PrefBlog

Paul Krugman writes an op-ed in the New York Times, Good and Boring, lauding the resilience of Canadian banks:

Canada has an independent Financial Consumer Agency, and it has sharply restricted subprime-type lending.

Above all, Canada’s experience seems to support those who say that the way to keep banking safe is to keep it boring — that is, to limit the extent to which banks can take on risk.
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More specifically, Canada has been much stricter about limiting banks’ leverage, the extent to which they can rely on borrowed funds. It has also limited the process of securitization, in which banks package and resell claims on their loans outstanding — a process that was supposed to help banks reduce their risk by spreading it, but has turned out in practice to be a way for banks to make ever-bigger wagers with other people’s money.
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Actually, the financial reform bill that the House of Representatives passed in December would significantly Canadianize the U.S. system. It would create an independent Consumer Financial Protection Agency, it would establish limits on leverage, and it would limit securitization by requiring that lenders hold on to some of their loans.

I suggest that Dr. Krugman has selected features of Canada’s system to further his domestic political arguments. The IMF has published suggestions that a critical factor is the stable deposit base of Canadian banks – which, I believe, is related to their national scope and oligopolistic position. Another major factor has been the banks’ control over the mortgage market – limited competition (no GSE’s here in Canada!) has allowed them to extract rents from hapless Canadian mortgagees, leaving much less necessity of reaching for yield. The sole Canadian bank that did fail during the crisis, Dundee Bank, failed because its lack of mortgage distribution channels encouraged it to go out on a limb provided by ABCP.

Paul Volcker testified to the Senate banking committee today:

Given strong legislative direction, bank supervisors should be able to appraise the nature of those trading activities and contain excesses. An analysis of volume relative to customer relationships and of the relative volatility of gains and losses would go a long way toward informing such judgments. For instance, patterns of exceptionally large gains and losses over a period of time in the “trading book” should raise an examiner’s eyebrows. Persisting over time, the result should be not just raised eyebrows but substantially raised capital requirements.

This is much more in line with my thinking than a flat prohibition, which will be subject to interpretation.

More generally, proprietary trading activity should not be able to profit from knowledge of customer trades.

That’s what the SEC’s supposed to be worrying about.

Mr. Volcker also noted that he had attached an essay to his official testimony, but I can’t find it!

A relatively directionless day for Canadian preferred shares, with PerpetualDiscounts losing 5bp and FixedResets gaining 1bp on moderate volume.

Comrade Peace-Prize wants to make the Build America programme permanent:

Obama will propose expanding the eligibility of the bonds to include original financing for capital projects when he submits his 2011 budget to Congress tomorrow, according to the official, who requested anonymity.

Under the Build America program, part of the economic stimulus package Obama signed into law last February, the federal government provides a 35 percent rebate on issuers’ interest costs. That would go down to 28 percent under the proposal in the president’s budget, according to a Treasury Department official who spoke on condition of anonymity.
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Build America Bonds “were successful in helping to repair a severely damaged municipal finance market, making much needed credit available at lower borrowing costs for infrastructure projects that create jobs,” Treasury Secretary Timothy Geithner said in an e-mailed statement released by his office. “By making Build America Bonds a permanent and expanded financing tool for state and local governments, we’re investing in our country’s long term economic growth in a cost-effective way.”

The ever-opportunistic CC&L group is establishing a mutual fund that will invest in these securities:

As at December 14, 2009, securities in the Indicative Portfolio had a weighted average Investment Grade credit rating of ‘‘AA’’
by S&P (or equivalent) and average Effective Duration of 11.1 years.
…
The Fund will have a term of approximately five years, terminating on or about February
, 2015, and the Fund’s investments will be liquidated prior to such termination at the then prevailing market prices.
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‘‘Effective Duration’’ is a measure of the estimated percentage change in price for a 100 basis point change in interest rates and takes into consideration changes in cash flows and values that can occur in bonds with embedded options such as call and put provisions.

“Yep”, says Granny Oakum, “I’m going to invest in long bonds, but it’s safe because the find winds up in five years!”

What I consider fascinating about the whole thing is the indication that municipalities’ financing needs can no longer be met in the US domestic tax-exempt market. Sic transit gloria mundi.

However, there is still a place for derivatives:

Investment bankers in the US have begun using equity derivatives to convert restricted shares paid as bonuses into cash, side-stepping new guidelines on remuneration which were designed to prevent bankers cashing out for at least three years, according to a headhunter.

The bankers are using over-the-counter equity derivatives strategies such as call options, put options and collars to monetise their shares now, albeit at a discount to what they would receive if they waited for the restrictions to lift.

Politicians reaffirmed their total committment to the idea that bank managers should embrace long-term thinking:

“We have to show short-term results,” French Finance Minister Christine Lagarde said in an interview at the conference shortly after chairing a private meeting between bankers, politicians and regulators.

U.K. Chancellor of the Exchequer Alistair Darling, White House economic adviser Lawrence Summers and U.S. House Financial Services Committee Chairman Barney Frank, who were all in Davos, also expressed frustration.

“We simply don’t have years to sort the problem out,” Darling told reporters in Davos on Jan. 29. “There needs to be a sense of urgency.”

Quck! How many years did it take to negotiate Basel II?:

However, despite its contributions, the [Basel I] accord was quickly perceived to be inadequate and since the early 1990s there began an on-going process of updating and reforming the accord to match changing realities in the world of banking, and the preferences and concerns of major players in the system. A series of adjustments were made to the accord in the early to mid-nineties before the inevitable realisation set in that a replacement accord was needed rather than piecemeal reform. In June 1999 the Basel Committee announced that it would begin negotiations on a new capital accord to replace the 1988 agreement.
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Of particular interest in this story is the continued dominance of the United States over European regulatory authorities. At several moments in the discussions the US has presented its European counterparts with a fait accompli in the content of the new accord, and has been willing only to discuss changes to the wording, not substance. Most damning, in spring 2003 after having gained most of the concessions it sought from fellow Basel members, the US announced that it would likely apply the accord to only a handful of banks, thus greatly weakening the potential impact of the accord and calling into question its validity.

My favourite corporate spokesman – ever – is Goldman Sachs’ Lucas Van Praag.

Not the greatest of days for the Canadian preferred share market, as PerpetualDiscounts lost 17bp while FixedResets gaoing 2bp, on moderate volume.

That’s a wrap!

The Canadian preferred share market closed the month on a sour note, with PerpetualDiscounts down 13bp and FixedResets losing 6bp on a well-behaved day with only one entry in the performance highlights – POW.PR.B, oddly enough, which I have used as a gauge of the market impact of the stupid trading in POW.PR.C. Volume was subdued and dominated by FixedResets.

PerpetualDiscounts closed the month yielding 5.81%, equivalent to 8.13% interest at the standard equivalency factor of 1.4x. Long Corporates returned 4.02% on the month to close with a yield of about 5.8%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 235bp, a little wider than the 230bp reported on January 27.