August 30, 2007

A relatively quiet day!

The Fed’s discount window is less dusty nowadays, averaging $1.3-billion in loans – but $1.3-billion isn’t a lot in the great scheme of things.

“There are very few people in the money markets that I talk to who think it is providing any relief beyond psychological relief,” said Christopher Low, chief economist at FTN Financial in New York. “It is too expensive. If a bank has decent credit, they can get a much lower rate in the market” than the discount rate.

True enough … but I’d hate to see what the market would look like if it didn’t have some psychological relief!

In a somewhat-sort-of related post, Tom Graff looked at Fed Funds today, as did the WSJ.

A reporter joined in the ‘blame the rating agency’ chorus today:

Moody’s recently added some new phrases to its lexicon of code words. When the rating company refers to “updating its methodology” or “refining its risk assessments,” what it really means is that its historical models say absolutely nothing about how the future might turn out.

Last week, for example, Moody’s summarized “the most recent refinements” to how it treats bonds backed by so-called Alternative-A mortgages. “In aggregate, the change in our loss estimates is projected to range from an increase of approximately 10 percent for strong Alt-A pools to an increase of more than 100 percent for weak Alt-A pools,” Moody’s said.

So a mortgage-backed security with a rating based on, say, a 1.5 percent loss rate might now suffer 3 percent losses in its collateral, Moody’s said. How’s that for missing something the first time?

The reporter did not disclose his track record; nor did he provide an indication of what it is he thought that Moody’s missed. The story was about the Solent & Avendis meltdown – the structures have been forced to sell assets for anything they would fetch after failing to refinance their ABCP. Quite a few shops haven’t refinanced! Commercial Paper outstanding continued to decline and is now down $244-billion in three weeks:

The total fall in the commercial paper may end up at $300 billion, the amount of mortgages funded by asset-backed commercial paper, wrote Tony Crescenzi, chief bond market strategist for New York-based Miller Tabak & Co. LLC, in a note today.

Poor Bernanke! Despite plaudits from Barrington Research (and me, by the way), he’s going to get an earful at the Jacksons Hole conference this weekend: 

The “big debate” will be about how subprime mortgages were turned into gold-plated securities, especially the collateralized debt obligations that have caused the headaches, said Hale, president of Hale Advisors LLC in Chicago.

Headaches is definitely the word, as investors and principals of Basis Capital can tell you:

The Yield Alpha Fund has assets of $100 million. That’s down from $436 million at Jan. 31, according to Bloomberg data. 

Basis Capital asked a Cayman Islands court for permission to liquidate the fund, according to a petition filed in New York yesterday

There is a growing school of thought that feels the problem is asymmetric information but, frankly, I’m not sure if any regulatory regime that addressed that issue in particular will have the desired effect. In order for information to be useful, the purchasing portfolio manager must

  • be able to get the information
  • analyze the information
  • draw logical conclusions from the information

I’m not convinced that a regulatory solution to step one will necessarily lead to steps two and three. And I suspect that it’s impossible to enforce due diligence in a broad and consistent manner. “Due Diligence” means “Having a bunch of binders in your office somewhere”.

The investment business is more about sales than performance and diligence. And to the extent that performance does matter:

Pushed by fierce competition to make it to the “funds-of-the week” top-ten list of pseudo-specialised financial reviews, with the comfortable belief that one will be handsomely compensated in the case of success and allured by the possibility of diversifying much of the risk away, many funds’ managers have probably taken up an increasingly inefficient amount of risk. A correct assessment of risk should instead consist in compensating funds managers just slightly less if the fund is listed, e.g., eleventh in the ranking (if only such an ideal ranking existed!)3. To be sure, this potential source of inefficiency does not lie in the funding of subprime loans per se, but in the excess funding of risky projects due to a perverse/distorted assessment of risk.

And it’s not just sub-prime:

Freddie Mac, the second-biggest U.S. mortgage finance company, reported quarterly profit fell 45 percent after setting aside $320 million for losses as the housing slump deepened.

as a lot of mortgage defaults are investments. However, there’s still plenty of money for good credits:

Rio Tinto Group, the world’s third- largest mining company, raised $40 billion in loans for the purchase of aluminum producer Alcan Inc., a record for a U.K. borrower.

…even for American companies:

General Electric Capital Corp., the financing arm of the world’s second-biggest company by market value, sold $3.2 billion of hybrid bonds in pounds and euros.

US Equities were off a bit, led by financials:

Lehman reduced its earnings estimates for investment banks two days after Merrill Lynch analysts slashed their projections. Financial shares in the S&P 500, which comprise about one-fifth of the index’s value, are headed for their worst quarter in five years amid concern that higher borrowing costs spurred by mortgage defaults by the riskiest borrowers will erode earnings.

It’s not just cost of funds that will have the investment banks worried – it’s possible wind-up or delevering of their best customers that is causing concern:

“The recent expansion of hedge-fund positions and trading activity has been so rapid and consistent that it is now no exaggeration to say that hedge funds are no longer just an important part of the market in some fixed-income products; they are the market,” according to the report, which covered the 12 months ended in April.

Hedge funds accounted for more than 80 percent of trading in the debt of financially distressed companies and high-yield derivatives such as credit-default swaps, the Greenwich, Connecticut-based consulting and research firm said. The loosely regulated investment pools generated almost half of U.S. trading volume in structured credit.

Canadian equities fell too, on growth concerns. Silly traders! John Tory’s election platform calls for continued normal growth and we all know what superstars of fiscal acumen the Ontario PCs are!

With all these scares US T-Bills continued their amazing journey and yield less than 4% again. Treasuries had another good day, with a parallel shift 5bp downwards. Canadas underperformed quietly.

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet 4.84% 4.86% 22,463 15.84 1 +0.0000% 1,044.5
Fixed-Floater 4.98% 4.79% 113,193 15.85 8 -0.2042% 1,023.6
Floater 4.94% -0.41% 74,295 7.92 4 -0.0606% 1,036.5
Op. Retract 4.84% 3.96% 79,729 2.99 15 -0.0169% 1,025.3
Split-Share 5.08% 4.78% 94,039 3.97 15 +0.0121% 1,044.4
Interest Bearing 6.24% 6.67% 67,487 4.60 3 -0.4001% 1,039.8
Perpetual-Premium 5.52% 5.09% 93,596 5.74 24 +0.1183% 1,027.8
Perpetual-Discount 5.11% 5.14% 266,383 15.26 39 -0.0337% 973.3
Major Price Changes
Issue Index Change Notes
BSD.PR.A InterestBearing -1.6895% Asset coverage of just under 1.8:1 as of August 24, according to Brookfield Funds. Now with a pre-tax bid-YTW of 7.21% based on a bid of 9.31 and a hardMaturity 2015-3-31 at 10.00.
IAG.PR.A PerpetualDiscount -1.3129% Now with a pre-tax bid-YTW of 5.09% based on a bid of 22.55 and a limitMaturity.
RY.PR.F PerpetualDiscount -1.1062% Now with a pre-tax bid-YTW of 5.01% based on a bid of 22.35 and a limitMaturity.
FBS.PR.B SplitShare +1.1863% Asset coverage of just over 1.9:1 according to TD Sponsored Companies. Now with a pre-tax bid-YTW of 3.89% based on a bid of 10.01 and a call 2008-1-14 at 10.00.
Volume Highlights
Issue Index Volume Notes
GWO.PR.H PerpetualDiscount 53,300 Desjardins crossed 50,000 at 23.63. Now with a pre-tax bid-YTW of 5.13% based on a bid of 23.60 and a limitMaturity.
ALB.PR.A SplitShare 15,439 Scotia crossed 14,900 at 25.00. Asset coverage of just over 2.0:1 as of August 23, according to Scotia Managed Companies. Now with a pre-tax bid-YTW of 4.37% based on a bid of 24.92 and a hardMaturity 2011-2-28 at 25.00.
RY.PR.G PerpetualDiscount 15,400 Now with a pre-tax bid-YTW of 5.04% based on a bid of 22.45 and a limitMaturity.
BAM.PR.N PerpetualDiscount 13,065 Now with a pre-tax bid-YTW of 6.00% based on a bid of 20.16 and a limitMaturity.
CM.PR.E PerpetualPremium 12,700 Now with a pre-tax bid-YTW of 4.73% based on a bid of 26.16 and a call 2012-11-30 at 25.00.

There were eight other $25-equivalent index-included issues trading over 10,000 shares today.

9 Responses to “August 30, 2007”

  1. jiHymas says:

    [Posted by Drew on another thread – moved here by JH]


    Two things you said today interest me:

    1. In reference to the reporter who wrote about methodological changes at Moody’s, you said “The reporter did not disclose his track record ….” That strikes me as a category mistake, in that reporters do not have track records in any sense of that term that might be applicable to the issue at hand.

    2. In private e mail with you earlier this week I suggested that the grievance directed at the rating agencies is that they acquiesced in the efforts of underwriters to transform garbage into gold simply by pooling it together. You denied this is what happened. I am in no position to challenge you on that, as I do not know enough about it, being entirely reliant upon press reports. But I am intrigued that you cited Hale above, who I believe is a widely respected economist and appears to make the point I tried to make; and you do not appear to cite him dismissively.

    The quote I am referring to is as follows: “The “big debate’’ will be about how subprime mortgages were turned into gold-plated securities, especially the collateralized debt obligations that have caused the headaches, said Hale, president of Hale Advisors LLC in Chicago.”

  2. jiHymas says:

    1. You are exactly correct. The reporter has disclosed no track record in any sense of that term that might be applicable to the issue at hand. Despite this, he has gone beyond a straight reporting of facts and transmission of informed opinion and done so in a very sneering manner. He can report all the facts he wants and I will eagerly read them; he can quote reams of opinion from informed and skilled practitioners and I will devour every word; but in spouting off regarding a topic in which he has no [disclosed and verifiable] track record, he’s behaving very poorly.

    2. Your suggestion (as I read it) was that sub-prime mortgages had been transformed into AAA securities in toto by the mere act of pooling; this is not what happened, as I attempted to explain in my post about tranching.

    As I read the quotation, Hale is simply opining on what’s going to be discussed at a conference that he attends regularly, as it relevant to his field of practice. If he were to opine about Canadian securities law, I would want to see a lot of evidence and argument behind his point before I took it into consideration.

  3. Drew says:

    1. I disagree with your construal of Hale’s quote. He does not say, as your construal has it, that the question is “if” the transformation occurred, but “how” it occurred, a question that is relevant only if one supposes that it did occur.

    2. Why is it impermissible for a reporter to “spout off” regarding a topic in which he has no disclosed and verifiable track record, but it is permissible for you to do so; or do you have a disclosed and verifiable track record that is relevant to the issue at hand (the only one I am aware of pertains to preferred shares); and how, precisely do you determine what is a relevant track record for a topic as broad as the one in issue? Further, but relatedly, how is it that a track record goes to the persuasiveness of an argument. It may go to the credibility of the person making the argument, but not to the persuasiveness (credibility) of the argument, and it is the latter that is in issue.

    3. Harry Koza, writing in the Globe and Mail today, reports on S&P’s “stunning” six notch downgrade of SIVs from AAA to A-, a mere two weeks after S&P announced that “SIV ratings are weathering the current market disruptions”. Frankly, I don’t care about Koyz’s “track record”. It is wholly irrelevant, as is mine and yours in attempting to evaluate his point.

    What I do care about is whether the inference he impliedly draws, namely that S&P either got the original ratings materially wrong or were negligently slow in altering them when it should have been clear (I would be interested to know when the market started marking them down; my guess is well before S&P did) that an alteration was in order, is logically sound. If we start with the assumption that one of the properties of the highest debt rating is fierce resistance to a material (an admittedly ambiguous concept, but sufficient for the purpose) downgrade in the span of several days (as I think has occurred), then it seems to me the inference is sound. Further, if that assumption is true, it suggests that the problem lies less in the tardiness of S&P’s response than in the original analysis by which the securities were assigned an AAA rating.

    And that, in my view, is the essence of the argument that most of the critics have been directing against the rating agencies.

  4. jiHymas says:

    1. Hale knows about tranching. You don’t.

    2. You are certainly free to criticize my commentary to your heart’s content. I have attached my name to them and feel quite comfortable letting readers form their own opinions regarding criticism that might come my way.

    3. (a) If you are willing to accept any randomly published newspaper column – as opposed to specific facts and arguments – without considering the track record of the columnist, go for it. That’s your choice. I have advised, and will continue to advise, that prior results be taken into account when considering an opinion offered by anybody. When my lawyer gives me a legal opinion, I listen. When my barber gives me a legal opinion, I laugh. When my barber sneers at my lawyer’s legal opinion without providing chapter and verse, I get annoyed.

    (b) As I have stated repeatedly, credit anticipation is an entirely valid method of fixed income management. Some – notably Deutsche Bank – got it right this time. If you choose to give Deutsche Bank a mandate to manage your investments with full discretion in the belief that they will continue to execute extremely profitable credit anticipation trades, I am sure they can find a vehicle for you. You are fully entitled to entrust your money to anybody you like.

    (c) Bank runs are bank runs. Nasty things will happen to Royal Bank if we all withdraw our deposits, cash our GICs, sell our bonds and refuse to roll their paper.

    (d) If you choose to disregard S&P’s ratings, be my guest. You’re a grown-up – that’s your choice.

    (e) I feel quite confident that in a free market economy S&P and other agencies will be able to shrug off criticism and continue to provide investment advice that is of far higher calibre than most of the nonsense that goes by that name. I am not so sure that this will be the case should the politicians be stampeded into regulating this function or even nationalizing it. The ill-informed commentary that is pervasive in the newspapers has at least some chance of hood-winking those who are entirely reliant on press reports; such people form the constituency of those grand-standing politicians.

  5. Drew says:

    As it appears to me that you have not addressed the points I have attempted to make, I have nothing further to say.

  6. jiHymas says:

    I will try again with respect to (2)

    The reporter in question did not make an argument. At the risk of turning this thread into a bad reprise of a Monty Python skit, there is absolutely nothing in the article that can be construed as an argument … unless you wish to construe ‘Haha, they changed the parameters of their model, therefore it was wrong in the first place, therefore they’re stupid, QED’ as an argument.

    Since there is nothing in the article but opinion, I wish to know the validity of the reporter’s past opinions and will discount the unsupported assertion until it is justified.

  7. Drew says:

    It is apparent from what you have said that there is an argument, albeit not articulated syllogistically and not one with which you agree. (Indeed, the argument is structually and substantively similar to the one that Koza presents, one that I tried to flesh out above, but which you ignored.) It seems that because you so vehemently disagree with it you find it necessary to characertise it as something other than an argument. A bad argument (if that is what it is) is still an argument. (I note that if you did not regard what the reporter had to say as constituting an argument, you would not have commented on the absence of a track record, as the latter can, on your analysis, only be relevant in evaluating the former.)

    Intellectual historians will tell you that one of the principal changes marking the early modern period was a transition from a reliance on authority for knowledge to a reliance upon individual reason. Whatever a person’s history of having “right” or “wrong” beliefs – as if such histories are ascertainable – it should be wholly irrelevant to our evaluation of the belief before us. The authority of the person may have a bearing on the credibility of the belief, but not on its merits. That can be judged only be evaluating it for ourselves.

  8. jiHymas says:

    Well, Drew, if you believe that the reporters remarks constitute an argument, go for it. I’d have to see a lot more flesh on those bones before considering that argument anything more than series of disconnected assertions.

    As far as Koza’s remarks are concerned, it’s the same thing. I feel quite sure that if S&P had the same benefit of hindsight as Mr. Koza had at the time he wrote his article, they would have issued a preliminary rating report in June stating that the ABCP market was going to collapse in August and that therefore the instrument was getting a lower rating than otherwise.

    As for me – before I start throwing words like “negligent” and “materially wrong” around, I like to know a bit more about what happened and what can realistically be expected of forecasts in a chaotic system such as finance.

    With respect to speed of response … well, right now, CIT Group has a Moody’s “Senior Unsecured or Equivalent” rating of A2 and a “Bond-Implied” rating of Ba3. Would you like to make the claim now that Moody’s is wrong? If so, please let me know – I’ve stared at the CIT financials for hours and haven’t a clue what the market is so worrried about. I can see that – maybe – a downgrade to A3 could be justified, but by and large feel that, as happens so often, the market’s just being hysterical.

    And Drew, if you’re so fond of evaluating the merits of a belief for yourself, let’s hear an argument from you that the ratings agencies are negligent and tardy – not just a repetition of some inferences somebody impliedly draws.

    As for me, I’ll continue my current policy of listening to agencies but not giving them a blank cheque to make my portfolio management decisions. I don’t have time to do a forensic audit on the books of every company in which I invest, form a judgement on their response to commercial paper markets drying up, bird flu killing half their staff, tsunamis making half their real-estate assets literally disappear or any of the other ten-million million-to-one shots … so for specialist judgements I will lean heavily on the judgement of those whose specialist judgements have been reasonably reliable in the past.

    Until somebody – whether it’s Sarkozy, a newspaper reporter, Harry Koza or you – can actually make a valid argument that not only is that imperfect (hell, I know that) but that there is a better method. But I’m not holding my breath waiting for anything constructive.

  9. jiHymas says:

    Oh yeah. This part is very important. It’s so important that I tend to take it for granted, but there are plenty of people who don’t.

    Having made my decision to listen to the agencies, I’ll take responsibility for it as a portfolio manager. It’s my decision to take that advice – it’s within my authority to override that advice whenever I feel that’s prudent.

    One of my responsibilities as a PM is to ensure that the portfolios are diversified enough so that one bad bet doesn’t sink the ship.

    How much sympathy do I feel for the PMs with 5-10% ABCP in their portfolios? Quite a bit – that stuff looked entirely reasonable to me, too; a lot more reasonable, for instance, than US 3-months at 3.50%.

    How much sympathy do I feel for the PMs with 50-100% ABCP in their portfolios? None whatsoever.

    The biggest mystery to me in this whole affair is – why are reckless PMs getting a free ride in the press?

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