PrefBlog

Julia Dickson of OSFI gave a good speech at the Asian Banker Summit, with the central point:

As pointed out by Counterparty Risk Management Policy Group (CPRMG) III “financial excesses fundamentally grow out of human behaviour…which on the upside of the cycle, fosters risk taking and on the downside fosters risk aversion”. The CPRMGIII report goes on to make a number of very basic recommendations: know the risk you are taking, determine a risk appetite and monitor it, have good corporate governance, and ensure that control functions have authority and independence from the business units, communicate well within the firm, among others. What were we doing before this crisis if we did not know the value of these recommendations? We keep learning that we should not assume risks that we do not understand, that we should be diversified, and more… and we keep relearning!

Unfortunately, she continued with the regulators’ obsession with the fact that some people make more money than they do and are sexier:

Why is it that people do not learn these lessons; is it because they have short memories? Memory does fade with time, but I would also suggest it is because powerful incentives are at play. Perhaps we should be looking at how these incentives can blind us to some basic common sense principles.

Looking at incentives requires us to look at a lot more than just bankers’ compensation packages. It requires us to go down some paths that might be quite sensitive; many of them involve the depth to which the financial sector has pervaded our culture.

If I thought all this musing would end with a de facto separation of investment banking and commercial banking, I wouldn’t be so worried. However, the trend seems to be towards further increases in staffing investment banks – and the associated asset management firms – with unmotivated 18-year-old bank tellers. Ultimately, this will cost us a lot of money; and we won’t, ultimately, get fewer instances of rampant idiocy, we’ll just get different ones. Chrysler & GM, propped up for years by the political allure of good jobs, are going to cost taxpayers a lot more money than any of the banks.

Ms. Dickson spoke approvingly of an essay by Claudio Borio of BIS, The macroprudential approach to regulation and supervision, who notes:

Just as an asset manager, who cares about the loss on her portfolio as a whole, focuses on the co-movement of the portfolio’s securities, so a macroprudential regulator would focus on the joint failure of institutions, which determines the loss for the financial system as a whole. The main policy question is how to design the prudential framework to limit the risk of losses on a significant portion of the overall financial system and hence its “tail risk”.

Some might wonder how a desirable object such as heterogeneity of banks might possibly be accomplished with homogeneous banking rules; but it seems to be the regulators’ position that “Regulatory Arbitrage” is a bad thing.

The WSJ has published some criticism of the European response to the Credit Crunch; in return, C-EBS has published a statement on stress-testing:

The Committee of European Banking Supervisors (CEBS) today publishes its statement on stress testing exercise.

– Supervisory authorities in the EU are, in the context of their regular risk assessment of the financial sector, carrying out an EU-wide forward looking stress testing exercise on the aggregate banking system.

– This is not a stress test to identify individual banks that may need recapitalization, as the assessment of specific institutions’ needs for recapitalization remains a responsibility of national authorities.

– This test builds on common scenarios and guidelines developed by the Committee of European Banking Supervisors (CEBS).

– The objective is an EU-wide exercise with common guidelines and scenarios, so as to increase the level of aggregate information among policy makers in assessing the European financial system’s potential resilience to shocks and to contribute to the convergence of best practices in the EU.

– CEBS’ next regular risk assessment will be ready by September 2009. The outcomes are confidential.

DBRS downgraded a big batch of sub-prime RMBS today:

DBRS has today downgraded 1,441 classes from 195 residential mortgage-backed securities (RMBS) transactions. Of the 195 affected transactions, 125 are backed by first-lien subprime collateral, 53 are backed by Alt-A collateral, 12 are backed by prime collateral and five are backed by second-lien subprime collateral.

The classes have been downgraded as a result of the continued rapid increase in serious delinquencies and cumulative losses relative to the available credit enhancement. Additionally, the persistent negative outlooks of the housing market and unemployment rates, coupled with low prepayment speeds, have contributed significantly to the increased default and loss expectations.

As a result, current credit support is not expected to sufficiently cover the anticipated losses. In many cases, subordinate classes have already been impaired, further weakening the available credit support for the remaining senior and mezzanine classes.

They also downgraded Toyota from AAA.

Morningstar reports:

Mutual fund rating agency Morningstar has ranked Canada mid-pack among 16 major countries as a good place for fund investors – but with a failing grade for fees and expenses.

Canada rates high for investor protection and investment transparency, and its overall grade was B-minus, based on criteria which also included taxation and investment choices.
…
Canada, by contrast, got the only F grade for fees among the 16 countries studied.

The typical Canadian fund investor pays a management expense ratio of 1.25 to 1.49 per cent for a bond fund, and between two and 2.5 per cent for an equity fund.

Canadians also typically face a front-end load of between four and five per cent, “primarily because investors are unaware that this fee is negotiable,” the Morningstar study adds.

And it notes that Canadian MERs contain trailer fees – “which are fees fairly specific to the Canadian market” – that are paid by fund companies on an ongoing basis to the advisers that sold the funds.

“Canadian investors are comfortable with the fees because they don’t know how low these fees should actually be,” the Morningstar study asserts.

“Assets tend to flow into average-or higher-fee funds because Canadian investors use financial advisers to help them make decisions,” it adds.

“Advisers direct client assets to funds that pay better trailers. And since the trailer is included in the MER, the result is that assets flow into higher-fee funds.”

I note that MAPF now has another competitor, AIC Preferred Income Fund, which pays a trailer of up to 1% out of a management fee of 2.00% plus expenses.

Price changes were mixed today in the preferred share market, netting out to about flat; volume was very good.

About a year ago, there were wild claims being made (e.g., Naked Capitalism) that grading US municipalities on a global scale would bring about Nirvana and the end of useless and expensive municipal bond insurance. It turns out – surprise, surprise – that despite the changes, there are still credit differences between municipalities and the weaker credits still need insurance to flog their bonds:

An early contender to replace them, Warren Buffett’s Berkshire Hathaway Assurance Corp., was downgraded to Aa1 by Moody’s Investors Service in April. The billionaire investor in February called tax-exempt bond guarantees “a dangerous business.” His firm insured $3.3 billion in issues last year, ranking third in the industry.

Buffett’s warning isn’t stopping Macquarie Group Ltd., Australia’s biggest securities firm, from backing a new guarantor: Municipal and Infrastructure Assurance Corp. plans to sell its first policy by July, said Richard E. Kolman, the New York-based startup’s executive vice chairman.

“It is surprising to find that municipal bond insurance is anything but moribund in the early going in 2009,” wrote Philip J. Fischer, a Merrill Lynch & Co. municipal strategist in New York, in an April 6 report.

The overall market price changes were minimal today, although volume continued strong. It was most interesting to see that FixedResets were shut out of the volume-leaders table … that hasn’t happened in a while!

In the wake of the Fed’s stress tests, there has been a flurry of American bank issues:

Wells Fargo & Co. and Morgan Stanley, ordered to increase capital after the U.S. stress tests, raised $15 billion in stock and bond sales today, the first banks to respond to the government’s mandate.

Wells Fargo sold $7.5 billion of common stock, 25 percent more than it originally planned, according to a person close to the situation, and Morgan Stanley raised $7.5 billion by selling stocks and bonds, up from $5 billion it said yesterday that it would raise. Citigroup Inc. is exchanging an additional $5.5 billion of preferred securities into common stock. Bank of America Corp. plans to sell as many as 1.25 billion shares of common stock in a shelf registration and an undetermined amount of debt that wouldn’t be guaranteed by the Federal Deposit Corp.

I’m more impressed by the ease of raising capital than the stress test results. However, USD LIBOR has dropped significantly:

The London interbank offered rate, or Libor, that banks charge for three-month loans fell two basis points to 0.94 percent today, according to the British Bankers’ Association, bringing its decline in the week to seven basis points, the most since the five days through March 20. The Libor-OIS spread, a barometer of the unwillingness of banks to lend, fell today to the lowest level in more than nine months.

Many Readers, even Assiduous ones, will not really appreciate how good it feels to be talking about significant moves while citing single-figure-beep changes!

Another strong day on continued heavy volume.