happen because they were stuffing AIG with toxic ABS CDOs.
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I hate to get sucked into the vampire squid line of thinking about Goldman, but the only explanation i can think of for why AIG got rescued and the monolines did not is because Goldman had significant exposure to AIG and did not have exposure to the monolines.

I spent a little time looking into the woes of CalPERS after reading a brief mention in the Economist:

That [range of benefits improvements], however, is not what outrages Mr Schwarzenegger, a Republican, or his brainy economic adviser David Crane, a Democrat. Rather, it is that the pension plans—above all the California Public Employees’ Retirement System (CalPERS), the largest such scheme in America—pretended that this generosity would not cost anything. In 1999 the dotcom bubble was still inflating, and the plans’ actuaries predicted that their retirement funds would gain enough value to pay the increased pensions. By implication, they assumed that the Dow Jones Industrial Average would reach 25,000 in 2009 and 28m in 2099. It is currently at around 10,300.

Remember, CalPERS is the enormous pension fund that don’t do their own credit analysis. In 1999…:

According to CaLPERS, employer retirement costs have been declining over the last 10 years as the result of significant investment returns and changes in actuarial assumptions. The members and retirees of CaLPERS have not benefited from these returns. As a result, CaLPERS contends that the new retirement formulas provided by this bill mark the first significant improvement in retirement benefits for most state and school members’ in approximately 30 years. It is anticipated that the increase in liability for these new benefits can be funded by the excess retirement assets that have been generated through investment income and changes in actuarial assumptions resulting in no immediate increase in costs to the employer.

2001 Actuarial assumptions of net investment returns between 7.50% and 8.25%. Current assumptions are:

Critics who argue that the current level of retirement benefits are “unsustainable” and should be reduced for new hires say CalPERS is too optimistic about its expected investment earnings, an annual average of 7.75 percent.

Among the experts who think average earnings will be less than 7.75 percent in the years ahead is Laurence Fink, chairman of BlackRock, the world’s largest money managing firm, who spoke to the CalPERS board last summer.

The CalPERS chief investment officer, Joe Dear, addressed the earnings issue last week during his monthly report to the board. He said 5.25 percent of the earnings assumption is “real” and 2.5 percent is inflation.

Dear said the 7.75 percent earnings assumption is below the national average for pension funds, 8 percent, and below the earnings average of CalPERS during the last two decades, 7.9 percent.

He said CalPERS believes, among other things, that stocks will yield 3 to 4 percent more on average than bonds and that private equity investments will average 3 percent more than domestic stocks.

Comrade Peace Prize is seeking to distort the economy even more:

President Barack Obama is on the verge of creating as much as $300 billion in credit for small businesses as bankers raise doubt about whether there’s demand for new loans and how much will be repaid.

The U.S. Senate may vote this week on a bill to funnel $30 billion of capital to community banks, whose business customers typically are small firms. Banks could leverage the sum to make $300 billion in loans that create jobs, according to a Senate summary. That could more than double the commercial and industrial loans at eligible banks as of the first quarter, according to data compiled by KBW Inc.

Bankers say the problem isn’t scarce credit, it’s lack of demand from creditworthy firms in a weak economy.
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Banks will be charged an initial interest rate of 5 percent, declining to 1 percent if they increase small-business loans or rising as high as 7 percent if the loans stay the same or decrease, according to Richard Carbo, spokesman for the Senate Small Business and Entrepreneurship committee.
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Wells Fargo & Co., which says it’s the biggest small- business lender, is “sitting here with tons of liquidity and we’re marching double time in search of more loans,” Chief Executive Officer John Stumpf said in an interview. “In most cases when I hear stories about small businesses not getting loans, it’s the case that more credit will not help them. They need more equity, they need more profitability.”

Interesting paper from the FRB-Boston Public Policy series by Scott Schuh, Oz Shy, and Joanna Stavins, Who Gains and Who Loses from Credit Card Payments? Theory and Calibrations:

Merchant fees and reward programs generate an implicit monetary transfer to credit card users from non-card (or “cash”) users because merchants generally do not set differential prices for card users to recoup the costs of fees and rewards. On average, each cash- using household pays $151 to card-using households and each card-using household receives $1,482 from cash users every year. Because credit card spending and rewards are positively correlated with household income, the payment instrument transfer also induces a regressive transfer from low-income to high-income households in general. On average, and after accounting for rewards paid to households by banks, the lowest-income household ($20,000 or less annually) pays $23 and the highest-income household ($150,000 or more annually) receives $756 every year. We build and calibrate a model of consumer payment choice to compute the effects of merchant fees and card rewards on consumer welfare. Reducing merchant fees and card rewards would likely increase consumer welfare.

I was surprised by the following:

The limited available data suggest that a reasonable, but very rough, estimate of the per-dollar merchant effort of handling cash is  = 0:5 percent. Available data suggest that a reasonable estimate of the merchant fee across all types of cards, weighted by card use, is  = 2 percent.

I would have thought cash handling costs would be higher – particularly for high-cash operations, such as grocery stores – given bank charges for cash deposits, security on cash movements, employee theft and bookkeeping problems. The footnote reads:

Garcia-Swartz, Hahn, and Layne-Farrar (2006) report that the marginal cost of processing a $54.24 transaction (the average check transaction) is $0.43 (or 0.8 percent) if it is a cash transaction and $1.22 (or 2.25 percent) if it is paid by a credit/charge card. The study by Bergman, Guibourg, and Segendorf (2007) for Sweden found that the total private costs incurred by the retail sector from handling 235 billion Swedish Crown (SEK) worth of transactions was 3.68 billion SEK in 2002, which would put our measure of cash handling costs at  = 1:6 percent. For the Norwegian payment system, Gresvik and Haare (2009) estimates that private costs of handling 62.1 billion Norwegian Crown (NOK) worth of cash transactions incurred by the retailers was 0.322 billion NOK in 2007, which would imply  = 0:5 percent.

Fed Governor Tarullo doesn’t think we’ll see contingent capital any time soon:

The Basel Committee has a number of initiatives and work programs related to capital requirements that go beyond the package of measures that we expect to be completed by the fall. These efforts include, among others, ideas for countercyclical capital buffers, contingent capital, and development of a metric for capital charges tied to systemic risk. Each of these ideas has considerable conceptual appeal, but some of the difficulties encountered in translating the ideas into practical rules mean that work on them is likely to continue into next year.

The BIS proposal for countercyclical buffers was discussed on July 19.

There was relaxed volume in the Canadian preferred share market today, as PerpetualDiscounts gained 16bp and FixedResets lost 4bp, taking the median weighted-average yield on the latter class back above the magic 3.5% figure. Not much volatility.

The European Stwess Tests appear farcical:

European stress tests on 91 banks will take into account bank losses only on government bonds they trade rather than those they hold to maturity, according to a draft European Central Bank document.

“The haircuts are applied to the trading book portfolios only, as no default assumption was considered,” according to a confidential document dated July 22 and titled “EU Stress Test Exercise: Key Messages on Methodological Issues.”

The tests will assume a loss of 23.1 percent on Greek debt, 14 percent of Portuguese bonds, 12.3 percent on Spanish debt, and 4.7 percent on German state debt, according to the document obtained by Bloomberg News. U.K. government bonds will be subject to a 10 percent haircut, and France 5.9 percent.

On cue, Hungary’s problems became more visible:

Standard & Poor’s said it may cut Hungary’s credit rating to junk after the collapse of talks with the International Monetary Fund and European Union. Moody’s Investors Service said it may also lower the country’s grade.

The IMF and EU on July 17 suspended talks with the government without endorsing Prime Minister Viktor Orban’s plans to control the budget deficit. The creditors provided Hungary with a 20 billion-euro ($25.9 billion) rescue package in 2008, which had served to reassure investors.

“We believe that without an EU/IMF program to anchor policy, Hungary is likely to face higher and more volatile funding costs, which in our view could weigh on financial sector balance sheets, the public finances, and economic growth,” S&P said today in a statement.

C-EBS has released the results. The report on the aggregate outcome makes the exercise appear to be rather gentle stwess! Initial reactions to the reports on individual banks are negative – the total capital shortfall is only USD 4.5-billion.

But the best line in the farce comes from a central banker:

ECB Vice President Vitor Constancio called the tests “severe” and explained they didn’t include a scenario of a national default because “we don’t believe there will be a default.”

That’s just great, Vitor! Maybe you’ll be put in charge of the government run credit rating agency the Europeans are thinking about, you know, the ones that will be much nicer to sovereigns than those mean old-style CRAs!

Seems to me that if the bank market is locking up because of fears of chaos after a sovereign default, then you restore confidence by proving the banking system is robust to sovereign default. But reasoning like this isn’t likely to get me appointed to any regulatory positions of note.

Increased regulation of the public markets is having a predictable effect: less public issuance:

The most sweeping regulatory legislation for Wall Street since the Great Depression, signed into law by President Barack Obama on July 21, makes ratings companies vulnerable to lawsuits when underwriters include their assessments in documents used to sell debt. The law subjects firms such as Moody’s Investors Service, Standard & Poor’s and Fitch Ratings to so-called expert liability, meaning they would face the same legal risks as accountants and other parties that participate in bond sales.

Under the new law, issuers weren’t able to obtain permission from ratings firms to include their rankings in their registration filings, according to the SEC.

As a result, sales were held up, said Malcolm Dorris, a senior partner in the securitization group at law firm Dechert LLP. Companies were considering alternatives to the public markets, such as selling in the 144a market, where sales aren’t registered with the SEC, Dorris said.

Ford Motor Co.’s finance arm canceled a planned sale of asset-backed debt, the Wall Street Journal reported July 21 on its website, citing market participants it didn’t name.

There’s an awfully odd senate investigation into Goldman:

Goldman Sachs Group Inc. told U.S. investigators which counterparties it used to hedge the risk that American International Group Inc. would fail, according to three people with knowledge of the matter.

The list was sought by panels reviewing the beneficiaries of New York-based AIG’s $182.3 billion government bailout, said the people, who declined to be identified because the information is private. Goldman Sachs, which received $12.9 billion after the 2008 rescue tied to contracts with the insurer, has said it didn’t need AIG to be rescued because it was hedged against the firm’s failure.

“We want to know the identity of those parties, partly just to know where American taxpayer dollars went, but partly to assess Goldman’s claim,” said Elizabeth Warren, chairman of the Congressional Oversight Panel, in a Senate hearing this week. “We cannot evaluate the credibility of their claim that they had nothing at stake one way or the other in the AIG bailout.”
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Goldman Sachs had $10 billion of exposure to AIG when the insurer was rescued in September 2008, offset by $7.5 billion of collateral and swaps, Viniar said. The hedges were one reason that Goldman wouldn’t accept anything less than full payment on the guarantees it purchased from AIG, he said.

It’s not clear to me why this is so important; I suspect its just another instance of Goldman being punished for being the only competently managed investment bank in the world. The politicians need mea culpas and cringing gratitude – and they’re not getting it from GS.

Magna bought out Stronach with a 93% positive vote, despite the efforts of the precious to ensure the world is aware just how precious they are (I think Teachers’ won, having purchased one share so they could be officially offended at the deal. Their beneficiaries should be most upset that management time and money is being spent tilting at other people’s windmills). The vote is good news for readers of financial newspapers, who may hope for an end to the eternal whining of morons who are surprised when their participating debentures – also known as subordinated voting shares – don’t give them much say in the company. ‘But that’s just mean!’ they bleat ‘Business and investing should be a cooperative game, just like we had in kiddiegarter!’

It was a quiet day in the Canadian preferred share market, with PerpetualDiscounts up 1bp and FixedResets gaining 4bp on low volume.

The Bank of Canada has released a working paper by David Dupuis and Yi Zheng titled A Model of Housing Stock for Canada:

Using an error-correction model (ECM) framework, the authors attempt to quantify the degree of disequilibrium in Canadian housing stock over the period 1961–2008 for the national aggregate and over 1981–2008 for the provinces. They find that, based on quarterly data, the level of housing stock in the long run is associated with population, real per capita disposable income, and real house prices. Population growth (net migration, particularly for the western provinces) is also an important determinant of the short-run dynamics of housing stock, after controlling for serial correlation in the dependent variable. Real mortgage rates, consumer confidence, and a number of other variables identified in the literature are found to play a small role in the short run. The authors’ model suggests that the Canadian housing stock was 2 per cent above its equilibrium level at the end of 2008. There was likely overbuilding, to varying degrees, in Saskatchewan, New Brunswick, British Columbia, Ontario, and Quebec.

The Bank of Canada also released the July 2010 Monetary Policy Report – good solid stuff, but nothing particularly noteworthy or interesting.

Volume was down a bit in the Canadian preferred share market, but still good, as PerpetualDiscounts came in with another solid gain of 15bp, while FixedResets gained 4bp, taking the yield on the latter class below 3.50%. This is the 12th-lowest yield on record for this index.

Nothing happened today. How dull.

Continued good volume in the Canadian preferred share market, a PerpetualDiscounts squeaked out a win of 1bp, while FixedResets were up 9bp, edging their median weighted average yield a little closer to 3.50%.

PerpetualDiscounts now yield 5.90%, equivalent to 8.26% interest at the standard equivalency factor of 1.4x. Long corporates now yield 5.6%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 265bp, a significant tightening from the 280bp reported on July 14.

Fabulous Fabio is fighting the SEC fraud charges:

Fabrice Tourre, the Goldman Sachs Group Inc. executive director sued by the Securities and Exchange Commission for fraud, disputed the claims and said he relied on his firm’s legal and compliance department.
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The firm is cooperating in the SEC’s investigation of Tourre, 31, who remains an employee. He is on leave, with legal expenses being paid by New York-based Goldman Sachs.

“The purported claims against Mr. Tourre and the allegations upon which they are based are improperly vague, ambiguous and confusing, and omit critical facts,” the filing said. “Mr. Tourre, a French citizen and engineer by training, reasonably relied on Goldman Sachs’ institutional process to ensure adequate legal review and disclosure of material information, and cannot be held liable for any alleged failings of that process.”In the filing, Tourre said he was aware that Paulson “was considering taking some or all of the short side” of the transaction. He added that the offering document for the CDO contained all relevant information for investors, including the complete portfolio of assets, the fact that no one was purchasing the equity portion of the deal and that a Goldman Sachs affiliate had a short interest and could transfer that interest.

“The portion of the offering document prepared by ACA and for which ACA assumed sole responsibility states that ACA will ‘select the Initial Reference Portfolio,’” the filing said.
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Senator Tom Coburn, a Republican from Oklahoma who serves on the Permanent Subcommittee on Investigations, repeatedly questioned Tourre and other Goldman Sachs executives on why the firm decided to release Tourre’s e-mails, including some that seemed unrelated to the hearing.

“If I worked for Goldman Sachs, I’d be real worried that somebody has made a decision, ‘he’s going to be a whipping boy, he’s the guy that’s getting hung out to dry,’” Coburn told Blankfein during the hearing.

So there’s nothing too surprising in all this, other than the fact that a politician made an intelligent comment in the final paragraph.

It is of interest that Goldman is continuing to pay Tourre’s legal expenses. It is quite common for regulators to claim that paying legal expenses for an employee constitutes lack of cooperation, therefore leaving the fall guy facing hundreds of government lawyers on the government payroll all by himself. Lucky for Tourre, that doesn’t yet appear to be the case in this instance.

I am glad that somebody (namely, Tourre) has finally brought to light the startling news that Goldman has a legal and a compliance department who were involved in the issue. Am I the only other person in the entire world who has wondered why, if Goldman-the-firm did such a Very Bad Thing, that only one single employee has been charged? Am I the only other person in the entire world who has noticed the total lack of SEC interest in going after all the people who signed off on the deal?

It’s a farce, a ridiculous farce, just another piece of regulatory extortion and political theatre. The fact that one guy who did a good job is at jeopardy of losing his reputation and entire career in the process doesn’t bother the apparatchiks at the SEC.

A day of mixed results on good volume for the Canadian preferred share market, with PerpetualDiscounts gaining 15bp and FixedResets down 7bp.