PrefBlog

Pussycat, in a desperate attempt to sound tough, is putting What-Debt? on “probation”:

[Pussycat] said his party is prepared to “swallow hard” and support the Conservative government, provided they agree to table regular updates outlining how they are living up to their commitments outlined in the federal budget.

We have now officially forgotten the lesson of hitting the wall in 1994 – I confidently predict twenty years of deficits until we hit the wall again.

Rubin has spoken out against fair-value accounting:

“I spent my whole life at Goldman Sachs believing in mark- to-market accounting, and having said that, if you look at the experience from the last two years, I think mark-to-market accounting has led to terrible vicious cycles in asset prices,” Rubin, the former U.S. Treasury secretary, said during a discussion at the 92nd St. YMCA late yesterday.

Companies including Citigroup and American International Group Inc. say mark-to-market, also known as fair-value accounting, doesn’t work when few buyers are willing to trade assets like subprime mortgages. Proponents such as the U.S. Financial Accounting Standards Board say the rule adds to transparency and gives investors information about companies.
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Under reserve accounting, assets like loans are carried at cost, offset by reserves for potential losses.

I have stated many times that the regulatory regime should differentiate between banks and investment firms. Fair value accounting is appropriate for investment firms, at which the default assumption is that they hold assets for a short period, then sell them. Reserve accounting is often (though not always) more appropriate for banks, at which the default assumption is that they hold assets until maturity.

The FOMC released its monetary policy statement today – no real surprises.

The BoC has released an analysis of bond auction formats by Olivier Armantier and Nourredine Lafhel, examining the methods by which bonds can be auctioned. Three systems are considered:

• discriminatory auctions: the highest bids are filled at the price bid until supply is exhausted
• at uniform-price auctions, bidders pay the stop-out price for all units they requested at prices exceeding the stop-out price.
• At Spanish auctions, bidders pay the average price of the bids for all their bids above the average and their bid price if it below the accepted average

it appears that the ranking of the two auction formats may only be established on a case-by-case basis.3 As demonstrated by A&S (2005), the presence of asymmetries across participants is an important factor in ranking auction formats in terms of the revenues they generate. Indeed, A&S show that risk averse and/or less-informed bidders may become relatively more aggressive at uniform-price auctions, since they do not have to pay their bids.
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Table 7 also indicates that, had the Canadian government conducted the 100 auctions in our sample under the Spanish format instead of the discriminatory format, it would have significantly increased its revenues by an average of 2:34%; or close to 52:71 million dollars, per auction. Furthermore, we can see in Table 8 that, given the assumptions underlying the model, Canadian government revenues would have been higher in roughly 62% of the auctions if it had conducted them under the Spanish format. Observe also that the Spanish format dominates in an additional dimension. Indeed, we can see in Table 7 that the standard deviation of the revenues generated across the 100 auctions is the smallest under the Spanish format. In other words, the stream of revenues generated by the Canadian government from one auction to the next would have been more stable than under the current pricing rule. Finally, Table 7 indicates that the additional revenues the Canadian government would generate by switching from the discriminatory to the Spanish format, would be almost equally spread across maturities. Indeed, we are unable to detect any clear pattern in the additional revenues generated at auctions for 30, 10, 5 or 2 years bonds.
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In other words, as found by Armantier and Sbaï (2006), the Spanish format appears to provide an appropriate compromise between asking bidders to pay up to their bids, and promoting aggressive behaviour by o¤ering participants the guarantee that they will not have to pay more than the average winning bid.

SplitShares did well today, presumably on hopes that the bad-bank bailout plan will lead to a world of smiling bankers and bonuses for everybody. Well … I wouldn’t want to say it’s a completely insane hope. I’ll just say that every effort yet to persuade banks to sell their so-called toxic assets in bulk and at a politically acceptable price has failed. I think that Caballero’s plan has a better chance of success.

Fixed-Resets were down again today while PerpetualDiscounts were up, in a continuing fine reversal of their standard form in 2008. Volume continued high. The new RY Fixed-Reset 6.25%+450 will commence trading tomorrow with the symbol RY.PR.R.

There will be a chance to see a milestone in the recovery of the credit market this week – commercial paper held by the Fed will mature:

About $245 billion of 90-day commercial paper that companies sold to the Federal Reserve starting in October will mature this week and next, central bank data show. As much as $50 billion to $70 billion of the debt may be rolled over and bought by investors, according to Barclays Capital in New York.
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Rates on AA ranked financial commercial paper due in 90 days fell to a record low of 0.28 percent on Jan. 8, or 21 basis points more than the U.S. borrowing rate, Fed data show. They have since jumped to 1.04 percent, or 94 basis points more than the government yield on 90-day Treasury bills, as investors prepared to absorb at least $486 billion of overall paper coming due this week, according to Fed data. The gap peaked at 374 basis points on Oct. 15.

The Fed demands 2.24 percent to own unsecured debt, including a one percentage point fee, under its Commercial Paper Funding Facility.
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Fed purchases declined in the first two weeks of the year as investors picked up the slack, reducing government buying to $179 million. First-tier commercial paper assets in prime money- market funds increased 26 percent to $790.6 billion as of Jan. 13, iMoneyNet data show.

Purchases jumped last week to $15.7 billion, the most since November, as some companies remained unable to sell 90-day commercial paper to investors at rates below the cost of issuing to the Fed.
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Policy makers also may force companies to wean themselves from federal help by making it “increasingly expensive” to use the CPFF, said Louis Crandall, the chief economist at Jersey City, New Jersey-based Wrightson ICAP, a research unit of ICAP Plc, the world’s largest inter-dealer broker.

The Fed should indeed be increasing its spread to get the banks inter alia to pick up the slack. This would be an important step in removing the Fed from routine intermediation and shrinking the balance sheet. Across the Curve, however, cites some street chatter to the effect that the rollover will be a non-event. But … that’s what we like. Non-events. Aren’t they lovely?

There is an encouraging sign! $150-billion in 84-day TAF money attracted only $136-billion bids and went at 0.25%. This follows a bid-to-cover of 0.72 on January 12, 0.69 on Dec 29, 0.42 on Dec 15 and 0.44 on Dec 2. So this is good. Unfortunately, the Fed is having to purchase agencies in size so don’t celebrate too soon! On the other hand – any more hands and I’ll become an economist – today’s $40-billion 2-Year auction went well and lit up the Treasury market.

I will admit though, that I am becoming a little concerned. Across the Curve contains several ecstatic references to positive carry today – for example, here and here. I heard a lot of remarks about positive carry in 1993 … and we all know what happened in 1994, don’t we?

Carney gave a speech on deflation:

It is worth noting that our lower overnight rates have largely been passed through at shorter maturities. Since the easing cycle began in December 2007, we have lowered the overnight rate by 350 basis points. The prime rate has fallen by 325 basis points, Bankers Acceptance rates (key short-term financing instruments for corporations) have fallen by about 380 basis points, and variable rate mortgages by about 185 basis points.

At longer maturities, the declines have been more modest. In part, this reflects the typical pattern, as long-term rates tend to be less volatile than short-term rates over the business cycle. For example, five-year fixed-rate mortgages have fallen by just over one and a half percentage points. Corporate bond yields have been virtually flat, as a substantial increase in the risk premium charged by investors has offset the decline in government bond yields. While the widening of spreads at longer maturities is larger than usual, this partly reflects the fact that these spreads were unusually narrow to begin with.

The Bank has taken into consideration the higher risk premiums demanded in today’s markets in setting its overnight rate. As well, it has taken into account the effect on future Canadian inflation of the lower level of foreign demand that has resulted, in part, from financial difficulties in other countries. The policy rate is lower than it otherwise would be in the absence of these difficulties.
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To conclude, let me say that the inflation target that has served Canada so well when inflation was above the 1 to 3 per cent control range, will also serve it well when inflation falls temporarily below that range. So let me leave no doubt, no uncertainty about the Bank’s commitment. Our focus is clear, our actions consistent, and our objective explicit: 2 per cent CPI inflation.

And the Bank published another working paper, What Accounts for the U.S.-Canada Education-Premium Difference?:

This paper analyzes the differences in wage ratios of university graduates to less than university graduates, the education premium, in Canada and the United States from 1980 to 2000. Both countries experienced a similar increase in the fraction of university graduates and a similar increase in skill biased technological change based on capital-embodied technological progress, but only the United States had a large increase in the education premium. Using a calibrated Krussel et al. (2000) model, the paper finds that the cross country difference is in equal proportion due to the effective stock of capital equipment, the growth in skilled labor supply relative to unskilled labor and the relative abundance of skilled population in 1980. Growth in the working age population is unimportant for the difference.

In other words, we don’t really need a lot more graduates; what we need is money to buy equipment for existing graduates to put their skills to use. I confidently predict that this nuance will be ignored in all future political debates.

Spend-Every-Penny introduced his pre-election budget today. There are some good things … some bad things. In summary:

After taking into account the cost of the measures proposed in Budget 2009 to support the economy, the Government is projecting deficits of $1.1 billion in 2008–09, $33.7 billion in 2009–10, $29.8 billion in 2010–11, $13.0 billion in 2011–12, $7.3 billion in 2012–13 and a surplus of $0.7 billion in 2013–14.

It will take many years of $0.7-billion surpluses to pay for the planned spending, but it didn’t stop him from cutting taxes, just like Mr. Bush:

Taxpayers will begin to benefit from the proposed personal income tax reductions as soon as the Canada Revenue Agency revises its tax withholding tables, in spring 2009.

It is estimated that, together, these measures will cost $470 million in 2008–09, $1,885 million in 2009–10 and $1,950 million in 2010–11.

There is funding for new infrastructure, but no indication that recipients must have a credible plan to pay for maintenance. The word “dividend” does not appear in the document, so I will assume that implications for preferred share investment are minor.

I will reserve special scorn for the “Extraordinary Financing Framework”, partially because it is doomed to be ignored by most. Essentially, the government will provide up to $200-billion worth of intermediation, taking assets onto its books financed by sale of Canada bonds. There’s nothing wrong with that, in principle. However:

To help manage the EFF, the Government will form the Advisory Committee on Financing. This committee will include users and suppliers of financing, along with other experts. The committee will advise on financing conditions and the design, scope and scale of initiatives under the EFF.

There’s already a competent body to administer the programme: it’s called the Bank of Canada. What-Debt’s politicization of monetary policy is absurd – but, after all, he’s the guy who went out of his way to politicize nuclear power regulation.

PerpetualDiscounts managed to eke out a marginal gain today, while FixedResets continued their recent decline.

I complained on January 19 that the political leverage given to politicians by the TARP funds would lead to calls to expand non-economic but politically attractive business methodologies. Dealbreaker passes along more commentary on this subject:

Surprise! Now anyone with public money is bathing in the gelatinous “squish” of a million squirming appetites, forced to submit to a literal morass of legislative tentacle sex with hundreds of pet projects, social theory experiments and personal causes (from the left and the right), not to mention the utter chaos and unpredictability of having every idiot in the House pop off about what new rule you should be following this week. Predicting what is or will be expected of you (or what you may or may not be paid) is a nightmarish prospect.

Dealbreaker also comments on the Caballero Insurance Plan that I have previously written about:

Typically when Congress can’t get the political backing to actually pass a bill to pay for something, they do the next best thing: get the political backing to guarantee something, or insure any losses. At the very least this reduces the cost of capital for the activity. Throw some tax benefits in and you go a long way to encouraging the behavior you are trying to stimulate. So potent can the effect be that you don’t even necessarily need a direct guarantee. (The “too big to fail” condition and the “implicit guarantee” of a Fannie Mae is a good example here).
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The problem with this level of insurance is that while it preserves public capital (and prevents dilution) you can write a lot of insurance before anyone starts to notice that you are on the hook for, well, a lot of insurance. (See e.g., Fannie and Freddie).

An interesting day in the preferred market! Split shares got hurt, presumably due to continued equity weakness – a lot of the January 22 NAVs are coming out and don’t look very pretty. FBS.PR.B is now valued below the preferred par value, but is still rated Pfd-2(low) by DBRS, and has been under review negative for three months now.

Fixed-Resets got hurt, presumably due to continued heavy issuance: a new CIBC fixed-reset 650+447 was announced today, bringing the total number of pending issues to five. Amidst all this, PerpetualDiscounts were up on the day, albeit marginally and with a certain sloppiness.

TD went into a frenzy of activity, trading a huge number of blocks after the close – remember that after hours trading is fine, but it all has to occur at the same price as the last trade of a board lot.