Category: Market Action

The Dutch government is in disarray:

Dutch Prime Minister Mark Rutte offered to quit, a move that would trigger early elections, as he sought to win parliamentary support for additional budget cuts needed to steer the Netherlands clear of the debt crisis.
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With budget deliberations dragging on since March 5, the fate of Rutte’s minority government was thrown into doubt on April 21 when Wilders and his Freedom Party unexpectedly withdrew its support over how to narrow the shortfall. That prompted Rutte to cite new elections as “an obvious scenario” to try to resolve the deadlock.

In the Netherlands, the euro-area’s fifth biggest economy, the 2013 budget shortfall is currently forecast at 4.6 percent of gross domestic product. To pare it to 3 percent as specified by the European Commission, Rutte needs to find at least 9.5 billion euros of extra cuts to submit to Brussels by April 30.

“The package is way too rigorous and it’s bad for the economy,” Emile Roemer, head of the Socialist Party, which would double its seats to 30 according to latest polls, said in broadcast remarks. “We need to have elections and clarity as soon as possible.”

The opposition Labor Party is willing to cooperate with the government on preparing a complete 2013 budget only if elections are held in September, party leader Diederik Samsom told NOS television April 21. Economic growth is more important than meeting the 3 percent deficit target, Samsom said.

I mentioned a classic example of how investment managers are hired on April 18, 2011. The CalPERS story continues:

The former chief executive of the California Public Employees’ Retirement System was sued by U.S. regulators over claims he defrauded an investment firm into paying $20 million in fees to a friend’s placement agencies.

Federico Buenrostro, who served as Calpers CEO from 2002 to 2008, and his friend Alfred Villalobos, the former deputy mayor of Los Angeles, fabricated documents given to New York-based private-equity firm Apollo Global Management (APO), the Securities and Exchange Commission said today in a lawsuit filed in U.S. District Court in Nevada. California regulators sued the two men in May 2010 over similar claims.
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The documents gave the false impression that Calpers had reviewed and signed placement-agent fee-disclosure letters in accordance with its established procedures, the SEC said. The lawsuit also names Villalobos and his firm ARVCO Capital Research LLC as defendants.

“Buenrostro and Villalobos not only tricked Apollo into paying more than $20 million in placement agent fees it would not otherwise have paid, but also undermined procedures designed to ensure that investors like Calpers have full disclosure of such fees,” John McCoy, associate regional director of the SEC’s Los Angeles office, said in a statement.

DBRS has released the Split Share Funds Quarterly Report – Q1 2012.

It was a mixed, unexciting day for the Canadian preferred share market, with PerpetualPremiums down 4bp, FixedResets up 5bp and DeemedRetractibles gaining 1bp. Volatility was muted. Volume was low.

Nothing happened today, so I went to a flamenco show. During an informal question and answer period after the show (you aren’t allowed to merely enjoy anything nowadays, particularly dance: you must show diligence in getting booked up) Ms. Enrique explained that the large fans held by the women were mocking the fans held at one time by the nobility at court, exaggerated for satirical purposes; the long trains on some of the dresses are in the same vein.

Which got me to wondering: how are the rich mocked today? I’m not convinced that they are, at least not in North America, where there is a degree of social mobility lacking in a structured society. We don’t mock their wine cellars – because we all want a 5,000 bottle wine cellar. We don’t mock their private planes – because we all want a private plane. Even rap artists, who one might expect to be the most logical source of mockery, make a big fuss about how wonderful it is to have big cars and drink champagne and all the rest of it. We don’t mock the rich, because they are us. The rich are not like you and me – they have more money!

It was a soft day for the Canadian preferred share market, with PerpetualPremiums gaining 3bp, FixedResets losing 16bp and DeemedRetractibles down 11bp. Volatility was good. Volume was heavy, with quite a few issues trading more than 100,000 shares.

There’s a dilemma the politicians are having a problem with: how can you square long-term lending risk with zero short term lender risk? The Europeans are trying hard!

European Union lawmakers are considering rules to protect bank depositors that may stymie two of the main funding sources for the region’s lenders.

The proposals risk limiting how much banks can raise from covered bond sales and European Central Bank loans by placing curbs on the assets they can use for security. The aim is to boost protection for account holders and other creditors.
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Tying up assets in collateralized fundraisings is known as encumbrance and pushes unsecured creditors further back in the queue for payment in a default. Any move to limit secured debt issuance risks hurting banks that have relied on record covered bond sales and the 1 trillion euros ($1.3 trillion) of loans that the ECB has pumped into the system since December.

But getting too cocky about Anglo-Saxon capitalism, remember US efforts to eliminate liquidity:

Wall Street banks will have two years to implement the so-called Volcker rule so long as they make a “good faith” effort to comply with the ban on proprietary trading, U.S. regulators said.

Banks will have the “full two-year period” provided by the Dodd-Frank financial overhaul law to “fully conform” their activities and investments, the Federal Reserve and four other U.S. agencies said in a statement today. The Fed has the authority to extend the period of compliance beyond July 21, 2014, the regulators said.

France and Spain paid up for funding:

France sold 8 billion euros ($10.5 billion) in debt today as risks linked to the French presidential election drove up yields.

The amount sold was at the maximum target set by Agence France Tresor, the country’s debt-management body. France sold 2.7 billion euros of benchmark five-year debt at an average yield of 1.83 percent, up from 1.78 percent on March 15.

Earlier today, Spain sold 2.54 billion euros in two- and 10-year bonds, slightly more than the maximum target of 2.5 billion euros. Borrowing costs rose as Spanish Prime Minister Mariano Rajoy’s struggles to meet deficit targets.

Scrutiny of both countries is increasing amid the fading effect of the European Central Bank’s longer-term refinancing operation, which injected about 1 trillion euros of liquidity into the region’s financial system. The yield on Spain’s benchmark 10-year bond has jumped about 1 percentage point since the beginning of March to above 6 percent, while the yield on the equivalent French debt has gained more than 10 basis points with Socialist Francois Hollande leading in election polls.

It would seem that the bond market shaves the Spanish barber:

Spain sold 2.54 billion euros ($3.3 billion) of bonds, just above the maximum target for the auction, and its borrowing costs rose. Bonds declined after the sale.

The Treasury sold its 10-year benchmark bond at an average yield of 5.743 percent, compared with 5.789 percent on the secondary market before the sale and 5.403 percent when it last sold them in January. It sold two-year securities at 3.463 percent.

It was a quiet day overall for the Canadian preferred share market, with PerpetualPremiums gaining 7bp, FixedResets up 3bp and DeemedRetractibles off 2bp. Oddly, there was a violent move in the PerpetualDiscount sector – the Performance Highlights table is comprised entirely of three losers of this ilk. However, these three issues were responsible for the entire PerpetualDiscount index move. Volume was below average.

Chapter 4 of the IMF Global Financial Stability Report is a fascinating review of longevity risk:

Private pension providers and governments are particularly exposed to longevity risk and this risk is greatly increased in the current low-interest-rate environment. In line with other estimates in the literature, the analysis in this chapter finds that the liabilities of U.S. pension plans would rise by 9 percent for a three-year increase in longevity. Governments may be even more exposed: many not only sponsor defined benefit pension plans for their employees, but maintain extensive old-age social security systems covering most of the population. In addition, the government is likely liable for the “tail” of longevity risk: in the case of a longevity shock affecting the entire population, the private sector would likely be overwhelmed by the financial consequences. In that case, the losses are likely to be assumed by the government in some way, including through pension fund guarantee schemes that take on the pension liabilities of failing institutions and social security schemes that aim to prevent old age poverty.

However, the section that attracted press attention was Chapter 2: Sovereigns, Banks, and Emerging Ma rkets: Detailed Analysis and Policies:

Looking ahead, many European banks have announced medium-term business plans with reductions in assets amounting to about $2.0 trillion in total.
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The variations in the scale of bank deleveraging across scenarios are mainly driven by differences in the extent of cyclical pressures. Under the complete policies scenario – where cyclical pressures ease – assets are cut back by $2.2 trillion, mostly reflecting banks’ own business plans. By contrast, in the weak policies scenario – where cyclical pressures are stronger – banks reduce assets by $3.8 trillion (Figure 2.27). As cyclical pressures intensify, the impact on EU credit rises disproportionately. This is because with stronger cyclical headwinds, more banks need to work their way further down the deleveraging pecking order when reducing their balance sheets, and so EU and domestic credit is curtailed more.

It was an unexciting day for the Canadian preferred share market, with PerpetualPremiums off 1bp, FixedResets flat and DeemedRetractibles down 5bp. A bright spot was the floating rate sector, which again scored a lock-out on the positive side of the Performance Highlights table. Volume was slightly below average.

PerpetualDiscounts now yield 5.18%, equivalent to 6.73% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.5% so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 225bp, a marked widening from the 215bp reported April 13.

The Bank of Canada sounded a warning note:

The Bank projects that the economy will grow by 2.4 per cent in both 2012 and 2013 before moderating to 2.2 per cent in 2014. The degree of economic slack has been somewhat smaller than the Bank had anticipated in January, and the economy is now expected to return to full capacity in the first half of 2013.

As a result of this reduced slack and higher gasoline prices, the profile for inflation is expected to be somewhat firmer than anticipated in January. After moderating this quarter, total CPI inflation is expected, along with core inflation, to be around 2 per cent over the balance of the projection horizon as the economy reaches its production potential, the growth of labour compensation remains moderate, and inflation expectations stay well-anchored.

Reflecting all of these factors, the Bank has decided to maintain the target for the overnight rate at 1 per cent. In light of the reduced slack in the economy and firmer underlying inflation, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate, consistent with achieving the 2 per cent inflation target over the medium term. The timing and degree of any such withdrawal will be weighed carefully against domestic and global economic developments.

Is this a first? If not globally, then for a super-major bank? Citibank had a negative say-on-pay vote:

Citigroup Inc. (C) shareholders rejected the bank’s executive compensation plan in an advisory vote amid criticism it would let Chief Executive Officer Vikram Pandit collect rewards too easily.

About 45 percent of the votes were in favor of the plan, which Citigroup had argued would help attract and retain top talent, according to a preliminary tally at the New York-based firm’s annual meeting in Dallas today.

“That’s a serious matter,” Chairman Richard Parsons said in response to the outcome. “The board of directors takes this matter seriously” and will seek a more quantitative, formula- based method for setting top executives’ pay, he said.

Comrade Peace-Prize is demonizing speculation:

President Barack Obama urged Congress to bolster federal supervision of oil markets, including bigger penalties for market manipulation and greater power for regulators to increase the amount of money that traders must put up to back their energy bets.

Obama asked Congress to fund a six-fold increase for surveillance and enforcement staff at the Commodity Futures Trading Commission to put “more cops on the beat” overseeing oil markets.

He is seeking to empower the CFTC to raise margin requirements for traders’ oil positions and also asked lawmakers to raise civil and criminal penalties for businesses that are guilty of market manipulation to $10 million from $1 million. The plan would cost $52 million.

“Rising gas prices means a rough ride for a lot of families” Obama said in remarks in the White House Rose Garden today. “When gas prices go up it’s like an additional tax that comes right out of your pocket.”

The European market is a shell game:

Spanish, Italian and Portuguese banks are loading up on bonds issued by their own governments, a move that shifts more of the risk of sovereign default to European taxpayers from private creditors.

Holdings of Spanish government debt by lenders based in the country jumped 26 percent in two months, to 220 billion euros ($289 billion) at the end of January, data from Spain’s treasury show. Italian banks increased ownership of their nation’s sovereign bonds by 31 percent to 267 billion euros in the three months ended in February, according to Bank of Italy data.

German and French banks, meanwhile, have cut holdings of those countries’ bonds, as well as Irish and Greek debt, by as much as 50 percent since 2010 in some cases. That leaves domestic firms on the hook for a restructuring such as Greece’s last month and their main financier, the European Central Bank, facing losses. Like Greece, governments would have to rescue their lenders with funds borrowed from the European Union.

“The more banks stop cross-border lending, the more the ECB steps in to do the financing,” said Guntram Wolff, deputy director of Bruegel, a Brussels-based research institute. “So the exposure of the core countries to the periphery is shifting from the private to the public sector.”

This is very much to the politicians’ advantage. Should there be another default, one in which the ECB loses money, they will be able to point at banks and evil bonus-seeking traders as the cause of the losses, rather than the sovereign default.

How does one get ahead in life? Bootlicking is a perennial favourite:

The Bank of England has its eye on Canada’s central bank chief, the Financial Times reports today.

The newspaper said that a member of the Bank of England’s court, the group that oversees the central bank but does not set policy, recently approached Mr. Carney about the idea of replacing Mervyn King in June, 2013.

The Bank of Canada told The Globe and Mail that the newspaper report indicating Mr. Carney had been approached as a potential candidate was not accurate. Mr. Carney, who is respected around the world, and most recently was also tapped to head the global Financial Stability Board, would not comment to the newspaper.

It’s rocket science! It’s an entirely unheard of approach to investing! Imagine, a pension plan sitting down to determine what they want to accomplish before investing!

Healthcare of Ontario Pension Plan’s big bet on bonds paid off in 2011, as the plan ended the year up 12.2 per cent on its investments and more than fully funded.

What happens, however, when rates rise and that bond bet turns around? Not what you might think, according to HOOPP. Yes, the bonds may decline in value, but that shouldn’t leave the plan with a funding gap.

HOOPP, which runs about $40-billion, is a booster of an approach to pension management known as liability driven investment (LDI). For adherents of LDI, beating market benchmarks is considered largely irrelevant and the goal is simply to remain in a fully funded state with enough assets to cover projected liabilities.

Geez, I don’t know about my Assiduous Readers, but I think these guys should all get Nobel Prizes. Two each! Taking account of client objectives prior to formulating an investment strategy is revolutionary!

There was a good upward move in the Canadian preferred share market today, with PerpetualPremiums gaining 3bp, FixedResets up 9bp and DeemedRetractibles winning 14bp. The Performance Highlights table is comprised entirely of winning Floaters, presumably driven up by thoughts of imminent BoC rate hikes. Volume was well below average.

Spain looks as if it’s sliding down the greasy path:

A Spanish minister called on the European Central Bank to do more to stem the sovereign debt crisis as the cost of insuring the country’s bonds against default surged to a record.

“They should step up purchases of bonds,” Jaime Garcia- Legaz, a deputy minister in Luis de Guindos’s Economy Ministry, said yesterday in an interview.

His comments came as ECB officials split over the steps to tame the crisis amid growing expectations that Spain will be the next euro member to seek a European bailout. Spanish banks’ borrowings from the ECB surged almost 50 percent in March, data showed yesterday, as they took almost a third of the longer-term lending offered to euro-region institutions.

But China is inching towards convertibility:

China’s decision to widen the yuan’s trading band against the dollar for the first time since 2007 signals a drive toward a convertible currency that also saw overseas investors get bigger investment quotas this month.

The increase to 1 percent from 0.5 percent takes effect tomorrow, the People’s Bank of China said on its website yesterday. This month, regulators raised quotas for foreigners buying onshore stocks and bonds to $80 billion from $30 billion and increased the amount of yuan held offshore that can be invested locally.

Spanish troubles have led the Europeans to admit that the Euro is only a reserve currency in good times – in bad times, not so much:

European officials travel to Washington this week seeking a larger global war chest to combat the two-year debt crisis as the Spanish government battles to quell renewed market turmoil over its finances.

Three weeks after European leaders unveiled emergency euro- area funding exceeding the symbolic $1 trillion mark, concerns about Spain’s position have ratcheted the nation’s borrowing costs to the highest levels this year. Crisis-fighting resources will dominate talks at the International Monetary Fund’s spring meeting in Washington from April 20-22.

Sarkozy wants the ECB to inflate Europe out of its difficulties, although he’s very careful to cast this in a more politically correct manner:

French President Nicolas Sarkozy, speaking to the biggest rally of his re-election bid, said the European Central Bank should do more to promote economic growth, reviving an issue he raised in his 2007 campaign.

“On the question of the ECB’s role in boosting growth, we French are going to open the debate,” Sarkozy told a crowd today in central Paris that his aides estimated at more than 100,000. “If Europe is not going to sink in the international economy, it must renew with growth.”
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“Europe must cut its debts, it has no choice,” Sarkozy said. “But between deflation and growth, it has no choice either. If it chooses deflation, it will disappear.”

Krugman is on board with the idea:

The way economist Paul Krugman sees it, Europe has two options.

It can continue with its current path, imposing austerity on governments in an attempt to rein in ever-worsening fiscal situations. Or, it can opt for the reverse, wherein the European Central Bank and eurozone leaders move to implement expansionary monetary and fiscal policies to spur growth.

Right now Europe has chosen austerity and according to Mr. Krugman, that choice is clearly showing that Europe is carrying out economic suicide.

“Europe has had several years of experience with harsh austerity programs, and the results are exactly what students of history told you would happen: such programs push depressed economies even deeper into depression,” he said in a column in the New York Times.

It was a modest day for the Canadian preferred share market, with PerpetualPremiums up 1bp, FixedResets gaining 4bp and DeemedRetractibles winning 5bp. Volatility was muted. Volume was below average, despite a fair amount of good-sized blocks.

Spanish CDSs hit a new high:

The cost of insuring against a Spanish default jumped to a record as Prime Minister Mariano Rajoy struggles to prevent the nation from becoming the fourth euro-region member to need a bailout.

Credit-default swaps on Spain rose 17 basis points to 498 as of 4 p.m. in London, surpassing the previous all-time high closing price of 493, according to CMA. The contracts are up from 431 at the start of the month and 380 at the end of 2011, signalling a deterioration in investor perceptions of credit quality.
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The rate on Spain’s 10-year note rose 17 basis points today to 5.99 percent, 21 basis points up from a week ago.

Given the fun ‘n’ games with Greek CDSs, I think that if I were buying European sovereign CDSs, I would want the trigger to be something other than formal default – maybe have something triggered by subordination to other instruments, or IMF loans.

A lot of Europeans are voting with their feet … or ATM card, anyway:

This analysis suggests that capital flight is happening on a scale unprecedented in the euro era — mainly from Spain and Italy to Germany, the Netherlands and Luxembourg (see chart). In March alone, about 65 billion euros left Spain for other euro- zone countries. In the seven months through February, the relevant debts of the central banks of Spain and Italy increased by 155 billion euros and 180 billion euros, respectively. Over the same period, the central banks of Germany, the Netherlands and Luxembourg saw their corresponding credits to other euro- area central banks grow by about 360 billion euros.

Click for Big

There’s more trouble at Air Canada:

Air Canada … is warning travellers of flight disruptions, saying some pilots are staging an illegal walkout.

There were cancellations of roughly 30 departures and 30 arrivals on Friday morning at Toronto’s Pearson International Airport, mostly affecting Air Canada, said airport spokesman Scott Armstrong.

This is easy to fix, fortunately. If Air Canada is so important that the Feds have to take away the right to strike, then the longer-term solution is to make Air Canada less important. Give the Emirates rights to the Toronto-Dubai route! Allow cabotage! Let anybody fly between any two points, as long as they meet safety standards and have bought the landing rights in a competitive auction!

BPO Properties, proud issuer of BPO.PR.F, BPO.PR.H, BPO.PR.J, BPO.PR.K, BPO.PR.K, BPO.PR.L, BPO.PR.N, BPO.PR.P and BPO.PR.R, was confirmed at Pfd-3 by DBRS:

DBRS has today confirmed the Issuer Rating of BPO Properties Ltd. (BPO or the Company) at BBB and its Cumulative Redeemable Preferred Shares rating at Pfd-3, with trends at Stable. The BBB rating incorporates the following credit strengths: (1) BPO has strong ownership and an experienced management team; (2) BPO has a premier Class-A to AAA office portfolio, located in the downtown markets in three of Canada’s largest office markets, namely Toronto, Calgary and Vancouver, featuring a number of flagship office properties, such as First Canadian Place, Bay Adelaide Centre West Tower, Bay Wellington Tower, Exchange Tower and Bankers Hall; (3) the portfolio has strong occupancy levels, which are above market comparables in each of its markets, with exception to Toronto; and (4) BPO’s reasonable credit metrics and certain debt restrictions.

Conversely, the rating incorporates the following associated risks: (1) BPO’s portfolio’s heavy concentration in the downtown markets of Toronto and Calgary; (2) significant property concentration with the Company’s top five properties, accounting for approximately 54.8% of the Company’s total leasable area in the portfolio; (3) above-average tenant concentration (however, this concern is somewhat mitigated by the high creditworthiness of the Company’s top 15 tenants).
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The stable outlook takes into consideration DBRS’s expectation for reasonable growth in operating cash flow in 2012, mainly due to the continued lease-up of Bay Adelaide Centre West Tower. In addition, minimal lease maturities in 2012 should continue to contribute stable cash flow and limit the Company’s exposure to market conditions and re-tenanting costs. DBRS expects BPO to maintain a good liquidity position and positive free cash flow position. The Company has no active commercial development projects and has manageable near-term capital commitments. Overall, DBRS expects BPO’s financial profile to remain stable in 2012, with support from higher cash flow levels and reasonable financial flexibility to fund manageable capital commitments (mainly maturing mortgages).

New rules for dark orders on Canadian exchanges will go into effect in in October:

The new framework involves several elements. Among them:

• Visible orders will have execution priority over dark orders on the same marketplace at the same price.
• In order to trade with a dark order, smaller orders must receive a minimum level of price improvement, which is defined as one trading increment or half a trading increment for securities with a bid-ask spread of one trading increment.
• The IIROC has the ability to designate a minimum size for dark orders, although it isn’t doing so at this time.

I confess that I have not yet looked at the details.

The CME had an incident today illustrative of the frictions between visible and dark trading:

Local traders in the CME Group Inc. (CME)’s Eurodollar options pit walked off the job today to protest a block trade yesterday.

“These guys that stand in there all day and make prices would have loved to participate in that particular price, but they weren’t able to,” Rocco Chierici, a broker at R.J. O’Brien & Associates on the floor of the Chicago Mercantile Exchange, said in a telephone interview.

Prices for the block trades of options on Eurodollar futures were higher than offers in the pit, which wouldn’t be allowed in open-outcry trading, Chierici said.
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“There are rules that prohibit that in the pit, but you can circumvent the pit” in a block trade, Chierici said. “I believe they wanted to make the point that the system is not fair.”

Six block trades totaling 215,200 options traded at 8:11 a.m. Chicago time yesterday, according to CME Group’s website. The trade was rolling positions from April contracts, which expired today, into June contracts.

“The block trade in question was managed by longstanding rules and processes of our exchanges,” Michael Shore, a CME Group spokesman, said in an e-mail. “It was a legitimate, well- managed trade, which was executed within one tick of the market and in one trade.”

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums up 12bp, while both FixedResets and DeemedRetractibles were off 1bp. The Performance Highlights table is comprised entirely of Floating Rate issues (the fact that they are all BAM issues is not indicative – BAM is the only issuer in these indices at this time). Volume was absurdly low.

Nothing happened today, although I was recently gratified to learn I’m not the only one in the world who is worried about central clearing houses:

IF THEY failed, there would be “mayhem”, says Paul Tucker of the Bank of England. Ben Bernanke, the chairman of the Federal Reserve, quotes a Mark Twain character, Pudd’nhead Wilson, to get the same point across: “If you put all your eggs in one basket, you better watch that basket.” Another regulator privately describes them as “too big to fail, on steroids”.

Central Clearing Houses are probably the single dumbest idea to come out of post-Credit Crunch reregulation. Who – other than a politician or a regulator – really thinks that a system susceptible to single-point failure is more stable than a network?

The Canadian preferred share market enjoyed a good uptick today, with PerpetualPremiums up 2bp, FixedResets gaining 14bp and DeemedRetractibles winning 21bp. Volatility was dominated by BAM, evenly split between winners and losers. Volume was light.

Spain’s in trouble again:

European Central Bank Executive Board member Benoit Coeure triggered speculation that the bank will revive its bond-purchase program to lower Spain’s borrowing costs as the region’s debt crisis threatens to boil over again.

Spanish “market conditions are not justified,” Coeure, who heads the ECB’s market operations division, said at an event in Paris today. “Will the ECB intervene? We have an instrument, the securities markets program, which hasn’t been used recently but it still exists.”
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The yield on Spanish 10-year bonds, which climbed to a four-month high of 5.99 percent this morning, slid to 5.82 percent after Coeure spoke. The euro gained more than a quarter of a cent to $1.3134 at 2 p.m. in Frankfurt and European stocks rose, with the Stoxx Europe 600 Index (SXXP) up 1 percent.

Spain’s 10-year borrowing costs have jumped more than 1 percentage point since March 2, when Prime Minister Mariano Rajoy said the country will miss a 2012 deficit goal approved by the European Union. The euro area’s fourth largest economy is in recession and unemployment is nearing 24 percent.

It will be interesting to see how this plays out. ECB intervention may lower the probability of default, but its super-senior creditor status (seen in the Greek default) will increase the severity of default.

The Canadian preferred share market drifted slightly upward today, with PerpetualPremiums winning 5bp, FixedResets gaining 2bp and DeemedRetractibles up 4bp. Volatility was good, with Floaters notable amongst the losers. Volume was a little below average.

PerpetualDiscounts now yield 5.07%, equivalent to 6.59% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.45%, so the pre-tax interest-equivalent spread (in this context, the Seniority Spread) is now about 215bp, unchanged from the report of April 4.

A mention in the Globe & Mail led me to an IMF publication (Chapter 3 of of the April, 2012, World Economic Outlook) titled Dealing with Household Debt:

Does household debt amplify downturns and weaken recoveries? Based on an analysis of advanced economies over the past three decades, we find that housing busts and recessions preceded by larger run-ups in household debt tend to be more severe and protracted. These patterns are
consistent with the predictions of recent theoretical models. Based on case studies, we find that government policies can help prevent prolonged contractions in economic activity by addressing the problem of excessive household debt. In particular, bold household debt restructuring programs such as those implemented in the United States in the 1930s and in Iceland today can significantly reduce debt repayment burdens and the number of household defaults and foreclosures. Such policies can therefore help avert self-reinforcing cycles of household defaults, further house price declines, and additional contractions in output.
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Macroeconomic policies are a crucial element of forestalling excessive contractions in economic activity during episodes of household deleveraging. For example, monetary easing in economies in which mortgages typically have variable interest rates, as in the Scandinavian countries,
can quickly reduce mortgage payments and avert household defaults. Similarly, fiscal transfers to households through social safety nets can boost households’ incomes and improve their ability to service debt, as in the Scandinavian countries.

Clearly, it is better to avoid such a situation in the first place, but there is only ineffective policy in place in Canada to do so at this time. Buying a larger house (or a small house or condominium instead of renting) is a means of capital formation, which is encouraged by low interest rates. That’s what lower interest rates are supposed to do, for heaven’s sake! However, housing is non-productive capital; so much so that it can almost be considered consumption.

So the question really is: in times of economic downturns, how should policy act to promote “good” capital formation as opposed to “bad” capital formation?

I suggest that both monetary and fiscal policy are very blunt tools – too blunt to address the issue. Instead, a regulatory response is required:

• Don’t be so damn eager to raise the limits on explicitly (Canada) or implicitly (US) government guarantees of mortgage debt. Set a limit, based on historical experience and rising with nominal GDP, of the amount of such guarantees. In 2006, CMHC insurance outstanding was $291-billion. In 2010 the plan was to have total outstanding of $533-billion. Why? Why do What-debt? and Spend-Every-Penny want to create a housing bubble? I can only assume that it is because this will give them more opportunity to micro-manage the economy, with credit-rationing and rule changes by government fiat, rather than the unexciting process of raising insurance prices when a reasonable limit is approached.
• Impose a capital surcharge the banks when their loan books get distorted. Mortgages are now 40% of the balance sheets; they used to be 30% not so very long ago. Such a sudden change indicates to me a strong possibility that this is simply regulatory arbitrage (why lend to Jimmy’s Barber Shop, with a risk-weighting of 100%, when you can lend to Jimmy himself as a mortgage, with a 35% risk-weight or maybe even a government guarantee with an even lower risk-weight?). So, in this case of distortion, and in every other case of material distortion, impose a surcharge. An extra 10% risk-weight (to 45% on mortgags) on loan book elements in material excess of their historical norms is my prescription.

Three cheers for offshore wind power!

Offshore wind costs about $232 a megawatt-hour of power generated, according to data from Bloomberg New Energy Finance. That compares with about $80 for onshore wind, $62 for gas-fired plants and $77 for coal. The government supports the industry with incentives for power produced by renewable energy sources.

It’s not clear if the price figures include provisions for back-up power and demand-timing differences (the wind tends to blow at night, when demand is relatively low, can sometimes die at highly inconvenient moments and electricity can’t be stored very well. This has a huge effect on honest cost assessment, and no effect on – shall we say – other assessments).

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums losing 4bp, FixedResets gaining 2bp and DeemedRetractibles down 2bp. Volatility was low. Volume was a little below average.