May 30, 2008

Naked Capitalism republishes a review of potential problems in the CDS market.

Changes were rumoured the LIBOR setting mechanism:

The group that sets the London interbank offered rate can restore its credibility by following the example of Australia and New Zealand, said Morgan Stanley. Or, the British Bankers’ Association could look to the U.S., according to UBS AG and Credit Suisse Group.

The loss of confidence in the benchmark rate for $350 trillion in derivatives and corporate bonds and 6 million U.S. mortgages spurred the world’s biggest banks to recommend fixes, though they reached no consensus. The BBA plans to announce after 5 p.m. today the first changes to Libor in 10 years after the Basel-based Bank for International Settlements suggested in March that some lenders were misstating borrowing costs to avoid speculation that they were in financial straits.

I imagine that being a world-scale benchmark is very useful for the participants; but the rumours were unfounded:

The group that oversees the London interbank offered rate will implement no changes to the way the measure is set, confounding critics who said it has become unreliable as a gauge of the cost of borrowing.

“The committee will be strengthening the oversight of BBA Libor,” the British Bankers’ Association said in an e-mailed statement today. “The details will be published in due course.” The composition of the bank panels that contribute rates were left unchanged, it said.

Berger and Nitsch have an interesting piece on VoxEU regarding the optimal size of Central Bank Governing Councils … there are concerns that too much democracy is enough!

A few weeks ago, the European Commission recommended that Slovakia should be allowed to join the eurozone as of January 1, 2009. When the member states follow this recommendation and accept Slovakia’s adoption of the euro, the country will become the sixteenth member of the European single currency zone. At the same time, the Governor of the National Bank of Slovakia, Ivan Sramko, will take a seat at the Governing Council of the European Central Bank (ECB), thereby increasing the membership size of the eurozone’s interest-setting body to 22 members.

Moreover, with the expected future enlargement of the eurozone, the Governing Council will expand further, perhaps soon comprising 30 or more members.

It sounds very political and reminiscent of Canadian federal cabinets … perhaps five actual decision-makers and twenty-five-odd regional makeweights. By all means, let the ECB have a regionally representative governing council – but devolve the actual decision making to a sub-committee. For instance, like the Fed:

The Federal Open Market Committee (FOMC) consists of twelve members–the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis. The rotating seats are filled from the following four groups of Banks, one Bank president from each group: Boston, Philadelphia, and Richmond; Cleveland and Chicago; Atlanta, St. Louis, and Dallas; and Minneapolis, Kansas City, and San Francisco. Nonvoting Reserve Bank presidents attend the meetings of the Committee, participate in the discussions, and contribute to the Committee’s assessment of the economy and policy options.

Willem Buiter posts an interesting essay (verging on polemic) regarding Lessons from the North Atlantic Financial Crisis:

I conclude that although the Fed did a reasonable job dealing with the immediate financial crisis, it did significantly worse than the other two central banks as regards macroeconomic stability and the prevention or mitigation of future financial crises.

I identify two main causes for this underperformance by the Fed. As regards macroeconomic stability, there are flaws in its model of the transmission mechanism of monetary policy and other macroeconomic shocks. Two prominent errors are the overestimation of the effect of changes in house prices on consumer demand and the unfortunate focus on the will-o’-the-wisp of core inflation rather than on medium-term headline inflation. The Fed also either ignores the need for a major increase in the US saving-investment balance or believes that this can be achieved without passing through an extended spell of below-capacity growth of demand.

Second, the Fed, unlike the Bank of England and the ECB, has regulatory and supervisory responsbility for part of the US banking system. This has the advantage of giving it institution-specific information of a kind not available to the Bank of England or the ECB. The disadvantage is that the Fed’s position invites regulatory capture.

The macroeconomic stability records of the Bank of England and of the ECB have been superior to those of the Fed. After climbing a quite steep liquidity learning curve in the early months of the crisis, the Bank of England is now performing its lender of last resort and market maker of last resort roles more effectively. It would be desirable to have the information in the public domain that is required to determine whether the ECB (through the Eurosystem) is pricing illiquid collateral appropriately. There is reason for concern that the ECB may be accepting collateral in repos and at its discount window at inflated valuations, thus joining the Fed in boosting future moral hazard through the present encouragement of adverse selection.

Future regulation will have to be base on size and leverage of institutions. It will have to be universal (applying to all leveraged institutions above a certain size), uniform, countercyclical and global.

Financial crises will always be with us.

The full version of the paper is published by NBER; it is an update of a previous paper that has been reviewed on PrefBlog. The current paper has also been given its own post.

Hard on the heels of Accrued Interest‘s speculations on the future of leveraged fixed income (linked on PrefBlog yesterday) comes news that Deutsche Bank is creating REMICs:

Deutsche Bank AG’s asset management business may join other firms in repackaging their home-loan bonds into new securities without creating collateralized debt obligations, which are being shunned by investors.

The unit of the Frankfurt-based bank has studied using the technique on bonds in the portfolios it oversees, Julian Evans, a director who helps manage insurer money at Deutsche Asset Management, said in an interview yesterday. Bankers including Goldman Sachs Group Inc. and JPMorgan Chase & Co. have created more than $5 billion of new home-loan securities called Re-REMICs out of existing ones this year, newsletter Inside MBS & ABS says.

The difference between a REMIC and a CDO is that a CDO can be actively managed, while a REMIC is brain-dead.

While finding that last link, by the way, I found Calculated Risk‘s Compleat Ubernerd page … links to some of the more … er … technical posts on that excellent blog.

The market was up slightly to end the month with the CPD Exchange Traded Fund up 0.28% on the day to make it up 1.42% on the month. It looks like Malachite Fund will be up somewhat less … only a few basis points behind, but rather annoying after spending most of the month up 25-50bp against CPD. But that’s what happens when the former price is based on trades in a thin market, while the other is based on bids!

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 4.30% 3.86% 50,008 0.08 1 +0.0394% 1,114.1
Fixed-Floater 4.84% 4.65% 64,087 16.08 7 -0.2431% 1,033.4
Floater 4.05% 4.10% 61,882 17.15 2 -0.5463% 932.6
Op. Retract 4.83% 2.21% 89,177 2.71 15 -0.0076% 1,056.2
Split-Share 5.27% 5.45% 68,974 4.14 13 -0.1040% 1,057.8
Interest Bearing 6.12% 6.12% 51,814 3.81 3 +0.0337% 1,112.5
Perpetual-Premium 5.89% 4.57% 127,867 4.66 9 +0.0444% 1,025.6
Perpetual-Discount 5.66% 5.71% 287,992 14.32 63 +0.0975% 926.5
Major Price Changes
Issue Index Change Notes
BAM.PR.K Floater -1.5996%  
BCE.PR.G FixFloat -1.2987%  
W.PR.H PerpetualDiscount -1.0666% Now with a pre-tax bid-YTW of 5.98% based on a bid of 23.19 and a limitMaturity.
SLF.PR.E PerpetualDiscount +1.0370% Now with a pre-tax bid-YTW of 5.50% based on a bid of 20.46 and a limitMaturity.
TD.PR.O PerpetualDiscount +1.0989% Now with a pre-tax bid-YTW of 5.45% based on a bid of 22.50 and a limitMaturity.
RY.PR.F PerpetualDiscount +1.1483% Now with a pre-tax bid-YTW of 5.53% based on a bid of 20.26 and a limitMaturity.
BCE.PR.A FixFloat +1.3214%  
SLF.PR.D PerpetualDiscount +1.7043% Now with a pre-tax bid-YTW of 5.49% based on a bid of 20.29 and a limitMaturity.
Volume Highlights
Issue Index Volume Notes
BNS.PR.M PerpetualDiscount 32,285 Now with a pre-tax bid-YTW of 5.46% based on a bid of 20.87 and a limitMaturity.
CM.PR.H PerpetualDiscount 25,930 Now with a pre-tax bid-YTW of 5.88% based on a bid of 20.68 and a limitMaturity.
BNS.PR.O PerpetualDiscount 25,800 Now with a pre-tax bid-YTW of 5.66% based on a bid of 25.02 and a limitMaturity.
RY.PR.B PerpetualDiscount 22,870 Now with a pre-tax bid-YTW of 5.59% based on a bid of 21.19 and a limitMaturity.
RY.PR.H PerpetualDiscount 21,265 Now with a pre-tax bid-YTW of 5.72% based on a bid of 24.98 and a limitMaturity.

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

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