Category: Market Action

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.
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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.
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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.
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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.
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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.
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“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.

The bond insurance business gets more interesting every day! Naked Capitalism has two pieces on it today, the first attempting to quantify the problem:

Bill Ackman of hedge fund Pershing Square has gotten a considerable amount of flack for his outspoken, negative views of the bond insurers, particularly MBIA and Ambac, which his firm has shorted. Ackman has been circulating a detailed analysis that estimates that the additional equity needed to maintain an AAA rating at the two biggest firms is roughly $15 billion.

This calculation is sharply contested by new rating agency Egan Jones (which also downgraded MBIA to a B+, a junk rating) which says the industry needs more than an order of magnitude more capital, namely $200 billion.

Egan-Jones was mentioned in PrefBlog on November 7. As a subscription-based credit advisor, they have an interest in saying exciting things … which is not to say they’re wrong, of course, but it is something to keep in mind. They received NRSRO status in December.

Naked Capitalism also takes a rather gloomy view of the New York Insurance Regulator’s bail-out facilitation – even gloomier than the one I remarked on yesterday. Until shown otherwise, I’m just going to assume the whole NY bail-out thing is plain-and-simple grandstanding … Mr. Dinallo, the head of the NY regulator, learned all about grandstanding in his last regulatory job:

Superintendent Dinallo served at the Office of Attorney General Eliot Spitzer from 1999 to 2003. As Chief of the Securities Bureau, he was charged with combining that bureau with the Real Estate Finance Bureau. The resulting Bureau was named the Investment Protection Bureau to reflect its focus, and Mr. Dinallo was named its first Chief. In that capacity, he led the reinvigorated Bureau’s investigations into the Wall Street Cases – conflicts of interest in the financial services industry, including research analyst cases and the spinning of hot initial public offerings. He produced more than 40 major civil and criminal matters, and led the Bureau through the beginning of the mutual fund industry investigations.

However, Barclays Capital has opined that there may be very serious knock-on effects should the insurers fail:

Banks that raised $72 billion to shore up capital depleted by subprime-related losses may require another $143 billion should credit rating firms downgrade bond insurers, according to analysts at Barclays Capital.

Banks will need at least $22 billion if bonds covered by insurers led by MBIA Inc. and Ambac Assurance Corp. are cut one level from AAA, and six times more for downgrades by four steps to A, Paul Fenner-Leitao wrote in a report published today. Barclays’ estimates are based on banks holding as much as 75 percent of the $820 billion of structured securities guaranteed by bond insurers.

I will have to do some more research into the bank capital regulations … it seems to me that having such levels of exposure to single names should attract a concentration charge on capital … I’m honestly not sure whether or not it does.

And Naked Capitalism draws to my attention (very good crop today, Yves!) an opinion piece by Willem Buiter, who is something of a regular on this blog:

Even with a few days worth of hindsight, the Fed’s out-of-sequence, out-of-hours 75 basis points cut in the target for the Federal Funds rate continues to look extraordinary and deeply misguided. Indeed, it looks less and less like a decisive pre-emptive move in response to unexpected bad news designed to meet the Fed’s triple mandate of maximum employment, stable prices and moderate long-term interest rates, than a knee-jerk panic reaction to a global stock market collapse.

Did the sharp global decline in stock values at the beginning of this week reflect a rational re-assessment of fundamentals? The only two candidate explanations I have heard are (a) that the collapse was probably triggered by concerns about the financial viability of the monolines and (b) that it was intensified by the unwinding by SocGen of the long equity positions taken by its employee of the year (not!). I find neither explanation convincing. If the collapse was a spurious, non-fundamental event, there is no reason for the Fed to react to it. The ability of the Fed to meet its fundamental objectives is seriously undermined if it is perceived as the poodle of the equity markets.

So sign up another member of the “But what about inflation?” camp.

Assiduous Readers will be familiar with my grumpiness about US Fiscal policy – the last six years have been permanent stimulation – but I’m in good company:

[Harvard Professor Jeffrey Frankel] explains:

“In 2001, very aggressive monetary and fiscal expansion reduced the severity and length of the recession. It is true that this time as well the Fed has been busy cutting interest rates and the government is working on a fiscal stimulus. But this time, before long, our policy makers will run into constraints. The government can’t keep cutting taxes, because the national debt is too high, the path of future deficits too steep, and the costs of the baby boomers’ retirement too imminent. The federal government needs to retain the confidence of the bond markets.

“This is different from 2001, which we entered with a record budget surplus, allowing room for stimulus. Similarly, the Fed can’t keep cutting interest rates because the dollar has been falling steeply, and America needs to retain confidence of foreign investors who are financing our deficits. This is different from 2001, when the dollar was strong, inflation was all but dead, and the Fed could cut interest rates by [5.5 percentage points].”

A few more details – and a bit more rational commentary – is emerging regarding the SocGen stock futures fiasco:

But a top French presidential advisor revealed that Kerviel had positions of more than 50 billion euros (73 billion dollars) — more than the bank’s current market capitalisation of 35.9 billion euros.
…
Many experts said it was difficult to believe a lone trader could have successfully hid such colossal losses.”

“The feeling in the dealing rooms is that it is not possible for an individual to do all that. They think Societe Generale has overdone the fraud to cover up some bad market operations,” said Elie Cohen, an economy professor and research director for the National Centre for Scientific Research (CNRS).

One example of such feelings as were noted by Elie Cohen is:

Let’s get this straight: the MainSwamp media (who are such profoundly ignorant whip-kissers that they think that the wankfest at Davos is worth reporting on) would have you believe that a single trader whose entire remuneration package (including bonuses) was 100k euro, had such free rein that he could rack up positions with aggregate losses of A$9 bill, with nobody noticing. (To get to an aggregate loss of A$9 bill, you need an actual position larger than that, no?)

A bank with owners equity of about $20 billion, and its processes are so poor that such a thing could happen? The Banque de France – who audits every bank every year, and knows if an individual Frenchman passes a bad cheque – knew nothing of it?

Sorry lads – no sale.

What has happened here, I bet, is that SocGen has found an internal culprit, and is hanging as large an amount on him as they think they can get away with. So this geezer might have sent $100 mill to Money Heaven – that amount could possibly be hidden for a week or so – and the Bank has used him as a scapegoat and has attributed half its subprime-related losses to him rather than the subprime book.

… and a bit more delicately:

“That’s when he made his first mistake,” said Jean-Pierre Mustier, head of investment banking at Societe Generale. “He no longer knew the type and calendar of the controls.”

The trading loss raises questions about the bank’s risk management procedures.

“I find it really improbable that this trader was not abetted by at the very least incompetence, if not assistance from others,” said Joseph Mason, a risk-management researcher and professor of finance at Drexel University in Philadelphia. “Ultimately, we’re talking about a breakdown of fundamental operational controls.”

“Calendar of the controls”? No wonder SocGen’s lost so much. And finally (hat tip: Financial Webring Forum), Jim Sinclair reviews the data and offers the opinion:

The USD $7,000 million loss reported as an action of a junior trader hiding a losing position for a considerable amount of time as stated is total bull.

You would have to be totally IGNORANT of market mechanics to buy that plausible denial.

The public and much of the media are.

The reported loss was a buyout of a failed to or chosen not to perform derivative.

One theory regarding the mechanics of the scheme that has been suggested to me is that the trader was writing single puts on multiple futures/forward contracts rather than multiple puts on single futures/forward contracts, then fiddling with the documentation to make it look like one put = one contract, rather than the actual one put = multiple contracts.

Well, that may be. I responded that most cases like this aren’t very complicated, really. It’s usually just a matter of dumb stealing from dumber. Or, perhaps, dumber turning a blind eye, as long as dumb was making money.

I’ll admit, one thing that makes me a little nervous about the whole episode is the continued emphasis on his background in operations:

Kerviel drew on knowledge he acquired during six years in Societe Generale’s back office, where he went to work in 2000 after completing a degree in market operations at the University of Lyon II, according to an alumni Web page. He had to breach five levels of controls to get away with his trades, Bank of France Governor Christian Noyer said at a press conference yesterday.

His “intimate and perverse” knowledge of the bank’s controls let him avoid detection, co-Chief Executive Officer Philippe Citerne told reporters.

This is the type of thing that might make a particularly overbearing, paternalistic and incompetent regulator (please don’t cry, Assiduous Readers, some such do exist) forbid such transitions.

I came up through operations. It was while working in operations on starvation wages that I got interested in finance. The background has served me well … back-office bullshitters find I’m asking them questions they’d rather not answer, on occasion. I’m hardly alone in this; the traditional manner of becoming a trader is by first becoming a traders’ clerk – something I wish I’d know when I got my first full-time operations job and spent several years kicking myself for asking for the higher-paying dead-end choice.

But we’ll see.

There’s a new inhabitant of litigation-land!

this move by New York City and State to sue lead manager Goldman, 25 other underwriters and accounting firms over a Countrwide stock offering is routine securities fraud, in this case making misrepresentations about the company’s prospects. No one has yet to develop a legal theory to go after Goldman for the move that has many offended, being net short subprime related debt while continuing to sell them to investors. And the latter is unlikely to go anywhere (saver perhaps serving as fodder for Congressional investigations) because that action didn’t violate any securities laws.

There is no indication as yet as to whether the New York City and State portfolio managers have even been asked as to whether they did a due diligence.

Well folks …. sorry! Prices are not yet available from the TSX and I’m going out for dinner. I’ve been keeping the HIMIPref™ indices up to date, by the way, after cramming in the prices at odd hours, just not reporting them. But I’ll see what I can do over the weekend to – at least – get today’s index levels up.

A so-called rogue trader socked it to SocGen … 4.9-billion Euros’ worth. So called? I haven’t seen any proof yet and won’t ever see it. Assiduous Readers might not believe this – but there are still some people in the world who believe that the honchos at Barings Bank were shocked – shocked! – to hear that Nick Leeson was speculating rather than arbitraging in order to make 10% of the bank’s profits. Fitch Ratings announced it:

has today downgraded Societe Generale’s (SG) Long-term (LT) Issuer Default Rating (IDR) to ‘AA-‘ (AA minus) from ‘AA’ and the Individual Rating to ‘B’ from ‘A/B’. SG’s Short-term (ST) IDR and Support Ratings are affirmed respectively at ‘F1+’ and ‘1’. The Outlook for the LT IDR is Stable and the Support Floor is affirmed at ‘A-‘ (A minus).

This action follows the profit warning announcement made by the bank today. The EUR4.9bn fraud-related trading loss uncovered at the bank is very substantial and has arisen within the bank’s equity trading division, core to SG’s business. While Fitch understands that SG has been the victim of fraud undertaken by one single trader under very specific circumstances, the extent to which the fraudulent positions taken were concealed raises questions about the effectiveness of the bank’s processing systems and creates reputational risk for the group.

Not much news today, frankly. I felt very hopeful about a VoxEU piece titled Ratings Agency Reform, but there’s no substance to it – it’s just a list of options with no accompanying argument, discussion or opinion.

The Congressional Budget Office does not believe the US is, or will be, in a recession – a slowdown, sure, but not an actual recession. Of far more interest than inane hairsplitting over definitions is their view on the US Federal deficit:

Our baseline – which assumes no change in current law — suggests that among other factors, the slowing economy will boost the deficit to $219 billion, or 1.5 percent of GDP, this year. If Congress provides the additional funding for operations in Iraq and Afghanistan requested by the Administration, the deficit would rise to $250 billion. And if a fiscal stimulus package is enacted, the 2008 deficit could be substantially higher – and at least from a short-term stimulus perspective, that could be desirable. The fiscal 2007 deficit was $163 billion, or 1.2% of GDP.

A mere $250-billion for fiscal 2008, without counting the stimulus package? Not a problem – just sell foreign investors a few more banks. It will be a lot easier than selling them LBO debt!

This is going to end in tears, you know. In Canada, we hit the wall in 1994 and since then politicians have found religion – even the NDP appears to be sincere when calling for balanced budgets. Mind you, the exercise is farcical … the federal deficit in Canada was what? $31-billion-odd in 1991, on top of huge provincial deficits? And there wasn’t anything extraordinarily stupid going on, most of that was just automatic stabilizers (welfare, unemployment insurance, reduced tax collections) acting as they should. And now we’re sitting with a massive national debt, huge health costs and reduced government revenues as the boomers retire while being told that $2-billion annually is a prudent and rational amount to pay on the national debt. It’s silly, really.

But anyway, my point is that the political climate regarding fiscal policy in Canada, for all its faults, is a lot healthier than in the States – and that’s going to get ugly when the chickens come home to roost. It’s not hard to imagine a scenario whereby nominal US allies – the ones with money – are politely asked to help defray the costs of US bases … and in the schoolyards in my neighborhood, that’s called “tribute”, “protection money” or “extortion” according to taste.

Naked Capitalism takes a gloomy view of the proposed monoline bailout – which I haven’t mentioned before because it’s not very interesting. Mr. Smith is greatly irritated by:

Sean Dilweg, the commissioner of insurance in Wisconsin, which regulates Ambac, sat in on the meeting but said he would be working with Ambac directly. Mr. Dilweg said he met separately on Tuesday with executives at Ambac, which is based in New York but chartered in Wisconsin.

“Eric is looking at the overall issue, but I am pretty confident that we will work through Ambac’s specific issues,” Mr. Dilweg said in a telephone interview. “They are a stable and well-capitalized company but they have some choices to make.”

and Mr. Smith responds:

the moron of a regulator from Wisconsin is not only not on the same page, but is dumb enough to undermine Dinallo by saying to the press that all is well in the land of cheeseheads. The odds of Ambac pulling through look even more remote.

This seems like very strong language. The potential monoline demise was mentioned in PrefBlog on January 18 when Fitch downgraded the insurer from AAA to AA. I’d say the regulator from Wisconsin is right – or, at least, he has not yet been proven wrong. What’s wrong with an AA rating from Fitch? Lots of companies would LOVE to have a AA rating from Fitch. They won’t be able to write much new business with that rating and a negative outlook, but why should the regulator care? An AA rating implies a very high probability of meeting the current obligations.

I guess I just don’t understand why this is considered a regulatory matter. I can see that the regulators should be interested, sure, and maybe send over a SWAT (Special Warning Accountancy Team), but public involvement does not yet appear to be warranted.

Again, there will be no tables for indices, performance and volume. Sorry about that!