PrefBlog

Worry over the fate of the USD continues to be a theme in the markets, and Menzie Chinn of Econbrowser has posted a review of the issues. I will admit, this post is notable mainly for its links to definitions and prior reviews of the issue, but these are good links. The 2005 post includes a link to a paper showing the futility of forecasting: it’s always gratifying to get some agreement with one’s prejudices! The examination of the interest-rate parity predictions are interesting, if only because I have seen it claimed – by a sophisticated retail investor – that carry trades are intrinsically unsound because interest-rate parity is guaranteed. Well … not in this world!

Accrued Interest reviewed the jobs numbers on the weekend, with a view to discussing the investment difference between “lawyers” and “detectives” – the former seeking evidence to support a particular view; the latter (greatly favoured) seeking to examine evidence to form a view.

What’s a good name for those, such as myself, who feel that the process is pointless because natural chaos will destroy any prediction as soon as it’s made? Weatherman, perhaps? I’m not going to predict a hurricane, but I will say that if there is a hurricane, you should have a good solid house; but if it’s sunny and pleasant, you’ll want nice windows; so build your house with the objective of surviving hurricanes with not too much damage while being able to enjoy the sunny times.

Perhaps this is stretching a metaphor too far! The markets can be outperformed, but you have to get your hands dirty and examine a wide variety of scenarios. And – assuming you are a rational investor and avoid the One Big Bet school of thought – you’re not going to double your money while everyone else goes broke, either! Ideally, you’ll outperform by a constant, small-but-worthwhile amount, irregardless of economic conditions.

The Northern Rock Saga continues:

Northern Rock, based in Newcastle, England, said in a statement today that money deposited after Sept. 19 will now be covered by the Bank of England, the U.K. Treasury and Financial Services Authority. The authorities previously only protected deposits made before then.

“This may make Northern Rock easier to sell,” said Philip Shaw, chief European economist at Investec Bank in London.
…
The case has been “damaging” for the reputation of the U.K., Financial Services Authority Chairman Callum McCarthy told the Treasury Select Committee of lawmakers today. Still, it was “impossible” to predict closure of the markets both for securitization and for short-term repurchase agreements, he said.

“We didn’t identify the probability of that happening,” McCarthy said. “No regulator anywhere around the world succeeded in predicting that.”

Sion Simon, a Labour Party member of the committee, said he had heard that relations between the FSA and the Bank of England were “poisonous” and compared McCarthy to a boxer.

“You are the Sugar Ray Leonard of the financial-services sector. You are a world-class ducker and diver.” Simon told McCarthy. “There was a run on the bank, the nation was a global laughing stock, and you say the provisions worked?”

Instead of saying ‘We didn’t predict it and neither did anybody else’, McCarthy should have blamed the credit rating agencies. That technique is working beautifully in North America!

Speaking of credit rating agencies, I see in the Globe today that State Street (among other Money-Market-Fund sponsors) is seeing a big uptick in business:

Executives at many small to mid-sized companies across Canada woke up in mid-August to find a portion of their supposedly liquid cash holdings were frozen, as a $30-billion segment of the asset-backed commercial paper market (ABCP) collapsed. Airline Transat A.T. Inc., for example, has $154-million of its $340-million in cash reserves stuck in a holding pattern.

“Corporate treasurers suddenly became aware that they face risks in their cash holdings, and they’re rushing to deal with these risks,” said Gregory Chrispin, president of State Street’s Canadian arm and former treasurer of Export Development Canada.

It is nice to see that some companies are taking my advice to stick to what they’re good at and pay for portfolio management. Whether or not there will be a surge of CFO replacements to accompany the sudden discovery that treasury departments have been speculating with shareholder assets remains to be seen! 

Treasuries drifted downwards, attributed to a ‘no-recession’ indication by the Fed, though today’s retail sales number provided no indication of a huge economic boom. Canadas fell, as a strong housing number decreased chances for a rate cut. US equities rose (no recession!) while Canadian equities were pretty quiet.

The news in the preferred share market today was that the TD New Issue and the closing of the BMO new issue combined to drive the PerpetualDiscount index to a new low. The prior low (since the temporary index was started, as of 2006-6-30, that is) was set on June 12, 2007. The four main indices since then have returned:

If we look at returns for CPD …

So, speculating on price movements in prefs has not been a jolly time for the past four months! Fortunately, the investments are paying the same income as they have done in the past, so income – which is the entire reason for investing in prefs, right? – is unaffected. Market timers may wish to kick themselves for getting it wrong, but an honest market timer is always kicking himself anyway, so there’s not much difference there.

It was nice to see some good volume in the pref market today, with a few good-sized crosses courtesy of Scotia.

There were sixteen other index-included $25.00-equivalent issues trading over 10,000 shares today.

Remember last month’s US jobs number? Don’t. It’s been revised upwards with an entirely solid number reported for September, which has been enthusiastically greeted by most economists, ( including JDH of Econbrowser) although Noriel Roubini sees the devil in the details. There was much the same thing in Canada. So, basically, bad news for bonds.

But in a reminder that, yes, sub-prime is really still a concern, both Merrill Lynch and Washington Mutual took big housing-related write-downs amidst reports of fire-sale liquidations and horrifying lack of quality in 2007-vintage sub-prime loans. Concern, yes; end of the world, no. For sure, $150-billion in sub-prime losses ($50-billion? $100-billion?) sounds like a very big number, but I’ll just take a moment to remind readers of Nortel’s market cap in 2000: almost $400-billion. So by all means, worry. But don’t try to tell me that this is an unprecedented disaster requiring extensive regulation. Accrued Interest has taken a look at contagion in non-RMBS asset-backed paper.

There’s entirely too much speculation that the credit crunch is over. Accrued Interest is concerned that the pendulum, having swung too far one way, will promply over-correct in the other direction. Panic, ecstasy … just another day in the markets. Those who wish to profit from panic without having access to institutional markets might wish to take a look at DG.UN, which was mentioned here on August 28 when it suspended redemptions (ABCP financing dried up). According to their September 26 Press Release:

its net asset value (“NAV”) per unit as at August 31, 2007 was $7.92 based on an indicative price received from a large international bank (the “Bank”) as of August 28, 2007.
…
The NAV on a particular date is equal to the aggregate value of the assets of the Trust, less the aggregate value of its liabilities (calculated in conformity with Generally Accepted Accounting Principles (GAAP)). The NAV does not reflect any eventual write-down resulting from the interruption of payments that MMAI is required to make to Global DIGIT under the swaps, nor does it reflect any potential impairment in the value of the assets of Global DIGIT from any eventual restructuring of MMAI debts, as it not possible at present to determine if, when and to what extent such payments to Global DIGIT under the swaps will resume or the effect of any eventual restructuring of any such MMAI debts.

So … there’s some warnings there and there could be legal problems and all sorts of things. But from what I could make out with a VERY brief look, the underlying credit was fine – it’s just liquidity that causes concern … and it’s quoted today on the TSX at 2.80-00, 8×23; so it seems to me it’s worth closer inspection by those willing to rip apart the books and make a few ‘phone calls prior to a decision.

The Economist has published a commentary on bank liquidity that echoes Dodge’s comments on the seemingly very high level of liquidity guarantees given by the banks. I suggest that one thing that be considered is a sliding scale of capital charges for liquidity guarantees: the charge is now a 10% CCF across the board; perhaps something like … “10% on the first capital-equivalent, 15% on the next, 20%…” might permit the market to operate efficiently while keeping the number of lines under control.

Brad Setser continues to worry about the USD, which has been a topic of some concern lately.

I added an ad to the recent reader inquiry; you don’t really need to do it all yourselves, you know! I’m willing to help!

The jobs numbers crushed bonds in both the US and Canada today.

It was an interesting day for prefs! The yield on PerpetualPremiums is finally back below PerpetualDiscounts, which is only sensible given the greater interest rate risk on the latter. Operating Retractibles and SplitShares have been virtually immune to the recent declines in perpetuals … this makes sense up to a point, but only up to that point.

There were four other index-included $25.00-equivalent issues trading over 10,000 shares today.

There was a report today of another sub-prime winner:

Harbinger Capital Partners, the hedge fund firm run by former Barclays Capital trader Philip Falcone, generated returns of more than 65 percent this year, helped by bets against subprime-mortgage bonds and gains on commodities.Harbinger’s $2.5 billion Special Situations fund increased 9.9 percent last month and more than 100 percent in 2007, said two of the firm’s investors. The $11 billion Harbinger Capital Partners fund rose 5.4 percent last month and 65 percent this year.

Lucky or smart? Does it matter?

The Fed released Commercial Paper Outstandings today; it would appear the situation is normalizing rapidly. ABCP outstanding was down about $6-billion on the week, a nice chunk of change but relatively small in the context of the $906-billion total outstanding. Quality spreads, while still high compared to the last six years, are in decline.

The following posts were either written or updated today:

• Whoosh! Market Adjustment Affects Fair Value of New Issues
• Early Commentary on Canadian ABCP
• Fed Regulation of US ABCP Liquidity Guarantees
• Query from a Reader: Time to Buy?

… which should go a long way towards explaining the brevity of today’s round-up!

There are some very thoughtful essays regarding the Northern Rock bail-out in the WSG Economics Blog and the Economist. There’s another link to an Economist article about the funding gap in British banking … there is an increased reliance on commercial paper, as opposed to deposits, to fund bank loans:

Meanwhile, the preferred share market showed a little stability today. There were some rather violent individual moves, but most of these were reversals of previous silliness.

There were eleven other index-included $25.00-equivalent issues trading over 10,000 shares today.

The latest passion on the Street is telling everybody how lousy everything is! PIMCO & TIAA-CREF hate the market, Greenspan hates the market, Credit Suisse hates the market … there’s no shortage. But it takes two to make a market! James Hamilton at Econbrowser takes a look at recent indicators and points out that – so far, anyway – the problems in the US housing market haven’t spread to other areas of the US economy. So take your choice!

The BIS Quarterly Review has a good review of the credit crunch.

I’ve updated the post about the Globe’s reporting of Dickson’s speech with a link and extract from the National Post’s article, which is much more reflective of what was actually said. You almost wonder if the reporters are reporting the same speech!

Fitch Ratings has announced that it completed its review of 2006-vintage sub-prime issues:

For first- and second-lien transactions combined, Fitch has affirmed 2,228 classes with a par balance of $155.1 billion and downgraded 1,003 classes with a par balance of $18.4 billion. While Fitch’s reviewed all rating categories, downgrades were most heavily concentrated among classes originally rated ‘BBB+’ or lower. Fitch believes that those classes that have been downgraded to below-investment grade have substantial risk of principal loss. However those bonds remaining investment grade still exhibit the ability to withstand the higher projected collateral default and loss expectations without principal loss. Those classes affirmed at ‘AAA’ are able to withstand a substantial multiple of expected collateral performance without experiencing loss.

This action was gleefully reported by Bloomberg and commented upon by Joseph Mason, an associate professor at Drexel University. Mr. Mason has testified to the Subcommittee on  Capital Markets, Insurance, and Government … woo-hoo! I haven’t read his testimony thoroughly yet, but a quick skim suggests that he doesn’t like the Credit Rating Agencies very much! I’d better get cracking on my reading, because his faculty web-page pointed me to a paper on the value of recourse which has implications for bank-sponsored ABCP. Briefly, it would appear – the authors claim – that the market is implicitly assuming that there will be support for conduits even when there doesn’t need to be; this is very similar to the US mortgage GSEs and implicit ‘off-balance-sheet’ Treasury backing.

By providing recourse in cases where none is explicitly required, the sponsor demonstrates the presence of de facto recourse and therefore previously unreported contingent liabilities. The present paper examines the effects of these revelations on the sponsor. On the face of it, one might expect that revealing previously unreported contingent liabilities could heighten asymmetric information about firm conditions, resulting in poor short- and long-term stock price performance, poor long-term financial performance, and reduced proceeds from subsequent loan sales. However, we find that, conditional on being in a position where honoring implicit recourse has become necessary and conditional on actually providing that recourse, the sponsors, on average, exhibit improved short- and long-term stock price performance, improved long-term financial performance, and similar proceeds from subsequent loan sales.

This is of interest in terms of assessing market discipline and credit analysis of the banks. For example, note 5 of the 2006 BMO Financials discloses that almost CAD 80-billion of liquidity guarantees had been extended, none of which found its way into risk-weighted assets (that’s none. N-U-N. none). Given the bank’s capital of CAD 16,641-billion, reported risk-weighted assets of CAD 162,794 and a CCF of 10%, this would not make a huge difference to the tier 1 capital ratio. But – given recent experience – is the CCF of 10% high enough? Eighty-billion landing suddenly on their balance sheet might give them collywobbles – and Rule #1 states that Everything Bad Happens at the Same Time.

Market discipline is something of a worry, despite the investment industry’s constant reiteration that we’re such a bunch of tough guys. However, Beloved Leader And Economic Genius for Life Stephen Harper is taking care of an oversight, and reminding investors that they are stupid:

Sources told The Canadian Press on Tuesday that Industry Minister Jim Prentice is concerned about foreign state-owned entities snapping up Canadian resource firms.

Among those currently being reviewed, sources said, is the PrimeWest acquisition, part of TAQA’s stated goal of dramatically growing its presence in Canada’s energy sector.

At a late Wednesday news conference in Ottawa, Prime Minister Stephen Harper said his government will address the lack of a national security test for foreign takeovers of Canadian companies.

It’s about time this country was protected from foreigners offering enormous bundles of cash! If such sums ever reach Canadian hands, we’ll just blow it on beer and prostitutes.

Volume picked up today, but perpetuals continued their slide. I confess that I find this continued weakness somewhat odd … but market volatility brings trading opportunities, and the passage of time brings dividends, so my curiosity is somewhat muted.

There were nineteen other index-included $25.00-equivalent issues trading over 10,000 shares today.