PrefBlog

Credit where credit is due! The obnoxiously misleading advertisement for IA Clarington, which I discussed yesterday, has already been attacked by Dan Bortolotti in a post on Canadian Couch Potato dated 2013-11-11 and in a Moneysense post of the same date. Scooped!

Today’s FOMC statement made it clear that things are getting better, but only by Great Recession standards:

Information received since the Federal Open Market Committee met in March indicates that growth in economic activity has picked up recently, after having slowed sharply during the winter in part because of adverse weather conditions.
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Beginning in May, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $20 billion per month rather than $25 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $25 billion per month rather than $30 billion per month.
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To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

Equities responded well:

The Standard & Poor’s 500 Index increased 0.3 percent to 1,883.95 at 4 p.m. in New York, ending April with a 0.6 percent gain, its third straight monthly advance. The Dow climbed 45.47 points, or 0.3 percent, to 16,580.84, topping the previous closing record reached Dec. 31. The Nasdaq Composite Index added 0.3 percent, after an earlier drop of 0.8 percent. About 6.9 billion shares changed hands on U.S. exchanges, in line with the three-month average.

The war on markets is having an effect:

More than 30 traders from 11 firms have been fired, suspended, taken leaves of absence or retired since October, when regulators said they were investigating the market, according to data compiled by Bloomberg. London-based Barclays Plc (BARC) and Zurich-based UBS AG (UBSN) have been the worst-hit, each suspending at least half a dozen employees, the data show.

“That’s a considerable percentage of the workforce,” said Brad Bechtel, managing director at Faros Trading LLC in Stamford, Connecticut, who estimated the world’s largest banks have 80 to 160 voice traders for spot rates in the currencies market. “That explains the lack of liquidity in the market, and why what would normally be considered a small trade can actually push the market around more than normal.”

The US Treasury lost $11-billion on GM:

The U.S. Treasury’s bailout fund lost $11.2 billion on the rescue of General Motors Co. (GM) with the government’s exit of the largest U.S. automaker, a report said.

The total includes $826 million that the Treasury wrote off in March for its remaining claim in old GM, the special inspector general for the Troubled Asset Relief Program said in a report to Congress today. In December, the government had put the loss at about $10.5 billion on its $49.5 billion investment.

Fannie Mae was profitable:

Fannie Mae will pay the Treasury Department $7.2 billion after posting an eighth straight quarterly profit, pushing total dividend payments above the $116.1 billion of aid it received after the financial crisis.

The mortgage-finance company, which is operating under federal conservatorship, had net income of $6.5 billion for the three months ended Dec. 31, Washington-based Fannie Mae (FNMA) said today in a regulatory filing. That brought earnings for 2013 to $84 billion, the highest ever for the 80-year-old firm.

Freddie Mac was profitable:

Freddie Mac, the U.S.-owned mortgage financier, will return $10.4 billion to the Treasury Department next month, bringing total payments to about $10 billion above what it got in aid after the 2008 credit crisis.

The McLean, Virginia-based company had net income of $8.6 billion for the quarter ended Dec. 31 and a profit of $48.7 billion for all of 2013, according to a regulatory filing today, a profit largely driven by rising home prices. Freddie Mac, which was taken into federal conservatorship in 2008 along with larger rival Fannie Mae, earned $11 billion in 2012.

In fact, while Treasury realized a few scattered losses in investments in small firms, TARP has been a huge money-spinner for the US government … except for GM.

The Canadian preferred share market closed the month with a pop, as PerpetualDiscounts won 25bp, FixedResets were up 19bp and DeemedRetractibles gained 16bp. Volatility was average. Volume was high.

PerpetualDiscounts now yield 5.36%, equivalent to 6.97% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 4.5%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 245bp, a significant decline from the 255bp reported April 9.

And that’s it for another month – it’s been a good one!

The scavenging of the corpse of Nortel is approaching an end:

Canadian pensioners at Nortel Networks Corp. are heading into a rare cross-border trial in May to try to ensure more of the defunct company’s remaining assets are allocated to the Canadian division in an effort to boost the company’s underfunded pension plan.

The hearing, which runs from May 12 to June 27, will be conducted using video links before two judges – one in Toronto and one in Delaware – and will hear arguments from lawyers from Canada, the U.S. and Britain about how the remaining Nortel assets should be divided among the three jurisdictions.

Creditors, including Nortel pension funds and bondholders, have submitted claims worth $36-billion, while estimated assets currently total about $9-billion, including $7.3-billion raised from asset sales.

Canadian pensioners say the heart of their battle is a dispute with Nortel’s bondholders, who they accuse of manoeuvring to have more assets assigned to Nortel’s U.S. estate in an effort to improve their odds of receiving more than $1-billion of unpaid interest on their bonds from the time Nortel filed for bankruptcy protection in 2009.

Andrew Hallam points out in the Globe that IA Clarington is being naughty:

Click for Big

In a recent advertisement, they claim market-beating performance for three of their funds. They compared their Strategic Income Fund, Strategic Equity Income and their Strategic Corporate Bond Fund to a Canadian stock index. By doing so, however, they compared toasters to microwaves. None of IA Clarington’s advertised market-beating funds hold significant amounts of Canadian stocks. So why compare them to a Canadian stock index? Investors should be wary of advertorial sleight of hand.

The advertisement states, “At IA Clarington we believe that truly active managers, ones who apply skill, conviction and opportunity, can and do consistently outperform [indexes] over the long term.” But the funds in the advertisement are less than three years old.
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I examined each of their funds with 10-year track records in six separate categories: Canadian Equity, Balanced, U.S. Equity, International Equity, Canadian Bond and Canadian Short Term Government Bond. Over the decade, IA Clarington’s fund performances fell 22.5 per cent short. They’re also the only firm I’ve compared in this series so far to underperform retail indexes in all six categories.

It was a strong day for the Canadian preferred share market, with PerpetualDiscounts winning 29bp, FixedResets gaining 13bp and DeemedRetractibles up 20bp. This burst the dam on the performance report, which features a fine host of winners; mostly FixedResets. Volume was high, with a big crop of six-figure volumes.

Assiduous Readers will recall that I ascribe increasing income inequality to technology. So I was astonished at the results of a Pew Poll on the subject:

Click for Big
(Sorry for lousy quality; can’t figure it out…)

Technological advance isn’t even mentioned! One possible explanation is that the poll’s question referred to “the rich”, whereas I think of income inequality in terms of quintiles; certainly the response “tax system” has a large effect if we think in terms of the gap between the fabled 1% and the rest of us (particularly in America) rather than, say, the gap between the second and fourth quintile. Even still, however, a lot of billionaires are self-made technologists:

Every year FORBES crunches the numbers to find out which Americans rank the richest–and each year it gets harder to join the exclusive Forbes 400 list. But you don’t have to inherit a fortune to become a Forbes 400 billionaire. In fact, the majority of our Forbes 400 members–273 of them–scrapped their way onto our list through their own efforts.

The self-made differ somewhat from their Forbes 400 counterparts in terms of how they gained their wealth. The most obvious difference between the groups, not surprisingly, is that many of the self-made earned fortunes through technology. A whopping 45 tycoons–nearly 25% of the Forbes 400–made their billions in tech, making it the second-most-popular industry overall for launching onto the Forbes 400.
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After technology, real estate produced the next largest group of self-made Forbes 400 members.
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Of course, the self-made and the inheritors share the Number 1 way of getting rich, which has long been “investing”–a catch-all category that describes hedge fund billionaires as well as others, like Warren Buffett, who have stakes in many industries.

We now know the secret of prosperity: corporate welfare:

Ontario Premier Kathleen Wynne is pledging $2.5-billion in new grants to attract more businesses to the province and help others expand.

The 10-year Jobs and Prosperity Fund, announced Monday, will be contained in this week’s budget, which could trigger an election.

Fifties are here!

Finance Minister Joe Oliver today announced that the Government of Canada successfully issued $1.5 billion in 50-year bonds.

This inaugural ultra-long issue is the first of its kind for the Government and is in line with its commitment since 2012–13 to reallocate short-term bond issuance towards long-term bonds to help reduce refinancing risk.

Quick Facts

• ◾Maturing on December 1, 2064, and with a yield of 2.96 per cent, this issuance will contribute to a reduction in refinancing risk at a low cost, which is consistent with the key objectives of the medium-term debt strategy.
• ◾Alone among the Group of Seven countries, Canada continues to receive the highest possible credit ratings, with a stable outlook, from all the major credit rating agencies.
• ◾Locking in low-cost funding for 50 years benefits taxpayers.

Theophilos Argitis and Cecile Gutscher at Bloomberg tell us:

The government doubled the size of the sale to C$1.5 billion ($1.36 billion) and won a yield 1 basis point below its 3.5 percent 2045 benchmark bond, according to details released by underwriters including BMO Capital Markets, CIBC World Markets Inc., Desjardins Securities and TD Securities Inc. on the Canadian Syndication System.

“From the standpoint of demand from long-duration players like life insurance and pension funds, the duration of a 50-year bond is not much different than a 30-year bond,” said Adrian Miller, director of fixed-income strategies at GMP Securities LLC in New York, by e-mail.

Demand from pension funds is driving purchases of longer-dated bonds to lock in higher returns while also matching liabilities and cutting exposure to equity market volatility. Former Finance Minister Jim Flaherty unveiled the ultra-long bond proposal in the 2013-14 budget as the government said it wanted to extend the maturity of its borrowings with rates at near historic lows.

The bonds, due Dec. 1, 2064, have a 2.75 percent coupon and yield 2.96 percent, one basis point less than the government benchmark note due December 2045 at the time of pricing.

Next WE WANT PERPS! All together, folks! WE WANT PERPS!

Today’s featured business model for budding entrepreneurs is the mug shot game:

California lawmakers took steps on Monday to bar so-called extortion websites from posting mug shots of people who have been arrested and then demanding payment to remove the photographs, even from people who are never charged with a crime.

A bill to make it unlawful to solicit or accept payment to remove, correct or modify mug shots online was unanimously passed by the California state senate on Monday, in the latest effort by more than a dozen U.S. states to stop such practices.
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In what legislative researchers for the senate called an unintended consequence of laws making mug shots and other arrest information available to the public, a growing industry has developed that publishes mug shots on a website and then charges those depicted in the photos to remove their images.

RioCan Real Estate Investment Trust, proud issuer of REI.PR.A and REI.PR.C, was confirmed at Pfd-3(high) by DBRS:

DBRS has today confirmed the ratings of RioCan Real Estate Investment Trust’s (RioCan or the Trust) Senior Unsecured Debentures and Senior Unsecured Debentures, Series 1, at BBB (high) and Preferred Trust Units at Pfd-3 (high), all with Stable trends. While the confirmation acknowledges RioCan’s steady growth in operating income and improvement in financial metrics over the past several years, the ratings continue to be constrained by the Trust’s high distribution payout ratio. DBRS notes that a positive rating action could occur, should the Trust continue to improve its EBITDA coverage (including capitalized interest) above 3.0 times (x) and lower its distribution payout ratio such that it is more consistent with the A (low) rating category.
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In terms of financial profile, RioCan is expected to continue to pay out essentially all of its internally generated cash flow in the form of distributions. DBRS anticipates RioCan will continue to fund investments with proceeds from asset dispositions and debt as the Trust recycles its asset base toward high-quality properties in growing urban markets. As such, DBRS expects RioCan’s key financial metrics will improve modestly within the current rating category in the near term (EBITDA interest coverage in the 2.70x to 2.90x range), based on continued growth in operating income and lower weighted-average interest rate.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts off 8bp, FixedResets up 7bp and DeemedRetractibles gaining 5bp. Volatility was average. Volume was above average.

There is an interesting trend in the commodities market:

As Barclays Plc, JPMorgan Chase & Co. and Morgan Stanley leave parts of the business, prices of commodities are moving more independently of stocks. The correlation between U.S. equities and corn, cattle and wheat fell to less than 0.05 in January, compared with almost 0.3 in 2008, an analysis by David Bicchetti and Nicolas Maystre, economic affairs officers at the UN Conference on Trade and Development in Geneva, shows.

Banks, hedge funds and other financial institutions piled into physical commodities and derivatives over the past 12 years, amplifying a run-up in prices for everything from copper to oil, in short supply before the 2008 global recession, the UN found in a 2011 study. The exodus is nudging futures markets back toward their original function, as a way for farmers, miners and other companies in the commodities business to hedge against price swings.

I’m not sure, but I think the study Bloomberg refers to above is by David Bicchetti and Nicolas Maystre, titled The synchronized and long-lasting structural change on commodity markets: evidence from high frequency data:

This paper analyses the intraday co-movements between returns on several commodity markets and on the stock market in the United States over the 1997- 2011 period. By exploiting a new high frequency database, we compute various rolling correlations at (i) 1-hour, (ii) 5-minute, (iii) 10-second, and (iv) 1-second frequencies. Using this database, we document a synchronized structural break, characterized by a departure from zero, which starts in the course of 2008 and continues thereafter. This is consistent with the idea that recent financial innovations on commodity futures exchanges, in particular the high frequency trading activities and algorithm strategies have an impact on these correlations.
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This paper documented striking similarities in the evolution of the rolling correlations between the returns on several commodity futures and the ones on the US stock market, computed at high frequencies. It also highlighted a structural change that took place recently in these markets. Prior to 2008, high-frequency co-movements between commodity and equity markets did not usually differ from zero over a long lasting period at such high frequencies. In the course of 2008, these correlations departed from zero and became strongly positive after the collapse of Lehman Brothers.

In our view, this finding adds to the growing empirical evidence supporting the idea that the financialization of commodity markets has an impact on the price determination process. Indeed, the recent price movements of commodities are hardly justified on the basis of changes of their own supply and demand. In fact, the strong correlations between different commodities and the S&P 500 at very high frequency are really unlikely to reflect economic fundamentals since these indicators do not vary at such speed. Moreover, given the large selection of commodities we analyse, we would expect to have different behaviours due to their seasonality, fundamentals and specific physical market dynamics. Yet, we do not observe these differences at any frequency. In addition, the fact that these correlations at high frequencies started during the financial shocks provides additional support for financial-based factors behind this structural change. Therefore, the very existence of cross-market correlations at high frequencies favours the presence of automated trading strategies operated by robots on multiple assets. Our analysis suggests that commodity markets are more and more prone to events in global financial markets and likely to deviate from their fundamentals.

It seems odd to me that the authors don’t spend much time discussing monetary policy. The links between commodity financialization and monetary policy were highlighted on PrefBlog on November 11, 2010 and in the post QE2 and Inflation.

Econbrowser is prominent in the above links, and the blog also hosts a recent piece titled Guest Contribution: Commodity-Price Comovement and Global Economic Activity:

Our approach to understanding the drivers of the comovement in commodity prices uses a theoretical model in which the prices of commodities are determined by two sets of forces. First, there are the forces that affect commodity prices directly, by which we mean forces which alter the supply or demand for commodities even for a fixed level of global economic activity. For example, we classify a technological improvement in the production of commodities as such a force, because it would increase the supply of commodities even in the absence of any subsequent effects on global economic activity. Of course, to the extent that these forces change commodity prices, they ultimately alter the level of global economic activity and feed back into commodity prices through general-equilibrium effects. But the key to identifying these forces is that they affect commodity prices even absent any endogenous response of global activity. By contrast, the second set of forces are those that affect commodity prices only through the changes that they induce in the level of global economic activity, i.e. “indirectly”. Changes in government spending, variation in the desired markups for the production of consumer goods, or improvements in the technology used to produce final goods are all examples of such forces. The composition of all such forces is summarized by the indirect factor. These two drivers are common to all commodity prices. The model also permits there to be idiosyncratic forces specific to individual commodities.

Looks like Abenomics is working on the data but not on embedded expectations:

Tokyo’s consumer prices rose 2.7 percent in April from a year earlier, the biggest jump since 1992, pumped up by a sales-tax increase and a year of unprecedented stimulus from the Bank of Japan.

Inflation excluding fresh food accelerated from 1 percent in the previous month, while nationally the same price gauge rose 1.3 percent in March from a year earlier, statistics bureau data showed today. The Tokyo price gains compared to a 2.8 percent median forecast in a Bloomberg News.

The Tokyo data provide a first look at the effects of the April 1 tax increase that’s damping consumer demand and is projected to tip the economy into a one-quarter contraction. Investors are assessing prospects for extra monetary easing, with Bank of Japan Governor Haruhiko Kuroda’s board set to meet on April 30 to review policy and release updated forecasts for inflation and growth.
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BOJ officials are increasingly concerned the nation’s bond market is failing to reflect emerging inflation, raising the risk of a sudden surge in yields, according to people familiar with the matter. Officials hope yields will rise gradually, in line with developments in the economy and prices, the people said. Benchmark 10-year government bonds yesterday yielded 0.615 percent, little changed from March 2013.

There’s one good aspect to the federal Target Date pension plans I’ve been complaining about recently:

Meanwhile Denis Lemelin, president of the Canadian Union of Postal Workers, said he fears the government will eliminate defined benefit plans for employees at Canada Post and other Crown corporations. “We’re really worried about this announcement,” he said.

Hey, that’s a good justification right there! Bring it on!

Assiduous Reader MG writes in about Target Date Pension Plans and says:

Hi James, thanks for including my response yesterday. Not to prolong the discussion but I just wanted to make on additional point regarding the pooling. Your last paragraph yesterday stated:

Well, OK. But pooling of longevity risk can be accomplished with an annuity. The basic problem is familiar; I wrote an article about it some time ago in another context and now can’t remember the article: risk cannot be destroyed. It can only be passed on or changed in form. And while I seem some risk-pooling for the beneficiaries here, I see no indication that the company bears any; therefore, it’s a DC plan with bells and whistles.

The issue with defined contribution plans is that you need to make decisions at the point of retirement which would not be required under target benefit plans. If you annuitize at the point of retirement, you are making a call on the timing of accumulated savings, i.e. if your investment went down prior to retirement you may be annuitizing a lower capital. You are also captive of the level of long term interest rates at the point of annuitization. If they were 18% (like when I started in the business), it is not an issue. If they are at 3.5%, it is a problem. A target benefit plan would likely be invested in such a way that there is some continuity, i.e. no call on timing of markets and long term rates when benefits start. In a defined contribution plan, you do not need to annuitize but then you have a lot of uncertainty due to unknown longevity, so there is a temptation to get it over with and just get whatever you get through an annuity purchase.

All of this may be a moot point, as I have seen similar arrangements proposed by the federal or provincial governments. Typically these have not been a success for a variety of reasons. In this situation, TB plans would only apply to federally regulated companies, unless provinces do the same. Federally regulated companies would include banks and transportation including CN and CP. Historically many of these already have defined benefit plans, so the only potential would be among employees of much smaller companies.

OK, fair enough. A DC plan member can transfer the value to a Locked-In Retirement Income Fund which – presumably – will have all the continuity he wants, but does not address mortality risk. So a Target-Date will pool the mortality risk for the participants, which is a benefit – it will be able to pay out more aggressively than a self-managed investment portfolio. On the other hand, this pooling occurs in the context of an active pension plan, while leaving the investment risk with the employee (on a pooled basis, of course). This might not be a good thing, depending on the risk characteristics of the pool vs. the risk characteristics of the client.

I will leave it to an actuary to comment on how risks taken by the Target Benefit plan on behalf of the entire pool impact on the risk sustained by the individual retirees! But now I’m wondering if the big insurers could offer such a thing for DC beneficiaries when they cash out. Offer mortality pooling in a mutual fund-like vehicle (but with investments irrevocably locked in!) with an actuarially blessed monthly pay-out, charge a fat fee …

S&P downgraded Russia:

• •In our view, the large capital outflows from Russia in the first quarter of 2014 heighten the risk of a marked deterioration in external financing, either through a significant shift in foreign direct investments or portfolio equity investments. We see this as a risk to Russia’s economic growth prospects.
• •We are therefore lowering our foreign currency ratings on Russia to ‘BBB-/A-3’ from ‘BBB/A-2’, lowering our local-currency long-term rating to ‘BBB’ from ‘BBB+’, and affirming our local-currency short-term rating at ‘A-2’.
• •The outlook on both the foreign and local currency ratings remains negative. If we perceived increased risks to Russia’s creditworthiness stemming from much weaker medium-term economic growth or due to reduced monetary policy flexibility, we could lower our sovereign ratings on Russia further. We could also lower our ratings on Russia if tighter sanctions were to result in additional weakening of Russia’s net external position.

The CMHC is fiddling around with mortgage insurance eligibility rules again:

Canada Mortgage and Housing Corp. is voluntarily tightening up the types of mortgage insurance it will offer.

The Crown corporation said Friday that it is going to stop offering mortgage insurance on second homes. It will also stop offering mortgage insurance to self-employed people whose income cannot be validated through traditional means. The changes on second homes also mean that anyone who has an insured mortgage will not be eligible to act as a co-borrower on another insured mortgage.
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CMHC says that its second home program and its self-employed-without-third-party-income-validation programs combined account for less than 3 per cent of its insurance business volumes in terms of the numbers of mortgages insured.

“Given the limited use of these products, their discontinuation is not expected to have a material impact on the housing market,” it stated in a press release.

More smoke and mirrors. Fiddling with the rules keeps the voters happy, but leaving the spigots open for plain vanilla insurance keeps the banks happy.

Pembina Pipelines, proud issuer of PPL.PR.A, PPL.PR.C and PPL.PR.E, was confirmed at Pfd-3 by DBRS:

DBRS has today confirmed the Issuer Rating and Senior Unsecured Notes of Pembina Pipeline Corporation (Pembina or the Company) at BBB, and the Preferred Shares at Pfd-3. The trends remain Stable. The confirmation largely reflects DBRS’s view that the Company’s exposure to fractionation spreads and seasonal pricing differentials has lowered considerably while its financial profile has improved over the past 24 months (since the April 2, 2012, closing of the Provident acquisition (the Acquisition)). The confirmation also reflects DBRS’s expectation that: (1) further improvement of the business risk profile will be achieved once the Company substantially completes all of its current expansion projects; and (2) Pembina will continue to finance its expansion with appropriate debt and equity to maintain its debt-to-capital structure in the range of below 40% and cash flow-to-debt ratio at least 25%.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts and FixedResets both gaining 8bp, while DeemedRetractibles were off 2bp. Volatility was totally nonexistent yet again. Volume was below average.

I renewed my mockery of Target Benefit Plans yesterday. Assiduous Reader MG writes in and says:

I used to be a pension actuary, however a long time ago. So I asked someone who retired more recently what he thought about target benefit plans. Here is the answer I received:

I am not sure of the details of the federal proposal. However, if it looks like the New Brunswick arrangements, then you get pooling of mortality risk, limited pooling of investment risk (across generations), and economies of scale with respect to plan expenses. In essence, you can think of it as a pooled RRSP. Employer contributions will be more or less fixed (limited ability to change contributions), employee contributions and benefits go up and down with plan experience

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Essentially I believe you are correct that employees assume most of the risks but it appears that it is not one-sided, i.e. they can win or lose depending on results.

I don’t believe this a great deal. I think it will have a limited impact. Except for some pooling, the main advantage is that it allows members to have a better idea of what the ultimate benefits might be (assuming assumptions are realized) which is a weakness of defined contribution plans.

Fair enough. I’m not sure how the beneficiary reporting is handled, but it seems to me that this reporting could be realized inside the framework of a one-choice DC plan by (i) Estimating the accumulated value on the projected retirement date, and (ii) Estimating the monthly benefit of a no-guaranty life annuity purchased on that date.

But there were some more details today:

The Conservative government released extensive details on a proposed target benefit plan Thursday that would see federal legislation lay out the rules as to what these funds would look like and how they should be managed.
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“Base benefits” could be reduced in cases where the pension fund is in deficit, but would have a high level of protection and could only be lowered “as a last resort,” according to the Finance Canada consultation paper released Thursday. Meanwhile “ancillary benefits” would have “a lower but reasonable level of protection” and would be reduced before base benefits were reduced and could also be increased when the plan is in a surplus situation.
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[Minister of State for Finance Kevin] Sorenson argued it would be better than a defined contribution plan.

“Unlike defined contribution plans, target benefit plans would offer a more predictable stream of benefit payments and high benefit security, since the target benefits would be based on a per-determined formula,” he said. “Members and retirees would benefit from the pooling of longevity risk, which is not a feature of defined contribution plans.”

Well, OK. But pooling of longevity risk can be accomplished with an annuity. The basic problem is familiar; I wrote an article about it some time ago in another context and now can’t remember the article: risk cannot be destroyed. It can only be passed on or changed in form. And while I seem some risk-pooling for the beneficiaries here, I see no indication that the company bears any; therefore, it’s a DC plan with bells and whistles.

Tapering is old news. The new worry is credit quality:

Corporate dealmaking that helped propel the Standard & Poor’s 500 stocks index to a record is playing out differently for debt investors, who must contend with the biggest threat to credit grades since 2009.

With borrowings to fund mergers and acquisitions accelerating amid an improving economy, the number of credit-ratings cuts linked to such deals is exceeding increases by the most since the fourth quarter of 2009, according to data from Moody’s Analytics. The firm’s credit-assessment unit lowered 96 ratings during the year ended March, while raising the rankings on 78.

The damage to balance sheets is coming amid a growing chorus of concerns that a sixth year of record-low interest rates engineered by the Federal Reserve has left bond prices overvalued and allowed borrowers to get away with financings that they wouldn’t be able to do in normal times. Valeant Pharmaceuticals International Inc. is pursuing Allergan Inc. in a takeover that may drop the Botox maker to junk status.

The Valeant / Allergan deal became notable for taxation reasons as well:

GE can tap the $57 billion of cash it has amassed overseas to finance a purchase of most of France’s Alstom SA (ALO), a person with knowledge of the matter said. By doing so, GE would take advantage of its overseas profits instead of bringing them back to the U.S., where they would be taxed at a higher rate.

Valeant’s pursuit of rival Allergan Inc. underscores another twist. Many drugmakers are buying companies in low-tax countries and then setting up operations there to avoid U.S. taxes. If the Canadian company succeeds in buying Allergan, the combined entity would have a tax rate in the single digits, Valeant Chief Executive Officer Michael Pearson said. Allergan paid a tax rate of about 26 percent in 2013, data compiled by Bloomberg show.

“You have effectively created an incentive to move to a low-tax country,” said Gordon Caplan, a partner at law firm Willkie Farr & Gallagher in New York. “There is competition between high-tax countries and low-tax countries.”

U.S. companies are keeping cash offshore to avoid paying up to a 35 percent tax rate on profits they earn around the world. They only pay taxes when the cash is repatriated. By spending money overseas, the effective cost for a buyer can also be lowered, making acquisitions easier.

I was surprised to hear a little while ago that many high-school students can’t do long division and was even more surprised to have that confirmed by a young relative. So I read an article in a men’s magazine titled 5 Math Lessons You Don’t Really Need in the Real World with great interest:

#5. Long Division

Long division is a calculation technique where one number can be divided by another using nothing more than note paper and a tremendous amount of time. And despite all the horrible things that have happened to my brain since grade five, I basically still remember how to do it. You start at the left and pick the largest nominator that can fit in the regulator, then take the leftovers and add them to the next downmost digit of the dividule, then repeat. Right?

Note that I’m talking about the usefulness of long division specifically here. Everyone obviously has to understand how basic division works, as that comes up all the time in the real world, when dividing up apples among friends or whatever. But the only division you ever really need to do in the real world is with integers under 100, and that takes rote memorization really, not long division. So what good is long division?

What They Say This Is Used For:

Long division is meant for those occasions when we need to divide large numbers and we don’t have a calculator at hand.

What a Normal Human Being Might Actually Use This For:

Nothing.

Basically the only people who use long division now are fifth-grade teachers teaching long division to fifth graders. Long division was added to our math curriculum in a primitive era when people smoked for their health and calculators were rare. But that’s obviously no longer the case; right now you probably have three or four devices within arm’s reach capable of doing division.

I’ve thought a bit about this – and even left a comment on another anti-long-division blog post, which I’m not sure will be published – arguing that right off the top of my head I can think of five crushing pro-long-division arguments:

• It’s a reasonably easy to understand algorithm for solving what looks incomprehensible in terms of procedures that are already known
• The thing that’s already known is multiplication – long division serves as good drill for multiplication without actually looking like drill
• It can serve as an introduction to the concept of limits
• It can help illustrate the difference between rational and irrational numbers
• It’s what I learned in school, therefore everybody should learn it in school

I like to think the first point is most important, although I confess that I’m not sure whether the last point is really what I’m trying to justify. Algorithms are important. The author of the other blog post I mentioned suggest the Euclidean algorithm as a competing example, but I think long division is better, since it builds on material already known.

And the introduction to algorithms is important and should be emphasized as such: a major complaint I have regarding my mathematical education is that nobody ever explained why we were being taught something. Not even once. Putting these abstract concepts – such as long division – into a framework would be much more satisfactory.

Just as another f’rinstance, the second item on Cracked writer’s list of complaints is Geometric Proofs. which is dismissed with:

All of this stuff is super useful if you’re an engineer. Actually, let’s say mandatory. Yeah. I’d kind of like the guys we have building bridges to really “get” triangles, thanks.

Also, the technique of taking simple axioms and combining those into more complicated theorems is great training for more complicated mathematical proofs. This is useful if you want to continue your career in mathematics, which boy, man, are you sure you want to continue your career in mathematics?

Two problems with that – first, yes, we want engineers to “get” triangles. But we also want people who “get” triangles to realize that they “get” them and realize that this makes them part of a skilled group. We don’t want to take a randomly chosen group of 18 year olds and send them off to engineering school. High school is not just about cramming irrelevant detail into your head, it’s also about becoming exposed to various simple things and learning what you like and what you’re good at.

Also – and this is a long-standing grievance of mine – the process of “taking simple axioms and combining those into more complicated theorems” isn’t a one way street into more mathematics. It’s the whole basis of argument! I have often thought that the first week of trigonometry – which I believe occurs in Grade 10 – should actually be taught in conjunction with English class, in which the English teacher discusses debating and argument. These aren’t just intimately related subjects, they’re the same damn thing; it’s just that axioms underlying mathematics are simpler and should therefore be easier to understand. Attacking a false argument about capital punishment is exactly the same process as attacking a false proof that two angles are equal, and this should be emphasized in mathematical education.

However, the proof of the pudding is in the eating. I suspect that none of the official pro- or anti-long-division contenders have actually tested education in the presence or absence of long-division to test their hypotheses. This is because they didn’t pay attention to the role of experimentation in confirming or negating hypotheses in their grade 11 physics class; or perhaps their physics teacher didn’t explain why you have to do experiments.

Three cheers for Rob Ford!

DBRS has today confirmed the ratings of the City of Toronto (the City or Toronto) at AA. All trends remain Stable, reflective of the City’s ability to levy taxes on a large, well-diversified economy, and its demonstrated fiscal prudence in recent years.
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The City posted a $1.3 billion operating surplus in 2012, on better-than-expected revenue growth and lower spending.
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DBRS notes that fiscal resolve has improved notably in recent years. The City estimates that the ongoing Service Review Program and other restraint measures have led to over $900 million in operating budget savings and generated an additional $30 million in user fee revenues between 2011 and 2014.

It was a strong day for the Canadian preferred share market, with PerpetualDiscounts winning 26bp, FixedResets gaining 13bp and DeemedRetractibles up 15bp. Volatility was surprisingly low, given the sharp move. Volume was average.

The Globe & Mail picked up a story in the New York Times titled The American Middle Class Is No Longer the World’s Richest:

While the wealthiest Americans are outpacing many of their global peers, a New York Times analysis shows that across the lower- and middle-income tiers, citizens of other advanced countries have received considerably larger raises over the last three decades.

After-tax middle-class incomes in Canada — substantially behind in 2000 — now appear to be higher than in the United States. The poor in much of Europe earn more than poor Americans.
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The findings are striking because the most commonly cited economic statistics — such as per capita gross domestic product — continue to show that the United States has maintained its lead as the world’s richest large country. But those numbers are averages, which do not capture the distribution of income. With a big share of recent income gains in this country flowing to a relatively small slice of high-earning households, most Americans are not keeping pace with their counterparts around the world.
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Three broad factors appear to be driving much of the weak income performance in the United States. First, educational attainment in the United States has risen far more slowly than in much of the industrialized world over the last three decades, making it harder for the American economy to maintain its share of highly skilled, well-paying jobs.
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A second factor is that companies in the United States economy distribute a smaller share of their bounty to the middle class and poor than similar companies elsewhere. Top executives make substantially more money in the United States than in other wealthy countries. The minimum wage is lower. Labor unions are weaker.
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Finally, governments in Canada and Western Europe take more aggressive steps to raise the take-home pay of low- and middle-income households by redistributing income.
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“Things are pretty flat,” said Kathy Washburn, 59, of Mount Vernon, Iowa, who earns $33,000 at an Ace Hardware store, where she has worked for 23 years. “You have mostly lower level and high and not a lot in between. People need to start in between to work their way up.”

I’m not a social scientist and have made no detailed study of the problem. But I suggest that part of the reason is productivity, which is still impressive in the States, despite recent problems:

ObamaCare is slowing economic recovery in many ways, ranging from implicitly increasing tax rates on individuals to hindering business growth by creating incentives for small business to remain below 50 employees or to only hire part-time workers. In larger businesses and corporations, uncertainty about the future of health-care costs is holding back investment and hiring.

Statistics suggest that new banking regulation may be significantly hindering small business lending. In July 2013, the Office of Advocacy of the U.S. Small Business Administration reported that small business loans (those less than $1 million) declined about 10% between 2010 and 2012. Reforms that reverse this trend are needed.

Reform is also required to make it easier for immigrants to start businesses. About half of the most successful high-tech startups in the U.S. were either founded or cofounded by immigrants. But U.S. law restricts immigration for people with the skills to start the next Intel. The current H1-B visa program for skilled workers is capped at around 65,000 workers, and the most recent year’s application for this visa was oversubscribed within one week.

This problem is so acute that Silicon Valley-based startup incubator Blueseed plans to launch a cruise ship next year to be docked 12 miles off of San Francisco in international waters so immigrants can start businesses without needing residency. Immigration reform is the biggest free lunch facing policy makers, yet its fate remains uncertain in Washington.

and further:

What the most recent numbers regarding prices of IT equipment imply is that the efficiency gains brought by the digital revolution may be petering out, and that will have a direct effect on our ability to become more efficient workers. And if we want to get back to the worker-productivity gains we were experiencing a decade ago, we need to somehow figure out how to encourage the kind of technological innovation that has led to previous waves of sharp productivity growth.

Of course, this raises the age-old question that economists have been arguing over for generations: What causes innovation? Conservative economists tend to believe that innovation is spawned mainly by the ingenuity of entrepreneurs. They rely on what is known as Say’s law, named after the classical economist Jean-Baptiste Say, which states that “supply creates its own demand.” … In this worldview, the entrepreneur is the instigator of growth, and therefore we must do what we can to avoid dampening his incentive to create.

But the entrepreneur isn’t the only source of productivity growth. Firms can simply invest more in existing technology, intellectual property, and research and development. And it turns out that growth of this sort of spending has slowed from an average of 4.7% per year in 1980 to 2000, to 2.8% per year over the past 10 years, according to the report.

Compare this angst to Canadian angst:

For three decades, growth in Canadian labour productivity (at its simplest, output in dollars per hour worked) has lagged behind productivity growth in the United States and other major countries. A recent update of the productivity data by Statistics Canada, to the end of 2011, has revealed that the problem has gotten even worse.

If we continue to discount or dismiss the productivity issue, Canadians’ future incomes will be threatened – particularly if there is a sustained downward adjustment in the price of key natural resources. If there ever was a time to take poor productivity growth seriously, that time has arrived.

So I will hypothesize that this median-income thing is not something to celebrate: I suggest it may be a direct result of our lousy productivity. The middle class did very well in the 20th century, when productivity improvements meant spending $250,000 to buy the machinery that turned a labourer into a skilled tradesman. I suggest that in this century, productivity improvements mean spending $1,000,000 to replace that skilled tradesman with some software.

And it is productivity that makes us rich, not equality.

I read a fascinating paper recently by Marc Oliver Rieger, Mei Wang and Thorsten Hens titled International Evidence on the Equity Premium Puzzle and Time Discounting:

We examine time discounting factors in an international survey. Our analysis reveals a significant relationship between time discount factors and historical equity premiums across 27 countries. This result implies that higher historical equity risk premiums are observed in countries where survey participants tend to be more short-term oriented. This finding is consistent with the explanation of the equity premium puzzle provided by myopic loss aversion.
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Our results suggest that differences in time discounting can indeed explain some of the differences in equity premiums. Admittedly, the causality can go into both directions; namely, a high equity premium can also lead to more time discounting because of the higher expected return. However, we find that the subjective discount rates measured in our survey are far higher than the equity premiums, suggesting that equity premiums may not be the main drivers of time discounting.

The excellent updated Equity Risk Premiums (ERP): Determinants, Estimation and Implications – The 2014 Edition has a very good section on equity liquidity:

The notion that market for publicly traded stocks is wide and deep has led to the argument that the net effect of illiquidity on aggregate equity risk premiums should be small. However, there are two reasons to be skeptical about this argument. The first is that not all stocks are widely traded and illiquidity can vary widely across stocks; the cost of trading a widely held, large market cap stock is very small but the cost of trading an over-the-counter stock will be much higher. The second is that the cost of illiquidity in the aggregate can vary over time, and even small variations can have significant effects on equity risk premiums. In particular, the cost of illiquidity seems to increase when economies slow down and during periods of crisis, thus exaggerating the effects of both phenomena on the equity risk premium.

While much of the empirical work on liquidity has been done on cross sectional variation across stocks (and the implications for expected returns), there have been attempts to extend the research to look at overall market risk premiums. Gibson and Mougeot (2004) look at U.S. stock returns from 1973 to 1997 and conclude that liquidity accounts for a significant component of the overall equity risk premium, and that its effect varies over time.12 Baekart, Harvey and Lundblad (2006) present evidence that the differences in equity returns (and risk premiums) across emerging markets can be partially explained by differences in liquidity across the markets.13

Canadian hedge funds aren’t winning any prizes:

Still, the poor performance relative to the TSX raises more questions about their long-term returns. Since Scotiabank created its index in 2004, hedge funds only beat the S&P/TSX composite and the S&P 500 when their returns are asset-weighted. When they are evenly-weighted, meaning they are calculated as a simple average, the returns are simply on par with the indexes.

Asset-weighted returns are a better reflection of the sector; but it’s a little surpising that equal-weighted returns aren’t better than asset weighted. There must be a fair number of clowns running small, lousy funds.

Remember the idiotic Target Benefit Plans that I mocked on October 1, 2013? Now they’re federal government policy!

The Conservative government is throwing a new idea into the heated debate over Canadian pensions, launching a national discussion over proposed new pension plans that share the investment risk between employers and employees.
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Under a target benefit plan, employers and employees jointly oversee the management of a plan that aims to collect defined contributions in order to achieve a targeted benefit in retirement.

However if returns come in lower than expected, employers are not obligated to top up the fund. Instead, the fund could reduce the size of the benefits, increase the size of contributions or both.

Similarly, if investments overperform, decisions could be made to increase benefits or lower contributions.

The goal is to encourage more employers to offer pensions and to entice those offering a defined contribution plan to offer something better.

Sadly, the Globe article does not explain how a Target Benefit Plan is supposed to be better than Defined Contribution. Maybe because If the beneficiaries, who are taking all the risk, get lucky, the company benefits via lower contributions?

Thomson Reuters, proud issuer of TRI.PR.B, was confirmed at Pfd-3(high) by DBRS:

DBRS expects the earnings profile of Thomson Reuters to remain well positioned within the current rating category as the Company continues to execute its restructuring indicatives and acquire higher growth businesses. That said, DBRS expects revenues from ongoing businesses in 2014 to remain relatively flat at approximately $12.5 billion as growth across most business lines is expected to mitigate continued declines in the Financial & Risk segment. DBRS expects the trajectory of declines in Financial & Risk to continue to moderate as the economy rebounds and the Company continues to improve its product offerings. DBRS forecasts adjusted operating margins to rise from 24.5% (including severance charges) in 2013 to between 26% and 27% in 2014, due a decline in restructuring expenses year over year, further cost-cutting and a continued shift towards higher margin growth businesses. As such, DBRS expects EBITDA from ongoing businesses should rise to approximately $3.3 billion in 2014 (including $120 million of remaining severance charges). DBRS expects the Company to generate $400 million in annual cost savings by 2017 through product simplification, restructuring initiatives, and the achievement of scalable benefits.

Going forward, DBRS believes Thomson Reuters’ financial profile will remain consistent with the current rating category. DBRS expects the Company to use free cash flow and issue incremental debt for acquisitions and share repurchases such that leverage remains within its newly set financial policy guidelines (i.e., a net debt-to-EBITDA ratio of up to 2.5x).

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts off 1bp, FixedResets up 6bp and DeemedRetractibles gaining 5bp. Volatility was minimal. Volume – with the exception of the new issue – was extremely low.