PrefBlog

OSFI is busily cementing its reputation as a bastion of political expediency:

The Office of the Superintendent of Financial Institutions, or OSFI, Canada’s banking regulator, plans to delve into the way that pay packages are designed at a variety of levels throughout banks. The goal is to prevent excessive risk taking by bankers in search of big bonuses, a behaviour that has been fingered as a key contributor to the U.S. banking meltdown.

What a complete joke. OSFI is incapable of running the simplest of simulations – they were astonished that underprovisioning for explected losses had an effect on the Assets-to-Capital multiple calculation, despite years of testing beforehand – and now they’re going to micro-manage bonuses; well, it gets headlines, anyway, and extends the bureaucratic empire.

CEBS is running a consultation process on the topic (the public meeting should be a hoot!), but OSFI already knows everything, so can’t be bothered.

This micro-management will result in the continued growth of hedge funds and the shadow-banking sector (almost certainly outside Canada) and, while it may prevent the occasional small collapse, will end up the same way every other politically inspired feel-goodism project ends up: a lot of money for well-connected consultants, no effect on those who make hiring decisions regarding how many ex-regulators need to be hired to sit on the compensation committee, further stifling of creativity … and a much larger eventual collapse when the chickens finally come home to roost. As they will, since the regulatory capture inherent in micromanagement means that small errors will be papered over with rule changes, interpretations and exemptions until they become … large errors.

However, this will come after the next election, so who cares? Bonus control is simply a method of grandstanding.

Paul Volcker has made some remarks interpreted as nostalgia for Glass-Steagall:

“Maybe we ought to have a kind of two-tier financial system,” Volcker, who heads President Barack Obama’s Economic Recovery Advisory Board, said today at a conference at New York University’s Stern School of Business.

Commercial banks would provide customers with depository services and access to credit and would be highly regulated, while securities firms would have the freedom to take on more risk and practice trading, “relatively free of regulation,” Volcker said.

Volcker’s remarks indicated his preference for reinstating some of the divisions between commercial and investment banks that were removed by Congress’s repeal in 1999 of the Great Depression-era Glass-Steagall Act.

Volcker’s proposals, included in a January report he wrote with the Group of 30, would allow commercial banks to continue to do underwriting and provide merger advice, activities traditionally associated with investment banking, he said.

I couldn’t agree more; I have argued for some time that what we really need is a three-tier financial system, with a rock-solid banking core surrounded by a layer of investment banks and brokerages, surrounded in turn by a wild-n-wooly world of hedge-funds and shadow banks.

I would not support legislating the differences. I will support a regulatory regime that offers a choice between business models: traditional banking or traditional investment banking. The former (core) model would focus on long-term lending and impose a high capital charge for trading and investment operations; the latter model would impose capital charge penalties for long-term positions.

Bankers can’t trade. Bankers can barely manage to bank!

Another cruddy day for equities, particularly insurers:

Canadian stocks fell to a five-year low as the highest U.S. unemployment rate in a quarter century reinforced concern that the global recession will hurt profits and deplete financial companies’ capital.
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Manulife, the country’s biggest insurance company, dropped 3.5 percent to C$9.65, the lowest intraday price since March 2000. The stock fell 25 percent this week.

Sun Life, Canada’s third-largest insurer, fell 2.7 percent to C$15.68 after it had its credit rating cut to A+ from AA- by S&P, which said declining stock and bond prices may reduce earnings. Great-West Lifeco Inc., the nation’s second-biggest insurer, fell 6.7 percent to C$12.12, the lowest since May 2000.

Canadian insurance stocks have fallen 46 percent this year on speculation that losses on securities will force them to sell stock or cut dividends to bolster capital. Wells Fargo, the fourth-largest U.S. bank, cut its quarterly dividend by 85 percent in a move to save $5 billion a year.

And preferreds were not immune…

There is now quantitative easing in the UK:

Bank of England Governor Mervyn King will take the unprecedented step of printing money to buy assets after cutting the interest rate by a half point to almost zero, the latest move by officials to combat the recession.

The bank said it will pump money into the economy by purchasing as much as 150 billion pounds ($211 billion) in government and corporate bonds, sparking a rally across the debt market. The central bank’s nine-member panel also reduced the benchmark interest rate to 0.5 percent, the lowest since the bank was founded in 1694.

As has been previously noted, this is the first severe contraction the world has ever seen in the presence of a deep and functional CDS market. The large negative basis has also been noted. And now, Dr. Hu’s debt-decoupling (at issue in the Lyondell bankruptcy) is having further reaching effects:

Amusement-park operator Six Flags Inc. and automaker Ford Motor Co. may be pushed toward bankruptcy by bondholders trying to profit from credit-default swaps that protect against losses on their high-yield debt.

By employing a so-called negative-basis trade, investors could buy Six Flags bonds at 20.5 cents on the dollar and credit- default swaps at 71 cents. If the New York-based chain defaults, the creditors would receive the face value of the debt, minus costs. In a Feb. 27 note, Citigroup Inc.’s high-yield strategists put that profit at 6 percentage points, or $600,000 on a $10 million purchase.
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“Before, you really had to worry mostly about where you were in the” company’s capital structure, [Matthew Eagan, an investment manager at Boston-based Loomis Sayles & Co.] said. “Now, you have to consider the possibility that you might have this large holder of CDS incentivized to see it go into bankruptcy. It’s something that’s going to come up more and more.”

A rather odd research paper was published by the Boston Fed today:Another Hidden Cost of Incentives: The Detrimental Effect on Norm Enforcement:

Monetary incentives are often considered as a way to foster contributions to public goods in society and firms. This paper investigates experimentally the effect of monetary incentives in the presence of a norm enforcement mechanism. Norm enforcement through peer punishment has been shown to be effective in raising contributions by itself. We test whether and how monetary incentives interact with punishment and how this in turn affects contributions. Our main findings are that free riders are punished less harshly in the treatment with incentives, and as a consequence, average contributions to the public good are no higher than without incentives. This finding ties to and extends previous research on settings in which monetary incentives may fail to have the desired effect.

There is one slight problem with the paper: I don’t believe a word of it. The trouble is that there is perfect transparency regarding decisions made by each participant and perfect clarity regarding the group effect of these decisions. In the real world, I believe that Norm Enforcement will become a tool of random backbiting; although I will concede that for some people in some situations, it will work better than incentives. There’s also the matter of self selection: give me a choice between Firm A with its group hugs, and Firm B with its massive bonuses for performance and you won’t wait long for my decision!

However, this paper is destined to become a central part of the campaign against Evil Bonuses.

Equities got hammered again today, especially financials:

Canadian stocks fell to the lowest in five years, led by energy and financial shares, after China signaled it won’t increase stimulus spending and Moody’s Investors Service said it may downgrade the biggest U.S. banks.
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Manulife Financial Corp., Canada’s largest insurer, fell 8.3 percent as declining equities worldwide fanned concern that insurance companies’ investment losses will increase.
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The Standard & Poor’s/TSX Composite Index fell 185.58 points, or 2.4 percent, to 7,629.17 in Toronto, the lowest value since October 2003. The benchmark erased yesterday’s rally and has tumbled 15 percent in 2009.
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A gauge of financial shares plunged 4.9 percent, led by Royal Bank of Canada, the country’s largest lender. JPMorgan Chase & Co., the largest U.S. bank by market value, had its ratings outlook cut by Moody’s to negative from stable.

Moody’s said it will review the long-term debt ratings of Wells Fargo, the second-largest U.S. bank, and Bank of America, ranked third, on concern that higher credit costs may damage capital ratios.
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Canadian Imperial Bank of Commerce, the country’s fifth- biggest bank by assets, fell 4.5 percent to C$37.86, after saying it will sell C$1.6 billion in notes to bolster its balance sheet. Bank of Nova Scotia fell 4.7 percent to C$26.21. Royal Bank of Canada declined 4.5 percent to C$29.22.

Manulife dropped 91 cents to C$10. Sun Life Financial Inc. slumped 10 percent to C$16.12.

… and Preferreds were not immune, although volume was light ….