Category: Market Action

The Fed is plotting its exit strategy:

The Federal Reserve is in talks with money-market mutual funds on agreements to help drain as much as $1 trillion from the financial system as policy makers prepare for the first interest-rate increase since June 2006, according to a person familiar with the discussions.

The central bank is looking to the $3.2 trillion money- market mutual-fund industry because the 18 so-called primary dealers that trade directly with the Fed have a capacity limited to about $100 billion, estimates Joseph Abate, a money-market strategist at Barclays Capital in New York.
…
The Fed is also considering reverse repurchase agreements with mortgage lenders Fannie Mae and Freddie Mac, said the person familiar with the discussions. Freddie Mac spokeswoman Sharon McHale declined to comment. Fannie Mae spokesman Brian Faith also declined to comment.

Meanwhile, the situation in Europe is having knock-on effects:

Investment-grade debt sales are drying up and returns on high-yield bonds have turned negative for the year as investors wait to see whether Europe will bail out Greece.

Borrowers in the U.S. and Europe sold $3.94 billion of high-grade securities this week, the least this year and less than … the average $52.9 billion, according to data compiled by Bloomberg.
…
Investors are avoiding credit risk as European Union leaders meet to hammer out an aid package for Greece. While relative borrowing costs in the U.S. remained steady yesterday and prices to insure against defaults fell, Huntsville, Alabama- based telephone service provider ITC Deltacom Inc. canceled a $325 million bond sale, citing “current market conditions.”
…
Corporate bonds have returned 1.39 percent this year, according to the Merrill index. Junk bonds lost 1.58 percent so far this month, the most in a year, the bank’s U.S. High Yield Master II Index shows.

The High Frequency Traders are taking over!:

Getco LLC, the high-frequency trading specialist founded a decade ago, agreed to become a so- called designated market maker at the New York Stock Exchange, a move that will add liquidity as the biggest U.S. equity venue seeks to halt share losses.

Getco purchased rights to handle floor trading in 350 stocks from Barclays Plc, according to a statement today from NYSE Euronext, owner of the New York Stock Exchange. The designation means Getco will be obligated to buy and sell shares at the national best bid and offer price, as well as participate in opening and closing trading sessions.

The agreement formalizes Getco’s role as a market maker with the NYSE after acting as one on electronic platforms through computer-driven strategies that produce hundreds of buy and sell orders every second.

This is a pleasant change from the usual state of affairs; normally it would be a big bank buying a private technology firm, rather than selling a chunk of their business to it. As far as I can tell from Getco’s website it’s a private company founded by two guys who, being capable of thought, were not suitable for employment at a big bank.

Off Topic! Giambrone has decided he does not wish to be laughingstock of Toronto for the next ten months, but will concentrate his efforts on solidifying his status as laughingstock of the TTC. Despite his young age, he has a distinguished record of sticking his hand up when Mayor Miller tells him to.

Another good day for the Canadian preferred share market, as PerpetualDiscounts gained 16bp while FixedResets squeezed out a gain of 1bp. Volume was relatively light and the market was well-behaved, with only four entries in the Performance highlights table – two of them BAM Floaters.

PrefBlog’s influence over global capital markets is proved yet again as Temasek is setting up an in-house investment firm:

Temasek Holdings Pte, Singapore’s state investment firm, is setting up a wholly owned multibillion dollar investment company with its own money, three people with knowledge of the matter said.

Seatown Holdings International will employ a multistrategy to invest in assets from stocks to bonds, targeting absolute returns, the people said, asking not to be identified because the information is private.

In-house is the only way to go for outfits that are big enough. Hire the best people, hold them accountable for results, let all layers of management concentrate on returns … you’ll do fine.

This is completely off-topic, but Toronto Distric School Board trustee Josh Matlow is in trouble again:

The showdown began last week when trustee Josh Matlow, the outspoken rogue of the TDSB, accused the board of going on a “drunken spending binge.”

The TDSB’s new sheriff, chair Bruce Davis, promptly demanded an apology and attached a deadline, Monday at 4 p.m., leaving Mr. Matlow the weekend to contemplate his fate.

Bruce Davis should take a civics course – he doesn’t appear to understand that cabinet solidarity only applies if one is in cabinet. However, I’m sure his responsibilities in ensuring seven-year olds are properly punished if they should, for instance, throw a snowball against a wall preclude any useful or intelligent use of time.

Today’s Treasury auction didn’t go all that well:

Treasuries tumbled after the U.S. sold a record-tying $25 billion of 10-year securities, the second of three note and bond auctions this week totaling $81 billion, and as investors weighed the prospects of European aid for Greece.
…
The yield on the current 10-year note climbed six basis points, or 0.06 percentage point, to 3.71 percent at 1:30 p.m. in New York, according to BGCantor Market Data. It increased as much as nine basis points yesterday, the most this year. The 30- year bond yield rose six basis points to 4.65 percent.

A marginally good day for Canadian preferred shares today, in constrast to all the recent marginally bad ones. PerpetualDiscounts gained 6bp and FixedResets gained 11bp, taking the yield on the latter down to 3.58%. The market was well-behaved as volume moderated, with only four performance highlights – three of them BAM issues in the Floating Rate class. The best of these, BAM.PR.K, also made it to the volume highlights.

PerpetualDiscounts now yield 5.87%, equivalent to 8.22% interest at the standard equivalency factor of 1.4x. Long Corporates continue to yield about 5.8%, so the pre-tax interest-equivalent spread has now widened to about 240bp, a slight widening from the 235bp reported February 3.

Lucas van Praag, World’s Greatest Corporate Spokesman, writes a rebuttal to the New York Times’ assertions in the Huffington Post. The most intruiging dispute is:

NYT assertion: “In addition, according to two people with knowledge of the positions a portion of the $11 billion in taxpayer money that went to Societe Generale, a French bank that traded with A.I.G, was subsequently transferred to Goldman under a deal the two banks had struck.”
The facts: The assertion is false and misleading. Goldman Sachs provided financing to many counterparties, but in that role we would not have known whether a counterparty had obtained credit default protection, let alone from whom or in what amount.

I have heard of things like this taking place. For instance, say Goldman wanted to do a deal with AIG but could not do so directly because of their risk management procedures. What they would do is call up their good friends at another bank – let’s call it the Clearly Idiotic Bunch of Clowns, or “Clowns” for short – and tell them the story. Goldman would do its deal with the Clowns and the Clowns would then lay off their exposure to AIG. The Clowns would take a spread of 15-25 bp on the transaction, record their profit, pad their bonus, shake hands and move on.

What the clowns didn’t consider important when doing the deal, however, was the fact that their deal with Goldman was collaterallized but their deal with AIG wasn’t. So as the value of the underlying instruments declined, they were getting margin calls from Goldman without being able to offset them with collateral from AIG … and, of course, as AIG itself went south, their exposure to AIG started looking more and more like a loss.

Fortunately for the Clowns, the Fed Fairy waved its magic wand and their contract with AIG was honoured. They honoured their contract with Goldman – but they would have done so anyway. The Fed Fairy’s action simply meant they could do so without taking the loss themselves.

Goldman did nothing wrong or even underhanded in this story, which is probably the explanation of the SocGen story that van Praag discusses. SocGen, of course, is renowned for it’s meticulous risk management procedures, as discussed by Jerome Kerviel.

Shed no tears for the Clowns, however! Nobody ever gets fired, or anything Dickensian like that. Only evil banks, such as Goldman, would ever dream of firing somebody for incompetence. They’ll get some extra coaching on risk management, between the “Respect in the Workplace” seminar and the workshop on throwing cream pies, and live happily ever after.

John Varley of Barclay’s testified to the UK’s Treasury Select Committee today. One of his startling revelations was that nice things cost money:

Barack Obama’s plans to stop banks engaging in risky trading activities will not stop another banking crisis, John Varley, chief executive of Barclays, said today.

Speaking before the Treasury select committee, Varley also tried to calm concerns that the crack down on proprietary trading, known as the Volcker rule, would knock Barclays’ profits.

“This initiative [Volcker] on its own will not lead to a safer system,” Varley said. “It is inconsequential. It is completely irrelevant [to Barclays].”
…
As he made a staunch defence of big banks like Barclays not being broken up by regulators, Varley warned MPs on the committee that the implication of demands that banks hold more capital and more liquid assets such as government bonds was that they would increase interest rates charged to customers.

“The cost of credit is going in one direction only – it’s going higher,” said Varley.

Bombardier is considering a new medium term note, but the terms are not yet final:

DBRS has today assigned a BB rating, with a Stable trend, to the proposed issuance of up to $1 billion in Senior Unsecured Notes (Notes) by Bombardier Inc. (BBD or the Company). The Notes are expected to be due before 2020. Proceeds from the issuance are likely to be used largely toward debt repayment, with no material change in the Company’s financial profile. Bombardier announced today that it has commenced a cash tender offer to purchase up to $550 million aggregate principal amount of its 6.75% Notes due 2012, 6.30% Notes due 2014 and Floating Rate Senior Notes due 2013. DBRS notes that the Company has the option to increase the tender offer to $1.25 billion.

Notes:
All figures are in U.S. dollars unless otherwise noted

The tender offer was announced yesterday. Regulators insist that this be kept secret from Italians so remember: if you’re Italian, you didn’t learn about the tender from me, OK?

Trading volumes picked up substantially today, but PerpetualDiscounts continued their slow descent, losing 8bp, while FixedResets were able to pick up 3bp.

Alessandro Beber and Marco Pagano have summarized their recent paper on short-selling bans in a VoxEU article Short-selling bans in the crisis: A misguided policy:

The evidence suggests that the knee-jerk reaction of most stock exchange regulators around the globe to the financial crisis – imposing bans or regulatory constraints on short-selling – was at best neutral in its effects on stock prices. The impact on market liquidity was clearly detrimental, especially for small-cap and high-risk stocks. Moreover, it slowed down price discovery.

Perhaps the main social payoff of this worldwide policy experiment has been that of generating a large amount of evidence about the effects of short-selling bans. The conclusion suggested by this evidence is best summarised by the words of the former SEC Chairman Christopher Cox on 31 December 2008: “Knowing what we know now, [we] would not do it again. The costs appear to outweigh the benefits”. We hope that this lesson will be remembered when security markets face the next crisis.

Also on VoxEU, Hans Gersbach makes an interesting proposal in Double targeting for Central Banks with two instruments: Interest rates and aggregate bank equity:

The central bank would have two instruments at its disposal:

(a) the short-term interest rate and

(b) the aggregate equity ratio of the banking sector defined as the ratio of total end-borrower lending (credit for non-financial firms, households, and governments) plus other non-bank assets to total equity in the banking sector. The aggregate equity ratio is the measure of the capital cushion of the banking sector.

As a consequence, there are two policy rules for the central bank: an interest rate rule and an aggregate equity ratio rule. The former is a traditional interest rate rule (see for example Gali (2008, Chapter 3)) that may include an additional variable capturing the current state of money and credit, as discussed below. The latter relates the required equity ratio of the banking system in the next period to the current aggregate equity ratio and to the state of money and credit.
…
The current proposal aims at separating the responsibilities and instruments regarding capital requirements and bank supervision. The proposal places a substantial burden on the shoulders of central banks with regard to inflation and financial stability. Together with current events, the function of central banks as a lender of last resort indicates that this burden cannot be avoided. Accordingly, it makes good sense to equip the central bank with two instruments (short-term interest rates and aggregate equity ratios of the banking system) to help them bear this burden, while leaving detailed bank regulation and supervision activities to separate authorities.

In other words, counter-cyclical capital requirements would be set by empirical judgement, rather than with any of the various formula-based currently being discussed.

Citigroup is developing a new derivative:

the CLX is constructed as a sum of the Sharpe ratio – deviations from the mean divided by volatility – of various market factors, such as equity volatilities, Treasury rates, swap spreads, corporate bond swaption-implied volatilities, and structured credit spreads. Citi will make the CLX tradable by using fixed historical values for the mean and volatility parameters, eliminating the need for costly recomputation from lengthy time series.
…
“The great thing about the index is that it hedges your funding costs while being very simple to trade. I believe it will reduce the systemic risk in the industry, akin to how the advent of swaps means people don’t worry about interest-rate exposures any more – they just pay a fee to hedge it,” [Terry Benzschawel, a managing director of quantitative credit trading strategy at Citi in New York and head of the team researching the product] says.
…
Chris Rogers, chair of statistical science at Cambridge University, said the only participants able to sell CLX-based products would probably be those who are too big to fail.

I have to wonder about the statement that funding costs can be hedged by the index … the only sure way of doing that is by borrowing longer in the first place and in a crisis funding costs are going to be highly company specific. And I must admit that I am deeply suspicious of an index based partly on “structured credit spreads” – not just idiosyncratic by instrument but also by whoever’s providing the quote and how much they want to quote firm.

Another day of relatively light trading; PerpetualDiscounts lost 4bp while FixedResets gained 3bp in a reasonably well-behaved market.

BofA / Merrill Lynch Plot Thickens!

When Bank of America Corp.’s board met to approve the acquisition of an investment bank on Sept. 15, 2008, members thought they were going to buy Lehman Brothers Holdings Inc., not Merrill Lynch & Co., according to New York Attorney General Andrew Cuomo.

However, the story has some support for my thesis that large corporations are riskier than smaller ones, on the grounds that you get ahead by telling your boss what he wants to hear:

[Company eMails and notes] also show Merrill kept [BofA ex-Chief Financial Officer Joe] Price informed of the losses as they grew, yet he resisted pressure from his lawyers to disclose them to shareholders.
…
When Price asked for a review of whether the [October 2008] losses — then $5 billion after taxes — should be disclosed to shareholders, his general counsel Timothy Mayopoulos said they should.
…
Mayopoulos was later fired by Price and replaced by Brian Moynihan, who later became CEO, Cuomo said.

This is just a hair off-topic, but I’ve often wondered what the big deal is about atmospheric CO₂ levels. I mean, assuming they’re causing problems, why not just fix it? Genetically engineer some yeast cells, or other bug, so that they eat CO₂ and excrete sugar, put them in a tank and Bob’s your uncle! If you want to get fancy, put some other bugs in the tank that eat sugar and excrete polysaccharides; if you want to make some money, sell the kits in one-liter sizes so that Mr. & Mrs. Precious can reduce their carbon footprint. Why can’t this be done? Converting CO₂ to sugar is no big deal – plants do it all day long and have time left over for sex with bees.

So it was a great relief to read Neil Reynolds column today, Profit motive is the solution to CO2 emissions:

A Santa Barbara, Calif., company called Carbon Sciences Inc. provides a convenient prototype. The company announced last week that it has developed a “breakthrough technology” that converts atmospheric carbon dioxide into commercial-grade gasoline, diesel fuel and jet fuel. Founded in 2006, Carbon Sciences had previously converted CO-2 into low-grade methanol using an enzyme-based technology. Now, it said, it has combined chemical and biological engineering in a bio-catalytic process that transforms carbon emissions into “a cost-efficient” energy resource.

Is the process really commercially viable, or at least on the way there? Is Carbon Sciences (OTCBB: CABN) a decent investment? I don’t know and I’d need to hire some expertise before I ventured an opinion. But I’m just glad I’m not the only person in the world who’s thought of this.

PerpetualDiscounts continued to slide today, losing 27bp on a day with sharply reduced volume. FixedResets were able to squeak out a gain of 2bp. There were only three entries for the Performance Highlights table!

Deutsche Bank is using the compensation hysteria to put golden handcuffs on the peons:

A significant proportion of compensation will, where applicable, be deferred. Deferred compensation will be a combination of restricted equity awards (75%) and restricted incentive awards (25%).

* The restricted equity award will vest in nine equal instalments over 3¾ years, while the restricted incentive award will vest in three equal instalments over three years.

* All restricted equity and restricted incentive awards will continue to be subject to claw-back in the case of policy/regulatory breach.

And, of course, if they don’t feel like living up to their side of the bargain, inventing a policy/regulatory breach is easy enough. The best job of the brave new world? Employment contract litigator.

Some players are reducing their risk:

Two Citigroup Inc. executives running a proprietary-trading unit quit to join hedge fund Moore Capital Management LP, amid concern the government might order U.S. banks to exit trading businesses that don’t cater to customers, people briefed on the matter said.

Matthew Carpenter, a 15-year Citigroup veteran who had assembled the unit over the past three years, is leaving the bank along with his deputy, Matthew Newton, Citigroup spokesman Alex Samuelson said. The group trades U.S. stocks in several industries, Samuelson said.

In yet another instance of regulatory extortion, the SEC has admitted that State Street did nothing wrong but is paying $300-million anyway. Nobody’s been fired, nobody’s lost their license, back to business as usual. The trend towards bureaucratic ursurpation of the role of the courts, in all aspects of life, continues.

PerpetualDiscounts continued to slide today, losing 17bp, while FixedResets were down slightly less than 1bp. Volume continued to be on the heavy side.

In yet another example of PrefBlog’s trendsetting nature, Citigroup has started a blog.

The market responded to my deprecating remarks about FixedResets by selling off PerpetualDiscounts, which lost 28bp on the day and buying FixedResets, which gained 5bp, on fairly heavy volume.

PerpetualDiscounts now yield 5.83%, equivalent to 8.16% interest at the standard equivalency factor of 1.4x. Long corporates continue to yield about 5.8%, so the pre-tax interest-equivalent spread is now about 235bp, which is where it was at month-end.

Paul Krugman writes an op-ed in the New York Times, Good and Boring, lauding the resilience of Canadian banks:

Canada has an independent Financial Consumer Agency, and it has sharply restricted subprime-type lending.

Above all, Canada’s experience seems to support those who say that the way to keep banking safe is to keep it boring — that is, to limit the extent to which banks can take on risk.
…
More specifically, Canada has been much stricter about limiting banks’ leverage, the extent to which they can rely on borrowed funds. It has also limited the process of securitization, in which banks package and resell claims on their loans outstanding — a process that was supposed to help banks reduce their risk by spreading it, but has turned out in practice to be a way for banks to make ever-bigger wagers with other people’s money.
…
Actually, the financial reform bill that the House of Representatives passed in December would significantly Canadianize the U.S. system. It would create an independent Consumer Financial Protection Agency, it would establish limits on leverage, and it would limit securitization by requiring that lenders hold on to some of their loans.

I suggest that Dr. Krugman has selected features of Canada’s system to further his domestic political arguments. The IMF has published suggestions that a critical factor is the stable deposit base of Canadian banks – which, I believe, is related to their national scope and oligopolistic position. Another major factor has been the banks’ control over the mortgage market – limited competition (no GSE’s here in Canada!) has allowed them to extract rents from hapless Canadian mortgagees, leaving much less necessity of reaching for yield. The sole Canadian bank that did fail during the crisis, Dundee Bank, failed because its lack of mortgage distribution channels encouraged it to go out on a limb provided by ABCP.

Paul Volcker testified to the Senate banking committee today:

Given strong legislative direction, bank supervisors should be able to appraise the nature of those trading activities and contain excesses. An analysis of volume relative to customer relationships and of the relative volatility of gains and losses would go a long way toward informing such judgments. For instance, patterns of exceptionally large gains and losses over a period of time in the “trading book” should raise an examiner’s eyebrows. Persisting over time, the result should be not just raised eyebrows but substantially raised capital requirements.

This is much more in line with my thinking than a flat prohibition, which will be subject to interpretation.

More generally, proprietary trading activity should not be able to profit from knowledge of customer trades.

That’s what the SEC’s supposed to be worrying about.

Mr. Volcker also noted that he had attached an essay to his official testimony, but I can’t find it!

A relatively directionless day for Canadian preferred shares, with PerpetualDiscounts losing 5bp and FixedResets gaining 1bp on moderate volume.

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.