PrefBlog

The Irish Government has announced its own bailout:

The Government has decided to put in place with immediate effect a guarantee arrangement to safeguard all deposits (retail, commercial, institutional and interbank), covered bonds, senior debt and dated subordinated debt (lower tier II), with the following banks: Allied Irish Bank, Bank of Ireland, Anglo Irish Bank, Irish Life and Permanent, Irish Nationwide Building Society and the Educational Building Society and such specific subsidiaries as may be approved by Government following consultation with the Central Bank and the Financial Regulator. It has done so following advice from the Governor of the Central Bank and the Financial Regulator about the impact of the recent international market turmoil on the Irish Banking system. The guarantee is being provided at a charge to the institutions concerned and will be subject to specific terms and conditions so that the taxpayers’ interest can be protected. The guarantee will cover all existing aforementioned facilities with these institutions and any new such facilities issued from midnight on 29 September 2008, and will expire at midnight on 28 September 2010.

Guaranteeing sub-debt is breathtaking!

Dexia got a massive European bail-out … equity based:

Belgium and France threw Dexia SA a 6.4 billion-euro ($9.2 billion) lifeline and ousted the chairman and chief executive officer as the widening financial crisis forced governments to prop up institutions across Europe.
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The capital infusion for Brussels- and Paris-based Dexia comes two days after Belgium, the Netherlands and Luxembourg agreed to inject 11.2 billion euros into Fortis, the largest Belgian financial-services company. Britain seized Bradford & Bingley Plc, the U.K.’s biggest lender to landlords, while Germany bailed out Hypo Real Estate Holding AG.

And as if poor old Fortis didn’t have enough problems, it looks like they have problems with an asset sale.

Writing in VoxEU, Daniel Gros & Stefano Micossi want to go even further and establish a permanent bail-out authority:

Europe’s largest banks are highly leveraged and thus vulnerable, as Fortis showed. But some of these banks are both too large to fail and too big to be rescued by a single government. The EU should: (1) urgently pass legislation to cover banks with significant cross-border presence and empower the ECB to provide direct support, and (2) create an EU-level rescue fund managed by an existing institution like the European Investment Bank.

And in a familiar scenario, UniCredit’s stock price has plunged because they might need to sell some:

UniCredit SpA, Italy’s biggest bank and the owner of Germany’s HVB Group, tumbled more than 10 percent for the second day in Milan trading amid concern the company may need to raise money to strengthen its finances.

UniCredit fell a record 38 cents, or 13 percent, to 2.60 euros, giving the bank a market value of about 34 billion euros ($48 billion). The stock, at its lowest since Dec. 4, 1997, has fallen 55 percent this year, compared with the 41 percent slide in the 69-member Bloomberg Europe Banks and Financial Services Index.

The fun isn’t confined to the banking sector: Jefferson County’s up against it:

Jefferson County, Alabama, faces a deadline today to reach a new agreement with creditors to avoid defaulting on bonds sold by its municipal sewer system that have pushed the state’s most populous county toward bankruptcy.

The county has won agreements since April with JPMorgan Chase & Co., bond insurers and other creditors to postpone full interest and principal payments on the $3.2 billion of debt it amassed building its sewers. The current agreement, which Governor Bob Riley brokered last month, expires today.

It’s a great time to be desperately in need of money, ain’t it? But don’t worry: Obama’s got a plan:

Barack Obama, the Democratic presidential nominee, today proposed increasing the Federal Deposit Insurance Corp. limit to $250,000 from the current level of $100,000.
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In proposing an increase, Obama noted that the current $100,000 limit was set 28 years ago and hasn’t been adjusted for inflation.

Utter craziness. $100,000 in the bank is comfortably in excess of what anybody should have for their day to day needs; small businesses and investors will just have to do their due diligence on their bank of choice if they need to hold more in a single bank. At that level of deposit, it is more than reasonable that bank customers be expected to understand the concept of diversification.

However, the decision appears to be unanimous: both presidential candidates and the FDIC itself want a deposit insurance limit of $250,000.

There has been some criticism of a diversification service which allows large deposits to be distributed amongst many banks and be entirely insured:

“When I first saw Promontory, I was amazed that the regulators would let it fly,” says Sherrill Shaffer, a former chief economist at the New York Federal Reserve Bank. “It undermines a lot of the safeguards around the FDIC deposit fund. I’m astounded that the FDIC has not picked up on that and tried to shut down that loophole.”

The loophole Promontory exploits is the FDIC rule that allows an individual to open up federally insured accounts of up to $100,000 at an unlimited number of banks.
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Edward Kane, senior fellow of the FDIC’s Center for Financial Research, says CDARS intercepts FDIC premiums.

“It’s portrayed as a public-spirited way to help customers as opposed to a way to game the system,” he says. “They’ve decided there’s a loophole that they’re in charge of.”

… which I confess I don’t understand. The only legitimate criticism I have been able to come up with is that it exploits the minimum and therefore deprives the financial system as a whole of the due diligence that would arise from a large depositor being worried about the soundness of the bank he uses. But this concern is not consistent with the criticism in the article, or with the level of disdain for the process expressed.

However, I have had some discussion with specialists in the field; the concern is that the FDIC is insuring all deposits anyway – the Wachovia deal – and should get paid for it. Infinite deposit insurance! Now there’s a moral hazard issue if ever there was one. Problems at IndyMac & WaMu and the subsequent wipe-out of common shareholders were brought to a head by a run on deposits … it seems to me that infinite deposit insurance will allow banks to ignore the hazards of losing confidence.

Rumours certain to get the Internuts into a lather are going around: Fair Value Accounting might be getting an overhaul … it’s the endless struggle … expected cash flows vs. market price …

… and the rumours proved true! There is an SEC press release offering “clarifications”:

When an active market for a security does not exist, the use of management estimates that incorporate current market participant expectations of future cash flows, and include appropriate risk premiums, is acceptable.
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Further, in some cases using unobservable inputs (level 3) might be more appropriate than using observable inputs (level 2); for example, when significant adjustments are required to available observable inputs it may be appropriate to utilize an estimate based primarily on unobservable inputs.
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Broker quotes may be an input when measuring fair value, but are not necessarily determinative if an active market does not exist for the security.
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when markets are less active, brokers may rely more on models with inputs based on the information available only to the broker.
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The results of disorderly transactions are not determinative when measuring fair value.
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Transactions in inactive markets may be inputs when measuring fair value, but would likely not be determinative.
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In general, the greater the decline in value, the greater the period of time until anticipated recovery, and the longer the period of time that a decline has existed, the greater the level of evidence necessary to reach a conclusion that an other-than-temporary decline has not occurred.

The last sentence is a classic of the genre.

And that’s all she wrote for September, 2008!

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

Pump up the volume! It has been a weekend of massive bank (almost-) failure and state intervention.

Details are still sketchy, but Citigroup is taking over Wachovia:

Citigroup Inc., the biggest U.S. bank by assets, will acquire banking operations of Wachovia Corp. for about $1.6 billion after shares of the North Carolina lender collapsed under the weight of overdue mortgages.

The all-stock deal equals about $1 a share for the Charlotte-based bank, ranked sixth by assets in the U.S. All depositors will be protected, according to the Federal Deposit Insurance Corp., which helped broker the takeover by Citigroup. The New York-based bank plans to cut its own dividend in half and raise $10 billion in capital as it takes on Wachovia’s senior and subordinated debt.

The FDIC states:

Citigroup Inc. will acquire the bulk of Wachovia’s assets and liabilities, including five depository institutions and assume senior and subordinated debt of Wachovia Corp. Wachovia Corporation will continue to own AG Edwards and Evergreen. The FDIC has entered into a loss sharing arrangement on a pre-identified pool of loans. Under the agreement, Citigroup Inc. will absorb up to $42 billion of losses on a $312 billion pool of loans. The FDIC will absorb losses beyond that. Citigroup has granted the FDIC $12 billion in preferred stock and warrants to compensate the FDIC for bearing this risk.

Dealbreaker has the Citi Investor Presentation.

The status of the Canadian subsidiary, Congress Financial Capital Company, is not entirely clear at the moment; they raised CAD 400-million in 2005; but since they are (via intermediaries) 100% owned by Wachovia Bank National Association I am assuming (pending confirmation from the company) that their debt is covered under the deal, but I note that S&P put the issue on Watch-Negative this afternoon; its current S&P rating is A+.

In the meantime, the Europeans were busy:

European governments stepped in to rescue Fortis, Bradford & Bingley Plc, and Hypo Real Estate Holding AG as tremors from the U.S. credit crisis reverberated around the world.

The U.K. Treasury seized Bradford & Bingley, Britain’s biggest lender to landlords, while governments in Belgium, the Netherlands and Luxembourg threw an 11.2 billion-euro ($16.3 billion) lifeline to Fortis. Germany guaranteed a loan to Hypo.

… and the Fed is revving up the helicopters:

The Fed increased its existing currency swaps with foreign central banks by $330 billion to $620 billion to make more dollars available worldwide. The Term Auction Facility, the Fed’s emergency loan program, will expand by $300 billion to $450 billion. The European Central Bank, the Bank of England and the Bank of Japan are among the participating authorities.

The question remains: How many helicopters?

Nouriel Roubin loathes TARP:

Indeed, the plan also does not address the need to recapitalize those financial institutions that are badly undercapitalized: this could have been achieved by using some of the $700 billion to inject public funds in ways other and more effective than a purchase of toxic assets: via public injections of preferred shares into these firms; via required matching injections of Tier 1 capital by current shareholders to make sure that such shareholders take first tier loss in the presence of public recapitalization; via suspension of dividends payments; via a conversion of some of the unsecured debt into equity (a debt for equity swap). All these actions would have implied a much lower fiscal costs for the government as they would have forced the shareholders and creditors of the banks to contribute to the recapitalization of the banks.

As I noted on September 25, I would prefer a system whereby Treasury would buy senior preferred shares in distressed – but still solvent – banks, with a punitive coupon and the proviso that no dividends be paid on shares junior to the new issue until the issue was retired.

Via Dealbreaker comes a link … it appears that Richard A. Posner holds the same views:

A more palatable approach would be for the government to drive a Warren Buffett style hard bargain, in which, rather than buying anything from banks, the government would invest in them in a form, such as purchase of newly issued preferred stock, or bonds with a long maturity, that would augment the banks’ capital and thus enable banks to make more loans. That would avoid conferring a windfall on the banks by overpaying them for their bad securities; no one thinks Buffett is conferring a windfall on Goldman Sachs. After the industry was back on its feet, the government could sell the bank stocks or bonds that it had acquired.

… although I will note that his implication that long-term bonds are, or are equivalent to, capital is at best imprecise.

And in the end TARP failed:

Markets plunged as the House rejected, by a vote of 228 to 205, the $700 billion measure to authorize the biggest government intervention in the markets since the Great Depression. The Dow Jones Industrial Average fell 564 points, or 5 percent to 10,579, at 3:05 p.m. New York time.

The defeat of the legislation set off a scramble among the plan’s backers for additional support before another vote, which likely won’t come until later in the week.

We now await Son of TARP.

James Hamilton of Econbrowser has a good piece on understanding the TED spread.

There are interesting reports that Treasury repos are being done for fail-money; Dealbreaker notes that failed trades are increasing. Now there’s an indication of a locked up credit market if ever there was one!

Laeven & Levine have an article on VoxEU, Governance of banks, looking forward to the end of the crunch and the new – or changed – regulation that will be coming. They warn:

We find that banks with more powerful owners (as measured by the size of their shareholdings) tend to take greater risks.

This supports arguments predicting that equity holders have stronger incentives to increase risk than non-shareholding managers and debt holders and that large owners with substantial cash flows have the power and incentives to induce the bank’s managers to increase risk taking.

Furthermore, the impact of bank regulations on bank risk depends critically on each bank’s ownership structure such that the relationship between regulation and bank risk can actually change sign depending on ownership structure.

· For example, our results suggest that deposit insurance is only associated with an increase in risk when the bank has a large equity holder with sufficient power to act on the additional risk-taking incentives created by deposit insurance.

· The data also suggest that owners seek to compensate for the loss in value of owning a bank from capital regulations by increasing bank risk.

· Stricter capital regulations are associated with greater risk when the bank has a sufficiently powerful owner, but stricter capital regulations have the opposite effect in widely held banks.

Ignoring bank governance leads to incomplete and sometimes erroneous conclusions about the impact of bank regulations on bank risk taking.

PerpetualDiscounts fell in line with general credit markets today, with an average pre-tax bid-YTW of 6.29% … on the way up it hit that figure on July 9, on the way down on August 5. That’s about 8.81% at the standard 1.4x equivalency factor and Long corporates now yield about 6.5% … so the pre-tax interest equivalent spread to long corporates remains fairly constant at about 331bp.

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

In a post tweaking Republicans for opposition to TARP, Menzie Chinn of Econbrowser passes along the fascinating observation that yield levels for non-financial commercial paper have become incalculable:

On Tuesday, the US Federal Reserve quietly admitted that it had been temporarily unable to calculate yield levels for non-financial commercial paper, issued by AA-rated companies for one to three months.

The problem, it seems, was a dire lack of activity; or, as Morgan Stanley says, “extreme levels of stress and illiquidity”. More specifically, while investors are still purchasing ultra short-term notes – say, for one or two days – on a massive scale, they are reluctant to buy instruments that last longer than a few days. That may be temporary (yesterday yield prices were apparently returning to the AA sector again although they were unusually high). However, even a temporary freeze is remarkable. After all, these non-financial companies typically have nothing to do with Wall Street or toxic mortgage debt.

The data is not to be found in the Federal Reserve Release H.15 for September 22: rates are listed for one- and two-month nonfinancial CP, but for three-month all we get is “n.a.”. The only ray of sunshine I can find is that the outstandings are in line with seasonal norms.

In a classic example of Banks’ advantage in hedging liquidity risk, it has been reported that corporations are drawing heavily on committed lines:

Goodyear Tire & Rubber Co., General Motors Corp., and International Lease Finance Corp. lead companies drawing on so- called revolving loans obtained before the credit crisis began in July 2007. Banks had more than $1.4 trillion in untapped loan commitments as of a year ago, the most on record, according to the Shared National Credit survey by four U.S. regulators including the Federal Reserve.

Corporate treasurers, blocked from accessing capital markets, are turning to the funding as the failure of Lehman Brothers Holdings Inc. sparks concern that other banks may be unable to provide funds. Pressure to find cheaper, longer-term capital is also building as costs rise in the $1.7 trillion short-term debt market. Banks are being forced to come up with the money after swallowing $521 billion of writedowns and losses.

We will have to see some of these borrowers biting the bullet and paying up to issue bonds before the strain on the Fed’s discount window (mentioned yesterday) will start to ease.

The JPM/WM takeover was discussed yesterday. We are told that:

Pressure on WaMu intensified in the last three months as market conditions worsened. An outflow of deposits began on September 15, 2008, totaling $16.7 billion. With insufficient liquidity to meet its obligations, WaMu was in an unsafe and unsound condition to transact business. The OTS closed the institution and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. The FDIC held the bidding process that resulted in the acquisition by JPMorgan Chase.

I would be most interested in learning what fraction of that $16.7-billion was uninsured deposits. One would imagine the answer would be “all”, but one sometimes imagines rational things in an irrational world!

There has been a similar revelation regarding a run on Lehman:

Lehman Brothers Holdings Inc.’s brokerage lost more than $400 billion in assets in the months before its parent filed for bankruptcy protection, according to the trustee overseeing customer accounts.

Lehman’s holding company filed for bankruptcy Sept. 15 claiming $639 billion in assets, using four-month-old data. The wholly owned brokerage unit had shrunk to less than $100 billion in assets from $500 billion “a few months ago,” according to a Sept. 19 court statement by James Giddens, the trustee overseeing the settling of Lehman brokerage customer accounts by the Securities Investor Protection Corp.

Dosado and allemande left! The banks continue square-dancing, with rumours that Wachovia has asked Citigroup if they could spend some time together at the social … now that WB’s been spurned by MS.

And here’s a little throwaway line in a virtually unrelated article:

TD Ameritrade said it would spend up to $50 million to offset losses for its customers who have money in the Reserve Primary Fund. Other investors still don’t know the fate of their savings.
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TD Ameritrade used the Reserve’s Primary Fund as one of its cash “sweep” accounts, a place where consumers could automatically park cash from a maturing certificate of deposit, for example.

In the past, I’ve expressed concern about bank-branded MMFs … perhaps I should have cast my net wider!

PerpetualDiscounts lost ground today, closing with a weighted-average bid-YTW of 6.23%, equivalent to 8.72% interest at the 1.4x equivalency rate. Long Corporates now yield 6.50%, so the pre-tax interest-equivalent spread is now 222bp … narrowing in slightly, but still at very elevated levels.

Massive crosses today by Scotia, with National Bank playing a supporting role. Today was the first day for an October settlement date and there wasn’t too much price movement for these issues … so my guess is that they were all internal crosses. Who wants to spend the weekend matching up the trades to the holdings of one of the big funds?

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