February 6, 2008

Willem Buiter was last mentioned in PrefBlog on January 25 in connection with inflation concerns. He’s back again today, preaching not just the likelihood, but the necessity of a US recession:

Therefore, to restore a sustainable external balance and to accumulate the financial assets that will support a greying US population in the style it would like to and hopes and expects to be accustomed to, the US private and public sectors must save more. To get to a higher saving and wealth trajectory, the US economy will first have to pass through the valley of the shadow of deficient effective demand, rising excess capacity and growing unemployment. Postponing the necessary adjustment will just make the pain of the eventual unavoidable correction that much greater.

The trouble with such a prescription is that it runs headlong into the American “can do” attitude. This attitude is admirable and has served them well … but sometimes it comes a cropper. “Reduce taxes and the deficit while increasing services? Can do!” “Bring Western Democracy to regions where even those who understand it don’t want it? Can do!”.

The failure of a few auctions for American Auction Rate Municipals has attracted some notice lately. Accrued Interest explains the situation … it all comes down to the monolines!

The bank was only willing to provide liquidity if there was some additional credit support. No problem, thought the municipal bond bankers! We’ll bring in a monoline insurer! The bank would therefore agree to provide liquidity so long as the bond insurer was rated at some minimal credit rating level. What that level is depends on the deal. Might be AA, might be A. I haven’t seen any that were actually AAA but they could be out there.

But what happens if the unthinkable happens? A monoline insurer gets downgraded? Well, the bank’s liquidity agreement becomes null and void. Where does that leave bond holders? It leaves them with no credit support at all. Only the issuer itself would remain.

Auction rate securities are a recurring niche in the markets – I remember (a long, long time ago) there were some Hees (remember Hees?) MAPS – Monthly Auction Preferred Shares. It’s really just another mechanism whereby issuers can finance long at short rates and investors can pretend they’re money-market superstars by outperforming the 3-month benchmark with 100-year paper … for a while.

And the mention of monolines reminds me of a funny story … remember MBIA’s line in the sand, discussed on January 31? Well, the tide’s come in:

MBIA Inc., the world’s biggest bond insurer, plans to raise an additional $750 million by selling about 50.3 million common shares, bolstering capital in an attempt to retain its AAA credit rating.

Investment firm Warburg Pincus will backstop the offering by purchasing as much as $750 million of convertible participating preferred stock, the Armonk, New York-based company said in a statement today. MBIA, which has already raised at least $1.5 billion since November, said it would contribute most of the proceeds to its MBIA Insurance Corp. unit.

Another article highlighted by Naked Capitalism delivers a rather vague exhortation for increased bank regulation while one particular example purporting to show the need concerns some recent problems with Wachovia:

AmeriNet was a “payment processor,” a company that creates unsigned checks on behalf of telemarketers to withdraw funds automatically from customer accounts. Such checks, once widely used by businesses collecting monthly fees, are legal if customers approve the transactions.

In 2006, an executive at Citizens Bank wrote via e-mail that thieves were routing unauthorized checks through Wachovia that stole from Citizens account holders.

“We have spoken to many of our customers who have been victimized by this scam,” wrote the Citizens executive, according to court documents. “We would appreciate it if you would shut down accounts of any customers of yours that may be engaging in improper activity.”

But Wachovia kept that account open until it was frozen by a federal court a few weeks later, as part of a government lawsuit against the client.

This is just more nonsense from the “Everything will be better with just a few more rules” camp. It is very tempting to believe that a few more rules will bring the new millennium, but those who argue in favour of this have never seen what happens in real life. Rules such as this – shutting down accounts due to suspicions of fraud – are not investigated by dispassionate keen-eyed investigators who have the evidence weighed by judicious descendents of Solomon. It is, in fact, a virtually random process in which facts become secondary to ass-covering.

In the quoted text above, the Citizens Bank executive should not have been contacting Wachovia – if they became involved at all, I suggest that police are generally considered the proper authorities for investigation of impropriety.

A bank clerk is not a cop I trust. A branch manager is not a judge I trust. And wishing won’t make it so.

But, that’s what happens when stuff hits the headlines – everybody’s an expert:

Regulators may restrict Moody’s Investors Service and Standard & Poor’s from advising banks on structured debt securities after criticism the firms failed to downgrade subprime-related debt as investor losses mounted.

Ratings firms may face a new code of conduct that limits their business and requires “reasonable steps” to ensure “a credible rating,” the International Organization of Securities Commissions in Madrid said in a statement today. IOSCO is the main forum for regulators, covering more than 100 countries from the U.S. to Japan.

I sure wish there was a code of conduct for regulators forcing them to take reasonable steps to ensure credible regulation!

An IMF research group has summarized a paper on VoxEU arguing that the subprime crisis is not unusual:

The subprime experience demonstrates that even highly-developed financial markets are not immune to problems associated with credit booms.

What can be done to curb bad credit booms? Historically, the effectiveness of macroeconomic polices in reducing credit growth has varied (see, for example, Enoch and Ötker-Robe, 2007). While monetary tightening can reduce both the demand and supply of bank loans, its effectiveness is often limited by capital account openness. This is especially the case in small open economies and in countries with more advanced financial sectors, where banks have easy access to foreign credit, including from parent institutions. Monetary tightening may also lead to significant substitution between domestic and foreign-denominated credit, especially in countries with (perceived) rigid exchange rate regimes. Fiscal tightening may also help reduce the expansionary pressures associated with credit booms, though this is often not politically feasible.

Fiscal tightening didn’t have much chance under a Republican administration! When in doubt, assume the best, right? It is very interesting to speculate as to what might have happened under Prof. Taylor’s counterfactual scenario of Fed tightening during the boom. We are certainly seeing that sub-prime sucked in a lot of money from Europe even with the relatively loose Fed policy during that time.

A very good day for the preferred share market, although I don’t see how the S&P/TSX Index was able to improve by 0.55% … half that, sure, two-thirds, maybe, but I suspect that this is an artefact of calculation caused either by low closes yesterday or high closes today.

Be that as it may, it was a strong day, with volume picking up and good strength throughout the entire PerpetualDiscount index. This index now has an interest-equivalent yield of 7.62% (at a conversion factor of 1.4), which is Canadas +350bp, Long Corporates +180bp. This latter (and probably more meaningful) figure has narrowed in about 30bp since last reviewed October 30, but still has a long way to go before reaching last spring’s levels of Long Corporates + ~110bp.

Hmmmm …. 70bp x 14years duration = … I’ll take it!

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 5.53% 5.55% 50,060 14.6 2 +0.3949% 1,074.6
Fixed-Floater 5.19% 5.69% 85,475 14.64 7 -0.1134% 1,015.2
Floater 4.96% 4.96% 76,713 15.55 3 +0.3437% 859.6
Op. Retract 4.82% 1.10% 80,875 2.49 15 +0.1808% 1,044.6
Split-Share 5.31% 5.54% 101,648 4.11 15 -0.0045% 1,036.2
Interest Bearing 6.24% 6.42% 61,338 3.60 4 +0.5748% 1,080.8
Perpetual-Premium 5.75% 5.50% 402,200 5.93 16 -0.0311% 1,024.7
Perpetual-Discount 5.41% 5.44% 301,279 14.75 52 +0.5889% 949.9
Major Price Changes
Issue Index Change Notes
WFS.PR.A SplitShare -1.6393% Asset coverage of just under 1.9:1 as of January 31, according to Mulvihill. Now with a pre-tax bid-YTW of 4.81% based on a bid of 10.20 and a hardMaturity 2011-6-30. Still a pretty crummy yield, if you ask me, but better than yesterday!
FTU.PR.A SplitShare -1.2295% Asset coverage of just under 1.8:1 as of January 31, according to the company. Now with a pre-tax bid-YTW of 6.18% based on a bid of 9.64 and a hardMaturity 2012-12-1 at 10.00.
BCE.PR.I FixFloat -1.2190%  
BNS.PR.K PerpetualDiscount +1.0035% Now with a pre-tax bid-YTW of 5.21% based on a bid of 23.15 and a limitMaturity.
NA.PR.L PerpetualDiscount +1.0323% Now with a pre-tax bid-YTW of 5.41% based on a bid of 22.51 and a limitMaturity.
POW.PR.B PerpetualDiscount +1.0352% Now with a pre-tax bid-YTW of 5.52% based on a bid of 24.40 and a limitMaturity.
PWF.PR.K PerpetualDiscount +1.0476% Now with a pre-tax bid-YTW of 5.38% based on a bid of 23.15 and a limitMaturity.
BCE.PR.G FixFloat +1.0799%  
CIU.PR.A PerpetualDiscount +1.0813% Now with a pre-tax bid-YTW of 5.36% based on a bid of 21.50 and a limitMaturity.
IAG.PR.A PerpetualDiscount +1.1574% Now with a pre-tax bid-YTW of 5.33% based on a bid of 21.85 and a limitMaturity.
SLF.PR.E PerpetualDiscount +1.1682% Now with a pre-tax bid-YTW of 5.24% based on a bid of 21.65 and a limitMaturity.
CM.PR.H PerpetualDiscount +1.2582% Now with a pre-tax bid-YTW of 5.55% based on a bid of 21.73 and a limitMaturity.
GWO.PR.G PerpetualDiscount +1.5748% Now with a pre-tax bid-YTW of 5.36% based on a bid of 24.51 and a limitMaturity.
MFC.PR.B PerpetualDiscount +1.7544% Now with a pre-tax bid-YTW of 5.08% based on a bid of 23.20 and a limitMaturity.
RY.PR.A PerpetualDiscount +1.7916% Now with a pre-tax bid-YTW of 5.15% based on a bid of 21.59 and a limitMaturity.
HSB.PR.D PerpetualDiscount +2.4670% Now with a pre-tax bid-YTW of 5.44% based on a bid of 23.26 and a limitMaturity.
BSD.PR.A InterestBearing +2.8602% Asset coverage of just under 1.6:1 as of February 1, according to Brookfield Funds. Now with a pre-tax bid-YTW of 6.73% based on a bid of 9.71 and a hardMaturity 2015-3-31 at 10.00.
Volume Highlights
Issue Index Volume Notes
PIC.PR.A SplitShare 293,875 Asset coverage of just under 1.6:1 as of January 31, according to Mulvihill. Now with a pre-tax bid-YTW of 5.83% based on a bid of 15.00 and a hardMaturity 2010-11-1 at 15.00.
RY.PR.B PerpetualDiscount 142,550 RBC crossed 100,000 at 22.35; then another 40,000 at the same price. Now with a pre-tax bid-YTW of 5.25% based on a bid of 22.45 and a limitMaturity.
TD.PR.Q PerpetualPremium 66,800 Now with a pre-tax bid-YTW of 5.44% based on a bid of 25.38 and a call 2017-3-2 at 25.00.
BAM.PR.N PerpetualDiscount 47,695 Now with a pre-tax bid-YTW of 6.40% based on a bid of 18.85 and a limitMaturity.
TD.PR.P PerpetualDiscount 36,948 Now with a pre-tax bid-YTW of 5.35% based on a bid of 24.65 and a limitMaturity.

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

9 Responses to “February 6, 2008”

  1. madequota says:

    Market Observations, February 7, mid-morning

    Good Morning!

    Since I’ve been visiting this fine blog, anyone scanning my musings would have noticed an abundance of commentary [not very flattering] on the selling habits of a trader I suspect to be an RBC mutual fund manager. I think he called in sick today, because the only place I see his “giveaway” stylings are with ELF.PR.G, and that’s been going on all week!

    On the flip side, I’ve noticed a number of “institutional”-calibre bids from BMO. Currently, he is underpinning MFC.PR.B, BNS.PR.L, TD.PR.O, BMO.PR.J, and CM.PR.J [to name a few] with substantial, slightly below market bids. When RBC started their campaign of pref share disposal back in the early fall, it was BMO’s presence on the buy side that kept a lot of issues from getting totally obliterated. BMO’s presence then, however, was far more muted than it seems to be over the past week or so; therefore, pref share investors might be wise to interpret this as a sign of better things to come!


  2. kaspu says:

    to whoever is bidding up CCS C:
    please stop, so that I can continue to accumulate at a reasonable price.
    Thank you for your consideration.

  3. kaspu says:

    sorry, that should be “whomever.”

  4. madequota says:


    “keep buying from me at $19.00, so I can pocket the half dollar per share profit, brought about by madequota’s brilliant and timely recommendation 2 days ago, and then I can increase my bid quantities below $18.50”!

    how’d I do with that?!

    madequota aka crystal-ball-gazer

    p.s. do you want my address, so you’ll know where to forward my tip?!

  5. […] PrefBlog Canadian Preferred Shares – Data and Discussion « February 6, 2008 […]

  6. […] On February 6 I noted some news reports about Auction Rate Municipals auctions failing … now they have been joined by some Student Loan securities: College Loan Corp., a San Diego- based lender, said some bonds it issued with rates determined through periodic auctions failed to attract enough bids. […]

  7. […] One example of this is the recent spate of Auction Rate Municipal auction failure. These auctions were last discussed – and explained! – on February 6. Another example is the market for Leveraged Buy-Out loans. Naked Capitalism provides an update to the commentary that was discussed February 11. Incidentally, there’s a new issue of CLO being touted: Goldman Sachs Group Inc. and Carlyle Group plan to sell a 2 billion-euro ($2.9 billion) collateralized loan obligation and invest their own funds in the riskiest portion, according to a person with direct knowledge. … The CLO will mostly hold loans used to finance European leveraged buyouts, purchasing directly from the managers of the transactions as well as loans traded in the market, the person said. Goldman is handling the CLO sale and Carlyle will manage the investments. … CELF Partnership Loan Funding 2008-1 […]

  8. […] Merrill Lynch is also cutting back its support. Auction Rate Municipals were introduced to PrefBlog readers on February 6. From esoteric trivia to world crisis in eight days! I feel certain that, like the Canadian ABCP market, this is all the fault of the credit rating agencies. Did you know they get paid by the issuers? […]

  9. […] Rule fame, discusses the causes of the crisis. He repeats his thesis, mentioned on PrefBlog on Feb. 6, 2008 and discussed on Econbrowser in its post The Taylor Rule and the Housing Boom: The classic […]

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