PrefBlog

Worries regarding Greek debt are affecting Argentina:

Argentine bonds tumbled last week, with the yield on 7 percent dollar bonds due in 2015 soaring 2.36 percentage points in three days, amid concern that Greece’s financial crisis would spread across Europe. The debt rallied since European leaders unveiled an almost $1 trillion bailout plan, climbing for a third day today as yields fell 17 basis points, or 0.17 percentage point, to 12.55 percent.

[Economy Minister Amado] Boudou, in New York to meet with creditors ahead of tomorrow’s deadline for institutional investors to tender their defaulted bonds without penalty, said the government is convinced the proposal for restructuring $20 billion of defaulted debt held out of a 2005 settlement is “the last opportunity” for investors.
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Argentina hasn’t tapped international credit markets since defaulting on $95 billion of debt in 2001.
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Argentina’s offer included securities due in 2033 worth 33.7 cents on the dollar, warrants linked to gross domestic product and past due interest with the 2017 bonds. The government didn’t offer to include past-due payments on the GDP warrants, and said it was considering a concurrent sale of $1 billion in additional 2017 bonds as part of the exchange.

Argentina’s offer — as measured in net-present value terms — is worth about 45.5 cents on the dollar for institutional investors, according to RBS Securities Inc. debt strategist Siobhan Morden. The value of the 2005 exchange was 59.63 cents on the dollar, Credit Suisse Group AG said.

Investigators of the May 6 Bungee Jump have identified a candidate trigger point:

Regulators examining the causes of the brief stock market free fall last Thursday are looking closely at heavy selling in the market for stock-index futures by a single trader, beginning 10 minutes before stock prices began to plummet.

Gary Gensler, the chairman of the Commodity Futures Trading Commission, said at a Congressional hearing on Tuesday that during that crucial time period, the futures trader, whom he would not identify, accounted for about 9 percent of trading volume in the most actively traded stock-index derivative contract, known as the 500 e-mini futures contract.

All of the trader’s orders were to sell, Mr. Gensler said, while most of the other 250 traders who were active in the same market that day were both buying and selling securities.
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The identity of the trader remained unclear. Terrence A. Duffy, executive chairman of the CME Group, which operates the Chicago exchange, said on Tuesday: “We obviously won’t divulge that market information. We are in contact with the folks that did the trade. There is no question that it is a bona fide hedger” and not someone intending to disrupt the markets.

There have been previous reports that the proximate cause was a $7.5-million options trade.

SEC Commissioner Luis Aguilar has released statement on fiduciary responsibility which aims to “clarify” earlier remarks (discussed on PrefBlog on April 30:

Currently, investors are receiving investment advice from broker-dealers who are not fiduciaries. This has serious and real consequences for investors who may not receive advice that is in their best interest. Moreover, investors may not be told that the broker-dealer registered representative sitting across from them may receive undisclosed compensation from the investment option he or she just recommended.

The big problem I have is his earlier insistence that institutional investors need the protection of a fiduciary relationship – which simply adds another layer to costs. Retail investors, as well, should be allowed to invest for themselves (if they’re not fiduciary to themselves, who is?) if they want to; or choose a fiduciary relationship.

I highlighted the savage effects of credible action in Greece on April 30. Moody’s is expecting credit effects to be severe:

Moody’s Investors Service lowered 22 billion euros ($28 billion) of Greek bonds backed by loans to consumers and companies as the country adopts austerity measures to qualify for European aid, leaving the notes under review for further downgrades.

The cuts “were prompted by Moody’s expectations of significant pool performance deterioration due to the stressed economic environment in Greece as well as increased operational risk due to the weakened financial strength of Greek banks,” the New York-based ratings company said today in a statement.

The securities, which are part of 23 transactions, included 10.7 billion euro of notes backed by residential mortgages, 3.9 billion euro of collateralized loan obligations, and an additional 7.2 billion euro of other asset-backed debt, according to the statement. The bonds appear less creditworthy considering “Greece’s austerity package and the resulting impact on the Greek economy and collateral performance,” Moody’s said.

Continued heavy volume today and, wonder of wonders, PerpetualDiscounts gained 11bp, while FixedResets gained 29bp. Volatility was high.

PerpetualDiscounts now yield 6.40%, equivalent to 8.96% interest at the standard equivalency factor of 1.4x. Long corporates now yield about 5.7%, so the pre-tax interest-equivalent spread is now about 325bp, a mild (and perhaps spurious) decline from the 330bp reported on May 5.

The Bank of Canada has released a working paper by Fousseni Chabi-Yo and Jun Yang titled Idiosyncratic Coskewness and Equity
Return Anomalies:

In this paper, we show that in a model where investors have heterogeneous preferences, the expected return of risky assets depends on the idiosyncratic coskewness beta, which measures the co-movement of the individual stock variance and the market return. We find that there is a negative (positive) relation between idiosyncratic coskewness and equity returns when idiosyncratic coskewness betas are positive (negative). Standard risk factors, such as the market, size, book-to-market, and momentum cannot explain the findings. We construct two idiosyncratic coskewness factors to capture the market-wide effect of idiosyncratic coskewness. The two idiosyncratic coskewness factors can also explain the negative and significant relation between the maximum daily return over the past one month (MAX) and expected stock returns documented in Bali, Cakici, and Whitelaw (2009). In addition, when we control for these two idiosyncratic coskewness factors, the return difference for distress-sorted portfolios found in Campbell, Hilscher, and Szilagyi (2008) becomes insignificant. Furthermore, the two idiosyncratic coskewness factors help us understand the idiosyncratic volatility puzzle found in Ang, Hodrick, Xing, and Zhang (2006). They reduce the return difference between portfolios with the smallest and largest idiosyncratic volatility by more than 60%, although the difference is still statistically significant.

Cuomo’s suing Ivy Management, a unit of BONY-Mellon:

The damaging information that Ivy discovered about Madoff and then failed to disclose includes:

In 1997, Ivy learned that there were not enough options to support Madoff’s purported trading strategy.

• Specifically, the volume of Standard and Poor’s 100 Index options (“OEX”) available would only support half of the amount of assets Ivy believed Madoff had under management. This strongly suggested that the trades Madoff had been reporting were not actually being made.
• Between 1997 and 1998, Madoff gave Ivy three vastly different explanations as to where and with whom he traded OEX options, all of which were inconsistent with Ivy’s observations and understanding of OEX options.
• Ivy received information from industry contacts indicating that Madoff was misusing client assets to fund his broker-dealer business instead of investing the money as he claimed he was doing.

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Internal e-mails reveal that [former Chief Executive Officer Lawrence] Simon and [former Chief Investment Officer Howard] Wohl intentionally failed to disclose their doubts about Madoff to their clients with heavy Madoff-related investments:

On December 16, 1998, the day after Madoff gave Ivy his third explanation about his option trades, Wohl recommended to Simon that Ivy withdraw all of the funds they personally managed from Madoff, including some of their own money, writing:

• “I’m concerned that he [Madoff] now admits that he does not execute all of the index options on the exchange that there are ‘unknown’ counterparties that if these options are not paid off he’d lose less than 100%. It remains a matter of faith based on great performance – this doesn’t justify any investment, let alone 3%.”
• In response, Simon argued that Ivy should not withdraw the investment it had placed with Madoff because that could lead Ivy’s clients to withdraw their money from Madoff as well, which would significantly impact their total revenue, writing: “Amount we now have with Bernie in Ivy’s partnerships is probably less than $5 million. The bigger issue is the 190 mil or so that our relationships have with him which leads to two problems, we are on the legal hook in almost all of the relationships and the fees generated are estimated based on 17+% returns …. [to be] $1.275 Million… Are we prepared to take all the chips off the table, have assets decrease by over $300 million and our overall fees reduced by $1.6 million or more, and, one wonders if we ever “escape” the legal issue of being the asset allocator and introducer, even if we terminate all Madoff related relationships?”

Just like with SocGen, Barings and just about every other fraud: willful blindness.

To my astonishment, Trichet actually gave a thoughtful speech, titled What role for finance?, although his premises do not support his conclusions:

Sellers of securitised products must disclose all information about the underlying loan structure so that both investors and rating agencies can correctly price the risks embedded in these products. More transparency can also be achieved by central counterparty clearing of bilateral over-the-counter trading arrangements.

There was lots of transparency in the sub-prime market; it just wasn’t used and – in some cases – the math was wrong. Additionally, firms were hired as collateral managers on the basis of – as far as I can tell – complete lack of managerial skill. Come on, people. The sell-side has no brains at all – they’re not paid to have brains, they’re paid to have bright smiles and firm handshakes while telling clients how astute they are. Give me a break. Fortunately, however, the buy-side isn’t presenting much of a challenge:

JPMorgan Chase & Co.’s traders matched those at Goldman Sachs Group Inc. in making money every day of the first quarter, a first for both companies.

Bank of America did the same:

During the three months ended March 31, 2010, positive trading-related revenue was recorded for 100 percent of the trading days of which 95 percent were daily trading gains of over $25 million. This compares to the three months ended December 31, 2009, where positive trading-related revenue was recorded for 86 percent of the trading days of which 58 percent were daily trading gains of over $25 million, 10 percent of the trading days had losses greater than $25 million and the largest loss was $90 million.

Back to Trichet:

For instance, investors are currently allowed to buy credit defaults swaps without holding the underlying asset, typically a bond. By first buying the credit default swaps and then trying to affect market sentiment by going short on the underlying bond, investors can make large profits without a change in the fundamental value of the reference entity and, worse, to its detriment.

If there is truly no change in the fundamental value of the reference entity, then there will be plenty of people stepping up to buy it cheaply. This is merely a problem of liquidity.

I commented yesterday that the EU bail-out was only a stop-gap the relies on future reforms; Bernanke agrees:

Federal Reserve Chairman Ben S. Bernanke told U.S. senators today that the euro region’s almost $1 trillion aid package to stem its debt crisis isn’t a cure- all, according to a participant.

“He said, ‘This is basically not a panacea,’” and that the measures are “temporary,” Alabama Senator Richard Shelby, the senior Republican on the Banking Committee, told reporters in Washington after a closed-door briefing Bernanke held with the panel. “There’s got to be fundamental underlying changes in their economies, not just Greece, but a lot of other countries,” Shelby cited Bernanke as saying.

The Canadian preferred share market continued recent trends today, with PerpetualDiscounts losing 10bp while FixedResets gained 10bp. Volume returned to heavy levels. There was quite a bit of volatility.

We can expect regulators, polititicans and the media to trumpet the latest Economist piece on Canada … but how many will quote from the last two paragraphs?

How much of the Canadian model can, or should, be exported? Critics of the Canadian banks reckon that their conservatism was the flip side of a cosy oligopoly. The big five were barred from merging and partly protected from foreign interlopers. They shared out a profitable domestic market and gave up competing on price. And keeping tabs on the banks is much easier when all are relatively small by international standards and are based within a few hundred yards of each other and of regulators in Toronto.

The result is that Canadians pay more for financial services than others and there is little innovation. Even so, as taxpayers elsewhere dig deep to pay for their bankers’ wheezes they might think that Canadians got a bargain. Replicating Canadian banking elsewhere would be hard. But when Americans and Europeans press Mr Harper at the G20 meeting to accept a tax on banks to curb their riskiness, he has reason to retort that Canadian-style regulation does the job better.

Good article on High Frequency / Algorithmic trading and risk control from the Chicago Fed (hat tip: Financial Webring Forum):

Sometimes, these trading errors have been the result of the removal of pre-trade risk controls to decrease latency. For example, futures broker MF Global suffered $141.5 million in losses in February 2008, when a rogue trader initiated transactions during off hours using a terminal intended for the business of major customers. One breakdown in MF Global’s internal risk systems was the removal of trade limits, which had been done to increase trading speeds.
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A well-built algorithm contains risk controls, such as price and quantity limits.

The Themis Trading blog has some good commentary on the May 6 Bungee Jump:

The story is a failed market structure. The market failed today.

The market melted down and “liquidity providers” quickly pulled all bids. According to today’s Wall Street Journal, high frequency firm, Tradebot, closed down its computer systems completely, as did New Jersey’s own Tradeworx, who was so critical of our silly market structure comments in their SEC comment letter. By the way, if you don’t know who or what Tradebot is, it is the proprietary trading engine that used to be part of the BATS exchange. In fact the reason BATS was rolled out as an exchange to begin with was to lower costs and facilitate trades for Tradebot (Tradebot’s 1251 NW Briarcliff Pkwy Kansas City address is next door to BATS’s North Mulberry Drive address fyi). In the WSJ article Mr. Cummings said his Tradebot system was designed to stop trading when the market becomes too volatile, because he “doesn’t want to compound the problem.” Too bad he doesn’t understand that that was and is the problem. To make matters worse, while some high frequency firms shut down yesterday and pulled their bids, as we warned they would do for over a year and a half, other high frequency firms turned from being liquidity providers to liquidity demanders, as they turned around and indiscriminately hit bids like Randolph and Mortimer Duke.
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Today’s price swings in a great number of stocks highlight the inherent and systemic risk of our automated stock market, which has few checks and balances in place. Once the market sensed stress, the bids were cancelled and market sell orders chased prices down to the lowest possible point. Investors who thought they were protecting themselves with the prudent use of stop orders were left with fills that were far away from the closing price. In some stocks like our SAM example above, this was $0.01. We warned of the potential for HFT to behave this way when we met with and showed our regulators the NY Fed study that highlighted HFT’s vanishing act around stressful news announcements in the currency markets.

We read this in a recent comment letter to the SEC about HFT and couldn’t agree more: “When markets are in equilibrium these new participants increase available liquidity and tighten spreads. When markets face liquidity demands these new participants increase spreads and price volatility and savage investor confidence.”
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The market action of May 6th has demonstrated that our equity market has major systemic risks built into it. There was a time today when folks didn’t know the true price and value of a stock. The price discovery process ceased to exist. High frequency firms have always insisted that their mini-scalping activities stabilized markets and provided liquidity, and on May 6th they just shut down. They pulled the plug, as we always said they would, and they even admit it in the papers this morning. We need a new mousetrap. This is not an isolated incident, and it will happen again.
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Significant Movers This Morning:

It doesn’t matter; earnings don’t matter. Our regulators have decreed that stock valuation shall be determined by the whims of “liquidity providing” HFT firms armed by our new breed of exchanges.

Earnings Today:

It doesn’t matter; earnings don’t matter. Our regulators have decreed that stock valuation shall be determined by the whims of “liquidity providing” HFT firms armed by our new breed of exchanges.

Expected Earnings Later:

It doesn’t matter; earnings don’t matter. Our regulators have decreed that stock valuation shall be determined by the whims of “liquidity providing” HFT firms armed by our new breed of exchanges.

Significant Upgrades and Downgrades:

It doesn’t matter; earnings don’t matter. Our regulators have decreed that stock valuation shall be determined by the whims of “liquidity providing” HFT firms armed by our new breed of exchanges.

While I have not dealt with Themis Trading, I do have a certain amount of respect for them as traders – they have clearly studied market microstructure quite intensively and if I were putting together a major US equity trading operation, I would certainly take the time to find out more about them and what they might be able to do for me.

However, trading is not investing and their closing comments betray their bias. Even after allowing for a fair amount of hyperbole, earnings matter and valuations matter. Accenture pays a semi-annual dividend of $0.375 and made $0.60 per share in 2Q10 (note: I have not actually analyzed Accenture and have no idea of its value. It’s just an example, and I’m assuming the quoted figures are sustainable). If some idiot wants to sell me shares at $0.01 each, I have no problem buying them all day long … and if the value is good, why should I care what the price is? Increased volatility brings a lovely range of potential entry and exit points – an actual investor can make quite a bit of extra money punishing the bozos.

The SEC release of public comments on the Equity Market Structure concept release included the Themis Trading response. There is no public comment from Tradeworx – they just had a meeting.

In the Themis response, they note:

Traditionally, exchanges have competed for revenues in three different areas: listings, transaction fees and market data revenue. A recent study by Grant Thornton details what the firm refers to as “The Great Delisting Machine Timeline.” They detail how a progression of regulation (including order handling, decimalization and Sarbanes-Oxley) has destroyed the economic incentive for traditional market making, investment banking and research.

It is interesting to compare this (claimed) equity market structure effect with the corporate bond market, in which the greater transparency provided by TRACE has led to a market that is tighter but with significantly less depth.

All in all though, I will be most interested to learn what the SEC finds in their investigation of the bungee jump – the data will be very good, I’m sure, although it may be presented in such a way as to provide support for whatever conclusions they wish to draw.

I suspect that there will be a certain amount of evidence that stop-loss orders will be implicated to at least some degree. Stop loss orders are the most idiotic order type known to man (if you’re willing to sell something at $45, why the hell aren’t you selling at $50? It makes no sense!) but have immense popularity. There are so popular, in fact, that even if the evidence shows they were 100% responsible for the bungee jump (it won’t: ain’t nuthin in the markets ever so clear cut; but just say), there will be no talk of banning them.

James Hamilton of Econbrowser mentions stop-loss orders in his discussion of the bungee jump:

… if momentum-chasing algorithms come to rule the financial world, those who try to follow them will be the biggest losers.

Another notion that’s popular with many financial gurus these days is the claim that you can eliminate certain risks to your portfolio with the right strategy of automatic trading and stop-loss sell orders. Again that claim invites an economic question– if you are getting an insurance policy, who is selling it to you? I believe the implicit answer is, you are counting on the market-maker to insure you by taking the other side of your escape transactions. But the curious thing about such an insurance policy is that the market-maker gets to decide what premium to charge you after you ask to collect on the policy. You just might find that the state of the world when you and your buddies all most desperately want to cash in on your insurance is exactly the time when the premium proves to be ruinously expensive.

The SEC has held a meeting about the bungee jump:

This morning, SEC Chairman Mary Schapiro had a constructive meeting with the leaders of six exchanges — the New York Stock Exchange, NASDAQ, BATS, Direct Edge, ISE and CBOE — and the Financial Industry Regulatory Authority to discuss the causes of Thursday’s market events, the potential contributing factors, and possible market reforms.

“As a first step, the parties agreed on a structural framework, to be refined over the next day, for strengthening circuit breakers and handling erroneous trades.

Too bad investors weren’t represented at the meeting; but then, investor scum would only get in the way.

The Greek crisis is now worse than the Lehman crisis – at least by one measure:

The cost of insuring against losses on European bank bonds soared to a record, surpassing levels triggered by the collapse of Lehman Brothers Holdings Inc., as the sovereign debt crisis deepened.

The Markit iTraxx Financial Index of credit-default swaps on 25 banks and insurers soared as much as 40 basis points to 223, according to JPMorgan Chase & Co. The index closed at 212 basis points March 9, 2009. Swaps on Greece, Portugal, Spain and Italy rose to or near all-time high levels.
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The spread between the three-month dollar London interbank offered rate and the overnight indexed swap rate, a barometer of the reluctance of banks to lend that’s known as the Libor-OIS spread, is at 18 basis points, up from 6 basis points on March 15 and near the highest level in more than five months. It’s still far from the record 364 basis points in October 2008, almost a month after Lehman’s bankruptcy.

Funny, isn’t it, that we are told that the Lehman crisis arose because of incompetent decision makers, while the Greek crisis is due to speculators and hedge funds. However, funding is sufficiently tight that the dollar swap line has been re-established:

In response to the re-emergence of strains in U.S. dollar short-term funding markets in Europe, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, and the Swiss National Bank are announcing the re-establishment of temporary U.S. dollar liquidity swap facilities. These facilities are designed to help improve liquidity conditions in U.S. dollar funding markets and to prevent the spread of strains to other markets and financial centers. The Bank of Japan will be considering similar measures soon. Central banks will continue to work together closely as needed to address pressures in funding markets.

The Federal Open Market Committee has authorized temporary reciprocal currency arrangements (swap lines) with the Bank of Canada, the Bank of England, the European Central Bank (ECB), and the Swiss National Bank. The arrangements with the Bank of England, the ECB, and the Swiss National Bank will provide these central banks with the capacity to conduct tenders of U.S. dollars in their local markets at fixed rates for full allotment, similar to arrangements that had been in place previously. The arrangement with the Bank of Canada would support drawings of up to $30 billion, as was the case previously.

These swap arrangements have been authorized through January 2011. Further details on these arrangements will be available shortly.

The Bank of Canada states:

The Bank of Canada and the Federal Reserve have agreed to re-establishment of the US$30 billion swap facility (reciprocal currency arrangement) that had expired 1 February 2010. This facility would be accessed, should the need arise, to provide U.S.-dollar liquidity in Canada. If drawn on by the Bank of Canada, the swap would provide liquidity facilities for use by financial institutions in Canada that are similar in nature to those being announced today by the other central banks. This swap facility expires in January 2011.

This agreement provides the Bank of Canada with flexibility to address rapidly evolving developments in financial markets. The Bank judges that it is not necessary for it to draw on this swap facility at this time, but that it is prudent to have the agreement in place. Should the swap be drawn on, the details of the liquidity facilities provided would depend on the specific market circumstances at the time.

Additionally, the Fed has approved a practice session with the Term Deposit Facility, whereby banks can deposit free Fed Funds with the Fed on a competitive basis.

The EU was able to agree on a bail-out:

European policy makers unveiled an unprecedented loan package worth nearly $1 trillion and a program of securities purchases as they spearheaded a drive to stop a sovereign-debt crisis that threatened to shatter confidence in the euro. Jolted into action by last week’s slide in the currency to a 14-month low and soaring bond yields in Portugal and Spain, governments of the 16 euro nations agreed to make loans of as much as 750 billion euros ($962 billion) available to countries under attack from speculators.

The “attack from speculators” line means the reporter has drunk the Kool-aid. The fund is all very well and good, but it is not as simple a matter as providing funding for a solvent but illiquid financial firm until such time as markets recover and its assets mature. Unless Club Med takes credible actions, not just to reduce their deficits to 3%, not just to balance the budget, but to pay down some of their debt … it’s only delaying the inevitable.

Continued heavy volume today, with PerpetualDiscounts continuing their slide and finishing down 3bp, while FixedResets continued their recovery, gainng 12bp.

Market fragmentation is being suggested as the cause of yesterday’s bungee jump:

Federal regulators reviewing yesterday’s stock plunge will try to determine if the fivefold increase in the number of American equity exchanges has left them unable to manage the biggest surges in volume.
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The rout showed how the fragmentation of the U.S. equity market may suppress demand when it’s needed most, especially when the New York Stock Exchange attempts to calm trading, said James Angel, a finance professor at Georgetown University in Washington. NYSE Euronext Chief Operating Officer Larry Leibowitz said the Big Board prevented a bigger decline.
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Rapid-fire orders trigger what the NYSE calls liquidity replenishment points, or LRPs, shifting the market into auctions. While the system is designed to restore order on the Big Board, trading is so fast during times of panic that orders routed past the exchange may swamp other venues and exhaust buy orders, said Angel at Georgetown.

That’s when prices may plummet as orders execute against so-called stub quotes from market makers. Brokers can set the quotes as low as a penny a share because they’re never expected to be used.
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Computer programs that increase sell orders when stocks are falling may have exacerbated yesterday’s plunge, said Nick Colas, chief market strategist at BNY ConvergEx Group LLC in New York. Programs that may have smoothed out trading during periods of low volatility can “make market moves a lot worse” when equities are plunging, he said.

I beg to differ. Market fragmentation did not cause the bungee jump. Stupid dumb trading triggered the bungee jump. What kind of idiot sends in a market order to sell Accenture when it’s down 99.9% on the day on no news?

The way to eliminate stupid dumb trading is to ensure that stupid dumb traders lose all their money, go bankrupt and die.

There’s trouble in the German real-estate mutual fund sector:

Two German real estate mutual funds with properties worth 10.5 billion euros ($13 billion) closed for redemptions yesterday after government proposals to impose an industrywide writedown of assets spooked investors.

SEB Asset Management AG closed its ImmoInvest fund and KanAm Grund KAG closed Grundinvest Fonds after German Finance Minister Wolfgang Schaeuble released a draft bill May 3 that proposed to introduce a 10 percent cut in asset values.

In the past five years, Germany’s 89 billion-euro real estate mutual-fund industry has been rocked by unprecedented waves of redemptions by investors. The writedown proposal is accompanied by a mechanism to smooth out violent swings in appraisal values, which the government blames for the surge in redemptions.
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Investors fled German property funds after Lehman Brothers Holdings Inc.’s bankruptcy in September 2008, which forced 12 to close for redemptions. That was only the second time in half a century that German funds had shut for redemptions.

Three closed in December 2005 and January 2006 after probes by Germany’s financial regulator and a Frankfurt prosecutor raised concern that property valuations had been inflated and led to the eventual withdrawal of 11.6 billion euros from all of the funds.

TMW Immobilien Weltfonds halted redemptions Feb. 8, just two months after reopening. That followed a 21 percent writedown in the assets of Aberdeen Asset Management’s DEGI Global Business, which also halted redemptions in November.

The New York Fed has released its Quarterly Research Review.

The SEC & CFTC have issued a joint statement:

Thursday’s unusual trading activity included extreme volatility for a number of individual securities. This is inconsistent with the effective functioning of our capital markets and we will make whatever structural or other changes are needed.

Extreme volatility is a good thing for long term investors, but I suppose that doesn’t matter when you’ve got to prove you’re Doing Something.

The Euro’s defense may include trading restrictions:

European leaders agreed to set up an emergency fund to halt the spread of Greece’s fiscal woes, seeking to prevent a sovereign debt crisis from shattering confidence in the 11-year-old euro.
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European officials declined to disclose the size of the stabilization fund, to be made up of money borrowed by the European Union’s central authorities with guarantees by national governments. Finance ministers will meet at 4 p.m. tomorrow in Brussels to flesh out the details.

“It will be a very clear signal against those who want to speculate against the euro,” German Chancellor Angela Merkel said.

Asked whether steps against speculation would include restrictions on short sales or credit default swaps, [European Commission President Jose] Barroso said “some of the points you have mentioned will be contemplated.”
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The extra yield that investors demand to hold Greek, Portuguese and Spanish debt instead of safer German bonds rose to euro-era highs yesterday. The premium on 10-year government bonds jumped as high as 973 basis points for Greece, 354 basis points for Portugal and 173 basis points for Spain.

Maybe Barroso can bring back the old Iron Curtain crimes of “economic sabotage” for trading foreign currency on the black market!

PerpetualDiscounts got whacked again, losing 30bp on continued heavy volume, while FixedResets fared better and lost only 5bp on the day.

More fun at Club Med?

Greek bond yields yesterday rose above their level before the government agreed on a European Union-led bailout on May 2 as escalating protests cast doubt on its ability to drive through austerity measures. Spanish and Portuguese bonds also renewed last week’s slide as investors question their ability to cut budget deficits that are among the highest in the euro area.
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The extra yield that investors demand to buy its debt over German bunds rose 21 basis points to a 14-month high of 117.8 points. Spain’s benchmark IBEX Index, the euro region’s worst performer after Greece, fell 5.4 percent to the lowest since July. Portugal’s spread rose 40 basis points to 247 yesterday.

The euro weakened 1.4 percent to $1.3011, the lowest in more than a year. The currency retreated further in Asian trading today, to $1.2961 as of 11 a.m. in Singapore.

The Swiss are making a big play to attract mobile professionals:

Swiss government officials and Geneva-based financial advisers have come to London to lure rich residents with glowing descriptions of the country’s low taxes, safe streets, private-banking options and convenient ski weekends.

“We are here to make it easier for you to come to Switzerland,” says Martin Meyer, head of economic development for the Swiss canton of Valais, which borders Lake Geneva, Bloomberg Markets reports in its June issue.

Next door, an overflow crowd of 50 more attendees enjoys wine and canapes as they watch the presentation on closed- circuit televisions in a mahogany-lined library, which includes a chart showing the prevalence of English as a language for doing business in Switzerland. A JPMorgan Chase & Co. banker who declined to be identified confides he’s planning to relocate next year. His main complaint: higher U.K. taxes, a theme the Swiss delegation has pounced upon.

Geithner has a solution to the problem: regulate everything!

No regulator or supervisor had the legal authority to look across the financial system and take action to prevent the diversion of activity away from regulation. A system that applied safety and soundness regulation only to banks was unable to protect the overall safety and stability of a financial system composed substantially of non-banks that played a role traditionally reserved for banks.

Moreover, accounting and disclosure requirements and regulatory capital requirements helped encourage the shift in risk to the parallel financial system, without adequately capturing the remaining exposure of banks to those risks.

When the crisis hit and huge swaths of the American financial system got caught in the run on the parallel banking system, many came running to the Federal Reserve for liquidity and for protection.

The emergency financial response to the run that started in the parallel financial system was necessary to protect our economy from an even greater calamity. But if our regulatory and supervisory systems had had the tools and authorities to prevent risks from accumulating in unregulated sectors of the financials system in the first place, such a large emergency response would not have been necessary. That is a key reason why financial reform is so essential.

This is disingenuous at best. The Fed had unlimited authority to penalize the exposure of the core financial system to the shadow financial system; by limiting such exposure it could have restrained the growth of the shadow sector and limited the damage when the bust occurred.

However, they elected to ignore concentration risk and things like Citigroup’s “liquidity puts” (discussed April 13 and risk-weighted liquidity guarantees at a low value; ignored concentration risk, and allowed risk-weighting of bank paper according to the credit rating of the sovereign.

Financial crises will never be abolished. GM & Chrysler have cost far more than the piddly little bank crisis, and Club Med is going to cost even more. But the former players are popular with blue-collar voters and the latter with expansionary EU politicians, while banks are always a popular target for regulatory opprobrium.

Hank Paulson commented on Bear Stearns today:

Former Treasury Secretary Henry Paulson said bets against the survival of Bear Stearns Cos. before the firm’s sale to JPMorgan Chase & Co. amounted to “the wolf pack trying to pull down the weak deer.”

“I don’t use the word collusive because it’s got a legal connotation,” Paulson said today at a hearing of the Financial Crisis Inquiry Commission in Washington. “It sure looked to me like some kind of coordinated action.”

Paulson said he wasn’t “saying there was behavior that was illegal” and he thinks short-selling “is essential for the price-discovery process.”

All this brings to mind the importance of liquidity. Price discovery requires liquidity. Say BSC is at $50, a bunch get shorted, and the price goes down. Theoretically, this should mean that holders of other brokerages will find BSC relatively more attractive and sell, say, JPM to buy BSC. Eventually, the price of the brokerage sector will go down and become relatively more attractive to holders of other sectors; a new equilibrium will be established.

But say all the potential buyers of BSC are full up? What if investment decisions are not made on the basis of hard-nosed facts, but on the basis of the marketting department’s evaluation of how much the clients want to see a troubled brokerage on their books? The slope of the demand curve will decline; perhaps go flat; and the price goes to zero. Contingent Capital is one way of ensuring that the demand for common is not flat (although forced selling by irate bond investors may further reduce the price), but it’s an interesting question and one that I have not yet been able to answer.

Common stock had an exciting day:

The Dow Jones Industrial Average plunged almost 1,000 points today before paring its decline and ended down 347.80 points, or 3.2 percent, at 10,520.32. About $700 billion of U.S. stock-market value was erased in less than 10 minutes, data compiled by Bloomberg show.
…
A total of 19 trades of 100 shares each [of Accenture common] were executed at 1 cent in seven seconds from 2:47 p.m. to 2:48 p.m. in New York, a minute after the Dow average plunged by the most since the market crash of 1987, the data showed.

Eighteen of the trades were executed on the CBOE Stock Exchange and were canceled. The first trade that sent Accenture to a penny was executed on the Nasdaq Stock Market. That transaction has yet to be canceled, the data showed.

Accenture shares closed today at $41.09, down 2.6 percent in New York Stock Exchange composite trading.

There is speculation that the plunge was due to trader error:

A possible culprit for the drop was a trader error in which someone entered a “b” for billion instead of an “m” for million in a trade. Multiple sources confirmed the report to CNBC and CNBC.com

The apparent trigger for the massive selloff, which began shortly after 2 pm ET, was the approval of austerity measures by the Greek Parliament, which sparked renewed rioting in Athens.

It could very well be trader error – the absence of a clear trigger, the steepness of the descent and the swift recovery make that plausible – but I’d be happier with such an explanation if some corroborative evidence were provided: ‘waves of selling in 23 liquid basket stocks’, for instance.

Update: Corroborative evidence?

While the first half of the Dow Jones Industrial Average’s 998.5-point plunge probably reflected normal trading, the selloff snowballed because of orders sent to venues with no investors willing to match them, [NYSE Euronext COO Larrry] Leibowitz said in an interview on Bloomberg Television.

“If you look at the charts you can see fairly clearly where the trades came in,” he said from New York. “It’s that V-shaped drop where it came down and snapped right back up. You had some very high-cap stocks trading down 50 percent or large percentages in a split instant because there really was no liquidity in electronic markets.”
…
“The fact that it snapped back so quickly made it clear that it was an aberration,” Leibowitz said. “When a large order or series of orders comes into electronic markets, they don’t really have any way to recognize either that they’re a mistake or to slow them to down to attract the proper liquidity on the other side. And so the electronic markets actually traded all the way through the slower New York Stock Exchange markets where we were trying to slow down trading.”

…End of update

The SEC & CFTC are looking into it:

The SEC and CFTC are working closely with the other financial regulators, as well as the exchanges, to review the unusual trading activity that took place briefly this afternoon. We are also working with the exchanges to take appropriate steps to protect investors pursuant to market rules.

“We will make public the findings of our review along with recommendations for appropriate action.

Just a little too precious for my taste. An “investor” has no need of protection in cases like this. The ones who need protection from volatility are better referred to as “bozos”.

The Canadian preferred share market was nowhere nearly as exciting, but went in the same direction as PerpetualDiscounts lost 28bp and FixedResets were down 13bp. Volume lightened considerably to well-maybe-just-a-little-above-average, with FixedResets scoring a shut-out on the volume highlights table.

Agreement has been reached on the US too-big-to-fail fund:

The deal would eliminate a proposed industry-paid $50 billion fund to cover the government’s costs of liquidating a failing financial firm, Dodd said today in an interview. Republicans said the fund would encourage bailouts rather than prevent them.
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The Dodd-Shelby agreement would apply to a section of the bill that would give the government authority to liquidate large failing financial firms whose collapse would threaten the economy. The two senators have agreed to replace the proposed pre-funded $50 billion reserve with language that would require regulators to impose fees on the financial industry to recoup costs for unwinding a company after a collapse, Dodd said today.

The amendment passed 93-5. Typical of modern Republicans – spend first, tax later. Much later!

The Club Med countries may be paying much, much later!

Greek bond yields yesterday rose above their level before the government agreed on a European Union-led bailout on May 2 as escalating protests cast doubt on its ability to drive through austerity measures. Spanish and Portuguese bonds also renewed last week’s slide as investors question their ability to cut budget deficits that are among the highest in the euro area.
…
That didn’t stop a sell-off in Spanish bonds yesterday. The extra yield that investors demand to buy its debt over German bunds rose 21 basis points to a 14-month high of 117.8 points. Spain’s benchmark IBEX Index, the euro region’s worst performer after Greece, fell 5.4 percent to the lowest since July. Portugal’s spread rose 40 basis points to 247 yesterday.

The euro weakened 1.4 percent to $1.3011, the lowest in more than a year. The currency retreated further in Asian trading today, to $1.2961 as of 11 a.m. in Singapore.

Volume in the Canadian preferred share market was off significantly today, but remains on the high side of normal. PerpetualDiscounts squeaked out another win, gaining 2bp, while FixedResets continued their recovery with a 15bp gain. Volatility was muted, with only four issues on the performance highlights list.

PerpetualDiscounts now yield 6.35%, equivalent to 8.89% interest at the standard equivalency factor of 1.4x. Long Corporates now yield 5.6% (gaining total return of +44bp on the month-to-date), so the pre-tax interest-equivalent spread is now about 330bp, an increase from the +320bp reported at month end, as long corporate yields have come in a little while PerpetualDiscounts have remained flat.

The Volcker Rule is costing Citigroup some employees:

[Citigroup prop trader Jay] Glasser, 53, who was based in New York and specializes in derivative and currency trades linked to Japanese interest rates, generated an average of more than $10 million a year of revenue for Citigroup from 2007 through 2009, people with knowledge of the matter said. He started at Nomura last week and is based in New York, said Peter Truell, a spokesman for the Tokyo-based firm.

Glasser told his former bosses at Citigroup, which has lost at least 10 proprietary traders this year, that he quit partly because of concern that President Barack Obama’s proposed Volcker rule may force U.S. banks to divest or close proprietary-trading units, people with knowledge of the matter said. As a Japanese securities firm, Nomura wouldn’t be subject to the rule. Citigroup is the third-biggest U.S. bank by assets.

The administration is warning that fragmentation can go too far:

Treasury Secretary Timothy F. Geithner said Congress won’t improve the stability of the financial system by forcing banks to split up core parts of their business.

In testimony today to the Senate Finance Committee, Geithner declined to comment on a specific proposal from Senator Blanche Lincoln to force Bank of America Corp., JPMorgan Chase & Co. and other lenders to separate swaps trading from commercial banking. The proposal is part of a broader financial overhaul proposed by Senate Banking Committee Chairman Christopher Dodd.
…
Federal Deposit Insurance Corp. Chairman Sheila Bair has come out against the proposal and the Federal Reserve has warned that the measure could be costly to the banks and their customers.

There is a push to ensure that big banks won’t be the only ones with ‘living wills’:

German Chancellor Angela Merkel’s coalition stepped up calls for allowing the “orderly” default of euro-region member states burdened with debt to avoid a repeat of the Greek fiscal crisis.
…
Merkel, who faces elections in Germany’s most populous state on May 9, is seeking to shift focus from the Greek bailout to drawing lessons from the euro’s biggest crisis. An “orderly insolvency” process would ensure that creditors participate in any future rescue, she said on ARD television yesterday.

In other words, the idea is that sovereign debt in the EU will less secure than previously … that could have some very interesting knock-on effects.

The CalPERS lawsuit against the rating agencies is proceeding:

Standard & Poor’s, Moody’s Investors Service and Fitch Ratings must face the California Public Employees Retirement System’s lawsuit claiming their faulty risk assessments on structured investment vehicles caused $1 billion in losses.

A state court judge in San Francisco rejected the companies’ requests to dismiss Calpers’ claims of negligent misrepresentation, Brad Pacheco, a spokesman for Calpers, the largest U.S. pension fund, said today in a phone interview.

Funny – I used to respect CalPERS. Now it seems that they don’t do their own credit analysis. I last mocked CalPERS and its lackadaisical attitude towards investment management on July 31, 2009.

Assiduous Reader KH writes in and says:

your comment today about the Goldman Sachs story. This story seems to be going in the wrong direction. In my view, what is being missed here is the reality that the buyers and sellers of these CDOs were purely gambling and knew (or should have known) they were doing so. I mean it’s not as if these synthetic CDOs represented any productive capital at work or any socially redeeming value. It was a zero-sum game bet, similar to betting a portion of an institutional portfolio on red at the roulette table. Isn’t the real issue whether pension portfolios should be allowed to gamble like this in the first place?

In the particular story about ABACUS, none of the players was a pension fund, but the point is well taken – particularly in light of the CalPERS lawsuit! However, I do not feel that securities laws and regulations should restrict the investments of pension funds. Structured notes can have characteristics that make them very useful for portfolio management (although they usually don’t. Structured notes are most often vehicles whereby the intent of investment mandates can be evaded; for instance, buying “S&P Bear” instruments in a portfolio that is supposed to be fully invested.).

I take issue with the implication that “redeeming social value” should be judged, with access to investments being restricted accordingly. In the first place, whether a particular investment action has redeeming social value is very much in the eye of the beholder. Secondly, as I pointed out yesterday, Paulson’s action in shorting the instruments had the effect of intercepting the ACA/IKB sub-prime investment in the financial marketplace; otherwise, that money would have gone into further distorting an already over-heated US housing market. Paulson’s action can be viewed as helping to precipitate the crisis sooner, rather than later, before the inefficient allocation of capital did even more damage to the real economy. Which is something I consider to be socially redeeming.

PerpetualDiscounts squeaked out a win today, gaining 2bp, while FixedResets continued their strong recovery with a win of 16bp. Volume was slightly off, but still at elevated levels dominated by FixedResets.