March 12, 2008

Econbrowser‘s James Hamilton has an interesting philosophical piece on the limits to the Fed’s ability to influence the economy, Asking too much of monetary policy:

I am certainly a believer in the potential real effects, sometimes for good, sometimes for ill, of monetary policy. But I just as certainly do not believe, nor should any reasonable person believe, that no matter what the economic problem might be, you can always solve it just by printing more money.

I would nevertheless caution that we need to be open to the possibility that no matter how low the Fed brings its target rate, it may not arrest the unfolding financial disaster. Unless the intention is to go all the way with enough inflation to avert the defaults, that means we need an exit strategy– some point at which we all admit that further monetary stimulus is doing nothing more than generating inflation, and at which point we acknowledge that the goal for monetary policy is no longer the heroic objective of making bad loans become good, but instead the more modest but also more attainable objective of making sure that fluctuations in the purchasing power of a dollar are not themselves a separate destabilizing influence.

Indeed, with the Treasury curve virtually decoupled from the corporate curve, it doesn’t look like there’s anything more the Fed can do. Cutting rates again probably will not have any major effect on corporate yields, or on banks’ willingness to lend; I think that the only justification for such a move would be to help increase profit margins at the banks in order to assist their recapitalization, as was done in 1993 – the year of the steepest yield curve on record, which led to 1994 – the year of the worst government bond market on record.

At the moment, I don’t think there’s a lot of evidence that such drastic treatment is necessary. Below are some graphs available from the FDIC showing the recovery of the American banking system from 1990-94 … sorry they’re not too clear, click on them for a better version, or just go directly to the full report.

Some of this was due to Resolution Trust, to be sure, but a good chunk was due to a very steep yield curve that made it very profitable to borrow short and lend long.

It is interesting to note, from the FDIC report, that data for 4Q93 (the point at which the Fed said, “OK, play-time’s over, we’re going to start hiking now”) indicated that the 13,220 institutions reporting had $375-billion in capital backstopping $4,707-billion in total liabilities and capital, an equity leverage ratio of 12.61. The current FDIC report, 4Q07, shows 8,533 institutions with capital of $1,352-billion backstopping $13,039-billion, equity leverage of 9.6:1.

One may well quibble over the 4Q07 equity figure … perhaps there are massive unrecorded losses about to appear. And one may quibble even more about the relative quality of assets between then and now – subprime and perhaps credit card and auto debt coming up for kicking in The Great Leverage Unwinding of 2007-08. But all in all, as I’ve pointed out in posts on loss estimates and loss distribution, I’m having a hell of a time finding credible, sober analysis concluding that Armageddon is Now.

Anyway, what I’m trying to say is that I agree with Prof. Hamilton (subject to quibbles about loss estimates), when he states:

The problem then is many hundreds of billions of dollars in loans that are not going to be repaid, the prospect of whose default could completely freeze the market for credit.

That, it seems to me, is a problem you can’t solve by lowering the fed funds rate.

By me, the Fed is doing the right thing with the TSLF introduced yesterday. The problem is liquidity, and there are many players with indigestible lumps of sub-prime paper on their books. These are, I’ll bet a nickel, on their books at marked-to-disfunctional-market prices well below ultimate recovery, but so what? They can’t sell them to hot money – hot money’s got its own problems:

At least a dozen hedge funds have closed, sold assets or sought fresh capital in the past month as banks and securities firms tightened lending standards. The industry is reeling from its worst crisis because bankers — staggered by almost $190 billion of asset writedowns and credit losses caused by the collapse of the subprime-mortgage market — are raising borrowing rates and demanding extra collateral for loans.

They can’t sell them to real money – real money read in the paper just last week that it’s all worthless junk. So the paper has to sit on the books for a while and be financed in the interim.

Perhaps not entirely coincidentally, there’s an article on VoxEU titled Why Monetary Policy Cannot Stabilize Asset Prices. VoxEU is up to its old tricks … the page is blank. To read the article, you have to click “View|Source” on your browser, pick a section to copy/paste, save this extract as a .html file on your hard drive and then open this with a browser. The graph has to be viewed separately.

Mechanical difficulties aside, it seems that this will soon be a CEPR discussion paper; the authors state:

Figure 1 analyses the effects of a 100 basis points increase in interest rates. Note that after about 8 quarters, interest rates have declined but remain about 35 basis points above their initial level. After 12 quarters, they have fallen further to a level some 10 basis points above the starting point. Overall, the increase in interest rates will dissipate in about three years.

Turning to real property prices, we note that these start to fall in response to the tightening of monetary policy. After 16 quarters, they reach a bottom of about 2.6% below the initial level and then start to return gradually to their starting level. Overall, property prices react quite slowly to monetary policy actions.

Next we consider the responses of real GDP.3 The figure shows that it also reaches a trough after 16 quarters, when it is some 0.8% below its initial level.4 Thus, the responses of real GDP are almost exactly 1/3 of those of real property prices.5 This is an important finding. To see why, suppose that monetary policy makers come to believe that a real property price bubble of 15% has developed, and decide to tighten monetary policy in order to bring down asset prices. In doing so, the average central bank in the 17 countries we study should also expect to depress the level of real GDP by 5%, a truly massive amount.

Whatever merits such a stabilisation policy has in theory, our research suggests that in practice, monetary policy is too blunt an instrument to be used to target asset prices – the effects on real property prices are too small, given the responses of real GDP, and they are too slow, given the responses of real equity prices. In particular, there is a risk that setting monetary policy in response to asset price movements will lead to large output losses that exceed by a wide margin those that would arise from a possible bubble burst.

In other news, Accrued Interest points out that It’s just a dead animal:

Now I’m not here to say whether Bear Stearns has liquidity problems or not. The recovery in both the stock and bond market for Bear paper would indicate that they probably don’t. But this kind of panicky trading is exactly why its hard to own financial bonds right now. I mean, anyone who had traded through bear markets knows that the rumor mill becomes very active. Right now everyone is nervous. The longs are nervous because they’ve been losing money and/or under performing their index for months now. I’m sure there are many portfolio managers and/or traders worried about losing their jobs over poor performance.

The shorts are nervous too. Right now corporate credit spreads are at all-time wides. That means that getting short a credit is expensive to begin with.

So amidst all this nervousness, it seems that Wall Street starts giving more credence to rumors.

Sit tight, do your homework, turn off the TV and stare at financial statements until you’re crosseyed, that’s the path to success. The bond market is excitable and always will be … ignore it, keep your company-specific bets small, your leverage non-existant and have another look at them financial statements.

In other news, it looks like Barney Frank, Chairman of the House Financial Services Committee wants to start his own credit rating agency:

U.S. Representative Barney Frank gave ratings companies a month to fix “ridiculous” standards that they apply to local government debt, as his House committee opened a hearing today on how the firms evaluate municipal bonds.

“I am going to say to the rating agencies and to the insurers: they have about a month to fix this,” Frank, the Massachusetts Democrat who chairs the House Financial Services Committee, told reporters in Washington yesterday. “We’re going to tell them they have to straighten it out.”

California Treasurer Bill Lockyer and other state officials are calling for Standard & Poor’s, Moody’s Investors Service, and Fitch Ratings to change a system they say costs taxpayers by exaggerating the risk that municipal issuers will default on their debts. Every state except Louisiana would be AAA if measured by the scale used for corporate borrowers, according to research by Moody’s.

“This notion of having a separate standard for the municipals because they would do too well on the other standard is ridiculous,” Frank said.

Cool! Credit ratings courtesy of the politicians! Doesn’t that make you feel safe? Sign me up!

Back on Earth, Berkshire Hathaway is worried that municipal bond insurance will return to ultra-cheap levels in a price-war:

The risk of guaranteeing municipal debt is increasing because the economy is slowing and some insurers may cut prices to regain lost business, said Ajit Jain, head of Berkshire Hathaway Inc.’s new bond insurer.

Fiscal stress in Vallejo, California, and Jefferson County, Alabama, may be the “tip of the iceberg” for municipal defaults, said Jain, who runs Warren Buffett’s Berkshire Hathaway Assurance Corp. He said downgrades of some insurers hurt the industry’s integrity and those firms may spark “pricing wars” if they regain their financial footing and seek to recoup lost business.

Ambac and MBIA, the two largest bond insurers, may trigger a price war if they stabilize their AAA ratings and start backing municipal bonds again, Jain said.

“That will be unavoidable,” he said in his testimony. “Unless you continue to believe that this is zero-loss business, that conduct assures a bleak future for this business.”

Another light day for volume. Split-shares got hammered, particularly the BNA issues that have something of a penchant for volatility. PerpetualDiscounts were also weak.

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 5.46% 5.47% 33,229 14.69 2 -0.1015% 1,094.4
Fixed-Floater 4.75% 5.55% 64,138 14.81 8 -0.1569% 1,045.1
Floater 4.79% 4.79% 85,140 15.91 2 +0.1465% 867.1
Op. Retract 4.85% 3.58% 76,364 2.79 15 +0.1893% 1,044.8
Split-Share 5.37% 5.89% 97,468 4.15 14 -0.8128% 1,025.1
Interest Bearing 6.15% 6.48% 69,095 4.24 3 +0.3395% 1,090.4
Perpetual-Premium 5.77% 5.48% 277,034 7.62 17 -0.0465% 1,022.8
Perpetual-Discount 5.48% 5.53% 311,507  14.60  52 -0.1323% 941.3
Major Price Changes
Issue Index Change Notes
BNA.PR.B SplitShare -4.8072% Asset coverage of 3.3+:1 as of January 31, according to the company. Now with a pre-tax bid-YTW of 8.50% based on a bid of 20.00 and hardMaturity 2016-3-25 at 25.00. Compare with BNA.PR.A (5.88% to hardMaturity 2010-9-30) and BNA.PR.C (7.22% to hardMaturity 2019-10-1).
FFN.PR.A SplitShare -2.8141% Asset coverage of just under 2.0:1 as of February 29, according to the company. Now with a pre-tax bid-YTW of 5.92% based on a bid of 9.67 and hardMaturity 2014-12-1 at 10.00.
BCE.PR.Z FixFloat -2.0417%  
POW.PR.D PerpetualDiscount -1.9870% Now with a pre-tax bid-YTW of 5.60% based on a bid of 22.69 and a limitMaturity.
MFC.PR.C PerpetualDiscount -1.5837% Now with a pre-tax bid-YTW of 5.18% based on a bid of 21.75 and a limitMaturity.
FBS.PR.B SplitShare -1.5609% Asset coverage of just under 1.5:1 as of March 6, according to TD Securities. Now with a pre-tax bid-YTW of 6.42% based on a bid of 9.46 and a hardMaturity 2011-12-15 at 10.00.
BNA.PR.C SplitShare -1.5454% See BNA.PR.A, above.
CIU.PR.A PerpetualDiscount -1.3005% Now with a pre-tax bid-YTW of 5.46% based on a bid of 21.25 and a limitMaturity.
POW.PR.B PerpetualDiscount -1.2689% Now with a pre-tax bid-YTW of 5.63% based on a bid of 24.12 and a limitMaturity.
DFN.PR.A SplitShare -1.2476% Asset coverage of just under 2.5:1 as of February 29, according to the company. Now with a pre-tax bid-YTW of 4.80% based on a bid of 10.29 and a hardMaturity 2014-12-1 at 10.00.
PWF.PR.I PerpetualPremium -1.0481% Now with a pre-tax bid-YTW of 5.70% based on a bid of 25.49 and a call 2012-5-30 at 25.00.
GWO.PR.E OpRet +1.6653% Now with a pre-tax bid-YTW of 4.60% based on a bid of 25.03 and a call 2011-4-30 at 25.00.
HSB.PR.C PerpetualDiscount +1.8605% Now with a pre-tax bid-YTW of 5.26% based on a bid of 24.25 and a limitMaturity.
BAM.PR.I OpRet +1.8652% Now with a pre-tax bid-YTW of 5.05% based on a bid of 25.53 and a softMaturity 2013-12-30 at 25.00. Compare with BAM.PR.H (5.30% to softMaturity 2012-3-30) and BAM.PR.J (5.40% to softMaturity 2018-3-30).
Volume Highlights
Issue Index Volume Notes
TD.PR.R PerpetualDiscount 771,292 New issue settled today. Now with a pre-tax bid-YTW of 5.65% based on a bid of 24.88 and a limitMaturity.
RY.PR.G PerpetualDiscount 55,330 RBC crossed 50,000 at 21.15. Now with a pre-tax bid-YTW of 5.36% based on a bid of 21.20 and a limitMaturity.
BMO.PR.H PerpetualDiscount 50,200 Nesbitt crossed 50,000 at 24.00. Now with a pre-tax bid-YTW of 5.53% based on a bid of 23.91 and a limitMaturity.
SLF.PR.E PerpetualDiscount 25,208 Desjardins crossed 25,000 at 21.40. Now with a pre-tax bid-YTW of 5.28% based on a bid of 21.36 and a limitMaturity.
MFC.PR.C PerpetualDiscount 17,310 Now with a pre-tax bid-YTW 5.18% based on a bid of 21.75 and a limitMaturity.

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

14 Responses to “March 12, 2008”

  1. […] PrefBlog Canadian Preferred Shares – Data and Discussion « March 12, 2008 […]

  2. prefhound says:

    Once again, I can’t understand BNA.PR.B/C, so I was selling recently acquired C (Nov-Dec) to buy B on Wednesday to pick up 125 bp in YTM (including 73 bp in current yield). I estimate the B should trade $2 more expensive than the C to reflect dividends only (never mind some slightly advantageous terms like retractibility for cash).

    Late last year, I was shorting B and buying C at a difference of $4.50 (since closed in January at around $2.00). Yesterday this difference on my trades was $0.10. I would arb this again, if I could get enough trading volume as spreads are super wide.

    I did manage to put on a short BAM.PR.M and long BAM.PR.N for $0.81 when it should be zero. When credit sucks, arbitrage trades that eliminate it are quite attractive.

  3. jiHymas says:


    I was wondering when the BNA.PR.B / BNA.PR.C chasm would tempt you! And yes, the BAM.PR.M / BAM.PR.N dichotomy is almost as good.

    Good luck with those and keep us posted!

  4. madequota says:

    The drifting continues

    Interesting day in prefs, this one. As seems to always be the case, there’s one culprit that wields so much girth, they can move the entire market. Who was it today? RBC? BMO? heck no, we had a relatively unique market crusher today . . . CIBC.

    The one I liked the best was his action on RY.PR.F . . . it’s trading it’s normal small volume in the $21 – $21.25 range; then at about 2:30, 79 drops an offering of 10,000 shares @ $20.90 . . . 2 minutes later he puts another 10,000 up @ $20.45 . . . this bunch was too much for the market to resist, and astute bargain-hunters were able to pick up some 5.5% paper with a potential redemption premium of almost 25% from the seemingly desperate CIBC fund manager. (I know; how do I know he’s a fund manager? could just be someone who needs to sell 20,000 shares a mile below market).

    He might have girth . . . but he’s a little short on style (and unit holders of his fund are a little shorter on account value today).

    TD.PR.R seems to be settling in just under par . . . will this continue? . . . or will it catch up to the other 5.6’s just above par? . . . or will the other 5.6’s get in the drifting mood themselves? stay tuned . . .


  5. jiHymas says:

    Yeah, RY.PR.F was fascinating today. There was a very similar story with ELF.PR.G, but with less volume.

  6. madequota says:

    why “stupid” sometimes fits

    I’ve been cautioned not to use words like this unless I have proof of it’s applicability.

    Let’s consider the CIBC fund manager who yesterday sold 10,000 shares of RY.PR.F @ 20.45 when it was previously trading over $21.00. Then today, he offered, and successfully sold, another 10,000 @ 20.60 when the last traded price was 20.90.

    RY.PR.F last traded @ 21.00.

    At an average realized selling price of 20.525, and an assumed real market value of, say, 20.90 (less than current market based on a reasonable volume discount), this seller left $7500 (20,000 shs x (20.90 – 20.525)) on the table.

    He (or she), then, by deductive logic . . . is . . . stupid.

    sorry CIBC . . . you’re starting to make me think RBC isn’t that dumb after all.


  7. jiHymas says:

    How do you know it was a “CIBC fund manager”? Their brokerage does have one or two other clients.

    What were the consequences of the client – whoever it was – not selling? Would not selling have cost them more or less than $7,500?

  8. madequota says:

    not selling at 20.525, and selling instead at 20.90, would have given them $7500 more for their stock . . . that’s the immediate item

    not selling at all, and waiting perhaps until later today might have allowed them to get a higher price than 20.90 . . .

    I’ve just noticed that the interest in this stock continues to be aroused (certainly by 79’s below market selling), and BMO’s come in with a 5300 share bid at 20.75 . . . the offer is the market maker with 1000 at 20.99 (probably bought earlier today or yesterday for a lot less), and then very little right up to 22.00

    It’s just odd to me that large holders of this type of stock are often willing to let it go way below market. I know what you’ll say to that — we don’t know what’s motivating the liquidation; perhaps they had no choice, etc. . . . all I’m saying is that a little more stamina would have gained the seller a better price (maybe he should have used an iceberg!)


  9. jiHymas says:

    not selling at 20.525, and selling instead at 20.90, would have given them $7500 more for their stock . . . that’s the immediate item

    20.90? Are you stupid? Not selling at 20.90 and selling at 50.90 instead would give them $450,000 more for their stock – ALMOST HALF A MILLION DOLLARS that you just want to leave lying around on the table for any idiot to pick up.

    I mean, if we’re going to criticize them for selling at an executable price rather than some fairy-tale price that has no justification, let’s use a really good fairy-tale price, eh?

    To move large volumes of prefs – and sometimes, in some markets, 10,000 shares counts as a large volume – you often have to price at a concession to market. David Berry made a very good living providing that sort of liquidity on a demand basis at prices that were a lot further off the market than a lousy forty cents.

    waiting perhaps until later today might have allowed them to get a higher price than 20.90

    “might”? What the hell good is “might”? The executable price “might” have moved to 18.43 by the afternoon. Would that suddenly have made this morning’s motivated seller a genius?

    Selling liquidity is immensely profitable. That does not mean that all liquidity buyers are always idiots. To judge, you’d have to look at the portfolio manager’s overall track record – and you don’t even know who he is.

  10. madequota says:

    actually, if the price moved to 18.43 (and if it got there by something other than his own shorting), he would be a genius . . . or privy to inside information, which would make him a criminal genius, or something like that.

    look, I know that “what-ifs” are hard to use as concrete evidence, but the reality . . . reality . . . is that he was wrong . . . at the very least, he could have got 20.75 as it turns out, and my criticism was based on my own experience with spreads, especially on this particular pref issue

    is it possible that I might actually be right now and then? *big smile!*

    have a great weekend, and we’ll see where the battle goes on Monday . . . how about the market reaction to all that Bear-Stearns stuff, eh?!


  11. jiHymas says:

    I’ll give you this much, anyway, madequota … if I, personally, was in a position where 10,000 shares of something had to be sold, and I had a choice about where to go, I would almost certainly have gone to one of the more active shops (Nesbitt / Desjardins / Scotia). CIBC doesn’t show up very often on the leaderboards.

    I will also note that I continue to try to find financing for my preferred share hedge fund, which will be able to go long/short virtually anything in good size on five minutes’ notice and thereby get a call when stuff like this is in the works. If you have contacts with the investment committee of any good sized pension funds, give them my number, eh?

  12. jiHymas says:

    These things are sent to try us … or, at least, to make us look silly.

    CIBC was busy today and put a few nice crosses on the board on what was otherwise a very quiet day. See March 14 for details.

  13. […] A horrible, horrible day for the preferred share market, particularly the PerpetualDiscounts, on light volume. The guy who sold a whack of RY.PR.F at 20.45 last week is starting to look a lot smarter! […]

  14. […] I agree with him, as I agreed with his recently expressed view on limits to monetary policy. It seems to me that as far as the overall economy is concerned, the Fed should be waiting to see what its cuts – now 300bp cumulative since August – do to the economy. At the moment, the problem is land-mines of illiquidity blowing up unexpectedly, and the TSLF, together with the occasional spectactular display of force are the best defense against that. […]

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