Category: Market Action

Nice piece in the WSJ on the Goldman/Greece thing, Swapping Blame over Athens:

Greece was not alone in using creative accounting to massage its numbers ahead of euro entry. It’s been known for years that Italy and Portugal also took advantage of derivatives contracts to dress up their budget numbers in the late 1990s. And as Allister Heath of the CityAM newspaper reminded us, even France “bought” long-term pension obligations from France Telecom in exchange for an upfront payment of £4.7 billion ($7.1 billion) that helped pave its entry into the single currency.
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There’s no small irony in the fact that the same governments that once took advantage of derivatives peddled by international financiers to help conceal their true financial condition are now claiming to be the victims of the same banks’ dealings in the derivatives market. But the blame-the-bankers theme in the nascent sovereign-debt panic is of a piece with the banker-baiting that came in the wake of the 2008-2009 financial crisis.

Once again, our political class has been all too eager to find someone else to blame for its own economic mismanagement

Another WSJ article Europe’s Original Sin asks the question: What’s a Grecian Earn?:

Europeans are blaming financial transactions arranged by Wall Street for bringing Greece to the brink of needing a bailout. But a close look at the country’s finances over the nearly 10 years since it adopted the euro shows not only that Greece was the principal author of its debt problems, but also that fellow European governments repeatedly turned a blind eye to its flouting of rules.

Though the European Commission and the U.S. Federal Reserve are examining a controversial 2001 swap arranged with Goldman Sachs Group Inc., Greece’s own budget moves, in clear breach of European Union rules, dwarfed the effect of such deals.
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Those revisions far exceed the impact of controversial derivative transactions Greece used to help mask the size of its debt and deficit numbers. The 2001 currency-swap deal arranged by Goldman trimmed Greece’s deficit by about a 10th of a percentage point of GDP for that year. By comparison, Greece failed to book €1.6 billion ($2.2 billion) of military expenses in 2001—10 times what was saved with the swap, according to Eurostat, the EU’s statistics authority.

Naturally, the episode is being used to promote various hobby-horses (I mean, besides Goldman-bashing):

Greece would have been dissuaded from using swaps to obscure the country’s deficit if the $605 trillion derivatives industry were properly regulated, U.S. Commodity Futures Trading Commission Chairman Gary Gensler said.

“Derivatives reform would have made it more difficult for Greece to hide their embedded loan,” Gensler said in a speech to be delivered today to Women in Housing and Finance, a Washington-based professional society.

Derivatives rules proposed in the U.S. would have required Greece to post collateral against its derivatives transactions, “thus canceling out the embedded loan and discouraging the country from entering into such a transaction in the first place,” he said. New York-based Goldman Sachs Group Inc. was at least one of the banks involved in swaps transactions with Greece.

Assiduous Readers will note that since the deal was uncollateralized, Goldman – and the ultimate buyer of the package – also bought a CDS on Greece; this is similar to their actions with uncollateralized exposure to AIG.

Australia’s hiked rates again:

Reserve Bank of Australia Governor Glenn Stevens increased the benchmark overnight cash rate target to 4 percent from 3.75 percent in Sydney today, as forecast by 14 of 19 economists surveyed by Bloomberg News. The rest predicted no change.

The biggest jobs boom in more than three years and a surge in business confidence suggest Australia’s economy is already growing at or close to trend, after escaping recession during the global crisis, Stevens said. “It’s appropriate for interest rates to be closer to average,” which he last week signaled may be another 75 basis points higher than the current rate.

PrefBlog’s Piggies-at-the-trough Department reports that cellulosic ethanol will be immensely profitable, if subsidized enough:

The industry insists the ethanol-from-waste technology will soon be commercially viable with the proper government incentives, including a some sort of price on carbon dioxide emissions that makes fossil fuels more expensive.

If the government really wanted economic ethanol, they’d fund academics with $50-million with the objective of developing something that, you know, actually works rather than forking over $500-million to the industrial smiley-boys, but Spend-Every-Penny is contemptuous of anything that smacks of schoolwork. So don’t hold your breath.

Some nice volume on a good day for the market, with PerpetualDiscounts gaining 5bp while FixedResets gained 14bp, taking yields on the latter down to 3.54%. Still a very well-behaved market, with only two entries in the Performance Highlights table.

AIG Chairman Harvey Golub says pay restrictions hurt the company. Bloomberg reports:

“While we can pay the vast majority of people competitively, on occasion, these restrictions and his decisions have yielded outcomes that make little business sense,” Golub, 70, said of Feinberg. “In some cases we are prevented from providing market-competitive compensation to retain some of our most experienced and best executives. This hurts the business and makes it harder to repay the taxpayers.”

Feinberg, the Obama administration’s special master on executive pay, has instituted a $500,000 base salary cap for most AIG employees. He has made exceptions for those deemed necessary for the insurer’s success, including Chief Executive Officer Robert Benmosche, who secured a $7 million salary and $3.5 million in long-term incentive awards.

Is it true or is he just pointing a finger? Well, we’ll never know, will we? That’s the trouble with dotted-line responsibility.

The Greece/Goldman/Eurostat kerfuffle is getting funnier by the minute:

Goldman Sachs did consult European statistics agency Eurostat on currency swaps traded with the Greek government, which allowed the sovereign to reduce the size of its reported debt, Gerald Corrigan, a managing director and chairman of Goldman Sachs Bank USA, told a House of Commons Treasury Select Committee hearing this afternoon. It is the first public comment to come out of a Goldman official since the currency swaps controversy reignited two weeks ago, and directly contradicts Eurostat’s claim the agency had no knowledge of the trade.
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Eurostat, however, has denied knowledge of the trades, saying it was alerted only when the story hit the headlines two weeks ago. “Greek authorities have not informed Eurostat about this kind of swap operation. It is only recently that Eurostat has heard from the press about this individual operation. Eurostat has requested information from the Greek authorities and will only give further comment on the issue when it has received the information,” said a Eurostat spokesperson.

Note that the lawyers have carefully worded Eurostat’s hairsplitting “Greek authorities” and “this individual operation”.

But does it matter? They were encouraging this type of deal!

Before 2002, deals of this kind occupied a grey area in European accounting rules, according to a 2001 report written for the US Council on Foreign Relations and the International Securities Market Association by Italian academic Gustavo Piga. In his report, Piga noted the inability of European authorities to decide whether the deals were permissible or not, and called for “a firm national accounting framework to deal with these window-dressing transactions” – citing as an example a swap put in place on a 1995-vintage three-year bond by the Italian government in 1996. In May 2002, the publication of ESA95 accounting rules answered Piga’s concern by explicitly permitting the transactions and providing a worked example of how to calculate the apparent reduction in national debt – not, perhaps, the reaction Piga had expected.

But, as Felix Salmon points out:

This is a failure of European transparency and coordination; Goldman is a scapegoat.

Of course, getting cash up front is hardly limited to European governments. US municipalities also liked the idea of cash upfront:

JPMorgan lured municipalities into derivative deals by offering upfront cash payments in exchange for a pledge by the local government to agree to enter interest-rate swaps with the bank at a future date.

In these deals, which were rarely put out for public competitive bidding, the bank said its clients would come out ahead if interest rates increased in the future.

JPMorgan and competitors routinely didn’t disclose their fees for these contracts, public records show. In some cases, the bank made more money than it paid out. In Erie, Pennsylvania, JPMorgan gave the school district $755,000 upfront and collected $1.2 million in fees.

The bank was able to lock in its income by selling a mirror-image swap contract on the open market for the higher amount. The transactions involved derivatives, which are unregulated contracts tied to the value of securities, indexes or interest rates.

The deals JPMorgan arranged used floating-rate bonds and interest-rate swaps. The swaps required a municipality and the bank to exchange payments as frequently as every month. The amounts that changed hands were based on various global lending rates.

One of the great joys of investing in US Treasuries is the occasional spike in demand for specific short-term issues due to municipal defeasance – which generally happens during a period of declining rates. That game isn’t being played much this time ’round:

Brill, 47, is caught in an unintended consequence of the Federal Reserve chairman holding overnight rates near zero to ease the worst recession since the 1930s. The city, facing a $212 million budget deficit for the current fiscal year, could sell tax-exempt obligations yielding less than 4 percent to retire 5 percent debt sold seven years ago. To do so, Brill would first have to park the proceeds of the new bonds in an escrow account investing in U.S. government securities that under Bernanke pay as little as 0.53 percent.

Local governments and other borrowers in the municipal market sold a record $378 billion of tax-exempt bonds in 2009, when yields fell to the lowest in at least 40 years. At the same time, so-called advance refundings of existing notes shrank to $48.1 billion in 2009 and $28.9 billion the year before, from $82.4 billion in 2003 when municipal yields were at a then-record low, though Treasury yields were higher than today, according to data compiled by Bloomberg.
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If Los Angeles were to advance refund $151.7 million of 5 percent bonds sold in 2003, new debt would be invested in the low-yielding Treasuries until the 5 percent issues are eligible for repayment on Sept. 1 of 2011, 2012 and 2013, according to bond documents.

While Brill estimates the city could sell new bonds at less than 4 percent, that cost would be higher than the rates of 0.53 percent to 1.62 percent the Treasury pays on special securities with maturities matching the earliest dates the 5 percent issues can be repaid.

The Bloomberg article quoted discusses SLGSs, but any Treasury obligation will do.

Moderate volume today, as PerpetualDiscounts fell 4bp while FixedResets gained 19bp. A very well-behaved market with only one entry in the performance highlights.

A nugget of information about Credit Default Swaps on sovereigns is being circulated:

The credit-default swaps traders being blamed by German and French leaders for fueling fears of sovereign debt crises would be doing so with less than 1 percent of the governments’ outstanding debt being wagered.

The CHART OF THE DAY shows the net notional value of credit swaps on 10 European countries including Greece, Spain, Italy and Portugal, as reported by the Depository Trust & Clearing Corp. The $108 billion figure, which is the maximum amount on the line if all of the countries were to default, is 0.98 percent of the $11 trillion in outstanding debt of those countries. In Greece, where the heaviest complaints about credit-swaps trading have been leveled, bets of $9 billion compare with $267 billion of debt.
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European leaders have said trading in the contracts fuels speculation that can distort perceptions and have warned hedge funds about trying to profit from the problems on the continent.

The last line quoted is the scary part. Remember September 25, 1992? The politicians don’t like it when the market says, instantly, that they’re being stupid. It is infinitely preferable to allow the stupidity to continue until it distorts the real economy and winds up on the backs of the electorate – who, it is assumed, will have long ago forgotten who’s to blame.

Remember Flash orders? There’s a really good explanation of the viewpoint of exchanges offering this order type from William Brodsky of the CBOE – dated 2009-11-18.

Fannie Mae needs more money:

Fannie Mae, the mortgage-finance company under federal conservatorship, said it will seek $15.3 billion in aid from the U.S. Treasury after posting a 10th straight quarterly loss.

A fourth-quarter net loss of $16.3 billion, or $2.87 a share, pushed the company to request its fifth draw on an unlimited lifeline from the government, Washington-based Fannie Mae said in a filing today with the Securities and Exchange Commission.

Fannie Mae, which posted $120.5 billion in losses over the previous nine quarters, has taken $59.9 billion in federal aid since April. Its shares, which peaked at $87.81 in December 2000, closed at 99 cents today in New York Stock Exchange composite trading. The Treasury owns 79.9 percent of Fannie Mae’s outstanding common shares.
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The fair value of Fannie Mae’s assets was negative $98.8 billion last quarter, compared with negative $90.4 billion at the end of September.

Banks can screw up, certainly, and must bear a lot of the blame for the credit crunch. It’s not as if working for a bank transforms you into a genius – quite the opposite, as far as I’ve ever been able to tell. But for horrific blunders of stupefying dimensions, you need a politician. Funny how all the “Too Big To Fail” handwringing always concerns JPMorgan et al. and not Fannie & Freddie, huh?

Finally something of a (dead cat?) bounce in the preferred share market today, with PerpetualDiscounts gaining 19bp and FixedResets down 1bp, with no losers at all in the performance highlights. Volume was off a bit, but still quite healthy.

PerpetualDiscounts now yield 5.90%, equivalent to 8.26% interest at the standard equivalency factor of 1.4x. Long Corporates yield about 5.9%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 235bp, which is where it was on February 24.

Johnny Mack thinks Wall Street compensation is too high:

Morgan Stanley Chairman John Mack said investment bankers are overpaid and Wall Street compensation won’t decrease much because firms don’t want to lose their best performers.
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Mack, who retired as CEO of the world’s biggest brokerage in December, cited a 28-year-old Morgan Stanley trader whose unit had earned $300 million to $400 million for the firm. After Morgan Stanley offered $11 million in compensation, the trader jumped to a hedge fund that paid him $25 million, Mack said.

I don’t understand what’s wrong with the example, frankly.

I will concede that the high level of compensation in the industry is symptiomatic of there being something wrong, but I don’t think that “something” is greed. The “something” is stupidity. The stupendous salaries that are possible in the industry – particularly on the sell side – are only possible because there are a lot of very, very stupid people managing investments and are leaving way too much money on the table. But how to get rid of them? The only idea I’ve ever been able to come up with is mandatory disclosure of performance history for all registered individuals; subject to regulatory audit and posted on the regulatory website and never erased. It might go at least a little way towards making it a bit more difficult for the smiley-boys to do business.

Risk magazine has a good explanatory article on the Greece-Goldman deal (hat tip: Financial Webring Forum, titled Revealed: Goldman Sachs’ mega-deal for Greece by Nick Dunbar:

The transactions agreed between the Greek public debt division and Goldman Sachs involved cross-currency swaps linked to Greece’s outstanding yen and dollar debt. Cross-currency swaps were among the earliest over-the-counter derivatives contracts to be traded, and have a perfectly routine purpose in debt management, namely to transform the currency of an obligation.
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However, according to sources, the cross-currency swaps transacted by Goldman for Greece’s public debt division were ‘off-market’ – the spot exchange rate was not used for re-denominating the notional of the foreign currency debt. Instead, a weaker level of euro versus dollar or yen was used in the contracts, resulting in a mismatch between the domestic and foreign currency swap notionals. The effect of this was to create an upfront payment by Goldman to Greece at inception, and an increased stream of interest payments to Greece during the lifetime of the swap. Goldman would recoup these non-standard cashflows at maturity, receiving a large ‘balloon’ cash payment from Greece.
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Goldman Sachs is known for its conservative approach to credit risk, and chose to hedge its exposure to Greece by immediately placing the risk with a well-known investor in sovereign credit: Frankfurt-based Deutsche Pfandbriefe Bank (Depfa). According to sources, Depfa entered into a credit default swap with Goldman Sachs, selling $1 billion of protection on Greece for up to 20 years. Depfa declined to comment.

Wow! Can you imagine? Goldman bought something from one counterparty, then sold it to another! Isn’t that evil? And they call themselves brokers! What’s a broker doing, buying things and selling things and taking out a spread? Brokers are supposed to … um … do something else.

And you know the date of the article? July 1, 2003. In other words, everybody who who needed to know about this has known it for well over six years. Those who didn’t know it have only themselves to blame.

But since when does a bureaucrat admit fault?

“Eurostat was not until recently aware of this alleged currency swap transaction made by Greece,” spokesman Johan Wullt said by e-mail yesterday.
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European politicians this week criticized New York-based Goldman Sachs for arranging the Greek swap and are pressing for more disclosure. Chancellor Angela Merkel’s Christian Democrats aim to push for new rules that will force euro-region nations and banks to disclose bond swaps that have an impact on public finances, financial affairs spokesman Michael Meister said yesterday.

“Goldman Sachs broke the spirit of the Maastricht Treaty, though it is not certain it broke the law,” Meister said in an interview yesterday. “What is certain is that we must never leave this kind of thing lurking in the shadows again.”

Goldman broke the spirit of the Maastricht Treaty? Goldman? And there I was, not even aware it was a signatory!

And why is there no mark-to-market on currency swaps? Nick Dunbar explained (almost seven years ago, remember) that it’s because the regulators decided that they didn’t want market marks on currency swaps:

The answer can be found in ESA95, a 243-page manual on government deficit and debt accounting, published by the European Commission and Eurostat in 2002. As revealed by Piga, the drafting of ESA95’s section on derivatives was the subject of fierce arguments between the government statisticians and debt managers of certain eurozone countries.

The statisticians wanted derivatives-related cashflows to be treated as financial transactions, with no effect on deficit or interest costs, and with the derivatives’ current market value stated as an asset or liability. The debt managers opposed this, insisting on having the freedom to use derivatives to adjust deficit ratios. The published version of ESA95 reflects the victory of the debt managers in this argument with a series of last-minute amendments.

In particular, ESA95 states in a page-long ‘clarification’ that ‘streams of interest payments under swaps agreements will continue… having an impact on general government net borrowing/net lending’. In other words, upfront swap payments – which Eurostat classifies as interest – can reduce debt, without the corresponding negative market value of the swap increasing it. According to ESA95, the clarification only covers ‘currency swaps based on existing liabilities’.

But at least Greece has some company:

Iceland walked out of talks with the U.K. and Netherlands on how to settle foreign claims, after both sides failed to reach an agreement on the terms of a loan the north Atlantic nation needs to cover depositor losses.

Iceland’s Finance Minister Steingrimur J. Sigfusson said a team of officials meeting Dutch and British counterparts in the U.K. today would return to Reykjavik after two weeks of talks in London failed to yield results. Iceland’s government will now discuss how to proceed with the country’s appointed negotiating team, according to a statement from the Finance Ministry.

But then, Icelanders are all terrorists, aren’t they?

InDefence was launched in late 2008 by British-educated citizens outraged by London’s use of anti-terror laws to freeze Icelandic assets, an unprecedented insult for a close NATO ally.

“There is tremendous anger,” said spokesman Johannes Skulason. “We feel deeply wronged that the Icelandic central bank was listed with al-Qaeda as a terrorist body. If Gordon Brown ever tries to set foot in this country he will be thrown back on the plane.”

A report by Sweden’s Riksbank said EU rules covering Icesave were incoherent and that it was unclear whether Icelandic citizens bear the full responsiblity. It said Britain’s authorities had acted incompetently and should share some of the compensation costs.

Brookfield’s getting some competition for General Growth:

The battle for General Growth Properties Inc., owner of more than 200 U.S. malls from Boston to Los Angeles, is turning into the biggest real estate fight since sale of Sam Zell’s Equity Office Properties Trust.

Westfield Group, a Sydney-based property investor with stakes in 55 U.S. retail centers, signed an agreement letting it assess General Growth’s finances, a person familiar with the pact said yesterday. That may put Westfield in position to vie for the bankrupt company’s assets as part of a contest already embroiling Simon Property Group Inc. and Brookfield Asset Management Inc.

Simon has forcefully responded to the Brookfield bid:

“General Growth’s proposed recapitalization amounts to a risky equity play on the backs of its unsecured creditors. While continuing to block the immediate and certain 100% cash recovery provided by Simon’s offer, General Growth has preempted its own self-proclaimed ‘process’ in favor of a highly speculative and risky plan to attempt to raise $5.8 billion of new capital in today’s uncertain markets — including $3.3 billion of dilutive new equity, $1 billion in asset sales and $1.5 billion in new debt — on top of the approximately $28 billion it already owes. Simon is providing $10 billion of real value — $3 billion to shareholders as well as $7 billion to creditors — as compared to a complex piece of financial engineering that is so highly conditional as to be illusory.”

The Canadian preferred share market slumped again today on continued high volume, with PerpetualDiscounts losing 13bp and FixedResets down 16bp. There were no winners in the performance highlights table.

The Boston Fed has released a Public Policy Discussion Paper by Oz Shy titled Person-to-Person Electronic Funds Transfers: Recent Developments and Policy Issues:

The paper investigates the reasons why person-to-person electronic funds transfers are still not very common in the United States compared with practices in many other countries. The paper also describes recent enhancements to online and mobile banking that provide account holders with low-cost interfaces to manage person-to-person electronic funds transfers via automated clearing house (ACH). On the theoretical side, the paper characterizes the critical mass levels needed for payment instruments to become widely adopted. Given the Fed’s long-term heavy involvement in check clearing, the paper concludes with policy discussions of whether intervention is needed.

One thing I found particularly fascinating was:

This paper provides international evidence on the use of online P2P fund transfers. P2P electronic funds transfers dominate some European countries where checkbooks are not used by households. For example, it is very common for a schoolteacher in Germany to collect money for a certain school activity (such as an end-of-year class trip) via this system. The teacher simply provides parents with her own bank account information, and parents use their Web access to their bank account to transfer any amount of money at no cost to them, adding a note stating the student’s name and the purpose of the transfer. Most bills in Germany (such as payments made to dentists, daycare centers, and landlords) are also paid via account-to-account electronic transfers because most people do not have a checkbook. Thus, in Germany, merchants and consumers view electronic transfers of this sort as the most practical and least costly alternative to cash and plastic card transactions (see Litan and Baily 2009).

I had no idea! Frankly, the idea terrifies me. Just another security nightmare, as far as I’m concerned … but then, I’m a Luddite. I don’t even have a debit card – when they came out, I couldn’t figure out why I would want to pay a transaction charge, when I could use cash or credit for free.

A bit like the scuffle I had with a custodian once. They hated our paper confirms that got faxed to them. ‘Why not use electronic files?’ they wanted to know ‘It will be easier!’ Then they told us that there would be a charge for electronics, vs. the free faxes. I’ve never been quite sure whether they were genuinely stupid, or whether they assumed that since it was only client’s money that we wouldn’t care. The latter is usually the case … but why were faxes (which they had to keypunch into their system) free, and the electronics expensive? I’ll never understand this world …

Hedge funds have made millions betting against helpless sovereigns … now it appears that Italy’s made bllions betting against hedge funds:

Italy’s Treasury earned 8.1 billion euros ($10.9 billion) from interest-rate and currency swap operations since 1998 in an eight-year winning streak.

The Rome-based Finance Ministry lost 392 million euros in 2008 and 337 million euros in 2007 in the transactions, according to 1998-2008 figures supplied by Eurostat, the European Union’s statistics office. Until then, the government had made money on the operations.

The Bloomberg story doesn’t make it clear whether this was speculation, or hedges that they were awfully, awfully glad they had in place.

I’m going to start trying to restrain myself; nobody’s said anything, but I suspect that PrefBlog is becoming a little too angry and may be perceived as bitter. Really, I’m going to try. But when one considers Greece’s excuse for its fiscal woes, isn’t calmness a sign of mental disease?

On Tuesday a German state finance minister said Greece had to help itself out of its precarious fiscal situation and cannot expect Germany or the European Union to bail it out.

Pangalos criticised Germany’s attitude towards the Greek crisis, saying Athens had never received compensation for the economic impact of the Nazi occupation during World War Two.

“They took away the Greek gold that was at the Bank of Greece, they took away the Greek money and they never gave it back. This is an issue that has to be faced sometime in the future,” he said.

“I don’t say they have to give back the money necessarily but they have at least to say ‘thanks’,” he said. “And they shouldn’t complain so much about stealing and not being very specific about economic dealings.”

Honestly! Doesn’t it remind you of a 45-year old woman complaining her life is a mess because her Mum wouldn’t let her go on dates until she was sixteen? Kick ’em out of the EU and let in Macedonia, that’s what I say!

I was in Commerce Court West yesterday attempting to transact some business … but GWL Realty Advisors has decided it’s a HIGH PROFILE TARGET FOR TERRORISTS and has installed security choke-points at the entrance to the elevators, complete with officious dolts who demand to know your itinerary if you don’t have a pass card. In the absence of any knowledge of a specific threat, I must conclude that GWLRA are a pack of hysterical old women; the terrorists I read about prefer high profile offices (such as the Parliament buildings … I don’t mind security there) and massacre of randomly chosen innocents.

The food court in the basement of the building is at far greater risk than any of the offices on the upper floors – but that doesn’t matter to self-aggrandizing security officers, does it? They must be doing a good job, they’re visible! And there must be what? Three, four bombs going off every day in Toronto, eh? Still, it makes the security guys feel important and – best of all – it makes the terrorists feel important, too. I suggest that all readers of PrefBlog who are terrorists write GWLRA a thank you note for their achievement. And, for God’s sake, if you’re planning an operation at Commerce Court West, make an appointment with somebody.

So I called my guy and told him to mail me the documents; I’m not going to perform as an extra in GWLRA’s Sergeant Rock fantasy.

The SEC has cemented its reputation as a panderer to politicians and upholder of feel-goodism by approving a new short-selling rule:

The alternative uptick rule (Rule 201) approved today imposes restrictions on short selling only when a stock has triggered a circuit breaker by experiencing a price decline of at least 10 percent in one day. At that point, short selling would be permitted if the price of the security is above the current national best bid.

Naturally, this rule will rarely be triggered and (as has been shown by extensive academic research) when triggered will do more harm than good. But the SEC not only gets a chance to Take Forthright And Decisive Action, but now there’s another gotcha in its bag of tricks. You don’t have procedures in place to enforce the rule? No written policy statements? No checklists? Gotcha!

Volume spiked upwards today but the market had no clear direction as both PerpetualDiscounts and FixedResets gained a little less than 1bp on the day.

PerpetualDiscounts now yield 5.90%, equivalent to 8.26% interest at the standard 1.4x equivalency factor. Long Corporates now yield about 5.9% – maybe a little under – so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 235bp, a modest (and perhaps spurious) tightening from the 240bp reported February 17.

Econbrowser‘s Menzie Chinn has written an interesting piece on ‘crowding out’:

A relevant question, is what happens when the Fed exits from quantitative easing (and relatedly, as slack in the economy declines). That being said, extreme upward pressure on interest rates, and reduction in investment expenditures, is not a foregone conclusion.

Crowding out has a strong hold on many people’s imagination. Some equate crowding out in the financial market with crowding out in the real side of the economy. Let me make a couple observations on why this simplistic equation need not hold.

First, the empirical magnitude of investment crowding out depends critically on the interest sensitivity of investment expenditures.

Second, if investment depends upon the change in GDP, as in a simple accelerator model (see a discussion of competing investment models here), then government spending that induces an increase in GDP can result in higher investment, despite an increase in interest rates.

Third, when one assumes three (or more) outside assets instead of two, then money and bonds are not necessarily substitutes. Benjamin Friedman laid out a model with money, bonds and equities/capital. Depending upon whether bonds are closer substitutes with capital or money, one can obtain crowding out or crowding in (see this powerpoint presentation).

I teach crowding out in the context of the IS-LM model. For those who want to work in the loanable funds framework, see DeLong, and Krugman.

Boyd Erman had a good column in the Globe & Mail today – Want to fix Ottawa’s books? Try working a bit harder. He starts off with the demographic problem – which Spend Every Penny considers “academic” – and ties it into lower Canadian productivity growth compared to the US:

It can’t be that Americans are more talented in almost every industry. Some of it has to come down to effort, to how hard Canadians squeeze their lemons, with all due respect to our self-image as a nation of sloggers.

A portion of the gap also seems to come down to risk taking. Americans will try new and novel ways to get at the last bit of juice in the lemon, even if there’s a chance it will fail, while Canadians default to the tried and true even if it’s less promising.

This is certainly true in the securities business. Imagine you work in New York as, say, an institutional bond salesman. You come up with a good idea for a new product or a new way of doing things or you want to provide one of your clients with a non-standard service … anything like that. So you go to your boss, tell him about it – and if it doesn’t take too much capital, he can approve it himself. If it takes more capital, there’s a clear path for approval and people are willing to work quickly because if the idea works they’re going to make some money too. And the deal is: if it works, you’re going to get rich. If it doesn’t work, you’re going to get fired. Wanna bet?

In Canada, I can tell you from personal experience that the environment for new products and new ideas is actively hostile. Each of the myriad approvals is granted by somebody who will be criticized if it fails, and not get anything if it works. There’s no clear path for approvals of anything, largely because management gets to be management by sucking arse and waiting for their boss to die. And, if by some miracle a new process gets off the ground and makes hundreds of millions of dollars for the firm … you’ll get your reputation blackened and get fired.

Retail stores work the same way, I believe. There is often criticism of the US on the grounds that it is “over-stored”, with too many stores chasing too few consumer dollars. But behind every one of these struggling stores – now going bankrupt by the boatload, just as in every recession – is somebody with an idea and a willingness to roll the dice with his capital while working sixteen hours a day.

I remember one anecdote along those lines; I can’t remember the non-American country, so I’ll call it Yougaria: A Yougarian looks at the rich folks’ mansions and feels bitter – because he knows in his heart that those mansions are built on his back. An American looks at the rich folks’ mansions and feels good – because he knows in his heart that one day he’ll be able to afford one just like it.

One of my favourite economists, Ken Rogoff (he’s a grandmaster at chess), had some interesting things to say about sovereign defaults:

Following banking crises, “we usually see a bunch of sovereign defaults, say in a few years,” Rogoff, a former chief economist at the International Monetary Fund, said at a forum in Tokyo yesterday. “I predict we will again.”

The U.S. is likely to tighten monetary policy before cutting government spending, sending “shockwaves” through financial markets, Rogoff said in an interview after the speech. Fiscal policy won’t be curbed until soaring bond yields trigger “very painful” tax increases and spending cuts, he said.

Another day of volume-good-results-bad as PerpetualDiscounts lost 15bp and FixedResets were flat. The day was enlivened by the GWO.PR.E call for redemption and the very expensive new issue of a 5.80% Straight by GWO.

The municipal bond insurance business looks sick:

Ambac Financial Group Inc., the second biggest bond insurer, faces as much as $1.2 billion in claims if a judge in Nevada allows Las Vegas Monorail Co., which runs a train connecting the city’s casinos, to reorganize in Chapter 11 bankruptcy. The City Council of Pennsylvania’s state capital shelved a plan to sell taxpayer-owned assets to meet payments on $288 million of debt used for an incinerator funded in part with bonds insured by a unit of Bermuda-based Assured Guaranty Ltd. Harrisburg is weighing a possible bankruptcy filing.
…
Last year, 183 tax-exempt issuers defaulted on $6.35 billion of securities, according to Miami Lakes, Florida-based Distressed Debt Securities Newsletter. That’s up from 2008, when 162 municipal borrowers failed to meet obligations on $8.15 billion of debt. In 2007, 31 of them defaulted on $348 million of bonds.

The timing of the UK Government disposition of its shares in banks is becoming a political issue:

David Cameron’s opposition Conservatives pledged to sell U.K. government stakes in Royal Bank of Scotland Group Plc and Lloyds Banking Group Plc to voters as their support continued to slip in opinion polls.

The plan to sell shares at a discounted price, outlined by Conservative Treasury spokesman George Osborne, comes as voters move away from the party after it called for spending cuts to start this year to reduce the budget deficit. A poll by YouGov Plc in the Sunday Times newspaper showed the Conservative lead over Prime Minister Gordon Brown’s Labour Party at its narrowest since December 2008.
…
Business Secretary Peter Mandelson dismissed the proposal in an interview with BBC Television as a “silly little gimmick,” saying retail investors already can buy shares at a “knock-down price.”

Chancellor of the Exchequer Alistair Darling says the government will only sell its stakes in the banks when the shares have recovered enough to make a profit for taxpayers. Neither party has committed itself to a timetable for disposal.

Mind you, the British government is run by a pack of schoolkids:

Staff working directly for U.K. Prime Minister Gordon Brown contacted a telephone helpline that offers advice for people who say they have been bullied in the workplace, the BBC reported, adding to reports that he mistreated staff.

Who’s more contemptible? I’ll say the guy who is so insecure that he wants crybabies on staff, myself.

It is with a heavy heart that I report that Judge Rakoff has reluctantly approved a revised BofA / SEC settlement:

Bank of America Corp., the largest U.S. bank, won court approval of a $150 million settlement with the Securities and Exchange Commission over alleged misstatements about the purchase of Merrill Lynch & Co.

U.S. District Judge Jed S. Rakoff in New York said today he “reluctantly” approved the settlement of two suits in which the agency accused the Charlotte, North Carolina-based bank of misleading investors following the announcement that it would acquire Merrill Lynch. He criticized the accord as “half-baked justice at best” and “inadequate and misguided,” while adding that the law compels him to defer to regulators seeking approval.

No admission of guilt, no proof of guilt, no arguments for, no arguments against, nobody’s losing their license, nobody’s barred from being directors or officers. Just another case of regulatory extortion, with so-called justice being administered by bureaucrates behind closed doors. I liked the first plan better.

Volume picked up somewhat on a rough day for the market in which PerpetualDiscounts lost 20bp and FixedResets were down 3bp. All of the gainers with noteworthy performances were various flavours of floating rate issue.

What-Debt? does not support a tax on financial institutions – taxes can be discussed, quantified and challenged in court: true to his authoritarian instincts, he seeks instead a transfer of power to regulators:

Canada opposes efforts to impose a new global tax on financial services in the world’s major economies, according to a government document obtained by Bloomberg News.

Prime Minister Stephen Harper’s government, which will host a summit of Group of 20 leaders in June, instead is urging countries to adopt sound regulatory practices such as Canada’s, according to an internal document distributed today to lawmakers from the governing Conservative Party.

Meanwhile, Spend Every Penny is proud of his total inability to think ahead:

“We know that other countries do this type of analysis [of the effects of demographics on government finances]. The U.S. does it annually. The U.K. does it annually. Scandinavians do it annually. Other countries do it every three years. This … needs to become a regular pattern in Canada.”

Finance Minister Jim Flaherty’s office suggested Mr. Page’s report is speculative. Spokesman Chisholm Pothier said the government is concerned with immediate challenges.

“Making assumptions and calculations 75 years into the future may be an important academic exercise for some, but Canadians expect their government to focus on today’s economy and securing the fragile economic recovery,” Mr. Pothier said.

I guess they’re too busy bragging to the G-20 about how often they lecture the banks about forward planning!
The Philadelphia SEC is incorporating social networks into market surveillance, which makes all kinds of sense:

“Our focus is on conducting trader-based investigations, rather than going security by security,” said [Philadelphia SEC Director Daniel] Hawke, who has run the Philadelphia office since 2006 and will now also serve as director of the new market abuse unit.

The goal, he said was to discover “hard-to-detect frauds.”

Much of the initial detective work that Hawke’s group is doing relies heavily on computers. The team cross-checks trading data on dozens of stocks with personal information about individual traders, such as where they went to business school or where they used to work.

Hawke said his investigators are looking for patterns of “behavior by traders across multiple securities” and seeing if there are any common relationships or associations between those traders.

The Boston Fed has released a Public Policy Brief by Katharine Bradbury titled State Government Budgets and the Recovery Act:

State and local governments, with revenues reduced sharply by the recession, are responding by cutting services, increasing tax rates, and drawing down reserves; they are also receiving some relief in the form of stimulus funds provided by the federal government. The stimulus funds legislated in the American Recovery and Reinvestment Act only partly offset the recession‐induced shortfalls and are scheduled to phase out before most analysts believe state and local governments will see fiscal recovery well underway. Thus, observers are concerned that the state‐local sector will create a substantial drag on the overall economy during fiscal year 2011 and into 2012. This brief compiles data on state gaps, responses, and stimulus funding nationwide and discusses potential implications for the national economy.

Volume remained at good levels to close the week, but prices were mixed; PerpetualDiscounts lost 16bp while FixedResets gained 8bp.

There are mutterings that maybe London isn’t as bad as all that, taxes and all:

Heavy tax demands on London’s under-fire hedge fund industry are unlikely to spark an exodus of operators to rival financial hubs such as Dublin or Geneva, a survey by property advisor Cushman & Wakefield showed.

The study into the impact of taxation on corporate locations showed only one in 10 UK-based companies considered national tax policy or government incentives as an “absolutely essential” factor when choosing a location for their businesses.

Instead, financial occupiers like hedge funds prize ease of international travel, good internal infrastructure and access to a diverse labour market over fiscal policy, putting London ahead of traditional rival Geneva on all counts, the report showed.

Volume moderated a little on a day enlivened by the ACO.PR.A redemption announcement and a a new FixedReset issue, 5.25%+262, from Brookfield Renewable Power Preferred Equity. PerpetualDiscounts lost 6bp and FixedResets were down 4bp.

Assiduous Readers will remember that I am rather curious about the social benefits of increasing bank capital. It is all very well to say that more capital is good, but in a world of limited resources, socking away huge amounts of capital and taking it away from productive investment elsewhere is going to have costs as well as benefits. I haven’t seen any econometric analysis of those costs, but JP Morgan is starting the conversation:

Top banks will need an extra $221 billion (139.6 billion pounds) of capital and see annual profits slump by $110 billion if all proposed regulations to reform the industry are brought in, leading analysts said on Wednesday.
If all the initiatives from regulators are implemented it would cut the average return on equity to 5.4 percent from 13.3 percent next year, hurt economic growth and raise costs for bank services, JPMorgan analysts warned.

“The cumulative impact of all the proposed regulation suggests that there is a real risk that we may move from a system that was under regulated to one that is over regulated and that that could cause a significant increase in lending costs and a negative impact on the economy,” Nick O’Donohue, head of research at JPMorgan, said in a research note.

KPMG has issued a TaxNewsFlash titled CRA Narrows GST-Exempt Financial Services; one of the items is:

Investment dealers’ trailer fees
In this example, an investment dealer who arranges to purchase units of a mutual fund for an investor receives a “trailer commission or fee” from the fund manager. The prospectus describes these fees as being paid in recognition of investment advice and ongoing administrative services provided by the dealer to the investors.

In this situation, the CRA says the services provided by the investment dealer including advice, arranging for the purchase of the units and ongoing administrative services are GST-taxable.

Volume picked up again today, but prices were off by a hair, with both PerpetualDiscounts and FixedResets losing 2bp on the day. The day was enlivened by the announcement of a new IAG 5.90% Straight after the close.

PerpetualDiscounts now yield 5.85%, equivalent to 8.19% at the standard equivalency factor of 1.4x. Long Corporates have eased of to a yield of about 5.9% so the pre-tax interest equivalent spread (also called the Seniority Spread) is now about 230bp, coming in a bit from the 240bp reported February 10.