October 19, 2007

 The box-score for today is:

In more interesting news, the media has reported somebody saying something intelligent about regulation:

“If you intervene in the system, the vultures stay away,” [Former Fed Chairman Greenspan] said. “The vultures sometimes are very useful.”

“When it breaks, it’s very abrupt and you just have to wait it out,” he added.

This was in an interview with Emerging Markets, which was in turn linked by the WSJ.

More rules will not stop market booms, busts or outright fraud. They can – sometimes – mitigate and contain the effects; I have previously suggested that rules for the capital treatment of liquidity guarantees be reviewed with an eye to ensuring the banking system, as a whole, can withstand bigger shocks than this piddly little liquidity crisis. But there are far too many people around who rush to revise the rule book every time something bad happens. Life sucks. Get used to it.

Specifically, Greenspan was opining on Super-Conduit:

But Greenspan argued that that a delicate market psychology could be speared by the move. “It could conceivably make [conditions affecting investor psychology] somewhat adverse because if you believe some form of artificial non-market force is propping up the market you don’t believe the market price has exhausted itself.

“What creates strong markets is a belief in the investment community that everybody has been scared out of the market, pressed prices too low and they’re wildly attractive bargaining prices there,” he said.

“If you intervene in the system, the vultures stay away,” he said. “The vultures sometimes are very useful.”

Well, I’ve speculated that Super-Conduit is the vulture; and that the aim of the exercise is to wipe out the junior note-holders of the shakier SIVs to leave only the strong still standing. This got a little support in an unsubstantiated, anonymous comment on Accrued Interest:

From Total Securitization:

“Citigroup Won’t Use Super SIV To Save Its Own

Citigroup officials, reacting to claims that the master liquidity enhancement conduit it is creating with JPMorgan and Bank of America will be used to specifically rescue Citi’s more than $80 billion SIV exposure, is expected to announce that it will not utilize the fund at all.”

Well, it ties in with my thought on Super-Conduit; but I don’t have a subscription to Total Securitization, so I’ll have to wait for those remarks to be reported elsewhere.

Cheyne and Rhinebridge officially defaulted on their commercial paper today:

Rhinebridge has $791 million of commercial paper and a portfolio with a face value of $1.1 billion, S&P said. The market value of the assets is now 63 percent of face value, having fallen $69 million since Oct. 16 alone, S&P said. Revaluations of CDOs of asset-backed securities have caused a “dramatic” fall in value, the rating company said.

Cheyne Finance’s managers said its assets are worth 93 percent of face value, enough to pay back all of its $6.6 billion of senior debt, S&P said. CDOs of asset-backed securities make up 6 percent of Cheyne Finance’s holdings.

The SIVs aren’t the only outfits being affected by the market revulsion to all things sub-prime – after announcing mark-to-market write-downs of $1.3-billion, Wachovia has discussed its earnings:

“Next line addresses other structured products [Total of $438MM]. Here we have the marks on warehouse positions and trading inventory, both of which we hold in trading portfolios. This includes the positioning Ken referred to in reference to sub prime mortgage exposure and AAA rated securities. $308 million is associated with sub prime securities [Their slides say $347 of the mark was related to subprime of which $308 was AAA subprime]. Basically there, we never would have expected that you see AAA securities trade so far so quickly from par.”

The same comments thread on Accrued Interest yielded the following revealing exchange:

Anonymous: IF my money market funds invest in this SIV I will sell them and buy one that doesn’t. Plain and simple.

Accrued Interest: A **TON** of investors have moved into government money market funds to ensure they don’t own any ABCP over the last 2 months. I think that’s the right move. Money Market funds aren’t a place to take any risk at all as far as I’m concerned.

In other – No Analysis Necessary. As soon as the dreaded words of power are spoken – SELL! It is no wonder that, as I mentioned yesterday:

asset-backed commercial paper backstopped by real assets and a full bank credit backstop yielding more than unsecured commercial paper issued by the same bank—in other words, the real assets as collateral viewed by market participants as a negative rather than a positive,

To how many people does this make sense? Stick yer hands up!

I’ve said before that the danger of the credit crunch has not passed – that we’ve got a long way to go before we’re out of the woods (and, I hasten to add, I am not suggesting that market timing is the investor’s answer; analysis and diversification is the investor’s answer). Some of the specific risks to markets over the next six(?) months are outlined at the WSJ

This may be a little off-topic; but I want to point out that the benefits of diversification are everywhere:

The Utah scientists are trying to sell farmers on the idea that more bee diversity is needed, which was a hard sell because farmers had to pay more for wild bees. Now that honeybee prices are rising, farmers are more willing to try other species, James says.

Getting back to Canada and economic news for a moment, the Canadian CPI numbers were released today, and:

It was the highest year-over-year increase in the all-items index since May 2006, and the sharpest acceleration since February of this year.

Gasoline prices were the primary cause of an increase in the 12-month variation of the Consumer Price Index (CPI) in most provinces.

The year-over-year increase in gasoline prices (+12.7%) owed more to a sudden drop in last year’s prices than to any significant developments in the most recent month. Indeed, on a month-to-month basis, gasoline prices barely budged, rising a mere 0.8% from August to September 2007.


Of particular interest is:

On a year-over-year basis, consumer prices increased at a faster pace than the national average in only four provinces in September: New Brunswick (+2.9%), Manitoba (+2.8%), Saskatchewan (+3.8%) and Alberta (+4.6%).

In other words, inflation (such as it is) remains fairly well localized to the petro-provinces (with the exception of poor old Brunny). This suggests – to me – that there is nothing much in this report that would lead anybody to expect a rate-hike in the near future. Mind you, there are many who believe that the level was sufficiently high that we shouldn’t expect any lowering, either:

The Canadian dollar jumped 0.98 of a cent to 103.68 cents US – a level last seen in mid-1976 – after going as high as 103.71 cents US on expectations the higher CPI reading means the Bank of Canada won’t be lowering interest rates any time soon. The bank stood pat on interest rates Tuesday.

All this talk of inflation inevitably leads to the Fed. James Hamilton of Econbrowser attended a St. Louis Fed conference and reports that a hot topic of conversation was whether the Fed should operate according to a few simple and mechanical rules. Well, I haven’t read the papers yet, but my gut reaction is: “Sort of”. There should be enough mechanical rules so that Fed action is reasonably predictable; but none so binding as prevent reaction to special cases. Of course, there’s always going to be a lot of pressure to declare a special case so, as Poole said in his concluding remarks, central bankers need to be people of unquestionable integrity.

Mainly, though, I liked the graph:

Actual path of fed funds rate (black line), path predicted by a Taylor Rule that uses actual values of inflation and GDP (blue line), and path predicted by a Taylor Rule that uses forecasts of inflation and GDP (red line). Source: Orphanides and Wieland (2007).

Look carefully! Do you see the bit that has Greenspan blamed for the housing bubble? He was relying on forecasts, wasn’t he?

Another day of heavy volume for preferreds – and, er, yields were up! Yes, hold that thought firmly in your minds … yields, and therefore expectations of future returns, were up!

This is starting to get somewhat annoying. According to Canadian Bond Indices, long corporates are up 1.64% on the month, but prefs are getting killed … CPD is down a little over 1.5% month-to-date, perpetualDiscounts are down about 2.8%. Yield on long corporates is around 5.9% … about the same as it was on October 10, when I looked at spreads on One Bull Checks In. Since then, the perpetualDiscount yield has increased from 5.42% to 5.49%, and return for this index has been -1.28% (this doesn’t work out nicely with the Modified Duration in the range of 14.7 because of rounding errors and the obscuring effects of averages and outliers).

I think retail is mistaking preferreds for common again! And with things like CM.PR.D yielding 5.81% at the bid (interest equivalent of 8.13%) … well, they can mistake preferreds for common all they like, I guess!

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 4.81% 4.77% 558,861 15.75 1 0.0000% 1,043.7
Fixed-Floater 4.87% 4.77% 104,288 15.84 7 +0.0119% 1,041.8
Floater 4.50% 3.27% 71,095 10.71 3 -0.0930% 1,042.9
Op. Retract 4.85% 3.91% 80,695 3.19 15 +0.1241% 1,030.0
Split-Share 5.15% 4.93% 85,241 3.90 15 +0.0081% 1,045.0
Interest Bearing 6.25% 6.37% 56,148 3.64 4 -0.0738% 1,058.4
Perpetual-Premium 5.71% 5.55% 97,542 9.95 17 -0.3077% 1,006.8
Perpetual-Discount 5.45% 5.49% 326,421 14.67 47 -0.2400% 923.6
Major Price Changes
Issue Index Change Notes
CM.PR.D PerpetualPremium (for now!) -2.1293% Now with a pre-tax bid-YTW of 5.81% based on a bid of 24.82 and a limitMaturity.
RY.PR.A PerpetualDiscount -2.1097% Now with a pre-tax bid-YTW of 5.42% based on a bid of 20.88 and a limitMaturity.
NA.PR.L PerpetualDiscount -1.7666% Now with a pre-tax bid-YTW of 5.75% based on a bid of 21.13 and a limitMaturity.
TD.PR.O PerpetualDiscount -1.3596% Now with a pre-tax bid-YTW of 5.41% based on a bid of 22.49 and a limitMaturity.
PWF.PR.E PerpetualDiscount -1.1837% Now with a pre-tax bid-YTW of 5.63% based on a bid of 24.21 and a limitMaturity.
HSB.PR.D PerpetualDiscount -1.1250% Now with a pre-tax bid-YTW of 5.31% based on a bid of 23.73 and a limitMaturity.
W.PR.H PerpetualDiscount -1.0105% Now with a pre-tax bid-YTW of 5.84% based on a bid of 23.51 and a limitMaturity.
LFE.PR.A SplitShare +1.1561% Asset coverage of 2.7+:1 as of October 15, according to the company. Now with a pre-tax bid-YTW of 4.22% based on a bid of 10.50 and a hardMaturity 2012-12-1 at 10.50.
Volume Highlights
Issue Index Volume Notes
SLF.PR.D PerpetualDiscount 588,980 Now with a pre-tax bid-YTW of 5.32% based on a bid of 21.15 and a limitMaturity.
SLF.PR.C PerpetualDiscount 411,725 Now with a pre-tax bid-YTW of 5.32% based on a bid of 21.15 and a limitMaturity.
MFC.PR.C PerpetualDiscount 267,380 Now with a pre-tax bid-YTW of 5.31% based on a bid of 21.45 and a limitMaturity.
BCE.PR.Z FixFloat 142,802  
BAM.PR.K Floater 70,655 Nesbitt crossed 70,000 at 23.90.

There were thirty-four other index-included $25.00-equivalent issues trading over 10,000 shares today.

2 Responses to “October 19, 2007”

  1. mclachlan8 says:

    James, I wondered if you had read the Fordham Law Review’s ‘Turning a Blind Eye’. One of the best eductional reads I have ever experienced, period. BEst detailed look at the sub-prime mess thus far.

  2. jiHymas says:

    Yes, I have. I mentioned it – relatively briefly – in a post in August.

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