Category: Market Action

I do apologize … many things came up today, so you’ll just have to do your own literature review.

PerpetualDiscounts didn’t go down today!

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

Gary Stern, President of the Minneapolis Fed, gave a speech in Singapore titled “Credit Market Developments: Lessons for Central Banking, which has provoked sharp disagreement from Yves Smith of Naked Capitalism

The theme of Mr. Stern’s speech is that there are no easy answers:

certainly some situations are far from resolved, and thus identification of principal lessons learned from the disruption will necessarily be incomplete and probably prioritized inadequately as well. Nevertheless, I think we can say something meaningful about potential reforms and about the tradeoffs inherent in their adoption. These are important matters; if I am right about tradeoffs, then some reforms might impose significant costs and contribute to outcomes we would prefer to avoid.
…
Policymakers will certainly find opportunities to improve current regulations and practices; the status quo will need to change in some areas. But, as we will see, and as foreshadowed previously, tradeoffs suggest that policymakers will want to be extraordinarily careful in addressing perceived inadequacies in the current environment.

This seems reasonable enough, but Mr. Smith says:

How do you want to count the damage that we need to count on one side of this tradeoff? Let’s see, we have subprimes at anywhere from $150 to $500 billion. We have the train wreck that is just starting in commercial real estate, which may be a mere $100 to $150 billion. Then we have losses and writeoffs on collateralized debt obligations, which we have said could add up to $750 billion (although some of that is already included in subprime losses). Of we could simply rely on the forecast by Goldman chief economist Jan Hatzius that home foreclosures could reach $400 billion and will trigger a $2 trillion reduction in lending, which in turn will trigger a “substantial recession.”

Even though regulation entails costs in terms of reduced efficiency and reduced profitability, the scale of the damage argues for incurring those costs. Yet, incredibly, Stern is arguing against meaningful change despite overwhelming evidence of serious problems.

… which doesn’t strike me as being a particularly useful response. There are certainly Bad Things happening, but this doesn’t mean that the system is not working as it should. As has so often been reiterated, markets exist in order that risks might be transferred. The fact that sometimes those risks have large effects – perhaps unforseen effects – is not sufficient to justify a full-court press on the regulatory front. Most importantly, before implementing regulatory changes, it is necessary to have a pretty good idea that rule changes will, in fact, be a net benefit … which is all that Mr. Stern is saying.

Mr. Stern’s first example is the “Originate and Distribute” model that results in so much asset securitization:

Because of the many hand-offs in the process—and the terms of the contracts between at least some of the firms—a number of the firms involved in the process did not have a clear stake in the longer-run performance of the mortgage. The incentives in this model, then, may have encouraged large-scale production of low-quality mortgages.
…
And the alternative—the originate to distribute model—has a core and fundamental economic advantage propelling it: specialization. Over time, firms have developed that specialize in the distinct steps of the lending process, from originating the loan to funding it. Such specialization contributes importantly to cost efficiencies, innovation, and a broadening of access to financial capital.  Another advantage of the model is diversification; the originate to distribute process allows a firm to significantly diversity the asset side of its balance sheet.

… to which Mr. Smith replies …

Ahem, don’t the 15% to 20% fall in housing prices, a falling dollar, and the recession that Hatzius and his colleagues increasingly predict represent an “adverse consequence for living standards’?

And Stern seeks to scare his audience into submission with a false dichotomy: you either accept the originate to distribute model as is, or you go back to having banks hold loans on their balance sheets. There is no willingness to consider methods to improve incentives or information flow, or more clearly define liability, that may reduce the bad outcomes of this system while keeping many of its virtues.

Mr. Smith’s suggestion for incremental improvement of the system is:

All residential mortgage brokers will be subject to Federal reporting and oversight (presumably at least along the lines of the requirements for brokers employed by regulated banks, although those may need to be toughened too).

… which is more than just a little vague. Federal reporting of what? oversight of what? you qualify for a license how? what do you need to do to lose it? Mr. Smith does not provide any argument for mortgage broker registration, merely the assertion that Rules Will Make Life Better.

According to a study released in 2005:

Among the findings for 2004 are these: there are 53,000 operating brokerages and they accounted for 68% of last year’s total origination activity; the mean firm originated $34.5 million with a mean of 7.9 employees; employment at the nation’s brokerages totaled 418,700; subprime and Alt-A loans accounted for 42.7% of brokerage’s total production volume; the average LO originated 26 loans in 2004; the average brokerage used a mean of 13 wholesale lenders; and average gross income per loan was 170 bp.

It’s a pretty big industry! What’s more, there is a host of existing laws and regulatory authorities at the State level already extant. What benefits are intended by federal regulation? What problems would these seek to correct?

Remember: it is not enough to say ‘there is a problem’. A solid argument that the proposed fix would be of net benefit is also necessary. It should also be remembered that the archetypal sub-prime borrower is not a Dickensian poor but honest family of four. The archetypal sub-prime borrower is a speculator, who put up the minimum downpayment while thinking of it as an “option to buy” more than anything else. I alluded to this on October 10 and a looking at data that is in this speech:

A first finding is that recent foreclosures have been disproportionately related to multifamily dwellings. In Middlesex County, Massachusetts, multi-family properties accounted for approximately 10 percent of all homes, but 27 percent of foreclosures in 2007. This highlights a potentially serious problem for tenants, who may not have known that the owner might be in a precarious financial position.

Yes, I know it’s not the most conclusive evidence that may be generalized! If anybody has any good data on the speculator/poor-but-honest-homeowner split amongst defaulting sub-prime, let me know!

Mr. Stern next addresses the Credit Ratings Agency issue in a manner that warms the cockles of my heart:

To be specific, it could be exceptionally costly for each investor to build the infrastructure required to conduct serious credit analysis, and these costs need to be weighed against the losses suffered by investors in the current regime. Moreover, were the agencies unique in underestimating the losses in, say, the subprime mortgage market?  It is not obvious that a different infrastructure will produce better results.
         
More positively, the rating agencies represent one way of economizing on the production of information on credit instruments. And by charging issuers, they also try to address the public nature of this information for, once the information is produced, there is almost no cost to distributing it and hence it is otherwise difficult to get paid. Absent these charges, there could be too little credit information produced.  Overall then, reforms that might compromise the viability of the agencies or discourage use of ratings present the tradeoff of potentially raising costs and ultimately requiring another solution to the issues the agencies help to address.

Now, I would like to hear more information about the proposal to lift the exemption from Regulation FD that now applies. But Mr. Stern admirably summarizes the major issue.

The next section is “Excess Liquidity”; I won’t re-hash the arguments about whether central banks should target asset prices here. In the conclusion to this section, Mr. Stern states:

Interestingly, the excesses in asset prices perceived in recent years seem related, at least casually, to innovation. Consider the run-up in prices of technology stocks in the late 1990’s and this year’s turbulence linked to pricing of structured financial products and subprime mortgages.  It may be costly to try to address these situations ex ante if, in fact, such actions would inhibit the underlying innovation. Common to all of these concerns is the difficulty of appropriately valuing financial assets.  It is quite plausible that, in pursuing preemptive action, the unintended consequences rival or exceed the desired outcomes.

which attracts the ire of Mr. Smith, who appears somewhat confused:

Similarly, his argument about innovation is specious. Innovation is not a virtue like faith or charity. A particular innovation is not valuable by virtue of merely being innovative (if so, virtually every venture capital proposal would be funded and become a barn-burning success); the measure of the value of an innovation is whether on balance it is beneficial. The jury is out on subprimes, but is it already clear that a lot of the so-called innovations, like no-doc loans, teasers, and high LTV loans, particularly in combination, weren’t innovations, but simply bad ideas.

Big Pharma is full of examples of promising drugs that never made it to market. Why? Either they failed to show sufficient efficacy, meaning they didn’t offer a compelling benefit, or they had potentially dangerous side effects. Why should the world of financial services innovation be any different? Their so-called innovations often deliver limited user benefits (but are more attractive for the producer) and in the case of products like subprime loans, came with toxic side effects, like bankruptcy.

It is not apparent how Mr. Smith would test financial innovation prior to putting it on the marketplace.

Mr. Stern’s concluding example is with respect to government support. He suggests:

In fact, by taking steps to reduce the threat that the failure of a large bank, or decline in asset values in one market, will spillover to other institutions or markets, policymakers can actually increase market discipline and simultaneously achieve greater financial stability.

… which suggests to me that if policy makers have sufficiently guarded against contagion to ensure that one failure won’t topple the system, they will be a lot more willing to allow that one failure; knowing this, banks will strive more carefully to ensure that they don’t become that isolated example; and creditors will strive more carefully to ensure they’re not (overly) exposed to that one example. It seems perfectly clear – but not to Mr. Smith:

“Limiting the size of losses” means “intervening earlier.” The lower the downside for taking risk, the greater the incentive to be reckless. How could this possibly increase moral hazard?

No, Mr. Smith, “Limiting the size of losses” does not necessarily mean “intervening earlier”. It may also mean “limiting contagion”. Mr. Stern made that clear.

All in all, a rather bland speech by Mr. Stern, a violent over-reaction by Mr. Smith.

Stephen Cecchetti was briefly mentioned here on August 27, and has now written another piece for VoxEU: Preparing for the Next Financial Crisis. He is apparently conducting a campaign to force as much financial trading as possible to occur on organized (and regulated!) exchanges; a previous essay that I missed was the topic of another Naked Capitalism post.

The core of Prof. Cecchetti’s argument is:

In order to reduce the risk that it faces, the clearinghouse requires parties to contracts to maintain deposits whose size depends on the details of the contracts. And at the end of every day, the clearinghouse posts gains and losses on each contract to the parties that are involved – positions are marked to market.

Since margin accounts act as buffers against potential losses, they serve the same role as capital does in a bank.   And marking to market creates a mechanism for the continuously monitoring the level of each participants capital.

It is important to realise that because they reduce risk in the system as a whole, clearinghouses are good for everyone. They are what economists refer to as “public goods”.

Well … I don’t buy it, although I would like to see further argument. If a particular security is 20 bid, 90 offered right now on the OTC market, I can think of all kinds of reasons why it will probably be 10 bid, par offered on a public exchange. The major effect of such a change will be to add a lot of instruments to the publicly quoted market that will be an awful lot like preferred shares … sure, you can trade small amounts through open outcry, but to get a big piece done you’ve got to call up a dealer who (if you’re lucky) will get busy and set up a cross.

Mainly, what you’re going to get is another big bureaucracy and 100,000 listed intruments with ludicrous spreads and no volume. Better pricing? Maybe sometimes. But Malachite Aggressive Preferred Fund has a section in the offering memorandum about pricing … if I don’t like the posted bid and offer, I can substitute my best guess (within limits!). I have seen lots of instruments quoted with no bid; many quoted with no offer; and lots quoted at spreads that make your eyes go pop. And believe me, prefs trade a lot more often than a lot of corporate bonds.

Mr. Ceccetti goes on to say:

On the information side, it is important that less-sophisticated investors realise the importance of sticking with exchange-traded products.  The treasurer who manages the short-term cash balances for a small-town government should not be willing to purchase commercial paper, or any security, that is not exchange traded. 

It is not and should not be the exclusive purpose of financial regulation to make life safer for the little guy. The treasurer in this example – and we shall assume for the moment that he’s just another wage-slave accountant, making a good faith effort to Do The Right Thing, but without the experience or the available time to be considered a market professional – should not purchase commercial paper at all. As I’ve pointed out before … there are plenty of institutional money market funds out there, available for 10bp per annum – if that – that provide all the good things regular mutual funds do for Joe Lunchbucket: instant diversification and professional management.

Mr. Cecchetti does not make clear just what problems exist in the current system that will be fixed – with net benefit – by a move to exchange trading. More information is urgently required!

There is good news today! Michael Mendelson (ex-president of Portus Asset Management) has been convicted of fraud. Hurrah!

What a strange day in the preferred share markets today! As far as I can tell, there is a “flight to brand-names” going on – sell everything that doesn’t have an ad on television!

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

Accrued Interest wrote an interesting post regarding market volatility, which is particularly timely in view of kaspu’s question in the November 15 comments. He reviews the constant 1-2% moves in the market (“Sub-prime’s over!” “Sub-prime’s worse!” “Buy!” “Sell!”) and concludes that as far as day-to-day excess volatility is concerned:

So if the market isn’t manic-depressive, and fundamental buyers don’t tend to jump in and out of their investments from day to day, who really is moving the market and why?The answer is so-called fast money. Mostly prop desks at the big dealers and some hedge funds.

I will agree that these players have a big influence; but will note that sometimes “real money” accounts hire “hot money” traders and, for better or worse, a huge pension fund can be taking a completely speculative ten-minute position. Lots of pension funds are explicitly invested in hedge-funds, for example, so the taxonomy becomes a little confused.

Other influences should not be disregarded. There are, for instance asymettric asymmetric rewards to stockbrokers: say that an issue that should be at $20 is trading at $18. After getting all their information and advice together, they are as sure of this as they will be of anything. But … say this thing is a pref that might default. If it goes to $20, they’ve made 11% on the investment and the client’s a little happier than otherwise. If it defaults, they lose the client. So they sell. Asymettric Asymmetric and non-aligned risk/reward profiles! If it subsequently defaults, they’ve got something to discuss with their clients for the next twenty years or so. If it subsequently goes to $20, they can simply emphasize how lucky the company was to avoid default and how no rational conservative investor would take such chances.

I myself have had extremely frustrating discussions with clients who want to sell something because it has gone down. If they sell it, they won’t have to worry about it any more. End of analysis.

Be that as it may, I think there’s some stuff left out of that; most notably that prices are set by the marginal buyer and seller. Royal Bank shares have a volume of what, maybe 2.5-million shares a day? The TSX advises that 1,276,215,683 common shares are outstanding, so daily volume is, on average, about maybe 0.2% of outstanding. So if Royal Bank goes up 2%, we can say that this is because investors worth 0.2% of the company decided it was worth 2% more, but holders of 99.8% of the company didn’t change their minds. There is no reason why every single one of the 0.2% minority can’t be real money.

It should be emphasized here that a great many models of efficient markets assume infinite liquidity – and infinite liquidity does not exist. If I’m a real money investor and I need to raise $10-million, the only things I can sell are the things I already own. So bang! there goes a $10-million sell order on the stock I choose and it may be expected that the price will go down, even though I haven’t changed my mind regarding that particular stock at all.

Such things are called market impact costs, virtually ignored by academics because it’s hard to measure, hard to model, and because it contradicts the Holy Efficient Market Hypothesis. One can make a whole lot of money – and many, many, many players do make a whole lot of money – simply by selling liquidity to the marketplace, taking the other side of those trades.

Accrued Interest makes another point with which I do not entirely agree -or, at least, that I feel deserves elucidation:

And of course, if XYZ is getting beat up, then other names in the same industry get beat up also. Maybe the buyer of protection on XYZ had a view specific to that company, but now there is momentum. Dealer desks will start buying protection against related companies. Suddenly a whole sector is 30-50bps wider on no news.

I have no doubt that in lots of cases the transmission mechanism is as silly as AI describes, but there is a more rational explanation.

Say I have a certain amount of my portfolio invested in Banks. At 9am I’m very happy about my portfolio, because it’s all in the cheapest bank, “A”. Without any news – or, at least, with no news I deem significant – Bank “B” starts diving. Quick! Update the valuation model! Yes! A swap is possible! Sell “A” and buy “B”! Thus, while acting as a strictly fundamental value investor, I am converting weakness in “B” to weakness in “A”.

Anyway … there was a bit more clarification on the Fannie Mae accounting panic discussed briefly yesterday. Fannie was so worried, they held a conference call. From what I could make out – without having done any prep on this, you understand; the kerfuffle is over one table in a set of three filed documents each being 100-odd pages long – what happens is this:

• FNMA securitizes & guarantees mortgage pools
• One mortage with a principal value of $100,000 goes bad.
• Fannie buys it from the pool for $100,000 (this is where they earn their guarantee fee)
• Fannie determines the actual value of the mortgage using its internal models
• Fannie determines the market value of the mortgage (this is the fun part … getting quotes on delinquent mortgages in this environment)
• Fannie puts the asset on the books at the lower of the two prices (guess which one that is) and charges the balance to expenses

As far as I could make out from the call, they are claiming:

• the expense skyrocketted this quarter because market value has plummetted, not because of any huge increase in volume, or because their internal recovery expectations have changed much
• they expect the majority of the delinquencies to be cured
• the loss recovery rate will be fairly large and will come back onto the balance sheet as income

I think. Bloomberg has a story on it too.

Same old same old in pref-land: volume is good, prices are strange.

 

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

Update, 2007-11-18: Spelling of assym asymett asymmetric has been corrected. Thanks to a Keen-Eyed Assiduous Reader!

Well, there won’t be much today, I’m afraid! What with fixing (well, patching, anyway) my server problem and a … rather exciting day in the markets, there hasn’t been much time to Stay Abreast of Current Events.

Richard Portes of the London Business School has written a very good essay on VoxEU: International Stability by Design which serves as an executive summary for a major work that he co-authored International Financial Stability.

Now, it is a little fishy of me to comment on his VoxEU essay without purchasing and reading the work on which it is based – but hey! I’m sure he doesn’t mind a little publicity. He deals with hedge funds first, denying any pressing need for regulation:

Many regulators in the US and other major markets believe that the best way to monitor hedge fund activity is indirectly, through their sources of funds.
…
We see no clear benefit from additional regulation.

So far so good! It was only yesterday that I reiterated my prediliction for a non-regulated – lightly regulated, anyway! Things like insider trading and false advertising still need to be looked at! – sector of the financial markets, where innovation is king.

He is not concerned about the potential for financial market destabilization due to carry trades.

He is concerned, however, about the regulation of Large Complex Financial Institutions:

This suggests that not only regulators, but also the major central banks must cooperate more closely in dealing with liquidity shocks.

but does not provide any specifics – in this summary – of what he means by this. The Bank of England lists LCFIs as:

LCFIs include the world’s largest banks, securities houses and other financial intermediaries that carry out a diverse and complex range of activities in major financial centres. The group of LCFIs is identified currently as: ABN Amro, Bank of America, Barclays, BNP Paribas, Citi (formerly Citigroup), Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan Chase & Co., Lehman Brothers, Merrill Lynch, Morgan Stanley, RBS, Société Générale and UBS.

LCFIs had the incomprehensible total of USD 23-trillion in assets in 2006, according to Chart 10 of the Bank of England’s April 2007 Financial Stability Report. The Financial Times had a very good report on this at the time.

The next section of Portes’ essay deals with the somewhat related issue of new financial instruments:

Given all the benefits from innovative financial instruments, the appropriate question is how to make these instruments safer. First, market-driven, but regulatory- and supervisory-authority-guided, approaches are necessary for successful financial risk management. As new instruments are designed, regulation must keep pace. Second, financial risk-management solutions must be global.

Finally, having prepared the ground by addressing LCFI regulation and financial novelty regulation, we get to the heart of the matter (and without this section my review of the essay would have been much more cursory!):

Transactions that do not transfer risk should not be treated by regulators as if they do
…
Many of the new instruments are illiquid, and the role of ratings firms in evaluating them is highly controversial. There has been a transfer of activity from regulated to unregulated investors.
…
The shift from ‘buy and hold’ to the ‘originate to distribute’ model should not (and probably cannot) be reversed. Policy-makers and industry bodies can try to make it work better, to push it towards a more balanced, market-based model through reforms that include:

• Regulators and market participants should pay particular attention to “tail risk”
• New regulations could require originators to retain equity pieces of their structured finance products.
• Regulators need aggregate information on structured finance instrument holdings and on the concentration of risk to assist in the regulatory process.
• Industry bodies should promote product standardisation and accurate pricing in the structured finance market.
• Credit market transactions that do not definitively transfer risk should not be treated by regulators or risk managers as if they do.
• Ratings firms should provide a range for the risk of each instrument rather than a point estimate, or should develop a distinct rating scale for structured finance products.

I consider these recommendations rather breathtaking – but there is doubtless argument to support the conclusions in the full report. I will merely point out that:

• the industry, to at least some extent, likes non-standardized products and inaccurate pricing. They can make more money trading that stuff against players who have no idea what they’re doing.
• how is the requirement that originators hold equity pieces of their transactions to be enforced? If I have some kind of risky revenue stream that I want to monetize, are the regulators really going to stop me? My instinct is to leave this kind of thing with the market and make the ability to say ‘We’ve got skin in this game’ a competitive advantage.
• the ‘new credit ratings scale’ recommendation has been floated so many times it is acquiring a veneer of inevitability. But Joe Broker does not want a new ratings scale. He wants something easy to explain to his client and his client just wants his hand held. I don’t know what kind of practical effect this cosmetic measure will have.
• all these recommendations will come to nothing for as long as investors don’t care about their returns – that is, forever.

My last point deserves at least a little elucidation. I have never talked to an investor who didn’t claim he was after performance … sometimes with less risk, sometimes with more risk, but all these guys have been pretty tough cookies, you know, and want good performance … or so they say.

The OSC issued a press release today regarding their review of ICPM marketting practices. I was on the long-list for their preliminary review – I believe every ICPM was. I had to provide them with a list of my websites and a copy of all printed marketting material; after submitting it, I never heard from them again.

Have a look at their summary of results … and bear in mind that these are Investment Counsel / Portfolio Managers that are being looked at, not mere stockbrokers:

Most of the deficiencies fall into one of the following areas:

1. preparation and use of hypothetical performance data
2. linking actual performance of the ICPM’s investment fund or investment strategy with the performance of another fund or investment strategy
3. construction and marketing of performance composites
4. construction and use of benchmarks in marketing materials
5. use of exaggerated and unsubstantiated claims in marketing materials

In the absence of actual deceit, not a single one of the sharp practices listed will withstand two minutes of questioning by a client who is concerned about performance. While the OSC’s efforts in this area are to be applauded, you cannot regulate common sense.

And, briefly, the bond-insurer saga continues, with fears of a USD 200-billion hit to markets if the insurers are downgraded … but the math looks bad enough without being as pessimistic as the very gloomy assumption required to get that high:

Then there is the $1 trillion market for insured securities backed by assets such as home-equity and consumer loans. Concerns about the underlying quality of the assets and the viability of the guarantors have caused investors to price some securities relative to the credit-default swaps of the insurers, according to David Land, a mortgage-bond fund manager at Advantus Capital Management. Advantus, based in St. Paul, Minnesota, oversees about $18 billion.

Insured securities backed by home equity-lines of credit have fallen by 15 percent, based on the rise in credit-default swap rates this year on Ambac’s insurance company. If the entire insured market were to drop that far, it would reduce the value of the securities by $150 billion.

There are some reports of a change in accounting treatment of credit losses by Fannie Mae – which readers will remember is a grossly undercapitalized Government Sponsored Enterprise. As I mentioned on September 20, the GSEs are helping to bail out the mortgage sector, to the condemnation of all right-thinking individuals and cheers from Congress.

As far as I can make out from the FDIC supervision manual, the change in accounting treatment relates to the discounts at which loans are purchased from a third party. If a $100,000 loan is purchased at $60,000 (due to credit concerns), it is no longer booked as a $100,000 loan with a $40,000 credit reserve; it’s booked as a $60,000 loan.

Given that the GSEs are now purchasing impaired loans (at least, to a far greater extent than they have in the past), one would definitely expect there to be a large difference between results from the old and new calculation methodologies. In other words, the issue sounds like a lot of fuss over nothing – but to confirm that I’d have to look very carefully at the source documents and I don’t have time. I’ll leave it as an exercise for the student.

A busy day in the preferred market, with prices falling amidst the now usual amount of completely strange relative pricing.

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

I must say, my respect for Arthur Levitt continues to decline – his Credit Rating Agency recommendations did not impress and now he is quoted in a manner which makes it appear he doesn’t understand investing:

The Florida agency that manages about $50 billion of short-term investments for the state, school districts and local governments holds $2.2 billion of debt that was cut below investment grade.
…
“It’s really disgraceful,” Levitt said. “I think what’s really bad about this is that the state has called for investments to be prudent and careful but clearly the custodians of this fund were reaching, they were trying to get maximum yield.”

Four percent of a portfolio goes bad (and I’ll bet a nickel that recovery handsomely exceeds 90%) and that is sufficient for Levitt to use words like “disgraceful”? This does not do a service to anyone. Four percent does not sound reckless to me; it sounds diversified – especially since there are four different vehicles involved. If Mr. Levitt wishes all public pension funds to be invested in guaranteed-no-default T-bills exclusively, he should say so, instead of gleefully crying “I told you so! Or, at least, I could have told you so if you’d asked me!” after the events.

The Prudent Man Rule goes both ways, Mr. Levitt. A Prudent Man will take Prudent Risks to increase return. Sometimes, Mr. Levitt, taking a risk will lose money. That’s why they’re called Risks, Mr. Levitt. There is nothing in Mr. Levitt’s remarks to indicate that the managers of the portfolio violated their mandate.

In somewhat related news, Naked Capitalism informs us that a GE Cash Management Fund has Broken the Buck. This is not a Money Market Fund, as regulatorially defined, but an enhanced yield fund – in addition to bailing out its MMF, Bank of America also bailed out its “institutional cash fund, which isn’t technically a money fund.” I have written an article, which I hope will be published shortly, on this general topic.

I’m a much bigger fan of Dallas Fed President Richard Fisher. He sounds much more reasonable when discussing a Central Banker’s favourite topic:

But he says rising food and energy prices are the big concern, creating “a risk of a more pernicious pass-through effect than we saw in the recent price increases of underlying commodities.”

The spread between food price inflation and core inflation hasn’t been so large in a quarter century, Mr. Fisher says. And energy prices are rising due to strong demand and trading activity. “All this gives me a sense of discomfort on the headline inflation front, and it is a reminder that the balance of risks is not skewed unilaterally toward slower growth.”
…
“You might say the credit markets have gone from the ridiculous to the subprime; the subprime and related derivatives market is the focus of angst, but the ridiculous practice of the suspension of reason in valuing all asset classes appears to be in remission, if not over,” he says.

While we’re on the topic of the Fed … explicit inflation targetting, the subject of some speculation November 12, has not been adopted. Meanwhile, Paul De Grauwe weighs in with an essay advocating:

• Asset-price targetting by Central Banks (a recurring theme discussed at the Jackson Hole conference and reported here August 31)
• Central Bank “regulation of all institutions that create credit and liquidity”.

His justification for the second point is:

During the last few years, a significant part of liquidity and credit creation has occurred outside the banking system. Hedge funds and special conduits have been borrowing short and lending long, and as a result, have created credit and liquidity on a massive scale, thereby circumventing the supervisory and regulatory framework. As long as this liquidity creation was not affecting banks, it was not a source of concern for the central bank. However, banks were heavily implicated. Thus, the central bank was implicitly extending its liquidity insurance to institutions outside the regulatory framework. It is unreasonable for a central bank to insure activities of agents over which it has no oversight, very much as it would be unreasonable for an insurance company selling fire insurance not to check whether the insured persons take sufficient precautions against the outbreak of fire.

I don’t buy it. Regular readers will remember that while I am all in favour of a very strong financial system, I am also a big fan of an unregulated “country bank” sector where innovation is king … a junior league where risks are taken and products are developed. While the existence of such a sector should not be allowed to endanger the core banking system, this policy objective does not require stringent regulation of the sector. What it requires is stringent regulation of the banking system’s exposure to this sector – readers with memories going back to October 15 will remember that I suspect that such exposure has not been stringent enough; the risk-weighted assets deemed to be on the banks’ balance sheets through such exposures should simply be weighted more highly.

Bear Stearns has ruthlessly prettied-up its balance sheet:

Bear Stearns Cos., after posting its biggest earnings decline in more than a decade, reduced subprime holdings by 50 percent in the past two months, limiting writedowns in the fourth quarter to $1.2 billion.
…
Bear Stearns is regaining hedge fund customers that defected amid the credit rout in the third quarter, Molinaro said.

Hedge fund balances are “coming back” to the firm’s prime brokerage unit, and have steadied in the current quarter, he said. The business is “on pace for a record year.”

I say “prettied up” rather than “improved” because I have no way of knowing whether the sale of sub-prime assets actually improved their financial condition or not. However, if you have assets held at $100 on the balance sheet with a “fair value” (whatever that means) of $90 and a market price of $80 that are being valued by investors in your company (and your customers!) at $50 … well, taking one consideration with another, you’re better off gritting your teeth and selling them at the lousy $80 price, which is $10 cheap. It pretties up the balance sheet.

Remember BCE? Geez, it’s been a long time since I’ve discussed BCE. There was a rather interesting story today about Cerberus and United Rentals:

“This deal was expected to close sometime this week,” wrote Stephen Volkmann, an analyst with J.P. Morgan Securities Inc. in New York. “The banks were struggling with selling the associated debt offering.”

The takeover agreement includes a $100 million termination fee that Cerberus, founded by former Drexel Burnham Lambert Inc. trader Stephen Feinberg, would be required to pay unless it can show that there was “material adverse change” in United Rentals financial condition.

Cerberus told United Rentals there had been no such change, according to the statement. Cerberus has commitments from its banks to finance the transaction through bridge facilities, United Rentals said, adding it believes the banks stand ready to fulfill their contractual obligations.

“It’s a combination of the financing being more expensive and they must also think the business is not as attractive,” said Steven Kaplan, a professor at the University of Chicago Graduate School of Business who studies private equity. “Paying $100 million is a better outcome than doing a deal that’s not going to work.”

I continue to have no opinion regarding whether the BCE/Teachers deal will actually be consumated – there’s simply no information available on which to base an opinion and things may change a lot between now and the last minute. But if it comes to the point at which the consortium believes it has a choice between losing $1-billion quickly or $10-billion slowly … I’ll bet a nickel I can tell you which way they’ll jump.

OK, let’s step back a bit and discuss a funny thing on the Internet I’ve seen today!

Canada Newswire has very strict terms of use, but I can’t link to them. I can only link to “CNW Group Home Page” as per their terms of use:

Unless you have a written agreement in effect with CNW Group which states otherwise, you may only provide a hypertext link to the CNW Group Web site on another Web site, provided that (a) the link is a text-only link clearly marked “CNW Group Home Page”; (b) the link “points” to (i.e. links the user directly to) the URL www.newswire.ca/en and not to other pages within the CNW Group Web site; (c) the appearance, position and other aspects of the link is not such as to damage or dilute the goodwill associated with CNW Group’s name and trade-marks; (d) the appearance, position and other aspects of the link does not create the false appearance that an entity is associated with or sponsored by any of us; (e) the link, when activated by a user, displays CNW Group Web site full-screen and not within a “frame” on the linked Web site; and (f) CNW Group reserves the right to revoke its consent to the link at any time in its sole discretion. [Emphasis added – JH]

Now, turn to any random press release. They invite you to use four different web cross-referencing techniques to link to a particular press release.

Well … I thought it was funny!

Indices will be delayed. Prices have been updated, but I’m having some kind of strange server problem, probably related to database size … buy you don’t want to know about that! I will update in the near future.

Update, 2007-11-15

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

Menzie Chinn at Econbrowser has reviewed credit and term spreads: 

He notes:

It might appear that the two phenomena are unrelated. But the DB article argues that while banks pursued off-balance sheet activities such as “rating transformation” (transmuting assets of one credit default risk category to another category by financial engineering), they moved away from reliance on maturity transformation and taking on credit risk. With the end of the structured credit market, and reorienting of banks’ operations, credit spreads and term spreads will reappear.

Interestingly, as Chart 6 illustrates, term and credit spreads are not back to where they were pre-2005. However, in terms of the latter, they’re close. And, as time on goes on, one might very well expect further curve steepening.

It would certainly be a pleasure to see some actual curve steepening! Preferably a bull steepening (in which the steepening is effected by a decline in shorter-term rates), just to wipe the smug smile off the faces of those who claim to be avoiding risk by shortening term! Bloomberg notes, however, that steepness and fear of inflation are intertwined.

In somewhat related news:

JPMorgan Chase & Co. CEO Jamie Dimon said SIVs, whose assets have dwindled by at least $75 billion since July, will “go the way of the dinosaur.”

“SIVs don’t have a business purpose,” Dimon, 51, said at the Merrill Lynch conference today.

I consider this “somewhat related” because of the term spread; a SIV is nothing more nor less than an unregulated “country bank”, seeking to make money from the term spread (financing long-term assets with short paper) and the credit spread (enhancing the credit quality of its debt by subordination of its senior tranches with equity tranches). What we are seeing now is the unravelling of the business model due to:

• General loss of confidence (equivalent to a bank run)
• Bad quality on their asset side

… which are the same things that will do in any bank.

While I agree that SIVs qua SIVs are dead, I’m not so sure that they served no business purpose; and feel entirely confident that other vehicles – probably better capitalized and not so aggressive with their financing models – will arise to take their place. People want to lend short and borrow long. In the aggregate, short-term money is available for the long term. Banks, SIVs and ABCP conduits all serve the same business purpose in this respect … so I’m not sure what Dimon meant.

I mentioned possible downgrades of bond insurers on November 9. Accrued Interest has continued his educational campaign by analyzing some scenarios for ABS default, insurance and recovery that sheds quite a bit of light on the matter.

The CDOs are tricksy things! Fitch Ratings indulged in a mass downgrade yesterday:

Derivative Fitch–New York–12 November 2007: Derivative Fitch has downgraded $37.2 billion (U.S. dollar and U.S. dollar equivalent) and affirmed $6.9 billion of structured finance collateralized debt obligations (SF CDOs) across 84 transactions. Fitch’s rating actions follow the completion of a review of 55 U.S. and European SF CDOs executed on a synthetic basis, and 29 U.S. and Asian SF CDOs executed on a cash/hybrid basis. Ratings on 66 U.S. cash and hybrid SF CDOs remain on Rating Watch Negative pending resolution on or before Nov. 21, 2007.

A downgrade:affirm ratio in excess of 5:1 is big news, especially since many of the downgrades are multi-level:

more than $14 billion worth of transactions falling from the highest-rated AAA perch to speculative-grade, or junk, status.

The implications can be as scary as you want them to be. Naked Capitalism provides excellent links to some informed discussion. Just to make things even more interesting – for those of you who are bored by mere multi-billion writeoffs – Naked Capitalism also reports on a now somewhat dated (two weeks) judgement refusing foreclosure to Deutsche Bank:

Judge Christopher A. Boyko of the Eastern Ohio United States District Court, on October 31, 2007 dismissed 14 Deutsche Bank-filed foreclosures in a ruling based on lack of standing for not owning/holding the mortgage loan at the time the lawsuits were filed.

Whether this was an isolated SNAFU by Deutsche, or indicative of lack of paper trail maintenance by the various intermediaries, is something regarding which I do not care to speculate at this time.

Naked Capitalism also takes issue with Countrywide funding its operations with Certificates of Deposit, but I can’t see any problem with that … provided that FDIC and Fed is supervising the bank properly and it’s solvent. Otherwise, of course, it would be a Bad Thing. I’m much more concerned about the back-door guarantees via the Federal Home Loan Banks, as I noted on October 30.

I noted yesterday that Legg Mason was bailing one of its MMFs out of SIV paper – now it appears that Sun Trust is doing the same thing along with Bank of America and at least two others. This is a very worrisome development for the investment industry as a whole … I am currently trying to finish an article on the topic, but there’s a lot going on in the market just now! In an overdue development:

The 10 largest managers of U.S. money funds have about $50 billion in short term debt of SIVs, some issued by vehicles such as Cheyne Finance Plc that defaulted as investors shunned the funds on concerns about losses from securities linked to subprime mortgages, according to reports from the companies.
…
BlackRock, the largest U.S. publicly traded asset manager, has been in contact with the Treasury, Fink said. BlackRock will raise “multibillion dollars” to invest in distressed securities that are resulting from the “chaos” in the market, Fink said, while declining to elaborate on fund details.

Well, whether Superconduit = Vulture or not, there’s at least one major player stepping up!

If today’s news has been too cheery for you: consider deadly bird flu!

Good volume, poor returns in the preferred share market today.

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

A quiet day, with bond markets closed for Rememberance Day.

There is speculation the Fed will move to explicit inflation targetting … but the WSJ can’t make up its mind. At a Bank of Canada conference in 2006, Alan Blinder, a former Fed Vice Chairman, commented on evolution of Bernanke’s thinking on the subject to that date.

There are some heavy-weight predictions of a US slowdown floating around, linked by both Naked Capitalism and WSJ. Willem Buiter points out that the banks are feeling some strain:

At the end of October 2007, the net worth of commercial banks in the US (as reported by the Fed) stood at just under $ 1.1 trillion (against assets of $10.7 trillion). Tier 1 capital stood approximately at $964 bn. While quite a significant share of the mortgage-related losses will be born by financial institutions other than commercial banks, such as investment banks, commercial banks’ capital will take a significant hit.
…
The combination of losses and unintended asset accumulation may depress the banks’ capital ratios to the point that dividends and share repurchases are threatened and even rights issues may have to be contemplated. All that does not do much for their willingness to engage in new lending, including to the real economy.
…
The single best thing that could happen would be for the true magnitude of the losses suffered by banks and other exposed parties to be revealed and put in the P&L. Until what happens, fear of getting stuck with the hot potato makes banks unnaturally unwilling to extend credit against the kind of collateral that they would not have thought about twice accepting at the beginning of the year.

Noriel Roubini, while acknowledging the banks’ problems, considers the wealth effect and increased difficulty of Home Equity Withdrawal to be more important.

Naked Capitalism points out that there is mass confusion over Super-Conduit, what it is supposed to be doing and whether there is economic reason to expect it to work … but quite frankly, I can’t be bothered to discuss the situation much any more. There’s no information – merely rumours. I’ll talk about it when there’s something to talk about.

But there is some related news illustrating the problem. Readers with exceptional memories may remember Ottimo Funding, briefly mentioned here on August 21:

Mortgage companies without any sub-prime on their books, such as Ottimo Funding LLC, are experiencing financing difficulties.

Well, it’s gone bust:

Ottimo Funding Ltd., whose name is Italian for “excellent,” started selling its $2.8 billion of mortgage bonds this week after being unable to raise debt financing in the commercial paper market, according to three people with knowledge of the sale.

The securities being auctioned are rated AAA and backed by Alt-A mortgages, a credit class above subprime, according to Standard & Poor’s. The sale probably won’t generate enough cash to fully repay investors who bought short-term debt from the fund, the ratings firm said last week.

As far as I can make out from S&P ratings reports, Ottimo was one of several Extendible asset-backed commercial paper (ABCP) conduits with no or partial third-party liquidity support – in other words, it was like a Canadian ABCP issuer, relying on credit enhancement and extendability to avoid liquidity squeezes.

In a fascinating report, the Asset Management firm Legg Mason has disclosed it is bailing one of its MMFs out of ABCP trouble:

Legg Mason Inc. invested $100 million in one of its money-market funds and arranged $238 million in credit for two others as a cushion against potential losses on commercial paper linked to subprime mortgages.

In related problems, E-Trade is in trouble:

Chief Executive Officer Mitchell Caplan’s strategy of building E*Trade’s bank by tripling loans outstanding backfired as borrowers fell behind on payments and U.S. home prices declined.
…
Bhatia estimated that E*Trade will post a loss in the fourth quarter after setting aside $500 million in extra money for bad loans and writedowns. Clients in the company’s brokerage unit may shift their accounts to rivals, while deposits at the bank could erode, said Bhatia, who cut his rating on the stock to “sell” from “hold.”

Citigroup is downgrading E*Trade “based on the higher probability of a run on the bank,” Bhatia said.

But let’s keep things in perspective. While there is lots of pain, while some people are losing their jobs, others their houses and an overall slowdown in forecast by some … Wall Street is still on track for a great year. They take risks and when it works against them the numbers are huge … but when they work out – as, by and large, they did in the first half of the year – the numbers are even bigger.

At least one Wallaby Street player is doing pretty well too:

Macquarie Group Ltd., Australia’s biggest securities firm, said first-half profit climbed 45 percent to a record on higher trading income and increased fees from mergers and acquisitions.

Net income rose to a record A$1.06 billion ($931 million), or A$4.02 a share, in the six months to Sept. 30, from A$730 million, or A$3.01 a share, a year earlier, the Sydney-based bank said in statement today. That beat the $1.03 billion median estimate of four analysts surveyed by Bloomberg.

It was a quiet day for prefs with relatively light volume … not only were the bond markets closed, but all eyes were on stocks and currencies! It was good to see BAM.PR.N among the volume leaders … but a continuing puzzle to see it among the loss leaders as well!

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

Well, there’s a day and a half!

US T-Bill yields plunged again and Fed Funds futures are now showing certainty of a cut to 4.25% in January, down from the current 4.5%. In what may be assumed to be related news, the Bank of Canada intervened to boost the overnight rate – presumably, there’s a lot of cash-equivalent money looking for a home.

There are alarming reports of gloomy consumers, but the direct catalyst is, as usual, more bad news from the banks. CIBC, ‘bank most likely to walk into a sharp object’, is taking a $463-million CDO/RMBS writedown, which offsets their gains from the VISA restructuring (TD has managed to hang on to its profit). Rumours that Barclays is looking at a big write-off triggered a temporary collapse of their share price, but they staggered back to more usual levels by the end of London’s trading day – Barclays’ CEO has stated “his refusal to comment on subprime writedowns indicates there is no truth to speculation about losses that wiped 29 percent off the bank’s market value in the past month”. Wachovia has disclosed $1.7-billion mark-to-market losses in October alone. Nouriel Roubini somewhat gleefully forecasts a total of $500-billion on a mark-to-market basis.

It’s almost a relief to see news of the first CDO liquidation:

Carina is the first CDO to begin unwinding after a slump in the credit worthiness of the underlying assets, S&P said. Thirteen others have informed S&P of an event of default, a precursor to liquidation. A widespread fire sale by CDOs, which package asset-backed securities and resell them in pieces, may further exacerbate declines in subprime-mortgage securities.

As these structures unwind it will become easier to sort out the winners from the losers … and easier for investors to price the assets!

On November 7 I made the comment:

Even worse, Citigroup has increased its exposure to CDO-issued CP, which has had the effect of ballooning the amount of Level 3 ‘Mark-to-Make-Believe’ assets. Citigroup’s cost of borrowing, as proxied through Credit Default Swaps, is skyrocketting.

I should make this more clear; banking & investment strategy is sometimes a little more complicated than can be summarized in a couple of casual sentences – particularly when discussing an institution that has more capital in the business than the Canadian Big Five-and-a-Half put together. It is not necessarily a Bad Thing for Citigroup to accumulate CDO paper and Level 3 assets. Panic has hit the markets and panics are the perfect time for an organization that has already done its homework to make an absolute killing taking unwanted assets off other people’s hands.

However, there are knock-on effects. If this same panic causes their borrowing costs (as proxied by CDS levels) to increase beyond the expected winnings, then the strategy becomes defunct. No matter how stupid the market is being in increasing the funding costs of such an investor. Blind fear in the marketplace can paralyze even a well-prepared investor.

What’s needed is for “real money” investors (those who will be perfectly happy holding on to the paper until maturity, like pension funds, retail investors and such, since they’re not completely at the mercy of mark-to-market; as opposed to “hot money” investors who want to flip it next week) to step up and buy the stuff. I suspect, however, that any pension fund manager who suggests such a plan at this stage of the game to an ordinary, unsophisticated pension board will get a blank stare and a chuckle instead of a mandate.

But at least one major player has gone bottom-fishing in the bond-insurers market:

MGIC Investment Corp. and PMI Group Inc., the two largest U.S. mortgage insurers, rose in New York trading after insurer Old Republic International Corp. disclosed it became the biggest investor in each company.

More news on the bond insurers’ front, as well. Fitch is reviewing the bond insurance industry, which may need to raise capital at one of the worst possible times to do so (typical!). Josef Ackerman, CEO of Deutsche, warns of a very strong impact on financial assets if a downgrade comes to pass, as has been previously stated by Accrued Interest. Naked Capitalism passes on the report that Fitch is outraged by the Financial Times misuse of technical terms in reporting the concerns … in times like this, when a misplaced comma in a Bernanke speech could cost billions, the technical guys want precision above all else! Two major municipal refinancings have been delayed due to market instability.

Naked Capitalism has a very good piece about Cuomo’s investigation of WaMu regarding possibly deliberately inflated appraisals of properties. I didn’t discuss it at the time, thinking it was just minor league grandstanding, but it seems more serious – especially since it appears Cuomo knows little about the business – or is disingenuously overstating his case. Lockhart’s letter, linked by Naked Capitalism, is priceless; Accrued Interest translates the refined prose into more every-day language.

However, I must take issue with Naked Capitalism’s characterization of the GSEs::

Cuomo astoundingly called the GSEs investment banks, and as the article points out, raises doubts about the value of their even though they are government backed. Huh? That is likely the basis for Lockhart’s “you may not understand remark.”

The last thing the securities market needs is doubts being cast on the creditworthiness of Freddie’s and Fannies’ paper.

GSEs are not, in fact, government backed. There is certainly a market perception that they are government backed … but if push comes to shove, Congress can let them rot. There is a very dangerous ambiguity in Fannie & Freddie’s status that should be clarified; they walk like banks, talk like banks and write cheques like banks – they should be regulated like banks. I often link to James Hamilton’s presentation to the Jackson Hole conference which addressed the issue: now I’ll link to it again. Speaking of Fannie Mae, they too aren’t doing too well in the current environment:

Fannie Mae, the biggest source of money for U.S. home loans, said its third-quarter loss more than doubled to $1.39 billion as a deepening housing slump increased mortgage delinquencies.

The net loss was caused by a $2.24 billion decline in the value of derivative contracts and $1.2 billion in credit losses among the $2.7 trillion of mortgage assets Fannie Mae owns or guarantees, the Washington-based company said today in a U.S. Securities and Exchange Commission filing.

Fannie Mae has a minimum capital requirement of $30-billion and maintains a 30% surplus over this figure. So say they’ve got twice the capital of Royal Bank (Fannie Mae is far more highly leveraged, due to the inadequacies of the legislation) … can you imagine the consternation if Royal Bank lost $700-million in a quarter?

A relatively calm day for preferreds, with good volume.

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

Thursday! The day when the US Commercial Paper Outstandings get reported! The Fed reports that ABCP outstanding declined by $29.5-billion, a marked increase in pace over the past month, as deleveraging is quickly becoming a major issue in the States. Bloomberg provides a review.

Bernanke is clearly a reader of PrefBlog – his testimony to the Joint Economic Committe echoed what I’ve been saying about Super-Conduit:

So … if it works properly I think it would speed up the recognition of values in part because it would remove some of the risk of fire sales, of rapid drawing down of assets in some of these vehicles and allow the market to stabilize and begin to make a better longer term valuation of what these assets are worth.”

He added, “If that’s the way it works, and again it depends on execution, it would remove some overhang from the market, it would create a stable financing source for those assets and it ought not to be inconsistent with the price discovery process.”

Mainly, though, he just told the politicians on the committee to mind their own bees-wax. Good for him! He may have enough to worry about soon enough – there’s at least one analyst raising the spectre of 5% headline inflation as the Ghost of Christmas Present!

Despite this horrifying projection (noting that, gee, the projection for core inflation isn’t quite so bad), Treasuries were up on expectations of a Fed cut, as early indications point to a lousy Christmas for retailers. 

In SIV news that I missed yesterday … one of the SIVs affected by Moody’s mass review was Links Finance … proudly owned and operated by our very own Bank of Montreal:

Links Finance Corporation (US$1.9 billion of debt securities affected)

Mezzanine Capital Notes

New Rating: Aa2 on review for possible downgrade

Previous Rating: Aa2

Standard Capital Notes

New Rating: A3 on review for possible downgrade

Previous Rating: A3

Links Finance’s net asset value declined to 83% from 94% since Moody’s last review on September 5th. Moody’s review will focus on the potential for further market value deterioration.

Cheery, eh? There’s more:

Managers of structured investment vehicles don’t expect their business model to survive as the value of assets shrinks and the companies struggle to borrow, Moody’s Investors Service analysts said today.

Sic transit gloria mundi.

Apropos of nothing, I ran across a Ministry of Finance puff-piece today, which made the claim:

The World Economic Forum’s Global Competitiveness Report for 2001-2002 ranked Canadian banks among the soundest financial institutions in the world (see Chart 5). The soundness of the Canadian banking industry has been demonstrated many times over the past several years. Canadian banks weathered the debt difficulties of the less developed countries in the early 1980s, the decline in real estate values a decade later, and the Asian crisis in the late 1990s without experiencing any systemic problems.

… which was kind of cool. Our second place finish has been repeated in the 2007-2008 Report, although you have to poke around a bit to verify that. (hint: Country Analysis / Balance Sheet).

And, as far as preferreds go … another day of entirely reasonable volume but disappointing returns. The long corporates index is now yielding just a hair under 5.8%. So let me think about this. You can get the same pre-tax yield with better quality owning GWO.PR.H, at the closing bid. Potential tax benefits – or potential capital gains when others recognize the potential tax benefits – are merely icing on the cake. If this makes sense to anybody, please let me know.

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

Update, 2007-11-09 Holy smokes! Yesterday I titled this “October 8” and have now changed it to, er, the right month. I had the day and year right! I must have been feeling nostalgic …

It looks like the Super-Conduit MLEC is having difficulty getting started even as SIVs are getting shakier by the day. Naked Capitalism reprinted a piece about a downgrade today by Moody’s of 16 SIVs representing about 10% of the market; but only two capital notes were actually downgraded; the senior paper and other capital notes are merely (!) under review according to Moody’s:

Moody’s Investors Service announced today that it has substantially completed another review of the Structured Investment Vehicle (SIV) sector following continued market value declines of SIV portfolios since our most recent review completed on September 5th of this year. As a result of this review, Moody’s has confirmed the short term ratings of the senior debt programmes of Kestrel Funding PLC and Kestrel Funding LLC (which hold approximately US$3 billion of debt securities) that were on review for possible downgrade. Moody’s also downgraded, or placed on review for possible downgrade, the ratings of 28 debt programmes of 16 SIVs (which hold approximately US$33 billion of debt securities) as described below.
…
The ongoing liquidity crisis facing SIVs has continued almost unabated since September 5th, when Moody’s completed its last review of the sector. The inability of some of the SIVs to issue sufficient Asset Backed Commercial Paper (ABCP) or Medium Term Notes (MTNs) over a prolonged period has led to the crystallisation of mark-to-market losses in some cases and the potential for such losses to be realised in others.
…
Moody’s has taken certain rating actions as a result of deteriorating credit and other market conditions. It seems clear that the situation has not yet stabilised and further rating actions could follow. As with previous actions, the rating actions Moody’s has taken today in response to the current situation are not a result of any credit problems in the assets held by SIVs, but rather a reflection of the continued deterioration in market value of SIV portfolios combined with the liquidity crisis.
…
SIV senior note ratings continue to be vulnerable to the unprecedented large and sustained declines in portfolio value combined with a prolonged inability to refinance maturing debt. SIV capital note ratings will be affected primarily by further deterioration in the market value of the portfolio. The risk of realised losses on capital and even senior notes is likely to increase significantly if the SIV is placed in a position where it must sell assets rapidly in a “fire sale.”

A lot of the problems are related to turmoil at Citigroup; its support of its SIVs (through the purchase of $7.6-billion in commercial paper) was discussed yesterday. Even worse, Citigroup has increased its exposure to CDO-issued CP, which has had the effect of ballooning the amount of Level 3 ‘Mark-to-Make-Believe’ assets. Citigroup’s cost of borrowing, as proxied through Credit Default Swaps, is skyrocketting.

They’re all in trouble! Latest estimates (which may have been padded to make them more interesting) are that Wall Street will take massive writedowns:

U.S. banks and brokers face as much as $100 billion of writedowns because of Level 3 accounting rules, in addition to the losses caused by the subprime credit slump, according to Royal Bank of Scotland Group Plc.

It would appear that at least some of the money written-off is finding its way into the profits of hedge funds:

Hedge funds returned 3.2 percent on average in October, the biggest gain in almost two years, as managers profited from rising stock prices and declining values of debt tied to home mortgages.

The monthly increase brought the advance to 12.3 percent so far this year, according to a report today from Chicago-based Hedge Fund Research Inc.

It should be noted that the dollar figures in the above paragraphs are US Dollars, not real money:

The dollar is “losing its status as the world currency,” Xu Jian, a central bank vice director, told a conference in Beijing. “We will favor stronger currencies over weaker ones, and will readjust accordingly,” Cheng Siwei, vice chairman of China’s National People’s Congress, said at the same meeting.

Chinese investors have reduced their holdings of U.S. Treasuries by 5 percent to $400 billion in the five months to August. China Investment Corp., which manages the nation’s $200 billion sovereign wealth fund, said last month it may get more of the nation’s reserves to invest to improve returns.

Analyst reactions to these specific remarks are split between yawning and mocking, but years of fiscal profligacy in the US are inexorably coming home to roost.  Maybe they should cut taxes again, or something. Giancarlo Corsetti provides a review of some possible outcomes; one scenario is

In their well-known work, Obstfeld and Rogoff (2005, 2007) propose the following scenario. Closing the US external deficit to within 5% of the US GDP will require the US terms of trade to fall between 5% and 15% – a surprisingly contained movement. By contrast, the fall in the internal relative price should be 3 to 5 times larger, namely the relative price of nontradeables inside the US must get between 20% and 30% cheaper.

To translate these figures into the current macroeconomic stance, keep in mind that, over time, productivity growth is faster in manufacturing (producing most tradables) than in services (mostly nontradables). These productivity differentials across sectors mean that the price of manufacturing decline steadily in terms of services. Now, relative to these long-run trends, we should see the price of US services drop by about one third in terms of US manufacturing, as the US eliminates their current account deficit.

… while another is …

Results from numerical exercises developed in joint work with Martin, and Pesenti, suggests that closing the US current account deficit (from 5% of GDP to zero) could lead to a combination of lower US consumption (-6%), and higher US employment (+3%), relative to trend. This would then correspond to a rate of real dollar depreciation of the order of 20% – close to what we have experienced so far.

We shall see! I will admit to having something of a bias in favour of Rogoff’s work – but only because he’s a chess player. I will have to ensure that bias doesn’t affect anything else!

To keep things interesting, there are predictions of bond-insurer failure:

MBIA may lose $20.2 billion on guarantees and securities holdings, Sean Egan, managing director of Egan-Jones, said on a conference call today. ACA Capital may take losses of at least $10 billion; New York-based Ambac may reach $4.3 billion; mortgage insurers MGIC Investment Corp. and Radian Group Inc. may see losses of $7.25 billion and $7.2 billion, respectively, Egan said.

“There is little doubt that the credit and bond insurers face massive losses over the next few quarters and many will be capital challenged,” Egan said.
…
Moody’s Investors Service and Standard & Poor’s will downgrade the ratings only after problems have become more obvious, Egan said.

Surprise!  Egan-Jones is a subscription-based rating service. Note that failure of an insurer could have serious knock-on effects in the US Municipals market.

Preferreds continued their recent showing of decent volume, but it seems like everybody was too busy financing their next trip to Buffalo by selling common shares to be fussed much about preferreds, which were … off a tad, but only technically.

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