Category: Market Action

The Bank of Canada has released a working paper by David Dupuis and Yi Zheng titled A Model of Housing Stock for Canada:

Using an error-correction model (ECM) framework, the authors attempt to quantify the degree of disequilibrium in Canadian housing stock over the period 1961–2008 for the national aggregate and over 1981–2008 for the provinces. They find that, based on quarterly data, the level of housing stock in the long run is associated with population, real per capita disposable income, and real house prices. Population growth (net migration, particularly for the western provinces) is also an important determinant of the short-run dynamics of housing stock, after controlling for serial correlation in the dependent variable. Real mortgage rates, consumer confidence, and a number of other variables identified in the literature are found to play a small role in the short run. The authors’ model suggests that the Canadian housing stock was 2 per cent above its equilibrium level at the end of 2008. There was likely overbuilding, to varying degrees, in Saskatchewan, New Brunswick, British Columbia, Ontario, and Quebec.

The Bank of Canada also released the July 2010 Monetary Policy Report – good solid stuff, but nothing particularly noteworthy or interesting.

Volume was down a bit in the Canadian preferred share market, but still good, as PerpetualDiscounts came in with another solid gain of 15bp, while FixedResets gained 4bp, taking the yield on the latter class below 3.50%. This is the 12th-lowest yield on record for this index.

Nothing happened today. How dull.

Continued good volume in the Canadian preferred share market, a PerpetualDiscounts squeaked out a win of 1bp, while FixedResets were up 9bp, edging their median weighted average yield a little closer to 3.50%.

PerpetualDiscounts now yield 5.90%, equivalent to 8.26% interest at the standard equivalency factor of 1.4x. Long corporates now yield 5.6%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 265bp, a significant tightening from the 280bp reported on July 14.

Fabulous Fabio is fighting the SEC fraud charges:

Fabrice Tourre, the Goldman Sachs Group Inc. executive director sued by the Securities and Exchange Commission for fraud, disputed the claims and said he relied on his firm’s legal and compliance department.
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The firm is cooperating in the SEC’s investigation of Tourre, 31, who remains an employee. He is on leave, with legal expenses being paid by New York-based Goldman Sachs.

“The purported claims against Mr. Tourre and the allegations upon which they are based are improperly vague, ambiguous and confusing, and omit critical facts,” the filing said. “Mr. Tourre, a French citizen and engineer by training, reasonably relied on Goldman Sachs’ institutional process to ensure adequate legal review and disclosure of material information, and cannot be held liable for any alleged failings of that process.”In the filing, Tourre said he was aware that Paulson “was considering taking some or all of the short side” of the transaction. He added that the offering document for the CDO contained all relevant information for investors, including the complete portfolio of assets, the fact that no one was purchasing the equity portion of the deal and that a Goldman Sachs affiliate had a short interest and could transfer that interest.

“The portion of the offering document prepared by ACA and for which ACA assumed sole responsibility states that ACA will ‘select the Initial Reference Portfolio,’” the filing said.
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Senator Tom Coburn, a Republican from Oklahoma who serves on the Permanent Subcommittee on Investigations, repeatedly questioned Tourre and other Goldman Sachs executives on why the firm decided to release Tourre’s e-mails, including some that seemed unrelated to the hearing.

“If I worked for Goldman Sachs, I’d be real worried that somebody has made a decision, ‘he’s going to be a whipping boy, he’s the guy that’s getting hung out to dry,’” Coburn told Blankfein during the hearing.

So there’s nothing too surprising in all this, other than the fact that a politician made an intelligent comment in the final paragraph.

It is of interest that Goldman is continuing to pay Tourre’s legal expenses. It is quite common for regulators to claim that paying legal expenses for an employee constitutes lack of cooperation, therefore leaving the fall guy facing hundreds of government lawyers on the government payroll all by himself. Lucky for Tourre, that doesn’t yet appear to be the case in this instance.

I am glad that somebody (namely, Tourre) has finally brought to light the startling news that Goldman has a legal and a compliance department who were involved in the issue. Am I the only other person in the entire world who has wondered why, if Goldman-the-firm did such a Very Bad Thing, that only one single employee has been charged? Am I the only other person in the entire world who has noticed the total lack of SEC interest in going after all the people who signed off on the deal?

It’s a farce, a ridiculous farce, just another piece of regulatory extortion and political theatre. The fact that one guy who did a good job is at jeopardy of losing his reputation and entire career in the process doesn’t bother the apparatchiks at the SEC.

A day of mixed results on good volume for the Canadian preferred share market, with PerpetualDiscounts gaining 15bp and FixedResets down 7bp.

BIS has released a Countercyclical capital buffer proposal:

The countercyclical capital buffer will work by giving each jurisdiction the ability to use their judgement to extend the size of the minimum buffer range established by the capital conservation buffer.
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Under this proposal, buffer add-on decisions would be preannounced by 12 months to give banks time to meet the additional capital requirements before they take effect, while reductions in the buffer would take effect immediately to help to reduce the risk of the supply of credit being constrained by regulatory capital requirements.
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A buffer range is established above the regulatory minimum Tier 1 capital requirement and capital distribution constraints will be imposed on the bank when capital levels fall within this range. The constraints imposed only relate to distributions, not the fundamental operations of the bank.

The distribution constraints imposed on banks when their capital levels fall into the range increase as the banks’ capital levels approach the minimum requirement. By design, the constraints imposed on banks with capital levels at the top of the range would be minimal. This reflects an expectation that banks’ capital levels will from time to time fall into this range. The Basel Committee does not wish to impose constraints for entering the range that would be so restrictive as to result in the range being viewed as establishing a new minimum capital requirement.

The table below illustrates how it is proposed that the capital conservation buffer operates using discrete bands. The numbers in the table are illustrative as the proposal still needs to be calibrated. Using the table as an example, the buffer range is divided into quartiles. If a bank suffers losses such that its capital level falls into the second quartile above the minimum requirement then the bank would be required to conserve 80% of its earnings in the subsequent financial year9 (ie payout no more than 20% in terms of dividends, share buybacks and discretionary bonus payments). If the bank wants to make payments in excess of the constraints imposed by this regime, it would have the option of raising capital in the private sector equal to the amount above the constraint which they wish to distribute. This would be discussed with the bank’s supervisor as part of the capital planning process.

Perhaps stung by IMF criticism of the pace of reforms, BIS has released a statement of progress highlighting their consultation paper on countercyclical buffers discussed above and inchoate proposals for contingent capital:

The Committee also reviewed proposals for the role of “gone concern” contingent capital in the regulatory capital framework and will issue shortly a proposal for consultation. It continues to assess proposals on contingent capital from a “going concern” perspective.

Themis Trading reports that internet gamers take their avocation more seriously than the average investment manager takes their fiduciary duty … and opines that this is a good thing:

Today we just got a call from a firm that sells specialized computing hardware for the online gaming industry. Apparently there are folks who play Call of Duty version XYZ, or whatever game, professionally for money, and these guys need faster speed. Anyways, this firm sells computer servers that are sitting in liquid, so that they are cooler, and can be faster. The gaming professionals buy these servers for this reason. This firm bragged to us that they just sold their server to a High Frequency Trading firm for the first time, and thought we might want one too.

Is this what are markets have come to?
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Are the capital markets really about making sure that these guys can turn the markets into a giant arms race, where everyone has to pay up for liquid-submersible computers and co-location rents just so that they can get fair access to the same bids and offers?

Moody’s cut Ireland a notch to Aa2.

The EU Stwess Tests will be published on June 23.

There was good volume on the Canadian preferred share market today, as PerpetualDiscounts gained 11bp and FixedResets lost 3bp.

The penny just dropped on US Financial Reform:

Bank of America Corp. led financial stocks lower after saying U.S. curbs on debit-card fees may trigger a $10 billion charge, spurring speculation that rival banks have underestimated their own costs.
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The slide began after Bank of America said rules in the financial industry overhaul, including the Durbin amendment’s curbs on debit-card fees, may prompt the charge and trim annual revenue by $2.3 billion, more than some of the most pessimistic estimates. JPMorgan Chase & Co., ranked second by assets in the U.S., dropped as much as 3.6 percent.
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Moody’s Investors Service said in June that Bank of America, Wells Fargo and JPMorgan, the three biggest U.S. debit-card issuers, may face $1.38 billion in annual lost revenue from the proposed cap on “swipe” fees. DBRS Inc., the Toronto-based ratings firm had said the impact just for Bank of America could be $1.9 billion.

Bank of America’s debit-card revenue could shrink by $1.8 billion to $2.3 billion starting in the third quarter of next year because of restrictions on fees merchants can charge for each swipe of a debit card, Chief Executive Brian Moynihan said in a presentation today.
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The bank also expects a goodwill charge of $7 billion to $10 billion in the third quarter tied to the value of the business after President Barack Obama signs the regulatory reform law approved by Congress this week, Chief Financial Officer Charles Noski said on a conference call.

Note that it looks like the Credit Rating Agencies got it wrong! It must be because they’re corrupt! They’re paid by the issuers, you know! Quick, make them a public utility, so they can be run as efficiently as the Toronto Transit Commission!

Speaking of the CRAs, DBRS has announced a GREAT LEAP FORWARD!!!

The International Organization of Securities Commissions (IOSCO) Code of Conduct Fundamentals for CRAs (IOSCO Code) requires that SF ratings be differentiated from corporate bond ratings, preferably through a different rating symbology.*
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Currently, DBRS press releases specify the type of rating being published, such as whether it is an SF rating, a Financial Institutions rating or a Public Finance rating (the PR Notation). Effective August 16, 2010, the PR Notation on all DBRS press releases will no longer be used.

For its SF modifier, DBRS will use the symbol “(sf)” next to the rating category for ratings that meet the requested criteria in its public press releases and rating reports. The “(sf)” symbol will only indicate that the security is an SF instrument and will not change the meaning or definition of the rating in any other way nor will it change the risk of any particular SF instrument. DBRS’s expectation of the performance of each rated SF instrument is not adjusted in any way by the SF modifier.

Isn’t that convenient? Investors will no longer have to read the prospectus to discover deeply hidden facts like such-and-such is a structured investment, it will be right there in the rating! No need for any thought at all! Thank you, IOSCO!

Another strong day on high volume for the Canadian preferred share market, with PerpetualDiscounts up 24bp and FixedResets up 16bp, taking the median weighted average Yield-to-Worst of the latter class down to 3.57%. The all-time low yield for that index is 3.31% on March 26.

Bernanke announced that his boss is doing a great job. The American Bankers’ Association isn’t so sure:

The American Bankers Association is very disappointed with the regulatory reform bill that is now headed for enactment. While its core provisions provide needed reform, it is overloaded with new rules and restrictions on traditional banks that did not cause the financial crisis. The result will be over 5,000 pages of new regulations on traditional banks and years of uncertainty as to what the massive new rules will mean.

To my great disappointment, Goldman knuckled under to regulatory extortion:

The Securities and Exchange Commission today announced that Goldman, Sachs & Co. will pay $550 million and reform its business practices to settle SEC charges that Goldman misled investors in a subprime mortgage product just as the U.S. housing market was starting to collapse.

However, the SEC agrees that Goldman committed no actual wrongdoing:

Goldman agreed to settle the SEC’s charges without admitting or denying the allegations by consenting to the entry of a final judgment that provides for a permanent injunction from violations of the antifraud provisions of the Securities Act of 1933.

The SEC trumpets the Goldman statement:

Goldman acknowledges that the marketing materials for the ABACUS 2007-ACI transaction contained incomplete information. In particular, it was a mistake for the Goldman marketing materials to state that the reference portfolio was “selected by” ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the portfolio selection process and that Paulson’s economic interests were adverse to CDO investors. Goldman regrets that the marketing materials did not contain that disclosure.

I can see it’s time to take legal advice; perhaps my fund documents should include a disclosure to the effect that “Everything the fund owns was sold to it by somebody else.”. Perhaps that will help keep me out of trouble.

The rally in the Canadian preferred share market continued on heavy volume today, with PerpetualDiscounts up 24bp and FixedResets up 18bp.

Nothing happened today, either. Except …

Another day of heavy volume and positive returns in the Canadian preferred share market today, with PerpetualDiscounts gaining 34bp and FixedResets up 24bp … taking the Yield-to-Worst for the latter index down below 3.50%. Hallucination! – JH 7/15

PerpetualDiscounts now yield 5.92%, equivalent to 8.29% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.5%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 280bp, a nice little tightening from the 290bp reported on July 7.

Nothing happened today.

PerpetualDicounts were up 16bp and FixedResets gained 8bp on very heavy volume.

Regulators have discovered there’s one teeny-tiny problem with quality: it costs money:

A push to water down stringent standards proposed last year by the Basel Committee on Banking Supervision, and to allow more time to implement them, is led by France and Germany, according to bankers, regulators and lobbyists involved in the talks. Representatives from the U.S. and the U.K., who have sought to rein in risk-taking, are willing to compromise on how capital is defined to reach an agreement at a committee meeting that begins tomorrow, the people said.

Another concession may involve granting transition periods of up to 10 years to ease concerns of some member countries that their banks and economies won’t be able to bear the burden of tougher capital requirements until a recovery takes hold. As a result, the amount of capital European banks will be forced to raise in the next two years won’t be as much as investors fear.
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One part of the definition would exclude minority interests that banks hold in other financial institutions when calculating common equity on the theory that they can’t readily withdraw the capital. Many European lenders, which have lobbied against the rule, have non-controlling stakes in emerging-market banks that would no longer count as the highest level of capital, while the assets of the subsidiaries would have to be included in the banks’ risks.
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European banks are likely to win a concession on the minority-stakes rule, according to the people involved in the talks. One possible compromise would allow a bank to count part of its stake in relation to the risk the capital is supposed to cover at the entity in which it invested, the people say.
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A study released in June by the Institute of International Finance, which represents more than 375 financial companies, said the regulations could erase 3.1 percent of gross domestic product in the U.S., the euro region and Japan by 2015. About 9.7 million fewer jobs could be created over the five-year period than would otherwise be the case, the IIF said.

Regulation is “never free,” said Bank of New York Mellon Corp. Chief Executive Officer Robert Kelly, who visited London and Brussels in June to meet lawmakers and regulators with the Financial Services Roundtable, a Washington-based industry group. “There has to be some impact on growth and jobs.”

The Basel committee, whose members have touted the benefits of financial stability, is preparing its own economic impact study with the help of the Bank for International Settlements in Basel and the International Monetary Fund.
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Banks currently need to hold capital equal to a minimum of 8 percent of risk-weighted assets. Half of that must be Tier 1 and half of the Tier 1 needs to be common stock. The Basel committee might triple the common ratio requirement and double Tier 1, [Paul Miller, an analyst for FBR Capital Markets] estimates.
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BNY Mellon’s Kelly said the original Basel proposals would have forced some banks’ return on equity, a measure of profitability, to mid-single digits.

“If that was true, then they effectively become government utilities, because you couldn’t really raise capital in the private markets after that,” he said.

The IIF report is titled Interim Report on the Cumulative Impact on the Global Economy of Proposed Changes in the Banking Regulatory Framework and is available via a lengthy press release.

I will be most interested to see the promised regulatory response to that and will review the papers on PrefBlog when available … but I am ecstatic that this is being discussed. In Canada we – or OSFI and the politicians, anyway – are always touting the benefits of a very highly capitalized banking system, but never discuss the cost; and there is a cost. That’s a lot of capital tied up that could be invested in other things. I’m not saying I advocate lower capitalization … what I am advocating is an honest debate.

The Canadian experience is interesting … with banks, we obsess about stability and never discuss cost, whereas with electricity we obsess about cost and never discuss stability.

A good day on low volume for the Canadian preferred share market, with PerpetualDiscounts gaining 11bp and FixedResets up 15bp.

Naturally, the poster child for the financial crisis is the American homeowner, flim-flammed into buying a house and now being foreclosed. But see Subprime mortgages: Myths and reality for one take on this … and now it’s hitting the papers:

Whether it is their residence, a second home or a house bought as an investment, the rich have stopped paying the mortgage at a rate that greatly exceeds the rest of the population.

More than one in seven homeowners with loans in excess of a million dollars are seriously delinquent, according to data compiled for The New York Times by the real estate analytics firm CoreLogic.

By contrast, homeowners with less lavish housing are much more likely to keep writing checks to their lender. About one in 12 mortgages below the million-dollar mark is delinquent.

Though it is hard to prove, the CoreLogic data suggest that many of the well-to-do are purposely dumping their financially draining properties, just as they would any sour investment.

One of the big problems with the US system is that, typically, mortgages are extended without recourse. Instead of layering on extra rules, as I reported Fannie Mae did on June 23, simply charge a premium for non-recourse mortgages. Piece of cake, and one big source of problems eliminated.

Low volume today, but prices did OK, with PerpetualDiscounts up 7bp and FixedResets up 5bp.