October 29, 2008

Deflation? Econbrowser‘s James Hamilton doesn’t think so!

If the U.S. were ever to arrive at such a situation, here’s what I’d recommend. First, have the Federal Reserve buy up the entire outstanding debt of the U.S. Treasury, which it can do easily enough by just creating new dollars to pay for the Treasury securities. No need to worry about those burdens on future taxpayers now! Then buy up all the commercial paper anybody cares to issue. Bye-bye credit crunch! In fact, you might as well buy up all the equities on the Tokyo Stock Exchange. Fix that nasty trade deficit while we’re at it! Print an arbitrarily large quantity of money with which you’re allowed to buy whatever you like at fixed nominal prices, and the sky’s the limit on what you might set out to do.

Of course, the reason I don’t advocate such policies is that they would cause a wee bit of inflation. It’s ridiculous to think that people would continue to sell these claims against real assets at a fixed exchange rate against dollar bills when we’re flooding the market with a tsunami of newly created dollars. But if inflation is what you want, put me in charge of the Federal Reserve and believe me, I can give you some inflation.

The Fed announced:

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 1 percent.

In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 1-1/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Cleveland, and San Francisco.

The cut to 1.00% Fed Funds was widely anticipated. Remember that interest on excess reserves is Fed Funds less 35bp … the Fed is earning a spread of only 60bp on excess reserves to Discount Window. I would have been much more comfortable had the discount rate been lowered only 25bp to 1.50%.

There are indications that CDS rates are being used to price loans:

Nestle SA, the biggest food producer, Nokia Oyj, the largest mobile-phone maker, FirstEnergy Corp., the Ohio-based owner of electric utilities, and at least three other companies bowed to banks’ demands to link the interest rate on credit lines to the swaps, which are used to bet on borrowers’ likelihood of default.

[First Energy] would pay Libor plus 3 percentage points to draw on the line, according to company filings. Based on yesterday’s levels, FirstEnergy would be charged an additional 1.70 percentage points, reflecting the levels of its credit- default swaps, and another 1.35 percent to account for the bank’s own spread, according to [First Energy Assistant Treasurer Randy] Scilla.

This is a worrisome development. Events of the past year have shown that the ease of shorting corporate debt with CDSs has led to huge volatility, with some credits (e.g., CIT Group) trading at amazing levels … 2500bp or more, while maintaining an “A(low)” rating that seems entirely justified. While I in favour of market based pricing in a general way, we have seen (in the pricing of AAA sub-prime tranches) that total reliance on market pricing implies total reliance on infinite liquidity … and we ain’t there, by a long shot.

Simply put, there isn’t enough depth in the CDS market to ensure that there will be sufficient supply of protection writers when the cowboys take a run at these companies.

On the other hand, the facilities arranged – so far – with these CDS-linked rates are commercial paper back-up lines. Together with the Big Scare due to the recent lock-up of the the CP market, we may see a reduced corporate reliance on money market paper, with a massive term extension – at least to five year notes – to handle the funding instead. This part is a Good Thing, because it will decrease the term mismatch between assets and liabilities on corporate balance sheets.

So right now, it is unclear how this will play out, as is the case with so much of the structural change that taking place in financial markets right now.

Speaking of shorts how about that VW, eh?:

Porsche, a rival seeking to build one of Europe’s great car dynasties, revealed it had increased its holdings in VW, giving it an economic stake equal to about 75 percent of the company’s voting shares.

Volkswagen’s stock soared to as high as 1,005 euros a share, about $1,258, on Tuesday before closing at 918 euros. The shares ended last week at 210 euros.

On Sunday, Porsche said it raised its stake in Volkswagen to 42.6 percent from 35 percent, and that it had taken options for another 31.5 percent.

Porsche said it made the announcement to give investors who sold the stock short “the opportunity to close their positions unhurriedly and without bigger risk.”

The opposite happened. The risk soared, and the short sellers were forced to act quickly.

Volkswagen is one of the 30 companies in the DAX index, Germany’s most prominent stock index, and index funds own a significant number of shares.

Those funds, however, may sell shares Wednesday. On Tuesday night the German stock exchange said it would reduce from 27 percent to 10 percent the weighting of VW in the index. To rebalance, the funds will have to sell VW and buy the 29 other companies.

The re-weighting of VW in DAX is a disgrace:

“This adjustment is an extraordinary measure,” Deutsche Boerse said in a statement yesterday. The reduction will take place on Nov. 3, and the weightings of other DAX companies will also be adjusted at that time.

Changing the rules because some short-sellers are getting toasted? That’s not your job, guys! If you want to create a capped index – as the Toronto Exchange did after the Nortel fiasco – that’s fine … but the occasional gruesome loss is part of the risk of being short, and the occasional bonus profit is part of the reward of being long.

As Dealbreaker so eloquently states:

That’s the other shoe dropping right there. Shares drop 50%, it’s a regulatory failure. Shares spike 400%, its a regulatory failure.

When are we going to let risk be risk? These are all big boys playing with Volkswagen. Had it gone right, they would have made big profits.

BCE has announced its 3Q08 Operating Results, and it doesn’t seem – to me – to help the chances for a successful conclusion of the takeover much.

BCE’s cash from operating activities was $1,649 million this quarter, up 2.7% from last year. BCE’s free cash flow [footnote 3] of $89 million this quarter was lower than $425 million in Q3 2007 due to the expenditure of $741 million for AWS spectrum licences partly offset by a reduction of $293 million in common dividends paid.

[Footnote 3 – extract] We define free cash flow as cash from operating activities after capital expenditures, total dividends and other investing activities.

BCE is also looking at a significant mark-to-market hit on its pension obligations.

Another fairly active day on the preferred market, with players trying to figure out where things are supposed to be! There are plenty of instances of yield relationships between issuers being completely haywire.

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.
The Fixed-Reset index was added effective 2008-9-5 at that day’s closing value of 1,119.4 for the Fixed-Floater index.
Index Mean Current Yield (at bid) Mean YTW Mean Average Trading Value Mean Mod Dur (YTW) Issues Day’s Perf. Index Value
Ratchet N/A N/A N/A N/A 0 N/A N/A
Fixed-Floater 5.59% 5.83% 68,587 14.79 6 +1.0406% 933.8
Floater 7.10% 7.21% 44,772 12.28 2 -4.5766% 486.6
Op. Retract 5.34% 6.28% 137,967 4.04 14 -0.2956% 991.7
Split-Share 6.41% 11.21% 57,372 3.97 12 +0.5435% 917.0
Interest Bearing 8.06% 13.63% 62,856 3.24 3 +4.3511% 877.2
Perpetual-Premium 7.10% 7.21% 51,697 12.26 1 +0.4108% 873.8
Perpetual-Discount 6.97% 7.03% 175,239 12.55 70 -0.0609% 780.2
Fixed-Reset 5.39% 5.10% 786,445 15.18 10 +0.0482% 1,069.1
Major Price Changes
Issue Index Change Notes
BAM.PR.B Floater -9.7943% Now trading in single digits! I don’t get it, really … 1.7x prime in perpetuity as a dividend from a company that, at the very least, is half-decent?
W.PR.H PerpetualDiscount -4.8451% Now with a pre-tax bid-YTW of 8.25% based on a bid of 16.89 and a limitMaturity. Closing quote 16.89-18.00, 3×1. Day’s range 16.90-50.
POW.PR.B PerpetualDiscount -3.6126% Now with a pre-tax bid-YTW of 7.35% based on a bid of 18.41 and a limitMaturity. Closing Quote 18.41-70, 1×1. Day’s range of 18.60-55.
TD.PR.S FixedReset -3.4985%  
BAM.PR.J OpRet +-2.8409% Now with a pre-tax bid-YTW of 9.59% based on a bid of 18.81 and a softMaturity 2018-3-30 at 25.00. Compare with BAM.PR.H (11.83% to 2012-3-30), BAM.PR.I (10.25% to 2013-12-30) and BAM.PR.O (10.87% to 2013-6-30).
BMO.PR.K PerpetualDiscount -2.6970% Now with a pre-tax bid-YTW of 7.11% based on a bid of 18.50 and a limitMaturity. Closing Quote 18.50-94, 15×3. Day’s range of 18.50-35.
CU.PR.A PerpetualDiscount -2.6614% Now with a pre-tax bid-YTW of 6.61% based on a bid of 22.31 and a limitMaturity. Closing Quote 22.31-23.74, 1×1. Day’s range of 22.00-23.50.
BNA.PR.B SplitShare -2.6048% Asset coverage of just under 2.8:1 as of September 30 according to the company. Coverage now of 2.1+:1 based on BAM.A at 22.25 and 2.4 BAM.A held per preferred. Now with a pre-tax bid-YTW of 11.55% based on a bid of 17.20 and a hardMaturity 2016-3-25 at 25.00. Compare with BNA.PR.A (20.02% to 2010-9-30) and BNA.PR.C (13.51% to 2019-1-10). Closing quote 17.20-90, 10×8. Day’s range 17.50-90.
POW.PR.D PerpetualDiscount -2.5316% Now with a pre-tax bid-YTW of 7.47% based on a bid of 16.94 and a limitMaturity. Closing Quote 16.94-00, 1X3. Day’s range of 17.00-74.
PWF.PR.E PerpetualDiscount -2.3798% Now with a pre-tax bid-YTW of 6.76% based on a bid of 20.51 and a limitMaturity. Closing Quote 20.51-90 0X3. Zero? Well, that’s according to TMXMoney.com, anyway! Day’s range of 20.90-00.
SLF.PR.C PerpetualDiscount -2.3077% Now with a pre-tax bid-YTW of 7.42% based on a bid of 15.24 and a limitMaturity. Closing Quote 15.24-70, 9×4. Day’s range of 15.15-65.
SLF.PR.D PerpetualDiscount -2.0487% Now with a pre-tax bid-YTW of 7.39% based on a bid of 15.30 and a limitMaturity. Closing Quote 15.30-90, 2×4. Day’s range of 15.13-16.45.
CM.PR.G PerpetualDiscount +2.0115% Now with a pre-tax bid-YTW of 7.68% based on a bid of 17.75 and a limitMaturity. Closing Quote 17.75-95, 11×7. Day’s range of 17.00-99.
ELF.PR.G PerpetualDiscount +2.4306% Now with a pre-tax bid-YTW of 8.15% based on a bid of 14.75 and a limitMaturity. Closing Quote 14.75-50, 20×20. Day’s range of 14.37-55.
LFE.PR.A SplitShare +2.7794% Asset coverage of 1.8+:1 as of October 15 according to the company. Now with a pre-tax bid-YTW of 9.51% based on a bid of 8.60 and a hardMaturity 2012-12-1 at 10.00. Closing quote of 8.60-98, 15×2. Day’s range of 8.60-90.
IAG.PR.A PerpetualDiscount +3.1250% Now with a pre-tax bid-YTW of 7.08% based on a bid of 16.50 and a limitMaturity. Closing Quote 16.50-90, 9×9. Day’s range of 16.10-50.
RY.PR.H PerpetualDiscount +3.2962% Now with a pre-tax bid-YTW of 6.36% based on a bid of 22.25 and a limitMaturity. Closing Quote 22.25-85, 40×27. Day’s range of 21.60-22.85.
BCE.PR.R FixFloat +3.6596%  
BNS.PR.R FixedReset +3.6596%  
FIG.PR.A InterestBearing +4.4595% Asset coverage of 1.3-:1 as of October 27, according to the company, assuming 0.71 Capital Units per preferred. Now with a pre-tax bid-YTW of 11.73% based on a bid of 7.73 and a hardMaturity 2014-12-31 at 10.00. Closing quote of 7.73-01, 1×3. Day’s range of 7.57-25.
FTN.PR.A SplitShare +4.9178% Asset coverage of 1.9+:1 as of October 15 according to the company. Now with a pre-tax bid-YTW of 9.38% based on a bid of 7.93 and a hardMaturity 2015-12-1 at 10.00. Closing quote 7.93-09, 3×10. Day’s range of 8.00-24
CU.PR.B PerpetualDiscount +5.6818% Now with a pre-tax bid-YTW of 6.57% based on a bid of 23.25 and a limitMaturity. Closing Quote 23.25-50, 5×10. Today’s only board lot traded at 23.50.
BSD.PR.A InterestBearing +9.9010% Asset coverage of 0.9+:1 as of October 24 according to Brookfield Funds. Now with a pre-tax bid-YTW of 18.45% based on a bid of 5.55 and a hardMaturity 2015-3-31 at 10.00 … though as pointed out by Assiduous Reader prefhound, use of $10.00 maturity value is, at the very least, something of a leap of faith. Closing quote of 5.55-56, 40×1. Day’s range of 5.25-65
Volume Highlights
Issue Index Volume Notes
WN.PR.B Scraps (would be OpRet but there are credit concerns) 301,500 Now with a pre-tax bid-YTW of 5.81% based on a bid of 25.00 and a optionCertainty 2009-6-30 at 25.00.
TD.PR.M OpRet 170,400 Now with a pre-tax bid-YTW of 5.15% based on a bid of 24.53 and a softMaturity 2013-10-30 at 25.00.
BMO.PR.I OpRet 167,280 Called for redemption.
MFC.PR.A OpRet 127,930 Now with a pre-tax bid-YTW of 4.84% based on a bid of 24.05 and a softMaturity 2015-12-18 at 25.00.
TD.PR.N OpRet 75,700 Now with a pre-tax bid-YTW of 4.79% based on a bid of 24.80 and a softMaturity 2014-1-30 at 25.00.

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

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