Category: Market Action

The SEC has charged Goldman Sachs with fraud:

According to the SEC’s complaint, filed in U.S. District Court for the Southern District of New York, the marketing materials for the CDO known as ABACUS 2007-AC1 (ABACUS) all represented that the RMBS portfolio underlying the CDO was selected by ACA Management LLC (ACA), a third party with expertise in analyzing credit risk in RMBS. The SEC alleges that undisclosed in the marketing materials and unbeknownst to investors, the Paulson & Co. hedge fund, which was poised to benefit if the RMBS defaulted, played a significant role in selecting which RMBS should make up the portfolio.

The SEC’s complaint alleges that after participating in the portfolio selection, Paulson & Co. effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (CDS) with Goldman Sachs to buy protection on specific layers of the ABACUS capital structure. Given that financial short interest, Paulson & Co. had an economic incentive to select RMBS that it expected to experience credit events in the near future. Goldman Sachs did not disclose Paulson & Co.’s short position or its role in the collateral selection process in the term sheet, flip book, offering memorandum, or other marketing materials provided to investors.

Bloomberg quoted a smiley-boy:

“I wouldn’t want to own Goldman stock right now,” said Keith Goddard, president of Capital Advisors, which oversees $810 million in Tulsa, Oklahoma. “If this turns out to be remotely true, do you want to be doing business with someone who doesn’t have your best interests in mind? That’s the accusation here.”

Institutional PMs routinely do business with those who don’t have their best interest in mind. It’s called trading as principal. As usual with PMs who have such an attitude, the Capital Advisors website does not appear to report any performance information.

DBRS noted:

Responding to the complaint, Goldman stated that the charges are unfounded and noted several critical points that it claims were missing from the SEC complaint. DBRS currently rates Goldman’s senior debt at A (high) and short-term instruments at R-1 (middle). The trend on all ratings is Stable.

DBRS is currently evaluating the potential impact of the allegation, which may have legal and financial ramifications for the Company. DBRS views this allegation as negatively affecting Goldman’s reputation, but the severity of any adverse impact is not yet known.

Goldman first fired back with the rather weak:

The SEC’s charges are completely unfounded in law and fact and we will vigorously contest them and defend the firm and its reputation

A little later, though, they got warmed up:

The Goldman Sachs Group, Inc. (NYSE: GS) said today:We are disappointed that the SEC would bring this action related to a single transaction in the face of an extensive record which establishes that the accusations are unfounded in law and fact.

We want to emphasize the following four critical points which were missing from the SEC’s complaint.

• Goldman Sachs Lost Money On The Transaction. Goldman Sachs, itself, lost more than $90 million. Our fee was $15 million. We were subject to losses and we did not structure a portfolio that was designed to lose money.

• Extensive Disclosure Was Provided. IKB, a large German Bank and sophisticated CDO market participant and ACA Capital Management, the two investors, were provided extensive information about the underlying mortgage securities. The risk associated with the securities was known to these investors, who were among the most sophisticated mortgage investors in the world. These investors also understood that a synthetic CDO transaction necessarily included both a long and short side.

• ACA, the Largest Investor, Selected The Portfolio. The portfolio of mortgage backed securities in this investment was selected by an independent and experienced portfolio selection agent after a series of discussions, including with Paulson & Co., which were entirely typical of these types of transactions. ACA had the largest exposure to the transaction, investing $951 million. It had an obligation and every incentive to select appropriate securities.

• Goldman Sachs Never Represented to ACA That Paulson Was Going To Be A Long Investor. The SEC’s complaint accuses the firm of fraud because it didn’t disclose to one party of the transaction who was on the other side of that transaction. As normal business practice, market makers do not disclose the identities of a buyer to a seller and vice versa. Goldman Sachs never represented to ACA that Paulson was going to be a long investor.

Background

In 2006, Paulson & Co. indicated its interest in positioning itself for a decline in housing prices. The firm structured a synthetic CDO through which Paulson benefitted from a decline in the value of the underlying securities. Those on the other side of the transaction, IKB and ACA Capital Management, the portfolio selection agent, would benefit from an increase in the value of the securities. ACA had a long established track record as a CDO manager, having 26 separate transactions before the transaction. Goldman Sachs retained a significant residual long risk position in the transaction

IKB, ACA and Paulson all provided their input regarding the composition of the underlying securities. ACA ultimately and independently approved the selection of 90 Residential Mortgage Backed Securities, which it stood behind as the portfolio selection agent and the largest investor in the transaction.

The offering documents for the transaction included every underlying mortgage security. The offering documents for each of these RMBS in turn disclosed the various categories of information required by the SEC, including detailed information concerning the mortgages held by the trust that issued the RMBS.

Any investor losses result from the overall negative performance of the entire sector, not because of which particular securities ended in the reference portfolio or how they were selected.

The transaction was not created as a way for Goldman Sachs to short the subprime market. To the contrary, Goldman Sachs’s substantial long position in the transaction lost money for the firm.

Hmm … let me see. Did tranche retention work in this instance? Would the SEC’s tranche retention idea have accomplished anything? Um … Nope.

But there are a few interesting things about the release. ACA Management LLC wasn’t a stand-alone management firm. It was a unit of the now defunct (I think) ACA Financial Guarantee Corp., a mono-line. No information is provided to indicate that it was not a shell firm, created to do some pretend-portfolio management. Goldman talks about its “experience”, always a suspicious sign … I know guys in this business with twenty, thirty, forty years of experience … and that experience has consisted of vapourizing client money. Don’t talk to me about “experience”.

Also, Goldman talks about losing money on the transaction. Define “transaction” please! Was it hedged? How was it positioned according to Goldman’s risk-management process?

All in all, however, it looks to me so far as if the charges are simply a mechanism whereby the boohoohoo brigade can blame Goldman for their bad investments. But we’ll see what comes out in court, if it ever gets that far.

There was an unsupported throwaway line in the DBRS response to the Basel 3 consultation that is certain to cause hilarity in some circles … so I might as well be the first to highlight it:

It is not clear to DBRS what is included or excluded from the definition of resecuritisation. DBRS would suggest that traditional ABCP be explicitly stipulated as excluded. Such assets generally performed well during the financial crisis.

A quiet day price-wise, but a heavy one volume-wise! PerpetualDiscounts lost 3bp while FixedResets lost 6bp and yields on the latter continued inching up towards 4%.

The financial reform process is getting chippy:

Banks, lobbyists and others have until tomorrow to submit comments to the committee, part of the Basel-based Bank for International Settlements. They have until the end of this month to tell their regulators how much the proposals will cost. The panel, made up of bank supervisors and central bankers from 27 countries and territories, will draft rules by the end of the year for lawmakers to implement by late 2012. The committee first published regulations in 1988 and revised them in 2004.

I was amused by this:

“That’s just a veiled threat,” [chief executive officer of the International Centre for Financial Regulation Barbara] Ridpath said. “You are going to make it too expensive for us to lend, so it is going to be your fault when there’s no economic growth. The truth, who knows? Who’s done the studies? Who has any real concept of what the real impact is of the price of credit and GDP growth?”

Umm…. Central Bankers, maybe? I suspect she was misquoted – or it’s just awkward construction – because she’s been in the business a while, not just as a regulator.

The U.S. banks argue that the liquidity rules could force lenders around the world to sell $6 trillion of new debt to meet the requirements. Under the rules, banks would have to maintain a “net stable funding ratio” of 100 percent, meaning they would need an amount of longer-term loans or deposits equal to their financing needs for 12 months, including off-balance-sheet commitments and anticipated securitizations. This would require that some short-term funding be replaced by longer-term debt.

Higher capital requirements and a stricter definition of capital may reduce lenders’ return on equity to 12.9 percent from the 13.8 percent estimated for 2012, according to UBS AG analysts. Britain’s Royal Bank of Scotland Group Plc, Germany’s Commerzbank AG and France’s Credit Agricole SA are among seven European lenders that may need to raise 60 billion euros ($82 billion) to comply with Basel’s capital rules, JPMorgan analyst Kian Abouhossein said in February.

The market’s telling the EU to put its money where its mouth is:

The 10-year bonds were little changed today after declining the past two days. The yield premium investors demand to hold the securities instead of benchmark German bunds rose above 400 basis points for the first time since euro-region finance ministers announced the aid package last weekend. The parliaments of Germany, France and Ireland will have to vote on whether to contribute their share of the loans, government spokesmen said yesterday. Dutch lawmakers will discuss Greek aid today.

“There are concerns that the money will not be available,” said Toby Nangle, who helps oversee 46 billion euros as director of asset-allocation research at Baring Investment Services Ltd. in London. “There are people who are willing to place their own money at risk in anticipation of this thing not going through.”
…
Pacific Investment Management Co., which owns the world’s largest bond fund, said this week it’s not yet ready to buy Greek bonds. BlackRock Inc., the world’s biggest asset manager, said that donor countries need to demonstrate they can withstand a backlash from their citizens.

I suspect that Nangle is talking about CDS protection buyers, but has to use code for fear of arrest and imprisonment.

In fact, late news brought the following:

Greek Prime Minister George Papandreou yesterday asked for a meeting with the EU, the International Monetary Fund and the European Central Bank, which agreed last week to back a 45 billion-euro ($61 billion) rescue package for the cash-strapped nation. Talks will begin in Athens on April 19.
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The government’s request came after the yield on Greece’s benchmark 10-year government bond surged to 7.319 percent yesterday, higher than the level before the rescue package was announced on April 11. Papandreou said that the Athens talks didn’t mean Greece was activating the aid request and still planned to finance its debt in financial markets.

Municipal authorities everywhere are attempting to evade responsibility for their decisions:

The town followed the advice of Deutsche Bank in taking out bets on interest rates in 2004 and 2005, according to Susanne Weishaar, Pforzheim’s budget director until March.

The bank gave her a 10-year chart showing long-term rates were consistently higher than short-term, she said. During an initial phase of guaranteed rates, the town paid 1.5 percent to the bank on 60 million euros of debt while receiving 3 percent to 3.75 percent.

In 2005 and 2006, the difference between long- and short- term rates collapsed. As potential losses soared in 2006, Weishaar bought more swaps from JPMorgan Chase & Co. in a vain attempt to protect the town budget. Today Pforzheim owes 55 million euros to New York-based JPMorgan, she said. That’s 11 percent of this year’s spending.

The Deutsche Bank swaps have a positive value for the city of about 9 million euros, Weishaar said, offset by the negative value of JPMorgan swaps set up to protect the city.

“It’s like Easter eggs,” said Weishaar, 45, who holds a degree in math and economics from the University of Ulm. “You want to buy one and somebody sells you a painted hand grenade instead.”

If the grenades explode — or when local officials decide to cut their losses and get out of long-term contracts when the market is against them — taxpayers foot the bill.

It’s always hard to tell exactly what’s going on from news reports, but it looks like Pforzheim sold fixed-rate debt and swapped it into floating. That’s a little strange (where’s the hedge?) but then doubling down when the market moved against the position is straight speculation. Ms. Weishaar appears to be either incompetent or disingenuous, one or the other.

OSFI’s Pension boss, Judy Cameron, testified today:

Two years ago, we reported that the December 2007 average solvency ratio of federal plans was estimated at 1.05. In other words, pension plan assets, on average, exceeded liabilities by an estimated five per cent. A year later, at year-end 2008, the ratio had declined to 0.85, meaning that the market value of pension plan assets would have been sufficient to cover, on average, only 85 percent of promised benefits on plan termination.

Our most recent estimates show that the average ratio has increased modestly to 0.90 at December 2009. An indicator that has shown a more marked improvement is the proportion of materially under-funded plans. Based on OSFI’s estimates, at the end of 2009, only 15 per cent of all federally regulated pension plans had a solvency ratio of less than 0.80, whereas at the end of 2008, the comparable proportion was 40 per cent.

The recent bounce in PerpetualDiscounts came to earth today, with PerpetualDiscounts losing 14bp and FixedResets down 9bp, bringing yields on the latter up to 3.96%. Volume remains at elevated levels.

Price volatility slowed considerably today, although recent trends continued weakly, with PerpetualDiscounts gaining 7bp and FixedResets losing 7bp on continued heavy volume.

PerpetualDiscounts now yield 6.17%, equivalent to 8.64% at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.7%, so the pre-tax interest-equivalent spread is now about 295bp, down substantially from the peak of 310bp reported April 7 though still wider than the 285bp reported at month-end.

Citigroup’s liquidity guarantees are attracting scrutiny:

Financial Crisis Inquiry Commission investigators may conclude a primary cause of Citigroup’s 2008 bailout was the use of “liquidity puts” by traders to bolster sales, Chairman Phil Angelides said in an interview yesterday. Those puts allowed customers to sell debt securities back to the bank at face value if credit markets froze, something that Citigroup’s traders bet would never happen, according to Angelides.
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To raise money to buy the assets, Citigroup sold commercial paper, with the assets pledged as collateral. Commercial paper is a type of debt that matures in less than a year and was popular with money-market funds and corporate treasurers who want to invest their surplus cash in readily redeemable funds while earning higher yields.

Liquidity puts were added to “facilitate” the sales of the commercial paper, [Citigroup CDO boss Nestor] Dominguez said; investors could “put back” the commercial paper to Citigroup if the market went cold. Dominguez described this as a “significant widening in credit spreads or a temporary inability to issue commercial paper.” Widening credit spreads, or the gap between a bond’s yield and benchmark rates, indicate slackening investor demand.
…
Citigroup used the liquidity puts partly because they required less capital support than backup credit lines that bank’s typically offer, Georgiou said.

The liquidity puts were subject to a 0.8 percent capital charge, [commission member Byron] Georgiou said. Put another way, the bank had to set aside $1 of capital for every $125 of commercial paper. That compares with Citigroup’s overall ratio of $1 for every $14.50 of loans, securities and other investments as of Dec. 31.

The International Monetary Fund has released the April 2010 Global Financial Stability Report. I haven’t had a chance to do much besides skim it, but the big news is that they’re recommending capital charges on “systemically important” banks based on regulatory fiat, rather than any kind of formula:

Regulators may find it necessary to weigh “direct preemptive measures,” including constraining the size of certain activities to limit the emergence of “systemically important” firms, the Washington-based IMF said today in its bi-annual Global Financial Stability Report.

The report precedes an April 23 meeting of the Group of 20 nations in Washington, where the IMF plans to detail for finance chiefs ways that financial firms may help pay for the costs of bailouts. Since the start of the credit crisis, governments and central banks have spent more than $11 trillion to support the financial industry, according to the Paris-based Organization for Economic Cooperation and Development.

The capital surcharge would be “a buffer” designed to increase “the resiliency of the institution to sustain different shocks,” Juan Sole, one of the report’s authors, told reporters in Washington today.

Political momentum to overhaul financial regulations in some countries may be weakening as economic growth returns, IMF Managing Director Dominique Strauss-Kahn said in an interview in Kenya last month.

Parts of the financial industry have gone “back to practices of risk taking, which is probably not the most appropriate to have a stable financial system at the global level,” he said.

Now, more than ever, it is important for large banks to offer cushy jobs to ex-regulators!

The rebound in the market continued today on heavy volume, with PerpetualDiscounts up 26bp while FixedResets lost 4bp … taking the yield on the latter index within striking distance of 4%!

Greece is getting a bail-out:

Forced into action by a surge in Greek borrowing costs to an 11-year high, finance ministers from the 16 euro countries said they and the International Monetary Fund would offer the loans at non-subsidized interest rates in case Greece runs out of money-raising options. European Union Economic and Monetary Affairs Commissioner Olli Rehn said that the rate on the loans could be around 5 percent.

There’s no word regarding the attached strings.

PerpetualDiscounts continued their recovery today, gaining 38bp on continued heavy volume, while FixedResets were basically unchanged, gaining 1bp.

More news from the discount aisles of Greece, where burning Sappho lunched and swum:

European Union officials said they are ready to rescue Greece if needed as Fitch Ratings cut the country’s credit rating to the lowest investment grade and economists at UBS AG said that a bailout may be imminent.

Germany restated its opposition to below-market rate loans to Greece as officials in Brussels hammered out details to the framework calling for joint EU-International Monetary Fund aid.
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The premium investors demand to buy Greek 10-year bonds instead of German bunds jumped to 442 basis points yesterday, the highest since the introduction of the euro. Prime Minister George Papandreou has said borrowing at those levels is unsustainable. Greece will need to seek emergency funding now to make debt repayments of more than 20 billion euros ($27 billion) in the next two months, UBS economists said in a note.

Yesterday I mentioned how Ontario is limiting pharmacists’ access to the trough; it appears that this action has been taken because they’ve been elbowed away by much sexier sucklings:

Residential customers in Ontario will pay $300 more a year on average for electricity by the end of 2011, an increase of 25 per cent, according to energy consultants. And the rate increases won’t end there. Investments of more than $8-billion in green energy projects unveiled by the Ontario government Thursday will add another $60 a year to hydro bills by 2012.
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The Ontario Power Authority announced Thursday that it has approved 185 wind, solar and biomass projects capable of generating 2,500 megawatts of electricity, enough to power 600,000 homes.
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Electricity consumers will pay another $5 a month by 2012, when the projects are up and running.

Let that be a lesson to everybody! University is useless! Go to charm school!

It was another counter-trend day for the Canadian preferred share market, as PerpetualDiscounts gained 74bp and FixedResets were down 11bp on continued heavy volume. To drive the point home, the volume highlights table was dominated by PerpetualDiscounts.

What’s a Grecian earn?:

Greece will probably be forced to request a financial rescue after a European Union aid pledge failed to stop Greek borrowing costs from surging, said economists at AXA Group and Nomura International Plc.

Greek bonds dropped for a seventh day today, driving up the yield on the 10-year security to 7.5 percent, with Prime Minister George Papandreou’s government needing to sell 11.6 billion euros ($15.4 billion) of debt by the end of May. The yield premium over benchmark German bonds widened to the most since the euro’s debut in 1999, based on Bloomberg generic data.

Let’s have a big hand for the newly Assiduous Reader mega56. Only been studying the pref market for twenty minutes and he’s already on the right track!

Regarding perpetuals and rising interest rates. I’ve read in many places that perpetuals are risky during a phase where rates are rising, stay away. When I’m looking at the numbers, I don’t see it.

Example: CM.PR.E currently sits at 22.43 @$1.40
a. if it gets called (worst), you’ve got a nice gain @25.00
b. if price drops with rising rates, you still get the dividend

I’m missing the downside here.

Geez, at this rate he’ll be my competition in a few weeks!

There was some testimony to the Crisis Committee regarding Citigroup and CDOs:

Nobody could have predicted that the bank’s highest-rated collateralized debt obligations — created by repackaging mortgage bonds into new securities — would lose so much money, Prince said. The chief risk officer didn’t understand the risks, nor did Citigroup’s senior traders and bankers, he said.

“Everyone, including our risk managers, other banks and CDO structurers, all believed that these securities held virtually no risk,” Prince, 60, said. “It is hard for me to fault the traders who made the decisions to retain these positions on Citi’s books.”

Not so hard for me! Assiduous Readers will know that CDOs have been in the news quite a lot lately:Tranche Retention in the sub-prime CDO Market, The Story of the CDO Market Meltdown and Hull & White on AAA Tranches of Subprime. In the last paper, Hull & White demonstrated that CDO risk evaluation was faulty as the distributions of the risks of the securities held in the CDO were significantly different from the distributions of the risks of more normal instruments.

But it doesn’t matter. It really doesn’t matter. It happened this time and it will happen next time. Traders are business school smiley-boys, who have the job of quoting securities, rolling over their inventory, making the spread each time and telling the customer whatever he wants to hear. Whenever they suffer from delusions of intelligence, trouble ensues. Trading is different from investing and the two simply don’t mix very well. The key mistake at Citigroup – and elsewhere – was allowing traders to accumulate aged inventory, and not to impose a capital charge on this aged inventory.

The Ontario government’s plan to reduce generic drug costs has led DBRS to put Shoppers’ Drug Mart on review negative. With respect to the plan itself, I’m amused by the existence of trailer fees in the drug business:

Eliminating abuse of the system by ending so-called ‘professional allowances’ – payments generic drug companies make to pharmacy owners intended to fund patient services, but are instead being used by many pharmacies as rebates to fund fringe benefits, bonuses, overhead costs and boost profits

… but perplexed by …

Lowering the cost of generic drugs by at least 50%, to 25% of the cost of the original brand name drug for Ontario’s public drug system, private employer drug plans, and people who pay for drugs out-of-pocket, saving taxpayers millions

How is this possible? Is there no competition for generic drugs? Has the drug plan been run with no attempt to lower the price to whatever the manufacturers will bear? Or has the price been supported by a dispensing oligopoly? How on earth is it even possible to reduce costs by 50% by simple government fiat? Shoppers’ response to the plan has the amusing phrase:

Key tenants of these proposals included:

… indicating illiteracy, but no real arguments about the economics of the Ontario drug plan paying for, you know, drugs.

The Canadian preferred share market continued to see heavy trading today and, in a sharp reversal of recent experience, PerpetualDiscounts gained 50bp while FixedResets fell 25bp, bringing yields on the latter up to 3.83%. Good volatility is evident on the Performance highlights table; FixedResets continue to dominate volume.

Think we’ve got it tough in the Canadian preferred share market? Be grateful you’re not holding Greek bonds!

U.S. and European stocks fell, led by commodity producers as oil and copper dropped, while the premium investors demand to hold Greek bonds widened to the most since 1998 on speculation the nation may default.
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Greece’s 10-year bond yields rose 0.16 percentage point to 7.14 percent and the yield premium to German debt widened to 4.03 percentage points, the most since before the euro was introduced in 1999.

How bad is it? CDSs on Greece are now trading above terrorist levels:

Swaps tied to Greece rose to 415 basis points today while those on Iceland traded at about 400 basis points, according to Markit data. The North American Markit index climbed the most since March 22 amid investor concern that contagion from a Greece default could spread to other assets, said Gavan Nolan, an analyst at Markit Group in London.

Remember Jim Kelsoe, proud portfolio manager of the worst bond fund in the history of the universe (so far)? He was last mentioned on PrefBlog on May 9, 2008. Now the SEC is alleging that his fund returns were, in fact, overstated:

The SEC’s Division of Enforcement alleges that Morgan Keegan failed to employ reasonable procedures to internally price the portfolio securities in five funds managed by Morgan Asset, and consequently did not calculate accurate “net asset values” (NAVs) for the funds. Morgan Keegan recklessly published these inaccurate daily NAVs, and sold shares to investors based on the inflated prices.

“This scheme had two architects — a portfolio manager responsible for lies to investors about the true value of the assets in his funds, and a head of fund accounting who turned a blind eye to the fund’s bogus valuation process,” said Robert Khuzami, Director of the SEC’s Division of Enforcement.

William Hicks, Associate Director in the SEC’s Atlanta Regional Office, said, “This misconduct masked from investors the true impact of the subprime mortgage meltdown on these funds.”

According to the Commission’s order instituting administrative proceedings, the SEC’s Enforcement Division alleges that James C. Kelsoe, Jr., the portfolio manager of the funds and an employee of Morgan Asset and Morgan Keegan, arbitrarily instructed the firm’s Fund Accounting department to make “price adjustments” that increased the fair values of certain portfolio securities. The price adjustments ignored lower values for those same securities quoted by various dealers as part of the pricing validation process. The Enforcement Division further alleges that Kelsoe actively screened and manipulated the pricing quotes obtained from at least one broker-dealer. With many of the funds’ securities backed by subprime mortgages, Kelsoe’s actions fraudulently prevented a reduction in the NAVs of the funds that otherwise should have occurred as a result of the deterioration in the subprime securities market.

Lots of winners and losers on a volatile day of continued heavy volume in which selling pressure on PerpetualDiscounts eased off a bit … they were down only 2bp today which, considering recent returns, is practically a win! It is interesting to speculate that the buying came from switches out of FixedResets, as they were down 16bp on the day to take yields up to 3.74%. FixedResets again scored a shut-out on the volume table.

PerpetualDiscounts now yield 6.30%, equivalent to 8.82% interest at the standard equivalency factor of 1.4x. Long Corporates continue their insouciance towards whatever it is that’s causing the current paroxysm in the preferred share market, having returned +8bp (total return) on the month-to-date and are now yielding about 5.7% (maybe a bit over?). Thus, the pre-tax interest-equivalent spread (also called the Seniority Spread) stands at about 310bp, rocketting upwards from the +285 bp reported March 31 and pushing well over what had been until recently the one-year high in the low 290s.

With help from the clerk of the committee, I can now post a link to The Standing Committee on Government Agencies Report on the OSC.

Preferred shares took a massive whacking today on very high volume. PerpetualDiscounts lost 126bp, while FixedResets were down 43bp – about what one might expect, given the respective Modified Durations. FixedResets again scored a shut-out on the volume highlights table.

That’s the worst day in over a year for PerpetualDiscounts. There were two worse days in 2009, March 5 and March 9. There were 17 worse days in 2008, eight of them in November.

The bright side of this is that I anticipate increased opportunities for heavy relative-values trading. My reports of candidate trades are getting lengthier…

The jobs number on Friday was encouraging:

Payrolls rose by 162,000 workers last month, the third gain in the past five months and the most since March 2007, figures from the Labor Department showed today in Washington.
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Among the top indicators the group uses is payrolls, according to its Web site. The government revised the January and February job count up by a combined 62,000, putting the March gain at 224,000 after including the updated data.

This knocked Treasuries for loop:

Government securities fell for a second consecutive week ahead of the Treasury’s scheduled offering of $82 billion of notes and bonds next week, including a record-tying $40 billion sale of three-year securities.
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The 10-year note yield rose 9 basis points, or 0.09 percentage point, to 3.94 percent, according to BGCantor Market Data. The yield touched the highest this week since it reached 4 percent on June 11. Two-year note yields rose 6 basis points to 1.1 percent. Thirty-year bond yields increased to as high as 4.81 percent, also the most since June.

… and over the weak, investors decided that German debt is better than EU promises:

The yield on Germany’s 10-year bund, Europe’s benchmark government security, fell 7 basis points in the week to 3.09 percent as of 5:30 p.m. in London yesterday. It dropped to 3.05 percent on March 23, the lowest this year. The two-year note yield slipped 5 basis points to 0.95 percent.

The Greek 10-year yield advanced 33 basis points to 6.56 percent, and the two-year yield soared 69 basis points to 5.28 percent.

The New York Times has an editorial on taxation of hedge fund fees:

To add insult to injury, some hedge fund managers and, more commonly, private equity fund managers are able to pay a much lower rate of tax than the typical working professional.

The tax disparity results from an outdated rule that lets a money manager in a private partnership treat a chunk of his fees as if they were long-term capital gains, taxed at a special low rate of 15 percent. Fees for managing someone else’s money should be taxed as ordinary income, like wages and salary, at rates as high as 35 percent.

President Obama has included a provision to end that special treatment in his most recent budget. For three years running, the House has passed a bill to close the loophole. In the Senate both Democrats and Republicans have resisted, all for fear of losing lucrative campaign donations.

This has been an issue for quite some time I remember commenting on the issue on the old “Captain’s Quarters” blog (the principal, Ed Morrisey, has now moved to Hot Air) … the idea of fixing the loophole by other commenters as a tax increase. By me, it’a a loophole. Preferential taxation of capital gains – regardless of what it may actually accomplish – should be restricted to those who have skin in the game. A hedge fund manager who achieves a total return of -100% will suffer a loss of capital only to the extent he has invested in the fund: capital gains tax rates should apply only to his earnings on that capital at risk.

Assiduous Reader GAndreone sends in this chart of Exchange Market Share for MFC.PR.C for your edification:

Click for Big

An interesting trend is corporate bonds that step-up on downgrades:

Bonds with built-in protection against rating cuts are making up a record share of debt issues as investors hedge against a slowdown in the economic recovery.

Anheuser-Busch InBev NV, the brewer of Budweiser and Stella Artois, is among companies issuing so-called step-up bonds, whose interest increases if a borrower is downgraded. Sales surged to $37.3 billion in March, or 12.4 percent of all debt issued, according to data compiled by Bloomberg. Most of the notes are sold in the U.S., where almost half of bonds rated as so-called junk or on the cusp of non-investment grade include the protection.
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Anheuser-Busch InBev, the world’s largest brewer, sold $3.25 billion of bonds with a step-up coupon on March 24, Bloomberg data show. The conditions require the Leuven, Belgium- based company to pay 25 basis points more in interest for every one rating notch it’s cut below investment grade, up to a maximum of 200 basis points, according to Bloomberg data. The brewer is rated Baa2 by Moody’s and one level higher at BBB+ by S&P.

It’s an interesting problem due to the potential for a cascading decline in credit quality. Quick! You’re the Grand Pooh-Bah of Financial Stability! Can you do anything? Should you do anything?

It has taken over a year, but finally the world is noticing the sheer brilliance and uncanny accuracy of PrefBlog’s commentary. Assiduous Readers will remember that I support internal management for large pension funds; not because of cost but because internal management has a captive customer, can concentrate of achieving good returns and doesn’t have to spend time, effort, and client portfolio positioning on the necessity of bringing in the Assets Under Management. As best as I can recall, I last discussed this on March 31, 2009. Janet McFarland has written a feature for the Globe, Canada’s Pension Funds: stronger returns, at a cost:

Despite the higher salary costs in Canada, internal management has been a bigger advantage than it has been a cost, said pension specialist Keith Ambachtsheer, director of the International Centre for Pension Management at the University of Toronto.

Research shows internal teams not only save money by cutting high external money management fees, but also perform better as investors because they are more closely aligned to the mission of the pension fund, he said.

According to data from CEM Benchmarking, internal management improves returns by 0.5 per cent annually over external management, Mr. Ambachtsheer said.

It is disappointing that the article followed fashionability to the extent it did, by focussing almost exclusively on the aspect of fees. It is far more interesting, and far more important for public policy purposes, to consider the aspect of the effects of structure on gross investment return.

The Globe also had an astonishingly patronizing editorial in today’s print edition (it does not appear to be available on-line) titled “The next complexity”:

The challenge for the future, however, is how to formulate rules that will cover the new mind-bending products that will emerge in the next wave of irrational exuberance and excessive financial ingenuity. In other words, legislators and regulators will need to decide what is too complex for unsophisticated investors.

I have some succinct advice for the Globe’s editorial board: shove it. While wearing my hat as a retail investor, I don’t want any pandering politician or smarmy regulator deciding what is and what is not too complex for unsophisticated investors who haven’t been annointed. Show me somebody – anybody – who got seriously hurt by ABCP and I’ll show you a fool. Canadian ABCP was a good product, of very good credit quality. The market was done in by lack of liquidity, not credit; and the only people who were badly hurt by it were the ones who were overexposed. Ain’t nothing gonna protect anybody from the downside of overexposure, whether it’s to ABCP or securities that have been blessed by the really, really savvy investors on the Globe’s editorial board.

I haven’t been able to find a copy of the report itself on-line. This may mean I’m insufficiently sophisticated at finding things, but it wouldn’t surpise me to learn that access to the report has been restricted to those smart enough to agree with the committee’s conclusions.

What the ABCP and Lehman crises showed was simply that the implicit sponsor guarantee on Money Market Funds needs to become explicit. Full stop.

Crash! Bang! Smash ’em up! PerpetualDiscounts got hit severely today, losing 76bp to bring median yield to 6.22%, while FixedResets were almost precisely flat. The performance highlights indicate that it was the major, high quality banks that bore the brunt of the sell off, although there are a few familiar names amongst the losers. Volume continued to be quite heavy and FixedResets scored a shut-out on the volume highlights table.