The broad market endured another volatile session, bouncing 4% between intraday peak and trough, until the news on Geithner was released, which sparked a 7.5% rally to the upside in the final hour of trading that made those 4% moves appear tame.
The market had been waiting for President-elect Obama’s Treasury pick for a couple of days now, as they had to watch Health and Human Services and Attorney General choices first – people were wondering why these posts came before Treasury, which is the second-most important position right now.
The certainty of the pick assuaged concerns as Geithner will bring continuity. He has specific knowledge of the TARP as well as various Fed facilities that have been put in place over the past year. He’s extremely talented, let’s hope he has the next president’s ear.
Market Activity for November 21, 2008
Yesterday President-elect Obama followed that up by choosing Lawrence Summers as his top economic advisor – what should be viewed as the most important post since the occupant will be devising the next stimulus package.
Mr. Summers is a quintessential Keynesian – one who sees rebate checks and public works programs as the best ways to stimulate. He also advocates higher tax rates.
The market has had enough with rebate checks after seeing they had virtually zero effect the past two times implemented – 2001 and 2008; it shuns tax hikes and can probably take or leave infrastructure projects. Problem with the latter, forgetting that productivity growth and allowing the market to direct capital are the best ways to create jobs and allocate resources – is that it takes 12-18 months to implement, at which time the economy could already be back on the road to recovery. (For those that watched the Obama’s YouTube address on Saturday it was obvious we’re getting infrastructure programs galore.) Plain and simple, the market must be free to allocate resources, central planning efforts to assume this role cannot achieve the desired effect. However, so long as tax rates are not raised, the market should be able to deal with it.
Two things were leaked with the Summers announcement. First, he will be next in line for the Fed Chairman job, which means Bernanke is gone in 2010. Second, the Obama team will wait for the current tax rates to expire at the end of 2010 instead of raising rates before then. This would be a huge announcement since some of what the market has priced in is that tax rates on capital and small businesses will be going up before then.
But that was yesterday’s news, this morning we have new developments as things move at light speed these days. Since Friday night it was being reported the government would offer assistance to Ctigroup as the stock got hammered by 55% over the last three sessions. The company has been saying its capital position is adequate, but few were believing it as the continuous write-down circle means Tier 1 capital ratios that exceed standards today can plunge below levels to be deemed “well-capitalized” two months later.
According to the plan, the government will use $20 billion in TARP money (on top of the $25 billion Citi just received, a lot of good that did) in exchange for $27 billion in preferred shares that yield 8%. The government will also backstop, or guarantee, $306 billion worth of troubled mortgages and toxic assets.
The good news seems to be that the short-sellers’ raid on bank stocks may end. The raids that began with the Bear Stearns deal was easy money for short-sellers as all they had to do was push a stock price low enough (of course a banks over-leveraged position allows this to occur, but mark-to-market accounting exacerbates the issue) at which point the government would step in and wipe-out the current shareholder, making sure the price dropped further – even below the bankruptcy price. Now that this deal, while it dilutes the current shareholder, does not wipe out the shareholder it may prove superior to the deals heretofore.
In the end though, it seems we can throw $50, $100 billion at Citi but I’m not sure what good it does after a few months time in terms of capital. What needs to be done is either to get these troubled assets off the balance sheets of banks – the original TARP proposal – or end the destructive policy of mark-to-market accounting for assets with a 10-20 year lives.
Moving to the standard that was in place prior to November 2007 seems to make much of the concerns disappear as banks do not have to raise more capital and provide more collateral (which means more asset sales and thus pushing asset prices even lower) each time the long-term assets are marked lower. The prior standard meant that capital ratios were determined by the original cost of the asset. This way firms do not allow their capital to decline when the asset rises in price as occurred during the housing boom and they do not have to have to raise capital when the asset falls in price now that the housing market is in serious correction mode.
Further, we may not see the end of this problem until these troubled assets start trading and we get some price discovery. This is why we’ve advocated eliminating capital gains taxes on these assets to get bids flowing. These assets, while some are truly toxic, have more value than they are currently being marked to and the vast majority have cashflows running off of them. That is, if the tax were eliminated, I think we’d find that values are closer to 60 cents on the dollar rather than the 20 cents that fire-sale prices are valuing these assets.
The Obama Team
President-elect Obama promulgates his economic team today, most of which we already know. Some are better then others in my view, but they are all extremely capable people. The market will want to officially hear that his tax-rate agenda is delayed until they expire December 2010. While it would be best to lower tax rates, or at least leave current rates unchanged, the market may receive another jolt from the announcement to delay. At that point, stock valuations will have to deal with lower after-tax return expectations in 2010, but may be able to deal with it better by then.
The Economy
On the economic front, this morning we’ll get existing homes sales for October, which will remain very weak if the pending home sales data we received two weeks back is any indication – and it generally is.
Have a great day!
Brent Vondera, Senior Analyst
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