PrefBlog

Bernanke had some cheerful commentary:

Federal Reserve Chairman Ben S. Bernanke said the economy is at risk from Europe’s debt crisis and the prospect of fiscal tightening in the U.S., while refraining from discussing steps the central bank might take to protect the expansion.
…
Bernanke also warned lawmakers that “a severe tightening of fiscal policy at the beginning of next year that is built into current law — the so-called fiscal cliff — would, if allowed to occur, pose a significant threat to the recovery.”

Spain gets more interesting daily:

Spanish Prime Minister Mariano Rajoy said he’s talking to his European peers about how to shore up the country’s banks as Fitch Ratings cut Spain’s credit grade to within two steps of junk.
…
Rajoy spoke minutes before Fitch downgraded Spain by three levels to BBB, within two steps of non-investment grade. Fitch said the cost to the state of shoring up banks may amount to as much as 100 billion euros ($126 billion) in the worst case, compared with its previous estimate of 30 billion euros, as Spain will remain in recession next year.
…
Spain’s 10-year bond yield fell to 6.088 percent yesterday from 6.282 percent on June 6, retreating from the 7 percent threshold that triggered bailouts in Greece, Ireland and Portugal. The Treasury met its issuance goal at a bond auction, selling 2.07 billion euros of Spanish securities, surpassing the maximum target of 2 billion euros.

It was a day of solid recovery for the Canadian preferred share market, with PerpetualPremiums gaining 6bp, FixedResets up 10bp and DeemedRetractibles winning 23bp. Of great interest is the observation that the Bozo Spread (Current Yield PerpetualDiscounts less Current Yield FixedResets) has returned to negative territory. Volatility was minor.

OSFI has released an outline of the new paperwork rules for bank mortgages:

Re-qualification at Renewal – Current practice regarding residential mortgage renewals has served FRFIs well. OSFI agrees, for example, that having a good payment record is one of the best indicators of credit worthiness. OSFI, therefore, expects that FRFIs themselves will remain responsible for deciding what level of review to place on borrowers’ qualifications at the time of renewal. FRFI renewal practices should be articulated in internal policies governing their underwriting of residential mortgage loans. FRFIs, however, will be expected to refresh the borrowers’ credit metrics periodically (not necessarily at renewal) so that FRFIs can effectively evaluate their credit risk.

2. Home Equity Lines of Credit (HELOCs) – OSFI is maintaining its position that the HELOC component of a mortgage be restricted to a maximum loan-to-value ratio of 65 per cent. HELOCs are inherently riskier products, given their revolving nature, persistence of debt balances and their ineligibility for mortgage insurance. However, HELOCs at or below an LTV ratio of 65 per cent will not be required to be amortized, as the revolving aspect of a HELOC is a fundamental feature of the product.

The BoC has released a discussion paper by Francisco Rivadeneyra titled The U.S.-Dollar Supranational Zero-Coupon Curve:

The author describes the construction of the U.S.-dollar-denominated zero-coupon curve for the supranational asset class from 1995 to 2010. He uses yield data from a cross-section of bonds issued by AAA-rated supranational entities to fit the Svensson (1995) term-structure model. Results show the expected pattern of interest rates over the U.S. business cycle. The author computes the spreads relative to the U.S. Treasury zero-coupon yields data of Gürkaynak, Sack and Wright (2007). The average spread for this period is equal to 44 basis points; it increases during recessions and narrows during expansions. Also, the slope of the term structure of spreads shows a countercyclical pattern.

The Toronto Water Department has confirmed that it was their gross incompetence that dumped sewage into Union Station and PATH last week:

On the morning of June 1, a brief, but intense rainfall event caused a rapid surge of storm water flow within the City’s sewer collection system and wastewater treatment plants. (The downtown area experienced rainfall ranging from 27mm to 37mm.) The heavy rainfall event did not exceed the capacity of the entire sewer collection system.

As part of the contract for the TTC’s Union Station New Platform Project in the subway, the TTC’s contractor is also reconstructing a large sewer on behalf of the City for the Union Station Revitalization Project. To enable construction of the new lowered sewer, a section of the existing sewer was removed and pumps put in place in order to install maintenance holes at one of the future connection points. During the heavy rainstorm, sanitary and storm water overflowed from the open section of sewer at this location (flooding was localized to this area of the City).

The contractor and the project management team are working to put in place measures to avoid a recurrence during construction. One such measure includes the installation of two additional pumps on site as contingency. As well, the pipe that was temporarily exposed to perform this work will be capped by Friday.

In other words, they placed a bet that full capacity of the sewage line would not be needed during repair. They lost the bet and Toronto paid. Thanks a lot, guys! Fortunately for the guys who should be fired, council’s got other things on its mind:

Plastic shopping bags will be banned in Toronto as of Jan.1, 2013 after city council, in a surprise move, voted to make Toronto the first major city in Canada to forbid retailers from providing plastic single-use carryout bags.
…
It’s not clear if the city even has the jurisdiction to pass such a ban.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums up 2bp, FixedResets winning 13bp and DeemedRetractibles down 4bp. Volatility was minor. Volume was very low.

PerpetualDiscounts now yield 5.09%, equivalent to 6.62% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.4% (OK, just a hair under) so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 225bp, a slight (and perhaps spurious) decline from the 230bp reported May 30.

Oh, the technology!

The Romney and Obama campaigns want supporters to be able to send contributions instantly using their smartphones, a step that would let telecommunications companies join in collecting fees that now flow to bank-card networks.
…
Campaigns will have access to texters’ phone numbers, creating the opportunity to “upsell” them for larger donations, according to Armour, a press secretary in Al Gore’s 1988 presidential campaign.
…
Political campaigns can expect to see 50 to 70 percent of a donation, with the rest going to fees to aggregators and carriers, Sege said. By comparison, a “card not present” transaction, such as one involving a credit card number entered into a campaign website, carries a fee ranging between 2 and 3 percent, according to Trish Wexler, spokeswoman for the Electronic Payments Coalition, a trade group that represents credit card networks and banks.

Tax the rich? It gets a little complex:

Increasing volatility in tax collections is complicating local governments’ emergence from the worst fiscal crisis since the Great Depression. States projected or dealt with a combined $54 billion of deficits in the fiscal year starting July 1, according to a report from the Center on Budget and Policy Priorities, a nonprofit group in Washington focusing on issues affecting lower-income Americans.

California Governor Jerry Brown, a Democrat, last month cut the most-populous state’s revenue forecast by $4.3 billion after capital gains receipts fell 5 percent, instead of gaining 15 percent as forecast. In response, he proposed steps such as reducing government employees’ workweek by 5 percent.
…
A one-step rating cut in January by Moody’s Investors Service, to Aa3, has contributed to weakness in Connecticut debt, said Brian Steeves, a portfolio manager at Belle Haven Investments in White Plains, New York. The rank is Moody’s fourth-highest.

Moody’s cited pension and debt costs as well as the state’s susceptibility to “financial market fluctuations,” given the dependence on capital gains.

There are more official worries about the US national debt:

The U.S. government risks a fiscal crisis unless it makes significant changes in tax and spending policies, the Congressional Budget Office said.

The nonpartisan agency said today that without policy changes, the national debt within 15 years will top the historical peak set after World War II. In 1946, government debt amounted to 109 percent of the economy.
…
The gap between projected taxes and spending is so large, the report said, that if lawmakers merely wanted to prevent the debt-to-GDP ratio from increasing over the next 25 years, they’d have to immediately and permanently cut $700 billion from the $3.6 trillion U.S. budget.

Nothing will happen until the Treasury Secretary has to ask the President to play “Bond Salesman”. That’s what it took in Canada in 1994.

There is more despairing acknowledgement that the TMX / Maple deal is anti-competitive:

Chief among the concerns is that the result will be higher costs for users of TMX’s services that provide trading and market data, RBC said in its submissions. ITG, another large trading house, echoed many of RBC’s concerns in its own comments, which were also handed to the OSC on Monday.
…
RBC argues that the Maple proposal “will require a significantly different approach to the regulation of fees and fee models in Canada,” and will require the OSC to bulk up to deal with the added workload.

“The commission should recognize the very substantial increase in its capacity and capability that will be required in order to make it an effective regulator of market structure and fees,” RBC said.
…
ITG’s suggestions were along the same lines, saying that “the structure proposed by the Maple acquisition is fraught with conflicts of interest across every facet of the trading, clearing and settlement infrastructure of this country” and those conflicts “have the potential to seriously affect the ability of other participants to compete effectively in our capital markets.”

A successful deal will mean more jobs for more important regulators! Golly, I wonder if the regulators will approve it.

Investors have learned to demand to be shown the money whenever the Europeans politicians talk about ending the crisis. They are not yet so realistic about the G-7:

Asian stocks rose as finance ministers and central bank governors from the world’s leading economies agreed to coordinate their response to Europe’s financial crisis and U.S. service-industry growth tempered concern the world’s largest economy is slowing.
…
Finance ministers and central bank governors from the Group of Seven economies agreed to coordinate their response to Europe’s financial crisis on a conference call yesterday. G-7 officials said they will work together to help Spain and Greece place their public finances on a sustainable footing, Japanese Finance Minister Jun Azumi told reporters in Tokyo following the call.

I’m just overjoyed that they’re going to work together to coordinate their response! Yay!

The latest wooly-thinking comes from commentary on the Wisconsin gubernatorial re-run:

Over the past year, Wisconsinites divided into two camps: those who see public unions as critical to ensuring a stable middle-class and those like Mr. Walker who see them as the source of ballooning government debts and higher taxes.

Wrong! Public unions are not the source of ballooning government debts and higher taxes. The source of ballooning government debts and higher taxes are gutless wonder politicians (and do-gooders and their wooly minded supporters) who agree to ludicrous contracts. You will never hear me criticize welfare recipients, whether of the human or corporate variety, who ask for government largesse. Anybody can ask for money! It’s a free country! The villains are the idiots who give it to them.

What, never? Hardly ever.

Much more interesting was the note that:

But since Mr. Walker signed the collective-bargaining bill, which was passed last year by Wisconsin’s Republican-controlled legislature amid weeks of protests around the state capitol, membership in the state’s public-sector unions has withered.

That is because the law ended the automatic deduction of union dues. Public workers must now choose to opt in to the union, rather than being included by virtue of their job.

The result is that the main union that represents state and municipal workers in Wisconsin saw its membership fall by more than half to about 29,000 from 63,000 in the past year. The Wisconsin wing of the American Federation of Teachers lost a third of its members.

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums gaining 10bp, FixedResets winning 18bp and DeemedRetractibles off 9bp. Insurance losers were again notable in the Performance Highlights table, but on a much less overwhelming basis than they were yesterday. Volume was average.

RBC is defending its capital markets exposure:

Frustrated with a recent ratings downgrade and worried by the imminent possibility of another, Royal Bank of Canada is intent on proving that its capital markets arm poses no real threat to its future.
…
Facing another blow, RBC lashed out, arguing that its inclusion in a review of too-big-to-fail firms was “unwarranted,” in part because its capital markets business represented less than 25 per cent of the bank’s bottom line.

Building on this argument, RBC put together a special presentation for analysts and investors on Friday that focused solely on its capital markets business. The bank did not come out and say that the presentation was designed to prove Moody’s wrong, but the potential downgrade was hinted at many times.
…
RBC also devoted a lot of time to risk management practices, another of Moody’s concerns. In February, the rating agency noted that “rapidly changing risk positions expose these firms to unexpected losses that can overwhelm the resources of even the largest, most diversified groups.” RBC noted that of the roughly 1,000 people added since 2008, the majority have been in the back office, where divisions such as risk management are housed.

Divisions such as compliance are also housed in the back office. The RBC Presentation proudly states that the Capital Market division is:

Strategically extending our loan book to deepen client relationships

• Modest sized loan book representing 13% of RBC’s total outstanding loans and acceptances
• Since 2009, increased the number of lending clients by 30% to over 1,200

… but I’m not sure if that’s a good thing for either the bank or society, despite all their protestations regarding diversification, exposure limits and profitability. The lending makes it difficult, if not impossible, for non-bank dealers to compete; and the dual purpose of the lending (to make a lending profit and to make a trading profit) makes these loans somewhat more suceptible to jiggery-pokery at approval time.

The OSC has a new policy:

Staff of the Compliance and Registrant Regulation Branch of the Ontario Securities Commission (the OSC) is sending this email to firms that are registered under the Securities Act (Ontario) (the Act) in the categories of exempt market dealer, scholarship plan dealer, or portfolio manager, to advise such firms of a new approach OSC staff will be adopting when performing compliance reviews under section 20 of the Act. Specifically, OSC staff will now contact clients of registered firms as a routine part of its compliance review process.

While OSC staff have historically not contacted clients of a registered firm as part of the compliance review process, we have done so in a number of exceptional cases and have found that client contact is a valuable method of assessing the firm’s compliance with Ontario securities law. Accordingly, we will be expanding our use of this important tool and will be contacting clients in the normal course of compliance reviews. Clients may be asked a variety of questions regarding their experience with their registered firm and representative, including such things as the accuracy of know-your-client information the firm has about them and investment recommendations and advice provided to them.

Unless OSC staff have reason to believe that regulatory action against a firm may be warranted, clients who are contacted by OSC staff will be informed that they are being contacted in the normal course of a compliance review of the firm, and that the call to them should not be interpreted as a sign of any misconduct by the firm. Clients will also be informed that they are not required to speak with OSC staff should they choose not to, and that their participation in the compliance review process is entirely voluntary.

The Globe has a very interesting piece on housing affordability:

Where things get weird is in how they calculate the average house price. What they’ve done is set the price at $144,600 in 1990, which is simply the average resale price at the time as calculated by the Canadian Real Estate Association (CREA). From that point, the Bank of Canada estimates the change in the average house price by averaging out gains as reported by Statistics Canada’s New House Price index (NHPI), and by Royal Lepage (i.e. CREA).

The issue here is that the NHPI is a quality-adjusted index, which means it seeks to measure the change in a comparable dwelling over time. This is a very important concept when it comes to tracking true inflation over time as you need an apples-to-apples comparison.
…
We know that the average size of new dwellings has risen in Canada, with the average new house being just under 2,000 square feet, according to data from the Canadian Home Builders Association. This is up markedly since the 1970s when the average house size in Canada was under 1,100 square feet. So as a society, we’ve changed our expectations for what constitutes a “normal sized” house. The problem is that as we’ve demanded larger and larger homes with better amenities and have been willing to stretch the household budget further to get those, the NHPI has been busy factoring out these changes.

The end result is that by pegging 50 per cent of the growth in house prices to the NHPI, the average house price used in the Bank of Canada affordability index has significantly underperformed other measures of house price appreciation. The chart above illustrates the change in value of the average house used in the Bank of Canada affordability index. If you believe that the average house in Canada is $260,000, I can see how you’d think that there was no problem with affordability in Canada.

The full piece is well-worth reading and is a good companion to the recent RBC quarterly report on the topic.

Henry Paulson has joined the fray on new US MMF rules:

Former Treasury Secretary Henry Paulson is backing U.S. Securities and Exchange Commission Chairman Mary Schapiro’s effort to impose new rules on money- market funds.

In a letter that the SEC published May 30 on its website, Paulson highlights excerpts of his 2010 book, “On the Brink,” which provides his account of the financial crisis. Paulson’s letter covered the period between Sept. 16 and Sept. 19, 2008 when Bank of New York Mellon Corp., BlackRock Inc. (BLK) and Northern Trust Corp. (NTRS) reported requests for “billions in redemptions” from their money funds. Such requests exacerbated a credit crisis that began earlier that month, he wrote.
…
Schapiro initially proposed requiring money-market firms float their $1 net asset value along with mandating more capital and preventing customers from withdrawing all of their funds for 30 days. The so-called holdback provision has been particularly controversial in the industry and Schapiro is said to be open to replacing it with a fee that would be imposed on customers who take out their money during a liquidity crisis.

Money-market firms have also fought the effort to move the industry to a floating net asset value. Paulson’s letter highlights a passage in his book that supports the floating value.

How is one to square the circle? MMFs invest in risky assets – corporate paper. No amount of rules will eliminate the credit risk. Only capital will do that – all MMFs must have either a second class of securities that will take the first loss following a credit event or a credible guarantee from their sponsors … nothing else will do. All together folks … MMFs ARE BANKS IN FUNDS’ CLOTHING! They should be regulated as such! And – importantly – since they are banks, they should hold more capital against holdings of bank paper – any bank paper, from any bank – than should be the case for non-bank paper!

It was a rotten day for the Canadian preferred share market, with PerpetualPremiums off 16bp, FixedResets down 26bp and DeemedRetractibles losing 41bp. To make things more interesting, Floaters got whacked for 431bp, so it is not enough to speak glibly about ‘rising interest rates’! A very lengthy list of losers in the Performance Highlights table was comprised almost entirely of insurance issues. Volume was below average.