Category: Market Action

Not a fun day for preferreds, with PerpetualDiscounts getting hammered … although not quite as badly as on March 5. They are now down 5.19% for March to date.

OSFI is busily cementing its reputation as a bastion of political expediency:

The Office of the Superintendent of Financial Institutions, or OSFI, Canada’s banking regulator, plans to delve into the way that pay packages are designed at a variety of levels throughout banks. The goal is to prevent excessive risk taking by bankers in search of big bonuses, a behaviour that has been fingered as a key contributor to the U.S. banking meltdown.

What a complete joke. OSFI is incapable of running the simplest of simulations – they were astonished that underprovisioning for explected losses had an effect on the Assets-to-Capital multiple calculation, despite years of testing beforehand – and now they’re going to micro-manage bonuses; well, it gets headlines, anyway, and extends the bureaucratic empire.

CEBS is running a consultation process on the topic (the public meeting should be a hoot!), but OSFI already knows everything, so can’t be bothered.

This micro-management will result in the continued growth of hedge funds and the shadow-banking sector (almost certainly outside Canada) and, while it may prevent the occasional small collapse, will end up the same way every other politically inspired feel-goodism project ends up: a lot of money for well-connected consultants, no effect on those who make hiring decisions regarding how many ex-regulators need to be hired to sit on the compensation committee, further stifling of creativity … and a much larger eventual collapse when the chickens finally come home to roost. As they will, since the regulatory capture inherent in micromanagement means that small errors will be papered over with rule changes, interpretations and exemptions until they become … large errors.

However, this will come after the next election, so who cares? Bonus control is simply a method of grandstanding.

Paul Volcker has made some remarks interpreted as nostalgia for Glass-Steagall:

“Maybe we ought to have a kind of two-tier financial system,” Volcker, who heads President Barack Obama’s Economic Recovery Advisory Board, said today at a conference at New York University’s Stern School of Business.

Commercial banks would provide customers with depository services and access to credit and would be highly regulated, while securities firms would have the freedom to take on more risk and practice trading, “relatively free of regulation,” Volcker said.

Volcker’s remarks indicated his preference for reinstating some of the divisions between commercial and investment banks that were removed by Congress’s repeal in 1999 of the Great Depression-era Glass-Steagall Act.

Volcker’s proposals, included in a January report he wrote with the Group of 30, would allow commercial banks to continue to do underwriting and provide merger advice, activities traditionally associated with investment banking, he said.

I couldn’t agree more; I have argued for some time that what we really need is a three-tier financial system, with a rock-solid banking core surrounded by a layer of investment banks and brokerages, surrounded in turn by a wild-n-wooly world of hedge-funds and shadow banks.

I would not support legislating the differences. I will support a regulatory regime that offers a choice between business models: traditional banking or traditional investment banking. The former (core) model would focus on long-term lending and impose a high capital charge for trading and investment operations; the latter model would impose capital charge penalties for long-term positions.

Bankers can’t trade. Bankers can barely manage to bank!

Another cruddy day for equities, particularly insurers:

Canadian stocks fell to a five-year low as the highest U.S. unemployment rate in a quarter century reinforced concern that the global recession will hurt profits and deplete financial companies’ capital.
…
Manulife, the country’s biggest insurance company, dropped 3.5 percent to C$9.65, the lowest intraday price since March 2000. The stock fell 25 percent this week.

Sun Life, Canada’s third-largest insurer, fell 2.7 percent to C$15.68 after it had its credit rating cut to A+ from AA- by S&P, which said declining stock and bond prices may reduce earnings. Great-West Lifeco Inc., the nation’s second-biggest insurer, fell 6.7 percent to C$12.12, the lowest since May 2000.

Canadian insurance stocks have fallen 46 percent this year on speculation that losses on securities will force them to sell stock or cut dividends to bolster capital. Wells Fargo, the fourth-largest U.S. bank, cut its quarterly dividend by 85 percent in a move to save $5 billion a year.

And preferreds were not immune…

There is now quantitative easing in the UK:

Bank of England Governor Mervyn King will take the unprecedented step of printing money to buy assets after cutting the interest rate by a half point to almost zero, the latest move by officials to combat the recession.

The bank said it will pump money into the economy by purchasing as much as 150 billion pounds ($211 billion) in government and corporate bonds, sparking a rally across the debt market. The central bank’s nine-member panel also reduced the benchmark interest rate to 0.5 percent, the lowest since the bank was founded in 1694.

As has been previously noted, this is the first severe contraction the world has ever seen in the presence of a deep and functional CDS market. The large negative basis has also been noted. And now, Dr. Hu’s debt-decoupling (at issue in the Lyondell bankruptcy) is having further reaching effects:

Amusement-park operator Six Flags Inc. and automaker Ford Motor Co. may be pushed toward bankruptcy by bondholders trying to profit from credit-default swaps that protect against losses on their high-yield debt.

By employing a so-called negative-basis trade, investors could buy Six Flags bonds at 20.5 cents on the dollar and credit- default swaps at 71 cents. If the New York-based chain defaults, the creditors would receive the face value of the debt, minus costs. In a Feb. 27 note, Citigroup Inc.’s high-yield strategists put that profit at 6 percentage points, or $600,000 on a $10 million purchase.
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“Before, you really had to worry mostly about where you were in the” company’s capital structure, [Matthew Eagan, an investment manager at Boston-based Loomis Sayles & Co.] said. “Now, you have to consider the possibility that you might have this large holder of CDS incentivized to see it go into bankruptcy. It’s something that’s going to come up more and more.”

A rather odd research paper was published by the Boston Fed today:Another Hidden Cost of Incentives: The Detrimental Effect on Norm Enforcement:

Monetary incentives are often considered as a way to foster contributions to public goods in society and firms. This paper investigates experimentally the effect of monetary incentives in the presence of a norm enforcement mechanism. Norm enforcement through peer punishment has been shown to be effective in raising contributions by itself. We test whether and how monetary incentives interact with punishment and how this in turn affects contributions. Our main findings are that free riders are punished less harshly in the treatment with incentives, and as a consequence, average contributions to the public good are no higher than without incentives. This finding ties to and extends previous research on settings in which monetary incentives may fail to have the desired effect.

There is one slight problem with the paper: I don’t believe a word of it. The trouble is that there is perfect transparency regarding decisions made by each participant and perfect clarity regarding the group effect of these decisions. In the real world, I believe that Norm Enforcement will become a tool of random backbiting; although I will concede that for some people in some situations, it will work better than incentives. There’s also the matter of self selection: give me a choice between Firm A with its group hugs, and Firm B with its massive bonuses for performance and you won’t wait long for my decision!

However, this paper is destined to become a central part of the campaign against Evil Bonuses.

Equities got hammered again today, especially financials:

Canadian stocks fell to the lowest in five years, led by energy and financial shares, after China signaled it won’t increase stimulus spending and Moody’s Investors Service said it may downgrade the biggest U.S. banks.
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Manulife Financial Corp., Canada’s largest insurer, fell 8.3 percent as declining equities worldwide fanned concern that insurance companies’ investment losses will increase.
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The Standard & Poor’s/TSX Composite Index fell 185.58 points, or 2.4 percent, to 7,629.17 in Toronto, the lowest value since October 2003. The benchmark erased yesterday’s rally and has tumbled 15 percent in 2009.
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A gauge of financial shares plunged 4.9 percent, led by Royal Bank of Canada, the country’s largest lender. JPMorgan Chase & Co., the largest U.S. bank by market value, had its ratings outlook cut by Moody’s to negative from stable.

Moody’s said it will review the long-term debt ratings of Wells Fargo, the second-largest U.S. bank, and Bank of America, ranked third, on concern that higher credit costs may damage capital ratios.
…
Canadian Imperial Bank of Commerce, the country’s fifth- biggest bank by assets, fell 4.5 percent to C$37.86, after saying it will sell C$1.6 billion in notes to bolster its balance sheet. Bank of Nova Scotia fell 4.7 percent to C$26.21. Royal Bank of Canada declined 4.5 percent to C$29.22.

Manulife dropped 91 cents to C$10. Sun Life Financial Inc. slumped 10 percent to C$16.12.

… and Preferreds were not immune, although volume was light ….

Sorry folks! Not much by way of commentary today!

PerpetualDiscounts were off again to yield 7.46%, equivalent to 10.44% interest at the standard equivalency factor of 1.4x. Long Corporates continue to hold at 7.50%, so the pre-tax interest-equivalent spread is now 294bp … who knows? It won’t take much before we’re breaching 300bp again.

Bernanke gave testimony today, making the important point:

With such large near-term deficits, it may seem too early to be contemplating the necessary return to fiscal sustainability. To the contrary, maintaining the confidence of the financial markets requires that we begin planning now for the restoration of fiscal balance. As the economy recovers and resources become more fully employed, we will need to withdraw the temporary components of the fiscal stimulus. Spending on financial stabilization also must wind down; if all goes well, the disposition of assets acquired by the Treasury in the process of stabilization will be a source of added revenue for the Treasury in the out years.

I want to see stimulus spending, yes. But I also want to see a plan – with immediate tax increases – that will provide some credence to the view that it will be paid for eventually. Aint seen such yet.

Separately, the Fed announced that TALF has been launched:

Under today’s announcement, the Federal Reserve Bank of New York will lend up to $200 billion to eligible owners of certain AAA-rated ABS backed by newly and recently originated auto loans, credit card loans, student loans, and SBA-guaranteed small business loans. Issuers and investors in the private sector are expected to begin arranging and marketing new securitizations of recently generated loans, and subscriptions for funding in March will be accepted on March 17, 2009. On March 25, 2009, those new securitizations will be funded by the program, creating new lending capacity for additional future loans.

The program will hold monthly fundings through December 2009 or longer if the Federal Reserve Board chooses to extend the facility.

Bernanke & Geithner minced no words when asked about the AIG bail-out:

“If there is a single episode in this entire 18 months that has made me more angry, I can’t think of one other than AIG,” Bernanke told lawmakers today. “AIG exploited a huge gap in the regulatory system, there was no oversight of the financial- products division, this was a hedge fund basically that was attached to a large and stable insurance company.”

Bernanke’s comments foreshadow tougher oversight of systemically important financial firms, and come as President Barack Obama seeks legislative proposals within weeks for a regulatory overhaul.
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The company “made huge numbers of irresponsible bets, took huge losses, there was no regulatory oversight because there was a gap in the system,” Bernanke said. At the same time, officials “had no choice but to try and stabilize the system” by aiding the firm.
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“AIG is a huge, complex, global insurance company attached to a very complicated investment bank, hedge fund that was allowed to build up without any adult supervision,” U.S. Treasury Secretary Timothy Geithner said today during testimony to the House Ways and Means Committee.

One fascinating sub-theme of the banking crisis has been the attempts by the Fed to insinuate itself into securities regulation, with proposals that it should be supervising large brokerages, the conversion of some of these large brokerages into banks, and the CDS clearinghouse coming readily to mind. Could this testimony be indicative of a desire to have a hand in the insurance supervision pie?

I will need a lot of convincing before I accept that idea. Whether central banking and bank regulation mix is a question debated world-wide; my instinctive reaction is that it gives one set of bureaucrats too much power. And if we’re going to talk about systemic risk, let us not forget that it was the Fed in charge of supervising Citibank.

Sweetness & Light unveiled his market recommendations today, in direct competition with What-Debt?. His market timing track record was not disclosed.

PerpetualDiscounts had another unhappy day.

Whoosh! In like a lion, all right!

Suncor Energy Inc. dropped 10 percent after its shares were downgraded at Raymond James & Associates Inc. on expectations of lower oil and gas prices. Potash Corp. of Saskatchewan Inc. fell 9.8 percent on speculation that the recession will cut demand for grains and fertilizers. Manulife Financial Corp. slumped to the lowest in almost nine years on renewed speculation that it will sell stock to cover investment losses and pay for an acquisition.

The Standard & Poor’s/TSX Composite Index fell 5.4 percent to 7,687.51 in Toronto, the steepest loss since Dec. 1. Only 20 of Canada’s main stock benchmark’s 215 members rose. The S&P/TSX is down 14 percent this year, adding to a 2008’s 35 percent drop.

How bad is liquidity? I understand TD Waterhouse refused to bid on about $20,000-worth (present value) of 20-year Ontario Hydro coupons for a retail account. Now, that’s bad.

Prefs were not unscathed, but managed to stagger to a not-as-horrible-as-November finish amidst very light volume. Given all the recent hand-wringing about MFC, it will be interesting to see how their new and wildly popular Fixed-Reset opens on Wednesday.

PerpetualDiscounts closed the month on a sour note, losing nearly 80bp to close yielding 7.29%, equivalent to 10.21% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 7.5%, so the pre-tax interest-equivalent spread now stands at 271bp – another updraft!

Whoosh! The seminar was a lot of fun but it took a lot out of me!

There’s an amusing story in the Financial Times:

A whistleblower contacted US regulators more than five years ago with allegations that Sir Allen Stanford’s businesses were involved in an “illegal Ponzi scheme”, the Financial Times has learnt, raising new questions about why authorities waited until last week to shut down the alleged $8bn fraud.

Leyla Basagoitia, a former Stanford employee, raised a series of red flags about the tycoon’s empire in a 2003 employment dispute with her company at a tribunal run by the finance industry’s self-regulatory body. Ms Basagoitia also alerted the US Securities and Exchange Commission at about the same time, her lawyer said, echoing criticisms the agency ignored early warnings about the alleged $50bn Ponzi scheme run by Bernard Madoff.

I think we’re going to see stories like this regarding every fraud for the next five-odd years. It’s hard to know how seriously take them … it’s like the “US was warned of Pearl Harbour” stories one sees … yes, I’m sure the US was warned about Pearl Harbour. I’m equally certain they were warned about Japanese alliances with Mexico (a la Zimmerman) and little green men in Idaho. What was the backup?

Sad but true … Bernanke did not resist a suggestion that the uptick rule be reinstated. We can only hope that cooler heads will prevail:

“In the kind of environment we have seen more recently” the so-called uptick rule “might have had some benefit,” Bernanke said in testimony before the House Financial Services Committee today. The rule, scrapped by the U.S. Securities and Exchange Commission in 2007, barred investors from betting against a stock until it sells at a higher price than the preceding trade.
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The SEC approved the rule in 1938 to prevent bear raids on companies. The agency eliminated the regulation after studying its effect on share prices and determining it was no longer relevant in markets dominated by fast-paced electronic trading.

Executives at UBS AG, Deutsche Bank AG and Knight Capital Group Inc. said in December that bringing back the rule wouldn’t reduce volatility in stock prices.

If a portfolio manager sees a price go down for a reason he doesn’t understand, there are three possibilities:

• Insider information
• The market’s being stupid and should be ignored or, better yet, exploited
• He isn’t doing his job

Crack down on insider information, tipping and rumour-mongering by all means. That’s a valid regulatory function. But let’s also see a crackdown on underperforming PMs – any advisor with discretionary authority should definitely see their results published by the regulators; same goes for advisory relationships, although I am more willing to listen to arguments about that one – and the cult of the salesman that regards investment management as being nothing more than an unfortunate cost.

PerpetualDiscounts were off marginally today to yield 7.23%, equivalent to 10.12% interest at the standard conversion factor of 1.4x. Long Corporates appear to have found a level at 7.5% (maybe just a hair under), so the pre-tax interest-equivalent spread has widened again, to … call it 265bp.

SplitShares had a good day, helped along, I think, by bidders failing to notice (or care) that there were a lot of ex-Days today.

Assiduous Readers will be aware that I am wary of regulatory initiatives that seek to protect investors from themselves. Well … if the following catches on and spreads, it may become illegal to buy equities in your RRSP:

[Vanguard Founder and Zombie Master] Bogle recommended a single defined contribution plan with annuities from low-cost providers. The single system would be overseen by an independent Federal Retirement Board to protect the interests of plan participants, Bogle said.
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Retirement savings are too exposed to market risk, according to Dean Baker, co-director of the Center for Economic and Policy Research in Washington and another witness at today’s hearing. Baker proposed a government-managed system that would provide a modest rate of return for employees. He said it would build on Social Security and allow workers a voluntary default contribution of at least 3 percent of their salaries.

Employees must work longer to extend retirement savings and Social Security, which “has shined during this crisis,” could be stabilized and supplemented by target-date funds, said Munnell. Target-date funds shift money into more conservative investments as an investor approaches retirement.

Dealbreaker reports an amusing anecdote regarding regulatory capture. It’s sad, but we never see any statistics regarding job migration between regulatory and industry roles. Golly, I wonder why that is!

There is a bit more news on the Lyondell bankruptcy:

Lyondell asked U.S. Bankruptcy Judge Robert Gerber to approve the loan at a hearing tomorrow. The financing terms, which may return as much as 20 percent in fees to some lenders, are the best and only terms available, Lyondell said. It also said a proposed “roll-up,” which would allow pre-bankruptcy lenders to convert old debt to new debt with a priority for repayment, is “permissible.”
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The so-called debtor-in-possession loan, designed to fund operations while Lyondell reorganizes, wasn’t made in “good faith,” the company’s committee of unsecured creditors said in court papers. They alleged the loan’s December maturity date is too early, and other financial covenants are “tripwires” for defaults that would hand control of the company to the lenders.

The Lyondell situation is interesting because of the allegations that CDS-protected creditors are not acting in good faith.

Another poor day for PerpetualDiscounts, with Royal issues again getting hit hard. SplitShares enjoyed a dead-cat bounce; and after the bell, MFC announced a new Fixed-Reset, 6.60%+456.