Category: Market Action

A nasty piece on VoxEU today – How to prick local housing bubbles in a monetary union: regulation and countercyclical taxes. A very prescriptive, central-planning approach … for example:

Whenever ECB interest rates become inappropriately low for a member state, for example, aggressive reductions in tax breaks on housing should aim to reduce the stimulus coming from ECB policy. For example, mortgage interest relief could be conditional on the real rather than the nominal interest rate. At the same time, tax incentives that favour fixed- over flexible-rate mortgages might be called for, as well as changes to the property tax and capital gains tax regime so that they act automatically as countercyclical stabilisers. In some cases, additional temporary tax measures to contain an emerging bubble will be required.
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All told, the three Divisions have examined the references to credit ratings in 44 of our rules and forms. The staff is recommending changes to 38 of them. Specifically, they are recommending the complete elimination of any reference to credit ratings in 11 rules and forms. They are recommending the substitution of a standard based on a more clearly stated regulatory purpose or other concept in 27 rules and forms. And they are recommending leaving the reference unchanged in 6 rules and forms.

Trouble is, bubbles are only apparent after the fact. And there is no evidence to suggest that, ultimately and in aggregate, the Wise Men have any better an idea of how to accomplish market-timing than anybody else. Canada, for example, can be thought of as resembling the EU to some extent, in that our different regions have very different economies – we periodically hear massive complaints about monetary policy, for instance, tightening when a particular region is already in the doldrums. Can you imagine the reaction to special taxes and mortgage regulation in response to, say, Calgary’s oil-fueled housing boom?

Christopher Cox of the SEC introduced some SEC rule changes regarding credit ratings on Wednesday:

The third part of this rulemaking, which we take up today, is focused on the way the Commission’s own rules refer to and rely upon credit ratings. For some time before the recent subprime crisis, we had been re-evaluating the basis for the SEC’s use of ratings as a surrogate for compliance with various regulatory conditions and requirements. The recent market turmoil, and the role that credit ratings played in it, has only further motivated our consideration of reform in this area.

To begin with, the SEC’s own rules don’t distinguish between ratings for corporate bonds and ratings for structured finance products. As a result, our own regulatory regime might be vulnerable to criticism on the same grounds as the ratings agencies’ use of common symbology: namely, that it doesn’t properly reflect the different risk characteristics of structured products, and the different kinds of information and ratings methodologies that go into ratings for structured products.

Second, several of our regulations implicitly assume that securities with high credit ratings are liquid and have lower price volatility.But since structured finance products can be very different from other rated instruments in these respects, there is good reason for us to examine the precise way that credit ratings are used in our rules as a surrogate for measurements of liquidity and volatility.

Third, several observers, including the Financial Stability Forum, have leveled the criticism that the official recognition of credit ratings for a variety of securities regulatory purposes may have played a role in encouraging investors’ over-reliance on ratings.

Eminently sensible stuff. It’s the Portfolio Manager’s job to evaluate risk.

In other encouraging news, the Fed has quorum:

Elizabeth Duke, a Virginia banker, was confirmed today by the Senate to a seat on the Federal Reserve Board of Governors, breaking a yearlong impasse between the Bush administration and Congress.
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Duke, who has been a banker for more than 30 years, was the first woman to chair the American Bankers Association, the industry’s Washington trade group, since its founding in 1875. She served as chairman from 2004 to 2005 and was on its board of directors from 1999 to 2006.

Duke served on the Richmond Fed bank’s board from 1998 to 2000. “She made great contributions then, and I know she’ll make tremendous contributions to the system now,” said Jeffrey Lacker, the bank’s president, who was research director at the time.
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Duke held at least $8.2 million in assets, including more than $5 million of stock in Wachovia, according to a financial- disclosure filing last year. Fed officials are required to divest themselves of bank shares.

Well … her shares in Wachovia are probably worth less now! Every little bit helps!

The Fed will report the value of its “Bear Stearns Portfolio” regularly, commencing July 3.

Fortis Bank is cutting its dividend to zero and raising funds with prefs:

The Belgian-Dutch financial services group was forced to take what it called “exceptional measures” by tough market conditions as well as its purchase of parts of its former Dutch rival ABN AMRO, sealed just as the credit crisis hit last year.

It said it would sell about 6 per cent more shares to institutions to raise €1.5-billion, plus up to €2-billion of non-dilutive preference shares. It will save €1.3-billion by not paying an interim 2008 dividend, sell €2-billion of non-core assets and sell and lease back real estate, and pay its full-year dividend in shares.

In the comments to June 26, Assiduous Reader prefhound professed himself insufficiently impressed by the +31bp spread between CM.PR.E & CM.PR.J to take a position.

So I’ll try again … the RY issues aren’t as good a sample, since most of them come with very, very similar coupons. But how about if we just look at the two yield extremes:…

Ha! +44bp when it should be negative! How about them apples, prefhound?

Another way to look at is that the difference in dividend is $0.1125 and the difference in bid price is $3.49 … payback time just over 31 years. Don’t show such investments to your accountant.

Now, whenever anybody wants to make an argument about, say, PWF being a significantly better/worse credit than SLF … go for it! Maybe I’ll learn something! And we can certainly discuss at length just how much yield premium is required to hold a preferred with a limited upside (aka negative convexity). Hey, make a case that it should be zero! I’ll listen! But if anybody were to tell me that the yield premium really should be significantly negative, as it was with the CM issues today and as it is with these two RYs … it will probably be a short conversation! The only things I can think of – given that the issuer is the same – are:

• A big difference in term to call
• A big difference in liquidity
• A big difference in other terms of the issue (e.g., voting rights, restrictive covenants, etc.)

None of these differences are applicable with the CM & RY issues I’ve highlighted. This is a very, very strange market.

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

Tireless researchers in PrefBlog’s Department of Things That Don’t Really Make a Whole Lot of Sense have been looking at the various Commerce issues lately…

So not only do we have the slope of the yields being in the wrong direction (see my articles on Convexity and Perpetual Hockey Sticks) but … doesn’t the spread seem a little … er … extreme to anybody? It’s almost as much as the spread on Westons that attracted comment last year!

The best performance of the day came from HPF.PR.B, which closed at 10.50-74, 12×23 … up 4.79% bid/bid. All 8,800 shares traded were bought by Nesbitt … could this be related to the Annual Retraction?

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

James Hamilton of Econbrowser provides an interesting piece on how big a contribution could oil speculation be making? … his conclusion:

We were only able to buy 19.9 mb/d in the first quarter when we offered a price near $100. So why would it have been possible to secure the 21 mb/d that consumers would likely have wanted at a price of $72?

Given these data, I think it is impossible to argue that the volume of futures market purchases alone could be the reason why oil prices went up this year. A key and necessary element of any speculation-based interpretation must be some explanation for the factors governing the physical quantity of oil being supplied to the market.

We’re hearing from a number of experts asserting that there’s no reason why the oil price should have gone up. I wish one of them would tell me where an extra million barrels per day in supply is supposed to come from.

Accrued Interest looks at the question of oil prices and their relationship to general inflation:

So over a period of three decades, it was rare that a move in Core CPI would not be mirrored in headline CPI. If one was elevated, the other was elevated. If one was tame, the other was tame.

However, the 21st century hasn’t followed the same pattern. From 2000-2008, the correlation between total CPI and Core CPI has broken down: only 7.6% measured monthly and 21.4% measured annually. This despite the energy portion of CPI rising at a 1970’s style 9.5% annualized. During the current decade, there has been no particular relationship between total inflation and core inflation.

What does this mean? The data is telling you that rising energy and food prices have been due to supply and demand conditions in those markets. Not classic inflation, which is a monetary phenomenon. In other words, rising oil is indeed due to strong demand from emerging markets and a lack of new supply. Not the weak dollar or loose monetary policy.

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

An interesting bit of NRSRO news today … the Treasury is jumping on the bandwagon, albeit with an afterthought that makes sense:

There must be changes in credit-rating companies’ practices, as well as in the way corporations use those ratings, he said

“The users of their services must rely less on, and appreciate more, the limitations of ratings products,” he said.

Bloomberg’s afraid to admit that the full speech has been posted by the Treasury department … I wish the media would quit these coy little games! He went on to say:

To aid in accomplishing this goal, a second private-sector group is outlining further steps that issuers, underwriters, and credit rating agencies can take to ensure the integrity and transparency of ratings, and to foster the appropriate use of ratings in risk assessment. The Asset Managers’ Group at SIFMA is leading this effort. They are exploring issues including: use and quality of ratings; business models; and credit rating agency independence. We expect their work to be completed by the end of July.

Once identified and assessed, risks must be better managed. During the past year, many financial institutions, money managers, and investors simply failed to appreciate the magnitude and nature of risks on their books. This inability to aggregate risk and transparently address public concerns led to even further uncertainty, volatility, and dislocations. We need improved risk management practices by investors and financial institutions.

Great. Better Living Through More Rules. More box-ticking to do and (inevitably) an increasingly vicious regulatory response towards asset managers unlucky enough to be invested in the cause celebre of the day.

Also on the credit ratings front, Naked Capitalism takes a dim view of the latest (rumoured) rules to decrease blind reliance on ratings in regulation of Money Market Funds.

Bloomberg has picked up on the story.

It’s all craziness. The Portfolio Manager is responsible for Everything. He may, or may not, wish to rely on Credit Rating Agency advice … although, as I have argued, it would be really nice if the Friendly Regulators did not ensure that Credit Rating Agencies have better access to information than us ordinary mortals.

The root of the trouble is this: performance doesn’t matter. Salesmen have taken over the industry and all they need is something to package and sell … whether the package is any good or not is something that really doesn’t enter into the question. If the regulators wish to avoid blow-ups and improve the quality of investment advice, then they must track performance. Anybody with a license to trade with discretion, or who is part of a team of advisors helping the PM to trade with discretion, should be reporting performance versus a benchmark. And that performance should become part of the regulatory record that is published by the regulators forever. No more burying of unsuccessful funds; no more coyness regarding long term results.

The Credit Rating Agencies, for instance, publish their track records going back 20 years. When was the last time any Assiduous Reader saw a stockbroker’s 20-year track record? Or saw a brokerage provide half the self-analysis that the NRSRO’s routinely produce?

When discussing the teleportation of US Municipal ratings to the global scale in Be Careful What You Wish For!, I suggested one flaw in the analysis was the assumption that all newly-indistinguishable credits would trade as if they were top-quality; Accrued Interest points out that there is hazard on the issuer side too:

The high ratings standards for municipals encourages some measure of fiscal conservatism. This is especially true for Aaa-rated credits, where loss of the rating would be politically embarrassing. Of course, municipalities are downgraded all the time, but clearly local politicians would rather maintain their rating than not. If the overwhelming majority of general obligation issuers are going to be rated Aaa anyway, that incentive is greatly reduced. In other words, a state like Georgia (rated Aaa) is currently incented to maintain its austerity. But if they could slide all the way down to California’s level (currently A1) and still be rated Aaa, they’ll probably do it.

But the rating hysteria is regulator/politician driven – neither group is notable for thinking things through.

The recently issued L.PR.A traded 24,250 shares today in a range of 23.00-24.40, closing at 24.00-15, 2×5. Nice range, eh? It does not reflect well on either the market maker or the underwriters. Those who sold today at 23.00 should be writing letters of complaint to the TSX regarding the day’s thoroughly appalling market-making.

Let’s see if these overpaid jokers can get it right tomorrow, when, I suspect, the excitement will be regarding BAM Flambé.

Another good day today, although not exceptional. Very good crossing volume in some of the near-term Operating Retractibles.

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

In one of the year’s easier calls, BCE issues skyrocketted today … now, if only I’d known that while Friday’s market was still trading! As suspected, the broader market followed. Volume was OK, but nothing special … my suspicion is that the Swoon in June was largely retail window dressing (based on the the strange price behaviour and relatively low volume) and that institutional players – such as they are – are looking at all this kerfuffle with an air of bemusement.

But what do I know?

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

Stop presses! Sit down! Have some smelling salts! The PerpetualDiscount index was actually up today (up almost 42bp, in fact), ending a string of twelve consecutive losses from June 4 to June 19, inclusive. Those twelve consecutive losses took the PerpetualDiscount index down 5.80%.

Average pre-tax bid-YTW for PerpetualDiscounts is now 6.07%, interest-equivalent 8.50%, long corporates .. oh, call it 6.17% and 30-year Canadas at 4.15%.

Work out the spreads and update the graphs yourselves, ya bums! What am I, your maid?

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

Accrued Interest has posted a good piece about CDS clearing and exposures; I have added the link to my discussion of his prior post on the issue.

OSFI has, essentially, banned “Global Market Disruption” lines of credit, which have been much discussed since non-bank ABCP sponsors found out just how little liquidity they actually provided. Banned? Well, not in so many words. But the credit conversion factor is now the same as a guaranteed line; therefore, the cost to the bank (in terms of capital when the line’s undrawn) will be the same; therefore it seems highly unlikely that anybody will ever want one. It’s an interesting issue and OSFI has included a fair bit of discussion with the advisory. I’ll try to review the rule change … soon!

Practically a return to good times today … PerpetualDiscounts were down only 40bp! Their pre-tax bid-YTW now averages 6.09%; at the standard factor of 1.4x, this is equivalent to 8.53% interest. Those feverishly updating their historical yield spread graphs will note that 30-year Canadas are now at 4.18% and long Corporates at a little over 6.10% … so call Canadas/Corporates at 195bp and preferreds/corporates at 240. This is a thoroughly bizarre market.

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

Another thoroughly appalling day for the preferred share market. The dividend yield on PerpetualDiscounts is now 6.07%, equivalent to interest of 8.50%. Long Corporates are now at about 6.15%, so the PerpetualDiscount Interest Equivalent spread to long corporates is now at a stunning 235bp, while the 30-year Canada is now at 4.15%. See Party Like It’s 1999! for an illustration of why the PDIE spread is “stunning”.

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

Again, busy!

I did come up with another rationale for the current … drop, shall we say? … and have updated the Negative Convexity? Negative Schmonvexity! post.

Today was a horrible, horrible day for preferreds, with the market down sharply (as noted by Assiduous Reader lystgl in the comments to “New Trough for Preferreds?”) on sharply increased volume.

For those keeping track, today wasn’t even the worst day this year for the PerpetualDiscount sector … that honour belongs to January 17. Hmmm … 17th both times, eh? I wonder what a technical analyst would make of that?

This drop is preferred-specific: the yield on the PerpetualDiscount index today was 6.00%, equivalent to 8.40% interest using a 1.4x conversion factor. Long Corporates continue to yield a shade under 6.2%; the 220bp spread is out of the 190-210bp range that has been recently established.

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

The OSFI/ABCP post has been updated with news of remarks by Supt. Dixon to the Commons Finance Committee.

Another very – very – poor day in the market. Volume, though, was relatively light. Now, this is getting a whole lot closer to Technical Analysis than I like, but this does lend some credence to my speculation that this downdraft is retail-driven. Whether or not that actually means anything in terms of future performance is, of course, another matter. entirely.

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