PrefBlog

The Federal Reserve Bank of Boston has released a Public Policy Brief by Jeffrey C. Fuhrer and Giovanni P. Olivei titled The Role of Expectations and Output in the Inflation Process: An Empirical Assessment:

This brief examines two issues of current interest concerning inflation: (1) whether “well-anchored” expectations will help to restrain inflation’s decline and whether an “un-anchoring” of expectations could lead to undesirably high inflation and (2) to what extent output (or utilization) gaps are useful components of empirical models of inflation and, if they are useful, to what extent current gaps might counterbalance the effect of expectations on inflation. The goals of conducting this examination are to articulate a reasonably coherent framework for the discussion, highlight the key areas of uncertainty, and provide new empirical evidence that sheds some light on these areas.

Nothing much happened in the credit markets, so I’ll discuss Toronto politics. Why not?

I am pleased to see that Queers Against Israeli Apartheid is being readmitted to the Pride Parade:

Pride Toronto has announced that its recent resolution to restrict the use of certain language during the 2010 Parade has been replaced by the requirement that each participating group read, sign and agree to abide by the City of Toronto’s Declaration of a Non-Discrimination Policy, and that all groups that uphold this policy are welcome to participate in the 2010 Pride Parade.

The requirement to “read, sign and agree to abide by the City of Toronto’s Declaration of a Non-Discrimination Policy” is more than just a little bit precious, but if Pride wants to jump through those hoops, that’s their business. To me, it just shows there’s not much point in getting involved with any sponsored civic activity.

Two mayoral hopefuls seem to think this is an issue in which the city should be involved:

“I want to express my disappointment and disgust with Pride Toronto’s decision to allow this hateful group to march,” said mayoral hopeful Rob Ford.

Giorgio Mammoliti, who is also running for mayor, will introduce a motion at council demanding that Pride return all city funding, about $250,000.

Pride’s done a lot more to bring money into the city than either of those two clowns ever have! I think they should concentrate a little more on how to get a souvlaki cart licensed in less than three years.

PerpetualDiscounts gained 14bp today to keep the streak alive – two more days and they will have gone the entire month of June without a loss. FixedResets were flat; volume was moderate; volatility was almost non-existent.

It looks like tranche retention will become law, as proposed by the SEC and supported by John Hull, among others:

Private lenders will be required to keep at least a 5 percent stake in loans they package and sell under an agreement reached by House and Senate lawmakers who are negotiating the financial-regulatory bill.

Lawmakers said the goal of the risk retention rule, also known as the skin-in-the-game provision, is to raise the quality of loans by keeping companies tied to the loans they make. Lax underwriting on subprime mortgages helped fuel the mortgage market collapse in 2007.

The measure would affect credit-card debt, auto loans, mortgages and other securitized debt. Issuers of asset-backed debt and the originators who supply them with pools of loans would be forced to retain at least 5 percent of the credit risk.

Lawmakers exempted many mortgages from the rules after lobbying by brokers and community banks, who said forcing lenders to keep loans on their books would tie up capital and lead to higher interest rates.

So higher interest rates is OK for credit-card debt, auto loans and other things, but not for Holy Mortgages? Haven’t I heard this song before?

The basic problem with the proposal is that tranche retention was the actual problem during the crisis – if the investment banks had be forced to sell their holdings to arms-length third parties, price discovery and lack of appetite would have been apparent much, much sooner.

I have even more disdain for the proposed underwriting rules:

Dodd proposed adding language based on the Merkley-Levin proposal to curb conflicts of interest by preventing firms that underwrite an asset-backed security from placing bets against the security.

The conflict-of-interest provision is aimed at addressing the fraudulent activity alleged in the Securities and Exchange Commission’s lawsuit against Goldman Sachs Group Inc. The SEC is alleging the bank created and sold collateralized debt obligations linked to subprime mortgages without disclosing that hedge fund Paulson & Co. helped pick the underlying securities and bet against the vehicles.

Every time a dealer sells me something as principal, he’s betting against it. Every single time! What’s the big deal here?

The congressional panel has approved a reconciled bill; most is as reported above, but there’s another thing:

An amendment introduced by Senator Susan Collins, the Maine Republican who joined Democrats in voting for the broader bill, will bar bank holding companies from keeping less capital than their bank subsidiaries. That will have an impact on the use of trust preferred securities, known as TruPS. Lawmakers bowed to pressure from banks, agreeing to a transition period for large firms and grandfathering of the securities for smaller lenders.

Banks with assets of at least $15 billion will get five years to replace TruPS with common stock or other securities that count as capital. Community banks that have raised cash through TruPS since 2000 will, in effect, get 20 years to make the switch because most of the securities have 30-year maturities. Smaller lenders sold roughly $45 billion of the $150 billion in TruPS issued by U.S. banks, which packaged them into collateralized debt obligations.

I’m not sure yet, but I think that this outlaws double leverage, at least as far as banks are concerned.

Importantly, there is a job-creation scheme for ex-regulators:

Large hedge and private equity funds will be forced to register with the SEC, subjecting them to mandatory federal oversight for the first time. Venture capital funds were exempted from the registration rule.
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Any firm with $150 million or more in assets, such as ESL Investments Inc. and Soros Fund Management, will be covered by the law. Funds also must hire a chief compliance officer and set up policies to avoid conflicts of interest.
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Complying with registration rules may cost hedge funds as much as $500 million in the first year, said Judith Gross, founder of JG Advisory Services LLC, a New York-based consulting firm to the hedge-fund industry. The estimate is based on 2,000 new registrants and reflects the cost of implementing necessary compliance procedures.

Salesmen are still salesmen, at least for a while:

Lawmakers scrapped a proposal that would have made securities firms more accountable to individual investors. Instead, the SEC is required to study whether changes are necessary.

The debate focused on whether stock brokers who offer clients investment advice should have a fiduciary duty that requires disclosure of all conflicts and restricts marketing to products that are in customers’ best interests. Currently, brokers must only ensure that a stock or bond is suitable before selling it to a client.

There is a States-rights turf battle brewing over insurance:

The bill creates a new Federal Insurance Office within the Treasury to monitor insurers, and requires a study that will recommend ways to further overhaul regulation of the industry. Industry groups say a new layer of oversight may complicate compliance and increase costs.
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Insurers, which are mainly regulated by states, will now have to deal with a national watchdog. State insurance commissioners are concerned federal oversight will interfere with rules already in place. Insurers are concerned that they will have to devote more resources to answer to multiple officials.

Morningstar is rating fundcos on how precious they are. To hell with performance!

Today’s lesson is on “getting it”, as explained by Kenneth Feinberg:

New government oversight should avert a return to the “good old days” of outsize bonuses and lavish perks on Wall Street even if bankers still don’t “get it,” Obama administration paymaster Kenneth Feinberg said.
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Earlier this week, Feinberg said he will step down from his Treasury Department pay post by the end of August to focus on his new job as the government-appointed administrator of BP Plc’s $20 billion fund to pay claims stemming from the Gulf of Mexico oil spill.

Feinberg gets it!

Turkey has announced that Mustafa Kemal Ataturk’s reputation is so dubious it requires special protection:

Furious over Internet insults of the country’s beloved founder, Turkey has gone on the offensive against Google, tightening a ban on YouTube and cutting public access to a host of Google-owned sites.
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The country began blocking access to websites in 2007, after parliament adopted an a law against cyber crime in an effort to curb child porn, prevent the dissemination of terrorist propaganda and stamp out illegal gambling. Websites deemed to be disrespectful of Turkey’s founder, Mustafa Kemal Ataturk, and of religious beliefs were also outlawed.

Under court order, Turkey’s telecommunications authority banned access to YouTube, the video-sharing site, in May 2008, after users complained that some videos insulted Ataturk. Earlier this month, Turkey expanded the ban to include some Google pages that use the same Internet Protocol addresses as YouTube, to prevent users from circumventing the ban. The search giant Google Inc. is YouTube’s parent company.

Volume was light today as all the part-timers stayed home to play with their dollies (though, to be fair, it is possible that somebody might be wearing a T-shirt with a slogan that might have made them uncomfortable (see May 18)). PerpetualDiscounts made another gain, 7bp this time, to keep the streak alive, while FixedResets gained 8bp.

How ’bout them Greek swaps, eh?:

Credit-default swaps on Greece rose 38 basis points to an all-time high of 970 basis points, according to CMA DataVision. Contracts on Portuguese government securities climbed 16 basis points to a two-week high of 336.5, while Spain rose 4 to 269.

The politicians have come up with a solution of how to solve their GSE mess: make the banks pay:

Bank executives were panicking last night over a proposed fix to Title II of financial reform literally penciled in at the last minute. The fear is that that the proposed change to the orderly liquidation authority could leave banks on the hook for a possible wind-down of Fannie Mae and Freddie Mac that could cost as much as $400 billion. In the House counter-offer below, Fannie and Freddie are penciled in as falling under the definition of ‘financial company,’ meaning they could be resolved by the orderly liquidation process. This process is paid for by the sale of the failing company’s assets and/or through assessments on other financial companies, possibly putting the Street in line to pay for the liquidation of the troubled housing giants.

Competition between Treasury and the FDIC to deal with private equity purchasers of banks was mentioned on April 30. That trend is continuing:

Buyout firms thwarted by regulators from taking over failed banks have found a solution: Acquire lenders that are still in business.

Moelis Capital Partners LLC, Thomas H. Lee Partners LP and the Carlyle Group are among firms that agreed to buy stakes in at least five U.S. banks since April. While most are small, with assets of less than $1 billion, their status as banks means they can buy more distressed lenders that can be merged and sold later — a tactic that made some private-equity investors billionaires in the 1990s.
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In at least three cases, the shift in tactics requires approval from the Treasury, which owns stakes in small banks through its injection of U.S. bailout funds. Capital infusions for Pacific Capital, Hampton Roads and Sterling are all contingent on the government writing down its investment.

The Canadian preferred share market continued to move ahead on lower than average volume today, with PerpetualDiscounts and FixedResets both gaining 7bp.

American real estate agents are going hungry:

Purchases of U.S. new homes fell in May to the lowest level on record after a tax credit expired, showing the market remains dependent on government support.

Sales collapsed an unprecedented 33 percent from April to an annual pace of 300,000, less than the median estimate of economists surveyed by Bloomberg News and the fewest in data going back to 1963, figures from the Commerce Department showed today in Washington. Demand in prior months was revised down.

Like the Fed says:

Business spending on equipment and software has risen significantly; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad. Bank lending has continued to contract in recent months.
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The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

But fear not! Fannie Mae is tightening standards:

Borrowers who have the means to make mortgage payments and don’t work with lenders to restructure loans will be banned from obtaining new mortgages backed by Fannie Mae for seven years from the date of foreclosure, the company said today in a statement.
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Homeowners walking away from mortgages they can afford accounted for about 12 percent of U.S. mortgage defaults in February, New York-based Morgan Stanley said in an April report.

It would be much more to the point if non-recourse mortgages carried a penalty rate; but that would be too logical.

Argentina is showing Greece how it’s done:

The results of Argentina’s debt swap offer exceeded the government’s expectations and will help close a chapter on the country’s record $95 billion default in 2001, Economy Minister Amado Boudou said.

Creditors holding about $12.1 billion of $18.3 billion in defaulted debt tendered their securities in the restructuring, which Boudou said was the result of “hard” negotiating on the part of Argentina. Combined with the results of a 2005 restructuring, a total of 92.4 percent of the defaulted debt has been swapped for a mix of new bonds, he said.
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The government has no fiscal need to issue debt and can wait until it is able to sell bonds that yield less than 10 percent, Boudou said.

Yields on the country’s benchmark dollar bonds due in 2015 rose 11 basis points, or 0.11 percentage point, to 12.86 percent at 10:59 a.m. New York time.

The question is … will a serial defaulter ever be able to issue bonds at less than 10%?

All the money that’s being dropped on the G-20 is having an effect.

PerpetualDiscounts kept the streak alive in the Canadian preferred share market, gaining 11bp, while FixedResets were down 11bp. Volume was moderate.

PerpetualDiscounts now yield 6.02%, equivalent to 8.43% interest at the standard equivalency factor of 1.4x. Long Corporates are now at about 5.55% so the pre-tax interest equivalent spread (also called the Seniority Spread) is now about 290bp, a significant widening from the +270bp reported on June 16 due to the sharp decline in long yields.

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