Category: Market Action

Comrade Peace-Prize wants to make the Build America programme permanent:

Obama will propose expanding the eligibility of the bonds to include original financing for capital projects when he submits his 2011 budget to Congress tomorrow, according to the official, who requested anonymity.

Under the Build America program, part of the economic stimulus package Obama signed into law last February, the federal government provides a 35 percent rebate on issuers’ interest costs. That would go down to 28 percent under the proposal in the president’s budget, according to a Treasury Department official who spoke on condition of anonymity.
…
Build America Bonds “were successful in helping to repair a severely damaged municipal finance market, making much needed credit available at lower borrowing costs for infrastructure projects that create jobs,” Treasury Secretary Timothy Geithner said in an e-mailed statement released by his office. “By making Build America Bonds a permanent and expanded financing tool for state and local governments, we’re investing in our country’s long term economic growth in a cost-effective way.”

The ever-opportunistic CC&L group is establishing a mutual fund that will invest in these securities:

As at December 14, 2009, securities in the Indicative Portfolio had a weighted average Investment Grade credit rating of ‘‘AA’’
by S&P (or equivalent) and average Effective Duration of 11.1 years.
…
The Fund will have a term of approximately five years, terminating on or about February
, 2015, and the Fund’s investments will be liquidated prior to such termination at the then prevailing market prices.
…
‘‘Effective Duration’’ is a measure of the estimated percentage change in price for a 100 basis point change in interest rates and takes into consideration changes in cash flows and values that can occur in bonds with embedded options such as call and put provisions.

“Yep”, says Granny Oakum, “I’m going to invest in long bonds, but it’s safe because the find winds up in five years!”

What I consider fascinating about the whole thing is the indication that municipalities’ financing needs can no longer be met in the US domestic tax-exempt market. Sic transit gloria mundi.

However, there is still a place for derivatives:

Investment bankers in the US have begun using equity derivatives to convert restricted shares paid as bonuses into cash, side-stepping new guidelines on remuneration which were designed to prevent bankers cashing out for at least three years, according to a headhunter.

The bankers are using over-the-counter equity derivatives strategies such as call options, put options and collars to monetise their shares now, albeit at a discount to what they would receive if they waited for the restrictions to lift.

Politicians reaffirmed their total committment to the idea that bank managers should embrace long-term thinking:

“We have to show short-term results,” French Finance Minister Christine Lagarde said in an interview at the conference shortly after chairing a private meeting between bankers, politicians and regulators.

U.K. Chancellor of the Exchequer Alistair Darling, White House economic adviser Lawrence Summers and U.S. House Financial Services Committee Chairman Barney Frank, who were all in Davos, also expressed frustration.

“We simply don’t have years to sort the problem out,” Darling told reporters in Davos on Jan. 29. “There needs to be a sense of urgency.”

Quck! How many years did it take to negotiate Basel II?:

However, despite its contributions, the [Basel I] accord was quickly perceived to be inadequate and since the early 1990s there began an on-going process of updating and reforming the accord to match changing realities in the world of banking, and the preferences and concerns of major players in the system. A series of adjustments were made to the accord in the early to mid-nineties before the inevitable realisation set in that a replacement accord was needed rather than piecemeal reform. In June 1999 the Basel Committee announced that it would begin negotiations on a new capital accord to replace the 1988 agreement.
…
Of particular interest in this story is the continued dominance of the United States over European regulatory authorities. At several moments in the discussions the US has presented its European counterparts with a fait accompli in the content of the new accord, and has been willing only to discuss changes to the wording, not substance. Most damning, in spring 2003 after having gained most of the concessions it sought from fellow Basel members, the US announced that it would likely apply the accord to only a handful of banks, thus greatly weakening the potential impact of the accord and calling into question its validity.

My favourite corporate spokesman – ever – is Goldman Sachs’ Lucas Van Praag.

Not the greatest of days for the Canadian preferred share market, as PerpetualDiscounts lost 17bp while FixedResets gaoing 2bp, on moderate volume.

That’s a wrap!

The Canadian preferred share market closed the month on a sour note, with PerpetualDiscounts down 13bp and FixedResets losing 6bp on a well-behaved day with only one entry in the performance highlights – POW.PR.B, oddly enough, which I have used as a gauge of the market impact of the stupid trading in POW.PR.C. Volume was subdued and dominated by FixedResets.

PerpetualDiscounts closed the month yielding 5.81%, equivalent to 8.13% interest at the standard equivalency factor of 1.4x. Long Corporates returned 4.02% on the month to close with a yield of about 5.8%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 235bp, a little wider than the 230bp reported on January 27.

The first exception to Comrade Peace-Prize’s vengeful tax on banks will probably be short-term funding through repos:

The administration wants to recover government fees spent during the financial crisis through a levy on banks, which is projected to recoup at least $90 billion over 10 years. The fee, proposed as a 15-basis-point tax on liabilities other than insured deposits, could make repo transactions money losers for firms because profit margins on trades may be less than the fee.

“One of the modifications I expect would be to exclude Treasury repo, in part because the Fed wants to drain reserves using the repo market,” said Joseph Abate, a money market strategist in New York at Barclays Plc, one of the 18 primary dealers that trade with the central bank. “The 15 basis points fee would obviously make the banks less willing to participate in those transactions.”
…
Government policy makers have acted to shield the repo market in the past. The House of Representatives passed a financial overhaul bill in December that would penalize fully secured creditors if a systemically important financial firm failed, after carving out an exemption for trades involving Treasury securities.

Bernanke’s appointment to a second term was confirmed by the senate, 70-30.

As a public service, The Toronto Star and the Toronto Police came together this week to illustrate for the man in the street the realities of regulation:

• A statistical blip is dressed up as a trend in order to sell newspapers
• Regulators take stern action to Show Who’s Boss
• Things get back to normal

I know one ETF that’s going to show a rather large tracking error this month …. on the month-to-date, the TXPR Total Return Index Value is -0.32%, while CPD is -0.53%. Allowing 4bp for their fees, that means that their execution of the index rebalancing cost them about 17bp. Given $393-million under management, that comes to about $668,000.

It wasn’t much of day for the Canadian preferred share market, with PerpetualDiscounts down 5bp on the day while FixedResets gained 2bp. There are only three entries on the Performance Highlights table, so individual issues were reasonably well behaved, while volume remained at reasonably normal levels.

The Securities & Exchange Commission has issued a statement SEC Approves Money Market Fund Reforms to Better Protect Investors. Some of the changes are cosmetic and boxticky, others serve the usual regulatory purpose of looking good without addressing the underlying issue. Their rationale for the changes is:

The financial crisis and the weaknesses revealed by the Reserve Primary Fund’s “breaking the buck” in September 2008 precipitated a full-scale review of the money market fund regulatory regime by the SEC. A money market fund “breaks the buck” when its net asset value (NAV) falls below $1.00 per share, meaning investors in that fund will lose money. The SEC’s new rules are intended to increase the resilience of money market funds to economic stresses and reduce the risks of runs on the funds by tightening the maturity and credit quality standards and imposing new liquidity requirements.

Reserve Primary Fund broke the buck because it had a relatively small position in commercial paper that defaulted; there was no backstop to cover the default. While it will be conceded that the mathematical chances of this happening again will be reduced by, say, the strong encouragement to MMFs to hold Treasury securities, the fundamental cause is not addressed: there was no backup.

I have argued that the Volcker proposals for MMF regulation be implemented. Nothing will ever guarantee that commercial paper won’t default; the only thing that will seriously affect the incidence of buck-breaking is a formalization of the current nod-and-wink guarantee by the sponsor; it will then require a double-default to break the buck.

The Boston Fed has released a book of conference proceedings titled Policymaking Insights from Behavioral Economics with chapters:

• Behavioral Economics: Its Prospects and Promises for Policymakers
• Behavioral Aspects of Price Setting and Their Policy Implications
• Household Savings Behavior in the United States: The Role of Literacy, Information, and Financial Education Programs
• The Behavioral Economics of the Labor Market: Central Findings and Their Policy Implications
• U.S. House Price Dynamics and Behavioral Economics
• Happiness, Contentment, and Other Emotions for Central Banks
• Behavioral Economics and Public Policy: Reflections on the Past and Lessons for the Future
• Implications of Behavioral Economics for Monetary Policy
• Behavioral Economics as “Psychologically Informed” Economic Inquiry

Comrade Peace-Prize’s bank regulation initiative caused some chatter at Davos.

A relatively quiet day on the Canadian Preferred Share market, with PerpetualDiscounts gaining 8bp and FixedResets losing 6bp on the day. Volume was normal, and there was only one issue exhibiting an interesting amount of price volatility.

PerpetualDiscounts closed yielding 5.78%, equivalent to 8.09% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.8%, so the pre-tax interest-equivalent spread is now about 230bp, continuing to widen from the 215bp reported January 20.

The International Monetary Fund has released the January 2010 Market Update to the Global Financial Stability Report, which contained some items of interest:

Credit losses arising from commercial real estate exposures are expected to increase substantially (Figure 2). The expected writedowns are concentrated in countries that experienced the largest run-ups in prices and subsequent corrections and are in line with our previous estimates.

And without wishing to become too think-tanky, I interpret the following as a warning shot against Comrade Peace-Prize’s unilateralism:

Policymakers should be mindful of the costs associated with uncertainty about future regulation, as this may hinder financial institutions’ plans regarding their business lines and credit provision. But they should also avoid the risks associated with too rapid deployment of new regulations without proper overall impact studies. It also continues to be vitally important that differences in international implementation of the new regulatory framework are minimized to avoid an uneven playing field and regulatory arbitrage that could compromise financial stability.

… but at least one guy thinks that nobody cares anyway, not even Comrade PP himself:

Philip Swagel, a former U.S. Treasury Department official who teaches at Georgetown University in Washington, said G7 officials would be wise not to worry too much about whether Mr. Obama’s boldest proposals will see the light of day, let alone fret about the U.S. gaining – or even seeking – enough global support that other countries end up having to replicate the measures.

“It’s not that they’re dead on arrival, they were never intended to be initiatives to push forward in the international agenda,” Mr. Swagel said in an interview. “They were aimed at domestic consumption, signalling to the American people that the President is as mad as they are.”

YES WE CAN indulge ourselves with cynical grandstanding!

A mixed day for Canadian preferreds with PerpetualDiscounts up 5bp and FixedResets losing 14bp. The market was well-behaved, with only four issues on the performance highlights list; one of the losers was our old friend POW.PR.C, gradually winding down toward normalcy. Volume continued at elevated levels.

There may be new restrictions on short-selling:

Concern that short-sellers accelerate stock declines may prompt the Securities and Exchange Commission to adopt a rule next month aimed at curbing bearish bets when equities are plunging.
…
Forcing short sellers to wait for a stock to rise above the best price bid may prevent them from flooding the market with sell orders and causing losses to multiply. Some exchange officials say the restrictions known as uptick rules don’t work, citing studies that shows they may be less effective during panics that drive prices down and volatility up.

“There is no empirical data to support the introduction of a new rule,” Hyndman said yesterday at a securities industry conference in Chicago. “But this is the least intrusive of the proposals the SEC was considering.”

BIS has released its Compensation Principles and Standards Assessment Methodology. I was amused by Principle 3:

Staff engaged in financial and risk control must be independent, have appropriate authority, and be compensated in a manner that is independent of the business areas they oversee and commensurate with their key role in the firm. Effective independence and appropriate authority of such staff are necessary to preserve the integrity of financial and risk management’s influence on incentive compensation.

Standard 2: For employees in the risk and compliance function:
o remuneration should be determined independently of other business areas and be adequate to attract qualified and experienced staff;
o performance measures should be based principally on the achievement of the objectives of their functions.

The boxtickers are making sure their post-regulatory positions will be lucrative and unaffected by the firm’s stock price!

Econbrowser‘s James Hamilton writes a spirited argument regarding Why Bernanke should be reconfirmed:

I shake my head when I look at the list of senators who say they’ll vote “no.” How could there possibly be an alternative whom Barbara Boxer (D-CA) and Jim DeMint (R-SC) would both prefer to Bernanke?

Perhaps some senators reason that a “no” vote could score them political points. If so, it’s all the more reason to be alarmed. One of my big criticisms of Bernanke has been that he has put in peril the independence of the central bank from political pressure to help solve the nation’s fiscal challenges. Even if the present skirmish over reconfirmation proves to be just a shot across the bow, it is not an encouraging development in terms of the long-run health of U.S. monetary policy.
…

Or if you’d like to hear others saying the same thing, check out
Edmund Andrews, King Banaian, Brad DeLong, Richard Green, and Mark Thoma.

POW.PR.C was relatively well-behaved today, easing off a little (gently, gently!) from its recent absurd highs. It traded a mere 5,890 shares on the TSX – back to normal there, anyway – in a range of 24.93-04 before closing at 24.90-04, 10×1. Still expensive! Dump ’em while they’re hot!

It was a good day for the Canadian Preferred Share market, as PerpetualDiscounts gained 10bp and FixedResets were up 12bp on good volume. The updraft was well-behaved, with only five issues showing a total return with an absolute value in excess of 1% on the day.

The bank regulators have spent the past few years decrying regulatory arbitrage – the idea that differing jurisdictions can have different rules. Looks like regulatory arbitrage will increase:

Prime Minister Gordon Brown distanced his government from proposals by President Barack Obama to split up banks, saying nations require solutions tailored to their own needs.

Brown’s plan to force banks to detail how they’d unwind in case of their demise is strong enough to protect the U.K., spokesman Simon Lewis told reporters today in London. In contrast, the opposition Conservative Party, said it wanted “Obama-style regulation” to prevent future banking crises.
…
Brown’s response underscores the failure of leaders to develop a coordinated approach to global banking regulations and opens a battle line with the Conservatives before an election that must be held by June. Opposition leader David Cameron praised the bid to keep banks from the “casino operations of proprietary trading.”

The Financial Services Authority, the U.K.’s banking regulator, called the U.S. plans “interesting.” FSA Chairman Adair Turner, who heads a committee examining the issue for the Financial Stability Board, which guides policy for the Group of 20 Nations, opposes a legal split of deposit-taking and trading units, and argues that capital charges on bank trading books help curb excessive risk.

Mind you, nobody knows the definition of proprietary trading:

Other analysts pointed to uncertainty surrounding the detail of Obama’s plan. “We are in the dark as to how proprietary trading activities can be effectively distinguished from Treasury activities and the risk-assumption inherent to market making,” analysts at Keefe, Bruyette and Woods Ltd. said in a note today.

Since prop trading will be allowed if it done to serve customers, and since a counterparty to a trade necessarily has a trading account with the bank and since somebody with an account is by definition a customer … a broad interpretation will have no effect whatsoever!

The Bank of Canada has published a working paper by Teodora Paligorova titled Corporate Risk Taking and Ownership Structure:

This paper investigates the determinants of corporate risk taking. Shareholders with substantial equity ownership in a single company may advocate conservative investment policies due to greater exposure to firm risk. Using a large cross-country sample, I find a positive relationship between corporate risk taking and equity ownership of the largest shareholder. This result is entirely driven by investors holding the largest equity stakes in more than one company. Family shareholders avoid corporate risk taking as their ownership increases unlike mutual funds, banks, financial and industrial companies. Stronger legal protection of shareholder rights is associated with more risk taking, while stronger legal protection of creditor rights reduces risk taking.

Hmm …. so the Bank Act, with its restrictions on control, serves to increase the propensity for risk taking by banks …. hmmmm …

Econbrowser‘s James Hamilton takes a look at inflation fears and concludes that we don’t need to worry … yet:

Click for big

Inflation is not something you should be afraid of for 2010. But what we need is a convincing commitment from the government to both near-term stimulus and longer-term fiscal responsibility in order to be assured that it’s not a concern over the next decade.

And that’s not what I’m seeing from the U.S. Congress.

POW.PR.C continued to trade well in excess of its normal volume but the peak of the idiocy appears to have passed. Moody’s massive downgrade of BMO Prefs did not have any immediate effect on their price.

Volume declined a little but remained elevated, as PerpetualDiscounts gained 6bp and FixedResets lost 5bp.

Sheila Bair criticized the size of banks’ prop trading books in her Crisis Committee testimony. Comrade Peace Prize is going one step further:

President Barack Obama will offer proposals to limit financial institutions’ size and trading activities as a way to reduce risk-taking, an administration official said.

Obama will announce the rules today after meeting with former Federal Reserve Chairman Paul Volcker at the White House. The proposals will be part of an overhaul of regulations and will specifically address firms’ proprietary trading, the official said yesterday on the condition of anonymity.

Hedge funds here we come! The above was written last night when the first news came out; I devoted a post to the actual announcement.

The Bank for International Settlements has released a massive collection of papers titled Monetary Policy and the Measurement of Inflation, Prices, Wages and Expectations.

The Bank of Canada has released the January 2010 Monetary Policy Report.

PerpetualDiscounts got slapped down today, losing 33bp, while FixedResets kept on trucking with a gain of 3bp. Heavy volume!

There was another big whack of retail-sized trades today in POW.PR.C, with Nesbitt buying 20,900 shares on the TMX (against total volume of 34,297) at an average price of 25.555. If CPD is behind the buying, this will almost certainly hurt performance.

Another day of good volume with the FixedResets scoring yet another shut-out on the volume table as – presumably – some players rejigged their portfolios with the closing of the AER.PR.A and BPO.PR.N issues.

PerpetualDiscounts lost 15bp on the day, while FixedResets lost 10bp.

PerpetualDiscounts now yield 5.75%, equivalent to 8.05% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.9% (maybe a hair more), so the pre-tax interest equivalent spread (also called the Seniority Spread) is now about 215bp, a widening from the 205bp reported January 13.

The repo market for mortgage-backed securities is looking a lot healthier:

Wall Street firms are loosening the terms of their lending to mortgage-bond investors as markets heal, an RBS Securities Inc. executive said.

Repurchase agreement, or repo, lending against the debt has expanded so much since freezing in late 2008 that some banks now offer as much as 10-to-1 leverage and terms as long as one year on certain securities backed by prime-jumbo home loans, said Scott Eichel, the Royal Bank of Scotland unit’s global co-head of asset- and mortgage-backed securities.
…
As asset values dropped during 2007 and 2008, leverage boosted losses, wiping out hedge funds run by London-based Peloton Partners LLP and New York-based Bears Stearns Cos., and damaged markets by leading to forced sales by firms including Santa Fe, New Mexico-based Thornburg Mortgage Inc., which filed for bankruptcy.

This is of particular interest because MBS have embedded put options reflecting the homeowner’s ability to refinance. This means that when yields on MBS – best reflected by the 10-year treasury – increase, the calculated average term of the mortgage increases, since nobody’s going to refinance a loan with a below-market coupon. To offset this, holders of MBS will short 10-year Treasuries … and the more prices go down, the more they have to short. During the bond market crash of 1994, 10-years behaved an awful lot more like long-term bonds than medium term!

The SEC has found something that is not regulated and is proposing forceful action to address the issue:

The requirement that a brokerdealer’s financial and regulatory risk management controls and procedures be reasonably designed to prevent the entry of orders that fail to comply with the specified conditions would necessarily require the controls be applied on an automated, pre-trade basis before orders route to an exchange or ATS, thereby effectively prohibiting the practice of “unfiltered” or “naked” access to an exchange or ATS.

Volume was heavy today and FixedResets recorded another shut-out on the volume tables, probably related to tomorrow’s closing of the AER 6.50%+375 and BPO 6.15%+307 FixedReset issues. Price action was muted, with PerpetualDiscounts up 2bp and FixedResets down 2bp.