PrefBlog

I am fascinated by the unfolding story of the Florida State Board of Administration’s Money Market fund that I discussed on December 3. Bloomberg reports that the Executive Director has quit:

Coleman Stipanovich, the head of an agency managing a troubled $14 billion Florida investment pool for local governments, quit as officials approved a plan by BlackRock Inc. to salvage the fund.
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Stipanovich, whose brother J.M. “Mac” Stipanovich is a Tallahassee lobbyist and Republican strategist who ran former Governor Jeb Bush’s campaign for governor in 1994, was appointed executive director of the state board in 2002.

In the late 1990s, Coleman Stipanovich worked as a lobbyist for PaineWebber Inc. in Florida and was paid $7,500 per month to help the firm win municipal bond business.

Stipanovich, a Vietnam veteran, has a master of science degree in criminal justice administration from Michigan State University and a bachelors of science in criminology from Florida State University.

Pretty impressive credentials for running an investment management firm with $184-billion under management, eh? There’s a small biography on the site:

As Executive Director of the State Board of Administration of Florida (SBA), Coleman Stipanovich serves as the Chief Investment Officer of the fifth largest pension fund in the United States. Total assets under management at the SBA are in excess of $150 billion, which includes the Florida Retirement System Pension Plan (Defined Benefit Trust Fund) and Investment Plan (Defined Contribution Trust Fund). Under broad authority granted by the Trustees, the Executive Director has administrative and investment authority and responsibility, within the statutory limitations and rules, to develop investment policies and tactically manage investments. The Trustees are Governor Charlie Crist, Chief Financial Officer Alex Sink, and Attorney General Bill McCollum.

But look at him:

 

Isn’t that just the kind of distinguished look that investment counsellors should all have? I haven’t been able to find any CV on the web that might possibly shed some light on why this man was considered suitable to run a large asset management firm – all I’ve found is a story about his 2002 appointment and a record of his reappointment. If anybody has information that might clarify the question of his qualifications, please share it.

But I suspect it’s just political patronage. Investment counsellors are all a bunch of overpaid yumps who, on average, perform averagely, right? So I suppose that since any idiot can do it and get paid extremely well while doing so, it doesn’t make any difference who you hire.

Just for comparison, let’s look at the CV of Jim Leech, CEO of Teachers.

Mr. Leech joined Teachers’ in 2001 to lead Teachers’ Private Capital and succeeded Claude Lamoureux as President and CEO in 2007.
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Before joining Teachers’, Mr. Leech was President and CEO of Unicorp Canada Corp., one of Canada’s first public merchant banks, and Union Energy Inc., then one of North America’s largest integrated energy and pipeline companies.

Now, I don’t know Mr. Leech. I haven’t worked with him, I haven’t studied his career in detail, I haven’t even spoken to the man. But I have a lot of respect for Teachers’ and whether or not Mr. Leech is the perfect man for the job, it seems to me that this is the way public funds should be run … a guy with a solid CV runs a division for six years, THEN gets to be boss. Maybe that CV is in investment management, maybe it’s in some other industry … but it’s solid.

I last reviewed Prof. Stephen Cecchetti‘s series on subprime on November 28. Part 3 of the series, Why Central Banks should be Financial Supervisors talks about some countries’ separation of function that are elsewhere combined:

In places like Italy, the Netherlands, Portugal, the United States and New Zealand, the central bank supervises banks. By contrast, in Australia, the United Kingdom, and Japan, supervision is done by an independent authority.

He notes that Bernanke is an ardent supporter of combination:

[Bernanke Speech]  Its supervisory activities also allow the Fed to obtain useful information about the financial companies that do business with the banking organizations it supervises. For example, some large banks are heavily engaged in lending and providing various services to hedge funds and other private pools of capital. In the process of ensuring that banks prudently manage these counterparty relationships, Fed staff members, collaborating with their colleagues from other agencies, learn a great deal about the business practices, investment strategies, and emerging trends in this industry.

The other side of the coin is:

[Cecchetti essay] the most compelling rationale for separation is the potential for conflict of interest. The central bank will be hesitant to impose monetary restraint out of concern for the damage it might do to the banks it supervises. The central bank will protect banks rather than the public interest. Making banks look bad makes supervisors look bad. So, allowing banks to fail would affect the central banker/supervisor’s reputation.

In this same vein, Goodhart argues for separation based on the fact that the embarrassment of poor supervisory performance could damage the reputation of the central bank.

Cecchetti quotes an amusing example of the benefits of combination:

On 20 November 1988 a computer software error prevented the Bank of New York from keeping track of its US Treasury securities trading. For 90 minutes orders poured in and the bank made payments without having the funds as normal. But when it came time to deliver the bonds and collect from the buyers, the information had been erased from the system. By the end of the day, the Bank of New York had bought and failed to deliver so many securities that it was committed to paying out $23 billion that it did not have. The Federal Reserve, knowing from its up-to-date supervisory records that the bank was solvent, made an emergency $23 billion loan taking the entire bank as collateral and averting a systemic financial crisis. Importantly, only a supervisor was in a position to know that the Bank of New York’s need to borrow was legitimate and did not arise from fraud.
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[note] At the time, computers could store only 32,000 transactions at a time. When more transactions arrived than the computer could handle, the software’s counter restarted at zero. Since the counter number was the key to where the trading information was stored, the information was effectively erased. Had all the original transactions been processed before the counter restarted, there would have been no problem.

(I should point out that computers, per se, are not to blame for the error – assuming that the malfunction happened as described, this was an example of poor programme management, design and testing as indicated in the main text, rather than a hardware error as implied in the note) … and then an example of the evils of separation …

Shortly after Bank of England Governor Mervyn King sent a letter to the Treasury Committee of the House of Commons,⁶ the U.K. Financial Services Authority made it known both that Northern Rock was on the verge of collapse, and that supervisors had known this for some time. Contrary to wide-spread perception of the position taken just a few days earlier in the Governor’s letter, the Bank of England was forced to make a substantial emergency loan, substantially tarnishing their public image.
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I will say is that things surely would have gone more smoothly had the Bank of England had supervisory authority so that the officials with intimate knowledge of Northern Rock’s balance sheet would have been sitting at the table on a regular basis with the management of the central bank.

Cecchetti is very persuasive! The arguments make a lot of sense to me – but I’ll keep my eyes open for something from the other side. His fourth and final essay in the series, Does Well-Designed Monetary Policy Encourage Risk Taking, is not nearly as interesting – as far as I’m concerned he could have written finis after the first sentence:

Yes, but isn’t that what it’s supposed to do?

… but he had to fill it out a little. I have often argued in this blog that by way of policy objectives, what we want is a rock-solid, highly regulated banking sector, well insulated from the outer (much more fun) layer of innovation and speculation. He concludes:

Some observers worry that recent central bankers’ responses to the subprime crisis of 2007 will encourage asset managers to take on more risk than is in society’s interest. I believe that this is wrong. Punishment is being meted out to many of those whose risky behaviour led to the problems, while central banks’ actions have, so far, reduced the collateral damage that this crisis could have inflicted on the economy.

As far as the series is concerned, he has made the following four concrete proposals:

• Trust, but verify. Investors should insist that asset managers and underwriters start by disclosing both the detailed characteristics of what they are selling together with their costs and fees. This will allow us to know what we buy and understand our bankers’ incentives.
• Standardisation and trading. Governments could help clarify the relative riskiness of assets by fostering the standardization of securities and encouraging trading on organized exchanges.
• Deposit insurance. A well-designed, rules-based deposit insurance scheme is essential to protecting the banking system from future financial crises. Lender of last resort actions are no substitute for deposit insurance.
• Central banks should be financial regulators. Central banks should have a direct role in financial supervision. In times of financial crisis – as in times of war – good policy-making requires a single ‘general’ directing the operations.

Item 1 is not really a policy issue – it’s a matter for investors, their investees and their advisors. Just make sure people are, in fact, feeling some pain from bad decisions and not bailed out – that’s enough policy.

Item 2 – I argued against this on November 19. However, it may be that in ensuring the stability of the banking system, margin & capital requirements could well be raised to the point at which exchange-trading (and clearing houses with daily mark-to-markets) become competitive. However, an exchange cannot function in a thin market – which Mr. Cecchetti, I am sure, will say is addressed by his urging for increased standardization. By way of policy … make sure the banks are stable, ensure capital requirements are conservative, and let exchange trading and standardization look after themselves.

Item 3 – full agreement from me!

Item 4 – very persuasive arguments have been put forward, but I’ll reserve judgement until I hear more from the other side. I am confident that each example of the benefits of unification can be matched with an example of harm.

PerpetualDiscounts continued to rock-and-roll today, while floaters just rolled over and played dead. Sadly, there are only two issues in this sub-index, both BAM, so it’s very hard to determine just how much is due to credit concerns, how much is Floater concerns and how much is just random vagaries of the market. There was reasonably good volume, a reasonable number of trades, and a reasonable time between the decline of prices and the market close, so I’d have to say this move is as real as anything else.

But really, how about them PerpetualDiscounts? I KNOW it’s only three days into the month and a lot can happen, but let me enjoy it while I can, won’t you? It’s been a long year.

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

Wow! How about them PerpetualDiscounts, eh?

It figures. The Bank of Canada cuts rates and retail figures that means all rates, ignoring the fact that long Canadas were down on the day … lower rates means higher inflation risks, says the Market. Also ignoring the idea that corporate spreads tend to widen during tough times, since there is higher default risk.

Or maybe pref investors are saying that they know all that, it’s just that the whole thing since March has been overdone. Who knows? Ask a priest. I’m just glad to see the fifth straight trading day of PerpetualDiscount gains and that sub-index off its lows. But who knows what tomorrow will bring?

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

Sorry – month-end is a busy time for me, so again, there’s not much colour today!

However, I was most interested in Accrued Interest’s essay on the implications of the Florida Money-Market Fund Freeze, together with the most recent Bloomberg story.

According to Bloomberg:

BlackRock, at a Tallahassee meeting today with officials from schools and cities in the Local Government Investment Pool, said it will recommend putting about 86 percent of the pool’s $14 billion of assets that have no risk of loss or default into a “fund A.” The remaining 14 percent will go into a “fund B,” said Simon Mendelson, chief operating officer of BlackRock’s cash management business.

“We want fund A to be really clean,” said Barbara Novick, vice chairman of BlackRock, who made the presentation with Mendelson. “We want to run it as a money-market fund.”

I don’t get it. When I look at the October 31 Holdings of the Florida fund, I don’t see 86% of the securities having “no risk of loss or defaults”. The only securities without default risk are central government securities denominated in the national currency (and their guarantees, if you want to be picky). Even then, “no risk” can be something of a relative term, as those who read about hyperinflation in the German Republic will remember:

The German Mark, the British shilling, the French franc, and the Italian lira all had about equal value, and all were exchanged four or five to the dollar. That was in 1914. In 1923, at the most fevered moment of the German hyperinflation, the exchange rate between the dollar and the Mark was one trillion Marks to one dollar, and a wheelbarrow full of money would not even buy a newspaper.

That was then and this is now, you say? I know a man with first-hand experience of Serbian hyperinflation:

In October of 1993 the created a new currency unit. One new dinar was worth one million of the old dinars. In effect, the government simply removed six zeroes from the paper money. This of course did not stop the inflation and between October 1, 1993 and January 24, 1995 prices increased by 5 quadrillion percent. This number is a 5 with 15 zeroes after it.
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Many Yugoslavian businesses refused to take the Yugoslavian currency at all and the German Deutsche Mark effectively became the currency of Yugoslavia. But government organizations, government employees and pensioners still got paid in Yugoslavian dinars so there was still an active exchange in dinars. On November 12, 1993 the exchange rate was 1 DM = 1 million new dinars. By November 23 the exchange rate was 1 DM = 6.5 million new dinars and at the end of November it was 1 DM = 37 million new dinars. At the beginning of December the bus workers went on strike because their pay for two weeks was equivalent to only 4 DM when it cost a family of four 230 DM per month to live. By December 11th the exchange rate was 1 DM = 800 million and on December 15th it was 1 DM = 3.7 billion new dinars. The average daily rate of inflation was nearly 100 percent. When farmers selling in the free markets refused to sell food for Yugoslavian dinars the government closed down the free markets. On December 29 the exchange rate was 1 DM = 950 billion new dinars.
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At the end of December the exchange rate was 1 DM = 3 trillion dinars and on January 4, 1994 it was 1 DM = 6 trillion dinars. On January 6th the government declared that the German Deutsche was an official currency of Yugoslavia. About this time the government announced a new new dinar which was equal to 1 billion of the old new dinars. This meant that the exchange rate was 1 DM = 6,000 new new dinars. By January 11 the exchange rate had reached a level of 1 DM = 80,000 new new dinars. On January 13th the rate was 1 DM = 700,000 new new dinars and six days later it was 1 DM = 10 million new new dinars.

So anyway, the moral of the story is: nothing is certain in this wicked world. There is default risk everywhere.

That being said, I find the holdings of the Florida fund rather surprising, in that (i) I don’t recognize a lot of the names held, and (ii) A lot of the names are of the form “XXX Funding LLC”. So, I’ll repeat, yet again, another moral we should all remember from the credit crunch: Diversify! Diversify! Diversify!

Without having had anything more than a casual once over of the Florida holdings, it seems to me that the managers were well diversified by name and tenor, but very poorly diversified by industry … I mean, geez, look at all those XXX Funding LLCs! You are not diversified if you have 1% of your portfolio in each of 100 different companies if each of those companies is in the business of manufacturing Britney Spears Fan Club kits.

As with Canadian ABCP – I have nothing but sympathy for portfolio managers who held 5-10% in the sector; it looked pretty good to me too, and (with the exception of Apsley Trust) the credit quality was fine – it was simply the liquidity that suddenly disappeared. But too much of a good thing is simply too much.

Accrued Interest‘s conclusions as to how the whole affair will play out look entirely reasonable to me … with one quibble:

Finally, government money market funds will likely become permanently more popular.

Permanently? I have my doubts. There have always been periodic flights to quality in the investment world, and sooner or later investor greed beats investor fear and competition forces the assumption of increased risk.

In sort-of related news on the MLEC/Super-Conduit front, Harrier Finance and Carrera Capital are being bailed out by their so-called off-balance-sheet sponsors, to the tune of $11-billion and $4.8 billion, respectively.

“Every day that goes by we are seeing more restructuring and liquidity provision by sponsors,” [Dresdner Kleinwort analyst Priya] Shah said in an interview today. “The longer M-LEC takes, the less of a need there will be for it.”

Another day of good volume and positive returns! Holy smokes, can this be the preferred market we’re looking at?

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