Category: Market Action

Yankee Bonds are surging in popularity:

Foreign borrowers are claiming the biggest share of the U.S. corporate bond market in at least a decade, taking advantage of record investor demand for dollar- denominated debt.

The overseas issuers, known as Yankee borrowers, account for 43 percent of sales this year, compared with 37 percent in 2009 and an average 23 percent from 1999 to 2009, according to data compiled by Bloomberg. Reliance Industries Ltd, India’s biggest company by market value, plans to sell at least $1 billion of bonds in its first benchmark offering in dollars.
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U.S. bond mutual funds have taken in $181 billion this year through September, compared with $7.3 billion for European bond funds, according to EPFR Global in Cambridge, Massachusetts. In the first nine months of 2009, U.S. fund inflows were $134.8 billion compared with $2.4 billion in Europe.

More divergence in the Canadian preferred share market today, as PerpetualDiscounts gained 14bp while FixedResets were basically flat, with continued heavy volume.

Towers Watson has released a series of promotional reports:Pension Finance Watch:

Long bond yields plunged in August, pushing liability values up dramatically. Equity values also declined significantly during the month. This rather unfortunate combination of capital market events means bad news for pension plan funded ratios. The Towers Watson Pension Index declined by 7.4% for the month to 60.0. This is the lowest recorded funded ratio in our data series extending back to 1990.

P&I / TW 300 Analysis:

Research conducted by Pensions & Investments and Towers Watson has found that total assets of the world’s largest 300 pension funds grew by over 8% in 2009, to US$11.3 trillion, up by around US$1 trillion from last year’s figure.

Some cheerful news from the States: the California 2010 Debt Affordability Report:

Because debt service is considered a fixed part of a State’s budget, credit analysts compare a state’s General Fund-supported debt service to its General Fund revenues as a measure of the state’s fiscal flexibility. California’s ratio of debt service to General Fund revenues was 6.69 percent in 2009-10, based on $5.790 billion in GO, lease revenue and Proposition 1A Receivables debt service payments versus $86.521 billion in General Fund revenues. This ratio is projected to be 7.17 percent in 2010-11, based on $6.558 billion5 in debt service payments versus $91.451 billion in General Fund revenues as projected by the Department of Finance.

The EU has an interesting approach to their sovereign debt crisis: make rating sovereigns a risky business:

Ministers are “ready to discuss” fines for ratings companies who mislead investors with poor quality ratings for securities, Swedish Finance Minister Anders Borg said in Brussels, while Didier Reynders, the Belgian finance minister, said “we do need a regulation on that, it’s very clear.”
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“Concern has been expressed on whether the ratings of sovereign debt are necessary at all given the fact that there is already a large degree of transparency in the markets as regards the situation of government finance,” according to the commission document, dated Sept. 15.

The European Union approved rules for credit-rating companies last year, requiring them to adhere to a code of conduct to reduce conflicts of interest between issuers and rating firms.

These are the guys, remember, who were willfully blind to the falsification of Greek debt data. as discussed on March 1.

The Canadian preferred share market started the quarter with another day of mixed results on heavy volume, as PerpetualDiscounts gained 24bp and FixedResets lost 9bp.

Fabulous Fab, the bond salesman scapegoated for personally causing the Panic of 2007, and useful misdirection from the SEC’s incompetence, has claimed the SEC has no jurisdiction anyway:

The Securities and Exchange Commission can’t sue Fabrice Tourre over a Goldman Sachs Group Inc. deal involving collateralized debt obligations because the transaction wasn’t in the U.S., his lawyers told a judge.

The U.S. Supreme Court ruled in June that U.S. securities laws don’t apply to claims of foreign buyers of non-U.S. securities on foreign exchanges, lawyers for the Goldman executive director said in a court filing yesterday. The collateralized debt obligations known as Abacus at issue in the SEC’s complaint weren’t listed on any exchange and the sole investor in the notes was a foreign bank that purchased them overseas, according to the filing.

Another junk fund is starting:

Brompton Advantaged Tactical Yield Fund is an investment fund established under the laws of the Province of Ontario and governed by the Declaration of Trust. See “Overview of the Legal Structure of the Fund”.

Rationale The Fund has been created to provide investors with the opportunity to gain exposure to a diversified Portfolio focused on North American High-Yield Bond and Dividend Paying Equity securities, which offer attractive yields along with upside participation in the ongoing economic recovery. The Portfolio Manager expects that the Portfolio will initially be invested as to approximately 70% in High-Yield Bonds, 20% in Dividend Paying Equity securities, and 10% in Investment Grade Bonds.

This comes after the launch of the nonsensical iShares(R) DEX HYBrid Bond Index Fund, which has nothing to do with hybrid bonds, as the term is understood by the entire world except for the TMX and Blackrock’s marketting team. They just needed a word with HY in it (for High Yield, since “junk” is considered pejoritive) and didn’t want to use “HYacinth” … or “HYundai” … or … um … er … “HYmas” (licencing fees on that one would have been astronomical).

And, of course, all the junk coming out of new preferred issues. This is going to end badly.

Mixed results in the Canadian preferred share market on continued heavy volume, as PerpetualDiscounts were almost precisely flat on the day while FixedResets continued their recent slide by losing 16bp.

PerpetualDiscounts now yield 5.53%, equivalent to 7.74% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.15%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 260bp, a meaningless apparent tightening from the 265bp reported September 29.

Long corporates have been on a tear this month:

Click for big

And that’s a wrap for another month and another quarter!

Germany will make its final Great War reparations payment on the weekend:

West Germany, formed after defeat in 1945, took on responsibility for most of the outstanding principle and interest, settling the bill in 1983.

But there was a clause in the so-called London Debt Agreement of 1953 that interest on multi-million pound foreign loans taken out in the Weimar Republic era, to pay off the reparations bill, should themselves be repaid if Germany were ever reunited.

Payments on this interest began again in 1996.

‘On Sunday the last bill is due and the First World War finally, financially at least, terminates for Germany,’ said Bild, the country’s biggest selling newspaper.

Most of the money goes to private individuals, pension funds and corporations holding debenture bonds as agreed under the Treaty of Versailles.

The German government did not reveal how the money will be disbursed but it is understood that it is transferred to a holding account before being sent to the relevant bond and debt holders.
Most of these are American and French.

The Ontario prostitution ruling is on-line. The judge’s opinion of the experts (paras 352-358) is hiliarious.

The Canadian preferred share market slid again today, with PerpetualDiscounts losing 10bp and FixedResets down 11bp. After the redemption of CM.PR.R and CM.PR.A was announced, I wondered what would happen to TD.PR.M and TD.PR.N. Well … they’re both on the unpleasant side of the performance highlights table, but nothing too terrible has happened … yet.

PerpetualDiscounts now yield 5.54%, equivalent to 7.76% interest at the standard equivalency factor of 1.4x. Long corporates now yield about 5.1% (!) so the pre-tax interest-equivalent spread (also called the Seniority Spread) now stands at about 265bp, a sharp increase from the 245bp reported September 22, as long corporate yields have plummetted about 20bp while PerpetualDiscount yields are unchanged.

John Hempton of Bronte Capital is keeping the Universal Travel Group pot boiling:

The only communication I have had from Universal Travel Group was a kind email from the acting Chief Financial Officer saying that I needed to provide proof that I was a shareholder to participate in the conference call that they are having on Wednesday, September 29, 2010, to discuss and answer any questions investors may have regarding the Company’s business and financial statements.

I have some questions and I forwarded them in advance to the company as requested.

The purpose of this post is to put the questions on the record in the hope that they are answered and not to entertain my regular readers.

The Fed’s Shared National Credit Review was positive:

Reasons for improvement included improved borrower operating performance, debt restructurings and bankruptcy resolutions, and improved borrower access to bond and equity markets. Industries contributing to improvement in credit quality included automotive, materials and commodities, and finance and insurance. The volume of poorly underwritten credits originated in 2006 and 2007 continued to adversely affect the overall credit quality of the portfolio. Refinancing risk within the portfolio is significant, with nearly 67 percent of criticized assets maturing between 2012 and 2014

I see that the prostitution laws have been struck down, which is a very good thing (unless, of course, you believe that morality can be legistlated). In an amazingly intelligent remark, the judge said:

Judge Himel also said that pimps who threaten or commit violence against prostitutes can still be prosecuted using other sections of the Criminal Code.

When defenders of the faith law wring their hands about human trafficking (it used to be called white slavery), they never explain why such actions don’t fall under the heading of extortion.

However, Judge Himel gave the Crown a 30-day window in which to make arguments against legalizing bawdy houses on account of a concern that “unlicenced brothels may be operated in a way that may not be in the public interest.”

You want to see a bawdy house? Go peek at any of the downtown hotels.

“Any time you are alone with a john, it is dangerous,” federal Crown Michael Morris told Judge Himel. “There is no safe haven when you are involved in prostitution. There is overwhelming evidence that johns can become violent at any moment.”

However, Mr. Young countered that prohibiting communication renders prostitutes unable to “screen” potential clients, hire security or move behind the relative safety of closed doors.

I supposed that somewhere in Canada there is someone who thought Morris’ argument was the killer line, and whose faith in justice would have been shaken if the lawyers had not dutifully plodded through it and its obvious refutation … but it horrifies me to learn I’m paying for the Crown to spout such nonsense, and for the court reporter to write it down, and for courtroom rental while the argument is made, and for the judge to listen to it and note it in her ruling… That’s what’s wrong with the justice system: its being smothered in trivia. Used to be that a murder trial took two days – now it might take two years and I’m not convinced the justice dispensed is commensuraly more just.

The Canadian preferred share market slid again today, with PerpetualDiscounts losing 17bp and FixedResets down 31bp – the median wieghted average yield to worst on the latter index is back up to 3.09%.

Nothing has happened since Friday.

Oh, well, I might as well mention Universal Travel Group, a story brought to my attention by the Divestor. It was savaged by John Hempton of Bronte Capital in a September 15 post … Mr. Hempton makes some very interesting points, which should be trivially easy to refute by a clean company:

It is pretty clear from this analysis that the main reason for owning the stock of Universal Travel Group is dubious. The online booking engine is dysfunctional – and the massive margins that it claims (84 percent for plane tickets) are thus also dubious.

All the profits that the company claimed it made out of the travel booking business (by far the bulk of its claimed profits) are similarly dubious – though there is a real travel company which might be making some profits.

The company claims in its most recent quarterly balance sheet to be carrying 43 million in cash and accounts receivable of almost 20 million. If the airline and hotel business are dubious then the profits generated that cash are dubious. In that case the cash itself is dubious.

I know people will buy this as Ben Graham net-net stock if it collapses. Unless this company can get a big four audit firm to sign-off for them I think you can – at least for the moment question the entire balance sheet.

What makes it interesting is the weakness of the response. On the day the blog post appeared, they issued a press release:

Universal Travel Group (NYSE: UTA) (“Universal Travel Group” or the “Company”), a leading travel services provider in China, today responded to allegations that appeared in the online blog by Bronte Capital. Universal Travel categorically denies all the allegations contained in the blog. The Company is consulting with its legal counsel as to the legal options available to it and will be aggressively pursuing all legal remedies against Bronte Capital and John Hempton for the damages caused to the Company and its shareholders.

“Categorically denies all the allegations”, eh? Very nice. Where’s the detail? Maybe there will be something in the conference call:

Universal Travel Group (NYSE: UTA) (“Universal Travel Group” or the “Company”), a leading travel services provider in China, today announced that it will hold a conference call at 9:00 a.m. ET on Wednesday, September 29, 2010, to discuss and answer any questions investors may have regarding the Company’s business and financial statements.
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To participate in the call, please dial (877) 779-7834 five minutes prior to the 9:00 a.m. start time and reference conference ID number 12534724. International callers should dial +1 (706) 902-2087.

A replay of the call will be available for 14 days beginning Wednesday, September 29, 2010, at 10:00 a.m. Eastern Time. To listen to the replay, dial (800) 642-1687 and enter the conference ID number 12534724. International callers should dial +1 (706) 645-9291. An audio recording will also be available on the Company’s website at http://us.cnutg.com .
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The Company’s headquarters and main base of operations is in Shenzhen in the Pearl River Delta region of China. More recently, Universal Travel Group has expanded its business into Western China, opening a second home base in the Chongqing Delta region, and other attractive, under-penetrated tier-two travel markets throughout the country.

C”mon, now! Shenzhen is not exactly the end of the earth any more. It’s basically next door to Hong Kong. And they couldn’t even get one western business reporter to walk around their headquarters and meet some of their “more than 200 professional staff”? Even Enron managed a better Potemkin village than that!

What gets me, though, is the complete lack of analysis I’ve been able to find. It has been over a week since the post appeared – and the stock took a big hit – but representative analysis is:

Universal Travel (NYSE: UTA): This is the latest casualty of a short attack based on rumor in innuendo this week. The free fall was precipitated by a professional short seller- John Hempton of Bronte Capital wrote a scathing “expose” wherein he demonstrated the company’s web sites didn’t provide him with Western style online travel services. He concluded the company is nothing but a phone in travel service, and claimed their numbers must be fraudulent based on their labor overhead vs their revenues. Conveniently, Hempton is located in Australia, and therefore enjoys a level of insulation from both civil law suit and SEC investigation.

There’s a few more examples of companies falling victim to either their own self induced foibles or fabricated attacks from those standing to gain. It’s the perfect storm for the short sellers to have their way with the public- the market environment is one in which investors will sell first to preserve capital, and find out the truth later. This group of short sellers is extremely well organized and knows how to work the media to their benefit.

Not a single point is addressed other than the condescending (and puzzling, considering their bias) sneer that we can’t judge Chinese web design by western standards. Just an ad hominem attack on short-sellers and vagueness.

I take no view on this stock. Before I took a view I would get my guy in Hong Kong to go across the border for an afternoon and knock on their door, among many other things. But the weakness of the management response is … interesting.

Wonder of wonders, the Canadian preferred share market actually fell today, with PerpetualDiscounts down 18bp and FixedResets losing 27bp – taking the median weighted-average yield of the latter back up to 3.00%. Volume continued to be heavy.

I speculated in the post Alpha Trading Systems to Offer Dark Pegged Orders:

I do not profess to be an expert on ATS marketting practices, but this appears to be an attempt by Alpha Group to forestall the creation of internal dark pools by its members (or pool the cost of such systems; Alpha is owned by the major dealers) by offering a sub-pennying mechanism in a manner that is smoothly integrated with extant trading systems.

The Alpha / TMX competition has now attracted some press notice and I am pleased to see that CIBC agrees:

We believe that, as described, the facility will operate more as a third party internalization engine rather than a proper dark pool, and do not have any concerns around this. We believe that the internalization activity enabled by this facility is common practice today, and that Alpha is simply commoditizing technology to offer dealers an alternative to building and operating their own costly internalization systems.

The TMX opposes sub-pennying:

To reiterate our position as outlined in TMX Group’s submission in response to CSA Consultation Paper 23-404, we believe that any dark trading, including internalizing features and practices, whether through a marketplace such as Alpha’s proposed facility, or through a dealer’s own systems, must provide meaningful price improvement over the displayed national best bid or offer (NBBO). It is critical that regulation encourages and supports the continued integrity and value of the visible market and price formation process by providing an incentive for the public display of liquidity. This requires internalized and non-displayed trading to provide meaningful price improvement over the displayed NBBO. Sub-penny price improvement is not adequate improvement to justify the yielding of priority of a previously posted visible quote. A minimum full cent price improvement is meaningful and should be required and enforced by regulators.

Other comments have been published.

Global hysteria over derivatives may engulf European property funds:

Europe’s commercial real estate owners, saddled with 1.9 trillion euros ($2.5 trillion) of debt, may be forced to make billions of euros in cash payments under planned laws that would treat them like hedge funds.

Property fund managers could face demands for cash collateral to cover bets on interest-rate movements, under European Commission proposals to regulate the derivatives industry. Interest-rate swaps were attached to about 130 billion pounds ($204 billion) of U.K. real estate debt at the end of 2009, according to a De Montfort University study. Most would be subject to such a payment.
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Real-estate buyers use swaps to secure a fixed interest rate when taking out a floating-rate loan to buy a building. That helps ensure that the property’s rental income will be enough to service the loan, even if rates rise unexpectedly. Under the EU plan, a demand for payment, or margin call, could result if rates go the opposite way than the swap anticipates. Businesses unable to pay could be declared to be in default.
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If the proposed regulations had been in place, U.K. borrowers would have needed to put up collateral of about 10 billion pounds to cover swaps that moved the wrong way, William Newsom, head of valuation at Savills Plc, estimated in June.

Now, all by itself, this isn’t a big deal. What will hapen is that the investment companies will take out a credit line at the same time as entering the swap; any demands for collateralization of the swap will be met by drawing down the credit facility. But it’s just another piece of regulatory garbage – lots of extra paperwork for zero net benefit.

There’s an amusing complication in the US adoption of Basel 3:

A 24-line section of the 848-page Dodd-Frank Act is delaying U.S. implementation of international rules for how much capital banks need to hold against securitized assets.

The financial-overhaul legislation, signed by President Barack Obama in July, requires regulators to remove all references to credit ratings of securities from their rules. Revised standards on how much capital banks need to hold against such assets in their trading books, approved by the Basel Committee on Banking Supervision in 2009, rely on such ratings.
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Current Basel trading-book rules treat all top-rated bonds the same, allowing banks to hold as little capital against AAA rated mortgage-backed securities as they do against Treasuries. The trading book is a subset of the balance sheet where banks park assets they intend to trade in markets, as opposed to the banking book where assets are meant to be held until maturity or at least for a longer period.

The new rules require higher capital charges for securitized bonds than for corporate or sovereign debt, bringing the trading-book standards in line with the banking book. Ratings scales of outside firms are used to calculate how much capital is required for different securities. The change will increase banks’ capital charges by as much as 4 percentage points, according to a Basel study.

It’s kind of nuts to use credit ratings with no qualifications. It was CDOs that sank the investment banks; say, f’rinstance, you have 10 “normal” securitizations. Each one has a senior tranche of $80-million rated AAA, and junior tranche of $15-million rated BBB, and an equity tranche of $5-million, unrated. You put together a CDO comprised of all the junior tranches, $150-million, and divide that up into a senior tranche of $115-million, rated AAA, a junior tranche of $15-million, rated BBB, and an equity tranche, unrated.

Now, the senior tranche may well be legitimately AAA, in that it has a 0.1% chance of defaulting. But if economic conditions change, you’ve got exposure to the fastest defaulting mortgages in a $1-billion pool (of the original mortgages). The rating is much more volatile, and loss given default is much more severe. See Hull & White on AAA Tranches of Subprime for more discussion.

The moral of the story is: You cannot describe any security, particularly not highly structured securities, with a single number. Credit risk is a vector quantity, not a scalar, no matter how much easier assuming the latter makes life for banks and their regulators

Even credit unions are being consumed by the commercial real estate vortex:

Credit unions in the U.S. may absorb as much as $9.2 billion in losses over the next decade as the industry strives to recover from sour investments in real estate and consumer loans, U.S. regulators said today.

Part of the plan to resolve the credit unions’ financial problems includes the National Credit Union Administration packaging $50 billion in distressed securities for sale as $35 billion in bonds carrying government guarantees, the agency said today. The debt will be backed primarily by bonds tied to home loans, with the first sale scheduled for next month.

The NCUA already sold more liquid securities from two credit unions that failed last year: U.S. Central Federal Credit Union in Lenexa, Kansas and Western Corporate Federal Credit Union in San Dimas, California. The administration said today that it assumed control of Members United Corporate Federal Credit Union of Warrenville, Illinois; Southwest Corporate Federal Credit Union of Plano, Texas; and Constitution Corporate Federal Credit Union of Wallingford, Connecticut.

There was continued heavy volume in the Canadian preferred share market today as the two major classes took divergent paths: PerpetualDiscounts gained 9bp while FixedResets were down 8bp.

I’m not the only one who thinks that the SEC’s extortion of $550-million from Goldman was conveniently timed:

Republican lawmakers asked SEC Inspector General H. David Kotz earlier this year to investigate how the SEC decided to file its April suit against Goldman, which settled the case in July for $550 million. The federal lawsuit alleged wrongdoing in a sale of mortgage securities called Abacus 2007 AC-1, and was filed as Senate Democrats were taking up the financial-regulation bill.

On the same day, the SEC released a scathing report by Mr. Kotz that concluded the agency had repeatedly missed chances to detect an alleged $7 billion fraud run by R. Allen Stanford, a money manager indicted by a federal grand jury last year. Mr. Stanford denies wrongdoing.

At a Senate Banking Committee hearing Wednesday, Mr. Kotz was questioned about the timing of the Goldman suit. He responded: “It would strain credulity to think it was coincidental.” He added: “I can’t give you a conclusion right now, but it was suspicious.”

Fabulous Fab is still in danger of losing his career over that thing … but that’s OK. He’s just a salesmen, while the SEC decision makers are heroic and selfless defenders of truth, beauty and small furry animals.

The boo-hoo-hoo brigade is practicing for contingent capital conversions:

Leona Miller, an 84-year-old retired beautician, says she was seeking safe and steady income from bonds two years ago when her Wachovia Corp. broker recommended she buy securities paying 9 percent interest.

Within six months, Miller had lost about 30 percent of her $20,000 investment and the bonds were converted into shares of Merck & Co. in a falling stock market. The San Diego resident, who still doesn’t understand what happened to her money, had purchased bonds known as structured notes that include built-in derivatives.

Sales to Miller and thousands of other individuals have driven structured note offerings up 58 percent to $31.9 billion through August, according to data compiled by Bloomberg. With U.S. interest rates near zero percent, investors are snapping up bonds such as reverse-convertible notes with knock-in put options or Leveraged CMS Curve and S&P 500 Index Linked Callable Notes, some with face values of as little as $10.

As everybody knows:

Breeden Capital Management manages a long-only equity investment fund utilizing active engagement to help undervalued, and often underperforming, portfolio companies improve performance and shareholder value.

Most people, however, are not aware that a lifetime in regulation equips one to have a keen – almost uncanny – knack for securities valuation:

Mr. Breeden has served since 2005 as Chairman and Chief Executive Officer of Breeden Capital Management LLC, the manager of a series of affiliated investment funds. He has also served since 1996 as Chairman of Richard C. Breeden & Co., LLC, a professional services firm specializing in strategic consulting, financial restructuring and corporate governance advisory services. Mr. Breeden graduated from Stanford University in 1972, and the Harvard Law School in 1975. After practicing law in the field of corporate financial transactions, Mr. Breeden worked in several senior government positions in the Administrations of Presidents Ronald W. Reagan, George H.W. Bush (41) and William Clinton. In 1989, Mr. Breeden served as Assistant to the President, and in that capacity he led successful efforts to develop a restructuring program for the U.S. savings and loan industry. From 1989-1993 Mr. Breeden served as Chairman of the U.S. Securities and Exchange Commission, after nomination by President Bush and unanimous confirmation by the U.S. Senate.

Sadly, there are some who still don’t get it:

The Employee Retirement System board of trustees voted via e-mail May 25 to terminate Greenwich, Connecticut-based Breeden Capital Management, according to information obtained from the city comptroller’s office under a public records request by Bloomberg News.
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As of June 30, the value of the city’s $136.5 million investment was $133.3 million. That was 2.3 percent less than what it gave Breeden since October 2008. The Standard & Poor’s 500 Stock Index lost 2.5 percent in the period.

The pension fund has paid the firm $6.2 million in fees, according to the comptroller’s records.

That’s over 2.00% p.a. Nice work if you can get it!

But all the schmoozing pays off:

Breeden also manages money for the California Public Employees’ Retirement System, or Calpers, and Maryland’s State Retirement and Pension System. The so-called activist investor buys stock in publicly traded companies and then presses for management changes to boost share prices.
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Since investing with Breeden in September 2007, Maryland has lost 12.8 percent compared with a 7.45 percent decline for the S&P 500, according to state pension records. The value of Maryland’s investment with Breeden was $134.1 million as of July 31.

Calpers has lost 4.5 percent investing with Breeden’s U.S. fund since June 2006, according to investment records for the quarter ending June 30. The market value of California’s investment in Breeden’s U.S. fund was $347.9 million.

The Boston Fed has released a working paper by José L. Fillat and Stefania Garetto titled Risk, Returns, and Multinational Production:

This paper starts by unveiling a new empirical regularity: multinational corporations systematically tend to exhibit higher stock market returns and earnings yields than non-multinational firms. Within non-multinationals, exporters tend to exhibit higher earnings yields and returns than firms selling only in their domestic market. To explain this pattern, we develop a real option value model where firms are heterogeneous in productivity, and have to decide whether and how to sell in a foreign market where demand is risky. Firms can serve the foreign market through trade or foreign direct investment,
thus becoming multinationals. Multinational firms are more exposed to risk: following a negative shock, they are reluctant to exit the foreign market because they would forgo the sunk cost that they paid to start investing abroad. We calibrate the model to match U.S. export and FDI dynamics, and use it to explain cross-sectional differences in earnings yields and returns.

DBRS has released its Methodology: Rating Sovereign Governments. It’s a little shy on specifics and examples to be of much interest.

The Canadian preferred share market continued its advance on continued heavy volume today, with PerpetualDiscounts up 12bp while FixedResets gained 4bp.

Lord Adair Turner, of Turner Report fame, has some things to say about bank regulation:

“If we were philosopher kings designing a banking system entirely anew for a greenfield economy, should we have set still higher capital ratios than in the Basel III regime? Yes I believe we should,” the Financial Services Authority’s Adair Turner told bankers at the Mansion House dinner in London’s financial district. “But starting from where we actually are, the Basel III reforms will significantly improve the resilience of our banking systems.”
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Turner said inadequate regulation was more to blame for the near collapse of the banking system than excessive leverage and bonuses.
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“We do need appropriate regulation of bonuses to reduce incentives for excessive risk taking,” Turner said. “We also need to move beyond the demonization of overpaid traders and their unnecessary CDO-squareds.”

The CBOE is attempting to resurrect Credit Default Options:

CBOE Holdings Inc. is seeking to resurrect credit-default options, or contracts that pay off when companies fail to repay their debt, as regulators try to shift some trading of over-the-counter derivatives onto exchanges.

The owner of the largest U.S. options exchange first created the derivatives in 2007. Trading volume amounted to 56 contracts in 2007 and 2008, and none changed hands last year, CBOE said. To generate interest, the settlement price for contracts would be less than the $100,000 value on the original options, according to a proposal filed with the U.S. Securities and Exchange Commission.

CBOE is trying to win business from the $29.6 trillion credit-default swap market, where contracts are traded over the counter. Among changes mandated by the Dodd-Frank Act, signed into law in July, are requirements that standardized interest- rate, credit-default and other swaps be processed by clearinghouses and traded on exchanges or similar systems.

We don’t have to worry about another bank crisis, because the Basel Committee did a great job! We know that, because they say so themselves:

The new rules are “extremely demanding” and “radically transform the regulatory capital framework,” Nout Wellink, chairman of the Basel Committee on Banking Supervision and president of the Bank of the Netherlands, said at a meeting in Singapore of officials who regulate the financial industry.

“If, prior to the crisis, banks had the levels of capital we are asking for, we likely would not have experienced such a deep crisis,” Mr. Wellink said, according to the text of his speech.

I continue to believe that the problem is not so much with capital, the numerator of the Pillar 1 ratios, but with the denominator – mainly risk-weighted assets. But those fixes would be harder to explain politically.

Daniel K Tarullo, Member of the Board of Governors of the Federal Reserve System, gave a speech at the Brookings Panel on Economic Activity, Washington DC, 17 September 2010. In contrast to my complaint about the Bail Outs and Financial Fragility paper, he draws a clear distinction between “illiquid” and “insolvent”:

But when the value of whole classes of the underlying collateral was drawn into serious question, initially by the collapse of the subprime housing market, participants’ lack of information about the collateral they held led to a shattering of confidence in all the collateral.

In the absence of the regulation and government backstop that have applied to the traditional banking system since the Depression, a run on assets in the entire repo market ensued. The resulting forced sale of assets into an illiquid market turned many illiquid institutions into insolvent ones. The fallout has been such that, to this day, the amount of repo funding available for non-agency, mortgage-backed securities, commercial mortgage-backed securities, high-yield corporate bonds, and other instruments backed by assets with any degree of risk remains substantially below its pre-Lehman levels.

He’s concerned about the potential for crowding out of the banks:

Where competition from unregulated entities is permitted, explicitly or de facto, capital and other requirements imposed on regulated firms may shrink margins enough to make them unattractive to investors. The result, as we have seen in the past, will be some combination of regulatory arbitrage, assumption of higher risk in permitted activities, and exit from the industry. Each of these outcomes at least potentially undermines the original motivation for the regulation.

Government apologist and sycophant Mark Carney gave a variation of the standard precious handwringing speech about productivity last March:

There are two imperatives–one domestic, one international–to secure strong, sustainable, and balanced economic growth for Canada. Both recall Aesop’s fable of the ant and the grasshopper, the moral of which can be best summed up as “idleness brings want.” In short, in a wicked world, Canada needs productive virtue.

I filled in yet another government form today – which took time away from programming – and found out that the super-cool fillable form was encrypted: which meant I could not save the completed version electronically or print it to a PDF. Instead I have to print it onto paper, fax it to the recipient, fax it to myself and (since I try to be productive and receive my faxes electronically) save the fax, then dispose of the idiotic and unnecessary paper.

Do you want to know the first step to productivity, Mr. Carney? How about morons on the government payroll thinking about what they’re doing?

The Globe’s in a tizzy about the potential cost of dementia care, but I don’t know what they’re worried about. Here’s the plan:

• Hire the cheapest caregivers (nurses, health aides) you possibly can
• Then cut their pay even more (make sure they’re all part-timers!)
• Give them more beds to look after than even the most competent practitioner could handle
• Keep the patients drugged up so they’re less work (make sure the doctor knows which side his bread’s buttered on!)
• Have a huge number of extremely detailed rules about patient care, endorsed by big-name practitioners
• Talk about the rules incessantly.
• Ensure all employees sign a statement that they have read, understood and will comply with all rules.
• Ignore the rules (ridiculous even to try, given patient load, staff and facilities)
• Every now and then, hang some poor sucker of a nurse who gave standard treatment to the wrong person. Wring your hands. Talk about the rules

I’m not saying it’s a good plan, but we all know that that’s what will happen eventually so why not start getting used to it now?

How ’bout that Canadian preferred share market, eh? It continues to move from strength to strength, with PerpetualDiscounts gaining 21bp today while FixedResets managed to eke out a 1bp win. Volume was very heavy. Nesbitt wrote some very nice tickets today, but that’s not necessarily the same thing as making good money. It depends on what kind of crosses they were.

PerpetualDiscounts now yield 5.54%, equivalent to 7.76% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.3% so the pre-tax interest-equivalent spread (also called the Seniority Spread) now stands at about 245bp, a continued tightening from the 255bp reported September 15

Ireland looks like it’s heading for the debt trap:

Ireland will today try to sell as much as 1.5 billion euros ($1.96 billion) in bonds as the government tries to convince investors the country can avoid a European Union bailout.

One day after the premium on Irish 10-year debt over German equivalents rose to a record, the Dublin-based National Treasury Management Agency is offering between 1 billion euros and 1.5 billion euros of four- and eight-year bonds. The auction results will be announced after 10 a.m.

Investors’ concerns about the fiscal health of some euro nations are resurfacing four months after the EU announced an almost $1 trillion rescue package to stamp out contagion from Greece’s fiscal crisis. The spread on Irish debt over bunds yesterday exceeded 400 basis points as the government struggles to cap the cost of bailing out its banking system. In Portugal, the spread climbed as high as 399 basis points.

The Bank Act review cycle has started again:

The Honourable Jim Flaherty, Minister of Finance, today launched the scheduled review of legislation governing federally regulated financial institutions.

“The Government reviews the statutes that govern federally regulated financial institutions every five years to ensure Canada remains a global leader in financial services,” said Minister Flaherty. “This practice sets Canada apart from almost every other country in the world.”
…
“Some fine-tuning to the system may be required, but wholesale change is not necessary,” he said. “The Government would like to hear the views of all Canadians on how to improve our financial system.”

My wish-list includes greater clarity on the status of Bankers’ Acceptances in bankruptcy (are they covered bonds? Can investors look through the bank guarantee to the actual issuer of the paper?) and a requirement that the seniority of instruments within the “general” bucket be specified … if I own a BDN, is that more or less senior than a BA?

The FOMC Statement was gloomy:

Information received since the Federal Open Market Committee met in August indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak. Employers remain reluctant to add to payrolls. Housing starts are at a depressed level. Bank lending has continued to contract, but at a reduced rate in recent months. The Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be modest in the near term.

and accordingly:

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period. The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings.

This had an effect:

Gold rose to a record, Treasury two-year yields slid to an all-time low while the dollar weakened as the Federal Reserve said it’s willing to ease monetary policy further if needed to boost the economy. Most U.S. stocks fell.

Gold futures surged as much as 0.9 percent to $1,292.40 an ounce as of 4 p.m. in New York as the dollar depreciated against 15 of 16 major counterparts. The 10-year Treasury yield lost 13 basis points to 2.58 percent and the 2-year yield slid to a record low of 0.4155 percent.

Quadravest, purveyor of SplitShare funds, has announced:

Dividend Select 15 Corp. (“The Company”) is pleased to announce the filing of a preliminary prospectus dated September 17, 2010 for a proposed new offering of equity shares at $10.00 per share.
The Company has been created to provide investors with an opportunity to invest in a portfolio (the “Portfolio”) of 15 high quality Canadian companies (the “Portfolio Companies”) whose shares provide an attractive dividend yield, and which have shown solid earnings growth and have a history of capital appreciation. The Company will employ a covered call writing strategy to generate additional income to the Portfolio. The 15 Portfolio Companies will be selected from among the following 20 companies listed on the Toronto Stock Exchange: [Usual suspects – JH]

Interestingly, the prospectus makes the flat statement:

The Company will not borrow money or use leverage as part of its investment strategies.

In accordance with the usual state of affairs, the prospectus fully discloses the investment managers’ experience, but is completely silent regarding the investment managers’ performance.

The Canadian preferred share market continued to move from strength to strength on heavy volume today, with PerpetualDiscounts up 27bp and FixedResets gaining 18bp.