PrefBlog

The migration from bank prop desks to hedge funds is continuing:

Citigroup Inc. may move a team of proprietary traders into its hedge-fund unit, one of at least three alternatives the U.S. bank is studying to comply with the Dodd-Frank Act, people briefed on the matter said.

Traders in the Citi Principal Strategies unit, led by Sutesh Sharma, would be reassigned to Citi Capital Advisors, which mostly oversees money for outside investors, said the people, speaking anonymously because the talks are preliminary. The bank would set up the traders as hedge-fund managers and seed their funds, then raise money from outside investors to redeem its stakes, the people said.

Good thing? Bad thing? Who knows? Who cares? This particular Volcker Rule is simply knee-jerk feel-goodism and the implications have never been studied.

Maybe the Citigroup guys can move to Singapore!

Singapore hedge fund startups are on the rise after the central bank approved new rules that didn’t impose a licensing requirement on most funds.

Seven new hedge funds set up in May and June, according to Eurekahedge Pte, after the Monetary Authority of Singapore said in April that small funds can keep operating without a license as part of its review.
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“Singapore did not shoot itself in the foot by putting up proposals that will kill off the business,” said Kher Sheng Lee, a senior associate in the financial services group at Philadelphia-based law firm Dechert LLP in Hong Kong. “While some places are moving towards over-regulation with rigid rules and increase in compliance costs, Singapore has attempted to go for sensible regulation.”

Singapore is vying with Hong Kong for a slice of the global $1.7 trillion hedge-fund industry as the region’s growth leads the world. Singapore has made it easier for hedge funds to set up shop on the island than in other Asian cities such as Hong Kong, where hedge-fund managers face the same licensing requirements as mutual-fund managers.

Plans are being drawn up for Bernanke’s hagiography:

In a new paper, the economists argue that without the Wall Street bailout, the bank stress tests, the emergency lending and asset purchases by the Federal Reserve, and the Obama administration’s fiscal stimulus program, the nation’s gross domestic product would be about 6.5 percent lower this year.

In addition, there would be about 8.5 million fewer jobs, on top of the more than 8 million already lost; and the economy would be experiencing deflation, instead of low inflation.

The paper, by Alan S. Blinder, a Princeton professor and former vice chairman of the Fed, and Mark Zandi, chief economist at Moody’s Analytics, represents a first stab at comprehensively estimating the effects of the economic policy responses of the last few years.
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If the fiscal stimulus alone had been enacted, and not the financial measures, they concluded, real G.D.P. would have fallen 5 percent last year, with 12 million jobs lost. But if only the financial measures had been enacted, and not the stimulus, real G.D.P. would have fallen nearly 4 percent, with 10 million jobs lost.

The combined effects of both sets of policies cannot be directly compared with the sum of each in isolation, they found, “because the policies tend to reinforce each other.”

A day of moderate volume in the Canadian preferred share market, with the volume totally dominated by FixedResets. PerpetualDiscounts were up 4bp and FixedResets gained 11bp on the day, with little volatility.

Update, 2010-7-29: PerpetualDiscounts now yield 5.90%, equivalent to 8.26% interest at the standard equivalency factor of 1.4x. Long Corporates yield 5.6%, so the pre-tax interest-equivalent spread is now about 265bp, unchanged from the figure reported on July 21.

Life has become a little more annoying for ETF investors:

Recently, BlackRock stopped publishing the management expense ratio for its ETFs on the iShares Canada website. Instead, investors are shown the management fee for iShares ETFs.

Management fees are just one component of the costs that investors pay to own ETFs and mutual funds. There are also operating expenses (administrative and legal costs, for example), and taxes.
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Bank of Montreal and Claymore Investments publish management fee info on their websites. To find out about MERs, you have to look at their semi-annual management reports on fund performance (download them at sedar.com).

The Bank of Canada has released a working paper by Emanuella Enenajor, Alex Sebastian, and Jonathan Witmer titled An Assessment of the Bank of Canada’s
Term PRA Facility:

This paper empirically assesses the effectiveness of the Bank of Canada’s term Purchase and Resale Agreement (PRA) facility in reducing short-term bank funding pressures, as measured by the CDOR-OIS spread. It examines the behaviour of this spread around both term PRA announcement dates and term PRA operation dates, using an event-study methodology to control for developments in other money markets (i.e., using the U.S. LIBOR-OIS spread) as well as proxies for Canadian banking sector credit risk. Overall, there is robust evidence that the term PRA announcements reduced bank funding costs at both 1-month and 3-month terms, whereas we find no evidence of an impact from term PRA operations. However, given the small number of term PRA announcements in our sample, caution should be taken in attributing the reduction in the CDOR-OIS spread solely to the term PRA announcements, since other concurrent events (including other announcements by the Bank of Canada) may have also contributed to a compression in the CDOR-OIS spread.

There’s some speculation that the European stress test actually worked:

The gap between European and U.S. benchmark credit-default swap indexes, used to hedge against losses or speculate on creditworthiness, narrowed to 0.7 basis point today, the lowest since June 4, prices from Markit Group Ltd. show. That premium soared to a record 23 basis points on May 7 on concern that budget deficits in southern Europe would infect credit markets worldwide.

Bond investors are turning their attention to the global economic recovery’s sustainability after European banks and regulators provided a better view into balance sheets of the region’s lenders and Spain sold 3.4 billion euros ($4.42 billion) of debt in an auction. Stress test results released July 23, which showed 84 of 91 banks passing, reassured investors by detailing their sovereign debt holdings.

However, this could just as well be relief over the softening of the Basel III proposals which was disussed yesterday:

Banks worldwide applauded changes to proposed capital and liquidity standards that relaxed aspects of the rules and gave lenders as much as eight years to comply.

Lobbying groups in Europe and the U.S. praised the changes announced July 26 by the Basel Committee on Banking Supervision as steps in the right direction, while firms including Deutsche Bank AG and UBS AG welcomed the softening of rules proposed by the committee in December. European and Japanese bank stocks surged.
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The 54-member Bloomberg Europe Banks and Financial Services Index rose 4.5 percent to 121.14, the biggest gain since European leaders crafted a 750 billion-euro ($973 billion) rescue package on May 10.

Sumitomo Mitsui Financial Group Inc., Japan’s second- largest bank by market value, led banks higher in Tokyo. Sumitomo Mitsui rose 2.8 percent to 2,587 yen, the most in more than two weeks. Mitsubishi UFJ Financial Group Inc., the nation’s largest bank, gained 2.5 percent, while Mizuho Financial Group Inc. climbed 2.2 percent.

U.S. bank stocks hardly budged.

The Canadian preferred share market had another good day on moderate volume, with PerpetualDiscounts up 12 bp and FixedResets gaining 1bp. Hardly any volatility.

Senator Phil Grassley, well known for his eagerness to support legislated subsidies for Alternative Fool lobbyists, does some more grandstanding with his questions regarding the Goldman-AIG pseudo-scandal:

The fifth largest amount listed is about $175 million that Lehman Brothers would have owed Goldman Sachs on CDS protection. However, given Lehman’s financial position at the time (September 15, 2008), isn’t it true that the real value of this hedge to Goldman would have been much less than $175 million? Wouldn’t it have only been worth the approximate value of any collateral that Lehman had already posted to Goldman up to that date?

2. Similarly, is it possible that financial health of the other institutions on the list may have prevented them from being able to pay Goldman in the event of an AIG default? Does this undermine Goldman’s claim that it was “fully collateralized and hedged” with regard to the risk of an AIG default, and thus demonstrate that Goldman did, in fact, receive a direct benefit from the government’s assistance to AIG?

3. Will the Panel be seeking additional details about these transactions in order evaluate Goldman’s claim to have been indifferent to whether AIG went bankrupt? If so, please describe the scope of your additional requests and inform the Committee if you do not receive complete cooperation.

In other words … ‘I don’t care whether you’ve got battery back-up, a fuel generator and three month’s worth of diesel stockpiled! Is it not true that in the event of the complete collapse of civilization, your electricity supply will fail to function?’

Attachment 1 (“Confidential Treatment requested by Goldman Sachs”) shows that Goldman bought a net value of USD 1.7-billion in CDSs on AIG. Canadian entries are Royal Bank (London Branch) $76-million; BNS, $36-million; BMO (London), $25-million; BMO (Chicago), $18-million; and Royal Bank [$43-million] [sold to] – that’s a net of about $100-million from Canadian banks. Naturally, there is no way of telling whether these positions were laid off against other investors.

Attachment 2 (“Confidential Treatment requested by Goldman Sachs”) shows the collateral shortfall on Goldman’s AIG deals – total of about $1.3-billion. So they were, it appears, over-hedged.

Despite all this, various analysts are still pointing out that Goldman would have lost money had an AIG bankruptcy coincided with a giant asteroid hitting New York City:

Joshua Rosner, an analyst at research firm Graham Fisher & Co. in New York, said the list of counterparties indicates that Goldman Sachs may have had difficulty collecting on those swaps.

“Clearly Goldman’s calculation was more tied to their expectation of the political dynamics of forcing moral hazard than the fundamental realities of the financial strength of counterparties,” Rosner said.
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“The financial institutions from whom we purchased protection were required to post collateral to settle their net exposure to us on a daily basis,” Lucas van Praag, a spokesman for New York-based Goldman Sachs, said yesterday. “A default by any particular counterparty would not reduce the effectiveness of a hedge provided by that entity if adequate collateral had already been posted. This was the case with the protection we bought, even during the most stressed periods of the fall of 2008.”
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“There’s a question about Citigroup’s ability to pay Goldman if AIG failed, given it had major problems,” said Ed Grebeck, CEO of Stamford, Connecticut-based debt-consulting firm Tempus Advisors and an instructor on derivatives at New York University.
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The document shows only the “notional” amount of money Goldman Sachs was owed by its counterparties, Cambridge Winter’s Date said. The firm is likely to have written down the value of at least some of the protection, he said.

Goldman Sachs “should have been haircutting the valuation of that protection pretty significantly as the viability of those firms looked more and more suspect,” Date said.

At least Goldman’s won something – the anti-Goldmanites have shifted their position from ‘an AIG bankruptcy would have killed Goldman’ to ‘an AIG bankruptcy and the simultaneous collapse of more than one other major global financial institution would have killed Goldman, provided they’re lying about the collateral, and even if they’re not lying about the collateral it was probably junk anyway.’

I once did some career mentoring for a young and idealistic high school student who wanted to get into the business – it was probably one of the most cynical mentoring sessions ever presented. But, for free, gratis and for nothing I will present to other idealists the lesson behind the Goldman debate: DON’T GIVE A SHIT AND DON’T EVER BOTHER DOING ANYTHING RIGHT. Goldman’s taking more grief for competently managing their AIG exposure than any of the clown-firms is taking for reckless idiocy.

But then … politicians across North America have shown a breathtaking disregard for creditors rights throughout this crisis – as best exemplified by the General Motors leapfrogging discussed on June 9, 2009. And if you have no rights, why would you want to protect them? The lunatic fringe even turns Goldman’s insistence on collateral into evidence of a dark plot:

Goldman wanted their counterparties to post collateral so they would have protection against corporate downgrades. The monolines refused to have collateral posting requirements in their CDS contracts. The rating agencies supported them in this position on the argument that maintaining their AAA rating was “fundamental to their business”.

AIG, on the other hand, agreed to collateral posting requirements. in fact, they used this as a competitive advantage – they got more business because of it and marketed their flexibility on this issue to the banks.
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All of the other banks got comfortable with the monolines not having to post collateral for CDS trades because of their AAA ratings. Goldman never did.

Of course, Goldman was one of the few banks that clearly set out to profit from shorting CDOs. They obviously realized that if their CDS counterparty was on the hook for a lot of ABS CDOs that were going to blow up, the insurance provider would likely get downgraded. If the downgrade of the insurer was very likely, the only way the short-CDO strategy worked was if the insurer would post collateral.
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So Goldman only used AIG, who would provide protection against their downgrade, which Goldman knew would happen because they were stuffing AIG with toxic ABS CDOs.
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I hate to get sucked into the vampire squid line of thinking about Goldman, but the only explanation i can think of for why AIG got rescued and the monolines did not is because Goldman had significant exposure to AIG and did not have exposure to the monolines.

I spent a little time looking into the woes of CalPERS after reading a brief mention in the Economist:

That [range of benefits improvements], however, is not what outrages Mr Schwarzenegger, a Republican, or his brainy economic adviser David Crane, a Democrat. Rather, it is that the pension plans—above all the California Public Employees’ Retirement System (CalPERS), the largest such scheme in America—pretended that this generosity would not cost anything. In 1999 the dotcom bubble was still inflating, and the plans’ actuaries predicted that their retirement funds would gain enough value to pay the increased pensions. By implication, they assumed that the Dow Jones Industrial Average would reach 25,000 in 2009 and 28m in 2099. It is currently at around 10,300.

Remember, CalPERS is the enormous pension fund that don’t do their own credit analysis. In 1999…:

According to CaLPERS, employer retirement costs have been declining over the last 10 years as the result of significant investment returns and changes in actuarial assumptions. The members and retirees of CaLPERS have not benefited from these returns. As a result, CaLPERS contends that the new retirement formulas provided by this bill mark the first significant improvement in retirement benefits for most state and school members’ in approximately 30 years. It is anticipated that the increase in liability for these new benefits can be funded by the excess retirement assets that have been generated through investment income and changes in actuarial assumptions resulting in no immediate increase in costs to the employer.

2001 Actuarial assumptions of net investment returns between 7.50% and 8.25%. Current assumptions are:

Critics who argue that the current level of retirement benefits are “unsustainable” and should be reduced for new hires say CalPERS is too optimistic about its expected investment earnings, an annual average of 7.75 percent.

Among the experts who think average earnings will be less than 7.75 percent in the years ahead is Laurence Fink, chairman of BlackRock, the world’s largest money managing firm, who spoke to the CalPERS board last summer.

The CalPERS chief investment officer, Joe Dear, addressed the earnings issue last week during his monthly report to the board. He said 5.25 percent of the earnings assumption is “real” and 2.5 percent is inflation.

Dear said the 7.75 percent earnings assumption is below the national average for pension funds, 8 percent, and below the earnings average of CalPERS during the last two decades, 7.9 percent.

He said CalPERS believes, among other things, that stocks will yield 3 to 4 percent more on average than bonds and that private equity investments will average 3 percent more than domestic stocks.

Comrade Peace Prize is seeking to distort the economy even more:

President Barack Obama is on the verge of creating as much as $300 billion in credit for small businesses as bankers raise doubt about whether there’s demand for new loans and how much will be repaid.

The U.S. Senate may vote this week on a bill to funnel $30 billion of capital to community banks, whose business customers typically are small firms. Banks could leverage the sum to make $300 billion in loans that create jobs, according to a Senate summary. That could more than double the commercial and industrial loans at eligible banks as of the first quarter, according to data compiled by KBW Inc.

Bankers say the problem isn’t scarce credit, it’s lack of demand from creditworthy firms in a weak economy.
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Banks will be charged an initial interest rate of 5 percent, declining to 1 percent if they increase small-business loans or rising as high as 7 percent if the loans stay the same or decrease, according to Richard Carbo, spokesman for the Senate Small Business and Entrepreneurship committee.
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Wells Fargo & Co., which says it’s the biggest small- business lender, is “sitting here with tons of liquidity and we’re marching double time in search of more loans,” Chief Executive Officer John Stumpf said in an interview. “In most cases when I hear stories about small businesses not getting loans, it’s the case that more credit will not help them. They need more equity, they need more profitability.”

Interesting paper from the FRB-Boston Public Policy series by Scott Schuh, Oz Shy, and Joanna Stavins, Who Gains and Who Loses from Credit Card Payments? Theory and Calibrations:

Merchant fees and reward programs generate an implicit monetary transfer to credit card users from non-card (or “cash”) users because merchants generally do not set differential prices for card users to recoup the costs of fees and rewards. On average, each cash- using household pays $151 to card-using households and each card-using household receives $1,482 from cash users every year. Because credit card spending and rewards are positively correlated with household income, the payment instrument transfer also induces a regressive transfer from low-income to high-income households in general. On average, and after accounting for rewards paid to households by banks, the lowest-income household ($20,000 or less annually) pays $23 and the highest-income household ($150,000 or more annually) receives $756 every year. We build and calibrate a model of consumer payment choice to compute the effects of merchant fees and card rewards on consumer welfare. Reducing merchant fees and card rewards would likely increase consumer welfare.

I was surprised by the following:

The limited available data suggest that a reasonable, but very rough, estimate of the per-dollar merchant effort of handling cash is  = 0:5 percent. Available data suggest that a reasonable estimate of the merchant fee across all types of cards, weighted by card use, is  = 2 percent.

I would have thought cash handling costs would be higher – particularly for high-cash operations, such as grocery stores – given bank charges for cash deposits, security on cash movements, employee theft and bookkeeping problems. The footnote reads:

Garcia-Swartz, Hahn, and Layne-Farrar (2006) report that the marginal cost of processing a $54.24 transaction (the average check transaction) is $0.43 (or 0.8 percent) if it is a cash transaction and $1.22 (or 2.25 percent) if it is paid by a credit/charge card. The study by Bergman, Guibourg, and Segendorf (2007) for Sweden found that the total private costs incurred by the retail sector from handling 235 billion Swedish Crown (SEK) worth of transactions was 3.68 billion SEK in 2002, which would put our measure of cash handling costs at  = 1:6 percent. For the Norwegian payment system, Gresvik and Haare (2009) estimates that private costs of handling 62.1 billion Norwegian Crown (NOK) worth of cash transactions incurred by the retailers was 0.322 billion NOK in 2007, which would imply  = 0:5 percent.

Fed Governor Tarullo doesn’t think we’ll see contingent capital any time soon:

The Basel Committee has a number of initiatives and work programs related to capital requirements that go beyond the package of measures that we expect to be completed by the fall. These efforts include, among others, ideas for countercyclical capital buffers, contingent capital, and development of a metric for capital charges tied to systemic risk. Each of these ideas has considerable conceptual appeal, but some of the difficulties encountered in translating the ideas into practical rules mean that work on them is likely to continue into next year.

The BIS proposal for countercyclical buffers was discussed on July 19.

There was relaxed volume in the Canadian preferred share market today, as PerpetualDiscounts gained 16bp and FixedResets lost 4bp, taking the median weighted-average yield on the latter class back above the magic 3.5% figure. Not much volatility.

The European Stwess Tests appear farcical:

European stress tests on 91 banks will take into account bank losses only on government bonds they trade rather than those they hold to maturity, according to a draft European Central Bank document.

“The haircuts are applied to the trading book portfolios only, as no default assumption was considered,” according to a confidential document dated July 22 and titled “EU Stress Test Exercise: Key Messages on Methodological Issues.”

The tests will assume a loss of 23.1 percent on Greek debt, 14 percent of Portuguese bonds, 12.3 percent on Spanish debt, and 4.7 percent on German state debt, according to the document obtained by Bloomberg News. U.K. government bonds will be subject to a 10 percent haircut, and France 5.9 percent.

On cue, Hungary’s problems became more visible:

Standard & Poor’s said it may cut Hungary’s credit rating to junk after the collapse of talks with the International Monetary Fund and European Union. Moody’s Investors Service said it may also lower the country’s grade.

The IMF and EU on July 17 suspended talks with the government without endorsing Prime Minister Viktor Orban’s plans to control the budget deficit. The creditors provided Hungary with a 20 billion-euro ($25.9 billion) rescue package in 2008, which had served to reassure investors.

“We believe that without an EU/IMF program to anchor policy, Hungary is likely to face higher and more volatile funding costs, which in our view could weigh on financial sector balance sheets, the public finances, and economic growth,” S&P said today in a statement.

C-EBS has released the results. The report on the aggregate outcome makes the exercise appear to be rather gentle stwess! Initial reactions to the reports on individual banks are negative – the total capital shortfall is only USD 4.5-billion.

But the best line in the farce comes from a central banker:

ECB Vice President Vitor Constancio called the tests “severe” and explained they didn’t include a scenario of a national default because “we don’t believe there will be a default.”

That’s just great, Vitor! Maybe you’ll be put in charge of the government run credit rating agency the Europeans are thinking about, you know, the ones that will be much nicer to sovereigns than those mean old-style CRAs!

Seems to me that if the bank market is locking up because of fears of chaos after a sovereign default, then you restore confidence by proving the banking system is robust to sovereign default. But reasoning like this isn’t likely to get me appointed to any regulatory positions of note.

Increased regulation of the public markets is having a predictable effect: less public issuance:

The most sweeping regulatory legislation for Wall Street since the Great Depression, signed into law by President Barack Obama on July 21, makes ratings companies vulnerable to lawsuits when underwriters include their assessments in documents used to sell debt. The law subjects firms such as Moody’s Investors Service, Standard & Poor’s and Fitch Ratings to so-called expert liability, meaning they would face the same legal risks as accountants and other parties that participate in bond sales.

Under the new law, issuers weren’t able to obtain permission from ratings firms to include their rankings in their registration filings, according to the SEC.

As a result, sales were held up, said Malcolm Dorris, a senior partner in the securitization group at law firm Dechert LLP. Companies were considering alternatives to the public markets, such as selling in the 144a market, where sales aren’t registered with the SEC, Dorris said.

Ford Motor Co.’s finance arm canceled a planned sale of asset-backed debt, the Wall Street Journal reported July 21 on its website, citing market participants it didn’t name.

There’s an awfully odd senate investigation into Goldman:

Goldman Sachs Group Inc. told U.S. investigators which counterparties it used to hedge the risk that American International Group Inc. would fail, according to three people with knowledge of the matter.

The list was sought by panels reviewing the beneficiaries of New York-based AIG’s $182.3 billion government bailout, said the people, who declined to be identified because the information is private. Goldman Sachs, which received $12.9 billion after the 2008 rescue tied to contracts with the insurer, has said it didn’t need AIG to be rescued because it was hedged against the firm’s failure.

“We want to know the identity of those parties, partly just to know where American taxpayer dollars went, but partly to assess Goldman’s claim,” said Elizabeth Warren, chairman of the Congressional Oversight Panel, in a Senate hearing this week. “We cannot evaluate the credibility of their claim that they had nothing at stake one way or the other in the AIG bailout.”
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Goldman Sachs had $10 billion of exposure to AIG when the insurer was rescued in September 2008, offset by $7.5 billion of collateral and swaps, Viniar said. The hedges were one reason that Goldman wouldn’t accept anything less than full payment on the guarantees it purchased from AIG, he said.

It’s not clear to me why this is so important; I suspect its just another instance of Goldman being punished for being the only competently managed investment bank in the world. The politicians need mea culpas and cringing gratitude – and they’re not getting it from GS.

Magna bought out Stronach with a 93% positive vote, despite the efforts of the precious to ensure the world is aware just how precious they are (I think Teachers’ won, having purchased one share so they could be officially offended at the deal. Their beneficiaries should be most upset that management time and money is being spent tilting at other people’s windmills). The vote is good news for readers of financial newspapers, who may hope for an end to the eternal whining of morons who are surprised when their participating debentures – also known as subordinated voting shares – don’t give them much say in the company. ‘But that’s just mean!’ they bleat ‘Business and investing should be a cooperative game, just like we had in kiddiegarter!’

It was a quiet day in the Canadian preferred share market, with PerpetualDiscounts up 1bp and FixedResets gaining 4bp on low volume.

The Bank of Canada has released a working paper by David Dupuis and Yi Zheng titled A Model of Housing Stock for Canada:

Using an error-correction model (ECM) framework, the authors attempt to quantify the degree of disequilibrium in Canadian housing stock over the period 1961–2008 for the national aggregate and over 1981–2008 for the provinces. They find that, based on quarterly data, the level of housing stock in the long run is associated with population, real per capita disposable income, and real house prices. Population growth (net migration, particularly for the western provinces) is also an important determinant of the short-run dynamics of housing stock, after controlling for serial correlation in the dependent variable. Real mortgage rates, consumer confidence, and a number of other variables identified in the literature are found to play a small role in the short run. The authors’ model suggests that the Canadian housing stock was 2 per cent above its equilibrium level at the end of 2008. There was likely overbuilding, to varying degrees, in Saskatchewan, New Brunswick, British Columbia, Ontario, and Quebec.

The Bank of Canada also released the July 2010 Monetary Policy Report – good solid stuff, but nothing particularly noteworthy or interesting.

Volume was down a bit in the Canadian preferred share market, but still good, as PerpetualDiscounts came in with another solid gain of 15bp, while FixedResets gained 4bp, taking the yield on the latter class below 3.50%. This is the 12th-lowest yield on record for this index.