Daily Insight

U.S. stocks slid yesterday, marking the biggest decline since Inauguration Day, on skepticism the Treasury Department’s bank “rescue” plan will work. Geithner’s comments that he is still “exploring a range of different structures” to boost capital adequacy ratios and remove “toxic” assets didn’t do much good on day in which the market was expecting the unveiling of a plan – you know, details?

Well, I guess the new Treasury Secretary has now learned firsthand that big buildups to press conferences only to underperform via a lack of specifics is the surest way to get thumped by the market. At least he delivered his comments with far greater aplomb than his predecessor could ever dream of, but that doesn’t matter much if the message entails zero new information.

As if it needs to be mentioned, financials took the brunt of the damage, down nearly 11% as measured by the S&P 500 index that tracks these shares. As you can see by the chart below, none of the major industry groups escaped the wreckage – maybe utilities, which were the relative winners down just 2.99%.

On the brighter side of things, Intel announced plans to spend $7 billion to upgrade its U.S. factories over the next two years. So while others refrain from capital spending projects, the semiconductor giant is stepping up.

This helps to illustrate U.S. corporations have the cash resources to engage in projects (granted not many quite have the huge cash levels that Intel enjoys) and once we can get some confidence into the market, this is one aspect of the economy that can fire things up. It is a huge mistake by policymakers not to use tax incentives to drive this aspect of the economy.

Market Activity for February 10, 2009

The (new) Financial Rescue Plan

The Treasury Secretary stated the financial “rescue” plan will involve capital injections into banks, new programs to help struggling mortgage borrowers, a significant expansion of the Fed’s consumer lending facility and an entity that will help facilitate the removal of “toxic” assets from bank balance sheets.

We have no way of knowing how the administration will offer assistance to struggling mortgage borrowers, the design was not explained. On the expansion of the Fed’s consumer lending facility (what’s known as the TALF), it will now include the purchase of securities backed by commercial real estate, increasing the program to $1 trillion from $200 billion. Formerly it only involved credit-card, student-loan and auto-loan debt.

This leaves us with the primary aspects of the plan – additional capital injections and the “bad bank” entity, which is being termed the Public-Private Investment Fund (PPIF).

On the first, I don’t see how it improves things as banks will continue to hoard cash so long as mark-to-market accounting forces them to write-down assets to distressed-market prices – even for assets that are performing as expected. They are unwilling to take on the level of lending that policymakers want, not only because this is a natural reaction in an economic downturn, but also for fear the new assets they take on via additional lending have to be marked-to-disaster and cause further erosion in capital ratios.

On the second, it appears that private investors will be able to buy a stake in the PPIF entity and then a certain amount of losses will be backstopped by the government – much like the original Paulson MLEC plan first suggested in late 2007. But the problem is no one is sure. Maybe, the Treasury will just offer loans to provide the funding for these purchases. A little clarity would be nice. The fund will begin at $500 billion and could rise to $1 trillion – this has become a popular figure.

Here too, the accounting rule is keeping bidders from the market, exacerbating the spiral. Firms are not willing to step in and buy, even if they see prices well-below intrinsic value on many assets, as they fear the endless write-down cycle will continue. (It took eight years into the Great Depression before policymakers got it through their thick skulls to abolish market-based accounting – the 1930s was the last time it was tried. The question is, how long and how much damage will it take this time?)

It is also key to understand that as the government is continually changing the rules, it freezes private capital. Investors are unwilling to step in without some level of certainty.

Monthly Small Business Survey

In the latest small business survey, The National Federation of Independent Business (NFIB) showed their optimism index weakened to 84.1 in January (the lowest level in its 23-year history) from 85.2 in December – 12 months ago the readings was 91.8.

The net percentage of small firms planning to hire was unchanged at -6% (that’s the difference between the percentage of firms increasing hiring minus those decreasing in the next three months) and firms raising selling prices fell to -15% (also a historic low for this survey). The readings were +9% and +8%, respectively, a year ago.

In general, lackluster sales and earnings trends resulted in the optimism index hitting a new low. As a result, hiring remains depressed. We have yet to see an indication (anywhere) that labor-market declines will ease anytime over the next couple of months.

My take is the current level of job losses are not sustainable and we will see the monthly employment declines ease 3-4 months out, but we have no evidence of this thus far. The caveat attached to this comment is that government refrains from policy that does additional harm to business and consumer sentiment.

The degree to which the government is involved makes it even more difficult than normal to gauge the direction of the economy. This is true for the business community as well as sales visibility seems to be as nonexistent as anytime in the post-WWII era.

Another Circus

This morning bank executives will be on Capitol Hill, all set up in a row to be lambasted by members of Congress in another TV sideshow.

Maybe if any of these guys have an ounce of testosterone left in them, they’ll remind the high-and-mighty that it was not that long ago in which they were being pressured to make credit to low-income borrowers more available, or be accused of redlining. When this combined with the easy money mistakes of the Fed, hindsight shows it was the perfect ignition for a boom/bust scenario.

There’s news this morning that Bank of America Chairman/CEO Ken Lewis is taking an eight-hour train ride to Washington, because of all the commotion over corporate jets no doubt. This degree of groveling is embarrassing to watch. We need a little more leadership from top-level business management and a lot less prostration. .

Have a great day!


Brent Vondera, Senior Analyst