The Spectre of Big Government Frightens the Street

Good Evening: Wall Street has been begging for more clarity and today brought us some of this highly sought commodity. I refer not to details surrounding the Obama administration’s plans for our banking system but instead to President Obama’s freshly unveiled budget plan. From tax rates to health care, and from business subsidies to carbon emissions, change has indeed come to Washington D.C. The size and scope of this change will affect many companies (even whole industries!), many of which sank with the sun as Thursday progressed. This change also comes with a staggering price tag (deficit estimates for the next few years start with a “T”), and the more investors had a chance to review Mr. Obama’s budget, the less they liked what they saw. The death of big government, as Mark Twain might say if he were alive today, has been greatly exaggerated.

Stock index futures were on the frisky side heading into this morning, and even another spate of weak economic couldn’t cool this early ardor for equities. Initial jobless claims spiked to a 27 year high of 667,000 in the latest reporting week, and continuing claims rose to an all time record of over 5 million. Durable goods orders were also much worse than expected, as the 5.2% drop was more than twice as large as the consensus estimate. Rounding out this trio of bad economic releases, new home sales plunged more than 10%, leaving this figure down more than 70% from its boom time peak. As a contrarian, I will offer a hopeful take on this brutal set of home sales figures. Perhaps sales for new and existing homes are falling not just because the economy continues to tank, but also because potential buyers have been waiting for the much-discussed, governmentally-funded home buying “incentives” to become the law of the land. I have absolutely no evidence to support this theory, but with the ink now dry on the stimulus bill, we shouldn’t have long to see this effect (or the lack of one).

Despite the harrowing economic news, stocks opened in positive territory. Word that the new Obama budget contained more funds for banks elicited some buying (or at least some short covering) of various financial names. The major averages were up some 2% after 90 minutes, which is approximately the time market participants found their reading glasses. Seeing that healthcare was appointed to meet with the budgetary knife, health-related companies of all types came under pressure. The utility companies also felt the lash when the strictness of the carbon-based emissions caps started circulating. It probably didn’t help that GM took the occasion as a cue to announce a world-beating loss in Q4. Take that, Toyota.

As the day progressed, industry after industry found loopholes closing or subsidies ending within the proposed Obama budget, and stocks steadily slid for the rest of the session. The final damage amounted to losses of between 1.2% (Dow) and 2.7% (Dow Transports) for the major averages. Again, despite weaker equity prices, bonds headed south. Cognizant of all the proposed spending, Treasury yields rose from 1 to 9 bps, the losses growing steeper as one ventured further out on the coupon curve (for BAC-MER’s take on the budget, see below). The dollar was a touch lower, and commodities continued their recent chug to the upside. A large advance in the energy sector propelled the CRB index to a gain of 2.5%.

At the bottom of this piece, you will find two different essays with two different takes on the ongoing credit crisis. The first set of opinions, courtesy of Sears Holdings Chairman, Edward Lampert, is woven inside his annual letter to SHLD shareholders. The second is the written testimony of former Federal Reserve Chairman, Paul Volcker, delivered to a joint committee of Congress this very morning. Both men try to tell the story of how this crisis began and evolved, and both offer regulatory prescriptions for the future.

Mr. Volcker’s observations are couched more in the historical run up to our present woes, while Mr. Lampert’s description starts, for some reason, with the demise of Bear Stearns less than a year ago. Few mentions are made about the root causes during Mr. Lampert’s longish tale that lands Bear, Lehman, AIG, FNM, FRE, and others in the dung heap, and he bemoans the tighter regulations that are most certainly on the way. Mr. Volcker, on the other hand, delves into the root causes and delivers a testimony better suited to a parent lecturing a teen about evils like drugs — or unsupervised leverage. Firm and enforceable limits for the banks, especially the large ones, are among Mr. Volcker’s considered recommendations.

To be fair, Mr. Lampert is mostly using the events of the last year to give his shareholders a sense of the extremely difficult operating environment for retailers in the latter half of 2008. He makes some decent points — the ones about unintended consequences are his best — but he is likely to lose his side of what has become a public debate. Still, that Congress will likely adopt many of Mr. Volcker’s suggestions when then finally do get around to regulatory reform is not the moral of this story. Mr. Volcker has been singing this same tune for years, whether privately, in the press, or before our elected representatives. Unfortunately, only a handful from either side of the aisle were paying him the least bit of attention. They were too busy asking his successor, the Maestro, for his disastrous advice. Mark Twain may not have said it and Mr. Lampert may not agree with it, but we are definitely reaping what we sowed.

— Jack McHugh

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