March 24, 2008

Menzie Chinn of Econbrowser reviews the policy response to the credit crunch:

First, methinks the Administration protests too much, about “not bailing out” investors. If it were indeed the case that it was against further contingent liabilities being taken on by the Federal government, it would not have allowed the increase in the maximum size of conforming loans guaranteed by the Government Sponsored Enterprises, Fannie Mae and Freddie Mac. Nor would capital requirements have been reduced at exactly the time that a higher capital cushion would be in order, given the state of the economy. In addition, it would have taken some sort of action to limit the borrowing taking place through the Federal Home Loan Banks (see [5], [6] for discussion of recent actions, and implications).

Second, whatever the reasons for the Administration’s actions, I think a very serious problem is that, by virtue of the Administration’s abdication of a substantive role (see Hubbard’s comment on this point), the Fed is lending to entitites it does not regulate. The Bear Stearns collapse might have been seen as a case where the Fed had to undertake unconventional actions, because of the rapidity of developments. But with the Administration providing an uncompromising stance, who will step in the next episode? If it’s the Fed again, then Blinder’s critique will take on heightened relevance.

I’ll agree with his first point – as I said most recently in the comments to March 20, a slight relaxation in the GSE capital requirements may be justifiable, but should be accompanied by a schedule whereby the capital standards would approach banks. Similarly, the FHLBs should be regulated like the banks they are.

Prof. Chinn’s second concern, the separation of regulatory and last-lender powers, does not seem quite so cut-and-dried to me. The issue was last discussed in PrefBlog in the post regarding Willem Buiter’s Prescription and on December 5 in response to a VoxEU article by Stephen Cecchetti. There are certainly good arguments to be made regarding combination of roles as far as the banks are concerned – and, by and large, I agree with these arguments – but the arguments for extending Fed oversight to the brokerages is a little less clear.

As I have stated so many times that Assiduous Readers are fed up to the back teeth with the incessant drone – we want a shadow banking system! We want to ensure that there are layers of regulation, with the banks at the inner core and a shock-absorber comprised of brokerages that will serve as a buffer between this core and a wild-and-wooly investment market. This will, from time to time, require (or, at least, encourage) the Fed to step in and take action, but the alternative is worse.

Which is not to say that regulation cannot be improved! Regulation can always be improved! Margining requirements for derivatives may have to be reviewed – interest rate swaps and credit default swaps particularly, without simply making the lawyers happy by getting them to invent a new instrument.

If I buy $1-million of a corporate bond from my broker, I have to put up 10% margin. Seems to me that if sell credit protection, I should have to put up 10% of notional. And if I buy credit protection, I should have to put up at least 10% of the present value of the contractual payments.

Similarly with an interest-rate swap: if I pay floating to receive fixed, that is functionally equivalent to going long a fixed-rate bond and short a floating-rate one. If I do this in the physical market, I will be allowed a consideration as far as offsetting credit risk is concerned, but I won’t get away scot-free! When done as a derivative, I should have to put up … 2%? … of notional.

And in both cases, positions should be marked to market at least monthly. As reported by the WSJ, Barney Frank, Chairman of the House Financial Services Committee, wants a review of margin requirements (among other things), but has no concrete proposals at this time:

Reassess our Capital, Margin and Leverage Requirements (and the nature of “capital” itself). This crisis has illustrated that seemingly well-capitalized institutions can be frozen when liquidity runs dry and particular assets lose favor.

The BSC/JPM deal was a big story again today, with the deal value quadrupling in exchange for a couple of things:

  • JPM is getting a new issue of 39.5% of BSC as treasury stock
  • A possibility that JPM will take $1-billion first-loss on the $30-billion Fed financing

Seems to me that this makes the deal a certainty, with the Fed managing to keep its self-respect by being able to point out that the billion dollars extra given to BSC shareholders has been met by a corresponding reduction in their loss-exposure on the financing. The certainty will be good news for JPM in terms of staff retention, as well as considerations that the guarantee of liabilities might have been poorly drafted, as reported upon by Naked Capitalism.

The WSJ has reported:

At the merger’s closing, the New York Fed will take control of about $30 billion of assets as collateral for $29 billion in financing from the New York Fed. The Fed will provide the funds at its primary credit rate, 2.5%, or a quarter percentage point above the benchmark federal funds rate. Under the new terms, J.P. Morgan would have to eat the first $1 billion in losses from those assets; the Fed would have rights to any gains.

The New York Fed plans to provide additional details about the deal’s terms later Monday.

The New York Fed hired BlackRock Financial Management Inc. to manage the $30 billion portfolio “to minimize disruption to financial markets and maximize recovery value,” it said in a statement. Fed officials sought out BlackRock, seeing it as one of the few firms without conflicts of interest that could handle the task in the timeframe that was necessary. The Fed hasn’t provided details of the portfolio, whose assets were valued on March 14, but it’s believed to include hard-to-trade securities tied to riskier home mortgages.

Boy, that BlackRock’s got a good gig, eh? Paid to manage a portfolio that’s virtually untradeable and in run-off mode. A New York Fed press release confirms the terms.

In yet another indication that Regulation FD and its Canadian equivalent, National Policy 51-201, are in urgent need of amendment, the Fitch / MBIA battle has hotted up:

Fitch Ratings said it will still assess MBIA Inc.’s financial strength, snubbing a request by the bond insurer to withdraw the ratings.

Fitch will rate MBIA as long as it can maintain a “clear, well-supported” view without access to non-public information, the ratings firm said today in a statement.

MBIA asked Fitch earlier this month to stop rating the company because of disagreements about modeling for losses. Fitch is the only credit rating company considering a downgrade of MBIA. Moody’s Investors Service and Standard & Poor’s both affirmed the company earlier this month after MBIA raised $3 billion in capital, eliminated its dividend and stopped issuing asset-backed insurance. Fitch will complete its review in “the next few weeks,” Joynt said.

Fitch probably won’t be able to continue rating the company for long, MBIA said today in a statement responding to the announcement.

“The non-public information currently in Fitch’s possession soon will become out of date, and public information alone will be insufficient to maintain the ratings,” MBIA said.

OK. So here we have MBIA saying that investors cannot possibly come to a well-supported conclusion about credit quality without access to material non-public information, which is available only to credit rating agencies that make their credit ratings public (the Lord alone knows what equity investors are supposed to conclude). How many times must this conclusion be repeated before the exemption is repealed and the required information is publicized?

Naked Capitalism has excerpted and colourized a post by Brad Setser regarding reliance of the US on foreign central banks:

So long as they are piling into safe US assets, central banks are contributing the “liquidity” to a market that doesn’t need any liquidity. They are helping to push Treasury rates down. And their activities, while rational from the point of view of conservative institutions seeking to avoid losses (beyond those associated with holding the dollar), also may be aggravating some of the difficulties in the credit markets. Private funds fleeing the risky US assets for the emerging world generally end up in central bank hands and currently seem to be recycled predominantly into safe US assets.

In January, official investors – central banks and sovereign funds – provided the US with $75.5 billion in financing. Annualized, that is about $900b. That’s huge. It is also more than the US current account deficit. Central banks and sovereign funds are effectively financing the runoff of some private claims on the US. If the US were an emerging economy, that might be called “capital flight.”

$53.4b of the $75.5b in overall official inflows came from the purchase of long-term US debt and equities. $22.1b came from a rise in short-term claims (the $15.2b increase in short-term Chinese claims likely explains most of the overall rise in short-term claims).

That $53.4b in long-term inflow was concentrated at the two poles of the risk distribution: Official investors purchased $36.1b in Treasuries, next to no agencies (*), sold corporate debt and bought $13.9b in US equity. This is what an anonymous (but well informed) commentator here called a barbell portfolio. Buy safe stuff or buy risky stuff but don’t buy much in between.

Well – that’s what happens when you run a fiscal deficit for so long … the country’s financial markets become the plaything of foreignors.

Volume picked up a little in the preferred share market today, but was nothing special – no major price trends either.

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 5.42% 5.45% 33,930 14.73 2 +0.0205% 1,088.0
Fixed-Floater 4.79% 5.51% 61,496 14.83 8 -0.2348% 1,038.3
Floater 4.77% 4.78% 79,829 15.91 2 -0.0260% 871.0
Op. Retract 4.84% 3.36% 75,111 2.75 15 +0.1457% 1,047.1
Split-Share 5.39% 6.04% 93,953 4.13 14 +0.5685% 1,023.1
Interest Bearing 6.21% 6.69% 66,556 4.22 3 +0.1365% 1,085.6
Perpetual-Premium 5.80% 5.69% 255,268 10.81 17 -0.0556% 1,018.8
Perpetual-Discount 5.56% 5.62% 297,245 14.46 52 +0.0450% 929.4
Major Price Changes
Issue Index Change Notes
HSB.PR.C PerpetualDiscount -3.1760% Now with a pre-tax bid-YTW of 5.68% based on a bid of 22.56 and a limitMaturity.
SLF.PR.D PerpetualDiscount -1.1566% Now with a pre-tax bid-YTW of 5.45% based on a bid of 20.51 and a limitMaturity.
BAM.PR.G FixFloat -1.1294%
BCE.PR.A FixFloat -1.0000%
FFN.PR.A SplitShare +1.0320% Asset coverage of 1.8+:1 as of March 14, according to the company. Now with a pre-tax bid-YTW of 5.73% based on a bid of 9.79 and a hardMaturity 2014-12-1 at 10.00.
BNA.PR.C SplitShare +1.1405% Asset coverage of 2.8+:1 as of February 29, according to the company. Now with a pre-tax bid-YTW of 7.41% based on a bid of 19.51 and a hardMaturity 2019-1-10 at 25.00. Compare with BNA.PR.A (6.93% to 2010-9-30) and BNA.PR.B (8.26% to 2016-3-25).
PWF.PR.J OpRet +1.2466% Now with a pre-tax bid-YTW of 4.03% based on a bid of 25.99 and a call 2010-5-30 at 25.00.
FTU.PR.A SplitShare +1.3714% Asset coverage of just under 1.4:1 as of March 14, according to the company. Now with a pre-tax bid-YTW of 8.35% based on a bid of 8.87 and a hardMaturity 2012-12-1 at 10.00.
ELF.PR.G PerpetualDiscount +1.5971% Now with a pre-tax bid-YTW of 6.15% based on a bid of 19.72 and a limitMaturity.
SBN.PR.A SplitShare +1.7699% Asset coverage of just under 2.1:1 as of March 13, according to Mulvihill. Now with a pre-tax bid-YTW of 4.66% based on a bid of 10.35 and a hardMaturity 2014-12-1 at 10.00.
POW.PR.D PerpetualDiscount +1.9128% Now with a pre-tax bid-YTW of 5.46% based on a bid of 22.91 and a limitMaturity.
BMO.PR.H PerpetualDiscount +2.4076% Now with a pre-tax bid-YTW of 5.57% based on a bid of 22.91 and a limitMaturity.
Volume Highlights
Issue Index Volume Notes
PWF.PR.K PerpetualDiscount 91,422 Nesbitt crossed 15,100 at 22.56, CIBC crossed 50,000 at 22.57, then Scotia crossed 25,000 at 22.57. Now with a pre-tax bid-YTW of 5.57% based on a bid of 22.55 and a limitMaturity.
TD.PR.R PerpetualDiscount 52,050 Now with a pre-tax bid-YTW of 5.66% based on a bid of 24.92 and a limitMaturity.
BNS.PR.O PerpetualPremium 49,057 Now with a pre-tax bid-YTW of 5.66% based on a bid of 25.11 and a limitMaturity.
PWF.PR.I PerpetualPremium 41,200 Desjardins crossed 20,000 at 25.50 … then did it again! Now with a pre-tax bid-YTW of 5.89% based on a bid of 25.36 and a call 2012-5-30 at 25.00.
SLF.PR.A PerpetualDiscount 35,145 Nesbitt crossed 25,000 at 22.00. Now with a pre-tax bid-YTW of 5.42% based on a bid of 22.00 and a limitMaturity.

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

3 Responses to “March 24, 2008”

  1. [...] interest in the post is the discussion of the alleged contract glitch that I briefly mentioned yesterday. Dealbreaker has posted twice on the issue, claiming that the conference call was crystal clear and [...]

  2. [...] to consider this change in terms of the Fitch / MBIA battle reported briefly on PrefBlog on March 24, with much better discussion available from Floyd Norris’ NYT blogs If you don’t like [...]

  3. [...] true – and if the attempt is successfull – I’m very pleased. As I said on March 24, 2008: As I have stated so many times that Assiduous Readers are fed up to the back teeth with the [...]

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