February 16, 2010

The Kansas City Fed has published a working paper by Pier Asso, George Kahn and Robert Leeson titled The Taylor Rule and the Practice of Central Banking, a review of the manner in which policymakers’ views have been shaped by the availability of a simple tool for prescribing systematic policy actions. Unfortunately, the KC Fed has seen fit to encrypt the file and content copying is not allowed … so if you want to learn a little more, you’ll have to read it yourself, because I’m sure not going to do all that retyping.

There may be funding pressure on the UK mortgage market:

British banks will struggle to refinance 319 billion pounds ($500 billion) of bonds backed by home loans as the government prepares to withdraw two aid programs, Moody’s Investors Service said.

“It is highly uncertain that the mortgage-backed securities market will have the capacity to absorb the level of refinancing needed in the required timeframe,” according to the report.

Banks have raised about 10 billion pounds of mortgage- backed securities publicly since mid-2009 without state aid, Moody’s said.

“The funding gap may once again put financial pressure on mortgage originators, in particular smaller lenders, ” according to the report.

Spend-Every-Penny announced new mortgage rules today:

The Government will therefore adjust the rules for government-backed insured mortgages as follows:

  • Require that all borrowers meet the standards for a five-year fixed rate mortgage even if they choose a mortgage with a lower interest rate and shorter term. This initiative will help Canadians prepare for higher interest rates in the future.
  • Lower the maximum amount Canadians can withdraw in refinancing their mortgages to 90 per cent from 95 per cent of the value of their homes. This will help ensure home ownership is a more effective way to save.
  • Require a minimum down payment of 20 per cent for government-backed mortgage insurance on non-owner-occupied properties purchased for speculation.

The backgrounder elucidates:

These adjustments to the mortgage insurance guarantee framework are intended to come into force on April 19, 2010. Exceptions would be allowed after April 19 where they are needed to satisfy a binding purchase and sale, financing, or refinancing agreement entered into before April 19, 2010.

My first impulse is to laugh. First, the politicians decide that borrowing for real estate is more socially worth-while than borrowing for (e.g.) capital investment, so subsidize it by writing cheap Credit Default Swaps out of the CMHC. Then they pretend to be surprised when the distorting effects of these subsidies become apparent. Finally, instead of yanking the price on the CDSs to reflect their contribution to overall systemic risk (a very cool phrase to use nowadays) they create new rules instead, to gratify their central planning instincts.

However, there was no announcement of one rule that needs action: extending deposit insurance to cover GICs and term deposits with more than a five-year term.

Testimony of Daniel K Tarullo of the Federal Reserve to the Senate Subcommittee on Security and International Trade and Finance,
Committee on Banking, Housing, and Urban Affairs lays out the case that the best possible institution to regulate systemic risk is (surprise!) the Federal Reserve. There was one item of note:

One key feature of the recent crisis was the heavy reliance on short-term sources of funds to purchase long-term assets, which led to a poor match between the maturity structure of the firms’ assets and liabilities. Such maturity transformation is inherently fragile and leaves institutions and entire markets susceptible to runs.

In Canada, of course, we address the problem, in part, by offloading the problem onto consumers of mortgages – by making 5-year terms standard – thus exacerbating housing price responses to changes in five-year rates. It’s a funny old world.

Prof Lars E O Svensson, Deputy Governor of the Sveriges Riksbank delivered a speech titled Inflation targeting after the financial crisis in which he opined:

Many have claimed that excessively easy monetary policy by the Federal Reserve after 2001 helped cause a bubble in house prices in the U.S., a bubble whose inevitable bursting proved to be a major source of the financial crisis.5However, as I see it, the crisis was mainly caused by factors that had very little to do with monetary policy and were mostly due to background macro conditions, distorted incentives in financial markets, regulatory and supervisory failures (also when central banks have been responsible for regulation and supervision), information problems and some specific circumstances, including the U.S. housing policy to support home ownership for low-income households.

Footnote: See Bean (2009) for an extensive and excellent discussion of the crisis, including the credit expansion and housing boom, the macroeconomic antecedents, the distorted incentives, the information problems, the amplification and propagation of the crisis into the real economy, the policy responses and the lessons for monetary policy and economics generally. The Bank for International Settlements (2009) provides a more detailed account of the possible macro- and microeconomic causes of the crisis.

Reference: Bean, Charles R. (2009), “The Great Moderation, the Great Panic and the Great
Contraction”, Schumpeter Lecture, Annual Congress of the European Economic Association,

A solid day for preferreds, with both PerpetualDiscounts and FixedResets gaining about 7bp on the day, amidst an uptick in volume. Floaters continued to astonish.

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
(at bid)
Mod Dur
Issues Day’s Perf. Index Value
Ratchet 3.01 % 3.65 % 27,762 20.23 1 -0.0532 % 1,835.2
FixedFloater 5.71 % 3.78 % 36,449 19.23 1 -0.2618 % 2,769.5
Floater 2.01 % 1.75 % 43,223 23.16 4 0.4866 % 2,290.7
OpRet 4.84 % -2.70 % 103,219 0.09 13 0.0059 % 2,325.2
SplitShare 6.29 % -2.40 % 132,977 0.08 2 0.1740 % 2,134.3
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.0059 % 2,126.2
Perpetual-Premium 5.76 % 5.37 % 86,341 1.99 7 -0.2258 % 1,897.0
Perpetual-Discount 5.82 % 5.85 % 165,964 14.09 69 0.0690 % 1,811.4
FixedReset 5.41 % 3.52 % 309,836 3.77 42 0.0654 % 2,187.5
Performance Highlights
Issue Index Change Notes
ELF.PR.F Perpetual-Discount -1.72 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-02-16
Maturity Price : 20.00
Evaluated at bid price : 20.00
Bid-YTW : 6.72 %
RY.PR.H Perpetual-Premium -1.05 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-02-16
Maturity Price : 24.33
Evaluated at bid price : 24.55
Bid-YTW : 5.78 %
BAM.PR.K Floater 1.03 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-02-16
Maturity Price : 16.72
Evaluated at bid price : 16.72
Bid-YTW : 2.37 %
POW.PR.D Perpetual-Discount 1.15 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-02-16
Maturity Price : 21.14
Evaluated at bid price : 21.14
Bid-YTW : 6.00 %
BMO.PR.M FixedReset 1.33 % YTW SCENARIO
Maturity Type : Call
Maturity Date : 2013-09-24
Maturity Price : 25.00
Evaluated at bid price : 26.60
Bid-YTW : 3.04 %
BAM.PR.B Floater 1.39 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-02-16
Maturity Price : 16.76
Evaluated at bid price : 16.76
Bid-YTW : 2.36 %
Volume Highlights
Issue Index Shares
MFC.PR.B Perpetual-Discount 53,153 RBC crossed 44,700 at 20.43.
Maturity Type : Limit Maturity
Maturity Date : 2040-02-16
Maturity Price : 20.40
Evaluated at bid price : 20.40
Bid-YTW : 5.81 %
RY.PR.A Perpetual-Discount 38,796 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-02-16
Maturity Price : 19.97
Evaluated at bid price : 19.97
Bid-YTW : 5.60 %
BMO.PR.P FixedReset 37,548 RBC crossed 25,000 at 27.15.
Maturity Type : Call
Maturity Date : 2015-03-27
Maturity Price : 25.00
Evaluated at bid price : 27.07
Bid-YTW : 3.58 %
TRP.PR.A FixedReset 36,337 YTW SCENARIO
Maturity Type : Call
Maturity Date : 2015-01-30
Maturity Price : 25.00
Evaluated at bid price : 26.02
Bid-YTW : 3.83 %
BNS.PR.P FixedReset 34,413 RBC crossed 10,800 at 26.50; Nesbitt bought 16,300 from CIBC at 26.41.
Maturity Type : Call
Maturity Date : 2013-05-25
Maturity Price : 25.00
Evaluated at bid price : 26.42
Bid-YTW : 3.22 %
BMO.PR.K Perpetual-Discount 31,870 YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2040-02-16
Maturity Price : 22.80
Evaluated at bid price : 22.96
Bid-YTW : 5.74 %
There were 32 other index-included issues trading in excess of 10,000 shares.

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