Here’s a good example of why government agencies should not regulate Credit Rating Agencies:
Now, incredibly, Egan-Jones is the sole rater that the SEC has decided to attack. The trouble for the firm started on July 16, 2011, when Egan-Jones downgraded the U.S.’s sovereign debt by one notch, to AA+ from AAA. Egan-Jones cited “the relatively high level of debt and the difficulty in significantly cutting spending.” Two days later, the SEC’s Office of Compliance Inspections and Examinations contacted the firm seeking information about its rating decision. (The next month, S&P also downgraded the U.S.’s sovereign debt, but neither Moody’s nor Fitch did.)
Then, on Oct. 12, Egan-Jones received a call from the SEC notifying the firm of a Wells Notice, an indication that it was being investigated. On April 5 of this year, Egan-Jones again downgraded the U.S. sovereign debt, to AA from AA+. On April 19, leaks started emanating from the SEC that it had voted to start an “administrative law proceeding” against the firm. And on April 24, the SEC filed its complaint.
Just what does the SEC object to so vehemently about Egan- Jones? The commission claims that on its 2008 supplemental application to be a “nationally recognized” ratings firm, Egan- Jones “falsely stated” that it had already rated the credit of 150 asset-backed securities and of 50 sovereign-debt issues. The SEC claims Egan-Jones “willfully made these misstatements and omissions to conceal the fact that it had no experience issuing ratings on ABS or government issuers.” The SEC intends to fine Egan-Jones and to possibly censure Sean Egan — neither move would be good for business.
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His lawyer, Alan S. Futerfas, told the Wall Street Journal that the SEC knows that Egan did rate the securities in question but it is “saying he didn’t disseminate it publicly.” Futerfas continued: “It’s a very technical argument the SEC is using; it’s not substantive. There’s nothing in this complaint that suggests or alleges that any rating was without integrity or was not accurate or was not predictive.”If he is right, that raises a question: Is the SEC retaliating against Egan and his firm for downgrading the U.S. sovereign debt?
Regulation of CRAs inevitably leads to a very tiresome discussion of conspiracy theories. There are certainly problems with “Issuer pays”; “Issuer regulates” is worse.
Is QE3 inflationary? Who cares?
Investors initially increased their inflation expectations on the Fed’s plan. The gap between yields on 10-year notes and same-maturity Treasury Inflation-Protected Securities, or TIPS, widened to 2.73 percentage points on Sept. 17, the highest level since May 2006. The so-called break-even rate, which measures how much traders anticipate consumer prices will rise over the life of the debt, narrowed last week to 2.42 percentage points.
In a startling new development, the SEC has hired somebody with a clue:
The U.S. Securities and Exchange Commission, stung by criticism that it lacks the knowledge to analyze the computerized trading that has come to dominate American stock markets, is planning to catch up.
Initiatives to increase the breadth of data received from exchanges and to record orders from origination to execution are at the center of the effort. Gregg Berman, who holds a doctorate in physics from Princeton University, will head the commission’s planned office of analytics and research.
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Berman, who studied experimental and nuclear physics, developed trading strategies in commodities and stocks at a hedge fund and became a founding member of RiskMetrics Group Inc. in 1998 when JPMorgan Chase & Co. spun off the company. He writes programming code and did some of the flash-crash modeling when the SEC examined how trade requests were withdrawn from exchange order books that day.The analytics and research office plans to hire traders from banks and hedge funds as well as financial engineers and individuals with quantitative and analytical skills. It’s looking for programmers in the C++ computer language and “UNIX gurus who really know how to get under the hood and in former lives may have written trading programs and now are going to write analytical programs,” Berman said.
Traditionalists will be relieved to learn that the new Office of Analytics and Research comes under the Division of Trading and Markets, which is headed by a lawyer.
He also served as counsel to Chairman Schapiro on issues involving the Division of Trading and Markets, including the agency’s analysis and response to the Flash Crash on May 6, 2010, and numerous other market structure and Dodd-Frank related rulemakings, studies, and programs.
Readers will remember that the agency’s response to the Flash Crash was a highly politicized put-up job.
Moody’s believes that the Spanish stress test was insufficiently conservative:
Spain’s banks face a capital shortfall that could climb to 105 billion euros ($135 billion), almost double the estimate the government provided last week, according to Moody’s Investors Service.
The nation’s lenders may need infusions of 70 billion euros to 105 billion euros to absorb losses and still keep capital ratios above thresholds outlined in legislation last year, Moody’s analysts wrote yesterday in a report. That compares with the 53.7 billion euro shortfall found last week after officials commissioned a stress test designed to lift doubts about the financial industry’s ability to withstand losses.
“The recapitalization amounts published by Spain are below what we estimate are needed for Spanish banks to maintain stability in our adverse and highly adverse scenarios,” the analysts, Maria Jose Mori and Alberto Postigo, said in the report. “If market participants are skeptical about the stress test, negative sentiment could undercut the government’s efforts to fully restore confidence in the solvency of Spanish banks.”
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While many assumptions in the stress test were conservative, some may be questioned, Moody’s said. The test used a 6 percent core capital ratio under a stressed scenario, while the ratings firm assumed capital ratios of 8 percent to 10 percent, according to the report. The rate used by Ireland for its test, including a buffer, was 9 percent.
What makes this interesting is that it continues to reflect one of the big problems of the Credit Crunch: bank capital is supposed to ensure that unexpected losses will bankrupt the company only once in 1,000 years (insert jokes about recent experience here).
The confidence level is fixed at 99.9%, i.e. an institution is expected to suffer losses that exceed its level of tier 1 and tier 2 capital on average once in a thousand years. This confidence level might seem rather high. However, Tier 2 does not have the loss absorbing capacity of Tier 1. The high confidence level was also chosen to protect against estimation errors, that might inevitably occur from banks’ internal PD, LGD and EAD estimation, as well as other model uncertainties.
But! In demanding that the banks maintain capital above the regulatory minimum even after experiencing these 1,000-year losses, we are demanding that they remain solvent even after experiencing 1,000 year losses in successive years (which is probably not a million-year two-year-loss; it will depend on the correlation between successive years). I don’t think anybody knows how to deal with this. The concept of a buffer is helpful, but it remains to be seen what will happen to a bank in times of great stress when it has used up its buffer.
It was a mixed day for the Canadian preferred share market, with PerpetualPremiums down 4bp, FixedResets gaining 2bp and DeemedRetractibles up 11bp. There weren’t many volatile issues, but they made up in energy what they lacked in numbers. Volume was low.
| HIMIPref™ Preferred Indices These values reflect the December 2008 revision of the HIMIPref™ Indices Values are provisional and are finalized monthly |
|||||||
| Index | Mean Current Yield (at bid) |
Median YTW |
Median Average Trading Value |
Median Mod Dur (YTW) |
Issues | Day’s Perf. | Index Value |
| Ratchet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.0190 % | 2,449.1 |
| FixedFloater | 4.40 % | 3.78 % | 35,425 | 17.71 | 1 | 0.5119 % | 3,619.7 |
| Floater | 2.99 % | 3.02 % | 57,351 | 19.71 | 3 | -0.0190 % | 2,644.3 |
| OpRet | 4.65 % | 2.77 % | 35,186 | 0.73 | 4 | 0.1549 % | 2,554.3 |
| SplitShare | 5.45 % | 4.93 % | 70,809 | 4.55 | 3 | -0.1586 % | 2,817.5 |
| Interest-Bearing | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.1549 % | 2,335.7 |
| Perpetual-Premium | 5.28 % | 2.11 % | 90,829 | 0.39 | 27 | -0.0423 % | 2,298.9 |
| Perpetual-Discount | 4.99 % | 4.85 % | 105,942 | 15.77 | 4 | 0.5440 % | 2,592.7 |
| FixedReset | 4.97 % | 2.98 % | 176,061 | 4.02 | 73 | 0.0175 % | 2,437.1 |
| Deemed-Retractible | 4.94 % | 3.52 % | 122,108 | 1.11 | 46 | 0.1138 % | 2,378.4 |
| Performance Highlights | |||
| Issue | Index | Change | Notes |
| IGM.PR.B | Perpetual-Premium | -2.97 % | YTW SCENARIO Maturity Type : Call Maturity Date : 2018-12-31 Maturity Price : 25.00 Evaluated at bid price : 26.15 Bid-YTW : 4.98 % |
| BAM.PR.N | Perpetual-Discount | 1.44 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2042-10-01 Maturity Price : 24.21 Evaluated at bid price : 24.70 Bid-YTW : 4.81 % |
| GWO.PR.N | FixedReset | 2.59 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.80 Bid-YTW : 3.62 % |
| Volume Highlights | |||
| Issue | Index | Shares Traded |
Notes |
| BAM.PR.X | FixedReset | 212,857 | Nesbitt crossed 201,400 at 25.15. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2042-10-01 Maturity Price : 23.23 Evaluated at bid price : 25.15 Bid-YTW : 3.24 % |
| CU.PR.C | FixedReset | 105,667 | Nesbitt crossed 48,900 at 26.10; RBC crossed 51,500 at the same price. YTW SCENARIO Maturity Type : Call Maturity Date : 2017-06-01 Maturity Price : 25.00 Evaluated at bid price : 26.10 Bid-YTW : 3.08 % |
| ENB.PR.P | FixedReset | 41,357 | Recent new issue. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2042-10-01 Maturity Price : 23.11 Evaluated at bid price : 25.05 Bid-YTW : 3.71 % |
| ENB.PR.N | FixedReset | 34,715 | TD crossed 16,300 at 25.37. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2042-10-01 Maturity Price : 23.21 Evaluated at bid price : 25.34 Bid-YTW : 3.80 % |
| BNS.PR.X | FixedReset | 32,437 | Scotia crossed 29,200 at 26.55. YTW SCENARIO Maturity Type : Call Maturity Date : 2014-04-25 Maturity Price : 25.00 Evaluated at bid price : 26.52 Bid-YTW : 1.95 % |
| SLF.PR.F | FixedReset | 32,000 | RBC crossed 26,000 at 26.48. YTW SCENARIO Maturity Type : Call Maturity Date : 2014-06-30 Maturity Price : 25.00 Evaluated at bid price : 26.44 Bid-YTW : 2.65 % |
| There were 21 other index-included issues trading in excess of 10,000 shares. | |||
| Wide Spread Highlights | ||
| Issue | Index | Quote Data and Yield Notes |
| IGM.PR.B | Perpetual-Premium | Quote: 26.15 – 26.90 Spot Rate : 0.7500 Average : 0.4477 YTW SCENARIO |
| TCA.PR.Y | Perpetual-Premium | Quote: 51.90 – 52.21 Spot Rate : 0.3100 Average : 0.1878 YTW SCENARIO |
| CU.PR.E | Perpetual-Premium | Quote: 26.20 – 26.48 Spot Rate : 0.2800 Average : 0.1587 YTW SCENARIO |
| BNS.PR.O | Deemed-Retractible | Quote: 26.51 – 26.87 Spot Rate : 0.3600 Average : 0.2553 YTW SCENARIO |
| POW.PR.C | Perpetual-Premium | Quote: 25.62 – 25.92 Spot Rate : 0.3000 Average : 0.2111 YTW SCENARIO |
| BAM.PR.X | FixedReset | Quote: 25.15 – 25.39 Spot Rate : 0.2400 Average : 0.1584 YTW SCENARIO |