:LPE:

Best summary I’ve seen so far on the role of “hard to price” in last summer’s hiccup. Link.

Whatever you say of the “co-ordinated private sector action” both here and south of the border to arrange an orderly unwinding of the frozen asset backed paper markets and create (in the US) a $100 bn “investment fund” to buy stuff no-one else will buy, and then re-sell it over the long term, both done with the blessing and encouragement of the central banks, Minister of Finance and Treasury Department, whatever you say about all this, don’t call it a bailout. Both heads of the central banks have been adamant that they only provide liquidity, not insurance, to markets, and governments have been at pains to indicate that no public money will go into the buyout funds.

I suppose it depends on your definition of bailout: the main point of those in denial seems to be that no public money is directly involved, although true, public interests are being served (as well as some pretty exposed private ones as well). LTCM was not a “bailout” either by those standards, it was only the federal reserve banks pressuring the large banks to unwind the fund without a massive insolvency event. So, no public monmey (like S&L in the late 80s, or the peso loan in the mid-1990s), and there is no need to be worried about “moral hazard”: people have learned their lesson and will not speculate in hard-to-price securities sold at a premium. Sounds about right…

Whatever the political merits of the Manley Commission, as it will be known, we have the advantage of already knowning what Manley thinks on the matter after exactly the same kind of review: he went to Afghanistan in 2002 and wrote a report on it. One assumes he will update it a bit, but not change his views significantly on major policy directions. Link.

For the record, my guess is that the conclusion to the Commission’s work will be more or less this statement:

there is no possible way to separate the development or humanitarian mission from the military one. There can be no meaningful progress on development without an improved security environment.

perhaps with some context about educating Canadians about the reconstruction projects. This is policy option #1 identified by the mandate, at least as reported in the papers: continue what we’re doing.

As for the others on the Commission, their bios show that they are top of their respective fields and among the sharper sticks in Canada. If their bios are accurate and comprehensive, they also have tangential connection to military operations, peace-keeping, or reconstruction and development in post-conflict zones, and are all loyal CPCers. With the exception of Burney, who also serves as a Board member on an NGO providing health services in conflict zones. They aren’t likely to sway Manley’s opinion away form the status quo.

The coordinated bailout of the ABCP market in Canada continues (the Montreal Accord) with Purdy Crawford’s steady hand at the helm, and most recently, according to weekend papers, European banks letting the group look at their books, to understand the exposure and valuation of their derivitave bets, in aid of a orderly valuation and perhaps even unwinding of the market.

South of the border, a similar bailout is being coordinated, reports the NYT. Link. This is a “private” fund of about $100bn US to be used to buy asset backed securities or structured products that no-one else will, and to be created by issuing - get ready - commercial paper, the very stuff frozen up in Canada.

Aside from the obvious point that this is a publicly-led bailout (yes, the pension funds will benefit too) without any real government discussion of the merits of allocating resources in this way, rather than in another, it is heartening to see that such coordinated global policy action back by massive financial resources and both private and public sectors is still possible. Where else might that example be applied?

and no surprises, I think: appeal dismissed because there was no “material change” during the prospectus filing period, and on the second issue, the business judgment rule is not a defence to failure to disclose. On the latter, from the headnotes:

While forecasting is a matter of business judgment, disclosure is a matter of legal obligation. The Business Judgment Rule is a concept well-developed in the context of business decisions but should not be used to qualify or undermine the duty of disclosure. The disclosure requirements under the Act are not to be subordinated to the exercise of business judgment. It is for the legislature and the courts, not business management, to set the legal disclosure requirements. The traditional justifications for the rule are that judges are less expert than managers in making business decisions.

Perhaps the real kicker for the plaintiff side is the costs award - about $1M against the plaintiff. That is going to discourage investor lawsuits, no doubt. This case was certainly not the best one to test the Securities Act provisions - its facts really stunk - but the prospective effect is chilly, the kind of weather Danier likes.

The oral submissions to the USSC on the Stonerigdge case took place yesterday, and the guess-what-they’re-thinking game has started. According to some of the bloggerati, Scalia more or less said isn’t this a matter for Congress, and the Chief Justice (who divested of the company specifically in order to hear the appeal, after initially recusing himself) pressed the parties to justify the “scheme liability” cause of action.

This case will be one of the most important in the securities litigation universe since Dura, as it answers the question of whether the scope of the PLSRA encompasses third parties that “assist” in a securities fraud by an issuer. More as events warrant.

…we have the inevitable speculation about where to re-shuffle the ownership arrangements in the next business cycle; put another way, find synergies for growth. The obvious candidate is the old M&A. Link.

Not sure I agree with everything said in that article, but it’s as good a guess as anything. The Globe has noted that this years IPO market in Canada is the worst in 10 years, a finding not unadjascent to the taxation of income trusts in a manner similar to corporations. Maybe not just a tax dodge, but nothing if not a tax dodge.

Back to the major forms of the next cycle. Debt is not as cheap, lenders and investors are hopefully sobered by recent events. Corporate profits continue to be positive, although there is some predictions of slowdown. Everyone expects workout plans by PE owners to have a 3-5 year horizon, and those workouts might revitalize the IPO market. Or, there is an M&A phase re-ordering ownership to create “growth” or “value” by buying, not making.

The interesting thing about M&As is that better studies of these cycles to date really don’t know if they’re worth it for the acquiring entity; they tend to be worth it for the target. That is, they really don’t have a good understanding if they are good “value propositions” in the sense that the Business Week article suggests . Share price history, the first take on things, has mixed evidence. Remember Time Warner AOL. More diverse measurments — such as underlying business position, development, reinvestment, and so-on, don’t make the case any clearer. “Soft” measurments like corporate culture clash and synergies do not make it any clearer. One of the things I heard a McGill academic say recently was that M&As may be justified not for the growth they generate but for the losses they prevent if the M&A were not to go through. I’m not sure the last part is free market capitalism at it’s finest, but it points the analysis to the old concentration-oligopoly-monoply concerns, and the use of M&A to consolidate institutional positions, that is, dominate markets and insulate from competition or the tendency to drive rent down to normal profits.

More in ongoing debrief about subprime. So far, we’ve heard from issuers and hedgies, who were short on analysis and long on pressuring central banks to inject liquidity to permit them to unwind bets (witness Cramer’s epic freak-out on TV), although some of them did admit that their models didn’t respond well to a wide-spread panic — there’s a thesis topic: models of panic. I think there was an Australian finance professor who did one.

Then we heard from the head of the Royal Bank and the Minister of Finance in short succession, both of whom thought that a single national securites regulator would have solved the problem, implying that a lack of it caused the problem. That didn’t make a lot of sense.

Now, from David Dodge, who makes much more sense. Link. In a nutshell, he says the BoC (and other regulators of the system) are not supposed to tell people what to buy and not buy, and that it is up to the “originators” (read: banks and issuers) of structured products to make sure they are properly packaged and priced for risk. We could take this as a normative statement: in our system, we should rely on issuers to be honest and if not honest to be transparent, so buyers and sellers can make economically rational decisions. We could take this statement as one of fact: in our system, we have come to rely on this transparency, and that transparency was perhaps clouded with respect to these complex products which are hard to price, sometimes move in illiquid markets, and so-on.

The first statement implies no further action (save, of course, the BoC injecting a billion or so into the system now and then to maintain prices, as they did 3 or 4 times this week, for reasons that are not clear to me yet).

The second statement implies we look a little harder at how structured products are developed, stamped with a pproval and then sold and re-sold. Somehow, the Caisse, a souped up pension fund, got into a position of holding 30% of the asset-backed commercial paper market in Canada, which froze solid when buyers no longer knew how to value these relatively simple products. We just don’t know how many staid investors are exposed to more complex derivatives or CDOs in their own holdings or through subsidairy holding in say alternative asset classes.

Dodge made some sanguine observations, and among the most interesting (if understated) were:

+ the “incentives” were wrong in the securitization market where banks sold securities based on portions of their balance sheet. In that situation, the incentive is to off-load as much risk associated with bad loans as possible, away from the institution most able to mangage and monitor it, the loan originator itself. Two key elements here: banks and others selling securities are supposed to “know their client” and assess their credit-worthiness, and make appropriate adjustments to their advice. Those adjustments are going to be against their own interests from time to time, and moreso where the product is moving risk to the buyer and is priced through some complex formula.

+ a key part of this process is the role of a ratings agency, which is hired by the originator to provide a rating for the security. Ratings agencies are riddled with conflicts of interest in this situation. Ratings agencies in effect perform the function of approving a security for “investment grade” or not, the former permitting a much wider array of institutional investors to buy them and meet their high standards for prudent investing.

+ complex instruments are by nature very difficult to price, even if the underlying deal is understood by the buyer. (Anecdotal evidence suggests that is not a safe assumptions most of the time). This was Stiglitz’s PhD thesis, I believe: information is always asymmetric, actors don’t make economically rational decisions, markets and market values are not always objective measurments of “true” value. The phrase “that’s what the market supports” can represent a very inefficient allocation.

All this has been said before, and better. The policy question is, do we “learn from the experience” and continue urging transparency and prudent pricing, but make no institutional or structural changes to the market, or do we “get the incentives right”, in Dodge’s phrase.