Category: Market Action

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:

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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.

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.