PrefBlog

BofA / Merrill Lynch Plot Thickens!

When Bank of America Corp.’s board met to approve the acquisition of an investment bank on Sept. 15, 2008, members thought they were going to buy Lehman Brothers Holdings Inc., not Merrill Lynch & Co., according to New York Attorney General Andrew Cuomo.

However, the story has some support for my thesis that large corporations are riskier than smaller ones, on the grounds that you get ahead by telling your boss what he wants to hear:

[Company eMails and notes] also show Merrill kept [BofA ex-Chief Financial Officer Joe] Price informed of the losses as they grew, yet he resisted pressure from his lawyers to disclose them to shareholders.
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When Price asked for a review of whether the [October 2008] losses — then $5 billion after taxes — should be disclosed to shareholders, his general counsel Timothy Mayopoulos said they should.
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Mayopoulos was later fired by Price and replaced by Brian Moynihan, who later became CEO, Cuomo said.

This is just a hair off-topic, but I’ve often wondered what the big deal is about atmospheric CO₂ levels. I mean, assuming they’re causing problems, why not just fix it? Genetically engineer some yeast cells, or other bug, so that they eat CO₂ and excrete sugar, put them in a tank and Bob’s your uncle! If you want to get fancy, put some other bugs in the tank that eat sugar and excrete polysaccharides; if you want to make some money, sell the kits in one-liter sizes so that Mr. & Mrs. Precious can reduce their carbon footprint. Why can’t this be done? Converting CO₂ to sugar is no big deal – plants do it all day long and have time left over for sex with bees.

So it was a great relief to read Neil Reynolds column today, Profit motive is the solution to CO2 emissions:

A Santa Barbara, Calif., company called Carbon Sciences Inc. provides a convenient prototype. The company announced last week that it has developed a “breakthrough technology” that converts atmospheric carbon dioxide into commercial-grade gasoline, diesel fuel and jet fuel. Founded in 2006, Carbon Sciences had previously converted CO-2 into low-grade methanol using an enzyme-based technology. Now, it said, it has combined chemical and biological engineering in a bio-catalytic process that transforms carbon emissions into “a cost-efficient” energy resource.

Is the process really commercially viable, or at least on the way there? Is Carbon Sciences (OTCBB: CABN) a decent investment? I don’t know and I’d need to hire some expertise before I ventured an opinion. But I’m just glad I’m not the only person in the world who’s thought of this.

PerpetualDiscounts continued to slide today, losing 27bp on a day with sharply reduced volume. FixedResets were able to squeak out a gain of 2bp. There were only three entries for the Performance Highlights table!

Deutsche Bank is using the compensation hysteria to put golden handcuffs on the peons:

A significant proportion of compensation will, where applicable, be deferred. Deferred compensation will be a combination of restricted equity awards (75%) and restricted incentive awards (25%).

* The restricted equity award will vest in nine equal instalments over 3¾ years, while the restricted incentive award will vest in three equal instalments over three years.

* All restricted equity and restricted incentive awards will continue to be subject to claw-back in the case of policy/regulatory breach.

And, of course, if they don’t feel like living up to their side of the bargain, inventing a policy/regulatory breach is easy enough. The best job of the brave new world? Employment contract litigator.

Some players are reducing their risk:

Two Citigroup Inc. executives running a proprietary-trading unit quit to join hedge fund Moore Capital Management LP, amid concern the government might order U.S. banks to exit trading businesses that don’t cater to customers, people briefed on the matter said.

Matthew Carpenter, a 15-year Citigroup veteran who had assembled the unit over the past three years, is leaving the bank along with his deputy, Matthew Newton, Citigroup spokesman Alex Samuelson said. The group trades U.S. stocks in several industries, Samuelson said.

In yet another instance of regulatory extortion, the SEC has admitted that State Street did nothing wrong but is paying $300-million anyway. Nobody’s been fired, nobody’s lost their license, back to business as usual. The trend towards bureaucratic ursurpation of the role of the courts, in all aspects of life, continues.

PerpetualDiscounts continued to slide today, losing 17bp, while FixedResets were down slightly less than 1bp. Volume continued to be on the heavy side.

In yet another example of PrefBlog’s trendsetting nature, Citigroup has started a blog.

The market responded to my deprecating remarks about FixedResets by selling off PerpetualDiscounts, which lost 28bp on the day and buying FixedResets, which gained 5bp, on fairly heavy volume.

PerpetualDiscounts now yield 5.83%, equivalent to 8.16% interest at the standard equivalency factor of 1.4x. Long corporates continue to yield about 5.8%, so the pre-tax interest-equivalent spread is now about 235bp, which is where it was at month-end.

Paul Krugman writes an op-ed in the New York Times, Good and Boring, lauding the resilience of Canadian banks:

Canada has an independent Financial Consumer Agency, and it has sharply restricted subprime-type lending.

Above all, Canada’s experience seems to support those who say that the way to keep banking safe is to keep it boring — that is, to limit the extent to which banks can take on risk.
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More specifically, Canada has been much stricter about limiting banks’ leverage, the extent to which they can rely on borrowed funds. It has also limited the process of securitization, in which banks package and resell claims on their loans outstanding — a process that was supposed to help banks reduce their risk by spreading it, but has turned out in practice to be a way for banks to make ever-bigger wagers with other people’s money.
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Actually, the financial reform bill that the House of Representatives passed in December would significantly Canadianize the U.S. system. It would create an independent Consumer Financial Protection Agency, it would establish limits on leverage, and it would limit securitization by requiring that lenders hold on to some of their loans.

I suggest that Dr. Krugman has selected features of Canada’s system to further his domestic political arguments. The IMF has published suggestions that a critical factor is the stable deposit base of Canadian banks – which, I believe, is related to their national scope and oligopolistic position. Another major factor has been the banks’ control over the mortgage market – limited competition (no GSE’s here in Canada!) has allowed them to extract rents from hapless Canadian mortgagees, leaving much less necessity of reaching for yield. The sole Canadian bank that did fail during the crisis, Dundee Bank, failed because its lack of mortgage distribution channels encouraged it to go out on a limb provided by ABCP.

Paul Volcker testified to the Senate banking committee today:

Given strong legislative direction, bank supervisors should be able to appraise the nature of those trading activities and contain excesses. An analysis of volume relative to customer relationships and of the relative volatility of gains and losses would go a long way toward informing such judgments. For instance, patterns of exceptionally large gains and losses over a period of time in the “trading book” should raise an examiner’s eyebrows. Persisting over time, the result should be not just raised eyebrows but substantially raised capital requirements.

This is much more in line with my thinking than a flat prohibition, which will be subject to interpretation.

More generally, proprietary trading activity should not be able to profit from knowledge of customer trades.

That’s what the SEC’s supposed to be worrying about.

Mr. Volcker also noted that he had attached an essay to his official testimony, but I can’t find it!

A relatively directionless day for Canadian preferred shares, with PerpetualDiscounts losing 5bp and FixedResets gaining 1bp on moderate volume.