PrefBlog

ABCP is in the news nowadays – and the Fed reports that outstandings are down another $11-billion over the week, as the unwinding / delevering continues. The total outstanding is now down about 21% from the July month-end figure.

The WSJ has published an article blaming the mess on London bankers, a piece of revisionism to which Naked Capitalism takes violent exception. Naked Capitalism has also reviewed the failure of Cheyne discussed here yesterday; the S&P Pre-sale report for Cheyne, dated May, 2005, has, perhaps, been accidentally left on the Web. Brad Setser applauds Naked Capitalism and points out that, for all the talk of globalization, a lot of US money is simply making a round-trip via London/Offshore right back to the US.

I can present some more support for my conception of Super-Conduit as Vulture Fund:

AAA-rated mortgage-backed securities selling at 85 or 90 cents on the dollar

asset-backed commercial paper backstopped by real assets and a full bank credit backstop yielding more than unsecured commercial paper issued by the same bank—in other words, the real assets as collateral viewed by market participants as a negative rather than a positive,

3-month LIBOR (the interbank deposit rate in London for dollars) as high as 100 basis points above the fed funds rate target—certainly possible if the monetary authorities were in the process of tightening monetary policy aggressively, but nearly inconceivable given the widely held expectation that the central bank would likely be cutting interest rates,

Treasury bill rates rising and falling 100 basis points in a single day, and

nearly a failed Treasury bill auction—total bids were barely sufficient to cover the amount the Treasury was offering. This near-miss occurred despite the fact that money market mutual fund investors were fleeing to rather than away from Treasury securities.

And, reported in the context of a $1.2-billion whoopsee by Rhinebridge Plc:

SIVs worldwide have been forced to sell about $75 billion of assets in the past two months to repay maturing debt as investors balked at buying securities linked to money-losing subprime mortgages.
…
As of late August, 79 percent of Rhinebridge’s holdings were in the U.S. and 80 percent in mortgage-backed bonds, Fitch Ratings estimated in an Aug. 22 report. Eighty-three percent of the assets had the highest-possible AAA rating, Fitch said.

Even Warren Buffett has opined on Super-Conduit!

Buffett said he was skeptical about the U.S. Treasury’s plan to create an $80 billion fund to buy distressed assets from structured investment vehicles linked to home lending.

“I don’t see any way that pooling a bunch of mortgages, changing the ownership, is going to change the viability of the mortgage instrument itself — whether people can make the payments,” he said. “It would be better to have them on the balance sheets so everyone would know what’s going on”

I hesitate to question the wildly popular Oracle of Omaha publicly, but I don’t see Super-Conduit as being merely a vehicle to change ownership – I see it as a matter of wiping out the old equity-holders and injecting new equity while keeping the note-holders happy and senior.

However, the Super-Conduit plan seems to be having trouble attracting supporters; this may be an indication that the potential players see it more as Citibank bail-out than as a vulture fund; or it may simply indicate that potential players would rather be vultures all by themselves. Without disclosure of every nuance of the negotiations, it’s hard to guess! 

Nouriel Roubini writes a very gloomy assessment of the chances for a major 1987-style stock market collapse and concludes:

To avoid such a meltdown, we need many reforms: better regulation and supervision of mortgages and of financial institutions, including the lightly or unregulated hedge funds; more transparency on who is holding which risky assets; better risk management by investors; avoidance of a bailout of reckless lenders and investors; a more competitive market for ratings as the small set of only three rating agencies seriously misread very complex and risky instruments; and hopefully a modest and soft—rather than hard—landing for the U.S. economy.

In other words: it would be a really wonderful world if only there were more rules in it! I won’t reiterate my past arguments against Regulation Nirvana; I’ll just say again that regulators should ensure there is a solid banking system at the core of financial operations, then let the rest of us play with it as we will. And strengthen the concept of fiduciary responsibility, so that those who recklessly violate Prudent Man rules end up wearing the losses.

Default Risk has published a paper on Equity Implied Ratings:

Fitch’s Equity Implied Ratings and Probability of Default (EIR) model is estimated to provide a view of a firm’s credit condition given its current equity price and available financial information.

This is an enhancement that I have been longing to bring into HIMIPref™ … perhaps someday!

There aren’t many bank runs nowadays and some credible analysis of the Northern Rock run is getting done. Two major conclusions: Northern Rock was overleveraged and UK Deposit Insurance is inferior. Deposit insurance in the UK covers:

100% of the first £2,000 (about $4,100) and 90% of the next £33,000 (about $ 67,500)

Various forms of deposit insurance were reviewed by BIS in 1998; I am somewhat surprised to learn that deposit insurance is something of a novelty in Europe:

While most commentators see some merit in the idea of deposit insurance, there is more disagreement as to whether deposit protection schemes should be explicit or not. Most commentators seem to accept the former position. One part of the argument is that, in the middle of a crisis, olicymakers will be forced to offer explicit protection to everyone. Thus, the costs to taxpayers may be very high. In contrast, Demirgüç-Kunt and Detragiache (2000) seem to argue that poor design can make the explicit protection route even more costly. This design issue is returned to below. Explicit deposit insurance schemes are certainly much more widespread than they used to be. The first nationwide system was introduced in 1934 in the United States, but other countries only began to follow in the postwar period. This trend accelerated in OECD countries in the 1980s, culminating with the introduction of limited deposit insurance in the European Union in 1994.

The argument against deposit insurance is moral hazard:

Erlend Nier and Ursel Baumann find, in a cross-country study, that enhanced disclosure by banks seems to induce banks to limit their risk of default by keeping higher capital buffers for given asset risk. Their results also suggest that market discipline is stronger for banks that are funded by uninsured liabilities and weaker for those that benefit from wide deposit protection schemes or other safety nets. The latter may therefore be introducing a degree of moral hazard.

I don’t buy it. The average retail investor is doing well if he can balance his chequebook – how can he be expected to analyze the soundness of a bank during a crisis? He’s going to know nothing and know he knows nothing; he will therefore withdraw his deposits and contribute to a run.

The North American system of providing full deposit insurance on amounts up to $100,000 per institution per person is a good solution; but as I have previously mentioned, the CDIC doesn’t have enough cash in the till to be credible during a genuine crisis. They should have at least enough to recapitalize their largest member completely and the Royal Bank has capital of about $26-billion. And further, not a single dime of the CDIC’s reserve fund should be invested in Canada!

Menzie Chinn of Econbrowser continues to worry about the prospects for the national debt:

… following her assault on the implausible economic assumptions of the Bush administration:

But real change in American fiscal policy will not happen until they become very close to hitting the wall. And, for all the dollar drama, they’re a long way from that point. It will be interesting to see if record lows against the Euro become an issue in the 2008 elections. Oil at USD 90 ain’t going to help the economy much!

Remember the Moody’s mass downgrade of October 11? In a fascinating development, Global DIGIT (last mentioned October 16, with a full post regarding its suspension of dividends) has announced:

As at October 3, 2007, the reference portfolios of Global DIGIT contained 8 of the securities downgraded by Moody’s.

The total exposure to downgraded instruments is $463-million – out of a total portfolio of $1.4-billion. Whoopsee!

Very good volume in the preferred share market today, but the perpetual indices resumed their descent.

There were forty-six other index-included $25.00-equivalent issues trading over 10,000 shares today.

Update: Typographical error on RY.PR.G yield corrected. Revised number is approximate.

This entry was posted on Thursday, October 18th, 2007 at 8:58 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.