PrefBlog

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.
…
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.
…
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.