PrefBlog

Looks like efforts to determine whodunnit have broken down amidst political jockeying:

Democrats and Republicans on the Financial Crisis Inquiry Commission, struggling for months to find consensus behind the scenes, haven’t even been able to agree on whether to include the phrases “Wall Street” and “shadow banking” in the final report. The report is now scheduled to be published in January and is likely to include dissents, FCIC members said yesterday.

The four Republicans on the 10-member panel made their views public in a nine-page document yesterday, saying they place much of the blame for the 2008 crisis on the government and mortgage firms Fannie Mae and Freddie Mac rather than banks.

The dissent itself commences with something sensible:

Bubbles happen. In retrospect, they always seem easy to identify, but as they are building, experts debate whether they exist—and, if so, why. The recent housing bubble was no different. Despite national home price appreciation well above the historical trend for almost a decade, and local markets with even more pronounced price swings, most homeowners and mortgage investors believed there were sound fundamentals underpinning their investments.

… and to a large extent blame the elephant:

There were three important ways that the government pushed investors toward investing in mortgage debt. First, the regulatory capital requirements associated with mortgage debt were lower than for other investments. Second, the government encouraged the private market to extend credit to previously underserved borrowers through a combination of legislation, regulation, and moral suasion. Third, and most important, during the bubble’s expansion, the largest investors in the mortgage market, the government-sponsored enterprises (GSEs)—Fannie Mae and Freddie Mac—were instruments of U.S. government housing policy.

All this is true. I’m disappointed to see that there is no criticism of structural problems in the US mortgage market: 30-year terms with the homeowner able to redeem at par at any time; no recourse to the borrower in the event of default; tax-deductibility of mortgage payments.

The Republicans address tranche retention:

Super-senior risk: The safest, “super-senior” tranches of mortgage-backed structured products were less attractive to investors because they did not provide a sufficient spread above other, safer securities, like U.S. Treasuries.

This looks like it’s glossing over some stuff, to put it mildly. Why is a brokerage creating products too expensive to sell? I don’t think we can paint the brokers as victims on this one.

As I have urged before, I believe there should be not one, but two regulatory regimes: one for banks, expected to buy-and-hold and surcharging trading activities; one for brokerages, expected to trade, surcharging aged inventory.

The Boston Fed has released a policy brief by Jihye Jeon, Judit Montoriol-Garriga, Robert K. Triest, and J. Christina Wang titled Evidence of a Credit Crunch? Results from the 2010 Survey of First District Community Banks:

This policy brief summarizes the findings of the Survey of Community Banks conducted by the Federal Reserve Bank of Boston in May 2010. This survey seeks to understand how the supply of, and demand for, bank business loans changed in the period following the financial crisis. The survey design focuses on assessing how much community banks were willing and able to lend to local businesses that used to be customers of large banks but lost access to credit in the aftermath of the financial crisis. The survey responses provide some evidence that lending standards for commercial loans have tightened moderately at community banks since late 2008, with the tightening being more severe for new customers than for those that already had a relationship with the respondent bank. The survey also reveals that expansions of several SBA guarantee programs since the crisis have ameliorated possible credit constraints on small businesses.

BIS has released the BIS Quarterly Review, December 2010 with features:

• The $4 trillion question: what explains FX growth since the 2007 survey?
• Derivatives in emerging markets
• Counterparty risk and contract volumes in the credit default swap market
• A user’s guide to the Triennial Central Bank Survey of foreign exchange
  market activity

Additionally, Basel III rules text and results of the quantitative impact study issued by the Basel Committee.

The Basel Committee issued today the Basel III rules text, which presents the details of global regulatory standards on bank capital adequacy and liquidity agreed by the Governors and Heads of Supervision, and endorsed by the G20 Leaders at their November Seoul summit. The Committee also published the results of its comprehensive quantitative impact study (QIS).
…
The rules text presents the details of the Basel III Framework, which covers both microprudential and macroprudential elements. The Framework sets out higher and better-quality capital, better risk coverage, the introduction of a leverage ratio as a backstop to the risk-based requirement, measures to promote the build up of capital that can be drawn down in periods of stress, and the introduction of two global liquidity standards.
…
With respect to the leverage ratio, the Committee will use the transition period to assess whether its proposed design and calibration is appropriate over a full credit cycle and for different types of business models. Based on the results of a parallel run period, any adjustments would be carried out in the first half of 2017 with a view to migrating to a Pillar 1 treatment on 1 January 2018 based on appropriate review and calibration.

OSFI notes:

As stated in the rules text, the BCBS is finalizing additional entry criteria related to non-viability contingent capital (NVCC) for instruments other than common equity. Once finalized, the additional criteria are to be added to the Basel III rules text. We currently expect this to occur early in 2011.
The Basel III rules affect the eligibility of instruments for inclusion in regulatory capital and provide for a transition and phase-out for instruments that do not meet the Basel III requirements. OSFI intends to adopt the Basel III changes in its domestic capital guidance for deposit-taking institutions (DTIs). As the Basel III rules text currently provides that the cap on non-qualifying capital will be applied to Tier 1 and Tier 2 instruments separately and refers to the total amount of non-qualifying capital, the finalization of rules related to NVCC may affect the operation of the cap on Tier 1 and Tier 2 non-qualifying instruments. Once the Basel III rules text governing NVCC requirements has been finalized by the BCBS, OSFI intends to issue guidance clarifying the phase-out of all non-qualifying instruments by DTIs, including OSFI’s expectations with respect to rights of redemption under regulatory event5 clauses.
…
This letter does not apply to regulated life insurance companies or insurance holding companies. While such insurers should be aware of developments related to DTIs on matters where OSFI has traditionally aligned its regulatory requirements (such as eligible capital instruments), OSFI intends to engage in consultation during 2011 before determining which Basel III rule changes will be applied to the life insurance industry and to thereafter issue guidance to insurers to reflect such changes.

The Feds are proposing Pooled Registered Pension Plans, which have been praised by insurance salemen in all walks of life. Blake’s explains:

The main items discussed in the Backgrounder are as follows:

1. Eligible Administrators of the PRPPs will be regulated financial institutions, including trust and insurance companies and other financial institutions with a trust subsidiary.
2. The Administrator will have a fiduciary duty to plan members.

3. The PRPPs will have a suitable low-cost default investment option for a broad group, and a manageable number of investment options for members to choose from.

4. Administrators will be required to provide all members with prescribed information on a regular, periodic basis.

5. There will be certain tasks that an employer that offers a PRPP must fulfill.

6. Employers may be permitted to enrol their employees into a PRPP at any stage of their employment and there may be rights of an employee to “opt out” shortly after enrolment.

7. The framework also provides that employers will have the ability to increase the employee’s default contribution rate from time to time, potentially subject to a new “opt out” right.

8. Employer contributions will be locked-in with some jurisdictions permitting what appears to be limited unlocking rights.

9. Jurisdictions will make a determination as to whether to require mandatory employer participation.

10. Employers contributing directly to a PRPP and their employees will be permitted to make contributions under the RPP limits, with the pension adjustment reporting. Self-employed persons and other employees will contribute on the basis of their available RRSP limit.”

The Canadian preferred share market had another poor day on high volume, with PerpetualDiscounts bearing the brunt of the losses. PerpetualDiscounts were down 32bp, while FixedResets lost 4bp.

The Financial Post published an interesting factoid on Canadas:

Canadian 10-year yields gained 47 basis points to 3.28% today, from 2.81% on Nov. 4, the day after the Fed unveiled plans to buy US$600-billion in Treasuries through June to spur economic growth. The yields are rising so fast they exceed all 18 of the March 2011 forecasts of economists in a Bloomberg survey. The highest, from Kurt Karl, Swiss Re’s chief U.S. economist, calls for yields at 3.2% by then. The weighted average estimate is 2.95%.

The Boston Fed has released a four-part video lecture on the Great Recession. I must say, I’m pleased and impressed at this sort of outreach programme – I prefer written commentary myself, but I know most people prefer video. We never see anything like this in Canada … pity.

TD CEO Ed Clark announced today that he is an enthusiastic proponent of moral hazard:

If policy makers want Canadians to stop borrowing too much, it’s up to Ottawa, not financial institutions, to force a change in behaviour, says one of Bay Street’s longest-serving senior bankers.

Toronto-Dominion Bank chief executive officer Ed Clark acknowledged Canadians’ alarming debt levels, but said the issue is a matter of public policy and would be best resolved by a tighter government rules on residential mortgages.

In an interview with The Globe and Mail, Mr. Clark said that no bank wants to be the first to impose stricter requirements on borrowers out of fear that it will suffer a major loss of customers to rivals. Personal banking “is a highly competitive industry,” Mr. Clark said. “If we said ‘Look, we’re going to be heroes and save Canada from itself, and we’ll impose a whole new [mortgage] regime on everyone else,’ the other four [large] banks would say ‘Let’s carve them up.’ ”

Listen up, Mr. Clark! Nobody wants or needs you to save Canada from itself. You’re being paid a rather fat salary to save TD Bank from itself. Why are you so eager to make mortgage loans to poor credits? Why are you so worried that the poor credits will stampede to other banks, leaving TD in the miserable position of having a high quality mortgage portfolio?

Mr. Clark proposes government action, citing rules on credit cards as an example of where the banks follow whatever guidelines are provided. The Canadian banking system is run by “adults” who are able to come together and work with the government to guide the process, he said, so there is no trouble sitting everyone down at the same table.

The Canadian banking system is run by weak-kneed oligarchy of idiots, who have the idea that tough management consists of begging Mama to tell them what to do.

Naturally, the Globe and Mail is quick to urge arbitrary measures:

From Gordon Nixon of Royal Bank of Canada, to Ed Clark of Toronto-Dominion Bank, to William Downe of Bank of Montreal, chief executives of big banks are all on the record with some version of the same refrain: Something needs to be done to slow the growth in consumer debt.

So who can do it? The banks, you say? They could just turn down customers seeking loans more often. It’s not going to happen. Saying no would make the banks the bad guys. Plus, the bank executives are wont to point out, probably rightly, that competitive pressures mean that even if one says no, another will probably say yes.

If the government is to do anything, it has two logical measures: tighten up the rules on the risk-weighting of loans (via OSFI) and/or charge more to insure risky mortgages (via the CMHC). Early on in the US housing crunch, I suggested a regime whereby 25% (or so) capital was required on mortgages. If the consumer didn’t put it up as a down payment, then the required amount gets deducted, dollar for dollar, from the bank’s tier 1 capital. That’s the capital part of the loan. Then the rest gets risk-weighted as a normal mortgage.

More and more, I’m seeing a move towards central planning. It always sounds good and it never works.

Good news on the Canadian preferred share market today, as investors lost less than usual on continued elevated volume. PerpetualDiscounts were down 15bp, while FixedResets managed to gain a whopping 3bp.

PerpetualDiscounts now yield 5.48%, equivalent to 7.67% interest at the standard equivalency factor of 1.4x. Long Corporates now yield about 5.6%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 210bp, a widening from the 200bp reported December 8 as long corporate yields increased but interest-equivalent PerpetualDiscount yields increased more.

The FOMC Statement held no surprises:

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.
…
Voting against the policy was Thomas M. Hoenig. In light of the improving economy, Mr. Hoenig was concerned that a continued high level of monetary accommodation would increase the risks of future economic and financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy.

It occurs to me that Mr. Hoenig is being used – probably with his enthusiastic cooperation – as a straw man. The Fed wants to send an explicit signal that they’ve thought about this, discussed this and reached a concensus to reject this. There’s no shortage of blogs out there claiming hyperinflation is imminent! Given the increased public discussion of economic data, with various levels of competence, one wonders if more public pronouncements by governments and their agencies will set up straw men in their releases and recognize that forecasts are necessarily imprecise.

“The Cabinet today decided that all protesters at G-20 meetings held in Canada will be billy-clubbed. Voting against the motion was the Public Safety Commissioner, who wished to place land-mines in approved protest areas”.

Oh boy, this is just like the old days! The Canadian preferred share market got clobbered today, with PerpetualDiscounts losing 70bp and FixedResets down 12bp. Volume continued at elevated levels.

CalPERS, the gigantic California pension fund most notable for not doing its own credit analysis, has been told to take a running jump:

Judge Richard Kramer in San Francisco state court said yesterday that the companies’ ratings of three structured investment vehicles that the California Public Employees’ Retirement System lost money on are a form of speech about an issue of public interest that is protected under a state law designed to fend off cases meant to chill public debate.
…
The companies all gave their highest ratings to Cheyne Finance LLC, Stanfield Victoria Funding LLC and Sigma Finance Inc., prompting Calpers to invest $1.3 billion in them in 2006, the fund said in its complaint.

The Australian covered bond market is attracting attention:

Westpac Banking Corp., Commonwealth Bank of Australia, Australia & New Zealand Banking Group Ltd. and National Australia Bank Ltd. may be able to issue three-year covered bonds priced to yield about 50 basis points more than the bank bill swap rate, less than the 85 basis-point spread on senior debt, according to Royal Bank of Scotland Group Plc. Moody’s Investors Service estimates savings of 20 percent.

Covered bonds are “essential weapons as banks look for cheaper and more diversified sources of funding,” John Manning, a credit analyst at RBS in Sydney, said in a telephone interview. Even when global credit markets seized up, European banks “had good access to covered bond markets and were able to access the funding they required at quite commercially acceptable rates,” he said.

The Australian government will amend the law to let financiers issue the securities for the first time, Treasurer Wayne Swan said Dec. 12 as he announced an overhaul package aimed at spurring competition in the banking industry. Global sales of the securities, including Pfandbriefe, as they are known in Germany, have surged 33 percent to a record 329 billion euros ($435 billion) in 2010, according to data compiled by Bloomberg, as investors seek the relative safety of debt backed by both the issuer and an underlying pool of assets.
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Investors in Europe demand 177 basis points of extra yield to hold covered bonds instead of government debt, according to Bank of America Merrill Lynch’s EMU Covered Bonds index. Spreads average 237 basis points, or 2.37 percentage points, on the region’s financial debt, a separate index shows.

Australia’s government will release draft amendments to the Banking Act to allow the sale of covered securities during the first sitting of Parliament next year, according to a federal document detailing the planned changes.

Allowing covered bonds will help “secure the long-term safety and sustainability” of Australia’s banking system, the document states. Treasury may impose a cap on the amount of covered bonds that each bank can sell, “for example five percent of an issuer’s total Australian assets,” it said.
…
Canadian Imperial Bank of Commerce raised A$750 million in October in the first sale of Australian dollar-denominated covered bonds since the start of the credit crisis in 2007. The Australian laws don’t block overseas banks issuing the notes.

The 5.75 percent notes due December 2013 were priced to yield 91.25 basis points more than similar-maturity government debt, according to a statement at the time. The spread has narrowed to 87 basis points, according to ANZ Bank prices on Bloomberg. A basis point is 0.01 percentage point.

It was clobberin’ time on the Canadian preferred share market, as high volume and losses continued. PerpetualDiscounts got smacked for 42bp, while FixedResets were down 10bp.

The most irritating news of the day was the closing quote on BNA.PR.E, which settled on Friday and has already been forgotten by the underwriters who made a nice little fee for flogging it. It traded 64,885 shares on the day in a range of 24.81-91. So far, so good, right? The closing quote was 22.00-24.80, 20×50. That’s a two dollar and eighty cent spread on issue that closed on the previous trading day. This is a disgrace; the market maker, the exchange and the underwriters should be ashamed of themselves.

One factoid of note is that Scotia was the only broker with any buying interest, responsible for 60,500 of the buy side, leaving only 4,385 for the rest of the street.

Meanwhile, remember GWO.PR.J? It was quoted Friday at 26.40-27.60 after trading 2,457 shares and today traded 5,764 shares in a range of 26.75-95 before closing with a quote of 26.80-60, 1×8.

This is simply not acceptable. Market makers get valuable privileges and if they want to keep them, should be required to earn them.

I have sent the following eMail to the Exchange:

Sirs,

I have not yet received a reply to the eMail below. Can you tell me when I might expect to receive it?

I note additionally that GWO.PR.J had a closing quote 26.40-27.60 on Friday and a quote of 26.80-60. Can you explain why you permit such incompetent market making?

I also note that BNA.PR.E, a new issue which settled on Friday, closed the second trading day of its existence with a quote of 22.00 – 24.80. Why does the Exchange permit such a lackadaisical attitude by those whom it rewards with market making privileges?

I sent the original eMail on December 2.