October 27, 2010

Forbes has an unusual perspective on the flash-crash:

In a talk at Columbia University’s sociology department, renowned social scientist Donald MacKenzie gave some words of warning and advice about the financial markets. MacKenzie, a professor of science and technological studies at the University of Edinburgh, compared the flash crash with Black Monday crisis of October 19, 1987.

“Computer systems don’t have a sense of morality,” exclaims MacKenzie, noting the take-one-for-the-team role played by floor specialists in keeping an orderly market–a role that’s been marginalized with trading so widely dispersed. A specialist’s duty was to keep price continuity and to intervene when they found imbalances, “and they did so at a certain risk to themselves,” remembered MacKenzie, “In ’87, on aggregate these specialists lost about two-thirds of their capital” to save the markets, he says. The intervention of specialists becomes harder today because high-frequency trading algorithms are extremely explicit and are largely devoid of such considerations of civic duty.

I haven’t met a trader yet with a sense of civic duty, quite frankly, but what I found most interesting was the claim that specialists took large losses in the Crash of ’87. I don’t have any such recollection, and I would very much like to see MacKenzie’s source for this statement.

There is this, from the Brady Report:

According to a rough survey conducted by the NYSE, specialists’ buying power fell by more than 60 percent from $2,308 million at the close of business on October 16 to $852 million at the close of business on October 19. Whatever the cause for the reduced extent of specialist intervention later on October 19, the road picture that emerges from the analysis of half hourly activity is one of significant intervention to support the market early in the day, net sales during the midday decline and much less extensive (and less effective) support of the market in the sharp decline in the last hour of trading.

However, loss of buying power is not equivalent to loss of capital – it simply means that a good chunk of their capital was committed. However, one point in favour of the specialist system is that the figures mean they were willing to hold their position overnight (although, as the report shows, they squared their books the next day).

So here’s yet another idea for a MBA thesis, assuming those guys have theses: is there any way of telling how much hot money is out there? I mean, really really hot money, for which “overnight” is a lengthy hold. Has this amount increased or decreased (relative to market value, or even relative to market fluctuations) since the Crash of ’87. We can be sure that the amount of formal market-maker capital has decreased, but how about hedge funds and HFT?

My guess is that the total capital has increased, but the amount of capital prepared to hold a position overnight has decreased. Prove me wrong!

Meanwhile, emerging markets are choosing survival over altruism:

Finance chiefs from South Korea to South Africa signaled they may act to slow gains in their currencies, just four days after the Group of 20 vowed to soothe trade tensions in the $4 trillion-a-day foreign-exchange market.

Asian currencies fell to a one-week low after Bank of Korea Governor Kim Choong Soo said today that measures to mitigate capital flows could be “useful.” Hours later, the rand dropped as South African Finance Minister Pravin Gordhan said his government will use part of higher-than-expected tax revenue to build foreign reserves as it attempts to weaken the currency.

The shifts suggest G-20 members will keep trying to defend their economies from the slide of the dollar and capital inflows even after the group promised Oct. 23 to refrain from “competitive devaluation” and to increasingly embrace market- determined currencies.

Gee … I suppose those guys take their responsibilities to their own citizens more seriously than their responsibilities to me! How odd! How thoroughly unmutual!

BIS has released a paper titled Calibrating regulatory minimum capital requirements and capital buffers: a topdown approach.

BIS has also released a working paper by Stefan Avdjiev and Nathan S Balke titled Stochastic Volatility, Long Run Risks, and Aggregate Stock Market Fluctuations:

What are the main drivers of ‡uctuations in the aggregate US stock market? In this paper, we attempt to resolve the long-lasting debate surrounding this question by designing and solving a consumption-based asset pricing model which incorporates stochastic volatility, long-run risks in consumption and dividends, and Epstein-Zin preferences. Utilizing Bayesian MCMC techniques, we estimate the model by …tting it to US data on the level of the aggregate US stock market, the short-term real risk-free interest rate, real consumption growth, and real dividend growth. Our results indicate that, over short and medium horizons, ‡uctuations in the level of the aggregate US stock market are mainly driven by changes in expected excess returns. Conversely, low frequency movements in the aggregate stock market are primarily driven by changes in the expected long-run growth rate of real dividends.

The SEC is planning to ban one-third of the market and encourage paid informers:

SEC commissioners will vote Nov. 3 on a rule that would require brokerages to implement risk controls to monitor client trades, the agency said today in a statement on its website. SEC officials first proposed the regulation in January, saying they were concerned that a computer malfunction or human error might trigger an order that could erode a firm’s capital.

The proposed rule would “effectively prohibit broker dealers from providing” so-called naked-sponsored access, in which a customer bypasses pre-trade risk controls, according to the agency’s statement. Naked access accounts for about 38 percent of U.S. equities trading, according to a December study by Aite Group LLC.

Commissioners will also vote next week on a proposal to expand the SEC’s ability to reward whistleblowers who provide tips on fraud.

Ah, the good old paid informers! They made the Roman Empire, the Soviet Union and East Germany what they are today!

Julie Dickson gave a remarkably unimportant speech today, titled Changing Times: The Regulatory Future and Canada’s Banking Sector:

In sum, there is no silver bullet to achieving a safe and sound financial sector. Rather, it is multi-dimensional – all parties that touch the sector have a role – bank management and boards, regulators and supervisors, governments, central banks, markets (investors, analyst and rating agencies), and auditors. Emphasis cannot be placed on one area to the exclusion of others.

Human nature trumps all of these. In an effort to save us all from ourselves, policies aimed at our own weaknesses and biases may be the most important of all.

The Toronto Star advises that the federal government writes Credit Default Swaps with no documentation at all:

The federal government does not know how often the loan program is a victim of fraud. About $1 billion a year is lent in small business loans. The number of defaulted loans is steadily increasing. Last year, $106 million of taxpayers money was paid back to banks for defaulted loans. That’s up from $75 million a year in defaulted loans three years before.

Under the Canada Small Business Financing Program, Industry Canada gives banks the job of approving applications

It only sees the paperwork if the loan goes into default.

One of the problems the Star uncovered is there is little incentive for the banks to conduct detailed background checks.

That’s because banks get a guarantee that the federal government will refund up to 85 per cent of the money to the banks if the loan goes into default. The banks typically also take a personal guarantee from the borrower for the remaining 15 per cent.

Just one of life’s little mysteries! I can’t cash a cheque for $1.98 without a rectal probe, but that does not apply to everyone!

Another day of good performance on the Canadian preferred share market today, on continued heavy volume. This is getting dull. PerpetualDiscounts gained 11bp while FixedResets eked out a 1bp win.

PerpetualDiscounts now yield 5.41%, equivalent to 7.57% interest at the standard 1.4x equivalency factor. Long Corporates jerked up to about 5.3% (maybe a little under) so the pre-tax interest-equivalent spread is now about 230bp, a significant decline from the 240bp reported on October 20.

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 0.1279 % 2,178.7
FixedFloater 0.00 % 0.00 % 0 0.00 0 0.1279 % 3,300.5
Floater 2.88 % 3.19 % 90,562 19.25 3 0.1279 % 2,352.4
OpRet 4.92 % 3.83 % 97,409 0.58 9 0.1903 % 2,368.7
SplitShare 5.86 % -20.50 % 66,607 0.09 2 -0.3821 % 2,404.4
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.1903 % 2,166.0
Perpetual-Premium 5.69 % 5.09 % 153,918 5.33 19 -0.0720 % 2,016.4
Perpetual-Discount 5.40 % 5.41 % 246,300 14.69 58 0.1141 % 2,021.7
FixedReset 5.27 % 3.03 % 343,656 3.24 47 0.0116 % 2,275.6
Performance Highlights
Issue Index Change Notes
GWO.PR.I Perpetual-Discount -1.14 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-27
Maturity Price : 20.77
Evaluated at bid price : 20.77
Bid-YTW : 5.48 %
BMO.PR.P FixedReset 1.00 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-03-27
Maturity Price : 25.00
Evaluated at bid price : 27.63
Bid-YTW : 2.70 %
Maturity Type : Call
Maturity Date : 2010-11-26
Maturity Price : 25.50
Evaluated at bid price : 26.01
Bid-YTW : -13.44 %
POW.PR.D Perpetual-Discount 1.22 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-10-27
Maturity Price : 23.02
Evaluated at bid price : 23.24
Bid-YTW : 5.41 %
Volume Highlights
Issue Index Shares
BNS.PR.P FixedReset 159,100 RBC crossed 50,000 at 26.51; Nesbitt crossed 20,000 at the same price. National crossed 50,000 at 26.52.
Maturity Type : Call
Maturity Date : 2013-05-25
Maturity Price : 25.00
Evaluated at bid price : 26.51
Bid-YTW : 2.47 %
CM.PR.K FixedReset 132,400 RBC crossed blocks of 50,000 and 72,800, both at 27.21. There were five inputs and four cancellations of the latter cross!
Maturity Type : Call
Maturity Date : 2014-08-30
Maturity Price : 25.00
Evaluated at bid price : 27.15
Bid-YTW : 2.89 %
BNS.PR.O Perpetual-Premium 103,712 Desjardins crossed 100,000 at 25.70.
Maturity Type : Call
Maturity Date : 2017-05-26
Maturity Price : 25.00
Evaluated at bid price : 25.70
Bid-YTW : 5.13 %
RY.PR.I FixedReset 72,950 RBC crossed 50,000 at 26.40.
Maturity Type : Call
Maturity Date : 2014-03-26
Maturity Price : 25.00
Evaluated at bid price : 26.36
Bid-YTW : 3.11 %
BNS.PR.L Perpetual-Discount 67,110 Desjardins crossed two blocks of 25,000 each, both at 22.50.
Maturity Type : Limit Maturity
Maturity Date : 2040-10-27
Maturity Price : 22.27
Evaluated at bid price : 22.41
Bid-YTW : 5.04 %
TD.PR.E FixedReset 63,300 TD crossed 50,000 at 27.77.
Maturity Type : Call
Maturity Date : 2014-05-30
Maturity Price : 25.00
Evaluated at bid price : 27.76
Bid-YTW : 2.98 %
There were 53 other index-included issues trading in excess of 10,000 shares.

One Response to “October 27, 2010”

  1. […] spread is now about 235bp, a slight (and perhaps meaningless) increase from the 230bp reported on October 27, but a sharp decline from the 260bp reported on September 30. The tightening was driven on both […]

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