PrefBlog

The US government is creaking slowly towards GSE reform:

A Dodd-Frank mandated Treasury study on Fannie Mae and Freddie Mac is almost certain to be the first step in federal legislation to reform government-sponsored enterprises and the secondary mortgage market. The study, which must be submitted to Congress by the end of January 2011, was mandated by an amendment offered by Senator Chris Dodd, Chair of the Banking Committee, codified as section 1074, as the Senate was beating back an amendment offered by Senator John McCain that would have either ended the conservatorship of Fannie and Freddie or disbanded them with no reasonable alternative offered.

All that being said, there is a growing consensus that the 112th Congress must pass legislation reforming the GSEs.

Mary Schapiro spoke about market structure today:

May 6 was clearly a market failure, and it brought to the fore concerns about our equity market structure. The staffs of the SEC and CFTC are finalizing a joint report on our inquiry into the day’s events that will be published in the coming weeks.

But we have not waited for the report to begin taking steps to address weaknesses identified on May 6.

There will doubtless be some who consider this admirable.

To understand where individual investors are coming from, we must truly recognize the impact of severe price volatility on their interests: one example is the use and impact of stop loss orders on May 6. Stop loss orders are designed to help limit losses by selling a stock when it drops below a specified price, and are a safety tool used by many individual investors to limit losses.

The fundamental premise of these orders is to rely on the integrity of market prices to signal when the investor should sell a holding. On May 6, this reliance proved misplaced and the use of this tool backfired.

A staggering total of more than $2 billion in individual investor stop loss orders is estimated to have been triggered during the half hour between 2:30 and 3 p.m. on May 6. As a hypothetical illustration, if each of those orders were executed at a very conservative estimate of 10 percent less than the closing price, then those individual investors suffered losses of more than $200 million compared to the closing price on that day.

This is the first time I’ve seen a number. OK, so users of stop loss orders lost a lot of money, which is now in the hands of less stupid people better able to allocate capital. So what? Isn’t this what markets are supposed to do?

We should consider the relevance today of a basic premise of the old specialist obligations — that the professional trading firms with the best access to the markets (and therefore the greatest capacity to affect trading for good or for ill) should be subject to obligations to trade in ways that support the stability and fairness of the markets.

For example, the stocks with broken trades on May 6 highlight the fact that the order book liquidity in those stocks completely disappeared, if only briefly, and caused trades to occur at absurd prices. Where were the high frequency trading firms that typically dominate liquidity provision in those stocks?

I anticipate that the May 6 report will discuss the reasons that caused these firms to pull back, which they believed to be in their interest. The issue, however, is whether the firms that effectively act as market makers during normal times should have any obligation to support the market in reasonable ways in tough times.

This is craziness. In the first place, specialists and market-makers have a lot more advantages than mere “access”. In the second place, it will be remembered that these paragons of virtue stepped back during the crash of 1987, as well.

It looks like the established order of do-nothing incompetents has renewed its hegemony over the SEC!

Reverberations over Greek debt continue:

Four months after the 110 billion- euro ($140 billion) bailout for Greece, the nation still hasn’t disclosed the full details of secret financial transactions it used to conceal debt.

“We have not seen the real documents,” Walter Radermacher, head of the European Union’s statistics agency Eurostat, said in a Sept. 2 interview in his Luxembourg office. Eurostat first requested the contracts in February.

Radermacher vows new toughness when officials from his staff head to Greece this month to come up with a “solid estimate” of the total value of debt hidden by the opaque contracts. “This is a new era,” he said.

Greece is the only euro country that lied about using these complex swap contracts after Eurostat told countries to report them in 2008, Radermacher, 58, said.
…
“You might say this is triumph of hope over experience,” [Yannis Stournaras, director general of the Foundation for Economic and Industrial Research in Athens] said, adding that the blame should be shared with the European Commission, which didn’t intervene despite years of warnings by Eurostat of problems with Greek data.

“We addressed the issue several times in meetings of finance ministers and we asked for enhanced powers for Eurostat in 2005, which we didn’t receive at the time,” said Amadeu Altafaj, a spokesman for the Commission.
…
In April 2009, the European Central Bank identified a Greek swap operation of unusual terms, according to a confidential ECB document dated March 3, 2010, obtained by Bloomberg News. The ECB said its executive board prepared internal reports on the swaps. ECB spokesman Niels Buenemann declined to comment on it.

Greece began using this type of contract for the 2001 budget year to avoid recording a spike in debt the first year after it adopted the euro, Stournaras said. It continued to use them after 2001 and increased their use after 2004, he said.

Under guidance set out in 2008 by Eurostat, any upfront payments linked to a swap must be counted as a loan.

Germany, Italy, Poland and Belgium, like Greece, received upfront payments from derivatives, Radermacher said at a hearing at the European Parliament in April. The difference, he said in the September interview, was that when Eurostat asked the other countries about the contracts in 2008, they provided the data and adjusted their debt figures.

See? As I said at the time, this was a case of willful blindness by European bureaucrats and politicians, for which they frantically tried to blame Goldman Sachs when the shit finally hit the fan.

On September 2 I indulged myself with a rant on the Lori Douglas case and found it remarkable that tenure-track law professors couldn’t mount an actual argument. An ink-stained wretch, Judith Timson, managed it in the Globe on Friday, arguing (arguing!) in a column titled The net killed sexual privacy that Douglas showed poor judgment in allowing the photos to be taken and that this poor judgment disqualifies her from the judiciary.

Well, it’s a murky area and it’s very easy to add increments to the situation until most people will agree that the conduct is inappropriate, with nobody agreeing on which increment tipped the scale. But to stick with the situation as it is, I have to disagree and I’m going to disagree on the grounds that “judgment” is too broad a term – even if I allow for the sake of an argument that her judgment was poor in that instance and I’m not convinced it was.

Judgment is not fungible. There are lots of people whose judgment I would trust absolutely on some matters, but not on others. I see fixed income portfolios from lots of people that simply don’t make any sense at all – and it doesn’t affect my respect for their knowledge within their field of specialization. If Ms. Douglas showed “poor judgment” in the matter of her sexual relationship with her spouse (and I’m not saying she did), I don’t believe you can draw any conclusions about her judgment on the bench.

BUt OK. For the sake of an argument, let’s concede not just the first point – that allowing risque pictures to be take shows poor judgment – but the second one as well – that this poor judgment will be reflected in the judge’s judicial skills. I’m still not convinced that the Ms. Douglas deserves to lose her job, because I’m not sure whether there’s a net benefit to this.

If we insist on asking about the bare existence of naughty pictures as part of a prospective judge’s background check, we’re going to get lied to. A lot. Some people will honestly forget, some will figure it’s so long ago it doesn’t matter, some will figure it’s none of our business and some honestly won’t know. In such a case, what we are doing is increasing the chance for blackmail: if the pictures come to light, the judge will lose his job. I am by no means convinced that the change in standards is a net benefit.

Additionally, by loading down the process with many specific rules, we’re in danger of establishing “Gotcha Regulation”, the same that exists in the securities business. Do the bosses want to get rid of somebody? Put enough people on the case and it’s easy enough to find some rule that was broken.

Still: well done Ms. Timson for providing an actual argument! I wonder if she’s considered applying to law school? Not as a student; I mean, for a tenured position, job for life. status, pay, benefits … she could do a lot worse, and can obviously apply logic better than many of the incumbents.

Why am I spending time on this issue? Why is it is important? Because bureaucrats have contempt for the judicial process:

Wendy Vanstralen, 47, has been charged under the province’s stunt driving legislation.

Her truck has been impounded for a week, and she has also lost her licence for seven days.

Ms. Vanstralen is due in court Nov. 2.

… and that’s a scary thing. Especially when bank regulation is heading the same way.

It was quite a good day on the Canadian preferred share market; volume was good, with PerpetualDiscounts gaining 16bp and FixedResets gaining 13bp … taking the YTW on the latter index down to 3.08%. Next stop: three percent! MFC continued to be highlighted on the volume table.

Mr Thomas C Baxter, Jr, Executive Vice President and General Counsel of the Federal Reserve Bank of New York, testified to the Financial Crisis Inquiry Commission regarding the Lehman bankruptcy:

As of that Friday, there were two prospective Lehman acquirers: Bank of America and Barclays. On Saturday, September 13, Bank of America abandoned the potential acquisition of Lehman and reached an agreement to acquire Merrill Lynch. Barclays was the only remaining suitor. On Sunday, September 14, with the consortium financing committed, we learned for the first time that Barclays would not be able to deliver a key document to carry the merger to conclusion: a guarantee of Lehman’s trading obligations between the signing of the merger agreement and its closing.

The Bear Stearns transaction taught us the importance of the guarantee to a successful rescue. A guarantee maintains the ability of the troubled company to operate as a going concern and, thus, preserves value. It does this by providing protection to counterparties during an especially vulnerable period – the period between merger contract and merger closing. Without such a guarantee, the creditors and counterparties of the firm would be at risk in the event that the merger fell apart because of a failed shareholder vote or some other contingency. Consequently, as a market matter, the guarantee is an indispensable part of any such rescue operation.

On Sunday, September 14, we learned that Barclays could not proffer the needed guarantee without a shareholder vote. This vote would take days, if not weeks or months, and there was no way to predict if the shareholders would even vote for the transaction to proceed. I explored with counsel whether the U.K. government, or one of its instrumentalities like the FSA, might waive this U.K. requirement, such that the guarantee could be delivered and the rescue effected. I learned that the U.K. authorities were not amenable to a waiver. Thus, Barclays ceased to be available as the willing buyer that we needed to rescue Lehman, and there was no other interest from any firm of sufficient size and capability that could acquire Lehman, a company with consolidated assets of about $600 billion.

I’m suspicious of any portfolio management model that includes the word “regression”, but there’s occasionally a good idea in there. Econbrowser‘s James Hamilton highlights his recent paper in a post Policy tools that could lower interest rates further:

Our starting point was a framework developed by Vayanos and Vila (2009), who interpret the term structure of interest rates as arising from the behavior of risk-averse arbitrageurs. This model is one way to capture formally the portfolio balance channel that Fed Chairman Bernanke indicated is central to the Fed’s understanding of how nonstandard monetary operations might affect the economy. Vayanos and Vila’s framework has previously been applied to our question by Greenwood and Vayanos (2010) and Doh (2010). One of our contributions is to develop specific measures of how the available supplies of Treasury securities of different maturities might be expected to influence the pricing of level, slope, and curvature risk of the term structure. Although I began as a skeptic of the claim that bond supplies would make much difference, we found pretty strong evidence that historically they have. For example, we found that over the 1990-2007 period, we could predict the excess return from holding a 2-year bond over a 1-year bond with an R² of 71% on the basis of the level, slope, and curvature of the yield curve along with our 3 Treasury supply factors.

The full research paper is The Effectiveness of Alternative Monetary Policy Tools in a Zero Lower Bound Environment.

Just when you thought that nothing good could be said about Russian politicians, they prove you wrong:

Speaking as the Russian government announces plan to raise duty on alcohol and cigarettes, [Russian Finance Minister] Alexei Kudrin said that by smoking a pack, “you are giving more to help solve social problems such as boosting demographics, developing other social services and upholding birth rates”.

“People should understand: Those who drink, those who smoke are doing more to help the state,” he told the Interfax news agency.

He’s got my vote.

It was a solid day on the Canadian preferred share market, with PerpetualDiscounts up 5bp and FixedResets gaining 3bp on average volume. There has been a lot of volume in MFC lately, presumably due to continued rebalancing after the downgrade.

Nothing happened in the financial markets today, so today the entire market update will be devoted to Canadian politics. Ain’t you lucky? But the integrity of the judicial system is important, as minority shareholders in Mascan Corp. can testify.

There’s a kerfuffle about a judge whose husband posted risque pictures of her on the Internet that has come to light because some little twerp has seen a chance for some legalized blackmail. There’s no indication the judge herself did anything wrong; unless you believe that allowing your spouse to take risque pictures of you is wrong. The whole story is no big deal, except for one incredible quote:

“If pictures of you naked end up on an internet site, it’s quite difficult to say you have the credibility to be a judge,” said Sébastien Grammond, dean of civil law at the University of Ottawa.

On the basis of what has been disclosed, I have no qualms about the credibility or ability of Associate Chief Justice Lori Douglas. However, I have deep qualms about the ability of Sébastien Grammond to think things through and to be responsible for the education of the next generation of lawyers. He should be removed from his post immediately.

Similarly:

“I think that no judge who has a cloud of scandal hanging over their heads is able to … act effectively as a member of the judiciary,” said Annalise Acorn, a law professor at the University of Alberta who specializes in ethics.

“I simply think it’s not consistent with the image of dignity and authority that the judiciary needs to have.”

Prof. Acorn said she would be “flabbergasted” if Judge Douglas stays on as a judge, and expects she might resign in the coming days.

It’s easy to tell member of a profession who are completely unable to do the work – they specialize in ethics. After all, how can you ever actually prove they’re wrong? It’s very convenient. The only surprising thing is that some authorities are actually willing to pay these people.

Alice Woolley claims that:

The problem is that her knowledge of those pictures prior to her appointment undermines the already fragile legitimacy of our appointments process. Applicants for judgeships are asked, “is there anything in your past or present which could reflect negatively on yourself or the judiciary, and which should be disclosed?” The question asks applicants to provide the committee with the information necessary to make a fair and appropriate assessment of the applicant’s qualifications to be a judge.

In this instance Douglas had to answer “yes” to that question.
…
It is not even about whether she would be a good judge. It is about whether people appearing before her could feel confident that their cases were being heard fairly and dispassionately. If those people included a black man, or a white woman divorcing a black man, or a Mexican family dealing with a child apprehension case, those people could reasonably wonder whether the racial stereotyping that the website reflects is one that Douglas shares, and that will impact her judgment.

The last sentence is pure bullshit. These people could wonder, complain and appeal, but not reasonably. If they wanted, they could always demand that the judge recuse herself. It’s just another legal manoevre.

But wait! We have not yet finished plumbing the depths of Alice Woolley’s ignorance. Clearly, Douglas’ behaviour is not, in and of itself, a factor. So what if … what if she’d be sunbathing topless and her husband had posted those pictures? What if it wasn’t her husband, but a voyeur posted pictures of her on the internet? What if he had identified her? What if he had claimed he could arrange sexual liasons with her? What if he claimed she liked Mexicans, wink-wink nudge-nudge? What if it wasn’t even a topless picture, it was her official picture taken during her investiture?

Alice Woolley’s series of assertions – they are far too childish to be honoured with the sobriquet of “argument” – work equally well in any of these situations.

We can go further. What if a tireless research finds that, while in high school, Douglas answered a Teen Queen Magazeen quiz by circling the “tall dark and handsome” choice for ‘Guy you want’. When we consider this situation, we’re at least looking at something she did herself, not something done by a third party without her knowledge or consent. Does this expression of preference make her forever unfit to be a judge? What if she hears a case involving some short, fair, average-looking guy? In Alice Woolley’s anarchic dream world, in which assertion of bias is deemed equivalent to proof of bias, such a thing would bar her – and, basically, every living, breathing human on the planet – from the judiciary.

Alice Woolley is a fool – and a dangerous fool at that, for urging standards that will accomplish nothing but making judges easier to blackmail.

Honestly, the howls for Douglas’ head are so shockingly removed from any semblence of intellectual rigour that one has to wonder if the real story is being told – when smart people say dumb things, it’s often because they don’t want to say the sleazy thing, as when doctors claim they won’t give terminal patients sufficient painkillers ‘because there is the chance of addiction’, when the real story is that they don’t want to get a call from the ministry and fill out the painkiller forms. Are the critics going after her for some other, less publicly expressible reason? Was she appointed by the wrong party? In Harper’s Canada, did she find the wrong person liable?

It was another good day on the Canadian preferred share market, with PerpetualDiscounts gaining 11bp and FixedResets winning 2bp. Volume and volatility were enough to make the day interesting.