PrefBlog

The Bank of Canada has released a working paper by Hajime Tomura, Heterogeneous Beliefs and Housing-Market Boom-Bust Cycles in a Small Open Economy:

This paper introduces heterogeneous beliefs among households in a small open economy model for the Canadian economy. The model suggests that simultaneous boom-bust cycles in house prices, output, investment, consumption and hours worked emerge when credit-constrained mortgage borrowers expect that future house prices will rise and this expectation is neither shared by savers nor realized ex-post. With sticky prices and a standard monetary policy rule, the model shows that the nominal policy interest rate and the CPI inflation rate decline during housing booms and rise as house prices fall. These results replicate the stylized features of housing-market boom-bust cycles in industrialized countries. Policy experiments demonstrate that stronger policy responses to inflation amplify housing-market boom-bust cycles. Also, higher loan-to-value ratios amplify housing-market boom-bust cycles by encouraging speculative housing investments by mortgage borrowers during housing booms and increasing liquidation of housing collateral during housing busts.

OSFI has released a new Corporate Brochure. The Bank for International Settlements has released Principles for sound stress testing practices and supervision.

DBRS has downgraded ABN AMRO:

ABN AMRO Bank’s outstanding trust preferred securities have been downgraded from BBB to BB. The trend on these securities is Negative. Considering the significant cyclical and company-specific headwinds that RBS faces, DBRS sees an elevated risk of nonpayment of preferred dividends (which DBRS defines as a default on these instruments) which would likely entail a nonpayment of dividends on these securities.

Volume continued at its elevated levels but the market’s ascent was checked; PerpetualDiscounts only just barely managed to squeak out a gain, while FixedResets were slightly negative. But how ’bout them Floaters, eh? Up 17.2% on the month-to-date.

BofA was able to raise significant equity capital yesterday:

Bank of America Corp., the biggest U.S. bank by assets, said it raised about $13.5 billion in a sale of common stock as part of an effort to boost capital and weather an extended recession.

The bank issued 1.25 billion shares at an average price of $10.77 each, according to a statement today. The Charlotte, North Carolina-based company plans to boost common equity capital by $17 billion through the sale of stock and by converting preferred shares mostly held by institutional investors, Chief Executive Officer Kenneth Lewis said May 7.
…
Bank of America expects to add $10 billion more in capital through asset sales and at least $7 billion from improved pretax profits, the company said on May 7. Those numbers may change as the bank considers options to achieve its $33.9 billion target, spokesman Jerry Dubrowski said.

The Pension Benefit Guaranty Fund in the States is having about as much fun as other guarantors:

Pension Benefit Guaranty Corp.’s deficit tripled to $33.5 billion in the past six months as more companies canceled retirement plans amid the U.S. recession, according to the head of the government-owned corporation.

About $11 billion is for “completed and probable terminations,” and $7 billion is from an increase in interest rates that boosted liabilities, Vince Snowbarger, the acting PBGC director, said in written testimony to be delivered tomorrow to the Senate Special Committee on Aging.
…
The potential for General Motors Corp. and Chrysler LLC to end their plans has left the PBGC facing the prospect of adding 900,000 current and future beneficiaries. The PBGC, which pays retirement income to almost 44 million Americans, estimates that $77 billion of the automotive industry’s pensions are underfunded, with about $42 billion of that not funded at all.

There’s a report by internal audit of the fund that claims former PBGC director Millard was, at least, sloppy in separating his various activities – with the Placement Agent scandal still being whipped up, the response could be draconian.

Looks like the SEC is losing the jurisdictional catfight with the Fed:

The Obama administration may call for stripping the Securities and Exchange Commission of some of its powers under a regulatory reorganization that could be unveiled as soon as next week, people familiar with the matter said.

The proposal, still being drafted, is likely to give the Federal Reserve more authority to supervise financial firms deemed too big to fail. The Fed may inherit some SEC functions, with others going to other agencies, the people said. On the table: giving oversight of mutual funds to a bank regulator or a new agency to police consumer-finance products, two people said.

The politicians have to assign blame and shuffle responsibilities in order to make it clear that nothing was their fault.

The Obama administrations shameful conduct in the Chrysler bankruptcy is having some repercussions:

Hedge fund manager George Schultze says he may avoid lending to any more unionized companies after being burned by President Barack Obama in Chrysler LLC’s bankruptcy.

Obama put Chrysler under court protection on April 30 after lenders balked at a proposal giving them about 29 cents on the dollar for their $6.9 billion in debt. The investors said the president’s plan favored a union retiree medical fund whose claims ranked behind them for repayment. It was offered a 55 percent equity stake in the automaker.

Pacific Investment Management Co., Barclays Capital and Fridson Investment Advisors have joined Schultze Asset Management LLC in saying lenders may be unwilling to back unionized companies with underfunded pension and medical obligations, such as airlines and auto-industry suppliers, because Chrysler’s creditors failed to block Obama’s move.

Whether or not the rhetoric influences yield spreads and whether those yield spreads influence conduct is something we’ll just have to wait and see.

Anne Sibert pens a provocative thesis on VoxEU, Why did the bankers behave so badly?:

Greedy bankers are getting most of the blame for the current financial crisis. This column explains bankers did behave badly for mainly three reasons. They committed cognitive errors involving biases towards their own prior beliefs; too many male bankers high on testosterone took too much risk, and a flawed compensation structure rewarded perceived short-term competency rather than long-run results.
…
In a fascinating and innovative study, Coates and Herbert (2008) advance the notion that steroid feedback loops may help explain why male bankers behave irrationally when caught up in bubbles. These authors took samples of testosterone levels of 17 male traders on a typical London trading floor (which had 260 traders, only four of whom were female). They found that testosterone was significantly higher on days when traders made more than their daily one-month average profit and that higher levels of testosterone also led to greater profitability – presumably because of greater confidence and risk taking. The authors hypothesise that if raised testosterone were to persist for several weeks the elevated appetite for risk taking might have important behavioural consequences and that there might be cognitive implications as well; testosterone, they say, has receptors throughout the areas of the brain that neuro-economic research has identified as contributing to irrational financial decisions.

Well, I don’t know what’s up with the Toronto Stock Exchange. There was a problem last Friday retrieving prices that were available and today there’s a problem with availability. So I’m using an approximate, late-in-day-update to prepare today’s report. I did update the details for SLF.PR.F, though, since that one’s important.

It was another really good day for the preferred share market – and here’s a landmark for you: BAM floaters are now trading in the double digits! The low close of 6.40-69 was reached on 2008-12-18 on volume of 27,351 shares.

PerpetualDiscounts now yield 6.39% (pre-tax bid-YTW), equivalent to 8.95% interest at the standard equivalency factor of 1.4x. Long Corporates are now at 7.0%, having returned 4.63% Month-to-date and 9.29% Year-to-Date, so the pre-tax interest-equivalent spread is now about 195bp.

The Bank for International Settlements has released its report on OTC derivatives market activity in the second half of 2008:

Facing significant price drops, markets for commodity and equity derivatives recorded volumes which were 66.5% and 36.2% lower, respectively. Against a background of severely strained credit markets combined with efforts to improve multilateral netting of offsetting contracts, credit default swap (CDS) volumes decreased by 26.9%. Foreign exchange and interest rate derivatives markets recorded their first significant downturns. Amounts outstanding of foreign exchange contracts fell by 21.0%, while amounts outstanding of
interest rate contracts slid by 8.6%.

Gross market values, which measure the cost of replacing all existing contracts, represent a better measure of market risk than notional amounts. Despite the drop in amounts outstanding, significant price movements resulted in notably higher gross market values, which increased by 66.5% to $33.9 trillion at the end of December 2008 (Graph 1, right-hand panel). The higher market values were also reflected in gross credit exposures, which grew 29.7% to $5.0 trillion.
…
In the second half of 2008 the market for OTC interest rate derivatives declined for the first time, after recording an above average rate of growth in the first half of the year. Notional amounts of these instruments fell to $418.7 trillion at the end of December 2008, 8.6% lower than six months before (Graph 2 and Table 3). Despite the decrease in notional amounts outstanding, declining interest rates resulted in a notable 98.9% increase in the gross market value of interest rate derivatives, to $18.4 trillion.

Their statement Gross market values, which measure the cost of replacing all existing contracts, represent a better measure of market risk than notional amounts. is incorrect. If I short a bond future, the market value at time of execution is zero, but I have full market exposure and counterparty risk to the extent that I might win money that doesn’t get paid. If the market moves in my favour, that increases my counterparty risk but doesn’t affect my market exposure.

There are straws in the wind that the too-big-to-fail problem will not be addressed by fixing extant rules, but by adding another layer of new rules that will grant politicians more discretionary power:

Neel Kashkari, former administrator of the $700 billion U.S. bank-rescue program, said firms deemed too big to fail have an unfair advantage over smaller rivals because they can more cheaply raise money in the debt markets.

Kashkari, who left government May 1, said in a speech last night that some officials have discussed the possibility of a “debt tax” or “systemic tax” on those institutions, without saying if he supported that approach.

“If you have some huge, global institution that is systemically important, too big to fail, too interconnected to fail, in a sense it will always be able to issue debt cheaper,” said Kashkari, 35, at the San Francisco campus of the University of Pennsylvania’s Wharton School. “People who buy that debt believe that the government is standing behind it.”

“Debt Tax”? “Systemic Tax”? Presumably this is much the same idea as existing deposit insurance, except that the degree of protection received in exchange for premia will not be spelled out. It is very simple to address the TBTF problem and systemic risk problem by adjusting extant rules:

• End the practice of risk-weighting bank debt according to the credit of the sovereign
• Impose an upwards adjustment to Risk-Weighted Assets based on size of the bank

Here’s a scary proposal: inflation targetting of 6%:

What the U.S. economy may need is a dose of good old-fashioned inflation.

So say economists including Gregory Mankiw, former White House adviser, and Kenneth Rogoff, who was chief economist at the International Monetary Fund. They argue that a looser rein on inflation would make it easier for debt-strapped consumers and governments to meet their obligations. It might also help the economy by encouraging Americans to spend now rather than later when prices go up.

“I’m advocating 6 percent inflation for at least a couple of years,” says Rogoff, 56, who’s now a professor at Harvard University. “It would ameliorate the debt bomb and help us work through the deleveraging process.”

Another strong day in the preferred market, with volume returning to elevated levels after the long weekend.

Those contemplating reverse mortgages would do well to incorporate the new OSFI advisory into their planning … the rules for qualification for optimal capital treatment will indubitably influence the packages offered by banks, notably:

• initial loan-to-value of less than 40%
• Ongoing loan-to-value of less than 60%

I regret that it is not possible for me to prepare the market report. There is a difficulty recovering prices from the TSX.

Update, 2009-5-16: Well, it took a little while, but eventually the TSX’s little computer that could spit out the data: Volume was down sharply in pre-holiday trading (which is always something of a mystery to me) but PerpetualDiscounts had a good up-day while FixedResets were flattish.