Category: Market Action

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

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

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

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

Bernanke roughly handled by the House Oversight Committee:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

I weep for this world. In a move mocking the rule of law, British banks are being asked (told) to sign extra-legal agreements with the government:

Chancellor of the Exchequer Alistair Darling will put pressure on senior executives at Britain’s banks to sign agreements promising to end all tax avoidance, a person with knowledge of the plans said.

The Revenue and Customs wing of the Treasury on Monday will seek board level agreement from all U.K. banks and consult them on how to implement the plan, the person said. Banks refusing to sign the code will face more intrusive inspections from tax authorities.

The revenue office wants to change behavior to make sure banks comply with the the spirit as well as the letter of the law, the person said.

Fascism doesn’t usually come with fiery oration and jackboots. Fascism comes with earnest and well-meaning bureaucrats.

There might be some excitement in the CMBS business:

The ratings on $235.2 billion in debt backed by commercial mortgages may be cut by Standard & Poor’s as the ratings company seeks to reflect how the securities would fare in an “extreme economic downturn.”

The possible reductions, disclosed today in a report, follow S&P’s May 26 statement that the ratings of as much as 90 percent of top-ranked commercial mortgage-backed bonds sold in 2007 may be cut because of the changes in how they’re assessed.

However, as mentioned on June 15, there are plenty of other CRAs available for discriminating ratings-shoppers. That post also mentioned how NAIC wanted to regulate AND provide credit ratings; apparently some have pointed out that this is Not A Good Idea:

Dierdre Manna, vice president of industry, regulatory and political affairs for the Property Casualty Insurers Association of America (PCI), questioned whether transferring rating responsibilities to regulators comports with the NAIC’s mission statement.

She also questioned whether it would be possible for the NAIC to fully separate regulatory and rating agency responsibilities.

A totally insane idea; much like grading schools and universities on their proportion of passing students … er, wait, we do that don’t we? Never mind.

US Banks made some pretty good money on derivative trading in the first quarter:

• The notional value of derivatives held by U.S. commercial banks increased $1.6 trillion in the first quarter, or 1%, to $202.0 trillion, due to the continued migration of investment bank derivatives business into the commercial banking system.
• U.S. commercial banks generated record revenues of $9.8 billion trading cash and derivative instruments in the first quarter of 2009, compared to a $9.2 billion loss in the fourth quarter of 2008.
• Net current credit exposure decreased 13% to $695 billion.
• Derivative contracts remain concentrated in interest rate products, which comprise 84% of total derivative notional values. The notional value of credit derivative contracts decreased by 8% during the quarter to $14.6 trillion.

There’s an essay on Credit Rating Agencies on VoxEU today, by Marc Flandreau & Norbert Gaillard, titled Icarus’ syndrome: Rating agencies and the logic of regulatory license:

But again, this per se does not explain why rating agencies were privileged by regulators over other instruments to promote forbearance. For instance, regulators could have used bond prices at the time of issue as a possible alternative. Our investigation revealed that what caused the emergence of rating agencies as a pillar of regulation was the perceived conflict of interest that investment banks and commercial banks involved in origination suffered at the time. It was perceived that bankers were “banksters” and had been unable to resist conflicts of interest between their role as originators and their role as gatekeepers of liquidity. As a result, the public suspected that the prices at which securities had been issued were likely to have been manipulated. Certification and regulatory intervention had to rest on some assessment of “value” that would be as far away from the origination process as conceivable. Rating agencies provided just this.

The rest of the story is well known. In doing this, regulators dragged the agencies closer to the core of the origination of new securities, which eventually proved damaging for their reputation. While some will emphasise the irony of now blaming the agencies for the very sins that caused their emergence in the first place, we suggest that there must be deep reasons for history to go in circles. And whatever they are, the lesson must be that there is no long-run, simple, and sustainable regulatory fix for our current troubles.

Deep reasons? I don’t think it’s all that deep:

• Doing a good job is not as important as one might hope. It’s all about sales.
• Forecasting the future is fraught with pitfalls. Only a pack of MBAs would bet their company’s future on a single forecast.
• The rating agencies are not paid to do a good job. Hardly anybody cares if they do a good job and even fewer are capable of evaluating ex ante whether they do a good job. They’re paid to be the fall-guy; they are now earning their pay.

PerpetualDiscounts took a break today, but FixedResets continued to rock ‘n’ roll. It’s astonishing! How low can yields on those suckers go? I’m amazed that a lot of new issuance isn’t being coaxed out of the woodwork … but if the price action is based on Current Yields rather than Yield-to-Worst (as I suspect is at least partially the case), perhaps it’s not as surprising as all that. Maybe it’s not even Current Yield – maybe it’s just the plain old coupon! It wouldn’t surprise me. mumble mumble … all these oh-so-clever quants running around, dividing one number by another number … I knew a quant once, he lost money.

The populist movement against Wall Street is having the desired effect:

Wall Street’s largest trade group has started a campaign to counter the “populist” backlash against bankers, enlisting two former aides to Treasury Secretary Henry Paulson to spearhead the effort.
…
Michele Davis, Paulson’s former spokeswoman, and Jim Wilkinson, his former chief of staff, are among those leading the effort. SIFMA is paying their firm, Brunswick Group LLC, a monthly retainer of $70,000, the documents show. Both Davis and Wilkinson declined to comment. Paulson left office in January.

Assisting them is a Democratic polling company, Brilliant Corners Research and Strategies, which is paid $5,000 a month. It is run by pollster Cornell Belcher, who worked on President Barack Obama’s campaign. BKSH & Associates Worldwide, a lobbying firm chaired by Republican strategist Charlie Black, signed on for $10,000.

I’ve been figuring that Dubai would be the logical refuge for hedge funds made unwelcome in the G-7. But who knows? Maybe it’s Singapore:

Assan Din, a former Lehman Brothers Holdings Inc. credit trader, is setting up a hedge fund to trade corporate bonds and derivatives in Asia.

SaKa Capital’s fund, which will have a capacity of more than $500 million, will start in September with $25 million to $50 million sourced mainly from founding members and friends, Din, 38, said. The Singapore-based firm will subsequently raise capital from institutional investors, including U.S. pension funds and endowments, once it builds a track record, he added.

A nice little bump in volume today, with a good solid up-day for preferreds. I suspect that some of the relatively short list of price movers were there because some players didn’t know (or didn’t care) that CM went ex-Dividend today.

C-EBS pays attention to the needs of investors when assessing the investment worthiness of banks, in accordance with the Basel Pillar 3 philosophy; this stands as a great contrast to OSFI. In C-EBS latest effort, they evaluate bank disclosures to investors:

In line with the July 2008 ECOFIN conclusions CEBS also analysed the Pillar 3 disclosures provided by 25 banks. CEBS recognises that a huge effort has been made to provide market participants with information allowing for better assessment of bank’s risk profile and capital adequacy.

Banks have notably enhanced the level of quantitative and qualitative information regarding credit risk and securitisation activities; however there are specific areas where further improvements could be made:

•the composition and characteristics of own funds;
•the back testing information for credit risk and market risk;
•the quantitative information on credit risk mitigations and counterparty credit risk; and
•the granularity of information on securitisations.
CEBS will continue to closely monitor Pillar 3 disclosures in order to ensure that market discipline mechanism operates effectively and contributes to enhance the quality and the comparability of the Pillar 3 disclosures.

While it is not envisaged issuing guidance in the area of Pillar 3 disclosures at this stage, CEBS nevertheless intends to foster further convergence of Pillar 3 disclosure practices through liaison with the industry. For this purpose an open meeting is foreseen to be held in early autumn 2009.

I understand that New York will probably soon have a subway stop named after Barclays:

Commuters passing through the Atlantic Avenue-Pacific Street and Flatbush Avenue subway station in Prospect Heights may soon hear the word “Barclays” to the already long subway station name.

Barclays, a London-based bank company, is the first buyer in the MTA’s five-year effort to sell the names of subway stations to raise more revenue. The company would pay the MTA installments of $200,000 per year over the next 20 years.

Now that times are tough and the idea has the imprimatur of a world-class city, perhaps Toronto-me-too will consider it. I continue to think that we could make an awful lot of money from Pfizer through a name change to “Viagra Makes Your Coxwell” station; I can’t understand why such an obvious source of revenue remains unexploited.

The SEC has requested public comment on a plan to continue to allow Money Market Fund sponsors to lie to investors:

The agency’s five commissioners voted 5-0 today to seek public comment on a plan to require that funds hold more liquid assets and reduce the average maturity of securities in their portfolios. The proposals resemble recommendations made in March by the Investment Company Institute, a Washington-based industry group.
…
The funds aren’t required to value their holdings at current market prices, except to reflect a permanent markdown. That lets them maintain a constant net-asset value, or NAV, and sell and redeem shares at $1 apiece. Funds drop below $1 a share when permanent losses exceed 0.5 percent of net assets, forcing the NAV to be rounded down to 99 cents.

President Barack Obama’s administration, in a plan for overhauling financial regulation released June 17, called on government agencies including the SEC, the Treasury Department and the Federal Reserve to review whether money funds should adopt a floating NAV. The Obama proposal also requested study of ways money funds could obtain access to “emergency” funding from “private sources.”

Andrew Donohue, director of the SEC unit that oversees money managers, said in an April speech that the stable $1 share prices encourages investors to flee money funds at the first sign of trouble.

The Investment Company Institute proposals have been discussed on PrefBlog.

Guys, guys, guys. Investment comes with risk. Pretending there’s no risk won’t make it so; it will simply increase the severity of public reaction when the internal contradictions blow up the model. This was proved beyond the shadow of a doubt after Reserve Primary explosion required extraordinary policy measures to ensure that the World as We Know It did not disappear completely. The Volcker proposals are far superior.

The FOMC statement was released today:

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

PerpetualDiscounts had a good day today, while most of the market was pretty quiet on lower volume. PerpetualDiscounts now yield 6.38%, equivalent to 8.93% interest at the standard 1.4x conversion factor. Meanwhile, long corporates are taking a breather, returning 5.66% month-to-date, 17.01% year-to-date, with a yield of about 6.45%; the pre-tax interest-equivalent spread is thus about 250bp, little changed from last week’s 255bp.

I mentioned the proxy battle over Trinorth Capital on June 11 … Management won. No concession or acknowledgement from the self-proclaimed Concerned Shareholders yet … I’m not holding my breath. However, management can now get back to doing what it does best: suspending dividends on their funds.

Speculation regarding Bernanke’s reappointment is mounting, with Larry Summers mentioned as a possible candidate. I can’t find great fault with Bernanke’s macro-economic handling of the crisis; it turned out that letting Lehman go was a mistake, but I, for one, didn’t forsee just how horribly things would turn out after that. Of greater concern is interference in private companies (the BAC/MER merger), but I think that one can be hung on Paulson.

Tara Perkins of the Globe passes on some speculation regarding the MFC/OSC Disclosure Kerfuffle:

The Ontario Securities Commission (OSC) appears to be examining whether Manulife properly disclosed, prior to last fall, how much risk it would face if markets tanked, noted Genuity Capital Markets analyst Mario Mendonca. Before then, Manulife only disclosed what would happen to it if stock markets fell by 10 per cent. Markets dropped more than 20 per cent in the fourth quarter.

It’s possible, although it would be most unfair if MFC was singled out for this practice when the effects of a 10% drop is all that’s disclosed by any insurer. I’m not saying, mind you, that I am against such improved disclosure; the effect of equity market declines on guarantees can be decidedly non-linear.

Who says that Dealbreaker is all fun ‘n’ games? Today there’s a very informative, yet entertaining, essay on Credit Default Swaps in Kazakhstan:

Emerging Markets and derivatives are like alcohol and barbiturates: each on its own has attractions but create a recipe for choking on one’s own vomit when combined.
…
There’s always some crazy eventuality that an emerging market can generate that defies the most thoughtfully drafted contract.

Mark Carney showed Canadian regulators’ traditional contempt for investors with some selective disclosure in Washington:

Bank of Canada Governor Mark Carney said his country’s recession is now as deep as in the U.S., according to a person who heard his remarks today in Washington.

Carney, 44, spoke at the Woodrow Wilson International Center for Scholars. No cameras or recording devices were allowed at the event, according to organizers.

Debt-Decoupling, a moral hazard feature of Credit Default Swaps is complicating restructuring efforts:

In the cover story for the The Deal magazine published Monday, Richard Morgan tells about the dire situation Gannett Co. (NYSE:GCI) finds itself in after nearly three-quarters of bondholders, hedged with credit default swaps, declined an exchange offer that expired May 5. Thanks to the CDSs, they stand to get a better payoff if Gannett defaults.

Morgan followed that story up with a report on McClatchy Co. (NYSE:MNI) in The Deal Pipeline on Monday (subscription required). It too tried to do an exchange offer on some troubled bonds, but reported last week that only a small minority of holders went for the offer, valued at around 33 cents on the dollar. Thanks to their CDS hedges, the bondholders can expect 100 cents if McClatchy defaults.

It’s an incentive some call perverse, and also one that couldn’t have existed before the CDS market sprang up. As Morgan writes, CDSs began the decade as a $900 billion market but ended last year with a notional value of $42 trillion. That’s a lot bigger than the $25 trillion market for outstanding corporate bonds, municipal bonds and structured investment vehicles that CDSs were designed to reference.

Dealbreaker remarks:

One of the primary complaints about the CDS market was the use of CDS by market participants as purely speculative tools. In this case, the players that hold the debt are hedging their exposure through CDS and capitalizing on a negative basis play. If hedging debt exposure through CDS becomes the next true villain in the attack on derivatives, there is really no hope for this market.

The “negative basis” refers to the fact that a long-bond plus protection-buy position will yield more than available elsewhere in the market with equivalent risk – this is due to funding pressures, since it’s hard (risky, anyway) nowadays to lever up a physical bond position 10:1; you can only do that by selling CDSs, driving down the spread. The newspapers’ woes are similar to problems highlighted by the Lyondell bankruptcy:

The potential for dispute and complexity in workouts and bankruptcies by reason of the existence of CDS was illustrated recently in the U.S. bankruptcy proceeding of the U.S. subsidiary of LyondellBasell, the world’s third-largest petrochemicals group. The U.S. company, LyondellBasell Chemical Company, filed for bankruptcy in New York in January 2009 after attempts to restructure its $26 billion debt were unsuccessful.70 The bankruptcy triggered a “default” under LyondellBasell Chemical Company’s CDS (i.e. CDS naming this company as the reference entity), but because its European parent and affiliates were not in bankruptcy, CDS covering bonds of those companies were not triggered.

Creditors sought to sue LyondellBasell’s parent company in Europe on guarantees and other obligations. These creditors included bondholders, and the U.S. company believed that the bondholders were seeking to enforce claims with the goal of triggering protection payments under their credit default swap contracts, which could have led to other parts of the corporate group being pushed into insolvency in Europe. Ultimately, U.S.-based LyondellBasell Chemical Company was able to persuade the U.S. bankruptcy court that such actions in Europe could undermine the chances of completing a successful bankruptcy in the U.S. The bankruptcy court issued a 60-day injunction prohibiting enforcement actions in Europe.

“The threat of CDS holders trying to force companies into an insolvency in order to trigger their recovery rights against their CDS counterparty will almost certainly be an issue in the wave of debt restructurings this year,” predicted LyondellBasell’s attorneys.

Note that legal manoeuverings regarding LyondellBasell have been phrenetic:

LyondellBasell Industries announced that LyondellBasell Industries AF S.C.A. has been voluntarily added to Lyondell Chemical Company’s reorganization filing under Chapter 11 of the U.S. Bankruptcy Code to protect the European holding company against claims by certain financial and U.S. trade creditors.

LyondellBasell Industries AF S.C.A. is a holding company incorporated in Luxembourg. It does not manufacture or sell products, and has no employees.

LyondellBasell is exercising an option available under U.S. law to prevent creditors from enforcing guarantees by LyondellBasell AF S.C.A. for pre-petition obligations of LyondellBasell’s U.S. businesses. It also prevents bondholders of Senior Notes due in 2015 from potentially pursuing remedies against LyondellBasell AF S.C.A. after an interest payment due on the notes in February was not paid. The company obtained a 60-day restraining order from the U.S. bankruptcy court in February to allow time for LyondellBasell to protect its European assets from these claims.

Extending Chapter 11 protection to LyondellBasell Industries AF S.C.A. is not an insolvency proceeding under any European law. No LyondellBasell manufacturing operation located outside of the United States has applied for or become involved in insolvency or bankruptcy proceedings in its respective home country.

… but they bought themselves enough time to get something done …

The European Commission Monday cleared U.S.-based industrial holding group Access Industries and German investor Andreas Heeschen’s ProChemie Holding to create a joint venture to take over troubled chemical company LyondellBasell Industries.

Both parties will have a 50% stake in LyondellBasell, parts of which are currently under bankruptcy protection, through a new holding company called ProChemie GmbH.

LyondellBasell was previously wholly owned by Access industries.

… the moral of the story being “Holding company guarantees are not necessarily worth much.”

The market drifted down just a tad today, with volume continuing high.

In recognition of the fact that investors get so much regulatory paper from their brokers that they don’t read it, the Canadian Securities Administrators are requiring the delivery of more paper. I’ll bet a nickel that every year the “Fund Facts” gets enlarged ‘because Granny didn’t know she could lose money if so-and-so went bankrupt’, until about twenty years from now, when new “Fund Briefer Facts” becomes mandated and then lucky buyers get even more mail to throw away without reading. Still, it keeps the regulators busy and Proactively Working In The Best Interest Of Investors, and that’s what counts, right?

Julia Dickson gave a speech in Vancouver lauding financial oligopolies:

One lesson everyone is relearning is the importance of proper consolidated oversight and supervision of financial groups, especially systemically important financial groups. This lesson has arisen in the context of AIG, where the parent holding company was regulated, but not to the extent required of a systemically important group of its size.

Canada is relatively well placed in this regard as there is already considerable consolidated oversight and supervision of the Canadian financial sector. The large securities firms are owned by the big banks, which OSFI oversees, meaning that securities firms must meet the same prudential standards as their parent bank. As well, the general structural model for large financial services groups is that they are headed by a regulated financial institution, which is overseen by OSFI, versus the holding company structure commonly seen in other jurisdictions.

Having a regulated Canadian financial institution at the top of such organizations enhances our ability to understand the risks facing the conglomerate. Further, given OSFI’s regulatory authority at the top level, we can intervene and require action to be taken, no matter where in the group we may have identified potential problems.

As a regulator, you need to have knowledge of the financial status and risk profile of all affiliates within a financial group. Indeed, as demonstrated by the AIG case, small parts of big companies can be hugely problematic.

She did not go so far as to say she wished to see an elimination of the holding company structure for insurers, but she is clearly headed in that direction. It is very disappointing to see such regulatory hostility to the concept of a layered financial system: banks – securities dealers – hedge funds, that can work quite well provided there are clear lines between the layers.

Plain vanilla for everyone! That’s the Canadian way!

C-EBS has published a consultation paper on implementation of hybrid capital guidelines.

Christopher Whalen, head of International Risk Analytics, had some home-truths for the Senate today:

Trading in credit-default swaps should be banned, Christopher Whalen, managing director of Institutional Risk Analytics in Hawthorne, California, said in prepared testimony for today’s Senate hearing. Regulators are too cozy with the banks in the market to be counted on to make changes, he said.

“The views of the existing financial regulatory agencies, and particularly the Federal Reserve Board and Treasury, should get no consideration from the committee since the view of these agencies are largely duplicative of the views of JPMorgan Chase & Co. and the large OTC dealers,” he said in the remarks.

I can’t find the full text of his testimony, but they will probably be posted soon.

Equities got hit today after the World Bank warned of lower future growth. The only way out of this mess is to hire more regulators:

Global Development Finance 2009: Charting a Global Recovery, warns that the world is entering an era of slower growth that will require tighter and more effective oversight of the financial system.

Perhaps in sympathy, PerpetualDiscounts were off somewhat today; while FixedResets were also down the loss of the latter was negligible. Volume continued high.

The Bank for International Settlements has released its Core Principles for Effective Deposit Insurance Systems.

Quis custodiet ipsos custodes?:

The Securities and Exchange Commission today charged two accountants who produced bogus financial statements and an Antiguan regulator who took bribes to look the other way as Robert Allen Stanford conducted an alleged $8 billion Ponzi scheme.
…
“Instead of buying the safe and sound investments he promised his clients, Stanford bought Antigua’s top securities cop,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “While Stanford quarterbacked his massive Ponzi scheme, he paid the referee to spy on the huddles and provide an insider’s play-by-play of the SEC’s investigation.”
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The SEC’s complaint alleges that King facilitated the Ponzi scheme by ensuring that the FSRC conducted sham audits and examinations of SIB’s books and records. In exchange for bribes paid to him over a period of several years, King made sure that the FSRC did not examine SIB’s investment portfolio. King also provided Stanford with access to the FSRC’s confidential regulatory files on him, including the SEC’s requests for information from FSRC in its investigation. King went so far as to allow Stanford to essentially dictate the FSRC’s responses to the SEC on those information requests. King made false assurances that there was no cause for concern about Stanford International Bank. He collaborated with Stanford to withhold significant information being requested by the SEC.

Speaking of scams, the FDIC is warning of a new one:

FDIC-insured institutions should be aware of any unsolicited deposits received through third-party referrals. Certain insurance companies and other financial services firms are offering above-market rate certificates of deposit (CDs) through FDIC-insured institutions to attract customers. However, the actual rate offered by the insured institution is usually much lower. In some cases, these third parties use the FDIC official sign, seal, logo or similar representations in connection with these offers.

When a customer expresses an interest in buying a CD, the third party takes the customer’s contact information for future marketing opportunities. When the customer buys the FDIC-insured CD, the third party refers the customer to an insured institution’s Web site. For the customer to receive the above-market rate CD, the third party must make a payment to the issuing institution on behalf of the customer to “make up” the difference between the institution’s actual rate and the above-market rate. This may misrepresent the actual rate offered by the insured institution by adding “promotional” funding to the principal balance of the CD, and therefore could be contradictory with the institution’s Truth-in-Savings disclosures. Institutions may become aware of such practices when they receive two checks for the purchase of a single CD. All insured institutions should have controls in place to flag unusual deposit activity.

Hmm … so at a relatively small cost, you get an address list of people who are willing to write large cheques … I couldn’t figure out the point of the scam at first!

The law firm of Wachtell, Lipton has come out strongly against Credit Default Swaps:

Any action the Commission attempts to take against manipulative short selling will not be completely effective without parallel, reinforcing reforms applied to the derivatives market, particularly with respect to credit default swaps (“CDS”). The responsiveness of equity prices to changes in CDS spreads makes the purchase of CDS a powerful device for bear raids, particularly when used in connection with short sales. Combining a short sale with the purchase of CDS sends a false signal into the marketplace about a company’s credit and, accordingly, causes a drop in the stock price that makes the short position profitable. Such manipulation is dangerously cost-effective, as a relatively small investment in an institution’s CDS is sufficient to spark rumors of default or a ratings downgrade and immediately sink stock prices.

To prevent this and other abuses of the CDS market, we believe that only those who are economically exposed to the underlying credit risk of a company should be allowed to buy CDS protection on the company. The purchase of a “naked” CDS, made by a purchaser with no exposure to the reference company, is more akin to gambling than obtaining insurance, and such instruments are capable of causing serious distortions in the market. A prohibition on naked CDS would allow the appropriate use of these instruments while restraining those using the CDS market in a manipulative and abusive way. As an intermediate step, the Commission should use its ability to regulate short sales to require a waiting period between any purchase of a CDS and short sale involving the same reference company. In addition, to alert the marketplace to situations when CDS are being used to manipulate share prices in conjunction with short selling, the Commission should require disclosure when an actual or synthetic short position in a company’s equity securities is accompanied by a long position in the company’s CDS.

Combining a short sale with the purchase of CDS sends a false signal into the marketplace about a company’s credit, eh? I guess there’s no possibility – none whatsoever – that it could be sending a true signal into the marketplace?

Volume in the preferred share market was off slightly today, but the market was able to advance a little.

The New York Times points out – albeit disapprovingly – one of the good elements of the Obama regulation plan: it leaves Credit Rating Agencies alone:

The proposals call for the agencies to improve disclosure and release more detailed information, as well as establish policies for “managing and disclosing conflicts of interest.”

But the plan does not alter the issuer-pay model, whereby the companies selling securities pay to have them rated. Nor does it encourage competitors to enter the industry, which many regard as an oligopoly.

The proposal does call for regulators to reduce their reliance on agency ratings when deciding whether structured investments are safe enough for banks, insurance companies, pension funds and money market mutual fund investors. Regulators should encourage more independent analysis, a Treasury official said, but the administration did not propose an alternative standard.

Bank of Canada Governor Mark Carney gave a speech today:

The performance of core funding markets during the crisis intensified the financial panic and helped trigger the recession. This is totally unacceptable. As a consequence, one of the Bank of Canada’s top priorities is to promote institutional changes to create more robust core funding markets. Promising avenues to break such (il)liquidity spirals include introducing clearing houses, standardizing products, implementing through-the-cycle margining, and ensuring more effective netting.

Does anybody else think this is non-sequiter? When I think of “core funding”, I think of deposits, deposit notes and GICs. One might well make the argument that the “promising avenues” might contain a mathod whereby the market for these instruments remains stable … but Mr. Carney doesn’t.

There is a possibility that the panel surveyed to calculate US LIBOR will increase:

The dollar rose versus the euro yesterday for the first time in three days after British Bankers’ Association said it may allow more institutions to take part in the daily survey that sets Libor, the benchmark for more than $360 trillion of financial products around the world.
…
“It would be a wider group of banks, so some ‘weaker’ ones who would submit higher rates, thus Libor would aggregate higher,” said Scott Ainsbury, a portfolio manager at New York- based FX Concepts Inc., the world’s largest currency hedge fund with about $12 billion in assets.

Not much price action today in Canadian Preferreds, but volume continued high.

That guy who had a baby in 1967 is about to become a grandfather:

The International Olympic Committee has yet to secure two more international sponsors, leading to a $30-million shortfall so far in the money Vancouver organizers had expected to receive from them.

And the recession has scared off potential suppliers, said John McLaughlin, the Vancouver committee’s chief financial officer.

TCA issued about $1.6-billion in equity to fund a major purchase and had its credit rating affirmed by DBRS.

S&P had a mass downgrade of US Banks today:

Standard & Poor’s reduced its credit ratings or revised its outlook on 22 U.S. banks, including Wells Fargo & Co., PNC Financial Services Group and KeyCorp, citing tighter regulation and increased market volatility.

“Financial institutions are now shedding balance-sheet risk and altering funding profiles and strategies for the marketplace’s new reality,” S&P credit analyst Rodrigo Quintanilla said in a statement today. “Such a transition period justifies lower ratings as industry players implement changes.”
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S&P lowered Carolina First Bank, Citizens Republic Bancorp Inc., Huntington Bancshares Inc., Synovus Financial Corp. and Whitney Holding Corp. to “junk” ratings. High-yield, high- risk, or junk, debt is rated below BBB- by S&P.
…
Capital One Financial Corp., BB&T Corp., Regions Financial Corp., U.S. Bancorp and were also among the lenders downgraded today.

Meanwhile, the stronger brethren repaid some funds:

JPMorgan Chase & Co. and three of the nation’s largest banks repaid $44.7 billion to the U.S. Treasury’s bailout fund in a step toward ridding themselves of government restrictions on lending and pay.

JPMorgan repaid $25 billion, Morgan Stanley gave back $10 billion, Minneapolis-based U.S. Bancorp refunded $6.6 billion and Winston-Salem, North Carolina-based BB&T Corp. paid $3.1 billion, the companies said today in separate statements.

Interesting that BB&T is on both lists!

Comrade Obama laid out his financial regulation plans today:

The central bank would get responsibility to oversee all systemically risky financial firms, a move that aims to eliminate gaps in oversight that contributed to the collapse of Bear Stearns Cos. and Lehman Brothers Holdings Inc. last year. The Fed would monitor not only banks but large financial companies, such as insurers or hedge funds, whose interconnections in the financial industry mean their failure would endanger the system.

“These firms should not be able to escape oversight of their risky activities by manipulating their legal structure,” the White Paper said. Through higher capital requirements and stronger regulatory scrutiny “our proposals would compel these firms to internalize the costs they could impose on society in the event of failure.”

So, since the Fed designed and supervised a system of bank regulation without a sufficient moat to protect it from EVIL HEDGE FUNDS, the solution is to regulate hedge funds. Goodbye Connecticut, hello Dubai!

And the chief purpose of any Central Bank, lender of last resort, is going to be politicized:

The Fed, while gaining a bigger role as the systemic regulator, would have some of its emergency lending power curbed. The plan calls for the Treasury secretary to approve in writing any emergency funding.

Oh, well, at leastRep. Scott Garrett is keeping his head:

President Barack Obama’s proposal to expand financial capital requirements to non-banking firms that trade in the $592 trillion over-the-counter derivatives market is misguided, said U.S. Representative Scott Garrett.
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“It is unclear how applying the regulatory system that so woefully failed the banking sector to the rest of the U.S. economy could possibly be helpful,” Garrett, the ranking Republican on a subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, said in an e-mail. The subcommittee is part of the House Financial Services Committee, which will have to turn the Obama proposal into legislation.

I’ve said all along: it’s clear that derivatives were a source of fear – and, in the case of AIG’s counterparties, a definite destabilizing force. This may be addressed simply by altering the existing capitalization rules … those exposed to loss (or those buying insurance and exposed to loss if the insurer fails) should obtain collateral. If the counterparty won’t put up the collateral (AIG, MBIA, et al.), then the required collateral is a straight deduction from the regulated entities’ capital. So what’s the problem? Increasing the scope of regulation is simply a make-work project.

The market was off a bit today, although damage to FixedResets was minimal. Volume continues high.

PerpetualDiscounts closed with a yield of 6.32%, equivalent to 8.85% interest at the standard equivalency factor of 1.4x. Long Corporates continued their yield decline to about 6.3%, sending the Perpetual-Discount Interest-Equivalent Spread to 255bp, as PDs continue to lag the extraordinary strength in bonds.