PrefBlog

Naked Capitalism provides a very good round-up of the BSC/JPM deal commentary. I will quibble with the repeated suggestion that formal bankruptcy Monday morning was the only alternative to a deal. I agree that their options (speaking strictly in terms of their economic interests as shareholders, not as employees and creditors) were both limited and unpalatable – I pointed that out on March 14, but there is the question of the Japanese banks. Naked Capitalism – Why didn’t Bear use its credit lines? – couldn’t understand why they didn’t draw their lines; and the Japanese banks have previously advertised their willingness to lend to any player who is sufficiently desperate.

So – I think – Bear had a choice, albeit one with which Hobson would be familiar. Of particular interest in the post is the discussion of the alleged contract glitch that I briefly mentioned yesterday. Dealbreaker has posted twice on the issue, claiming that the conference call was crystal clear and then backing up his statement with the transcript. Upon thinking about it a little more myself – and reviewing the transcript – I’m inclined to believe that Dealbreaker is correct and the alleged glitch was in fact an explicitly desired thing.

Look: What’s the point of the guarantee in the first place? To ensure that Bear can operate until they’re formally taken over, right? If Bear had difficulties finding counterparties on the Friday, those difficulties were going to double on Monday (assuming that they did not file for bankruptcy at the crack of dawn). In order to serve its purpose, the guarantee had to be absolutely binding – who’s going to enter into a trading committment of a year, say (CDSs and Swaps will typically be 5 years) on the basis of a guarantee that might vanish in a month? JPM had to make the guarantee binding and lengthy, or there was no point going through the motions.

In familiarly cheery news, the US housing price drop is accellerating:

Home prices in 20 U.S. metropolitan areas fell in January by the most on record, a sign the housing recession is deepening, a private survey showed today.

The S&P/Case-Shiller home-price index dropped 10.7 percent from January 2007, after a 9 percent year-on-year decrease through December 2007. The gauge has fallen for 13 consecutive months.
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Lehman Brothers Holdings Inc. forecasts home prices as measured by Case-Shiller will decline another 10 percent by the end of 2009. It predicts new-home sales will bottom in the middle of this year and existing-home sales and housing starts will reach a trough in the third quarter.

“Prices have reached what might be called a fair value,” Dan North, chief U.S. economist at Euler Hermes ACI in Owings Mills, Maryland, said in a Bloomberg Television interview before the report. “However, prices have still got to go substantially past that” to trigger demand and a recovery.

A separate report from the Office of Federal Housing Enterprise today showed home values fell 3 percent in January from a year ago, and 1.1 percent from December.

The S&P/Case-Shiller index measures repeat home sales in 20 U.S. cities, regardless of mortgage size, while the Ofheo monthly index excludes sales of homes with mortgages higher than $417,000, the maximum allowed during that time for homes bought by government-chartered Fannie Mae and Freddie Mac.

There is further commentary on the WSJ Blog.

In other news of interest Jeffrey Frankel argues that commodity prices are rising due to low real interest rates rather than due to new demand from the BRIC bloc.

Assiduous Readers will be familiar with my view that banking regulation needs to be improved; primarily by drawing a brighter line between the core banking system and the shadow banking system (e.g., by increasing capital requirements for committed – or effectively committed, as is the case with bank-sponsored SIVs – credit lines) and reviewing capital requirements for non-core-but-still-bloody-important institutions like investment banks (such as margin requirements on derivatives, as mentioned yesterday). I’m not alone in this view: Mark Thoma of Economist’s View got some ink in the WSJ Blog by musing about the need for reform:

There is quite a bit of discretionary authority in the hands of regulators. As the philosophy of both parties has drifted toward a hands off approach over time, and as appointment after appointment to this or that agency has reflected that changing philosophy, the accompanying regulatory oversight has changed along with it. The changes have been more dramatic under Republican administrations, and the current administration strongly prefers a hands off approach on all matters involving economic policy (with the exception of tax cuts for the wealthy), so it’s no surprise that the same philosophy has, over the last several years, filtered into the offices charged with regulatory oversight more so than in the past (and appointments based upon how much someone contributed and the strength of their ideology rather than their competence hasn’t helped).

Very – very! – light on specifics, but it’s a start. I might as well stake out my position pretty clearly right now … I want a core banking system, an investment banking system and a shadow banking system, with exposure between the levels being determined by margin and capital requirements rather than flat prohibitions and directives. What’s more, I believe that the appropriate policy response can better be described as “tweaking” rather than “reform”. The pendulum never swings half-way however, so it will be a fight – and certainly the political response so far has been to erode capital at the GSEs and FHLBs to protect Americans’ God-given right to McMansions.

The Fed has announced that yesterday’s TAF auction ($50-billion, one month) came in at 2.615% for one month money – about 4bp less than current LIBOR. This continues to be a good sign – a rate significantly above LIBOR would imply that there were players shut out of the interbank market desperate for funds. For those having trouble with the plethora of new Fed acronyms, remember that the TAF is restricted to banks and is fully collateralized.

In news that will cause fear and trembling amongst BCE investors (the equity kind, anyway), the Clear Channel buy-out looks sick:

Clear Channel Communications Inc. dropped in extended trading after the Wall Street Journal reported its $19.5 billion private-equity buyout is close to falling apart.

The buyout group, led by Thomas H. Lee Partners LP and Bain Capital Partners LLC, hasn’t been able reach an agreement on terms with the banks financing the transaction, the newspaper said today, citing people familiar with the matter. The lenders include Citigroup Inc., Morgan Stanley, Deutsche Bank AG, Credit Suisse Group, Royal Bank of Scotland Group and Wachovia Corp.
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Clear Channel, the largest U.S. radio broadcaster, dropped 14 percent to $28 after closing at $32.56 in New York Stock Exchange composite trading. Since the buyout was announced in November 2006, the stock has traded below the $39.20-a-share offer price because of investor concerns that the deal won’t be completed. Credit-market turmoil has made it harder for buyout firms to obtain financing.
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Clear Channel’s 5.5 percent notes due in September 2014 rose 2.75 cents, or 4.4 percent, to 65 cents on the dollar to yield 13.9 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

A day enlivened by the BMO new issue of 5.80% perps. Volume picked up nicely, but perpetualDiscounts got smacked as players adjusted their portfolios to account for … for … for … for what they think the new standard is. Or something.

There were twenty-four other index-included $25-pv-equivalent issues trading over 10,000 shares today.

Menzie Chinn of Econbrowser reviews the policy response to the credit crunch:

First, methinks the Administration protests too much, about “not bailing out” investors. If it were indeed the case that it was against further contingent liabilities being taken on by the Federal government, it would not have allowed the increase in the maximum size of conforming loans guaranteed by the Government Sponsored Enterprises, Fannie Mae and Freddie Mac. Nor would capital requirements have been reduced at exactly the time that a higher capital cushion would be in order, given the state of the economy. In addition, it would have taken some sort of action to limit the borrowing taking place through the Federal Home Loan Banks (see [5], [6] for discussion of recent actions, and implications).

Second, whatever the reasons for the Administration’s actions, I think a very serious problem is that, by virtue of the Administration’s abdication of a substantive role (see Hubbard’s comment on this point), the Fed is lending to entitites it does not regulate. The Bear Stearns collapse might have been seen as a case where the Fed had to undertake unconventional actions, because of the rapidity of developments. But with the Administration providing an uncompromising stance, who will step in the next episode? If it’s the Fed again, then Blinder’s critique will take on heightened relevance.

I’ll agree with his first point – as I said most recently in the comments to March 20, a slight relaxation in the GSE capital requirements may be justifiable, but should be accompanied by a schedule whereby the capital standards would approach banks. Similarly, the FHLBs should be regulated like the banks they are.

Prof. Chinn’s second concern, the separation of regulatory and last-lender powers, does not seem quite so cut-and-dried to me. The issue was last discussed in PrefBlog in the post regarding Willem Buiter’s Prescription and on December 5 in response to a VoxEU article by Stephen Cecchetti. There are certainly good arguments to be made regarding combination of roles as far as the banks are concerned – and, by and large, I agree with these arguments – but the arguments for extending Fed oversight to the brokerages is a little less clear.

As I have stated so many times that Assiduous Readers are fed up to the back teeth with the incessant drone – we want a shadow banking system! We want to ensure that there are layers of regulation, with the banks at the inner core and a shock-absorber comprised of brokerages that will serve as a buffer between this core and a wild-and-wooly investment market. This will, from time to time, require (or, at least, encourage) the Fed to step in and take action, but the alternative is worse.

Which is not to say that regulation cannot be improved! Regulation can always be improved! Margining requirements for derivatives may have to be reviewed – interest rate swaps and credit default swaps particularly, without simply making the lawyers happy by getting them to invent a new instrument.

If I buy $1-million of a corporate bond from my broker, I have to put up 10% margin. Seems to me that if sell credit protection, I should have to put up 10% of notional. And if I buy credit protection, I should have to put up at least 10% of the present value of the contractual payments.

Similarly with an interest-rate swap: if I pay floating to receive fixed, that is functionally equivalent to going long a fixed-rate bond and short a floating-rate one. If I do this in the physical market, I will be allowed a consideration as far as offsetting credit risk is concerned, but I won’t get away scot-free! When done as a derivative, I should have to put up … 2%? … of notional.

And in both cases, positions should be marked to market at least monthly. As reported by the WSJ, Barney Frank, Chairman of the House Financial Services Committee, wants a review of margin requirements (among other things), but has no concrete proposals at this time:

Reassess our Capital, Margin and Leverage Requirements (and the nature of “capital” itself). This crisis has illustrated that seemingly well-capitalized institutions can be frozen when liquidity runs dry and particular assets lose favor.

The BSC/JPM deal was a big story again today, with the deal value quadrupling in exchange for a couple of things:

• JPM is getting a new issue of 39.5% of BSC as treasury stock
• A possibility that JPM will take $1-billion first-loss on the $30-billion Fed financing

Seems to me that this makes the deal a certainty, with the Fed managing to keep its self-respect by being able to point out that the billion dollars extra given to BSC shareholders has been met by a corresponding reduction in their loss-exposure on the financing. The certainty will be good news for JPM in terms of staff retention, as well as considerations that the guarantee of liabilities might have been poorly drafted, as reported upon by Naked Capitalism.

The WSJ has reported:

At the merger’s closing, the New York Fed will take control of about $30 billion of assets as collateral for $29 billion in financing from the New York Fed. The Fed will provide the funds at its primary credit rate, 2.5%, or a quarter percentage point above the benchmark federal funds rate. Under the new terms, J.P. Morgan would have to eat the first $1 billion in losses from those assets; the Fed would have rights to any gains.
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The New York Fed plans to provide additional details about the deal’s terms later Monday.

The New York Fed hired BlackRock Financial Management Inc. to manage the $30 billion portfolio “to minimize disruption to financial markets and maximize recovery value,” it said in a statement. Fed officials sought out BlackRock, seeing it as one of the few firms without conflicts of interest that could handle the task in the timeframe that was necessary. The Fed hasn’t provided details of the portfolio, whose assets were valued on March 14, but it’s believed to include hard-to-trade securities tied to riskier home mortgages.

Boy, that BlackRock’s got a good gig, eh? Paid to manage a portfolio that’s virtually untradeable and in run-off mode. A New York Fed press release confirms the terms.

In yet another indication that Regulation FD and its Canadian equivalent, National Policy 51-201, are in urgent need of amendment, the Fitch / MBIA battle has hotted up:

Fitch Ratings said it will still assess MBIA Inc.’s financial strength, snubbing a request by the bond insurer to withdraw the ratings.

Fitch will rate MBIA as long as it can maintain a “clear, well-supported” view without access to non-public information, the ratings firm said today in a statement.
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MBIA asked Fitch earlier this month to stop rating the company because of disagreements about modeling for losses. Fitch is the only credit rating company considering a downgrade of MBIA. Moody’s Investors Service and Standard & Poor’s both affirmed the company earlier this month after MBIA raised $3 billion in capital, eliminated its dividend and stopped issuing asset-backed insurance. Fitch will complete its review in “the next few weeks,” Joynt said.

Fitch probably won’t be able to continue rating the company for long, MBIA said today in a statement responding to the announcement.

“The non-public information currently in Fitch’s possession soon will become out of date, and public information alone will be insufficient to maintain the ratings,” MBIA said.

OK. So here we have MBIA saying that investors cannot possibly come to a well-supported conclusion about credit quality without access to material non-public information, which is available only to credit rating agencies that make their credit ratings public (the Lord alone knows what equity investors are supposed to conclude). How many times must this conclusion be repeated before the exemption is repealed and the required information is publicized?

Naked Capitalism has excerpted and colourized a post by Brad Setser regarding reliance of the US on foreign central banks:

So long as they are piling into safe US assets, central banks are contributing the “liquidity” to a market that doesn’t need any liquidity. They are helping to push Treasury rates down. And their activities, while rational from the point of view of conservative institutions seeking to avoid losses (beyond those associated with holding the dollar), also may be aggravating some of the difficulties in the credit markets. Private funds fleeing the risky US assets for the emerging world generally end up in central bank hands and currently seem to be recycled predominantly into safe US assets.
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In January, official investors – central banks and sovereign funds – provided the US with $75.5 billion in financing. Annualized, that is about $900b. That’s huge. It is also more than the US current account deficit. Central banks and sovereign funds are effectively financing the runoff of some private claims on the US. If the US were an emerging economy, that might be called “capital flight.”

$53.4b of the $75.5b in overall official inflows came from the purchase of long-term US debt and equities. $22.1b came from a rise in short-term claims (the $15.2b increase in short-term Chinese claims likely explains most of the overall rise in short-term claims).

That $53.4b in long-term inflow was concentrated at the two poles of the risk distribution: Official investors purchased $36.1b in Treasuries, next to no agencies (*), sold corporate debt and bought $13.9b in US equity. This is what an anonymous (but well informed) commentator here called a barbell portfolio. Buy safe stuff or buy risky stuff but don’t buy much in between.

Well – that’s what happens when you run a fiscal deficit for so long … the country’s financial markets become the plaything of foreignors.

Volume picked up a little in the preferred share market today, but was nothing special – no major price trends either.

There were fifteen other index-included $25-pv-equivalent issues trading over 10,000 shares today.