Category: Market Action

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.

There’s an amusing story today about bonus policies at Credit Suisse:

Credit Suisse Group AG’s investment bank has found a new way to reduce the risk of losses from about $5 billion of its most illiquid loans and bonds: using them to pay employees’ year-end bonuses.

The bank will use leveraged loans and commercial mortgage- backed debt, some of the securities blamed for generating the worst financial crisis since the Great Depression, to fund executive compensation packages, people familiar with the matter said. The new policy applies only to managing directors and directors, the two most senior ranks at the Zurich-based company, according to a memo sent to employees today.
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Credit Suisse is the first to use the debt to pay employees. Outside investors may also be permitted to invest in the facility, according to the people familiar with the matter, who declined to be identified because the plan hasn’t been made public. The bank will boost the potential for returns by providing leverage to the facility, and will be paid back first, according to the people.

If I am correct – with the support of the BoE – and bank assets have, in general, been written down to far below fundamental value, this is a clever way for the executives to (a) earn brownie points, and (b) give themselves enormous bonuses.

In sad news for bond investors, General Electric’s debt ratings are at risk. This is particularly grievous because GE has long had a well-deserved AAA rating but has yielded like a single-A … and any time you can pick up free credit quality is a Good Time.

Allan Greenspan opines in an Economist op-ed Banks need more capital:

As recently as the summer of 2006, with average book capital at 10%, a federal agency noted that “more than 99% of all insured institutions met or exceeded the requirements of the highest regulatory capital standards.”

Today, fearful investors clearly require a far larger capital cushion to lend, unsecured, to any financial intermediary. When bank book capital finally adjusts to current market imperatives, it may well reach its highest levels in 75 years, at least temporarily (see chart). It is not a stretch to infer that these heightened levels will be the basis of a new regulatory system.

Note that the chart shows “Book equity as % of book assets”. I believe that this is equal to the FDIC’s ratio “Equity capital to assets”. The FDIC defines this as “Total equity capital as a percent of total assets”, whereas the more commonly referenced “Leverage Ratio” is

Tier 1 (core) capital as a percent of average total assets minus ineligible intangibles.

Tier 1 (core) capital includes: common equity plus noncumulative perpetual preferred stock plus minority interests in consolidated subsidiaries less goodwill and other ineligible intangible assets. The amount of eligible intangibles (including mortgage servicing rights) included in core capital is limited in accordance with supervisory capital regulations. Average total assets used in this computation are an average of daily or weekly figures for the quarter.

The equity capital ratio for all FDIC insured institutions was reported in their 3Q08 Report to be 9.63%, compared to 10.45% (3Q07); 10.25% (3Q05); and 9.13% (3Q03). Note that Mr. Greenspan’s chart forecasts a massive increase in this ratio without this forecast being justified in the text.

Moody’s cut Citigroup from Aa3 to A2:

Moody’s Investors Service lowered the debt ratings of Citigroup Inc. (senior debt to A2 from Aa3) and the ratings on its lead bank, Citibank N.A. (long-term bank deposits to Aa3 from Aa1). The financial strength rating on the bank was lowered three notches to C from B, which translates to a change in the baseline credit assessment to A3 from Aa3. The outlook on the bank financial strength rating is negative and the rating outlooks on the deposit and debt ratings at both the bank and the holding company are stable.
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Moody’s said that its downgrade of Citigroup’s debt and deposit ratings was moderated by Moody’s opinion that Citigroup enjoys a very high probability of systemic support from the U.S. government. The benefits of this systemic support partially offset the deterioration in Citigroup’s stand-alone credit quality, which is driven by worsening asset quality and the likelihood that Citigroup could see further decline in its tangible capital base in the next two years.

This had immediate contagion effects, with HSBC getting hammered in Hong Kong. Look out below!

Holy smokes, what a day. Very heavy volume and the market tanked. An Assiduous Reader wrote in:

Another dismal day for PerpetualDiscounts on fairly big volume. Could this downward momentum be caused by margin calls…forced selling…or panicking investors and their advisors?

I’m ready to pull the sell trigger myself….Clients will be in disbelief with Dec 31st statements.

Well … I still like the tax-loss-selling hypothesis. It fits with the season, volume and direction. Margin calls and forced selling, not so much, because I don’t think a lot of prefs are bought on margin, or are held in margin accounts that are levered to the max (I could be wrong. It would be interesting to see some figures). Panicking clients? I would think that any client with the guts to hang in this long will consider recent declines to be a mere bagatelle, but panicking advisors sounds more possible. There will be a fair number of clients who haven’t received a statement since September and things …. are a little different now.

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

Ha-ha! Gone fishin’!

Toronto Stock Exchange and TSX Venture Exchange will not resume trading today due to continuing technical issues with its data feeds.

The market will be put into a Pre-Open state from 3:00PM to 5:00PM to allow participants the option of cancelling, adding or changing orders.

The company intends to open the exchanges tomorrow morning.

Additional information on the nature of the problem will be provided when the investigation is complete.

and:

TMX Group technology team has isolated the issue that resulted in the halt of trading on Toronto Stock Exchange and TSX Venture Exchange. Remedial action was taken to restore all data feeds at 3:41PM, and the company confirms that the Exchanges will open on Thursday, December 18, 2008 as per normal.

Initial findings indicate a network firmware issue resulted in complications with data sequencing, which impacted the delivery of the Level 1 data feeds.

Next step, quantitative easing! The FOMC announced:

The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.
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As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses.
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In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco. The Board also established interest rates on required and excess reserve balances of 1/4 percent.

The Fed also announced:

The federal banking and thrift regulatory agencies today approved a final rule that would permit a banking organization to reduce the amount of goodwill it must deduct from tier 1 capital by any associated deferred tax liability.
Under the final rule, the regulatory capital deduction for goodwill would be equal to the maximum capital reduction that could occur as a result of a complete write-off of the goodwill under generally accepted accounting principles (GAAP). The final rule is in substance the same as the proposal issued in September. The final rule will be effective 30 days after publication in the Federal Register. However, banking organizations may adopt its provisions for purposes of regulatory capital reporting for the period ending December 31, 2008.

The final rule was approved by the Federal Reserve Board, Federal Deposit Insurance Corporation, Office of the Comptroller of the Currency, and Office of Thrift Supervision. The draft Federal Register notice is attached.

The uninformed reporting of this rule change was discussed by PrefBlog when the rule was proposed.

In a sign of the times, redemptions on a real-estate seg fund have been suspended:

The Great-West Life Assurance Company today announced a temporary moratorium on redemptions from its Canadian Real Estate Investment Fund No. 1 effective close of business (4:00 p.m. EST) December 15, 2008.

The Great-West Life Real Estate Fund is a Segregated Fund which holds a diversified portfolio of high-quality income producing properties. Given the current economic environment, redemption requests have recently increased. Real estate assets are generally less liquid than other major asset classes and cannot be rapidly liquidated. Therefore, in accordance with the terms of
the Information Folder governing the Fund, it has been determined that a temporary moratorium on redemptions is necessary to ensure equitable treatment for all investors in the Fund.

I have a good illustration of why preferreds in general and BAM in particular are down so much this year. It’s in a post on Financial Webring Forum:

I am continuously amazed at the prices for BAM retractables. Forgetting the dividend for a moment, the O series are priced to return a 52% capital gain by August 2013 (assuming a $25 payout). That’s 9.4% annualized, and that’s just the capital gain. The YTW which James calculated yesterday is 16.65% based on a price of $16.

That’s ifBrookfield Assets Management can pay up in 2013, right ? And if Brookfield is still in business in 2013.

I hate to sound like the voice of doom, but these days anything can happen, and often does.

Voice of doom? Voice of ignorance is more like it. Look at that post: ZERO discussion, ZERO analysis, ZERO accountability. The quoted poster has a bright future ahead of him in the financial services industry, because he’s got the sales pitch down pat.

If somebody does an analysis of BAM and doesn’t like it, that’s fine. Maybe they’ve got too much exposure to real estate. Maybe they’ve got too much debt. Maybe … you name it, we can think about it and discuss it.

On the other hand, maybe somebody does an analysis of BAM, takes a view on what yield it should have, compares it to the yields available elsewhere with similar risk profile, and says Holy Smokes! Buy! Maybe the exposure to real-estate isn’t the totality of the company. Maybe the real-estate assets can be jettisoned (BAM has, effectively, a put on BPO. BPO has a put on the individual properties) with damage done, to be sure, but not life-threatening. Maybe since all that debt is secured by individual properties with no recourse and with well staggered maturities, it’s not as scary as it looks at first. Maybe … you name it, we can discuss it.

And if you like it, you can plunk a little money down (not too much because you might be wrong) and if you’ve done your homework properly you’ll make a good return – not necessarily on every investment, but on the totality of your portfolio.

Because, contrary to the ravings of efficient market zealots, the market is not efficient. The market is not comprised solely of highly intelligent people who work hard. The market is comprised of guys like the Mr. Voice of Doom quoted above – and poor performance does not weed them out. They just come back with a new line of patter and a new client list. Markets are moved by salesmen, not analysts.

Another down day on very heavy volume – but PerpetualDiscounts are still a little ahead on the month-to-date. SplitShares seem to be hesitantly recovering, and BNA activity appears to be dominated by retractors.

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

A House of Congress committee head announced today that he wants the heart of the financial world to move to Dubai:

Credit-default swap clearing would become mandatory under legislation slated to be introduced next month by House of Representatives Agriculture Committee Chairman Collin Peterson.

Peterson of Minnesota, the Democratic chairman of the committee, said in an interview today he had Republican support to proceed with a comprehensive bill. The committee oversees the Commodity Futures Trading Commission and the U.S. futures exchanges it regulates.
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“It’s hard for me to understand what useful purpose these things are serving,” Peterson said, referring to CDS contracts. “I’m not out to get Wall Street, but what’s gone on there is jeopardizing the entire global economy.”

Apparently the current moves to reduce systemic risk aren’t good enough, which is one in the eye for the Treasury Secretary designate.

it has been reported that Royal Bank placed client money with Madoff:

Royal Bank of Canada (TSX: RY.TO) says some of its clients have less than $50 million in exposure to alleged US$50-billion Ponzi scheme run by Wall Street investment manager Bernard Madoff.

In a statement issued Monday, the bank said it doesn’t have any direct exposure to the investments, which has left the U.S. financial industry reeling.

I will admit I look forward with some fascination to the various determinations of due-diligence with respect to the Madoff funds.

The market was down again today on continued high volume.

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

Volume continued heavy today, but should start slowing next week. Still, the deadline for tax-loss selling is Wednesday Dec 24, so we shall see!

PerpetualDiscounts now yield an average of 6.99% 7.99% pre-tax, equivalent to 9.79% 11.19% pre-tax interest at the standard 1.4x conversion factor. Long corporates are at 7.60%, so the Pre-Tax Interest-Equivalent spread is now 219bp 359bp.

Many thanks to Assiduous Reader Chris, who points out in the comments below that I am an idiot.

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

JPMorgan, or one of their clients, wants to make a big bet on Collatteralized Loan Obligations:

JPMorgan Chase & Co., the largest U.S. bank, is seeking as much as $780 million of AAA rated portions of collateralized loan obligations, according to a list of securities the company circulated to traders and investors.
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New York-based JPMorgan, which has received capital from the government and has obtained loans from the Federal Reserve, told traders it may be willing to accept yields of about 4 percentage points more than the three-month London interbank offered rate for dollars, three of the people said. That’s less than the spread of 5 percentage points that the securities typically trade at, according to JPMorgan’s research department.
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The purchase may aid the $475 billion CLO market, where prices began falling after the July 2007 collapse of two Bear Stearns Cos. hedge funds that owned collateralized debt obligations.

CLOs, which are a type of CDO, repackage loans used to fund leveraged buyouts and other non-investment-grade, or junk, rated companies into new securities with varying ratings.

The world has gone mad and it has been a week of what Portfolio.com calls a trend of “Rich white men throwing it all away for nothing.”.

And they didn’t even mention the Sextant thing! The OSC has alleged:

15. At November 28, 2008, approximately 5% of the assets of the Sextant Fund were invested in a portfolio of cash, stocks and futures contracts, including stocks of private companies. The portfolio is held in accounts with Newedge Canada Inc. (“Newedge”), the custodian and prime broker for the Sextant Fund.

16. The balance of the assets in the Sextant Fund are invested in two private Luxembourg companies: Iceland Glacier Products S.a.r.l. (“IGP”) and Iceland Global Water 2 Partners SCA (“IGW”).

17. At November 28, 2008, 92% of the assets of the Sextant Fund were invested in IGP and 2.5% of the assets were invested in IGW. These investments are not recorded or valued on Newedge’s books and records.

18. IGP and IGW both purportedly own rights to glaciers in Iceland and intend to use those rights for the purpose of developing and selling bottled water. Neither IGP or IGW have earned any revenue and there are no indications that they will do so in the immediate future. Neither is currently operating.

19. Despite having earned no revenue and having no immediate prospect of doing so, IGP’s shares have purportedly increased in value from an initial average cost of €0.226 to €2.45, or approximately 984% since initial investment by the Sextant Fund. This has contributed to the increase in value of the Sextant Fund by 730.7% over the less than three years between its inception in February 2006 and November 28, 2008.

20. There are no third party valuation reports that support the monthly, material upward revisions in value of IGP, and therefore there is inadequate support for the claimed rate of return of the Sextant Fund.

21. Significant performance fees, in excess of $3 million dollars have flowed out of the Sextant Fund based entirely on its purported rate of return. Fees for the month of November 2008 alone were assessed at over $1.5 million.

22. IGP and IGW are owned almost entirely by the Sextant Fund, the Sextant Offshore Funds and Spork.

The Globe and Mail notes:

Mr. Spork also runs two offshore funds totalling $100-million (U.S.) – Sextant Strategic Hybrid2 Hedge Resource Fund Offshore Ltd. and Sextant Strategic Global Water Fund Offshore Ltd. – which do not have Canadian investors.

After his fund shot up 74 per cent in July alone, Mr. Spork was reluctant then to reveal how his commodities-focused strategy has been racking up stellar returns.

“We make our returns or business grow by having an edge that is not transparent,” Mr. Spork told The Globe and Mail at that time.

Just what the investors were receiving by way of disclosure is not clear. And I am not an expert in the exciting new field of glacier investing. But it seems to me that before I wrote a large cheque – especially to buy large ice-cubes – I would want to know a little more about the non-transparent edge.

Then today after the markets closed the SEC released allegations against Bernard Madoff:

alleged that Madoff yesterday informed two senior employees that his investment advisory business was a fraud. Madoff told these employees that he was “finished,” that he had “absolutely nothing,” that “it’s all just one big lie,” and that it was “basically, a giant Ponzi scheme.” The senior employees understood him to be saying that he had for years been paying returns to certain investors out of the principal received from other, different investors. Madoff admitted in this conversation that the firm was insolvent and had been for years, and that he estimated the losses from this fraud were at least $50 billion.
…
According to regulatory filings, the Madoff firm had more than $17 billion in assets under management as of the beginning of 2008. It appears that virtually all assets of the advisory business are missing.

It’s not clear to me how the two figures cited are reconciled, but with numbers that big it doesn’t matter much does it? One wonders what his client list looked like and what the collateral damage tomorrow is going to be.

It’s not going to be the only headline, either! Carmakers won’t get bailed out:

Senate negotiations for a U.S. automaker bailout plan collapsed, in a blow to General Motors Corp. and Chrysler LLC, which may run out of cash early next year.

“It’s over with,” Majority Leader Harry Reid said on the Senate floor in Washington. “I dread looking at Wall Street tomorrow. It’s not going to be a pleasant sight.”
…
Connecticut Democrat Christopher Dodd, who was involved in the negotiations, said the final unresolved issue was a Republican demand that unionized autoworkers accept a reduction in wages next year, rather than later, to match those of U.S. autoworkers who work for foreign-owned companies, such as Toyota Motor Corp.

“More than saddened, I’m worried this evening about what we’re doing with an iconic industry,” Dodd said. “In the midst of deeply troubling economic times we are going to add to that substantially.”

Accrued Interest has a post about negative yields on US T-Bills, asking:

So when I heard that there were T-Bill trades occurring above par, I was more stunned that Princess Leia aboard the Tantive IV. Who bought T-bills above par? Why would you enter into that trade with a certain loss when you can simply hold currency at no loss?

Currency? How currency? Put it in a bank, it’ll go bust. Put it under your mattress, you’ll get robbed. Put it into actual folding paper in a safe deposit box, you’ve got transaction costs out the wazoo, what with money laundering laws and safekeeping fees, not to mention a certain risk of your employees robbing you. How currency?

There are some good comments to that post. I’ll suggest that the commenter Oregon Guy has the right of it:

Say you have a $2,000,000 CD maturing. You can deposit the proceeds in a money market account with FDIC insurance, but the insurance won’t cover the $2,000,000 and you don’t want the bother of opening a plethora of accounts. Treasuries are bubble-priced, so you don’t want to go there. Corporates are shaky because defaults are high and you’re risk adverse. You can roll-over the CD, but that opens up the possibility of uninsured loss again.

I will suggest the additional mechanism of segmentation. There are a LOT of T-Bill funds out there, and a lot more private-manager mandates that will only allow T-Bills. They HAVE to buy bills – they don’t even have the currency option.

Volume continued heavy today, but the market was down this time.

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

This is funny. Goldman is being criticized for advising shorting municipal credit (via credit default swaps):

It’s “disturbing” to advise investors to bet against the financial health of a state whose bonds Goldman helps sell, Assemblyman Gary S. Schaer, a Democrat who chairs the Financial Institutions and Insurance Committee, said last week in a letter to Chief Executive Officer Lloyd C. Blankfein.

“New Jersey needs to maximize its presence in the credit markets, not to see its presence undermined.” Schaer wrote.
…
As part of a September presentation to institutional investors on “Best Long and Short Risk Strategies,” Goldman recommended buying credit-default swaps on “a basket of liquid State General Obligation credits with current and worsening fiscal outlooks,” including California, Florida, Nevada, Ohio, Wisconsin and Michigan.

The firm also recommended the derivatives on states with “significant unfunded pension” and other retiree obligations, including Illinois, Connecticut, Hawaii, New Jersey, Massachusetts and Nevada.

The practice of betting against such states is “distasteful,” said Frank Hoadley, Wisconsin’s director of capital finance in Madison.

Didn’t we do the whole “analyst independence” thing a few years ago? However, the original Newark Star-Ledger story, while attempting to sell newspapers, is better balanced than Bloomberg’s efforts.

I do apologize … but I am YET AGAIN neglecting to present the price-movement and volume-highlight tables. At some point, perhaps, I will have caught up on other committments – but not tonight.