Category: Market Action

The situation in Europe is slowly getting worse:

The cost of insuring against default on European sovereign debt climbed to records and European stocks fell amid concern Portugal is next in line for a bailout. Portuguese securities reversed declines after three traders with knowledge of the deals said the ECB purchased the government’s bonds.

With European governments including Portugal and Spain due to borrow at least $43 billion this week, attention is shifting to whether Europe is doing enough to stem the crisis. Chancellor Angela Merkel was today forced to deny that Germany was pushing Portugal to seek a bailout to alleviate the market pressure.
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The cost of insuring Portuguese bonds against default rose to a record today, while Belgian and Spanish bonds declined on funding concerns. The benchmark Stoxx Europe 600 Index lost 0.9 percent to 278.48 at the 4:30 p.m. close in London, the biggest drop since Dec. 30.

For the first time, investors view western European government bonds as riskier than emerging-market debt, the Markit iTraxx SovX Western Europe Index of credit-default swaps showed last week.

Mr Patrick Honohan, Governor of the Central Bank of Ireland, gave a speech:

The current impact of the banking losses on the economy is not so much via the net long-term taxpayer cost, but comes mainly as a result of the accumulation of debt. The jump in debt associated with these losses is of the same order of magnitude as the rest of the borrowing 2009–10 (Fig. 4). Either of these components would have been unproblematic, together they make the markets and the rating agencies nervous. The fiscal adjustment could possibly have been delayed by a year or two had it not been for the banking losses; now it cannot wait.

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Sell-side analysis has been worse than usual lately:

Companies in the Standard & Poor’s 500 Index that analysts loved the most rose 73 percent on average since the benchmark for U.S. equity started to recover in March 2009, while those with the fewest “buy” recommendations gained 165 percent, according to data compiled by Bloomberg. Now, banks’ favorites include retailers and restaurant chains, the industry that did best in last year’s rally and that are more expensive than the S&P 500 compared with their estimated 2011 profits.

The brokerage houses are great for data and a good source of ideas. Actionable investment recommendations… not so much.

In another example of “gotcha regulation”, the SEC has commenced proceedings to enforce Rule 105 of Regulation M:

Rule 105 of Regulation M of the Exchange Act provides, in pertinent part:
In connection with an offering of equity securities for cash pursuant to a registration statement. . . filed under the Securities Act of 1933 (“offered securities”), it shall be unlawful for any person to sell short . . . the security that is the subject of the offering and purchase the offered securities from an underwriter or broker or dealer participating in the offering if such short sale was effected during the period (“Rule 105 restricted period”) that is the shorter of the period: (1) Beginning five business days before the pricing of the offered securities; or (2) Beginning with the initial filing of such registration statement . . . and ending with the pricing. … Rule 105 of Regulation M is designed to protect the independent pricing mechanism of the securities market shortly before follow-on or secondary offerings.

For the life of me, I can’t make out why this rule exists, or what useful purpose it might serve.

Bernanke scolded Congress:

However, an important part of the federal budget deficit appears to be structural rather than cyclical; that is, the deficit is expected to remain unsustainably elevated even after economic conditions have returned to normal. For example, under the Congressional Budget Office’s (CBO) so-called alternative fiscal scenario, which assumes that most of the tax cuts enacted in 2001 and 2003 are made permanent and that discretionary spending rises at the same rate as the gross domestic product (GDP), the deficit is projected to fall from its current level of about 9 percent of GDP to 5 percent of GDP by 2015, but then to rise to about 6–1/2 percent of GDP by the end of the decade. In subsequent years, the budget outlook is projected to deteriorate even more rapidly, as the aging of the population and continued growth in health spending boost federal outlays on entitlement programs. Under this scenario, federal debt held by the public is projected to reach 185 percent of the GDP by 2035, up from about 60 percent at the end of fiscal year 2010.

The CBO projections, by design, ignore the adverse effects that such high debt and deficits would likely have on our economy. But if government debt and deficits were actually to grow at the pace envisioned in this scenario, the economic and financial effects would be severe. Diminishing confidence on the part of investors that deficits will be brought under control would likely lead to sharply rising interest rates on government debt and, potentially, to broader financial turmoil. Moreover, high rates of government borrowing would both drain funds away from private capital formation and increase our foreign indebtedness, with adverse long-run effects on U.S. output, incomes, and standards of living.

It is widely understood that the federal government is on an unsustainable fiscal path. Yet, as a nation, we have done little to address this critical threat to our economy. Doing nothing will not be an option indefinitely; the longer we wait to act, the greater the risks and the more wrenching the inevitable changes to the budget will be. By contrast, the prompt adoption of a credible program to reduce future deficits would not only enhance economic growth and stability in the long run, but could also yield substantial near-term benefits in terms of lower long-term interest rates and increased consumer and business confidence. Plans recently put forward by the President’s National Commission on Fiscal Responsibility and Reform and other prominent groups provide useful starting points for a much-needed national conversation about our medium- and long-term fiscal situation. Although these various proposals differ on many details, each gives a sobering perspective on the size of the problem and offers some potential solutions.

The Fed’s reintermediation made a good profit:

The U.S. Federal Reserve System, which includes the Board of Governors in Washington and 12 regional banks based in cities such as New York and San Francisco, returned a record $78.4-billion (U.S.) to the Treasury in 2010 – a remarkable 65-per-cent increase from 2009.

Toronto Mayor Rob Ford is making the right noises:

Toronto Mayor Rob Ford has issued a clear warning to any managers or staff who defy his cost-cutting edicts: Rein in spending or find a new job.

“If they are unable to manage effectively in the best interest of the taxpayers, then we will have to find new managers that can,” Mr. Ford said Monday.

Mr. Ford singled out Toronto police for its proposed 3-per-cent budget increase and summoned Chief Bill Blair to his office at 2 p.m. Monday.

The mayor toned down his rhetoric by the time he and Chief Blair emerged from their hour-and-a-half-long meeting. “I have the utmost confidence in the chief continuing to do the job. We had a very, very constructive meeting and I support the chief 100 per cent,” Mr. Ford said.

I have sent him an eMail, titled “Police Force Gravy Train”:

As you are probably aware, there are many instances of poor personnel management in the Toronto Police Service that are very costly to Toronto taxpayers.

i) Overtime for court appearances. A considerable amount of money is spent on this, with the TPS being unable or unwilling to schedule shifts to match required court appearances. Will you be seeking change in this area, if necessary by increasing the TPS complement so that officers in court can have their duties covered by another officer on straight time?

ii) Paid-Duty. Organizers of special events hire Constables and more senior officers at a high premium to officers’ regular wages, as is entirely normal in any private sector operation. However, the bulk of this premium is paid to the officers directly, instead of being retained by TPS, the contractor. Will you be seeking to arrange matters such that policing for special events is explicitly performed by the TPS, assigning officers on regular shifts as much as possible? Again, I recognize that the TPS complement may need to be increased to facilitate the mandate.

It was a mixed day on the Canadian preferred share market, with PerpetualDiscounts gaining 20bp and FixedResets down 2bp. Volume was average; there is but a single entry on the Performance Highlights table.

Willem Buiter of Citibank is predicting a bail-out of Portugal:

“Now that the Irish government has reached an agreement with the EU/IMF on a financial support package and associated conditionality, the market’s attention will turn to Portugal, whose sovereign, at current levels of interest rates and growth rates, we judge to be less dramatically, but quietly insolvent,” Buiter wrote in a research note Friday.

“We consider it likely that Portugal, too, will need to access the EFSF/EFSM soon.” Buiter said.

Buiter said the current size of the liquidity facilities in place within the European Union is sufficient to deal with another speculative attack or as he puts it “even fund Spain completely for three years”

I don’t normally report brokerage analysis on considerations of quality – but I was quoting Buiter before he got the cushy job, so why not?

But Portugal’s not shut out just yet:

The Portuguese government issued 1 billion euros ($1.29 billion) of 2.5-year notes through a private placement as the nation seeks to narrow its budget gap.

Portugal sold zero-coupon debt due July 2012 in a transaction led by Deutsche Bank AG, according to data compiled by Bloomberg. The Finance Ministry confirmed the medium-term note offering in an e-mail today without providing more details.
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Portugal sold 500 million euros of six-month bills on Jan. 5, according to the country’s debt agency. The yield on the bills jumped to 3.686 percent from 2.045 percent at a sale of similar-maturity securities in September. A year ago, the country paid just 0.592 percent to borrow for six months.

The FDIC’s attempt to risk-weight deposit insurance premia, discussed in the post FDIC Addresses Systemic Risk is having some interesting knock-on effects:

Increased FDIC fees may cut into banks’ interest income and drive money market rates lower, the strategists said. The volume weighted average for overnight fed funds, the so-called effective rate, may slide by as much as 0.1 percentage point if the FDIC change is implemented, according to Wrightson ICAP LLC, a Jersey City, New Jersey research unit of ICAP Plc.
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Even lower short-term interest rates will potentially make it even harder for the $2.8 trillion money-market fund industry to retain customer assets. The FDIC changes will add to catalysts for lower money-market rates, chiefly the Fed siphoning of about $1 trillion in Treasuries from the market through its debt purchases by June, according to New-York based Brian Smedley, a strategist at Bank of America Merrill Lynch, a unit of Bank of America Corp.

“The Fed will likely achieve lower short-term rates even without lowering the 25 basis points it currently pays on banks’ excess reserve balances,” said Smedley, a former senior trader at the Federal Reserve Bank of New York. With short-term interest rates likely to decline this year, “it will make money- market mutual fund managers lives more difficult and could lead to further consolidation of the industry.”

Deborah Cunningham, chief investment officer in Pittsburgh for taxable money markets at Federated Investors Inc., which manages more than $336 billion in money-market investments, said a fall in overnight rates would at most be only about five basis points and wouldn’t be sufficient to speed any consolidation of the money-fund industry.

OSFI reports that Jean-Claude Ménard, Chief Actuary, gave a speech on mortality and the CPP:

The actuarial report on the Canada Pension Plan is based on the projection of its revenues and expenditures over a long period of time. Under a set of best-estimate assumptions, the most recent actuarial report confirms that the legislated contribution rate of 9.9% is sufficient to pay future expenditures and accumulate assets of $275 billion in 2020, or 4.7 times the expenditures. Having said that, both the length of the projection period and the number of assumptions required ensure that actual future experience will not develop precisely in accordance with the best-estimate assumptions. For the second time, in the most recent actuarial reports, many of the sensitivity tests are determined based on stochastic modeling techniques that estimate the probability distribution of the outcome for each of the main assumptions.

This chart shows the evolution of the asset to expenditure ratio under three scenarios: the best-estimate assumption and the two stochastically determined scenarios based on a 80% confidence interval. The result is that the minimum contribution rate required to finance the plan over a 75-year period could fall between 9.3% and 10.3%.

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It was a relatively quiet, but nevertheless profitable day on the Canadian preferred share market, with PerpetualDiscounts up 10bp and FixedResets gaining 5bp on average volume.

On December 14 I highlighted Hoenig’s dissent from the FOMC decision and speculated:

It occurs to me that Mr. Hoenig is being used – probably with his enthusiastic cooperation – as a straw man. The Fed wants to send an explicit signal that they’ve thought about this, discussed this and reached a concensus to reject this. There’s no shortage of blogs out there claiming hyperinflation is imminent! Given the increased public discussion of economic data, with various levels of competence, one wonders if more public pronouncements by governments and their agencies will set up straw men in their releases and recognize that forecasts are necessarily imprecise.

Hoenig has delivered a speech on the topic, titled Monetary policy and the role of dissent:

Based on audience questions, news coverage and pundit columns throughout the year, it has become obvious to me that the role of dissent in the FOMC is misunderstood and viewed without context. The idea that a dissenting vote is confusing, counterproductive, and generally undesirable is unhealthy. It is also historically inaccurate.

In my remaining time today, I will discuss why dissenting views at the FOMC are critical to the success of the Federal Reserve System and that public debate was the intent of its congressional founders. I will also describe how open debate and dissent are fundamental to achieving transparency of FOMC deliberations and to supporting the credibility of the committee in difficult economic times.
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As an economist, I cannot be certain that my views are correct. Certainly, a majority of my counterparts on the FOMC last year did not agree with my views. But it is important to recognize that in the face of uncertainty, arriving at the best policy decision is built on divergent opinions and vigorous debate.

Because of this, the role of open dissent is at least as critical to FOMC monetary policy decisions as it is to deliberations by the Supreme Court, the United States Congress or any other body with important public responsibilities from the local through the federal level. If you find it unusual to consider the FOMC as being similar to these other deliberative bodies, it is perhaps because many–including some former Federal Reserve officials–tend to speak of Fed policy as being done by a single actor.
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A deliberative body does not gain credibility by concealing dissent when decision making is most difficult. In fact, credibility is sacrificed as those on the outside realize that unanimity – difficult in any environment – simply may not be a reasonable expectation when the path ahead is the most confounding.
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As for me, I recognize that the committee’s majority might be correct. In fact, I hope that it is. However, I have come to my policy position based on my experience, current data and economic history. If I had failed to express my views with my vote, I would have failed in my duty to you and to the committee.

In these days of political obsession with staying “on message”, and puerile voters who want a simple story just like mommy used to tell them, Hoenig’s expression of his views is rather refreshing!

Contingent Capital as a concept has often been criticized on the basis that it might be difficult to sell – but banks have been selling this type of issue with gusto:

Barclays Plc, based in London, and UBS AG in Zurich led more than a dozen banks selling reverse convertibles, which are short-term bonds generally marketed to individuals that convert into stock if a company’s share price plummets.
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Structured note sales rose 46 percent last year to a record $49.4 billion in the U.S., Bloomberg data show. The securities fed demand from individual investors frustrated with record low rates on everything from certificates of deposit to money market funds with the Federal Reserve holding its target interest rate for overnight loans between banks in a range of zero to 0.25 percent since 2008. Banks issued $33.9 billion in 2009, according to StructuredRetailProducts.com, a database used by the industry.

Royal Bank of Scotland Group Plc sold $1.15 million in three-month notes tied to Rochester, New York-based Eastman Kodak Co. on June 10 that paid 24 percent annualized interest, a filing with the U.S. Securities and Exchange Commission shows. That’s 24 times the average rate on one-year certificates of deposit, according to data from Bankrate Inc. in North Palm Beach, Florida.

Buyers couldn’t lose money unless shares of the camera maker fell to below $3.54 from $5.06. Kodak dropped to $3.50 on Aug. 31 in New York trading. RBS converted the bonds into stock and investors lost about 18 percent even with the high interest rate.

I will admit, however, that the perpetual nature of Contingent Capital is another difficulty in flogging it.

Regular debt is selling pretty well, too!

Company bond sales in the U.S. surged to the most on record this week and relative yields on investment-grade debt shrank to the narrowest since May as investors boosted bets that economic growth is gaining momentum.

Issuance soared to $48.2 billion, eclipsing the $46.9 billion raised in the week ended May 8, 2009, as General Electric Co.’s finance unit sold $6 billion of notes in the largest sale in 11 months, according to data compiled by Bloomberg. Investment-grade bond spreads narrowed to 162 basis points, or 1.62 percentage points, the tightest since May 4, 2010, Bank of America Merrill Lynch index data show.

Investors’ appetite for company debt is growing even after annual sales topped $1 trillion for the second consecutive year as the securities outperform Treasuries.
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Offerings from foreign borrowers dominated U.S. sales this week, with transactions by companies from Sydney-based Macquarie Group Ltd. to the U.K.’s Barclays Plc accounting for 57 percent of the total, Bloomberg data show. Relative yields on U.S. corporate bonds became narrower than those on company debt worldwide last month for the first time on record, Bank of America Merrill Lynch index data show.

The Canadian preferred share market had a good day on average volume, with PerpetualDiscounts gaining 21bp and FixedResets up 10bp. Sun Life PerpetualDiscounts saw some good volume.

Manulife has announced that:

Between October 1, 2010 and December 31, 2010, the Company:

• Shorted approximately $5 billion of equity futures contracts as part of the Company’s macro hedging program.
• Modestly increased its dynamic variable annuity hedging program by adding $800 million of in-force variable annuity guaranteed value to the program.
• Sold $200 million of on-balance sheet public equities backing insurance liabilities

The WSJ has a story today titled Bondholders Are Rattled by Prepayment Covenants, republished by the Globe, but not on-line. It seems there are a lot of calls for redemption in the junk bond world, surprising many managers … I tell you, it’s a good thing so few of my competitors read prospectuses; that would make outperformance more difficult.

Assiduous Reader DW brings to my attention a working paper by Zhiwu Chen, Roger G. Ibbotson and Wendy Hu titled Liquidity as an Investment Style:

We first show that liquidity, as measured by stock turnover or trading volume, is an economically significant investment style that is distinct from traditional investment styles such as size, value/growth, and momentum. We then introduce and examine the performance of several portfolio strategies, including a Volume Weighted Strategy, an Earnings Weighted Strategy, an Earnings-Based Liquidity Strategy, and a Market Cap-Based Liquidity Strategy. Our backtest research shows that the Earnings-Based Liquidity Strategy offers the highest return and the best risk-return tradeoff, while the Volume Weighted Strategy does the worst. The superior performance of the liquidity strategies are due to equilibrium, macro, and micro reasons. In equilibrium, liquid stocks sell at a liquidity premium and illiquid stocks sell at a liquidity discount. Investing in less liquid stocks thus pays. Second, at the macro level, the growing level of financialization of assets in the world makes today’s less liquid securities increasingly more liquid over time. Finally, at the micro level, the strategy avoids, or invests less, in popular, heavily traded glamour stocks and favors out-of-favor stocks, both of which tend to revert to more normal trading volume over time.
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The negative relation between liquidity and stock returns is not always straight forward. Lee and Swaminathan (1998) show that the return spread between past winners and past losers (i.e., the momentum premium) is much higher among high-volume stocks. Trading volume serves as an indicator of demand for a stock. When a stock falls into disfavor, the number of sellers dominates buyers, leading to low prices and low volume. When a stock becomes popular or glamorous, buyers dominate sellers, resulting in higher prices and higher volume. Thus, relatively low turnover is indicative of a stock near the bottom of its expectation cycle, while a relatively high turnover is indicative of a firm close to the top of its expectation cycle.

Today’s installment in the “Incredible Bullshit Banks are Allowed To Get Away With” series features the Bank of Montreal:

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Risk Free! Lehman should have thought of that line, they would have been able to sell a great many more of their PPNs.

A mixed day on the Canadian preferred share market, with PerpetualDiscounts gaining 10bp and FixedResets losing 16bp. Volume was on the high side of average.

PerpetualDiscounts now yield 5.43%, equivalent to 7.60% interest at the standard equivalency factor of 1.4x. Long corporates now yield about 5.5%, so the pre-tax interest-equivalent spread (also known, around here, as the Seniority Spread) is now about 210bp, a dramatic tightening from the 225bp reported on December 31.

European bank regulation may become far more intrusive:

National regulators of cross-border banks may be able to require “changes to legal or operational structures” if the lender would need “extraordinary public financial support” during a crisis, according to draft proposals obtained by Bloomberg News.
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The plan also envisages measures “requiring the credit institution to limit its maximum individual and aggregate exposures” or forcing banks to “limit or cease” some activities, according to the document, dated December 2010.

Regulators should assess lenders and “satisfy themselves that critical functions could be legally and economically separated from other functions” during a crisis, according to the draft proposals.

I can’t think of a better way to reinforce structural groupthink.

Japan has interesting bond sales methods:

Japan will sell a record 144.9 trillion yen ($1.8 trillion) of debt in the fiscal year starting April 1, it said in a budget plan on Dec. 24 that also detailed the changes in its retail bonds. The Ministry of Finance tried to find new buyers for the debt last year with magazine advertisements saying, “Men who hold JGBs are popular with women!”

An investor who decided to buy floating-rate retail notes after reading the ads would have seen yields shrink to a range of 0.25 percent to 0.53 percent at the twice-yearly coupon payouts for the 10-year securities.

I mentioned the Greg Walsh kerfuffle briefly on December 30 – he’s the Peterborough hockey coach who had hysterics when one of his players was called a nasty name. The blog dahn batchelor’s opinions also posted on the topic in a post titled A foul-mouthed brat caused this problem; I left a comment on the moderated blog, but it hasn’t appeared yet, possibly due to a technical problem. So I’ll publish it here:

I am surprised that someone with such a lengthy profile would publish such a shoddy analysis.

You acknowledge that the players were in an on-ice confrontation and that they heckled each other in the penalty box. You profess dismay at the idea that the heckling included the word “nigger” and substitute “brat” as your own politically correct childish insult of choice – both in the headline and the text.

These kids are 16-17 years old – more balls than brains if my own recollections of adolescence can be trusted. Sometimes they say stupid things. Surprise! Not everybody invariably chooses their words as carefully as a retired lawyer tapping away at his keyboard in his surroundings of choice.

What should the punishment be for such a breach of public dignity in the context of a schoolyard yelling match? A three game suspension sounds harsh to me, but it’s not so harsh that I care much one way or the other.

What should the punishment be? Walsh seems to think it should involve a public apology – at best a lesson in hypocrisy, at worst a public humiliation of the kind civilized nations have eliminated from the criminal code.

Your own rather incoherent response seems to include coaches – the ones who should support their players – imposing extra-judicial punishment, benching them for the rest of the game. Unable to find any other support in today’s world for your thesis, you are forced to dredge up a case from thirty-seven years ago, and the recollections of a 54-year old man speculating on what he thinks he would have done differently.

The PMHA seems to think that penalties should include a criminal record.

In a year or two, these kids will be eligible to go to Afghanistan, where the Taliban may well call them nasty names and even – gasp! – hit them with sticks. It really is too bad that Greg Walsh, Dahn Batchelor and others are attempting to prepare them for the rigors and conflicts of adulthood by telling them that the way to deal with adversity is to run home crying to mommy.

Jackie Robinson would never even have been able to watch major league baseball with that attitude.

I hadn’t known that the PMHA had gone to the police about this. My lord, don’t they realize that when there are horrific penalties for minor transgressions, you simply get selective reporting? Or don’t they care? Or do they, in their heart of hearts, believe that this shouting match is worthy of police time and a possible criminal record? But then, we live in a world with some very strange priorities – or, at least, one in which very strange rationales are given credence by the press.

The Canadian preferred share market had a good day as volume returned to more normal levels. PerpetualDiscounts gained 15bp and FixedResets lost 3bp.

It was an extremely slow and boring day on the Canadian preferred share market to end the year, with PerpetualDiscounts up about half a beep and FixedResets losing 6bp.

PerpetualDiscounts now yield 5.48%, equivalent to 7.67% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.4%, so the pre-tax interest-equivalent spread is now about 225bp, a slight (and perhaps spurious) widening from the 220bp reported December 29

Malachite Aggressive Preferred Fund has had another good year – I’ll put a little cinnamon in my coffee tonight, to celebrate – but I’ll have the final report out on that in the near future.

It has been a great year for corporate debt issuance:

Rabobank Nederland, the world’s largest agricultural lender, and Fairfield, Connecticut-based General Electric Co.’s finance unit led $3.19 trillion of offerings, according to data compiled by Bloomberg. Ally Financial Inc., Ford Motor Credit Co. and 509 other speculative-grade companies sold $287 billion of debt in the U.S., smashing the previous record of $162.7 billion in 2009.

Signs the global economic recovery is gaining strength encouraged investors to lend money to borrowers at lower interest rates, allowing Johnson & Johnson and Wal-Mart Stores Inc. to sell bonds at what were then record-low coupons. In the U.S., bond funds took in $234.8 billion this year through October, while investors withdrew money from stock funds, according to the Investment Company Institute in Washington.
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Sales still declined 18 percent from last year’s $3.88 trillion as governments withdrew bond guarantees for financial companies trying to weather the credit crisis. Concern that Europe’s sovereign debt crisis would worsen slowed sales in the region.

BIS has released a working paper by Marc Flandreau, Norbert Gaillard and Frank Packer titled To err is human: rating agencies and the interwar foreign government debt crisis:

During the 1930s, rating agencies took up a central role in regulatory supervision that they still have today. The proximate cause for this changeover was the economic shock of the Great Depression. Exploring the performance of rating agencies in assessing the risks of sovereign debt, an important segment of the bond market, we do not find that superior forecasting capacities can explain the agencies’ growing importance.
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This paper makes a contribution to this emerging literature on the history of ratings by focusing on the assessment of foreign government debt by US rating agencies during the interwar period. There are two reasons for this focus. … Second, looking at the government debt crisis may add a useful perspective on what remains one of the most (perhaps the most) violent foreign debt disaster in financial history. Between 1931 and 1939, more than half of sovereign borrowers who had issued in New York during 1920–29 defaulted. The episode, an integral part of the catastrophic interwar financial system dislocation, has not yet been studied from this vantage point, although many other aspects of the crisis have been discussed in detail.
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We document a large degree of procyclicality of ratings over the period. Perhaps more surprisingly, rating agencies do not appear to have performed particularly well relative to financial markets in forecasting the approaching mess: when we compare the predictive power of agency ratings with that of synthetic ratings based on market yields, we find little that suggests strongly superior performance. Our results leave open the reasons for the emergence of ratings as regulators’ preferred instrument, for superior performance does not appear to have motivated the initial regulatory use of ratings.

Gee, it’s a good thing we’re so much smarter now than they were in the thirties, eh? Imagine, sovereign defaults, depression, the rise of authoritarianism … thank God that could never happen again.

Spain has cut its financing requirements:

Spain’s Treasury said it had managed to cut borrowing from markets in 2010 and would do so again in 2011 because of austerity measures adopted by the government.

For the year ahead, the Treasury estimated net financing needs of &eur;47.2-billion ($62.4-billion) — a decline of 24%from 2010.

But the figure was slightly higher than previously announced because of the country’s &eur;3.588-billion contribution to a European financial rescue for Greece.

Net bond issues in 2010 amounted to €62.1-billion, compared to the &eur;76.8-million forecast at the start of the year, the Treasury said. It was a sharp decline from the &eur;116.7-billion in net bond issues for 2009.

Financing needs declined in 2010 “because of the fiscal austerity measures put in place by the government mid-year to strengthen the stabilization of public accounts.”

PrefBlog doesn’t have a very long list of favourite politicians, but Pennsylvania Governor Ed Rendell comes close:

His latest pronouncement came on Sunday after the National Football League’s rare postponement of a game due to a forecast of snow. In Rendell’s world, real men live to make a touchdown in the snow.

“This is football. Football’s played in bad weather,” Rendell said before the storm struck his city on Sunday but after the NFL had postponed the Sunday-night game.
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“We’ve become a nation of wusses,” Rendell declared. “The Chinese are kicking our butt in everything. If this was in China do you think the Chinese would have called off the game? People would have been marching down to the stadium, they would have walked and they would have been doing calculus on the way down.”

It’s a good column. Later on, the author states:

Pre-wussification, we were an economic powerhouse, and our children were the best-educated in the world, until we decided to sheathe our little princes and princesses in bubble wrap. We give them graduation ceremonies for getting through nursery school, a trophy just for showing up at soccer. We’ve removed play from the playground to keep them from scraping a knee. We intervene like lawyers in every dispute.

For sure. Look at the recent case of Greg Walsh. He was coaching a team of 16-year-olds when:

At the game in question, [black player Andrew] McCullum and a player on the opposing Austin Trophies team were sent to the penalty box after a confrontation. There, two game officials witnessed the player call McCullum “the N-word.”

The other boy’s coach benched him for the rest of the second period, but when he rejoined the ice at the beginning of the third period without anyone coming over to apologize or offer an explanation, Walsh was outraged.

The whole team agreed to forfeit the game they were winning in support of McCullum.

Walsh was suspended for a year by the OMHA, amidst controversy – the Star made this a cause celebre, canonizing the coach for ‘standing by his player’..

Think about it. These were two 16-17 year old boys, more balls than brains if my memories of adolescence can be trusted, they had been in a “confrontation” on the ice for which they had been penalized, they were jawing back and forth at each other in the penalty box … It certainly doesn’t sound like anything was either organized or premeditated. What message is the Star sending here? “If you’re involved in an activity and somebody calls you a nasty name, then what you should do is run home crying to mommy”, that’s what it sounds like to me.

Jackie Robinson wouldn’t have been able to even watch a major league game with that attitude.

It was another very slow day in the Canadian preferred share market, but the rally was hot enough, as PerpetualDiscounts gained 18bp and FixedResets were up 11bp.

There’s an interesting, albeit badly in need of editing, paper by Alessandro Fontana titled The persistent negative CDS-bond basis during the 2007/08 financial crisis:

I study the behavior of the CDS-bond basis – the difference between the CDS and the bond spread – for a sample of investment-graded US firms. I document that, since the onset of the 2007/08 financial crisis it has become persistently negative, and I investigate the role played by the cost of trading the basis and its underlying risks. To exploit the negative basis an arbitrageur must finance the purchase of the underlying bond and buy protection. The idea is that, during the crisis, because of the funding liquidity shortage and the increased risk in the financial sector, which exposes protection buyers to counter-party risk, the negative basis trade is risky. In fact, I find that basis dynamics is driven by economic variables that are proxies for funding liquidity (cost of capital and hair cuts), credit markets liquidity and risk in the inter-bank lending market such as the Libor-OIS spread, the VIX , bid-asks spreads and the OIS-T-Bill spread. Results support the evidence that during stress times asset prices depart form frictionless ideals due to funding liquidity risk faced by financial intermediaries and investors; hence, deviations from parity do not imply presence of arbitrage opportunities.

The Basel Committee continued its attempts to deflect public attention from its incompetence with the release of Pillar 3 disclosure requirements for remuneration. The financial crisis had a lot more to do with tranche retention and the lack of minimum turnover standards for securities designated Available For Sale than any compensation packages.

Econbrowser‘s James Hamilton discusses the 2010 changes in the yield curve in his post Changes in the Yield Curve:

One goal of the Fed’s second round of quantitative easing begun at the start of November was to flatten the yield curve. That obviously didn’t happen, and I discussed some of the reasons why a few weeks ago. A second goal was to increase inflationary expectations, which was achieved.

Even so, all we’ve done is moved back to about where we were a year ago. And a year ago, if you recall, things really weren’t that great.

But at least now we’re moving in the right direction.

The Globe & Mail ran a story on insurance fraud on Monday that I confess I don’t fully understand:

Again, the real money was made through a clinic, by submitting stacks of claims for false treatments under Ontario’s no-fault insurance system that averaged more than $250,000 per accident.
…
For an initial fee of $500, any person – not necessarily a doctor – can register as the owner of a clinic, hire practitioners and bill insurers for claims. In order to file those claims, a doctor or registered practitioner’s name, signature, and other billing information is needed, but this is sometimes forged.

Using confidential documents obtained from U.S. investigators, which were then cross-referenced with information gathered from court and corporate searches in Canada, The Globe and Mail has learned that at least one person indicted in the biggest auto insurance crackdown ever seen in the United States has since opened a rehabilitation business in Ontario, operating under the noses of regulators and lawmakers.

I don’t get it. OK, I understand the bit about since the regulators basically allow cost-plus charging of premiums, there’s very little incentive to show any initiative in checking out possible fraud. But honestly, when a clinic you’ve never heard of sends you a bill for $250,000 … don’t you send some clerk to go check them out? Call the practitioners involved? Ask for some back-up? and flag the clinic for a higher rate of spot checks until they’ve been in business for a year? This seems to me to be such a basic part of good business practice that I am astounded it’s not standard, especially considering that cashing a $500 cheque requires a rectal probe.

The Globe published my letter regarding the Mordecai Richler tempest.

The Canadian preferred share market rally continued today on unsurprisingly very low volume, with PerpetualDiscounts gaining 15bp and FixedResets up 3bp.

PerpetualDiscounts now yield 5.43%, equivalent to 7.60% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.4%, so the pre-tax interest-equivalent spread is now about 220bp, with all figures basically unchanged from December 22.

There’s less room at the trough for wind and solar lobbyists:

Investors pulled 931 million euros ($1.2 billion) in the first 10 months, already eclipsing the full-year withdrawals in 2008 when the global financial crisis spooked investors, according to data compiled by Lipper Inc. Last year clean-energy funds captured 1.3 billion euros of new money, Lipper said.
…
“The new-energy market and related stocks were significantly impacted by the credit crisis,” Robin Batchelor, manager of the $2.9 billion BlackRock New Energy Fund, said in an e-mail. Reduced demand for energy and “the fact that governments were perceived to have many new worries on their agenda combined to create a difficult environment,” he said. New York-based BlackRock is the world’s largest money manager.
…
U.S. investment slumped this year amid investor doubt about government energy policy, while the sovereign debt crisis has limited prospects for economic growth in Europe. Governments in Germany, Spain and Italy cut subsidies for photovoltaic panels.

China continues to push offshore yuan trading:

Hong Kong banks will be allowed to tap the 20 billion yuan ($3 billion) fund from next month should the city’s yuan clearing bank run out of funds set under a quarterly quota.

The Hong Kong Monetary Authority made 10 billion yuan available in October using a swap agreement with China’s central bank after an 8 billion yuan quota proved insufficient. Chinese Premier Wen Jiabao is allowing the currency to become more readily available beyond China’s borders to reduce reliance on U.S. dollars in trade and finance.

“They’re hurtling toward this now,” said Gavin Parry, managing director of Hong Kong-based Parry International Trading Ltd. “They’re really using Hong Kong as the settlement and clearing hub for offshore deposit and transactions” in yuan, he said.

Hong Kong aims to grow as an offshore center for yuan trading and HKMA Chief Executive Norman Chan said yesterday deposits totaled 280 billion yuan at the end of November, up from 220 billion yuan a month earlier. The city received 130 billion yuan in net trade payments from China in the first 11 months, he told reporters in Hong Kong.

That’s a lot more useful than whimpering about global resolutions to develop a new currency!

Together with the above, dim sum bond issuance is booming:

HSBC Holdings Plc and Standard Chartered Plc, the biggest foreign underwriters of yuan bonds sold in Hong Kong, say sales will double in 2011 as demand outstrips supply and the yuan appreciates.

New issues may increase to a record 80 billion yuan ($12 billion) next year, with as much as 30 billion yuan of sales in the first quarter, according to HSBC, the No. 2 underwriter of so-called dim sum bonds. Standard Chartered, the fourth largest this year, says sales could top as much as 100 billion yuan as Moscow-based United Co. Rusal and BP Plc plan issues. Offerings in 2010 total 40.7 billion yuan, data compiled by Bloomberg show.

The Bank of Canada has released a working paper by Kimberly Beaton, René Lalonde and Stephen Snudden titled The Propagation of U.S. Shocks to Canada: Understanding the Role of Real-Financial Linkages:

This paper examines the transmission of U.S. real and financial shocks to Canada and, in particular, the role of financial frictions in affecting the transmission of these shocks. These questions are addressed within the Bank of Canada’s Global Economy Model (de Resende et al. forthcoming), a dynamic stochastic general-equilibrium model with an active banking sector and a detailed role for financial frictions. We find that U.S. financial shocks, as well as real shocks, have important effects on the Canadian economy. Moreover, financial frictions on both the demand and supply sides of credit amplify the first round impact of all types of U.S. shocks on the U.S. economy, as well as the second round impact on Canada. Real-financial linkages also increase the persistence of the Canadian response to U.S. shocks. We find that the interaction between the endogenous response of commodity prices and U.S. financial frictions plays an important role in the propagation of U.S. shocks to the Canadian economy. Finally, real-financial linkages also help to generate the positive cross correlation between domestic demand in the United States and Canada observed in the data, which is difficult to explain with a model where the transmission of shocks between countries is only based only on trade.

Unsurprisingly enough, it was a sleepy foreshortened day on the Canadian preferred share market, but the rally managed to sputter along, with PerpetualDiscounts gaining 9bp and FixedResets basically flat.

Allied Irish has joined the cortege:

Ireland’s High Court said Allied Irish Banks Plc can be taken over by the government without shareholder approval, as the lender became the fourth bank to fall under state control since 2008.

Finance Minister Brian Lenihan secured approval from the Dublin-based court today to inject 3.7 billion euros ($4.8 billion) into the lender by Dec. 31 and raise its stake to 92 percent from 19 percent, the Finance Ministry said in a statement. Allied Irish, Ireland’s biggest company by market value in 2007, recorded its biggest share price drop in 22 months in Dublin trading. Worth almost 21 billion euros at its peak, the bank’s market value today was 341 million euros.

In Hungarian news:

Fitch cut Hungary’s long term foreign currency credit rating to BBB- with a negative outlook on Thursday, warning that the lack of a coherent medium-term fiscal strategy undermined confidence in the sustainability of public finances.

“The reversal of pension reforms and lack of a coherent medium-term fiscal strategy undermines confidence in the long-term sustainability of the public finances,” it said in a statement.

The Bank of Canada has published a few working papers of note lately … I haven’t gone through them carefully (they’re in a HUGE pile, marked “later”), but the first one is by H. Evren Damar, Césaire A. Meh and Yaz Terajima, titled Leverage, Balance Sheet Size and Wholesale Funding:

Some evidence points to the procyclicality of leverage among financial institutions leading to aggregate volatility. This procyclicality occurs when financial institutions finance their assets with non-equity funding (i.e., debt financed asset expansions). Wholesale funding is an important source of market-based funding that allows some institutions to quickly adjust their leverage. As such, financial institutions that rely on wholesale funding are expected to have higher degrees of leverage procyclicality. Using high frequency balance sheet data for the universe of banks, this study tries to identify (i) if such a positive link exists between the assets and leverage in Canada, (ii) how wholesale funding plays a role for this link, and (iii) market and macroeconomic factors associated with this link. The findings of the empirical analysis suggest that a strong positive link exists between asset growth and leverage growth, and the use to wholesale funding is an important determinant of this relationship. Furthermore, liquidity of several short-term funding markets matters for procyclicality of leverage.

The second one is by Étienne Bordeleau and Christopher Graham, titled The Impact of Liquidity on Bank Profitability:

The recent crisis has underlined the importance of sound bank liquidity management. In response, regulators are devising new liquidity standards with the aim of making the financial system more stable and resilient. In this paper, the authors analyse the impact of liquid asset holdings on bank profitability for a sample of large U.S. and Canadian banks. Results suggest that profitability is improved for banks that hold some liquid assets, however, there is a point at which holding further liquid assets diminishes a banks’ profitability, all else equal. Moreover, empirical evidence also suggests that this relationship varies depending on a bank’s business model and the state of the economy. These results are particularly relevant as policymakers devise new standards establishing an appropriate level of liquidity for banks. While it is generally agreed upon that banks undervalued liquidity prior to the recent financial crisis, one must also consider the tradeoff between resilience to liquidity shocks and the cost of holding lower-yielding liquid assets as the latter may impact banks’ ability to generate revenues, increase capital and extend credit.

OSFI released a final version of the Capital Adequacy Requirements Guidelines A-1 and A for deposit taking institutions.

Volume in the Canadian preferred share market eased off to merely average levels, but the rally spluttered along, with PerpetualDiscounts up 1bp and FixedResets gaining 22bp.

There is an early close on the Toronto Stock Exchange tomorrow, as all the players have to rush home and tell their mommies how hard they work. It is also the last day of trading for settlement in 2009, which is important for tax purposes, so watch the clock as closely as if you worked for a fundco!