September 5, 2008

James Hamilton of Econbrowser passes on a debunking of Shadowstats … I confess, I have not examined the issues raised very closely, but this is the sort of thing I like to see. The internet has offered looney-tunes a pulpit, which is generally a bad thing; on the other hand, it makes this kind of thinking more visible and susceptible to criticism.

You can tell where my sympathies lie, despite my professed ignorance regarding this particular issue! Assiduous Readers will remember the forecast of the end of the world last February, narrowly averted when it was shown that Armageddonists can’t read balance sheets or do arithmetic.

Accrued Interest reviews the GSE situation and sets up a straw-man proposal:

What if the Treasury agreed to guaranty the principal (not the interest) on a preferred stock offering.

The preferreds would be callable after 5 years, with the call becoming automatic if the GSEs share price reaches some milestone. The idea would be that if the GSEs are able to issue common equity, then they would be forced to call the tax-payer backed preferred and issue their own securities of some variety.

The Treasury could charge some fee in exchange for the guaranty.

Here are the advantages of such a plan. First, it could be implemented right away, allowing for stability in the mortgage market and likely a decline in mortgage lending rates. Second, its probably a cheaper plan for tax payers when compared with other options.

Unfortunately, this kind of solution has a number of problems. First, it creates all kinds of moral hazard, as common equity holders wind up benefiting from the tax payers risk.

Second, this plan doesn’t move us any closer to a more permanent solution to the problem of macro risk and the GSEs.

Well, I don’t like the plan either! I continue to feel that nothing should happen until the GSEs either fall below their regulatory minimum capital (a la IndyMac), or become unable to finance themselves in a normal commercial manner (a la Bear Stearns). Then Treasury steps in and backstops a rights issue of senior preferred shares convertible into common at a dollar, possibly with a provision that no dividend be paid on the existing and suddenly junior preferreds until some specified capital ratios are met.

Any GSE bail-out will be politically divisive enough; to take action before the last minute will simply exacerbate the attention paid to side issues while increasing the potential for future moral hazard without providing a solution that is necessarily any more effective.

And what to do now? Start drafting legislation that turns the GSEs into regular banks. And start weaning the American mortgage market off fully open mortgages with a 30-year term. That’s the root of the problem.

But stay tuned! After the markets closed, the WSJ said Treasury is Close to Finalizing Plan to Backstop Fannie, Freddie. There are no details, but speculation is rampant on, for instance, Accrued Interest, Bloomberg and Dealbreaker.

Jian Wang of the Dallas Fed writes an interesting review on VoxEU: Understanding exchange rates as asset prices and comes to a conclusion that is consistent with my understanding of the FX markets and markets in general:

In a seminal paper, Richard Meese and Kenneth Rogoff (1983) found that economic fundamentals – such as the money supply, trade balance and national income – were of little use in forecasting exchange rates, at least over short to medium time horizons. They compared existing models to an alternative in which fundamentals are excluded and any exchange rate changes are purely random. They found the “random walk” model to be just as good.

We argue that exchange rate movements may be driven by both a permanent long-term trend and some transitory noise. These noisy terms can drive exchange rates away from their long-run levels in the short run. As time passes, exchange rates gradually move back to their long-run levels, exhibiting long-horizon predictability. In several models, such as the monetary model and the Taylor rule model in Engel and West (2005), the short-term noise is related to a fundamental that isn’t observable – the risk premium for holding a currency, for example.

Not much price action today, on reasonable volume. All eyes were on the stock market!

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 N/A N/A N/A N/A 0 N/A N/A
Fixed-Floater 4.57% 4.34% 65,758 16.42 6 +0.4525% 1,119.4
Floater 4.36% 4.42% 51,043 16.48 2 +0.2742% 902.4
Op. Retract 4.93% 4.22% 127,499 3.08 14 +0.0907% 1,054.5
Split-Share 5.34% 5.84% 52,627 4.34 14 -0.0524% 1,045.1
Interest Bearing 6.35% 6.94% 52,382 5.22 2 -1.4082% 1,112.2
Perpetual-Premium 6.18% 5.57% 61,195 2.23 1 -0.0395% 1,004.9
Perpetual-Discount 6.03% 6.09% 188,537 13.75 70 -0.0011% 883.4
Major Price Changes
Issue Index Change Notes
BSD.PR.A InterestBearing -2.9381% Asset coverage of 1.6+:1 as of August 29 according to Brookfield Funds. Now with a pre-tax bid-YTW of 7.50% based on a bid of 9.25 and a hardMaturity 2015-3-31 at 10.00.
SLF.PR.E PerpetualDiscount -2.0451% Now with a pre-tax bid-YTW of 6.04% based on a bid of 18.68 and a limitMaturity.
PWF.PR.E PerpetualDiscount -1.6603% Now with a pre-tax bid-YTW of 6.00% based on a bid of 23.10 and a limitMaturity.
IAG.PR.A PerpetualDiscount -1.1721% Now with a pre-tax bid-YTW of 6.22% based on a bid of 18.55 and a limitMaturity.
CM.PR.G PerpetualDiscount +1.1472% Now with a pre-tax bid-YTW of 6.48% based on a bid of 21.16 and a limitMaturity.
BAM.PR.K Floater +1.3333% On volume of 36 – count ‘em, 36 – shares.
Volume Highlights
Issue Index Volume Notes
BAM.PR.O OpRet 393,310 Now with a pre-tax bid-YTW of 7.38% based on a bid of 22.92 and optionCertainty 2013-6-30 at 25.00. Compare with BAM.PR.H (6.19% to 2012-3-30), BAM.PR.I (5.32% TO 2013-12-30) and BAM.PR.J (6.43% to 2018-3-30) … well … looks to me like they finally found their level and this is the inventory blow-out special!
L.PR.A Scraps (would be OpRet, but there are credit concerns) 210,112 Now with a pre-tax bid-YTW of 8.26% based on a bid of 22.40 and a softMaturity 2015-7-30 at 25.00. Assiduous Reader adrian2 gets his wish and the Loblaws issue – very poorly received when issued in June – makes it on the board despite its less-than-stellar credit. I’d say that, as above, after two-plus months of trying, the underwriters have found a level where this thing will sell … and that they’re under the gun to get it off the shelf well before bank year end in October.
TD.PR.M OpRet 128,110 Now with a pre-tax bid-YTW of 3.82% based on a bid of 26.16 and a softMaturity 2013-10-30 at 25.00.
NA.PR.K PerpetualDiscount 27,294 Now with a pre-tax bid-YTW of 6.19% based on a bid of 23.85 and a limitMaturity.
TD.PR.R PerpetualDiscount 25,300 Now with a pre-tax bid-YTW of 5.70% based on a bid of 24.84 and a limitMaturity.
TD.PR.O PerpetualDiscount 17,670 Now with a pre-tax bid-YTW of 5.78% based on a bid of 21.28 and a limitMaturity. Look at this, compared with TD.PR.R! You can pick up both yield and upside, credit neutral, by giving up coupon!

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

5 Responses to “September 5, 2008”

  1. [...] PrefBlog Canadian Preferred Shares – Data and Discussion « September 5, 2008 [...]

  2. [...] Readers will remember that on September 5 I noted a paper regarding foreign exchange rate prediction – there is another paper on VoxEU today [...]

  3. [...] advice regarding the structuring of the GSE rescue, but they didn’t follow my instructions of September 5: I continue to feel that nothing should happen until the GSEs either fall below their regulatory [...]

  4. RTGreenwood says:

    Geometric weighting is invalid. On the face of it, it makes no sense to lower the weighting of price because it is rising fast. The rise is itself inflation. If the fast rising price is a short term phenomenon, the a deflationary force will be forthcoming.

    Any Inflation/CPI calculation that allows substitution is invalid.

    In fact, inflation and CPI are monetary phenomena that deal only with goods and services and the amount of money in the economy available to pay for those goods and services. A price borne by the market is the price. There are no qualifiers to that price.

    Consumer decision making is irrelevant.

    Substitution within category which Hamilton says is valid is INVALID.

    Example: If hamburger and hot dogs are in the same category, then the consumer buys hot dogs at 0% increase and forgoes the 1% increase in hamburger. The next month, the consumer buys hamburger which goes up 0% and forgoes hot dogs that have risen 1%. At the end of two months both hot dogs and hamburgers are up 1% but count 0% in the CPI.

    John Williams is absolutely correct and when he refers to “under the cover of academic theory” applies to Hamilton. One wonders where Hamilton’s research money is coming from. Could it be the U.S. government?

  5. jiHymas says:

    I have expressed my own doubts about the universal correctness of commodity substitution in the post BoC Releases Summer 2012 Review.

    However, I don’t believe that flat statements rejecting substitution have any greater credibility than blanket substitution itself. Electrical heating for houses, for instance, was once favoured due to its low cost, but with the rising cost of electricity there has been a huge amount of substitution into natural gas and oil. I believe that natural gas is extremely favoured currently due to its low price – and projections of future low prices (additionally, if the electricity is produced by natural gas, then the waste heat is lost at the generating station; if you burn the gas at home then the waste heat … is useful).

    As a consumer, I really couldn’t care less about the price of natural gas, electricity or heating oil. I care about the price of heating my home. Because of this, substitution is entirely appropriate when it comes to calculating the impact of these prices on overall inflation.

    Example: If hamburger and hot dogs are in the same category, then the consumer buys hot dogs at 0% increase and forgoes the 1% increase in hamburger. The next month, the consumer buys hamburger which goes up 0% and forgoes hot dogs that have risen 1%. At the end of two months both hot dogs and hamburgers are up 1% but count 0% in the CPI.

    This example assumes that consumer response to price changes is instantaneous with 100% participation, which is rather an extreme position to take. You are also assuming that a rebalancing of the CPI basket occurs instantaneously.

    John Williams is absolutely correct and when he refers to “under the cover of academic theory” applies to Hamilton. One wonders where Hamilton’s research money is coming from. Could it be the U.S. government?

    Conspiracy theories and ad hominem attacks are great fun, but are usually an indication that the theorist can find nothing of substance in the opposing view to attack.

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