Category: Market Action

European banks have a lot of refinancing to do:

Banks in Europe’s most indebted nations need to refinance $122 billion of bonds this year, likely paying high interest costs even after receiving a clean bill of health from regulators.

Italy’s Intesa Sanpaolo SpA has the most debt coming due at $28 billion, followed by UniCredit SpA with $21 billion, according to data compiled by Bloomberg. Italian banks must refinance a total $69 billion of bonds this year and $157 billion in 2011, while Spanish lenders have $28 billion and $73 billion of debt that needs to be paid.

Banks in so-called peripheral European countries from Greece to Ireland have been largely shut out of debt markets since April amid concern their governments will struggle to cut budget deficits.
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The extra yield investors demand to own European financial- company bonds has climbed 0.5 percentage point to 2.17 percentage points from a 29-month low on April 16, according to Bank of America Merrill Lynch’s EMU Financial Corporate Index.

Spanish bank spreads average 333 basis points, 62 percent wider than at the beginning of April. Portuguese lenders’ margins average 495 basis points, 85 percent wider, while Irish financial debt pays a 585 basis-point margin, 35 percent more. Italian bank spreads are 218 basis points, an increase of 34 percent compared with four months ago.

With many frozen out of the bond market, banks in the peripheral countries are relying on the European Central Bank for the bulk of their funding. Spanish lenders, which account for 10.5 percent of assets in the EU financial system, borrowed a record 126.3 billion euros from the Frankfurt-based ECB in June, the most recent Bank of Spain data show.

The Americans found out during the S&L Crisis that there is a vital difference between “illiquid” and “insolvent” banks, and that the Fed should not prop up the latter. Have the Europeans learnt the same lesson?

There are encouraging reports from Greece:

Prime Minister George Papandreou has raised taxes, cut wages and overhauled the state-run pension system, while braving months of strikes against the measures that helped shrink the budget gap by 45 percent in the first half. Sustaining the effort and qualifying for another 9 billion euros of EU-IMF funds will be complicated by a recession that has been deepened by his steps.
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For Papandreou, abiding by the EU-IMF recommendations may trigger further protests. Both institutions have said part of the inflation jump is from a lack of competitiveness that can be addressed in part by opening up professions deemed “closed,” such as trucking.

Truckers last week starved Greek gas stations of fuel as they opposed the government’s plan to issue the first new licenses since 1971. The strike was called off on Aug. 1 after the government commandeered trucks and said the drivers would be prosecuted. Papaconstantinou has pledged to push ahead with changes to open up professions ranging from pharmacists to architects.

“Closed professions will open,” he said in Parliament on July 28. “They will open because prices must fall. They will open because this will help the budget of each household and they will open because that is how the country’s growth will be helped.”

I’m not sure how far their deficit numbers can be trusted, but increased competition amongst previously closed shops has to be a good thing.

There is the possibility that US Banks are finally putting their excess reserves to work, buying Mortgage-Backeds:

Large U.S. commercial banks added $51.4 billion of so- called agency mortgage-backed securities in the two weeks ended July 21, according to the latest data released by the Federal Reserve. The holdings fell from $696.6 billion in the middle of 2009 to $687.2 billion on July 7 even as the lenders’ portfolios of Treasuries and agency corporate debt grew $104 billion.

Large banks, which now hold $736.8 billion of the securities, avoided the debt as the Fed’s $1.25 trillion of buying drove down yield premiums to record lows relative to 10- year Treasuries, and acquisitions by private investors then restrained spreads.
Fannie Mae’s current-coupon notes, or those trading closest to face value, yield 3.54 percent as of 12:37 p.m. in New York, according to data compiled by Bloomberg. That’s 0.64 percentage point more than 10-year Treasuries, up from a record low of 0.54 percentage point reached July 30, Bloomberg data show.

Checking accounts, among the means through which banks raise money that they can invest in securities, pay depositors 0.53 percent on average, according to Bankrate.com data. Rates on the accounts typically vary based in part on the Fed’s target rates. A rise in banks’ deposits, which Fed data show growing for large banks by $37 billion from April 21, has contributed to their desire to invest more in mortgage securities, [Barclays analyst Derek] Chen wrote.

Additionally, excess reserves are down by a preliminary $35-billion in the period June 2 – July 28. Who knows? Maybe this new-found interest in RMBS is a tiny step towards James Hamilton’s archetypal car loans.

The SEC’s Department of Making Prospectuses Longer has been working overtime:

U.S. regulators said mutual funds aren’t telling investors enough about why they use derivatives, with some funds providing “generic” disclosures and others failing to explain how the products affect performance.

Regulators said they are concerned that the use of derivatives has increased in the mutual-fund industry without shareholders comprehending the risks or investment strategies. Some funds offer information that “may not be consistent with the intent” of required registration forms, the Securities and Exchange Commission wrote in a July 30 letter to the Investment Company Institute, the industry’s biggest trade group.

The SEC also raised concerns about “abbreviated” disclosures that give investors a false sense of security about how much funds rely on derivatives.

Speaking of the SEC, former Countrywide CEO Mozila is fighting his battles in (gasp!) court:

“The undisputed evidence establishes, and the SEC now admits, that stockholders understood Countrywide’s underwriting guidelines expanded over time,” lawyers for Mozilo and the two other defendants said in the filing.

The SEC admitted in response to inquiries from the defendants’ lawyers that information about its riskier loans was reflected in the company’s stock price, according to Mozilo’s filing. Countrywide provided information about those loans in prospectus supplements for mortgage-backed securities sold in the secondary market, Mozilo said in the filing.

John McCoy, a lawyer for the SEC, didn’t immediately return a call seeking comment.

The SEC sued Mozilo in June 2009, saying he publicly reassured investors about the quality of Countrywide’s loans while he issued “dire” internal warnings and sold about $140 million of his own Countrywide shares. Mozilo wrote in an e-mail that Countrywide was “flying blind” and had “no way” to determine the risks of some adjustable-rate mortgages, according to the SEC complaint.

I don’t have a view on Mozilo’s guilt or innocence … but I have a view on the desirability of the SEC getting a black eye!

Interesting article about Somali piracy, but the world has become awfully wussy. Julius Caesar knew what to do about pirates; so did Thomas Jefferson.

Premier Dad has clearly identified “morons” as a crucial demographic for the next election with his ‘Zero-Brains’ policy on young drivers and alchohol. “Better enforcement tools for the police!” cheer the dimwits. “So much more efficient than the silly old court system!”. After all, police would never abuse their authority, would they? And they always tell the truth, right? So what do we need the courts for, anyway?

The Canadian preferred share market moved up today on light trade, as PerpetualDiscounts gained 2bp and FixedResets gained 16bp, taking the median weighted average yield to worst of the latter class all the way down to 3.44%. That’s the eighth lowest yielding close on record … can we push past the 3.31% mark, set March 26? Stay tuned! The Bozo Spread (Current Yield PerpetualDiscounts less Current Yield FixedResets) remains in its range at 51bp … which makes me laugh.

There was a very good essay (which means: “one that I agree with”) in The Economist of July 24 titled Too many laws, too many prisoners that included the information:

For bringing some prescription sleeping pills into prison, he was put in solitary confinement for 71 days. The prison was so crowded, however, that even in solitary he had two room-mates.

Comrade Peace Prize is touting the automaker bail-out (far more expensive than the banking bail-out, but probably cheaper than the Fannie/Freddie bail-out):

Heading into a congressional election season in which polls show the public skeptical about the $84.8 billion rescue and anxious about economy, Obama is using the backdrop of Detroit- area plants owned by GM and Chrysler to promote what he says is an industry revival that has saved more than a million jobs.
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“We are going to get all the money back that we invested in those car companies,” Obama said on ABC’s “The View” program.

For sure the money will be paid back! All GM needs is more subsidies:

The price tag? About $41,000. Luxury car prices for a car that is much more about what is under the hood than between the doors. Comfort and feature-wise, the volt is more like a Focus than a Lexus. For that kind of sticker-price you can get a BMW convertible, a Cadillac CTS or a number of well-known luxury cars. This creates a problem in making the desired electric vehicle commercially viable.

In order to compensate for the high cost and the desire to have a more ‘green’ economy, the Federal government implemented a $7,500 tax credit for electric vehicles, reducing the overall price of the Volt to $33,500. That’s right, much like the abomination that was the “Cash for Clunkers” program, our federal government is spending other people’s tax dollars to subsidize the purchase of cars by people who might otherwise choose to buy something else. By doing so they hope that the price tag will be more acceptable to potential buyers.

At least with Cash for Clunkers this taxpayer money was spread around the industry. In this case, however, the qualifying candidates for the program are narrow indeed, although it has provided a boon to the golf cart industry by allowing this subsidy to be given to purchasers of road-worthy golf carts, if equipped with side mirrors and seat belts (wittily referred to by the Wall Street Journal as a “Cash for Clubbers” program).

Still, even after the tax break, the Volt remains a pricey alternative to the typical gasoline-only cars.

Why do we subsidize the auto industry? Because they’re good jobs. Why are they good jobs? Because they’re subsidized.

Moody’s is increasingly dubious regarding whether Iceland is investment grade:

Moody’s is “taking it too far,” Economy MinisterGylfi Magnusson said in an interview yesterday, after the rating service cut the outlook on Iceland’s Baa3 foreign currency debt to negative. Moody’s said it will lower the rating to junk if a June court ruling banning some foreign loans hurts the recovery or forces the government to raise debt levels by bailing out the banks.
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Iceland’s financial crisis was exacerbated by banks that borrowed in currencies such as Japanese yen and Swiss francs to take advantage of lower interest rates, then repackaged them as kronur loans for clients. The krona has lost 38 percent against the yen and 30 percent against the franc since Sept. 15, 2008. The government is struggling to pay down a gross debt burden that will swell to 150 percent of economic output this year, Moody’s estimates.

The prospect that Iceland’s economy will return to growth next year is “subject to significant downside risks,” Moody’s said. The economy contracted 6.5 percent in 2009 and will probably shrink a further 2.6 percent this year, the central bank estimates. Output will expand 3.4 percent in 2011, the bank said in its latest forecast in May.

CIBC has reopened some USD covered bond deals:

DBRS has today assigned ratings of AAA to the Series CB5 (Tranche 2) and Series CB7 (Tranche 2) covered bonds issued under the Canadian Imperial Bank of Commerce (CIBC) Global Public Sector Covered Bond Programme (the Programme). The USD 400 million Series CB5 (Tranche 2) covered bonds are a re-opening of the existing Series CB5 (Tranche 1) covered bonds and have the same coupon rate (2.00%) and maturity date (February 4, 2013). Similarly, the USD 600 million Series CB7 (Tranche 2) covered bonds are a re-opening of the existing Series CB7 (Tranche 1) covered bonds and have the same coupon rate (2.60%) and maturity date (July 2, 2015). All covered bonds issued under the Programme (the Covered Bonds) rank pari passu with each other.

I wasn’t able to learn the price at which these went out the door, but was able to learn that they were issued as Rule 144a private placements: so retail can go suck eggs, the regulators have destroyed the market.

And now Toronto hosts Caribana again – complete with its perennial funding problems, despite the fact that it brings a tidal wave of cash into the city. Meanwhile, the totally synthetic Luminato is awash in cash (like its cousin, Nuit Blanche) despite having an economic impact, as near as I can figure, of half a dozen extra coffees being sold so the ribbon cutters can stay awake during each others’ speeches. But synthetic events are just so much easier to control than grass-roots ones, don’t you agree? And provide employment for the right sort of people. But anyway, have fun at Caribana, everyone – and if you’re under thirty, kiss a girl for me!

The month ended on a somnolent note, with very quiet trading in the Canadian preferred share market. PerpetualDiscounts gained 4bp and FixedResets were up 10bp, taking the median weighted average yield to worst on the latter class down to 3.46% – the eighth-lowest on record. All seen lower market yiels were at the end of March, 2010.

PerpetualDiscounts now yield 5.89%, equivalent to 8.25% interest at the standard 1.4x conversion factor. Long Corporates now yield about 5.5%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now 275bp, a surprising increase from the 265bp recorded on July 28. Corporates have been on wheels!

Click for Big

The Europeans are taking a look at High Frequency Trading:

High-frequency trading will be investigated by regulators to “better understand any risks,” Europe’s top market watchdog said in a report on proposed industry rules.

A planned European Union market regulator should also have the power to set standards for the tools used by high-frequency traders, such as the practice of placing computer servers close to trading venues to speed up market access, the Committee of European Securities Regulators told the European Commission.

Powers for the proposed European regulator should keep pace “with new technological advances, increasingly fragmented equity markets” and “shortcomings” in post-trade information, Sally Dewar, a managing director at the U.K. Financial Services Authority, said in an e-mailed statement today.

There’s nothing wrong with them familiarizing themselves with the issue – the rules-makers should know how the game is played! – but the Europeans have come up with so much wierd stuff lately that it will be most interesting to see what comes of it.

The bill to encourage banks to extend small-business credit has stalled in the Senate:

Senate Republicans blocked a measure that would cut taxes and ease credit for small businesses, saying they objected that Democrats refused to consider their amendments to extend expiring tax breaks.

The Senate voted 58-42 today to end debate on the bill, falling short of the 60 votes required to consider the legislation for passage.
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The legislation was faulted by Republicans such as Senator Richard Shelby of Alabama for being a government rescue similar to the $700 billion bank bailout of 2008. The program might induce banks to make risky loans, lawmakers said.

“The lack of credit for small businesses is a problem that needs to be addressed,” Shelby said during Senate debate last week. “I do not, however, believe that we should try and solve this problem with another expensive and bureaucratic government program.”

There will be congressional hearings into Basel III, which should satisfy my desire to understand the changes better. I mean, we’re certainly not going to see any discussion by OSFI or the Ottawa Mickey Mouse League, are we?

Christopher Dodd and Barney Frank, authors of the U.S. financial overhaul, plan hearings on the status of global talks to revise bank-capital standards amid worries that proposed rules are being watered down.
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The Senate Banking Committee, chaired by Dodd, will hold the discussions on the Basel process in September, said Sean Oblack, a spokesman for the Connecticut Democrat. Frank, the Massachusetts Democrat who heads the House Financial Services Committee, also plans to hold a hearing on the subject, said spokesman Steven Adamske. Neither panel has set a date nor decided who will be asked to testify.

Say what you like about what comes out of Congress – and I do! – the research that goes into these hearings is first-rate.

TD Bank has issued 5-year covered bonds in USD at 2.20%:

DBRS has today finalized the rating of AAA on the Covered Bonds, Series 1 (the Covered Bonds) issued under The Toronto-Dominion Bank (TD) EUR 10 billion Global Public Sector Covered Bond Programme (the Programme). The Covered Bonds (USD 2 billion) have a coupon rate of 2.20% and a hard-bullet maturity date of July 29, 2015.

The ratings are based on several factors. First, the Covered Bonds are senior unsecured direct obligations of TD, which is the second largest bank in Canada and rated AA and R-1 (high) with a Stable trend by DBRS. Second, in addition to a general recourse to TD’s assets, the Covered Bonds are supported by a diversified collateral pool (the Cover Pool) of prime credit home equity lines of credit (HELOCs) insured by Canada Mortgage & Housing Corporation (CMHC). CMHC is an agent of Her Majesty in right of Canada and is rated AAA by DBRS. The Cover Pool was approximately $10.7 billion as of April 19, 2010. Third, the Covered Bonds benefit from several structural features, such as a reserve fund, when applicable; a minimum rating requirement for swap counterparties, servicer and cash manager; and, lastly, the funding of pre-maturity liquidity if TD’s rating falls below certain thresholds.

Little of interest happened on reasonably good volume today, with PerpetualDiscounts up 2bp and FixedResets about as close to flat as you can get.

The migration from bank prop desks to hedge funds is continuing:

Citigroup Inc. may move a team of proprietary traders into its hedge-fund unit, one of at least three alternatives the U.S. bank is studying to comply with the Dodd-Frank Act, people briefed on the matter said.

Traders in the Citi Principal Strategies unit, led by Sutesh Sharma, would be reassigned to Citi Capital Advisors, which mostly oversees money for outside investors, said the people, speaking anonymously because the talks are preliminary. The bank would set up the traders as hedge-fund managers and seed their funds, then raise money from outside investors to redeem its stakes, the people said.

Good thing? Bad thing? Who knows? Who cares? This particular Volcker Rule is simply knee-jerk feel-goodism and the implications have never been studied.

Maybe the Citigroup guys can move to Singapore!

Singapore hedge fund startups are on the rise after the central bank approved new rules that didn’t impose a licensing requirement on most funds.

Seven new hedge funds set up in May and June, according to Eurekahedge Pte, after the Monetary Authority of Singapore said in April that small funds can keep operating without a license as part of its review.
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“Singapore did not shoot itself in the foot by putting up proposals that will kill off the business,” said Kher Sheng Lee, a senior associate in the financial services group at Philadelphia-based law firm Dechert LLP in Hong Kong. “While some places are moving towards over-regulation with rigid rules and increase in compliance costs, Singapore has attempted to go for sensible regulation.”

Singapore is vying with Hong Kong for a slice of the global $1.7 trillion hedge-fund industry as the region’s growth leads the world. Singapore has made it easier for hedge funds to set up shop on the island than in other Asian cities such as Hong Kong, where hedge-fund managers face the same licensing requirements as mutual-fund managers.

Plans are being drawn up for Bernanke’s hagiography:

In a new paper, the economists argue that without the Wall Street bailout, the bank stress tests, the emergency lending and asset purchases by the Federal Reserve, and the Obama administration’s fiscal stimulus program, the nation’s gross domestic product would be about 6.5 percent lower this year.

In addition, there would be about 8.5 million fewer jobs, on top of the more than 8 million already lost; and the economy would be experiencing deflation, instead of low inflation.

The paper, by Alan S. Blinder, a Princeton professor and former vice chairman of the Fed, and Mark Zandi, chief economist at Moody’s Analytics, represents a first stab at comprehensively estimating the effects of the economic policy responses of the last few years.
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If the fiscal stimulus alone had been enacted, and not the financial measures, they concluded, real G.D.P. would have fallen 5 percent last year, with 12 million jobs lost. But if only the financial measures had been enacted, and not the stimulus, real G.D.P. would have fallen nearly 4 percent, with 10 million jobs lost.

The combined effects of both sets of policies cannot be directly compared with the sum of each in isolation, they found, “because the policies tend to reinforce each other.”

A day of moderate volume in the Canadian preferred share market, with the volume totally dominated by FixedResets. PerpetualDiscounts were up 4bp and FixedResets gained 11bp on the day, with little volatility.

Update, 2010-7-29: PerpetualDiscounts now yield 5.90%, equivalent to 8.26% interest at the standard equivalency factor of 1.4x. Long Corporates yield 5.6%, so the pre-tax interest-equivalent spread is now about 265bp, unchanged from the figure reported on July 21.

Life has become a little more annoying for ETF investors:

Recently, BlackRock stopped publishing the management expense ratio for its ETFs on the iShares Canada website. Instead, investors are shown the management fee for iShares ETFs.

Management fees are just one component of the costs that investors pay to own ETFs and mutual funds. There are also operating expenses (administrative and legal costs, for example), and taxes.
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Bank of Montreal and Claymore Investments publish management fee info on their websites. To find out about MERs, you have to look at their semi-annual management reports on fund performance (download them at sedar.com).

The Bank of Canada has released a working paper by Emanuella Enenajor, Alex Sebastian, and Jonathan Witmer titled An Assessment of the Bank of Canada’s
Term PRA Facility:

This paper empirically assesses the effectiveness of the Bank of Canada’s term Purchase and Resale Agreement (PRA) facility in reducing short-term bank funding pressures, as measured by the CDOR-OIS spread. It examines the behaviour of this spread around both term PRA announcement dates and term PRA operation dates, using an event-study methodology to control for developments in other money markets (i.e., using the U.S. LIBOR-OIS spread) as well as proxies for Canadian banking sector credit risk. Overall, there is robust evidence that the term PRA announcements reduced bank funding costs at both 1-month and 3-month terms, whereas we find no evidence of an impact from term PRA operations. However, given the small number of term PRA announcements in our sample, caution should be taken in attributing the reduction in the CDOR-OIS spread solely to the term PRA announcements, since other concurrent events (including other announcements by the Bank of Canada) may have also contributed to a compression in the CDOR-OIS spread.

There’s some speculation that the European stress test actually worked:

The gap between European and U.S. benchmark credit-default swap indexes, used to hedge against losses or speculate on creditworthiness, narrowed to 0.7 basis point today, the lowest since June 4, prices from Markit Group Ltd. show. That premium soared to a record 23 basis points on May 7 on concern that budget deficits in southern Europe would infect credit markets worldwide.

Bond investors are turning their attention to the global economic recovery’s sustainability after European banks and regulators provided a better view into balance sheets of the region’s lenders and Spain sold 3.4 billion euros ($4.42 billion) of debt in an auction. Stress test results released July 23, which showed 84 of 91 banks passing, reassured investors by detailing their sovereign debt holdings.

However, this could just as well be relief over the softening of the Basel III proposals which was disussed yesterday:

Banks worldwide applauded changes to proposed capital and liquidity standards that relaxed aspects of the rules and gave lenders as much as eight years to comply.

Lobbying groups in Europe and the U.S. praised the changes announced July 26 by the Basel Committee on Banking Supervision as steps in the right direction, while firms including Deutsche Bank AG and UBS AG welcomed the softening of rules proposed by the committee in December. European and Japanese bank stocks surged.
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The 54-member Bloomberg Europe Banks and Financial Services Index rose 4.5 percent to 121.14, the biggest gain since European leaders crafted a 750 billion-euro ($973 billion) rescue package on May 10.

Sumitomo Mitsui Financial Group Inc., Japan’s second- largest bank by market value, led banks higher in Tokyo. Sumitomo Mitsui rose 2.8 percent to 2,587 yen, the most in more than two weeks. Mitsubishi UFJ Financial Group Inc., the nation’s largest bank, gained 2.5 percent, while Mizuho Financial Group Inc. climbed 2.2 percent.

U.S. bank stocks hardly budged.

The Canadian preferred share market had another good day on moderate volume, with PerpetualDiscounts up 12 bp and FixedResets gaining 1bp. Hardly any volatility.

Senator Phil Grassley, well known for his eagerness to support legislated subsidies for Alternative Fool lobbyists, does some more grandstanding with his questions regarding the Goldman-AIG pseudo-scandal:

The fifth largest amount listed is about $175 million that Lehman Brothers would have owed Goldman Sachs on CDS protection. However, given Lehman’s financial position at the time (September 15, 2008), isn’t it true that the real value of this hedge to Goldman would have been much less than $175 million? Wouldn’t it have only been worth the approximate value of any collateral that Lehman had already posted to Goldman up to that date?

2. Similarly, is it possible that financial health of the other institutions on the list may have prevented them from being able to pay Goldman in the event of an AIG default? Does this undermine Goldman’s claim that it was “fully collateralized and hedged” with regard to the risk of an AIG default, and thus demonstrate that Goldman did, in fact, receive a direct benefit from the government’s assistance to AIG?

3. Will the Panel be seeking additional details about these transactions in order evaluate Goldman’s claim to have been indifferent to whether AIG went bankrupt? If so, please describe the scope of your additional requests and inform the Committee if you do not receive complete cooperation.

In other words … ‘I don’t care whether you’ve got battery back-up, a fuel generator and three month’s worth of diesel stockpiled! Is it not true that in the event of the complete collapse of civilization, your electricity supply will fail to function?’

Attachment 1 (“Confidential Treatment requested by Goldman Sachs”) shows that Goldman bought a net value of USD 1.7-billion in CDSs on AIG. Canadian entries are Royal Bank (London Branch) $76-million; BNS, $36-million; BMO (London), $25-million; BMO (Chicago), $18-million; and Royal Bank [$43-million] [sold to] – that’s a net of about $100-million from Canadian banks. Naturally, there is no way of telling whether these positions were laid off against other investors.

Attachment 2 (“Confidential Treatment requested by Goldman Sachs”) shows the collateral shortfall on Goldman’s AIG deals – total of about $1.3-billion. So they were, it appears, over-hedged.

Despite all this, various analysts are still pointing out that Goldman would have lost money had an AIG bankruptcy coincided with a giant asteroid hitting New York City:

Joshua Rosner, an analyst at research firm Graham Fisher & Co. in New York, said the list of counterparties indicates that Goldman Sachs may have had difficulty collecting on those swaps.

“Clearly Goldman’s calculation was more tied to their expectation of the political dynamics of forcing moral hazard than the fundamental realities of the financial strength of counterparties,” Rosner said.
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“The financial institutions from whom we purchased protection were required to post collateral to settle their net exposure to us on a daily basis,” Lucas van Praag, a spokesman for New York-based Goldman Sachs, said yesterday. “A default by any particular counterparty would not reduce the effectiveness of a hedge provided by that entity if adequate collateral had already been posted. This was the case with the protection we bought, even during the most stressed periods of the fall of 2008.”
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“There’s a question about Citigroup’s ability to pay Goldman if AIG failed, given it had major problems,” said Ed Grebeck, CEO of Stamford, Connecticut-based debt-consulting firm Tempus Advisors and an instructor on derivatives at New York University.
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The document shows only the “notional” amount of money Goldman Sachs was owed by its counterparties, Cambridge Winter’s Date said. The firm is likely to have written down the value of at least some of the protection, he said.

Goldman Sachs “should have been haircutting the valuation of that protection pretty significantly as the viability of those firms looked more and more suspect,” Date said.

At least Goldman’s won something – the anti-Goldmanites have shifted their position from ‘an AIG bankruptcy would have killed Goldman’ to ‘an AIG bankruptcy and the simultaneous collapse of more than one other major global financial institution would have killed Goldman, provided they’re lying about the collateral, and even if they’re not lying about the collateral it was probably junk anyway.’

I once did some career mentoring for a young and idealistic high school student who wanted to get into the business – it was probably one of the most cynical mentoring sessions ever presented. But, for free, gratis and for nothing I will present to other idealists the lesson behind the Goldman debate: DON’T GIVE A SHIT AND DON’T EVER BOTHER DOING ANYTHING RIGHT. Goldman’s taking more grief for competently managing their AIG exposure than any of the clown-firms is taking for reckless idiocy.

But then … politicians across North America have shown a breathtaking disregard for creditors rights throughout this crisis – as best exemplified by the General Motors leapfrogging discussed on June 9, 2009. And if you have no rights, why would you want to protect them? The lunatic fringe even turns Goldman’s insistence on collateral into evidence of a dark plot:

Goldman wanted their counterparties to post collateral so they would have protection against corporate downgrades. The monolines refused to have collateral posting requirements in their CDS contracts. The rating agencies supported them in this position on the argument that maintaining their AAA rating was “fundamental to their business”.

AIG, on the other hand, agreed to collateral posting requirements. in fact, they used this as a competitive advantage – they got more business because of it and marketed their flexibility on this issue to the banks.
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All of the other banks got comfortable with the monolines not having to post collateral for CDS trades because of their AAA ratings. Goldman never did.

Of course, Goldman was one of the few banks that clearly set out to profit from shorting CDOs. They obviously realized that if their CDS counterparty was on the hook for a lot of ABS CDOs that were going to blow up, the insurance provider would likely get downgraded. If the downgrade of the insurer was very likely, the only way the short-CDO strategy worked was if the insurer would post collateral.
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So Goldman only used AIG, who would provide protection against their downgrade, which Goldman knew would happen because they were stuffing AIG with toxic ABS CDOs.
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I hate to get sucked into the vampire squid line of thinking about Goldman, but the only explanation i can think of for why AIG got rescued and the monolines did not is because Goldman had significant exposure to AIG and did not have exposure to the monolines.

I spent a little time looking into the woes of CalPERS after reading a brief mention in the Economist:

That [range of benefits improvements], however, is not what outrages Mr Schwarzenegger, a Republican, or his brainy economic adviser David Crane, a Democrat. Rather, it is that the pension plans—above all the California Public Employees’ Retirement System (CalPERS), the largest such scheme in America—pretended that this generosity would not cost anything. In 1999 the dotcom bubble was still inflating, and the plans’ actuaries predicted that their retirement funds would gain enough value to pay the increased pensions. By implication, they assumed that the Dow Jones Industrial Average would reach 25,000 in 2009 and 28m in 2099. It is currently at around 10,300.

Remember, CalPERS is the enormous pension fund that don’t do their own credit analysis. In 1999…:

According to CaLPERS, employer retirement costs have been declining over the last 10 years as the result of significant investment returns and changes in actuarial assumptions. The members and retirees of CaLPERS have not benefited from these returns. As a result, CaLPERS contends that the new retirement formulas provided by this bill mark the first significant improvement in retirement benefits for most state and school members’ in approximately 30 years. It is anticipated that the increase in liability for these new benefits can be funded by the excess retirement assets that have been generated through investment income and changes in actuarial assumptions resulting in no immediate increase in costs to the employer.

2001 Actuarial assumptions of net investment returns between 7.50% and 8.25%. Current assumptions are:

Critics who argue that the current level of retirement benefits are “unsustainable” and should be reduced for new hires say CalPERS is too optimistic about its expected investment earnings, an annual average of 7.75 percent.

Among the experts who think average earnings will be less than 7.75 percent in the years ahead is Laurence Fink, chairman of BlackRock, the world’s largest money managing firm, who spoke to the CalPERS board last summer.

The CalPERS chief investment officer, Joe Dear, addressed the earnings issue last week during his monthly report to the board. He said 5.25 percent of the earnings assumption is “real” and 2.5 percent is inflation.

Dear said the 7.75 percent earnings assumption is below the national average for pension funds, 8 percent, and below the earnings average of CalPERS during the last two decades, 7.9 percent.

He said CalPERS believes, among other things, that stocks will yield 3 to 4 percent more on average than bonds and that private equity investments will average 3 percent more than domestic stocks.

Comrade Peace Prize is seeking to distort the economy even more:

President Barack Obama is on the verge of creating as much as $300 billion in credit for small businesses as bankers raise doubt about whether there’s demand for new loans and how much will be repaid.

The U.S. Senate may vote this week on a bill to funnel $30 billion of capital to community banks, whose business customers typically are small firms. Banks could leverage the sum to make $300 billion in loans that create jobs, according to a Senate summary. That could more than double the commercial and industrial loans at eligible banks as of the first quarter, according to data compiled by KBW Inc.

Bankers say the problem isn’t scarce credit, it’s lack of demand from creditworthy firms in a weak economy.
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Banks will be charged an initial interest rate of 5 percent, declining to 1 percent if they increase small-business loans or rising as high as 7 percent if the loans stay the same or decrease, according to Richard Carbo, spokesman for the Senate Small Business and Entrepreneurship committee.
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Wells Fargo & Co., which says it’s the biggest small- business lender, is “sitting here with tons of liquidity and we’re marching double time in search of more loans,” Chief Executive Officer John Stumpf said in an interview. “In most cases when I hear stories about small businesses not getting loans, it’s the case that more credit will not help them. They need more equity, they need more profitability.”

Interesting paper from the FRB-Boston Public Policy series by Scott Schuh, Oz Shy, and Joanna Stavins, Who Gains and Who Loses from Credit Card Payments? Theory and Calibrations:

Merchant fees and reward programs generate an implicit monetary transfer to credit card users from non-card (or “cash”) users because merchants generally do not set differential prices for card users to recoup the costs of fees and rewards. On average, each cash- using household pays $151 to card-using households and each card-using household receives $1,482 from cash users every year. Because credit card spending and rewards are positively correlated with household income, the payment instrument transfer also induces a regressive transfer from low-income to high-income households in general. On average, and after accounting for rewards paid to households by banks, the lowest-income household ($20,000 or less annually) pays $23 and the highest-income household ($150,000 or more annually) receives $756 every year. We build and calibrate a model of consumer payment choice to compute the effects of merchant fees and card rewards on consumer welfare. Reducing merchant fees and card rewards would likely increase consumer welfare.

I was surprised by the following:

The limited available data suggest that a reasonable, but very rough, estimate of the per-dollar merchant effort of handling cash is  = 0:5 percent. Available data suggest that a reasonable estimate of the merchant fee across all types of cards, weighted by card use, is  = 2 percent.

I would have thought cash handling costs would be higher – particularly for high-cash operations, such as grocery stores – given bank charges for cash deposits, security on cash movements, employee theft and bookkeeping problems. The footnote reads:

Garcia-Swartz, Hahn, and Layne-Farrar (2006) report that the marginal cost of processing a $54.24 transaction (the average check transaction) is $0.43 (or 0.8 percent) if it is a cash transaction and $1.22 (or 2.25 percent) if it is paid by a credit/charge card. The study by Bergman, Guibourg, and Segendorf (2007) for Sweden found that the total private costs incurred by the retail sector from handling 235 billion Swedish Crown (SEK) worth of transactions was 3.68 billion SEK in 2002, which would put our measure of cash handling costs at  = 1:6 percent. For the Norwegian payment system, Gresvik and Haare (2009) estimates that private costs of handling 62.1 billion Norwegian Crown (NOK) worth of cash transactions incurred by the retailers was 0.322 billion NOK in 2007, which would imply  = 0:5 percent.

Fed Governor Tarullo doesn’t think we’ll see contingent capital any time soon:

The Basel Committee has a number of initiatives and work programs related to capital requirements that go beyond the package of measures that we expect to be completed by the fall. These efforts include, among others, ideas for countercyclical capital buffers, contingent capital, and development of a metric for capital charges tied to systemic risk. Each of these ideas has considerable conceptual appeal, but some of the difficulties encountered in translating the ideas into practical rules mean that work on them is likely to continue into next year.

The BIS proposal for countercyclical buffers was discussed on July 19.

There was relaxed volume in the Canadian preferred share market today, as PerpetualDiscounts gained 16bp and FixedResets lost 4bp, taking the median weighted-average yield on the latter class back above the magic 3.5% figure. Not much volatility.

The European Stwess Tests appear farcical:

European stress tests on 91 banks will take into account bank losses only on government bonds they trade rather than those they hold to maturity, according to a draft European Central Bank document.

“The haircuts are applied to the trading book portfolios only, as no default assumption was considered,” according to a confidential document dated July 22 and titled “EU Stress Test Exercise: Key Messages on Methodological Issues.”

The tests will assume a loss of 23.1 percent on Greek debt, 14 percent of Portuguese bonds, 12.3 percent on Spanish debt, and 4.7 percent on German state debt, according to the document obtained by Bloomberg News. U.K. government bonds will be subject to a 10 percent haircut, and France 5.9 percent.

On cue, Hungary’s problems became more visible:

Standard & Poor’s said it may cut Hungary’s credit rating to junk after the collapse of talks with the International Monetary Fund and European Union. Moody’s Investors Service said it may also lower the country’s grade.

The IMF and EU on July 17 suspended talks with the government without endorsing Prime Minister Viktor Orban’s plans to control the budget deficit. The creditors provided Hungary with a 20 billion-euro ($25.9 billion) rescue package in 2008, which had served to reassure investors.

“We believe that without an EU/IMF program to anchor policy, Hungary is likely to face higher and more volatile funding costs, which in our view could weigh on financial sector balance sheets, the public finances, and economic growth,” S&P said today in a statement.

C-EBS has released the results. The report on the aggregate outcome makes the exercise appear to be rather gentle stwess! Initial reactions to the reports on individual banks are negative – the total capital shortfall is only USD 4.5-billion.

But the best line in the farce comes from a central banker:

ECB Vice President Vitor Constancio called the tests “severe” and explained they didn’t include a scenario of a national default because “we don’t believe there will be a default.”

That’s just great, Vitor! Maybe you’ll be put in charge of the government run credit rating agency the Europeans are thinking about, you know, the ones that will be much nicer to sovereigns than those mean old-style CRAs!

Seems to me that if the bank market is locking up because of fears of chaos after a sovereign default, then you restore confidence by proving the banking system is robust to sovereign default. But reasoning like this isn’t likely to get me appointed to any regulatory positions of note.

Increased regulation of the public markets is having a predictable effect: less public issuance:

The most sweeping regulatory legislation for Wall Street since the Great Depression, signed into law by President Barack Obama on July 21, makes ratings companies vulnerable to lawsuits when underwriters include their assessments in documents used to sell debt. The law subjects firms such as Moody’s Investors Service, Standard & Poor’s and Fitch Ratings to so-called expert liability, meaning they would face the same legal risks as accountants and other parties that participate in bond sales.

Under the new law, issuers weren’t able to obtain permission from ratings firms to include their rankings in their registration filings, according to the SEC.

As a result, sales were held up, said Malcolm Dorris, a senior partner in the securitization group at law firm Dechert LLP. Companies were considering alternatives to the public markets, such as selling in the 144a market, where sales aren’t registered with the SEC, Dorris said.

Ford Motor Co.’s finance arm canceled a planned sale of asset-backed debt, the Wall Street Journal reported July 21 on its website, citing market participants it didn’t name.

There’s an awfully odd senate investigation into Goldman:

Goldman Sachs Group Inc. told U.S. investigators which counterparties it used to hedge the risk that American International Group Inc. would fail, according to three people with knowledge of the matter.

The list was sought by panels reviewing the beneficiaries of New York-based AIG’s $182.3 billion government bailout, said the people, who declined to be identified because the information is private. Goldman Sachs, which received $12.9 billion after the 2008 rescue tied to contracts with the insurer, has said it didn’t need AIG to be rescued because it was hedged against the firm’s failure.

“We want to know the identity of those parties, partly just to know where American taxpayer dollars went, but partly to assess Goldman’s claim,” said Elizabeth Warren, chairman of the Congressional Oversight Panel, in a Senate hearing this week. “We cannot evaluate the credibility of their claim that they had nothing at stake one way or the other in the AIG bailout.”
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Goldman Sachs had $10 billion of exposure to AIG when the insurer was rescued in September 2008, offset by $7.5 billion of collateral and swaps, Viniar said. The hedges were one reason that Goldman wouldn’t accept anything less than full payment on the guarantees it purchased from AIG, he said.

It’s not clear to me why this is so important; I suspect its just another instance of Goldman being punished for being the only competently managed investment bank in the world. The politicians need mea culpas and cringing gratitude – and they’re not getting it from GS.

Magna bought out Stronach with a 93% positive vote, despite the efforts of the precious to ensure the world is aware just how precious they are (I think Teachers’ won, having purchased one share so they could be officially offended at the deal. Their beneficiaries should be most upset that management time and money is being spent tilting at other people’s windmills). The vote is good news for readers of financial newspapers, who may hope for an end to the eternal whining of morons who are surprised when their participating debentures – also known as subordinated voting shares – don’t give them much say in the company. ‘But that’s just mean!’ they bleat ‘Business and investing should be a cooperative game, just like we had in kiddiegarter!’

It was a quiet day in the Canadian preferred share market, with PerpetualDiscounts up 1bp and FixedResets gaining 4bp on low volume.

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.