PrefBlog

I’m not the only one who thinks that the SEC’s extortion of $550-million from Goldman was conveniently timed:

Republican lawmakers asked SEC Inspector General H. David Kotz earlier this year to investigate how the SEC decided to file its April suit against Goldman, which settled the case in July for $550 million. The federal lawsuit alleged wrongdoing in a sale of mortgage securities called Abacus 2007 AC-1, and was filed as Senate Democrats were taking up the financial-regulation bill.

On the same day, the SEC released a scathing report by Mr. Kotz that concluded the agency had repeatedly missed chances to detect an alleged $7 billion fraud run by R. Allen Stanford, a money manager indicted by a federal grand jury last year. Mr. Stanford denies wrongdoing.

At a Senate Banking Committee hearing Wednesday, Mr. Kotz was questioned about the timing of the Goldman suit. He responded: “It would strain credulity to think it was coincidental.” He added: “I can’t give you a conclusion right now, but it was suspicious.”

Fabulous Fab is still in danger of losing his career over that thing … but that’s OK. He’s just a salesmen, while the SEC decision makers are heroic and selfless defenders of truth, beauty and small furry animals.

The boo-hoo-hoo brigade is practicing for contingent capital conversions:

Leona Miller, an 84-year-old retired beautician, says she was seeking safe and steady income from bonds two years ago when her Wachovia Corp. broker recommended she buy securities paying 9 percent interest.

Within six months, Miller had lost about 30 percent of her $20,000 investment and the bonds were converted into shares of Merck & Co. in a falling stock market. The San Diego resident, who still doesn’t understand what happened to her money, had purchased bonds known as structured notes that include built-in derivatives.

Sales to Miller and thousands of other individuals have driven structured note offerings up 58 percent to $31.9 billion through August, according to data compiled by Bloomberg. With U.S. interest rates near zero percent, investors are snapping up bonds such as reverse-convertible notes with knock-in put options or Leveraged CMS Curve and S&P 500 Index Linked Callable Notes, some with face values of as little as $10.

As everybody knows:

Breeden Capital Management manages a long-only equity investment fund utilizing active engagement to help undervalued, and often underperforming, portfolio companies improve performance and shareholder value.

Most people, however, are not aware that a lifetime in regulation equips one to have a keen – almost uncanny – knack for securities valuation:

Mr. Breeden has served since 2005 as Chairman and Chief Executive Officer of Breeden Capital Management LLC, the manager of a series of affiliated investment funds. He has also served since 1996 as Chairman of Richard C. Breeden & Co., LLC, a professional services firm specializing in strategic consulting, financial restructuring and corporate governance advisory services. Mr. Breeden graduated from Stanford University in 1972, and the Harvard Law School in 1975. After practicing law in the field of corporate financial transactions, Mr. Breeden worked in several senior government positions in the Administrations of Presidents Ronald W. Reagan, George H.W. Bush (41) and William Clinton. In 1989, Mr. Breeden served as Assistant to the President, and in that capacity he led successful efforts to develop a restructuring program for the U.S. savings and loan industry. From 1989-1993 Mr. Breeden served as Chairman of the U.S. Securities and Exchange Commission, after nomination by President Bush and unanimous confirmation by the U.S. Senate.

Sadly, there are some who still don’t get it:

The Employee Retirement System board of trustees voted via e-mail May 25 to terminate Greenwich, Connecticut-based Breeden Capital Management, according to information obtained from the city comptroller’s office under a public records request by Bloomberg News.
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As of June 30, the value of the city’s $136.5 million investment was $133.3 million. That was 2.3 percent less than what it gave Breeden since October 2008. The Standard & Poor’s 500 Stock Index lost 2.5 percent in the period.

The pension fund has paid the firm $6.2 million in fees, according to the comptroller’s records.

That’s over 2.00% p.a. Nice work if you can get it!

But all the schmoozing pays off:

Breeden also manages money for the California Public Employees’ Retirement System, or Calpers, and Maryland’s State Retirement and Pension System. The so-called activist investor buys stock in publicly traded companies and then presses for management changes to boost share prices.
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Since investing with Breeden in September 2007, Maryland has lost 12.8 percent compared with a 7.45 percent decline for the S&P 500, according to state pension records. The value of Maryland’s investment with Breeden was $134.1 million as of July 31.

Calpers has lost 4.5 percent investing with Breeden’s U.S. fund since June 2006, according to investment records for the quarter ending June 30. The market value of California’s investment in Breeden’s U.S. fund was $347.9 million.

The Boston Fed has released a working paper by José L. Fillat and Stefania Garetto titled Risk, Returns, and Multinational Production:

This paper starts by unveiling a new empirical regularity: multinational corporations systematically tend to exhibit higher stock market returns and earnings yields than non-multinational firms. Within non-multinationals, exporters tend to exhibit higher earnings yields and returns than firms selling only in their domestic market. To explain this pattern, we develop a real option value model where firms are heterogeneous in productivity, and have to decide whether and how to sell in a foreign market where demand is risky. Firms can serve the foreign market through trade or foreign direct investment,
thus becoming multinationals. Multinational firms are more exposed to risk: following a negative shock, they are reluctant to exit the foreign market because they would forgo the sunk cost that they paid to start investing abroad. We calibrate the model to match U.S. export and FDI dynamics, and use it to explain cross-sectional differences in earnings yields and returns.

DBRS has released its Methodology: Rating Sovereign Governments. It’s a little shy on specifics and examples to be of much interest.

The Canadian preferred share market continued its advance on continued heavy volume today, with PerpetualDiscounts up 12bp while FixedResets gained 4bp.

Lord Adair Turner, of Turner Report fame, has some things to say about bank regulation:

“If we were philosopher kings designing a banking system entirely anew for a greenfield economy, should we have set still higher capital ratios than in the Basel III regime? Yes I believe we should,” the Financial Services Authority’s Adair Turner told bankers at the Mansion House dinner in London’s financial district. “But starting from where we actually are, the Basel III reforms will significantly improve the resilience of our banking systems.”
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Turner said inadequate regulation was more to blame for the near collapse of the banking system than excessive leverage and bonuses.
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“We do need appropriate regulation of bonuses to reduce incentives for excessive risk taking,” Turner said. “We also need to move beyond the demonization of overpaid traders and their unnecessary CDO-squareds.”

The CBOE is attempting to resurrect Credit Default Options:

CBOE Holdings Inc. is seeking to resurrect credit-default options, or contracts that pay off when companies fail to repay their debt, as regulators try to shift some trading of over-the-counter derivatives onto exchanges.

The owner of the largest U.S. options exchange first created the derivatives in 2007. Trading volume amounted to 56 contracts in 2007 and 2008, and none changed hands last year, CBOE said. To generate interest, the settlement price for contracts would be less than the $100,000 value on the original options, according to a proposal filed with the U.S. Securities and Exchange Commission.

CBOE is trying to win business from the $29.6 trillion credit-default swap market, where contracts are traded over the counter. Among changes mandated by the Dodd-Frank Act, signed into law in July, are requirements that standardized interest- rate, credit-default and other swaps be processed by clearinghouses and traded on exchanges or similar systems.

We don’t have to worry about another bank crisis, because the Basel Committee did a great job! We know that, because they say so themselves:

The new rules are “extremely demanding” and “radically transform the regulatory capital framework,” Nout Wellink, chairman of the Basel Committee on Banking Supervision and president of the Bank of the Netherlands, said at a meeting in Singapore of officials who regulate the financial industry.

“If, prior to the crisis, banks had the levels of capital we are asking for, we likely would not have experienced such a deep crisis,” Mr. Wellink said, according to the text of his speech.

I continue to believe that the problem is not so much with capital, the numerator of the Pillar 1 ratios, but with the denominator – mainly risk-weighted assets. But those fixes would be harder to explain politically.

Daniel K Tarullo, Member of the Board of Governors of the Federal Reserve System, gave a speech at the Brookings Panel on Economic Activity, Washington DC, 17 September 2010. In contrast to my complaint about the Bail Outs and Financial Fragility paper, he draws a clear distinction between “illiquid” and “insolvent”:

But when the value of whole classes of the underlying collateral was drawn into serious question, initially by the collapse of the subprime housing market, participants’ lack of information about the collateral they held led to a shattering of confidence in all the collateral.

In the absence of the regulation and government backstop that have applied to the traditional banking system since the Depression, a run on assets in the entire repo market ensued. The resulting forced sale of assets into an illiquid market turned many illiquid institutions into insolvent ones. The fallout has been such that, to this day, the amount of repo funding available for non-agency, mortgage-backed securities, commercial mortgage-backed securities, high-yield corporate bonds, and other instruments backed by assets with any degree of risk remains substantially below its pre-Lehman levels.

He’s concerned about the potential for crowding out of the banks:

Where competition from unregulated entities is permitted, explicitly or de facto, capital and other requirements imposed on regulated firms may shrink margins enough to make them unattractive to investors. The result, as we have seen in the past, will be some combination of regulatory arbitrage, assumption of higher risk in permitted activities, and exit from the industry. Each of these outcomes at least potentially undermines the original motivation for the regulation.

Government apologist and sycophant Mark Carney gave a variation of the standard precious handwringing speech about productivity last March:

There are two imperatives–one domestic, one international–to secure strong, sustainable, and balanced economic growth for Canada. Both recall Aesop’s fable of the ant and the grasshopper, the moral of which can be best summed up as “idleness brings want.” In short, in a wicked world, Canada needs productive virtue.

I filled in yet another government form today – which took time away from programming – and found out that the super-cool fillable form was encrypted: which meant I could not save the completed version electronically or print it to a PDF. Instead I have to print it onto paper, fax it to the recipient, fax it to myself and (since I try to be productive and receive my faxes electronically) save the fax, then dispose of the idiotic and unnecessary paper.

Do you want to know the first step to productivity, Mr. Carney? How about morons on the government payroll thinking about what they’re doing?

The Globe’s in a tizzy about the potential cost of dementia care, but I don’t know what they’re worried about. Here’s the plan:

• Hire the cheapest caregivers (nurses, health aides) you possibly can
• Then cut their pay even more (make sure they’re all part-timers!)
• Give them more beds to look after than even the most competent practitioner could handle
• Keep the patients drugged up so they’re less work (make sure the doctor knows which side his bread’s buttered on!)
• Have a huge number of extremely detailed rules about patient care, endorsed by big-name practitioners
• Talk about the rules incessantly.
• Ensure all employees sign a statement that they have read, understood and will comply with all rules.
• Ignore the rules (ridiculous even to try, given patient load, staff and facilities)
• Every now and then, hang some poor sucker of a nurse who gave standard treatment to the wrong person. Wring your hands. Talk about the rules

I’m not saying it’s a good plan, but we all know that that’s what will happen eventually so why not start getting used to it now?

How ’bout that Canadian preferred share market, eh? It continues to move from strength to strength, with PerpetualDiscounts gaining 21bp today while FixedResets managed to eke out a 1bp win. Volume was very heavy. Nesbitt wrote some very nice tickets today, but that’s not necessarily the same thing as making good money. It depends on what kind of crosses they were.

PerpetualDiscounts now yield 5.54%, equivalent to 7.76% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.3% so the pre-tax interest-equivalent spread (also called the Seniority Spread) now stands at about 245bp, a continued tightening from the 255bp reported September 15

Ireland looks like it’s heading for the debt trap:

Ireland will today try to sell as much as 1.5 billion euros ($1.96 billion) in bonds as the government tries to convince investors the country can avoid a European Union bailout.

One day after the premium on Irish 10-year debt over German equivalents rose to a record, the Dublin-based National Treasury Management Agency is offering between 1 billion euros and 1.5 billion euros of four- and eight-year bonds. The auction results will be announced after 10 a.m.

Investors’ concerns about the fiscal health of some euro nations are resurfacing four months after the EU announced an almost $1 trillion rescue package to stamp out contagion from Greece’s fiscal crisis. The spread on Irish debt over bunds yesterday exceeded 400 basis points as the government struggles to cap the cost of bailing out its banking system. In Portugal, the spread climbed as high as 399 basis points.

The Bank Act review cycle has started again:

The Honourable Jim Flaherty, Minister of Finance, today launched the scheduled review of legislation governing federally regulated financial institutions.

“The Government reviews the statutes that govern federally regulated financial institutions every five years to ensure Canada remains a global leader in financial services,” said Minister Flaherty. “This practice sets Canada apart from almost every other country in the world.”
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“Some fine-tuning to the system may be required, but wholesale change is not necessary,” he said. “The Government would like to hear the views of all Canadians on how to improve our financial system.”

My wish-list includes greater clarity on the status of Bankers’ Acceptances in bankruptcy (are they covered bonds? Can investors look through the bank guarantee to the actual issuer of the paper?) and a requirement that the seniority of instruments within the “general” bucket be specified … if I own a BDN, is that more or less senior than a BA?

The FOMC Statement was gloomy:

Information received since the Federal Open Market Committee met in August indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls. Housing starts are at a depressed level. Bank lending has continued to contract, but at a reduced rate in recent months. The Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be modest in the near term.

and accordingly:

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period. The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings.

This had an effect:

Gold rose to a record, Treasury two-year yields slid to an all-time low while the dollar weakened as the Federal Reserve said it’s willing to ease monetary policy further if needed to boost the economy. Most U.S. stocks fell.

Gold futures surged as much as 0.9 percent to $1,292.40 an ounce as of 4 p.m. in New York as the dollar depreciated against 15 of 16 major counterparts. The 10-year Treasury yield lost 13 basis points to 2.58 percent and the 2-year yield slid to a record low of 0.4155 percent.

Quadravest, purveyor of SplitShare funds, has announced:

Dividend Select 15 Corp. (“The Company”) is pleased to announce the filing of a preliminary prospectus dated September 17, 2010 for a proposed new offering of equity shares at $10.00 per share.
The Company has been created to provide investors with an opportunity to invest in a portfolio (the “Portfolio”) of 15 high quality Canadian companies (the “Portfolio Companies”) whose shares provide an attractive dividend yield, and which have shown solid earnings growth and have a history of capital appreciation. The Company will employ a covered call writing strategy to generate additional income to the Portfolio. The 15 Portfolio Companies will be selected from among the following 20 companies listed on the Toronto Stock Exchange: [Usual suspects – JH]

Interestingly, the prospectus makes the flat statement:

The Company will not borrow money or use leverage as part of its investment strategies.

In accordance with the usual state of affairs, the prospectus fully discloses the investment managers’ experience, but is completely silent regarding the investment managers’ performance.

The Canadian preferred share market continued to move from strength to strength on heavy volume today, with PerpetualDiscounts up 27bp and FixedResets gaining 18bp.

Stub quotes will be butted out:

NYSE Euronext, Nasdaq OMX Group Inc. and Bats Global Markets sought permission from regulators yesterday to eliminate stub quotes, or bids and offers as low as pennies or as high as thousands of dollars provided by market makers that were blamed for worsening the May 6 crash.
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Stub quotes are placeholders provided by market makers at prices as low as 1 cent to satisfy a regulatory obligation to submit both bids and offers. Transactions aren’t meant to occur at those levels.

I don’t understand why stub quotes were ever allowed in the first place. As some HFT firms have pointed out:

In exchange for meeting stricter obligations, market makers are generally given advantages over other market participants, which act like subsidies,” RGM, Hudson River, Allston and Quantlab said in their letter. “These advantages have typically involved preferential access to the markets, lower fees and informational advantages. These advantages come at a substantial cost for all investors as they degrade competition and raise barriers to entry for new participants.”

Why market makers would be permitted to pay for these presumably valuable privileges with stub quotes is quite beyond me.

The pointless nature of financial journalism was well illustrated by two stories published back to back. The first was Fed Will Retain Policy on Assets, Low-Rate Pledge, Survey Shows:

The Federal Reserve next week is likely to affirm its pledge to keep interest rates low for an “extended period” and maintain the floor on its holdings of securities, say economists surveyed by Bloomberg News.

The Fed’s Open Market Committee at its Sept. 21 meeting will hold off from expanding the balance sheet by purchasing securities, according to 60 of 64 analysts surveyed Sept. 16-17. Fifty-four of 63 economists said the Fed will leave unchanged a sentence saying high unemployment and low inflation warrant “exceptionally low” rates for an “extended period.”

… and the second was Treasury Notes Gain on Bets Fed’s Statement Will Signal More Accommodation:

Treasury 10-year notes rose for the first time in four weeks as traders speculated the Federal Reserve will be more accommodative in its policy statement next week as the economic recovery showed signs of stalling.

A rally in two-year notes pushed yields down this week the most since May after the central bank bought shorter-maturity government debt and as investors bet that Japan’s purchases of securities will favor the front end of the U.S. yield curve after it sold the yen to weaken its currency. Notes climbed before the Sept. 21 Fed meeting as the annual rate of inflation excluding food and energy stayed at a 44-year low.

There’s a negative CDS basis in bank bonds:

Gaps between credit-default swaps and bonds have widened to 25 basis points from less than 2 basis points about three months ago, according to Citigroup Inc. Pimco, the manager of the world’s largest bond fund is finding as much as 1 percent of extra yield even after paying to insure bank debt, said Mark Kiesel, a managing director at the Newport Beach, California- based firm.

A rally that started in June may gain momentum as the divergence between swaps and yields gives investors extra incentive to own corporate debt. The increase in the so-called negative basis is attracting buyers that seek to profit by buying the debt while also purchasing credit swaps.
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The 100-basis-point gaps Pimco is identifying in bank bonds and 25 basis points in the broader market compare with the average difference of more than 250 basis points after the bankruptcy of Lehman Brothers Holdings Inc. two years ago, just before bonds posted a record rally. The all-time wide gaps emerged as credit markets seized up, causing bond spreads to soar while demand for swap protection failed to keep up.

“When capital is scarce, the basis becomes more negative,” said Alberto Gallo, a New York-based strategist at Goldman Sachs Group Inc. He said the basis should narrow as monetary policy and regulation reduce risk in the financial system and stabilize funding costs.

Negative-basis CDS spreads were discussed in Canadian Bond Liquidity Premia

I have sent the following communication to Canada Post and True North Public Affairs, where James Roche, Chairman of the Canada Post Foundation for Mental Health, has his day-job:

Sirs,

One of your clerks advised me that you were “collecting for mental health” today while I was purchasing stamps and requested a donation.

I strongly object to being importuned by beggars while going about my business and wish to advise you that I will have my first class mail serviced by your competitors in future.

I have often observed that precious little do-gooders tend to behave as thugs and therefore have a question: do you make it clear to your front-line staff that participation in this disgraceful exhibition of poor manners is entirely voluntary and there will be no repercussions on those who do not wish to humiliate themselves by begging? Or are they forced to participate as a condition of employment?

Sincerely,

Beggars! It’s enough to make a strong man go postal!

Hellzapoppin’ on the Canadian preferred share market today, with PerpetualDiscounts up 55bp and FixedResets gaining 12bp on heavy volume.