PrefBlog

S&P’s chief economist has more tapering chatter:

• That the Fed did not announce tapering in September did not surprise us, as we have stuck to our December call.
• Starting to taper was conditional on U.S. growth moving up a notch, which has not happened; in fact, the Fed has lowered its growth outlook.
• In the wake of a financial crisis and deep recession, central banks face asymmetric risks: Tightening policy too early carries higher risks than leaving policy loose for too long.
• Forward guidance attempts to guide markets, but, by incentivizing markets to hang on every central bank utterance, and react in a globally synchronized way, it risks amplifying the policy signals and creating volatility.
• The new Fed chair should resist the temptation to overengineer forward guidance, but rather double down on the core message: The Fed has the requisite tools and is determined to use them.

Julie Dickson of OSFI made a speech to the 2013 National Insurance Conference of Canada:

Given that catastrophic risk seems to be growing, going forward we may also see insurers more actively expanding risk transfer mechanisms through Insurance Linked Securities (ILS). Catastrophe bonds can be used to help companies to reduce exposure to certain risks, including earthquakes. Cat bonds are an effective way to transfer risk to capital markets, instead of reinsurance markets, and to spread risks. At the same time, they do not eliminate all risk. For example, basis risk, where the trigger for a claim might not be directly matched to the losses of the insurer, could result in the insurer experiencing losses with no protection. From a capital perspective, if the link is not one-for-one with the expected losses, there is no capital benefit. But such catastrophe bonds can be a good addition to an insurer’s risk management program.

While issuance of catastrophe bonds may be a good addition to a company’s risk management tools, investments in catastrophe bonds could present risks to investors, particularly if the investments are being made in a search for yield, without regard to an understanding of the risks involved.

Another example of search for yield, which has recently been expressed in international circles [Footnote], is concern about too much capital from institutional investors (such as pension funds) entering the insurance system in search of yield. Such excess funding or capital can put downward pressure on premium rates, and assuming those rates were properly reflective of risk, this is not what should be happening (for example, where the increased severity and frequency of actual catastrophe risk is on the rise).

While we have not seen similar behaviours in Canada thus far, it is important to continue to be on the lookout for any evidence of a search for yield and unintended consequences.

[Footnote reads]:September 4, 2013, Lloyd’s chairman warns on ‘systemic risk’ of capital rush, Alistair Gray, Financial Times. The article can be found at the following link (subscription required): http://www.ft.com/intl/cms/s/0/04b80c2e-15aa-11e3-b519-
00144feabdc0.html

There’s a report on the report referenced in the footnote here.

I don’t consider this a big deal, but it’s one of the more precious initiatives around:

We are proposing amendments to Item 402 of Regulation S-K to implement Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 953(b) directs the Commission to amend Item 402 of Regulation S-K to require disclosure of the median of the annual total compensation of all employees of an issuer (excluding the chief executive officer), the annual total compensation of that issuer’s chief executive officer and the ratio of the median of the annual total compensation of all employees to the annual total compensation of the chief executive officer. The proposed disclosure would be required in any annual report, proxy or information statement or registration statement that requires executive compensation disclosure pursuant to Item 402 of Regulation S-K. The proposed disclosure requirements would not apply to emerging growth companies, smaller reporting companies or foreign private issuers.

On the other hand, this one is just stupid:

The OCC, Board, FDIC, Commission, FHFA, and HUD (the agencies) are seeking comment on a joint proposed rule (the proposed rule, or the proposal) to revise the proposed rule the agencies published in the Federal Register on April 29, 2011, and to implement the credit risk retention requirements of section 15G of the Securities Exchange Act of 1934 (15. U.S.C. 78o-11), as added by section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). Section 15G generally requires the securitizer of asset-backed securities to retain not less than 5 percent of the credit risk of the assets collateralizing the asset-backed securities. Section 15G includes a variety of exemptions from these requirements, including an exemption for asset-backed securities that are collateralized exclusively by residential mortgages that qualify as “qualified residential mortgages,” as such term is defined by the agencies by rule.

It was credit risk retention by the brokerages that sparked the crisis in the first place!

Power Corporation, proud issuer of POW.PR.A, POW.PR.B, POW.PR.C, POW.PR.D, POW.PR.F and POW.PR.G, was confirmed at Pfd-2(high) by DBRS:

The credit strength of POW is directly tied to its roughly two-thirds equity interest in Power Financial Corporation (PWF), which represents a substantial majority of the Company’s earnings and cash flow, as well as the Company’s estimated net asset value.
…
As the controlling shareholder of PWF, and, by extension, of GWO and IGM, POW defines the strategic vision for its financial services investments, while setting the “tone from the top” in terms of conservative management style and risk analysis and tolerance. The Company’s senior officers and delegates exercise a greater degree of influence through their active participation on the respective boards and board committees of POW’s various subsidiaries than is generally the case at more widely held companies. Such an integrated management and governance approach is seldom encountered and has served the Company’s stakeholders well. On a stand-alone basis, POW’s financial profile is conservative, with debt and preferred shares representing just over 13% of capitalization. Financial leverage appears to be used to fund a portfolio of cash and short-term investments and a modest level of working capital. The Company’s liquidity is strong, with nearly $700 million in cash and short-term securities at June 30, 2013.

Power Financial Corporation, proud issuer of PWF.PR.A, PWF.PR.E, PWF.PR.F, PWF.PR.G, PWF.PR.H, PWF.PR.I, PWF.PR.K, PWF.PR.L, PWF.PR.M, PWF.PR.O, PWF.PR.P, PWF.PR.R and PWF.PR.S, has also been confirmed at Pfd-1(low) by DBRS:

The financial strength of PWF is largely derived from its controlling interests in two of Canada’s leading financial service providers: Great-West Lifeco Inc. (GWO; rated AA (low), Stable), one of the three largest life insurance concerns in Canada, and IGM Financial Inc. (IGM; rated A (high), Stable), one of the largest mutual fund complexes in Canada.
…
The Company’s almost 30% indirect equity interest in Pargesa Holding S.A. (Pargesa), a Geneva-based holding company, provides some additional geographic and industry diversification. While Pargesa does pay a small dividend, which is normally passed through to the Company, it is primarily managed to maximize net asset value over the long term.

The Company’s financial leverage has been maintained at a reasonable level for the past ten years. The Company’s capitalization remains conservative, with a less than 20% unconsolidated total debt (including preferred shares) ratio at the end of June 2013. Fixed charge coverage ratios are similarly strong relative to both earnings and cash flow. Liquidity is not a source of concern, with approximately $800 million in cash and short-term securities at the holding company level at June 30, 2013, in addition to stores of liquidity at both GWO and IGM.

I’m sure we’ll soon be seeing some commentary on FFH, in the wake of their big deal:

BlackBerry Ltd. (BB) reached a tentative agreement for a $4.7 billion buyout by a group led by its biggest shareholder, forging a path to go private after years of losing ground to Apple (AAPL) Inc.’s iPhone and Google Inc.’s Android.

The group led by Fairfax Financial Holdings Ltd. (FFH) would offer $9 a share in cash, according to a statement today — a 3.1 percent premium over BlackBerry’s closing price last week. The consortium is still seeking financing for the offer, which will be subject to due diligence and further negotiation.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts and FixedResets both off 3bp, while DeemedRetractibles were up 14bp. The performance highlights table is surprisingly lengthy, given the modest overall moves. Volume was average.

We’re getting a good start on October tapering chatter:

Federal Reserve Bank of St. Louis President James Bullard, a voter on policy this year who has backed record stimulus, said a small tapering of bond buying is possible next month after the Fed made a close call this week in deciding not to slow purchases.

“That was a borderline decision” after “weaker data came in,” Bullard said today on Bloomberg Television’s “Bloomberg Surveillance” with Tom Keene and Sara Eisen. “The committee came down on the side of, ‘Let’s wait.’”

Bullard called October a “live meeting,” because “it’s possible you could get some data that change the complexion of the outlook and could make the committee be comfortable with a small taper in October.”

Meanwhile, political games in Washington may have an effect:

The U.S. House voted to finance the federal government through Dec. 15 and choke off funding for President Barack Obama’s health-care law, setting up what could be a prolonged showdown with the Senate and White House.

House Republicans said they wouldn’t accept Senate Majority Leader Harry Reid’s plan to remove the health-care language from the bill next week and warned of a temporary government shutdown after the fiscal year ends Sept. 30.

“We’ll add some other things that they hate and make them eat that, and we’ll play this game up until either Sept. 30, Oct. 3, somewhere in between,” said freshman Representative Richard Hudson, a North Carolina Republican. “At that point Harry Reid’s going to realize we’re serious and hopefully at that point, he’ll begin to negotiate with us.”

Inflation continues to be the least of our worries:

Canada’s inflation rate slowed for the first time in four months in August, approaching the bottom of the central bank’s target band, on lower costs for mortgage interest and prescription drugs.

The consumer price index rose 1.1 percent in August from a year ago, following July’s 1.3 percent pace, Statistics Canada said today from Ottawa. The core rate, which excludes eight volatile products, slowed to 1.3 percent from 1.4 percent.

Bank of Canada Governor Stephen Poloz, who sets policy to keep price gains in the middle of a 1 percent to 3 percent range, has said inflation will remain below 2 percent until mid-2015. The central bank’s key lending rate has been 1 percent for three years, the longest pause since the 1950s, and economists surveyed by Bloomberg predict Poloz won’t raise borrowing costs until the second half of 2014.

I must tell you about my wonderful new flashlight I purchased a few days ago from Baby Point Hardware

Click for big

The light source is a 3×8 grid of halogen lamps; it’s powered by 3 AA batteries. The light is very bright and by itself is reason to be impressed. There’s a magnet on the back – so I’ve got mine stuck to my fridge – and there’s also a plastic fold-out hook (like the hook on a clothes hanger) for hanging it somewhere convenient. What I find very impressive is that the halogen bulbs are recessed behind a cover that has a lens in front of each bulb. When you shine the light at a wall, it doesn’t make a diffuse rectangular pattern as one might expect, it makes a circular pattern just like a regular single-light-source flashlight would. I think this is really great engineering and – best of all – it only cost ten bucks and change!

My only complaint is that there is no manufacturer information on the case – the only clue is a logo for “Lightway”. However logical the name “Lightway” might be for a flashlight, it doesn’t help much with Google searches, which bring up a lot of Christian ministries but not a single flashlight manufacturer.

What a great time to be alive! Even little things like flashlights are being improved out of all recognition!

In markets, Canadian equity volume was huge as some tech firm did what tech firms do best.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts up 24bp, FixedResets off 2bp and DeemedRetractibles gaining 2bp. The Performance Highlights table is longer than might be expected, but with mixed contents. Volume was very low.

There seems to be a growing feeling that US regulators have gotten completely out of control:

Rather than trying to take a stand on the conspiracy theory, I am raising the fundamental question of the regulatory dysfunctioning of the United States regulatory system.

The accumulation of fines and legal fees could potentially, more than market movements affect the performance, reputation and future of the US largest bank. Is that the objective? Of course not, even thought the accumulation of recent fines represents almost 10 percent of the bank’s equity.

The problem is that nobody is in charge of asking that question, and therefore focusing on its answer. Where is the Federal Reserve on this? Absent, since it does not want interfere with other agencies: the usual intra regulatory “territorial respect.” This is the biggest failure of the current regulatory reform: by not rationalizing the number of institutions and by not giving a global leadership to the Federal Reserve who is in charge of the US Systemically Important Financial Institutions, they become the target of every single of the 22 agencies who has some money to ask or some issues to resolve.

It is urgent to call it off. Fines should be suspended until the Administration comes with a sensible way to deal with failures and misbehavior of financial institutions. Unless they would like to spend billions in lawyers’ fees to answer class actions from SIFI’s shareholders, some form of coordination is needed.

The US regulatory web has definitely become a systemic risk. Jamie Dimon had actually anticipated it.

Jonathan Weil of Bloomberg points out:

One nagging question: Which federal securities laws did JPMorgan admit to violating? The bank didn’t say. It’s as if the lawyers for the SEC and JPMorgan were going out of their way to frustrate any outsider who was trying to read and understand the document’s contents.

The SEC, which fined JPMorgan $200 million as part of an administrative proceeding, clearly specified which laws it accused JPMorgan of violating. Those included Section 13(a) of the Securities Exchange Act of 1934, which sets requirements for companies’ disclosures to investors.

Why couldn’t the SEC get JPM to admit exactly what laws it violated? Beats me. The agency should have had the company over a barrel. Once again, the SEC has demonstrated that requiring defendants to admit to violations of specific rules or laws is the third rail of U.S. securities regulation. The SEC simply won’t go there and won’t touch it. Instead, the commission is content to say that JPMorgan agreed to admit “wrongdoing,” which is a spinmeister’s term that has no precise meaning.

Matt Levine mocks the FERC fines:

The details are in this marvelously complicated FERC order and settlement agreement,1 but the outlines of the story are simple. FERC built a terrible box, and the box had some buttons that were labeled “push here for money,” and JPMorgan pushed them and got money. You can understand the category mistake very easily:

• FERC thought the box was for generating electricity at market prices but with a robust backup system to ensure reliable supply, and
• JPMorgan thought the box was for dispensing money.

…
BCR is “bid cost recovery,” the system under which CAISO pays operators non-market bonuses to basically make sure they have their plants on when needed. The strategy is simple enough:

• The market clearing price for electricity will be, say, $30/MWh.
• Your inefficient old plants cost about $40/MWh to produce electricity.
• So you offer to be a price taker every third hour, selling your electricity at $30/MWh.
• The other two hours you offer $80/MWh, which is way way way above market.
• The system always lifts the offers of price-takers, so you’re contracted to supply electricity every third hour.
• But the system, in its infinite wisdom, understands that you can’t just turn a power plant on and off like that.
• So it tells you to produce energy, at the prices you offered – effectively $80, $80, $30 – for each of those three hours.
• The system, in its frankly circumscribed wisdom, doesn’t understand (1) that you are fucking with it or (2) that your average price for those three hours is actually $63.
• So you make a profit of $23/MWh instead of the loss of $10/MWh that you’d have at market rates.

I mean! The only proper response to that is, the first time you do it, CAISO calls you up and tells you to knock it off, and then changes its rules to prevent this sort of obvious gaming. JPMorgan didn’t write in big block letters at the top of its bid that day “HI GUYS WE FOUND A LOOPHOLE AND THIS IS IT” but surely its bid should have had the same effect.

So in other words. FERC fined JPMorgan because JPMorgan pointed out that the boys at FERC are stupid.

This, by the way, is similar to another kerfuffle involving idiots writing idiotic contracts:

But not that many people used the IDCH/Nasdaq interest rate swap futures contract, for reasons having to do with territoriality (no bank wants to give up its lucrative OTC swap business to trade exchange-traded products) and with the fact that the contract was terrible. The terribleness was that the contract was meant to, and IDCH/Nasdaq advertised that it would, exactly replicate the value of an over-the-counter interest rate swap. But it didn’t. IDCH/Nasdaq just designed it wrong, so its value was slightly but meaningfully different from the value of a swap with the same terms. What they got wrong isn’t exactly rocket science but it’s, let’s say, footnote science, so.**

And Matt Levine observes:

The upshot is that about half of the JPMorgan fines so far are not for the traditional bread-and-butter of financial enforcement, disclosure failings, but for just doing dumb trades.*****

Mostly I just want to flag how odd that is. But I guess there are a few other things to think about it.
Thing one is: There’s a reason why regulators tend not to pursue cases against big companies just for dumbness. I mean, there are a lot of reasons, like a general assumption that businesspeople know their business better than regulators do, and a policy desire not to deter innovation by punishing mistakes. But there’s one big reason, which is that dumbness is its own reward. You actually don’t need to fine JPMorgan $900 million for losing $6.2 billion! Losing $6.2 billion completely and accurately punishes them for losing $6.2 billion.******

Thing two is: How dumb was this trade, really? I have myself been pretty sneery about some of the decisions made in putting it on, but the basic crash-hedge theory at its heart was not nuts. More importantly, though, the notion that this trade exposed JPMorgan to material risk of unsoundness is odd. I mean, $6.2 billion is a lot of money to lose. But JPMorgan’s net income in 2012, after those losses, was $21.3 billion. The $6.2 billion loss was less than 2 percent of the assets in JPMorgan’s Chief Investment Office, and less than 0.2 percent of JPMorgan’s total assets. Spinning it into an existential threat to the bank looks … I mean, just sort of wrong.

And to complete the regulatory review for today it looks like the solution I first advocated twenty years ago will be adopted:

The federal government has struck a deal with Ontario and B.C. to create a new securities regulator that covers roughly two-thirds of Canadian capital markets, reigniting a long fight over a national securities regulator.

The three governments said Thursday the other provinces and territories will be invited to join the new “co-operative” regulator, slated to be operational by 2015.

The regulator would be based in Toronto, with offices across the country and initially run jointly by Ontario and B.C.

Spend-Every-Penny grabbed the mic:

Finance Minister Jim Flaherty said the proposed new system would help attract more investment, better protect investors, make it easier to prosecute white collar criminals and manage risks to the financial system.

I find it very difficult to believe that it will make enforcement better. But I support it because it will make compliance cheaper … or, at least, less of a complete waste of time registering the same information with different provincial regulators.

It was another good day for the Canadian preferred share market, with PerpetualDiscounts winning 32bp, FixedResets up 4bp and DeemedRetractibles gaining 1bp. A relatively long Performance Highlights table is skewed towards winning PerpetualDiscounts and insurance-issued DeemedRetractibles. Volume was above average.