PrefBlog

I weep for this world. In a move mocking the rule of law, British banks are being asked (told) to sign extra-legal agreements with the government:

Chancellor of the Exchequer Alistair Darling will put pressure on senior executives at Britain’s banks to sign agreements promising to end all tax avoidance, a person with knowledge of the plans said.

The Revenue and Customs wing of the Treasury on Monday will seek board level agreement from all U.K. banks and consult them on how to implement the plan, the person said. Banks refusing to sign the code will face more intrusive inspections from tax authorities.

The revenue office wants to change behavior to make sure banks comply with the the spirit as well as the letter of the law, the person said.

Fascism doesn’t usually come with fiery oration and jackboots. Fascism comes with earnest and well-meaning bureaucrats.

There might be some excitement in the CMBS business:

The ratings on $235.2 billion in debt backed by commercial mortgages may be cut by Standard & Poor’s as the ratings company seeks to reflect how the securities would fare in an “extreme economic downturn.”

The possible reductions, disclosed today in a report, follow S&P’s May 26 statement that the ratings of as much as 90 percent of top-ranked commercial mortgage-backed bonds sold in 2007 may be cut because of the changes in how they’re assessed.

However, as mentioned on June 15, there are plenty of other CRAs available for discriminating ratings-shoppers. That post also mentioned how NAIC wanted to regulate AND provide credit ratings; apparently some have pointed out that this is Not A Good Idea:

Dierdre Manna, vice president of industry, regulatory and political affairs for the Property Casualty Insurers Association of America (PCI), questioned whether transferring rating responsibilities to regulators comports with the NAIC’s mission statement.

She also questioned whether it would be possible for the NAIC to fully separate regulatory and rating agency responsibilities.

A totally insane idea; much like grading schools and universities on their proportion of passing students … er, wait, we do that don’t we? Never mind.

US Banks made some pretty good money on derivative trading in the first quarter:

• The notional value of derivatives held by U.S. commercial banks increased $1.6 trillion in the first quarter, or 1%, to $202.0 trillion, due to the continued migration of investment bank derivatives business into the commercial banking system.
• U.S. commercial banks generated record revenues of $9.8 billion trading cash and derivative instruments in the first quarter of 2009, compared to a $9.2 billion loss in the fourth quarter of 2008.
• Net current credit exposure decreased 13% to $695 billion.
• Derivative contracts remain concentrated in interest rate products, which comprise 84% of total derivative notional values. The notional value of credit derivative contracts decreased by 8% during the quarter to $14.6 trillion.

There’s an essay on Credit Rating Agencies on VoxEU today, by Marc Flandreau & Norbert Gaillard, titled Icarus’ syndrome: Rating agencies and the logic of regulatory license:

But again, this per se does not explain why rating agencies were privileged by regulators over other instruments to promote forbearance. For instance, regulators could have used bond prices at the time of issue as a possible alternative. Our investigation revealed that what caused the emergence of rating agencies as a pillar of regulation was the perceived conflict of interest that investment banks and commercial banks involved in origination suffered at the time. It was perceived that bankers were “banksters” and had been unable to resist conflicts of interest between their role as originators and their role as gatekeepers of liquidity. As a result, the public suspected that the prices at which securities had been issued were likely to have been manipulated. Certification and regulatory intervention had to rest on some assessment of “value” that would be as far away from the origination process as conceivable. Rating agencies provided just this.

The rest of the story is well known. In doing this, regulators dragged the agencies closer to the core of the origination of new securities, which eventually proved damaging for their reputation. While some will emphasise the irony of now blaming the agencies for the very sins that caused their emergence in the first place, we suggest that there must be deep reasons for history to go in circles. And whatever they are, the lesson must be that there is no long-run, simple, and sustainable regulatory fix for our current troubles.

Deep reasons? I don’t think it’s all that deep:

• Doing a good job is not as important as one might hope. It’s all about sales.
• Forecasting the future is fraught with pitfalls. Only a pack of MBAs would bet their company’s future on a single forecast.
• The rating agencies are not paid to do a good job. Hardly anybody cares if they do a good job and even fewer are capable of evaluating ex ante whether they do a good job. They’re paid to be the fall-guy; they are now earning their pay.

PerpetualDiscounts took a break today, but FixedResets continued to rock ‘n’ roll. It’s astonishing! How low can yields on those suckers go? I’m amazed that a lot of new issuance isn’t being coaxed out of the woodwork … but if the price action is based on Current Yields rather than Yield-to-Worst (as I suspect is at least partially the case), perhaps it’s not as surprising as all that. Maybe it’s not even Current Yield – maybe it’s just the plain old coupon! It wouldn’t surprise me. mumble mumble … all these oh-so-clever quants running around, dividing one number by another number … I knew a quant once, he lost money.

The populist movement against Wall Street is having the desired effect:

Wall Street’s largest trade group has started a campaign to counter the “populist” backlash against bankers, enlisting two former aides to Treasury Secretary Henry Paulson to spearhead the effort.
…
Michele Davis, Paulson’s former spokeswoman, and Jim Wilkinson, his former chief of staff, are among those leading the effort. SIFMA is paying their firm, Brunswick Group LLC, a monthly retainer of $70,000, the documents show. Both Davis and Wilkinson declined to comment. Paulson left office in January.

Assisting them is a Democratic polling company, Brilliant Corners Research and Strategies, which is paid $5,000 a month. It is run by pollster Cornell Belcher, who worked on President Barack Obama’s campaign. BKSH & Associates Worldwide, a lobbying firm chaired by Republican strategist Charlie Black, signed on for $10,000.

I’ve been figuring that Dubai would be the logical refuge for hedge funds made unwelcome in the G-7. But who knows? Maybe it’s Singapore:

Assan Din, a former Lehman Brothers Holdings Inc. credit trader, is setting up a hedge fund to trade corporate bonds and derivatives in Asia.

SaKa Capital’s fund, which will have a capacity of more than $500 million, will start in September with $25 million to $50 million sourced mainly from founding members and friends, Din, 38, said. The Singapore-based firm will subsequently raise capital from institutional investors, including U.S. pension funds and endowments, once it builds a track record, he added.

A nice little bump in volume today, with a good solid up-day for preferreds. I suspect that some of the relatively short list of price movers were there because some players didn’t know (or didn’t care) that CM went ex-Dividend today.

C-EBS pays attention to the needs of investors when assessing the investment worthiness of banks, in accordance with the Basel Pillar 3 philosophy; this stands as a great contrast to OSFI. In C-EBS latest effort, they evaluate bank disclosures to investors:

In line with the July 2008 ECOFIN conclusions CEBS also analysed the Pillar 3 disclosures provided by 25 banks. CEBS recognises that a huge effort has been made to provide market participants with information allowing for better assessment of bank’s risk profile and capital adequacy.

Banks have notably enhanced the level of quantitative and qualitative information regarding credit risk and securitisation activities; however there are specific areas where further improvements could be made:

•the composition and characteristics of own funds;
•the back testing information for credit risk and market risk;
•the quantitative information on credit risk mitigations and counterparty credit risk; and
•the granularity of information on securitisations.
CEBS will continue to closely monitor Pillar 3 disclosures in order to ensure that market discipline mechanism operates effectively and contributes to enhance the quality and the comparability of the Pillar 3 disclosures.

While it is not envisaged issuing guidance in the area of Pillar 3 disclosures at this stage, CEBS nevertheless intends to foster further convergence of Pillar 3 disclosure practices through liaison with the industry. For this purpose an open meeting is foreseen to be held in early autumn 2009.

I understand that New York will probably soon have a subway stop named after Barclays:

Commuters passing through the Atlantic Avenue-Pacific Street and Flatbush Avenue subway station in Prospect Heights may soon hear the word “Barclays” to the already long subway station name.

Barclays, a London-based bank company, is the first buyer in the MTA’s five-year effort to sell the names of subway stations to raise more revenue. The company would pay the MTA installments of $200,000 per year over the next 20 years.

Now that times are tough and the idea has the imprimatur of a world-class city, perhaps Toronto-me-too will consider it. I continue to think that we could make an awful lot of money from Pfizer through a name change to “Viagra Makes Your Coxwell” station; I can’t understand why such an obvious source of revenue remains unexploited.

The SEC has requested public comment on a plan to continue to allow Money Market Fund sponsors to lie to investors:

The agency’s five commissioners voted 5-0 today to seek public comment on a plan to require that funds hold more liquid assets and reduce the average maturity of securities in their portfolios. The proposals resemble recommendations made in March by the Investment Company Institute, a Washington-based industry group.
…
The funds aren’t required to value their holdings at current market prices, except to reflect a permanent markdown. That lets them maintain a constant net-asset value, or NAV, and sell and redeem shares at $1 apiece. Funds drop below $1 a share when permanent losses exceed 0.5 percent of net assets, forcing the NAV to be rounded down to 99 cents.

President Barack Obama’s administration, in a plan for overhauling financial regulation released June 17, called on government agencies including the SEC, the Treasury Department and the Federal Reserve to review whether money funds should adopt a floating NAV. The Obama proposal also requested study of ways money funds could obtain access to “emergency” funding from “private sources.”

Andrew Donohue, director of the SEC unit that oversees money managers, said in an April speech that the stable $1 share prices encourages investors to flee money funds at the first sign of trouble.

The Investment Company Institute proposals have been discussed on PrefBlog.

Guys, guys, guys. Investment comes with risk. Pretending there’s no risk won’t make it so; it will simply increase the severity of public reaction when the internal contradictions blow up the model. This was proved beyond the shadow of a doubt after Reserve Primary explosion required extraordinary policy measures to ensure that the World as We Know It did not disappear completely. The Volcker proposals are far superior.

The FOMC statement was released today:

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

PerpetualDiscounts had a good day today, while most of the market was pretty quiet on lower volume. PerpetualDiscounts now yield 6.38%, equivalent to 8.93% interest at the standard 1.4x conversion factor. Meanwhile, long corporates are taking a breather, returning 5.66% month-to-date, 17.01% year-to-date, with a yield of about 6.45%; the pre-tax interest-equivalent spread is thus about 250bp, little changed from last week’s 255bp.

I mentioned the proxy battle over Trinorth Capital on June 11 … Management won. No concession or acknowledgement from the self-proclaimed Concerned Shareholders yet … I’m not holding my breath. However, management can now get back to doing what it does best: suspending dividends on their funds.

Speculation regarding Bernanke’s reappointment is mounting, with Larry Summers mentioned as a possible candidate. I can’t find great fault with Bernanke’s macro-economic handling of the crisis; it turned out that letting Lehman go was a mistake, but I, for one, didn’t forsee just how horribly things would turn out after that. Of greater concern is interference in private companies (the BAC/MER merger), but I think that one can be hung on Paulson.

Tara Perkins of the Globe passes on some speculation regarding the MFC/OSC Disclosure Kerfuffle:

The Ontario Securities Commission (OSC) appears to be examining whether Manulife properly disclosed, prior to last fall, how much risk it would face if markets tanked, noted Genuity Capital Markets analyst Mario Mendonca. Before then, Manulife only disclosed what would happen to it if stock markets fell by 10 per cent. Markets dropped more than 20 per cent in the fourth quarter.

It’s possible, although it would be most unfair if MFC was singled out for this practice when the effects of a 10% drop is all that’s disclosed by any insurer. I’m not saying, mind you, that I am against such improved disclosure; the effect of equity market declines on guarantees can be decidedly non-linear.

Who says that Dealbreaker is all fun ‘n’ games? Today there’s a very informative, yet entertaining, essay on Credit Default Swaps in Kazakhstan:

Emerging Markets and derivatives are like alcohol and barbiturates: each on its own has attractions but create a recipe for choking on one’s own vomit when combined.
…
There’s always some crazy eventuality that an emerging market can generate that defies the most thoughtfully drafted contract.

Mark Carney showed Canadian regulators’ traditional contempt for investors with some selective disclosure in Washington:

Bank of Canada Governor Mark Carney said his country’s recession is now as deep as in the U.S., according to a person who heard his remarks today in Washington.

Carney, 44, spoke at the Woodrow Wilson International Center for Scholars. No cameras or recording devices were allowed at the event, according to organizers.

Debt-Decoupling, a moral hazard feature of Credit Default Swaps is complicating restructuring efforts:

In the cover story for the The Deal magazine published Monday, Richard Morgan tells about the dire situation Gannett Co. (NYSE:GCI) finds itself in after nearly three-quarters of bondholders, hedged with credit default swaps, declined an exchange offer that expired May 5. Thanks to the CDSs, they stand to get a better payoff if Gannett defaults.

Morgan followed that story up with a report on McClatchy Co. (NYSE:MNI) in The Deal Pipeline on Monday (subscription required). It too tried to do an exchange offer on some troubled bonds, but reported last week that only a small minority of holders went for the offer, valued at around 33 cents on the dollar. Thanks to their CDS hedges, the bondholders can expect 100 cents if McClatchy defaults.

It’s an incentive some call perverse, and also one that couldn’t have existed before the CDS market sprang up. As Morgan writes, CDSs began the decade as a $900 billion market but ended last year with a notional value of $42 trillion. That’s a lot bigger than the $25 trillion market for outstanding corporate bonds, municipal bonds and structured investment vehicles that CDSs were designed to reference.

Dealbreaker remarks:

One of the primary complaints about the CDS market was the use of CDS by market participants as purely speculative tools. In this case, the players that hold the debt are hedging their exposure through CDS and capitalizing on a negative basis play. If hedging debt exposure through CDS becomes the next true villain in the attack on derivatives, there is really no hope for this market.

The “negative basis” refers to the fact that a long-bond plus protection-buy position will yield more than available elsewhere in the market with equivalent risk – this is due to funding pressures, since it’s hard (risky, anyway) nowadays to lever up a physical bond position 10:1; you can only do that by selling CDSs, driving down the spread. The newspapers’ woes are similar to problems highlighted by the Lyondell bankruptcy:

The potential for dispute and complexity in workouts and bankruptcies by reason of the existence of CDS was illustrated recently in the U.S. bankruptcy proceeding of the U.S. subsidiary of LyondellBasell, the world’s third-largest petrochemicals group. The U.S. company, LyondellBasell Chemical Company, filed for bankruptcy in New York in January 2009 after attempts to restructure its $26 billion debt were unsuccessful.70 The bankruptcy triggered a “default” under LyondellBasell Chemical Company’s CDS (i.e. CDS naming this company as the reference entity), but because its European parent and affiliates were not in bankruptcy, CDS covering bonds of those companies were not triggered.

Creditors sought to sue LyondellBasell’s parent company in Europe on guarantees and other obligations. These creditors included bondholders, and the U.S. company believed that the bondholders were seeking to enforce claims with the goal of triggering protection payments under their credit default swap contracts, which could have led to other parts of the corporate group being pushed into insolvency in Europe. Ultimately, U.S.-based LyondellBasell Chemical Company was able to persuade the U.S. bankruptcy court that such actions in Europe could undermine the chances of completing a successful bankruptcy in the U.S. The bankruptcy court issued a 60-day injunction prohibiting enforcement actions in Europe.

“The threat of CDS holders trying to force companies into an insolvency in order to trigger their recovery rights against their CDS counterparty will almost certainly be an issue in the wave of debt restructurings this year,” predicted LyondellBasell’s attorneys.

Note that legal manoeuverings regarding LyondellBasell have been phrenetic:

LyondellBasell Industries announced that LyondellBasell Industries AF S.C.A. has been voluntarily added to Lyondell Chemical Company’s reorganization filing under Chapter 11 of the U.S. Bankruptcy Code to protect the European holding company against claims by certain financial and U.S. trade creditors.

LyondellBasell Industries AF S.C.A. is a holding company incorporated in Luxembourg. It does not manufacture or sell products, and has no employees.

LyondellBasell is exercising an option available under U.S. law to prevent creditors from enforcing guarantees by LyondellBasell AF S.C.A. for pre-petition obligations of LyondellBasell’s U.S. businesses. It also prevents bondholders of Senior Notes due in 2015 from potentially pursuing remedies against LyondellBasell AF S.C.A. after an interest payment due on the notes in February was not paid. The company obtained a 60-day restraining order from the U.S. bankruptcy court in February to allow time for LyondellBasell to protect its European assets from these claims.

Extending Chapter 11 protection to LyondellBasell Industries AF S.C.A. is not an insolvency proceeding under any European law. No LyondellBasell manufacturing operation located outside of the United States has applied for or become involved in insolvency or bankruptcy proceedings in its respective home country.

… but they bought themselves enough time to get something done …

The European Commission Monday cleared U.S.-based industrial holding group Access Industries and German investor Andreas Heeschen’s ProChemie Holding to create a joint venture to take over troubled chemical company LyondellBasell Industries.

Both parties will have a 50% stake in LyondellBasell, parts of which are currently under bankruptcy protection, through a new holding company called ProChemie GmbH.

LyondellBasell was previously wholly owned by Access industries.

… the moral of the story being “Holding company guarantees are not necessarily worth much.”

The market drifted down just a tad today, with volume continuing high.