PrefBlog

Donald C. Langevoort made a good point about trade-throughs in his paper U.S. SECURITIES REGULATION AND GLOBAL COMPETITION:

Gadinis points out that U.S. and European regulation is similar in one strategy—trying to force trading interest into public view in the form of limit order quotes so that the price can reflect available supply and demand at increments a little higher or lower than the last sale. Reg NMS goes one step further, however, by forcing the trade-through of orders to the market with the best displayed price, so long as that market has fast (that is, fully automated) execution capacity. This is required for two reasons: first, to give protection to and thereby encourage the display of quotations and limit orders; second, as a mechanism to try to ensure that brokers offer their customers best execution. In contrast, European market regulation does not have a trade-through regime, and leaves best execution to negotiation between broker and customer. For obvious reasons, many institutional investors feel hampered by Reg NMS, and many investors, brokers, and trading sites have taken advantage of exceptions in the regulation to accommodate so-called “dark pools”—undisclosed trading interest—and trading that is based on non-price preferences.

The differences in approach are not hard to understand. The national market system in the United States is a legacy of public markets wherein retail investors are protected not only from the abuses of monopolistic trading sites but also from being elbowed aside by large traders in an increasingly institutional marketplace. Europe has little direct retail participation, and so that legacy is not present. What Gadinis describes there is precisely what one would expect from markets that have been built in recent years almost entirely for the benefit of the institutional trade.
…
U.S. institutional investors have ways of moving trading abroad when the domestic regulatory burdens are too much. As a result, Reg NMS is probably quite unstable. To date, the SEC has conditioned the cross-border mergers of exchanges (for example, New York Stock Exchange and Euronext) on keeping them separate for purposes of compliance with domestic market regulation. But that is inefficient, and probably hopeless in the long run. The right vision is no longer of a national market system but a global market system, and there is simply no way the SEC can impose its retail investor legacy extraterritorially. One suspects that it is simply a matter of time before the SEC does in this area what it did with IFRS: abandon exceptionalism in an effort to gain greater influence over market structure evolution around the world.

The issue of trade-throughs was discussed on August 27.

BIS has released preliminary results from its survey of FX and OTC derivatives:

•Activity in OTC interest rate derivatives grew by 24%, with average daily turnover of $2.1 trillion in April 2010. Almost all of the increase relative to the last survey was due to the growth of forward rate agreements (FRAs), which increased by 132% to reach $601 billion

The Bank of Canada has published its specific contribution, with the nugget:

Similarly, as an approximation, the three execution methods—(i) customer direct (over the telephone), (ii) multi-bank dealing systems, and (iii) single bank proprietary platforms—can be viewed as being execution methods primarily for customers. On that basis, 77 per cent of all customer trades in Canada are undertaken directly with the customer over the telephone, and 23 per cent are executed through either multi-bank or single-bank electronic trading systems.

In possibly the most amazing news story in the history of the universe, Bloomberg advises that Hong Kong i-bankers are competing on fees:

Hong Kong bankers are charging the lowest fees on record to arrange initial public offerings as firms vie for deals in a market where IPOs are raising more than in the U.S. and U.K. combined.

Initial sales by 37 companies in Hong Kong have paid average fees of 2.2 percent in 2010, the lowest level since Bloomberg began tracking the data in 1999. While companies going public raised $18.7 billion, 64 percent more than American IPOs, banks earned about 43 percent less underwriting in the territory, the data show.

Goldman Sachs Group Inc., JPMorgan Chase & Co. and Deutsche Bank AG are leading Wall Street in reducing fees and winning sales where Chinese companies go public to help finance the fastest growth among the world’s biggest economies. The firms are facing more competition from mainland banks that have boosted their share by 50 percent since the start of the financial crisis.

We won’t be seeing that here in hurry!

It looks like there’s a bit of capital flight from Greece:

Withdrawals by cash-strapped customers such as Efthymiou, as well as by Greeks moving money out of the country, helped push deposits at the nation’s banks down by 9 percent since the end of 2009.
…
Business and household deposits in June fell for a sixth straight month to 216.5 billion euros ($277.3 billion) from 238 billion euros at the end of 2009, according to figures from the Bank of Greece.

The reporter, the politicians and the banks are emphasizing the ‘draw-down of savings to offset government payment reduction’ idea, but Greece’s GDP is USD 356-billion. So that’s about 6% of GDP in reduced bank deposits. I vote for capital flight and eagerly await compelling evidence and incisive arguments proving me wrong.

PrefBlog’s Strange Funds Department has come up with another exhibit:

Connor, Clark & Lunn Capital Markets Inc. (the “Manager”) is pleased to announce that a preliminary prospectus for HBanc Capital Securities Trust (the “Fund”) has been filed
…
The Fund was established to provide investors with high levels of stable, tax-advantaged distributions through exposure to Capital Securities issued by HSBC Holdings plc, a conservatively positioned and strongly capitalized global bank.

CC&L is best known for packaging multi-name Credit Default Swaps as preferred shares and thereby vaporizing a lot of client money. More than once. However, I am confident that the time spent developing and managing these products will be properly accounted for as “experience” in the prospectus for the new fund.

Mayoral candidate Joe Pantalone has presented his vision of doing business in the city:

“I have no problem with people finding loopholes, if they’re good people,” says councillor Joe Pantalone, who spearheaded the moratorium.

“I know Albino well and I can’t say enough about what a good Torontonian he is.”

I have no idea how one gets to be a “good Torontonian”, but presumably it involves cash and being a friend of Joe Pantalone.

The Canadian preferred share market continued to gain today, with both PerpetualDiscounts and FixedResets up 9bp. Volume was good, but volatility was subdued, with the performance highlights table being empty.

PerpetualDiscounts now yield 5.78%, equivalent to 8.09% interest at the standard equivalency factor of 1.4x. Long Corporates now yield 5.3%, so the pre-tax interest equivalent spread is now 280bp, a significant rebound from the 265bp reported at August 31; however, note that in the interim there has been a migration of high-coupon, high-yield issues from PerpetualDiscounts to PerpetualPremiums, which has artificially reduced the yield on the PerpetualDiscount index.

The SEC has announced that it:

today issued a report cautioning credit rating agencies about deceptive ratings conduct and the importance of sufficient internal controls over the policies, procedures, and methodologies the firms use to determine credit ratings.

The SEC’s Report of Investigation stems from an Enforcement Division inquiry into whether Moody’s Investors Service, Inc. (MIS) — the credit rating business segment of Moody’s Corporation — violated the registration provisions or the antifraud provisions of the federal securities laws.
…
According to the Report, an MIS analyst discovered in early 2007 that a computer coding error had upwardly impacted by 1.5 to 3.5 notches the model output used to determine MIS credit ratings for certain constant proportion debt obligation notes. Nevertheless, shortly thereafter during a meeting in Europe, an MIS rating committee voted against taking responsive rating action, in part because of concerns that doing so would negatively impact MIS’s business reputation.

MIS applied in June 2007 to be registered with the Commission as an NRSRO. The Report notes that the European rating committee’s self-serving consideration of non-credit related factors in support of the decision to maintain the credit ratings constituted conduct that was contrary to the MIS procedures used to determine credit ratings as described in the MIS application to the SEC.

Was this a Very Bad Thing by Moody’s? Yes.

Does Moody’s deserve to lose some credibility over this? Yes.

Should this be any of the SEC’s business? Ummm … that part’s not so clear. However, I eagerly anticipate an immense volume of paper out of the brokerages once their salesmen analysts start making the same kind of disclosure … on stuff they actually made a buy/sell recommendation about.

JP Morgan is closing their energy prop desk:

JPMorgan Chase & Co., the second- largest U.S. lender by assets, told traders who bet on commodities for the firm’s account that their unit will be closed as the company begins to shut down all its proprietary trading, according to a person briefed on the matter.

The bank eventually will end all proprietary trading to comply with new curbs on investment banks, said the person, who asked not to be identified because JPMorgan’s decision isn’t public. The New York-based bank will shut proprietary trading in fixed-income and equities later, the person said.

At the very least, the exercise will give us some data on the importance of dealer risk capital to the market – although how you can sort out prop strategies from regular market making remains something of a mystery to me. Maybe they just change the name.

The FDIC has released its 2Q10 Quarterly Banking Profile, with headlines:

• Quarterly Earnings Are Highest in Almost Three Years
• Reduced Loan-Loss Provisions Boost Net Income
• Margins Improve at a Majority of Banks
• Noninterest Income Is Lower
• Charge-Offs Fall for First Time Since 2006
• Noncurrent Loans Post First Decline in More than Four Years
• Reserves Fall as Large Banks Reduce Loan-Loss Provisions
• Rising Securities Values Contribute to Equity Capital Growth
• Loan Balances Continue to Decline
• Banks Reduce Nondeposit Funding
• No New Charters Were Added During the Quarter

EWT LLP writes a highly informative comment letter on market microstructure:

Based upon our vantage point on that day, taken in combination with our years of experience in various markets throughout the world and their handling of unexpected volatility and erroneous transactions,1 we respectfully offer our observations on both these events and some related recommendations. In so doing, we have focused on the following four key areas:

• Inaccurate NBBO feeds. Market center trading system problems (e.g., severely lagged and discontinuous market data) revealed single points-offailure in the market infrastructure. In particular, as illustrated below, the poor performance of National Best Bid or Offer (“NBBO”) feeds was a significant contributor to the aberrant events of that day. In our view, these feeds could be improved significantly through investment in available technology.
• Inconsistent and Ambiguous Market Center Practices. While they may be well-intentioned, certain inconsistent market center practices (e.g., Liquidity Replenishment Points or “LRPs”) and ambiguous rules regarding potentially erroneous transactions fragmented and curtailed liquidity provision on May 6 by increasing uncertainty under extreme market conditions. Replacing these practices and rules with uniform, industry-wide rules establishing limits on upward and downward price movement in a given period of time (i.e., a limitup/limit-down approach) and consistent rules for canceling erroneous transactions would accomplish the same objectives with fewer unintended consequences.
• Market Orders. “Market” and “stop” orders likely steepened the market decline on May 6 by intensifying selling pressure. A limit-up/limit-down approach would address this issue by providing a de facto collar on market orders. In the absence of a limit-up/limit-down approach, we recommend that customer market orders be collared or converted to limit orders by their brokers prior to submission to a trading center and that broker-dealers be required to specify a limit price on all orders.
• Concentrations of Liquidity Risk. Reliance on a small subset of firms or systems to provide or control liquidity as a result of exchange-specific incentive programs left the National Market System vulnerable on May 6 to failures by single firms or systems. To address these issues, the Commission should set uniform standards for market making, and require that all exchange-based market maker incentive programs be non-exclusionary and open to all who qualify.

I’m still upset about police actions during the G-20 meeting. So are some others, but there are few who really couldn’t care less, one way or another:

The largest mass arrest of Canadians in history and the Grits primary concern is that the cops were overwhelmed.
…
At a wintry moment in the history of Canadian civil rights, the Liberal Party is AWOL.

We are poorly served by our politicians of all stripes. Still, with the pseudo-opposition being led by Torture Boy, I suppose we should be grateful nothing worse than vindictive time-wasting seems to have occurred. This time.

The Canadian preferred share market closed the month with another good day on elevated volume, with PerpetualDiscounts up 19bp and FixedResets winning 9bp.

PerpetualDiscount now yield 5.69%, equivalent to 7.97% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.1% (!) 5.3%, so the pre-tax interest-equivalent spread is now about 285bp 265bp, a significant increase decrease from the 275bp reported on August 25 and the 275bp reported July 30. For another month, it’s simply a case of the preferred share market showing more inertia than the red-hot corporate bond market!

Click for Big

Econbrowser‘s Jim Hamilton has been busy building a database on the term structure of Treasuries. One of the byproducts is a graph of the average term of publicly held US debt:

Click for big

Senator Kaufman’s letter to the SEC, highlighted here on August 27, attracted comment in the Financial Times which was in turn republished on the Themis Trading blog under Fixing Equity Markets Ain’t Easy:

The challenge of fixing our equity markets is not as simple as “fixing” the market structure by widening spreads. Widening spreads across the board will only remove trading opportunities and increase trading costs. I would love to say widen spreads and tax the HFTs and everything will be fine, but in the end, I think increased spreads will only force institutional and retail investors to pay more for execution and make it harder to get in or out of an investment . . . and profits will just be re-allocated from the fast and fleet to slower players with larger pockets.

If we think by taxing high-frequency firms we will go back to a time when markets were slow and humans made trading decisions – forget it. When was the last time we replaced computers with humans?

For “slower players with larger pockets”, read ‘established dinosaurs with more money than brains who are currently having their lunch eaten’.

A good day with continued elevated volume on the Canadian preferred share market today, with PerpetualDiscounts up 27bp and FixedResets gaining 2bp.

Regulators are seeking to ensure that their post-regulatory employment options include non-competitive alternative exchanges:

The fine shows regulators are getting serious about demanding that brokerage firms hook up to all the alternative trading systems in Canada to ensure they are shopping around for investors to get the best price on trade orders.

BMO Nesbitt dallied in hooking up to Omega, long the smallest ATS, and it wasn’t alone. Sources say regulators are also looking at firms like RBC Dominion Securities and have put them on notice that there have been too many so-called trade-throughs taking place in the market.

Trade-throughs in industry parlance are trades that don’t take place at the best price available in the marketplace.
…
The industry has griped that some marketplaces are too small to warrant the expense of a hookup.
…
Regulators clearly aren’t buying that. They have been sending long lists of trade-throughs spotted by market surveillance systems to offending desks. BMO got two warnings, IIROC said, in December, 2008, and February, 2009 “that it was responsible for a larger-than-average number of ‘trade through’ alerts.”

The focus on trade-throughs puts pressure on not only the big firms, but tiny shops that are already stretched thin for resources in a tough market. However, given that the end result is supposed to be protection for investors, it’s hard for regulators to look the other way.

The settlement notice specifies:

Pursuant to the Settlement Agreement, BMONB admitted to the following misconduct:

• Between October 2008 and October 2009, it failed to make reasonable efforts to connect to the Omega ATS protected marketplace, contrary to UMIR 5.2 and UMIR Policy 5.2.

Pursuant to the Settlement Agreement, BMONB agreed to pay a fine in the amount of $250,000 and costs of $15,000.

Fortunately, however, no individual was disciplined or even named by IIROC. This serious misconduct, worth a quarter of a million bucks, did not occur as a result of a decision, or negligence, or human behaviour of any kind, in fact … it just happened.

I think it fair to say that Omega ATS is not a particularly important exchange:

In terms of market share, Omega ATS is still relatively small, says Eric Stoop, chairman of Omega ATS, “We’re around 1% of the market this year,” he explained.

It is interesting to consider how this might tie in with sub-pennying; I speculated in a post about Alpha Trading Systems that the extant exchanges might be introducing order types to forestall the big brokers from setting up captive dark pools.

I would be quite happy with a statement from any brokerage house with whom I might deal as to just which exchanges they belonged to; if the regulators want some busy-work, they could always specify that this disclosure should include statistics on trade-throughs. But such a system would involve consumer choice and competition; anathema to the regulatory mind.

Terence Corcoran gave bank capital regulation another try, but assumes that an increase in global capital requirements will be matched in Canada. This is not necessarily the case, since Canadian banks are capitalized well above the current minimum.

I have previously remarked that a good deal of all the whining regarding overwhelming message traffic generated by High Frequency Traders could be eliminated through a novel proposal – charging for message traffic. I am pleased to see that a variant of this idea has been proposed by BMOCM’s Quantitative Execution Services team in a paper titled Drowning in Data:

We have suggested in the past that the street’s regulatory bill be split into two portions – human resources and technology. The HR cost, that is the cost of having regulatory staff, should be divided amongst the street based on either volume of shares traded, or number of trades. This reflects the fact that staff time is spent looking at actual trades. The technology portion should then be allocated based on share of message traffic. This reflects the fact that technology costs are driven by message traffic not traded volume. This type of allocation system would result in inefficient strategies having to pay a higher portion of the total bill. This would be true of any inefficient strategy, whether it be an agency pairs trading algorithm or a passive rebate HFT strategy. (Currently the total cost is allocated to trading venues based on volume traded market share, which they then charge back to the dealers using the same metric).

They also talked about trade-through protection:

Canada is the only developed marketplace that enforces full depth of book trade-through as opposed to top of book for each marketplace venue. This implies that the Smart Order Routers in Canada have to process the entire depth of book in all markets in order to satisfy trade-through obligations. The order changes on the entire depth of book dwarf the order changes on just top of book and thus force the Canadian market participants to be consumers of this glut of data. We feel the regulators need to review the trade-through obligations from a technology lens.

The BMOCM idea regarding charging has been picked up by Senator Edward Kaufman, who has written to the SEC suggesting:

Accordingly, the Commission should require trading venues to allocate system costs at least partially based on message traffic rather than traded volume. A similar framework should be applied to pay for the consolidated audit trail and other technology and surveillance costs that regulatory agencies incur.

Sen. Kaufman also suggests:

It may seem counterintuitive, but the Commission should even examine whether regulation should aim not to facilitate narrow spreads with little size or depth of orders, but instead promote deep order books -and if necessary -wider markets with large protected quote size. Wider spreads with a large protected quote size on both sides may facilitate certainty of execution with predictable transparent costs. Narrow fluctuating spreads, on the other hand, with small protected size and thin markets, can mean just the opposite -and actual trading costs can be high, hidden and uncertain. Deep stable markets will bring back confidence, facilitate the capital formation function of the markets and diminish the current dependence on the dark pool concept. At a minimum, the Commission must carefully scrutinize and empirically challenge the mantra that investors are best served by narrow spreads. In reality, narrow spreads of small order size may be an illusion that masks a very “thin crust” of liquidity (which leave markets vulnerable to another flash crash when markets fail their price discovery function only next time . within the bounds of circuit breakers) and difficult-to-measure price impacts (that might be harmful to average investors and which diminish investor confidence), both of which the Commission must examine and possibly address.

This leads to an interesting conundrum: there is lots of academic evidence (e.g., from TRACE and from the Toronto Exchange’s changes to limit book transparency in the early nineties) that increasing transparency results in thinner books with tighter spreads. I suspect, however, that prohibiting dissemination of Level 2 – or Level 1 – pricing information will prove to be unpopular should anybody have the guts to make the suggestion.

ProPublica has published a good investigative piece on CDO Tranche Retention (otherwise known as self-dealing) titled Banks’ Self-Dealing Super-Charged Financial Crisis:

Faced with increasing difficulty in selling the mortgage-backed securities that had been among their most lucrative products, the banks hit on a solution that preserved their quarterly earnings and huge bonuses:

They created fake demand.

A ProPublica analysis shows for the first time the extent to which banks — primarily Merrill Lynch, but also Citigroup, UBS and others — bought their own products and cranked up an assembly line that otherwise should have flagged.

Independent manager? Independent schmanager!:

There were supposed to be protections against this sort of abuse. While banks provided the blueprint for the CDOs and marketed them, they typically selected independent managers who chose the specific bonds to go inside them. The managers had a legal obligation to do what was best for the CDO. They were paid by the CDO, not the bank, and were supposed to serve as a bulwark against self-dealing by the banks, which had the fullest understanding of the complex and lightly regulated mortgage bonds.

It rarely worked out that way. The managers were beholden to the banks that sent them the business. On a billion-dollar deal, managers could earn a million dollars in fees, with little risk. Some small firms did several billion dollars of CDOs in a matter of months.

“All these banks for years were spawning trading partners,” says a former executive from Financial Guaranty Insurance Company, a major insurer of the CDO market. “You don’t have a trading partner? Create one.”
…
It remains unclear whether any of this violated laws. The SEC has said [5] that it is actively looking at as many as 50 CDO managers as part of its broad examination of the CDO business’ role in the financial crisis. In particular, the agency is focusing on the relationship between the banks and the managers. The SEC is exploring how deals were structured, if any quid pro quo arrangements existed, and whether banks pressured managers to take bad assets.
…
A Wall Street Journal article [9] ($) from late 2007, one of the first of its kind, described how Margolis worked with one inexperienced CDO manager called NIR on a CDO named Norma, in the spring of that year. The Long Island-based NIR made about $1.5 million a year for managing Norma, a CDO that imploded.

“NIR’s collateral management business had arisen from efforts by Merrill Lynch to assemble a stable of captive small firms to manage its CDOs that would be beholden to Merrill Lynch on account of the business it funneled to them,” alleged a lawsuit filed in New York state court against Merrill over Norma that was settled quietly after the plaintiffs received internal Merrill documents.
…
“I would go to Merrill and tell them that I wanted to buy, say, a Citi bond,” recalls a CDO manager. “They would say ‘no.’ I would suggest a UBS bond, they would say ‘no.’ Eventually, you got the joke.” Managers could choose assets to put into their CDOs but they had to come from Merrill CDOs. One rival investment banker says Merrill treated CDO managers the way Henry Ford treated his Model T customers: You can have any color you want, as long as it’s black.

Once, Merrill’s Ken Margolis pushed a manager to buy a CDO slice for a Merrill-produced CDO called Port Jackson that was completed in the beginning of 2007: “‘You don’t have to buy the deal but you are crazy if you don’t because of your business,'” an executive at the management firm recalls Margolis telling him. “‘We have a big pipeline and only so many more mandates to give you.’ You got the message.” In other words: Take our stuff and we’ll send you more business. If not, forget it.’

And that, boys and girls, is the way the investment business works. Which is why you should always check the performance track record of a manager and ignore the “experience” so beloved of the regulators.

On an unrelated note, I will leave you with a weekend thought: it is striking just how many people urgently tell me how friendly their dogs are, as if I care. Hardly anybody ever says “My dog is aggressive and obnoxious. I’m too stupid and lazy to train it”.

It was a very nice day for the Canadian preferred share market today, with PerpetualDiscounts up 11bp and FixedResets gaining 15bp, on continued elevated volume.

Algos gone wild!:

Infinium, a household name in Chicago’s burgeoning trading community, relies on computer horsepower and quantitative models to earn razor-thin profits from short-term trading. It uses its own money to make markets and capitalize on tiny imbalances, a common high-frequency strategy. The documents, dated March, reveal that Infinium used an algorithm that was less than a day old to execute a “lead/lag” strategy between an exchange-traded fund called United States Oil Fund (USO.P: Quote), which tracks oil prices, and the U.S. crude benchmark future, West Texas Intermediate

The algorithm was turned on at 2:26:28 p.m. (Eastern) on Feb. 3, less than four minutes before NYMEX closed floor trading and settled oil prices. It immediately started uncontrollably buying oil futures, according to the documents, which include letters from Infinium’s lawyer to the regulation unit of CME Group, and cite notes from a company developer. Infinium placed 2,000 to 3,000 orders per second before its flooded order router “choked” and was “dead in the water” a few seconds later, the developer’s notes said. The algorithm was shut down five seconds after it was turned on. By then, the documents show, the firm had sent 4,612 “buy limit” orders into the market. It quickly offset the position, mostly with large “block” trades in the next few minutes, leaving it with a $1.03-million loss.

Econbrowser‘s Jim Hamilton speculates that the Fed is setting up for a new round of quantitative easing in his post More thoughts on what to expect from the Fed. He notes an article from the Wall Street Journal, Commercial Property Owners Choose to Default:

“We don’t do this lightly,” said Robert Taubman, chief executive of Taubman Centers Inc. The luxury-mall owner, with upscale properties such as the Beverly Center in Los Angeles, decided earlier this year to stop covering interest payments on its $135 million mortgage on the Pier Shops at Caesars in Atlantic City, N.J.

Taubman, which estimates the mall is now worth only $52 million, gave it back to its mortgage holder.

The Canadian preferred share market had a down day amid continued elevated volume, with PerpetualDiscounts down 4bp and FixedResets losing 1bp.

As I have previously noted, I am very pleased to see that we are finally having a debate on the cost of bank regulation. Less, more, whatever … but let’s get some idea of the cost before swallowing OSFI’s Kool-Aid and saying more is always better. I’ve highlighted the BoC study and the BIS report … so our first debater is Terence Corcoran, who wrote a column titled The high cost of bank regulation … the web version is encouragingly headed by:

CORRECTION: Terence Corcoran’s column, The High Cost of Bank Regulation, contained several factual errors regarding a Bank of Canada report on increased bank capital ratios.

An increase in capital of 2% results in a long-run annual impact on the level of GDP of -0.3%, or cumulative -6.0 % (or $92-billion) in present value terms, not -0.5 or -13.0% (or $200-billion). If the increase is 4%, the costs are -10% (or $153-billion) in present value terms , which does not equal $300-billion.

By avoiding future financial crises, the economy will benefit anywhere from 21.6% to 32.0% in present value terms, which is $332-billion to $492-billion. The chances of a financial crisis elsewhere is every 20 to 25 years if the probability is 4.5%, not every 60 years. The benefits to Canada were based on the reduced chance of a foreign crisis.

The impact of a Canadian crisis was based on the lower probability (1.7%) of a Canadian crisis. Finally, bank capital is made of equity, retained earnings, reserves, etc.

The Post regrets the errors.

Next debater, please!

The Congressional Oversight Panel has released – with very little press attention – its report The Global Context and International Effects of the TARP:

The dealings of Goldman Sachs with respect to the CDSs on CDOs that were eventually acquired by Maiden Lane III provide a compelling example of the effect of counterparty relationships on the flow of funds across borders, as 96.9 percent of the cash received by Goldman effectively flowed to non-U.S. institutions. (footnote) (These institutions, as well as other indirect foreign beneficiaries of the AIG rescue – entities that sold hedges on AIG to Goldman and benefited from not having to make good on that protection – are listed in Annex II.)

Footnote reads: According to recently released documents, there were 32 Goldman CDS counterparties that benefited directly from government assistance provided through the Maiden Lane III facility, and 31 of these entities are foreign. Each of the foreign entities listed below held a CDO for which Goldman had written CDS protection and entered into contracts with AIG laying off that risk. While Goldman was required to perform under its contracts whether or not AIG performed, when the government made the decision to pay AIG‟s counterparties at par –including Goldman – the following foreign entities were direct beneficiaries:…

And in Annex 2:

As the following data make clear, taxpayer aid to AIG became aid to Goldman, and aid to Goldman became aid to a number of domestic and foreign investors. In some cases, the aid was in the form of repayment in full of obligations that, without government help, could have ended in default. In other cases, the aid was in the form of guarantees that other parties did not have to pay because the government prevented any defaults.

AIG provided credit default swap (CDS) protection on a number of collateralized debt obligations (CDOs), which were the source of continuing collateral demands on AIG. As part of the AIG rescue, the CDOs underlying the CDSs were acquired by a special-purpose vehicle primarily funded by the government, Maiden Lane III. The entities set out in the table below held CDSs written by Goldman against the CDOs that were eventually acquired by Maiden Lane III. In order to sell those CDOs to Maiden Lane III, in most cases Goldman had to obtain them from these counterparties, so the Maiden Lane III funds effectively flowed to Goldman‟s counterparties. Nearly all of these second-level counterparties, both by number and dollar amount, were non-U.S. institutions, with European banks making up by far the largest contingent.

It will be remembered that the US Congress is almost the opposite of a sausage factory … what comes out of it may certainly be deprecated, but the research that goes into it is first rate (at some point I want to take a look for myself at exactly what they had in front of them when voting to invade Iraq – but that was an issue that never had the slightest amount of fact-motivation from the beginning).

It’s very odd, but I have not been able to find the conclusions regarding Goldman Sachs’ hedging reported on any of the lunatic fringe sites. I tried searching for the phrase “Investigation has concluded that Goldman Sachs was indeed well hedged in its dealings with AIG. Its risk management process was robust even to the events of September 2008, and if all financial firms had been half as competent in managing their exposures, the Panic of 2007 would have been a mere bad spell, a footnote in the history of banking.”, but I have not yet been able to find such a statement. I will post further on this subject when I find such a sentiment, or something approximating it, expressed on the sites of any of Goldman’s erstwhile critics.

There was heavy volume today and minimal overall movement in the market indices masked a surprisingly large amount of volatility in individual issues. MFC prefs were hurt again today – just look at that MFC.PR.D FixedReset, now yielding close to 5% to the call date from the bid price; there are currently five issues trading more than 200bp through that level! You can tell me that BMO is a better credit than MFC and I won’t blink; tell me it’s worth a spread of 200bp for four year money and we might have something to discuss! The strong performance by IAG is a little odd … not that there’s anything wrong with IAG, but those issues went ex-dividend today and it appears nobody noticed.

Nesbitt had a good day, volume-wise, but there is no information available to me regarding what kind of crosses they did … if they were internal crosses, for instance, (between different accounts under the same investment manager), then they won’t have got much commission out of it.

PerpetualDiscounts squeaked out a gain of 1bp, while FixedResets were up 9bp. The median average weighted yield-to-maturity on FixedResets is now a mere 3.16%.

PerpetualDiscounts now yield 5.77%, equivalent to 8.08% interest at the standard 1.4x equivalency factor. Long corporates now yield about 5.3% (!), so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 275bp, up marginally – and perhaps spuriously – from the 270bp reported on August 18.