PrefBlog

Enrico Perotti & Javier Suarez write a piece on VoxEU, Liquidity Insurance for Systemic Crises, proposing:

to establish a mandatory liquidity charge, to be paid continuously to a regulator who is able to provide emergency liquidity (and perhaps capital) during systemic crisis. The charge should be increasing in the maturity mismatch of assets and liabilities, and would be applicable to all institutions with access to safety net guarantees. Its effect should be to make short and medium term (up to one year) bank funding comparable in cost. Retail deposits would be exempted, as they are more stable thanks to their own separate insurance.

Revenues would go into an Emergency Liquidity Insurance Fund (ELIF), with legal autonomy and pre-packaged access to central bank liquidity and government funds backing. Upon significant aggregate liquidity runs (not concerning single banks), the payment of insurance would be triggered by the relevant supervisor, resulting in immediate liquidity support, guarantees on uninsured wholesale funding, and some automatic capital injections. Specific conditions may be attached, such as restrictions on compensation and dividends, as well as on some strategic choices.

The insurance charges could be thought of as prepayment for future rescue costs.

Restrictions on compensation have certainly become fashionable!

I don’t want to dismiss the idea out of hand; I will certainly agree that the next Basel Accord should address the degree of maturity transformation in some way. But:

• Liquidity crunches are black swan events. Any level of insurance premium will be a guess.
• It is the job of the central bank to address liquidity crunches, by making funds available against good collateral at a punitive rate of interest. A liquidity crunch, per se, is profitable for the central bank

From Across the Curve via PrefBlog’s Liquidity is Valuable Department comes another reminder:

One unintended consequence of the Fed [Agency] purchases is that the purchases have been concentrated in the large liquid issues. That has led to a substantial gulf between that paper and some smaller older illiquid paper. The illiquid securities now trading as much as 50 basis points cheap to the more liquid stuff.

PerpetualDiscounts eked out a small gain today to close with a pre-tax bid-YTW of 6.95%, equivalent to 9.73% interest at the standard conversion factor of 1.4x. Long corporates continue to yield 7.6%, so the spread remains fairly constant at 213bp. A fairly unexciting day, with volumes continuing normal, with pockets of frantic activity from recent Fixed-Reset issues.

However, today’s excitement was the downgrade of the BCE Prefs, which had no real effect on prices, but does mean that the HIMIPref™ Ratchet and Fixed-Floater sub-indices are about to disappear.

The Fed has announced:

that it is prepared to undertake a substantial expansion of the Term Asset-Backed Securities Loan Facility (TALF). The expansion could increase the size of the TALF to as much as $1 trillion and could broaden the eligible collateral to encompass other types of newly issued AAA-rated asset-backed securities, such as commercial mortgage-backed securities, private-label residential mortgage-backed securities, and other asset-backed securities. An expansion of the TALF would be supported by the provision by the Treasury of additional funds from the Troubled Asset Relief Program.

The Board’s objective in expanding the TALF would be to provide additional assistance to financial markets and institutions in meeting the credit needs of households and businesses and thus to support overall economic growth in the current period of severe financial strains. Decisions concerning the expansion of the TALF, which will be made in consultation with the Treasury Department, will draw on initial experience in administering the program and the Board’s assessment of the likely effectiveness of possible enhancements to the program in advancing its broad economic goals.

Under the current specification of the TALF, the Federal Reserve Bank of New York will lend to eligible owners of certain AAA-rated asset-backed securities (ABS). The Federal Reserve had previously announced that it would accept AAA-rated asset-backed securities backed by newly and recently originated auto loans, credit card loans, student loans, and SBA-guaranteed small business loans as collateral for TALF loans. The date that the TALF will commence operations will be announced later this month.

They will make credit available against good collateral – exactly what a central bank is supposed to do – but I will note that Across the Curve disagrees:

If I read the literature correctly, I would conclude that the TALF will be financed with a large scoop of funding from the central bank. Maybe I am being rigid in my thinking but that does not seem like something which should properly fall within the purview of the central bank.

This sounds like fiscal policy and not monetary policy and it would seem to me that the proper path would be for the elected representatives of the people should authorize the expenditure of one of the largest pools of money in human history. Allowing the Federal Reserve that much latitude, without a proper grant of authority from Congress seems literally undemocratic.

It also begs the question of Federal Reserve independence. The central bank has surrendered independence as the crisis has unfolded and Congress should step forward and provide a clear demarcation and definition of [roles] for the Treasury and its companion.

I disagree. I take the view that it only becomes fiscal policy if and when credit losses are expected and until then it’s monetary policy. I will presume that Bernanke & Co. are insisting on good enough collateral with high enough haircuts to keep it in the latter camp; and I will defend their authority to make the decision until it has been clearly shown otherwise.

Canadian auto subsidies have attracted notice from a Belgian academic, Johannes Van Biesebroeck, in a VoxEU piece Money for Nothing?:

Firms can draw on a long list of programmes for investment support. As of January 2009, the Ontario government’s web portal for initiatives to attract foreign investors listed 78 programmes offering subsidies or tax credits. Among the most important programmes are the Advanced Manufacturing Investment Strategy ($500 million over five years) geared towards innovation and advanced technologies, Strategic Manufacturing Investment grants (average annual budget of $63 million), and the Next Generation Jobs Fund ($650 million over five years) for green technologies.

Total support from just the four largest Ontario programmes has averaged a staggering $400 million per year, much of it for automotive investments.
…
Government discretion is often viewed with suspicion on political economy grounds, but a pure rules-based approach runs the risk of the winner’s curse if there is competition with other jurisdictions (Van Biesebroeck 2008). The largest subsidy package will be offered by the participant with the most upwardly biased information on potential benefits of the project. When the actual benefits become clear over time, the winner might regret having won.
…
On the day of the announcement, Canadian Press Harris-Decima completed a four-day survey showing strong popular support for a bailout of the carmakers. Supporters outnumbered opponents by a large margin – 56% versus 33% of respondents. This makes it easier to understand why the politicians stepped in. Ontario Premier McGuinty said “Our choice is to passively preside over the demise of the industry in Canada and observe its consolidation in the (US) or to act. We chose to act.” Apart from slowing down the demise, they have not made it clear what they hope to achieve with their actions.

Why do we subsidize them? Because they’re good jobs. Why are they good jobs? Because they’re subsidized.

Here’s a cheery update from the CDO market:

Almost half of all the complex credit products ever built out of slices of other securitised bonds have now defaulted, according to analysts, and the proportion rises to more than two-thirds among deals created at the peak of the cycle.

The defaults have affected more than $300bn worth of these collateralised debt obligations, which were built from bits of other asset backed securities (ABS) such as mortgage bonds, other CDOs and structured bonds, or derivatives of any of these, according to analysts at Wachovia and Morgan Stanley.
…
CDOs of ABS were used increasingly at the peak of the credit bubble to keep the securitisation machine moving by recycling hard to sell bits of subprime mortgage bonds and other risky tranches into new structures with top-notch credit ratings.

However, the ratings of these deals proved unsustainable, as evidenced by the fact they have accounted for 92.9 per cent of all 16,587 ratings downgrades globally from all rating agencies since the beginning of last year, according to Morgan Stanley.

The way these complex and risky transactions were exploited at the peak of the bubble can be seen in data from analysts at Wachovia, who reckon that 47.6 per cent of all CDOs of ABS by volume issued since the market substantively began in 2002 have now hit an event of default.

Equity markets expressed extreme disappointment with the Stimulus and Financing package as a whole, shocked that Obama didn’t wave his magic wand and make everything go away. Across the Curve has rather daringly republished a JP Morgan analysis of the Fed’s statements.

Canadian bonds had a reasonably good day, but the pref market simply yawned. Split shares did poorly, presumably due to asset coverage fears.