PrefBlog

Faced with criticism of their conduct and market disdain for their chances going forward, European politicians are taking decisive action – prohibit criticism!

The European Commission said yesterday it will investigate trades in sovereign credit-default swaps in the wake of the Greek crisis, which has pushed the euro lower and prompted officials to warn hedge funds they shouldn’t try to profit from the woes of the region’s nations.

… with further details:

Banks and regulators across Europe were summoned by the European Commission to discuss regulation of the market for sovereign credit-default swaps in the wake of the Greek debt crisis.

The European Union’s executive agency will hold a meeting in Brussels “shortly,” Chantal Hughes, a commission spokeswoman, said in an e-mailed statement today. The talks, which will take place as soon as March 5, will cover CDS pricing and links to the sovereign bond market, according to three people familiar with the discussions.

Remember the little boy who shouted that the Emperor had no clothes? The soldiers slaughtered him, his family, and anybody who heard the treacherous remark. Later, the Emperor’s wardrobe expenses caused taxes to rise so high that a famine resulted and the Empire collapsed. But that’s show-biz.

There’s more jostling in the Brookfield / General Growth deal, with Ackman’s role being criticized:

General Growth Properties Inc’s unsecured creditors and suitor Simon Property Group on Tuesday criticized William Ackman’s role in the mall owner’s restructuring plan, alleging conflicts of interest given his position as a director and largest shareholder.

Ackman has backed a reorganization plan that calls for his Pershing Square Capital Management hedge fund to offer Brookfield Asset Management certain protections in return for the Canadian firm financing General Growth’s stand-alone exit from bankruptcy.
…
The official committee of General Growth’s unsecured creditors said in a court filing that the agreement between Pershing Square and Brookfield effectively restricts General Growth from considering alternative transactions because it puts the company into “an obvious conflict of interest situation.”

“The Debtors must choose between the best interests of the estates and the economic interests of one of their most active and vocal directors,” it added, referring to Ackman.

Simon, a General Growth creditor, also questioned the arrangement between Brookfield and Ackman’s Pershing Square in a separate filing Tuesday.

RBC CEO Gord Nixon spoke at the annual meeting:

“Political rhetoric is distorting the cause of this recent crisis and potentially distorting the cure,” he told shareholders at the bank’s annual meeting in Toronto Wednesday. “This crisis was not caused by Wall Street, executive compensation, nor proprietary trading, although they all played a part. The root cause of the crisis was the failure of the U.S. residential mortgage market,” he said, adding that “the basic requirement to qualify for a large mortgage in the United States was a pulse.”

I would say ‘triggered’ rather than ’caused’. The recession is bringing to light a lot of bad practices: General Motors, Chrysler, Greece …

“The bulk of the losses during the crisis arguably resulted from lending practices and excessive concentration related, primarily, to U.S. residential real estate and over-extended consumers, not those activities addressed by the proposed reforms,” he said.

Glad to hear someone talking about concentration. Bad investments can hurt you, but over-concentration can kill you … as, for instance, many Canadian ABCP players found out. He says Basel III is fraying ’round the edges:

“While a few months ago it appeared as if there was a high degree of co-operation among the Financial Stability Board countries, we are now experiencing a divide with different countries trying to initiate rules that best suit their jurisdictions,” he said. “The unified response that was necessary and commendable during the darkest days of the crisis now risks being replaced by regulatory and legislative one-upmanship, as various governments pursue local agendas.”
…
And, while he said he agrees that it’s important for banks to be conservatively capitalized, he said that “the current Basel III proposals, as they’re referred to, are so complex and onerous that we run the risk of no agreement being reached.”

I was quoted in the Advisor.ca budget wish-list:

James Hymas, president, Hymas Investment Management Inc.

• A clear-cut plan for a balanced budget through the cycle.
• I want to see statements of planned spending cuts and tax increases that will not just eliminate the deficit (a childish half-measure), but ensure – insofar as such things can be ensured – that surpluses built up in relatively good times will pay for this recession and put us in a good position to cope with the next one.

Volume dropped to more normal levels on a steady day in the Canadian preferred share market, with PerpetualDiscounts gaining 5bp and FixedResets gaining 9bp … taking the YTW on the latter class down to 3.52%.

PerpetualDiscounts now yield 5.89%, equivalent to 8.25% interest at the standard equivalency factor of 1.4x. Long Corporates are now yielding about 5.8%, so the pre-tax interest-equivalent spread (also called the Seniority Spread) now stands at 245bp, a sharp, bond-driven widening from the 235bp recorded at month-end.

Nice piece in the WSJ on the Goldman/Greece thing, Swapping Blame over Athens:

Greece was not alone in using creative accounting to massage its numbers ahead of euro entry. It’s been known for years that Italy and Portugal also took advantage of derivatives contracts to dress up their budget numbers in the late 1990s. And as Allister Heath of the CityAM newspaper reminded us, even France “bought” long-term pension obligations from France Telecom in exchange for an upfront payment of £4.7 billion ($7.1 billion) that helped pave its entry into the single currency.
…
There’s no small irony in the fact that the same governments that once took advantage of derivatives peddled by international financiers to help conceal their true financial condition are now claiming to be the victims of the same banks’ dealings in the derivatives market. But the blame-the-bankers theme in the nascent sovereign-debt panic is of a piece with the banker-baiting that came in the wake of the 2008-2009 financial crisis.

Once again, our political class has been all too eager to find someone else to blame for its own economic mismanagement

Another WSJ article Europe’s Original Sin asks the question: What’s a Grecian Earn?:

Europeans are blaming financial transactions arranged by Wall Street for bringing Greece to the brink of needing a bailout. But a close look at the country’s finances over the nearly 10 years since it adopted the euro shows not only that Greece was the principal author of its debt problems, but also that fellow European governments repeatedly turned a blind eye to its flouting of rules.

Though the European Commission and the U.S. Federal Reserve are examining a controversial 2001 swap arranged with Goldman Sachs Group Inc., Greece’s own budget moves, in clear breach of European Union rules, dwarfed the effect of such deals.
…
Those revisions far exceed the impact of controversial derivative transactions Greece used to help mask the size of its debt and deficit numbers. The 2001 currency-swap deal arranged by Goldman trimmed Greece’s deficit by about a 10th of a percentage point of GDP for that year. By comparison, Greece failed to book €1.6 billion ($2.2 billion) of military expenses in 2001—10 times what was saved with the swap, according to Eurostat, the EU’s statistics authority.

Naturally, the episode is being used to promote various hobby-horses (I mean, besides Goldman-bashing):

Greece would have been dissuaded from using swaps to obscure the country’s deficit if the $605 trillion derivatives industry were properly regulated, U.S. Commodity Futures Trading Commission Chairman Gary Gensler said.

“Derivatives reform would have made it more difficult for Greece to hide their embedded loan,” Gensler said in a speech to be delivered today to Women in Housing and Finance, a Washington-based professional society.

Derivatives rules proposed in the U.S. would have required Greece to post collateral against its derivatives transactions, “thus canceling out the embedded loan and discouraging the country from entering into such a transaction in the first place,” he said. New York-based Goldman Sachs Group Inc. was at least one of the banks involved in swaps transactions with Greece.

Assiduous Readers will note that since the deal was uncollateralized, Goldman – and the ultimate buyer of the package – also bought a CDS on Greece; this is similar to their actions with uncollateralized exposure to AIG.

Australia’s hiked rates again:

Reserve Bank of Australia Governor Glenn Stevens increased the benchmark overnight cash rate target to 4 percent from 3.75 percent in Sydney today, as forecast by 14 of 19 economists surveyed by Bloomberg News. The rest predicted no change.

The biggest jobs boom in more than three years and a surge in business confidence suggest Australia’s economy is already growing at or close to trend, after escaping recession during the global crisis, Stevens said. “It’s appropriate for interest rates to be closer to average,” which he last week signaled may be another 75 basis points higher than the current rate.

PrefBlog’s Piggies-at-the-trough Department reports that cellulosic ethanol will be immensely profitable, if subsidized enough:

The industry insists the ethanol-from-waste technology will soon be commercially viable with the proper government incentives, including a some sort of price on carbon dioxide emissions that makes fossil fuels more expensive.

If the government really wanted economic ethanol, they’d fund academics with $50-million with the objective of developing something that, you know, actually works rather than forking over $500-million to the industrial smiley-boys, but Spend-Every-Penny is contemptuous of anything that smacks of schoolwork. So don’t hold your breath.

Some nice volume on a good day for the market, with PerpetualDiscounts gaining 5bp while FixedResets gained 14bp, taking yields on the latter down to 3.54%. Still a very well-behaved market, with only two entries in the Performance Highlights table.

AIG Chairman Harvey Golub says pay restrictions hurt the company. Bloomberg reports:

“While we can pay the vast majority of people competitively, on occasion, these restrictions and his decisions have yielded outcomes that make little business sense,” Golub, 70, said of Feinberg. “In some cases we are prevented from providing market-competitive compensation to retain some of our most experienced and best executives. This hurts the business and makes it harder to repay the taxpayers.”

Feinberg, the Obama administration’s special master on executive pay, has instituted a $500,000 base salary cap for most AIG employees. He has made exceptions for those deemed necessary for the insurer’s success, including Chief Executive Officer Robert Benmosche, who secured a $7 million salary and $3.5 million in long-term incentive awards.

Is it true or is he just pointing a finger? Well, we’ll never know, will we? That’s the trouble with dotted-line responsibility.

The Greece/Goldman/Eurostat kerfuffle is getting funnier by the minute:

Goldman Sachs did consult European statistics agency Eurostat on currency swaps traded with the Greek government, which allowed the sovereign to reduce the size of its reported debt, Gerald Corrigan, a managing director and chairman of Goldman Sachs Bank USA, told a House of Commons Treasury Select Committee hearing this afternoon. It is the first public comment to come out of a Goldman official since the currency swaps controversy reignited two weeks ago, and directly contradicts Eurostat’s claim the agency had no knowledge of the trade.
…
Eurostat, however, has denied knowledge of the trades, saying it was alerted only when the story hit the headlines two weeks ago. “Greek authorities have not informed Eurostat about this kind of swap operation. It is only recently that Eurostat has heard from the press about this individual operation. Eurostat has requested information from the Greek authorities and will only give further comment on the issue when it has received the information,” said a Eurostat spokesperson.

Note that the lawyers have carefully worded Eurostat’s hairsplitting “Greek authorities” and “this individual operation”.

But does it matter? They were encouraging this type of deal!

Before 2002, deals of this kind occupied a grey area in European accounting rules, according to a 2001 report written for the US Council on Foreign Relations and the International Securities Market Association by Italian academic Gustavo Piga. In his report, Piga noted the inability of European authorities to decide whether the deals were permissible or not, and called for “a firm national accounting framework to deal with these window-dressing transactions” – citing as an example a swap put in place on a 1995-vintage three-year bond by the Italian government in 1996. In May 2002, the publication of ESA95 accounting rules answered Piga’s concern by explicitly permitting the transactions and providing a worked example of how to calculate the apparent reduction in national debt – not, perhaps, the reaction Piga had expected.

But, as Felix Salmon points out:

This is a failure of European transparency and coordination; Goldman is a scapegoat.

Of course, getting cash up front is hardly limited to European governments. US municipalities also liked the idea of cash upfront:

JPMorgan lured municipalities into derivative deals by offering upfront cash payments in exchange for a pledge by the local government to agree to enter interest-rate swaps with the bank at a future date.

In these deals, which were rarely put out for public competitive bidding, the bank said its clients would come out ahead if interest rates increased in the future.

JPMorgan and competitors routinely didn’t disclose their fees for these contracts, public records show. In some cases, the bank made more money than it paid out. In Erie, Pennsylvania, JPMorgan gave the school district $755,000 upfront and collected $1.2 million in fees.

The bank was able to lock in its income by selling a mirror-image swap contract on the open market for the higher amount. The transactions involved derivatives, which are unregulated contracts tied to the value of securities, indexes or interest rates.

The deals JPMorgan arranged used floating-rate bonds and interest-rate swaps. The swaps required a municipality and the bank to exchange payments as frequently as every month. The amounts that changed hands were based on various global lending rates.

One of the great joys of investing in US Treasuries is the occasional spike in demand for specific short-term issues due to municipal defeasance – which generally happens during a period of declining rates. That game isn’t being played much this time ’round:

Brill, 47, is caught in an unintended consequence of the Federal Reserve chairman holding overnight rates near zero to ease the worst recession since the 1930s. The city, facing a $212 million budget deficit for the current fiscal year, could sell tax-exempt obligations yielding less than 4 percent to retire 5 percent debt sold seven years ago. To do so, Brill would first have to park the proceeds of the new bonds in an escrow account investing in U.S. government securities that under Bernanke pay as little as 0.53 percent.

Local governments and other borrowers in the municipal market sold a record $378 billion of tax-exempt bonds in 2009, when yields fell to the lowest in at least 40 years. At the same time, so-called advance refundings of existing notes shrank to $48.1 billion in 2009 and $28.9 billion the year before, from $82.4 billion in 2003 when municipal yields were at a then-record low, though Treasury yields were higher than today, according to data compiled by Bloomberg.
…
If Los Angeles were to advance refund $151.7 million of 5 percent bonds sold in 2003, new debt would be invested in the low-yielding Treasuries until the 5 percent issues are eligible for repayment on Sept. 1 of 2011, 2012 and 2013, according to bond documents.

While Brill estimates the city could sell new bonds at less than 4 percent, that cost would be higher than the rates of 0.53 percent to 1.62 percent the Treasury pays on special securities with maturities matching the earliest dates the 5 percent issues can be repaid.

The Bloomberg article quoted discusses SLGSs, but any Treasury obligation will do.

Moderate volume today, as PerpetualDiscounts fell 4bp while FixedResets gained 19bp. A very well-behaved market with only one entry in the performance highlights.