September 3, 2010

Mr Thomas C Baxter, Jr, Executive Vice President and General Counsel of the Federal Reserve Bank of New York, testified to the Financial Crisis Inquiry Commission regarding the Lehman bankruptcy:

As of that Friday, there were two prospective Lehman acquirers: Bank of America and Barclays. On Saturday, September 13, Bank of America abandoned the potential acquisition of Lehman and reached an agreement to acquire Merrill Lynch. Barclays was the only remaining suitor. On Sunday, September 14, with the consortium financing committed, we learned for the first time that Barclays would not be able to deliver a key document to carry the merger to conclusion: a guarantee of Lehman’s trading obligations between the signing of the merger agreement and its closing.

The Bear Stearns transaction taught us the importance of the guarantee to a successful rescue. A guarantee maintains the ability of the troubled company to operate as a going concern and, thus, preserves value. It does this by providing protection to counterparties during an especially vulnerable period – the period between merger contract and merger closing. Without such a guarantee, the creditors and counterparties of the firm would be at risk in the event that the merger fell apart because of a failed shareholder vote or some other contingency. Consequently, as a market matter, the guarantee is an indispensable part of any such rescue operation.

On Sunday, September 14, we learned that Barclays could not proffer the needed guarantee without a shareholder vote. This vote would take days, if not weeks or months, and there was no way to predict if the shareholders would even vote for the transaction to proceed. I explored with counsel whether the U.K. government, or one of its instrumentalities like the FSA, might waive this U.K. requirement, such that the guarantee could be delivered and the rescue effected. I learned that the U.K. authorities were not amenable to a waiver. Thus, Barclays ceased to be available as the willing buyer that we needed to rescue Lehman, and there was no other interest from any firm of sufficient size and capability that could acquire Lehman, a company with consolidated assets of about $600 billion.

I’m suspicious of any portfolio management model that includes the word “regression”, but there’s occasionally a good idea in there. Econbrowser‘s James Hamilton highlights his recent paper in a post Policy tools that could lower interest rates further:

Our starting point was a framework developed by Vayanos and Vila (2009), who interpret the term structure of interest rates as arising from the behavior of risk-averse arbitrageurs. This model is one way to capture formally the portfolio balance channel that Fed Chairman Bernanke indicated is central to the Fed’s understanding of how nonstandard monetary operations might affect the economy. Vayanos and Vila’s framework has previously been applied to our question by Greenwood and Vayanos (2010) and Doh (2010). One of our contributions is to develop specific measures of how the available supplies of Treasury securities of different maturities might be expected to influence the pricing of level, slope, and curvature risk of the term structure. Although I began as a skeptic of the claim that bond supplies would make much difference, we found pretty strong evidence that historically they have. For example, we found that over the 1990-2007 period, we could predict the excess return from holding a 2-year bond over a 1-year bond with an R2 of 71% on the basis of the level, slope, and curvature of the yield curve along with our 3 Treasury supply factors.

The full research paper is The Effectiveness of Alternative Monetary Policy Tools in a Zero Lower Bound Environment.

Just when you thought that nothing good could be said about Russian politicians, they prove you wrong:

Speaking as the Russian government announces plan to raise duty on alcohol and cigarettes, [Russian Finance Minister] Alexei Kudrin said that by smoking a pack, “you are giving more to help solve social problems such as boosting demographics, developing other social services and upholding birth rates”.

“People should understand: Those who drink, those who smoke are doing more to help the state,” he told the Interfax news agency.

He’s got my vote.

It was a solid day on the Canadian preferred share market, with PerpetualDiscounts up 5bp and FixedResets gaining 3bp on average volume. There has been a lot of volume in MFC lately, presumably due to continued rebalancing after the downgrade.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
(at bid)
Mod Dur
Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 0.3414 % 2,034.9
FixedFloater 0.00 % 0.00 % 0 0.00 0 0.3414 % 3,082.7
Floater 2.73 % 3.24 % 57,446 19.07 3 0.3414 % 2,197.2
OpRet 4.88 % 3.46 % 99,458 0.24 9 0.0472 % 2,357.5
SplitShare 5.99 % -38.02 % 68,324 0.09 2 0.2277 % 2,350.1
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.0472 % 2,155.7
Perpetual-Premium 5.75 % 5.57 % 123,528 5.39 14 0.0113 % 1,969.4
Perpetual-Discount 5.69 % 5.76 % 187,422 14.22 63 0.0513 % 1,911.8
FixedReset 5.26 % 3.11 % 281,286 3.34 47 0.0282 % 2,256.7
Performance Highlights
Issue Index Change Notes
HSB.PR.D Perpetual-Discount 1.08 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-03
Maturity Price : 22.35
Evaluated at bid price : 22.51
Bid-YTW : 5.65 %
POW.PR.B Perpetual-Discount 1.45 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-03
Maturity Price : 22.80
Evaluated at bid price : 23.05
Bid-YTW : 5.89 %
POW.PR.D Perpetual-Discount 1.48 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-09-03
Maturity Price : 21.66
Evaluated at bid price : 21.98
Bid-YTW : 5.76 %
Volume Highlights
Issue Index Shares
SLF.PR.F FixedReset 161,950 Nesbitt crossed 160,000 at 27.50.
Maturity Type : Call
Maturity Date : 2014-07-30
Maturity Price : 25.00
Evaluated at bid price : 27.50
Bid-YTW : 3.15 %
BNS.PR.T FixedReset 131,059 TD crossed blocks of 83,400 and 25,100, both at 28.00.
Maturity Type : Call
Maturity Date : 2014-05-25
Maturity Price : 25.00
Evaluated at bid price : 27.93
Bid-YTW : 3.09 %
MFC.PR.C Perpetual-Discount 71,180 Nesbitt crossed 35,000 at 18.36.
Maturity Type : Limit Maturity
Maturity Date : 2040-09-03
Maturity Price : 18.34
Evaluated at bid price : 18.34
Bid-YTW : 6.16 %
MFC.PR.D FixedReset 66,062 Scotia crossed 25,000 at 26.60.
Maturity Type : Call
Maturity Date : 2014-07-19
Maturity Price : 25.00
Evaluated at bid price : 26.57
Bid-YTW : 4.77 %
BMO.PR.O FixedReset 57,987 RBC crossed blocks of 10,000 and 38,500, both at 28.30.
Maturity Type : Call
Maturity Date : 2014-06-24
Maturity Price : 25.00
Evaluated at bid price : 28.30
Bid-YTW : 2.89 %
MFC.PR.E FixedReset 56,502 RBC bought 19,700 from Scotia at 25.86.
Maturity Type : Call
Maturity Date : 2014-10-19
Maturity Price : 25.00
Evaluated at bid price : 25.81
Bid-YTW : 4.68 %
There were 30 other index-included issues trading in excess of 10,000 shares.

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