PrefBlog

The concept of credit protection on the United States of America has captured imaginations all around, with Accrued Interest referring to it as a “chaos trade” – defining this as “positions designed to produce big returns if all hell breaks loose” and Naked Capitalism comparing US Treasuries to senior debt of the GSEs. Certainly the greenback continues to sink against the Euro.

Equities did very poorly today, with General Motors suspending its dividend.

Cheyne Finance, last mentioned on October 22 and November 13, is having a $6-billion fire sale:

The first auction of assets by a structured investment vehicle drove Moody’s Investors Service to downgrade the Cheyne Finance Plc SIV by five levels, describing it as a “fire sale.”

The $6 billion SIV set up by London-based Cheyne Capital Management (UK) LLP is scheduled to auction its assets this week or transfer them to a new company under a reorganization by receivers Deloitte & Touche LLP and Goldman Sachs Group Inc. Moody’s said it cut the SIV’s senior debt to Ca, its second- lowest grade, in a report today.

And Willem Buiter fulminates on the real meaning of the GSE bailout:

The Treasury has taken another big step on the road to Utter Fiscal Obfuscation. It is doing everything it can to disguise the fact that it is entering in commitments that create potentially massive contingent liabilities for the US tax payer. Even if the purpose served by this increase in contingent liabilities is worth the cost, the manner in which it is done is designed to avoid fiscal accountability. This is as welcome to the Executive as it is to the Congress.

Note to all aspiring politicians: guarantees are not a cost-free method of accomplishing social goals. They will be called in at the most inopportune time.

Here’s an interesting factoid:

The S&P 500 Financials Index dropped 3 percent, capping its steepest-ever five-day retreat and giving the industry a smaller market value than health care for the first time since 1992, S&P data show.

Amidst all this gloom, I will remind readers that Bombardier first halved, then suspended its common dividend a few years back – the common dividend has only recently been reinstated. But the preferreds kept on paying through the period. First loss protection is not just a theoretical construct!

What a life! If anything, the panic is spreading … the price-movers list is longer today than it was, there were a number of block trades in the volume highlights and the PerpetualDiscount index was down more than a point for the second day running, to yield 6.58% … 9.21% interest-equivalent, long corporates +311bp. On the other hand, a few CM issues were up significantly on the day … which could imply the emergence of bottom fishers, it could be a dead-cat bounce, or it might mean absolutely nothing at all. I’ll let you know when it’s all over.

There were thirty other index-included $25-pv-equivalent issues trading over 10,000 shares today.

The implicit guarantee of the GSE will – probably – shortly become explicit.

James Hamilton of Econbrowser reviews the situation and approves of the plan:

The first thing I like about this plan is the fact that the ultimate determination of the level of risks to be absorbed by the federal government is being left to Congress.
…
The second thing I like about the plan is that such action by Congress would take the form of a dollar limit– here’s how much we’re willing to stake, and no more– with residual losses presumably laid on the GSE creditors.

Accrued Interest mourns bad decisions of the past:

its a sad day for free markets. I see the Treasury as between a rock and a Depression, and has selected the rock. I’d have done the same. I don’t blame Treasury so much as I lament that its come to this. Exactly who to blame for this or what could have been done differently in the past is a discussion for another time.

The WSJ Economics Blog collected some opinion from Street economists – mostly neutral and a bit bewildered, but with one interesting observation that it made shorting the stock a riskier proposition than otherwise. Jim Rogers and George Soros hate it. Naked Capitalism supplies further clippings.

From the Interesting Factoid department comes an estimate of Canadian banks’ exposure to the US:

BMO had the highest loan exposure at $51 billion, while TD’s exposure was estimated to be $46 billion. The two Canadian banks have focused their U.S. banking businesses on different regions – Chicago and the Midwest in the case of Bank of Montreal and the U.S. Northeast in the case of Toronto-Dominion.

Commercial loans to real estate and financial services companies made up about 43 per cent of the total amount at both banks.

[Blackmont Capital analyst Brad] Smith also noted that Royal Bank (TSX: RY.TO) only had a “modest exposure” worth $25 billion or 10 per cent of the outstanding loans, “surprisingly, given its well-established U.S. retail banking and global capital markets business.”

The least at risk were CIBC (TSX: CM.TO) and Scotiabank (TSX: BNS.TO), both with single-digit exposure.

He concludes … :

[TD & BMO] could see their earnings per share decline as much as seven per cent next year

Wow, earnings down as much as 7%, eh? Holy smokes! There’s a little perspective for you! Stockbrokers, I’m sorry to say, are busily attempting to convince clients that preferred dividends from banks in Canada are at risk. I’ll start paying attention when I hear a little less “could” and “might” and a few more numbers.

This market is getting surreal. PerpetualDiscounts are now yielding 6.49%, equivalent to 9.09% interest at a conversion factor of 1.4x. Long corporates continue to yield 6.1%, so the Pre-tax Interest-Equivalent spread is now just a hair under 300bp.

In the volume leaders, only two blocks were traded – both by CIBC and both 60,000 shares, so there’s even a possibility they’re related.

If I was seeing any confirmation in the bond market that the world was about to end, I’d be taking this a lot more seriously. I wouldn’t necessarily agree with the bond market’s analysis, understand, but I would have to consider predictions of impending doom with a sharper eye to detail. But we’re not seeing any of that. Volume is light and there are incredible moves happening on featherweights! PerpetualDiscounts were down over 1% today! That’s a bad MONTH!

There were fourteen other index-included $25-pv-equivalent issues trading over 10,000 shares today.

Panic, Chaos, Confusion! And then it got worse!

It looks like the US administration, quite properly, will ensure investors are wiped out before taking over Fannie & Freddie:

A government takeover of one or both companies is among several options that have been considered, Joshua Rosner, an analyst at Graham Fisher & Co., said after meetings with administration officials. U.S. Treasury Secretary Henry Paulson said today that federal regulators are backing Fannie Mae and Freddie Mac in “their current form.”

“The administration is considering all options in its contingency planning,” Rosner said. “That doesn’t mean to say that we’re at an inflection point where any decision is required immediately.”

The U.S. is reluctant to step in before Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac, which own or guarantee about half the $12 trillion in home loans outstanding, exhaust their options for raising capital, according to Rosner and U.S. Representative Spencer Bachus of Alabama.

… but this will have very serious knock-on effects …

“It is impossible to contemplate all of the negative events that will occur if Fannie and Freddie go under,” said Richard Bove, an analyst at Ladenburg Thalmann & Co.

Fannie Mae fell $4.40 to $8.78 as of 11:21 a.m. after closing at the lowest level in 17 years yesterday. Freddie Mac slid $2.85 to $5.15.
…
“Fannie and Freddie’s demise mean the investment banks can’t do any more securitization for a while, but their securitization revenue being zero has been written off from their share prices already,” said Brad Hintz, an analyst at Sanford C. Bernstein & Co.

There is considerable opposition to a bail-out:

Former U.S. Treasury Secretary John Snow said that Fannie Mae and Freddie Mac have relied on leverage to fund their businesses in the same fashion as a hedge fund, and that the government should avoid taking them over.

“Congress ought to be embarrassed” for years of delays in passing legislation aimed at strengthening regulation of the two companies, Snow, now chairman of New York-based buyout fund Cerberus Capital Management LP, said in a telephone interview. He said he flagged when in office that “the business model they were using was really the model of a hedge fund.”

The government-chartered companies, which grew to account for almost half of the $12 trillion in U.S. mortgages, were able to borrow at cheap rates because of an implicit federal guarantee, Snow said. His opposition to a full government takeover echoes the signal sent today by his successor, Treasury Secretary Henry Paulson.

Naked Capitalism has further clippings.

After the bell IndyMac was siezed by regulators:

IndyMac Bancorp Inc. became the second-biggest federally insured financial company to fail today after a run by depositors left the California mortgage lender short on cash.

The Federal Deposit Insurance Corp. will run a successor institution, IndyMac Federal Bank, starting next week, the Office of Thrift Supervision said in an e-mail today. Customers will have access to funds this weekend via automated teller machines.

The Pasadena, California-based bank specialized in so-called Alt-A mortgages, which didn’t require borrowers to provide documentation on their incomes. Its home state has been among the hardest hit by foreclosures.
…
IndyMac becomes the largest OTS-regulated savings and loan to fail and second-biggest financial institution to close behind Continental Illinois in 1984, according to the FDIC.

The lender racked up almost $900 million in losses as home prices tumbled and foreclosures climbed to a record. California ranked second among U.S. states, with one foreclosure filing for every 192 households in June, 2.6 times the national average.

The Office of Thrift Supervision comments:

The immediate cause of the closing was a deposit run that began and continued after the public release of a June 26 letter to the OTS and the FDIC from Senator Charles Schumer of New York. The letter expressed concerns about IndyMac’s viability. In the following 11 business days, depositors withdrew more than $1.3 billion from their accounts.

“This institution failed today due to a liquidity crisis,” OTS Director John Reich said. “Although this institution was already in distress, I am troubled by any interference in the regulatory process.”

Schumer comments:

“If OTS had done its job as regulator and not let IndyMac’s poor and loose lending practices continue, we wouldn’t be where we are today,” Schumer, a New York Democrat, said in an e-mail today. “Instead of pointing false fingers of blame, OTS should start doing its job to prevent future IndyMacs.”

Naked Capitalism has other media clippings.

Credit woes? You know things are really getting out of hand when people need to be reassured about … :

U.S. debt is “well within” the guidelines for an Aaa rating, said Steven Hess, vice president and senior credit officer at Moody’s in New York. The U.S.’s AAA rating is not at risk, said Nikola Swann, S&P’s primary U.S. credit analyst.

Treasuries got crushed and Accrued Interest provides us with a little nugget about credit swaps:

credit default swaps on the United States of America moved 11bps wider today (from 9bps to 20bps).

Who’s the counterparty?

Accrued Interest comments on monoline re-structuring initiatives with the telling line:

In other words, bonds are trading as though there is a penalty for once carrying Ambac or MBIA insurance. While this would seem to present a buying opportunity, be sure you can handle the illiquidity. Many institutional municipal buyers don’t want to explain to their clients why they hold so much MBIA paper, so even at higher yields, bids can be hard to come by.

This is an unfortunate reality of the business. There are many who take great joy in pointing out that the average investment manager (by which they generally mean “stockbroker”, an entirely different thing) is average. Chasing rainbows, panicking … there are a great many investment managers (and many more stockbrokers) who simply reflect the greed and fear of their clients without adding any value of their own. But … if they don’t reflect the greed and fear of their clients, they’ll get fired and the next guy will reflect this greed and fear.

Investment pundits love a hard-nosed maverick who sticks to his guns, right or wrong … until the first time he’s wrong.

Things went blahooey today all right! Yet another ghastly day, with some extremely sloppy trading (great market making there, guys! Keep up the good work!), not terribly exciting volume and … none of the volume leaders had any block trades at all. Retail’s panicking, Institutional’s at the cottage … I get a little trading done now and then. Not much, but enough to be worthwhile.

There were sixteen other index-included $25-pv-equivalent issues trading over 10,000 shares today.