PrefBlog

Bernanke’s Jackson Hole speech carried a warning and a promise:

Second, fiscal policy, at both the federal and state and local levels, has become an important headwind for the pace of economic growth. Notwithstanding some recent improvement in tax revenues, state and local governments still face tight budget situations and continue to cut real spending and employment. Real purchases are also declining at the federal level. Uncertainties about fiscal policy, notably about the resolution of the so-called fiscal cliff and the lifting of the debt ceiling, are probably also restraining activity, although the magnitudes of these effects are hard to judge. It is critical that fiscal policymakers put in place a credible plan that sets the federal budget on a sustainable trajectory in the medium and longer runs. However, policymakers should take care to avoid a sharp near-term fiscal contraction that could endanger the recovery.
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Over the past five years, the Federal Reserve has acted to support economic growth and foster job creation, and it is important to achieve further progress, particularly in the labor market. Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.

It’s good to know that there is one defender of shareholder rights in this world of cooperative games:

New York-based Mason, which controls just fewer than 20 per cent of Telus’s voting shares, announced Friday that it is calling its own meeting of Telus’s shareholders.

The purpose of the meeting, scheduled for 10 a.m. local time on Oct. 17 in Burnaby, B.C., is to give investors a chance to vote on the hedge fund’s proposal to give voting shareholders a “minimum” premium in the event that Telus completes a share-consolidation transaction.

It’s easy to be a rugged fiscal conservative when times are good. But what will happen in Alberta now?:

Alberta is veering toward a deficit as high as $3-billion this year, more than three times larger than expected, as a slump in oil prices forces the government to find ways to slash spending.

Finance Minister Doug Horner, who delivered the first-quarter fiscal update Thursday, blamed a shaky global economy and said Alberta’s bottom line for 2012-13 has been hammered by weak royalties from bitumen and conventional oil, and low land lease sales to energy producers.

S&P warns that financial repression is not a panacea:

When faced with the painful task of balancing budgets, some governments–we believe–will increasingly be tempted to use instead administrative controls over their monetary systems to lower interest rates below the level at which they would otherwise settle. In other words, they will repress their financial systems to mitigate the premium investors require when inflation expectations become more entrenched. In Standard & Poor’s Ratings Services’ opinion, financial repression creates distortions whose costs exceed the benefits of lower interest rates, until a government’s creditworthiness has become very weak. Under our criteria, this course of action would have mixed effects on sovereign ratings (see “Sovereign Government Rating Methodology And Assumptions,” published June 30, 2011, on RatingsDirect).
High-rated sovereigns likely would suffer because resorting to financial repression would imply an inability or unwillingness to undertake stronger fiscal or structural measures to improve economic dynamics. Sovereigns that we rate lower would benefit from lower interest costs, though this would provide only a small uplift because financial repression would also diminish their economic growth prospects. Both effects would likely be part of broader trends that could have an even more determinate impact on ratings.
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What Is Financial Repression?Financial repression refers to actions that governments and central banks take to depress real interest rates and to increase demand for their own paper. This creates an inefficient allocation of credit, which hinders the financing of economic activity. Ronald McKinnon and Edward Shaw coined the term (2). The work of Carmen Reinhart (3) has partly informed our views on financial repression. Here are some examples.

Directed lending to the government Governments can offer incentives to financial institutions to allocate a portion of their assets to government debt. For example, low or no capital charges against government debt can make it more attractive to hold than other assets for a bank trying to satisfy a capital ratio. Favoring government paper over other paper for central bank operations can also increase its demand. Minimum pension fund allocations to government securities would be another example of directed lending to the government. When these macro prudential rules change, they can change the demand for government paper. When existing balances of pension funds are redirected or when bank capital or liquidity requirements are changed to favor additional holdings of government debt, it can be a sign of worsening conditions for the sovereign

Good news! Increased regulation is having the desired effect!

Under changes made by the Dodd-Frank Act, the annual rate changes for fees paid under Section 6(b) of the Securities Act of 1933 and Sections 13(e) and 14(g) of the Securities Exchange Act of 1934 must take effect on the first day of each fiscal year. Therefore, effective Oct. 1, 2012, the Section 6(b) fee rate applicable to the registration of securities, the Section 13(e) fee rate applicable to the repurchase of securities, and the Section 14(g) fee rates applicable to proxy solicitations and statements in corporate control transactions will increase from $114.60 per million dollars to $136.40 per million dollars. The Section 6(b) rate is also the rate used to calculate the fees payable with the Annual Notice of Securities Sold Pursuant to Rule 24f-2 under the Investment Company Act of 1940.

Harvard has a current scandal regarding possible mass cheating in a class titled “Introduction to Congress. I would have thought that would get them all As!

The Canadian preferred share market closed the month on a happy note, with PerpetualPremiums gaining 4bp, FixedResets winning 8bp and DeemedRetractibles up 2bp. Volatility was minimal. Volume was ugly, pathetic and bad.

Nice piece from the New York Fed by Robert Battalio, Hamid Mehran, and Paul Schultz titled Market Declines: What Is Accomplished by Banning Short-Selling?:

In 2008, U.S. regulators banned the short-selling of financial stocks, fearing that the practice was helping to drive the steep drop in stock prices during the crisis. However, a new look at the effects of such restrictions challenges the notion that short sales exacerbate market downturns in this way. The 2008 ban on short sales failed to slow the decline in the price of financial stocks; in fact, prices fell markedly over the two weeks in which the ban was in effect and stabilized once it was lifted. Similarly, following the downgrade of the U.S. sovereign credit rating in 2011—another notable period of market stress—stocks subject to short-selling restrictions performed worse than stocks free of such restraints.
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Our analysis of the empirical evidence from the United States suggests that the bans had little impact on stock prices. Even with the bans in place, prices continued to fall. At the same time, the bans lowered market liquidity and increased trading costs. On the latter point, we estimate that the ban raised total trading costs in the U.S. equities options market by $500 million in the period between September 18 and October 8, 2008.
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The equity markets provide telling evidence of the costs imposed by short-sale bans. In their multivariate analysis, Boehmer, Jones, and Zhang (2009) find that the 2008 short-sale ban in the United States was associated with a 32 basis point increase, on average, in relative effective bid-ask spreads for the banned stocks. For the 404 financial stocks that were subject to the ban for its duration—September 18 through October 8, 2008—the increase in spreads represents an increase in liquidity costs of more than $600 million.

David Berman comments in the Globe:

All of which suggests that short-sellers are far from being enemies of normal market activity – and banning their activities is unlikely to turn bear markets into bull markets, or even provide much-needed stability when stocks are falling .

One commenter on the Globe piece writes:

There were more sellers than buyers then, so obviously stocks went down. Short sellers would have made it even worse. How dumb does one have to be to miss that obvious fact

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Quite right, short sellers will indeed increase the speed of loss … until the market reaches it clearing price. Short sellers assist the market to reach the clearing price faster.

Sorry this is so late, folks! But better late than never!

There’s a chance that Apple might have shot itself in the foot by winning the patent case with Samsung. A post-secondary friend tells me that she’s hearing a lot of people saying ‘If the iPhone and the Galaxy are the same thing … why pay more?’

I saw this one coming … now that Lapdog Carney has successfully floated the trial balloon, Spend-Every-Penny is urging companies to piss away the nest-egg:

Stimulating the economy ultimately falls on the heads of the private sector, Finance Minister Jim Flaherty said Monday.

“We’ve done a lot through the tax system to encourage Canadian executives, business people, to start utilizing some of the capital they have on their balance sheets,” said Mr. Flaherty.

“At a certain point, it’s not up to the government to stimulate the economy, it’s up to the private sector, and they have lots of capital.”

This is the man who has turned the federal surplus into a structural deficit. He needn’t be taken seriously. However, his use of the central bank governor as a spokesman – a junior minister – for the government is a disgrace and Carney has disgraced himself for allowing central bank independence to be compromised. This politicization of what should be among the most technocratic arms of the civil service will end in tears – but probably not before the next election, which is all that counts.

How wise are pension fund managers? Not much!

The SEC alleges that Fabrizio Neves conducted the scheme while working at LatAm Investments LLC, a broker-dealer that is no longer in business. He was assisted by Jose Luna. The pair defrauded two Brazilian public pension funds and a Colombian institutional investor that purchased from LatAm the structured notes issued by major commercial banks. To conceal the excessive markups that Neves charged customers, Neves directed Luna to alter the banks’ structured note term sheets in half of the transactions by either whiting out or electronically cutting and pasting the markup amounts over the actual price and trade information, and then sending the forged documents to customers. Neves and Luna further concealed the egregious markups in most transactions by first purchasing the notes into accounts in the name of nominee entities they controlled in the British Virgin Islands.
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According to the SEC’s complaint against Neves and Luna filed in U.S. District Court for the Southern District of Florida, Neves negotiated with several U.S. and European commercial banks to structure 12 notes on his customers’ behalf from 2006 to 2009. But instead of purchasing the notes for his customers’ accounts for prices around the banks’ issuance amounts – which totaled approximately $70 million – in most transactions Neves first traded the notes with one or more accounts in the name of offshore nominee entities that he and Luna controlled. Neves then sold the notes to his customers with undisclosed markups as high as 67 percent.

Clearly, the wise investors bought whatever their friendly salesman told them to buy.

Scotia is buying ING Bank Canada:

Bank of Nova Scotia, Canada’s third- largest lender, agreed to buy ING Bank of Canada for C$3.13 billion ($3.16 billion) in its largest takeover to add to its retail deposits.

Scotiabank will buy the ING Groep NV (INGA) unit in a cash deal, the Toronto-based bank said today in a statement. It will sell 29 million shares at C$52 each in a bought deal, for gross proceeds of C$1.51 billion to fund the takeover.

DBRS confirmed BBBD:

DBRS has today confirmed the Issuer Rating and the Senior Unsecured Debentures rating of Bombardier Inc. (BBD or the Company) at BB with a Stable trend. BBD’s Preferred Shares have also been confirmed at Pfd-4 with a Stable trend. The confirmation reflects our expectation that the Company’s financial measures, while acceptable for the current rating, are unlikely to materially improve in the next two to three years because of high capex requirements, continued demand uncertainty in the Company’s aerospace division (BA, accounting for about half of total EBIDTA in the first half of 2012) and softening of economic conditions in Europe and Asia Pacific, two of BBD’s key geographic markets. BBD is a leading global manufacturer of transportation equipment, including a broad range of business and commercial aircraft as well as rail transportation equipment.

It was a mildly positive day for the Canadian preferred share market, with PerpetualPremiums flat, FixedResets gaining 3bp and DeemedRetractibles up 7bp. Volatility was minimal. Volume had its bright spots, but retail is still on holiday.

PerpetualDiscounts now yield 4.96%, equivalent to 6.45% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.3%, so the pre-tax interest-equivalent spread is now about 215bp, a widening from the 205bp reported August 22 as corporates have improved over the past week while PerpetualDiscounts have been flattish.

Commissioner Daniel M. Gallagher and Commissioner Troy A. Paredes of the SEC collaborated on an astonishingly ignorant Statement on the Regulation of Money Market Funds:

Our decision not to support the Chairman’s proposal, based on the data and analysis currently available to us, has also been informed by our concern that neither of the Chairman’s restructuring alternatives would in fact achieve the goal of stemming a run on money market funds, particularly during a period of widespread financial crisis such as the nation experienced in 2008. The Reserve Primary Fund did not “break the buck” in a vacuum, but rather in the midst of a financial crisis of historic proportions.

Since the Commission adopted Rule 2a-7, the principal rule that governs money market funds, the Commission on multiple occasions has reviewed the efficacy of the rule and has adopted amendments to make improvements. Most recently, in 2010, the Commission adopted changes to Rule 2a-7 that have improved the liquidity and transparency of money market funds and decreased the credit risk of their portfolios with the objective of making such funds more resilient.

Reserve Primary broke the buck because it held some paper that defaulted. Any commercial paper can default. The changes to Rule 2a-7 – that I mocked at the time for their substitution of box-ticking for capital – may well have decreased the credit risk of MMF portfolios, but it cannot have eliminated credit risk.

Second, the necessary analysis has not been conducted to demonstrate that a floating NAV or capital buffer coupled with a holdback restriction would be effective in a crisis. Indeed, both alternatives disregard the predominant incentive of investors in a crisis to flee risk and move to safety. Reason indicates that such behavior — the “flight to quality” — is likely to overwhelm the buffer proposed by the Chairman and swamp the effect of a holdback. As for the floating NAV proposal, even if there is no stable $1.00 NAV — i.e., even if, by definition, there is no “buck” to break — investors will still have an incentive to flee from risk during a crisis period such as 2008, because investors who redeem sooner rather than later during a period of financial distress will get out at a higher valuation. Thus, if neither the floating NAV proposal nor the capital-buffer-with-holdback proposal will solve the money market fund run problem, then neither proposal will foreclose the possibility that policymakers might once again face the prospect of supporting the commercial paper market in response to a widespread financial crisis.

The holdback provision means that investors who redeem their holdings – possibly with a threshold, so the holdback would apply only to accounts with more than $X invested – have a much reduced incentive to run, because the holdback will be at risk. Logic does not appear to be a strong point of Messrs. Gallagher & Paredes, both of whom have legal, rather than investing backgrounds.

Their profound ignorance of the simplest principles of portfolio management lead them to support gating as an alternative:

We have urged that the Chairman take a different way forward for strengthening the resiliency of money market funds. This approach would (i) empower money market fund boards to impose “gates” on redemptions; (ii) mandate enhanced disclosure about the risks of investing in money market funds; and (iii) conduct a searching inquiry into, and a critical analysis of, the issues raised by the questions we pose below.

In particular, it would be useful to receive comment on a proposal that would permit money market fund boards, as they deem appropriate and consistent with their fiduciary obligations to investors and without having to seek an exemptive order from the Commission, to “gate” redemptions to stave off a run and to allow the fund manager time to mitigate the concerns of investors who otherwise may be inclined to redeem. The Commission’s 2010 amendments allowed boards to unilaterally suspend redemptions if the fund is put into liquidation. At that time, the Commission received input recommending that the Commission allow boards to impose a gate when they deemed appropriate, consistent with the boards’ fiduciary duties to the fund’s shareholders.

Discretionary gating directly responds, we believe, to run risk, both as to an individual fund and across multiple funds, as well as to the potential disparate treatment between retail and institutional investors.

If your redemption can be blocked by the fund in toto, then you cannot rely on converting your holdings to cash on a moment’s notice, an idea which I am sure Assiduous Readers will agree is the whole point of MMFs. I consider the holdback option to be inferior to enforced holding of permanent capital, but even with the holdback at least you get almost all your money back when wanted and you put a cap on your losses to boot.

Sorry folks! The Project That Would Not Die staggered out from its crypt tonight and ate all my time. So the preferred share market action tables will be delayed a bit.

Update:

Good news! There’s a sign of success in the politicians’ and regulators’ war on finance!

Investment bankers in the U.K. favor working in Singapore over New York and London, where they face lower wage growth and higher taxes, according to recruitment firm Astbury Marsden.

Thirty-one percent of respondents chose Singapore as their most favored location, followed by New York (20 percent) and London (19 percent), the recruiter said in its annual “Preferred Location Survey.” Hong Kong and Dubai got 16 percent and 15 percent, respectively. The survey found 60 percent of bankers expect the Asia-Pacific region to the largest financial center in 10 years.

“A fast growing, low-tax and bank-friendly environment like Singapore stands as a perfect antidote to the comparatively high-tax and anti-banker sentiment of London and New York,” Mark Cameron, chief operating officer at Astbury Marsden, said in the statement. “Financial centers in the West have taken a real battering since the start of the financial crisis.”

The OSC approved settlements with Boaz Manor, John Ogg and Michael Labanowich.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums down 4bp, FixedResets flat and DeemedRetractibles up 5bp. Volatility was average. Volume picked up a little, but is still dead.

Let’s all reach for yield!

German insurers, which came through the subprime mortgage crisis largely unscathed, are seeking to boost investment returns by buying junk loans to corporate borrowers.

Senior secured loans, which are repaid first in a default, are originated by banks for borrowers considered high yield or high risk as they usually have a significant level of debt relative to equity. The loans are then are sold on to investors.
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Leveraged loan prices plunged to 59.2 cents on the dollar in mid-December 2008 as investors dumped risky debt two months after the collapse of Lehman Brothers Holdings Inc. They averaged 95.12 cents on Aug. 22, which was the highest since June 2011, according to the S&P/LSTA U.S. Leveraged Loan 100 Index. The measure, which tracks the 100 largest dollar- denominated first-lien leveraged loans, has climbed from 90.75 at year-end.

The OSC is giving itself more money:

Canada’s largest securities commission says it is facing a financial shortfall this year and needs a major increase in the annual fees it charges to public companies and those registered to work in the securities industry.
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The fee increase will total 15.5 per cent in each of the next three years for issuers – companies that have issued securities in Ontario. Compounded over three years, that means fees will be 54 per cent higher by 2015 than they are today.
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Registrants – firms and individuals registered to work in the securities industry – would face increases of 7.9 per cent annually over the next three years, the OSC said. Compounded, that means an increase of about 25 per cent by 2015.

I am sure we will all sleep better at night now. But I’m considering visiting their offices on Monday:

A key figure in the multimillion-dollar Portus financial scandal, a complicated investment scheme that collapsed in 2005, has reached a tentative settlement with officials at the Ontario Securities Commission.

An agreement between Portus co-founder Boaz Manor and the OSC’s enforcement branch, announced Friday, will be put before a panel of commissioners at a hearing scheduled for Monday afternoon.
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Earlier this week, the OSC reached settlements with two lesser figures in the Portus saga — Michael Labanowich and John Ogg. Hearings for those settlements are scheduled for Monday morning, before the hearing for the Manor settlement.

Ain’t it great what a little lobbying can do?

SEC Chairman Mary Schapiro this week abandoned a four-year effort to adopt tougher rules for money funds as three fellow commissioners said they wouldn’t support her proposal. The announcement marks a victory for the fund industry, which had lobbied against the plan.
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Schapiro has argued the funds’ stable $1 share price encourages investors to flee at the first sign of trouble. That’s because those who react quickly can sell their shares at $1 each even if the net asset value has dropped below that level.

Schapiro’s staff this month produced a list for Congress of more than 300 instances over the past 40 years in which fund companies have sought permission from the SEC to support funds. The list was presented as evidence that funds weren’t as stable as the funds industry maintained.
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Schapiro’s plan would have given fund managers a choice of switching to a floating share price that reflected the market value of holdings, or establishing a capital buffer to protect against credit losses and redemption restrictions to discourage investor flight.

I was gratified by a reference to a speech by Eric Rosengren, boss of the Boston Fed, titled Our Financial Structures – Are They Prepared for Financial Instability?:

As recent studies have highlighted, it is quite common for money market mutual funds that have impaired assets to obtain support from their sponsors.[12] Whether this is a cash infusion or a purchase at face value of an impaired asset,[13] this support can represent draws on capital[14] at times when the sponsoring organization is facing other capital pressures.
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In the absence of such reforms for all money market mutual funds, an alternative for funds with depository institution or depository institution affiliated sponsors would be to include likely money market mutual fund support in the sponsor’s stress tests. Based on the historical experience of their money market funds, the historical experience of similar funds, and their money market funds’ exposures, sponsors could calculate the likely capital support needed from the organization in a stress scenario.

Again, this is an admittedly partial approach, in the absence of more comprehensive reforms that I hope will occur. But this approach would at least make more banking organizations more resilient (it would not be just money market mutual fund structures that would need capital – any financial structure that broke down during stress would need more capital) but it would also make clearer to money market mutual fund investors that banks had capital that could support funds during stressful periods. It would thus make clear that money market mutual funds with well capitalized sponsors are likely to be less risky than those that do not have well capitalized sponsors.

Similarly, other financial products that circumvent standard capital requirements – such as non 2a-7 “money market like” funds, stable value wrap products, and asset-backed commercial paper – could lead investors to expect that the sponsor holds capital for the support that these products could need in times of stress. While some firms are likely to argue they would not provide support for so-called capital efficient products, the high frequency of support of money market mutual funds and other off-balance-sheet items during the crisis makes such claims dubious.

I have long advocated consolidating banks’ balance sheets with their sponsored funds.

It was a mildly negative day for the Canadian preferred share market, with PerpetualPremiums down 5bp and FixedResets and DeemedRetractibles both off 1bp. Volatility was OK. Volume was virtually non-existent – I’m not reporting a single block today!

There good news on photovoltaics:

A technology that would enable low-cost, high efficiency solar cells to be made from virtually any semiconductor material has been developed by researchers with the U.S. Department of Energy (DOE)’s Lawrence Berkeley National Laboratory (Berkeley Lab) and the University of California (UC) Berkeley. This technology opens the door to the use of plentiful, relatively inexpensive semiconductors, such as the promising metal oxides, sulfides and phosphides, that have been considered unsuitable for solar cells because it is so difficult to tailor their properties by chemical means.
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Photovoltaics are the ultimate source of clean, green and renewable energy but today’s technologies utilize relatively scarce and expensive semiconductors, such as large crystals of silicon, or thin films of cadmium telluride or copper indium gallium selenide, that are tricky or expensive to fabricate into devices.

“Solar technologies today face a cost-to-efficiency trade-off that has slowed widespread implementation,” Zettl says. “Our technology reduces the cost and complexity of fabricating solar cells and thereby provides what could be an important cost-effective and environmentally friendly alternative that would accelerate the usage of solar energy.”

Academic research in the States provides the skills, the patents and the profits. The research wasn’t done in Ontario because we blew the budget installing shoddy and expensive technology. Yay us.

Sorry folks – the tables will be delayed. On the bright side, I’ve just finished a major project, so things are looking up!

Update, 2012-08-24: