Category: Market Action

Interesting mutual fund idea:

BlackRock Inc., the world’s largest asset manager, and Blackstone Group LP’s GSO Capital Partners LP are forming mutual funds to invest in loans as the London interbank offered rate rises to the highest level since August.

Within the past two months, the firms have joined Goldman Sachs Group Inc. in announcing funds that invest in leveraged loans pegged to short-term interest rates. Investors poured more than $2.5 billion into bank loan mutual-funds in March and the first three weeks of April, more than triple the amount for March and April last year, according to Lipper FMI data.
…
The S&P/LSTA U.S. Leveraged Loan 100 Index has returned 5.68 percent this year, building on last year’s record 52 percent as lending continues to open up. New money “will provide financing, which will help” merger and acquisition deals get done, according to Invesco Ltd.’s Tom Ewald.
…
This year, $91.6 billion in leveraged loans have been underwritten, more than four times the figure from the same period in 2009, according to data compiled by Bloomberg. The interest charge on leveraged loans is typically tied to Libor.

However, the only term-criteria for inclusion in the index is:

Minimum initial term of one year

… which suggests that – as always – people are so fixated on interest-rate risk that credit risk is forgotten. It brings up a number of issues … we’ve seen (oh boy, have we ever seen) how the redemption on demand nature of mutual funds doesn’t mix too well with borrowers’ desire for long-term funding at short term rates (see Volcker to Regulate Money Market Funds as Banks? and The US Dollar Shortage & Policy Response).

This dichotomy will not play out in precisely the same manner as the USD MMF crisis, of course, since the loans have a contractual term that didn’t begin as money-market …. but a similar crunch could lead to forced selling that that will put the Credit Crunch to shame.

There are rumours that regulatory extortion works as well as ever:

After 11 hours of accusations by members of the Senate Subcommittee on Permanent Investigations, people close to the bank said Goldman is mulling closing the SEC fraud-case chapter on the belief the firm’s reputation, already damaged, might not endure a street fight with the Wall Street watchdog.

“It’s almost a certainty that there will be a settlement,” said a source.

As another person put it, the SEC has an “unlimited supply of ammunition” in the form of e-mails and records that it could release, and Goldman officials would like to avoid having those documents fired back at them the way they were on Tuesday.

Predictably, the boo-hoo-hoo brigade is in full cry. For example, there are reports that Basis Yield Alpha Fund is claiming that it did not independently analyze its investment and simply bought whatever their salesman offered:

Citing several people familiar with the matter, The FT said Basis Yield Alpha Fund was seeking compensation over its $100 million investment in Timberwolf, a so-called hybrid collateralized debt obligation that Goldman took to market in March 2007, Reuters reported.

As far as I can tell, Basis Yield Alpha Fund was run by Basis Capital. It is worthwhile to note the company’s Executive Team page; the proprietors, Steven Howell and Stuart Fowler tout their experience but not their results.

There is pressure to use German banks as a political tool:

German lawmakers considering a bill to aid Greece challenged Chancellor Angela Merkel to involve banks in the rescue, refusing to back down after her government said that would send a “fatal signal” to markets.

The main opposition Social Democratic Party threatened to withhold support for aid next week when the bill is fast-tracked through parliament unless banks are asked to contribute. Members of Merkel’s Christian Democrats said the government should ask banks to voluntarily accept losses on their investments.

After having been hammered by dumb investments in CDOs, the banks should be grateful to the politicians for pointing out better investments, eh?

So-called “Strategic Mortgage Defaults” in the States are increasing:

Decisions by U.S. homeowners to walk away from mortgages they can afford account for an increasing share of defaults, according to Morgan Stanley.

About 12 percent of all mortgage defaults in February were “strategic,” up from 4 percent in mid-2007, New York-based Morgan Stanley analysts led by Vishwanath Tirupattur wrote in a report today. Borrowers are more likely to stop paying their mortgages the higher their credit scores and the larger their loans, the analysts said.

Defaults by borrowers who owe more than their homes’ values are among the biggest risks for the housing market, according to analysts including Zelman & Associates’ Ivy Zelman and Amherst Securities Group LP’s Laurie Goodman. Last month, the Obama administration said it would adjust its anti-foreclosure program to encourage reductions to borrowers’ principal amounts, instead of just the payments they make, to address the issue.

The importance of asset-ratio relative to income-ratio in mortgage default analysis was discussed in the post Redefault on Modified Mortgages

You knew this was coming, didn’t you? The US Senate financial regulation bill says that pension fund managers are too dumb to act as principal or, to put it another way, only the sell-side has the ability to analyze financial instruments:

Fannie Mae, Freddie Mac and Harvard University are among public and private entities that could be shut out of the $605 trillion privately negotiated derivatives market they use to manage risks under legislation being debated in the U.S. Senate, according to an industry group.

The bill would impose a fiduciary duty on swaps dealers doing business with cities, states, government agencies, pension plans and endowments, applying standards that would require banks such as JPMorgan Chase & Co. and Goldman Sachs Group Inc. to put the interest of those entities ahead of their own.

But I guess it all makes sense, eh? The politicians have to do something to show they are Responding To The Credit Crunch and since the buy side was (approximately, more or less, give or take) unscathed by the horror, the sell side (which nearly destroyed itself) must take on responsibility for advising it.

A mixed day on continued heavy volume for the Canadian preferred share market, as PerpetualDiscounts were able to record a gain of 9bp, while FixedResets continued their descent, losing 17bp to bring the median average yield-to-worst up to 4.56%. That’s a point more than their yield on March 31. A full point!

Spain’s been downgraded:

Spain had its credit rating cut one step by Standard & Poor’s to AA, putting it on a par with Slovenia, as contagion from Greece’s debt crisis spreads through the euro region.

S&P said in a statement today that the outlook on Spain is negative, reflecting the chance of a possible further downgrade if the “budgetary position underperforms to a greater extent than we currently anticipate.” Spain was last cut by S&P in January 2009.

The risk premium investors demand to hold Spanish bonds surged to the highest in more than a year today and the price of insuring Spanish bonds against default reached a record as doubts about Greece’s ability to pay its debt spilled over into Spanish and Portuguese markets.

… and S&P is making recovery-on-default estimates for Greece:

The ratings firm yesterday cut Greece three steps to BB+, or below investment grade, and said bondholders may recover only 30 percent to 50 percent of their investments if the nation fails to make debt payments. Europe’s most-indebted country relative to the size of its economy has about 296 billion euros of bonds outstanding, according to data compiled by Bloomberg.

OSFI’s Assia Billig gave a presentation on the Canada Pension Plan. Real returns on the fund’s portfolio are estimated to be 4.2% +/- 1.5% with 95% confidence. It won’t be holding a lot of government bonds!

Senator Levin is doing some more grandstanding:

Levin, who questioned Goldman Sachs executives during a hearing in Washington yesterday, said the regulatory reform bill being weighed in the Senate will address conflicts where companies have undisclosed interest in betting against clients.

Today’s FOMC statement was encouraging for fixed-income investors:

Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability.

With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

Another day of poor performance on high volume for the Canadian preferred share market, as PerpetualDiscounts lost 16bp while FixedResets were down 12bp.

PerpetualDiscounts now yield 6.35%, equivalent to 8.89% interest at the standard equivalency factor of 1.4x. Long corporates (which are up 0.70% on the month-to-date and +5.76% year-to-date) now yield about 5.7% (edging towards 5.6%!) so the pre-tax interest-equivalent spread is now about 320bp, a significant widening from the 305bp reported April 22, above the recent high of +310bp reported April 7 and a big move wider than the +285bp reported on March 31.

Nomura is finding out that rainmakers are mobile:

Nomura has been hitting turbulence. At least 12 senior former Lehman managers, including Nomura’s deputy investment banking chief, have defected since the firm began paying out guaranteed bonuses last month, casting doubt on Watanabe’s efforts to bridge cultural gaps. Japan’s largest brokerage is struggling to match a rebound in profit at Morgan Stanley, Goldman Sachs Group Inc. and Citigroup Inc.

“Investment banking is ferociously competitive,” said Giorgio Questa, a finance professor at London’s Cass Business School. “I strongly doubt Nomura can develop a strong international investment banking business” because it will struggle to integrate Lehman’s culture, he said.

In shocking news, it appears that Goldman personnel discussed which asset management firms might have wanted to sell what other clients wanted to buy:

Newly disclosed Goldman Sachs Group Inc. internal e-mails cast light on how the investment bank devised collateralized debt obligations called Abacus, including one at the center of a U.S. Securities and Exchange Commission fraud lawsuit.

The e-mails show employees discussed which outside firms would be “easiest” to work with while creating Abacus CDOs to bet against the housing market.

The e-mails were released yesterday by Senator Carl Levin, the Michigan Democrat who leads the Senate’s Permanent Subcommittee on Investigations, as the panel prepares to question Goldman Sachs executives today. In one message, a Goldman Sachs worker asked which outside firm would most likely approve assets that hedge fund Paulson & Co. wanted to include in a CDO and bet against.

“The way I look at it, the easiest manager to work with should be used for our own axes,” the author wrote in December 2006, using industry jargon that can refer the firm’s financial interest in a deal. The writer also expressed concern that two firms being considered weren’t likely to sign off on Paulson’s suggested assets. “They will never agree to the type of names [P]aulson want to use[.]”

Even more horrifically, Senator Levin has learned that Goldman was acting as principal:

In another December 2006 e-mail, Tourre discussed other business opportunities for Abacus, outlining a strategy in which Goldman Sachs would “‘rent’ our Abacus platform to counterparties” that wanted to short the market. The messages show “Goldman repeatedly put its own interest and profit ahead of the interests of its clients,” Levin said.

Can you imagine? Putting a trade in front of an asset manager, just as if they were adults? The mind boggles!

In the actual hearing, Senator Levin stated that in the future, institutional clients will not be allowed to take views on the market that are contrary to those of their broker’s research department:

“Goldman Sachs didn’t just make money, it profited by taking advantage of its clients’ reasonable expectation that it would not sell products that it did not want to succeed and that there was no conflict of economic interest between the firm and its customers,” Levin said today in his opening remarks. “Its conduct brings into question the whole conduct of Wall Street.”

The political rhetoric is getting a little wearisome. Senator Levin is, I am quite confident, a knowledgable and intelligent man with a knowledgable and intelligent staff and access to knowledgable and intelligent Treasury / Fed / private analysts. So I can only find solace in the idea that it’s just political breast-beating with the aim of passing his favoured legislation and extorting a little fuck-off money from Goldman to highlight in his next re-election brochures.

There’s nothing on the the company website, no press releases I can find and nothing on SEDAR … but Canadian Banc Recovery Corp. had a footer ad on the front page of the Globe & Mail Report on Business today touting their “Attractive Distribution” … and the PrefBlog Forecasting Department thinks this means that a treasury offering will be forthcoming soon for BK and BK.PR.A.

Another rough day for the Canadian preferred share market, with PerpetualDiscounts down 21bp while FixedResets lost 27bp. Volume continued heavy.

IIROC has announced that downtown Toronto will be safe and accessible under any conceivable conditions:

IIROC recently decided to cancel the industry business continuity planning test that was scheduled for June 26, 2010 due to complications associated with the G20 meeting which is now scheduled in Toronto for June 26-27, 2010. IIROC considered rescheduling the test for the latter part of 2010 but that again proved to be impractical considering the length of time utilities require for participation in such tests.

As a result we have rescheduled the industry test to September 10, 2011. Subsequent business continuity planning tests will be conducted on a bi-annual basis thereafter.

We can only hope that when Al-Quaeda decides to nuke Toronto, they give the utilities proper notice. It is of interest to learn that firms must, by regulatory decree, prepare for fire, famine, earthquakes, terrorism, tornados and plagues of frogs; but that G-20 meetings are considered Acts of God. Our glorious Finance Minister will be pleased!

Senator Carl Levin is shocked at Goldman Sachs’ attitude:

“Investment banks such as Goldman Sachs were not simply market-makers, they were self-interested promoters of risky and complicated financial schemes that helped trigger the crisis,” Levin, 75, said in a statement released with the e-mails.

Self-interest? Promotion? In the co-operative game that is the financial world? Oh, the horror!

At least Fabulous Fab writes entertaining eMails:

The so-called ABX index is “the type of thing which you invent telling yourself: ‘Well, what if we created a ‘thing,’ which has no purpose, which is absolutely conceptual and highly theoretical and which nobody knows how to price?’” [Goldman Sachs executive director Fabrice] Tourre said in a Jan. 29, 2007, e-mail released yesterday by Goldman Sachs. Watching the index fall is “a little like Frankenstein turning against his own inventor.”

The shortcomings – well, they’re more like odd nuances, actually – of the ABX index have been discussed on PrefBlog throughout the Credit Crunch.

DBRS has commented on the Bank of Ireland capital raise:

Today’s comment follows Bank of Ireland’s announcement of a fully underwritten proposal to raise EUR 3.421 billion equity tier 1 capital. This proposal includes a EUR 0.5 billion institutional placing of ordinary shares, a partial conversion of the Irish Government’s preference shares of EUR 1.036 billion to ordinary shares, and a rights issue of up to EUR 1.885 billion. The latter rights issue may be reduced by the equity generation and profits from the also just announced debt for equity exchange offer.
…
Importantly, the completion of the proposed actions will allow Bank of Ireland to fulfil its obligation to raise an additional EUR 2.7 billion of equity capital to meet the requirement established as part of the completion of the Financial Regulator’s Prudential Capital Assessment Review for the Irish banking sector. As a result of these actions and the expected National Asset Management Agency (NAMA) transfers, the Group’s equity tier 1 capital ratio, on a pro-forma basis, at 31 December 2009, will increase to 8.0% and the Group will be able to maintain a minimum equity tier 1 ratio of greater than 7% going forward. Moreover, the announcement includes the full cancellation of the Government’s warrants in the Group in return for a cash payment of EUR 491 million, reducing the potential for the Government to increase its holdings in the Group. As a result, the Irish Government’s maximum ownership will be 36% that compares to a current fully diluted ownership of 34%, prior to completion of this transaction.

The Irish bank capital requirements have been previously discussed.

PerpetualDiscounts were hit hard today, losing 26bp on heavy volume while FixedResets lost a mere 4bp,

Greece has gone to the well:

Debt-stricken Greece appealed to its European partners and the IMF for emergency loans on Friday, yielding to overwhelming market pressure to set in motion the first financial rescue of a member of the euro zone.

Prime Minister George Papandreou requested the 45 billion euro ($60.5 billion) package after a months-long selloff by investors pushed borrowing costs to record levels and undermined Athens’ efforts to cut its 300 billion euro debt pile.

“This is the moment. The time that was not granted to us by the markets will be given to us by the support of the euro zone,” Papandreou said in a statement broadcast live from the remote, tiny Aegean island of Kastellorizo.

It appears that, at the very least, there was internal strife at Moody’s:

In September 2007, a manager at the New York-based ratings company resisted a plan to grade new collateralized debt obligations filled with mortgage bonds by including the assumption that Moody’s rankings on the underlying home-loan securities were no longer accurate, Eric Kolchinsky told the Senate Permanent Subcommittee on Investigations in prepared testimony today.

A more senior manager eventually agreed to allow the new policy, which Kolchinsky, who headed the company’s mortgage-bond CDO group, thought was needed after a meeting earlier that month where its home-loan securities analysts revealed that they planned to downgrade a large number of subprime notes, he said. The change was announced Sept. 21, 2007, and followed a similar shift at Standard & Poor’s announced in July.

“I believed that to assign new ratings based on assumptions which I knew to be wrong would constitute securities fraud,” said Kolchinsky, who said he was demoted as a result of his actions then and later suspended after complaining about “a nearly identical situation” in 2009.

An employee at hedge-fund firm Paulson & Co. said it had a chance to keep betting against subprime mortgages in January 2007 in part because companies including ratings firms had “incentives to keep the game going,” the Securities and Exchange Commission said April 16 in suing Goldman Sachs Group Inc. over a CDO that the agency alleged Paulson helped create.

An 18-month inquiry by the congressional panel, led by Senator Carl Levin, found that ratings companies “used outdated models and inadequate data, were too influenced by investment bankers, allowed chronic resource shortages to undermine ratings, and delayed downgrading investments,” according to a statement yesterday from the Michigan Democrat.

There’s some fascinating revelations about IKB, one of Goldman’s so-called victims:

Yesterday, I reported that IKB Deutsche Industriebank was not the sucker at the table that the SEC depicts in its lawsuit against Goldman. Indeed, its executives were wily and wealthy financiers who employed financial engineering shenanigans to escape the watchful of eye of regulators, shareholders, and auditors.

Now a document exclusively obtained by the Daily Beast demonstrates (view them here) that just a few months before it invested in the derivatives at the center of the SEC’s case, the German bank was touting its prowess as a sophisticated investor in those derivatives

In other words, IKB were not just sophisticated financial professionals. They were—or claimed to be—sophisticated and experienced when it came to exactly the kind of junky CDOs, dubbed Abacus, they bought from Goldman Sachs.

“Securitisation and CDO investments are an integral part of IKB AG’s business model,” the document—a marketing brochure for one of IKB’s off-balance sheet conduits—claims.

The brochure describes a man named Dr. Thomas Wolwer as the “Senior Portfolio Manager,” who has the “responsibility for investing in CDOs both cash and synthetic.” His qualifications include working for Dresdner Kleinwort, where he structured and sold various cash and synthetic CDOs. In short, this guy was as experienced in these black financial arts as you can get.

In short, according to me, this guy was just another sell-side bozo. I will never understand why people listen to track-recordless stockbrokers and institutional salesmen. But they do! Even their managers do! The financial crisis has shown that even people in a very good position to know otherwise somehow equate the ability to keep inventory turning over with regularity with an understanding of what it is.

It’s like hiring the best used-car salesman you can find as chief mechanic! It’s exactly the same thing as the Madoff fiasco … Funds of Funds were talking up their due diligence while stuffing money down the Madoff rat-hole. So-called due diligence is mostly just box-ticking by staff completely unable to do a proper job anyway.

One way or another, the marketting document obtained by The Daily Beast is in the very best tradition of investment sales … experience of everybody on the team is meticulously recorded and there’s not a word about performance.

However, the whole thing has become a political issue:

U.S. Securities and Exchange Commission Chairman Mary Schapiro may face an investigation into whether politics drove the agency’s decision to sue Goldman Sachs Group Inc. for fraud.

Representative Darrell Issa, a California Republican, asked SEC Inspector General H. David Kotz to determine whether the agency’s April 16 lawsuit was timed to bolster the Obama administration’s push to overhaul U.S. financial rules. Schapiro, a political independent, said on April 21 that neither the White House nor Congress have any influence on SEC enforcement actions.

The IMF’s bank tax is not a slam-dunk:

Group of 20 finance ministers and central bank governors pushed a debate over a global bank tax to June, saying more study is needed on how best to ensure banks, rather than taxpayers, pick up the cost of future bailouts.
…
“We call on the IMF for further work on options to ensure domestic financial institutions bear the burden of any extraordinary government interventions where they occur, address their excessive risk-taking and help promote a level playing field, taking into consideration individual countries’ circumstances,” the G20 said in a statement at the conclusion of the meeting.

Britain, Germany, France and the United States – among the world’s most powerful nations – all have been supportive of a global bank tax. The decision to order the IMF back to the drawing board suggests that Mr. Flaherty, who was the co-chair of the meeting, was successful in rallying countries such as Australia and Russia to resist the push for a global levy. For weeks, Mr. Flaherty has mounted a vocal stand against the pro-tax lobby, saying it would unfairly punish countries such as Canada that avoided multi-billion dollar bank rescues during the financial crisis.

Canadian inflation declined:

Statistics Canada reported Friday that Canada’s annual inflation rate slipped by two-tenths of a point to 1.4 per cent, and the closely watched Bank of Canada core rate fell even further – by four-tenths of a point to 1.7 per cent in March.
…
The agency said the big reason for the drops in both annual indexes was that the price-distorting Olympics ceased being a major contributor to inflation with the conclusion of the Winter Games at the end of February.

Prices for traveller accommodation soared 16 per cent in February – 64.1 per cent in British Columbia – but in March they dropped back to earth to a more tame 2.8-per-cent increase from March, 2009.

Volume continued heavy in the Canadian preferred share market today, as PerpetualDiscounts lost 6bp while FixedResets put in a gain of 27bp. FixedResets scored a shut-out on the volume table.

Moody’s has downgraded Greece one notch:

Greece had its credit rating cut one step by Moody’s Investors Service as the government’s debt servicing costs surge on concern that the country will struggle to reduce its budget deficit.

Moody’s lowered the rating to A3 from A2, four grades above junk, the company said in a statement today. Moody’s also put a “negative” outlook on Greek debt, indicating it’s more likely to cut it again than raise it or leave it unchanged.

“This decision is based on Moody’s view that there is a significant risk that debt may only stabilize at a higher and more costly level than previously estimated,” a team led by Pierre Cailleteau in London said in the statement.

The Bank of Canada has released its April 2010 Monetary Policy Report:

Core infl ation has been firmer than projected in January, the result of both transitory and more fundamental factors. Although core infl ation was expected to remain relatively stable over the near term, it rose from 1.5 per cent in November to 2.1 per cent in February (Chart 13). This upward movement partly refl ects transitory factors, such as the unusual pricing pattern for new passenger vehicles since the introduction of the 2010 models into the CPI in November, and the surge in the price of travel accommodation associated with the 2010 Winter Olympics in Vancouver.

More broadly, the firmness of core inflation over the past year, despite the large amount of excess supply in the economy, refl ects the resilience in the prices of some components of core services, including a significant rise income regulated prices (e.g., communications, tuition fees, and cable services). This resilience refl ects the slower-than-anticipated deceleration in wages, since labour costs represent a large portion of total production costs in core services. Shelter prices have also increased at a faster-than-expected rate, refl ecting the more rapid rebound in housing demand as households pulled forward some of their expenditures.

SEC boss Mary Schapiro has denied the Goldman charges are politically motivated:

“The SEC is an independent law enforcement agency. We do not coordinate our enforcement actions with the White House, Congress or political committees. We do not time our cases around political events or the legislative calendar.

“The fact is that regulatory reform has been pending for over a year. We have brought many cases related to the financial crisis over that period.

“On a personal level, I am disappointed by the rhetoric.

Goldman disagrees:

Yesterday, Lloyd Blankfein attacked the SEC’s fraud suit in calls to Goldman clients–describing it as a political hit job that will ultimately hurt the country.

He also brought up the exculpatory evidence that the SEC left out of its complaint, saying that a staffer of the supposedly swindled ACA knew that Paulson & Co. was planning to go short the Abacus CDO.

This case might even go to trial!

[The Financial Times] said that in conversations with private equity executives and others, Blankfein left clients with an impression he is eager to fight the case in court.

I hope so – it would be marvellous to see a rebuff of regulatory extortion. But given the highly unequal risks experienced by the two parties, a settlement of some kind seems more likely – that’s why regulatory extortion works in the first place, right?

Former (Republican) SEC boss Harvey Pitt thinks the SEC is taking a big risk:

this SEC litigation takes it places it hasn’t been before—

• challenging the premier firm of Goldman Sachs,
• about a synthetic derivative transaction,
• on which Goldman lost millions of dollars,
• where the parties were sophisticated and not in obvious need of SEC protection,
• after a year-and-a-half investigation,
• filed immediately after the President threatened vetoing financial reform legislation that doesn’t strongly regulate derivatives,
• and a few hours before release of the Inspector General’s Report on SEC inadequacies in attacking Alan Stanford’s Ponzi scheme,
• but apparently without giving Goldman advance notice of the filing,
• or exploring possible settlement, and
• splitting 3-2 along political lines in a major enforcement action.

What do I think? It can hardly have been something so overt as a call from Comrade Peace Prize ordering Schapiro to take down Goldman. That would be sufficiently unethical that neither party would have anything to do with such a thing (maybe). But a lot can be done with nods and winks … the SEC desperately needs a scalp … and Goldman – as the sole major investment bank to get through the crisis without blowing up – is the most luxuriant one out there.

There’s more commentary on the BNN Blog (hat tip: Assiduous Reader MS):

But after trillions of dollars in destroyed value, the near collapse of the global financial markets, millions in lost jobs and the deepest recession since the Second World War, is this the best the chief law enforcement agent on Wall Street can muster? That Goldman let a then little-known hedge fund pick some mortgage bonds and put them into a pedestrian-sized CDO?

It’s hardly the plot of an Oliver Stone movie. But it serves a purpose. Especially when the suit was filed four days before Goldman released its first quarter earnings, and published what it plans to set aside for bonuses.

It also doesn’t hurt if your objective is to gather support in Congress for a far-reaching financial services bill that was expected to hit the floor of the Senate this week.

Julie Dickson, Superintendent of Financial Institutions, has delivered a speech to the Empire Club. No new OSFI initiatives were announced, nor were there any hints regarding policy.

The International Monetary Fund has released the April 2010 Global Financial Stability Report, with chapters:

• Resolving the Crisis Legacy and Meeting New Challenges to Financial Stability
• Systemic Risk and the Redesign of Financial Regulation
• Making Over-the-Counter Derivatives Safer: The Role of Central Counterparties
• Global Liquidity Expansion: Effects on “Receiving” Economies and Policy Response Options

Continued heavy volume today saw PerpetualDiscounts getting wallopped for 41bp, while FixedResets were down a mere 4bp.

Goldman may be showing the same cut-throat ruthlessness in its personnel policy as it shows in its customer relations:

Goldman Sachs Group Inc. said the U.S. fraud case against the firm hinges on the actions of the employee it placed on paid leave this week.

Fabrice Tourre, the 31-year-old Goldman Sachs executive director who was accused of misleading investors about a mortgage-linked investment in 2007, will also be de-registered from the Financial Services Authority, a spokeswoman at the firm in London said yesterday.

“It’s all going to be a factual dispute about what he remembers and what the other folks remember on the other side,” Greg Palm, Goldman Sachs’s co-general counsel, said in a call with reporters yesterday, without naming Tourre. “If we had evidence that someone here was trying to mislead someone, that’s not something we’d condone at all and we’d be the first one to take action.”

By characterizing the case as a dispute involving a single employee, Goldman Sachs may be taking its first steps to publically distance itself from Tourre in the case, some lawyers said. That could reduce bad publicity and ultimately make it easier for the company to settle the case.

Very surprising, if true. Regulatory announcements and responses are generally well-orchestrated, with all parties concerned knowing what’s going to happen by the time an issue becomes public; but after two days of honourable conduct by management, it loos like Tourre’s being thrown to the wolves.

There are rumours that Tourre has agreed to testify to a US Senate panel; there is no word on whether anybody from, you know, the Selection Agent will be asked any questions like, f’rinstance: why did you agree to buy this stuff?

In the meantime, Rabobank has sued Merrill regarding similar allegations, which seems to me to be an admission that Rabobank is completely incapable of evaluating a potential investment.

Paulson has addressed investor concerns regarding the issue. In 2007, Paulson wasn’t seen as a member of the Savvy Investor Club (I presume they didn’t have enough employees from the right schools) and the Smart Money was more than happy to bet against them:

Mr. Paulson sent a letter to investors Tuesday night saying that in 2007 his firm wasn’t seen as an experienced mortgage investor, and that “many of the most sophisticated investors in the world” were “more than willing to bet against us.”
…
On the conference call, Mr. Paulson calmly explained the trade with Goldman, which involved a “short” bet on mortgage bonds. He said that the very nature of the transaction required both a “long” and “short” investor, suggesting that investors knew that a bearish investor had bet against the deal.

Mr. Paulson suggested to clients that the large investors who purchased the Goldman deal and others relied on rating firms, and didn’t do enough of their homework, investors say.

For those of you who don’t understand the whole Goldman / ACA / Paulson / Rabobank / Merrill / regulators / government thing, here’s a helpful graphic illustrating the financial world in mid-2007:

The spread on Greek bonds hit an all-time high:

The yield on the Greek 10-year bond surpassed 8 percent today, the highest in more than a decade and more than twice the comparable German rate. The spread, or difference between the security and bunds, Europe’s benchmark government securities, climbed to an all-time high of 521 basis points.

This is all happening as US debt issuance is cresting:

The U.S. Treasury may sell an unprecedented $128 billion in notes next week as expectations increase that the amount of securities auctioned by the government is peaking with the economy strengthening.

The U.S. will sell $44 billion in two-year notes, $42 billion in five-year securities, $32 billion in debt maturing in seven years and $10 billion in five-year Treasury Inflation Protected Securities, according to the average estimate of nine primary dealers in a Bloomberg News survey. The $118 billion in nominal debt matches a record. The U.S. will announce the amounts tomorrow for the auctions conducted over four days beginning April 26.

Good interview on the Queers Against Israeli Apartheid thing that was mentioned yesterday; at best – at absolute best – this is a cat-fight between competing visions of the Pride Parade, in which city bureaucrats have been stupid enough to become involved. It’s strictly an internal matter for Pride. In fact, the Pride parade ceased to have much to do with Gay Pride years ago – nowadays it’s a celebration of sex, the kinkier the better. Ah, to be twenty again! Not that this little news-stream has much to do with finance, of course, but I reserve the right to go off on tangents occasionally whenever I find something particularly annoying.

It was a very rough day for the Canadian preferred share market, with PerpetualDiscounts losing 60bp and FixedResets down 83bp (!) bringing the median weighted average yield on the latter index up to 4.38%, a level not seen since the beginning of July, 2009. Volume was exceptionally high and the Volume Highlights table is split equally between FixedResets and PerpetualDiscounts.

PerpetualDiscounts now yield 6.26%, equivalent to 8.76% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.7% (maybe just a little more?) so the Pre-Tax Interest-Equivalent Spread (also called the Seniority Spread) is now about 305bp, up substantially from the 295bp reported April 14 and pushing the high of 310bp reported April 7.

I don’t usually provide mid-day comments on the market, but this is really interesting.

As of about 1pm, PerpetualDiscounts have lost 43bp and FixedResets are down 77bp, with three issues in the latter class down over 2% on the day so far: IAG.PR.C, MFC.PR.D and GWO.PR.J

There are many, many issues down between 1% and 2%.

Yet more commentary on Goldman, which has been selected for SEC charges:

The case against Goldman Sachs Group Inc. may turn on the meaning of the word “selected.”

The Securities and Exchange Commission must prove that the most profitable company in Wall Street history defrauded investors by failing to disclose that a hedge-fund firm betting against them played a role in creating what they bought. It must also counter Goldman Sachs’s assertion that an independent asset manager, which the SEC said rejected more than half of the securities initially proposed by Paulson & Co. for a collateralized debt obligation, signed off on the selections.

“The question is whether Paulson’s undisclosed role in portfolio selection was material,” said Larry Ribstein, a law professor at the University of Illinois in Champaign who has written about 140 articles and 10 books on topics including securities law and professional ethics. “There’s no clear and well-defined definition of what you have to disclose in this type of transaction.”

“Selected” means whatever you want it to mean. Anybody who has been selected to receive a special mail-order offer knows that. In this particular case, I’d say that ACA’s role as portfolio manager was quite clear: ACA had full authority and full responsibility, full stop.

Meanwhile, politicians in the native land of Magna Charta displayed a lynch-mob mentality:

Goldman Sachs should be suspended from working for the Government until the outcome of a fraud case brought against the investment bank by US regulators is known, opposition politicians said yesterday.

The demand from the Tories and the Liberal Democrats came as the Financial Services Authority (FSA) began an investigation into the Wall Street giant’s operations in London. Goldman Sachs is on a rota of investment banks that advise the Treasury about debt issuance, which has risen dramatically as the budget deficit has escalated.
…
After Gordon Brown described the US bank as “morally bankrupt” at the weekend, Vince Cable, the Liberal Democrat Treasury spokesman, said yesterday: “The Government should not be paying for the services of a bank that is being investigated on both sides of the Atlantic. The allegations made against Goldman Sachs are extremely serious. Not a penny of taxpayers’ money should be paid while these allegations hang over [the bank].”

The Conservatives also questioned whether Goldman should still be on the roster of approved banks. Mark Hoban, the shadow Financial Secretary to the Treasury, said: “If Gordon Brown believes Goldman Sachs are ‘morally bankrupt’, why is he still using them as advisers? … He is lashing out at the people he was very happy to work with over the last 13 years as both Chancellor and Prime Minister.”

I’d remark on just who in this story has demonstrated moral bankruptcy, but those familiar with the elements of fundamental justice will know that already.

The UK hasn’t yet cut off its nose to spite its face:

“I don’t think you can stop doing business with a firm because an individual is accused of doing something,” [Chancellor of the Exchequer Alistair] Darling said in an interview as he traveled by train to Worcester, central England, today.

Britain’s Financial Services Authority said in a statement today it will formally investigate Goldman Sachs’s London units after the U.S. Securities and Exchange Commission sued the bank for fraud last week over its marketing of a collateralized debt obligation. A Goldman Sachs vice president named in the SEC case, Fabrice Tourre, works at the bank’s London office.

An element of Goldman’s defense has leaked out:

The company failed to disclose that hedge fund Paulson & Co. helped pick the underlying securities in a collateralized debt obligation and then bet against them, the SEC said in a lawsuit filed April 16. After being told in July 2009 that the SEC planned to bring a complaint, New York-based Goldman Sachs argued it had been compelled to keep Paulson’s role secret.

The SEC’s “proposed theory ignores the fact that, as a broker-dealer acting as an intermediary on behalf of a client, Goldman Sachs had a duty to keep information concerning its client’s (Paulson’s) trades, positions and trading strategy confidential,” the company said in a Sept. 10, 2009, document addressed to the agency.

Goldman also points out that such client confidentiality is normal practice. Deal Journal has an expanded version of Friday’s press release.

Beyond politics, there’s another proposed rationale for the SEC’s irrational lawsuit:

SEC Chairman Mary Schapiro, 54, is expanding protection of so-called sophisticated investors such as pension funds, insurance companies and banks after financial companies worldwide lost more than $1.78 trillion since the start of 2007 in the worst economic crisis since World War II.

“The days of ‘buyer beware’ may be changing,” said Todd Henderson, a law professor at the University of Chicago. “In light of the financial crisis and the fact that sophisticated investors aren’t just losing their own money but taxpayers’ money, the interest of regulators is higher.”

God save me from regulatory protection!

Meanwhile, in Toronto the Precious, using the words “Apartheid” and “Israel” in the same sentence is considered not just objectionable, but a major issue:

But, she said, the city has told them that Toronto Pride had contravened its anti-discrimination policy on the grounds that “those words make certain participants feel uncomfortable.”

Golly, it’s just terrible that some things some people say make other people uncomfortable, isn’t it? This rivals the Barenaked Ladies moronicity for sheer pointlessness. Perhaps I should write my local councillor – but which stamp should I use? The march comes with credible estimates of $125-million into the city, with additional spending by locals of about $89-million; despite the fact that (I’ll bet a nickel) I can find a lot more Torontonians offended by the whole idea of the march than might be made to “feel uncomfortable” at the sight of a few childish political slogans.

Still, at least we’re not as precious as Vancouver!

Another day of startling relative returns in the Canadian Preferred Share market, with PerpetualDiscounts down 20bp and FixedResets losing 55bp to bring yields on the latter class up to 4.14%. One could argue that this type of flattening in the preferred share yield curve is a rational response to today’s BoC announcement, but such an argument has too high a level of rationality to it to be appealing. Volume picked up again and was quite heavy.

There are no winners on the performance highlights table, which is dominated by FixedResets; these issues also dominate the volume highlights (but that’s considerably more usual!).

TD has bought three failed US banks:

Toronto-Dominion added $3.1 billion in deposits to the $117 billion it holds in two other U.S. lenders, according to a company statement. The lender picked up 69 branches in yesterday’s purchases, bringing its total in Florida to 100.
…
Toronto-Dominion, which has about 1,000 U.S. branches, has spent more than $15 billion over five years buying Portland, Maine-based TD Banknorth and Cherry Hill, New Jersey-based Commerce Bancorp.

The Toronto-based lender acquired the Florida assets and deposits of Clement-based AmericanFirst Bank, First Federal Bank of North Florida in Palatka and Riverside National Bank of Florida of Fort Pierce.

The FDIC press release states:

As of December 31, 2009, AmericanFirst Bank had total assets of $90.5 million and total deposits of $81.9 million; First Federal Bank of North Florida had total assets of $393.3 million and total deposits of $324.2 million; and Riverside National Bank of Florida had total assets of $3.42 billion and total deposits of $2.76 billion. Besides assuming all the deposits from the three Florida institutions, TD Bank, N.A. will purchase virtually all their assets.

The FDIC and TD Bank, N.A. entered into a loss-share transaction on $2.20 billion of the failed institutions’ assets. Initially, TD Bank, N.A. and the FDIC will share in the losses on assets on a 50% – 50% basis.
…
The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) for AmericanFirst Bank will be $10.5 million; for First Federal Bank of North Florida, $6.0 million; and for Riverside National Bank of Florida, 491.8 million.

DBRS comments:

This transaction has limited downside credit risk as there is a loss-sharing agreement in place (FDIC has a share in 50% of the loan losses up to certain thresholds and then 80% in excess of those thresholds). It also has no material impact on earnings and a minimal impact on capital. DBRS notes that TD purchased $3.8 billion in assets, including $2.1 billion in loss-covered loans, and assumed $3.1 billion in deposits.

Stories in Saturday’s Globe by Derek DeCloet and Boyd Erman failed to include any of the Goldman’s four critical points highlighted here on April 16. I guess reporting what the defendant has to say isn’t really exciting news.

Scribd has the marketting material, which shows that Goldman Sachs is the protection buyer; it would be expected in the normal course of events that this would be laid off to clients, rather than retained by the firm. The more I learn about this transaction, the more convinced I am that the SEC charges are a load of hooey. ACA, as the selection agent, can only buy what others want to sell. If there was any malfeasance, it has to be because ACA did not exercise due diligence in its purchases; not because they bought stuff from Goldman’s menu of available instruments without knowing who wrote the menu. ACA, by the way, did not have a meaningful track-record as PMs for this type of deal.

I mean, hey! If I’m running the Very Big Preferred Share Fund and I need to buy 100,000 PerpetualDiscounts to get my allocations where I want them, and I call Friendly Brokers Inc. to find some for me, and they do and it’s executed as a cross …. does it really matter to me who the client on the other side of the cross was? If the shares’ issuer goes bankrupt tomorrow, is the broker really liable because the seller was the Very Smart Preferred Share Fund and they didn’t tell me that because it was none of my business? Really?

Basically, what the SEC is saying in this lawsuit is that “Me too!” constitutes due diligence and safe harbour for Portfolio Managers.

But it’s all just politics:

“We must pass Wall Street reform to bring practices like these into the light of day and protect our economy,” Senate Banking Committee Chairman Christopher Dodd, the Connecticut Democrat who wrote the bill, said in a statement.

Senate Majority Leader Harry Reid, a Nevada Democrat, said the Goldman Sachs case reinforces the need to “pass strong Wall Street reform this year,” and urged Republicans to “stop obstructing our efforts to hold Wall Street accountable.”

and:

President Barack Obama’s political advisers are trying to harness the government’s case against Goldman Sachs Group Inc. to build support for a financial- markets overhaul pending in Congress.

A Google Inc. search of “Goldman Sachs SEC” yields an advertisement entitled “Help Change Wall Street” that is sponsored by Organizing for America, Obama’s official political arm outside the White House.

“Help Pres. Obama Reform Wall Street and Create Jobs,” the ad says. “Families First!”

and:

The U.S. Securities and Exchange Commission split 3-2 along party lines to approve an enforcement case against Goldman Sachs Group Inc., according to two people with knowledge of the vote.

SEC Chairman Mary Schapiro sided with Democrats Luis Aguilar and Elisse Walter to approve the case, said the people, who declined to be identified because the vote wasn’t public. Republican commissioners Kathleen Casey and Troy Paredes voted against suing, the person said.

You know what I figure? I figure it’s the whole David Berry thing all over again. They spent untold hours, untold millions of dollars trying to nail the firm – and the best they could come up with is THAT? The guys at Goldman must be saints.

One commenter has suggested:

To make matters worse, Goldman Sachs is circling the wagons around Fabrice Tourre which I believe is a big mistake. The company should have simply issued a press release saying:

Goldman Sachs does not comment on any current litigation and will address any issues in court proceedings.

In addition, Goldman Sachs could have said that:

The company takes any allegations of impropriety seriously and is placing Fabrice Tourre on leave pending the outcome of the SEC litigation.

In any company, especially a company that is the size of Goldman Sachs, there are always some employees who bend the rules or break the law and end up getting a company in legal trouble. By circling the wagons around Fabrice Tourre, Goldman Sachs raised the ante from a single employee issue involving a certain corporate transaction to a corporate wide issue involving the entire company. A very dumb move!

In other words, that Mr. Tourre should be assumed guilty and thrown to the wolves; that management should not stand up for their staff in times of trouble. Let’s just say that I’m glad I don’t work for that blogger!

But the smarminess is spreading:

Prime Minister Gordon Brown today called for the Financial Services Authority to start an investigation, saying he was “shocked” at the “moral bankruptcy” indicated in the suit. Germany’s financial regulator, Bafin, asked the SEC for details on the suit, a spokesman for Chancellor Angela Merkel said.

Goldman has other problems: the EU wants to scapegoat them for Greece:

providing swaps to the Greek government to help reduce its budget deficit will be “profound and thorough,” EU Monetary Affairs Commissioner Olli Rehn said.

The investigation relates to “our relationship with Goldman Sachs,” Rehn said at a press conference in Madrid today after a meeting of EU finance chiefs and central bankers. “I have asked the Ecofin and Eurostat to conduct a profound and thorough investigation in which the Greek authorities are very well cooperating.”

As discussed on March 1, Eurostat explicitly endorsed the type of transaction Goldman facilitated (note the word “facilitated”, and note that they owed no duty to either Eurostat or the EU) at the time.

There was a bit of a switch in the preferred share market today, with PerpetualDiscounts losing 5bp, while FixedResets lost 19bp to take the median weighted average yield on the latter index up above 4%, territory last traversed in November 2009. Volume was down a bit from the peaks, but remains elevated (FixedResets dominating), while price volatility remains muted.