Category: Market Action

Remember Jefferson County? It was last mentioned on September 28 … it’s becoming more farcical all the time:

Circuit Judge David Rains allowed the county in March to collect and spend the tax while the Legislature considered alternatives to the levy whose repeal was affirmed in January. Lawmakers adjourned on May 18 without approving a new measure, and the county couldn’t draw upon those funds.

Preferreds closed the month on a winning note on continued heavy volume. PerpetualDiscounts now yield 6.33%, equivalent to 8.86% interest at the standard equivalency factor of 1.4x. This compares with long corporates at 7.0%, indicating a pre-tax interest-equivalent spread of 186bp … wow! Getting lower by the day!

The Treasury Market Practices Group has released a new closing-time convention that should help the Treasury fails situation – at least to some extent:

Some buy-side market participants expressed dissatisfaction with the existing market convention under which dealers can deliver securities to customers until 3:15 p.m., but customers can usually only deliver securities to dealers until 3:00 p.m.6 This convention can sometimes leave a customer who had, at 3:00 p.m., an uncompleted obligation to receive securities and a matching uncompleted obligation to deliver the same securities in the position of taking in the securities after 3:00 p.m. without being able to turn the securities around and redeliver them on the same day. Instead of a pair of matched fails, the customer is left with an unmatched fail to deliver, resulting in higher interest expenses and/or an overdraft charge. Some buy-side market participants expressed the view that closing times should treat all market participants the same, regardless of whether they are real money investors, leveraged investors, or dealers.

It will now be 3:00pm for everybody and 3:15pm for sophisticated participants (who will mostly be dealers).

It is unusual, but not unheard of, for “real money” accounts to buy and sell the same issue on the same day; but it would be more of a problem for hot money accounts like hedge funds.

Not much price volatility today, as the market eased off a little bit on continued good volume. I forgot to do the spreads-to-corporates yesterday … today PerpetualDiscounts closed to yield 6.42%, equivalent to 8.99% at the standard 1.4x equivalency factor. Long Corporates currently yield about 7.0%, so the pre-tax interest-equivalent spread is now about 199bp – in line with what may be considered Credit-Crunch-but-not-Credit-Terror levels.

The FDIC has issued a call for papers to be delivered at the 9th Annual Bank Research Conference. Guess what the focus is:

The on-going financial sector crisis has focused attention on compensation and governance practices. It has been alleged that compensation and governance systems reward management for risk taking and short term profits and the size and scope of corporate operations expanded at the expense of shareholders and taxpayers. In response to incentives, the management of many financial services firms pursued investment strategies that proved to be unsustainable despite extensive resources devoted to prudential oversight and financial stability monitoring. Recent events highlight the need to examine the management incentives and governance structures in place in the financial services industry, including the supervisory agencies and central banks that regulate and service the industry.

Treasuries got hammered today:

The so-called yield curve steepened to 2.75 percentage points, surpassing the previous record of 2.74 percentage points set on Aug. 13, 2003. Yields on 10-year notes have risen more than 100 basis points since Fed officials said in March they would buy up to $300 billion of U.S. debt over six months to drive consumer rates down and lift the economy from recession.

“The markets are starting to grapple with the issue of what happens when the Fed exits and the Treasury needs to continue at the same pace,” said David Greenlaw, the chief financial economist in New York at Morgan Stanley, one of the 16 primary dealers that trade with the Fed and are required to bid at government bond auctions.

U.S. 10-year notes have lost 8.7 percent this year, according to Merrill Lynch & Co. indexes, while 30-year bonds have lost 25.5 percent. Two-year notes have gained 0.3 percent.

Across the Curve reports that:

The yield on the 2 year note increased 2 basis points to 0.97 percent. The yield on the 3 year note climbed 3 basis points to 1,49 percent. The yield on the 5 year note soared 11 basis points to 2.41 percent. The yield on the 10 year note catapulted 17 basis points higher to 3.72 percent. The yield on the bond rocketed 14 basis points to 4.63.

The 2year/10 year spread is a record 275 basis points.

The 2year/30 year spread is 366 basis points. The record on that is 369 on October 05 1992 at about 1130 AM.

Continued heavy volume for preferred shares today; PerpetualDiscounts took a break from their ascent; BAM issues were (presumably) hurt by the new issue announcement.

Bloomberg reports that low reported LIBOR rates are masking a high level of credit stratification.

It appears that – to nobody’s surprise – dubious loans were marked down too low during the crisis and buyers of these loans will make a killing as the cash trickles in:

When JPMorgan bought WaMu out of receivership last September for $1.9 billion, the New York-based bank used purchase accounting, which allows it to record impaired loans at fair value, marking down $118.2 billion of assets by 25 percent. Now, as borrowers pay their debts, the bank says it may gain $29.1 billion over the life of the loans in pretax income before taxes and expenses.

Spend-every-penny has stated the federal deficit will be $50-billion this year. Interest – just the interest – on this amount alone – never mind next year’s deficit, or the accumulated national debt, or any other trivialities – will soak up the $2-billion annually he neglected to spend during the boom. So much for the party of fiscal probity. Throw the rascals out!

Holy smokes, look at them Floaters go! Now up 31% ON THE MONTH … looks like a few speculators are betting on increased prime AND decreased yields AND a lower than 100% bankruptcy rate …

Volume was quite heavy again today, PerpetualDiscounts continued their ascent and FixedResets continued their pause.

Click for big

Holy smokes, how ’bout them floaters, eh? I’ll have to write a follow-up to my article … maybe give another another seminar.

Volume continued to be elevated on what was supposed to be a sleepy day, given the US holiday, assisted by large blocks in SLF issues, which went ex-Dividend today.

Every now and then an Assiduous Reader writes in and asks whether the banks will be purchasing thier deeply discounted prefs on the market to save themselves a few bucks …. and every now and then I have to resort to handwaving about leverage, Tier 1 capital, OSFI permissions and all that.

It is something of a relief to see that similar questions are being asked in New York:

The state, without bothering to take advantage of market interest rates, paid face value for auction-rate bonds in February and March when the same debt traded at discounts of as much as 40 percent, Municipal Securities Rulemaking Board prices show. The securities, maturing in 2011 and 2022, are part of $1.13 billion of auction-rate debt New York has remaining, which it might be able to repurchase at a discount of 10 percent, according to Kevin O’Connor, a managing director at New York- based Secondmarket.com.
…
“There are legal and investor relations issues involved, and we are reviewing these issues,” said Jeffrey Gordon a spokesman for the Division of Budget, in an e-mail.
…
Anticipation that government issuers will pay face value is keeping prices higher than they would be otherwise, said O’Connor, a former banker who helped start the auction-rate bond trading desk at New York-based JPMorgan Chase & Co. in 2000.
…
The 2011 and 2022 New York bonds’ indentures, or documents that spell out the rights of issuers and investors, say “the state may from time to time purchase bonds” at the prevailing price and retire them.

There’s no prohibition on local governments buying their bonds in the open market, said Troy Kilpatrick, a managing director at Bank of New York Mellon in Pittsburgh, a trustee of auction-rate bonds. “You just don’t see a lot of it happen.”

My guess? Bureaucratic inertia. Remember, this is the financial world we’re talking about, folks. Today was a short trading day because Monday is a holiday – a feature of the bond market that has irritated me since I first calculated a yield.

The Canadian Life Insurers Assurance Facility (whereby insurers can get a government guarantee for their debt in exchange for a fee) is officially under way.

The Fed has published as special rule allowing TARP preferreds to be part of Tier 1 Capital (as well as sub-debt, for smaller banks who were caught in a legalistic tangle and couldn’t issue preferred). There were problems with the dividend step-up and the issuance limits:

In particular, the Senior Perpetual Preferred Stock issued under the CPP has an initial dividend rate of five percent per annum, which will increase to nine percent per annum five years after issuance. In addition, following the redemption of all the Senior Perpetual Preferred Stock issued under the CPP, a banking organization will have the right to repurchase any other equity security of the organization (such as warrants or equity securities acquired through the exercise of such warrants) held by Treasury.

In the preamble to the interim rule, the Board recognized that some of the features of the Senior Perpetual Preferred Stock issued under the CPP if included in preferred stock issued to private investors would render the preferred stock ineligible for tier 1 capital treatment or limit its inclusion in tier 1 capital under the Board’s capital guidelines for bank holding companies. Bank holding companies generally may not include in tier 1 capital perpetual preferred stock (whether cumulative or noncumulative) that has a dividend rate step-up. Furthermore, the amount of eligible cumulative perpetual preferred stock that a bank holding company may include in its tier 1 capital generally is subject to a 25 percent limit.

In part of his continuing plan to make Dubai the world’s financial centre, Geithner’s about to unveil regulated pay scales:

Treasury Secretary Timothy Geithner called for major changes in compensation practices at financial companies and said the Obama administration’s plan to help realign pay with performance will be rolled out by mid-June.

“I don’t think we can go back to the way it was,” Geithner said in an interview on Bloomberg Television’s “Political Capital with Al Hunt,” to be aired tonight and over the weekend. “We’re going to need to see very, very substantial change.”

He said that Wall Street’s pay practices, which include big year-end bonuses, encouraged excessive risk-taking and helped precipitate the financial crisis. What’s needed is a set of broad standards that financial supervisors can use to make sure that doesn’t happen again, he said.

Typical penis-envy: he can’t negotiate worth a damn himself:

While 17 financial institutions have repaid TARP funds, only two have come to terms with the U.S. on the value of the rights to buy stock that taxpayers received for the risk of recapitalizing the industry. The first was Old National Bancorp in Evansville, Indiana, which gave the Treasury Department $1.2 million last week for warrants that may have been worth $5.81 million, according to the data.

If Geithner makes the same deal for all companies in the rescue program, lenders may walk away with 80 percent of profits taxpayers might have claimed.

All this interference might lead to the death of dealers. There is no reason why a hedge fund can’t make it known that it is willing to call a market on any security it pleases; and creating a trading desk organized on the same principles as an institutional desk. Dealers will be left trading governments. Hell, I’ve been trying to organize such a hedge fund for preferred shares for years; sadly, the pension funds I’ve talked to have advised me that one can’t make any money trading preferred shares as principal.

However, increased importance of hedge funds will make the insurers happy:

The cost of insuring hedge funds against negligence has risen as much as 20 percent in the past six months after Lehman Brothers Holdings Inc.’s bankruptcy and Bernard Madoff’s Ponzi scheme increased the threat of lawsuits.

A fund manager with $200 million of assets running a “straightforward” strategy is typically paying as much as $60,000 a year for $5 million of coverage, up from $50,000 at the end 2008, said Brian Horwell, director of professional risks at London-based Miller Insurance Services Ltd.

The FDIC has approved a proposal to increase the insurance premia charged to banks:

On October 7, 2008, the FDIC established a Restoration Plan for the DIF.2 The Restoration Plan called for the FDIC to set assessment rates such that the reserve ratio would return to 1.15 percent within five years. The plan also required the FDIC to update its loss and income projections for the fund and, if needed to ensure that the fund reserve ratio reached 1.15 percent within five years, increase assessment rates. The FDIC amended the Restoration Plan on February 27, 2009, and extended the time within which the reserve ratio must be returned to 1.15 percent from five years to seven years due to extraordinary circumstances.3 The FDIC also adopted a final rule (the assessments final rule) that, among other things, set quarterly initial base assessment rates at 12 to 45 basis points beginning in the second quarter of 2009.4 However, given the FDIC’s estimated losses from projected institution failures, these assessment rates will not be sufficient to return the fund reserve ratio to 1.15 percent within seven years and are unlikely to prevent the DIF fund balance and reserve ratio from falling to near zero or becoming negative in 2009.

The Designated Reserve Ratio is defined as the reserve fund size divided by insured deposits (which, by the way, makes the charging of premia on assets less Tier 1 capital a little suspicious; they should charge insurance premia only on what they’re insuring).

One may note that back here in Canada:

million.We increased our provision for insurance losses by $50 million to $650 million, a move that reflects CDIC’s increasing insurance risk. This provision, combined with retained earnings, resulted in our ex ante funding reaching $1.6 billion as at March 31, 2008. This represents 35 basis points of insured deposits, below our target range of 40 to 50 basis points.

Well, it’s a good thing our bankers are so smart, that’s all I can say!

PerpetualDiscounts continued their ascent on continued elevated – albeit declining, probably a knock-on effect from the short trading day in the US – volume, while FixedResets were basically unchanged.

The Bank of Canada has released a working paper by Hajime Tomura, Heterogeneous Beliefs and Housing-Market Boom-Bust Cycles in a Small Open Economy:

This paper introduces heterogeneous beliefs among households in a small open economy model for the Canadian economy. The model suggests that simultaneous boom-bust cycles in house prices, output, investment, consumption and hours worked emerge when credit-constrained mortgage borrowers expect that future house prices will rise and this expectation is neither shared by savers nor realized ex-post. With sticky prices and a standard monetary policy rule, the model shows that the nominal policy interest rate and the CPI inflation rate decline during housing booms and rise as house prices fall. These results replicate the stylized features of housing-market boom-bust cycles in industrialized countries. Policy experiments demonstrate that stronger policy responses to inflation amplify housing-market boom-bust cycles. Also, higher loan-to-value ratios amplify housing-market boom-bust cycles by encouraging speculative housing investments by mortgage borrowers during housing booms and increasing liquidation of housing collateral during housing busts.

OSFI has released a new Corporate Brochure. The Bank for International Settlements has released Principles for sound stress testing practices and supervision.

DBRS has downgraded ABN AMRO:

ABN AMRO Bank’s outstanding trust preferred securities have been downgraded from BBB to BB. The trend on these securities is Negative. Considering the significant cyclical and company-specific headwinds that RBS faces, DBRS sees an elevated risk of nonpayment of preferred dividends (which DBRS defines as a default on these instruments) which would likely entail a nonpayment of dividends on these securities.

Volume continued at its elevated levels but the market’s ascent was checked; PerpetualDiscounts only just barely managed to squeak out a gain, while FixedResets were slightly negative. But how ’bout them Floaters, eh? Up 17.2% on the month-to-date.

BofA was able to raise significant equity capital yesterday:

Bank of America Corp., the biggest U.S. bank by assets, said it raised about $13.5 billion in a sale of common stock as part of an effort to boost capital and weather an extended recession.

The bank issued 1.25 billion shares at an average price of $10.77 each, according to a statement today. The Charlotte, North Carolina-based company plans to boost common equity capital by $17 billion through the sale of stock and by converting preferred shares mostly held by institutional investors, Chief Executive Officer Kenneth Lewis said May 7.
…
Bank of America expects to add $10 billion more in capital through asset sales and at least $7 billion from improved pretax profits, the company said on May 7. Those numbers may change as the bank considers options to achieve its $33.9 billion target, spokesman Jerry Dubrowski said.

The Pension Benefit Guaranty Fund in the States is having about as much fun as other guarantors:

Pension Benefit Guaranty Corp.’s deficit tripled to $33.5 billion in the past six months as more companies canceled retirement plans amid the U.S. recession, according to the head of the government-owned corporation.

About $11 billion is for “completed and probable terminations,” and $7 billion is from an increase in interest rates that boosted liabilities, Vince Snowbarger, the acting PBGC director, said in written testimony to be delivered tomorrow to the Senate Special Committee on Aging.
…
The potential for General Motors Corp. and Chrysler LLC to end their plans has left the PBGC facing the prospect of adding 900,000 current and future beneficiaries. The PBGC, which pays retirement income to almost 44 million Americans, estimates that $77 billion of the automotive industry’s pensions are underfunded, with about $42 billion of that not funded at all.

There’s a report by internal audit of the fund that claims former PBGC director Millard was, at least, sloppy in separating his various activities – with the Placement Agent scandal still being whipped up, the response could be draconian.

Looks like the SEC is losing the jurisdictional catfight with the Fed:

The Obama administration may call for stripping the Securities and Exchange Commission of some of its powers under a regulatory reorganization that could be unveiled as soon as next week, people familiar with the matter said.

The proposal, still being drafted, is likely to give the Federal Reserve more authority to supervise financial firms deemed too big to fail. The Fed may inherit some SEC functions, with others going to other agencies, the people said. On the table: giving oversight of mutual funds to a bank regulator or a new agency to police consumer-finance products, two people said.

The politicians have to assign blame and shuffle responsibilities in order to make it clear that nothing was their fault.

The Obama administrations shameful conduct in the Chrysler bankruptcy is having some repercussions:

Hedge fund manager George Schultze says he may avoid lending to any more unionized companies after being burned by President Barack Obama in Chrysler LLC’s bankruptcy.

Obama put Chrysler under court protection on April 30 after lenders balked at a proposal giving them about 29 cents on the dollar for their $6.9 billion in debt. The investors said the president’s plan favored a union retiree medical fund whose claims ranked behind them for repayment. It was offered a 55 percent equity stake in the automaker.

Pacific Investment Management Co., Barclays Capital and Fridson Investment Advisors have joined Schultze Asset Management LLC in saying lenders may be unwilling to back unionized companies with underfunded pension and medical obligations, such as airlines and auto-industry suppliers, because Chrysler’s creditors failed to block Obama’s move.

Whether or not the rhetoric influences yield spreads and whether those yield spreads influence conduct is something we’ll just have to wait and see.

Anne Sibert pens a provocative thesis on VoxEU, Why did the bankers behave so badly?:

Greedy bankers are getting most of the blame for the current financial crisis. This column explains bankers did behave badly for mainly three reasons. They committed cognitive errors involving biases towards their own prior beliefs; too many male bankers high on testosterone took too much risk, and a flawed compensation structure rewarded perceived short-term competency rather than long-run results.
…
In a fascinating and innovative study, Coates and Herbert (2008) advance the notion that steroid feedback loops may help explain why male bankers behave irrationally when caught up in bubbles. These authors took samples of testosterone levels of 17 male traders on a typical London trading floor (which had 260 traders, only four of whom were female). They found that testosterone was significantly higher on days when traders made more than their daily one-month average profit and that higher levels of testosterone also led to greater profitability – presumably because of greater confidence and risk taking. The authors hypothesise that if raised testosterone were to persist for several weeks the elevated appetite for risk taking might have important behavioural consequences and that there might be cognitive implications as well; testosterone, they say, has receptors throughout the areas of the brain that neuro-economic research has identified as contributing to irrational financial decisions.

Well, I don’t know what’s up with the Toronto Stock Exchange. There was a problem last Friday retrieving prices that were available and today there’s a problem with availability. So I’m using an approximate, late-in-day-update to prepare today’s report. I did update the details for SLF.PR.F, though, since that one’s important.

It was another really good day for the preferred share market – and here’s a landmark for you: BAM floaters are now trading in the double digits! The low close of 6.40-69 was reached on 2008-12-18 on volume of 27,351 shares.

PerpetualDiscounts now yield 6.39% (pre-tax bid-YTW), equivalent to 8.95% interest at the standard equivalency factor of 1.4x. Long Corporates are now at 7.0%, having returned 4.63% Month-to-date and 9.29% Year-to-Date, so the pre-tax interest-equivalent spread is now about 195bp.

The Bank for International Settlements has released its report on OTC derivatives market activity in the second half of 2008:

Facing significant price drops, markets for commodity and equity derivatives recorded volumes which were 66.5% and 36.2% lower, respectively. Against a background of severely strained credit markets combined with efforts to improve multilateral netting of offsetting contracts, credit default swap (CDS) volumes decreased by 26.9%. Foreign exchange and interest rate derivatives markets recorded their first significant downturns. Amounts outstanding of foreign exchange contracts fell by 21.0%, while amounts outstanding of
interest rate contracts slid by 8.6%.

Gross market values, which measure the cost of replacing all existing contracts, represent a better measure of market risk than notional amounts. Despite the drop in amounts outstanding, significant price movements resulted in notably higher gross market values, which increased by 66.5% to $33.9 trillion at the end of December 2008 (Graph 1, right-hand panel). The higher market values were also reflected in gross credit exposures, which grew 29.7% to $5.0 trillion.
…
In the second half of 2008 the market for OTC interest rate derivatives declined for the first time, after recording an above average rate of growth in the first half of the year. Notional amounts of these instruments fell to $418.7 trillion at the end of December 2008, 8.6% lower than six months before (Graph 2 and Table 3). Despite the decrease in notional amounts outstanding, declining interest rates resulted in a notable 98.9% increase in the gross market value of interest rate derivatives, to $18.4 trillion.

Their statement Gross market values, which measure the cost of replacing all existing contracts, represent a better measure of market risk than notional amounts. is incorrect. If I short a bond future, the market value at time of execution is zero, but I have full market exposure and counterparty risk to the extent that I might win money that doesn’t get paid. If the market moves in my favour, that increases my counterparty risk but doesn’t affect my market exposure.

There are straws in the wind that the too-big-to-fail problem will not be addressed by fixing extant rules, but by adding another layer of new rules that will grant politicians more discretionary power:

Neel Kashkari, former administrator of the $700 billion U.S. bank-rescue program, said firms deemed too big to fail have an unfair advantage over smaller rivals because they can more cheaply raise money in the debt markets.

Kashkari, who left government May 1, said in a speech last night that some officials have discussed the possibility of a “debt tax” or “systemic tax” on those institutions, without saying if he supported that approach.

“If you have some huge, global institution that is systemically important, too big to fail, too interconnected to fail, in a sense it will always be able to issue debt cheaper,” said Kashkari, 35, at the San Francisco campus of the University of Pennsylvania’s Wharton School. “People who buy that debt believe that the government is standing behind it.”

“Debt Tax”? “Systemic Tax”? Presumably this is much the same idea as existing deposit insurance, except that the degree of protection received in exchange for premia will not be spelled out. It is very simple to address the TBTF problem and systemic risk problem by adjusting extant rules:

• End the practice of risk-weighting bank debt according to the credit of the sovereign
• Impose an upwards adjustment to Risk-Weighted Assets based on size of the bank

Here’s a scary proposal: inflation targetting of 6%:

What the U.S. economy may need is a dose of good old-fashioned inflation.

So say economists including Gregory Mankiw, former White House adviser, and Kenneth Rogoff, who was chief economist at the International Monetary Fund. They argue that a looser rein on inflation would make it easier for debt-strapped consumers and governments to meet their obligations. It might also help the economy by encouraging Americans to spend now rather than later when prices go up.

“I’m advocating 6 percent inflation for at least a couple of years,” says Rogoff, 56, who’s now a professor at Harvard University. “It would ameliorate the debt bomb and help us work through the deleveraging process.”

Another strong day in the preferred market, with volume returning to elevated levels after the long weekend.

Those contemplating reverse mortgages would do well to incorporate the new OSFI advisory into their planning … the rules for qualification for optimal capital treatment will indubitably influence the packages offered by banks, notably:

• initial loan-to-value of less than 40%
• Ongoing loan-to-value of less than 60%

I regret that it is not possible for me to prepare the market report. There is a difficulty recovering prices from the TSX.

Update, 2009-5-16: Well, it took a little while, but eventually the TSX’s little computer that could spit out the data: Volume was down sharply in pre-holiday trading (which is always something of a mystery to me) but PerpetualDiscounts had a good up-day while FixedResets were flattish.