PrefBlog

Trichet’s recent comments on fiscal discipline illustrate the number one problem with regulation:

European Central Bank President Jean-Claude Trichet called for “more ambitious” rules to force member countries to maintain fiscal discipline and punish those who don’t.

“For the euro area, more ambitious reforms are needed to ensure the smooth functioning of monetary union,” Trichet said in a speech at the World Policy Conference in Marrakech. There must be “greater automaticity, accelerated timelines and reduced room for discretion in procedures.”

European Union finance ministers meet in Luxembourg on Oct. 18 to consider European Commission proposals to fix budget management and avoid runaway deficits that led to Greece’s near- default this year. France is balking at calls for the faster imposition of sanctions on deficit-ridden governments, putting it at odds with Germany and the ECB over how to prevent a repeat of the debt crisis.

Greece’s problems vis a vis the EU did not result from any lack of rules. There were lots of rules, and there was lots of knowledge about what Greece was doing. The problem was political wilfull blindness and lack of enforcement; more rules will not alter the human condition.

Espen Gaarder Haug shares my views on the Norwegian day-traders:

“Robot trading always involves a risk of weakness in the algorithm,” Haug points out.

“It is therefore important to monitor whether such risks pops up, so that these algorithms can be adjusted, or turn off. If you choose to let the robot run without supervision, you take an unnecessary, additional risk,” says Haug.

The ongoing court case in Oslo have revealed that the two charged day traders was able to exploit the same weakness over and over again.

Timber Hill (who is a part of the Interactive Broker Group) was not aware of this before the Oslo Stock Exchange contacted them on March 14th this year.

Testifying before the court on Tuesday, Thomas Borchgrevink, manager of market surveillance at the Oslo Stock Exchange, said: “I felt that they were not aware of this. They were not on the ball.”

Timber Hill closed down, temporarily, the robot in question when the Oslo Stock Exchange made them aware of the error, and has since modified the algorithms.

As noted on October 14 the Norwegian day traders have been convicted on charges of shouting that the emperor has no clothes.

John Hempton of Bronte Capital reports that Universal Travel Group has suffered the resignation of its auditor. The company seems to go through auditors rather quickly … Issues with Universal Travel Group were last reported here on September 28. The Motley Fool published a blanket recommendation of the company on September 20.

Reaching for yield is having a noticable effect:

The incentive for companies to reward shareholders at the expense of bondholders is on the rise as the benefits of maintaining high ratings disappears, signaling that two years of improved creditworthiness may be peaking.

Non-financial companies rated A by Standard & Poor’s have a cost of capital 0.1 percentage point more than those rated one tier lower at BBB, according to Morgan Stanley analysts, diminishing the value of the higher credit grade and erasing their 0.3 percentage point advantage 18 months ago.

Reuters has published a survey on some of the big shops’ willingness to invest in CoCos. The related article makes it appear that write-ups / write-downs (a la Rabobank) are currently favoured:

Other European banks are looking at bonds with write-down and write-up features that do not convert to equity. Italian bank Intesa SanPaolo’s hybrid Tier 1 bond issue last month had some of these elements.

Barclays is working on a new bond with a write-down and write-up structure that has no equity conversion.

I am not in favour of the write-down/write-up structure. It’s not a bond, it’s an insurance policy and, in Rabobank’s case, there was not necessarily any first loss protection. The prices of these things will become wildly volatile when close to the line and there is the potential for purchasers of new capital to get diluted instantly, which will make it harder – not easier! – to issue this new capital.

Jonathan Brogaard of Northwester University has written a paper titled High Frequency Trading and its Impact on Market Quality:

This paper examines the impact of high frequency traders (HFTs) on the U.S. equity market. I analyze a unique data set to study the strategies utilized by HFTs, their profitability, and their relationship with characteristics of the overall market, including liquidity, price discovery, and volatility. The 26 high frequency trading (HFT) firms in my dataset participate in 74% of all trades and make up a larger percent of large market capitalization firms. I find the following key results: (1) HFTs tend to follow a price reversal strategy driven by order imbalances, (2) HFTs make approximately $3 billion annually, (3) HFTs do not seem to systematically front run non-HFTs, (4) HFTs rely on a less diverse set of strategies than do non-HFTs, (5) HFTs trading level changes only moderately as volatility increases, (6) HFTs add substantially to the price discovery process, (7) HFTs provide the best bid and offer quotes for a significant portion of the trading day, but only around one-fourth of the book depth as do non-HFTs, and (8) HFTs do not seem to increase volatility and may in fact reduce it.
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Froot, Scharfstein, and Stein (1992) find that short-term speculators may put too much emphasis on short term information and not enough on fundamentals. The result is a decrease in the informational quality of asset prices.

Vives (1995) obtains the result that the market impact of short term investors depends on how information arrives. The informativeness of asset prices is impacted differently based on the arrival of information, “with concentrated arrival of information, short horizons reduce final price informativeness; with diffuse arrival of information, short horizons enhance it” (Vives, 1995). The theoretical work on short horizon investors thus suggests that HFT may be benefit or may harm the informational quality of asset prices.

The Froot reference is the reason why all value investors should vigourously support HFT. The less information quality, the more chance to apply information profitably. I regret that I do not yet understand the Vives quote, but suspect it may be relevant to the behaviour of long bond prices in the ten minutes surround the release of the US jobs number.

I haven’t read it yet, but intend to when things calm down a little … maybe forty years? Themis Trading doesn’t like it:

The study’s author weighted the 120 stocks by market cap to approximate the amount of profits HFT earns in the industry. More important,however, is extrapolating results by actual trading volume. Doing that, the estimate of profits jump to $6 billion, and not $3 billion.
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Finally, as with another study that was pro-HFT recently, it calls any HFT originating order that is a limit order Passive, and any HFT order that takes the other side Aggressive. I guess HFT does not exist in wide-spread mid and small cap stocks. If I place a bid in one of those stocks, and an automated HFT strategy places a limit order ahead of mine, because it is a limit order it is Passive, and not Aggressive, and predatory.

As this data is provided to the author of the study by an exchange, who in their for-profit model caters quite extensively to HFT firms, how can anyone place any credence in its conclusions ( HFT only makes $3 billion, HFT dampens volatiltity, and tightens spreads)?

Six Billion estimated profit? No wonder the entitled frat boys of the establishment are up in arms about somebody eating their lunch. Price improvement is predatory? Tell that to the player on the other side, who’s getting a better price. But if Themis can’t do better than an ad hominem attack on the data source, that’s rather telling in and of itself.

One way or another, the emphasis on price-reversal strategies is reminiscent of What Happened to the Quants in August 2007?.

Barrie McKenna had a column in today’s Globe titled Ottawa takes another shot at getting R&D on right track:

The government announced in its March budget that it was reviewing its R&D efforts. It took seven months just to pick six people to sit on the panel. Now it will take another 12 months to come up with recommendations, which history suggests will quickly be put on a shelf and left there.

In case anyone is counting, this marks at least the fifth time in less four years the government has launched a review of some aspect of the program. And almost nothing, innovative or otherwise, has yet come of it all.
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Larger, public companies want access to the generous 35 per cent refundable tax credits that now go exclusively to private companies. Small and medium-sized companies worry that large public companies would quickly suck up most of the credits if the rules are loosened.
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Even the accounting business has a lot riding on the review. The country’s major accounting firms earn steep “success fees” for securing credits for their clients. It is not unusual for an accountant to pocket $300,000, or 30 per cent, on a $1-million credit.

Well, there’s the problem right there, isn’t it? The objective is not to innovate, the objective is to funnel government welfare cheques to companies of the politically correct size. And, as the accountants can tell you (joining the chorus of Air Canada executives and dairy farmers, inter alia), why bother innovating when it’s much less hassle to suck the government tit?

Meanwhile the Globe squared its rot for a good boohoohoo about a recent arbitration award:

Martin Teplitsky, a prominent arbitrator and civil litigation lawyer, said in his decision that he would appear to be “a minion of government” if he took into account the university’s ability to pay. The inevitable result will be that the university must cut elsewhere to reward the professors, who are described in the arbitration case as “top-of-the-market”; they are certainly not among the wretched of the Earth, summoned to rise up in the socialist song The Internationale.

The award may be defensible under the abstract criteria of arbitration law – in this instance “a replication model of interest arbitration.” Fortunately the award is effective only until June 30, 2011. That gives some time for more legislation. Dalton McGuinty, the Premier of Ontario, and other first ministers across Canada, need to think hard about giving the force of law to more of their budgetary policies – turning labour arbitrators into their minions, if necessary.

Angela Hildyard, UofT’s Vice-President, Human Resources & Equity, explains:

The University and UTFA commenced discussions in January, 2009. Early in the process we agreed to ask Mr. Teplitsky to act as both mediator and, if necessary, arbitrator in the event we were unable to reach mutual agreement.

So the University gave up its ability to lock out the staff, and gave up its right to take its ability to pay into consideration when negotiating staff salaries. All the union had to do was to be stubborn and “ability to pay” would be taken off the table – and they were told this early in the process. Gee, isn’t it mysterious how they were unable to reach agreement?

So the university agrees – blindly – to an agreement they can’t afford, and the Globe bleats that politicians should change the rules, instead of demanding to know who got fired? Does the Globe really want to know why Canada has a productivity problem? Reason #1 is because stupid people don’t get fired.

Constable Adam Josephs, serving with 52 Division of the Toronto Police has disgraced himself, is emblematic of all that wrong with the police response to the G-20 protests, and is fully deserving of ridicule, scandal and contempt both personally and as a member of the Toronto Police Service.

Another blog has published what purports to be a screenshot of Officer Bubbles’ facebook page that shows an employment description consistent with his behaviour as seen on video: it would be interesting to have this screenshot confirmed or denied.

I do not feel safer on Toronto streets knowing that Adam Josephs has police authority. I do not feel any civic pride knowing the manner in which Adam Josephs represents me. And the funny thing is – if it hadn’t been for this ill-advised, crybaby lawsuit, I never would have heard of him! I’ve seen the cartoons at issue (published elsewhere) – they’re no worse than juvenile.

It was another strong day for the Canadian preferred share market, with PerpetualDiscounts up 9bp and FixedResets gaining 12bp, on continued heavy volume.

I see that commodity ETF promoters have had good idea – and the boohoohoo brigade is in full cry:

Plans by ETF Securities and others to launch a range of base metal exchange-traded funds (ETFs) backed by metal in LME-registered warehouses rather than futures contracts have been met with a mix of skepticism and fear.
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Returns on futures funds have disappointed because the cost of rolling expiring contracts forward in a contango, or where the futures price is higher, has offset gains in spot prices. Physical ETFs are unlikely to perform better because fund owners will be charged fees to cover the cost of storing the metal, which could be as high as 6 percent per year.

But there is fear too that if physical ETFs actually did become popular they would disrupt the normal flow of raw materials from producers to consumers that lies at the heart of the industrial economy.

If consumers want some physical metal, they can buy ETFs and cash them in. They’ll be in a better position to negotiate now, because they have another vendor – which will reduce the influence of the oligopolies.

As predicted, there is a movement from prop-trading into hedge funds:

UBS AG, the largest Swiss bank, said it has been in talks with “dozens” of proprietary traders from firms worldwide who may start their own hedge funds as banks seek to comply with new U.S. rules aimed at curbing risk.
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Some traders are teaming up to form groups, said [UBS’s global head of prime brokerage Stuart] Hendel, who is based in New York and was in Singapore to attend UBS’s annual hedge fund conference. Managers will also leave existing hedge-fund firms that haven’t reached their high-water mark, or the historical peak net asset value of a hedge fund, he said.

“Funds with poor performance will splinter,” he said.

It will be harder to raise assets as investors need managers to put in place the necessary infrastructure and risk management platforms before putting their money into hedge funds, he said.

“The bar is going up,” Hendel said. “You can’t start with three people in a garage anymore on your Mastercard.”

I agree – regulation is crushing entrepreneurialism. Is this a good thing or a bad thing? Who knows, who cares, nobody’s ever bothered to think it through.

It seems that Countrywide’s Angelo Mozilo did nothing wrong – he merely attracted the attention of extortionists:

Former Countrywide Financial Corp. Chief Executive Officer Angelo Mozilo agreed to pay a record $67.5 million to settle U.S. Securities and Exchange Commission allegations that he misled investors.

Mozilo, 71, will pay a $22.5 million penalty and disgorge $45 million in gains from the sale of shares at inflated prices under the terms of the settlement read today at a hearing in federal court in Los Angeles. Former Chief Financial Officer Eric Sieracki and former Chief Operating Officer David Sambol also reached settlements. None of the men, who had been scheduled to go on trial Oct. 19, admitted wrongdoing.

The Canadian preferred share market was down today on continued heavy volume, with PerpetualDiscounts losing 12bp and FixedResets off 5bp.

It looks like the Flash Crash will be simply an excuse:

Data firm Nanex LLC has since questioned regulators’ finding, suggesting Waddell’s algorithm actually did factor in price because data show a slowdown in selling by Waddell during the market’s steepest decline.

CFTC Economist Andrei Kirilenko on Tuesday left open the possibility that the algorithm didn’t completely ignore prices.

The staff is “not aware of any specific price limit that was built into the algorithm,” he told CFTC Chairman Gary Gensler. But just because there wasn’t a price limit didn’t mean the algorithm didn’t “take into account prices and quantities,” he added.

OK – so the Flash Crash report is now highly suspect. Intellectual dishonesty is running rampant. But why would they be dishonest?

Commodity Futures Trading Commission enforcement attorney Bob Pease said the agency is eyeing the use of trading algorithms and a practice known as “quote stuffing” as possible areas that could be deemed disruptive under a provision in the Dodd-Frank financial law enacted in July.
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Mr. Pease, the CFTC lawyer, said the agency is looking to see if automated algorithms are “inherently disruptive” and if market players should have certain responsibilities in how they execute these orders.

Well, because you’ve got two-bit Napoleons like Bob Pease anxious to lump use of trading algorithms in the same category as quote-stuffing to push a regulatory agenda in which everything is regulated.

Speaking of algorithms, the two Norwegians discussed October 5 have been convicted on charges of smart trading:

Two Norwegian day traders have been handed suspended prison sentences for market manipulation after outwitting the automated trading system of a big US broker.

The two men worked out how the computerised system would react to certain trading patterns – allowing them to influence the price of low-volume stocks.
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Prosecutors said Mr Larsen and Mr Veiby “gave false and misleading signals about supply, demand and prices” by manipulating several Norwegian stocks through Timber Hill’s online trading platform.

Anders Brosveet, lawyer for Mr Veiby, acknowledged that his client had learnt how ­Timber Hill’s trading algorithm would behave in response to ­certain trades but denied this amounted to market manipulation. “They had an idea of how the computer would change the prices but that does not make them responsible for what the computer did,” he told the Financial Times. Both men have vowed to appeal against their convictions.

Precisely. While I suspect that this is one of those cases where the keys to the puzzle are too complex to make it into the newspaper, I cannot fathom how exploiting an idiotic algorithm – using only arm’s length trades between willing counterparties – can possibly be seen as a crime.

CFTC Chairman Gary Gensler has been criticized on PrefBlog – but there can be no doubt he is a fine regulator:

Gensler has asked Congress to increase the agency’s budget by 69 percent next year to $286 million and predicts the agency’s budgeted staff of about 650 will need to grow to more than 1,000 to meet its new demands.

There are rumours that the capital surcharge talks are in trouble:

Leaders of the world’s largest economies, divided over how to curb risk-taking by their biggest banks, will likely fail to agree on a capital surcharge.

Instead, the Financial Stability Board, which is weighing measures to prevent such institutions from causing another economic crisis, will recommend a range of options without setting a level of extra capital to be imposed globally, said members of the group who declined to be identified because the discussions are private. The FSB will meet in Seoul next week.

The fissures running through the group are similar to those that split the Basel Committee on Banking Supervision when it considered tighter capital requirements for all banks this year. Germany, France and Japan are resisting a surcharge for big lenders, as are lobbyists for those firms, while the U.K., U.S. and Switzerland advocate the approach, members say. That camp agreed to soften some of the Basel capital rules with the understanding that more would be done to restrain the largest banks through the FSB.
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France, Japan and Germany are opposing capital surcharges for big lenders because they say their banking systems are different from those in the U.S., U.K. and Switzerland, where the largest blow-ups occurred during the crisis, members say. U.S. regulators have been skeptical of contingent and bail-in capital as alternatives to straightforward surcharges, arguing that they’re untested mechanisms that might not fulfill their intended purposes during the next crisis.

“We can’t rely on them yet,” Sheila Bair, chairman of the Federal Deposit Insurance Corp., said in a telephone interview last week. “There’s not much of a market for them. Triggering them could end up destabilizing the bank and the markets. We just got rid of TruPS because they did not provide loss absorption in the crisis. We could end up with the same problem with these new instruments.”

Low US mortgage rates are having an effect – just not the intended effect, that’s all:

Rates for 30-year fixed loans declined to 4.19 percent in the week ended today from 4.27 percent, Freddie Mac said in a statement. It is the lowest rate since the McLean, Virginia- based company began tracking the data in 1971. The average 15- year rate tumbled to 3.62 percent from 3.72 percent.

A six-month decline in mortgage rates has spurred a surge in refinancing while doing little to increase property demand as U.S. unemployment hovers near 10 percent. Sales of existing homes were the second-lowest on record in August, the National Association of Realtors in Washington said Sept. 23.

The Canadian preferred share market had another strong day on extremely heavy volume, with PerpetualDiscounts up 22bp and FixedResets gaining 6bp.

The CFTC will step up its efforts to ensure markets are a cooperative game in which everybody wins:

The top U.S. commodity regulator will review algorithmic trading and other practices such as “spoofing” and “quote stuffing” as part of the largest rewrite of Wall Street rules since the 1930s.
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Pease said the agency’s staff is examining strategies in which traders submit and then cancel thousands of orders in milliseconds. CFTC investigators want to know whether the practice is a form of “spoofing” in which market participants try to trick other computers into making decisions that can be exploited for profit, Pease said.

The Dodd-Frank financial overhaul, named for Massachusetts Representative Barney Frank and Connecticut Senator Christopher Dodd, both Democrats, attempts to relieve the commission of the burden of proving a trader intended to manipulate prices. Instead, the CFTC will have to show the trading was “reckless.”

He wants to see a reckless trade? Well, any market order is reckless. Any stop-loss order is reckless and stupid. Any Technical Analysis is reckless, stupid and … I can’t think of a suitable epithet. Anyway, those three categorizations should be enough to get them started.

OSFI has published more boxtickingwork for banks, titled Internal Capital Adequacy Assessment Process (ICAAP) for Deposit-Taking Institutions.

A top contender for “Most Ridiculous Fund of 2010” closed today:

Connor, Clark & Lunn Capital Markets Inc. (the “Manager”) is pleased to announce the closing of the initial public offering of HBanc Capital Securities Trust (the “Fund”). The Fund raised gross proceeds of $147,572,325 from the sale of 5,797,393 Class A Units, Series 1 and 105,500 Class A Units, Series 2, respectively, at a price of $25 per Unit. These amounts include the Class A, Series 1 Units issued in respect of the over-allotment option which was exercised in full. The Fund also raised gross proceeds of U.S. $26,332,225 from the sale of 1,042,724 Class U Units, Series 1 and 10,565 Class U Units, Series 2, respectively, at a price of U.S. $25 per Unit. These amounts include 171,035 Class U Units, Series 1 and 2,165 Class U Units, Series 2 that were issued pursuant to the exchange option. The Class A Units, Series 1 are listed on the Toronto Stock Exchange under the symbol HSC.UN. Class A Units, Series 2 and Class U Units will not be listed on a stock exchange but may be converted into Class A Units, Series 1 on a weekly basis.

The Fund was established to provide investors with high levels of stable, tax-advantaged distributions through exposure to Capital Securities issued by HSBC Holdings plc, a conservatively positioned and strongly capitalized global bank.

I am often struck by how much money gets raised for products like this, while I find that selling my own fund is more like pulling teeth. I wonder if this has anything to do with it?

Nahhhh … I must be missing something.

A mixed day on heavy volume for the Canadian preferred share market with PerpetualDiscounts gaining 19bp and FixedResets losing 5bp.

PerpetualDiscounts now yield 5.42%, equivalent to 7.59% interest at the standard equivalency factor of 1.4x. Long corporates now yield about 5.2%, so the pre-tax interest-equivalent spread now stands at about 240bp, as slight (and perhaps meaningless) tightening from the 245bp reported on October 6.