Category: Market Action

More news today on the LIBOR front … the ECB is offering unlimited Euros for a two week term at 4.21%. There was an instant reduction in two week Euro-LIBOR:

The rate banks charge each other fell to 4.45 percent from 4.94 percent, the European Banking Federation said today. The reluctance to lend money after the collapse of the U.S. subprime market pushed interbank euro rates for two weeks to the highest level in at least six years earlier this week.The additional cash “reflects the extra tightness in the market,” said Lena Komileva, an economist at Tullett Prebon in London. “However, it doesn’t address the fundamental issues of banks hoarding cash and while the central bank has succeeded in stabilizing the shorter term rates, it makes little impact on the longer term rates.”

Even the hawkish Bank of England opened the spigots:

The BoE, meanwhile, auctioned 10 billion pounds (more than $20 billion) of three-month funds on Tuesday. Notably, it accepted bids as low as 5.36 percent, which is 14 basis points below its 5.5 percent base rate. Three-month sterling Libor fell to 6.38625 percent from 6.43125 percent on Monday.

Two-week sterling Libor jumped by around a whopping 75 basis points to 6.51250 percent but that was only down to calendar effects over the turn of the year, and mirrored similar increases in two-week euro and dollar rates last week.

Naked Capitalism reprints a piece by Ken Rogoff from the Financial Times:

The real town/gown problem is one of horizon rather than perspective. Monetary policy has long and variable lags, particularly on slow-moving inflation expectations. Sharper Fed interest rate cuts today might well mute the housing price collapse, at least in nominal terms. However, if the Fed should ease too far, too fast, it could get hit by a boomerang a couple of years down the road, in the form of sustained higher inflation.

For the Fed, two to three years is the medium term, and it matters. For many financial market participants, two to three years is an eternity, and it does not matter.

Accrued Interest is driving himself crazy trying to forecast US Housing Prices. Bloomberg has a fascinating story today on the antics at a Californian sub-prime origination office. A complicating factor is foreign ownership, especially by snowbacks:

“Fifteen of my friends are on buying trips down here, and we’re all cheap,” Mr. Sirockman said. He brought his family to Scottsdale this month while he submitted a lowball all-cash offer for a three-bedroom home.

“I don’t want to take advantage of a guy who’s having trouble in the market and is losing his shorts,” Mr. Sirockman said. “But I have no problem with a guy from California who bought on spec and has five houses in Arizona and never lived in them.”
…
The market has shifted totally in the buyer’s favour, especially those offering cash, said Jeff Russell of Alberta. Last month, Russell snapped up a patio home next to a golf course in Scottsdale with a $299,000 check. It was listed at $463,000.
…
Mr. Sirockman also returned to Canada without a house after the owner of the Scottsdale home turned down his offer. No worries. Mr. Sirockman told the seller there were a thousand other homes like his on the market, and someone was going to deal.

When I need to hire a trader, I know who I’m going to invite over for an interview!

As noted on December 13, the consolidation of SIV assets by their major sponsoring banks has greatly reduced the need for the MLEC/Super-conduit (although it could still be useful in Canada!), but the plan is going ahead anyway:

The “SuperSIV” fund, set up to provide cash to structured investment vehicles hurt by subprime- mortgage holdings, plans to start buying assets “within weeks,” its sponsors said today.

The fund’s size, originally envisioned at about $80 billion, will be determined by “SIVs’ needs and evolving market circumstances,” Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. said in an e-mailed statement. New York- based BlackRock Inc., the largest publicly traded U.S. asset manager, will oversee the fund.

BlackRock, I suspect, is going to have to earn its money the hard way. Now that the major sponsors have bitten the bullet, the urgency of the cash requirement has declined considerably, which gives considerable scope to traders playing games. The idea has been presented as pricing the assets to be bought at the levels of small transactions – rather than as a vulture fund – which may lead to a certain amount of cherry-picking as the banks’ traders try to pick off the fund. We shall see!

Another very active, negative day for preferreds. The Claymore ETF is now down for the month-to-date … but it looks as if Malachite Fund is hanging on to very good relative returns, anyway. So far! It is interesting to note that what I consider to be the four “main” HIMIPref™ indices (Operating Retractible, Split Share and the two Perpetuals) are all still up on the month – most of the damage to date has been done to the floating rate indices and especially the non-investment-grade issues.

As recently as the December 6 review of the Weston issues, WN.PR.E (to choose one) was quoted at 16.46-53 … it closed today at 15.10-17 after going ex-dividend Dec 12 for $0.296875. That’s a loss of almost 7.5%!

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

There has been a lot of commentary regarding the coordinated liquidity injection (discussed on December 12) led by the Fed. First to the plate was Stephen Cecchitti, who has written many high quality essays for VoxEU, the most recent of which was discussed on December 5.

The problem of credit tightness has as its most visible sympton a spike in LIBOR, as discussed on December 13 and December 14 (after the announcement) with a graph shown on November 28. Mr. Cecchetti claims that:

Clearly, they were worried about the quality of the assets on the balance sheets of the potential borrowers. My guess is that banks were having enough trouble figuring out the value of the things they owned, so they figure that other banks must be having the same problems. The result has been paralysis in inter-bank lending markets.

and that the critical problem being addressed is:

The Fed can get liquidity to the primary dealers, but it has no way to ensure that those reserves are then lent out to the banks that need them.
…
Not only do Central Banks need to ensure distribution of funds within a country’s banking system, they also need to make sure that cross-border distribution is adequate to meet the needs of banks in one country that require the currency of another. Today we have the new problem that dollars are in short supply outside of the United States.

He emphasizes that:

Standard open market operations give the Fed control over the level of short-term interest rates. The purpose of the Term Auction Facility is to give them a tool for influencing interest rate spreads.  

This is what I noted (in a much less knowledgable manner) on December 13:

The redemption of T-Bills is significant: it means there is (basically) no net improvement in systemic liquidity. What there is is simply a smearing of the extant Fed-provided liquidity over a broader section of the market. For a while.

James Hamilton of Econbrowser reviews the facility and concludes:

So why is it the responsibility of the Fed to try to set not just the level of the fed funds rate but also the spread between the funds rate and the LIBOR rate? One possibility is that the Fed thinks that the market is currently overweighting the riskiness of short-term interbank loans. If so, that seems to be a different vision of the role of monetary policy from that articulated by Ben Bernanke in 2002:

I think for the Fed to be an “arbiter of security speculation or values” is neither desirable nor feasible.

A second possible justification is that the market is correctly pricing the riskiness of these assets, but that the chief risk involves an aggregate financial event that the Fed, through actions like the TAF, could mitigate or avoid altogether.

I’m not sure that Professor Hamilton is focussing on the most relevant part of the Bernanke speech he references. I take note of:

Finally, if a sudden correction in asset prices does occur, the Fed’s first responsibility is to do its part to ensure the integrity of the financial infrastructure–in particular, the payments system and the systems for settling trades of securities and other financial instruments. If necessary, the Fed should provide ample liquidity until the immediate crisis has passed. The Fed’s response to the 1987 stock market break is a good example of what I have in mind

Bernanke’s speech continues with a presentation of the arguments in favour of accounting for asset prices when formulating central bank policy:

I think one can usefully boil down many of these arguments to the idea that it may be worthwhile for the Fed to take out a little “insurance,” so to speak, against the formation of an asset-price bubble and its potentially adverse effects. Like all forms of insurance, bubble insurance carries a premium, which includes (among other costs) the losses incurred if the Fed misjudges the state of the asset market or the cost of a possible reduction in the transparency of Fed policies. But, as a matter of theory, it is rarely the case in economics that the optimal amount of insurance in any situation is zero. On that principle, proponents of leaning against the bubble have argued that completely ignoring incipient potential bubbles, if in fact they can be identified, can’t possibly be the best policy. I will discuss below why I believe that, nevertheless, “leaning against the bubble” is unlikely to be productive in practice.
…
But as a practical matter, this is easier said than done, particularly if we intend to use monetary policy as the instrument, for two main reasons. First, the Fed cannot reliably identify bubbles in asset prices. Second, even if it could identify bubbles, monetary policy is far too blunt a tool for effective use against them.
…
The Federal Reserve went on to make a number of serious additional mistakes that deepened and extended the Great Depression of the 1930s. Besides trying to pop the stock market bubble, the Fed made little or no effort to protect the banking system from depositor runs and panics. Most seriously, it permitted a severe deflation in the price level, which drove real interest rates sky-high and greatly increased the pressure on debtors. A small compensation for the enormous tragedy of the Great Depression is that we learned some valuable lessons about central banking. It would be a shame if those lessons were to be forgotten.

The Fed Jackson Hole conference was discussed in PrefBlog on August 31 and September 4; a great deal of debate there centred on the proper role of Central Banks when confronted with a market pricing problem. I suggest that the Fed is terrified of a lock-up in the interbank markets and, by the new liquidity injection, is taking steps to ensure that such a lock-up doesn’t happen. This may thought of as the downside analogue of ‘leaning against the bubble’.

It may be thought to represent a change of thinking at the highest levels of the Fed, but I’m not so sure. I have a lot of confidence in these guys and do not think that they are idealistic zealots, parsing every suggestion for ideological purity and substituting slogans for thought. I suggest that they are beyond that and take a pragmatic approach: Whatever Works.

Paul Krugman of Princeton University, for instance, takes the view that the risk of a “liquidity trap” is rising:

Mr. Krugman, now at Princeton University, said no, but the risk of one has increased. “In general, we wouldn’t say that there’s a liquidity trap unless you’re up against the zero bound,” that is, when the short-term interest rate falls to zero, and can’t fall any lower. “So we’re not in one by the normal definition, which is a situation in which people are indifferent between cash and bonds, so that open-market operations in which the central bank trades monetary base for bonds have no effect.”

But he added: “What you could say, though, is that the unwillingness of banks to lend has reduced the effectiveness of Fed policy — and increased the likelihood that we’ll find ourselves in a liquidity trap sometime soon.”

If there’s one thing the Fed must do, it’s ensure its continued relevance! At the moment there is little evidence that credit tightening has affected the real economy and the Fed wants to keep it that way.

Prefs were down again today – particularly the BAM issues, which lends credence to prefhound‘s speculation in the comments to December 14 that Brookfield weakness could be due to their Hudson Yards project, which got a lot of ink in the Globe on the weekend.

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

Update: Typo has been struck out of the notes for BNA.PR.C.

Headline inflation in the US came in a 4.3% yoy today, powered by Food (+4.8%) and Energy (+21.4%). The core rate, which excludes these two items, was +2.3% yoy. Not a good report, according to economists surveyed by the WSJ – the Fed is now caught between a rock and a hard place on rates. Stagflation, anyone?

On what might possibly be a related note, William C. Dudley, EVP of the Fed, gave a speech on TIPS (hat tip: WSJ Blogs and Economist’s View):

Put simply, I come here to praise TIPS… In my opinion, the benefits of the TIPS program significantly exceed the costs of the program.
…
we might start by comparing the difference in funding costs to the Treasury of TIPS versus a program of comparable duration nominal Treasuries.

But we should also be careful not to ignore other potential benefits of the TIPS program. As I see it, these potential benefits include:

• Greater diversification of the Treasury’s funding sources, which presumably has favorable implications for the Treasury’s funding costs.
• The potential for TIPS issuance to reduce the variability of the U.S. government’s net financial position.
• Access to a market-determined measure of inflation expectations that can help inform the conduct of monetary policy.
• The provision of a virtually risk-free investment that provides value to risk-averse investors.

One point that was discussed during Canada’s introduction of RRBs (Real Return Bonds) was that this indexing makes it at least a little bit more difficult for the government to deliberately inflate away the debt – which is also, explicitly, an argument in favour of borrowing in foreign currencies.

Continuing with the inflationary theme, Tommaso Monacelli of the Università Bocconi, Milan has written a very hawkish piece regarding the recent ECB decision to leave policy rates unchanged:

Can the ECB publish inflation forecasts between 2 and 3 percent and decide not to raise interest rates? Given that its explicit mandate is to keep inflation below but close to 2 percent, what type of signal is the Bank sending to the markets, especially as regards its own credibility?
…

In this mounting inflation context, more than ever, the lack of transparency in the ECB policy points to the need of a more rigorous (arguably “scientific”) framework in which its policy decisions can be rationalized. Much of the recent literature describes the optimal conduct of monetary policy in terms of ‘inflation forecast targeting’. Two are the basic ingredients. First, a numerical target for inflation (as it is well-known from the experience of many countries in the world that have adopted inflation targeting, including emerging-market economies). Second, and more importantly, a management of the path of interest rates such that in each period the inflation forecast at some horizon, and conditional on that same instrument path, are in line with the inflation target.

He also criticizes what he sees as a somewhat circular reasoning process:

Reading carefully through the technical notes in small print (not really an example of transparency), one observes that the staff projections are based on the markets’ expectations of future interest rates. Hence they are conditional not on the future interest rate path that the Bank itself foresees as most likely, but on the interest rate path that the markets foresee as most likely.

The projection for 2008 inflation does indeed note:

The technical assumptions about interest rates and both oil and non-energy commodity prices are based on market expectations, with a cut-off date of 14 November 2007. With regard to short-term interest rates, as measured by the three-month EURIBOR, market expectations are derived from forward rates, reflecting a snapshot of the yield curve at the cut-off date. They imply an average level of 4.9% in the fourth quarter of 2007, falling to 4.5% in 2008 and 4.3% in 2009. The market expectations for euro area ten-year nominal government bond yields imply a flat profile at their mid-November level of 4.3%. The baseline projection also includes the assumption that bank lending spreads will rise slightly over the projection horizon, reflecting the current episode of heightened risk consciousness in financial markets.

… but saying that this is in small print seems to me to be overstating the case a little! The iterative process that leads to the final Euroland forecast has led to the forecast:

On the basis of the information available up to 23 November 2007, Eurosystem staff have prepared projections for macroeconomic developments in the euro area.1 Average annual real GDP growth is projected to be between 2.4% and 2.8% in 2007, between 1.5% and 2.5% in 2008, and between 1.6% and 2.6% in 2009. The average rate of increase in the overall HICP is projected to be between 2.0% and 2.2% in 2007, between 2.0% and 3.0% in 2008, and between 1.2% and 2.4% in 2009.

“HICP” is the “Harmonised Index of Consumer Prices”. I don’t see anything wrong with the system myself … it seems to me that basing projections on market expectations is as good as any other method and better than most. After having prepared these projections, the output (HICP) may be examined and if it’s outside the desired range then the actual policy decision may be made taking the expectation as a guide.

The most interesting part of all this, however, is that the spectre of inflation is intruding more often into public debate. Should stagflation become a more credible threat than it is now, I suspect policy makers will favour the stag- over the -flation and tighten even faster than they are currently easing … which could have major implications for long-bonds and therefore preferreds.

Mind you, though, the market as represented by LIBOR is ignoring the policy makers … at least for now:

The rates banks charge each other for three-month loans held at seven-year highs for a second day after policy makers in the U.S., U.K., Canada, Switzerland and the euro region agreed to ease the logjam in short-term credit markets. The cost of borrowing in euros stayed at 4.95 percent, the British Bankers’ Association said today, up from last month’s low of 4.57 percent and 3.68 percent a year ago.

“The market clearly doesn’t believe central banks can do anything about this crisis,” said Nathalie Fillet, senior interest-rate strategist at BNP Paribas SA in London. “This is not going to be a magical solution to the problem.”

There has been a certain amount of sensationalism regarding the deal – Accrued Interest doesn’t buy it:

Waldman says it’s a bailout because the Fed is offering loans that other banks wouldn’t be willing to offer. Here again, any bank who went to the discount window would borrow under the same terms. Does the continued existence of the discount window constitute a bailout? Put another way, banks would never use the discount window if financing was available elsewhere at similar costs elsewhere. So any time a bank uses the discount window, it’s a bailout by Waldman’s definition. This is why I am loathe to use that term.

Which brings us to the highly interesting topic of dissing the banks. Moody’s dissed Citibank today:

Moody’s Investors Service downgraded the long-term ratings of Citigroup Inc. (Citigroup) (senior to Aa3 from Aa2) and lowered the Bank Financial Strength Rating (BFSR) of Citibank, N.A. (Citibank) to B from A-. The rating on Citibank for long-term deposits and senior debt was lowered to Aa1 from Aaa. The rating outlook is stable.

The downgrade was prompted by Moody’s view that Citigroup’s capital ratios will remain low. According to Senior Vice President Sean Jones, “this situation is likely because management will need to take sizable write-downs against its subprime RMBS and CDO portfolio.” The bank is also expected to make significant sustained provisions against its residential mortgage book, which is over $200 billion. These charges are likely to occur when Citigroup’s normal earnings power is depressed, particularly in the United States.

“During 2008,” the analyst said, “Citigroup’s weak earnings should prohibit the bank from rapidly restoring capital ratios, despite its recent issuance of $7.5 billion hybrid capital.”
…
For Citigroup’s ratings to be upgraded, the company would need to rebuild its capital ratios to levels maintained prior to 2007. As well, the firm’s pre-provision earnings power has to return to its previous strong level, while reducing its concentration risks.

The company’s failure to restore its capital ratios in the medium term would possibly lead to a further downgrade

Remember the BCE/Teachers deal? It is not, repeat: not, being renegotiated:

BCE Inc. (TSX, NYSE: BCE) is today issuing a statement in response to certain rumours in the market regarding the status of its definitive agreement to be acquired by an investor group led by Teachers’ Private Capital, the private investment arm of the Ontario Teachers’ Pension Plan, Providence Equity Partners Inc. and Madison Dearborn Partners, LLC (the Investor Group).

While it is BCE’s policy not to comment on market rumours or speculation, in the interest of its shareholders, the company is today confirming that neither BCE nor its Board of Directors is involved in any discussions regarding any renegotiation of any of the terms of the definitive agreement entered into on June 29, 2007.

Under the terms of the definitive agreement, the Investor Group has agreed to acquire all of BCE’s outstanding common shares for $42.75 per share in cash and all of BCE’s outstanding preferred shares at prices set out in the definitive agreement.

And you’ll have to parse the significance of that yourselves, because I’m not touching it!

There may be a certain amount of turmoil in the US markets Monday, as the Moody’s announcement on Monolines is digested:

Moody’s Investors Service has updated its evaluation of US mortgage market stress on the ratings of financial guaranty companies, and has considered those companies’ plans for strengthening capitalization, as well as their developing strategies. The following actions are the result of that evaluation. The Aaa ratings of Financial Guaranty Insurance Company and XL Capital Assurance Inc. were placed on review for possible downgrade. The Aaa ratings of MBIA Insurance Corporation and CIFG Guaranty were affirmed, but the rating outlooks changed to negative. The Aaa ratings of Ambac Assurance Corporation, Assured Guaranty Corp, and Financial Security Assurance Inc. and the Aa3 rating of Radian Asset Assurance were all affirmed with a stable outlook.
…
As a result of these reviews, the Moody’s-rated securities that are “wrapped” or guaranteed by FGIC and XL Capital Assurance are also placed under review for possible downgrade. A full list of these securities will be made available later this evening under “Ratings Lists” on the company’s website at http://www.moodys.com/guarantors
…
Moody’s will also be hosting a teleconference on Monday, December 17 at 11:00 EST/16:00 GMT/17:00 CET to discuss these actions in further detail. To register for this teleconference, go to www.moodys.com/events.

There was supposed to be an announcement about the Montreal Accord and Canadian ABCP today … after the close … later, but I don’t see anything yet! Apparently, the banks are getting sticky about liquidity guarantees:

Bank of Canada Governor David Dodge and governor designate Mark Carney pushed the bank chief executives on a conference call Thursday night to make commitments for liquidity backup that could be as much as $1-billion for some of the big five banks, said people familiar with the situation.

The liquidity issue is one of the final hurdles in the hoped for re-jig of the frozen short-term debt, which if successful, would help to avoid a meltdown that could have massive ripple effects in financial markets.

I confess, I don’t understand why a liquidity guaranty is important – the entire purpose of the plan is to avoid the necessity for refinancing prior to the new notes’ maturity.

Another very active day in the preferred share market, with weak prices. Tax-loss selling? Sheer boneheadism? You tell me. The BAM issues continue to get hurt badly, which seems to me somewhat mysterious.

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

Well … it looks like yesterday’s shock-and-awe effort to provide liquidity has failed – assuming the point of the exercise was to lower EURIBOR:

The cost to borrow for three months remained at 4.95 percent, the British Bankers’ Association said today. That’s 95 basis points, or 0.95 percentage point, more than the European Central Bank’s benchmark interest rate, compared with 57 basis points a month ago. The difference averaged 25 basis points in the first half of the year, before losses on securities linked to U.S. subprime mortgages contaminated credit markets.

The TED Spread also ignored the theatricals:

Banks remain reluctant to lend to each other. The so-called “TED” spread, the difference between three-month Treasury bill yields and the London interbank offered rate for the same maturity, was 2.21 percentage points, near the highest since August. The increase indicates banks are charging more to lend to each other.

Mind you, Naked Capitalism focusses on the collateral that will be accepted for these loans and concludes:

Most of the CDO and subprime paper held by banks is AAA. Now I have no idea where this stuff is trading, and the fact is that a lot of it is not trading. However, lot of people are using the ABX as a proxy for subprime and other risky mortgage credit risk. So it may not be a price, but it’s a reference point for pricing. And it has AAA credits at 70 cents on the dollar.

So the Fed’s temporary facility could be used, quite legitimately, to mark anything that the Fed would accept as a repo at its collateral value for accounting purposes (you could theoretically have made the same argument for the discount window, but that’s an emergency facility, while this is intended for all comers). That places a very big floor under a lot of now-questionable credit. That move would reduce writedowns, the accompanying loss of confidence, and the need for additional equity well out of proportion to the paltry $40 billion the Fed is throwing into the mix.

It could well be. I argued in the comments to JDH’s Econbrowser post that the problem with credit markets is funding. People have the equity needed to put a floor under the markets – even a position levered up 10:1 has 10% equity in the position – but can’t reliably borrow the funds required to make the effort worthwhile. It may be that the Central Banks are trying to encourage the banks to lend against collateral of, shall we say, non-traditional quality by assuring them that the collateral may be rehypothecated in time of need.

Greg Ip supports this view – that the point of the exercise is to expand the definition of acceptable collateral – in a WSJ post:

Ironically, the Fed for a long time has been unhappy with the fact that it can even accept agencies, seeing it as an implicit subsidy to Fannie and Freddie.
…
If Fed officials had the same freedom these central banks did, they may not have created the new “term auction facility.” As it is, the facility is a form of legal arbitrage — a way for the Fed to get around the artificial constraints imposed by the Federal Reserve Act. It “gives us a tool that lies somewhere between our open market operations” and the discount window, Mr. Geithner said. “It provides a mechanism for expanding the range of collateral against which we provide funds to the market — in effect to change the composition of our balance sheet — in ways we cannot do through traditional open market operations.”
…
The Fed, nonetheless, is hopeful (confident would be too strong) its facility will do some good. The 3-month Libor, a key gauge of stress in the bank funding market, was fixed at 4.99% today, down from 5.06% Wednesday. The New York Fed announced today it would redeem all $15.2 billion of the Treasury bills it holds that mature on Thursday. That will cause its balance sheet to shrink, contracting the money supply. To offset the effect, it expects to lend up to $20 billion through the new facility on Monday.

The redemption of T-Bills is significant: it means there is (basically) no net improvement in systemic liquidity. What there is is simply a smearing of the extant Fed-provided liquidity over a broader section of the market. For a while.

In monoline news, Ambac is trying to stay afloat by reinsuring some of its portfolio:

Ambac Financial Group Inc., the world’s second-largest bond insurer, will pass off the risk of $29 billion in securities it guarantees in an effort to convince ratings companies that it still deserves a AAA credit rating.

Assured Guaranty Ltd. will reinsure the securities, New York-based Ambac said today in a statement.

Ambac, whose credit rating stands behind $556 billion of securities, is among seven AAA rated bond insurers under the scrutiny of Moody’s Investors Service, Fitch Ratings and Standard & Poor’s. Moody’s and Fitch said last month that Ambac was “moderately likely” to breach capital requirements because of a deterioration in the credit quality of the securities it guarantees.

“Reinsurance is a valuable, capital-efficient and shareholder-friendly tool for managing risk and capital,” Ambac Chief Executive Officer, Robert Genader said in the statement.

Assured Guaranty has just been affirmed AAA by Fitch:

The affirmation of AGL’s ratings is based on the company’s disciplined underwriting strategy exemplified by minimal exposure to higher-risk structured finance collateralized debt obligations (SF CDOs), improving financial results and sufficient excess capital for its given rating. AGL’s capital position has been further supplemented by today’s announced $300 million equity issuance, with the proceeds to be down-streamed to its reinsurance affiliate, Assured Guaranty Re (AG Re), to provide capital to help fund increasing opportunities to support other ‘AAA’ financial guarantors’ reinsurance needs.
…
AGL’s capital position remains satisfactory for an ‘AAA’ company, and the additional $300 million capital issuance should help support rapid growth which is taking place in the fourth quarter of 2007. After analyzing AGL’s SF CDO and second lien exposures, Fitch believes that the impact on AGL’s capital cushion is minimal, between $125 and $150 million, which corresponds to a Core Capital Adequacy Ratio of about 1.07x our minimum AAA standard of 1.00x.

In other words, they kept their powder dry, raised capital for expansion rather than to repair damage, and I’ll bet they’re really sticking it to poor old Ambac! Guaranteed, most assuredly.

CIBC made the big-time today, with a Bloomberg story that was picked up by Calculated Risk:

CIBC’s lightly guarded secret is the name of a “U.S. financial guarantor” that faces a possible downgrade on its A credit rating and is “not necessarily rated by both Moody’s & S&P.” That’s how CIBC last week described the company that is insuring $3.47 billion, or about a third, of the collateralized- debt obligations it holds that are tied to U.S. subprime mortgages.

The company’s identity matters because the bank said these hedged CDOs were worth just $1.76 billion at Oct. 31, down almost half from their face amount. If the guarantor goes poof, CIBC loses its hedge on these derivative contracts. And the Toronto-based bank would have to recognize the loss, which is growing.
…
Analysts watching CIBC, including Darko Mihelic of CIBC World Markets, quickly fingered what they believe is the unlucky backer: ACA Financial Guaranty Corp.

While we’re on the topic of enormous write-offs, how about that Washington Mutual, eh? This was discussed yesterday; they’ve now released a prospectus for a new preferred issue, with some interesting snippets:

As a result of the fundamental shift in the mortgage market and the actions we are taking to resize our Home Loans business, we will incur a fourth quarter after-tax charge of approximately $1.6 billion for the write-down of all the goodwill associated with the Home Loans business. This non-cash charge will not affect our tangible or regulatory capital or our liquidity.

Loan Loss Provision. Continued deterioration in the mortgage markets and declining housing prices have led to increasing fourth quarter charge-offs and delinquencies in our loan portfolio. As a result, we now expect our fourth quarter 2007 provision for loan losses to be between $1.5 and $1.6 billion, approximately twice the level of expected fourth quarter net charge-offs.

We currently expect our first quarter 2008 provision for loan losses to be in the range of $1.8 to $2.0 billion, reflecting an increase in provision which we expect to be well ahead of charge-offs, which are also expected to increase significantly during that quarter. The first quarter 2008 range reflects our current view that prevailing adverse conditions in the credit and housing markets will persist through 2008.

While difficult to predict, we also currently expect quarterly loan loss provisions through the end of 2008 to remain elevated, generally consistent with our expectation for the first quarter of 2008. We anticipate that there may be some additional variation depending on the level of credit card securitization activity during any quarter.

It’s a $3-billion issue, convertible into common, paying 7.75%; their shareholders’ equity is currently (September 30, 3rd Quarter) $23.9-billion. I found the discussion of taxes fairly entertaining:

Under current law, if a U.S. holder is an individual or other non-corporate holder, dividends received by such U.S. holder generally will be subject to a reduced maximum tax rate of 15% for taxable years beginning before January 1, 2011, after which the rate applicable to dividends is scheduled to return to the tax rate generally applicable to ordinary income. The rate reduction does not apply to dividends received to the extent that U.S. holders elect to treat the dividends as “investment income,” for purposes of the rules relating to the limitation on the deductibility of investment-related interest, which may be offset by investment expense. Furthermore, the rate reduction will also not apply to dividends that are paid to such holders with respect to the Series R Preferred Stock or our common stock that is held by the holder for less than 61 days during the 121-day period beginning on the date which is 60 days before the date on which the Series R Preferred Stock or our common stock become ex-dividend with respect to such dividend. (A 91-day minimum holding period applies to any dividends on the Series R Preferred Stock that are attributable to periods in excess of 366 days.)

Yeah, I could put some adjustments into HIMIPref™ to analyze it properly … but holy smokes, they’d be messy!

In what is probably the death-knell for MLEC/Super-Conduit, Citigroup is taking its SIVs onto its own balance sheet:

As assets continue to be sold, Citi’s risk exposure, and the capital ratio impact from consolidation, will be reduced accordingly.

Given the high credit quality of the SIV assets, Citi’s credit exposure under its commitment is substantially limited. Approximately 54% of the SIV assets are rated triple-A and 43% double-A by Moody’s, with no direct exposure to sub-prime assets and immaterial indirect sub-prime exposure of $51 million. In addition, the junior notes, which have a current market value of $2.5 billion, are in the first loss position.

…

The commitment is independent of the “Master Liquidity Enhancement Conduit” (“M-LEC”). Citi continues to support the formation of the M-LEC, which is an initiative that involves Citi and other financial institutions.

Another active day in the preferred share market, with a slight drift downwards.

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

James Hamilton of Econbrowser took a look at yesterday’s market action and got confused:

the January fed funds futures contract, which historically has proven to be an excellent predictor of the monthly average fed funds rate. This had been trading at 4.18% prior to the meeting. Since the FOMC is not scheduled to meet again until January 29/30, one might have read this as implying a 30% chance of having seen a 50-basis-point cut from yesterday’s meeting:
…
But here’s the curious thing: as of this writing, the price of that contract still has not budged more than half a basis point from where it stood at the close of trading last Friday. Fed funds futures traders seem not to have been surprised in the least by the outcome of Tuesday’s meeting.
…
If that’s the case, then why did the stock market appear to be so shocked that the Fed only cut its target yesterday by 25 basis points?Here’s the official Econbrowser answer– Beats me!

Fitch has placed a monoline insurer on Watch Negative:

This action follows completion of the updated assessment by Fitch of SCA’s exposure to structured finance collateralized debt obligations (SF CDOs) backed by subprime mortgage collateral, as well as SCA’s exposure to residential mortgage-backed securities (RMBS). This review indicates that SCA’s capital adequacy under Fitch’s Matrix financial guaranty capital model currently falls below guidelines for an ‘AAA’ IFS rating by more than $2 billion, due to sharp downgrades by Fitch in a number of SCA’s insured SF CDO exposures. Fitch originally announced it was conducting a review of all ‘AAA’ rated financial guarantors’ exposures to subprime-exposed insured transactions on Nov. 5, 2007.

If within the next 4-6 weeks, SCA is able to obtain firm capital commitments, and/or put in place reinsurance or other risk mitigation measures in order to meet capital guidelines, Fitch would expect to affirm SCA’s ratings with a Stable Rating Outlook. If SCA is unable to meet capital guidelines in the noted timeframe, Fitch would expect to downgrade SCA’s ratings. Based on the result of our updated capital analysis, Fitch would expect the IFS rating to be downgraded to the ‘AA’ rating category, assuming little change to the company’s current capital position. Fitch understands that SCA is actively working to address its current capital shortfall.

So, in other words, Security Capital has to get $2-billion in equity in the next 4-6 weeks or they’re basically out of business. When your business consists of renting out your credit rating, it can’t have any dents in it.

What’s a monoline insurer, you ask? Well, S&P has the answer!

Monoline insurer—An insurer that writes only financial guaranty insurance.

Multiline insurer—An insurer that writes many types of property and casualty insurance.

Today’s big news was the Central Bank USD Term Repo Extravaganza:

The Federal Reserve, European Central Bank and three other central banks moved in concert to alleviate a credit squeeze threatening global growth, in the biggest act of international economic cooperation since the Sept. 11 terrorist attacks.

For example, the Swiss:

In addition to its Swiss franc open market operations, the Swiss National Bank will offer a US dollar repo transaction on 17 December 2007. The maximum amount offered will be USD 4 billion. The USD repo transaction against SNB-eligible collateral will be conducted in the form of a variable rate tender auction and will provide funds for 28 days, with settlement on 20 December 2007. This measure is intended to facilitate the US dollar funding of SNB counterparties in the Swiss repo system.

… the Canadians …

As part of its continuing provision of liquidity in support of the efficient functioning of financial markets, the Bank of Canada announced today that it will enter into term purchase and resale agreements (term PRA) extending over the calendar year-end as follows:

Amount	Transaction and Settlement	Maturity
$2 billion	13 December 2007	10 January 2008
Minimum of $1 billion	18 December 2007	4 January 2008

… the Britons …

The Bank of England has already scheduled long-term repo open market operations (OMOs) on 18 December and 15 January. In those operations reserves will, as usual, be offered at 3, 6, 9 and 12-month maturities against the Bank’s published list of eligible collateral. But the total amount of reserves offered at the 3-month maturity will be expanded and the range of collateral accepted for funds advanced at this maturity will be widened.

The total size of reserves offered in the operations on 18 December and on 15 January will be raised from £2.85 billion to £11.35 billion, of which £10bn will be offered at the 3-month maturity.

… the Europeans …

The Governing Council of the ECB has decided to take joint action with the Federal Reserve by offering US dollar funding to Eurosystem counterparties.

The Eurosystem shall conduct two US dollar liquidity-providing operations, in connection with the US dollar Term Auction Facility, against ECB-eligible collateral for a maturity of 28 and 35 days. The submission of bids will take place on 17 and 20 December 2007 for settlement on 20 and 27 December 2007, respectively. The operational details can be obtained from the ECB’s website (www.ecb.europa.eu). The US dollars will be provided by the Federal Reserve to the ECB, up to $20 billion, by means of a temporary reciprocal currency arrangement (swap line).

It is reminded that the Governing Council previously decided on 8 November 2007 to renew at maturity the two supplementary longer-term refinancing operations (LTROs) that were allotted in August and September 2007. As an additional measure, the Governing Council decided on 13 November to lengthen the maturity of the main refinancing operation settling on 19 December 2007 to two weeks, thereby maturing on 4 January 2008 instead of 28 December 2007.

… all supported by the Fed:

Actions taken by the Federal Reserve include the establishment of a temporary Term Auction Facility (approved by the Board of Governors of the Federal Reserve System) and the establishment of foreign exchange swap lines with the European Central Bank and the Swiss National Bank (approved by the Federal Open Market Committee). 

Under the Term Auction Facility (TAF) program, the Federal Reserve will auction term funds to depository institutions against the wide variety of collateral that can be used to secure loans at the discount window.  All depository institutions that are judged to be in generally sound financial condition by their local Reserve Bank and that are eligible to borrow under the primary credit discount window program will be eligible to participate in TAF auctions.  All advances must be fully collateralized.  By allowing the Federal Reserve to inject term funds through a broader range of counterparties and against a broader range of collateral than open market operations, this facility could help promote the efficient dissemination of liquidity when the unsecured interbank markets are under stress.

Each TAF auction will be for a fixed amount, with the rate determined by the auction process (subject to a minimum bid rate).  The first TAF auction of $20 billion is scheduled for Monday, December 17, with settlement on Thursday, December 20; this auction will provide 28-day term funds, maturing Thursday, January 17, 2008.  The second auction of up to $20 billion is scheduled for Thursday, December 20, with settlement on Thursday, December 27; this auction will provide 35-day funds, maturing Thursday, January 31, 2008.  The third and fourth auctions will be held on January 14 and 28, with settlement on the following Thursdays.  The amounts of those auctions will be determined in January.  The Federal Reserve may conduct additional auctions in subsequent months, depending in part on evolving market conditions.

If this doesn’t tame the TED Spread, now at its widest levels since the crash of ’87, ain’t nuthin’ gonna do it! Initial reactions are favourable and Naked Capitalism has the news that LIBOR fell immediately:

Laurent Fransolet at Barclays Capital said Libor rates could be fixed lower in the days ahead by as much as 20 basis points.

The biggest impact will likely be seen in sterling rates, where higher fixings have had “the strongest, most direct” effect, and the most limited in the euro zone.

But it will take time for the recent market carnage to heal.

“While this would still be way above pre-crisis levels, we suspect it will be difficult for the market to fully recover in the near term. After all, the ABCP market in the U.S. is about 30 percent smaller than at its peak and that of the euro area has almost halved, making the combined shrinkage more than $500 billion over the past five months,” he wrote in a note.

If Libor rates do fall Thursday, it will be the first downward move in three-month euro Libor for over a month. 

The Fed cut rates by 25bp, to 4.25%.

Many were disappointed it wasn’t 50bp.

Stocks tanked.

But bonds benefitted from asset reallocation, even in Canada.

‘Nuff said?

A very active day in the preferred market, but with no major trends. The poor old BAM floaters finally caught a bid!

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

My quotation from the Bear Stearns Asset Backed Securities Trust prospectus on December 7 was well received, with both Econbrowser and Calculated Risk kind enough to credit me in their posts. My interest was more regarding the investor in the conduits being concerned the cash flows from the pool were being reduced; these two commenters are more interested in Treasury involvement.

It seems that the legal structure for these investments is a REMIC – real estate mortgage investment conduit, which has to be brain-dead in order to qualify for advantageous tax treatment. Without some assurance from the IRS that The Plan would not disqualify the conduit, there would be no plan – however, some such assurance is expected shortly; no great surprise since Paulson runs Treasury and Treasury runs IRS.

Calculated Risk also provides commentary on the involvement of FHA & FHASecure in The Plan.

Meanwhile, reverberations about the entire sub-prime fiasco continue, with UBS, Washington Mutual and MBIA announcing major equity infusions today. Meanwhile, Bank of America is winding up an Enhanced Money Market Fund that broke the buck on SIV paper, SocGen is consolidating a SIV onto its books and good old MLEC/Super-Conduit is being ridiculed as too little, too late.

Accrued Interest thinks we’ll see more of this:

However, my view is that this won’t be the end of MBIA’s need for more capital. MBIA has about $84 billion in residential ABS and “multi-sector” CDOs, vs. about $82 billion with AMBAC. I recently estimated that AMBAC would need $2-3 billion in new capital, so I’d suspect that before this is all said and done, MBIA comes back to the market for more. Note I didn’t say that MBIA would get downgraded. I have a strong suspicion that the bond insurers have been tipped off by Moody’s and Fitch as to how the capital adequacy studies are going. I further suspect that any capital improvements you hear about in the coming days are over and above what Moody’s and Fitch will announce (supposedly next week) is needed.

David Dodge used a speech at the Empire Club to plug the Financial System Review article on the credit rating agencies. He also lends a certain amount of support to calls for repeal of the credit agencies favoured position with respect to material non-public information (in the US, this means exemption from Regulation FD; I don’t know what the legal framework is in Canada):

Let me touch briefly on the role of credit-rating agencies in all of this. There is an article in the current FSR that expands on the issues related to the possible reform of the credit-rating process. One thing that is clear is that in the future, credit-rating agencies will find it to their advantage to explain more clearly the rationale for, and limitations of, their ratings for highly structured products. There are some natural, self-correcting market forces at work that should lead the rating agencies to improve their processes. Indeed, those credit-rating agencies that do not work harder to improve their processes will likely have fewer clients willing to pay for their services. As I understand it, most agencies are working on such improvements.

But credit-rating agencies are not to blame for the lack of information about those highly structured products that were sold to highly-sophisticated investors in the so-called exempt market. In the retail market, securities regulators impose strict requirements about the information that must be provided through a prospectus or term sheet. But there are no such requirements in the exempt market. It seems to me that some very basic disclosure is needed in every market. And since securities designed for the exempt market are usually required to carry a rating from a credit-rating agency, one way to ensure that appropriate information is available could be to require issuers to publicly disclose the same information that they make available to credit-rating agencies. In this way, investors would have access to the information they need in order to make informed decisions.

I’d like to see more discussion of this issue; removal of the special privilege might mean that everybody gets to see the information; it might mean that nobody gets to see the information.

For example, it is my understanding that the guarantee of Principal Protected Notes by international banks has a two-tiered price structure: you can get the guarantee with or without using the name of the guarantor in your advertising. In the current system, the credit rating agency can (I think) look at all the information and rate the notes while taking into account the non-public nature of the guarantee. In the proposed system, not even the credit rating agency would get to see the terms of the notes and the guarantor, unless it was all public and therefore more costly.  

I spent some time today at the David Berry hearing. You know why lawyers get paid so much? It’s because they have to listen to so much mind-numbing detail, that’s why. The part I heard was an assertion by RS staff that RS does indeed have authority to make a finding of misconduct should they wish to do so. This has been challenged by Mr. Berry on a variety of grounds including – as far as I can make out – that the TSE was not timely in changing its rules to reflect the hand-off of regulatory powers to RS and that, while Mr. Berry was employed by a Member of the TSE at the time of the alleged offence, he is not so employed now.

To my great astonishment, the documents presented to the panel hearing the case have not been published on the RS website.

I’ve found a bit more information on the Coleman Stipanovich story:

Stipanovich has worked for the board since 1999. Before that he was president of an investment consulting firm in Gainesville. He has worked for Paine Webber as a consultant and investment executive. He has a master of science degree in Criminal Justice Administration from Michigan State University and a bachelor of science in criminology from Florida State University.

Democrats have questioned why Stipanovich, whose brother is lobbyist and Republican strategist J.M. “Mac” Stipanovich, was hired. “This administration is taking the friends-and-family plan to the extreme,” Democratic Party spokesman Ryan Banfill said. “A $100-billion fund — it seems to me to be a no-brainer that you would do a national search.”

And a report – how accurate I don’t know – on his salary:

After seven years of overseeing Florida’s investment portfolio, Coleman Stipanovich suddenly resigned his $182,000 job moments ago amid upheaval over a massive withdrawal of the local government investment pool.

So let me see if I have this straight … the CEO of a fund with $184-billion in assets is being paid $182,000? And was hired without a national search? Not that a national search would have found anyone well qualified, because you don’t need to be a very well established portfolio manager – not boss of investment firm, I mean portfolio manager – to make more than $182,000 anyway.

I just lost all sympathy for the Florida municipalities – regardless of how much, if any, of the blame for their mess can be laid at Mr. Stipanovich’s door, they deserve exactly what they’re getting.

Another day of good volume and good performance by the perpetuals today.

Dear Santa, I have tried very hard all year to be a good Portfolio Manager. All I want for Christmas is to keep the month-to-date relative returns for the fund. Sincerely, JH. P.S., If you have any relative returns left over, of course, I’ll take them. JH.

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

The Internet is alive with discussion of the sub-prime bail-out announced by George Bush yesterday:

Representatives of HOPE NOW just briefed me on their plan to help homeowners who will not be able to make the higher payments on their sub-prime loan once the interest rates goes up — but who can at least afford the current, starter rate. HOPE NOW members have agreed on a set of industry-wide standards to provide relief to these borrowers in one of three ways: by refinancing an existing loan into a new private mortgage, by moving them into an FHA Secure loan, or by freezing their current interest rate for five years.

Lenders are already refinancing and modifying mortgages on a case-by-case basis. With this systematic approach, HOPE NOW will be able to help large groups of homeowners all at once.

The first question to occur to both Naked Capitalism and Jim Hamilton of Econbrowser was: how is this legal?

The natural question is then, Why did lenders volunteer to receive a lower interest rate than that to which borrowers had previously committed? And why was the announcement coming from the government rather than the creditors themselves?

Joshua Rosner – last mentioned in this blog in connection with an early – if somewhat self-serving – attack on the Credit Rating Agencies was quoted by Bloomberg:

“The modification of existing contracts, without the full and willing agreement of all parties to these contracts, risks significant erosion of 200 years of contract law,” said Joshua Rosner, managing director at Graham-Fisher & Co., an independent research firm in New York.

This got me interested in the actual contract language, so I went back to the security issue that I have been using as an – unscientifically chosen and possibly completely unrepresentative – example of a tranched RMBS CDO : Bear Stearns Asset Backed Securities Trust 2005-1. In order to find out what the contract between the securities holders and the securities issuers says, I’m going to try my hand at reading the contract. Old-fashioned of me, I know, but I’m an old-fashioned guy. The prospectus says by way of warning:

Modifications of mortgage loans agreed to by the master servicer in order to maximize ultimate proceeds of such mortgage loans may extend the period over which principal is received on your certificates, resulting in a longer weighted average life. If such modifications downwardly adjust interest rates, such modifications may lower the applicable interest rate cap, resulting in a lower yield to maturity on your certificates.

Continuing a text search for the word “modification” (finding out that “modification” was the right word to search on to find this stuff took me an hour last night, so I hope this post is greatly appreciated) we find the good part in the section “COLLECTION AND OTHER SERVICING PROCEDURES”:

EMC, as master servicer, will make reasonable efforts to ensure that all payments required under the terms and provisions of the mortgage loans are collected, and shall follow collection procedures comparable to the collection procedures of prudent mortgage servicers servicing mortgage loans for their own account, to the extent such procedures shall be consistent with the pooling and servicing agreement and any insurance policy required to be maintained pursuant to the pooling and servicing agreement. Consistent with the foregoing, the master servicer may in its discretion (i) waive any late payment charge or penalty interest in connection with the prepayment of a mortgage loan and (ii) extend the due dates for payments due on a mortgage note for a period not greater than 125 days. In addition, if (x) a mortgage loan is in default or default is imminent or (y) the master servicer delivers to the trustee a certification that a modification of such mortgage loan will not result in the imposition of taxes on or disqualify any trust REMIC, the master servicer may (A) amend the related mortgage note to reduce the mortgage rate applicable thereto, provided that such reduced mortgage rate shall in no event be lower than 7.5% and (B) amend any mortgage note to extend the maturity thereof, but not beyond the Distribution Date occurring in March 2035.

So – the legality of proposed loan modifications looks clear enough. The servicer has discretion, provided:

• New rate is not lower than 7.5%
• New maturity date is not later than the Distribution Date in 2035
• “procedures comparable to the collection procedures of prudent mortgage servicers servicing mortgage loans for their own account” have been followed

So there you have it. It is the Prudent Man Rule that applies to loan mods, and all that Bush and New Hope Alliance have done is changed the definition of what may be prudently done.

Prof. Nouriel Roubini, as always, writes a very insightful and entertaining commentary:

Also the actual legal challenges to these loans modifications – that a number of authors have expressed concerns about – are also way overstated: leaving aside technical legal issues litigation will be very limited only because investors in these instruments are better off under this plan than the nightmarish alternative of massive defaults and foreclosure; investors are not stupid and will find out on their own that they are better off in a world where mortgage are orderly and massively restructured.

Naked Capitalism has an entire post devoted to what Prudent Men used to do in the old days and claims that in the rough and tumble of corporate law, there might be enough ammunition to inflict damage on the New Hope Alliance. I don’t buy it – at least, not yet, and not as far as the Bear Stearns Asset Backed Trust prospectus is concerned. If you have all these people saying (i) it’s prudent, and (ii) it’s what they do when servicing mortgages they own themselves, I can’t see a judge saying that they’re not prudent according to contemporary standards.

Would I go to court on this? Not in a million years. I’d get the advice of a real lawyer, and that would be AFTER I’d spent a full week reading the entire prospectus extremely carefully myself. But I haven’t seen this explained anywhere else, so I thought I’d take a stab at it. Anyway, it was once explained to me that the first thing you learn as a law student is that a contract is holy. The first thing you learn as a practicing lawyer is that a contract is a reasonably convenient place to start. So let’s not hear any more about contracts, OK?

Accrued Interest asks a much more interesting question: what’s in it for me?:

So my view is that the deal benefits senior tranche holders, and REALLY benefits monoline insurers, who mostly care about the senior holders. If the odds of senior holders remaining whole for a longer period of time goes up, that’s certainly good for AMBAC, MBIA, etc.

Moody’s commented:

Moody’s has cited insufficient use of loan modifications, along with underlying loan defaults and home price depreciation, as a contributing factor to recent subprime RMBS downgrade actions. (See the October 11, 2007 Special Report “Rating Actions Related to 2006 Subprime First-Lien RMBS”.) We believe that judicious use of loan modifications can be beneficial to securitization trusts as a whole.

Based on our recent servicer survey results, the number of modifications to date has been relatively small. The proposed framework seems to provide a reasonable approach for identifying borrowers suitable for streamlined modifications and should expedite the number of modifications going forward. Time will tell how successful servicers are in identifying and modifying the loans most appropriate for modification. The ability of servicers to determine a borrower’s eligibility for FHA Secure or other refinancing options may vary, since a servicer’s expertise generally lies in servicing and not in underwriting. Larger servicers with both servicing and origination arms may be better equipped to manage this process.

Generally speaking, a higher level of interest rate modifications should decrease delinquencies post reset, thereby also potentially contributing to ratings stability for securities backed by subprime collateral.

Fitch has also weighed in:

Fitch Ratings believes that on balance, by mitigating the impact of ARM resets on borrower default rates, the framework can help to reduce the risk of principal loss on senior subprime RMBS. Increased refinancing opportunities via FHA and other programs are also important to stabilizing default rates. The implications for subordinated RMBS classes are unclear, as they may be exposed to a complex interaction of variables that can be difficult to analyze. Implementation of the proposed data reporting will aid analysis of the impact of streamlined modifications, and analysis of loan modifications generally.
…
If substantial number of borrowers prove to be eligible for streamlined modification and accept the five-year fixed rate, this should lead to lower default and loss rates than might be expected, if borrowers incurred a large payment increase at ARM reset. A major concern regarding the large-scale conversion to five-year fixed-rates is that excess interest within RMBS will decrease. Excess interest is an important source of credit enhancement which compensates for loss of cash flow due to mortgage losses. Uncertainty around the benefit of loan modifications is centered on the relative reduction in loss, versus reduction in excess interest that could be incurred. On balance, Fitch believes that stabilization of loss rates can outweigh excess interest reduction when analyzing the impact on senior RMBS. Greater refinancing opportunity can also help senior bond performance, as it will cause those bonds to prepay and reduce the risk of principal loss.

For subordinated RMBS, excess interest is a much greater component of credit enhancement, and in some instances only substantially lower loss rates would offset a reduction in excess interest. Fitch also notes that extensive use of rate ‘freezing’ will lead to lower collateral weighted average coupon (WAC), which in turn could lead to more extensive Available Funds Cap (AFC) interest shortfalls. AFC shortfall risk is not addressed by Fitch’s credit ratings.

and, as far as everything else goes:

“At best, it may stop some of the hemorrhaging of the housing market, but it doesn’t necessarily turn things around,” said Nicolas Retsinas, director of Harvard University’s Joint Center for Housing Studies in Cambridge, Massachusetts. “The fundamental problem with housing is oversupply.”

Existing home prices may fall as much as 15 percent by 2009 from their peak last year, even if interest rates are frozen on one fifth of 2006 subprime loans resetting next year, said Mark Zandi, chief economist at Moody’s Economy.com, a unit of New York-based Moody’s Corp. About 2.8 million mortgage loan defaults will occur in 2008 and 2009, Zandi said in Dec. 5 testimony before the U.S. Senate Judiciary Committee.

Meanwhile, US ABCP yields are spiking:

Yields on commercial paper backed by assets such as credit cards and mortgages rose at the fastest pace in at least a decade as investors retreated from buying debt that may contain subprime mortgage assets.

Yields on 30-day asset-backed commercial paper rose 91 basis points to 6.06 percent this week, or 82 basis points more than the one-month London interbank offered rate, the largest gap on record, according to data compiled by Bloomberg.

What makes this even more interesting is that outstandings fell another $23.1-billion this week and are now down to $801.2-billion from the July month-end level of $1,186.6-billion. However … the Super-Conduit/MLEC is up and running!

The banks also began marketing the fund to smaller institutions, aiming to raise $75 million to $100 million, including their own undisclosed contributions, said the people, who asked not to be named because details of the SuperSiv haven’t been made public. The banks, the three largest in the U.S., are set to meet with potential contributors on Dec. 10.

Well … up and stumbling, anyway. The three big sponsors are making undisclosed contributions? Perhaps this is just my lack of marketting skills showing up again, but it seems to me that if the sponsors really wanted it to fly, they’d have a big news conference announcing that they’d put $1-billion each into the things capital notes.

But capital notes aren’t looking too good nowadays:

Standard & Poor’s said it lowered credit ratings on capital notes of 13 structured investment vehicles and placed debt of 18 SIVs on negative outlook as the funds struggle to finance themselves.

Orion Finance Corp., managed by asset manager Eiger Capital Ltd., became the fourth SIV to enter “enforcement mode,” requiring the appointment of a trustee to protect senior debt holders. Premier Asset Collateralized Entity Ltd., an SIV sponsored by Societe Generale SA is close to breaching capital tests that would trigger enforcement, S&P said in a statement.

Expectations for a massive easing by the Fed are being reduced:

Futures contracts on the Chicago Board of Trade indicated a 24 percent chance that policy makers will lower the 4.5 percent target rate for overnight lending between banks by a half- percentage point at their meeting Dec. 11, compared with a 36 percent likelihood yesterday. The odds of a quarter-point cut were 76 percent.

… while Prof. Gilles Saint-Paul of Toulouse encourages the Fed to play tough:

To summarise, the low interest rate policy led to a wrong intertemporal price of consumption – consumption was too cheap today relative to the future – which led to excess spending and trade deficits. It also led to a mis-pricing of housing, which led to excess residential investment and excess borrowing by households. That is the price that was paid to make the 2001-2002 slowdown milder.
…
the Fed has been under pressure to cut rates. The problem is that such a policy is likely to perpetuate the current imbalances. Indirectly, it amounts to bailing out the poor loans and poor investment decisions made by many banks and households in the last five years. The bail-out comes at the expense of savers and new entrants in the housing market.
…
All this suggests that the US has to go through a recession in order to get the required correction in house prices and consumer spending. Instead of pre-emptively cutting rates, the Fed should signal that it will not do so unless there are signs of severe trouble (and there are no such signs yet since the latest news on the unemployment front are good) and decide how much of a fall in GDP growth it is willing to go through before intervening. As an analogy, one may remember the Volcker deflation. It triggered a sharp recession which was after all short-lived and bought the US the end of high inflation.

PerpetualDiscounts were up again today. *yawn* Remember the old days, when they sometimes went down? Life was more interesting then.

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

After CIBC’s earnings release this morning, Moody’s announced that it had:

affirmed the ratings of Canadian Imperial Bank of Commerce (CIBC) and rated subsidiaries and changed their rating outlooks to negative from stable. CIBC is rated B- for bank financial strength, Aa2 for long-term deposits, and P-1 for short-term obligations. This rating action follows CIBC’s earnings report for the fourth quarter of 2007 in which it disclosed details of a hedged portfolio of Collateralized Debt Obligations (CDO). 

The change in outlook is based on Moody’s view that this exposure highlights weaknesses in the firm’s strategic risk management. Moody’s concern centers on the concentration of counterparty risks to which it has exposed itself via a rapid and recent build-up of its CDO activities. Though Moody’s believes that any losses related to these particular exposures are manageable for CIBC, risk management weaknesses may expose the firm to further risks. Moody’s is also concerned that it has cited CIBC in the past for risk management weaknesses, and despite expected improvements, it now appears the bank has not fully addressed appropriate risk-taking at a senior, strategic level.

In other words … Moody’s is saying that CIBC got away with it this time, but they’ve been more lucky than smart.

In Super-Conduit/MLEC news, yet another bank is acting immediately:

Rabobank [RABN.UL] is taking the remaining assets of its structured investment vehicle (SIV) Tango Finance onto its balance sheet, the unlisted Dutch bank said on Thursday.

Rabobank, which manages Tango with Citigroup (C.N: Quote, Profile , Research), said the SIV has only 5.2 billion euros ($7.6 billion) in cash assets, down from 9.7 billion in July. Rabobank had warned on Wednesday that Tango’s size had almost halved as it has been selling off assets.

And the Northern Rock auction is running into trouble:

U.S. buyout firm J.C. Flowers’ offer to buy British bank Northern Rock (NRK.L: Quote, Profile , Research) was in doubt late on Thursday as people familiar with the matter said its interest had cooled.

J.C. Flowers remains interested in buying Northern Rock but is finding it increasingly difficult to meet the requirements of shareholders and the government, Bank of England and regulators, all of whom are involved in the auction, a person familiar with the matter said.
…
A consortium led by Virgin Group [VA.UL] has been picked as preferred bidder, but Flowers was considered its nearest challenger.

A consortium led by investment group Olivant is expected to submit a revised offer for the bank by Friday, sources have said.

And that’s all the colour for today! There wasn’t too much of interest anyway, other than the American Sub-Prime Plan, which has attracted considerable comment, not to mention buying.

But how about them PerpetualDiscounts, eh? Holy smokes … if they can keep up this performance every day for a couple of months, it’ll be a good year.

I didn’t understand it on the way down … I don’t understand it on the way up.

I feel reasonably confident when I say “on the way up”, because this looks just as much like a buying frenzy as anything else I’ve seen in the past … um … year, but who knows? Maybe everything will reverse itself tomorrow … and finding out is what makes it interesting to get up in the morning.

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

I am fascinated by the unfolding story of the Florida State Board of Administration’s Money Market fund that I discussed on December 3. Bloomberg reports that the Executive Director has quit:

Coleman Stipanovich, the head of an agency managing a troubled $14 billion Florida investment pool for local governments, quit as officials approved a plan by BlackRock Inc. to salvage the fund.
…
Stipanovich, whose brother J.M. “Mac” Stipanovich is a Tallahassee lobbyist and Republican strategist who ran former Governor Jeb Bush’s campaign for governor in 1994, was appointed executive director of the state board in 2002.

In the late 1990s, Coleman Stipanovich worked as a lobbyist for PaineWebber Inc. in Florida and was paid $7,500 per month to help the firm win municipal bond business.

Stipanovich, a Vietnam veteran, has a master of science degree in criminal justice administration from Michigan State University and a bachelors of science in criminology from Florida State University.

Pretty impressive credentials for running an investment management firm with $184-billion under management, eh? There’s a small biography on the site:

As Executive Director of the State Board of Administration of Florida (SBA), Coleman Stipanovich serves as the Chief Investment Officer of the fifth largest pension fund in the United States. Total assets under management at the SBA are in excess of $150 billion, which includes the Florida Retirement System Pension Plan (Defined Benefit Trust Fund) and Investment Plan (Defined Contribution Trust Fund). Under broad authority granted by the Trustees, the Executive Director has administrative and investment authority and responsibility, within the statutory limitations and rules, to develop investment policies and tactically manage investments. The Trustees are Governor Charlie Crist, Chief Financial Officer Alex Sink, and Attorney General Bill McCollum.

But look at him:

Isn’t that just the kind of distinguished look that investment counsellors should all have? I haven’t been able to find any CV on the web that might possibly shed some light on why this man was considered suitable to run a large asset management firm – all I’ve found is a story about his 2002 appointment and a record of his reappointment. If anybody has information that might clarify the question of his qualifications, please share it.

But I suspect it’s just political patronage. Investment counsellors are all a bunch of overpaid yumps who, on average, perform averagely, right? So I suppose that since any idiot can do it and get paid extremely well while doing so, it doesn’t make any difference who you hire.

Just for comparison, let’s look at the CV of Jim Leech, CEO of Teachers.

Mr. Leech joined Teachers’ in 2001 to lead Teachers’ Private Capital and succeeded Claude Lamoureux as President and CEO in 2007.
…
Before joining Teachers’, Mr. Leech was President and CEO of Unicorp Canada Corp., one of Canada’s first public merchant banks, and Union Energy Inc., then one of North America’s largest integrated energy and pipeline companies.

Now, I don’t know Mr. Leech. I haven’t worked with him, I haven’t studied his career in detail, I haven’t even spoken to the man. But I have a lot of respect for Teachers’ and whether or not Mr. Leech is the perfect man for the job, it seems to me that this is the way public funds should be run … a guy with a solid CV runs a division for six years, THEN gets to be boss. Maybe that CV is in investment management, maybe it’s in some other industry … but it’s solid.

I last reviewed Prof. Stephen Cecchetti‘s series on subprime on November 28. Part 3 of the series, Why Central Banks should be Financial Supervisors talks about some countries’ separation of function that are elsewhere combined:

In places like Italy, the Netherlands, Portugal, the United States and New Zealand, the central bank supervises banks. By contrast, in Australia, the United Kingdom, and Japan, supervision is done by an independent authority.

He notes that Bernanke is an ardent supporter of combination:

[Bernanke Speech]  Its supervisory activities also allow the Fed to obtain useful information about the financial companies that do business with the banking organizations it supervises. For example, some large banks are heavily engaged in lending and providing various services to hedge funds and other private pools of capital. In the process of ensuring that banks prudently manage these counterparty relationships, Fed staff members, collaborating with their colleagues from other agencies, learn a great deal about the business practices, investment strategies, and emerging trends in this industry.

The other side of the coin is:

[Cecchetti essay] the most compelling rationale for separation is the potential for conflict of interest. The central bank will be hesitant to impose monetary restraint out of concern for the damage it might do to the banks it supervises. The central bank will protect banks rather than the public interest. Making banks look bad makes supervisors look bad. So, allowing banks to fail would affect the central banker/supervisor’s reputation.

In this same vein, Goodhart argues for separation based on the fact that the embarrassment of poor supervisory performance could damage the reputation of the central bank.

Cecchetti quotes an amusing example of the benefits of combination:

On 20 November 1988 a computer software error prevented the Bank of New York from keeping track of its US Treasury securities trading. For 90 minutes orders poured in and the bank made payments without having the funds as normal. But when it came time to deliver the bonds and collect from the buyers, the information had been erased from the system. By the end of the day, the Bank of New York had bought and failed to deliver so many securities that it was committed to paying out $23 billion that it did not have. The Federal Reserve, knowing from its up-to-date supervisory records that the bank was solvent, made an emergency $23 billion loan taking the entire bank as collateral and averting a systemic financial crisis. Importantly, only a supervisor was in a position to know that the Bank of New York’s need to borrow was legitimate and did not arise from fraud.
…
[note] At the time, computers could store only 32,000 transactions at a time. When more transactions arrived than the computer could handle, the software’s counter restarted at zero. Since the counter number was the key to where the trading information was stored, the information was effectively erased. Had all the original transactions been processed before the counter restarted, there would have been no problem.

(I should point out that computers, per se, are not to blame for the error – assuming that the malfunction happened as described, this was an example of poor programme management, design and testing as indicated in the main text, rather than a hardware error as implied in the note) … and then an example of the evils of separation …

Shortly after Bank of England Governor Mervyn King sent a letter to the Treasury Committee of the House of Commons,⁶ the U.K. Financial Services Authority made it known both that Northern Rock was on the verge of collapse, and that supervisors had known this for some time. Contrary to wide-spread perception of the position taken just a few days earlier in the Governor’s letter, the Bank of England was forced to make a substantial emergency loan, substantially tarnishing their public image.
…
I will say is that things surely would have gone more smoothly had the Bank of England had supervisory authority so that the officials with intimate knowledge of Northern Rock’s balance sheet would have been sitting at the table on a regular basis with the management of the central bank.

Cecchetti is very persuasive! The arguments make a lot of sense to me – but I’ll keep my eyes open for something from the other side. His fourth and final essay in the series, Does Well-Designed Monetary Policy Encourage Risk Taking, is not nearly as interesting – as far as I’m concerned he could have written finis after the first sentence:

Yes, but isn’t that what it’s supposed to do?

… but he had to fill it out a little. I have often argued in this blog that by way of policy objectives, what we want is a rock-solid, highly regulated banking sector, well insulated from the outer (much more fun) layer of innovation and speculation. He concludes:

Some observers worry that recent central bankers’ responses to the subprime crisis of 2007 will encourage asset managers to take on more risk than is in society’s interest. I believe that this is wrong. Punishment is being meted out to many of those whose risky behaviour led to the problems, while central banks’ actions have, so far, reduced the collateral damage that this crisis could have inflicted on the economy.

As far as the series is concerned, he has made the following four concrete proposals:

• Trust, but verify. Investors should insist that asset managers and underwriters start by disclosing both the detailed characteristics of what they are selling together with their costs and fees. This will allow us to know what we buy and understand our bankers’ incentives.
• Standardisation and trading. Governments could help clarify the relative riskiness of assets by fostering the standardization of securities and encouraging trading on organized exchanges.
• Deposit insurance. A well-designed, rules-based deposit insurance scheme is essential to protecting the banking system from future financial crises. Lender of last resort actions are no substitute for deposit insurance.
• Central banks should be financial regulators. Central banks should have a direct role in financial supervision. In times of financial crisis – as in times of war – good policy-making requires a single ‘general’ directing the operations.

Item 1 is not really a policy issue – it’s a matter for investors, their investees and their advisors. Just make sure people are, in fact, feeling some pain from bad decisions and not bailed out – that’s enough policy.

Item 2 – I argued against this on November 19. However, it may be that in ensuring the stability of the banking system, margin & capital requirements could well be raised to the point at which exchange-trading (and clearing houses with daily mark-to-markets) become competitive. However, an exchange cannot function in a thin market – which Mr. Cecchetti, I am sure, will say is addressed by his urging for increased standardization. By way of policy … make sure the banks are stable, ensure capital requirements are conservative, and let exchange trading and standardization look after themselves.

Item 3 – full agreement from me!

Item 4 – very persuasive arguments have been put forward, but I’ll reserve judgement until I hear more from the other side. I am confident that each example of the benefits of unification can be matched with an example of harm.

PerpetualDiscounts continued to rock-and-roll today, while floaters just rolled over and played dead. Sadly, there are only two issues in this sub-index, both BAM, so it’s very hard to determine just how much is due to credit concerns, how much is Floater concerns and how much is just random vagaries of the market. There was reasonably good volume, a reasonable number of trades, and a reasonable time between the decline of prices and the market close, so I’d have to say this move is as real as anything else.

But really, how about them PerpetualDiscounts? I KNOW it’s only three days into the month and a lot can happen, but let me enjoy it while I can, won’t you? It’s been a long year.

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