PrefBlog

A nugget of information about Credit Default Swaps on sovereigns is being circulated:

The credit-default swaps traders being blamed by German and French leaders for fueling fears of sovereign debt crises would be doing so with less than 1 percent of the governments’ outstanding debt being wagered.

The CHART OF THE DAY shows the net notional value of credit swaps on 10 European countries including Greece, Spain, Italy and Portugal, as reported by the Depository Trust & Clearing Corp. The $108 billion figure, which is the maximum amount on the line if all of the countries were to default, is 0.98 percent of the $11 trillion in outstanding debt of those countries. In Greece, where the heaviest complaints about credit-swaps trading have been leveled, bets of $9 billion compare with $267 billion of debt.
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European leaders have said trading in the contracts fuels speculation that can distort perceptions and have warned hedge funds about trying to profit from the problems on the continent.

The last line quoted is the scary part. Remember September 25, 1992? The politicians don’t like it when the market says, instantly, that they’re being stupid. It is infinitely preferable to allow the stupidity to continue until it distorts the real economy and winds up on the backs of the electorate – who, it is assumed, will have long ago forgotten who’s to blame.

Remember Flash orders? There’s a really good explanation of the viewpoint of exchanges offering this order type from William Brodsky of the CBOE – dated 2009-11-18.

Fannie Mae needs more money:

Fannie Mae, the mortgage-finance company under federal conservatorship, said it will seek $15.3 billion in aid from the U.S. Treasury after posting a 10th straight quarterly loss.

A fourth-quarter net loss of $16.3 billion, or $2.87 a share, pushed the company to request its fifth draw on an unlimited lifeline from the government, Washington-based Fannie Mae said in a filing today with the Securities and Exchange Commission.

Fannie Mae, which posted $120.5 billion in losses over the previous nine quarters, has taken $59.9 billion in federal aid since April. Its shares, which peaked at $87.81 in December 2000, closed at 99 cents today in New York Stock Exchange composite trading. The Treasury owns 79.9 percent of Fannie Mae’s outstanding common shares.
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The fair value of Fannie Mae’s assets was negative $98.8 billion last quarter, compared with negative $90.4 billion at the end of September.

Banks can screw up, certainly, and must bear a lot of the blame for the credit crunch. It’s not as if working for a bank transforms you into a genius – quite the opposite, as far as I’ve ever been able to tell. But for horrific blunders of stupefying dimensions, you need a politician. Funny how all the “Too Big To Fail” handwringing always concerns JPMorgan et al. and not Fannie & Freddie, huh?

Finally something of a (dead cat?) bounce in the preferred share market today, with PerpetualDiscounts gaining 19bp and FixedResets down 1bp, with no losers at all in the performance highlights. Volume was off a bit, but still quite healthy.

PerpetualDiscounts now yield 5.90%, equivalent to 8.26% interest at the standard equivalency factor of 1.4x. Long Corporates yield about 5.9%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) is now about 235bp, which is where it was on February 24.

Johnny Mack thinks Wall Street compensation is too high:

Morgan Stanley Chairman John Mack said investment bankers are overpaid and Wall Street compensation won’t decrease much because firms don’t want to lose their best performers.
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Mack, who retired as CEO of the world’s biggest brokerage in December, cited a 28-year-old Morgan Stanley trader whose unit had earned $300 million to $400 million for the firm. After Morgan Stanley offered $11 million in compensation, the trader jumped to a hedge fund that paid him $25 million, Mack said.

I don’t understand what’s wrong with the example, frankly.

I will concede that the high level of compensation in the industry is symptiomatic of there being something wrong, but I don’t think that “something” is greed. The “something” is stupidity. The stupendous salaries that are possible in the industry – particularly on the sell side – are only possible because there are a lot of very, very stupid people managing investments and are leaving way too much money on the table. But how to get rid of them? The only idea I’ve ever been able to come up with is mandatory disclosure of performance history for all registered individuals; subject to regulatory audit and posted on the regulatory website and never erased. It might go at least a little way towards making it a bit more difficult for the smiley-boys to do business.

Risk magazine has a good explanatory article on the Greece-Goldman deal (hat tip: Financial Webring Forum, titled Revealed: Goldman Sachs’ mega-deal for Greece by Nick Dunbar:

The transactions agreed between the Greek public debt division and Goldman Sachs involved cross-currency swaps linked to Greece’s outstanding yen and dollar debt. Cross-currency swaps were among the earliest over-the-counter derivatives contracts to be traded, and have a perfectly routine purpose in debt management, namely to transform the currency of an obligation.
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However, according to sources, the cross-currency swaps transacted by Goldman for Greece’s public debt division were ‘off-market’ – the spot exchange rate was not used for re-denominating the notional of the foreign currency debt. Instead, a weaker level of euro versus dollar or yen was used in the contracts, resulting in a mismatch between the domestic and foreign currency swap notionals. The effect of this was to create an upfront payment by Goldman to Greece at inception, and an increased stream of interest payments to Greece during the lifetime of the swap. Goldman would recoup these non-standard cashflows at maturity, receiving a large ‘balloon’ cash payment from Greece.
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Goldman Sachs is known for its conservative approach to credit risk, and chose to hedge its exposure to Greece by immediately placing the risk with a well-known investor in sovereign credit: Frankfurt-based Deutsche Pfandbriefe Bank (Depfa). According to sources, Depfa entered into a credit default swap with Goldman Sachs, selling $1 billion of protection on Greece for up to 20 years. Depfa declined to comment.

Wow! Can you imagine? Goldman bought something from one counterparty, then sold it to another! Isn’t that evil? And they call themselves brokers! What’s a broker doing, buying things and selling things and taking out a spread? Brokers are supposed to … um … do something else.

And you know the date of the article? July 1, 2003. In other words, everybody who who needed to know about this has known it for well over six years. Those who didn’t know it have only themselves to blame.

But since when does a bureaucrat admit fault?

“Eurostat was not until recently aware of this alleged currency swap transaction made by Greece,” spokesman Johan Wullt said by e-mail yesterday.
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European politicians this week criticized New York-based Goldman Sachs for arranging the Greek swap and are pressing for more disclosure. Chancellor Angela Merkel’s Christian Democrats aim to push for new rules that will force euro-region nations and banks to disclose bond swaps that have an impact on public finances, financial affairs spokesman Michael Meister said yesterday.

“Goldman Sachs broke the spirit of the Maastricht Treaty, though it is not certain it broke the law,” Meister said in an interview yesterday. “What is certain is that we must never leave this kind of thing lurking in the shadows again.”

Goldman broke the spirit of the Maastricht Treaty? Goldman? And there I was, not even aware it was a signatory!

And why is there no mark-to-market on currency swaps? Nick Dunbar explained (almost seven years ago, remember) that it’s because the regulators decided that they didn’t want market marks on currency swaps:

The answer can be found in ESA95, a 243-page manual on government deficit and debt accounting, published by the European Commission and Eurostat in 2002. As revealed by Piga, the drafting of ESA95’s section on derivatives was the subject of fierce arguments between the government statisticians and debt managers of certain eurozone countries.

The statisticians wanted derivatives-related cashflows to be treated as financial transactions, with no effect on deficit or interest costs, and with the derivatives’ current market value stated as an asset or liability. The debt managers opposed this, insisting on having the freedom to use derivatives to adjust deficit ratios. The published version of ESA95 reflects the victory of the debt managers in this argument with a series of last-minute amendments.

In particular, ESA95 states in a page-long ‘clarification’ that ‘streams of interest payments under swaps agreements will continue… having an impact on general government net borrowing/net lending’. In other words, upfront swap payments – which Eurostat classifies as interest – can reduce debt, without the corresponding negative market value of the swap increasing it. According to ESA95, the clarification only covers ‘currency swaps based on existing liabilities’.

But at least Greece has some company:

Iceland walked out of talks with the U.K. and Netherlands on how to settle foreign claims, after both sides failed to reach an agreement on the terms of a loan the north Atlantic nation needs to cover depositor losses.

Iceland’s Finance Minister Steingrimur J. Sigfusson said a team of officials meeting Dutch and British counterparts in the U.K. today would return to Reykjavik after two weeks of talks in London failed to yield results. Iceland’s government will now discuss how to proceed with the country’s appointed negotiating team, according to a statement from the Finance Ministry.

But then, Icelanders are all terrorists, aren’t they?

InDefence was launched in late 2008 by British-educated citizens outraged by London’s use of anti-terror laws to freeze Icelandic assets, an unprecedented insult for a close NATO ally.

“There is tremendous anger,” said spokesman Johannes Skulason. “We feel deeply wronged that the Icelandic central bank was listed with al-Qaeda as a terrorist body. If Gordon Brown ever tries to set foot in this country he will be thrown back on the plane.”

A report by Sweden’s Riksbank said EU rules covering Icesave were incoherent and that it was unclear whether Icelandic citizens bear the full responsiblity. It said Britain’s authorities had acted incompetently and should share some of the compensation costs.

Brookfield’s getting some competition for General Growth:

The battle for General Growth Properties Inc., owner of more than 200 U.S. malls from Boston to Los Angeles, is turning into the biggest real estate fight since sale of Sam Zell’s Equity Office Properties Trust.

Westfield Group, a Sydney-based property investor with stakes in 55 U.S. retail centers, signed an agreement letting it assess General Growth’s finances, a person familiar with the pact said yesterday. That may put Westfield in position to vie for the bankrupt company’s assets as part of a contest already embroiling Simon Property Group Inc. and Brookfield Asset Management Inc.

Simon has forcefully responded to the Brookfield bid:

“General Growth’s proposed recapitalization amounts to a risky equity play on the backs of its unsecured creditors. While continuing to block the immediate and certain 100% cash recovery provided by Simon’s offer, General Growth has preempted its own self-proclaimed ‘process’ in favor of a highly speculative and risky plan to attempt to raise $5.8 billion of new capital in today’s uncertain markets — including $3.3 billion of dilutive new equity, $1 billion in asset sales and $1.5 billion in new debt — on top of the approximately $28 billion it already owes. Simon is providing $10 billion of real value — $3 billion to shareholders as well as $7 billion to creditors — as compared to a complex piece of financial engineering that is so highly conditional as to be illusory.”

The Canadian preferred share market slumped again today on continued high volume, with PerpetualDiscounts losing 13bp and FixedResets down 16bp. There were no winners in the performance highlights table.