Friday, October 03, 2008

What now, my loves?

Dusting off the old crystal ball.

The bailout bill passed. So why did the stock market experience a 457 point swing and its worst week since 9/11?

Because passing that piece of crap sandwich of a rescue plan was the easy part.

The bailout's passage was already priced into the market and the traders are already looking ahead. What did they see today? Economic indicators that suck. Jobless claims are up and are expected to continue to rise - there were 159,000 jobs lost in September, the most in 5 years.

Today, LIBOR (the rate banks charge each other) hit an all time high and credit markets are not only still frozen, they're a mere shadow of their former self. There's talk of the fed having to step in on Monday with an emergency rate cut. Earnings season kicks off on Tuesday (when publicly traded companies report their earnings numbers to the street) and this is when the full extent of the credit crunch will start to be seen as the economic downturn and increased financing costs start showing up on balance sheets.

The short selling ban will expire Wednesday, October 8 and that will likely result in an increase in downward pressure and lots of roller coaster volatility. Unless it gets extended that is. Look for pressure on the small and mid caps of the Russell 2000. These companies have to rely more on credit than companies found in the other indices and will likely be hit harder. These guys should be a pretty good indicator of what's going on.

Oil will probably continue to shadow the stock market barring any unforeseen upsets in the global market and world at large. Recession = decreased demand for oil. Decreased demand for oil = decrease in price.
That age old theory of supply and demand in action.

Having said all that, it's still a big mess. (Master of the Obvious here - hah-hah)

And it's gonna be a mess for a while.

So what's next? Treasury will be taking steps to purchase the toxic assets from the banks, injecting confidence back in the system - hopefully. The cash proceeds from the sale of these assets will then allow the banks to inject liquidity back into the credit markets - hopefully. And the banks will start lending again. (Back in the day I remember that the Wall Street firms used to look down their nose at the Commercial Banks. Hah! Now there are only two of the White Shoe wall street firms left! )

The status of the mark to market accounting rule change is still up in the air: The SEC is to conduct a study and Congress wants a report in 90 days.

Mark-to-market accounting will remain the standard for the banking industry’s books: The financial-system bailout signed into law by President Bush today won’t require that the SEC suspend mark-to-market rules, as some House conservatives had wanted.

Instead, the House went along with the Senate’s language on the issue, giving the SEC the authority to suspend the rules, but not mandating the move.

In the interim:

Under political pressure, the SEC and the Financial Accounting Standards board eased up on the rules in a "clarification" issued Tuesday. The change may allow banks to avoid further huge write-downs of mortgage assets. That was enough to satisfy House conservatives, for the moment.

You'll be hearing a lot about TARP, the Targeted Assets Relief Program and this is what I've been able to find out about it so far:

A Treasury official, speaking on condition of anonymity because details of the agency's plans are still being worked out, said it's unlikely that Paulson would begin purchasing distressed assets from Wall Street banks until after the Nov. 4 election.

It could take up to six weeks, the official said, for Treasury to hire about two dozen full-time employees for the effort and to contract anywhere from five to 10 asset-management companies to help purchase and later resell troubled assets. Treasury also will have to publish procurement rules, adding to the delay before bad assets can actually be purchased and relief come to troubled banks.

"We would expect the Treasury to start ramping up the size of auctions over the next several weeks to fund the program - with an initial target of perhaps $100 to $200 billion in the program account by mid-November, but ... actual purchases of securities are not likely until perhaps the second half of November," said Brian Bethune, an economist with forecaster Global Insight, in a note to investors.

Over the next several weeks, Treasury must convert the legislation - so vaguely worded that it amounted to a virtual blank slate - into an action plan. "They need to figure out how best to ensure there are no conflicts of interest, they need to think about accounting treatment, how sales affect balance sheets of firms that have like assets," said Travis Larson, a spokesman for the Securities Industry and Financial Markets Association.

What Larson's getting at is this: Current accounting rules require that banks express on their balance sheets the present-day value of these assets that no one wants to buy, which means those assets aren't worth much at all. Once banks start unloading distressed mortgage bonds to the government, the banks must reflect on their balance sheets not the price they received from government, but the assets' present-day market price. If someone sells similar assets for less, that price must count.

Part of what Paulson hopes to accomplish is to help create a price level in dysfunctional markets for products no one now wants.

"The reality is the markets are frozen today in part because buyers and sellers can't agree on a price, and this process will create price discovery and find a market price," Larson said. But for that to happen, another important detail will be how Treasury carries out the expected reverse auctions. Instead of offering a starting price for the bad assets and bidding it up, the government will lay out the most it will pay for a particular asset and the companies interested in unloading will race each other down in price.

Treasury must walk a fine line. It can't pay too high a price above what's perceived as fair-market value or there will be public outcry, but it must pay a price high enough to accomplish its goal - to provide banks an infusion of cash large enough to boost their balance sheets so they'll begin lending again.

"Treasury will be buying something higher than the distressed price, but they are not going to buy them at a price so high that it is going to make everyone solvent," said Vincent Reinhart, a former top economist at the Federal Reserve and now a scholar at the American Enterprise Institute, a conservative think tank. "In some ways what the legislation does is help facilitate consolidation" in the financial market.

It's going to be all about the pricing of these assets and is just getting interesting, possums. Stay tuned and keep that seat belt fastened low and tight across your lap...