PrefBlog

The Boston Fed has released its 2H10 Research Review:

• Public Policy Discussion Papers
  • Who Gains and Who Loses from Credit Card Payments? Theory and Calibrations, Scott Schuh, Oz Shy, and Joanna Stavins
  • $1.25 Trillion Is Still Real Money: Some Facts about the Effects of the Federal Reserve’s Mortgage Market Investments, Andreas Fuster and Paul S. Willen
  • Reasonable People Did Disagree: Optimism and Pessimism about the U.S. Housing Market Before the Crash Kristopher S. Gerardi, Christopher L. Foote, and Paul S. Willen (discussed on PrefBlog)
  • A Profile of the Mortgage Crisis in a Low-and-Moderate-Income Community, Lynn M. Fisher, Lauren Lambie-Hanson, and Paul S. Willen
• Working Papers
  • In Search of Real Rigidities, Gita Gopinath and Oleg Itskhoki
  • Strategic Choice of Preferences: The Persona Model, David H. Wolpert, Julian C. Jamison, David Newth, and Michael Harre
  • Some Evidence on the Importance of Sticky Wages, Alessandro Barattieri, Susanto Basu, and Peter Gottschalk
  • Imputing Household Spending in the Panel Study of Income Dynamics:
    A Comparison of Approaches, Daniel H. Cooper

  • The Distress Premium Puzzle, Ali K. Ozdagli
  • Characterizing the Amount and Speed of Discounting Procedures, Dean T. Jamison and Julian C. Jamison
  • Internal Sources of Finance and the Great Recession, Michelle L. Barnes and N. Aaron Pancost
  • Affective Decision Making: A Theory of Optimism Bias, Anat Bracha and Donald J. Brown
  • The Financial Structure of Startup Firms: The Role of Asset, Information, and Entrepreneur Characteristics, Paroma Sanyal and Catherine L. Mann
• Public Policy Briefs
  • Evidence of a Credit Crunch? Results from the 2010 Survey of First District Community Banks, Jihye Jeon, Judit Montoriol-Garriga, Robert K. Triest, and J. Christina Wang
• Multimedia
  • The Great Recession (video), Christopher L. Foote

My discussion with Assiduous Reader Drew (in the comments to February 11) got me thinking about the propriety of allowing Exchanges to determine who gets listed. For instance, it is possible that this made sense long ago, when (I’m speculating) listing fees were a lower proportion of Exchnge revenue than they were now? Is it possible that the rationale behind the regulatory contracting-out of this gatekeeper function is now obsolete?

I went looking for a chart showing proportions of Exchange revenue over time.

I counldn’t find one, but it turns out – naturally enough – that this has not only been thought of before, but has been a big issue. Jonathan Macey and Maureen O’Hara (who has been mocked on PrefBlog) wrote paper titled From Markets to Venues: Securities Regulation in an Evolving World:

Few issues better reflect this divergence of interests than the listing and delisting of securities. Exchanges have traditionally used listing standards to support their “signaling role” of attesting to the quality of firms trading on the exchange. In return for this endorsement, listing firms paid both initial listing fees and continuing listing fees. These fees have been an important source of revenue for stock markets, particularly in the U.S where listing fees have often been upwards of 30% of the NYSE’s overall revenues.

When it was the case that where firms listed determined where shares traded, these fees could be justified as paying for the ongoing regulation of trading. As we have argued earlier, however, the listing-trading connection has broken down, and trading currently takes place on whichever venue provides the greatest liquidity. There is increased competition for listings. Listing fees now represent almost a fee for access to the US markets, a monopoly rent as it were to the few exchanges and venues empowered to list firms. From a purely economics perspective, since exchanges can list firms whose stocks they may not actually end up trading, the incentives are surely to list more firms than would be optimal if listing and trading were linked. Concerns over such perverse incentives were recently raised in Hong Kong, where a government appointed commission pushed for the transfer of the listing function to the regulator from the exchange arguing that “As a listed company motivated by profitability, the HKEx has a clear interest in listing as many companies as possible since listing fees represent a significant portion of revenues (18% in 2002) and there is a disincentive to allocate revenues to enforcement with is costly and produces no revenues.”

Which is my point exactly. A potential criticism of the TMX-LSE deal is that the TMX has regulatory functions and we might not want those to be under foreign control. But assuming that the functions need to be performed at all, should they be performed by the TMX in the first place? Would it be reasonable, for instance, to say … “OK, go ahead and merge …. on the condition that the Listing Authority gets spun out as a stand-alone company.” … ?

For the security market as a whole, however, listing and delisting standards play an important role by delineating the quality of firms allowed to access a country’s capital markets. Restricting access or denying trading privileges is thus a public good in that it enhances the overall quality of the market. Entrusting this decision to self-regulating exchanges is suboptimal because as with any public good, the social costs exceed the private costs. As we have argued above, self-regulation cannot succeed when this is the case.

Vehemently disagree. This has the implicit view that capital markets are stupid and it is wise regulators who should decide who gets to take advantage of the suckers.

It was another mixed day on the Canadian preferred share market,with PerpetualDiscounts losing 6bp while FixedRestes gained 3bp and DeemedRetractibles were up 6bp. Volatility remained low. but volume picked up and can be described as heavy.

PerpetualDiscounts now yield 5.62%, equivalent to 7.87% interest at the standard equivalency factor of 1.4x. Long corporates continue to yield 5.6%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 225bp, This marks a significant decline from the 240bp recorded February 9; it should be remembered that while the two figures mentioned are compable (with the caveate that there aren’t too many issuers in that index any more), they are less comparable – and a good comparison would require explicit assumptions of spreads between issuers, etc. – with all earlier data.

Daniel K Tarullo, Member of the Board of Governors of the Federal Reserve System, testified before the Committee on Financial Services, US House of Representatives, Washington DC, 15 February 2011, in an effort titled Assessing the regulatory, economic, and market implications of the Dodd-Frank derivatives title. Very non-committal and not much meat, but there was one interesting admission that I believe has been downplayed in the debate so far:

Title VIII of the act complements the role of central clearing in Title VII through heightened supervisory oversight of systemically important financial market utilities, including systemically important facilities that clear swaps. This heightened oversight is important because financial market utilities such as central counterparties concentrate risk and thus have the potential to transmit shocks throughout the financial markets. As part of Title VIII, the Board also was given new authority to provide emergency collateralized liquidity in unusual and exigent circumstances to systemically important financial market utilities. We are carefully considering ways to implement this provision in a manner that protects taxpayers and limits any rise in moral hazard.

Additionally, he floated an idea for discretionary exemptions; seeking these exemptions will create jobs for lobbyists and other smiley-boys:

Within these statutory constraints, the Board and the other prudential regulators are working to implement the margin provisions in a way that takes appropriate account of the relatively low systemic risk posed by most end users. For example, we are considering if it would be appropriate to allow a banking organization that is a dealer or major participant to establish a threshold with respect to an end-user counterparty, based on a credit exposure limit that is approved and monitored as part of the credit approval process, below which the end user would not have to post margin. The Board appreciates that posting margin would impose costs on end users, possibly inhibiting their ability to manage their risks. The Board also believes that the margin regime should be applied only to contracts entered into after the new requirement becomes effective.

It was a mixed day on the Canadian preferred share market, with PerpetualDiscounts losing 1bp, FixedResets down 7bp while DeemedRetractibles gained 15bp. Not much volatility, volume was average, and the “Last” spread on FTS.PR.G was rather wide. SLF blocks were the volume highlight.

The Basel Committee has released its Revisions to the Basel II market risk framework – updated as of 31 December 2010, complete with a PDF that has now crashed my Internet Explorer twice. The press release states:

Since the financial crisis began in mid-2007, an important source of losses and of the build up of leverage occurred in the trading book. A main contributing factor was that the current capital framework for market risk, based on the 1996 Amendment to the Capital Accord to incorporate market risks, does not capture some key risks. In response, the Basel Committee on Banking Supervision (the Committee) supplements the current value-at-risk based trading book framework with an incremental risk capital charge, which includes default risk as well as migration risk, for unsecuritised credit products. For securitised products, the capital charges of the banking book will apply with a limited exception for certain so-called correlation trading activities, where banks may be allowed by their supervisor to calculate a comprehensive risk capital charge subject to strict qualitative minimum requirements as well as stress testing requirements. These measures will reduce the incentive for regulatory arbitrage between the banking and trading books.

An additional response to the crisis is the introduction of a stressed value-at-risk requirement. Losses in most banks’ trading books during the financial crisis have been significantly higher than the minimum capital requirements under the former Pillar 1 market risk rules. The Committee therefore requires banks to calculate a stressed value-at-risk taking into account a one-year observation period relating to significant losses, which must be calculated in addition to the value-at-risk based on the most recent one-year observation period. The additional stressed value-at-risk requirement will also help reduce the procyclicality of the minimum capital requirements for market risk.

As I have often stated here, I’m not completely certain that this is a step forward. Trading is functionally different from holding, and a trader may well wish to hold a position in El Crapola Corporation paper for a while because he knows he’s got a buyer. Problems can arise – and did arise during the crisis – when the paper that couldn’t be sold was kept on the trading book, instead of migrating to the banking book as it aged.

I haven’t seen any discussion of this point anywhere, so this is either a very profound point, or a very naive one. Take your pick.

Sell Side analysts are a hoot:

So, when analysts are raising their recommendations on a stock, that should be telling people to buy more of it (or, sell less of it); when they are cutting their recommendations, that’s telling people to sell more (or, buy less). In both cases, especially when you’re talking about well-known analysts at major firms, we would expect this to filter down to the stocks themselves – downgrades serve to drive stock prices lower, upgrades to push them higher. Right?

As it turns out, not so much. In fact, it would appear that as long as they spell your company’s name right,upgrades and downgrades are both good news for your stock.

Laszlo Birinyi and Amanda Crumb, of independent stock-market research firm Birinyi Associates Inc., recently analyzed more than 2,700 upgrades and downgrades issued by 19 Wall Street firms since the market bottomed in March, 2009. They found that – as expected – upgraded stocks rose an average of 2.03 per cent on the day of their upgrade, while downgraded stocks averaged a 2.02-per-cent drop on the day of the news.

But once they looked even a mere week further out, this expected trend no longer held. Yes, the upgraded stocks continued to move higher, both on an absolute basis and relative to the S&P 500 benchmark, and these gains got stronger as time passed. What wasn’t expected, though, was that the same was also true for the downgrades.

Downgraded stocks not only typically rose in the weeks to months following the downgrades, but after an initial underperformance relative to the S&P 500 in the first week, they significantly outperformed the benchmark at one month and three months out. What’s more, this surprising upward trend among downgrades didn’t appear to have been skewed by some large incorrect calls at a couple of firms; the gains were seen across virtually all 19 investing firms.

Remember 2005? Remember how it was so friggin’ obvious that subprime was a nascent disaster? Remember giving learned lectures about how big the real estate bubble was? Remember how it was all the fault of evil bonus-loving Wall Street vampires? I don’t. The Boston Fed has a similarly faulty memory. And, it would seem, John Paulso, most famous for making a fortune betting against it, and second-most famous for being disrespected in the Boston Fed paper, can’t remember that either:

As one of the few winners from the financial crisis, John A. Paulson looks pretty smart. His hedge fund firm, Paulson and Company, netted $15 billion betting against the subprime mortgage market — and he continues to profit from his wager on gold.

But in audio recordings recently released by Financial Crisis Inquiry Commission, Mr. Paulson reveals just how much flack he got from professionals and peers, who in the early days of the turmoil derided his big bet as the misguided move of a “novice.”

“Most of them, when we did express our viewpoints, thought we were inexperienced novices in the mortgage market,” Mr. Paulson said in an interview with the commission in 2010. “We were very, very much in the minority. If I said a thousand-to-one, we were the one. Even friends of ours thought we were so wrong, they felt sorry for us.”

The Evil, bonus-seeking Fabulous Fab, as one may recall, was the one who (as discussed on April 21, 2010) conspired with the smart cookies at ACA and IKB to fleece the poor neophyte. Oh, no, wait, sorry, it was the other way ’round.

It was another relatively quiet, slowly rising day on the Canadian preferred share market, with PerpetualDiscounts up 5bp, FixedResets gaining 1bp and DeemedRetractibles winning 9bp, all on quiet, “normal” volume with very little price volatility.

There is one problem with directing tax revenue to debt reduction: it means you can’t spend it. EU plans are running into roadblocks:

Greece joined Italy in objecting to annual numerical debt-reduction targets in a fresh challenge to the German-led drive for tougher economic safeguards to underpin the euro.

Greece, the first deficit-riddled euro country to fall back on financial aid, says the proposed rule would force it to make impossibly large cuts once its support package runs out in 2013, according to a draft of European Union legislation.

“All member states except two already accepted the proposal,” said an EU briefing note obtained by Bloomberg News before next week’s debate among finance ministers. “Italy and Greece have a reserve on the numerical benchmark.”

Greece or Italy alone could veto the rule, undercutting the tougher enforcement demanded by Germany as a condition for beefing up the 750 billion-euro ($1 trillion) rescue fund for distressed states.

Assiduous Readers will remember it was France and Germany who scuttled the 3% deficit rule when it was no longer convenient to them.

The Fannie & Freddie problem is lurching towards the limelight:

U.S. Treasury Secretary Timothy F. Geithner presented Congress with a set of options for weaning the $11 trillion mortgage market from its dependence on the government, while calling for changes to be phased in “responsibly and carefully” to avoid economic disruptions.
…
The options suggest differing degrees of government involvement in the system. The most dramatic would involve a “privatized” system of housing finance, with a government role to help “narrowly targeted” low-income and veteran buyers.

A middle ground would replace Fannie and Freddie with a system that helps low-income and veteran buyers in normal times and also provides an expanded guarantee that the government could ramp up in a crisis. The paper suggests using high-priced guarantee fees or restricted amounts of public insurance to achieve this goal.

A third option has the biggest government role and would hew closest to the current system. It would impose more regulation and give the government a role in “catastrophic reinsurance behind significant private capital,” so as to provide a backstop in times of crisis.

We have a wee bit of xenophobia happening:

Ontario Finance Minister Dwight Duncan has turned up the heat in the political debate surrounding the proposed transatlantic stock-exchange transaction, saying he does not want a “strategic asset” owned by the Middle East.

“We do business with the Middle East,” Mr. Duncan told reporters at Queen’s Park on Friday. “I am just not sure I want them owning our stock exchange.”

Then buy it yourself – jerk. He doesn’t even have the “finite natural resource” excuse. Seems to me that if a foreign-owned TMX stops doing its job properly, then there are a few Alternative Trading Systems that would be pleased to pick up the slack. Or somebody will write the code to start up a new one. But I guess Duncan thinks Canadians are too stupid to do that.

It was a quiet day on the Canadian preferred share market, with PerpetualDiscounts up 1bp, FixedResets down 6bp and DeemedRetractibles gaining 5bp. Volatility was small and volume was muted.