Category: Market Action

CIT has hired a bankruptcy specialist:

CIT Group Inc., the century-old lender to 950,000 businesses that has been unable to persuade the Federal Deposit Insurance Corp. to guarantee its debt sales, hired bankruptcy specialist Skadden, Arps, Slate, Meagher & Flom LLP as an adviser amid a plunge in its stock and bonds.

CIT has stated:

in response to recent media reports regarding its pending Temporary Liquidity Guarantee Program (TLGP) application with the FDIC, confirmed that its application to participate in the TLGP remains outstanding. CIT continues to be in active dialogue with the government. There can be no assurance that CIT’s application will be approved by the FDIC, nor as to the timing or terms of any such determination.

and

today confirmed that it remains in active discussions with its principal regulators on a series of measures to improve the company’s near-term liquidity position.

Among the matters being discussed are the Company’s application to participate in the FDIC’s Temporary Liquidity Guarantee Program. The Company is also actively discussing liquidity solutions that do not involve access to the TLGP program, such as the near-term transfer of assets into CIT Bank through Section 23A waivers and the transfer of its Vendor Finance and Trade Finance businesses into CIT Bank; these transfers if approved would enhance CIT’s liquidity position

After the bell, it was reported that:

The U.S. government is in advanced discussions to give aid to CIT Group Inc., the Wall Street Journal reported on its Web site, without saying where it got the information.

One option would have the FDIC backing the company’s debt, according to the newspaper.

The fallout from the BofA/Merrill takeover continues to be fascinating:

Regulators contend Bank of America owes at least part of a $4 billion fee it agreed to pay in January — even without a completed legal document — because the company benefited from implied U.S. backing on about $118 billion of Merrill Lynch assets, such as mortgage-backed bonds, people familiar with the matter said. The Charlotte, North Carolina-based bank says it owes the Treasury nothing, according to the people, who declined to be identified because the negotiations are confidential.

The major subindices squeaked out another win today, amidst good volume.

Bloomberg has a little more speculation regarding the CIT death-spiral:

The Federal Deposit Insurance Corp. is unwilling to guarantee CIT Group Inc.’s bond sales because the commercial lender’s credit quality is worsening, according to people familiar with the regulator’s thinking.

The FDIC, which has backed $274 billion in bond sales under its Temporary Liquidity Guarantee Program since Nov. 25, is concerned that standing behind CIT debt would put taxpayer money at risk, said the people, who declined to be identified because the application process is private.

The federal agency, run by Chairman Sheila Bair, is in discussions with CIT about how the lender can strengthen its financial position to get approval, including raising capital, said one of the people. New York-based CIT’s measures to improve its credit quality, such as by transferring assets to its bank, have been insufficient, the person said.

Comrade Obama is proposing extraordinary powers for the SEC:

The Obama administration is seeking to give the U.S. Securities and Exchange Commission power to prohibit pay practices at brokerages and investment advisers and broader authority to bar individuals from work in the industry.

The Treasury Department today sent Congress legislation that would let the SEC ban “sales practices, conflicts of interest and compensation schemes” deemed harmful to investors. The measure authorizes the agency to remove individuals who violate rules from all aspects of the industry, rather than just a specific segment such as selling securities or managing money.
…
The measure gives the SEC authority to reward whistle blowers who give the agency tips about those violating all securities laws. The SEC currently has power to pay individuals who provide the agency with tips on insider-trading violations.

Super! Paid informers! Just the thing that’s needed to further improve society’s moral fibre!

No response or acknowledgement from MFC regarding my queries on the MLI IT1C issue. What a surprise!

Continued gains, albeit pretty small ones, for preferred shares today. Volume dropped off a bit.

Bradford & Bingley is defaulting on its sub-debt:

— Bradford & Bingley Plc’s failure to pay interest on some of its subordinated bonds will trigger settlement of credit-default swaps linked to about $414 million of the nationalized mortgage lender’s debt.

Dealers and investors agreed today that the Bingley, England-based company’s decision not to pay interest on 125 million pounds ($202 million) of 6.625 percent subordinated bonds maturing 2023 was a “credit event,” the International Swaps and Derivatives Association said on its Web site.

The ruling will prompt an auction to settle credit swap contracts even though the U.K. government changed the terms of the bank’s nationalization in February, allowing it to miss coupon payments without that constituting a default. Bradford & Bingley said in May it didn’t intend to pay interest on the notes, which form part of the bank’s so-called lower Tier 2 capital.

This shows the authorities’ determination to make holders of capital paper suffer, a major factor in the DBRS revision of its rating methodology.

The more I think about the recent MLI Tier 1 Issue, the less I understand it. I have updated my discussion of the issue with some questions sent to MFC’s Investor Relations department.

S&P should be revising the TXPR index soon – but I still don’t see any announcement on their index news page. The last revision was announced 2009-1-9, while last summer’s revision was announced 2009-7-11 (which included the addition of a called issue, FAL.PR.H, which was later quietly dropped).

The Credit Crunch isn’t over yet, as evidenced by Fun ‘n’ Games regarding the pricing of senior debt of CIT, a TARP beneficiary. CIT has, for all intents and purposes, been locked out of the bond market for well over a year and has been downgraded to just above, or below, junk status by the ratings agencies (depending on which ones you listen to; Fitch has them at single B). They were able to issue a short-term TALF-eligible securitization in early June; 2Q09 results will be announced on July 23.

The Boston Fed has released another Policy Briefing (they’ve been busy this week!), this one regarding A Proposal to Help Distressed Homeowners: A Government Payment-Sharing Plan:

This public policy brief presents a proposal, originally posted on the website of the Federal Reserve Bank of Boston in January of this year, designed to help homeowners who are unable to afford mortgage payments on their principal residence because they have suffered a significant income disruption and because the balance owed on their mortgage exceeds the value of their home. These homeowners represent a subset of the population of distressed homeowners, but according to our research they face an elevated risk of default and are unlikely to be helped by current foreclosure-reduction programs. The plan is a government payment-sharing arrangement that works with the homeowner’s existing mortgage and provides a significant reduction in the homeowner’s monthly mortgage payment. The plan does not involve principal reduction. Two options are presented; both are designed to help people with negative equity and a significant income disruption, such as job loss. In one version, the assistance comes in the form of a government loan, which must be repaid when the borrower returns to financial health. The second version features government grants that do not have to be repaid. In either case, the homeowner must provide evidence of negative equity in the home and of job loss or other significant income disruption. The costs of the plan are moderate, and the benefits should help not only the participating homeowners but also the housing industry, the financial markets, and the economy more broadly.

Another strong day for preferreds, with FixedResets outperforming yet again. I’m finding the yields on those things increasingly difficult to believe! When will it end?

PerpetualDiscounts closed to yield 6.30%, equivalent to 8.82% interest at the standard equivalency factor of 1.4x. Long corporates now yield 6.4%, so the pre-tax interest-equivalent spread is now 242bp, tightening in a little from the 250bp they recorded June 30.

The New York Fed has announced:

RBC Capital Markets Corporation has been added to the list of primary dealers, effective July 8, 2009.

… and note …

Primary dealers are banks and securities broker-dealers that trade in U.S. Government securities with the Federal Reserve Bank of New York.

.
Bloomberg reports:

RBC is the first Canadian firm to join the Fed’s network since CIBC Wood Gundy in 1996. The first Canadian primary dealer was Nesbitt Burns, which was given the designation in 1995. Nesbitt Burns was renamed BMO Nesbitt Burns in 2000 and abandoned its dealership in 2002. CIBC left in February 2007, before the start of the financial crisis which led to the flight-to-quality in U.S. government securities. Royal Bank of Canada is the nation’s largest lender.

The International Monetary Fund has released its Global Financial Stability Report – Market Update, July 2009:

Financial conditions have improved, as unprecedented policy intervention has reduced the risk of systemic collapse and expectations of economic recovery have risen. Nonetheless, vulnerabilities remain and complacency must be avoided. The financial sector continues to be dependent on significant public support, resulting in an unparalleled transfer of risk from the private to the public sector. At the same time, however, work will need to begin on exit strategies from the various financial, monetary, and fiscal support policies in order to address market uncertainty. Medium-term policies need to ensure that steps taken to normalize policies and markets are consistent with establishing a lasting framework of sound financial regulation, sustainable fiscal balances, and the maintenance of price stability.

I am glad to hear that, in the opinion of the quasi-regulators at the IMF, that there is a continued need for quasi-regulators.

On July 3 I remarked on the idiocy of solemn discussions about “What Should be the World’s Reserve Currency?”. There’s a guy in China who has a better grasp of affairs than his political masters:

Huang Xinyuan, who sells mining equipment and pesticides to customers across China’s border with Vietnam, says he no longer wants payment in U.S. dollars and prefers the yuan.

Sales using the greenback at Guangxi Jinbei Group, where Huang is vice president, dropped to 30 percent of contracts in 2008 from 87 percent in 2007. The yuan, which has gained 21 percent since it was allowed to strengthen against the dollar starting in 2005, offers greater stability, he said.

That’s how reserve currency status gets decided … what people will take. Anyone who was in an Eastern Bloc country in the ’80’s, or even ’90’s, furtively exchanging greenbacks for local currency at prices bearing no relationship to the official market, knows that.

There are consultations progressing between private equity players and the FDIC regarding the failed bank buy-out rules discussed on PrefBlog on July 3.

Treasury has announced that the Legacy Securities Public-Private Investment Program and the Legacy Loan Program are moving forward. Of highest importance, of course, is making sure the lolly is distributed to appropriate parties:

Collectively, the nine pre-qualified PPIP fund managers have established 10 unique relationships with leading small-, veteran-, minority-, and women-owned financial services businesses, located in five different states, pursuant to the Legacy Securities PPIP. Moreover, as Treasury previously announced, small-, veteran-, minority-, and women-owned businesses will continue to have the opportunity to partner with selected fund managers following pre-qualification.

Continued good volume today, without much price action. FixedResets were actually down, albeit by such a marginal amount as to be meaningless. The median Yield-to-Worst on OperatingRetractibles continues to be negative.

Treasury is going to avoid voting its shares in companies that received TARP funds:

On many resolutions offered by investors — from demanding pro- environment policies to allowing domestic partner benefits to reining in executive bonuses — the Treasury plans to ask that its ballots be counted in the same proportion as the votes of other stockholders so it won’t impact the results.

An investment manager could probably go to jail for that! But Dealbreaker, bless its heart, sees the truth:

As Kenny Lewis can attest to, when it comes to the stuff that really matters, backroom waterboarding is a far more compelling tool than shareholder votes.

The Lewis affair was discussed on April 24: Lewis’ BofA was basically forced by Treasury to buy Merrill, despite “staggering deterioration” of Merrill’s balance sheet.

Looks like there will be increased regulatory control over oil & gas speculation. There is, naturally, considerable doubt as to whether speculation is harmful.

California’s having a little difficulty getting its IOUs accepted:

A group of the biggest U.S. banks said they would stop accepting California’s IOUs on Friday, adding pressure on the state to close its $26.3 billion annual budget gap.
…
Amid the budget deadlock, Fitch Ratings on Monday dropped California’s bond rating to BBB, down from A minus, the latest in a series of ratings downgrades for the state.

The group of banks included Bank of America Corp., Citigroup Inc., Wells Fargo & Co. and J.P. Morgan Chase & Co., among others. The banks had previously committed to accepting state IOUs as payment. California plans to issue more than $3 billion of IOUs in July.

BIS has released a working paper by Naohiko Baba and Frank Packer titled From turmoil to crisis: dislocations in the FX swap market before and after the failure of Lehman Brothers:

This paper investigates dislocations in the foreign exchange (FX) swap market between the US dollar and three major European currencies. After the failure of Lehman Brothers in September 2008, deviations from covered interest parity (CIP) were negatively associated with the creditworthiness of US financial institutions (as well as that of European institutions), consistent with the deepening of a dollar liquidity problem into a global phenomenon. US dollar term funding auctions by the ECB, SNB, and BoE, as well as the US Federal Reserve commitment to provide unlimited dollar swap lines are found to have ameliorated the FX swap market dislocations.

The Ontario Securities Commission has released its 2009 Annual Report. To my mind, the most interesting sentence was:

The OSC, Quebec’s Autorité des marchés financiers and the Investment Industry Regulatory Organization of Canada (IIROC) are reviewing complaints received in connection with the organization, sale or distribution of non-bank sponsored ABCP products.

Not much price action today, but the PerpetualDiscount and FixedReset sectors both posted gains, with yields on FixedResets continuing what seems like an inexorable march downwards.

Willem Buiter wants to clamp down on CDS trading:

CDS provide an example. Just as short selling equity is potentially efficiency enhancing but naked short selling is just gambling, so insuring credit default risk is potentially efficiency enhancing when the buyer has an insurable interest and the writer of the CDS is sufficiently capitalised. Current arrangements permit ‘naked’ CDS buying (buying CDS on a security in excess of the face value of your holdings of that security).

I would not follow George Soros and ban CDS outright. I would require that any writer of CDS or other forms of credit risk insurance be properly capitalised and post additional collateral immediately when his creditworthiness is adversely affected. In addition, I would stipulate that it is only possible to buy CDS when you have an insurable interest in the security it is written on, and that you cannot make good, following default on a security, any claim under a CDS written on that security unless you can present to the writer of the CDS an amount of that security with the same face value as your claim.

The reference to George Soros links to a column by Ed Hammond:

George Soros, the billionaire financier, this week called for the scrapping of CDS contracts. He used the example of the bankruptcy of General Motors as a reason for outlawing these contracts. This, he said, was because it was in the interest of some bondholders to see the company go under as they were also in possession of CDS contracts, which paid out on the carmaker’s default.

… which is just the old debt-decoupling problem that has so many people (not me!) so upset.

I fail to understand Mr. Buiter’s equation of naked-shorting (protection buying) with gambling. The exposure to the shorting party is the same; there may well be risk to the counterparty that is not disclosed in a naked short; and this potential counter-party risk may well be destabilizing and therefore Bad; but I don’t understand why it should be deprecated as gambling and thus distinguished from the price-discovery process assisted by shorting.

I do try to stay away from politics in this blog – except where they explicitly impinge on the financial world, but this Toronto Star article is too good to pass by: Green Bins: A wasted effort:

The City of Toronto boasts that its green bin program diverts a third of our garbage and turns it into “black gold” compost. But a Star investigation shows that the program – although nobly conceived – is a sham.

There are two problems. First, the city’s claim of how much waste the program diverts from landfill is inflated. Second, some of the compost that is being produced will kill your plants because of its high salt content, according to laboratory tests.

The Star’s headline is incorrect: the Green Bin programme is serving its purpose perfectly. It is enabling earnest feel-gooders to feel good about themselves. If the purpose was actually to accomplish something useful, we’d just incinerate it all. But that’s regulation for you!

UK CMBS are not feeling very happy:

Investor Simon Halabi’s real-estate companies failed to remedy a default on 1.15 billion pounds ($1.9 billion) of commercial mortgage bonds at a time when, according to Fitch Ratings, “pretty much” all such European deals would breach loan-to-value conditions if they were tested.
…
“With capital values having fallen on average by 43 percent, pretty much any loan that has a loan-to-value covenant if tested today would be in breach,” said Andrew Currie, head of Europe commercial mortgage-backed securities at Fitch Ratings in London. Most servicers of commercial mortgage bonds haven’t tested these conditions, “storing up trouble” for the future, he said before today’s announcement.

White Tower is the largest commercial mortgage bond sold by a single borrower to default this year in Britain, which is Europe’s largest market and accounts for about 50 percent of issuance, according to Fitch. Banks that financed a real-estate buying spree at the top of the market are weighed down with about 230 billion pounds of commercial property loans, data compiled by De Montford University show, making them unwilling to refinance existing deals when they come due.

FixedResets continued to roar ahead (as well as hogging up all the spots on the volume highlights table) and are now more than two points through perpetuals, a price that sounds really, really extreme. At current spreads, of course, redemption at first call looks more likely than not, but there is still a significant amount of extension risk in the structure … we will see how it turns out. My bet? It ends in tears.

The FDIC – which shut down a boatload of banks yesterday – has published draft rules for private equity buyers interested in sniffing around the assets. Very, very stringent, and at first glance, I have to agree with the statement:

“The FDIC’s proposed guidance would deter future private investments in banks that need fresh capital,” Douglas Lowenstein, president of the industry group the Private Equity Council, said in a statement yesterday.

The rules that catch my eye have to do with a 15% minimum Tier 1 Capital Ratio, three year ownership lockup and cross-guarantees from other depository institutions owned by the investor. Unfortunately, the proposals are presented in bald, finished form without discussion, so I am at a loss to determine whether there is any real purpose being served by the proposals.

There was some more some more Chinese mischief-making today:

“There should be a system to maintain the stability of the major reserve currencies,” Zeng, the head of a Chinese research center, said in Beijing today. He advocated supervision of fiscal and current-account deficits, adding that “your currency is likely to become my problem.”

Premier Wen Jiabao said in March that he was “worried” about his nation’s holdings of Treasuries as spiraling U.S. debt threatens the value of the dollar. China, the owner of the world’s biggest foreign-exchange reserves, called yesterday for a stable dollar and damped speculation that it is seeking talks on a new international reserve currency at next week’s Group of Eight meeting.

If China doesn’t like the USD as a reserve currency, that’s an easy problem to solve: don’t hold it. They can keep their reserves in gold, if they like, although copper or oil would probably be a better choice. And making their currency freely exchangeable and doing so much business with the rest of the world that the remnimbi becomes a reserve currency is another option.

And the idea of solemnly going into the G-8 meeting proposing to elect a new reserve currency is utter nonsense. It’s like having a vote to determine who’s tallest. I’m convinced that this is all just posturing to put the US on notice China won’t be pushed around at the meeting … but there’s a better way to do that, too … aircraft carriers.

Sabre-rattling aside, looks like they’re going for the asset-backed reserve currency idea:

Teck Resources Ltd., Canada’s largest diversified mining company, sold a 17 percent stake to China’s $200 billion fund sovereign wealth fund for C$1.74 billion ($1.5 billion) to reduce debt.

China Investment Corp., also known as CIC, will buy 101.3 million Class B subordinate voting shares for C$17.21 each, Vancouver-based Teck Resources said today in a statement. Teck said the deal will give CIC a 6.7 percent voting interest.

There’s some talk about an Argentinian oil deal, too.

Macroblog‘s John Robertson was kind enough to mention an old PrefBlog post in his commentary, A funny thing happened on the way to the federal funds market. While the institution of the Excess Balance Account will relieve some of the leverage-driven selling of Fed Funds, there’s yet another nuance:

Technically, the FHLBs [Federal Home Loan Banks], like other government-sponsored enterprises, are ineligible to earn interest on their own reserve balances held at the Fed, but the FHLBs were given an exemption under the interim rule published last year, which did not distinguish between an FHLB’s own reserve balances and those of their respondents. With the amended Reg. D, the pooling of reserves will no longer be allowed. Thus, the FHLBs will not be able to earn interest on their own reserve balances.

Will this change matter to them? A look at the FHLB consolidated balance sheet suggests it could. For instance, as of Sept. 30, 2008, the FHLBs were sellers of some $94 billion of fed funds and held zero on deposit at the Fed. But as of Dec. 31, 2008, after the Fed started paying interest on reserves, the FHLBs sold only $40 billion of fed funds and held $47 billion on deposit at the Fed.
…
Fed funds market nerds stay tuned.

I object! I’m not a Fed Funds nerd; I’m a Fed Funds geek!

Another strong day for preferreds – especially FixedResets! – on reduced volume; probably due to the US holiday.

Interesting news from Peru today:

IShares, the world’s biggest provider of exchange-traded funds, reached an agreement with Peru’s pension funds that will increase the assets of the first Peruvian exchange traded fund in the U.S., according to Gonzalo Presa, a pension fund manager at Lima-based AFP Horizonte.

The Peruvian pension funds, known as AFPs, will swap shares of local companies in exchange for shares in the iShares MSCI All Peru Capped Index Fund, said Presa. BlackRock Inc. agreed to buy Barclays Plc’s global fund unit, including iShares, for $13.5 billion in June.

“We’ll give Barclays shares to build up this ETF,” Presa, who helps manage $3.4 billion as head of local equities at AFP Horizonte, said in a phone interview. “The idea is to issue $300 million in new shares in two, three weeks.”

Presa said it would be “very difficult” for Barclays to acquire the shares in the local market because of the lack of liquidity.

There’s no information given as to whether the pension funds got a sweetheart deal on fees.

I hadn’t known this in advance, but to my astonishment there was no early close of the bond markets today:

“SIFMA’s Board of Directors and membership reassessed the early close policy, recognizing that additional access to the liquidity provided by our members would benefit all market participants. The interconnected, global nature of the fixed income markets and the significant–and nearly round the clock–access to liquidity that many members provide would be enhanced by this change. Since shortened trading days may limit the liquidity window and create possible market risks which could be mitigated with a full functioning fixed income market on days when liquidity could be normal, we have determined eliminating some of the early closes is a better solution,” said Randy Snook, executive vice president at SIFMA. “This step will allow firms of all sizes around the globe to have access to fixed income liquidity on an almost continuous basis on most trading days of the year.”

Early close recommendations will be eliminated for the following holidays:

· Friday before Martin Luther King, Jr. Day
· Friday before President’s Day
· Day before Independence Day
· Friday before Labor Day
· Day before Columbus Day
· Day before Veterans Day
· Day before Thanksgiving

I’ve heard a rumour that this is TARP-related, which may well be true, but I’m glad of it anyway. Ever since I got into this business, I’ve been amazed that the highest paid profession on earth has had a half-day in advance of long weekends. All the B-School Babies will be whining about having to put in a full day’s work, poor things.

The SEC may be preparing a short-selling cosmetic makeover:

Given the climate in Washington, as well as the running suspicion of Wall Street, new rules seem inevitable, analysts say. Mary L. Schapiro, chairwoman of the S.E.C., has said that considering new rules restricting short-selling is a priority. Members of Congress like Barney Frank, the Massachusetts Democrat who heads the House financial services committee, are calling for quick action.

For the moment, the most likely outcome may be for the S.E.C. to reinstate a rule that the commission itself abolished with a unanimous vote in 2007, under its previous chairman, Christopher S. Cox. Known as the uptick rule, it would bar investors from shorting a stock until its price ticks at least a penny above its previous trading price.

But current and former S.E.C. staff members appear to doubt that reinstating the uptick rule would have much of an effect on trading. Some say the change would be merely cosmetic.
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Sally Miller, a spokesman for the A.B.A., said the member banks thought there was clear link between the market turmoil and the rule change. “All of a sudden subsequent to 2007 they can see all their stocks going haywire,” Ms. Miller said. “It’s cause and effect.”

I wonder what Ms. Miller actually said, in context. She surely can’t be claiming that the most important determinant of bank equity price volatility in the 2007-09 period was the removal of the uptick rule!

Still and all, I wonder what BIS thinks of it. Their annual report contains an argument in favour of short sales as a bubble-controller.

Continued strength in FixedResets brings the yield-to-worst down to 4.55%! Holy smokes, how low can they go?

Sorry, folks! The June 30 closing price data is not yet available from the TSX, so I can’t close off the day.

When I have the data, you’ll get the data!

Update: Continued heavy trading and positive performance closed the month. Preliminary index figures indicate a gain for PerpetualDiscounts of 1.66% on the month, while FixedResets returned +2.70%.

PerpetualDiscounts closed the month yielding 6.36%, equivalent to 8.90% at the standard 1.4x equivalency factor. This compares to Long Corporates at about 6.4%, so the pre-tax interest-equivalent spread is near-as-dammit to 250bp, as declines in PerpetualDiscount yields did not keep pace with the extraordinary strength of the long corporate bonds … they returned +6.14% for the month and are now +17.55% YTD, which ain’t bad!

Bernanke roughly handled by the House Oversight Committee:

Republican lawmakers who have consistently opposed government rescues of financial companies have accused the central bank of overstepping its authority in pressuring Bank of America to absorb Merrill Lynch.

Republican congressional staff wrote in a memo on documents received by the House panel from the Fed through a subpoena that a “gun placed to the head of Bank of America” forced the Charlotte, North Carolina-based bank to go through with the merger, which was announced in mid-September.

but has found defenders in Econbrowser‘s James Hamilton’s post On Grilling the Fed Chair:

It is one thing to have different views from those of the Fed Chair on particular decisions that have been made– I certainly have plenty of areas of disagreement of my own. But it is another matter to question Bernanke’s intellect or personal integrity. As someone who’s known him for 25 years, I would place him above 99.9% of those recently in power in Washington on the integrity dimension, not to mention IQ. His actions over the past two years have been guided by one and only one motive, that being to minimize the harm caused to ordinary people by the financial turmoil. Whether you agree or disagree with all the steps he’s taken, let’s start with an understanding that that’s been his overriding goal.

and in a somewhat more lukewarm manner by Accrued Interest’s Ben Bernanke: Smooth Criminal:

Now the morons in congress are coming for Ben Bernanke for how he handled the Bank of America/Merrill Lynch merger. Seriously? Now, let there be no doubt. Ken Lewis was pressured by the Fed in a way that should leave a bad taste in the mouth of any free citizen. But we were in the middle of an economic war. Sometimes some bad shit happens on the battlefield and sometimes its OK if we look the other way.

Willem Buiter remarks that Too Big to Fail is Too Big (emphasis added):

In banking and most highly leveraged finance, size is a social bad. Fortunately, there is quite a list of effective instruments for cutting leveraged finance down to size.

• Legally and institutionally, unbundle narrow banking and investment banking (Glass Steagall-on-steroids).
• Legally and institutionally prevent all banks (narrow banks and investment banks) from engaging in activities that present manifest potential conflicts of interest. This means no more universal banks and similar financial supermarkets.
• Limit the size of all banks by making regulatory capital ratios an increasing function of bank size.
• Enforce competition policy aggressively in the banking sector, by breaking up banks if necessary.
• Require any remaining systemically important banks to produce a detailed annual bankruptcy contingency plan.
• Only permit limited liability for narrow banks/public utility banks.
• Create a highly efficient special resolution regime for all systemically important financial institutions. This SRR will permit an omnipotent Conservator/Administrator to financially restructure the failing institutions (by writing down the claims of the unsecured creditors or mandatorily converting them into equity), without interfering materially with new lending, investment and funding operations.

The Geithner plan for restructuring US regulation is silent on the too big to fail problem. That alone is sufficient to ensure that it will fail to result in a more stable and safer US banking and financial system.

Of the laundry list, Assiduous Readers will know that I am most in favour of making regulartory capital requirements an increasing function of bank size: it requires the least judgement by regulators and politicians, is the most transparent and allows the highest degree of forward planning by the banks and by the investors in those banks.

I also want to see an unbundling of narrow banking and investment banking, but preferably not by legislative fiat. I want to see the regulations altered to recognize that there is a difference in institutional culture between these two activities and offer institutions a choice between capital requirement regimes. Those opting for Narrow Banking will find they can lever up their buy-and-hold holdings of consumer loans a little more, but find their trading activities require more capital to cover; those opting for Investment Banking will find it relatively easier to lever up a trading operation, but when paper stays on the books for more than a few months it requires progressively more capital.

I recently read a fascinating paper on the origins of corporate boards; Franklin A. Gevurtz’s The Historical and Political Origins of the Corporate Board of Directors:

Prompted by the litany of complaints about corporate boards – as once again highlighted by recent corporate scandals – this paper seeks to add to the literature on why corporation laws in the United States (and, indeed, around the world) generally call for corporate governance by or under a board of directors. Moreover, this paper takes a very different approach in searching for an answer. Instead of theorizing, this paper examines historical sources in order to look at how and why an elected board of directors came to be the accepted mode of corporate governance. This will entail a reverse chronological tour all the way back to the antecedents of today’s corporate board in fourteenth through sixteenth century companies of English merchants engaged in foreign trade. The central insight of this chronology is that the corporate board of directors did not develop as an institution to manage the business corporation. Rather, it is an institution the business corporation inherited when the business corporation evolved out of societies of independent merchants. This paper also shows how these merchant societies based their adoption of the antecedents of today’s corporate board on widespread political theories and practices in medieval Europe that, although hardly democratic, often called for the use of collective governance by a body of representatives. The discovery of the historical and political origins of the corporate board, besides being interesting in its own right, suggests that the current frustration with corporate boards may arise from confusing an institution designed to achieve political legitimacy through consent of the governed, with the goal of assuring efficient management of a business on behalf of passive investors.

A good solidly strong day for preferreds as FixedResets continued to rock ‘n’ roll on continued heavy volume. I will be most interested to see what tomorrow brings, given the DBRS Mass Downgrade of Bank Prefs & IT1C … probably not much effect, but the banks that got downgraded two notches (HSB, NA, LB) rather than just one (BMO, BNS, CM, RY, TD) might see some effects.