PrefBlog

The BoC has released a working paper by Donald Coletti, René Lalonde, Paul Masson, Dirk Muir and Stephen Snudden titled Commodities and Monetary Policy: Implications for Inflation and Price Level Targeting:

We examine the relative ability of simple inflation targeting (IT) and price level targeting (PLT) monetary policy rules to minimize both inflation variability and business cycle fluctuations in Canada for shocks that have important consequences for global commodity prices. We find that commodities can play a key role in affecting the relative merits of the alternative monetary policy frameworks. In particular, large real adjustment costs in energy supply and demand induce highly persistent cost-push pressures in the economy leading to a significant deterioration in the inflation – output gap trade-off available to central banks, particularly to those pursuing price level targeting.

Jonathan Weil of Bloomberg decries dynamic provisioning:

Dynamic provisioning is a euphemism for an old balance- sheet trick called cookie-jar accounting. The point of the technique is to understate past profits and shift them into later periods, so that companies can mask volatility and bury future losses. Spain’s banks began using the method in 2000 because their regulator, the Bank of Spain, required them to.
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The danger with the technique is it can make companies look healthy when they are actually quite ill, sometimes for years, until they finally deplete their excess reserves and crash. The practice also clashed with International Financial Reporting Standards, which Spain adopted several years ago along with the rest of Europe. European Union officials knew this and let Spain proceed with its own brand of accounting anyway.

Assiduous Readers with long memories will remember my post titled FRBB Looks at Dynamic Provisioning. The FRBB paper concluded, in part:

We argue that, had U.S. banks set aside general provisions in positive states of the economy, they would have been in a better position to absorb their portfolios’ loan losses during the recent financial turmoil. The allowances accumulated by means of the hypothetical dynamic provision during the cyclical upswing would have reduced by half the amount of TARP funds required. However, the cyclical buffer for the aggregate U.S. banking system would have been depleted by the first quarter of 2009, which suggests that the proposed provisioning model for expected losses might not entirely solve situations as severe as the one experienced in recent years.

So just remember: just because something is good doesn’t mean it’s a panacea. Ain’t nuthin a panacea.

Meanwhile, Spend-Every-Penny wants countries to guarantee deposits in banks they don’t regulate:

Canada is urging the euro zone to embrace a common bank-deposit guarantee as a concrete step to boost market confidence.

The stand – confirmed Friday in a speech by Finance Minister Jim Flaherty – provides the first specifics as to what Canada will push for next week when Prime Minister Stephen Harper and Mr. Flaherty attend the G20 leaders’ summit in Los Cabos, Mexico.

In his speech in Ottawa, the minister praised a proposal from Mario Draghi, the head of the European Central Bank, who has called for a fund to guarantee bank deposits in the 17-member euro zone.

It’s not clear to me why anybody would think that any rational person would base his finances on the word of a European politician anyway. I wouldn’t have any significant money deposited in any of the shaky-country banks anyway … and, if I lived there, would be inclined to be dubious about any European deposits for fear of post-exit confiscation anyway. My preference would be hard assets, by which I mean a box of Krugerrands and a pistol.

Alpha Trading asks the question – can a bank-owned utility do anything useful?:

Alpha, Canada’s newest stock exchange, wants to become the home to the country’s technology sector.

A Deloitte Inc. study commissioned by Alpha found what most observers of the tech sector in this country already know: that the tech industry is stunted. Tech as a percentage of GDP is below the G-20 average and forecast to fall behind Mexico and Saudi Arabia in a few years, the report found.
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The report, which included interviews with 22 tech sector leaders, laid out a five-point agenda for fixing the problem. The proposed solutions include more support for crowdfunding, establishing a pre-initial public offering “grey” market in tech securities and creating an exchange that focuses on tech. Alpha wants to be that exchange.

BBD.PR.D got whacked today after the announcement of the reset rate, closing down 1.40, or 7.89%, on heavy volume (for this issue!) of 32,479 shares. However, even at the quote of 15.90-35, it’s still idiotically expensive relative to BBD.PR.B at 14.95-05, with which it is interconvertible. I’ve been warning of this in PrefLetter for months. With charts and diagrams!

It was a mixed day for the Canadian preferred share market, with PerpetualPremiums off 5bp, FixedResets down 9bp and DeemedRetractibles gaining 15bp. Volatility was average. Volume was very low.

The ECB won’t disclose records of EU collusion with fuzzy Greek bookkeeping:

The European Central Bank said it can’t release files showing how Greece may have used derivatives to hide its borrowings because disclosure could still inflame the crisis threatening the future of the single currency.

Bloomberg News is suing the ECB to provide the documents under European Union freedom-of-information rules. The papers may help show the role EU authorities played in allowing Greece to mask its deficit for almost a decade before the nation’s troubled finances necessitated a 240 billion-euro ($301 billion) bailout and the biggest debt restructuring in history

Disclosing the files when Bloomberg News first sought them in 2010 would have “fueled negative perceptions about Greece’s ability to honor its debt,” ECB lawyer Marta Lopez Torres said at a hearing of the European Union’s General Court in Luxembourg today. “It’s the same now with Spain” which “isn’t able to borrow money,” she said. “Markets are reacting in very volatile ways. It’s affecting the euro economy.”

Sorry this is so late, folks! There were technical difficulties at TMX DataLinx.

I can’t say I’m against this move – but it does open up a can of worms:

Denmark’s government agreed to ease rules for the country’s pension firms to help reduce their liabilities as record-low bond yields inflate the value of their obligations.

Pension companies and life insurers will be allowed to raise the discount rate they use to calculate their liabilities to better reflect long-term growth and inflation prospects, the Business and Growth Ministry in Copenhagen said in a statement late yesterday. The decision sent yields on longer-maturity bonds soaring as the industry’s need to buy up debt assets to match their pension obligations was reduced.
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The Danish move follows similar changes in Sweden, where 10-year yields surged 30 basis points on June 7 after the country’s regulator put a floor on the discount rate pension funds use to calculate liabilities. Nordic pension funds had come under pressure to increase their asset purchases as the region’s haven status from the debt crisis sent bond values higher and swelled the value of their liabilities.

The US housing market has a new kind of problem:

Funds planning to invest more than $6 billion to buy and rent foreclosed homes are finding it easy to raise money. The difficulty is spending it.

The number of low-cost foreclosed homes coming to market has dropped, bulk sales have been slow to materialize and prices are recovering in markets such as Phoenix, making it hard for private-equity firms, hedge funds and pension systems to buy as many homes as they need.
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Investors are trying to spend at least $6.4 billion on single-family rentals, including from funds such as Colony Capital LLC, GTIS Partners, KKR & Co., Oaktree Capital Group LLC (OAK), Och-Ziff Capital Management Group LLC (OZM) and the Alaska Permanent Fund Corp. They want to take advantage of U.S. home prices that are 35 percent below the 2006 peak and growing demand for rentals as the homeownership rate sits at the lowest level since 1997.

There is brinksmanship in Greece:

Alexis Tsipras said he expects the European Union will do all it can to keep Greece in the euro even if he wins elections and carries out his promise to repeal the austerity measures required to receive emergency loans.

“We have no sense that European partners will follow this tactic of blackmail heard from some quarters and stop funding,” Tsipras, whose Syriza party is vying for first place in pre- election polls, said in an interview in Athens today with Bloomberg Television. “Something like that would be catastrophic not only for Greece but for the entire euro area.”

BIS has released a working paper by Mathias Drehmann, Claudio Borio and Kostas Tsatsaronis titled Characterising the financial cycle: don’t lose sight of the
medium term!:

We characterise empirically the financial cycle using two approaches: analysis of turning points and frequency-based filters. We identify the financial cycle with the medium-term component in the joint fluctuations of credit and property prices; equity prices do not fit this picture well. We show that financial cycle peaks are very closely associated with financial crises and that the length and amplitude of the financial cycle have increased markedly since the mid-1980s. We argue that this reflects, in particular, financial liberalisation and changes in monetary policy frameworks. So defined, the financial cycle is much longer than the
traditional business cycle. Business cycle recessions are much deeper when they coincide with the contraction phase of the financial cycle. We also draw attention to the “unfinished recession” phenomenon: policy responses that fail to take into account the length of the financial cycle may help contain recessions in the short run but at the expense of larger recessions down the road.
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Against this backdrop, if the policymakers “overreact” to short-term developments and lose sight of the (medium-term) financial cycle that may lie behind them, they can store up bigger trouble down the road. Arguably, this is what happened both in the mid-1980s/early 1990s and in the period 2001-2007. In both cases, policymakers reacted strongly to collapses in
equity prices – the global stock market crashes of 1987 and 2001, which ushered in slowdowns in economic growth and/or actual recessions. As we have seen, however, equity prices are not a reliable indicator of the medium-term financial cycle. In fact, in both episodes credit and property prices continued to increase, benefiting from a second breath of life. A few years later, the credit and property price booms in turn collapsed, causing serious financial disruptions and dragging down the economy with them. From the perspective of the medium-term financial and business cycles, the slowdowns or contractions in 1987 and 2001 can thus be regarded as “unfinished recessions”.

We might be headed into one of the periodic outbreaks of handwringing about productivity:

Canada can’t live off its resource wealth forever and must get serious about chronically lagging productivity and innovation, says the Organization for Economic Co-operation and Development.
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“Canada is blessed with abundant natural resources, but it needs to do more to develop other sectors of the economy if it is to maintain a high level of employment and equitable distribution of the fruits of growth,” said Peter Jarrett, head of the OECD’s Canada division and one of the authors of the study.
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But the 128-page report’s main focus is productivity and innovation policy. The OECD pointed out that while per capita incomes are growing, productivity has stagnated for decades, and has actually declined since 2002.

Canada’s productivity and innovation conundrum isn’t a new theme for Canada. Those challenges were at the heart of last year’s federal task force report on research and development policies, chaired by Open text Corp. chairman Tom Jenkins. Ottawa moved to address several of the report’s recommendations in its March 29 budget.

R&D policies are a joke – they do nothing for productivity, they reward businesses who are willing to jump through the bureaucratic hoops – and reward the specialist lawyers and accountants who help with the application. That’s not productivity, that’s welfare. The three major impediments to Canadian productivity are a coddled financial sector, a coddled transportation sector and a coddled telecommunication sector, but these aren’t the best examples of anti-productive government policy.

I’ll believe that a Canadian government has started to care about about productivity when dairy farmers are told that 50-cow herds, and their massive indirect subsidy granted by import restrictions and dairy quotas, are nothing more than a national cash drain. Dairy farming is the most egregious Canadian example of low productivity.

There’s an interesting funding gap at Deutsche Bank:

Deutsche Bank AG (DBK) has a funding gap of as much as 14 billion euros ($17.5 billion) at its Italian and Spanish units which could reduce capital levels at the firm if those countries leave the euro, according to analysts at Espirito Santo Investment Bank.

Deutsche Bank’s loans amount to 205 percent of deposits at the Italian unit and 314 percent in Spain, according to London- based analyst Andrew Lim, who cited company filings. If those countries exit the euro and the new currencies fall 30 percent, the Frankfurt-based lender could lose as much as 4.2 billion euros of equity as the value of assets at those divisions declines while some funding remains in euros, he said.

Such cross-border funding gaps can be dangerous:

The government forced commercial banks to swallow exchange- rate losses on foreign-currency denominated mortgages by giving borrowers the option to repay their loans in a lump sum at below-market rates. Two-thirds of housing loans were denominated in foreign currencies, mostly in Swiss francs, and installments on them soared as the forint weakened.

Hungarians repaid 170,000 mortgages under the plan in a value of 1.4 trillion forint ($6.3 billion), cutting the total amount of outstanding foreign-currency mortgages by 23.3 percent, the financial market authority said in a report today.

It was a surprisingly uneventful day on the Canadian preferred share market, despite an enormous number of dividends going ex. PerpetualPremiums were off 3bp, FixedResets down 1bp and DeemedRetractibles gained 3bp. Volatility was non-existent, but volume was very high.

PerpetualDiscounts now yield 5.04%, equivalent to 6.55% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.4%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 215 bp, a significant decline from the 225bp reported June 6.

Play the exciting new Spanish Shell Game!

Spanish bond yields surged the most in four months in the first trading after the government in Madrid sought a bailout for its banks. Investors speculated the 100 billion euros ($125 billion) may not be enough.

The lifeline from the euro area, aimed at loosening the connection between banks and the state, risks doing the opposite as foreign investors continue to shun the nation’s bonds and Prime Minister Mariano Rajoy’s government grows increasingly dependent on domestic lenders.

“This 100 billion will be added to the public finances of Spain so it just reinforces the link between banks and the sovereign,” Olly Burrows, credit analyst at Rabobank International, said in a phone interview from London. “Spain is receiving funds to bail out its banks, which have been buying Spanish debt while everyone else has been getting out.”
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Spanish banks were among the biggest beneficiaries of 1 trillion euros of three-year emergency loans from the ECB, which were recycled into sovereign bonds in a trend Economy Minister Luis de Guindos said in April “increased the correlation between sovereign risk and banking risk.” The ECB may need to offer another round of that financing to ensure local banks can fund the sovereign, [co-chief economist at Deutsche Bank AG in London Gilles] Moec said.

Meanwhile:

French securities slid with benchmark German bunds as Fitch Ratings said it may cut credit grades across Europe because policy makers are failing to demonstrate they can bring the debt crisis under control. The yield on Italian 10-year securities jumped to the most since January as the country prepared to sell bonds on June 14. Germany will offer 10-year bunds, Europe’s benchmark securities, tomorrow, after Austria and the Netherlands auctioned debt today.

Most governments do all they can to attract high-earning migrants. Not the UK:

U.K. lawyers are fielding a flood of questions from multinational firms as a government shake-up of visa rules threatens to cut short the careers of top traders and other executives transferred from overseas.

Changes in the past two years include a five-year cap on how long employees who moved to the U.K. under the Intra Company Transfer system can stay, and the removal of their right to settle permanently. The introduction of a cooling-off period between visa applications means employees have to spend at least 12 months out of the country once their permit expires.

“We’ve seen quite significant panic among a number of clients,” said Ben Sheldrick, a partner with Magrath LLP Solicitors in London. “The government wants to be seen to be tough on immigration and one of the only groups they can be seen to be reducing is the skilled migrants sponsored by multinational firms.”

Canadian banks are worrying about appraisals:

Several Canadian banks have been quietly re-evaluating their appraisal strategies amid increased worries about the accuracy of property values in a market deemed at risk of overheating.

Lenders use a variety of techniques, including full appraisals, so-called “drive-by” appraisals based on the exterior of the home, and databases of market prices, to evaluate homes. The values they arrive at help determine how much money they should lend to mortgage borrowers. They are also key for measures such as the loan-to-value ratio that are used to track the health of loan portfolios and borrowers’ debt loads.

Banks are emphasizing on-site visits to value properties, especially those above a certain price or in rural areas. They are also paying closer attention to who does the appraisal.
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TD lends 80 per cent loan-to-value up to $900,000, but after that only lends 50 per cent, to protect itself against inflated values on expensive homes.
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California-based First American Financial Corp. had been selling Canadian banks a “guaranteed valuation” product that guaranteed the valuation of a property was accurate on the day a mortgage was issued. If it turned out later that it wasn’t, the bank could make a claim.

But First American posted a first-quarter loss in 2011 as it took a $45-million reserve strengthening charge relating to this obscure Canadian product.

Policies that were experiencing claims had been written mostly in 2007 and 2008. Sources say the issue stemmed mainly from Alberta, where the housing market underwent a correction starting in 2007, and problems became apparent as default rates increased, leading banks to seize more homes as collateral.

If I were worried about an overheated property market, I’d convert today’s appraisal into 2008’s equivalent and lend against that – which is much the same thing as lowering the LTV ratio.

It was a positive day for the Canadian preferred share market, with PerpetualPremiums gaining 4bp, FixedResets winning 11bp and DeemedRetractibles up 7bp. Volatility was low. Volume was well below average.