PrefBlog

More news today on the LIBOR front … the ECB is offering unlimited Euros for a two week term at 4.21%. There was an instant reduction in two week Euro-LIBOR:

The rate banks charge each other fell to 4.45 percent from 4.94 percent, the European Banking Federation said today. The reluctance to lend money after the collapse of the U.S. subprime market pushed interbank euro rates for two weeks to the highest level in at least six years earlier this week.The additional cash “reflects the extra tightness in the market,” said Lena Komileva, an economist at Tullett Prebon in London. “However, it doesn’t address the fundamental issues of banks hoarding cash and while the central bank has succeeded in stabilizing the shorter term rates, it makes little impact on the longer term rates.”

Even the hawkish Bank of England opened the spigots:

The BoE, meanwhile, auctioned 10 billion pounds (more than $20 billion) of three-month funds on Tuesday. Notably, it accepted bids as low as 5.36 percent, which is 14 basis points below its 5.5 percent base rate. Three-month sterling Libor fell to 6.38625 percent from 6.43125 percent on Monday.

Two-week sterling Libor jumped by around a whopping 75 basis points to 6.51250 percent but that was only down to calendar effects over the turn of the year, and mirrored similar increases in two-week euro and dollar rates last week.

Naked Capitalism reprints a piece by Ken Rogoff from the Financial Times:

The real town/gown problem is one of horizon rather than perspective. Monetary policy has long and variable lags, particularly on slow-moving inflation expectations. Sharper Fed interest rate cuts today might well mute the housing price collapse, at least in nominal terms. However, if the Fed should ease too far, too fast, it could get hit by a boomerang a couple of years down the road, in the form of sustained higher inflation.

For the Fed, two to three years is the medium term, and it matters. For many financial market participants, two to three years is an eternity, and it does not matter.

Accrued Interest is driving himself crazy trying to forecast US Housing Prices. Bloomberg has a fascinating story today on the antics at a Californian sub-prime origination office. A complicating factor is foreign ownership, especially by snowbacks:

“Fifteen of my friends are on buying trips down here, and we’re all cheap,” Mr. Sirockman said. He brought his family to Scottsdale this month while he submitted a lowball all-cash offer for a three-bedroom home.

“I don’t want to take advantage of a guy who’s having trouble in the market and is losing his shorts,” Mr. Sirockman said. “But I have no problem with a guy from California who bought on spec and has five houses in Arizona and never lived in them.”
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The market has shifted totally in the buyer’s favour, especially those offering cash, said Jeff Russell of Alberta. Last month, Russell snapped up a patio home next to a golf course in Scottsdale with a $299,000 check. It was listed at $463,000.
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Mr. Sirockman also returned to Canada without a house after the owner of the Scottsdale home turned down his offer. No worries. Mr. Sirockman told the seller there were a thousand other homes like his on the market, and someone was going to deal.

When I need to hire a trader, I know who I’m going to invite over for an interview!

As noted on December 13, the consolidation of SIV assets by their major sponsoring banks has greatly reduced the need for the MLEC/Super-conduit (although it could still be useful in Canada!), but the plan is going ahead anyway:

The “SuperSIV” fund, set up to provide cash to structured investment vehicles hurt by subprime- mortgage holdings, plans to start buying assets “within weeks,” its sponsors said today.

The fund’s size, originally envisioned at about $80 billion, will be determined by “SIVs’ needs and evolving market circumstances,” Citigroup Inc., Bank of America Corp. and JPMorgan Chase & Co. said in an e-mailed statement. New York- based BlackRock Inc., the largest publicly traded U.S. asset manager, will oversee the fund.

BlackRock, I suspect, is going to have to earn its money the hard way. Now that the major sponsors have bitten the bullet, the urgency of the cash requirement has declined considerably, which gives considerable scope to traders playing games. The idea has been presented as pricing the assets to be bought at the levels of small transactions – rather than as a vulture fund – which may lead to a certain amount of cherry-picking as the banks’ traders try to pick off the fund. We shall see!

Another very active, negative day for preferreds. The Claymore ETF is now down for the month-to-date … but it looks as if Malachite Fund is hanging on to very good relative returns, anyway. So far! It is interesting to note that what I consider to be the four “main” HIMIPref™ indices (Operating Retractible, Split Share and the two Perpetuals) are all still up on the month – most of the damage to date has been done to the floating rate indices and especially the non-investment-grade issues.

As recently as the December 6 review of the Weston issues, WN.PR.E (to choose one) was quoted at 16.46-53 … it closed today at 15.10-17 after going ex-dividend Dec 12 for $0.296875. That’s a loss of almost 7.5%!

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

There has been a lot of commentary regarding the coordinated liquidity injection (discussed on December 12) led by the Fed. First to the plate was Stephen Cecchitti, who has written many high quality essays for VoxEU, the most recent of which was discussed on December 5.

The problem of credit tightness has as its most visible sympton a spike in LIBOR, as discussed on December 13 and December 14 (after the announcement) with a graph shown on November 28. Mr. Cecchetti claims that:

Clearly, they were worried about the quality of the assets on the balance sheets of the potential borrowers. My guess is that banks were having enough trouble figuring out the value of the things they owned, so they figure that other banks must be having the same problems. The result has been paralysis in inter-bank lending markets.

and that the critical problem being addressed is:

The Fed can get liquidity to the primary dealers, but it has no way to ensure that those reserves are then lent out to the banks that need them.
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Not only do Central Banks need to ensure distribution of funds within a country’s banking system, they also need to make sure that cross-border distribution is adequate to meet the needs of banks in one country that require the currency of another. Today we have the new problem that dollars are in short supply outside of the United States.

He emphasizes that:

Standard open market operations give the Fed control over the level of short-term interest rates. The purpose of the Term Auction Facility is to give them a tool for influencing interest rate spreads.  

This is what I noted (in a much less knowledgable manner) on December 13:

The redemption of T-Bills is significant: it means there is (basically) no net improvement in systemic liquidity. What there is is simply a smearing of the extant Fed-provided liquidity over a broader section of the market. For a while.

James Hamilton of Econbrowser reviews the facility and concludes:

So why is it the responsibility of the Fed to try to set not just the level of the fed funds rate but also the spread between the funds rate and the LIBOR rate? One possibility is that the Fed thinks that the market is currently overweighting the riskiness of short-term interbank loans. If so, that seems to be a different vision of the role of monetary policy from that articulated by Ben Bernanke in 2002:

I think for the Fed to be an “arbiter of security speculation or values” is neither desirable nor feasible.

A second possible justification is that the market is correctly pricing the riskiness of these assets, but that the chief risk involves an aggregate financial event that the Fed, through actions like the TAF, could mitigate or avoid altogether.

I’m not sure that Professor Hamilton is focussing on the most relevant part of the Bernanke speech he references. I take note of:

Finally, if a sudden correction in asset prices does occur, the Fed’s first responsibility is to do its part to ensure the integrity of the financial infrastructure–in particular, the payments system and the systems for settling trades of securities and other financial instruments. If necessary, the Fed should provide ample liquidity until the immediate crisis has passed. The Fed’s response to the 1987 stock market break is a good example of what I have in mind

Bernanke’s speech continues with a presentation of the arguments in favour of accounting for asset prices when formulating central bank policy:

I think one can usefully boil down many of these arguments to the idea that it may be worthwhile for the Fed to take out a little “insurance,” so to speak, against the formation of an asset-price bubble and its potentially adverse effects. Like all forms of insurance, bubble insurance carries a premium, which includes (among other costs) the losses incurred if the Fed misjudges the state of the asset market or the cost of a possible reduction in the transparency of Fed policies. But, as a matter of theory, it is rarely the case in economics that the optimal amount of insurance in any situation is zero. On that principle, proponents of leaning against the bubble have argued that completely ignoring incipient potential bubbles, if in fact they can be identified, can’t possibly be the best policy. I will discuss below why I believe that, nevertheless, “leaning against the bubble” is unlikely to be productive in practice.
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But as a practical matter, this is easier said than done, particularly if we intend to use monetary policy as the instrument, for two main reasons. First, the Fed cannot reliably identify bubbles in asset prices. Second, even if it could identify bubbles, monetary policy is far too blunt a tool for effective use against them.
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The Federal Reserve went on to make a number of serious additional mistakes that deepened and extended the Great Depression of the 1930s. Besides trying to pop the stock market bubble, the Fed made little or no effort to protect the banking system from depositor runs and panics. Most seriously, it permitted a severe deflation in the price level, which drove real interest rates sky-high and greatly increased the pressure on debtors. A small compensation for the enormous tragedy of the Great Depression is that we learned some valuable lessons about central banking. It would be a shame if those lessons were to be forgotten.

The Fed Jackson Hole conference was discussed in PrefBlog on August 31 and September 4; a great deal of debate there centred on the proper role of Central Banks when confronted with a market pricing problem. I suggest that the Fed is terrified of a lock-up in the interbank markets and, by the new liquidity injection, is taking steps to ensure that such a lock-up doesn’t happen. This may thought of as the downside analogue of ‘leaning against the bubble’.

It may be thought to represent a change of thinking at the highest levels of the Fed, but I’m not so sure. I have a lot of confidence in these guys and do not think that they are idealistic zealots, parsing every suggestion for ideological purity and substituting slogans for thought. I suggest that they are beyond that and take a pragmatic approach: Whatever Works.

Paul Krugman of Princeton University, for instance, takes the view that the risk of a “liquidity trap” is rising:

Mr. Krugman, now at Princeton University, said no, but the risk of one has increased. “In general, we wouldn’t say that there’s a liquidity trap unless you’re up against the zero bound,” that is, when the short-term interest rate falls to zero, and can’t fall any lower. “So we’re not in one by the normal definition, which is a situation in which people are indifferent between cash and bonds, so that open-market operations in which the central bank trades monetary base for bonds have no effect.”

But he added: “What you could say, though, is that the unwillingness of banks to lend has reduced the effectiveness of Fed policy — and increased the likelihood that we’ll find ourselves in a liquidity trap sometime soon.”

If there’s one thing the Fed must do, it’s ensure its continued relevance! At the moment there is little evidence that credit tightening has affected the real economy and the Fed wants to keep it that way.

Prefs were down again today – particularly the BAM issues, which lends credence to prefhound‘s speculation in the comments to December 14 that Brookfield weakness could be due to their Hudson Yards project, which got a lot of ink in the Globe on the weekend.

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

Update: Typo has been struck out of the notes for BNA.PR.C.

Headline inflation in the US came in a 4.3% yoy today, powered by Food (+4.8%) and Energy (+21.4%). The core rate, which excludes these two items, was +2.3% yoy. Not a good report, according to economists surveyed by the WSJ – the Fed is now caught between a rock and a hard place on rates. Stagflation, anyone?

On what might possibly be a related note, William C. Dudley, EVP of the Fed, gave a speech on TIPS (hat tip: WSJ Blogs and Economist’s View):

Put simply, I come here to praise TIPS… In my opinion, the benefits of the TIPS program significantly exceed the costs of the program.
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we might start by comparing the difference in funding costs to the Treasury of TIPS versus a program of comparable duration nominal Treasuries.

But we should also be careful not to ignore other potential benefits of the TIPS program. As I see it, these potential benefits include:

• Greater diversification of the Treasury’s funding sources, which presumably has favorable implications for the Treasury’s funding costs.
• The potential for TIPS issuance to reduce the variability of the U.S. government’s net financial position.
• Access to a market-determined measure of inflation expectations that can help inform the conduct of monetary policy.
• The provision of a virtually risk-free investment that provides value to risk-averse investors.

One point that was discussed during Canada’s introduction of RRBs (Real Return Bonds) was that this indexing makes it at least a little bit more difficult for the government to deliberately inflate away the debt – which is also, explicitly, an argument in favour of borrowing in foreign currencies.

Continuing with the inflationary theme, Tommaso Monacelli of the Università Bocconi, Milan has written a very hawkish piece regarding the recent ECB decision to leave policy rates unchanged:

Can the ECB publish inflation forecasts between 2 and 3 percent and decide not to raise interest rates? Given that its explicit mandate is to keep inflation below but close to 2 percent, what type of signal is the Bank sending to the markets, especially as regards its own credibility?
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In this mounting inflation context, more than ever, the lack of transparency in the ECB policy points to the need of a more rigorous (arguably “scientific”) framework in which its policy decisions can be rationalized. Much of the recent literature describes the optimal conduct of monetary policy in terms of ‘inflation forecast targeting’. Two are the basic ingredients. First, a numerical target for inflation (as it is well-known from the experience of many countries in the world that have adopted inflation targeting, including emerging-market economies). Second, and more importantly, a management of the path of interest rates such that in each period the inflation forecast at some horizon, and conditional on that same instrument path, are in line with the inflation target.

He also criticizes what he sees as a somewhat circular reasoning process:

Reading carefully through the technical notes in small print (not really an example of transparency), one observes that the staff projections are based on the markets’ expectations of future interest rates. Hence they are conditional not on the future interest rate path that the Bank itself foresees as most likely, but on the interest rate path that the markets foresee as most likely.

The projection for 2008 inflation does indeed note:

The technical assumptions about interest rates and both oil and non-energy commodity prices are based on market expectations, with a cut-off date of 14 November 2007. With regard to short-term interest rates, as measured by the three-month EURIBOR, market expectations are derived from forward rates, reflecting a snapshot of the yield curve at the cut-off date. They imply an average level of 4.9% in the fourth quarter of 2007, falling to 4.5% in 2008 and 4.3% in 2009. The market expectations for euro area ten-year nominal government bond yields imply a flat profile at their mid-November level of 4.3%. The baseline projection also includes the assumption that bank lending spreads will rise slightly over the projection horizon, reflecting the current episode of heightened risk consciousness in financial markets.

… but saying that this is in small print seems to me to be overstating the case a little! The iterative process that leads to the final Euroland forecast has led to the forecast:

On the basis of the information available up to 23 November 2007, Eurosystem staff have prepared projections for macroeconomic developments in the euro area.1 Average annual real GDP growth is projected to be between 2.4% and 2.8% in 2007, between 1.5% and 2.5% in 2008, and between 1.6% and 2.6% in 2009. The average rate of increase in the overall HICP is projected to be between 2.0% and 2.2% in 2007, between 2.0% and 3.0% in 2008, and between 1.2% and 2.4% in 2009.

“HICP” is the “Harmonised Index of Consumer Prices”. I don’t see anything wrong with the system myself … it seems to me that basing projections on market expectations is as good as any other method and better than most. After having prepared these projections, the output (HICP) may be examined and if it’s outside the desired range then the actual policy decision may be made taking the expectation as a guide.

The most interesting part of all this, however, is that the spectre of inflation is intruding more often into public debate. Should stagflation become a more credible threat than it is now, I suspect policy makers will favour the stag- over the -flation and tighten even faster than they are currently easing … which could have major implications for long-bonds and therefore preferreds.

Mind you, though, the market as represented by LIBOR is ignoring the policy makers … at least for now:

The rates banks charge each other for three-month loans held at seven-year highs for a second day after policy makers in the U.S., U.K., Canada, Switzerland and the euro region agreed to ease the logjam in short-term credit markets. The cost of borrowing in euros stayed at 4.95 percent, the British Bankers’ Association said today, up from last month’s low of 4.57 percent and 3.68 percent a year ago.

“The market clearly doesn’t believe central banks can do anything about this crisis,” said Nathalie Fillet, senior interest-rate strategist at BNP Paribas SA in London. “This is not going to be a magical solution to the problem.”

There has been a certain amount of sensationalism regarding the deal – Accrued Interest doesn’t buy it:

Waldman says it’s a bailout because the Fed is offering loans that other banks wouldn’t be willing to offer. Here again, any bank who went to the discount window would borrow under the same terms. Does the continued existence of the discount window constitute a bailout? Put another way, banks would never use the discount window if financing was available elsewhere at similar costs elsewhere. So any time a bank uses the discount window, it’s a bailout by Waldman’s definition. This is why I am loathe to use that term.

Which brings us to the highly interesting topic of dissing the banks. Moody’s dissed Citibank today:

Moody’s Investors Service downgraded the long-term ratings of Citigroup Inc. (Citigroup) (senior to Aa3 from Aa2) and lowered the Bank Financial Strength Rating (BFSR) of Citibank, N.A. (Citibank) to B from A-. The rating on Citibank for long-term deposits and senior debt was lowered to Aa1 from Aaa. The rating outlook is stable.

The downgrade was prompted by Moody’s view that Citigroup’s capital ratios will remain low. According to Senior Vice President Sean Jones, “this situation is likely because management will need to take sizable write-downs against its subprime RMBS and CDO portfolio.” The bank is also expected to make significant sustained provisions against its residential mortgage book, which is over $200 billion. These charges are likely to occur when Citigroup’s normal earnings power is depressed, particularly in the United States.

“During 2008,” the analyst said, “Citigroup’s weak earnings should prohibit the bank from rapidly restoring capital ratios, despite its recent issuance of $7.5 billion hybrid capital.”
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For Citigroup’s ratings to be upgraded, the company would need to rebuild its capital ratios to levels maintained prior to 2007. As well, the firm’s pre-provision earnings power has to return to its previous strong level, while reducing its concentration risks.

The company’s failure to restore its capital ratios in the medium term would possibly lead to a further downgrade

Remember the BCE/Teachers deal? It is not, repeat: not, being renegotiated:

BCE Inc. (TSX, NYSE: BCE) is today issuing a statement in response to certain rumours in the market regarding the status of its definitive agreement to be acquired by an investor group led by Teachers’ Private Capital, the private investment arm of the Ontario Teachers’ Pension Plan, Providence Equity Partners Inc. and Madison Dearborn Partners, LLC (the Investor Group).

While it is BCE’s policy not to comment on market rumours or speculation, in the interest of its shareholders, the company is today confirming that neither BCE nor its Board of Directors is involved in any discussions regarding any renegotiation of any of the terms of the definitive agreement entered into on June 29, 2007.

Under the terms of the definitive agreement, the Investor Group has agreed to acquire all of BCE’s outstanding common shares for $42.75 per share in cash and all of BCE’s outstanding preferred shares at prices set out in the definitive agreement.

And you’ll have to parse the significance of that yourselves, because I’m not touching it!

There may be a certain amount of turmoil in the US markets Monday, as the Moody’s announcement on Monolines is digested:

Moody’s Investors Service has updated its evaluation of US mortgage market stress on the ratings of financial guaranty companies, and has considered those companies’ plans for strengthening capitalization, as well as their developing strategies. The following actions are the result of that evaluation. The Aaa ratings of Financial Guaranty Insurance Company and XL Capital Assurance Inc. were placed on review for possible downgrade. The Aaa ratings of MBIA Insurance Corporation and CIFG Guaranty were affirmed, but the rating outlooks changed to negative. The Aaa ratings of Ambac Assurance Corporation, Assured Guaranty Corp, and Financial Security Assurance Inc. and the Aa3 rating of Radian Asset Assurance were all affirmed with a stable outlook.
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As a result of these reviews, the Moody’s-rated securities that are “wrapped” or guaranteed by FGIC and XL Capital Assurance are also placed under review for possible downgrade. A full list of these securities will be made available later this evening under “Ratings Lists” on the company’s website at http://www.moodys.com/guarantors
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Moody’s will also be hosting a teleconference on Monday, December 17 at 11:00 EST/16:00 GMT/17:00 CET to discuss these actions in further detail. To register for this teleconference, go to www.moodys.com/events.

There was supposed to be an announcement about the Montreal Accord and Canadian ABCP today … after the close … later, but I don’t see anything yet! Apparently, the banks are getting sticky about liquidity guarantees:

Bank of Canada Governor David Dodge and governor designate Mark Carney pushed the bank chief executives on a conference call Thursday night to make commitments for liquidity backup that could be as much as $1-billion for some of the big five banks, said people familiar with the situation.

The liquidity issue is one of the final hurdles in the hoped for re-jig of the frozen short-term debt, which if successful, would help to avoid a meltdown that could have massive ripple effects in financial markets.

I confess, I don’t understand why a liquidity guaranty is important – the entire purpose of the plan is to avoid the necessity for refinancing prior to the new notes’ maturity.

Another very active day in the preferred share market, with weak prices. Tax-loss selling? Sheer boneheadism? You tell me. The BAM issues continue to get hurt badly, which seems to me somewhat mysterious.

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