Category: Market Action

As far as I can make out, the National Association of Insurance Commissioners is reviewing their blind faith in credit ratings while trying to make it look like the agencies’ fault:

State insurance regulators scheduled a hearing to review the role of credit rating firms and whether changes are necessary after the companies gave top ratings to mortgage-linked securities that plunged in value.

Representatives of ratings firms, insurance companies and pension funds will be invited to testify at the Sept. 24 hearing, acting New York Insurance Superintendent James Wrynn said today in an e-mailed statement. Wrynn and Michael McRaith of Illinois lead a group appointed by the National Association of Insurance Commissioners to evaluate watchdogs’ reliance on the firms.
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“The hearing will examine the role of these credit rating agencies in the insurance regulatory system and what changes may be needed in light of the financial crisis,” Wrynn’s office said in the statement.

NAIC was last mentioned on PrefBlog on June 26 in connection with the hallowed practice of rating-shopping; whereby investors choose the most optimistic agency they can find, so that they can blame them for over-optimism if things don’t work out. To update that story, here’s the NAIC staff report on RealPoint.

A quiet day, price-wise, for the major sub-indices, with PerpetualDiscounts gaining 9bp total return, while FixedResets were down 2bp. This brings the yield on PerpetualDiscounts down to 5.74%, equivalent to 8.04% interest at the standard equivalency factor of 1.4x. Long Corporates yield a smidgen under 6.0%, so the pre-tax interest-equivalent spread is now about 205bp, a slight (and possibly completely technical) narrowing from the 210bp recorded on September 2.

Volume continued to be OK.

The G-20 summit resulted in a communique of little interest. As always, the interesting parts were not official:

Curtailing bankers’ pay and bonuses has been seen as key by some countries as the current payment culture, considered as having encouraged risky behavior, was blamed for fueling the financial crisis.

Alistair Darling, Britain’s chancellor of the exchequer, or finance minister, and host of the G-20 meeting, said that there must be no more cases in which “people are being rewarded for reckless behavior.” Heading into the talks in the British capital, European countries had pushed for the G-20, which represents 80 percent of the world’s economic output, to enforce an official cap on individual payouts as well as collective bonus pots at financial firms.

Britain supported the general effort to rein in bonuses, but not the cap, while the United States was more intent on pushing its proposal for a global accord to force banks to hold more capital reserves.

During the talks, the G-20 agreed to give the Financial Stability Board, an international body established at the London summit of G-20 leaders in April, the task of drawing up practical proposals on which the leaders meeting in Pittsburgh on Sept. 24 and 25 could agree.

Treasury’s proposals for capital reserves have been previously reported.

I mentioned the latest lawsuit against the CRAs on September 3. Jim Hamilton’s World of Securities Regulation has a better summary of the legal issues:

The court also rejected the defense that the ratings were non-actionable opinions. The investors alleged actionable misrepresentations, said Judge Scheindlin, because they alleged that the rating agencies did not genuinely or reasonably believe that the ratings they assigned to the asset-backed securities were accurate and had a basis in fact. Similarly, disclaimers in the information memorandum that the credit rating was an opinion and not a guarantee or a recommendation to buy were unavailing and insufficient to protect the agencies from liability for promulgating alleged misleading ratings.
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Also, the rating agencies received fees in excess of their normal fees for rating the securities, noted the court, fees that increased in tandem with the growth of the structured investment vehicle. Unknown to investors, the compensation of the rating agencies was contingent on the receipt of high ratings for the notes.
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While conceding that the investors were sophisticated, the court found that the market at large, including sophisticated investors, have come to rely on the independence of rating agencies because of their NRSRO status and, as here, their access to non-public information that even sophisticated investors cannot obtain. Thus, the court concluded that the investors stated their reasonable reliance on the alleged false ratings.

Congress has struck a Financial Crisis Inquiry Commission:

The Financial Crisis Inquiry Commission this month will begin probing how the U.S. financial system came perilously close to collapse in the fall of 2008, leading to the worst economic downturn since the Great Depression.

Congress ordered the 10-person commission to examine 22 causes of the debacle, “from A to V” as Angelides puts it. They range from things that were done, like mortgage fraud, to things mostly left undone, like over-the-counter derivatives regulation.

Armed with subpoena power to bring witnesses and spring documents, the panel is supposed to find out what caused the collapse of major financial institutions, like Lehman Brothers Holdings Inc, from August 2007 to April 2009 — as well as those that would have failed without government aid, like American International Group Inc.

The first public meeting is set for September 17, with the group to issue a report to Congress by December 2010.

Consumer credit in the States is under pressure:

Consumer credit fell by a record $21.6 billion, or 10 percent at an annual rate, to $2.5 trillion, according to a Federal Reserve report released today in Washington. Credit dropped by $15.5 billion in June, more than previously estimated. Credit fell for a sixth month, the longest series of declines since 1991.

The credit crunch, stagnant incomes and declines in household wealth are casting doubt on the strength of the economic recovery. The arrival of the government’s “cash for clunkers” program in late July wasn’t enough to keep credit that covers car loans from plummeting by a record amount, as consumers delayed other purchases.

There wasn’t much direction in the preferred market today, with PerpetualDiscounts gaining 8bp and FixedResets as close to flat as makes no difference. Volume was relatively light, with FixedResets gaining most of the places on the highlights table.

There are fears of a new wave of bank failures triggered by commercial real estate loans:

Capmark Financial Group Inc.’s possible collapse may signal a new wave of real estate losses for banks — this one tied to business property — that could push the year’s tally of failures past 100.

Capmark, ranked among the largest U.S. commercial real estate lenders by Moody’s Investors Service, posted a $1.6 billion quarterly loss on Sept. 2 and said it might go bankrupt.
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Assets originated by Capmark that are no longer collecting interest more than doubled to 7.6 percent of total assets as of June 30 from the end of 2008, after accounting for reserves, the company said. Capmark posted losses in North America, Asia and European units during the quarter and raised the provision for bad loans to $345.8 million from $10.4 million.
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The company struck a deal with Warren Buffett’s Berkshire Hathaway Inc. and Leucadia National Corp. to sell its loan servicing and mortgage units for as much as $490 million.

Capmark today had its debt rating cut by Moody’s to C because the asset sale and declining value of its remaining units increase the odds that creditors won’t get paid.

However, to make us all feel better about the long weekend, three banks were closed today: one tiny one:

As of June 30, 2009, First Bank of Kansas City had total assets of $16 million and total deposits of approximately $15 million.
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The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $6 million.

… a larger one:

As of August 3, 2009, InBank had total assets of $212 million and total deposits of approximately $199 million.
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The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $66 million.

… and a larger one still:

As of August 28, 2009, Vantus Bank had total assets of $458 million and total deposits of approximately $368 million.
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The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $168 million.

Update: Another one just trickled in:

Platinum Community Bank, as of August 29, 2009, had total assets of $345.6 million and total deposits of $305.0 million.
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Platinum Community Bank is the 88th FDIC-insured institution to fail this year and the 15th in Illinois. The last bank to be closed in the state was Inbank, Oak Forest, earlier today. The FDIC estimates the cost of the failure to its Deposit Insurance Fund to be approximately $114.3 million.

Update: Holy smokes, long weekend and the FDIC’s working overtime!

As of July 24, 2009, First State Bank had total assets of $105 million and total deposits of approximately $95 million.
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The FDIC estimates that the cost to the Deposit Insurance Fund (DIF) will be $47 million.

Even better, the recent slide in the preferred share market took a break today, with PerpetualDiscounts up 7bp and FixedResets gaining 5bp … little movement on little volume.

There’s an interesting twist in emerging Credit Rating Agency law:

A U.S. judge refused to dismiss a lawsuit against Moody’s Investors Service Inc. and Standard & Poor’s, rejecting arguments that investors can’t sue over deceptive ratings of private-placement notes because those opinions are protected by free-speech rights.
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U.S. District Judge Shira Scheindlin in New York rejected the ratings firms’ arguments yesterday, forcing them and Morgan Stanley, which was also sued, to respond to fraud charges in a class-action by investors claiming the raters hid the risks of securities linked to subprime mortgages.
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Scheindlin said in her ruling that the First Amendment of the U.S. Constitution doesn’t provide a defense the case because the rating firms’ comments were distributed privately to a select group of investors and not to the general public.

Without ruling on the merits of the lawsuit, the judge said opinions by the ratings companies may be the basis for a lawsuit “if the speaker does not genuinely and reasonably believe it or if it is without basis in fact.” She said there are enough facts alleged against the two agencies and Morgan Stanley, the sixth-biggest U.S. bank by assets, for the lawsuit to go forward with evidence gathering needed for any trial.

It seems pretty strange to me, but I’m prepared to concede that Scheindlin knows American constitutional law than I do! I don’t understand, however, why the CRAs have a duty to tell the truth. So they lie. So? The only person who’s paying them is the issuer. It also seems to me to be a reasonably easy lawsuit to defend: the CRAs simply have to show that they used a reasonable model such as the one they used for everything else.

Private Equity methodology is changing:

The world’s biggest private-equity firms, shut out of the market for leveraged buyouts as banks curtail lending, are turning to bankruptcy courts to make acquisitions.

KKR & Co., the New York takeover firm co-founded by Henry Kravis, is part of a group converting loans made to Lear Corp. into a controlling stake in the bankrupt car-seat maker. Late yesterday, Hayes Lemmerz International Inc. said it reached an agreement with the lenders who financed its bankruptcy, giving them an equity stake in the maker of wheels for cars. This year, 162 companies merged or were bought out of bankruptcy, a 60 percent jump from the same period in 2008 and almost triple the amount in 2007, according to data compiled by Bloomberg.
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“It’s not a tactic that private-equity firms have historically employed, but it seems to be an idea whose time has come,” said Steven Smith, global head of leveraged finance and restructuring at UBS AG in New York. “This is clearly one of the new and most distinctive features of the current wave of restructurings.”

PerpetualDiscounts continued to give ground today, losing 31bp agains a FixedReset gain of 6bp; all this happened on relatively light volume and muted volatility: the Performance Highlights chart is pretty skimpy today.

The Boston Fed has prepared a foreclosure & house-price graphic for Massachussets:

This interactive graphic, showing changing patterns in foreclosure
rates and subprime mortgage originations across Massachusetts cities and towns since 1990 and their association with house-price changes, has been updated with 2008 data and enhanced with a new set of maps displaying the changing pattern of house-price changes from 1990 to 2008.

The slow pullback in the preferred share market continued, with PerpetualDiscounts losing 17bp and FixedResets down 7bp on the day. PerpetualDiscounts closed yielding 5.73%, equivalent to 8.02% interest at the standard equivalency factor of 1.4x. Long corporates now yield about 5.9%, so the pre-tax interest-equivalent spread is now roughly 210bp, up 10bp from August 31.

Guillermo Calvo of Columbia University writes an interesting piece for VoxEU, Dumping Russia in 1998 and Lehman ten years later: Triple time-inconsistency episodes:

This column introduces “triple time-inconsistent” episodes. First, a public institution is expected to cave in and offer a bailout to prevent a crisis. Then, in an attempt to regain credibility, it pulls back. Finally, it resumes bailing out the survivors of the wreckage caused by the policy surprise. This column characterises the 1998 Russian crisis and the current crisis as triple time-inconsistency episodes and says that a financial crisis may simply be a bad time to try to build credibility.
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It is far from me to chastise or ridicule those involved in triple time inconsistency. There are always good reasons why bright and well-intentioned public officials make serious mistakes during major crises. The two cases singled out in this note took place in arguably “unprecedented” circumstances. In situations like these, “shooting from the hip” becomes the rule, and errors are to be expected. However, I believe that there are at least two lessons that we could draw from these episodes, which could help to lower the incidence of triple time inconsistency and other inefficiencies:

• •A financial crisis is not the best time for reform or building credibility, especially if those actions go against the private sector’s expectations. Policymakers should focus their attention on putting out the fires and minimise the short-run social costs.
• •Policymakers should spend more time discussing worst-case scenarios before crises occur. These discussions should be carried out with some regularity (much like fire drills) and involve a wide spectrum of public officials that might eventually have to be involved in rescue operations during crisis. This will ensure a better understanding of the involved risks and tradeoffs, and improve the effectiveness of policies that need to be implemented in the spur of a moment.

Fat chance of the second one! When was the last time you saw a ten-year government deficit projection that included a discussion of the projected effects of a severe recession?

CIT is going to defer interest payments on its sub-debt:

Commercial lender CIT Group Inc. said in a regulatory filing Tuesday it will defer interest payments on some outstanding junior notes.

CIT was to make the next interest payment on the junior notes on Sept. 15, according to the Securities and Exchange Commission filing. The deferred interest will continue to accrue and compound until payments are made, the company said.

Interest is being deferred on junior subordinated notes due March 15, 2067.

Deferring interest payments can help CIT Group continue to reduce its near-term debt burden, furthering its efforts to remain in business after nearly collapsing earlier in the year.

The SEC filing on CIT’s site is copy-protected – idiots.

The Boston Fed has published an interesting paper by Katharine Bradbury and Jane Katz, Trends in U.S. Family Income Mobility, 1967-2004:

Using data from the Panel Study of Income Dynamics and a number of mobility concepts and measures drawn from the literature, we examine mobility levels and trends for U.S. working-age families, overall and by race, during the time span 1967–2004. By most measures, we find that mobility is lower in more recent periods (the 1990s into the early 2000s) than in earlier periods (the 1970s). Most notably, mobility of families starting near the bottom has worsened over time. However, in recent years, the down-trend in mobility is more or less pronounced (or even non-existent) depending on the measure, although a decrease in the frequency with which panel data on family incomes are gathered makes it difficult to draw firm conclusions. Measured relative to the overall distribution or in absolute terms, black families exhibit substantially less mobility than whites in all periods; their mobility decreased between the 1970s and the 1990s, but no more than that of white families, although they lost ground in terms of relative income.

Taken together, this evidence suggests that over the 1967-to-2004 time span, a low-income family’s probability of moving up decreased, families’ later year incomes increasingly depended on their starting place, and the distribution of families’ lifetime incomes became less equal.

It should be noted, however, that:

We do not address shorter‐term “volatility”—shocks to family incomes from year to year—or longer‐term “intergenerational mobility”—how much a person’s adult family income level (or position) depends on the level (position) of his/her parents during childhood.

This is a shame, because it the latter measure that I find to be of most interest. The authors conclude, in part:

What are the implications for policy? Because we find no evidence to suggest that the typical poor family is more likely to move up and out of poverty within several years than it was 40 years ago, policy remedies for those at the bottom should aim beyond short‐term help, as the poor at any point in time are likely to have low long‐term incomes. Beyond short‐term relief, the choice of policy presumably hinges, at least in part, on the reasons for the decline in mobility, for example, whether it reflects rising barriers to opportunity or rising returns to highstakes labor market promotion practices, including tournament‐style regimes common in the professions.

I’m not sure how to take this report. It sees to me that the results could come from increased efficiency in determining the starting point – e.g., you get that good job right out of school instead of having to pay your dues for twenty years and waiting for your supervisor to die. As I noted, I am far more concerned by inter-generational income mobility.

Volume picked up a little today, but the market didn’t, really, with PerpetualDiscounts down 19bp and FixedResets up 5bp. Just to make things more confusing, PerpetualPremiums were up 11bp … geez, it’s nice to see a healthy population in that slot!

Spend-Every-Penny has declared:

As the United States and other countries debate giving more authority to central banks and other regulatory agencies, [Spend-Every-Penny] Sunday said he is sticking with his current approach to systemic oversight, which brings together the heads of the Bank of Canada, the federal banking regulator and other key authorities on a regular basis to compare notes. The decision means a previously obscure grouping of senior officials – the Financial Institutions Supervisory Committee – will be thrust into the spotlight as Canada’s answer to the pledge the federal government and its allies in the Group of 20 made to correct regulatory failings that contributed to the financial crisis.

[Spend-Every-Penny] made clear that even though unelected public servants will play crucial roles, responsibility for ensuring that Canada stays out of financial trouble rests with him.

There’s a very good chance that there won’t be another major banking crisis before he retires, so it’s a pretty safe way to appear tough and authoritative. In most countries, however, the idea that the politicians are ultimately responsible for the performance of their appointees is generally understood. I can’t find a public copy of the speech anywhere, by the way. I hope Spend-Every-Penny won’t be so shy when something bad happens … but I won’t bet on it.

I see that Toronto, well known for its inability to license a souvlaki cart in less than three years is attempting to create a bigger sink-hole than the one on Finch Avenue by bidding to host the Pan-Am games. Send in the clowns!

I noted on March 23 that Liddy, the last CEO of AIG, demonstrated his lack of qualification for the office by throwing his people to the wolves during the bonus controversy. The new guy, Benmosche, is much better:

Benmosche criticized Cuomo and lawmakers during a town-hall style meeting this month for life insurance workers in Houston. Cuomo subpoenaed AIG in March during a national furor about $165 million in retention bonuses sent after the firm’s bailout and said those who returned the cash wouldn’t have their names published. That month, some employees received death threats and protesters visited the Connecticut homes of two AIG executives.

“What he did is so unbelievably wrong,” Benmosche said during the Aug. 11 remarks, according to a record obtained by Bloomberg. “He doesn’t deserve to be in government, and he surely shouldn’t be the attorney general of the state of New York. What he did is criminal. You don’t create lynch mobs to go out to people’s homes and do the things he did.”

Speaking of bonuses…:

U.S. Securities and Exchange Commission Chairman Mary Schapiro, in a letter to brokerage chiefs, warned that burgeoning recruitment bonuses may push employees to engage in improper sales and trades.

Large, up-front bonuses and enhanced commissions may lead brokers “to believe they must sell securities at a sufficiently high level to justify special arrangements,” she wrote today. “Those pressures may in turn create incentives to engage in conduct that may violate obligations to investors.”

Brokers may be motivated to make excessive trades to generate fees, a process known as churning, Schapiro said. They might recommend products that don’t suit their clients’ objectives or generate fees with transactions that aren’t in their customers’ interest, Schapiro said.

Warning! Increased political scrutiny may lead regulators to believe they must make gratuitously precious statements about activities that are already illegal.

Volume ticked upward today, but the market ended a very good month on a sour note, with PerpetualDiscounts losing 13bp and FixedResets down 14bp. The latter may be related to the BPO new issue.

PerpetualDiscounts closed with a pre-tax bid-YTW of 5.66%, equivalent to 7.92% interest at the standard equivalency factor of 1.4x. Long Corporates closed the month with a yield of about 5.95% (after generating +2.83% total return in August), implying that the pre-tax interest-equivalent spread remains at about 200bp.

Credit markets are recovering on the back of credit markets:

Banks are increasing lending to buyers of high-yield company loans and mortgage bonds at what may be the fastest pace since the credit-market debacle began in 2007.

Credit Suisse Group AG and Scotia Capital, a unit of Canada’s third-largest bank, said they’re offering credit to investors who want to purchase loans. SunTrust Banks Inc., which left the business last year, is “reaching out to clients” to provide financing, said Michael McCoy, a spokesman for the Atlanta-based bank. JPMorgan Chase & Co. and Citigroup Inc. are doing the same for loans and mortgage-backed securities, said people familiar with the situation.

Spend-Every-Penny announced his plan to profit from a stronger CAD:

The Honourable [Spend-Every-Penny], Minister of Finance, today announced that the Government of Canada plans to issue a US-dollar-denominated global bond in the near future, subject to market conditions. This will be the Government’s first foreign currency global bond issue in more than a decade.

The US-dollar bond issue will provide funds to supplement Canada’s foreign exchange reserves and to meet foreign currency requirements to support current and anticipated lending by the International Monetary Fund.

Canada holds its foreign exchange reserves in the Exchange Fund Account (EFA). EFA assets provide foreign currency liquidity and support the promotion of orderly conditions for the Canadian dollar in foreign exchange markets. Funds for the EFA can be raised through cross-currency swaps of Canadian-dollar borrowings, foreign-currency-denominated debt issues and outright purchases of foreign currency. In recent years, the Government has relied primarily on cross-currency swaps to finance the EFA. The global bond issue will prudently diversify the Government’s sources of foreign currency financing.

I have nothing against diversification of financing, but the timing of this issue is a little odd, given all the weeping and wailing over CAD strength.

Volume slowed down a little today, but the market continued its winning ways, with PerpetualDiscounts up 20bp, leading FixedResets which finished up 6bp.

FixedResets outperformed PerpetualDiscounts today, +13bp vs. -8bp, and grabbed the top three spots in the volume table. Volume eased off a little.

The FDIC is reducing the capitalization requirements for private equity firms buying banks:

The FDIC board approved the rules today at a meeting in Washington, agreeing to lower to 10 percent from the proposed 15 percent the Tier 1 capital ratio private-equity investors must maintain after buying a bank.

This issue was last discussed on PrefBlog on July 28.

I’m not usually a big fan of bureaucrats, but Jed Rakoff, the US District Judge hearing the SEC / BAC / MER case is saying some unusually sensible things:

U.S. District Judge Jed Rakoff has twice refused to approve the Securities and Exchange Commission’s $33 million settlement over the bank’s failure to better disclose bonuses it had authorized Merrill Lynch & Co, which it was acquiring, to pay.

Rakoff has faulted the SEC for appearing to let the bank off too easily, and dismissed as nonsensical why the bank would agree to pay anything without admitting it had done anything wrong.

Hear, hear, Mr. Rakoff! Regulators are quick to tout their negotiated settlements, but a negotiated settlement without admission of guilt is either a license to cheat or simple regulatory extortion. The politicians who ultimately bear responsibility for the conduct of their regulators should revise legislation such that negotiated settlements are banned.

Not content with saying one sensible thing, Judge Rakoff continued:

In the Bank of America case, executives said they relied on lawyers’ judgments as to what bonus details should be revealed. Yet the bank did not waive attorney-client privilege, meaning the names of the decision makers remained secret. An exasperated Judge Rakoff questioned why the SEC would agree to this.

“If the company does not waive the privilege,” the Manhattan judge wrote, “the culpability of both the corporate officer and the company counsel will remain beyond scrutiny. This seems so at war with common sense.”

The SEC’s position, if it has been reported correctly by Reuters, is nothing short of insane. Everything’s OK as long as you sought legal counsel? This implies that the SEC has out-sourced the interpretation, prosecution and judgement of securities law to any two-bit shyster with a law degree who happens to be consulted. By the SEC’s reasoning, if I put every cent of client money into sub-prime paper and lose the whole whack, I should be able to claim that I consulted the rating agencies and so did nothing wrong!

Where is the responsibility here? Regardless of what was discussed with whom, the fact is that BofA – and BofA’s executives – knew X and disclosed Y. The consultation of legal advisors is irrelevant to the question of whether X is sufficiently close to Y to meet their legal obligations; the consultation is not wholly irrelevant to personal responsibility, but it is merely a detail.

The preferred share market halted its decline today, with FixedResets up 11bp and PerpetualDiscounts eking out a 6bp gain. This left PerpetualDiscounts yielding 5.66%, equivalent to 7.92% interest at the standard equivalency factor of 1.4x. Long Corporates are a little under 6%, call it 5.95%, so the pre-tax interest-equivalent spread is now near-as-dammit to 200bp, widening 12bp from August 19 and bang on what I have come to call ‘Credit Crunch Normal’.