Category: Market Action

James Hamilton of Econbrowser takes a brief look at the US Inflation numbers and concludes:

there is a clear need to net out the May-to-July energy price increase– it’s already been reversed. The US national average gas price is back to $3.78/gallon, right where it was in mid-May. Thus, even without any further drop in the price of gasoline– and personally, I do expect further drops– the 4-1/2% number is a better summary of where we stand right at the moment than 5-1/2%.

So no, I don’t think that yesterday’s CPI numbers will cause the Fed to panic. Because yesterday’s news is already way of out of date.

Stephen Foley of The Independent looks at the Fed/SEC turf battle (hat tip: Naked Capitalism):

But [SEC Chairman Christopher Cox] starts an important battle for the soul of US financial regulation several laps behind the Federal Reserve and opponents on Wall Street who see this as the perfect time to take a few teeth out of the SEC.

A blueprint for regulatory reform by Mr Paulson, which envisages the Fed as a super-regulator with only a narrow role for the SEC, was forged out of Wall Street’s frustration with SEC red tape and what investment banks complained was their diminishing competitive advantage over London. Britain, they argued, had a risk-based approach to regulation that was light-touch in day-to-day matters and only descended on institutions regarded as risking damage to the financial system. The SEC, with its raft of rules, would be wrapped into a much-diminished third-tier regulator responsible for protecting investors and market participants from fraud and market manipulation.

Now, I don’t want it to seem as if I’m defending the SEC and its regulatory approach – for one thing, I’m simply not familiar enough with the issues. But although there are some very good arguments to be made that central banks should combine the regulatory and lender of last resort functions, I’m not sure how well this works in practice. Particularly when applied to investment banking – which is supposed to be wilder and riskier than regular banking, by design! – this simply places too much power in the hands of a single agency. Many nations separate the regulatory and lending functions (Canada, to name but one) without huge problems; it seems to me that separation of function is Good.

After all, isn’t this what the regulators are always telling us about separation of function when they pontificate? Bookkeepers should not cut cheques. Internal Audit should not sell IPOs. And lenders should not be regulators.

We may, eventually, be getting towards the end of the ABCP legal saga:

Investors in the frozen $32-billion asset-backed commercial paper market will find out on Monday what will happen to the money they put into the troubled paper when an appeals court renders its decision.

The Ontario Court of Appeal says it will release its decision on the restructuring plan on Monday at 5 p.m. ET.
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An Ontario Superior Court judge accepted the plan, but the decision also left open a 21-day window for individual and corporate investors to file appeals on the case.

Several corporations with the paper filed appeals claiming that the plan wrongfully granted immunity from litigation to the banks, brokers and the rating agency involved in ABCP.
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The decision will be posted on the court’s website …

The Canadian Press reporter was good enough to note that the decision will be posted on the court’s website, but got the address wrong. The announcement is here.

PerpetualDiscounts continued their recovery today, but the total return index remains a hair below its level of June 30. The weighted average yield to maturity for these issues is currently 6.13%, compared to 6.07% on June 30 and a high of 6.63% on July 16.

The fund is doing quite well this month; trading volume has been quite heavy since mid-July (when chaos and confusion reigned unchallenged in the sector) and these relative-value trades are starting to pay off handsomely. How handsomely? I’d better keep my mouth shut, but I will say that I’m feeling a lot happier halfway through August than I was halfway through July!

Volume was light today.

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

Accrued Interest comments on the extraordinary new-issue concession for Citigroup 5-years:

The new issue was sold at a yield spread of 337.5bps over the 5-year Treasury. Prior to the announcement of the new issue, Citigroup’s 5.5% bond due in April 2013 was bid at +275.
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First, this is an extreme concession for a plain vanilla debt sale of a Aa3 rated bank. In 2006, the concession might have been 5 or 10bps at the most for a new issue. Alternatively, Baa-rated Deutsche Telecom recently brought a new 10-year issue, and the concession was around 15bps. This tells you that while there are buyers of Citigroup debt, they pretty much have to give it away.

Second, at a spread to Treasuries of +337.5, the deal has a very large negative basis to credit default swaps. This means that buyers of Citi bonds could also buy CDS and realize an arbitrage. Citi CDS closed Tuesday at 160bps and 5-year swap spreads closed at +98.5.

Meanwhile, in an incident that doesn’t have the credit rating agencies looking all that good, Bluepoint’s gone BK:

Wachovia Corp.’s BluePoint Re Ltd. unit, which insures structured finance and municipal transactions, filed for bankruptcy protection, citing defaults on securitized mortgages.

BluePoint filed a petition in Manhattan yesterday, saying it has more than $100 million in debt.
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Wachovia, the fourth-biggest U.S. bank, reported a $330 million charge in the second half of 2007 related to BluePoint’s losses on credit default swaps on collateralized debt obligations, or CDOs. BluePoint decided to liquidate after failing to negotiate a restructuring with banks including UBS AG that were counterparties to its swaps, according to court papers.
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BluePoint Re, the smallest reinsurer in the bond-insurance industry according to Moody’s Investors Service, had its credit rating cut 14 levels to Ca from A2 by the agency yesterday. Moody’s had lowered its rating two notches from Aa3 on July 11.

The only possible excuse I can find for such a swift downgrade is found in Moody’s press release:

In contrast to most other financial guarantors, BluePoint Re is much more exposed to liquidity risk in its CDS contracts due to payment and settlement terms, including market value termination rating triggers that take effect below the single-A rating level.

… but it doesn’t look good! S&P said:

it lowered its financial strength and financial enhancement ratings on BluePoint Re Ltd. to ‘R’ from ‘A’. An insurer rated ‘R’ is under regulatory supervision because of its financial condition.

According to a S&P request for comment, the lowest 3-year projected rating for an issue currently rated A is B:

Under the proposal, when assigning and monitoring ratings, we would consider whether we believe an issuer or security has a high likelihood of experiencing unusually large adverse changes in credit quality under conditions of moderate stress (for example, recessions of moderate severity, such as the U.S. recessions of 1960 and 1991 and the European recession of 1991 or appropriate sector-specific stress scenarios). In such cases, we would assign the issuer or security a lower rating than we would have otherwise.

I don’t like the proposal, by the way. I prefer a volatility modifier.

Yet another day of recovery for PerpetualDiscounts; their total return index has returned to above that of July 2, but still below the June 30 close. Average yield is 6.14%, equivalent to 8.60% interest (with the 1.4x equivalency factor), which is long corporates +250bp.

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

Asset- and mortgage-backed spreads are widening:

Fannie’s current-coupon 30-year fixed-rate bonds currently yield 6.04 percent, 212 basis points more than 10-year Treasuries, according to data compiled by Bloomberg. That’s 26 points from the 22-year high of 238 basis points reached March 6, a week before the Federal Reserve engineered a bailout of Bear Stearns & Co.
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The yield over the one-month London interbank offered rate on AAA rated auto asset-backed bonds maturing in three years rose 25 basis points to a 12-month high of 200 in the week ended Aug. 7, according to Bank of America Corp. data. Spreads on similar credit-card securities rose 15 basis points to a three-month high of 110 over Libor. Libor is currently set at 2.47 percent.
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BlackRock has out muscled competitors such as Legg Mason Inc. in the current crisis. The company collected $63.2 billion in new business from investors in the second quarter, including advisory assignments, the most of any publicly traded asset manager.

This may have to do with rumbling that Lehman is seeking to delever:

Lehman Brothers Holdings Inc., seeking to restore investor confidence after a $2.8 billion second-quarter loss, is negotiating to sell commercial real estate assets to a group including BlackRock Inc., said three people briefed on the discussions.

Lehman is seeking to sell about $14 billion of its $40 billion in commercial property and related securities by the end of the year, according to two potential buyers approached by the New York-based firm.
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[Ladenburg Thalmann & Co. analyst Richard] Bove expects Lehman to sell its entire $29.4 billion commercial mortgage portfolio. The firm also owns $10.4 billion of property. It may record a loss of $4.9 billion on the sale of the commercial mortgages, Sanford C. Bernstein & Co. analyst Brad Hintz estimated in a report last week.

Last year, as the market collapsed, Lehman underwrote more mortgage-backed securities than any other firm, accumulating an $85 billion portfolio, 44 percent more than Morgan Stanley’s and almost four times the $22.5 billion of shareholder equity Lehman had as a buffer against losses.

An interesting column on VoxEU looks at Optimal Central Bank Transparency, reasoning that since:

Inflation targeting has been the most popular monetary policy regime of recent decades. Under this policy, central banks effectively target inflation forecasts. To a large extent these forecasts are determined by expectations of economic agents. Communicating information is the central bank’s major instrument for managing expectations. It is therefore logical that the issue of central bank transparency came to the fore when inflation targeting became the dominant monetary policy strategy, often studied in the context of a New Keynesian model.

and:

More recently, the potential negative effects of higher transparency have attracted attention (see Ellen Meade’s Vox column).

Since transparency has positive and negative aspects, the obvious next step is to investigate the notion of an optimal degree of central bank transparency.

The authors make some good points more generally related to investments:

It is well known that people sometimes neglect important information when it is supplied with a lot of other information. People also fall back to simple rules of thumb if the content of the information becomes too complicated.
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By providing more and more information, paradoxically central banks show how little they actually know.
This risk is especially relevant when the central bank provides information on all the uncertainties surrounding forecasts and analyses. By doing so, it may also convey how dependent the central bank ultimately is on the relatively powerless instrument that is the very short-term interest rate. Thus result may be a drop in the central bank’s credibility.

With respect to transparency, Willem Buiter has recently opined that The ECB should vote on interest rates and then publish its minutes:

Even French president Nicolas Sarkozy can be right about some things – malgré soi. He wants the ECB to publish the minutes of the rate-setting meetings of its Governing Council, including an account of each member’s view on the appropriate level of the ECB’s official policy rate – the inelegantly named Main refinancing operations Minimum bid rate. And about time too. But before it makes sense for the ECB to publish the minutes of its rate-setting meetings, the ECB has to start voting on its interest rate decisions.

Remarkably, the fact that the ECB’s Governing Council has never voted on the interest rate it sets does not appear to be widely known.
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The ECB has never had a formal vote on interest rates. I know this straight from the mouths of horses who between them have attended every single one of the ECB Governing Council’s rate-setting meetings since the first one in January 1999. Instead of voting on the interest rate, the ECB’s Governing Council ‘reach a consensus’ without ever taking a vote.
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To conclude: corruption of the mandate and purpose of the ECB are much more likely when there is no voting on rate decisions, when the individual votes are not in the public domain and when no informative minutes explaining individual votes are published.

It is clear that the Treaty and Protocols (a) require voting on interest rates (why bother with the voting procedures otherwise) and (b) permit the publication of individual voting records and minutes. Article 10.4 of the Protocol states: 10.4. The proceedings of the meetings shall be confidential. The Governing Council may decide to make the outcome of its deliberations public.

Another up-day for PerpetualDiscounts, making the eleventh straight trading day without a loss. There has only been one down-day (July 28) in the nineteen trading days since the nadir on July 16.

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

Freddie Mac has announced that they will no longer buy New York subprime mortgages:

Freddie Mac, the second-largest U.S. mortgage finance company, will stop buying subprime loans issued in New York state as a new law takes effect that holds investors accountable for mortgage fraud.

Freddie won’t buy loans dated on or after Sept. 1 that meet the state’s subprime definition, the McLean, Virginia-based company said today in a lender bulletin on its Web site. New York Governor David Paterson last week signed new foreclosure and lending laws that tighten legal protections for borrowers.

The story has been picked up – very briefly – by Calculated Risk and Naked Capitalism.

Sadly, nobody seems to want to delve into the legislation and the arguments that can be made; I don’t have a lot of information on this, so I won’t say much … but, at least to some extent, this is what I’ve been afraid of as a regulatory response: there are so many liabilities built into the system that the business is no longer worth doing. Maybe, in this particular case, this is a desirable result. As I said, I don’t have any details (if anybody has links to some informed discussion, they will be greatly appreciated!). But the regulators at all their levels are at great risk of throwing babies out with the bathwater.

PerpetualDiscounts had another good day, returning +0.42% to yield 6.18% dividends, equivalent to 8.65% interest at the 1.4x equivalency factor. With long corporates yielding 6.1% the pre-tax interest-equivalent spread is now 255bp. PerpetualDiscounts have now returned +7.63% since the July 16 nadir and the total return index has almost crawled back to July 2 levels.

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

Today’s top news is that inflation is no longer a problem:

Schroder Investment Management’s David Scammell is so convinced inflation has crested that the bond fund manager this quarter has sold securities designed to protect from rising consumer prices.
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Scammell is no lonely voice. A survey out today of 25 bond fund managers controlling $1.41 trillion of assets by Jersey City, New Jersey-based Ried, Thunberg & Co. found that 79 percent expect inflation “to moderate late this year into 2009.”

And certainly the market expectations computed by the Cleveland Fed are in a downturn. Isn’t it exciting? I wonder how the world will end next week!

Somebody made a massive bet against Bear Stearns just before its collapse, which is leading to mutterings that the firm’s collapse was a confidence game. This was last discussed on July 17. The Internuts’ position to date has been that BSC was a stupid firm, leveraged up to the eyeballs with junk and having a negative net worth. It will be most interesting to see if they switch to the “evil hedge fund rumour-monger” meme. As for me … sudden losses of confidence happen. Bear Stearns was an extreme example; they shouldn’t have gone under, but management shouldn’t have made them vulnerable either.

Predictions, of course, have a very poor track record. But there’s one prediction I hope comes true … the bond vigilantes were FUN:

The bond vigilantes who’ve been missing in action under George W. Bush may be preparing for a return engagement once Barack Obama or John McCain takes office next year.
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“Though times are different and a lot of the government spending is necessary, we’re going to see rates rise in a saw- tooth pattern over the next few years,” says E. Craig Coats Jr., the head of Salomon Brothers’ government securities desk when it was the world’s biggest bond trader. Coats considers himself one of the original vigilantes, the bearish traders who drove up long-term interest rates, persuading Clinton to place deficit-reduction above fulfilling his spending promises.

That course-reversal prompted Clinton political adviser James Carville to observe at the time: “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

Another good strong day in the markets, with volume picking up slightly.

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

Another common equity dividend cut that leaves the preferreds unscathed! This sort of stuff does my heart good!

Fannie Mae, the largest U.S. mortgage- finance company, cut its dividend 86 percent after posting a loss that was more than three times analysts’ estimates and said the worst housing slump since the Great Depression is deepening.
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Mudd has raised $14.4 billion since late last year and reduced the dividend from 50 cents since December, though still failed to quell concerns that the company is short of capital. As worries escalated, he dispatched executives to Asia to calm investors. Fannie’s core capital was $47 billion at the end of the quarter, up from $42.7 billion in March, after the company sold $7.4 billion of preferred stock.

The fact that they were able to finance themselves with preferreds underlines the importance to operating companies of maintaining the dividends … Fannie Mae issued $2-billion at 8.25%, $2.25-billion at 8.75% + mandatory conversion and $7-billion at LIBOR+423 last December. The convertable issue, of course, cannot be considered a fixed income security … but the extra security of the dividend until conversion is quite valuable!

The UK Financial Services Authority has concluded its investigation into the HBOS share collapse. Assiduous Readers will remember that the HBOS rights issue flopped. Not suprisingly:

Despite the likelihood that the rumours contributed to the fall in the share price, the FSA has not uncovered evidence that they were spread as part of a concerted attempt by individuals to profit by manipulating the share price.

Of interest is:

The effect of algorithmic trading strategies, which amplified the impact of the initial downward trend in the HBOS share price.

My expectation would have been that algorithmic trading strategies would cushion the downward trend, rather than amplifying it, as swaps between banks became more attractive. Certainly, “algorithmic” doesn’t mean anything in itself, but I would be most interested in learning the details of this automated positive feedback loop … and I bet the FSA is puzzling over this type of trading even now!

Well, a week-odd in to August and things are looking a little better! PerpetualDiscounts are up every day month-to-date, totalling 1.38%. They have had only one down-day (July 28) since the trough on July 16 and are now up 6.62% since trough-date. Average dividend yield is now 6.23%, equivalent to 8.72% interest for taxable holders with a 1.4x equivalency factor; long corporates now yield about 6.15% so the PTIE spread is 257bp … still above the previous ten-year high of 250bp.

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

Update: Assiduous Reader prefwatcher takes me to task in the comments for not hating the Fannie Mae preferreds and suggests I look at the charts … so here’s the common vs. FNMPRG:

Clearly, not pretty for the preferreds – but, my point was, even less pretty for the common.

My glee at seeing common dividends cut while preferreds continue rolling along is, perhaps, a little exagerated … but there are so many commentators who take the view that preferred dividends are easy to cut I take great pleasure in pointing out contrary evidence. Fannie’s preferred stock is rated A1 Review-Negative by Moody’s, by the way. This note has also attracted attention at FWR.

Menzie Chinn of Econbrowser passes along a very gloomy paper on the interaction of recessions, credit contractions, housing price declines and stock market declines:

In particular, we show that recessions associated with credit crunches and house price busts are deeper and last longer than other recessions are.

Citigroup has agreed to a plan to bail-out holders of Auction Rate Securities:

Cuomo accused Citigroup of fraud in an Aug. 1 letter, claiming the firm should have told clients the auction-rate market survived between August 2007 and February 2008 only because of bidding from the bank. The letter demanded Citigroup buy back investors’ holdings in the “immediate future,” reimburse their damages and pay a “significant” fine.

Total craziness. If the politicians and the bureaucrats really think they’re helping the capital markets in the long-term with this sort of nonsense, their successors will have another think coming. All that is accomplished by this sort of thing is the creation of an aversion for anything but the plainest of vanilla offerings from the big investment banks. If any retail-scum investor actually wishes to buy things like this in the future – too bad! It will be too risky for the bank to sell it to you.

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

Freddie Mac took a big loss on subprime:

Freddie wrote down the value of subprime and low-quality mortgage securities for the first time, taking a loss of $826 million, adding to signs the company sees tougher times ahead.
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Freddie today reported a second-quarter net loss of $821 million, or $1.63 a share, its fourth straight loss, compared with the 54 cents a share average estimate of nine analysts in a Bloomberg survey.

The common-share dividend will be reduced to 5 cents or less from 25 cents, the second reduction in nine months. The preferred stock dividend won’t be affected, Freddie said in a statement.

Syron, 64, said in a statement today he still plans to raise capital after agreeing to sell $5.5 billion in equity.

So the common shareholders are seeing their dividends slashed and their equity diluted … while preferred shareholders are not (yet!) affected. It will be most interesting to track these things over the first decade of this century to see just how the risk/reward ultimately turns out.

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

Another up day on extremely light volume – and even more extremely light commenting!

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

Another solid up-day, on very light volume.

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