PrefBlog

Not much today!

Prof. Stephen Cecchetti (regularly quoted on PrefBlog) has written a review of the Fed’s actions in fighting the credit crunch, in both full and ultra-condensed versions. It’s nice to have all the actions and numbers in one place, but there’s nothing particularly new or startling in the piece. He concludes:

In the heat of a financial crisis, the central bank is the only official body that can act quickly enough to make a difference. Politicians are not well-equipped to take actions literally from one day to the next. So, while we might want to reassess the role of the central bank once the crisis is over, for now it is difficult to fault the Federal Reserve’s creative responses to the crisis that began in August 2007. Let’s just hope that they work.

A complicating factor is that only five of the seven governor’s seats are filled; all in all, the crunch will be fodder for learned papers and theses for many, many years to come.

California was able to refinance some auction debt:

California is offering general obligation bonds to institutions such as mutual funds and insurers today after collecting $898 million of orders from individuals, according to Tom Dresslar, spokesman for state Treasurer Bill Lockyer. Denver International Airport also plans to refinance auction-rate securities by selling $445 million of fixed-rate bonds.
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Long-term municipal bonds have risen four of the past five days as investors buy tax-exempt securities whose yields have exceeded those on benchmark Treasuries.
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The gains drove yields on top-rated, 30-year municipal debt to 4.80 percent, the lowest in six weeks, according to Municipal Market Advisors. That still exceeds the 4.35 yield on the 30- year U.S. Treasury bond.
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Municipal bonds dropped in late February after hedge funds liquidated some of their holdings in the tax-exempt market, as asset values fell and funding costs rose.
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Such leveraged investors typically buy fixed bonds, fund their purchases by issuing lower-yielding variable-rate notes to money-market mutual funds, and then hedge their investments with interest-rate contracts.

Such a strategy by hedge funds will involve basis risk – if they buy a long-term bond and sell an interest-rate swap against it, they will be receiving LIBOR plus a spread. If this spread exceeds the spread they’re being paid on their own commercial paper, they’re happy … otherwise, not so much. It’s all part of the arbitrage that exists because borrowers want long-term funding and lenders want short term risk … and it works … usually.

Bernanke gave a speech today reviewing the situation. There will be more rules!

the Federal Reserve has used its authority under the Home Ownership and Equity Protection Act to propose and seek comment on new rules that, for higher-cost loans, would strengthen consumer protections. The rules would restrict the use of prepayment penalties and low-documentation lending, require the use of escrow accounts for property taxes and homeowner’s insurance, and ensure that lenders give sufficient consideration to borrowers’ ability to repay. In addition, for all mortgage loans, we have proposed rules regarding broker compensation methods and the ability of appraisers to provide judgments free of undue influence, as well as rules regarding the accuracy of advertisements and solicitations for mortgage loans and the timeliness of required disclosures. We also plan to propose a revised set of required mortgage disclosures based on the results of a program of consumer testing already under way.

… and pension boards might have to do something at their meetings …

Some investors, such as public pension funds, are subject to government oversight, and in these instances, the PWG will look to their government overseers to reinforce implementation of stronger due diligence practices. When investors employ advisers, the mandates and incentives given to these advisers should be structured so as to induce a more careful and nuanced evaluation of the risks and returns of alternative products.

Another “key priority” is:

analytical weaknesses and inadequate data underlay many of the problems in the ratings of structured finance products. Beyond improving their methods, however, the credit rating agencies would serve investors better by providing greater transparency. Credit rating agencies should, for example, publish sufficient information about the assumptions underlying their rating methodologies and models so that users can understand how a particular rating was determined. It is also important for the credit rating agencies to clarify that a given rating applied to a structured credit product may have a different meaning than the same rating applied to a corporate bond or a municipal security.

Different rating scales is a cosmetic change … but publishing assumptions is a little fishy. What if the assumptions relate to regulation FD? The only real problem with the credit rating agencies is that investors cannot reproduce their work without access to the material non-public information to which the agencies have access.

With respect to bank supervision:

Prudential supervisors in the affected financial markets began joint work late last summer to identify common deficiencies on which they and the firms should focus. The supervisors concluded that the firms that suffered the most significant losses tended to exhibit common problems, including insufficiently close monitoring of off-balance-sheet exposures, inadequate attention to the implications for the firm as a whole of risks taken in individual business lines, dependence on a narrow range of risk measures, deficiencies in liquidity planning, and inadequate attention to valuation issues.
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The PWG also will be asking U.S. regulators, working together and through international groups such as the Basel Committee on Banking Supervision, to enhance their guidance in a variety of areas in which weaknesses were identified. I expect, for example, to see work forthcoming on liquidity risk management, concentration risk management, stress testing, governance of the risk-control framework, and management information systems.

It will be most interesting to see what they come up with respect to liquidity risk management. The banks don’t like the idea … liquidity is a chancy thing!

On the regulatory front RS has a contested hearing about some allegations that are remarkable for their triviality. I truly hope that there’s a lot of back-story to the case that isn’t specified … the potential fine of $3-million seems far out of proportion to the wrongdoing. For heaven’s sake, shouldn’t these trade cancellations have resulted in an automatic penalty of $1,000, end of story? The stenographer at the hearing will cost more than the clients were harmed – even if you agree that the clients were harmed.

A quiet day today. A number of issues traded over 100,000 shares, but volume was highly, highly concentrated in these issues.

There were seven other index-included $25-pv-equivalent issues trading over 10,000 shares today.

Update: Late update here from the PrefBlog 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’ 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.

Apparently, Pimco’s Gross Holds Most Mortgage Debt Since 2000:

Pacific Investment Management Co.’s Bill Gross lifted holdings of mortgage debt in the world’s largest bond fund to the highest since 2000, while putting on the biggest bet against government debt since at least the same year.

The $125.1 billion Pimco Total Return Fund had 59 percent of assets in mortgage debt in March, up from 52 percent the prior month and 23 percent in March 2007, according to data on the Newport Beach, California-based firm’s Web site. The fund’s cash position dropped to 32 percent, the lowest since July 2006, from 34 percent in February.

This entry was posted on Thursday, April 10th, 2008 at 8:42 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.