Category: Market Action

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.
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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.
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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.
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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.

CIT Group is getting a $2.33-billion TARP infusion. A lot of people who bought protection at 2500+bp are not going to be very happy.

Holy smokes! On continued heavy volume – that I remain convinced is tax-loss selling, perhaps with a bit of year-end window-dressing thrown in, PerpetualDiscounts were up today! That breaks a seven day losing streak. Not only that, but the behaviour of BNA.PR.C … well, it’s in the tables twice. Be sure to be sitting down when examining!

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

Dealbreaker has a highly entertaining commentary on quants, inspired by a somewhat more serious Reuters piece:

Because some of their mathematical models failed to take into account factors that later turned out to be crucial, quants have been blamed for compounding risk and exacerbating the crash in financial markets.
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The profession’s reputation took a beating in August 2007, when some quant funds — which try to beat the market by crunching vast amounts of data at lightning speed — lost a third of their value in a matter of days.
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As the mortgage crisis gathered steam last year and financial markets became volatile, quant funds, which make up about 7 percent of the hedge fund universe, were caught flat-footed.

To raise cash, they started selling stocks, which created unusual moves in stock prices, throwing other quant models off. Finally, the selling snowballed into a full market panic.

“Before you know it, you have a chain reaction and the whole market dives on the basis of what amounts to a mathematical prediction,” said Peter Morici an economics professor at the University of Maryland.

“You create a mathematical herd. That’s why so often these schemes based on math models end in tears.”
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Nassem Taleb, a former trader who wrote the best seller “Black Swan: The Impact of the Highly Improbable,” is even more outspoken. “Quants and quant programs are dangerous to society,” he said.

The failure last year to foresee that subprime borrowers might default on their mortgages is only the latest example of mathematical models that rule out possible sets of circumstances because they were highly unusual.

In 1998, Connecticut hedge fund Long-Term Capital Management collapsed because its mathematical model failed to foresee the Russian debt crisis.

I have found that generalizing about “quants” is not a wise thing to do. There are quants and then there are pseudo-quants; the difference between the two can usually be found only by detailed analysis of the model, preferrably at the code level. I also find the idea of “quant schools” to be somewhat odd. It’s putting the cart before the horse! A more rational way of getting into the area is to do many, many calculations on the back of an envelope, executing your trades according to your model, and making money for your clients. You then realize that if you could do your calculations more rapidly, you could take advantage of shorter-lived anomalies; you also realize that increasing the size of your universe will give you more opportunities to exploit your model. So you end up “crunching vast amounts of data at lightning speed”, but the model is the main thing, not the amount of data or the speed.

I should also point out that the rescuers of LTCM made out like bandits; the relationships were basically valid, it was margin calls caused by transient anomalies that killed them. The danger is not quantitative analysis; the danger is over-leverage. But just try telling a salesman that the idea that “one” is good does not necessarily imply that “two” is better – especially when they can charge a full point to make it “three”!

The August 2007 quant debacle has been previously discussed on PrefBlog. Pseudo-quants got hammered; everybody else made out just fine.

There are fears of a wave of defaults on commercial property:

U.S. commercial properties at risk of default could triple if rental income from office, retail and apartment buildings drops by even 5 percent, a likely possibility given the recession, according to research by New York-based real estate analysts at Reis Inc.

Lenders that used optimistic rent estimates to grant mortgages beginning in 2005 stand to lose as much as $23.1 billion, or 7.02 percent, of total unpaid balances if landlords lose 5 percent of net operating income, according to Reis. Analysts examined data on 22,890 properties that together may account for unpaid loans of about $329 billion in 2009, said Victor Calanog, director of research.
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Reis estimates at least 353 properties, or 1.5 percent of the total number analyzed, could fall into default as net operating income, mainly from rent, barely clears loan payments.

Properties at risk include those with net operating income less than 1.1 times their loan payment, Calanog said. That “base case” translates to $9.08 billion of unpaid balances, or 2.76 percent of the total dollar value outstanding on the mortgages.

Brookfield is always – well, recently – a hot topic of discussion on PrefBlog, so here are some numbers from the Brookfield Properties 3Q08 Report:

Income coverage is not the same thing as profitability, of course (there’s depreciation to be covered, among other things), but there is no indication here of impending cash flow difficulties with Brookfield’s consolidated property arm.

Strange and violent action in the CMBS and derivative markets on November 20. I was hoping for some good CMBS colour on Across the Curve, but he’s taking the week off. Huh! I wanted to spend Christmas with my loved ones, too … but the banks are closed.

I’ve argued here interminably that what we want right now by way of fiscal policy is infrastructure spending. Daniel Gros argues on VoxEU that it’s too hard to get shovels in the ground quickly enough and advocates tax cuts and deferrals:

Even in the US, this instrument will only have limited importance, as public infrastructure spending is projected to increase from around 2.6% (in 2007) to 3.6% of GDP (in 2009), thus constituting only a small fraction of the overall deficit, which is now projected to climb to around 8%–9% of GDP.
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Households that depend on credit to finance their consumption will be most affected by the credit crunch and are thus most likely to react to a tax cut by maintaining their consumption. For this type of household, a tax cut (or an increase in expenditure) will be an effective tool to prevent an even sharper drop in consumption.
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The fact that the marginal propensity to save is likely to be much higher in countries with solvent households (Germany and most of rest of continental Europe) also implies that the multiplier effect of spending on public infrastructure will also be lower than in the Anglo-Saxon countries where households are close to bankruptcy. This is another reason why the German government should be more hesitant than others to engage in a big fiscal stimulus.

A similar reasoning applies to the corporate sector – in a credit crunch investment will be strongly affected by the liquidity situation of enterprises. This implies that in countries where the corporate sector is a heavy borrower (Spain, France and Italy) it would be important to improve the liquidity situation of enterprises. One simple way to do this would be to allow all corporations to postpone payment of corporate income taxes for 1-2 years. This would not result in higher deficits as usually measured, but the cash deficit would increase as governments would effectively extend a credit to the corporate sector. Such a measure would thus be very different from a tax cut because it would not lead to larger debt levels and thus should not lead to sustainability problems later on. Postponing the payment of corporate income tax would of course help only enterprises that make a profit, but this should be considered an advantage because it would mitigate the impact of the credit crunch for sound enterprises, i.e. those that deserve to be saved. Companies that did not pay corporate income tax because they were not able to turn a profit even during the boom would not benefit, but they are also the most likely ones to be insolvent anyway.

I cannot think that the tax deferral option is realistic. If I managed a large profitable corporation and was told my tax was deferred and would be due in 1-2 years, I wouldn’t rush out and spend the money. Nope. I’d buy some high quality short term bonds, book a little free profit and not increase my business risk.

The direct household stimulus argument is a little harder to deal with; my main point was actually brought up by the author:

Even in the US, where the private savings rate has been close to zero, households still chose to save more than half of the tax rebate decided earlier in 2008.

while my other point is also referred to:

Households that depend on credit to finance their consumption will be most affected by the credit crunch and are thus most likely to react to a tax cut by maintaining their consumption. For this type of household, a tax cut (or an increase in expenditure) will be an effective tool to prevent an even sharper drop in consumption.

See? They’ll just blow it on beer and prostitutes.

A recession is nature’s way of telling us we’ve been doing it wrong … one reason why I think we should be very cautious about bailing out the big automakers. Infrastructure spending – as long as it is genuinely useful infrastructure spending – is the way to go.

The Fed has approved CIT Group’s application to become a bank holding company.

Yet another horrible day for the market, with PerpetualDiscounts losing 1.0128% on heavy volume. That’s its seventh straight losing day … but look at the bright side! There are only two more days of tax-loss selling to go … and one of them a short day … and then I’ll have to think up another rationale!

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

S&P cut a whack of bank ratings today, on the following grounds:

• overall assessment of industry risk has been increased
• sensitivity of ratings model to reliance on short term funding has increased
• levels of stress are expected to be higher than typical cycles
• model emphasizing risk-adjusted capital; developing framework that is more risk-sensitive than Basel I and more conservative than Basel II, particularly with respect to market risk and private equity risk.
• “Systemically important” banks will have potential government support recognized

Rating changes were:

• Bank of America, AA- from AA
• Barclays, AA- from AA
• Citibank, A+ from AA
• Credit Suisse, A+ from AA-
• Deutsche Bank, A+ from AA-
• Goldman Sachs, A from AA-
• HSBC, AA (negative outlook) from AA (stable)
• JPMorgan, AA- from AA
• Morgan Stanley, A from A+
• Royal Bank of Scotland, A+ from AA-
• UBS, A+ from AA-
• Wells Fargo, AA+ (negative outlook) from AAA (Watch negative)

Some pretend-managers, very upset by Deutsche Bank’s refusal to execute an out-of-the-money call are very upset:

Deutsche Bank AG’s decision to pass up an opportunity to redeem 1 billion euros ($1.39 billion) of bonds is a setback for financial market stability, according to U.K. and German investment management and insurance groups.

The bank’s choice “will weigh on the markets for months,” said Andreas Fink, a Frankfurt-based spokesman for the BVI German Investment and Asset Management Association, whose 92 members oversee about 1.4 trillion euros of assets.
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“This is a setback for the stabilization of banking markets and is likely to increase funding costs for banks generally,” Jonathan French, the London-based spokesman for the Association of British Insurers, said in an e-mailed statement to Bloomberg News.

S&P’s note on their bank downgrades stated:

We believe that the difficult operating environment will increase payment deferral risk of most regulated financial institutions’ hybrid capital securities in the U.S. and Europe, including the large systemically important banks covered in this review. This is because the difficult environment is expected to pressure financial performance.

Both Sarkozy and our very own Spend-Every-Penny are grandstanding about what a great banking system there would be if only they ran it. However, not all Canadian politicians have their ideas forgotten! California’s civil servants will get Rae days!

Accrued Interest brings an update on the new Term Auction Loan Facility; it looks like the Fed is desperate to get the securitization market started again.

Via Dealbreaker comes a link to a NYT article, Even Winners May Lose with Madoff:

One client said he invested more than $1 million with Mr. Madoff over a decade ago. As his portfolio rose in value, he took out several million dollars. While his statements showed several million dollars in his Madoff account when the fund collapsed last week, the client still ended up ahead.
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But previous court rulings regarding financial frauds suggest the winners could be forced to give up some of their gains to losers.
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Yet even Mr. Madoff’s most fortunate clients may wind up having to give back some of their gains, as investors might have to do in another recent financial fraud, the collapse of the hedge fund Bayou Group in 2005.

In the Bayou case, in which investors lost $400 million, a bankruptcy judge ruled that investors who withdrew money even before Bayou collapsed might have to return their profits, and possibly some of the initial investments, to the bankruptcy trustee overseeing the unwinding of Bayou.

The returned money is to be distributed among all investors, who are expected to receive only about 20 to 40 percent of their original investments.

Mr. Madoff’s winning clients are likely to face similar legal challenges. In fact, the Madoff client who profited from his investment spoke on the condition that he not be identified, out of concern that he might be sought out to repay some of his gains to the receiver or bankruptcy trustee for Mr. Madoff.

This is the worst thing that can happen in a fraud like this. The highlighted investor, it would seem, did everything right (except due-diligence, and nobody does that; it’s too expensive and if you do do it, you’ve got to listen to some whiny little geek who can’t even sell investment strategies tell you that you can’t put your [client’s] money into a sure thing with a great story): he regarded his hedge fund investment as high-risk and rebalanced regularly, taking his money off the table. He has adjusted his investment portfolio – and quite possibly his entire lifestyle – as a result of his ethereal winnings and now has to give them back.

I was once part (a very small, clerical level part) of an investigation of a stockbroker who had been naughty. Little Joe & Jane Lunchbucket had gone out and bought houses – retired, even, if memory serves – on the basis that their accounts were worth lots of money and would support them. The firm made good on actual losses, but not on fictitious winnings. It was a really, really bad situation.

There’s a marvellous post regarding the Madoff scandal on Bronte Capital and a thoroughly fascinating letter to the SEC via the WSJ.

What-Debt? is musing about a $30-billion deficit. I don’t have any problems with a deficit of that size, and I support Econbrowser‘s James Hamilton’s call for the stimulus to take the form of unrestricted grants to lower levels of government. I would go farther than that: there are hospitals and charities (a friend specifically mentioned Habitat for Humanity) who can get shovels in the ground next week if they can get some funding. There should be controls, of course, to ensure that the capital projects are actually useful (unlike Japan’s Ibaraki Airport discussed on December 4); but speed in spending the money is important.

No, my problem with a $30-billion deficit is that we don’t have the money already. Planned debt reduction of $3 billion per year for 2010–11 to 2012–13 based on rosy forecasts of continued good times won’t pay for a lot of recessions. But What-Debt? and Spend-Every-Penny have crippled Canada’s ability to maintain a surplus through a normal business cycle, importing the simplistic US Republican thesis that tax cuts are always good, particularly if the cuts are completely bone-headed, like the GST cut. Throw the rascals out!

Another day of very heavy volume and … the sixth straight decline in PerpetualDiscounts, which now yield 8.31%; edging closer to their recent high of 8.63%. The former, current, figure is equivalent to 11.63% interest at the standard conversion factor of 1.4x; given that long corporates yield about 7.50%, the pre-tax interest-equivalent spread is an astonishing 413bp.

PerpetualDiscounts are currently down 1.48% total return on the month; Split-shares have had a better time of it and are now up 13.11% on the month; probably due to the market’s discovery of monthly retraction possibilities.

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