PrefBlog

We’re getting a good start on October tapering chatter:

Federal Reserve Bank of St. Louis President James Bullard, a voter on policy this year who has backed record stimulus, said a small tapering of bond buying is possible next month after the Fed made a close call this week in deciding not to slow purchases.

“That was a borderline decision” after “weaker data came in,” Bullard said today on Bloomberg Television’s “Bloomberg Surveillance” with Tom Keene and Sara Eisen. “The committee came down on the side of, ‘Let’s wait.’”

Bullard called October a “live meeting,” because “it’s possible you could get some data that change the complexion of the outlook and could make the committee be comfortable with a small taper in October.”

Meanwhile, political games in Washington may have an effect:

The U.S. House voted to finance the federal government through Dec. 15 and choke off funding for President Barack Obama’s health-care law, setting up what could be a prolonged showdown with the Senate and White House.

House Republicans said they wouldn’t accept Senate Majority Leader Harry Reid’s plan to remove the health-care language from the bill next week and warned of a temporary government shutdown after the fiscal year ends Sept. 30.

“We’ll add some other things that they hate and make them eat that, and we’ll play this game up until either Sept. 30, Oct. 3, somewhere in between,” said freshman Representative Richard Hudson, a North Carolina Republican. “At that point Harry Reid’s going to realize we’re serious and hopefully at that point, he’ll begin to negotiate with us.”

Inflation continues to be the least of our worries:

Canada’s inflation rate slowed for the first time in four months in August, approaching the bottom of the central bank’s target band, on lower costs for mortgage interest and prescription drugs.

The consumer price index rose 1.1 percent in August from a year ago, following July’s 1.3 percent pace, Statistics Canada said today from Ottawa. The core rate, which excludes eight volatile products, slowed to 1.3 percent from 1.4 percent.

Bank of Canada Governor Stephen Poloz, who sets policy to keep price gains in the middle of a 1 percent to 3 percent range, has said inflation will remain below 2 percent until mid-2015. The central bank’s key lending rate has been 1 percent for three years, the longest pause since the 1950s, and economists surveyed by Bloomberg predict Poloz won’t raise borrowing costs until the second half of 2014.

I must tell you about my wonderful new flashlight I purchased a few days ago from Baby Point Hardware

Click for big

The light source is a 3×8 grid of halogen lamps; it’s powered by 3 AA batteries. The light is very bright and by itself is reason to be impressed. There’s a magnet on the back – so I’ve got mine stuck to my fridge – and there’s also a plastic fold-out hook (like the hook on a clothes hanger) for hanging it somewhere convenient. What I find very impressive is that the halogen bulbs are recessed behind a cover that has a lens in front of each bulb. When you shine the light at a wall, it doesn’t make a diffuse rectangular pattern as one might expect, it makes a circular pattern just like a regular single-light-source flashlight would. I think this is really great engineering and – best of all – it only cost ten bucks and change!

My only complaint is that there is no manufacturer information on the case – the only clue is a logo for “Lightway”. However logical the name “Lightway” might be for a flashlight, it doesn’t help much with Google searches, which bring up a lot of Christian ministries but not a single flashlight manufacturer.

What a great time to be alive! Even little things like flashlights are being improved out of all recognition!

In markets, Canadian equity volume was huge as some tech firm did what tech firms do best.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts up 24bp, FixedResets off 2bp and DeemedRetractibles gaining 2bp. The Performance Highlights table is longer than might be expected, but with mixed contents. Volume was very low.

There seems to be a growing feeling that US regulators have gotten completely out of control:

Rather than trying to take a stand on the conspiracy theory, I am raising the fundamental question of the regulatory dysfunctioning of the United States regulatory system.

The accumulation of fines and legal fees could potentially, more than market movements affect the performance, reputation and future of the US largest bank. Is that the objective? Of course not, even thought the accumulation of recent fines represents almost 10 percent of the bank’s equity.

The problem is that nobody is in charge of asking that question, and therefore focusing on its answer. Where is the Federal Reserve on this? Absent, since it does not want interfere with other agencies: the usual intra regulatory “territorial respect.” This is the biggest failure of the current regulatory reform: by not rationalizing the number of institutions and by not giving a global leadership to the Federal Reserve who is in charge of the US Systemically Important Financial Institutions, they become the target of every single of the 22 agencies who has some money to ask or some issues to resolve.

It is urgent to call it off. Fines should be suspended until the Administration comes with a sensible way to deal with failures and misbehavior of financial institutions. Unless they would like to spend billions in lawyers’ fees to answer class actions from SIFI’s shareholders, some form of coordination is needed.

The US regulatory web has definitely become a systemic risk. Jamie Dimon had actually anticipated it.

Jonathan Weil of Bloomberg points out:

One nagging question: Which federal securities laws did JPMorgan admit to violating? The bank didn’t say. It’s as if the lawyers for the SEC and JPMorgan were going out of their way to frustrate any outsider who was trying to read and understand the document’s contents.

The SEC, which fined JPMorgan $200 million as part of an administrative proceeding, clearly specified which laws it accused JPMorgan of violating. Those included Section 13(a) of the Securities Exchange Act of 1934, which sets requirements for companies’ disclosures to investors.

Why couldn’t the SEC get JPM to admit exactly what laws it violated? Beats me. The agency should have had the company over a barrel. Once again, the SEC has demonstrated that requiring defendants to admit to violations of specific rules or laws is the third rail of U.S. securities regulation. The SEC simply won’t go there and won’t touch it. Instead, the commission is content to say that JPMorgan agreed to admit “wrongdoing,” which is a spinmeister’s term that has no precise meaning.

Matt Levine mocks the FERC fines:

The details are in this marvelously complicated FERC order and settlement agreement,1 but the outlines of the story are simple. FERC built a terrible box, and the box had some buttons that were labeled “push here for money,” and JPMorgan pushed them and got money. You can understand the category mistake very easily:

• FERC thought the box was for generating electricity at market prices but with a robust backup system to ensure reliable supply, and
• JPMorgan thought the box was for dispensing money.

…
BCR is “bid cost recovery,” the system under which CAISO pays operators non-market bonuses to basically make sure they have their plants on when needed. The strategy is simple enough:

• The market clearing price for electricity will be, say, $30/MWh.
• Your inefficient old plants cost about $40/MWh to produce electricity.
• So you offer to be a price taker every third hour, selling your electricity at $30/MWh.
• The other two hours you offer $80/MWh, which is way way way above market.
• The system always lifts the offers of price-takers, so you’re contracted to supply electricity every third hour.
• But the system, in its infinite wisdom, understands that you can’t just turn a power plant on and off like that.
• So it tells you to produce energy, at the prices you offered – effectively $80, $80, $30 – for each of those three hours.
• The system, in its frankly circumscribed wisdom, doesn’t understand (1) that you are fucking with it or (2) that your average price for those three hours is actually $63.
• So you make a profit of $23/MWh instead of the loss of $10/MWh that you’d have at market rates.

I mean! The only proper response to that is, the first time you do it, CAISO calls you up and tells you to knock it off, and then changes its rules to prevent this sort of obvious gaming. JPMorgan didn’t write in big block letters at the top of its bid that day “HI GUYS WE FOUND A LOOPHOLE AND THIS IS IT” but surely its bid should have had the same effect.

So in other words. FERC fined JPMorgan because JPMorgan pointed out that the boys at FERC are stupid.

This, by the way, is similar to another kerfuffle involving idiots writing idiotic contracts:

But not that many people used the IDCH/Nasdaq interest rate swap futures contract, for reasons having to do with territoriality (no bank wants to give up its lucrative OTC swap business to trade exchange-traded products) and with the fact that the contract was terrible. The terribleness was that the contract was meant to, and IDCH/Nasdaq advertised that it would, exactly replicate the value of an over-the-counter interest rate swap. But it didn’t. IDCH/Nasdaq just designed it wrong, so its value was slightly but meaningfully different from the value of a swap with the same terms. What they got wrong isn’t exactly rocket science but it’s, let’s say, footnote science, so.**

And Matt Levine observes:

The upshot is that about half of the JPMorgan fines so far are not for the traditional bread-and-butter of financial enforcement, disclosure failings, but for just doing dumb trades.*****

Mostly I just want to flag how odd that is. But I guess there are a few other things to think about it.
Thing one is: There’s a reason why regulators tend not to pursue cases against big companies just for dumbness. I mean, there are a lot of reasons, like a general assumption that businesspeople know their business better than regulators do, and a policy desire not to deter innovation by punishing mistakes. But there’s one big reason, which is that dumbness is its own reward. You actually don’t need to fine JPMorgan $900 million for losing $6.2 billion! Losing $6.2 billion completely and accurately punishes them for losing $6.2 billion.******

Thing two is: How dumb was this trade, really? I have myself been pretty sneery about some of the decisions made in putting it on, but the basic crash-hedge theory at its heart was not nuts. More importantly, though, the notion that this trade exposed JPMorgan to material risk of unsoundness is odd. I mean, $6.2 billion is a lot of money to lose. But JPMorgan’s net income in 2012, after those losses, was $21.3 billion. The $6.2 billion loss was less than 2 percent of the assets in JPMorgan’s Chief Investment Office, and less than 0.2 percent of JPMorgan’s total assets. Spinning it into an existential threat to the bank looks … I mean, just sort of wrong.

And to complete the regulatory review for today it looks like the solution I first advocated twenty years ago will be adopted:

The federal government has struck a deal with Ontario and B.C. to create a new securities regulator that covers roughly two-thirds of Canadian capital markets, reigniting a long fight over a national securities regulator.

The three governments said Thursday the other provinces and territories will be invited to join the new “co-operative” regulator, slated to be operational by 2015.

The regulator would be based in Toronto, with offices across the country and initially run jointly by Ontario and B.C.

Spend-Every-Penny grabbed the mic:

Finance Minister Jim Flaherty said the proposed new system would help attract more investment, better protect investors, make it easier to prosecute white collar criminals and manage risks to the financial system.

I find it very difficult to believe that it will make enforcement better. But I support it because it will make compliance cheaper … or, at least, less of a complete waste of time registering the same information with different provincial regulators.

It was another good day for the Canadian preferred share market, with PerpetualDiscounts winning 32bp, FixedResets up 4bp and DeemedRetractibles gaining 1bp. A relatively long Performance Highlights table is skewed towards winning PerpetualDiscounts and insurance-issued DeemedRetractibles. Volume was above average.

Tapering? Schmapering!

Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.

The editors at Bloomberg make some good points before tapering off into an absurd conclusion:

Together with the exuberant market reaction, though, the Fed’s move demonstrates a problem: Investors still don’t make a distinction between its plans for bond purchases and its pledge to keep short-term interest rates low until after the economy recovers. In futures markets, for example, the expected date of the Fed’s first increase in its interest-rate target immediately moved out by about a month, even though there was no major change in interest-rate policy.

The perception of tapering as a proxy for the Fed’s overall stance on stimulus is unfortunate, because there may be good reasons to taper that are not related to the outlook for the economy. The Fed, for example, might become concerned that the size of its holdings will leave it too exposed to losses or hamper the functioning of markets. As a result, perfectly sensible moves to cut back on bond purchases can send the wrong signal. Alternatively, the desire to manage perceptions can push the Fed into maintaining quantitative easing against its better judgment.

Dan Hallett writes an excellent piece in the Globe titled Investing in floating rate notes? Here’s what the industry isn’t telling you emphasizing the fact that interest rate risk is not the same as credit risk:

While FRNs offer protection against rising rates, the largely-corporate profile of FRN issuers (including a good proportion of below-investment grade companies) means that FRN fund investors are assuming a good deal of credit risk. A significant but less concerning risk is the decreasing returns that would result in a falling interest rate environment.
…
Trimark Floating Rate Income fund lost 27 per cent of its value during the financial crisis – significant but not insurmountable. The fund has fully recovered, having long surpassed its previous peak. But BMO Floating Rate Income fund is different story.

BMO’s fund lost nearly half of its value – more than many stock funds – and remains under water as of August 31. Its previous peak is more than seven years into the past. It’s no surprise that BMO Floating Rate Income sports the highest risk rating of its peers.

The Canadian preferred share market roared ahead on the non-tapering news, with PerpetualDiscounts winning 69bp, FixedResets gaining 24bp and DeemedRetractibles up 36bp. The Performance Highlights table is suitably enormous, heavily weighted towards winning Straight Perpetuals. Volume was quite high.

PerpetualDiscounts now yield 5.65%, equivalent to 7.34% interest at the standard equivalency factor of 1.3x. Long Corporates now yield about 5.0%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 235bp, a sharp decline from the 250bp reported September 11.

Nothing happened today, but I’m sure there was more tapering chatter.

It was another fine day for the Canadian preferred share market, with PerpetualDiscounts up 22bp, FixedResets gaining 18bp and DeemedRetractibles winning 37bp. The Performance Highlights table is short by current standards, skewed heavily towards winners. Volume was heavy, with the Volume Highlights table comprised entirely of relatively low-coupon FixedResets.