Category: Market Action

Bernanke & Geithner continued their campaign to have the Fed become the regulator of everything:

The top two U.S. economic leaders called for new powers to take over and wind down failing financial companies after the government’s troubled rescue of American International Group Inc.

“As we have seen with AIG, distress at large, interconnected, non-depository financial institutions can pose systemic risks just as distress at banks can,” Treasury Secretary Timothy Geithner said in testimony to a House Financial Services Committee hearing today in Washington. Federal Reserve Chairman Ben S. Bernanke said “AIG highlights the urgent need for new resolution procedures.”

I can’t support it. The only reason AIG posed a risk to the banking system was because the banks were insufficiently regulated … by the Fed. Why were the banks allowed to pair off their long/short CDS positions to such an extent? This would only be appropriate in the case in which AIG had posted a lot of collateral … and they didn’t post any collateral. Had the banks & brokerages been required to put up capital against this lack of collateralization, it wouldn’t have been a problem.

PerpetualDiscounts advanced and FixedResets declined, the latter on heavy volume as it appears that the RY new issue announcement caused a certain amount of portfolio rejigging.

There was an interesting joint Treasury / Fed Press Release today that raised as many questions as it answered:

The Federal Reserve to avoid credit risk and credit allocation
The Federal Reserve’s lender-of-last-resort responsibilities involve lending against collateral, secured to the satisfaction of the responsible Federal Reserve Bank. Actions taken by the Federal Reserve should also aim to improve financial or credit conditions broadly, not to allocate credit to narrowly-defined sectors or classes of borrowers. Government decisions to influence the allocation of credit are the province of the fiscal authorities.

This is eminently sensible – but why is it being repeated? There has been some concern expressed that the Fed is usurping fiscal functions (which I have disagreed with) – are these concerns gaining traction?

Need for a comprehensive resolution regime for systemically critical financial institutions
The Treasury and the Federal Reserve remain fully committed to preventing the disorderly failure of systemically critical financial institutions. To reduce the risk of future crises, the Treasury and the Federal Reserve will work with the Congress to develop a regime that will allow the U.S. government to address effectively at an early stage the potential failure of any systemically critical financial institution. As part of the framework set forth, the legislation should spell out to the extent possible the expected role of the Federal Reserve and other U.S. government agencies in such resolutions.

It looks like the Fiscal Stability Regulator plan is going to happen.

In the longer term and as its authorities permit, the Treasury will seek to remove from the Federal Reserve’s balance sheet, or to liquidate, the so-called Maiden Lane facilities made by the Federal Reserve as part of efforts to stabilize systemically critical financial institutions.

Is this an admission that the Maiden Lane facilities were not, in fact, adequately collateralized?

Equities were on fire today:

Canadian stocks rose the most in three months after the U.S. Treasury said it will spend $1 trillion to purchase distressed assets and Petro-Canada agreed to be bought in the biggest deal for a Canadian oil company.

Manulife Financial Corp., Canada’s largest insurer, climbed 16 percent after the Treasury said it will provide capital and financing for private investors to buy illiquid loans and securities held by banks.
…
Royal Bank of Canada increased 7.6 percent to C$37.94. Toronto-Dominion Bank rose 10 percent to C$45.50. A gauge of financial shares surged 8.7 percent, the most of the 10 industries in the S&P/TSX.

The Treasury’s Public-Private Investment Program will use $75 billion to $100 billion from the $700 billion Troubled Asset Relief Program enacted last year, giving the government “purchasing power” of $500 billion. The Treasury said the program may double “over time.”

Thoughts of imminent mass-bankruptcy disappeared (at least for today) and prefs did really well – in fact, the sub-investment grade split share preferreds did really, really well.

Late Update: Andrew Cuomo proudly announced the success of his extortion racket:

New York state’s attorney general, Andrew Cuomo, said late Monday that 15 of the top 20 recipients of $165 million in retention bonuses from American International Group Inc.’s Financial Products unit have agreed to give back their bonuses — amounting to in excess of $30 million in cash.
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He added that he sees no public interest in disclosing the names of people who return their bonuses, and he acknowledged that returning the money is a difficult decision for many people in the unit who weren’t involved in devising the problematic transactions that helped topple AIG.

I like to think I’d hang on to the money and force Congress to illustrate the depths of their moral bankruptcy by taxing it all way. I also like to think I’d quit – CEO Liddy threw his people to the wolves rather than stand up for them. CEO Liddy is not a leader.

Assiduous Readers will remember I am following the Lyondell bankruptcy – the last mention was on February 24 … there’s more news today:

LyondellBasell Industries AF SCA missed an interest payment on bonds that will trigger payouts on credit-default swaps guaranteeing as much as $1.5 billion of the company’s debt.

Dealers and investors in the market will start the process of settling contracts linked to Netherlands-based LyondellBasell after it failed to pay interest on 500 million euros ($679 million) of bonds maturing in 2015, the International Swaps and Derivatives Association said in a statement today.
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Traders had bought or sold a net $744 million in protection on LyondellBasell debt through credit swaps as of March 13, according to data from the Depository Trust & Clearing Corp., which runs a central registry for the market. Another $786 million of protection was bought through index contracts that include LyondellBasell among a group of 50 companies.

The net figures don’t include contracts covering a gross amount of about $16.6 billion that economically offset each other and typically wouldn’t be paid as long as there are no defaults by the firms selling the protection, DTCC data show.
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Credit-default swaps on LyondellBasell, one of the world’s largest closely held chemical producers, cost 94 percent upfront and 5 percent a year, according to CMA Datavision prices at 5 p.m. in London. That means it costs 9.4 million euros in advance and 500,000 euros a year to protect 10 million euros of the company’s bonds from default for five years.

That’s a nice price for protection, eh? I wonder if anybody paid it!

Good volume and fine performance from the Fixed-Resets today, probably inspired by some portfolio reshuffling with the closing of BMO.PR.O. PerpetualDiscounts continued their recovery from their recent dip.

A correlation has been found between fails-to-deliver (associated with naked shorts) and the demised of Bear Stearns & Lehman:

As Lehman Brothers Holdings Inc. struggled to survive last year, as many as 32.8 million shares in the company were sold and not delivered to buyers on time as of Sept. 11, according to data compiled by the Securities and Exchange Commission and Bloomberg. That was a more than 57-fold increase over the prior year’s peak of 567,518 failed trades on July 30.

The SEC has linked such so-called fails-to-deliver to naked short selling, a strategy that can be used to manipulate markets. A fail-to-deliver is a trade that doesn’t settle within three days.
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Twice last year, hundreds of thousands of failed trades coincided with widespread rumors about Lehman Brothers. Speculation that the company was being acquired at a discount and later that it was losing two trading partners both proved untrue.

After the 158-year-old investment bank collapsed in bankruptcy on Sept. 15, listing $613 billion in debt, former Chief Executive Officer Richard Fuld told a congressional panel on Oct. 6 that naked short sellers had midwifed his firm’s demise.

The Fed has announced:

that the set of eligible collateral for loans extended by the Term Asset-Backed Securities Loan Facility (TALF) is being expanded to include four additional categories of asset-backed securities (ABS):

• ABS backed by mortgage servicing advances
• ABS backed by loans or leases relating to business equipment
• ABS backed by leases of vehicle fleets
• ABS backed by floorplan loans

“Floorplan loans”, by the way, are loans made to auto dealers to finance inventory, secured by that inventory.

Another good day for prefs – PerpetualDiscounts are now up 1.89% Year-to-Date and up 5.20% from the low on March 10, but still down 5.36% from the high on January 13.

AIG bonuses are all over the news; I haven’t commented on them (specifically) due to the total absence of facts. But some people like to talk about it. Econbrowser‘s James Hamilton labels them “outrageous” and “one of the very factors that caused our current problems” without, as far as I can tell, having any more idea about what is going on than I do.

I have no idea what the functions of these exectuives are, what decisions they made, and how much responsibility they should take for decisions made by their boss’ boss’ boss.

There’s a bit more news today:

The head of battered insurance giant AIG told Congress on Wednesday that “we’ve heard the American people loudly and clearly” in their rage over executive bonuses and appealed to employees to voluntarily return at least half of the money.

Voluntarily, eh?

This is a very simple problem to solve, if you feel the game is worth the candle (Matthew, 16:26). All you need to do is threaten each executive with an army of accountants and lawyers, going over everything they’ve ever done in the course of their employment looking for an undotted “i” or an uncrossed “t”. Anything that’s found becomes fodder for just-cause dismissal, lawsuits, regulatory action and/or criminal charges.

Easy. All it takes is a total absence of business ethics.

Another day of solid across-the-board gains, on decent volume. PerpetualDiscounts now yield 7.41%, equivalent to 10.37% interest at the standard equivalency factor of 1.4x. Long Corporates still yield 7.5% (bor-ring!) so the pre-tax interest-equivalent spread has come in a bit to a “mere” 287bp.

Also of interest was the fact that Five-Year Canadas came in 18bp today and now yield 1.55%; this is presumably an arbitrage-thing against Treasuries on the back of the Fed quantitative easing. And rate resets went up anyway. I guess investors are discounting the current turmoil as transient … or something.

PrefBlog’s SEDAR-watching Department, otherwise known as Assiduous Reader MP, points out that Sun Life Financial has issued a new $5-billion shelf prospectus. Of particular interest are the Class B Preferred Shares:

The Class B Shares of each series rank on a parity with the Class B Shares of each other series with respect to the payment of dividends and the return of capital on the liquidation, dissolution or winding-up of SLF. The Class B Shares are entitled to preference over the Common Shares and any other shares ranking junior to the Class B Shares with respect to the payment of dividends and the return of capital, but are subordinate to the Class A Shares and any other shares ranking senior to the Class B Shares with respect to the payment of dividends and return of capital.

However, there are no shares of this class currently outstanding (all the extant SLF preferreds are Series A) and the ability to issue Class Bs has been around for some time – see, for example, the shelf prospectus dated November 4, 2005.

Canadian equities continued their rally today and PerpetualDiscounts rose with them. SplitShares did quite well today – not surprisingly, what with asset coverage improving by leaps and bounds.

Monetary stimulus appears to be having an effect in the UK:

By buying government securities to increase the supply of money, Bank of England Governor King is taking a step that Federal Reserve Chairman Bernanke has only talked about. Early results have been encouraging: Yields on 10-year U.K. government bonds fell to 2.94 percent March 13, at least a 20-year low, from 3.64 percent before King announced the policy March 5.

“The BOE is providing an actual experiment in answering some of the concerns that the Fed has about the effectiveness” of using the strategy to effectively print more money, says former Fed Governor Laurence Meyer, now vice chairman of St. Louis-based Macroeconomic Advisers LLC.
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King — whose office adjoined Bernanke’s when the two were visiting professors at MIT in Cambridge, Massachusetts, during the 1980s — is pursuing both approaches.

Gilt Purchases

He is aiming to expand reserves in the financial system through purchases of U.K. government bonds, known as gilts — a strategy he describes as “conventional unconventional” monetary policy. He will also buy private-sector assets as Bernanke is doing — an approach the Bank of England chief calls “unconventional unconventional.”

Nobody knows what to call things nowadays! I called it “monetary stimulus” because it is government securities that are being purchased; I would not call this “quantitative easing”. I presume that King refers to the process as “conventional unconventional” because “conventional conventional” would be buying government securities at issue time.

The crisis is going to re-write the economics textbooks all right! Especially the glossary!

Tempers are flaring about TARP’s populism and stress tests:

When the U.S. Treasury persuaded the nation’s nine biggest banks to accept capital investments in October, it signaled the whole industry was weak, Kovacevich, 65, said in a March 13 speech at Stanford University in California. Even though Wells Fargo didn’t want the money, it must comply with the same rules that the government placed on banks that did need it, he said.

“Is this America — when you do what your government asks you to do and then retroactively you also have additional conditions?” Kovacevich said. “If we were not forced to take the TARP money, we would have been able to raise private capital at that time” and not needed to cut the dividend to preserve cash, he said.
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Kovacevich said the government is still making mistakes as it tries to save the industry. The “stress test,” designed to determine which of the 19 largest U.S. banks need more capital, provides opportunities for short-sellers to drive down bank stocks and can hurt confidence in the system even more, he said.
…
“We do stress tests all the time on all of our portfolios,” Kovacevich said. “We share those stress tests with our regulators. It is absolutely asinine that somebody would announce we’re going to do stress tests for banks and we’ll give you the answer in 12 weeks.”

I noted on March 12 that CIBC had issued a collateral call to MAV Trust (the successor to non-bank ABCP) … it wasn’t met:

As noted in the DBRS press release dated March 12, 2009, the deadline for providing additional collateral was 5:00 p.m. on March 13, 2009. DBRS was advised that MAVII did not receive the funding of $19.3 million. Since no funding was advanced, CIBC had the option to terminate all or a portion of the leveraged credit default swap transactions collateralized by MAVII. The resulting reduction in collateral supporting the MAVII notes is capped at $107,742,597 (or approximately 1.1% of the assets of MAVII). DBRS was advised today that the entire notional amount of these credit default swap transactions was terminated.

As indicated in the DBRS press release dated March 6, 2009, confirming the ratings of the MAVI and MAVII Class A-1 and Class A-2 Notes (the Notes), the potential for transactions not subject to the 18-month moratorium to unwind was considered by DBRS when assigning the “A” rating to the Notes, and no rating action is warranted at this time.

Willem Buiter writes an interesting piece on VoxEU regarding resolution of the banking crisis – but it is crippled by his idea that markets are efficient. They’re not. There must be some way of cross-training academics & market practitioners such that the former could lose some their awe for the latter. Perhaps an in-depth study of some of the successful pension funds might be a good start?

Another good day for PerpetualDiscounts, which have now recovered 3.88% from their recent low on March 10 … but they’re still down 6.55% from their 2009 high reached on January 13.

Alas, no time for extensive commentary!

PerpetualDiscounts rocketted up, led by insurers, in a day of fairly light volume.

Jon Danielsson, Hyun Song Shin & Jean-Pierre Zigrand (there’s a multicultural author’s list for you!) write a piece in VoxEU, Modelling financial turmoil through endogenous risk, based on their Risk Appetite and Endogenous Risk, in which they show that regulating individual banks and trading institutions according to the same template leads to cliff risk:If the purpose of financial regulation is to shield the financial system from collapse, then basing regulation on individually optimal risk management may not be enough.

The bane of quants and the downfall of pseudo-quants is the fact that different things are important at different times; these effects are best minimized by ensuring that datasets are as homogeneous as meaningfully possible. But it’s particularly aggravating when the authorities change relationships on purpose:

Trichet is allowing the ECB’s deposit rate, which lenders earn on overnight deposits with the central bank, to usurp the benchmark refinancing rate and become the main driver of short- term borrowing costs. At just 0.5 percent, the deposit rate matches the Bank of England’s key setting and is only a step away from the zero-to-0.25-percent range the Federal Reserve uses.
…
The deposit rate is “very, very low,” Trichet said three times in an hour at a press conference on March 5.

He “is implicitly admitting that the deposit rate has now become the key barometer of the ECB’s policy,” said Nick Kounis, chief European economist at Fortis in Amsterdam. “The ECB has become more and more comfortable in pointing that out, not least because it’s been accused of keeping interest rates too high.”

There’s some excitement in ABCP-land! The Master Asset Vehicles (I & II) are the successors to Canadian Non-Bank ABCP … and now CIBC has delivered a collateral call:

DBRS has today commented on the recent series of trigger event notices delivered by Canadian Imperial Bank of Commerce (CIBC) to Master Asset Vehicle I (MAVI) and Master Asset Vehicle II (MAVII; collectively, the MAVs) requesting additional collateral.

As described in the DBRS Canadian Structured Finance Newsletter dated February 19, 2009, CIBC is the swap counterparty for four leveraged credit default swaps (CDS) collateralized by the MAVs that are not subject to the 18-month moratorium period applicable to all other CDS transactions entered into by the MAVs. The collateralization triggers on these transactions were breached on March 3, 2009, prompting CIBC to deliver trigger event notices to the MAVs requesting additional collateral. On March 6, 2009, and March 9, 2009, CIBC delivered subsequent trigger event notices to the MAVs with respect to subsequent trigger breaches. The additional collateral demanded under the March 9, 2009, trigger event notice was withdrawn on March 11, 2009. The total amount of additional collateral demanded by CIBC now stands at $95.4 million for MAVI and $19.3 million for MAVII. CIBC has stated that the deadline for providing additional collateral is 5:00 p.m. on March 13, 2009.

At the time of issuance of this press release, DBRS had not been informed of the posting of additional collateral. As noted in the March 3, 2009, Canadian Structured Finance Newsletter, the failure of the MAVs to post additional collateral will result in a partial or total unwind of the CIBC transactions with the MAVs. For MAVII, the resulting reduction in collateral supporting the notes is capped at $107,742,597 (or approximately 1.1% of the assets of MAVII).

Canadian equities had a great day, led by financials:

Canadian stocks notched their best three-day gain since November as financial and energy shares soared after better-than-estimated U.S. retail sales fanned speculation that the worst of the credit crisis may have passed.

Royal Bank of Canada climbed 4.3 percent, sending financial shares to their steepest three-day gain in 21 years after Bank of America Corp. became the latest U.S. bank to say it made a profit in the past two months. Suncor Energy Inc. rallied to the highest price since October as crude oil rose more than $4 a barrel.

The Standard & Poor’s/TSX Composite Index added 3.4 percent to 8,282.27 in Toronto, its highest close in three weeks, as six stocks rose for each that fell.
…
Royal Bank, Canada’s biggest lender, added C$1.43 to C$35. Bank of Montreal, the fourth-largest, rose 6.1 percent to C$31.93. Canadian Imperial Bank of Commerce, the fifth-biggest, advanced 4.9 percent to C$43.96. Manulife Financial Corp., the country’s biggest insurance company, rose 13 percent to C$12.70. Sun Life Financial Inc. soared 11 percent to C$19.96.

U.S. stocks rallied, led by financial companies, after General Electric Co. said that the loss today of its top credit rating from Standard & Poor’s won’t hurt its business or that of its finance arm.

Financial shares in the S&P/TSX added 5.6 percent, pacing gains in eight of the index’s 10 industries. The gauge rose 20 percent in three days, the best such rally since at least 1987.

XFN, the capped financial index fund, is now back to where it was on February 13, but PerpetualDiscounts are down 7.56% from that date. So go figure.

Still, a few more days like this could be fun!

There is a report that the London Office of AIG’s now notorious Financial Products Group took on notional exposure of USD 500-billion in sub-prime CDSs … not bad leverage for one office of one division, considering AIG’s total equity was $104-billion in June 07, just before the fun started.

Econbrowser‘s James Hamilton advocates having AIG default on its CDSs:

But the issue for me has always been not to exact retribution or instill market discipline, but instead the very pragmatic question of how to use available resources to minimize collateral damage. I accept the argument that a complete failure of AIG would have unacceptable consequences. The relevant question then is, what combination of parties is going to absorb the loss?

The concern I wish to raise is that any reasonable answer to that question would include Goldman Sachs, Merrill Lynch, Societe Generale, and Calyon, to pick a few names at random, as major contributors to this particular collateral-damage-minimization relief fund.
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Then there’s the domino effect to consider. What do we do when this brings down the next player who can’t continue operations without those payments AIG (or the taxpayers) were supposedly going to deliver? I say, we implement the parallel operation there.

I can’t agree. This would have knock-on effects akin to another Lehman; the cure would be worse than the disease. The policy focus should not be on minimizing cost, but on minimizing harm.

I certainly agree that it is unfortunated that taxpayers are getting hurt and it is clear that regulation must be improved. However, pain is part of the game. Western economies in general and Amercian taxpayers in particular have been well served by the financial system.

Who wants to live in a country without a functional banking system, particularly the mortgage market? I don’t know what the system is like now, but I understand the Indian mortgage market was basically non-existent not too many years ago. So the middle class had to save all their lives to buy a place and maybe be able to look around by the time they were 55. Housing 55! There’s a good insurance slogan!

However, the drumbeat of retribution continues:

Debt investors are an attractive target because of the size of their holdings — more than $1 trillion just at the four largest U.S. banks — and because they’ve emerged almost unscathed so far. Since any reduction in debt at a bank helps boost capital ratios, members of Congress including U.S. Representative Brad Sherman, a California Democrat, say it’s time for bondholders to share the pain.

“These banks can go into receivership, shed their shareholders, shed or reduce the amount they owe to their bondholders and come back out much stronger institutions,” said Sherman, who sits on the House Financial Services Committee, in a statement to Bloomberg News. More U.S. capital might be offered as part of the package, he said.

Go for it, Sherman. Regardless of the situation a year ago, these institutions now have TARP money and bond-holders are senior to TARP money. You might find yourself on the wrong end of a cramdown.

With this kind of talk floating around, is it any wonder the US Corporate market is dysfunctional?:

I think the corporate bond market is still fractured. It is not as dysfunctional as it was in October and November but the realization that solid well established companies need to provide as much of a concession as these entities are here is a sign that there is a very long road to travel before the corporate bond market functions with a degree of normality.

Meanwhile, the GSEs are a continuing disaster:

Freddie Mac, the mortgage-finance company thrust into a leading role in President Barack Obama’s homeowner rescue plans, said it will tap $30.8 billion in federal aid as its loan holdings and other assets deteriorated.

The company, which owns or guarantees more than 20 percent of U.S. home loans, today posted a wider fourth-quarter net loss of $23.9 billion, or $7.37 a share. The results pushed the value of Freddie’s assets below its liabilities, the McLean, Virginia- based company said in a statement, and come as Chief Executive Officer David Moffett leaves after six months on the job.
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Freddie and larger competitor Fannie Mae have been pressured to carry out policy initiatives, including offering low-cost mortgage refinancings, since the government takeover. The often conflicting demands of appeasing regulators and pursuing profit may have led Moffett to resign, [F&R Capital Markets analyst Paul] Miller said.

“They want these guys to refi mortgages without new appraisals and to keep mortgage rates very low; those are not sound business decisions,” Miller said. “They are being used as a public policy tool to save the housing market. That is just going to make it more difficult for them to be floated out as public companies down the road.”

In what is almost certainly an orchestrated move, Bernanke’s proposed Financial Stability Regulator has attracted support:

JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon said the U.S. needs a “systemic risk regulator” and should set up procedures to deal with potential failures of large financial institutions.

“Failure is fine as long as it’s orderly, controlled, leads to resolution and doesn’t cause systemic failure,” Dimon, 52, said at a conference hosted by the U.S. Chamber of Commerce in Washington.

Dimon said at a Feb. 3 conference that he believed the Federal Reserve should have the authority to regulate all companies within the banking system.

CDS junkies, by the way, may wish to read the Observations on Management of Recent Credit Default Swap Credit Events.

The Cleveland Fed has released its March Econotrends, with an interesting chart-pack on the impact of credit easing so far. The Fed’s balance sheet has begun to bloat again:

Annoyed at having been called insane, PerpetualDiscounts rose 90bp to yield 7.52%, equivalent to 10.53% interest at the standard equivalency factor of 1.4x. Long Corporates now yield 7.6%, so the pre-tax interest-equivalent spread is now about 290bp … certainly at the high end of its range, although nowhere near the November end-of-the-world levels.