Category: Market Action

Bill Gross of PIMCO (whose forecast of FedFunds at 3.50% was mentioned here on October 29) has called for rough justice for the monolines:

As long as the illusion lasted, however, it is clear that monoline guarantees fostered an expansion of our modern shadow banking system and therefore an extension of US and even global economic prosperity.
…
…authorities through both official and backdoor channels now endorse a rescue effort. What is good for Ambac, they reason, is good for the country – and by extension the world.
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As stock markets rise on optimistic workout developments, it is clear that it is – in the short run. But like General Motors a half century back, the sense of stability imparted to an oligopolistic industry with visible flaws is not likely to last, nor may the hope for a return to economic growth of recent years. The modern US financed-based economy has a striking resemblance to Barney Fife, guaranteeing global prosperity without the productive industrial-based firepower to back it up. Neither ultra-low interest rates or tax rebates, nor investor-led and authority-based monoline bailouts are likely to change that significantly during the next few years.

I’m inclined to agree with him … as far as I can tell – without specializing in such matters – the monolines are better characterized as hedge funds than anything else. Let them fail!

Treasury trading is showing increasing nervousness:

Traders drove two-year note yields to 172 basis points below 10-year rates, the widest gap since September 2004. The spread signals increasing demand for shorter-maturity debt in anticipation that interest rates will fall. Longer-dated securities are more vulnerable to speculation that rate cuts will revive the economy, spurring inflation and eroding the bonds’ fixed payments.

Two-year notes are poised for the longest stretch of weekly gains since October 1998, while 10-year notes are headed for their biggest weekly loss in almost two months. Thirty-year yields have risen this week by the most in nine weeks.

I am fearful of US inflation, but it takes two to make a market! Janet Yellen, president of the Federal Reserve Bank of San Francisco, takes the other view:

I expect core inflation to moderate over the next few years, edging down to around 1¾ percent under appropriate monetary policy. Such an outcome is broadly consistent with my interpretation of the Fed’s price stability mandate. Moreover, I believe the risks on the upside and downside are roughly balanced. First, it appears that core inflation has been pushed up somewhat by the pass-through of higher energy and food prices and by the drop in the dollar. However, recently, energy prices have turned down in response to concerns that a slowdown in the U.S. will weaken economic growth around the world, and thereby lower the demand for energy.… Another factor that could restrain inflationary pressures is the slowdown in the U.S. economy. This can be expected to create more slack in labor and goods markets, a development that typically has been associated with reduced inflation in the past.

We shall see! 

I’ve added another blog to the blogroll … Across the Curve. As with Accrued Interest, I don’t know the guy (John Jansen) and haven’t verified any of his claimed credentials … but I’ve read his posts and yes, he’s been a player.

I discussed the effect of the TAF on bank reserves – and hysterical reactions thereof – on January 29. Naked Capitalism is now republishing a UBS research note that, frankly, I don’t understand at all:

What if the Fed’s rate cuts aren’t motivated by the desire to stave off recession, rather they’re to prevent a major banking crisis. Not one of escalating subprime losses or monoline downgrades, but actually a sheer lack of cash. The Fed’s not telling anyone what it’s up to because it doesn’t want to cause panic, but the evidence is actually there in its own data…

Ok, so things might not be quite as bad as that, but the situation isn’t far off. That’s because of the TAF. ….a savvy bank can put down lesser quality paper that it can’t generally do very much with (and certainly no one else really wants it), raise funds through the TAF, then use those funds to put down as reserves, and then conveniently gets paid a modest rate of interest against those reserves (which acts as a partial offset against the TAF). While there’s a small net cost to the banks, the real loser here is the Fed, what it gets stuck with is an ever growing pile of collateral.

Now consider this – that collateral is actually what’s backing the entire US banking system by way of its conversion to dollars and then the flow of those same dollars back to the Fed….

All this changes the complex of the US banking system somewhat. From the gold standard to the subprime standard perhaps?

In the first place, there is no interest paid on reserve balances. In the second place, the monetary effect of the TAF was neutralized by the Fed’s sale of T-Bills. I note Caroline Baum’s column and say: one may take a view on the advisability of the TAF, one may take a view on capital adequacy, and one may take a view on inter-bank lending; but any hullaballoo over “negative non-borrowed reserves” is hysterical nonsense:

The writer of the e-mail directs his readers to the most recent H.3 report, which shows total reserves ($41.6 billion) less TAF credit ($50 billion) less discount window borrowings ($390 million) equals non-borrowed reserves (minus $8.8 billion). The negative number is really an accounting quirk: If banks borrow more than they need, non-borrowed reserves are a negative number.

This gentleman is overlooking the fact that the Fed is “a monopoly provider of reserves,” said Jim Glassman, senior U.S. economist at JPMorgan Chase & Co. “This is a non-starter. There is no such thing as a banking system short of reserves. The Fed has absolute control over the supply.”

[Update: See also Felix Salmon at Why Non-borrowed Reserves Don’t Matter] 

On the Better-Living-Through-More-Rules front, SEC Chairman Christopher Cox made a speech today:

Among the proposals that the Commission may consider in the spring are rules that would require credit rating agencies to make disclosures surrounding past ratings in a format that would improve the comparability of track records and promote competitive assessments of the accuracy of past ratings. In addition, the Division may propose rules aimed at enhancing investor understanding of important differences between ratings for municipal and corporate debt and for structured debt instruments.

I have also asked the Division to present proposed rules to the Commission that begin to address the significant shortcomings that we’ve identified in the municipal market. The recent financial stress on monoline insurers has heightened the importance of timely and rigorous disclosure that investors can understand. We have had ample illustration already of what happens when investors fail to look past an AAA rating to do independent analysis themselves — a problem that was exacerbated when important information was not supplied to the market in real time.

Well, I don’t have any problems with the transition analyses that the agencies currently publish, but I suppose if a standard format for these is defined it’s not horrible. I fail to see the point of the other stuff, though: “may propose rules aimed at enhancing investor understanding”; “what happens when investors fail to look past an AAA rating to do independent analysis themselves”. Seems to me these are due diligence issues, to be addressed at the SEC/Advisor level; with performance issues to be Client/Advisor.

I love the way that Mr. Cox assumes that advisors at fault in the sub-prime debacle will actually read additional information if it is available. All the rules in the world won’t make a genius out of a bad advisor.

It was a very quiet day for prefs. PerpetualDiscounts had their first down day since January 28 – they have gained 3.1% since then.

In the continuing saga of the credit rating agencies, S&P has announced the creation of an ombudsman position, together with other reforms:

Among the changes set to be announced today, S&P will rotate lead rating analysts after five years of following the same company, government bond issuer, or structured-finance arranger. The new practice, which will be phased in, should prevent professional or personal relationships from affecting ratings, company officials said.

Analysts who leave S&P to work at a bond issuer will have some deals they previously rated reviewed to make sure their objectivity wasn’t compromised by the prospect of the new job.

Hey! That makes all kinds of sense, doesn’t it? Perhaps, now that I’ve been offering advice on preferred shares for over five years, the regulators should insist that I be rotated to, say, junior oil equity. Naked Capitalism isn’t much impressed:

The real problem that the agencies are paid by the very organizations they rate, and as long as this conflict remains, all other measures are mere window-dressing. The creation of an ombudsman role is an inadequate, unrealistic remedy for a problematic payment structure.

Well, last I heard, this was still a reasonably free country. Anybody who doesn’t want to take S&P’s advice is (as far as I know) welcome to listen to somebody else. But nothing, particularly not logic, will dampen expectations for certainty and a risk-free investment environment … portfolio managers should, if anything, welcome the provision of bad advice (if we may make the assumption, for the moment, that S&P’s advice is bad), since this will lead to market mispricing that may be exploited.

Andrew Cuomo, well known for his uncanny expertise at fixed income credit analysis, isn’t much impressed either:

New York Attorney General Andrew Cuomo said “supposed reforms” by Standard & Poor’s and Moody’s Investors Service, which gave high ratings to subprime debt that later plummeted, are “too little, too late.”
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“Both S&P and Moody’s are attempting to make piece-meal changes that seem more like public relations window dressing than systemic reform,” Cuomo said in the statement.

In more interesting news, it appears that Credit Default Swaps may have increased the corellation in the mononlines sector:

Separately, the Financial Times reports on yet another largely unrecognized hole in the bond insurers’ balance sheets. Wall Street was apparently fond of a so-called negative basis trades. If they bought a bond, hedged it with credit default swaps, then hedged the risk of the guarantor defaulting (generally a monoline) with a different guarantor (generally a different monoline), they could accelerate the expected profits over the life of the deal into the current period. The result is that the bond insurers have an unknown (to the outside world) but potentially significant number of guarantees written on each other.

There is at least one player trying to whip up the panic:

Deutsche Bank AG Chief Executive Officer Josef Ackermann said rating downgrades for bond insurers pose risks that could match the U.S. subprime market collapse.

“It could be a tsunami-like event comparable to subprime,” Ackermann said in a Bloomberg Television interview in Frankfurt today. Deutsche Bank, Germany’s biggest bank, is “well positioned” on its risk from bond insurers, he said

But there is another player – one not trying to sell a specific product – who has an opinion. Bernanke is concerned that monoline problems could cause banks’s balance sheets to gross-up. And Moody’s has downgraded SCA:

Security Capital Assurance Ltd.’s bond insurance units, hobbled by a decline in subprime mortgage securities, lost their Aaa credit rating at Moody’s Investors Service.

XL Capital Assurance Inc. and XL Financial Assurance Ltd. were cut six levels to A3, New York-based Moody’s said today in a statement. The outlook for both is negative, Moody’s said.

And MBIA, desperate to avoid such a fate, has embarrassed itself even more than it did yesterday by selling even more equity at an even lower price:

MBIA Inc., the world’s biggest bond insurer, raised $1 billion by selling shares at $12.15 each in an effort to protect its AAA insurance rating.

The 82.3 million shares were sold at a 14 percent discount to Armonk, New York-based MBIA’s $14.20 closing price today, according to data compiled by Bloomberg.

MBIA increased the sale from a planned $750 million, though accepted a lower price than it had anticipated. The sale matches the price private-equity firm Warburg Pincus LLC had agreed to pay to backstop the transaction in case no buyers could be found.

Speaking of downgrades, Loblaws was downgraded today, which has implications for Weston. I’ve updated the post about Weston’s credit. 

The Cleveland Fed has updated its estimate of inflation expectations from TIPS … very interesting indeed. The breakeven rate is increasing slightly, but the analytical rate – which attempts to incorporate adjustments for the inflation-risk-premium and liquidity-premium – is skyrocketting. This epsiode will be very useful in determining the validity of these adjustments!

I have opined many times in the past that the Fed’s easing may well rebound in an unfavourable manner vis-a-vis inflation – scarcely the most original of views, but I do what I can. In this context, it was interesting to read the following report on the Treasury Bond auction:

U.S. 30-year Treasuries fell the most since June as demand was weaker than expected at the government’s $9 billion auction of the securities.

Ten- and 30-year securities declined a second straight day as investors balked at buying at this week’s auctions, with yields at record lows. Investors are also betting that the Federal Reserve’s five interest-rate cuts since September will revive economic growth and cause inflation to accelerate, reducing the value of Treasuries’ fixed payments.

“The auction went as poorly as one could imagine,” said Andrew Brenner, co-head of structured products in New York at MF Global Ltd., the world’s largest broker of exchange-traded futures and options contracts. “There isn’t a lot of demand for bonds at these levels.”

These fears are finding support at high levels:

Federal Reserve Bank of Dallas President Richard Fisher, who voted against cutting interest rates last week, warned that aggressive reductions in response to a weak economy may “juice up” inflation.
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“Given that I had yet to see a mitigation in inflation and inflationary expectations from their current high levels, and that I believed the steps we had already taken would be helpful in mitigating the downside risk to growth once they took full effect, I simply did not feel it was the proper time” for more rate cuts, Fisher said.

Another good day! PerpetualDiscounts continued to improve and volume remained above the recent average.

There were twenty-six other index-included $25.00-equivalent issues trading over 10,000 shares today.

Willem Buiter was last mentioned in PrefBlog on January 25 in connection with inflation concerns. He’s back again today, preaching not just the likelihood, but the necessity of a US recession:

Therefore, to restore a sustainable external balance and to accumulate the financial assets that will support a greying US population in the style it would like to and hopes and expects to be accustomed to, the US private and public sectors must save more. To get to a higher saving and wealth trajectory, the US economy will first have to pass through the valley of the shadow of deficient effective demand, rising excess capacity and growing unemployment. Postponing the necessary adjustment will just make the pain of the eventual unavoidable correction that much greater.

The trouble with such a prescription is that it runs headlong into the American “can do” attitude. This attitude is admirable and has served them well … but sometimes it comes a cropper. “Reduce taxes and the deficit while increasing services? Can do!” “Bring Western Democracy to regions where even those who understand it don’t want it? Can do!”.

The failure of a few auctions for American Auction Rate Municipals has attracted some notice lately. Accrued Interest explains the situation … it all comes down to the monolines!

The bank was only willing to provide liquidity if there was some additional credit support. No problem, thought the municipal bond bankers! We’ll bring in a monoline insurer! The bank would therefore agree to provide liquidity so long as the bond insurer was rated at some minimal credit rating level. What that level is depends on the deal. Might be AA, might be A. I haven’t seen any that were actually AAA but they could be out there.

But what happens if the unthinkable happens? A monoline insurer gets downgraded? Well, the bank’s liquidity agreement becomes null and void. Where does that leave bond holders? It leaves them with no credit support at all. Only the issuer itself would remain.

Auction rate securities are a recurring niche in the markets – I remember (a long, long time ago) there were some Hees (remember Hees?) MAPS – Monthly Auction Preferred Shares. It’s really just another mechanism whereby issuers can finance long at short rates and investors can pretend they’re money-market superstars by outperforming the 3-month benchmark with 100-year paper … for a while.

And the mention of monolines reminds me of a funny story … remember MBIA’s line in the sand, discussed on January 31? Well, the tide’s come in:

MBIA Inc., the world’s biggest bond insurer, plans to raise an additional $750 million by selling about 50.3 million common shares, bolstering capital in an attempt to retain its AAA credit rating.

Investment firm Warburg Pincus will backstop the offering by purchasing as much as $750 million of convertible participating preferred stock, the Armonk, New York-based company said in a statement today. MBIA, which has already raised at least $1.5 billion since November, said it would contribute most of the proceeds to its MBIA Insurance Corp. unit.

Another article highlighted by Naked Capitalism delivers a rather vague exhortation for increased bank regulation while one particular example purporting to show the need concerns some recent problems with Wachovia:

AmeriNet was a “payment processor,” a company that creates unsigned checks on behalf of telemarketers to withdraw funds automatically from customer accounts. Such checks, once widely used by businesses collecting monthly fees, are legal if customers approve the transactions.
…
In 2006, an executive at Citizens Bank wrote via e-mail that thieves were routing unauthorized checks through Wachovia that stole from Citizens account holders.

“We have spoken to many of our customers who have been victimized by this scam,” wrote the Citizens executive, according to court documents. “We would appreciate it if you would shut down accounts of any customers of yours that may be engaging in improper activity.”

But Wachovia kept that account open until it was frozen by a federal court a few weeks later, as part of a government lawsuit against the client.

This is just more nonsense from the “Everything will be better with just a few more rules” camp. It is very tempting to believe that a few more rules will bring the new millennium, but those who argue in favour of this have never seen what happens in real life. Rules such as this – shutting down accounts due to suspicions of fraud – are not investigated by dispassionate keen-eyed investigators who have the evidence weighed by judicious descendents of Solomon. It is, in fact, a virtually random process in which facts become secondary to ass-covering.

In the quoted text above, the Citizens Bank executive should not have been contacting Wachovia – if they became involved at all, I suggest that police are generally considered the proper authorities for investigation of impropriety.

A bank clerk is not a cop I trust. A branch manager is not a judge I trust. And wishing won’t make it so.

But, that’s what happens when stuff hits the headlines – everybody’s an expert:

Regulators may restrict Moody’s Investors Service and Standard & Poor’s from advising banks on structured debt securities after criticism the firms failed to downgrade subprime-related debt as investor losses mounted.

Ratings firms may face a new code of conduct that limits their business and requires “reasonable steps” to ensure “a credible rating,” the International Organization of Securities Commissions in Madrid said in a statement today. IOSCO is the main forum for regulators, covering more than 100 countries from the U.S. to Japan.

I sure wish there was a code of conduct for regulators forcing them to take reasonable steps to ensure credible regulation!

An IMF research group has summarized a paper on VoxEU arguing that the subprime crisis is not unusual:

The subprime experience demonstrates that even highly-developed financial markets are not immune to problems associated with credit booms.

What can be done to curb bad credit booms? Historically, the effectiveness of macroeconomic polices in reducing credit growth has varied (see, for example, Enoch and Ötker-Robe, 2007). While monetary tightening can reduce both the demand and supply of bank loans, its effectiveness is often limited by capital account openness. This is especially the case in small open economies and in countries with more advanced financial sectors, where banks have easy access to foreign credit, including from parent institutions. Monetary tightening may also lead to significant substitution between domestic and foreign-denominated credit, especially in countries with (perceived) rigid exchange rate regimes. Fiscal tightening may also help reduce the expansionary pressures associated with credit booms, though this is often not politically feasible.

Fiscal tightening didn’t have much chance under a Republican administration! When in doubt, assume the best, right? It is very interesting to speculate as to what might have happened under Prof. Taylor’s counterfactual scenario of Fed tightening during the boom. We are certainly seeing that sub-prime sucked in a lot of money from Europe even with the relatively loose Fed policy during that time.

A very good day for the preferred share market, although I don’t see how the S&P/TSX Index was able to improve by 0.55% … half that, sure, two-thirds, maybe, but I suspect that this is an artefact of calculation caused either by low closes yesterday or high closes today.

Be that as it may, it was a strong day, with volume picking up and good strength throughout the entire PerpetualDiscount index. This index now has an interest-equivalent yield of 7.62% (at a conversion factor of 1.4), which is Canadas +350bp, Long Corporates +180bp. This latter (and probably more meaningful) figure has narrowed in about 30bp since last reviewed October 30, but still has a long way to go before reaching last spring’s levels of Long Corporates + ~110bp.

Hmmmm …. 70bp x 14years duration = … I’ll take it!

There were twenty-six other index-included $25.00-equivalent issues trading over 10,000 shares today.

The roar erupts from the angry crowds: when is PrefBlog going to get any work done? Again today, general commentary will be greatly foreshortened. In my defence, I can only say that I was able to post about Seniority of BAs, ruin Kaspu‘s day with a comment on CCS.PR.C, report on performance of Malachite Aggressive Preferred Fund (my little fund did well! So why is it a little fund?), Best & Worst January Performers and finally January Index Performance.

So, apart from time constraints, my fingers are tired.

Econbrowser‘s Menzie Chinn commented on the Bush Budget and highlights the Reuters report by David Lawder :

“I think the main deceptions in the budget are the same ones we’ve seen for five years. The costs for Iraq and Afghanistan has consistently been $200 billion a year, but they’ve only put aside $70 billion,” said Chris Edwards, economist at the libertarian Cato Institute. “The war will cost $100 (billion) to $150 billion a year until 2012 or so.”

Coupled with unrealistic growth forecasts, the additional war costs mean the fiscal 2008 deficit will likely top $500 billion, he said.

Even Captain’s Quarters, a political blog which can usually be counted on to toe the Republican party line, has thrown in the towel on any hopes for fiscal conservatism. I continue to think that American fiscal profligacy will continue until conditions are in a lot worse shape than they are now – and, as in Canada, it will be the non-(so-called)-conservative party that does it, because they’re the ones who can’t be attacked for preaching hard times and shooting the hippo.

Fun and frolic for CDOs continued, with Fitch revamping its model and taking a gloomier view on the underlying securities chance of default. But nobody trades those things anymore, do they?:

Buying and selling of collateralized debt obligations based on mortgage bonds, high-yield loans or preferred shares has ground to a near-halt, traders said at the securitization industry’s largest conference.

“We’re definitely in a period of very low liquidity at the moment, which has actually been dropping precipitously in the last few weeks,” Ross Heller, an executive director at JPMorgan Securities Inc., said yesterday during a panel discussion at the American Securitization Forum’s annual conference in Las Vegas. “It’s a challenging time.”

I should note that the story is referring to American preferred shares, not Canadian ones. While some American issues are eligible for preferential tax treatment, this is a major bone of political contention, as I noted on January 10 (and continued after the charts, in the “Update” section). Without tax advantages, prefs are simply deeply subordinated debt.

This model revision is also having knock-on effects on … wait for it … the monolines:

MBIA Inc.’s AAA bond insurance ranking was placed back under review for a downgrade by Fitch Ratings less than a month after being affirmed with a stable outlook.

Fitch, which also put CIFG Financial Guaranty back under review, is updating its assumptions for higher losses on U.S. subprime-mortgage securities, the New York-based ratings company said today in a statement. If loss projections rise materially, the AAA ratings on bond insurers may no longer be appropriate regardless of how much capital they hold, the company said.

And it’s not as if the monolines don’t recognize their problems:

XL Capital Ltd., the Bermuda-based business insurer, said it lost $1.06 billion in the fourth quarter as it wrote down the value of investments including a stake in bond insurer Security Capital Assurance Ltd.

XL lost $6.01 a share, compared with a net profit of $481.1 million, or $2.62 a year earlier, the company said today in a statement. Excluding investment losses, XL earned 66 cents a share, lagging the $1.45 average estimate of 14 analysts surveyed by Bloomberg.

It seems, however, that business conditions aside, some portion of the monoline damage is self-inflicted … hedges aren’t perfect (hat tip: MarketRant).

Speaking of hedges … there is much concern and consternation about the BCE deal and the seemingly different probabilities assigned by the stock and bond markets (hat tip: Financial Webring Forum):

When it comes to the chances of the $35-billion BCE Inc. buyout falling through, the bond market isn’t buying what the equity market is selling.

Many stock market investors clearly believe the deal is likely to fail. The stock finished Friday at $36 on the Toronto Stock Exchange, well below the $42.75 that Ontario Teachers’ Pension Plan and its partners agreed to pay last June before global markets went haywire.
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Those in the bond market, on the other hand, are much more convinced the transaction will close later this year.

According to the credit-default swaps (CDS) market, an influential backroom of the financial system where big bond investors place bets, there’s at least a 70-per-cent chance that the deal succeeds.

To me, this sounds normal. Each market is taking a gloomy view. Didn’t the lawsuit over Hemlo take a billion dollars off the combined market cap of the adversaries, when logically it should have been a wash? Seems to me that if I were a hedge fund, I’d be devoting enormous resources to calculating what proportion of equity and bonds I should have in a basket that … maybe, possibly, subject to fearsome market punishment … would have an expected positive return irrespective of the outcome.

A relatively quiet day in the preferred market. I’ll admit, I view the precipituous decline in the number of issues on the “Price Mover” list with mixed feelings … on the one hand, it means I have a whole lot less typing to do (I still haven’t caught up with HIMIPref™ Preferred Indices, so I still have to do it all manually); on the other hand, huge price movements are often a source of wonderful trades. Oh well, we’ll just see how it goes.

WFS.PR.A is behaving strangely … the huge volume today is unusual, but not strange; what’s strange is the day’s high price: $10.75. Holy smokes, at that level you’re amortizing the premium by over $0.20 annually against dividends of $0.525 to wind up with a Yield-to-Maturity of about 3.1%, according to Mr. Calculator. Geez, and there I am, thinking it’s overpriced at $10.37, yielding 4.26%! 

There were seventeen other index-included $25.00-equivalent issues trading over 10,000 shares today.

There ain’t too much commentary today, folks! No great loss, since nothing much happened, but there was one item of great pith and moment: Moody’s is considering a separate rating scale for structured products:

Moody’s Investors Service is considering a new ratings system based on numbers for structured- finance securities that would abandon the letter grades created by founder John Moody about a century ago.

Moody’s in a letter today asked investors for comments on five options it is reviewing to improve ratings including a numerical scale and a designation of “.sf” to differentiate a structured finance ranking from a corporate credit grade.

The use of a different scale has been proposed before – it was mentioned by the Bank of Canada and has been advocated elsewhere – like, f’rinstance, by Richard Portes on VoxEU as discussed on November 15. Frankly, I have difficulty understanding why it’s considered worthy of discussion.

And I would like to mention that Malachite Aggressive Preferred Fund has been priced for monthend … and achieved a return of 1.28% for the month, vs. an estimated ZERO for the index. I’ll try to post properly about this tomorrow … but those who speculate that I’m rather pleased about this (especially after the superb performance in December) may very well win a kewpie doll.

Another good strong day in the preferred share market – the perpetualDiscount index is now within a hair of the 945.3 January peak, which it hit on January 16, the day before the announcement of the BNS new issue knocked it for a loop. Volume wasn’t particularly exciting … on the low side of normal, but not by much.

I should hire Assiduous Reader madequota as colour commentator … his daily comments are much better than mine!

There were seventeen other index-included $25.00-equivalent issues trading over 10,000 shares today.

There ain’t gonna be much today! Month end duties call, with a shrill, unpleasant voice.

However, remember Springfield, MA’s complaint against Merrill Lynch, discussed here on January 4. They’ve settled … and a certain amount of vital information – previously ignored by the media – has finally been reported:

Merrill and two of its brokers sold “unsuitable” securities to Springfield last year after the firm was hired to help manage the city’s short-term investments, Massachusetts Secretary of State William Galvin said in a complaint filed today.
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“Merrill was supposed to invest in only safe money-market like investments,” Galvin said in the lawsuit.
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Merrill, the world’s largest brokerage, bought CDOs for Springfield between April and June last year after it was hired to help manage the city’s cash. It didn’t give the city a detailed description of the investment until November, when it sent officials a private placement memorandum on Centre Square CDO, one of the series of securities it bought.

Why it has not previously been reported that Merrill was acting as Portfolio Manager for the city and therefore had a fiduciary obligation (which would not have been the case if they had simply sold it on a principal to principal basis) is something that I don’t understand.

Given my usual month-end woes, there will be no report on the indices today, which is too bad. It was a really strong day! Volume picked up a little, but not to any spectacular extent.

There were twenty other index-included $25.00-equivalent issues trading over 10,000 shares today.

Econbrowser‘s James Hamilton noted the Fed 50bp rate cut and pondered how long it will take for the easing to reach Main Street:

My bottom line: the Fed’s moves this month have to help relative to where we would have been without them, but it will take some time to see by how much. If indeed a recession began in December (and I repeat that no one knows for sure whether or not it did), things are going to get worse before they get better.

I’m not sure about Prof. Hamilton’s use of the Fed Funds Rate as the independent variable in the regression – it is more usual to use the yield on the 10-year Treasury note, as has been done (casually) by the Federal Reserve Bank of San Francisco … :

Figure 1 shows monthly data for the 10-year Treasury note rate from the beginning of 1995 through June of this year. The figure also shows the average subprime mortgage rate of lenders in the MIC sample (approximately 30 subprime lenders), beginning in January 1998. For comparison, the average mortgage rate for “prime” mortgages also is shown, for the whole period.
…
it appears that the prime mortgage rate tends to go up and down, by roughly proportional amounts, with the Treasury rate, but the subprime mortgage rate, although positively correlated with the Treasury rate over the period as a whole, does not follow it as closely. Statistics confirm this; the correlation coefficient between the prime mortgage rate and the 10-year Treasury note rate over the 1998-2001 period is 0.9, whereas the correlation coefficient for the subprime mortgage rate is only 0.4. (Two sets of numbers that are perfectly correlated have a correlation coefficient of 1.)

… and in the pricing of RMBS:

There are good reasons to choose the 10-year yield and the spread between this yield and the 3-month T-bill rate for capturing the salient features of MBSs. The MBSs analyzed in this paper have 30 years to maturity; however, due to potential prepayments and scheduled principal payments, their expected lives are much shorter. Thus, the 10-year yield should approximate the level of interest rates which is appropriate for discounting the MBS’s cash flows. Further, the 10-year yield has a correlation of 0.98 with the mortgage rate (see Table 1B and Figure 3). Since the spread between the mortgage rate and the MBS’s coupon determines the refinancing incentive, the 10-year yield should prove useful when valuing the option component.

The Fed Funds Rate may be expected to have influence, to be sure (of course it does! If it didn’t, it wouldn’t be so important, right?) but if this influence is exerted via the 10-year rate, then transmission to the real economy can be hung up by all the things that hang up the 3-month-to-10-year slope … which can vary a lot! 

Professor Jon Faust, however, writes an article for VoxEU that supports my own view about predictions and economic drivers in general:

We find the surprising result that no model clearly outperforms the univariate autoregressive model. This is one of the simplest possible models: it basically forecasts in every period that the GDP growth will simply follow its historical average rate back to the mean. This may be sobering for not only the Fed but for the macroeconomics profession as a whole: knowledge of interest rates, labour market conditions, capacity utilisation, inflation, or any of about 50 additional variables does not systematically improve our ability to foretell where real activity is headed.

In other words … forecasting, schmorecasting. It’s a chaotic world. Meanwhile, Paul Krugman of the NYT asks:

So: is it even possible for the Fed to cut interest rates enough to create a renewed housing boom? (The Fed can cut the overnight rate all the way to zero, but even large changes in the overnight rate can have only modest effects on mortgage interest rates, if the market perceives those changes as temporary.) If it can’t, how much can the Fed really do to help the economy?

Transmission is a hot topic. Menzie Chinn of Econbrowser reviewed the various channels whereby monetary policy influences GDP and concludes:

What is the (policy) upshot of this discussion? In answer to the question of which sector can fulfill the role previously filled by housing, I would say the only candidate is net exports. The decline in the Fed Funds rate has led to a depreciation of the dollar. In the future, net exports will be higher than they otherwise would be. However, the behavior of net exports, unlike other components of aggregate demand, depends substantially on what happens in other economies. If policy rates decline in the UK, the euro area, and elsewhere, additional declines of the dollar might not occur. (And as I’ve pointed out before, if rest-of-world GDP growth declines (as seems likely [2]), then net exports might decline even with a weakened dollar).

I think the main point is that the decreases in interest rates, working through the traditional channels, will have a positive impact on components of aggregate demand. With respect to the credit view channels, the impact on lending is going to be quite muted, I think, given the supply of credit is likely to be limited. In fact, I suspect monetary policy will only be mitigating the negative effects of slowing growth and a reduction of perceived asset values working their way through the system.

While the collapse of the US housing market actually had an effect on the real economy, we are now getting news that the collapse of US housing investments is having an effect on real companies:

Bristol-Myers Squibb Co. narrowed its loss in the fourth quarter as surging sales of its anti- clotting pill Plavix partially offset charges for costs that include investments backed by subprime securities.

The net loss was $89 million, or 5 cents a share. The company wrote off $275 million in investments in the quarter, which could rise to as much as $417 million, said Rebecca Goldsmith, a spokeswoman for the New York-based drugmaker, in a telephone interview today.

Speaking of the real economy (remember that?) today brought another example of the Great Credit Bubble Popping of 2007-??:

New York real estate developer Harry Macklowe will sell the General Motors Building on Fifth Avenue in Manhattan next month to help pay debts he owes to Deutsche Bank AG, said two people with knowledge of the plans.
…
Macklowe, 70, bought seven Manhattan skyscrapers from billionaire Sam Zell’s Equity Office Properties Trust for $7.2 billion a year ago, spending $50 million of his own money and borrowing the rest. The developer reached an agreement to turn the properties over to lenders because he was unable to refinance as real estate values declined over the past year, the Wall Street Journal reported today.

Holy smokes! I know that there are a lot of seminars on How to Buy Real Estate With No Money Down, but I hadn’t quite realized leverage of 144:1 was possible for big deals!

While Naked Capitalism republishes an essay that takes a much harsher view of the medicine required:

It is easy to lose sight of the overall picture. Main Street consumers have overspent and over-borrowed and are unable to meet their obligations. The fact that households may have so behaved because they were enticed by “teaser loans” does not change the facts; it only assigns blame. Consumption has been above sustainable levels and needs to adjust down, whatever view one has about the responsibility of adults over their financial decisions.

The adjustment of private consumption to sustainable levels is necessary, but is likely to have a negative influence in the short run on the growth of aggregate demand, of which it represents more than 70 per cent. It is hard for this adjustment to take place without bringing down the rate of growth of gross domestic product, possibly to negative numbers.
…
The US should face its need for adjustment with courage and reason, not fear. It should stop behaving as the whiner of first resort, ready to waste all its dry powder on a short-sighted attempt to prevent a 2008 recession. Many poorer countries with weaker markets and institutions have survived and benefited from an adjustment that involves a year of negative growth. Faster bank recapitalisation, fiscal investment stimulus and international co-ordination should be first on the ­policy agenda.

And inflation is becoming an increasing worry:

“The Fed as well as the government are responding to recession fears,” said Mike Pond, head of Treasury and inflation-linked strategy at Barclays. “At the same time they are sparking inflation concerns from a longer term perspective.” He thinks those concerns are justified. “We see pressures not just from the domestic economy but from import prices as well as global pressures on food and energy prices. And from a longer term perspective, a Fed who was focused more on risks to growth than higher inflation should put upward pressure on inflation risk premiums.”

It should be noted, however, that these data were used using the breakeven rate. Assiduous readers will remember that the Cleveland Fed attempts to adjust the breakeven rate for other factors affecting TIPS pricing. Their data is updated only once per month, on the first … we will see shortly if there is some independent confirmation!

Meanwhile, the monoline question is getting more interesting, with MBIA first reporting a big loss:

The bond insurer announced $2.3 billion of losses for the fourth quarter which included $3.4 billion of writedowns ($3.5 billion according to the Wall Street Journal). Premiums also fell, indicating new business is falling off, not surprising given the doubts about the AAA rating. The press release also stated that Warburg Pincus nevertheless closed on its $500 million investment in the firm.

… and then drawing a line in the sand, daring the ratings agencies and speculators to cross:

MBIA Inc. Chief Executive Officer Gary Dunton said the world’s largest bond insurer has more than enough capital to keep its AAA credit rating and dismissed speculation the company may go bankrupt.

Dunton, speaking on a conference call after Armonk, New York-based MBIA reported a $2.3 billion fourth-quarter loss, blamed “fear mongering” and “distortion” for driving the company’s stock down more than 80 percent in the past year.

S&P has stated, in effect, ‘Don’t be so sure, chum!’, while William Ackman stepped over that line long ago!

Not a bad day on the market! The new issues TD.PR.Q and BNS.PR.O settled, trading lots in a tight range slightly above par … however, trading in the ratchet / fix-float / floater section was again terribly sloppy. Volume was reasonable … but still on the light side of normal.

And, best of all, it’s month-end! The Claymore ETF, symbol CPD, finished with a NAV of 17.95, unchanged on the month, after hitting a low of $17.76 just after the announcement of the new issues. A price of 17.75 would have been near as dammit to a new trough. I am very pleased with the performance of Malachite Aggressive Preferred Fund for the month … my monthly NAV computation chore still awaits, but will show substantial outperformance vs. the indices.

There were eightteen other index-included $25.00-equivalent issues trading over 10,000 shares today.

OK, OK, OK. Let’s get this over with. The Fed cut 50bp to 3.00% and the yield curve steepened.

In news that I have not yet become completely fed up with, Fitch has cut the rating of FGIC, a monoline insurer:

Financial Guaranty, a unit of New York-based FGIC Corp., was cut two levels to AA, New York-based Fitch said today in a statement. The company had been AAA since at least 1991. Moody’s Investors Service and Standard & Poor’s are also reevaluating their ratings.
…
“This announcement is based on FGIC’s not yet raising new capital, or having executed other risk mitigation measures, to meet Fitch’s AAA capital guidelines within a timeframe consistent with Fitch’s expectations,” the ratings company said today.

Speaking of downgrades, how about them sub-primes, eh?

Standard & Poor’s said it cut or may reduce ratings on $534 billion of subprime-mortgage securities and collateralized debt obligations, the most sweeping action in response to rising home-loan defaults.

The downgrades may extend bank losses to more than $265 billion and have a “ripple impact” on the broader financial markets, S&P said in a statement today. The securities represent $270.1 billion, or 47 percent, of subprime mortgage bonds rated between January 2006 and June 2007.

Naked Capitalism has an update on monolines in general and the bail-out in particular and advocates more regulation:

While it’s probably a good idea to keep insurers away from risky instruments they have demonstrated they don’t understand, the remedy, closing a loophole dating from 1998, is a bit late in coming. The article focuses on how this bond insurers muscled their way into a business that it proving to be their undoing. Nevertheless, the regulators sound surprisingly timid, fearful of inhibiting innovation. Someone might point out that lobotomies and zeppelins were also innovations.

In other words, this would be a much better world, if only there were more rules.

Look – there has clearly been a screw-up. I must say, I’m not sure why bond insurers come under the purview of regulators, but let’s assume there’s a good reason … which is a hell of an assumption to make, but otherwise we’re left to mumbling libertarian slogans to each other. In the first place … just how is insuring a municipal bond different from writing a CDS? Not much, is the basic answer. There might be some legal differences in the bankruptcy games (mentioned in a recent update to the CDS Primer); credit risk is (almost certainly) greater; structural risk and analysis is (almost certainly) more complex. But what of it? Analysis of these elements and comfort-offering to potential investors who don’t want to do it, are what monolines do for a living.

If they didn’t do it very well, then they can go bankrupt. Just what, exactly, is the problem here? Which members of the unsophisticated public are we attempting to protect?

The only rational regulatory response I see is that of brokers and banks … and, quite frankly, I’m not 100% convinced about whether the brokers warrant a regulatory response. As I suggested on January 25, there may be cause to protect the banking system by reviewing the concentration rules for capital exposure … if the troubles of a single counterparty have the ability to bring down – or seriously wound – a bank, then the exposure should attract a charge against capital in excess of what the same bundle of risks would if it was spread around a little more …. just as if the counterparty was explicitly a hedge fund, rather than what may well be described as a hedge fund masquerading as a monoline.

There’s some interesting economic news that has added significance due to the precipituous decline in the Fed Funds rate: US GDP growth came in at a mere 0.6% annualized rate. Both the WSJ and Econbrowser pointed out that a chunk of the slowness was due to inventory reduction:

big surprise was a big drop in inventories. That means that production growth was not as strong as sales, and hence, reduces the estimate of GDP, though it may leave businesses in a little better position to weather any further drops in demand. Without the inventory correction, real final sales grew at a 1.8% annual rate in the fourth quarter, somewhat less alarming than the headline GDP numbers alone.

And, to make sure we’re all thoroughly confused regarding signals from the financial markets and economic reports, there is hope for tomorrow’s jobs number:

Nonfarm private employment surged by a seasonally adjusted 130,000 during the month, ADP said. Adding in 22,000 government jobs (the average gain over 12 months), total nonfarm payroll gains are estimated at 152,000 for the month. That’s more than double most economists’ estimates for Friday’s Labor Department report. It would also represent a huge rebound from the 18,000-job increase the government reported for December. (ADP revised its December number down to a gain of 37,000.)

Maybe some suddenly employed Americans will be able to afford some of the vacant housing!

There’s an interesting essay by John Dizard (hat tip: Naked Capitalism) that argues that disintermediation – referred to by its mechanism, securitization – will become more prevalent in the future, and that this is a secular change rather than a mere transient reaction to market forces. The trouble is, the essay makes sweeping statements regarding ‘what central bankers believe’ and I don’t know on what basis the author makes these claims. I have referenced an academic paper that presents evidence that banks’ balance sheets balloon in times of stress, as the madding crowd runs to familiar, regulated entities … but eventually the crisis passes and investors wonder why they’re letting the bank take a spread on their investment. So, until I see a little more meat on the bones of Mr. Dizard’s argument, I’ll remain very skeptical that a fundamental paradigm shift has occurred.

Accrued Interest has finally returned from his vacation and offers an endorsement of junk bonds at current spreads:

If we do have a recession in 2008, high-yield default rates will certainly increase. But at today’s valuation levels, high-yield already has a recession priced in. Given that there is good reason to believe credit losses will be no worse, or perhaps even better than the last two recessions, high-yield looks fundamentally attractive.

I’m not sure about this and a large chunk of my skepticism is based on the new developments in the CDS market, which can create players who have both negative exposure to the firms AND a seat at the creditors’ table (by going long the actual bonds, but even longer on Credit Default Swaps). These players take such positions because they can actively create a lower return for the class of securities they own, contrary to all expectations and procedures in bankruptcy.

The more I think about this development, the less convinced I am that the CDS market has a future. Who will sell CDS protection in such an environment? But a lot will depend on the precise wording of the individual CDS contracts – when does the cash settlement price get calculated? In this counter-intuitive scenario, it is best for the hedge fund to delay calculation until some point during the bankruptcy process, rather than at entry.

So anyway … until somebody shows me different, my attitude is … spreads, schmeads. With holders like those, junk bonds become even more risky than usual.

The continued preoccupation with Jerome Kerviel’s back office background continues. I expressed concern about this on January 25 and I’m going to do so again, in light of an emphasized quote in a Bloomberg story:

Jean-Pierre Mustier, the head of investment banking at Societe Generale, has said Kerviel didn’t take the “usual path to the trading floor.” The bank normally hires traders straight from university with degrees in math or finance, Mustier said on a Jan. 27 conference call with reporters.

Kerviel was promoted from the back office in recognition of his “excellent” work, Mustier said.

This is just another attempt to keep barrow boys out of the club.

Mustier is an example of the type of talent Societe Generale normally grooms.

He took classes at Ecole Polytechnique, a French engineering school that has produced prominent French executives such as BNP Paribas SA Chairman Michel Pebereau, before transferring to Ecole des Mines, which focuses on science and technology.

The system you ran didn’t work very well, did it, M. Mustier? How did it really happen? The triggerman himself has an idea:

I can’t believe that my superiors were not aware of the amounts I was committing, it’s impossible to generate such profits with small positions, which leads me to say that when I’m in the black, my superiors close their eyes about the methods and volumes committed.

A good strong day in the preferred market, but there was some very sloppy trading in the Ratchet / FixFloat / Floater sectors … doubtless people are rather nervous, not just about BCE (common down $0.44 today to $34.00).

There were fifteen other index-included $25.00-equivalent issues trading over 10,000 shares today.

Somewhat to my surprise, the problems in the bond insurance industry continue to make headlines – much to the chagrin of the risk-control specialists at Royal Bank:

At the time, “we had noted there that we had exposure to one monoline [bond insurer] that was rated a single-A, that we had taken a provision against that exposure, and [that] the current mark-to-market as of Oct. 31st was $104-million,” RBC chief financial officer Janice Fukakusa told a financial services conference Tuesday.

“That monoline subsequently is in difficulty, so we have written off the balance of our exposure there in our first quarter results,” she said. That quarter ends this week, on Jan. 31, and the bank will release its results in late February.

There is the usual speculation regarding the monolines – Naked Capitalism sticks to its gloomy view:

So the benefit of this operation is not to assure payouts, but to prevent a downgrade because that leads to forced sales by investors who can only hold paper than falls in certain ratings buckets, and in turn forces the Street to price similar holdings lower. But the level of capital required to maintain an AAA is far larger than that required to merely assure that claims are paid for the next year or two 

… while CreditSights (a subscription-based ratings agency often quoted in the press) feels that the monolines are in a losing race against time:

“Given the number of competing interests and levels of commitment of participants involved, we think it is unlikely that an agreement sponsored by Dinallo could be hammered out within the appropriate timeframe,” CreditSights analysts Rob Haines, Craig Guttenplan and Joe Di Carlo in New York wrote in a report. “In the offchance that any deal could be solidified, the rating agencies are likely to have already taken action.”

The Fed will announce its rate decision tomorrow. The target rate for FedFunds is now 3.5%, but the futures contract is showing almost certainty of a cut to 3.0% … and about 2.5% by May. Economic concern is growing as the real (after inflation) rate approaches 0%; this concern is dismissed by others:

To be sure, inflation excluding food and energy prices — so-called core inflation — has exceeded the upper end of the Fed’s implicit comfort zone during most of the past four years. Including food and energy prices, the overage has been much more pronounced. Therefore, the emphasis of some Fed officials on preventing further increases in inflation is understandable. However, core inflation exhibits substantial inertia, so upward movements in inflation usually occur gradually. In contrast, output and employment can slump more rapidly, and the fragile state of the financial system today accentuates the risk of a reinforcing downward spiral. With a possible plunge on one side of the road and a less abrupt embankment on the other, a wise driver stays on the side of the shallower drop.

Not much new regarding the SocGen Futures Fiasco today … but a Jerome Kerviel fansite has been started! (hat tip: Financial Webring Forum). Apparently, SocGen is having a little difficulty convincing the authorities that actual criminal fraud was involved.

French prosecutors will not appeal against a decision to throw out the accusation of fraud levelled against a trader blamed for huge losses at Societe Generale, a senior judicial source said on Tuesday.

If confirmed, the move would represent a blow for SocGen managers, who last week branded trader Jerome Kerviel a “fraudster” and said the bank had been the victim of “massive fraud.”

The refusal to lay fraud charges will, in fact, be appealed, which leaves the “senior judicial source” looking a little silly.

In other enforcement news, the FBI confirms it’s looking at sub-prime:

The Federal Bureau of Investigation is investigating 14 corporations for possible accounting fraud and other crimes related to the subprime lending crisis, officials said.
…
The probes add to federal and state scrutiny of the home- loan industry as prosecutors and regulators seek to assign culpability for the mortgage rout that has forced people from their homes and resulted in losses to investors. The biggest banks and securities firms have posted at least $133 billion in credit losses and writedowns related to the loans, which are typically made to buyers with the weakest credit.

And also related to sub-prime, the current House Resolution 1540 increases the maximum mortage size for Fannie Mae, Freddie Mac & the FHA, e.g.:

For mortgages originated during the period beginning on July 1, 2007, and ending at the end of December 31, 2008:

• (1) FANNIE MAE- With respect to the Federal National Mortgage Association, notwithstanding section 302(b)(2) of the Federal National Mortgage Association Charter Act (12 U.S.C. 1717(b)(2)), the limitation on the maximum original principal obligation of a mortgage that may be purchased by the Association shall be the higher of–
  • (A) the limitation for 2008 determined under such section 302(b)(2) for a residence of the applicable size; or
  • (B) 125 percent of the area median price for a residence of the applicable size, but in no case to exceed 175 percent of the limitation for 2008 determined under such section 302(b)(2) for a residence of the applicable size.

… and the jerks are so desperate to appear to be Doing Something that they didn’t even bother to extract any capitalization-related concessions from the GSEs as a condition of increasing the limit.

Naked Capitalism is very concerned about a precipituous decline in non-borrowed reserves at the Fed, but I’m not convinced there’s a story here. In the current H3 release, it is disclosed that, of $41,475-million in reserves, only $199-million are non-borrowed. Usually, non-borrowed reserves will be roughly equal to total reserves – implying that net free reserves is about zero. The chart tells the story:

So … what are reserves? The Fed has the answer:

• Reserve requirements, a tool of monetary policy, are computed as percentages of deposits that banks must hold as vault cash or on deposit at a Federal Reserve Bank.
• Reserve requirements represent a cost to the banking system. Bank reserves, meanwhile, are used in the day-to-day implementation of monetary policy by the Federal Reserve.
• As of December 2006, the reserve requirement was 10% on transaction deposits, and there were zero reserves required for time deposits.

There are two things to note here: first, Canada does not have a fractional reserve requirement and second, banks get ZERO interest on their reserves:

The Fed has long advocated the payment of interest on the reserves that banks maintain at Federal Reserve Banks. Such a step would have to be approved by Congress, which traditionally has been opposed because of the revenue loss that would result to the U.S. Treasury. Each year the Treasury receives the Fed’s revenue that is in excess of its expenses. The payment of interest on reserves would, of course, be an additional expense to the Fed.

Thus, all banks will attempt to keep their reserves as close to their requirements as possible. If they have any excess in the system, they will either try to lend them on the Fed Funds market – at the infamous Fed Funds Rate – or withdraw them, to invest the money in … basically anything. Even a one-week T-bill, even now, pays more than ZERO.

Now, along comes the Term Auction Facility. Its value of $40,000-million is – surely not fortuitously! – roughly equal to the total US bank reserve requirement … and it’s available cheap – 3.123%, as pointed out by Naked Capitalism.

If these borrowed term funds were to be left at the Fed – on top of the reserve balances that had been held there previously – then the banks would be borrowing at 3.123% and lending at ZERO. It is my understanding that this sort of negative margin on loans is not considered the road to riches at banking school. But an American stockbroker heard about this, got all excited and appears to have stampeded Naked Capitalism into unnecessary worry.

A good day in the preferred market – as noted by a New Assiduous Reader on another thread – but the index is still negative on the month. Volume was on the light side, but reasonable.

There were nineteen other index-included $25.00-equivalent issues trading over 10,000 shares today.

There were some very interesting tid-bits of news today. Naked Capitalism posted an article regarding some of the unintended consequences of Credit Default Swaps. I have commented on this news more thoroughly on the PrefBlog CDS Primer Post.

And the SocGen Futures Fiasco continues its fascination:

Europe’s largest futures exchange queried the bank about its trades as early as November.

“Eurex was alarmed by the size of the positions,” Prosecutor Jean-Claude Marin said at a press conference today, citing Kerviel. He said the trader was able to explain away the concerns.
…
Jean-Pierre Mustier, chief executive officer of Societe Generale’s corporate and investment bank, said on a conference call yesterday that trades by Kerviel that exceeded limits had been caught by the bank’s back office before.

“He would admit he had made a mistake, the transaction would be canceled and he would replace it by another one that would be controlled by another department,” Mustier said. “He wasn’t making more mistakes than other traders.”
…
The case has raised fresh doubts about risk management at the world’s biggest financial institutions and prompted calls for increased disclosure from French President Nicolas Sarkozy. He also suggested top managers should bear a greater share of the blame.

“When someone is very highly paid, even when it’s probably justified, you can’t avoid responsibility when there’s a major problem,” Sarkozy told reporters today after giving a speech outside Paris.
…
“There was clearly a fault in the bank’s control systems,” said Jean Peyrelevade, a former CEO of Credit Lyonnais and a member of the board of Barings when Leeson’s losses brought down the bank.

It pains me to have to quote Sarkozy actually saying something sensible on a topic related to capital markets, but hey – even a stopped clock is right twice a day!

Apparently, Kerviel didn’t take his vacations:

He took only four days off last August and postponed a vacation at the end of the year, Societe Generale said. Banks often make trading staff take time off so any concealed positions will become evident in their absence.

… and, although I can no longer find the link, was mentioned somewhere as having a departmental password that gave him some information. Well … maybe a departmental password is acceptable for access to the page that provides information about the staff Christmas party, but I can’t see any other rational use! And, of course, there’s the “calendar of the controls” issue that I mentioned on Friday.

There’s no real information available. It’s in the bank’s interest to make this guy out to be a combination of Einstein and Satan … it’s not in their interest to provide a full and dispassionate account of how the little accident occurred. This is particularly the case since given the short period of time since the discovery, the only people who really have a thorough knowledge of the situation and industry comparables are the ones with their asses on the line.

But really, it’s sounding to me more and more like everybody involved in the policy-making for the controls, from the department manager to the risk committee of the board of directors, now has the onus to explain why they should be allowed to keep their job.

Naked Capitalism also ruminates on the bond insurer bail-out and the failure of the ratings agencies to update the status of their reviews:

there is every reason to expect the rating agencies to knuckle under if Dinallo can raise a modest amount of dough, even as little as, say, $2 billion. The agencies through their mistakes have now created the situation where they could be the ones to Destroy the Financial World as We Know It. They will take any route offered to keep from pushing the button, in the hopes that either the economy will miraculously recover or other events will lead to credit repricing, so that the eventual downgrade of the insurers has far less impact than one now.

I still don’t think a bailout is likely to succeed, despite the considerable costs of a bond guarantor downgrade. But the fact that the rating agencies will probably go along with any remotely plausible scheme means that a smoke and mirrors version might be put into place.

With respect to this particular tale, it is fascinating to learn that JPMorgan has increased its Ambac stake to 7.7% from 5.4%.

And, in news that will be not be welcomed by those speculating that BCE / Teachers will succeed, another LBO in the States has bitten the dust … but for a novel reason:

Blackstone Group LP’s $6.6 billion leveraged buyout of credit-card payments processor Alliance Data Systems Corp. may collapse because bank regulators have placed “unacceptable” requirements on the acquisition.

Alliance Data plunged 35 percent in New York trading today after Blackstone said conditions requested by the U.S. Office of the Comptroller of the Currency would impose “unlimited and indefinite” liability on the firm. It will try to keep the deal alive, the New York-based company said in an e-mailed statement.
…
The Federal Deposit Insurance Corp. also regulates Alliance Data because it operates an industrial bank. Before today, Alliance Data shares had dropped more than 10 percent four times since Nov. 29 on speculation the transaction will be reworked or abandoned. Three times Alliance Data issued public statements that the two sides were working to complete the deal.

Now, I don’t believe that banking regulators have any direct involvement in BCE / Teachers, but this deal’s collapse seems to have had a ripple effect anyway! BCE was down $1.34 on the day, to close at $34.95.

The TSX is late again with my daily prices. The indices (and HIMIPref™) are being updated at various odd hours, but will be unavailable on a daily basis until the data becomes available at a reasonable time.