PrefBlog

Willem Buiter & Anne Sibert write a review of The collapse of Iceland’s banks: the predictable end of a non-viable business model. As an aside, they note:

In addition, outrageous bullying behaviour by the UK authorities (who invoked the 2001 Anti-Terrorism, Crime and Security Act, passed after the September 11, 2001 terrorist attacks in the USA, to justify the freezing of the UK assets of the of Landsbanki and Kaupthing) probably precipitated the collapse of Kaupthing – the last Icelandic bank still standing at the time. The official excuse of the British government for its thuggish behaviour was that the Icelandic authorities had informed it that they would not honour Iceland’s deposit guarantees for the UK subsidiaries of its banks. Transcripts of the key conversation on the issue between British and Icelandic authorities suggest that, if the story of Pinocchio is anything to go by, a lot of people in HM Treasury today have noses that are rather longer than they used to be.

This is the real danger of counter-terrorism laws … they will be twisted to justify anything the bosses want to justify. And be re-elected in a landslide by frightened sheep. Anyway, back to economics … the authors claim that Iceland’s business model was not viable due to:

the “vulnerable quartet” of (1) a small country with (2) a large banking sector, (3) its own currency and (4) limited fiscal capacity

With this in mind, they warn:

Iceland’s circumstances were extreme, but there are other countries suffering from milder versions of the same fundamental inconsistent – or at least vulnerable – quartet:
…
Countries that come to mind are:

Switzerland,
Denmark,
Sweden
and even to some extent the UK, although it is significantly larger than the others and has a minor-league legacy reserve currency.

Ireland, Belgium, the Netherland and Luxembourg possess the advantage of having the euro, a global reserve currency, as their national currency. Illiquidity alone should therefore not become a fatal problem for their banking sectors. But with limited fiscal spare capacity, their ability to address serious fundamental banking sector insolvency issues may well be in doubt.

Coincidentally, I’m sure, Dennis P. Quinn & Hans-Joachim Voth argue that benefits of international diversification are declining:

After Bretton Woods, it took half a century to restore the full openness of capital accounts in advanced countries. Many Eurozone countries only revoked the last restriction in the 1990s, in the run-up to the euro’s introduction.

We argue that it is no accident that the age of restrictive capital accounts also saw remarkably low equity market correlations. Cross-border diversification opportunities identified by early papers (Grubel 1968) were indeed “too good to be true.” Once investors can take advantage of low correlations elsewhere, they will rise. Initial investors may benefit since liberalisations tend to be followed by capital gains (Henry 2000). Yet risks will not fall anywhere near as much as initially hoped, as the covariance with other stock markets inevitably increases.

How tight is the bond market? The credit card companies have maxed-out:

Credit card companies were shut out of the market for bonds backed by customer payments in October for the first time in more than 15 years, as investors shunned the debt amid the global credit freeze.
…
It’s the first month since April 1993 that there have been no sales, according to Wachovia Corp. data. Issuers sold $17.1 billion of the debt in October 2007, the data show.
…
Top-rated credit card-backed securities maturing in three years traded at a gap, or spread, of 475 basis points over the London interbank offered rate, or Libor, during the week ended Oct. 30, JPMorgan Chase & Co. data show, 25 basis points higher than the previous week. The debt was trading at 50 basis points more than Libor in January.

PerpetualDiscounts eased off today, but volume was strong. There are many very strange yield relationships between issuers in the market; its hard to tell whether the degree of credit stratification is more or less surprising than the degree of credit inversion!

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

Another good day for prefs, with the PerpetualDiscounts again up over a point for the third day in a row. Before anybody gets too excited though … we’ve not yet recovered to October 22 levels and the 6.77% yield is almost 50bp over the September 30 level of 6.29%.

The 6.77% yield is equivalent to 9.48% interest at the standard 1.4x factor, while long corporates are still chugging along in the 7.5% area … so we’re back to a spread of about 200bp. Long corporates are actually down fractionally on the month-to-day and recovery in this market should, logically, now become a major factor in preferred share performance.

On the other hand, the market hasn’t really behaved logically for over a year and a half, so who knows?

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

Assiduous Readers will remember that the Fed’s balance sheet has been swollen as it has borrowed from Treasury and lent to … various third parties. The fact that Treasuries are being sold to finance the lending makes the various programmes monetarily neutral and therefore, to a first approximation, non-inflationary (inflation may still result if the process generates false signals regarding use of capital funds, but that’s a second order effect). Today the butcher’s bill came in:

The U.S. Treasury predicted it would borrow this quarter more than three times the amount initially forecast as weaker economic growth and the costs of a new bank rescue package swell the budget deficit.

Borrowing needs will rise to $550 billion in the three months to Dec. 31, compared with the $142 billion predicted in July, the Treasury said in a statement in Washington. That would be more than double the largest ever — a record $244 billion in new marketable debt in the first three months of this year.

I am an enthusiastic supporter of the Fed’s actions, but this is illustrative of the need for fiscal restraint in good times – which has been sorely lacking. At some point – as has happened in Taiwan with insurers and agency paper, as mentioned October 28 – the rest of the world will decide it has quite enough US paper, thank you very much, and then we’re all in trouble.

Econbrowser‘s (admittedly partisan) Menzie Chinn provides a comparison of the McCain and Obama tax ‘n’ stimulus plans:

Dr. Chinn also provides a link to the Committee for a Responsible Federal Budget’s Guide to Stimulus Proposals: The 2008 Presidential Election. I confess I have not investigated campaign or third-party reactions to this analysis – but it makes for good reading!

He also performs calculations based on analyses of the Tax Policy Centre:

I have added a bonus spreadsheet to the post regarding my essay on CPD.

A very strong day for PerpetualDiscounts, but volume returned to normal levels.

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