Category: Market Action

The ABX index derivatives (which reference either the lowest or the penultimate AAA tranche of structured subprime mortgage products) are getting hammered today due to fears of pending legislation:

it appears that a bill to allow bankruptcy judges to alter loan balances has picked up a head of steam as Citibank broke ranks with other lenders and no longer opposes the measure.

The jobs number was appalling:

The U.S. lost more jobs in 2008 than in any year since 1945 as employers fired another 524,000 people in December, indicating a free-fall in the economy just days before President-elect Barack Obama takes office.
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The Labor Department reported that the nation lost 2.589 million jobs in 2008, just shy of the 2.75 million decline at the end of World War II. The unemployment rate climbed more than economists forecast, to 7.2 percent in December, the highest level in almost 16 years.

The Great Perpetual Rally of 2009 continued today, with PerpetualDiscounts posting their eleventh straight trading day of gains from the low of Dec. 22 to show a total gain of 21.87% over the period. The median pre-tax bid-YTW has declined from 8.48% to 6.86% … what can I say? The interest-equivalent is now 9.60%, while long corporates continue to hold steady at 7.50% – so we’re back down to a 210bp pre-tax interest-equivalent spread, which is just a little over the last patch of relative stability experienced in the first half of 2008.

The Congressional Budget Office released its Ten Year Outlook for the US Economy, and my-oh-my, but it’s gloomy:

Under an assumption that current laws and policies regarding federal spending and taxation remain the same,
CBO forecasts the following:

• A marked contraction in the U.S. economy in calendar year 2009, with real (inflation-adjusted) gross domestic product (GDP) falling by 2.2 percent.
• A slow recovery in 2010, with real GDP growing by only 1.5 percent.
• An unemployment rate that will exceed 9 percent early in 2010.
• A continued decline in inflation, both because energy
  prices have been falling and because inflation excluding energy and food prices—the core rate—tends to ease during and immediately after a recession; for 2009, CBO anticipates that inflation, as measured by the consumer price index for all urban consumers (CPI-U), will be only 0.1 percent.

• A drop in the national average price of a home, as measured by the Federal Housing Finance Agency’s purchase-only index, of an additional 14 percent between the third quarter of 2008 and the second quarter of 2010; the imbalance between the supply of and demand for housing persists, as reflected in unusually high vacancy rates and a low volume of housing starts.
• A decrease of more than 1 percent in real consumption in 2009, followed by moderate growth in 2010;
• the rise in unemployment, the loss of wealth, and tight consumer credit will continue to restrain consumption—although lower commodity prices will ease those effects somewhat.
• A financial system that remains strained, although some credit markets have started to improve; it is too early to determine whether the government’s actions to date have been sufficient to put the system on a path to recovery.

There is more commentary by Paul Krugman of the NYT and Menzie Chinn of Econbrowser.

And there are some straws in the wind regarding the future of US bank regulation:

The biggest U.S. banks may face the threat of lower profits or pressure to break up under greater regulation following the financial crisis.

Federal Reserve officials have made tackling the issue of firms that are too big to fail a priority. Options may include banning or restricting activities that could threaten the stability of the financial system, analysts said.

I continue to suggest that there needs to be a clear delineation of the difference between banking and investment banking. We want a rock-solid banking core, a somewhat more exciting layer of investment banking around that, surrounded by a wild-n-wooly world of hedge funds and shadow banks.

To that end, I suggest that capital rules be modified to emphasize the functionality of these layers. Banks buy-and-hold assets. Therefore, trading should attract a higher capital charge for them. Investment banks buy-and-sell assets. Therefore, aging assets should attract a higher capital charge for them. And, perhaps, hedging inefficiencies should be recognized such that a long and short hedge will attract a small, but non-zero, capital charge on the gross position.

There are indications that the CP market in the US is recovering:

Corporate borrowing in the commercial paper market expanded to the highest level since before Lehman Brothers Holdings Inc. filed for bankruptcy in September as companies took advantage of the lowest rates on record.

U.S. commercial paper outstanding rose $83.1 billion, or 4.9 percent, during the week ended Jan. 7 to a seasonally adjusted $1.76 trillion, the Federal Reserve said today in Washington. That’s the highest since the week ended Sept. 10, five days before Lehman’s filing.

Julia Dickson, OSFI Superintendent, gave a speech on regulatory pro-cyclicity, but there is not much substance to it.

Watson Wyatt has released some cheerful analysis:

Market declines caused by the global financial crisis have left the solvency of Canadian defined benefit (DB) pension plans at historical lows and defined contribution (DC) plan members with shrinking retirement savings, according to an analysis by Watson Wyatt Worldwide, a leading global consulting firm.

The pension solvency funded ratio (the ratio of market value of plan assets to plan solvency liabilities) of the typical pension plan declined 27 percentage points in 2008, dropping from 96 percent at the beginning of the year to 69 percent at year-end. Watson Wyatt’s Pension Barometer, which reflects the combined impact of investment performance and interest rates on the solvency funded ratio of a typical Canadian pension plan, indicates that the funded status of the typical pension plan decreased 11 percentage points in the fourth quarter alone.

PerpetualDiscounts managed to stagger to another gain today, with some evidence that the market is becoming a little (just a little!) less sloppy. To my surprise, Fixed-Resets also did very well.

I’m almost finished fiddling with the format of the performance table, and am about to commence fiddling with the volume table. Once I’m happy with the machine-generated tables, I’ll be adding the occasional comment, as I did way back in 2008. Assiduous Readers will have no idea how happy I am that the drudgery of table preparation is now computerized …

There is speculation that huge issuance may saturate the market for government bonds in the UK. Reception of a €6-billion issue of 10-year Bunds was sufficiently poor that the auction is being labelled a failure:

Germany’s sale of 10-year bunds lured the least demand in six months as investors shied away from a flood of government securities.

Investors bid for 5.2 billion euros of the bonds offered today, a level of demand that prompted the Bundesbank to retain 32 percent of the securities, according to the central bank’s Web site.

The press release tells the tale. A momentary blip? Or a sign of a turn in the tide from the flight-to-safety? Across the Curve notes “flight from risk-averse assets” and a tightening of credit spreads. Place yer bets, gents!

The Fed announced today that the Money Market Investor Funding Facility is being expanded:

the set of institutions eligible to participate in the MMIFF was expanded from U.S. money market mutual funds to also include a number of other money market investors. The newly eligible participants include U.S.-based securities-lending cash-collateral reinvestment funds, portfolios, and accounts (securities lenders); and U.S.-based investment funds that operate in a manner similar to money market mutual funds, such as certain local government investment pools, common trust funds, and collective investment funds.
…
the Board authorized the adjustment of several of the economic parameters of the MMIFF, including the minimum yield on assets eligible to be sold to the MMIFF, to enable the program to remain a viable source of backup liquidity for money market investors even at very low levels of money market interest rates
…
The MMIFF is designed to serve as a source of liquidity to money market mutual funds and other eligible money market investment vehicles, thereby increasing their ability to meet redemption requests and their willingness to invest in money market instruments, particularly term money market instruments. Under the MMIFF, the Federal Reserve Bank of New York provides a credit facility to a series of special purpose vehicles (SPVs) established by the private sector. The SPVs will purchase certain U.S. dollar-denominated, highly rated, short-term certificates of deposit, bank notes, and commercial paper from eligible money market investors

Speaking of the US, Across the Curve has some interesting colour today:

I had an interesting conversation with a relative value trader in the Treasury market. He loves the 2 year note at 80 basis points. With a zero handle, they would seem like an instrument which should have step child status.

However, he notes that with the ride down the yield curve and the positive carry from financing them at virtually zero, it is as if you own them at 1.75 percent one year from now.

That is the breakeven on a one year coupon. He makes the valid point that for that 1.75 percent to lose money one would need to posit a funds rate close to one percent. Given the tenor of comments from the central Bank, that does not seem likely.

Wild. Riding the yield curve from a 80bp starting point at a time when Treasury auction issuance is at record levels and there is fear of auction failures. This situation is not sustainable.

There’s an interesting development in US distressed mortgages:

Private National Mortgage Acceptance Company LLC, an investor in troubled mortgages run by a former president of Countrywide Financial Corp., bought $558 million of home loans that the Federal Deposit Insurance Corp. acquired last year after First National Bank of Nevada collapsed.

Known as PennyMac and led by Stanford Kurland, the firm is paying an average of 30 cents to 50 cents on the dollar for the loans and the FDIC is sharing some of the risk, spokesman Andrew Chang said.
…
“This asset sale did not provide any loss-sharing,” said FDIC spokesman David Barr in an interview about the PennyMac deal. “It is a participation sale, however, which means the FDIC benefits from cash-flow generated from these loans.”

The FDIC will receive 80 percent of the loan’s cash flow until a certain, undisclosed level of payments are received, then 60 percent thereafter, he said.

David Barr’s comments are disingenuous. “Participation” is equivalent to “Loss Sharing” – full stop.

PerpetualDiscounts managed to eke out another gain today – and, much to my surprise, so did fixed-resets! I would have thought that continued issuance would have pounded down the sector, but it is showing significant resilience. And I still have to fiddle with the damn programming of the damn tables.

Yet another banner day for preferreds, although Fixed-Resets are (not surprisingly) reacting poorly to the flood of new issuance (RY, 6.25%+419, NA, 6.60%+463, TD, 6.25%+437) at higher coupons.

Formatting of the tables is horrible today. Yesterday’s fiddling may be on the right track programatically, but definitely a step backward esthetically. Sorry, guys! I’d like to write more (especially with Spend-Every-Penny mumbling about putting Canada into a permanent structural deficit, just like Mr. Bush) … but I have to do some more fiddling …

American corporates were on fire today amidst a dramatic steepening in Treasuries; the 2-30 spread widened 26bp. Canadian 2-30s steepened as well, but only by 12bp; a mere bagatelle.

Jon Danielsson has an interesting essay on VoxEU : The myth of the riskometer:

There is a widely held belief that financial risk is easily measured – that we can stick some sort of riskometer deep into the bowels of the financial system and get an accurate measurement of the risk of complex financial instruments. Such misguided belief in this riskometer played a key role in getting the financial system into the mess it is in.
…
One of the biggest problems leading up to the crisis was the twin belief that risk could be modelled and that complexity was good. Certainly the regulators who made risk sensitivity the centrepiece of the Basel 2 Accord believed this.

Under Basel 2, bank capital is risk-sensitive. What that means is that a financial institution is required to measure the riskiness of its assets, and the riskier the assets the more capital it has to hold. At a first glance, this is a sensible idea, after all why should we not want capital to reflect riskiness? But there are at least three main problems: the measurement of risk, procyclicality (see Danielsson et. al 2001), and the determination of capital.

To have risk-sensitive capital we need to measure risk, i.e. apply the riskometer. In the absence of accurate risk measurements, risk-sensitive bank capital is at best meaningless and at worst dangerous.

Risk-sensitive capital can be dangerous because it gives a false sense of security.
…
The unreliability of capital calculations becomes especially visible when we compare standard capital calculations under international standards with the American leverage ratio. The leverage ratio limits the capital to assets ratio of banks and is therefore a much more conservative measure of capital than the risk-based capital of Basel 2. Because it is more conservative, it is much harder to manipulate.
…
As Philipp Hildebrand (2008) of the Swiss National Bank recently observed “Looking at risk-based capital measures, the two large Swiss banks were among the best-capitalised large international banks in the world. Looking at simple leverage, however, these institutions were among the worst-capitalised banks”

I take issue with the description of the leverage ratio as inherently conservative. Its virtue is simplicity, full stop.

Another glorious day for preferreds amidst continued heavy volume. It’s nice to see.

Great news! I’ve made the switchover to the “December Revision” of the HIMIPref™ Preferred Indices for daily reporting purposes. While this may not mean a lot to you, it is very important to me, since the tables are prepared programmatically.

There’s some problems: inclusion of dividend effects is haphazard at best and for some reason the tables on daily performance and volume are getting the index assignments wrong, but I’ll figure out how to address these quirks shortly. The main thing is: I can now push a button and get my damn reports output by HIMIPref™ as nice clean HTML code … or at least, it will be clean once I get some other quirks ironed out.

This will save me considerable time!

And – oh, yeah – the market was up again today. But then, the market always goes up, doesn’t it?

There were twelve other index-included $25-p.v.-equivalent issues trading over 10,000 shares today.

Well, holy-smokes-and-a-half, that’s all I can say! Preferreds continued to rocket upwards on normal-for-non-tax-loss-selling-season volume. PerpetualDiscounts were at their lowest on December 22; in the five trading days since they they are up 14.29%, with yield coming in from 8.40% to 7.37%. A little over a point! Maybe I’ll stretch a point, and make that holy-smokes-and-three-quarters.

I’ll bet some shops took a week off in the middle of portfolio rebalancing since nothing would be happening – that’ll teach them to whimper about their precious work-life balance!

That was sufficient to bring the monthly return on the PerpetualDiscount subindex to +11.45%, the best month in my records. Unfortunately, I now have to throw out all those abject client letters I was drafting, since I can now point out that preferreds really do go up sometimes and really are different from equities. Thank you Santa!

How about a bond comparison? Long corporates were up 1.64% on the month and down 11.70% on the year (PerpetualDiscounts were down 17.11% on the year), with the bonds continuing to yield 7.50%, or maybe a shade under. The PerpetualDiscount yield of 7.37% at the close today equates to 10.32% at the standard 1.4x equivalency factor, so the spread is still an impressive 282bp.

And so goes another year! Happy New Year, everybody, and good riddance to the old one!

There were twenty other index-included $25-pv-equivalent issues trading over 10,000 shares today.

As far as I can tell, the market has decided that there is a faint possibility that not every financial institution in Canada will go bankrupt in 2008. But we’ll see what tomorrow brings.

Best day for PerpetualDiscounts since 2006-6-30 at latest, which is the earliest date for which I have convenient daily return figures. How ’bout them SunLifes, eh?

There were twenty-seven other index-included $25-pv-equivalent issues trading over 10,000 shares today.

There is the potential for US Municipals to become even more attractive to taxable US investors:

Congressional Democrats are seeking to expand funding for airport runways, housing projects and sewage-treatment plants through a new tax break for municipal bondholders.

The proposal is designed to make so-called private-activity bonds more attractive by exempting the interest on them from the alternative minimum tax. Richard Neal, chairman of the House Ways and Means subcommittee that drafts tax measures, wants to include the plan in economic recovery legislation that President-elect Barack Obama has made a top priority.

A crazy idea; if implemented it will simply increase distortions in the capital markets.

Accrued Interest points out that Bad liquidity cuts both ways in municipals and the same thing is true (with slightly different mechanical details, of course) in preferreds.

Volume was down sharply to normal levels today and prices were up up UP!, providning one day’s worth of support for the hypothesis that tax loss selling was behind the recent weakness (as pointed out on Financial Webring Forum).

There were twenty-four other index-included $25-pv-equivalent issues trading over 10,000 shares today.

Treasury is touting a slew of small TARB allocations to small banks.

Cox has admitted that the short-selling ban was dumb:

Cox said the biggest mistake of his tenure was agreeing in September to an extraordinary three-week ban on short selling of financial company stocks. But in publicly acknowledging for the first time that this ban was not productive, Cox said he had been under intense pressure from Treasury Secretary Henry M. Paulson Jr. and Fed Chairman Ben S. Bernanke to take this action and did so reluctantly. They “were of the view that if we did not act and act at that instant, these financial institutions could fail as a result and there would be nothing left to save,” Cox said.

Meanwhile, Spend-every-Penny is attempting to deflect attention from the complete lack of a long-term fiscal plan that includes the occasional recession by bashing the banks. Political Science 101. If you don’t have an external enemy, invent one.

A foreshortened day, with volume easing off from the highs of the last full tax-loss selling days, but impressive by any other standards. The market was very strong – perhaps timers at work, trying to pick off their predicted lowest day of the year and getting invested for 2009. Most notably, the two sad-sacks of 2008, BAM & CM, had strong days, leading to questions of ‘how come?’. Well … there was no solid news on the down days this year … why should up-days be any different? The FloatingRate index, comprised of BAM.PR.B & BAM.PR.K had a marvellous day and found itself back at mid-November levels.

There were sixty-eight other index-included $25-pv-equivalent issues trading over 10,000 shares today.