PrefBlog

More fun at Club Med?

Greek bond yields yesterday rose above their level before the government agreed on a European Union-led bailout on May 2 as escalating protests cast doubt on its ability to drive through austerity measures. Spanish and Portuguese bonds also renewed last week’s slide as investors question their ability to cut budget deficits that are among the highest in the euro area.
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The extra yield that investors demand to buy its debt over German bunds rose 21 basis points to a 14-month high of 117.8 points. Spain’s benchmark IBEX Index, the euro region’s worst performer after Greece, fell 5.4 percent to the lowest since July. Portugal’s spread rose 40 basis points to 247 yesterday.

The euro weakened 1.4 percent to $1.3011, the lowest in more than a year. The currency retreated further in Asian trading today, to $1.2961 as of 11 a.m. in Singapore.

The Swiss are making a big play to attract mobile professionals:

Swiss government officials and Geneva-based financial advisers have come to London to lure rich residents with glowing descriptions of the country’s low taxes, safe streets, private-banking options and convenient ski weekends.

“We are here to make it easier for you to come to Switzerland,” says Martin Meyer, head of economic development for the Swiss canton of Valais, which borders Lake Geneva, Bloomberg Markets reports in its June issue.

Next door, an overflow crowd of 50 more attendees enjoys wine and canapes as they watch the presentation on closed- circuit televisions in a mahogany-lined library, which includes a chart showing the prevalence of English as a language for doing business in Switzerland. A JPMorgan Chase & Co. banker who declined to be identified confides he’s planning to relocate next year. His main complaint: higher U.K. taxes, a theme the Swiss delegation has pounced upon.

Geithner has a solution to the problem: regulate everything!

No regulator or supervisor had the legal authority to look across the financial system and take action to prevent the diversion of activity away from regulation. A system that applied safety and soundness regulation only to banks was unable to protect the overall safety and stability of a financial system composed substantially of non-banks that played a role traditionally reserved for banks.

Moreover, accounting and disclosure requirements and regulatory capital requirements helped encourage the shift in risk to the parallel financial system, without adequately capturing the remaining exposure of banks to those risks.

When the crisis hit and huge swaths of the American financial system got caught in the run on the parallel banking system, many came running to the Federal Reserve for liquidity and for protection.

The emergency financial response to the run that started in the parallel financial system was necessary to protect our economy from an even greater calamity. But if our regulatory and supervisory systems had had the tools and authorities to prevent risks from accumulating in unregulated sectors of the financials system in the first place, such a large emergency response would not have been necessary. That is a key reason why financial reform is so essential.

This is disingenuous at best. The Fed had unlimited authority to penalize the exposure of the core financial system to the shadow financial system; by limiting such exposure it could have restrained the growth of the shadow sector and limited the damage when the bust occurred.

However, they elected to ignore concentration risk and things like Citigroup’s “liquidity puts” (discussed April 13 and risk-weighted liquidity guarantees at a low value; ignored concentration risk, and allowed risk-weighting of bank paper according to the credit rating of the sovereign.

Financial crises will never be abolished. GM & Chrysler have cost far more than the piddly little bank crisis, and Club Med is going to cost even more. But the former players are popular with blue-collar voters and the latter with expansionary EU politicians, while banks are always a popular target for regulatory opprobrium.

Hank Paulson commented on Bear Stearns today:

Former Treasury Secretary Henry Paulson said bets against the survival of Bear Stearns Cos. before the firm’s sale to JPMorgan Chase & Co. amounted to “the wolf pack trying to pull down the weak deer.”

“I don’t use the word collusive because it’s got a legal connotation,” Paulson said today at a hearing of the Financial Crisis Inquiry Commission in Washington. “It sure looked to me like some kind of coordinated action.”

Paulson said he wasn’t “saying there was behavior that was illegal” and he thinks short-selling “is essential for the price-discovery process.”

All this brings to mind the importance of liquidity. Price discovery requires liquidity. Say BSC is at $50, a bunch get shorted, and the price goes down. Theoretically, this should mean that holders of other brokerages will find BSC relatively more attractive and sell, say, JPM to buy BSC. Eventually, the price of the brokerage sector will go down and become relatively more attractive to holders of other sectors; a new equilibrium will be established.

But say all the potential buyers of BSC are full up? What if investment decisions are not made on the basis of hard-nosed facts, but on the basis of the marketting department’s evaluation of how much the clients want to see a troubled brokerage on their books? The slope of the demand curve will decline; perhaps go flat; and the price goes to zero. Contingent Capital is one way of ensuring that the demand for common is not flat (although forced selling by irate bond investors may further reduce the price), but it’s an interesting question and one that I have not yet been able to answer.

Common stock had an exciting day:

The Dow Jones Industrial Average plunged almost 1,000 points today before paring its decline and ended down 347.80 points, or 3.2 percent, at 10,520.32. About $700 billion of U.S. stock-market value was erased in less than 10 minutes, data compiled by Bloomberg show.
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A total of 19 trades of 100 shares each [of Accenture common] were executed at 1 cent in seven seconds from 2:47 p.m. to 2:48 p.m. in New York, a minute after the Dow average plunged by the most since the market crash of 1987, the data showed.

Eighteen of the trades were executed on the CBOE Stock Exchange and were canceled. The first trade that sent Accenture to a penny was executed on the Nasdaq Stock Market. That transaction has yet to be canceled, the data showed.

Accenture shares closed today at $41.09, down 2.6 percent in New York Stock Exchange composite trading.

There is speculation that the plunge was due to trader error:

A possible culprit for the drop was a trader error in which someone entered a “b” for billion instead of an “m” for million in a trade. Multiple sources confirmed the report to CNBC and CNBC.com

The apparent trigger for the massive selloff, which began shortly after 2 pm ET, was the approval of austerity measures by the Greek Parliament, which sparked renewed rioting in Athens.

It could very well be trader error – the absence of a clear trigger, the steepness of the descent and the swift recovery make that plausible – but I’d be happier with such an explanation if some corroborative evidence were provided: ‘waves of selling in 23 liquid basket stocks’, for instance.

Update: Corroborative evidence?

While the first half of the Dow Jones Industrial Average’s 998.5-point plunge probably reflected normal trading, the selloff snowballed because of orders sent to venues with no investors willing to match them, [NYSE Euronext COO Larrry] Leibowitz said in an interview on Bloomberg Television.

“If you look at the charts you can see fairly clearly where the trades came in,” he said from New York. “It’s that V-shaped drop where it came down and snapped right back up. You had some very high-cap stocks trading down 50 percent or large percentages in a split instant because there really was no liquidity in electronic markets.”
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“The fact that it snapped back so quickly made it clear that it was an aberration,” Leibowitz said. “When a large order or series of orders comes into electronic markets, they don’t really have any way to recognize either that they’re a mistake or to slow them to down to attract the proper liquidity on the other side. And so the electronic markets actually traded all the way through the slower New York Stock Exchange markets where we were trying to slow down trading.”

…End of update

The SEC & CFTC are looking into it:

The SEC and CFTC are working closely with the other financial regulators, as well as the exchanges, to review the unusual trading activity that took place briefly this afternoon. We are also working with the exchanges to take appropriate steps to protect investors pursuant to market rules.

“We will make public the findings of our review along with recommendations for appropriate action.

Just a little too precious for my taste. An “investor” has no need of protection in cases like this. The ones who need protection from volatility are better referred to as “bozos”.

The Canadian preferred share market was nowhere nearly as exciting, but went in the same direction as PerpetualDiscounts lost 28bp and FixedResets were down 13bp. Volume lightened considerably to well-maybe-just-a-little-above-average, with FixedResets scoring a shut-out on the volume highlights table.

Agreement has been reached on the US too-big-to-fail fund:

The deal would eliminate a proposed industry-paid $50 billion fund to cover the government’s costs of liquidating a failing financial firm, Dodd said today in an interview. Republicans said the fund would encourage bailouts rather than prevent them.
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The Dodd-Shelby agreement would apply to a section of the bill that would give the government authority to liquidate large failing financial firms whose collapse would threaten the economy. The two senators have agreed to replace the proposed pre-funded $50 billion reserve with language that would require regulators to impose fees on the financial industry to recoup costs for unwinding a company after a collapse, Dodd said today.

The amendment passed 93-5. Typical of modern Republicans – spend first, tax later. Much later!

The Club Med countries may be paying much, much later!

Greek bond yields yesterday rose above their level before the government agreed on a European Union-led bailout on May 2 as escalating protests cast doubt on its ability to drive through austerity measures. Spanish and Portuguese bonds also renewed last week’s slide as investors question their ability to cut budget deficits that are among the highest in the euro area.
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That didn’t stop a sell-off in Spanish bonds yesterday. The extra yield that investors demand to buy its debt over German bunds rose 21 basis points to a 14-month high of 117.8 points. Spain’s benchmark IBEX Index, the euro region’s worst performer after Greece, fell 5.4 percent to the lowest since July. Portugal’s spread rose 40 basis points to 247 yesterday.

The euro weakened 1.4 percent to $1.3011, the lowest in more than a year. The currency retreated further in Asian trading today, to $1.2961 as of 11 a.m. in Singapore.

Volume in the Canadian preferred share market was off significantly today, but remains on the high side of normal. PerpetualDiscounts squeaked out another win, gaining 2bp, while FixedResets continued their recovery with a 15bp gain. Volatility was muted, with only four issues on the performance highlights list.

PerpetualDiscounts now yield 6.35%, equivalent to 8.89% interest at the standard equivalency factor of 1.4x. Long Corporates now yield 5.6% (gaining total return of +44bp on the month-to-date), so the pre-tax interest-equivalent spread is now about 330bp, an increase from the +320bp reported at month end, as long corporate yields have come in a little while PerpetualDiscounts have remained flat.

The Volcker Rule is costing Citigroup some employees:

[Citigroup prop trader Jay] Glasser, 53, who was based in New York and specializes in derivative and currency trades linked to Japanese interest rates, generated an average of more than $10 million a year of revenue for Citigroup from 2007 through 2009, people with knowledge of the matter said. He started at Nomura last week and is based in New York, said Peter Truell, a spokesman for the Tokyo-based firm.

Glasser told his former bosses at Citigroup, which has lost at least 10 proprietary traders this year, that he quit partly because of concern that President Barack Obama’s proposed Volcker rule may force U.S. banks to divest or close proprietary-trading units, people with knowledge of the matter said. As a Japanese securities firm, Nomura wouldn’t be subject to the rule. Citigroup is the third-biggest U.S. bank by assets.

The administration is warning that fragmentation can go too far:

Treasury Secretary Timothy F. Geithner said Congress won’t improve the stability of the financial system by forcing banks to split up core parts of their business.

In testimony today to the Senate Finance Committee, Geithner declined to comment on a specific proposal from Senator Blanche Lincoln to force Bank of America Corp., JPMorgan Chase & Co. and other lenders to separate swaps trading from commercial banking. The proposal is part of a broader financial overhaul proposed by Senate Banking Committee Chairman Christopher Dodd.
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Federal Deposit Insurance Corp. Chairman Sheila Bair has come out against the proposal and the Federal Reserve has warned that the measure could be costly to the banks and their customers.

There is a push to ensure that big banks won’t be the only ones with ‘living wills’:

German Chancellor Angela Merkel’s coalition stepped up calls for allowing the “orderly” default of euro-region member states burdened with debt to avoid a repeat of the Greek fiscal crisis.
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Merkel, who faces elections in Germany’s most populous state on May 9, is seeking to shift focus from the Greek bailout to drawing lessons from the euro’s biggest crisis. An “orderly insolvency” process would ensure that creditors participate in any future rescue, she said on ARD television yesterday.

In other words, the idea is that sovereign debt in the EU will less secure than previously … that could have some very interesting knock-on effects.

The CalPERS lawsuit against the rating agencies is proceeding:

Standard & Poor’s, Moody’s Investors Service and Fitch Ratings must face the California Public Employees Retirement System’s lawsuit claiming their faulty risk assessments on structured investment vehicles caused $1 billion in losses.

A state court judge in San Francisco rejected the companies’ requests to dismiss Calpers’ claims of negligent misrepresentation, Brad Pacheco, a spokesman for Calpers, the largest U.S. pension fund, said today in a phone interview.

Funny – I used to respect CalPERS. Now it seems that they don’t do their own credit analysis. I last mocked CalPERS and its lackadaisical attitude towards investment management on July 31, 2009.

Assiduous Reader KH writes in and says:

your comment today about the Goldman Sachs story. This story seems to be going in the wrong direction. In my view, what is being missed here is the reality that the buyers and sellers of these CDOs were purely gambling and knew (or should have known) they were doing so. I mean it’s not as if these synthetic CDOs represented any productive capital at work or any socially redeeming value. It was a zero-sum game bet, similar to betting a portion of an institutional portfolio on red at the roulette table. Isn’t the real issue whether pension portfolios should be allowed to gamble like this in the first place?

In the particular story about ABACUS, none of the players was a pension fund, but the point is well taken – particularly in light of the CalPERS lawsuit! However, I do not feel that securities laws and regulations should restrict the investments of pension funds. Structured notes can have characteristics that make them very useful for portfolio management (although they usually don’t. Structured notes are most often vehicles whereby the intent of investment mandates can be evaded; for instance, buying “S&P Bear” instruments in a portfolio that is supposed to be fully invested.).

I take issue with the implication that “redeeming social value” should be judged, with access to investments being restricted accordingly. In the first place, whether a particular investment action has redeeming social value is very much in the eye of the beholder. Secondly, as I pointed out yesterday, Paulson’s action in shorting the instruments had the effect of intercepting the ACA/IKB sub-prime investment in the financial marketplace; otherwise, that money would have gone into further distorting an already over-heated US housing market. Paulson’s action can be viewed as helping to precipitate the crisis sooner, rather than later, before the inefficient allocation of capital did even more damage to the real economy. Which is something I consider to be socially redeeming.

PerpetualDiscounts squeaked out a win today, gaining 2bp, while FixedResets continued their strong recovery with a win of 16bp. Volume was slightly off, but still at elevated levels dominated by FixedResets.

This one will cause some angst for the bubble-gum crowd:

Warren Buffett, the Wall Street critic who invested $5 billion in Goldman Sachs Group Inc., said he supports the bank’s Chief Executive Officer Lloyd Blankfein “100 percent” after the firm was sued by regulators for fraud.
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Buffett said he will discuss the trade at the center of the regulator’s suit later today at the meeting and “I will bet that of the 40,000 people in there, 39,900 of them have a misconception.”

God endorses Satan! Of course, Buffett achieved his status by a very rare process known technically as “thinking about what he was doing”.

He went further later on:

“I can’t see what difference it makes if it were Paulson on the other side of the deal or Goldman Sachs or Berkshire Hathaway,” Buffett said today at his company’s annual meeting in Omaha, Nebraska. Buffett said it “wasn’t so obvious” when the investments were sold in 2007 that the housing market would collapse.

Gracious heavens, the bubble-gum crowd is going to have a collective nervous breakdown!

Buffett said today that Berkshire has four decades of experience with Goldman Sachs and no expectation that the bank would offer investment advice or disclose its own stance on trades.

“We are in the business of making our own decisions,” Buffett said. “They do not owe us a divulgence of their position.”

A grown-up! An actual grown-up! Quick, call the nannies! It occurs to me that one reason Buffett has done so well is that he’s an adult in a world of kiddies.

Suprisingly, I don’t see his comments highlighted in one of the sacred places where the acolytes proselytize and interpret the Holy Word. I guess Buffett can only be considered wise when he recites platitudes that people want to hear … but that’s the marketting biz!

Blankfein has learned that lesson and is attempting to distance himself and the firm from some headlined eMails:

Lloyd Blankfein, chief executive officer of Goldman Sachs Group Inc., said a “callousness” toward clients demonstrated in some e-mails released to the public this week is unacceptable and doesn’t represent the firm.

“There were some e-mails where some people were projecting I would say, at best indifference, and at worst a callousness,” Blankfein, 55, said in an interview on the “Charlie Rose” television show last night, according to a transcript. While he said those e-mails aren’t representative of the firm, “it’s inexcusable if 10 people think that way or thought that way.”

But, of course, you don’t get to be head of a big (public) firm by telling people what they don’t want to hear. I’ve had a look, but unfortunately have been unable to find a link to the actual transcript.

Never let it be said that PrefBlog doesn’t report both sides of the story: Suna Reyent writes a post on Seeking Alpha titled Why SEC has a Strong Case Against Goldman, Part 1. She states, for instance:

SEC alleges that Goldman not only hid Paulson’s role from all long parties via making it appear like a third long party (ACA) picked the portfolio, which is a material misrepresentation on its own, but it also made one investor (ACA) believe that Paulson was interested in the long side of the deal.

That’s where I stopped reading. ACA was the Selection Agent; they were paid to be the Selection Agent; they had fiduciary responsibility as the Selection Agent. The idea that Goldman made one investor (ACA) believe that Paulson was interested in the long side of the deal. is:

• contested by Goldman & Tourre
• completely non-material and irrelevent even if true.

Some light reading with a moral… Never Kick Your Chief Regulator in the Nuts. Or, to put it another way, never disclose that the emperor has no clothes. The light reading is best accompanied by SEC Fraud Allegations against MBIA. Of course, since this was settled without admission of guilt, we’ll never know whether they were really guilty, or whether not paying up would have constituted kicking the Chief Regulator in the Nuts.

Ackman, by the way, agrees with PrefBlog and Buffet about Goldman Sachs:

Ackman also staunchly defends Goldman Sachs. He says that the media misrepresents the charges against Goldman Sachs. He states that it would have been unethical had Goldman disclosed who the counter party(John Paulson) was on the trade. Ackman states that SEC laws require client confidentiality. Paulson himself did not know who was the long on the trade nor did he care.

I’ll go further, actually. Any fiduciary who cared about the identity of the seller, or who would have allowed the identity of the seller to influence his decision on the investment in any way whatsoever should be in jeopardy of losing his license. Investing is not a kiddie game of follow the leader … or shouldn’t be.

Trichet gave a speech decrying the propensity of investment managers to act in (what they believe to be) their clients’ best interest:

Gradually, the focus of finance shifted in the recent past. From its traditional role of helping the real economy to cope with economic risk, finance became a self-referential activity. The notion of “financial engineering” is a striking illustration of the shift of attitudes that spearheaded the changing focus of finance.

The ABACUS transaction is a good illustration of the point. ACA & IKB beleived that sub-prime borrowers were getting a deal favourable to the lenders. Paulson thought they were getting way too rich a deal. Goldman got between them, as brokers do, and created a security referencing the deals. Had this deal not gone forward, Paulson would not have been able to take a view on the market (it’s hard to short houses with mortgages!); the ACA/IKB money would have eventually have flowed into the sub-prime market, thus distorting the real economy even further. By creating a vehicle to interupt the inefficient allocation of capital to an overheated sector of the market, Goldman did the world financial system a great service, and deserves our thanks … but I suppose that profits on the books and expectations of future profits from similar deals will satisfy them.

James Hamilton of Econbrowser writes a post on the evolution of investment strategy at Reserve Primary Fund, which has attracted (so far) some very good comments. That post bulds on a very good post he wrote previously in which he traced the flow of funds into the US housing market.

The Greek bail-out conditions have been released. The effect on the total economy is fearsome:

*Economic contraction of 4 percent this year and 2.6 percent in 2011. Growth will return in 2012 at 1.1 percent and 2.1 percent in 2013 and 2014.

*Debt will rise from 133.3 percent of GDP this year to 145.1 percent in 2011, 148.6 in 2012 and peak at 149.1 percent in 2013. It is projected to fall to 144.3 percent in 2014.

*Budget deficit will shrink to 8.1 percent this year, 7.6 percent next year, 6.5 percent in 2012, 4.9 percent in 2013 and below the 3 percent demanded by the European Union in 2014.

There is some speculation that regulatory uncertainty is affecting the real economy:

Bank are increasing purchases of U.S. government securities to pump up profits while lending to businesses languishes near the lowest levels since credit markets started to freeze almost three years ago.

Holdings of Treasuries rose each of the past five weeks, an increase of $63.2 billion to $1.5 trillion, according to Federal Reserve data. At the same time, commercial and industrial loans climbed less than 1 percent to $1.27 trillion and are down 23 percent from the record high level in October 2008.
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“The risk of owning Treasures is lower than creating loans,” said Anthony Crescenzi, a market strategist and money manager at Newport Beach, California-based Pacific Investment Management Co., the world’s largest bond-fund manager. “There is no clarity on what the capital climates will be domestically or on a global scale with regulation coming down the pipes, which means banks will be banking their money in safer assets.”

Jerome Kerviel, the SocGen trader last discussed on PrefBlog on July 28, 2009, has written a book:

The five-billion-Euro rogue trader Jerome Kerviel will claim in a book this week that he was merely a “prostitute” in the “great banking orgy” and should be treated leniently in his trial next month.

Kerviel, 33, has broken a long silence with an autobiography and two newspaper interviews in which he says that his €4.9bn losses in rogue trades in 2006-07 should be blamed on a world banking industry “disconnected from reality”.

One reason not to ban shorting is that it’s a risky business:

Hedge funds that profit from falling shares have seen 34 percent of their value evaporate since February 2009, according to Chicago-based Hedge Fund Research Inc. Zions Bancorp., Sears Holdings Corp. and Wynn Resorts Ltd., among the favorites of so- called short-sellers, caused the biggest losses as their shares more than tripled.
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The combination of record-low interest rates, first-quarter economic growth of 3.2 percent and analyst estimates for the fastest profit gains in 14 years erased 94 percent of the HFRI EH Short Bias Index’s advance from June 2007 to February 2009. The better news for bulls is that the percentage of New York Stock Exchange shares that remain shorted is higher than any time before 2008, providing more grist for gains should speculators be forced to retreat.

Some recovery in the Canadian preferred share market today on continued heavy volume, with PerpetualDiscounts squeaking out a win of 5bp, while FixedResets were up 36bp.