Daily Insight

U.S. stocks got hammered after the government made clear their running the show with regard to GM and Treasury Secretary Tim Geithner stated some banks will need “large amounts” of assistance – more government involvement is not what the market wants to hear but the administration has a tin ear. At the least, one would think Tumultuous Tim to have learned this by now. His thoughtless comments of the past, comments that were followed by large slides in stock prices, would have led the rational person to do things differently.

The ancillary effects of an auto industry bankruptcy, namely the job dislocations that would result, also weighed on the market. Beyond the Geithner comments, the hit financial shares took were also a function of this issue as a large ramp up in job losses means higher credit-card delinquencies and overall loan default rates. Nevertheless, the correct path is to just get on with it for it is many times more damaging to protect jobs that are not needed and redundant -- the economic contraction will drag on if the government chooses this path

The decline in stock prices yesterday trimmed the rebound off of the devilish low of 666 (S&P 500) on March 9 to 16%. With this the last day of the first quarter, the S&P 500 is on track to slide 12% for March, which follows a 10.99% decline in February and an 8.57% decline in January. You have to go back to the fall of 1987 to match a three-month decline of this magnitude – before that, the fourth-quarter of 1937.

Market Activity for March 30, 2009

“Too Smart by Half” Proposals

There are growing signs regulators are getting closer to promulgating a modification to mark-to-market accounting rules. The Financial Accounting Standards Board (FASB) proposed changes to the rule a couple of weeks back, but an official announcement will be needed to keep this rally going. And no, this won’t cloud transparency; it may even improve it as the current environment of forcing even well-performing assets to be marked to distressed price levels engenders opacity. Besides, investors can still see the marks in quarterly statement footnotes, just as has always been the case.

Modifying mark-to-market certainly makes much more sense than the government’s convoluted Public-Private Investment Program (PPIP), and all of the unintended consequences that would follow. It’s important for us to understand that the implementation of mark-to-market in November 2007 (specifically regarding its link to regulatory capital) allowed hedge funds to game the system – they used this change to make their short positions more profitable. (All one had to do, especially since there was no margin requirement, was to bid up credit default swaps (CDSs) – as the price of CDSs were bid higher, it increased the likelihood -- or at least the perception -- that the default risk on derivatives these swaps were meant to insure would rise. This drove the value of securities banks held on their books to very low levels and mark-to-market forced the banks to mark down even assets that were performing on schedule.)

Now, the Treasury needs private investors to place bids on the “troubled” assets that are sitting on banks’ balance sheets. But as Andy Kessler pointed out last week, what do you think they’ll do? It’s likely they’ll bid CDSs higher, thus driving down the value of the “troubled” assets they’ll be buying under PPIP and increasing their profit potential -- with very very low government financing, mind you. And they’ll have plenty of time to do so as PPIP won’t get off the ground until June at the earliest. And then what do you think is going to happen after private investors make big profits off of this trade, again all with very low government (taxpayer) funding? This will further drive the populist wave in Congress and that spells trouble for the economy as the political class will enact all kinds of harmful regulation/legislation, no matter the harm done to long run growth or possibly even the rule of law as a result.

A better idea, especially since the PPIP acknowledges that these “troubled” assets have a higher intrinsic value than their current price illustrates (otherwise one couldn’t argue in favor of the program) is to allow banks to hold these assets on their books, and they’ll be able to do so with modification of mark-to-market. Modify, or ditch completely, this accounting rule and the banking industry’s regulatory capital will no longer be unjustifiably vaporized, they’ll feel more comfortable with boosting lending activity when it makes sense to do so – which is exactly the ultimate goal Geithner states as the reasoning behind PPIP. But then the government wouldn’t have the power to direct lending, which is why they’ll remain obstinate and force PPIP upon the industry anyway.

Important Week for Data

We were without a meaningful economic release yesterday, but begin an important week of data this morning with Chicago PMI (the most important regional manufacturing report).

Chicago is expected to come in basically unchanged from last month’s low reading of 34.2. Based on the readings out of the New York and Philadelphia regions we may even see the figure decline a bit from February’s low print. However, it is quite likely the factory gauges will bounce a bit some time over the next three months as the inventory dynamic will work to boost activity – businesses have significantly reduced stockpiles and this should mean a little production will ensue to restore those levels during the second quarter.

Tomorrow we’ll get ISM for March (the national factory index). Same is true for this number as for Chicago. We look for the figure to remain in the mid-30s. What you look for is ISM to bounce into the 40s (still contraction mode but a meaningful improvement); when it does it will signal the economy has bottomed and we’re headed for some degree of expansion.

On Thursday, per usual we’ll get initial jobless claims. This is another very important coincident indicator (ISM and jobless claims are the most important indicators currently), and we’ll need to see improvement before getting excited about an economic rebound. The number is expected to remain in the 650,000 range. A move back to the 500K handle should signal we’re on to something. We may be a few weeks away from this move still.

On Friday we get the all-important monthly jobs report, this time for March. We expect another 600K-plus decline in payroll postions and an increase in the unemployment rate to 8.5% from 8.1% as of February.


Have a great day!


Brent Vondera, Senior Analyst