PrefBlog

More trader games in the CDS market – and now the rules might change:

At issue in the Amherst trades is whether sellers of protection on mortgage bonds can purchase loans underlying the debt at above-market prices to prevent a default that would trigger payments to buyers of the contracts. Credit-default swaps pay the buyer if the securities aren’t repaid as expected.

The call of the securities at their face value of $29 million, the amount remaining in the 2005 subprime-mortgage bond issue, caused the banks to lose money. Bankers on the American Securitization Forum call probably couldn’t ban the strategy for existing trades, the people said.

Proposals included creating agreements for new swaps that would force sellers to disclose whether they have the right to call the securities, and “best practices” guidelines to say such trades shouldn’t be executed, they said.

$29-million? Banks are prepared to admit that their traders lost a lot of money in a $29-million market?

They haven’t learned a damn thing, have they? Giving a block of capital to some kid with an MBA but not enough brains to realize you don’t play in a rigged market – or one that’s small enough to rig. $29-million? That’s not even a big ticket.

What does buying CDS protection mean, anyway? It’s nothing more nor less than shorting a bond. What kind of moron shorts into a $29-million market? What kind of useless twerp is the moron’s supervisor?

Let’s not have any more rules. Let’s just see a few bozos get fired. Or, at least, eating their losses like big boys and learning from the experience. As I have stressed many times on this blog, debt decoupling can result in strange things happening … particularly in a rinky dink $29-million market.

The Federal Reserve Bank of Boston has released a working paper by Todd Prono that looks interesting, but which I don’t have time to read now. So, without comment, here’s the abstract:

A pricing restriction is developed to test the validity of the CAPM conditional on a prior belief about the correlation between the true market return and the proxy return used in the test. Distinguishing this pricing restriction from competing tests also based upon the relative efficiency of the proxy return is a consideration for the proxy’s mismeasurement of the market return. Failure to account for this mismeasurement biases tests of the CAPM towards rejection by overstating the inefficiency of the proxy. A time-varying version of this pricing restriction links mismeasurement of the market return to time-variation in beta

Pretty much a nothing day in the major sectors of the market, but volume continued heavy and Floating Rate issues continued to shine.

Incompetent Portfolio Managers now have a new object of veneration: the Globe and Mail has published a hagiography of St. Busseri the Crybaby after he squared his rot for a good boo-hoo-hoo:

Mr. Busseri found himself in the crosshairs of what he called a “character assassination” attempt by TriNorth.

The attack came in the form of a published group letter that criticized his management skills at previous jobs, including his stint restructuring Environmental Management Solutions Inc., a onetime proxy battle target now known as Englobe Corp.

“When you’re married and have kids, it’s disturbing and disappointing when people behave like this,” Mr. Busseri said. “It feels like intimidation.”

The published group letter makes interesting reading:

Busseri has no record of creating shareholder value as a leader of a public company.
The facts are:
• From October 2004 to January 2008, while Busseri was President and CEO and a Board Member of EnGlobe Corp. (TSX: EG) the company share price fell 58%.
• The TSX Composite rose 56% over the same period.
• Between 2004 and 2007, EnGlobe had cumulative operating losses of about $8.2 million, on $317 million of revenues
• Busseri led Capital Environmental Resources Inc. (later re-named Waste Services Inc.) from 1997 until his departure in August 2000.
• In the last 14 months of Busseri’s tenure, Capital / Waste Services share price fell 73%.
• The S&P rose 17% over the same period.
• Busseri was no longer employed with the company after Capital / Waste Services reported a loss of $6.6 million – its largest loss ever.
• Busseri recently left the position of Executive Vice President at Hanfeng Evergreen Inc. in April 2009 after a four-month tenure.

Um … where’s the character assassination? Where’s the stuff that makes marriage and kids such an issue?

I have no idea who is better suited to lead Trinorth. I don’t care. It makes no difference to me. But in mounting his proxy battle, Busseri has necessarily voiced his opinion on the competence of Trinorth’s board:

It is clear to the Concerned Shareholders that the Current Board – the same directors being nominated by management of TriNorth – are either unable or unwilling to preserve, protect and build value for all shareholders.

OK, so he’s got an opinion. It’s necessarily an opinion. So the competence of the person giving that opinion is fair game. I see nothing in the Trinorth letter that is objectionable: they didn’t make any allegations regarding his personal life; they stuck very closely to the man’s business track record.

When I read someone’s opinion about the markets, I want to know their track records – which is why opinions from journalists and sell-side analysts are ignored, although data is always gratefully received. I suppose, in Mr. Busseri’s eyes – and in the eyes of the extremely sympathetic Globe reporters – my desire to review performance track records when assessing opinion makes me a Bad Person. And, I suppose, non-disclosure of performance history is to be considered an entirely reasonable adjunct to dispensing portfolio advice.

The Basel Committee on Banking Supervision has expanded:

The Basel Committee on Banking Supervision decided to broaden its membership and to invite as new members representatives from the G20 countries that are not currently in the Basel Committee. These are Argentina, Indonesia, Saudi Arabia, South Africa and Turkey. In addition, Hong Kong SAR and Singapore have also been invited to become members. The Basel Committee’s governing body will likewise be expanded to include central bank governors and heads of supervision from these new member organisations.

Since the New Activism will create a lot of jobs for ex-regulators, it’s important that regulators everywhere have a chance to burnish their resumes!

The Bank of Canada has published a new working paper by Bruno Feunou, Jean-Sebastian Fontaine and Romeo Tedongap, The Equity Premium and the Volatility Spread: The Role of Risk-Neutral Skewness:

We introduce the Homoscedastic Gamma [HG] model where the distribution of returns is characterized by its mean, variance and an independent skewness parameter under both measures. The model predicts that the spread between historical and risk-neutral volatilities is a function of the risk premium and of skewness. In fact, the equity premium is twice the ratio of the volatility spread to skewness. We measure skewness from option prices and test these predictions. We find that conditioning on skewness increases the predictive power of the volatility spread and that coefficient estimates accord with theory. In short, the data do not reject the model’s implications for the equity premium. We also check the model’s implications for option pricing and show that the information content of skewness leads to improved in-sample and out-of-sample pricing performances as well as improved hedging performances. Our results imply that expanding around the Gaussian density is restrictive and does not offer sufficient flexibility to match the skewness and kurtosis implicit in option data. Finally, we document the term structure of option-implied volatility, skewness and kurtosis and find that time-dependence in returns has a greater impact on skewness.

I do not pretend to be an expert on option pricing theory, but the paper looks very interesting!

Mark Carney made a speech today – nothing much new, but he wants to create new jobs for regulators:

Fourth, all countries must accept their responsibilities for promoting an open, flexible, and resilient international monetary system. Responsibility means recognizing spillovers between economies and financial systems and working to mitigate those that could amplify adverse dynamics. It means submitting to peer review within the Financial Stability Board and external review by the International Monetary Fund.

Treasuries bounced back when the long bond auction did not go as badly as expected:

The yield on the 10-year note fell nine basis points, or 0.09 percentage point, to 3.86 percent, after climbing as high as 4.0038 percent, at 4:40 p.m. in New York, according to BGCantor Market Data. The yield last touched 4 percent on Oct. 16. The 3.125 percent security maturing in May 2019 rose 23/32, or $7.19 per $1,000 face amount, to 94.

The 30-year bond yield fell seven basis points to 4.69 percent. It earlier touched 4.8391 percent, the highest since October 2007.

The bonds sold today drew a yield of 4.72 percent, the highest since August 2007. The average forecast by eight bond- trading firms surveyed by Bloomberg News was 4.80 percent. The sale is a reopening of the $14 billion 30-year bond auction on May 7, which drew a yield of 4.288 percent.

Incidentally, those who are impressed by how much long corporates have tightened may be interested to learn … it ain’t just Canada:

One veteran salesman and friend of the blog notes that there are no sellers and only buyers. He offers that volume is lighter than one would expect because the street is not carrying much paper and that has made some paper very prices.

By way of example of the steaminess of the market he cited the McDonald 2018 bond which traded at T + 90 today. One month ago the bond was at 150 and two months ago around 20.

There is a 2035 Walmart which traded + 105 yesterday. That boond was T+ 200 a month ago.

The rally is relentless and marches on.

Mind you, that’s not as impressive as it sounds. A month ago, long Treasuries were at 4.18%.

PerpetualDiscounts shone today on continued heavy volume.

Here’s a switch! Treasuries were under pressure today … Russia’s concerned about credit quality:

Thirty-year bond yields reached the most in a year after a Russian central bank official said the nation may buy International Monetary Fund bonds.
…
Russia’s central bank may switch some of its reserves from Treasuries to International Monetary Fund bonds, the bank’s first deputy chairman, Alexei Ulyukayev, said in Moscow today. His comments were confirmed by a bank official who declined to be named, citing bank policy.

Finance Minister Alexei Kudrin said last month that Russia planned to buy $10 billion of IMF bonds using money from its foreign reserves.

Russia holds $138.4 billion of U.S. debt. China is the largest U.S. creditor, with $767.9 billion. The U.S. government must rely on foreign investors to sustain record borrowing.

The dollar fell as Russia’s announcement added to speculation central banks around the world may try to diversify their reserves away from the U.S. currency. The Dollar Index, used by the ICE to track the greenback against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona, decreased 0.2 percent to 79.649, after sliding 1.3 percent yesterday.

“The market is reacting to this Russia thing,” said Arthur Bass, a managing director of derivatives in New York at the brokerage Newedge USA LLC. “The dollar has restarted its dive to lower levels.”

Perhaps not surprisingly, the Treasury 10-year auction was horrible:

Treasuries declined, pushing 10-year yields to the highest level since October, as the government sold $19 billion of the securities and Russia said it may switch some reserves from U.S. debt.

The notes drew a yield of 3.99 percent, the highest since August 2008. The auction was the second of three sales this week that will raise $65 billion, part of the government’s record borrowing program. A Russian central bank official said the nation may buy International Monetary Fund bonds.

“There are an awful lot of Treasuries being auctioned and there’s going to be more and more and more and more,” said Jay Mueller, who manages about $3 billion of bonds at Wells Fargo Capital Management in Milwaukee.

The yield on the 10-year note rose seven basis points, or 0.07 percentage point, to 3.92 percent at 2:44 p.m. in New York, according to BGCantor Market Data. It earlier reached 3.99 percent, the highest since Oct. 16. The 3.125 percent security maturing in May 2019 declined 1/2, or $5.00 per $1,000 face amount, to 93 1/2.

The 30-year bond yield touched 4.83 percent, the highest in a year. The government is scheduled to sell $11 billion of the securities tomorrow.

Lots of volume but not much price action for preferreds today, although Floaters got hit – largely due to TRI.PR.B, which had low volume and a high closing spread, so it’s not clear how seriously the decline should be taken. PerpetualDiscounts closed with a yield of 6.35%, equivalent to 8.89% interest at the standard equivalency factor of 1.4x; long corporates are now yielding about 6.6%, having returned +3.43% on the month-to-date, so the pre-tax interest-equivalent spread is now about 229bp … up from the 213bp calculated on June 4 due almost entirely to a decline in long corporate bonds that has – over the week – been unmatched by preferred shares … the yield on PerpetualDiscounts is actually fractionally higher that it was at the last calculation.