PrefBlog

Unlike Quebecor, the monoline ACA Capital Holdings (of CIBC and Merrill Lynch fame) was given a little breathing room by its creditors, presumably on the grounds that it doesn’t make much difference. Three comments from the story are of interest:

Most of those guarantees are in the form of derivatives. Unlike insurance, these contracts are required to be valued at market rates.
…
“The monolines are dead, their business model is dead,” said David Roche, head of investment consultancy Independent Strategy in London. “The government is going to have to recapitalize this industry or there will be communities in the U.S. where they can’t even flush their toilets” because they can’t afford the services.
…
New York State Insurance Superintendent Eric Dinallo is examining whether to limit the types of debt that can be guaranteed by bond insurers, department spokesman David Neustadt said last week.

The first item of interest is the explicit recognition of the problem inherent in the originate-and-distribute model … or perhaps we should refer to it as a problem in the originate-and-hold model! When a bank grants a mortgage, funds it with, say, a GIC and keeps everything on their books, mark-to-market problems are minimized. But if it buys that same mortgage as a security, it is exposed to market fluctuations in the value of that mortgage. I’m sure I’ve mentioned this issue before, but can’t find my reference! Perhaps this exposure to price volatility should have been mentioned as a “friction” in the Fed research paper by Ashcraft & Schuermann.

The second note … well, I’m certainly not an expert on the US Municipal market! Sounds to me a little bit like hysteria, though!

And the third not shows what we can expect over the next few years – the dead hand of regulation stifling the securities business, or at least threatening to do so.

Naked Capitalism reprinted an interesting piece by Wolfgang Munchau regarding the nature of the … projected? imminent? current? …US recession, arguing that it will be extended due its nature:

Interest rate cuts work their way through to the real economy by a number of transmission channels. During the 2001 recession in the US, the most important was housing credit. The rate cuts came at a time when the housing market was already booming. They turned the boom into a super-boom. Inflationary expectations were low. People expected interest rates to remain low. It was a great moment to take on extra debt, and this was precisely what Americans did.

The current US downturn could not be more different. House prices are falling, and have further to fall before reaching a more sustainable level (in terms of the price-to-rent ratios as well as several other measures).
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The corporate credit channel works more slowly. A company faced with an acute downturn in demand for its products is not going to start investing immediately when interest rates fall.
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With core inflation stubbornly over 2 per cent, the current 10-year yield of 3.8 per cent seems a touch optimistic. So we might be seeing a simultaneous fall in short-term rates and a rise in long-term rates.
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Cui bono? The banks, of course. The bank-bailout channel will be the only monetary transmission mechanism to function like clockwork. The steeper the yield curve, the greater the profits for banks, which make a living by borrowing at short interest rates and lending at long rates.
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As time goes on, the financial sector’s health will gradually improve. Eventually, the credit squeeze will be over – and the next irresponsible lending boom can begin.

These are important concepts … particularly for those who are outraged by the banks’ so-called defiance of the Bank of Canada, reported here January 16.

Great excitement in Canadian equities today:

The Standard & Poor’s/TSX Composite Index fell 604.98, or 4.8 percent, to 12,132.14 in Toronto for its worst drop since Feb. 16, 2001. The benchmark has retreated 17 percent from near a record on Oct. 31 to the lowest in 15 months, approaching a “bear market” drop of 20 percent.

Given that Tokyo is now getting hammered, it should be an official bear market at the opening tomorrow.

Oddly enough, the carnage spilled over into preferred shares, with the S&P/TSX  Preferred Share Index down 0.87%. Panic? Confusion? Cool-headed efficiency? You tell me. Volume was on the light side of normal.

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

This entry was posted on Monday, January 21st, 2008 at 10:55 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.