PrefBlog

Follow the leader, part 1:

Research In Motion Ltd. (RIMM), the maker of the BlackBerry smartphone struggling to revive falling sales, surged as much as 7.4 percent on speculation that activist investor Carl Icahn is buying a stake in the company.

Follow the leader, part 2:

Warren Buffett’s determination that Berkshire Hathaway Inc. (BRK/A) shares are cheap enough to buy back may mean the Standard & Poor’s 500 Index is also a bargain.

Some Wisconsin school districts bought an investment that went down – even after they leveraged their investment by nearly 6x! Fear not, gentle readers, the SEC is Putting Things Right:

According to the SEC’s order instituting administrative proceedings, RBC Capital marketed and sold to trusts created by the school districts $200 million of credit-linked notes that were tied to the performance of synthetic collateralized debt obligations (CDOs). The school districts contributed $37.3 million of district funds to the investments with the remainder of the investment coming from funds borrowed by the trusts. The sales took place despite significant concerns within RBC Capital about the suitability of the product for municipalities like the school districts. Additionally, RBC Capital’s marketing materials failed to adequately explain the risks associated with the investments.

RBC Capital agreed to settle the SEC’s charges by paying a total of $30.4 million that will be distributed in varying amounts to the school districts through a Fair Fund.

The SEC also wants to ensure that nasty old volatility isn’t too volatile:

The Securities and Exchange Commission began an overhaul of rules adopted after the Crash of 1987 designed to shut down the stock market during periods of volatility, proposing that curbs be triggered when the Standard & Poor’s 500 Index falls 7 percent.

The changes would switch the index used for the circuit breakers to the S&P 500 from the Dow Jones Industrial Average, according to proposals submitted by U.S. equities exchanges and the Financial Industry Regulatory Authority. The duration of the halts, which also pause trading in stock futures, would be shortened, according to a summary of the proposals from the SEC.

S&P 500 declines of 7 percent, 13 percent and 20 percent from the prior day’s close would set off halts across all markets, narrowing the current thresholds of 10 percent, 20 percent and 30 percent, according to the SEC.

Regulators are sticking to their guns on capital surcharges:

Global regulators may make adjustments to how they calculate capital surcharges for the world’s biggest banks after largely agreeing to maintain plans for levies of as much as 2.5 percent at meetings today in Basel, Switzerland, according to three people familiar with the talks.

The Basel Committee on Banking Supervision today discussed how to respond to criticisms from banks including BNP Paribas SA and Citigroup Inc. (C) that the measures are flawed and may stymie the financial system’s recovery, according to the people, who couldn’t be identified because the discussions are private.

Regulators at the meeting acknowledged that some complaints made by lenders on the method for calculating the surcharges may be partly valid and require further study, two of the people said. Surcharges would be applied to as many as 28 banks if the current proposals were already in place, the Basel committee has said.
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Under the surcharge proposals, lenders whose failure could send shock waves throughout the financial system would face stricter minimum capital requirements of 1 to 2.5 percentage points of core reserves. This would be on top of an already- announced tripling in the amount of core capital that all internationally active banks must hold.

The levies would be calculated using a methodology based on banks’ size, interconnectedness, complexity, global reach, and the ability of other firms to take over their activities if they fail.

Readers will remember that I favour capital surcharges, but not one that is directed solely at a defined list of Globally Significant Financial Institutions. Apply it to all banks on a progressive basis is my position.

Greece managed to avert immediate disaster:

Greek Prime Minister George Papandreou won parliamentary backing for a property tax to meet deficit-reduction targets required to avoid default.

Papandreou’s Socialist Pasok party won the vote in Athens late today by 155 to 142 after Finance Minister Evangelos Venizelos told Greeks they face economic collapse if they don’t plug a budget gap that is exceeding the target set in a bailout, putting an 8 billion-euro ($11 billion) aid payment due next month at risk.
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The property levy, to be collected via electricity bills, will provide an annual yield of 1.1 percent of GDP.

Venizelos also announced an additional 20 percent wage cut, on top of 15 percent for the civil service and 25 percent in the wider public sector. Pensions are being reduced 4 percent on average, in addition to previous cuts of 10 percent. A lowering of the tax-free threshold to 5,000 euros will mean higher taxes for all Greeks.

More than 74 percent of 1,002 Greeks polled by Rass for To Paron newspaper opposed the property tax. The poll also showed that 59 percent believed Papandreou’s government won’t be able to avert a default. The survey had a 3.1 percentage point margin of error. Papandreou’s government trails the opposition party in all polls.

As far as I can tell, the official position right now is that Greece won’t default as long as investors take sufficient completely voluntary write-downs:

Financial stocks pared gains as the Financial Times reported that some euro-area countries are demanding private creditors take bigger writedowns on their Greek bond holdings.
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The Financial Times reported that as many as seven of the 17 nations using the euro believe private creditors should absorb bigger losses on their Greek bond holdings, a division that may threaten an agreement reached with private investors in July. The paper cited unnamed senior European officials.

Richard Fisher of the Dallas Fed gave a speech explaining his dissent on Operation Twist:

In the interest of time, I will not dwell on the decision to reinvest proceeds in the agency and mortgage-backed markets. Since the beginning of this year, the spreads between mortgage-backs and Treasuries have been widening and have accelerated, especially lately, to levels last seen in early 2009. This decision, while not expected by the markets, was acceptable for me as a tactical way to provide limited assistance to the mortgage market at little cost. The decision to embark on an “Operation Twist,” however, was a strategic decision where I did not feel the benefits outweighed what I perceived to be the costs. So, I will dwell on that difficult decision.
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The FOMC seeks to drive down the cost of capital for businesses in order to induce them to invest more in expansion and create more jobs. Implicitly, the program may also lift short-term rates, albeit mildly given the expectation that rates at the short end will remain at “exceptionally low levels” through mid-2013, perhaps providing some relief to money market funds that, in searching for yields sufficient to cover their costs, have been invested in foreign bank paper now considered by many analysts to be somewhat toxic.
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The Dallas Fed tracks 178 items in the consumer basket through a constantly updated series dating back to 1977. Using this data, we calculate what we call a “trimmed mean” analysis of personal consumption expenditures (PCE) in order to ascertain the level of inflation affecting real consumers. This is my preferred compass for charting the direction of inflation. It presently suggests that headline inflation will decline from its current level—just shy of 3 percent as measured by the PCE and 3.75 percent as measured by the Consumer Price Index—to 2 percent, a level that the majority of the committee believes a tolerable target. Thus, while I remain on constant watch for signs of inflationary impulses, I believe the most urgent issue is job creation and the reduction of the scourge of unemployment.

I believe, however, that there is significant risk that the policies recently undertaken by the FOMC are likely to prove ineffective and might well be working against job creation.
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Before every FOMC meeting, I survey a select group of 30 or so private business and banking operators, imparting no information about monetary policy but listening carefully to their perspectives on developments in the economy as seen at the ground level. For weeks leading up to the meeting, there was speculation in the financial markets and in the press that an Operation Twist was being contemplated. I received an earful of opinions on these rumors. What I gleaned from those conversations was as follows:

Embarking on an Operation Twist would provide an even greater incentive for the average citizen with savings to further hoard those savings for fear that the FOMC would be signaling the economy is in worse shape than they thought. They might view an Operation Twist as setting the stage for a new round of monetary accommodation―a QE3, if you will. Such a program was considered redundant by business operators given their surplus of undeployed cash holdings and bankers’ already plentiful excess reserves. In addition, such a program might frighten consumers by further driving down the yields they earn on their savings and/or lead to long-term inflation that would erode the value of those savings;

The earning power of banks, both large and small, would come under additional pressure by suppressing the spread between what they can earn by lending at longer-term tenors and what they pay on the shorter-term deposits they take in;
Pension funds would have to reassess their potential returns, with the consequence that public and private direct-benefit plans would have to set aside greater reserves that might otherwise have gone to investments stimulating job creation;
Expanding the holdings of the Fed’s book of longer-term debt would likely compound the complexity of future policy decisions. Perversely, the stronger the economy, the greater the losses the Fed would incur as interest rates rise in response and the prices of those longer-term holdings depreciate. The political incentive to hold rates down might then become stronger precisely when we want to initiate tighter monetary policy. This concern, of course, would be a good news/bad news issue: The good news is that it would stem from a stronger economy; the bad is that might hurt our maneuverability and, in doing so, might undermine confidence in the Fed to conduct policy independently.

One other factor gave me pause and that was, and remains, the moral hazard of being too accommodative. For years, I have been arguing that monetary policy cannot solve the problem of substandard economic performance unless it is complemented by fiscal policy and regulatory reform that encourages the private sector to put to work the affordable and abundant liquidity we are able to create as the nation’s monetary authority.

I’ve decided that Fisher is my favourite FOMC member:

Federal Reserve Bank of Dallas President Richard Fisher said the central bank’s independence is under attack from both ends of the political spectrum in Congress, and he singled out two of the critics by name.

“We are being attacked from the right and from the left, and I don’t see much difference between a certain congressman from Texas named Ron Paul and a certain congressman from Massachusetts named Barney Frank,” Fisher said in response to audience questions after a speech in Dallas. Paul is a Republican and Frank is a Democrat.
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“I don’t see any difference between them,” Fisher said, referring to Frank and Paul. “They believe we have too much independence. They believe that Congress should be in charge of monetary policy.”

There has been an odd credit rating action on BMO covered bonds:

• We have affirmed at ‘AAA’ our ratings on Bank of Montreal Global Public Sector Covered Bond Programme and all series issued under it.
• The outlook for all of the covered bonds issued under the program is stable.
• We have subsequently withdrawn our ratings on Bank of Montreal’s covered bond program and all the series issued under it, at the issuer’s request.

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Today’s rating actions follow a review of the most current asset and cash flow information the issuer has provided to us. The data we analyzed were as of July 31, 2011. As of that date, the cover pool comprised approximately C$7.263 billion of mortgage assets. There are currently three series of covered bonds outstanding in an equivalent amount of approximately C$5.066 billion.
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As a result of this analysis, we have determined the maximum potential rating uplift for BMO’s covered bond program to be six notches above BMO’s long-term issuer credit rating of ‘A+’. This is based on a program categorization of “2” and an ALMM classification of “low”.

This seems very odd; but I can’t find any discussion of this move anywhere.

Happy news for 53-year-olds:

In a cross section of prime borrowers, middle-aged adults made fewer financial mistakes than either younger or older adults. We conclude that financial mistakes follow a U-shaped pattern, with the cost-minimizing performance occurring around age 53.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts winning 9bp, FixedResets down 4bp and DeemedRetractibles up 8bp. These figures might lead one to expect volatility to be low, but one might be wrong! Volume was low, but RBC scored a shut-out for the blocks reported.

Julie Dickson gave a speech to the Economic Club of Canada titled The Lasting Impact of the Crisis on the Global Financial System but said nothing new.

One of the lessons of the Flash Crash was that dealer capital, which would make markets with a time horizon of a week, was being replaced with much more evanescent High Frequency Trading capital, which has an intra-day time horizon. This was strongly deprecated at the time. We may therefore look on with admiration at the latest proposals to implement the Volcker Rule:

U.S. banks would have to change the way they compensate traders involved in market-making activities under one of the proposed restrictions of the so-called Volcker rule, according to a draft circulating among regulators.

The rule, which aims to ban most proprietary trading by banks with federally insured deposits, would exempt trades related to market-making as long as the activity met at least seven standards, or principles. One principle would be that traders get paid from fees and the spread of the transactions rather than the appreciation or profit from their positions, according to a copy of the draft reviewed by Bloomberg News.
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A forced change to pay structure “could have the effect of driving people out of the regulated industry to the unregulated industry,” said Douglas Landy, a partner at Allen & Overy LLP who once worked at the Federal Reserve Bank of New York.

The regulators could, if they so desired, seek to re-sharpen the lines between investing and trading by imposing surcharges on aged positions in the trading book. But that wouldn’t sound so tough.

It might be the right thing to do, to move longer-term market-making out of the banks and into the hedge funds. I don’t know. My problem is that I don’t think anybody else knows, either. Or cares. Except maybe Dealbreaker.

TransAlta Corporation, proud issuer of TA.PR.D, was confirmed at Pfd-3 by DBRS:

DBRS has today confirmed the ratings of TransAlta Corporation’s (TAC or the Company) Unsecured Debt/Medium-Term Notes and Preferred Shares at BBB and Pfd-3, respectively, both with Stable trends. The confirmation reflects the Company’s strong cash flow generated by its generation facilities, which are subject to legislatively mandated Alberta power purchase agreements (APPAs), longer-term power contracts on its non-regulated facilities and its diversified generation portfolio.

TAC’s credit profile and ratings are supported by its highly contracted diversified portfolio of assets. TAC currently has approximately 70% of its capacity contracted over the next seven years, with over 95% contracted for 2011 and up to 90% for 2012, in line with its stated objective of having at least 75% of its capacity under medium- and long-term contracts with creditworthy counterparties, thus reducing the Company’s cash flow volatility. DBRS remains comfortable with this strategy as it allows TAC to participate in any upside potential to improving market conditions.
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As the Company starts to generate more cash flow from new assets placed in service in 2011 and 2012, DBRS expects that on a normal course basis, the Company’s adjusted net debt-to-capital should remain below 50% and cash flow-to-debt will remain in the 25% range, levels that DBRS considers adequate for the rating, given the largely contracted fleet. The Company had $2.0 billion in committed credit facilities as of June 30, 2011, of which $0.8 billion was available.

At this time, DBRS remains comfortable with the Company’s disciplined growth strategy, financial flexibility and adequate liquidity. It is expected that TAC will maintain a low-to-moderate risk profile, underpinned by a more diversified and contracted portfolio of assets. DBRS expects the Company to continue to finance growth in line with its credit metrics.

Gold did not do well:

Gold fell, capping the biggest three-session slump since 1983, and silver closed below $30 an ounce on investor sales to cover losses in other assets.
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Gold futures for December delivery fell $45, or 2.7 percent, to settle at $1,594.80 an ounce at 1:36 p.m. on the Comex in New York, extending the three-session slide to 12 percent, the most since March 1983. Earlier, the price plunged as much as $104.80 to $1,535, the lowest for a most-active contract since July 8. The all-time high earlier this month was $1,923.70.

In October 2008, gold tumbled 18 percent as the most-severe slump since the Great Depression spurred losses in global equity and commodity markets. The metal jumped 23 percent in the next two months.

Silver futures for December delivery fell 12.5 cents, or 0.4 percent, to $29.976. Earlier, the price touched $26.15, the lowest since Nov. 18. In electronic trading after the settlement, the metal topped $30. On April 25, the price reached a 31-year high of $49.845 on April 25.

On Sept. 23, CME Group Inc., the owner of the Comex, trading margins on gold futures by 21 percent and boosted the minimum cash deposit for silver by 16 percent, effective today.

The Canadian preferred share market put in a good day’s work, with PerpetualDiscounts up 10bp, FixedResets gaining 8bp and DeemedRetractibles winning 14bp. Volatility was quite good, but volume was light.

Sorry about the lateness, folks, but the Shaw Festival was calling my name this weekend.

It was a rotten day for the Canadian preferred share market, with PerpetualDiscounts down 17bp, FixedResets off 16bp and DeemedRetractibles losing 36bp. Volatility reflected the market move; volume was average.

Equities got creamed today:

The MSCI All-Country World Index plunged 4.5 percent at 4:39 p.m. New York time and is down 22 percent from its May peak, while emerging-market stocks tumbled the most in almost three years. The Standard & Poor’s 500 Index lost 3.2 percent to 1,129.56 after briefly falling below its 2011 closing low. The Dow Jones Industrial Average slid the most over two days since 2008. Ten-year Treasury yields lost as much as 16 basis points to 1.6961 percent. The Dollar Index rose 1.4 percent.

The Federal Reserve said yesterday it saw “significant downside risks” in the economy and it will replace $400 billion of short-term debt with longer-term Treasuries to spur growth as the recovery falters. China’s manufacturing may shrink for a third month, U.S. jobless claims topped estimates and euro-area services and manufacturing output contracted for the first time in more than two years, reports showed.

The Europeans have figured out where to get the money to save the Euro: they’re going to print it:

European finance chiefs said they may use leverage to increase the financial firepower of their regional bailout fund as a selloff in stocks signaled renewed concern that policy makers are failing to ward off a global economic slump.
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That has fanned speculation Europe may eventually ratchet up the fund’s spending power, perhaps by using the bonds it sells as collateral to borrow more cash from the European Central Bank. Another proposal is to mimic a U.S. program established following the 2008 collapse of Lehman Brothers Holdings Inc. by allowing the fund to offer the ECB credit protection for buying more sovereign bonds.

The Canadian preferred share market got smacked today in the backwash of the equity excitement, with PerpetualDiscounts losing 71bp, FixedResets off a mere 26bp and DeemedRetractibles down 49bp. Naturally enough, given these returns, the Performance Highlights table is quite lengthy, with only one winner. Volume continued to be very sluggish.

The SEC continues its struggle against free markets:

The Securities and Exchange Commission may ask stock markets to impose fees on trading firms that submit a high number of quotations in relation to executed transactions, an executive at the regulator said.

The SEC is considering whether to urge exchanges to impose a fee for exceeding a certain order-to-execution ratio or for sending messages, which include quotes, updates, cancellations and executions, said David Shillman, associate director at the regulator’s division of trading and markets. That’s because they impose a cost on brokerages, said Shillman, who spoke in an interview at a Securities Industry and Financial Markets Association conference in New York.

There is, of course, no indication that a free market solution, like charging every order $0.0001, was ever considered. This would deny the SEC the opportunity to define Good Firms and Bad Firms.

There will be a new version of Quantitative Wheezing:

Federal Reserve policy makers will replace much of the short-term debt in their portfolio with longer-term Treasuries in an effort to further reduce borrowing costs and keep the economy from relapsing into a recession.

The central bank will buy $400 billion of bonds with maturities of six to 30 years through June while selling an equal amount of debt maturing in three years or less, the Federal Open Market Committee said today in Washington after a two-day meeting. The action “should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative,” the FOMC said.
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The amount of debt to be sold represents about three- fourths of Fed holdings of between three months and three years. The central bank will release a schedule of purchases and sales of bonds for October on Sept. 30.

The Standard & Poor’s 500 Index fell 1.6 percent to 1,183.22 at 2:37 p.m. in New York. The yield on the 10-year Treasury note slid seven basis points to 1.87 percent after declining to a record low of 1.85 percent.

The IMF’s September 2011 GFSR – Chapter 1 has many cheerful things to say about banks and insurers:

For the first time since the October 2008 Global Financial Stability Report, risks to global fi nancial stability have increased (Figures 1.2 and 1.3), signaling a partial reversal in progress made over the past three years. The pace of the
economic recovery has slowed, stalling progress in balance sheet repair in many advanced economies. Sovereign stress in the euro area has spilled over to banking systems, pushing up credit and market risks. Low interest rates could lead to excesses as the “search for yield” exacerbates the turn in the credit cycle, especially in emerging markets. Recent market turmoil suggests that investors are losing patience with the lack of momentum on financial repair and reform (Box 1.1). Policymakers need to accelerate actions to address longstanding financial weaknesses to ensure stability.

Another golden straw in the wind:

The surging price of gold is fueling inflation from India to Indonesia and forcing statisticians to decide whether jewelry made of the metal still belongs in consumer-price indexes.

In South Korea, gold rings will be dropped from the inflation basket for the first time since 1975 as part of a scheduled reweighting in December, Bang Tae Kyoung, deputy director of the statistics agency, said in an phone interview from Daejeon. “People are now buying gold mostly for investment purposes, and so it should be classified as an asset, rather than spending,” Bang said.

It was a lethargic day for the Canadian preferred share market, with PerpetualDiscounts winning 6bp, FixedResets basically flat and DeemedRetractibles up 4bp. Volatility was minimal. Volume was below average.

PerpetualDiscounts now yield 5.33%, equivalent to 6.93% interest at the standard equivalency factor of 1.3x. Long Corporates now yield about 4.8%, so the pre-tax interest-equivalent spread is now about 215bp, a widening from the 200bp reported on September 7.