The hills are alive with speculation that the Fed might buy mortgage paper:
The Federal Reserve is considering contingency plans for expanding its lending power in the event its recent steps to unfreeze credit markets fail.
…
The Fed, like any central bank, could print unlimited amounts of money, but that would push short-term interest rates lower than it believes would be wise. The contingency planning seeks ways to relieve strains in credit markets and restore liquidity without pushing down rates.The Fed is reluctant to heed calls from some Wall Street participants and foreign officials for the Fed to directly purchase mortgage-backed securities to help a market that still is not functioning normally.
Such speculation has even reached Canada (hat tip: Assiduous Reader madequota):
Canadian Finance Minister Jim Flaherty said on Wednesday he expects Group of Seven finance ministers to adopt the Financial Stability Forum report with “perhaps some amendments.”
…
One of the many options is a plan to recapitalize banks and repurchase mortgages, with the possible use of taxpayer money.
… but US participation in such a plan seems a little dubious:
“The use of public balance sheets may be needed to help financial and housing markets,” Simon Johnson, the IMF’s chief economist, said at a news conference on the fund’s report today in Washington. Fund economists anticipate a 14 percent to 22 percent slide in U.S. house prices.
The Bush administration has opposed using government funds to purchase mortgages or mortgage-backed securities, as proposed by some U.S. lawmakers.
… although some big players favour the idea:
A March 13 proposal by Senator Christopher Dodd and Congressman Barney Frank that the Federal Housing Administration insure refinanced mortgages after lenders reduce the loan principal to make payments more affordable to homeowners “is the next step,” Senator Charles Schumer, a New York Democrat, said in a Bloomberg Television interview on March 19. It’s a “broader step, but not as broad as [Resolution Trust Corp. (RTC)],” he said.
For Pimco’s Gross that’s not enough. “If Washington gets off its high `moral hazard’ horse and moves to support housing prices, investors will return in a rush,” he wrote in a note to investors published Feb. 26. Gross, who runs the $122 billion Total Return Fund from Newport Beach, California, didn’t return calls seeking additional comment.
An RTC-like entity may not be “the best idea, but maybe it’s the idea that gets us through this,” said New York Life Investment Management’s Girard. “The likelihood of it happening has certainly increased.”
A certain amount of impetus for the idea comes, apparently, from the Bank of England. A recent speech by PMW Tucker of the BoE outlines the central banks’ conundrum:
The serious puzzle which that underlines is why there is a dearth of buyers for the supposedly undervalued paper. With the terms and availability of financing from banks and dealers having tightened, levered funds are hardly likely to be the US Cavalry. But it is interesting that there has not been more interest from investment institutions with ostensibly long holding periods, which are largely unlevered and are not exposed to liquidity risk from borrowing short and lending long. What we commonly hear from contacts is that investment managers do not want to be caught out if asset prices fall further before they recover. But no one can seriously believe that they can spot the bottom of the market, and short-term horizons should not weigh heavily in longer-term investment institutions. All of which suggests that there may be structural impediments. Those could include some combination of the reasonable difficulty that some asset managers experience in assessing the quality of securitised assets; and mandates and accounting policies that may have the effect of shortening asset managers’ time horizons.
… which, to a certain extent, underlines the difference between asset management and the selling of asset management capability that I whine about from time to time. According to Mr. Tucker, at any rate, there is undervalued paper out there that is known to be undervalued. Asset managers, however, are constrained from buying it because all their clients know that it’s all worthless garbage and will fire them if they do. Even if their clients – who are largely pension funds – are OK with the idea, the pension funds might expect difficulties from their clients, the beneficiaries, should this paper be bought and the prices move down a penny. So we have a coordination problem and overall conditions get worse.
Willem Buiter has no problems with the idea in principle:
If the central bank, or some other government agency, were to act as Market Maker of Last Resort and buy the impaired asset at a price no greater than its fair value but higher than what it would fetch in the free but unfair illiquid market, such a purchase would not be a bail-out. It would also be welfare-increasing.
The central bank is especially well placed to play this role because, as long as the distressed/impaired assets are denominated in domestic currency, the central bank will never become illiquid or insolvent by purchasing them.
Should, despite the fact that the impaired asset was purchased at a price below its fundamental value, the central bank eventually make a loss on the asset, recapitalisation of the central bank by the Treasury (that is, the tax payer) may well be necessary, or at least desirable, if the only alternative is self-recapitalisation by the central bank through monetary issuance.
This possibility of a capital loss and fiscalisation of this loss does not mean that the transaction ex-ante involved a subsidy by the central bank to the owner of the impaired asset, or a bail-out of the owner.
A subsidy is present only if the expected, risk-adjusted, rate of return for the central bank on the purchase of the impaired asset is less than the central bank’s opportunity cost of funds. There is no economic subsidy if the price paid to the seller exceeds what the seller would have received from a sale in the free but illiquid market, as long as the central bank expects to earn an appropriate risk-adjusted rate of return on the purchase.
… but he has not, as far as I know, actually advocated taking that step right now in this instance.
I don’t see a need, at this point, for the central banks to take that ultimate step. The success of regulation – yes, I used the word “success” and I have used it advisedly! – is shown by the fact that the system is still functioning at all. No major players have gone bankrupt (although some may wish to quibble about Bear Stearns) and capital ratios – while certainly lower than optimal and under strain – remain relatively strong.
At this moment, as I’ve said before, I think Bernanke’s got it right in acting as a lender of last resort. My only quibble is that I would like to see a penalty rate applied when lending to investment banks against mortgage collateral … say, maybe, discount rate + 25bp … or maybe a little bit more, just to ensure that the borrowers have a negative carry on the deal and feel some (well, OK, let’s make it “a lot of”) pain, without actually going bankrupt. Additionally, it should be made clear that the facility will be cancelled as soon as the situation has stabilized sufficiently that one or two of them can go bankrupt without causing systemic collapse.
Along these lines, there are reports that Citigroup is biting the bullet and selling $12-billion in loans at a big loss, just to get them off the books.
On a lighter note, the Fed has pointed out that a stunning proportion of the populace is financially illiterate. He feels that financial literacy should be a requirement for a high school diploma … well, first I want to know what will be thrown overboard to make room for such a thing. Make the information available and make it part of optional courses – sure, I have no problems with that.
The market moved up strongly today, with volume continuing fair.
| 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 | 5.17% | 5.21% | 28,567 | 15.22 | 2 | 0.0000% | 1,088.8 |
| Fixed-Floater | 4.80% | 5.31% | 63,337 | 15.11 | 8 | +0.9912% | 1,039.4 |
| Floater | 5.13% | 5.17% | 72,219 | 15.24 | 2 | +0.0031% | 811.9 |
| Op. Retract | 4.85% | 3.71% | 83,631 | 3.32 | 15 | +0.0839% | 1,047.4 |
| Split-Share | 5.36% | 5.87% | 90,443 | 4.09 | 14 | +0.0449% | 1,031.0 |
| Interest Bearing | 6.18% | 6.14% | 65,528 | 3.90 | 3 | +0.0684% | 1,096.0 |
| Perpetual-Premium | 5.90% | 5.23% | 210,830 | 2.99 | 7 | +0.3100% | 1,020.9 |
| Perpetual-Discount | 5.66% | 5.69% | 303,187 | 14.04 | 63 | +0.3321% | 919.6 |
| Major Price Changes | |||
| Issue | Index | Change | Notes |
| HSB.PR.D | PerpetualDiscount | -1.2866% | Now with a pre-tax bid-YTW of 5.66% based on a bid of 22.25 and a limitMaturity. |
| RY.PR.G | PerpetualDiscount | +1.0224% | Now with a pre-tax bid-YTW of 5.51% based on a bid of 20.75 and a limitMaturity. |
| TD.PR.P | PerpetualDiscount | +1.0593% | Now with a pre-tax bid-YTW of 5.51% based on a bid of 23.85 and a limitMaturity. |
| RY.PR.D | PerpetualDiscount | +1.1203% | Now with a pre-tax bid-YTW of 5.50% based on a bid of 20.76 and a limitMaturity. |
| CM.PR.G | PerpetualDiscount | +1.5138% | Now with a pre-tax bid-YTW of 5.94% based on a bid of 22.80 and a limitMaturity. |
| TD.PR.O | PerpetualDiscount | +1.5277% | Now with a pre-tax bid-YTW of 5.22% based on a bid of 23.26 and a limitMaturity. |
| CIU.PR.A | PerpetualDiscount | +1.6497% | Now with a pre-tax bid-YTW of 5.57% based on a bid of 20.95 and a limitMaturity. |
| BCE.PR.R | FixFloat | +2.1277% | |
| BCE.PR.G | FixFloat | +2.1739% | |
| BCE.PR.Z | FixFloat | +2.7273% | |
| Volume Highlights | |||
| Issue | Index | Volume | Notes |
| BMO.PR.I | OpRet | 272,800 | Nesbitt crossed 20,000 at 25.25; TD bought 48,700 in three tranches from Nesbitt at 25.26. Now with a pre-tax bid-YTW of 1.48% based on a bid of 25.21 and a call 2008-5-9 at 25.00. |
| SLF.PR.B | PerpetualDiscount | 152,170 | Nesbitt crossed 150,000 at 21.70. Now with a pre-tax bid-YTW of 5.56% based on a bid of 21.70 and a limitMaturity. |
| RY.PR.K | OpRet | 109,247 | TD bought 82,500 from Nesbitt in three tranches at 25.30; “Anonymous” bought 17,500 from Nesbitt at the same price. Now with a pre-tax bid-YTW of -0.59% based on a bid of 25.26 and a call 2008-5-9 at 25.00. |
| BCE.PR.A | FixFloat | 100,800 | CIBC crossed 46,000 at 24.00; Nesbitt crossed 50,000 at 24.05. |
| TD.PR.Q | PerpetualDiscount | 93,260 | Scotia crossed 50,000 at 25.00. Now with a pre-tax bid-YTW of 5.60% based on a bid of 24.99 and a limitMaturity. |
There were seventeen other index-included $25-pv-equivalent issues trading over 10,000 shares today.
OK, here’s an excerpt from the latest little piece on this subject:
——————————-
‘Duped’ retail investors want Ottawa to step in
HEATHER SCOFFIELD
Thursday, April 10, 2008
OTTAWA — Retail investors who feel they were “duped” into losing their life savings by investing in non-bank asset backed commercial paper want the federal government to get involved in recuperating their losses.
At a hearing before the House of Commons Finance Committee, investor activists gave harsh accounts about how their financial advisers had stashed their savings in non-bank ABCP, telling their clients it was as safe as Guaranteed Investment Securities or treasury bills.
“Everything has turned horribly wrong,” said Murray Candlish, a semi-retired farmer who put his inheritance and much of his life savings in non-bank ABCP — the same commercial paper that has been frozen since last August.
“Please help the individual investors…to get back what is rightfully ours,” he asked the committee. “If individual investors are guilty of anything, they are guilty of trusting the Canadian banking system.”
—————————-
This sounds to me a little like . . . whining. Perhaps they may succeed; if so, do you think that, as perveyor of all that is analytical on the subject of preferreds, that you might trek to Ottawa (along with PH, K, and madequota of course), and lobby that the banks should also give back market losses on pref shares that are the direct result of the banks’ dilutive behaviour (possibly to fund ABCP support)? After all, the pref investor is guilty of nothing, other than trusting the Canadian banking system!
madequota
Those quotes sound to me more than just a little like … whining.
As I said on December 3:
Mr. Candlish’s investment strategy – his inheritance and much of his life savings in non-bank ABCP – was unbelievably foolish. Placing all your assets in a single asset – or even a single asset class – is a high risk strategy.
There are more substantive quotes in the Canadian Press report:
These investors might, possibly, have grounds for compensation from their brokers on grounds of “suitability”, given their extremely high concentration in a single asset class; Ms. Miles might (from the quoted allegation) be able to make a charge of unauthorized discretionary trading stick.
It would be most interesting to get the full facts behind these assertions. But we never will.
On top of the points you make, Canaccord’s latest position accepting accountability could establish a pretty wild prescedent in this situation.
On the Wynne Miles example, it is very possible that she was fully and accurately disclosed to at the time of investment, the only reality being that she didn’t understand what was being disclosed to her, only the hype and rhetoric that accompanied it.
And you are right; the full facts will probably never be known.
madequota
I really don’t think you can call having all one’s investments in a Money Market fund a “high risk strategy” at least as far as the broker was concerned. I bet the broker recommending the fund didn’t even know the ABCP was in there, or any of the nuances about it.
From a broker’s perspective, the lowest risk investment a client can make or have made for them (one that would keep them on the good side of “prudent” advisors, and earn fees, of course) is a Money Market fund. If they leave it in cash they risk being accused of making unwarranted profits off the client by not having invested it in Money Market. [These are just the optics; the reality is that some broker cash accounts actually yield more than money market and some money market fees are ridiculous].
Even GICs or a bank deposit (in 4 banks to avoid CDIC limits) has limits to protection, and many banks have taken the ABCP back onto their balance sheets (which I know James is not happy with).
Thus, it is not the Federal Government that needs to bail out burned investors, it is the brokers who failed their fiduciary duty.
But, just in case, save me a seat on the pref share bus going to Ottawa to whine…..
prefhound … The investments were not in a Money Market Fund – they were directly invested in ABCP.
When you don’t have enough capital (or expertise) to ensure both efficient trading and prudent diversification, they SHOULD be in a MMF – but weren’t.
And we don’t know for sure, in these cases, who said what to whom when, which is kind of important. In a post last September, I noted reports of an investor who, it would appear, managed millions of other people’s money because he enjoyed being a big shot.
For those curious, I explain why I am not happy about the bank buy-back of ABCP in this publication.
Sorry, my error on the Money Market vs direct investment in ABCP. This addresses about 90% of my comment’s intentions.
Perhaps the investors weren’t in a money market fund because of the fees — it would be lower cost to own directly (though obviously they should diversify; which they may have done by some parameters other than ABCP, like term, issuer, etc).
Anyway I’m pretty sure the banks would lose litigation for not explaining the risk to clients they advise (and maybe even discount brokerage), so have taken their own low-cost choice to make customers whole on ABCP as an asset management business decision.
I seem to recall Manulife had to help investors out when Norshield collapsed.
Bringing ABCP onto the balance sheet seems to be a consequence of being in several different financial services, one of which is banking. At least the in-house solution is probably cheaper for the banks than Cannacord having to get an outside buyer. And, of course, with my investor advocate hat on, I applaud the move.
Now that we know this is possible, we (investor hat on now) can consider your proposal for an appropriate capital charge for the potential or implied guarantee. However, I’ll bet banks are going to be a lot smarter in the future, so this exact problem isn’t going to recur….
Perhaps the investors weren’t in a money market fund because of the fees
My hobby-horse exactly! Professional advice is always expensive until you realize six months later you should have got some.
lose litigation for not explaining the risk … so have taken their own low-cost choice to make customers whole on ABCP as an asset management business decision. … I seem to recall Manulife had to help investors out when Norshield collapsed.
At this point, anyway, the question of litigation for not explaining the risk is a matter of opinion. I don’t think such a thing would fly. You run EXACTLY THE SAME RISK with a Bankers Acceptance from Royal Bank.
My opinion about litigation would be that concentration risk would be the most likely avenue … the principal is the same as the little old lady loaded up on Tech stocks.
I think you mean Portus, not Norshield.
At least the in-house solution is probably cheaper for the banks than Cannacord having to get an outside buyer. And, of course, with my investor advocate hat on, I applaud the move.
Why wouldn’t an investor advocate take the part of investors in Cannacord?
I’ll bet banks are going to be a lot smarter in the future
National is the only bank that had retail investors in ABCP. The other banks effectively restricted the investment to institutional clients.
Should you be correct, clients of banks (and, to some extent, brokerages) will be ever more restricted to expensive, plain vanilla investments. Why is this a good thing?
Flaherty says provincial regulators are to blame.
Me, I’m just going to leave that one alone, I am.
[…] Looking Gift Horses in the Mouth Department. Remember PIMCO’s Bill Gross’ comment yesterday?: For Pimco’s Gross that’s not enough. “If Washington gets off its high `moral hazard’ […]
Plain vanilla a good thing?
For 95% of retail investors, YES! Complexity has primarily been introduced (to these folks) as a way to increase fees: just look at the FTU discussion we were having the other day — lots of fees, not much return, all well hidden under a veneer of apparent gains. Look at index ETFs (0.12% or lower MER) vs mutual funds (up to 3%+).
Pro investors can have more complexity (hedge funds and sub-prime) if they like, but as we see daily, even pros can be bamboozled by complexity.
I don’t believe, in an economic sense, complexity adds value. It just contributes to frictional losses and opportunities for to unnecessary middlemen — which is an economic drag. The more efficient an economy and financial system is, the better it can allocate capital and grow.
I wonder if the Pooh-Bah of Allowable Investments will allow you to continue shorting stocks. That’s pretty risky, you know!
Complexity, in general, allows for a closer match between the characteristics sought by an investor and the characteristics of available investments. As a very general rule, I shun such things myself – but I am not prepared to forbid others from doing what they want to do with their own capital.
[…] seem to get interested in the whimpering over this fiasco, despite the discussion in the comments to April 9. Flaherty is claiming a federal regulator would have made everything better, but doesn’t say […]