Alea

From the BofE

Credit default swap (CDS) premia for banks and securities houses — which provide a measure of the cost of insuring against default — rose sharply in February and early March (see picture below). CDS premia peaked around the time of the collapse of Bear Stearns, a US securities house. However, they have subsequently fallen back, perhaps in response to the rescue of Bear Stearns and the measures announced by various central banks around the world. In addition, many institutions have announced plans to raise new capital. That will strengthen their balance sheets and is therefore likely to have been a factor contributing to the decline in CDS premia. Nevertheless, the premia remain well above their pre-crisis levels, and are likely to stay elevated until the location and magnitude of financial losses is fully resolved.

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TBA May 30th, according to Angela Knight, CEO of the BBA.

Libor Poised for Shake-Up as Credibility Is Doubted

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I would vote for that but will be difficult. For a spread, there is more than one price and for a price there is more than one spread.

The price of a CDS is always uncertain. There is no single answer, CDS trade on “spreads” but the price depends on models and inputs. To quote a famous textbook exemple, suppose that you bought protection on Marconi at 250 bp sometimes in the late 90s, in 2001 the spread had widened to 4000 bp. You are rich or so you think. The unwind price depends entirely on recovery assumptions, at 30% recovery you would get 51% of par, at 99% you would get 1% of par, that is you would “lose” even though you got the scenario right.

Felix Salmon: Moving Towards Exchange-Traded Credit Default Swaps
A Wish List for Fixing Wall Street

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Speech by Ben Bernanke

Ultimately, market participants themselves must address the fundamental sources of financial strains–through deleveraging, raising new capital, and improving risk management–and this process is likely to take some time. The Federal Reserve’s various liquidity measures should help facilitate that process indirectly by boosting investor confidence and by reducing the risks of severe disruption during the period of adjustment. Once financial conditions become more normal, the extraordinary provision of liquidity by the Federal Reserve will no longer be needed. As Bagehot would surely advise, under normal conditions financial institutions should look to private counterparties and not central banks as a source of ongoing funding.

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Our foreclosure bus tours are every saturday and bus leaves at 11:30a.m. Your just a bus tour away from buying your home . Equity awaits!

Repo Home Tour
Repo home tours: Should you jump in?

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The Federal Reserve is planning to ask Congress for authority - starting this year - to pay interest on commercial-bank reserves, in an effort to gain better control over interest rates and more leverage to battle the credit crunch.
The ECB has done so from day one. Time will if it will work, I am skeptical.
The big difference between the Fed and the ECB is that the ECB is the ultimate top credit within Euroland something that the Fed is not and in a flight to quality the ECB minimum deposit rate acts as a floor for interest rates, something that may not work for the Fed. I have mentionned somewhere that in Euroland it is not possible to have negative repos rates or government t-bills trading below the minimum deposit rate.
The European Central Bank and The Federal Reserve: paper by Stephen G. Cecchetti and Róisín O’Sullivan
Fed seeks approval to pay interest on reserves: report

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By my calculation, the Fed has only about $55 bn in T-Bills left in stocks, down from $275 bn one year ago.

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Legalize Insider Trading

Sex, Drugs and Credit Derivatives

Ex-gambler turns software ace

Martin Fridson to quit Leverage World, to start a fund investing in high-yield debt

Ace’s Revenge

Logos ? Yep can be useful…

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Martin Wolf: Seven habits finance regulators must acquire

Fannie Mae to Loosen Policies to Combat Housing Slump

BOLI troubles at Wachovia

BOLI for Dummies

Some Signs of a Recovery for the Dollar

Skills pay the bills

NYSE hopes to get into credit derivatives

Advisers in wonderland

Book: Rumors in Financial Markets: Insights into Behavioral Finance

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ABX.HE.PENAAA 06-1 Initial List
Here is a list of current factors for the 06-1 serie. ( 1- FACTOR ) is what has been paid back.
One deal, J.P. MORGAN MORTGAGE ACQUISITION CORP. 2005-OPT1, has paid back in full the top 3 AAA tranches.

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At 2.22% the latest TAF comes in below the discount rate [2.25%] and far below 1-month Libor [2.67%]

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This is from the Fed:

This paper seeks to put forward a framework, from the perspective of practitioners and policymakers, for how the known, unknown, and unknowable vary by risk type within banking. We define total bank risk in terms of earnings volatility, which can be broken down into five major classes of risk: market, credit, asset/liability, operational, and business risks. For our purposes, risk is “known” (K) if it can be enumerated, in the sense of being identified, and quantified; it is “unknown” (u) if the set of risks can be identified and enumerated but not meaningfully quantified; and it is “unknowable” (U) if the existence of the risk or set of risks is not predictable ex ante, let alone quantifiable. Based on these definitions, we position the five sources of bank risk within the K, u, U space based on evidence from industry practice and suggest that K decreases, and u and U increase, along a spectrum from market risk to credit risk, asset/liability risk, operational risk, and business risk. Using bank-level data we attempt to quantify or “size” both total bank risk and the contribution from each risk type based on a large sample of earnings volatility data for US bank holding companies over the 1986-2005 period. We find that a) total earnings volatility is protected by minimum regulatory capital requirements at implied credit rating levels ranging from about A- to BBB, depending on the sample; b) when allocating among the different risk types, market risk accounts for only about 5%, credit for almost half, structural interest rate risk for about 18%, and non-financial risks, including both operational and business risk, for about 30% of total risk; c) the diversification benefit, i.e. the difference between the whole and the sum of the parts, is about one third.
Not surprisingly, large banks also seem to experience fewer extreme adverse outcomes.

What We Know, Don’t Know and Can’t Know About Bank Risk: A View from the Trenches

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“Money market or Libor illiquidity is not a function of banks distrusting one another, as is so often reported. Rather it is a function of external investors not trusting the banks,” says Tim Bond, head of global assert allocation at Barclays Capital.

Time for money market funds to help

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The last TSLF auctions have seen weak demand.

The Federal Open Market Committee authorized an expansion of the collateral that can be pledged in the Federal Reserve’s Schedule 2 Term Securities Lending Facility (TSLF) auctions. Primary dealers may now pledge AAA/Aaa-rated asset-backed securities, in addition to already eligible residential- and commercial-mortgage-backed securities and agency collateralized mortgage obligations, beginning with the Schedule 2 TSLF auction to be announced on May 7, 2008, and to settle on May 9, 2008. The wider pool of collateral should promote improved financing conditions in a broader range of financial markets.

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From the Fed:

The Federal Reserve announced today an increase in the amounts auctioned to eligible depository institutions under its biweekly Term Auction Facility (TAF) from $50 billion to $75 billion, beginning with the auction on May 5. This increase will bring the amounts outstanding under the TAF to $150 billion.

In conjunction with the increase in the size of the TAF, the Federal Open Market Committee has authorized further increases in its existing temporary reciprocal currency arrangements with the European Central Bank (ECB) and the Swiss National Bank (SNB). These arrangements will now provide dollars in amounts of up to $50 billion and $12 billion to the ECB and the SNB, respectively, representing increases of $20 billion and $6 billion. The FOMC extended the term of these reciprocal currency arrangements through January 30, 2009.

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Grammatical Evolution Tutorial

Science in Finance IX: In defence of Black, Scholes and Merton

Hedge Funds, Financial Intermediation, and Systemic Risk

Cudgel Over the Quants

Committee to Save the World Plans 10th Reunion: Caroline Baum

How LSD brought us vegeburgers

Al Gore: Crossover Climate Fund

On the brink, newspapers face extinction [chapter 67]

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Welcome development.

Markit will add a Penultimate AAA Sub-Index to existing and future series of the Markit ABX.HE indices. The new ABX.HE.PENAAA Sub-index will reference AAA rated bonds that are 2nd to last in principal distribution priority from the existing ABX.HE deals as well as future qualifying deals. The ABX.HE.PENAAA will be added to the existing series of ABX.HE indices on May 14, 2008.

As not many people know, the AAA referenced by Markit is the lowest ranking AAA as there are as many as 4 or 5 AAA senior to the one listed.
Related:
Misleading Index of the Year : ABX.HE
Cash investors should use ABX to lock in current prices, says Wachovia

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ICAP to launch NYFR: New York Funding Rate

NYFR differs with the Libor system by offering anonymity to the banks surveyed.

Other NYFR features which differ from Libor:

The survey will be conducted at 9:30 a.m. New York time and the NYFR rates will be generated at about 10 a.m. This compares with 11 a.m. London time, or 6 a.m. in New York, when the BBA sets Libor in all currencies.

ICAP will collect rates on 1- and 3-month overseas dollar deposits. BBA’s dollar Libor rates go out to 12 months.

NYFR will encompass unsecured bank funding sources such as certificates of deposits, money market mutual funds and government-sponsored enterprises. Libor is explicitly defined as an interbank deposit rate.

Related:
A Good Bet on Derivatives

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Expected credit losses on AAA tranches: ZERO
Mark to market losses so far on AAA tranches: around $ 175 bn

Source: BofE

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BofE says: Prices of AAA tranches of the ABX index appear to be particularly out of line with credit fundamentals.
Risk premia are unusually high across a number of other markets under stress.
Note: Total principal writedowns on ABX tranches to date: ZERO

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Source: BofE

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By popular demand:

This study examines the potential of an evolutionary automatic programming methodology, Grammatical Evolution, to uncover a series of useful fuzzy technical trading rules for the ISEQ, the official equity index of the Irish Stock Exchange. Index values for the period 29/03/93 to 4/12/1997 are used to train and test the model. The preliminary findings indicate that the methodology has much potential.

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FYI, the [must read] Minsky book “Stabilizing an Unstable Economy” is back in print.

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Ex-Fed Official: Bear Deal ‘Worst Policy Mistake in a Generation’

Settlement Delays in the Money Market

US muni credit default swap index to start soon

Danger Ahead: Fixing Wall Street Hazardous to Earnings Growth

There’s info-arbitrage in cyberchatter

Pretty vacant: 18.6 million empty homes

How Important is it to Jail Insider Traders?

The Five Forces Circles of Hell

One Dozen Notes on Our Manic Capital Markets

Time to pull the plug on the Olympics

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Paper: Credit Classification Using Grammatical Evolution
Anthony Brabazon and Michael O’Neill

Grammatical Evolution (GE) is a novel data driven, model induction tool, inspired by the biological geneto-protein mapping process. This study provides an introduction to GE, and demonstrates the methodology by applying it to model the corporate bond-issuer credit rating process, using information drawn from the financial statements of bond-issuing firms. Financial data and the associated Standard & Poor’s issuer credit ratings of 791 US firms, drawn from the year 1999/2000 are used to train and test the model. The best developed model was found to be able to discriminate in-sample (out-of-sample) between investment grade and junk bond ratings with an average accuracy of 87.59 (84.92)% across a five-fold cross validation.

Related book:
Biologically Inspired Algorithms for Financial Modelling

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Option Model Calibration Using a Bacterial Foraging Optimization Algorithm
Jing Dang, Anthony Brabazon, Michael O’Neill, and David Edelman

The Bacterial Foraging Optimization (BFO) algorithm is a biologically inspired computation technique which is based on mimicking the foraging behavior of E.coli bacteria. This paper illustrates how a BFO algorithm can be constructed and applied to solve parameter estimation of a EGARCH-M model which is then used for calibration of a volatility option pricing model. The results from the algorithm are shown to be robust and extendable, suggesting the potential of applying the BFO for financial modeling.

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Success.
$75bn offered, $59,460bn submitted and accepted at the minimum rate of 25 bp.
This was a roll from the march 26 th auction where:
$75bn were offered, $86,100 submitted and $75bn accepted at 33 bp.
Going back to normal slowly…
NB: for this type auction low bidding is good.

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Sleazy trader will forfeit his $26k gain and pay $130k fine.

From Bloomberg:

A former Schottenfeld Group LLC trader will pay $156,000 to settle claims he spread false rumors about Blackstone Group LP’s bid for Alliance Data Systems Corp., the first U.S. regulatory case to target stock manipulation during the credit crisis.

Paul Berliner, 32, sought to profit by messaging traders at brokerages and hedge funds on Nov. 29, claiming Alliance Data’s board was meeting to discuss a reduced offer by Blackstone, the Securities and Exchange Commission said today in a suit at federal court in Manhattan. The shares plunged 17 percent in half an hour that day.

“The story disseminated by Mr. Berliner was a figment of his imagination,” said Scott Friestad, an SEC attorney overseeing its case, said in an interview. “Conduct like this is particularly insidious because it harms investors by distorting the information they use to make investment decisions.”

U.S. regulators are hunting for traders who are exploiting the credit crisis by falsely stoking panics about the stability of companies including Bear Stearns Cos. to profit from drops in their stock price. SEC Chairman Christopher Cox told the Senate Banking Committee April 3 the agency takes such manipulation “very seriously” and that lawmakers’ hopes for a crackdown would be “met or exceeded.”

“The commission will vigorously investigate and prosecute those who manipulate markets with this witch’s brew of damaging rumors and short sales,” Cox said in a statement.

Alliance Data’s stock jumped 7 percent to $56.79 as of 12:43 p.m. in New York Stock Exchange composite trading.

Price Drop

Berliner sent 31 instant messages to traders and other Wall Street professionals, asserting that Blackstone was revising its bid because of problems in Alliance Data’s credit-card bank, according to the SEC. Blackstone wanted to lower its bid from $81.50 a share to $70, he allegedly said.

“ADS getting pounded — hearing the board is now meeting on a revised proposal,” the SEC quoted his message as saying. “Blackstone is negotiating a lower price due to weakness in World Financial Network — part of ADS’ Credit Services Unit.”

The plunge in the Dallas-based credit-card processor’s stock drew news reports on the rumor and forced the New York Stock Exchange to temporarily halt trading in the shares, the SEC said. Alliance Data also released a public statement denying it was renegotiating the takeover.

$130,000 Fine

Berliner, who was shorting the stock to profit from the drop in price, made more than $25,000 before the shares recovered, according to the SEC. He didn’t admit or deny the agency’s claims in agreeing to forfeit his gains, plus interest, and pay a $130,000 fine.

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Global CDO issuance peaked last year:
Q1-2007 at $186.467bn
Q1-2008: $11.710bn

Source: SIFMA

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Graphs: CMA DataVision

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Remember that one ?

A bestseller in Europe: already over 35,000 copies sold in German and French. No. 1 on bestseller list in Europe for seven months!

“Why did Cabiallavetta, the CEO of the Union Bank of Switzerland, agree to such a deal?” asked The Economist on January 31, 1998. The deal was a merger between UBS and Swiss Bank Corp., a smaller rival. One reason, The Economist speculated, was that there was, “in UBS’s London based derivatives business, a hole of unknown (but possibly huge) proportions.”

By mid-1997, the bank’s trading division, built by Cabiallavetta, was falling apart with estimated losses of 1 billion Swiss francs ($700 / L416 million). The Financial Times estimated the loss at 650 million Swiss francs.

Was this the real reason for the UBS/SBC merger? And were there, as The Economist also speculated, parallels to the decline of Barings, the respected British investment bank brought to ruin in early 1995 by one rogue trader. Who was the rogue trader at UBS?

In UBS case, Nick Leeson’s role might have been played by a former Israeli army officer born in 1950 in Haifa, the Israeli seaport, who had been a member of an elite paratrooper division and decorated fighter in the Arab-Israeli Wars of 1967 and 1973. His name was Ramy Goldstein, although few UBS employees in Switzerland knew who he was.

Goldstein was the head of GED, the global equity derivatives unit at UBS, and over the years had become the bank’s shining star and highest-paid employee. Reliable sources estimated that his bonus for 1996 was approximately 15 million Swiss francs ($10 / L6.25 million). The same year, Cabiallavetta paid taxes on an income of 2.1 million Swiss francs ($1.4 / L0.875 million), and Robert Studer, the chairman of the board, earned 1.4 million Swiss francs.

What happened at UBS is a complicated story involving power, ambition and vanity. It shows that risk management controls in the largest of the Swiss banks had not extended far enough from the experience. And the responsibility for the failure falls principally on Cabiallavetta.

Essential reading for business and finance professionals: a complicated story of power, ambition, vanity and a lack of risk management controls at one of Europe’s largest banks.

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I will be off for some time.
Best to all.

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TAF not working but the TSLF is.
Today’s was bid for only $33.95 billion all accepted for $50 billion offered, at the minimum spread of 25 bp.
For the TSLF, success means low bidding or no bidding.
Related:
TSLF: Success
Results

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TAF has failed says John Taylor et al
Paper by John Taylor [Stanford University] and John Williams Federal Reserve Bank of San Francisco

At the center of the financial market crisis of 2007-2008 was a highly unusual jump in spreads between the overnight inter-bank lending rate and term London inter-bank offer rates (Libor). Because many private loans are linked to Libor rates, the sharp increase in these spreads raised the cost of borrowing and interfered with monetary policy. The widening spreads became a major focus of the Federal Reserve, which took several actions—including the introduction of a new term auction facility (TAF)—to reduce them. This paper documents these developments and, using a no-arbitrage model of the term structure, tests various explanations, including increased risk and greater liquidity demands, while controlling for expectations of future interest rates. We show that increased counterparty risk between banks contributed to the rise in spreads and find no empirical evidence that the TAF has reduced spreads. The results have implications for monetary policy and financial economics.

A Black Swan in the Money Market
Related:
Paul Krugman: Not over yet

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Related:
What Could the Fed Do?
The size of the Fed’s balance sheet limits the scale of the public’s losses

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Terse statement from Goldman Sachs 10-Q, page 108

Goldman, Sachs & Co. has received requests for information from various governmental agencies and self-regulatory organizations relating to certain auction products, the interest rate or dividend rate of which is reset at a periodic auction, and the related recent failure of such auctions in whole or part. Goldman, Sachs & Co. is cooperating with the requests.

Goldman says regulators probe auction-rate matters

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Goldman’s share of Level 3 assets surged 39 percent to $96.4 billion at the end of February from $69.2 billion in November. The ratio of Level 3 to total assets rose to 8.1 percent from 6.2 percent.

Goldman’s Growing Question Mark
Goldman Sachs Level 3 Assets Jump, Exceeding Rivals’

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[click to enlarge]
Goldman Sachs

Morgan Stanley

Lehman Brothers

Related:
Goldman Had More Trading-Loss Days Than Morgan Stanley, Lehman says Bloomberg.

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New, G7 plot to save the world:

The Group of Seven economic powers are likely to deploy an international team to keep closer tabs on the world’s big banks as well as demanding better risk management and information disclosure across financial markets.

Finance ministers from the G7 countries have also invited the bosses of about 10 banks to discuss the global markets crisis which could cost close to $1 trillion in losses and downgrades in the value of toxic assets accrued over years of investor euphoria.

The moves to improve the behavior of banks, and supervision of financial markets more generally, are due to be announced at a meeting on Friday in Washington. They are based on a list of recommendations from the Financial Stability Forum, a body they created in response to Asian financial crises of the late 1990s.

Among the key FSF ideas, elements of which were published in the Wall Street Journal and confirmed to Reuters by a G7 source on Wednesday, is the creation by the end of this year of a team of supervisors to watch over the biggest international banks.

Ministers would dine with the bankers on Friday, the official said. “It’s an informal meeting … We will ask banks why (the crisis) occurred and what steps to take from here.”

If implemented, the plan should “minimize the possibility that the challenges we’ve faced will reoccur”, David McCormick, U.S. Undersecretary of the Treasury for International Affairs, said, according to the Wall Street Journal.

FSF recommendations include:

* By July, supervisors should improve their guidelines for the way banks plan for cash shortages. Banks should run “stress tests” to ensure they can get cash in emergencies.

* By the end of the year, teams of supervisors from major countries should be assigned to monitor the biggest banks which work across international borders.

* Banks and securities firms should publicize the risks they face from complex securities, such as those backed by subprime mortgages.

* The Basel Committee on Banking Supervision, an international body of regulators, should require banks to keep more capital in reserve to protect against failures of complex securities and off-balance-sheet investments. Banks should disclose their uses of off-balance-sheet setups to house their risky investments.

* Credit rating firms should distinguish the grades they give for regular securities, such as municipal or corporate bonds, from those they assign to more complex investments.

* Investors should take responsibility for their own due diligence to ensure credit ratings reflect the risks of their investments.

G7 readies response to market crisis

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Latest from the IMF:
We estimate total losses from broad credit market deterioration of $945 billion globally, $565 billion of which is due to losses on residential mortgage debt, $240 billion on commercial real estate debt, $120 billion on corporate debt, and $20 billion on consumer credit debt.

Here is what the half-wit gnomes said:

As residential mortgages traditionally have one of the lowest rates of credit losses, mortgage lenders already hold less capital relative to their asset size than most other lenders under Basel I (mortgages carry a 50% risk weight, against 100% for unsecured personal and corporate loans).

Basel II further recognises the safety of residential mortgages by reducing their weight under the standardised approach from 50% to 35% for loans with a loan-to-value ratio (LTV) of up to 80%. Loans to highly rated corporate borrowers (ie, relatively safe companies) will see an even larger reduction in risk weighting but loans to many other corporates will continue to be weighted 100%. For banks using the retail IRB approach, the risk weight attached to mortgages will depend on the lender’s historical loss experience, which will drive the internal risk model. But it is expected that their risk weights on mortgages will be below 35%, perhaps substantially so. On average, it is thought that mortgage lenders could be the largest beneficiaries of Basel II, seeing capital requirements falling relative to other lenders.

About 85% of the losses projected by the IMF come from mortgages.

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