Category: Market Action

The IMF has released the March 2010 edition of Finance & Development.

Europe will bail out Greece, if necessary:

Europe’s blueprint for a financial lifeline to Greece amounts to an unprecedented bet by finance ministers that they can avert a euro crisis by sidestepping the no-bailout rules intended to sustain the 11-year-old currency.

Improvising their way through the euro’s harshest test since its debut in 1999, officials meeting in Brussels late yesterday and today worked out a strategy for emergency loans in case Greece’s plan for 4.8 billion euros ($6.6 billion) in tax increases and wage cuts fails to stave off fiscal disaster.

There is no word as to whether the EU will demand management changes, vilify the top guys, claw back pay or threaten criminal charges. S&P affirmed Greece at BBB+.

Moody’s is shift municipal ratings to the global scale:

Municipal bond issuers led by California Treasurer Bill Lockyer began pressing companies that rate their debt two years ago to show investors how they would be rated on a corporate scale. They claimed that the scale cost them more in interest rates because state and local borrowers default at a lower rate than higher-rated corporations.

U.S. Representative Barney Frank, a Massachusetts Democrat who chairs the House Financial Services Committee, called the different rating scales “ridiculous” at a hearing on the $2.8 trillion market in May 2008.

This cosmetic change was last reported on PrefBlog in September 2008 in Global Scale for Municipal Credit Ratings a Bust?. So, the story so far is: CDOs, etc., must get their own scale because global scales are ridiculous. Municipalities must get their own scale because the global scale is ridiculous. Can’t tell your players without a political programme, can you?

In a speech at the Heyman Center on Corporate Governance, Julie Dickson acknowledged the issue of regulatory capture, but didn’t offer any insights:

Simon Johnson, a professor at MIT, says that the failure of supervisory judgement is often linked to regulatory capture. Regulatory capture refers to supervisors thinking like the industry they regulate because they either come from industry, or hope to work in the industry. In some cases there may be a belief that it is easier to just agree with industry rather than to fight their lobbying efforts. He has written many articles on this, which I read with great interest as they contribute to the debate around regulators, incentives, and judgement.

My own view is that clear mandates and accountabilities, independence, resources, and international assessment programs are key to getting the incentives right. I would also say that I have seen some very courageous supervisors in my time, and that sometimes people recruited from industry are even more demanding, having experienced first hand some of the dynamics within institutions. So this issue is rather complex.

There was an interesting and unusual note in today’s FOMC release:

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh. Voting against the policy action was Thomas M. Hoenig, who believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to the buildup of financial imbalances and increase risks to longer-run macroeconomic and financial stability.

A good day in the Canadian preferred share market, with volume at above-average levels. Six issues traded more than 100,000 shares on the Toronto Exchange. PerpetualDiscounts gained 3bp and FixedResets were up 8bp, which took yields of the latter down to 3.47%, the second-lowest on record.

Under proposed legislation, the New York Fed will be politicized:

The Federal Reserve Bank of New York president, who supervises five of the seven largest U.S. banks, would be subject to White House appointment and lawmakers’ approval under legislation proposed today.

Also, one member of the Fed Board of Governors would be designated vice chairman for supervision, and no firm under Fed oversight would be allowed to vote for or have past or present employees serve as directors of regional Fed banks, according to the bill to overhaul financial regulation. Senate Banking Committee Chairman Christopher Dodd, a Democrat from Connecticut, unveiled the proposed legislation in Washington.

This might make a bit of sense if one could point to elements of the Credit Crunch and make a case that Fed failure to regulate was responsible. Unfortunately for logic lovers, however, it was basically Fed-regulated entitites who bailed out Non-Fed-regulated entities (JPM/BSC, BAC/MER) and the spectactular bankruptcies (AIG, LEH) were non-regulated. But it’s not logic, it’s politics!

CLOs are coming back!:

The market for collateralized debt obligations backed by high-yield, high-risk loans is poised to reopen in the U.S. for the first time in a year after losses on mortgages prompted investors to flee bundled securities.

Citigroup Inc. is underwriting a $500 million fund managed by New York-based WCAS Fraser Sullivan Investment Management LLC, scheduled to price as soon as this week, according to people familiar with the offering, who declined to be identified because terms are private. The deal refinances an existing collateralized loan obligation and increases its size by more than 50 percent.

The offering would mark the first new issue backed by widely syndicated loans in the $440 billion market for CLOs since last March and a return to investments that contributed to $1.76 trillion of writedowns and credit losses at the world’s largest financial institutions. Citigroup and WCAS Fraser Sullivan are marketing the deal after prices on CLO debt staged a record rally on signs of economic recovery.
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JPMorgan Chase & Co., Bank of America Corp. and Deutsche Bank AG have also been approaching managers of leveraged loans since last year to offer terms for new CLOs to restart the market, according to people familiar with the discussions. CLOs pool loans and slice them into securities of varying risk intended to provide higher returns than similarly rated investments.

Volume slackened off today, with only twenty-two issues trading more than 10,000 shares. PerpetualDiscounts lost 9bp on the day – yields are approaching 6.00% – and FixedResets hovered at their 3.50% yield level.

Another boring day, as far as actual news was concerned. An explanation of Lehman’s financing technique looked interesting at first, but turned out to be only legal hairsplitting. OK, OK, so the outward leg of the repo is recorded as a true sale and that delevers the balance sheet. Fair enough. But how did they avoid putting the inward leg on the balance sheet? Fortunately, volume 3 of the Examiner’s report makes that part clear:

Unlike an ordinary repo transaction, Lehman did not record the borrowing of cash from a Repo 105 transaction even though Lehman was obliged to repay the borrowing. Instead, Lehman established a long inventory derivative asset representing the obligation under a forward contract to repurchase the full amount of securities “sold.”3009 As Lehman’s internal Repo 105 Accounting Policy explained, assuming Lehman borrowed $100 cash in exchange for a pledge of $105 of fixed income collateral, Lehman booked a $5 derivative, which represented Lehman’s obligation to repurchase the securities at the end of the term of the repo transaction. The $5 arose from the fact that when it came time to repurchase the pledged securities, Lehman paid $100 cash for $105 worth of securities. The transaction therefore had a $5 value to Lehman reflecting the market value of the “overcollateralization” amount of the Repo 105 transaction. Because it had a positive fair value of $5, the derivative was recorded as an asset under SFAS 133.

Volume stayed perky today, while PerpetualDiscounts lost 8bp and FixedResets gained 14bp, taking yields on the latter down to 3.50%. Yields on FixedResets have only been below 3.50% on three days – ever! – with the all time low being 3.46% on January 11, 2010.

March 12 is the fourth-lowest FixedReset index yield of all time, March 11 is fifth-lowest.

Nothing happened again today.

Volume was good in the Canadian preferred share market today, and so was the direction, with PerpetualDiscounts gaining 9bp and FixedResets gaining 7bp, with yields on the latter edging closer to the magic 3.50% level.

No news worth reporting today. There was some more Greek speculator-blame being tossed around, but I can’t make fun of Greek politicians every day!

It was a quiet day for Canadian preferred shares, but volume was good. PerpetualDiscounts lost 4bp and FixedResets gained 3bp, yields on the latter edging slowly, slowly, closer to 3.50%. Only a single entrant for the performance highlights; no prizes for guessing which sub-class of preferred!

PerpetualDiscounts now yield 5.94%, equivalent to 8.32% interest at the standard equivalency ratio of 1.4x. Long Corporates now yield about 5.9% – maybe a bit under – so the pre-tax interest-equivalent spread (also called the seniority spread) now stands at about 245bp, unchange from the level reported March 3.

The Brookfield Renewable Power FixedReset, 5.25%+262, announced February 18, commences trading tomorrow with the symbol BRF.PR.A.

Brookfield’s dalliance with General Growth Properties got a boost:

General Growth Properties Inc. said its biggest debt and equity holders offered to jointly invest $3.93 billion in the company, bolstering a plan with Brookfield Asset Management Inc. to bring the mall owner out of bankruptcy.

The investments from Bruce Berkowitz’s Fairholme Capital Management LLC and William Ackman’s Pershing Square Capital Management LP would allow unsecured creditors to be paid in full with cash, General Growth said in a statement last night. Their funds are in addition to $2.63 billion pledged by Brookfield.

Royal Bank may make US acquisitions, but only if they’re big enough to generate fawning press commentary:

Royal Bank of Canada is interested in U.S. banks with $10 billion in assets or more to add to its consumer lending business, said James Westlake, an executive who oversees the international unit.
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“Most of the deals we are seeing are 12 branches or 25 branches and they don’t really move the needle,” Westlake said. “But I wouldn’t detect anything that suggests we aren’t welcome.”

The recent Federal Budget had a paragraph I missed (on page 104):

One of the lessons of the global financial crisis is that financial institutions need to have access to a variety of funding sources. The Government will help federally regulated financial institutions diversify their funding sources by introducing legislation setting out a framework for covered bonds. Covered bonds are debt instruments that are secured by high quality assets, such as residential mortgages. The legislation will increase legal certainty for investors in these debt instruments, thereby making it easier for Canadian financial institutions to access this low-cost source of funding.

RBC recently issued CAD 850-million five-years at 3.188%. As stated by RBC’s Hiren Lalloo in the ECBC 2009 Handbook:

There is no dedicated legal framework for the issuance of Covered Bonds in Canada. As such, Canadian Covered Bonds are based on contractual agreements structured within the general legislation.

The lack of specific legislation has been referred to as a risk factor for buyers of Canadian originated covered bonds, most recently in the DBRS assessment of the new RBC issue:

Despite the above strengths, the Covered Bonds have the following challenges. … And lastly, there is no specific covered bond legislative framework in Canada. This is mitigated by the contractual obligations of the transaction parties, supported by the opinions provided by legal counsel to RBC and a generally creditor-friendly legal environment in Canada.

Good volume on the Canadian preferred share market today, with PerpetualDiscounts off again, down 9bp this time, while FixedResets gained 3bp, bringing them closer to the 3.50% yield barrier. The market was again well-behaved, with only three issues gaining or losing more than 1% … two of them were Floating Rate gainers!

The US Budget squabbling has begun:

President Barack Obama’s budget proposal would generate bigger deficits than advertised every year of the next decade, with the shortfalls totaling $1.2 trillion more than the administration estimated, according to the Congressional Budget Office.

The nonpartisan agency said today the deficit will remain above 4 percent of the nation’s gross domestic product for the foreseeable future while the publicly held debt will zoom to $20.3 trillion, amounting to 90 percent of GDP by 2020.

A rise of debt to 70% of GDP in 1994 was nearly enough to trigger failure of bond auctions in 1994. Of course, the CAD is not a reserve currency, but 90% still looks scary! That implies that about 5% of GDP has to be taxed away just to pay interest!

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It should be remembered, when looking at the above graph for international comparisons, that it does not include provincial debt, which serves as an effective constraint on how much income can be taxed away for federal interest payments. Total Net Debt is a better figure, but I don’t have a time-series for that:

Click for Big

The CBO projection does not include another recession:

CBO does not try to project business-cycle fluctuations in the economy beyond the short term (in this case, beyond 2014) but instead identifies and projects trends in the factors that underlie potential output, including growth in the labor force, the rate of capital accumulation, and the growth of productivity. During the first half of the 10-year projection period, real GDP is expected to grow rapidly enough to close the substantial gap that existed in 2009 between it and potential GDP. Then, during the remainder of the projection period, real GDP is projected to grow at about the same rate as potential GDP. That approach does not preclude the possibility of recession in the latter years of the projection period; instead, it assumes that the likelihood of booms or recessions in the future is about the same as it was in the past.

I’m pretty suspicious of medium-term budget projectionst that don’t include a recession – at least as a scenario. Averages aren’t much good, frankly.

I mocked MLEC when it was suggested and I mocked PPIP when its turn came around. So far, PPIP looks like a fizzle.

The Icelandic terrorists have rejected the IceSave shakedown. There is no word on whether this is causing a reconsideration of the Basel rules whereby bank debt is risk-weighted according to the credit rating of its sovereign.

The Europeans are musing about a possible European Monetary Fund:

German Finance Minister Wolfgang Schaeuble said the Greek crisis shows the euro region should consider creating an organization with powers similar to the International Monetary Fund.

“For the internal stability of the euro zone, we need an institution that has the powers and know-how of the IMF,” he said in an interview with Welt am Sonntag published today. “We shouldn’t rule anything out, including the creation of a European Monetary Fund.”
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The comments come after proposals for a European Monetary Fund were put forward last month by Deutsche Bank AG Chief Economist Thomas Mayer and Daniel Gros, director of the Centre for European Policy Studies in Brussels. Countries could draw on funds equivalent to the money deposited at the EMF and exceed that amount if they agreed to a “tailor-made adjustment program” supervised by the European Commission and governments, they said.

The EMF could also ease the disruption caused by the default of a member state by offering investors new EMF bonds in exchange for the defaulted bonds, they said. Bond holders would be required to take a “haircut.”

Meanwhile, Papandreou is worried about speculators:

Greek Prime Minister George Papandreou, drawing parallels with the 1947 fight to contain communism in Europe, called for trans-Atlantic cooperation to combat “unprincipled speculators” who threaten to bring a new global financial crisis.

“Europe and America must say ‘enough is enough’ to those speculators who only place value on immediate returns, with utter disregard for the consequences on the larger economic system,” he said in a speech today in Washington. “An ongoing euro crisis could cause a domino effect, driving up borrowing costs for other countries with large deficits and causing volatility in bond and currency rates across the world.”

Oh, golly! We wouldn’t want countries with large deficits to incur higher borrowing costs, would we?

Marc Auboin of the WTO is concerned that Basel III may choke trade finance:

There was a time when trade finance received favourable regulatory treatment. It was viewed as one of the safest, most collateralised, and self-liquidating forms of finance. This was reflected in the moderate of capitalisation for cross-border trade credit in the form of letters of credit and similar securitised instruments under the Basel I regulatory framework put in place in the late 1980s and early 1990s. The Basel I text indicates that “Short-Term self-liquidating trade-related contingencies (such as documentary credits collateralised by the underlying shipments)” would be subject to a credit conversion factor equal or superior to 20% under the standard approach. This meant that for unrated trade credit of $1,000,000 to a corporation carrying a normal risk-weight of 100% and hence a capital requirement of 8%, the application of a credit conversion factor of 20% would “cost” the bank $16,000 in capital.
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One of the key measures proposed by the Basel Committee to reduce systemic risk is to supplement risk-based capital requirements with a leverage ratio, to reduce incentives for “leveraging”. The intention of reducing such incentives is relatively consensual, and has been shared by economists, regulators, and bankers. The idea, under Paragraph 24 to 27 of the BIS draft proposals, is to impose such a “leverage” ratio, in the form of a flat 100% credit conversion factor to certain off-balance sheet items.

Ranjit Lall has published a working paper titled Why Basel II Failed and Why Basel III is Doomed:

According to conventional wisdom, the Basel II Accord – a set of capital adequacy standards for international banks drawn up by a committee of G-10 supervisors – is essential if we are to avoid another financial crisis. This paper argues that this conclusion is false: Basel II is not the solution to the crisis, but instead an underlying cause of it. I ask why Basel II’s creators fell so short of their aim of improving the safety of the international banking system – why Basel II failed. Drawing on recent work on global regulatory capture, I present a theoretical framework which emphasises the importance of timing and sequencing in determining the outcome of rule-making in international finance. This framework helps to explain not only why Basel II failed, but also why the latest raft of proposals to regulate the international banking system – from the US Treasury’s recent financial white paper to the latest round of G-20 talks in Pittsburgh – are likely to meet a similar fate.
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Basel II’s failure, I argue, lies in regulatory capture, ‘de facto control of the state and its regulatory agencies by the ‘regulated’ interests, enabling these interests to transfer wealth to themselves at the expense of society’. Large international banks were able to systematically manipulate outcomes in Basel II’s regulatory process to their advantage, at the expense of their smaller and emerging market competitors and, above all, systemic financial stability.

Good volume and mixed performance in the Canadian preferred shares market today: PerpetualDiscounts lost 24bp, but FixedResets gained 8bp, taking their yield down to 3.55%. It will be most interesting to see whether they can edge past the 3.50% boundary … with a Modified Duration of only 3.72, it seems that price gain in the neighborhood of 15-20bp will do it.

European leaders are continuing their desperate efforts to divert attention from the causes of the Greek crisis:

German Chancellor Angela Merkel said that Greece doesn’t need financial aid, as she turned her focus to restricting the use of derivatives to halt “speculators” from exploiting countries’ budget deficits.

“Credit-default swaps, where you insure your neighbor’s house just to destroy it and make money from it, that’s exactly what we have to curb,” Merkel said at a joint press conference in Berlin today with Greek Prime Minister George Papandreou.
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Merkel said that Greece has done its work and that Europe and the U.S. must ensure that financial-market speculators aren’t allowed to inflict further damage on Greece or on other countries.

“We must succeed at putting a stop to the speculators’ game with sovereign states,” Merkel said. “We can’t allow speculators to be the profiteers of Greece’s difficult situation.” While “technically not easy,” derivatives including credit-default swaps “must be curbed,” she said.

The Greek situation has spiralled (almost?) out of control due to European complacency. After years of turning a blind eye to the problem, they now have to face it … and no politician likes problems. Shoot the messenger!

Volume was good today but price action was muted, with PerpetualDiscounts gaining 2bp and FixedResets up 3bp. There were only two entries on the performance highlights tables – from the Floating Rate class, naturally enough!

The Credit Rating Agencies are now being drawn into the Greece fiasco:

European Union finance ministers are pushing the European Central Bank to develop its own rating system for euro zone countries, German business daily Handelsblatt reported on Wednesday, citing EU finance ministry sources.

The paper quoted one official saying the plan would free the euro zone from its dependency on international rating agencies such as Standard & Poors, Moody’s and Fitch.
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Fitch and S&P have downgraded Greece into ‘B’ territory and should Moody’s follow suit, banks would no longer be able to exchange Greek government debt for cash in ECB refinancing operations from January 2011.

On the one hand, this is no big deal. Central Banks have always had, and should always have, the power to determine just what constitutes the good collateral they lend against. On the other hand, this could very easily become simply another method of papering over the cracks in the system, prior to the Big Collapse.

I’m always pointing out that despite the reset mechanism, FixedResets are not five-year instruments, which I’ll point out again in the wake of the new TRP FixedReset 4.00%+128. Why not? Well, here’s one example:

Two years after the auction-rate bond market froze, Hawaii has lost about $250 million in market value on $1 billion in student-loan securities sold by a single Citigroup Inc. broker as a cash substitute that the state has had difficulty unloading.

Hawaii purchased half of the securities for its short-term treasury account from Honolulu broker Pete Thompson, 60, in the eight months before the market collapsed, according to Scott Kami, an administrator at the state finance department.
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Auction-rate securities typically have maturities as long as 40 years and yields that are reset in periodic sales held as frequently as every seven days. As the global credit crisis deepened in 2008, banks that underwrote the obligations reversed decades of support for the market when they declined to bid for the debt.

Cash Substitute

The action left purchasers such as Hawaii, which viewed auction-rate debt as a higher-yielding cash substitute, unable to sell without taking losses. Citigroup provided the state with a valuation on Dec. 28 saying securities with a face value of about $1 billion were worth $752 million, according to bank documents.

“It was represented to us that these were liquid investments that we could get out every seven to 10 days,” Kami said in an interview.

Hawaii’s suing. Why these situations are the fault of the salesman and not the moron who bought them in such huge quantities is quite beyond me.

The Federal Budget is a total waste of time and I can’t be bothered with it.

Good volume today, perhaps sparked by the TRP FixedReset 4.00%+128 new issue announcement and the closing of GWO.PR.M, but the market came off, with PerpetualDiscounts down 28bp and FixedResets down 7bp.

Faced with criticism of their conduct and market disdain for their chances going forward, European politicians are taking decisive action – prohibit criticism!

The European Commission said yesterday it will investigate trades in sovereign credit-default swaps in the wake of the Greek crisis, which has pushed the euro lower and prompted officials to warn hedge funds they shouldn’t try to profit from the woes of the region’s nations.

… with further details:

Banks and regulators across Europe were summoned by the European Commission to discuss regulation of the market for sovereign credit-default swaps in the wake of the Greek debt crisis.

The European Union’s executive agency will hold a meeting in Brussels “shortly,” Chantal Hughes, a commission spokeswoman, said in an e-mailed statement today. The talks, which will take place as soon as March 5, will cover CDS pricing and links to the sovereign bond market, according to three people familiar with the discussions.

Remember the little boy who shouted that the Emperor had no clothes? The soldiers slaughtered him, his family, and anybody who heard the treacherous remark. Later, the Emperor’s wardrobe expenses caused taxes to rise so high that a famine resulted and the Empire collapsed. But that’s show-biz.

There’s more jostling in the Brookfield / General Growth deal, with Ackman’s role being criticized:

General Growth Properties Inc’s unsecured creditors and suitor Simon Property Group on Tuesday criticized William Ackman’s role in the mall owner’s restructuring plan, alleging conflicts of interest given his position as a director and largest shareholder.

Ackman has backed a reorganization plan that calls for his Pershing Square Capital Management hedge fund to offer Brookfield Asset Management certain protections in return for the Canadian firm financing General Growth’s stand-alone exit from bankruptcy.
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The official committee of General Growth’s unsecured creditors said in a court filing that the agreement between Pershing Square and Brookfield effectively restricts General Growth from considering alternative transactions because it puts the company into “an obvious conflict of interest situation.”

“The Debtors must choose between the best interests of the estates and the economic interests of one of their most active and vocal directors,” it added, referring to Ackman.

Simon, a General Growth creditor, also questioned the arrangement between Brookfield and Ackman’s Pershing Square in a separate filing Tuesday.

RBC CEO Gord Nixon spoke at the annual meeting:

“Political rhetoric is distorting the cause of this recent crisis and potentially distorting the cure,” he told shareholders at the bank’s annual meeting in Toronto Wednesday. “This crisis was not caused by Wall Street, executive compensation, nor proprietary trading, although they all played a part. The root cause of the crisis was the failure of the U.S. residential mortgage market,” he said, adding that “the basic requirement to qualify for a large mortgage in the United States was a pulse.”

I would say ‘triggered’ rather than ’caused’. The recession is bringing to light a lot of bad practices: General Motors, Chrysler, Greece …

“The bulk of the losses during the crisis arguably resulted from lending practices and excessive concentration related, primarily, to U.S. residential real estate and over-extended consumers, not those activities addressed by the proposed reforms,” he said.

Glad to hear someone talking about concentration. Bad investments can hurt you, but over-concentration can kill you … as, for instance, many Canadian ABCP players found out. He says Basel III is fraying ’round the edges:

“While a few months ago it appeared as if there was a high degree of co-operation among the Financial Stability Board countries, we are now experiencing a divide with different countries trying to initiate rules that best suit their jurisdictions,” he said. “The unified response that was necessary and commendable during the darkest days of the crisis now risks being replaced by regulatory and legislative one-upmanship, as various governments pursue local agendas.”
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And, while he said he agrees that it’s important for banks to be conservatively capitalized, he said that “the current Basel III proposals, as they’re referred to, are so complex and onerous that we run the risk of no agreement being reached.”

I was quoted in the Advisor.ca budget wish-list:

James Hymas, president, Hymas Investment Management Inc.

• A clear-cut plan for a balanced budget through the cycle.
• I want to see statements of planned spending cuts and tax increases that will not just eliminate the deficit (a childish half-measure), but ensure – insofar as such things can be ensured – that surpluses built up in relatively good times will pay for this recession and put us in a good position to cope with the next one.

Volume dropped to more normal levels on a steady day in the Canadian preferred share market, with PerpetualDiscounts gaining 5bp and FixedResets gaining 9bp … taking the YTW on the latter class down to 3.52%.

PerpetualDiscounts now yield 5.89%, equivalent to 8.25% interest at the standard equivalency factor of 1.4x. Long Corporates are now yielding about 5.8%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) now stands at 245bp, a sharp, bond-driven widening from the 235bp recorded at month-end.