PrefBlog

Sheila Bair, head of the FDIC has written a New York Times op-ed piece, The Case Against a Super-Regulator:

The truth is, no regulatory structure — be it a single regulator as in Britain or the multiregulator system we have in the United States — performed well in the crisis.

The principal enablers of our current difficulties were institutions that took on enormous risk by exploiting regulatory gaps between banks and the nonbank shadow financial system, and by using unregulated over-the-counter derivative contracts to develop volatile and potentially dangerous products.

The reference to derivative contracts and shadow banks is almost certainly made with AIG specifically in mind. Assiduous Readers will know that I have no problems with these two things … what made AIG a systemic threat was regulatory incompetence that allowed regulated institutions to have a lot of AIG paper on their books without sufficient collateral or capital charges.

We can’t put all our eggs in one basket. The risk of weak or misdirected regulation would be increased if power was consolidated in a single federal regulator.

Hear, hear!

One advantage of our multiple-regulator system is that it permits diverse viewpoints. The Federal Deposit Insurance Corporation voiced strong concerns about the Basel Committee on Banking Supervision’s relatively relaxed rules for determining how much capital banks should have on hand.

If I remember correctly, it was the FDIC that insisted that the leverage ratio be maintained as a regulatory measure.

The Bank of Canada has announced a new discussion paper by Kimberly Beaton, René Lalonde, and Corinne Luu, A Financial Conditions Index for the United States:

The financial crisis of 2007–09 has highlighted the importance of developments in financial conditions for real economic activity. The authors estimate the effect of current and past shocks to financial variables on U.S. GDP growth by constructing two growth based financial conditions indexes (FCIs) that measure the contribution to quarterly (annualized) GDP growth from financial conditions. One FCI is constructed using a structural vector-error correction model and the other is constructed using a large-scale macroeconomic model. The authors’ results suggest that financial factors subtracted around 5 percentage points from quarterly annualized real GDP growth in the United States in 2008Q4 and 2009Q1 and should subtract another 5 percentage points from growth in 2009Q2. Moreover, to assess the effect of financial shocks in terms of policy interest rate equivalent units, the authors convert the effect of financial developments on growth into the number of basis points by which the federal funds rate has been tightened. The authors show that the tightening of financial conditions since mid-2007 is equivalent to about 300 basis points of tightening in terms of the federal funds rate. Thus, the aggressive monetary easing undertaken by the Federal Reserve over the financial crisis has not been sufficient to offset the tightening of financial conditions. Finally, in a key contribution to the literature, the authors assess the relationship between financial shocks and real activity in the context of the zero lower bound. They find that the effect of the tightening of financial conditions on GDP growth in the current crisis may have been amplified by as much as 40 per cent due to the fact that policy interest rates reached the zero lower bound.
…
In particular, our MFCI adjusted for the binding lower bound suggests that financial factors subtracted around 5 percentage points from quarterly annualized growth in 2008Q4 and 2009Q1. Moreover, in order to assess the effect of financial shocks in terms of policy interest rate equivalent units, we have converted the effect of financial developments on growth into the number of basis points by which the federal funds rate has been tightened. The results suggest that the net tightening of financial conditions since mid-2007 is equivalent to about 300 basis points of tightening in terms of the federal funds rate, despite the actual 500 basis point decline in the policy rate. Given the ongoing disruptions in financial markets, the degree of tightening of price and non-price credit conditions and the substantial losses in wealth over 2008, and the long transmission lags between a shock to financial conditions and its impact on the real economy, these financial conditions are expected to continue to dampen growth going forward.

Standard & Poor’s published a Preferred Stock Primer dated 2009-3-25:

Preferred stock returns have low correlations with common stock returns, making them good diversifiers. They also have relatively low correlations with bonds, with expected volatility and returns between those of common stocks and bonds. This characteristic makes them a good complement to a bond portfolio.

Later on in the paper they cite a preferred/bond correlation of 0.309 and a preferred/common correlation of 0.491.

There are many types of preferreds and preferred trademark names. However, most preferreds are based on two main structural models: Traditional Preferreds and Trust Preferreds. Traditional Preferreds are closer to stocks and are generally REIT preferreds, foreign preference shares trading in the U.S. and straight preferred stocks issued by U.S. corporations.

Traditional preferreds are a senior form of equity which rank above common shares but below corporate debt in creditor standings. Dividends from traditional preferreds are taxed as capital gains. Trust Preferreds are closer to bonds and thus rank higher in general creditor standings than regular preferreds. Dividends from trust preferreds are taxed as ordinary income. As of February 27, 2009, the S&P Preferred Stock Index contained 35 trust preferreds out of a total 72 constituents.

Somwhate confusingly, they later state:

Some preferred stocks have qualified dividend distributions that are taxed in the same manner as qualified dividends of common stocks. Others have their dividends charged as interest income and are subject to higher tax rates. Those that do have qualified dividend distributions have holding period requirements that are higher than those for common stocks. Investors need to contact their tax advisors to assess their tax situation. The favorable tax treatment for some preferreds is a result of tax laws passed in 2003, and this may change in the future.

Figuring out the tax status of US preferreds sounds like a full-time job in itself!

The modern era for preferred stocks started in the early 1990s. Since then, the preferred stock market has grown rapidly, quadrupling in size by 2005 to $193 billion. Concerns about default and conversion risk shrunk the market to about $100 billion in early 2008. For a comparative perspective, the total size of the U.S. stock market was in the range of $9.5 trillion; and the U.S. corporate bond market was in the range of $4 trillion.