Thursday, March 25, 2010

Kroszner: The Financial Crisis and Reform: A Close-up View

"...a revival of the Glass-Steagall Act that separated commercial and investment banking, or the so-called “Volcker Rule” barring investment banks from proprietary trading and running hedge or private equity funds, would have unintended consequences. “This pressure to break things up is only going to increase these interconnections and potentially make the system more fragile,” he said.

The priority should be to make market infrastructure more robust, particularly by improving the bankruptcy resolution regimes..."

Tuesday, March 23, 2010

Valukas: examiner's report on Lehman

US growth from FT

"...From the trough of the 2002 recession – as measured by the National Bureau of Economic Research – to that in 2009, real US gross domestic product grew on average only 1.7 per cent a year. The Federal Reserve Bank of Atlanta calculates that only straight after the second world war, when the economy shrank in real terms, has growth been weaker in any trough-to-trough period since 1933..."

Tett: Municipalities in swaps

"...The reason is derivatives. Earlier this week, the City of Milan announced that it is suing Deutsche, UBS, JPMorgan and Dexia, for allegedly misleading the city on swaps that adjusted interest payments on some €1.7bn ($2.3bn) of deals. The allegations, which the banks deny, will start in May.

Meanwhile, on the other side of the Atlantic - if not cultural spectrum - another battle has recently played out in relation to bonds and swaps arranged by JPMorgan for Birmingham county, Alabama. Last year, JPMorgan agreed to pay a $25m civil fine, make a $50m payment to Birmingham and forfeit $647m in termination fees linked to swaps deals. This came after the Securities and Exchange Commission accused JPMorgan of malpractice (a claim that the bank neither admitted nor denied on settlement)..."

Hughes on Lehman

Banks use repurchase agreements, known as repos, all the time for short-term financing. One borrows cash and gives the other securities, such as government bonds, as collateral. Both agree to unwind the arrangement on a set date. The deals, which usually run only for days or weeks, are accounted for as financings, and remain on the books with banks recording an asset – the cash – and a matching liability in the promise to buy back the collateral.

Lehman’s 105 was different – instead of handing over securities equivalent to the cash it received, the bank gave more than was necessary. The point was to exploit a loophole allowing such over-collateralised deals to be accounted for as true sales. Lehman then reported its obligation to repurchase the securities at a fraction of the full cost, and used the cash it had received to pay off its liabilities, thereby “shrinking” its balance sheet.

Use of Repo 105 spiked sharply at the end of each accounting quarter – more so in 2008 as pressure grew on Lehman to reduce its leverage – and fell just as dramatically soon after the new accounting period began, as deals were unwound.

Copyright The Financial Times Limited 2010. You may share using our article tools.

Wednesday, March 17, 2010

Politi: Outlook for US economy upgraded

FOMC statement March 16

Wolf: China and Germany unite to impose global deflation

Meyer: Oil traders look to James Bond-style data collection

"People care about Cushing," Mr Zein says. "It's the Nymex delivery point, and more importantly the correlation between the steepness of the forward curve on Nymex and level of storage at Cushing is very high."

Guerrara, Sender: Lehman file rocks Wall St

Tett: Is this the lull before the storm for US mortgages?

"...the degree of assistance that the Fed has provided has been eye-poppingly large: right now it is holding some $1,200bn of MBS, representing about half of its (currently enormously bloated) balance sheet (or about a quarter of the total stock of high-quality outstanding MBS)...Now it is possible that, as the Fed slowly withdraws its assistance, investors will gradually adjust too. But it is equally possible that there could be nasty shocks ahead, particularly if money market or Treasury rates rise. After all, will investors really keep buying MBS instruments if say, Treasury rates shoot up? Have American banks even hedged themselves against the chance of a sudden 1994-style swing in interest rates? What might happen if the US Fed actually starts selling its current holdings of MBS (as opposed to simply refusing to buy any more)? And what is the future of Fannie and Freddie?.."

Wolf: Germany's eurozone crisis nightmare

"...But Germany can be Germany – an economy with fiscal discipline, feeble domestic demand and a huge export surplus – only because others are not. Its current economic model violates the universalisability principle of Germany’s greatest philosopher, Immanuel Kant...

Eurozone financial balances

This, then, would be a classic case for intervention by the International Monetary Fund. Normally, the latter would offer temporary liquidity support in return for a devaluation and fiscal stringency. Yet the German government rejects the idea that an outside body should dictate policy to a country that shares Germany’s money. It suggests, instead, that a European Monetary Fund should be created, to provide conditional liquidity support. Under the direction of the other members of the eurozone, the EMF would dictate fiscal policy to the sinner..."

Jones: Funds' role in Greek drama examined

Monday, March 8, 2010

Keister, McAndres: Why Are Banks Holding So Many Excess Reserves?

The buildup of reserves in the U.S. banking system during the financial crisis has fueled concerns that the Federal Reserve’s policies may have failed to stimulate the flow of credit in the economy: banks, it appears, are amassing funds rather than lending them out. However, a careful examination of the balance sheet effects of central bank actions shows that the high level of reserves is simply a by-product of the Fed’s new lending facilities and asset purchase programs. The total quantity of reserves in the banking system reflects the scale of the Fed’s policy initiatives, but conveys no information about the initiatives’ effects on bank lending or on the economy more broadly.

Afonso, Kovner: Stressed, Not Frozen: The Federal Funds Market in the Financial Crisis

This paper examines the impact of the financial crisis of 2008, specifically the bankruptcy of Lehman Brothers, on the federal funds market. Rather than a complete collapse of lending in the presence of a market-wide shock, we see that banks became more restrictive in their choice of counterparties. Following the Lehman bankruptcy, we find that amounts and spreads became more sensitive to a borrowing bank’s characteristics. While the market did not contract dramatically, lending rates increased. Further, the market did not seem to expand to meet the increased demand predicted by the drop in other bank funding markets. We examine discount window borrowing as a proxy for unmet fed funds demand and find that the fed funds market is not indiscriminate. As expected, borrowers who access the discount window have a lower return on assets. On the lender side, we do not find that the characteristics of the lending bank significantly affect the amount of interbank loans it makes. In particular, we do not find that worse performing banks began hoarding liquidity and indiscriminately reducing their lending.

Baribeau: Fed expands reverse repos counterparties

Fed statement:

The initial efforts of the New York Fed will be aimed at firms that typically provide large amounts of short-term funding to the financial markets. This approach will ensure that the Federal Reserve quickly achieves significant capacity for conducting reverse repo operations while allowing the Trading Desk at the New York Fed to utilize its current infrastructure for conducting and settling such operations. Over time, the New York Fed expects it will modify the counterparty criteria to include a broader set of counterparties.

Major foreign Treasury holds, end June 2009

Mackenzie: Chinese reserves rebalancing

"...In terms of China's portfolio of Treasuries in the Tic report, the December data show a further big reduction in holdings of short-dated bills and buying of longer-dated coupon debt. China's T-bill holdings dropped by $38.8bn in December while its holdings of notes rose by $4.6bn.

Rather than selling any of its holdings, China appears to have let the bills mature and then used some of the proceeds to buy longer-dated coupons, analysts say. Extending its purchases along the yield curve is, partly, a sign of China's confidence in the US government's ability to service its debt. The Tic data show that China has not diversified into US equities or corporate bonds.

During the financial crisis, China built up holdings of short-dated T-bills from $14bn in mid-2008 to $210bn by May 2009 and they are now back around $70bn.

"The latest data is consistent with them shrinking the T-bill mountain rapidly, although there is more to come, as the likely underlying desirable holdings of T-bills is probably nearer $20bn," says Alan Ruskin, strategist at RBS Securities.

"China is simply fine tuning its portfolio and as US banks and consumers continue deleveraging, there will be enough domestic demand to buy Treasuries," says John Brady, senior vice-president of global interest rates at MF Global..."

Mackenzie on the primary dealing system

"The primary dealer system acts as the underwriter of the Treasury sales which are sold in a Dutch-style auction, writes Michael Mackenzie in New York .

Under this approach, primary dealers and other investors make bids at set dollar amounts and enter them into a computer system, hot-wired to the Federal Reserve Bank of New York. From there the US Treasury collates all the bids and determines the rate at which it can sell the debt. Ahead of the 1pm auction deadline, dealers and investors try to ascertain what yield will be awarded for the sale. A guide is the grey market, which indicates where the pending security will trade.

If investors need to own the issue, they will place bids below the grey market yield, while others, banking on weak demand, may choose to place bids at higher yields.

Gauging the demand from investors who buy through the dealers, known as the "indirect bid" or other financial institutions who buy directly from the Treasury is the crucial element.

The indirect bids handled by primary dealers are split into two types of orders: those from customers such as hedge funds and money managers and the "house" bid from the banks' bond desks."

MacKenzie: Treasury buyers buying direct

"...That could make bond sales more volatile and potentially more expensive for the US Treasury as the debt is issued at higher yields. "The high direct bid is creating uncertainty on the part of dealers and that could lead to more volatile auctions and trading as dealers become more cautious about providing aggressive prices," says Mike Pond, Treasury strategist at Barclays Capital..."

"...The growing size and number of auctions in the past year has encouraged more investors to wait for debt sales, rather than accumulate Treasury holdings over time.

For some time, liquidity has been better around auctions, than the secondary market, say investors and dealers.

"Auctions can be viewed as liquidity events," says Tony Crescenzi, portfolio manager at Pimco. "They are a time when investors can buy a large amount of Treasuries without causing a big change in prices."

If this manifests itself as a growing direct bid, it could mean a less efficient bond market for investors and ultimately the taxpayer as dealers adjust to a new auction dynamic.

"To the extent that the US Treasury likes a stable government bond market, this could mitigate that objective and over time become more costly for taxpayers," says Mr Pond..."

Tuesday, March 2, 2010

Mackenzie: Bunds and Treasuries

"...traders are focusing on something else, namely the long-term interest rate differentials between the US and Europe as an indicator of where the currencies should be trading against each other.

The relationship between 10-year German Bund yields and US Treasuries grabs the attention of the currency market from time to time. The reason this is happening now is because of the divergence that is emerging between the monetary policy of the US Federal Reserve and that of the European Central Bank.

"The currency market starts paying attention to this yield relationship whenever there are contrasts in central bank expectations," says Ashraf Laidi, chief market strategist at CMC Markets.

He says this is the currency market's "money play": the ECB needs to keep supplying liquidity as worries about fiscally weak countries on the eurozone periphery weigh on market sentiment, while the Fed has started talking about its exit strategy from easy monetary policy..."